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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON AUGUST 17, 2000
REGISTRATION NO. 333-30574
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM S-1
AMENDMENT NO. 2
TO
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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EMERALD -- DELAWARE, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C> <C>
DELAWARE 7371 91-1745906
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
</TABLE>
EMERALD -- DELAWARE, INC.
111 SW 5TH AVENUE, 27TH FLOOR
PORTLAND, OR 97204
(503) 276-2900
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
MARTIN WRIGHT
PRESIDENT AND CHIEF EXECUTIVE OFFICER
EMERALD -- DELAWARE, INC.
111 SW 5TH AVENUE, 27TH FLOOR
PORTLAND, OR 97204
(503) 276-2900
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)
COPIES TO:
<TABLE>
<S> <C>
WILLIAM D. SHERMAN, ESQ. PATRICK O'BRIEN, ESQ.
JUSTIN L. BASTIAN, ESQ. CHRISTOPHER J. AUSTIN, ESQ.
NICHOLAS J. PACE, ESQ. CHAD D. PERRY, ESQ.
MARY ANNE BECKING, ESQ. ROPES & GRAY
MORRISON & FOERSTER LLP ONE INTERNATIONAL PLACE
755 PAGE MILL ROAD BOSTON, MASSACHUSETTS 02110
PALO ALTO, CALIFORNIA 94304 (617) 951-7000
(650) 813-5600
</TABLE>
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after the effective date of this Registration Statement.
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ] _________
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ] _________
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ] _________
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. [ ]
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL HEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SUCH SECTION 8(a),
MAY DETERMINE.
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<PAGE> 2
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE
MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH
THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS
NOT AN OFFER TO SELL THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO
BUY THESE SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT
PERMITTED.
SUBJECT TO COMPLETION, DATED AUGUST 17, 2000
EMERALD LOGO
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4,000,000 Shares
Common Stock
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This is the initial public offering of Emerald -- Delaware, Inc., and we are
offering 4,000,000 shares of our common stock. We anticipate that the initial
public offering price will be between $11.00 and $13.00 per share. We have
applied to list our common stock on the Nasdaq National Market under the symbol
"EMSO."
INVESTING IN OUR COMMON STOCK INVOLVES RISKS. SEE "RISK FACTORS" BEGINNING ON
PAGE 5.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS
PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
UNDERWRITING PROCEEDS TO
PRICE TO DISCOUNTS AND EMERALD
PUBLIC COMMISSIONS SOLUTIONS
<S> <C> <C> <C>
Per Share $ $ $
Total $ $ $
</TABLE>
A selling stockholder has granted the underwriters the right to purchase up to
600,000 shares to cover any over-allotments. We will not receive any proceeds
from the sale of these shares in the event the over-allotment option is
exercised.
DEUTSCHE BANC ALEX. BROWN
ROBERTSON STEPHENS
ADAMS, HARKNESS & HILL, INC.
PACIFIC CREST SECURITIES
THE DATE OF THIS PROSPECTUS IS , 2000.
<PAGE> 3
PROSPECTUS SUMMARY
This summary highlights information described more fully elsewhere in this
prospectus. This summary may not contain all the information that you should
consider before investing in our common stock. You should read the entire
prospectus, including "Risk Factors" and the financial statements and related
notes, before making an investment decision.
OUR COMPANY
Emerald Solutions is a leading provider of professional services that are
designed to create, transform and integrate digital business. Digital business
is conducted by organizations that use the Internet, information technology and
new forms of commerce to gain competitive advantage, spur growth and enhance
stockholder value. The solutions demanded by digital business are becoming
increasingly complex and require more than just implementation of the latest
technology. We believe that both the seamless delivery and breadth of our core
services are crucial to the delivery of successful projects. Our solutions
incorporate a broad range of skills encompassing business strategy, creative
design and technical engineering. Our 39 strategic professionals provide
executive-level business consulting as well as Internet strategy consulting. Our
46 creative professionals deliver services ranging from digital branding to user
experience design to Internet advertising. Our 403 technical professionals
deliver a wide variety of services, including web-based customer relationship
systems, online supply chain management systems and custom enterprise
application software.
We deliver comprehensive digital business solutions by combining a broad
range of skills and disciplines into a single delivery model providing
accountability, continuity and consistency. Through this approach we create a
strategic vision, identify and design a program of initiatives and build systems
in a series of iterative releases. Local client management teams, located in 13
offices throughout the United States, use this approach to offer viable and
successful client engagements. We supplement these local teams with the
expertise of our national practices, focused on specific industries or
possessing specific solution capabilities. This integrated delivery model
enables us to understand key business issues facing clients in specific
industries and apply a wide variety of skill sets.
We have successfully provided digital business solutions for Fortune 1000
and emerging high growth companies in industries such as telecommunications,
transportation, pharmaceuticals, financial services and digital markets. Our
clients include American Airlines Cargo, AT&T, Coca-Cola, Disney, Dun &
Bradstreet, Hasbro, Lucent Technologies, Lucy.com, Pfizer, Priceline.com, Sabre
and Warner Lambert.
Our objective is to become the leading provider of comprehensive digital
business solutions. To achieve our objective, we seek to:
- Target clients with the potential for large, complex digital business
needs;
- Expand our capabilities through industry and solutions expertise;
- Recruit, retain and motivate experienced professionals;
- Expand our geographic presence; and
- Increase our brand awareness.
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RECENT DEVELOPMENTS
AT&T SOLUTIONS ALLIANCE
In March 2000, we entered into a strategic alliance agreement with AT&T
Solutions to take advantage of both of our sales channels and our combined
business expertise to provide clients with digital business solutions. Under the
terms of the agreement, AT&T has incentives to direct $84 million of revenue to
us by March 31, 2002 through joint marketing efforts, but there is no assurance
that we will realize any future revenues as a result of this agreement. As part
of the agreement, we granted AT&T a warrant to purchase up to 600,000 shares of
our common stock.
ALLIANCE CONSULTING GROUP ACQUISITION
In July 2000, we acquired Alliance Consulting Group, Inc., a consulting
firm that had 36 employees. Alliance provides strategy and management consulting
services. In connection with the acquisition, we paid cash consideration,
incurred acquisition costs, issued promissory notes and assumed Alliance's net
current liabilities and long-term obligations totaling approximately $7.1
million, and issued 2,585,780 shares of our common stock to stockholders and
employees of Alliance. We are also obligated to pay up to $5.0 million in
earn-out payments in the event certain revenue and profit targets are met during
the twelve-month period following the closing of the merger. This transaction
has been accounted for under the purchase method of accounting.
-------------------------
We incorporated in the State of Washington in November 1996 under the name
Emerald Solutions, Inc. Our substantive operations began in January 1997. We
reincorporated in the State of Delaware in April 1999 under the name
Emerald -- Delaware, Inc., and conduct business using the name Emerald
Solutions. We are not affiliated with Emerald Solutions, Inc., a Delaware
corporation. Our principal executive offices are located at 111 SW 5th Avenue,
27th Floor, Portland, Oregon 97204 and our telephone number is (503) 276-2900.
Our web site is located at www.emeraldsolutions.com. Information contained on
our web site does not constitute a part of this prospectus. Our fiscal year ends
on the last Saturday of each calendar year.
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THE OFFERING
Common stock offered........................ 4,000,000 shares
Common stock to be outstanding after this
offering.................................... 35,713,304 shares
Use of proceeds............................. For repayment of debt and
general corporate purposes,
including working capital
Proposed Nasdaq National Market symbol...... EMSO
SUMMARY FINANCIAL INFORMATION
<TABLE>
<CAPTION>
SIX MONTHS
FISCAL YEAR ENDED ENDED
------------------------------------------ -------------------
DECEMBER 27, DECEMBER 26, DECEMBER 25, JUNE 26, JUNE 24,
1997 1998 1999 1999 2000
------------ ------------ ------------ -------- --------
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Revenues................................ $ 2,721 $15,011 $34,711 $14,286 $ 33,966
Income (loss) from operations........... (3,816) 777 (5,440) (846) (8,863)
Net income (loss)....................... (3,853) 708 (5,425) (814) (9,202)
Net income (loss) available to common
stockholders.......................... (3,853) 708 (6,117) (1,091) (11,668)
Net earnings (loss) per share applicable
to common stockholders:
Basic earnings (loss) per share....... $ (0.23) $ 0.04 $ (0.31) $ (0.05) $ (0.57)
Diluted earnings (loss) per share..... $ (0.23) $ 0.03 $ (0.31) $ (0.05) $ (0.57)
Shares used to calculate:
Basic earnings (loss) per share..... 16,739 19,488 19,930 19,904 20,405
Diluted earnings (loss) per share... 16,739 20,364 19,930 19,904 20,405
</TABLE>
<TABLE>
<CAPTION>
AS OF JUNE 24, 2000
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PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
------- ----------- -----------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents............................... $ 350 $ 9,568 $ 44,079
Working capital (deficit)............................... (5,807) 1,887 45,724
Total assets............................................ 30,130 59,005 93,220
Total debt and capital leases including current
portion............................................... 9,973 12,024 2,698
Redeemable convertible preferred stock.................. 12,834 -- --
Total stockholders' equity (deficit).................... (5,082) 33,140 76,680
</TABLE>
The total number of outstanding shares of our common stock is based on
20,675,800 shares of our common stock actually outstanding as of June 24, 2000.
The pro forma data above give effect to the issuance of 2,585,780 shares of
common stock in connection with the acquisition of Alliance, the issuance of
2,318,392 shares of Series C Preferred Stock in July 2000 and the subsequent
automatic conversion of all outstanding shares of our Series C Preferred Stock
and all other outstanding shares of our preferred stock into 8,451,724 shares of
common stock upon completion of this offering.
The pro forma as adjusted data above also give effect to the sale of the
4,000,000 shares of common stock in this offering at an assumed public offering
price of $12.00 per share, less estimated underwriting discounts and
commissions, estimated offering expenses and the application of the net
proceeds. See "Use of Proceeds" and "Capitalization" for additional information
regarding our use of proceeds from this offering and our common stock.
The above information excludes:
- 6,576,198 shares of common stock issuable upon exercise of options
outstanding as of June 24, 2000, at a weighted average exercise price of
$2.08 per share; the grant in
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July 2000 of 375,250 shares of common stock issuable upon exercise of
options to Alliance employees at an exercise price of $6.25;
- 1,803,997 shares of common stock available for issuance under our
incentive option plans as of July 31, 2000;
- 28,600 shares of common stock issuable to ZCom employees in connection
with the ZCom acquisition; and
- 653,639 shares of common stock issuable upon exercise of outstanding
warrants.
See Note 7(b) of Notes to Financial Statements for an explanation of the
determination of the number of shares used in computing per share data.
Unless otherwise specifically stated, information throughout this
prospectus:
- reflects the automatic conversion of all outstanding shares of redeemable
convertible preferred stock upon completion of this offering into
8,451,724 shares of common stock; and
- assumes no exercise of the underwriters' over-allotment option.
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<PAGE> 7
RISK FACTORS
This offering and an investment in our common stock involve a high degree
of risk. You should carefully consider the risk factors and the other
information in this prospectus before investing in our common stock. Our
business and results of operations could be seriously harmed by any of the
following risks. The trading price of our common stock could decline due to any
of these risks, and you may lose part or all of your investment.
RISKS RELATED TO OUR MARKETS AND FINANCIAL CONDITION
OUR LIMITED OPERATING HISTORY AND THE NEW INTERNET PROFESSIONAL SERVICES MARKET
IN WHICH WE OPERATE MAY MAKE IT DIFFICULT FOR YOU TO EVALUATE OUR FUTURE
SUCCESS.
Because we began operations in 1997, we have a limited operating history
upon which you can evaluate our business. In addition, we compete in a
relatively new market known as the Internet professional services market. The
limited amount of historical information about us and our market makes it more
difficult for you to predict whether or not we will be successful. You should
evaluate our chances of financial and operational success in light of the risks
and uncertainties associated with starting a new business, such as risks
relating to our ability to:
- continue to attract and retain a broad customer base;
- negotiate and maintain favorable strategic relationships;
- expand our direct sales force and indirect sales channels;
- attract, integrate, retain and motivate qualified professionals;
- continually enhance our products and services to meet market demand and
customer needs; and
- plan and manage our growth effectively.
Many of these factors are beyond our control. Our failure to successfully
address the issues facing our business or our market could harm our ability to
obtain new clients, retain existing clients and recruit and retain
highly-skilled employees.
WE HAVE A HISTORY OF LOSSES AND EXPECT TO INCUR LOSSES IN THE FUTURE.
We incurred net losses of $3.9 million during fiscal year 1997, realized
net income of $708,000 during fiscal year 1998, incurred a net loss of $5.4
million in fiscal year 1999 and incurred a net loss of $9.2 million for the six
months ended June 24, 2000. As of June 24, 2000, we had an accumulated deficit
of $17.8 million. We cannot assure you that we will achieve profitability in the
future. Further, our operating expenses are to a large degree fixed, and any
shortfall in anticipated revenue in any given period could harm our operating
results. We also expect to continue to incur increasing sales and marketing,
infrastructure development and general and administrative expenses. As a result,
we will need to generate significant revenues to achieve profitability. If we do
achieve profitability, we may not be able to sustain or increase profitability
on a quarterly or annual basis.
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<PAGE> 8
OUR QUARTERLY REVENUES AND OPERATING RESULTS ARE VOLATILE AND MAY CAUSE OUR
STOCK PRICE TO FLUCTUATE.
Our quarterly revenues and operating results are volatile and difficult to
predict. As a result, we believe that historical quarterly revenues and
operating results are not necessarily indicative of future performance. A number
of factors that are likely to cause volatility in the future include:
- variability in market demand for the Internet and for Internet
professional services;
- substantial fixed expenses, incurred in opening new offices and in
advance of contracts for projects, including personnel and related costs;
- the length and variability of our sales cycle;
- the varying efficiency with which we utilize our employees, including our
ability to rapidly transition employees from completed projects to new
projects and among offices;
- the introduction of new services by our competitors;
- seasonality in revenues due to variations in the number of holidays from
quarter to quarter;
- changes in pricing policies by our competitors;
- our relatively small number of customers and relatively large individual
projects in proportion to total revenue;
- market reaction to any future acquisitions, joint ventures, mergers or
other business combinations;
- how well we estimate the resources we need to complete projects; and
- our ability to attract and retain professionals.
Due to these factors, it is possible that in some future quarter or
quarters our operating results will be below the expectations of public market
analysts or investors. In such event, the market price of our common stock may
decline significantly.
IF WE FAIL TO ACCURATELY ESTIMATE THE RESOURCES NECESSARY FOR COMPLETION OF
FIXED-FEE CONTRACTS, WE COULD LOSE MONEY ON THOSE CONTRACTS.
For the six months ended June 24, 2000, we generated almost 45% of our
revenues from contracts that have fees that are capped or that have a fixed fee.
We work with complex technologies in compressed timeframes which makes it
difficult for us to judge the time and resources any particular project may
require. We have occasionally had to commit unanticipated additional resources
to complete projects, and we expect we may have to take similar action in the
future. If we fail to accurately estimate the resources required for a project,
then our costs to complete the project could increase substantially and our
results of operations could suffer.
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RISKS RELATED TO OUR BUSINESS AND STRATEGY
WE ARE HEAVILY DEPENDENT ON REVENUES GENERATED FROM A LIMITED NUMBER OF CLIENTS,
AND A REDUCTION IN THE WORK WE PERFORM FOR THESE CLIENTS COULD NEGATIVELY AFFECT
THE RESULTS OF OUR OPERATIONS.
We derive a significant portion of our revenues from a limited number of
clients. As a percentage of total revenues, revenues derived from our five
largest clients decreased from 92% in fiscal year 1997 to 78% in fiscal year
1998, to 64% in fiscal year 1999, and to 41% for the six months ended June 24,
2000. AT&T accounted for more than 35% of our revenues in fiscal year 1999 and
for 15% of our revenues in the six months ended June 24, 2000. In March 2000 we
entered into a two-year strategic alliance agreement with AT&T Solutions. No
other client accounted for more than 10% of our revenues in fiscal year 1999 or
for the six months ended June 24, 2000. We expect to continue to derive a
significant portion of our revenues from a limited number of clients. The loss
of any significant client or a reduction or deferral in the work performed for
any significant client could significantly reduce our revenues.
IF OUR CLIENTS DO NOT REHIRE US FOR NEW PROJECTS, OR IF THEY TERMINATE OR REDUCE
THE SCOPE OF EXISTING PROJECTS, IT COULD NEGATIVELY AFFECT THE RESULTS OF OUR
OPERATIONS.
A significant portion of our revenues is derived from fixed-time, fixed-fee
contracts for discrete projects. If clients do not retain us for subsequent
projects, then our revenues could decline. Our projects typically have terms
ranging from one to nine months and usually comprise several integrated phases.
Each sequential phase of a project represents a separate contractual commitment.
The client may elect at any time not to proceed to the next phase of a project,
which could reduce our revenues.
Similarly, a client may attempt to cancel or reduce the scope of any phase
of a project. It is possible that we may agree to the cancellation or reduction
in scope, or that the client may prevail in the event of a dispute over whether
it has the right to cancel or reduce the scope of a project. The cancellation or
reduction in scope of a project could have a negative impact on our revenues.
Further, a client could reject a solution in whole or in part. In this event, we
could be required either to forego the associated revenues or to expend
additional unanticipated resources which could cause us to exceed our expected
budget for the project. Either circumstance could result in a negative impact on
our results of operations.
IF WE DO NOT MEET CLIENT EXPECTATIONS AND EXPAND OUR NAME RECOGNITION, WE WILL
NOT REMAIN COMPETITIVE.
We believe that establishing and maintaining a good reputation and name
recognition is critical for attracting and expanding our targeted client base.
We also believe that the importance of reputation and name recognition will
increase due to the growing number of Internet professional services firms. If
our reputation is damaged or if potential clients do not know what services we
provide, we may become less competitive or lose our market share. Promotion and
enhancement of our name will depend largely on our success in providing
high-quality digital business solutions. If clients do not perceive our digital
business solutions to be effective or of high quality, our brand name and
reputation could be seriously harmed.
OUR BUSINESS IS LABOR INTENSIVE AND IF WE ARE UNABLE TO RECRUIT AND RETAIN
QUALIFIED PROFESSIONALS, WE MAY NOT BE ABLE TO COMPLETE, RETAIN OR BID FOR
PROJECTS.
Because we are an Internet professional services firm, our success depends,
in large part, on identifying, hiring, training and retaining qualified
professionals. Because of the recent growth
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of the Internet, there is currently a shortage of professionals with the
appropriate Internet-related skills and experience we seek and we expect this
trend to continue for the foreseeable future. We compete with other companies to
recruit and hire from this limited pool. If we cannot hire and retain qualified
personnel, we may be unable to complete or retain existing projects or bid for
new projects of similar scope and associated revenues.
OUR RESULTS OF OPERATIONS COULD SUFFER IF WE DO NOT MANAGE OUR GROWTH
EFFECTIVELY.
We have grown rapidly and expect to continue to grow rapidly both by hiring
new employees and serving new business and geographic markets. Our headcount has
grown from 169 people as of December 26, 1998, to 457 people as of December 25,
1999 and to 687 people as of July 31, 2000, and certain members of our
management team have only recently joined us. This growth has strained, and will
continue to strain in the future, our managerial and operational resources. To
manage our growth, we must establish new offices in appropriate geographic
locations, establish profitable pricing and maintain high employee utilization
rates and project quality. If we are not able to do this effectively, our
results of operations will be harmed.
THE LOSS OF OUR PRESIDENT AND CHIEF EXECUTIVE OFFICER, OR OTHER KEY PERSONNEL,
MAY ADVERSELY AFFECT OUR FUTURE GROWTH AND PROFITABILITY.
We believe that our success depends on the continued employment of our
senior management team. This dependence is particular to our business because
personal relationships are a critical element of obtaining and maintaining
client projects. If one or more of these key personnel were unable or unwilling
to continue in their present positions, they would be very difficult to replace
and our business could be seriously harmed. To date, a majority of our revenues
have been generated by the selling efforts of our senior management.
Accordingly, the loss of one or more members of our senior management team,
including our President and Chief Executive Officer, Martin Wright, could have a
direct adverse impact on our future sales. In addition, if any of these key
employees joins a competitor or forms a competing company, some of our clients
might choose to use the services of that competitor or new company instead of
our own. Furthermore, clients or other companies seeking to develop in-house
digital business capabilities may hire away some of our key employees. This
would not only result in the loss of key employees but could also result in the
loss of a client relationship or a new business opportunity. Any losses of
client relationships could adversely affect our future growth and profitability.
OUR RECENT AND POTENTIAL FUTURE ACQUISITIONS COULD BE DIFFICULT TO
INTEGRATE, DILUTE STOCKHOLDER VALUE AND ADVERSELY AFFECT OUR OPERATING RESULTS.
We have acquired other businesses in the past, and may undertake additional
acquisitions in the future to grow our business. For example, in March 2000, we
acquired ZCom, a creative design firm that had 28 employees. In July 2000, we
acquired Alliance, a strategy consulting firm that had 36 employees. We may
undertake additional acquisitions in the future to grow our business. Both our
recent and potential future acquisitions may involve a number of risks,
including:
- inability to integrate the acquired business;
- dilution of stockholder value;
- diversion of management attention;
- amortization of substantial goodwill, adversely affecting our reported
results of operations;
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- inability to retain the management, key personnel and other employees of
the acquired business;
- inability to establish uniform standards, controls, procedures and
policies;
- inability to retain customers of our acquired companies; and
- exposure to legal claims for activities of the acquired business prior to
the acquisition.
OUR CLIENTS WHO ARE EMERGING HIGH-GROWTH COMPANIES COULD HAVE LIMITED OPERATING
HISTORIES AND SIGNIFICANT NET LOSSES.
Many of our clients that are high-growth companies, including some Internet
companies, have been recently organized, have limited operating histories, have
significant net losses and have limited corporate sponsorship or financial
resources. The volatility of the stock market in recent months has made it
difficult for many of these companies to raise funds, and a number of comparable
companies have recently gone bankrupt. If our clients who are emerging
high-growth companies are adversely affected by this volatility, we could
experience greater than expected customer loss or an inability to collect fees
from our customers in a timely manner. This would adversely affect our ability
to achieve revenue and earnings targets or maintain an adequate cash position.
IF WE ARE NOT SUCCESSFUL IN OPENING AND GROWING NEW OFFICES, OUR BUSINESS WILL
BE HARMED AND A KEY COMPONENT OF OUR GROWTH STRATEGY WILL HAVE FAILED.
A key component of our growth strategy is to open offices in new geographic
locations. Once we select a new location, we typically devote substantial
financial resources as well as significant management time and energy to launch
and grow that office. The financial cost of opening an office is dependent on a
number of factors, including geographic location and the size and cost of the
facility. We may not select appropriate markets to enter, open new offices
efficiently or manage new offices profitably. If we commit significant resources
to launching and growing a new office which then fails, our results of
operations could be harmed.
IF WE FAIL TO COMPETE SUCCESSFULLY, OUR BUSINESS COULD BE SERIOUSLY HARMED AND
OUR REVENUES COULD GROW MORE SLOWLY THAN EXPECTED.
The Internet and information technology consulting industry is relatively
new and intensely competitive, and we expect competition to intensify as this
industry evolves. We believe that our competitors fall into several categories,
including the following:
- Internet services firms, such as Lante, Proxicom, Razorfish, Sapient,
Scient, Viant and Zefer;
- strategic consulting firms, such as Bain & Company, Booz-Allen &
Hamilton, Boston Consulting Group, Diamond Technology Partners and
McKinsey & Company;
- global IT services firms, such as the Big Five accounting firms, Computer
Sciences Corporation, EDS and IBM Global Services;
- digital design agencies, such as Agency.com, Modem Media and Organic; and
- in-house information technology, marketing and design departments of our
potential and current clients.
Many of our competitors have longer operating histories, more clients,
longer relationships with their clients, greater brand or name recognition and
significantly greater financial, technical, marketing and public relations
resources than we do. As a result, our competitors may be in a
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stronger position to respond quickly to new or emerging technologies and changes
in client requirements. They may also develop and promote their products and
services more effectively than we do.
Because there are relatively low barriers to entry into our industry, we
also expect other competitors to enter our market. In addition, we do not own
any patented technology that would protect our market share or prohibit existing
competitors or new entrants from providing services similar to ours. As a
result, new and unknown market entrants pose a threat to our business.
Current or future competitors may develop or offer services that are
comparable or superior to ours at a lower price, which could harm our revenues
and profitability. Further, competitors may have extensive knowledge of our
industry and well-established relationships with our current or potential
clients. As a result, our competitors may be able to respond more quickly to new
or emerging technologies and changes in client requirements than we can. If we
fail to compete successfully against our competitors who may develop services
that are either superior to ours or comparable to ours but are available at a
lower price, then our business could be seriously harmed and our revenues could
grow more slowly than expected.
RISKS RELATED TO TECHNOLOGY AND THE INTERNET
DEMAND FOR OUR SERVICES MAY DECREASE IF EXPECTED GROWTH IN THE USE OF THE
INTERNET IS NOT ACHIEVED.
Our business is dependent upon continued growth in the use of the Internet
by our clients and prospective clients and their customers and suppliers. If the
number of users of the Internet does not increase and e-commerce does not become
more accepted and widespread, demand for our services may decrease and, as a
result, our revenues may decrease. The factors that may affect Internet usage or
e-commerce adoption include:
- actual or perceived lack of security of information;
- lack of access and ease of use;
- congestion of Internet traffic;
- inconsistent quality of service;
- increases in access costs to the Internet;
- governmental regulation;
- uncertainty regarding intellectual property ownership;
- reluctance to adopt new business methods; and
- costs associated with deploying new technologies necessary for
e-commerce.
IF WE FAIL TO KEEP UP WITH TECHNOLOGICAL CHANGES, OUR ABILITY TO ATTRACT AND
RETAIN CLIENTS MAY BE HARMED.
We generate our revenues from creating complex, integrated digital business
solutions that are based upon today's leading technologies. The Internet
professional services market and the enabling technologies used by our clients
are characterized by rapid technological change, which causes evolving industry
standards and changing client needs. Accordingly, our future success will
depend, in part, on our ability to keep pace with these technological changes.
Our ability to
10
<PAGE> 13
do this will depend on our success in hiring, training and retaining qualified
professionals who can:
- influence and respond to emerging industry standards and other
technological changes;
- understand the changes in technology affecting our industry; and
- deliver effective solutions that utilize the most innovative
technologies.
Failure to respond successfully to these changes in a timely and effective
manner may harm our ability to attract and retain clients.
RISKS RELATED TO LEGAL UNCERTAINTY
DISPUTES RELATING TO RIGHTS TO SOLUTIONS WE DEVELOP FOR SPECIFIC CLIENTS COULD
LIMIT OUR ABILITY TO REUSE SOFTWARE AND CAUSE US TO INCUR ADDITIONAL EXPENSES.
Our business often involves the development of software applications for
specific client projects. Clients may negotiate assignment of ownership or
restrictions on our use of these related applications. We also develop software
applications for our own internal use and we retain ownership of these
applications. Issues relating to the ownership of and rights to use software can
be complicated and, although we have not experienced disputes as to the
ownership of applications developed for specific clients, these kinds of
disputes may arise and could affect our ability to reuse software. This could
require us to incur additional expenses to develop new solutions for future
products.
IF WE DO NOT PROTECT OUR INTELLECTUAL PROPERTY, WE MAY NOT BE COMPETITIVE.
We believe our trademarks and other proprietary rights are important to our
success and competitive position. If we are unable to protect our trademarks and
other proprietary rights against unauthorized use by others, our reputation
among existing and potential clients could be damaged and our competitive
position harmed. We have registered one trademark in the United States and have
four applications pending for service marks. We use our best efforts to limit
access to and distribution of our proprietary information, as well as
proprietary information licensed from third parties. These strategies may not be
adequate to deter misappropriation of our proprietary information and material
due to:
- non-recognition or inadequate protection of our proprietary rights in
certain foreign countries;
- undetected misappropriation of our proprietary information or materials;
- development of similar software or applications by our competitors; and
- unenforceability of the non-competition agreements entered into by our
key employees.
If our intellectual property protection strategies are inadequate, we could
incur significant costs to defend our rights and our management's attention
would be diverted. In addition, if claims are made, whether or not they have
merit or are successful, our trademarks and other proprietary rights may decline
in value or may not be enforceable. See "Business -- Intellectual Property" for
more information concerning our proprietary intellectual property.
11
<PAGE> 14
INTELLECTUAL PROPERTY CLAIMS COULD BE TIME CONSUMING AND COSTLY TO DEFEND
AGAINST AND, IF WE ARE UNSUCCESSFUL, OUR ABILITY TO USE INTELLECTUAL PROPERTY IN
THE FUTURE COULD BE LIMITED OR WE COULD BE SUBJECTED TO DAMAGES.
We are obligated under some agreements to indemnify other parties as a
result of claims that we infringe on the proprietary rights of third parties.
Although we do not believe that the solutions that we develop for clients
infringe on any third-party proprietary rights, third parties may assert
infringement claims against us in the future and these claims may be successful.
We could incur substantial costs and diversion of management resources to defend
any claims relating to proprietary rights, which could harm our business. If any
party successfully asserts a claim against us relating to proprietary technology
or information, we may need to obtain licenses to the disputed intellectual
property. We may not, however, be able to obtain these licenses on commercially
reasonable terms, if at all, which could cause our business results to suffer.
Successful infringement claims against us may also result in monetary liability
and may disrupt our business.
WE MAY BECOME SUBJECT TO GOVERNMENT REGULATION OF THE INTERNET THAT COULD REDUCE
DEMAND FOR OUR SERVICES OR INCREASE THE COST OF DOING BUSINESS.
The Internet Tax Freedom Act, enacted in October 1998 and effective through
October 2001, bars state and local governments from imposing taxes that would
subject buyers and sellers of electronic commerce to taxation in multiple
states. The Act also bars state and local governments from imposing taxes on
Internet access through October 2001. When the Act expires or if the Act is
repealed, Internet access and sales across the Internet may be subject to
additional taxation by state and local governments. This could discourage
purchases over the Internet and reduce demand for our services.
Other laws, rules and regulations relating to the Internet in the United
States, at the state, local and federal levels, and the European Union are still
new and evolving. As a result, we are not certain how these laws, rules and
regulations will impact our business. We may be indirectly affected by new
legislation to the extent it impacts our clients and potential clients. In
addition, U.S. and foreign governmental bodies are considering, and may consider
in the future, other legislative proposals that would regulate the Internet. We
cannot predict if or how any future legislation would impact our business,
results of operations or financial condition. Legislation that dampens the
growth of the Internet or decreases its acceptance as a communications or
commercial medium could reduce demand for our services or increase the cost of
doing business.
RISKS RELATED TO THIS OFFERING
YOUR ABILITY TO INFLUENCE CORPORATE MATTERS MAY BE LIMITED BECAUSE OUR OFFICERS
AND DIRECTORS HAVE SIGNIFICANT VOTING POWER.
Immediately following this offering, our officers, directors and 5% or
greater stockholders will hold approximately 23,127,151 shares of our common
stock, or 64.8% of the outstanding shares. These stockholders, if acting
together, have the ability to control all matters submitted to our stockholders
for approval, including the election and removal of directors, amendments to our
charter documents and the approval of any business combinations. In addition,
without the consent of these stockholders, we could be prevented from entering
into transactions that could be beneficial to other stockholders or us. Also,
third parties could be discouraged from making a tender offer or bid to acquire
our company at a price per share that is above the then-current market price.
12
<PAGE> 15
MANAGEMENT MAY INVEST OR SPEND THE PROCEEDS OF THIS OFFERING IN WAYS WITH WHICH
YOU MAY NOT AGREE.
Our management has significant discretion in applying the net proceeds of
this offering and may determine to apply them in ways with which you may not
agree. See "Use of Proceeds" for a detailed description of how management
intends to apply the net proceeds of this offering.
OUR STOCK PRICE COULD BE EXTREMELY VOLATILE AND YOU MAY NOT BE ABLE TO SELL YOUR
SHARES AT OR ABOVE THE INITIAL OFFERING PRICE.
Prior to this offering, there has been no public market for our shares. A
public trading market may fail to develop due to lack of investor interest in
us, or it may develop but not become very liquid. The initial public offering
price for our common stock will be determined by negotiations between us and
representatives of the underwriters. This price may not be indicative of prices
that will prevail later in the market. The stock market has experienced
significant price and volume fluctuations, and the market prices of technology
companies, particularly Internet-related companies, have been highly volatile.
You may not be able to sell your shares at or above the initial public offering
price. See "Underwriting" for a discussion of the factors to be considered in
determining the initial public offering price.
In the past, following periods of volatility in the market price of a
company's securities, securities class action litigation has often been
instituted. A securities class action suit against us could result in
substantial costs and the diversion of management's attention and resources,
which could affect our business results.
FUTURE SALES OF OUR COMMON STOCK IN THE PUBLIC MARKET MAY DEPRESS OUR STOCK
PRICE.
Our current stockholders hold a substantial number of shares, which they
will be able to sell in the public market in the future. Sales of a substantial
number of shares of our common stock after this offering could cause our stock
price to fall.
The following table indicates approximately when the 31,715,135 shares of
our common stock that were outstanding as of July 31, 2000, assuming conversion
of all outstanding shares of convertible preferred stock into 8,451,724 shares
of common stock, will be eligible for sale into the public market:
<TABLE>
<CAPTION>
RESTRICTED SHARES ELIGIBLE
FOR SALE IN
THE PUBLIC MARKET
--------------------------
<S> <C>
On the date of this prospectus.............................. 0
180 days after the date of this prospectus.................. 27,564,665
At various times more than 180 days after
the date of this prospectus............................... 4,150,470
</TABLE>
Additionally, there were options outstanding to purchase 6,576,198 shares
of common stock and warrants outstanding to purchase 653,639 shares of common
stock as of June 24, 2000 and 375,250 shares of common stock issuable upon
exercise of options granted to former employees of Alliance in July 2000.
The sale of these shares could impair our ability to raise capital through
the sale of additional stock. See "Shares Eligible for Future Sale" for a more
detailed discussion of when shares will become freely tradeable.
13
<PAGE> 16
WE MAY NEED TO RAISE ADDITIONAL CAPITAL IN THE FUTURE, WHICH MAY NOT BE
AVAILABLE ON REASONABLE TERMS TO US, IF AT ALL.
We expect that the net proceeds of this offering will be sufficient to meet
our working capital needs for at least the next 12 months. However, we may need
additional capital prior to that and after that period if we do not generate
sufficient revenue from operations to offset our operating or other expenses. As
a result, in the future, we may need to raise additional funds through public or
private debt or equity financings. We may not be able to borrow money or sell
more of our equity securities to meet our cash needs. Even if we are able to do
so, it may not be on terms that are favorable or reasonable to us. If we are not
able to raise additional capital when we need it in the future, we may not be
able to:
- hire, train and retain qualified Internet and information technology
professionals;
- develop new services;
- respond to competitive pressures;
- take advantage of opportunities, including acquisitions of complementary
businesses or technologies; and
- open new offices, in the United States and internationally.
If we are not able to do any of the above, our business results would
suffer. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" for a more complete description of our historical
financial condition, results of operations and liquidity.
OUR CHARTER DOCUMENTS COULD DETER A FINANCIALLY ATTRACTIVE TAKEOVER ATTEMPT.
Our certificate of incorporation and bylaws are designed to make it
difficult for a third party to acquire control of us, even if a change in
control would be beneficial to stockholders. Any third-party takeover not
supported by the board of directors, even if beneficial to our stockholders,
could be subject to significant delays and difficulties. See "Description of
Capital Stock" for a more detailed description of the terms of our charter
documents that could hinder a third party's attempt to acquire control.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements. These statements
relate to future events or our future financial performance. In some cases, you
can identify forward-looking statements by terminology such as "may," "will,"
"should," "expects," "plans," "anticipates," "believes," "estimates,"
"predicts," "potential," or "continue" or the negative of such terms or other
comparable terminology. These statements are only predictions. Actual events or
results may differ materially. In evaluating these statements, you should
specifically consider various factors, including the risks outlined under "Risk
Factors." These factors may cause our actual results to differ materially from
any forward-looking statement.
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. Unless required by law to do so, we are
under no duty to update any of the forward-looking statements after the date of
this prospectus to conform such statements to actual results.
14
<PAGE> 17
USE OF PROCEEDS
We expect to receive net proceeds from the sale of the 4,000,000 shares of
common stock in this offering of approximately $43.5 million at an assumed
initial public offering price of $12.00 per share, after deducting estimated
underwriting discounts and commissions and estimated offering expenses. We will
not receive any of the net proceeds from any sale of shares by the selling
stockholder in connection with the exercise of the underwriters' over-allotment
option.
We intend to use approximately $10 million of the net proceeds from this
offering to repay all outstanding debt under our current revolving credit
facility. Borrowing under this credit facility bears interest at the bank's
prime rate plus 1.75%. We intend to use approximately $1.4 million of the net
proceeds from this offering to repay promissory notes payable to two former ZCom
stockholders and we intend to use approximately $1.1 million of the net proceeds
from this offering to repay a promissory note payable to a former Alliance
employee. The notes payable to the two former ZCom stockholders bear interest at
a rate of 8% per annum and the notes payable to a former Alliance stockholder
bear interest at a rate of 10% per annum. We intend to use the remaining
proceeds from this offering primarily for general corporate purposes, including
working capital. The amounts that we actually expend will vary significantly,
depending on a number of factors, including future revenue growth, if any, and
the amount of cash we generate from operations. As a result, we will retain
broad discretion in the allocation of the net proceeds of this offering. In
addition, we may use a portion of the net proceeds to acquire complementary
products, technologies or businesses; however, we currently have no commitments
or agreements and are not involved in any negotiations with respect to any such
transactions. Pending use of the net proceeds of this offering, we intend to
invest the net proceeds in interest-bearing, investment-grade securities.
DIVIDEND POLICY
We have never declared or paid any dividends on our capital stock. We
currently expect to retain future earnings, if any, for use in the operation and
expansion of our business and do not anticipate paying any cash dividends in the
foreseeable future. In addition, our existing bank line of credit prohibits the
payment of dividends without our bank's consent.
15
<PAGE> 18
CAPITALIZATION
The following table sets forth our capitalization as of June 24, 2000 on:
- an actual basis;
- a pro forma basis to give effect to the issuance of 2,585,780 shares of
common stock in connection with the acquisition of Alliance, the issuance
of 2,318,392 shares of Series C Preferred Stock in July 2000 and the
subsequent automatic conversion of all outstanding shares of our Series C
Preferred Stock and all other outstanding shares of our preferred stock
into 8,451,724 shares of common stock upon completion of this offering;
and
- a pro forma as adjusted basis to also give effect to the sale of
4,000,000 shares of common stock in this offering at an assumed initial
public offering price of $12.00 per share, less estimated underwriting
discounts and commissions and estimated offering expenses, and the
application of the net proceeds.
You should read this table in conjunction with our financial statements and
related notes, Selected Financial Data and Management's Discussion and Analysis
of Financial Condition and Results of Operations, included elsewhere in this
prospectus.
<TABLE>
<CAPTION>
AS OF JUNE 24, 2000
------------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
-------- --------- -----------
(IN THOUSANDS)
<S> <C> <C> <C>
Cash and cash equivalents................................... $ 350 $ 9,568 $ 44,079
======== ======== ========
Total debt and capital leases including current portion..... $ 9,973 $ 12,024 $ 2,698
Preferred stock, $0.001 par value, 15,333,334 shares
authorized, issued and outstanding actual; 17,651,726
shares authorized, none issued and outstanding pro
forma; and 2,000,000 shares authorized, none issued or
outstanding pro forma as adjusted....................... 12,834 -- --
Stockholders' equity (deficit):
Common stock, $0.001 par value: 73,666,666 shares
authorized, 20,675,800 issued and outstanding actual;
78,000,000 shares authorized, 31,713,304 shares issued
and outstanding pro forma; and 78,000,000 shares
authorized, 35,713,304 issued and outstanding pro forma
as adjusted............................................. 21 32 36
Additional paid-in capital................................ 21,218 64,303 107,839
Deferred compensation..................................... (8,333) (13,207) (13,207)
Accumulated deficit....................................... (17,772) (17,772) (17,772)
Less stock subscriptions receivable....................... (216) (216) (216)
-------- -------- --------
Total stockholders' equity (deficit)............... (5,082) 33,140 76,680
-------- -------- --------
Total capitalization........................................ $ 17,725 $ 45,164 $ 79,378
======== ======== ========
</TABLE>
The data in the table above excludes:
- 6,576,198 shares of common stock issuable upon exercise of options
outstanding as of June 24, 2000, at a weighted average exercise price of
$2.08 per share; the grant in July 2000 of 375,250 shares of common stock
issuable upon exercise of options to employees at an exercise price of
$6.25; and 1,803,997 shares of common stock available for issuance under
our incentive option plans as of July 31, 2000;
- 28,600 shares of common stock issuable in connection with the ZCom,
Incorporated acquisition; and
- 653,639 shares of common stock issuable upon exercise of outstanding
warrants.
See "Management -- Stock Plans," "Certain Transactions," "Description of
Capital Stock" and Notes 6 and 11 of Notes to Financial Statements for
additional information regarding these shares.
16
<PAGE> 19
DILUTION
If you invest in our common stock, your interest will be diluted to the
extent of the difference between the public offering price per share of our
common stock and the pro forma as adjusted net tangible book value per share of
common stock after this offering. Our pro forma net tangible book value as of
June 24, 2000 was $8,201,000, or $0.26 per share of common stock. Pro forma net
tangible book value per share represents the pro forma amount of our total
tangible assets less total liabilities, divided by the pro forma number of
shares of common stock outstanding. Pro forma net tangible book value per share
gives effect to the issuance in July 2000 of 2,318,392 shares of Series C
Preferred Stock, the automatic conversion of all outstanding shares of our
Series C Preferred Stock and all other outstanding shares of our preferred stock
into 8,451,724 shares of common stock upon completion of the offering and our
acquisition of Alliance. Dilution in pro forma net tangible book value per share
represents the difference between the amount per share paid by purchasers of
shares of common stock in this offering and the pro forma as adjusted net
tangible book value per share of common stock immediately after the completion
of this offering. After giving effect to the sale of the 4,000,000 shares of
common stock in this offering at an assumed public offering price of $12.00 per
share less estimated underwriting discounts and commissions and estimated
offering expenses, our pro forma as adjusted net tangible book value as of June
24, 2000 would have been $52,038,000, or approximately $1.46 per share. This
represents an immediate increase in net tangible book value of $1.20 per share
to existing stockholders and an immediate dilution in net tangible book value of
$10.54 per share to new investors, or approximately 87.8% of the initial public
offering price of $12.00 per share. The following table illustrates this per
share dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share............. $12.00
Pro forma net tangible book value per share as of June 24,
2000................................................... $0.26
Increase per share to existing stockholders............... 1.20
-----
Pro forma as adjusted net tangible book value per share
after this offering....................................... 1.46
------
Dilution per share to new investors......................... $10.54
======
</TABLE>
The following table shows, on a pro forma basis as of July 31, 2000, and
after giving effect to this offering, the differences between existing holders
of common stock and the new investors with respect to the number of shares of
common stock purchased from us, the total consideration paid to us and the
average price per share paid based on an assumed initial public offering price
of $12.00 per share, before deducting estimated underwriting discounts and
commissions and estimated offering expenses.
<TABLE>
<CAPTION>
Shares Purchased Total Consideration Average
---------------------- ---------------------- Price Per
Number Percent Amount Percent Share
----------- ------- ----------- ------- ---------
<S> <C> <C> <C> <C> <C>
Existing stockholders..... 31,715,135 88.8% $32,943,669 40.7% $ 1.04
New investors............. 4,000,000 11.2% 48,000,000 59.3% 12.00
----------- ----- ----------- ------
Total........... 35,715,135 100.0% $80,943,669 100.0% $ 2.27
=========== ===== =========== ======
</TABLE>
The foregoing discussion and table are based on pro forma shares
outstanding on July 31, 2000, and assume no exercise of any stock options or
warrants outstanding as of that date. As of July 31, 2000 there were options
outstanding to purchase 6,949,617 shares of common stock at a weighted average
exercise price of $2.30 per share and warrants to purchase 653,639 shares of
common stock. To the extent any of these options are exercised, there will be
further dilution to investors. See "Capitalization," "Management -- Stock
Plans," "Description of Capital Stock" and Notes 6 and 11 of Notes to Financial
Statements for a more detailed discussion of dilution to investors.
17
<PAGE> 20
SELECTED FINANCIAL DATA
You should read the selected financial data set forth below in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our Financial Statements and related Notes included elsewhere in
this prospectus. The statements of operations data for the fiscal years ended
December 27, 1997, December 26, 1998 and December 25, 1999 and the balance sheet
data as of December 26, 1998 and December 25, 1999, are derived from, and are
qualified by reference to, the audited Financial Statements and related Notes
appearing elsewhere in this prospectus. The financial data as of and for the six
months ended June 26, 1999 and June 24, 2000 are unaudited, but have been
prepared on a basis consistent with our audited financial statements and the
notes thereto and include all adjustments, which include only normal recurring
adjustments, which we considered necessary for a fair presentation of the
information. Historical results are not necessarily indicative of results to be
expected for any future period. Although we were incorporated in November 1996,
our substantive business activities did not begin until January 1997.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED SIX MONTHS ENDED
------------------------------------------ -------------------
DECEMBER 27, DECEMBER 26, DECEMBER 25, JUNE 26, JUNE 24,
1997 1998 1999 1999 2000
------------ ------------ ------------ -------- --------
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Revenues..................................... $ 2,721 $15,011 $34,711 $14,286 $ 33,966
Expenses:
Cost of revenues -- professional services
(excluding stock compensation)........... 2,418 7,742 19,281 7,552 17,760
Cost of revenues -- AT&T warrant........... -- -- -- -- 754
Sales and marketing (excluding stock
compensation)............................ 407 2,401 6,590 2,345 7,862
General and administrative (excluding stock
compensation)............................ 3,474 4,091 14,261 5,235 14,228
Stock compensation......................... -- -- 19 -- 2,226
Loss on investment in subsidiary held for
disposal................................. 238 -- -- -- --
------- ------- ------- ------- --------
Total operating expenses................. 6,537 14,234 40,151 15,132 42,830
------- ------- ------- ------- --------
Income (loss) from operations................ (3,816) 777 (5,440) (846) (8,864)
Interest income (expense), net............... (37) (9) (19) 32 (338)
------- ------- ------- ------- --------
Income (loss) before income taxes............ (3,853) 768 (5,459) (814) (9,202)
Income taxes................................. -- 60 (34) -- --
------- ------- ------- ------- --------
Net income (loss)............................ (3,853) 708 (5,425) (814) (9,202)
Accretion of redemption value of redeemable
convertible preferred stock................ -- -- 692 277 626
Effect of beneficial conversion feature of
the Series B Preferred Stock............... -- -- -- -- 1,840
------- ------- ------- ------- --------
Net income (loss) applicable to common
stockholders............................... $(3,853) $ 708 $(6,117) $(1,091) $(11,668)
======= ======= ======= ======= ========
Net earnings (loss) per share applicable to
common stockholders:
Basic earnings (loss) per share............ $ (0.23) $ 0.04 $ (0.31) $ (0.05) $ (0.57)
======= ======= ======= ======= ========
Diluted earnings (loss) per share.......... $ (0.23) $ 0.03 $ (0.31) $ (0.05) $ (0.57)
======= ======= ======= ======= ========
Shares used to calculate:
Basic earnings (loss) per share............ 16,739 19,488 19,930 19,904 20,405
Diluted earnings (loss) per share.......... 16,739 20,364 19,930 19,904 20,405
</TABLE>
18
<PAGE> 21
The following table presents selected balance sheet data as of June 24,
2000, on a pro forma basis to reflect the following:
- the issuance of 2,318,392 shares of Series C Preferred Stock in July
2000;
- the automatic conversion of all outstanding shares of our preferred stock
into 8,451,724 shares of common stock upon completion of this offering;
- the effect of the issuance of 2,585,780 shares of common stock in
connection with the July 2000 acquisition of Alliance, as well as cash
consideration, acquisition costs, issuance of a promissory note and
assumption of liabilities totaling $8.8 million.
The following table also presents selected balance sheet data as of June
24, 2000 on a pro forma as adjusted basis to give effect to the pro forma
adjustments and the receipt of the estimated net proceeds from the sale of
shares of our common stock in this offering at an assumed initial public
offering price of $12.00 per share after deducting underwriting discounts and
commissions and estimated offering expenses payable by us.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED AS OF JUNE 24, 2000
------------------------------------------ ----------------------------------
DECEMBER 27, DECEMBER 26, DECEMBER 25, PRO FORMA
1997 1998 1999 ACTUAL PRO FORMA AS ADJUSTED
------------ ------------ ------------ -------- --------- -----------
(IN THOUSANDS) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents ..... $ 182 $ 303 $ 1,708 $ 350 $ 9,568 $44,079
Working capital (deficit)...... (607) 892 (782) (5,807) 1,887 45,724
Total assets................... 3,049 4,646 14,885 30,130 59,005 93,220
Total debt and capital leases
including current portion.... 209 175 5,406 9,973 12,024 2,698
Redeemable convertible
preferred stock.............. -- -- 7,207 12,834 -- --
Total stockholders' equity
(deficit).................... 1,151 2,646 (3,457) (5,082) 33,140 76,680
</TABLE>
See Notes 1 and 7 of Notes to Financial Statements for a discussion of the
determination of the shares used in computing basic and diluted net earnings
(loss) per share.
19
<PAGE> 22
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of our financial condition and results of
operations should be read in conjunction with "Selected Financial Data" and our
Financial Statements and related Notes included elsewhere in this prospectus.
OVERVIEW
We are a professional services firm that delivers comprehensive digital
solutions that may include strategic consulting, creative design, software
development, web integration, and information technology planning. We deliver
our solutions through our locally based client management teams that can draw
upon the expertise of our national practices which specialize in specific
industries or specific solution capabilities. Our clients are Fortune 1000
companies and emerging high growth companies seeking to capitalize on Internet
and new digital technology opportunities. As of July 31, 2000 we employed 687
persons, including 488 digital solutions professionals, in 13 offices across the
United States.
We have generated substantially all of our revenues to date from
professional services fees. We provide our professional services on either a
fixed-fee or a time-and-materials basis, depending on the nature of the project.
Approximately 55% of our engagements are on a time-and-materials basis and the
balance are on a fixed-fee basis. We enter into services agreements with our
clients that establish the general terms and conditions of the relationship.
Each client relationship has the potential to yield one or more projects for
that client. As specific projects are identified by a client, we enter into
separate statements of work with that client which outline the time frame and
fees applicable to the specific project. We determine the proposed price for a
fixed-fee project by estimating the type and overall complexity of the project,
the anticipated number of professionals needed and their associated billing
rates, and the estimated duration of, and risks associated with, the project.
All fixed-fee proposals are approved by a member of our senior management team.
Additionally, finance department personnel meet regularly with senior management
or project managers to help ensure that the budgeted costs to complete a
project, which are used to calculate revenue recognition, reflect the actual
status of the project and the anticipated costs to complete the project. Our
contracts typically permit us to make adjustments to the fixed fee if the scale
of the project changes.
Revenues earned under fixed-fee contracts are generally recognized as
services are rendered, using the percentage-of-completion method of accounting,
which is based on the ratio of hours worked to date to the estimated total hours
required for completion. Revenues earned under time-and-materials contracts are
generally recognized as services are provided. Revenues exclude reimbursable
expenses charged to clients. Billings in advance of services performed are
recorded as deferred revenues. Revenues recognized in advance of billings are
recorded as cost in excess of billings. Although we have not experienced
material losses on any project to date, if the resources or time required to
complete a project were to exceed the fixed fee, we would recognize any
estimated losses on projects in progress in their entirety in the period such
losses became known.
We derive a significant portion of our revenues from a limited number of
clients. For the six months ended June 24, 2000, AT&T accounted for 14.8% of our
revenues. No other single client accounted for more than 10% of our revenues for
the six months ended June 24, 2000. As a percentage of total revenues, revenues
derived from our five largest clients decreased from 90.1% in fiscal year 1997
to 78.4% in fiscal year 1998 to 64.3% in fiscal year 1999 and to 40.7% for the
six months ended June 24, 2000. These decreases were a result of increases in
both the size and number of client projects. In addition, 9.7% of fiscal year
1999 revenues and 6.6% of revenues for the six months ended June 24, 2000, were
earned from a related
20
<PAGE> 23
party. See Note 2 of Notes to Financial Statements. The loss of any significant
client or a reduction or deferral in the work performed for any significant
client could significantly reduce our revenues.
Cost of revenues -- professional services consists primarily of
compensation and benefits for employees engaged in the delivery of digital
business services and non-reimbursable expenses related to client projects. We
expect that our cost of revenues will increase as the number of our professional
services personnel grows and as competitive wages increase and inflation
requires adjustments. In addition, these expenses may increase after this
offering because prospective employees may give less weight to the stock option
component of our compensation package and require higher cash compensation.
Sales and marketing expenses consist primarily of compensation, benefits
and travel costs for employees in the sales and marketing groups. Sales and
marketing expenses increase as we increase branding efforts, increase the number
of sales and marketing personnel and increase advertising and promotional
activities.
General and administrative expenses consist primarily of compensation,
benefits, training and travel costs for employees in our management, human
resources, recruiting, finance, information technology and administration
groups. These expenses increase as we open new offices, increase personnel and
incur additional costs related to the operation of our business.
We incurred a net loss of $3.9 million during fiscal year 1997, and
reported net income of $708,000 during fiscal year 1998. We incurred a net loss
of $5.4 million in fiscal year 1999 and a net loss of $9.2 million for the six
months ended June 24, 2000. As of June 24, 2000, we had an accumulated deficit
of $17.8 million. As of June 24, 2000 we had provided a full valuation allowance
on our net deferred tax assets because of uncertainties regarding
recoverability. See Note 9 of Notes to Financial Statements for additional
information regarding limitations on our net operating loss carryforwards.
The number of our employees increased from 90 as of December 27, 1997, to
169 as of December 26, 1998, to 457 as of December 25, 1999 and to 635 as of
June 24, 2000. Personnel compensation and facilities costs represent a high
percentage of our operating expenses and are relatively fixed in advance of each
quarter. In the near term, as we continue to grow our business and open new
offices, we expect our costs will continue to exceed our revenues.
Stock Compensation
Stock compensation results from the grant of stock options to employees at
exercise prices subsequently deemed to be less than the fair value of the common
stock on the date of grant. These charges are amortized ratably over the
five-year vesting period of the options and were approximately $1.3 million for
the six months ended June 24, 2000. At June 24, 2000, deferred stock
compensation related to options was $3.6 million. We expect the amortization of
deferred stock compensation to be at least $1.1 million in the remaining six
months of 2000, $1.3 million in 2001, $693,000 in 2002, $375,000 in 2003 and
$146,000 in 2004.
It is possible that the amount of our total deferred compensation, and
therefore the amount of expense we incur each year, may increase as a result of
factors such as the grant of additional stock awards with a purchase price below
the deemed fair market value of our common stock.
Additionally, during the six months ended June 24, 2000, one of our
stockholders sold shares of our common stock to others at prices subsequently
deemed to be less than the fair value of the common stock, for which we recorded
$950,000 in stock compensation.
21
<PAGE> 24
Accretion of Redemption Value and Deferred Conversion Feature of Redeemable
Convertible Preferred Stock
In connection with our issuance of Series A Preferred Stock and Series B
Preferred Stock, $692,000 in 1999 and $627,000 for the six months ended June 24,
2000 was recorded relating to accretion, over the period through redemption, of
the difference between the carrying amount and the redemption value of the
redeemable convertible preferred stock. The Series A and Series B Preferred
Stock will convert into common stock upon completion of our initial public
offering.
The Effect of Beneficial Conversion Feature of Series B Preferred Stock
We recorded a charge of approximately $1.8 million for the beneficial
conversion feature related to Series B Preferred Stock sold during February
2000. The Series B Preferred Stock was convertible into common stock which was
subsequently deemed to have a fair market value greater than the price at which
the Series B Preferred Stock was initially sold. Because the preferred stock is
immediately convertible into common stock, the difference in values, measured as
the intrinsic value of the feature, is analogous to a dividend and is being
recognized immediately as a return to the preferred stockholders.
RECENT DEVELOPMENTS
AT&T Solutions Alliance. On March 15, 2000, we entered into a strategic
alliance agreement with AT&T Solutions to take advantage of both of our sales
channels and our combined business expertise to provide clients with digital
business solutions. As part of the agreement, we granted AT&T a warrant to
purchase up to 600,000 shares of common stock, 40,000 of which were immediately
exercisable at a price of $6.25 and the remainder will be exercisable at the
fair market value of our common stock determined as of August 1, 2000. The
remainder of the AT&T warrant becomes exercisable on March 15, 2007. However,
this portion of the warrant may become immediately exercisable upon the first or
second anniversary of the grant based upon the amount of revenue AT&T has
directed to us through joint marketing efforts as of those dates. In order to
accelerate the exercisability of its warrant, AT&T must direct a minimum of $12
million of revenues to us prior to the first anniversary of the grant or $30
million prior to the second anniversary. Once a threshold has been met, then the
AT&T warrant becomes exercisable ratably based on the proportion the revenue
generated by this relationship within the two-year period ended March 14, 2002,
bears to $84 million. The examples below are for illustrative purposes only:
<TABLE>
<CAPTION>
THEN THE AGGREGATE NUMBER OF
SHARES SUBJECT TO THE
IF REVENUES DIRECTED AT&T WARRANT
TO US BY AT&T ARE THAT WOULD ACCELERATE WOULD BE
-------------------- ------------------------------
<S> <C>
$12 million............................................................ 80,000
30 million............................................................200,000
48 million............................................................320,000
66 million............................................................440,000
84 million............................................................560,000
</TABLE>
As of June 24, 2000, we have recorded revenues attributable to AT&T
pursuant to this agreement of $7.2 million. However, AT&T is not obligated to
direct any further revenues to us. As a result, we cannot assure you that we
will realize any future revenues as a result of this agreement.
22
<PAGE> 25
ZCom Acquisition
In March 2000, we acquired ZCom, a creative design firm that had 28
employees. ZCom provided Internet marketing solutions, branding strategies and
digital and Internet design services to large and small businesses. In
connection with the acquisition, we issued promissory notes totalling
approximately $1.4 million and 431,742 shares of our common stock valued at $5.4
million. We are also obligated to pay up to $900,000 in earn-out payments in the
event certain revenue and profit targets are met during the twelve-month period
following the closing of the merger. This transaction has been accounted for
under the purchase method of accounting.
Alliance Acquisition
In July 2000, we acquired Alliance, a consulting firm that had 36
employees. Alliance provided strategy and management consulting services to
large and small businesses. In connection with the acquisition, we paid cash
consideration, incurred acquisition costs, issued a promissory note and assumed
liabilities totaling approximately $8.8 million and issued 1,364,738 shares of
our common stock and 441,224 vested shares of common stock under restricted
stock plans to stockholders of Alliance. Additionally, we issued 779,818
unvested shares of common stock under restricted stock agreements with employees
of Alliance. We are also obligated to pay up to $5 million in earn-out payments
in the event certain revenue and profit targets are met during the twelve-month
period following the closing of the merger. This transaction has been accounted
for under the purchase method of accounting.
23
<PAGE> 26
RESULTS OF OPERATIONS
The following table sets forth financial data for each of the fiscal years
ended December 27, 1997, December 26, 1998 and December 25, 1999, and for the
six months ended June 26, 1999 and June 24, 2000, as a percentage of total
revenues:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED SIX MONTHS ENDED
------------------------------------------ -------------------
DECEMBER 27, DECEMBER 26, DECEMBER 25, JUNE 26, JUNE 24,
1997 1998 1999 1999 2000
------------ ------------ ------------ -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Revenues................................ 100.0% 100.0% 100.0% 100.0% 100.0%
Expenses:
Cost of revenues -- professional
services (excluding stock
compensation)....................... 88.9 51.6 55.6 52.9 52.3
Cost of revenues -- AT&T warrant...... -- -- -- -- 2.2
Sales and marketing (excluding stock
compensation)....................... 14.9 16.0 19.0 16.4 23.1
General and administrative (excluding
stock compensation)................. 127.7 27.3 41.1 36.6 41.9
Stock compensation.................... -- -- -- -- 6.6
Loss on investment in subsidiary held
for disposal........................ 8.7 -- -- -- --
------ ----- ----- ----- -----
Total operating expenses....... 240.2 94.9 115.7 105.9 126.1
------ ----- ----- ----- -----
Income (loss) from operations........... (140.2) 5.1 (15.7) (5.9) (26.1)
Interest income (expense), net.......... (1.4) -- -- 0.2 (1.0)
------ ----- ----- ----- -----
Income (loss) before income taxes....... (141.6) 5.1 (15.7) (5.7) (27.1)
Income taxes............................ -- 0.4 (0.1) -- --
------ ----- ----- ----- -----
Net income (loss)....................... (141.6) 4.7 (15.6) (5.7) (27.1)
Accretion of redemption value of
redeemable convertible preferred
stock................................. -- -- 2.0 1.9 1.9
Effect of beneficial conversion feature
of Series B Preferred Stock........... -- -- -- -- 5.4
------ ----- ----- ----- -----
Net income (loss) applicable to common
stockholders.......................... (141.6)% 4.7% (17.6)% (7.6)% (34.4)%
====== ===== ===== ===== =====
</TABLE>
COMPARISON OF THE SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000
REVENUES
Revenues increased from $14.3 million for the six months ended June 26,
1999, to $34.0 million for the comparable period in 2000. This increase was due
to an increase in the size of projects for existing clients and an increase in
the number of clients.
EXPENSES
Cost of Revenues -- Professional Services
Cost of revenues -- professional services increased from $7.6 million for
the six months ended June 26, 1999 to $17.8 million for the comparable period in
2000. This increase was due primarily to costs associated with hiring additional
professionals. The number of our professionals increased from 225 as of June 26,
1999 to 444 as of June 24, 2000. As a percentage of total revenues, cost of
revenues of 52.3% stayed relatively consistent with the comparable period in
1999.
24
<PAGE> 27
Cost of Revenues -- AT&T Warrant
During the six months ended June 24, 2000 we recorded approximately
$754,000 of amortization for the fair value of the warrant to purchase up to
600,000 shares of our common stock granted to AT&T. We expect to recognize the
remaining fair value of the warrant of approximately $4.7 million ratably over
the two-year period of the agreement.
Sales and Marketing
Sales and marketing expenses increased from approximately $2.3 million for
the six months ended June 26, 1999 to $7.9 million for the comparable period in
2000. This increase was due primarily to the growth in the number of sales and
marketing personnel from 19 to 64. As a percentage of total revenues, sales and
marketing expenses increased from 16.4% for the six months ended June 26, 1999
to 23.1% for the comparable period in 2000. The increase was due primarily to
the growth in sales and marketing expenses outpacing revenue growth.
General and Administrative
General and administrative expenses increased from $5.2 million for the six
months ended June 26, 1999 to $14.2 million for the comparable period in 2000.
This increase was due primarily to the increase in the number of general and
administrative personnel from 54 as of June 26, 1999 to 127 as of June 24, 2000.
As a percentage of total revenues, general and administrative expenses increased
from 36.6% for the six months ended June 26, 1999 to 41.9% for the comparable
period in 2000. The increase was due primarily to provisions for doubtful
accounts of approximately 4% of revenues for the six months ended June 24, 2000.
COMPARISON OF FISCAL YEARS 1997, 1998 AND 1999
REVENUES
Revenues increased from $2.7 million in fiscal year 1997, to $15.0 million
in fiscal year 1998, and to $34.7 million in fiscal year 1999. These increases
were due primarily to increases in the number of our clients.
EXPENSES
Cost of Revenues -- Professional Services
Cost of revenues -- professional services increased from $2.4 million in
fiscal year 1997, to $7.7 million in fiscal year 1998 and to $19.3 million in
fiscal year 1999. These increases were due primarily to the hiring of additional
professionals and to increases in salaries paid to our professional staff. We
had 127 professionals at the end of 1998 and 327 professionals at the end of
1999. As a percentage of total revenues, cost of revenues decreased from 88.9%
in fiscal year 1997 to 51.6% in fiscal year 1998, and increased to 55.6% in
fiscal year 1999. The decrease in fiscal year 1998 was due to revenue growth
ahead of the growth of our professional staff and a decrease in lower-margin
Year 2000 code remediation project engagements. The increase in fiscal year 1999
was due to additional hiring of professionals in anticipation of increased
demand for our services.
Sales and Marketing
Sales and marketing expenses increased from $407,000 in fiscal year 1997,
to $2.4 million in fiscal year 1998, and to $6.6 million in fiscal year 1999.
These increases were due to an increase in the number of sales personnel from 17
as of December 26, 1998 to 34 as of
25
<PAGE> 28
December 25, 1999. As a percentage of total revenues, sales and marketing
expenses increased from 14.9% in fiscal year 1997 to 16.0% in fiscal year 1998,
and increased to 19.0% in fiscal year 1999. The increase in fiscal year 1998 was
due to revenue growth outpacing the growth in sales and marketing expenses, and
the increase in fiscal year 1999 was due to the growth of our marketing and
branding efforts.
General and Administrative
General and administrative expenses increased from $3.5 million in fiscal
year 1997, to $4.1 million in fiscal year 1998, and to $14.3 million in fiscal
year 1999. These increases were due primarily to expenses associated with the
increase in the number of our employees from 25 as of December 26, 1998 to 96 as
of December 25, 1999, and to a lesser extent to an increase in lease
expenditures in connection with the expansion of offices. As a percentage of
total revenues, general and administrative expenses decreased from 127.7% in
fiscal year 1997 to 27.3% in fiscal year 1998, and increased to 41.1% in fiscal
year 1999. The decrease in fiscal year 1998 was due to revenue growth outpacing
the growth in general and administrative expenses, and the increase in fiscal
year 1999 was due to the expansion of our infrastructure to support our growth
in systems and professionals.
NET INCOME (LOSS)
We recorded a net loss of $3.9 million in fiscal year 1997, net income of
$708,000 in fiscal year 1998, and an additional net loss of $5.4 million in
fiscal year 1999. Our 1997 results of operations include a one-time charge of
$239,000 relating to the disposal of a subsidiary. See Note 10 of Notes to
Financial Statements for a discussion of amounts related to our 1997 subsidiary.
26
<PAGE> 29
QUARTERLY RESULTS OF OPERATIONS
The following table sets forth a summary of our unaudited quarterly
operating results for each of the quarters in the two most recent fiscal years
and for the two quarters ended June 24, 2000. This data has been derived from
our unaudited interim financial statements which, in our opinion, have been
prepared on substantially the same basis as the audited financial statements
contained elsewhere in this prospectus and include all normal recurring
adjustments necessary for a fair presentation of the financial information for
the periods presented. These unaudited quarterly results should be read in
conjunction with our financial statements and related notes included elsewhere
in this prospectus. The operating results in any quarter are not necessarily
indicative of the results that may be expected for any future period.
<TABLE>
<CAPTION>
QUARTER ENDED
---------------------------------------------------------------------------------------
MAR. 28, JUN. 27, SEPT. 26, DEC. 26, MAR. 27, JUN. 26, SEPT. 25, DEC. 25,
1998 1998 1998 1998 1999 1999 1999 1999
-------- -------- --------- -------- -------- -------- --------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Revenues......................... $2,632 $3,143 $4,177 $5,059 $5,929 $8,357 $ 9,763 $10,662
Expenses:
Cost of revenues -- professional
services (excluding stock
compensation)................. 1,800 1,623 2,069 2,250 3,328 4,224 5,257 6,472
Cost of revenues -- AT&T
warrant....................... -- -- -- -- -- -- -- --
Sales and marketing (excluding
stock compensation)........... 462 378 573 988 989 1,356 1,779 2,466
General and administrative
(excluding stock
compensation)................. 861 696 1,145 1,389 2,321 2,914 3,785 5,241
Stock compensation*............. -- -- -- -- -- -- -- 19
------ ------ ------ ------ ------ ------ ------- -------
Total operating
expenses................. 3,123 2,697 3,787 4,627 6,638 8,494 10,821 14,198
------ ------ ------ ------ ------ ------ ------- -------
Income (loss) from operations.... (491) 446 390 432 (709) (137) (1,058) (3,536)
Interest income (expense), net... (2) (3) (2) (2) (15) 47 (13) (38)
------ ------ ------ ------ ------ ------ ------- -------
Income (loss) before income
taxes........................... (493) 443 388 430 (724) (90) (1,071) (3,574)
Income taxes..................... -- 16 25 19 -- -- (34) --
------ ------ ------ ------ ------ ------ ------- -------
Net income (loss)................ (493) 427 363 411 (724) (90) (1,037) (3,574)
Accretion of redemption value of
redeemable convertible preferred
stock........................... -- -- -- -- 69 208 207 208
Effect of beneficial conversion
feature of Series B Preferred
Stock........................... -- -- -- -- -- -- -- --
------ ------ ------ ------ ------ ------ ------- -------
Net income (loss) applicable to
common stockholders............. $ (493) $ 427 $ 363 $ 411 $ (793) $ (298) $(1,244) $(3,782)
====== ====== ====== ====== ====== ====== ======= =======
(*) Allocation of stock
compensation expense
Cost of revenues--
professional services........... -- -- -- -- -- -- -- --
Sales and marketing.............. -- -- -- -- -- -- -- --
General and administrative....... -- -- -- -- -- -- -- 19
<CAPTION>
QUARTER ENDED
-------------------
MAR. 25, JUN. 24,
2000 2000
-------- --------
(IN THOUSANDS)
<S> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Revenues......................... $14,830 $19,136
Expenses:
Cost of revenues -- professional
services (excluding stock
compensation)................. 7,885 9,875
Cost of revenues -- AT&T
warrant....................... 74 680
Sales and marketing (excluding
stock compensation)........... 3,046 4,816
General and administrative
(excluding stock
compensation)................. 5,874 8,354
Stock compensation*............. 1,222 1,004
------- -------
Total operating
expenses................. 18,101 24,729
------- -------
Income (loss) from operations.... (3,271) (5,593)
Interest income (expense), net... (112) (226)
------- -------
Income (loss) before income
taxes........................... (3,383) (5,819)
Income taxes..................... -- --
------- -------
Net income (loss)................ (3,383) (5,819)
Accretion of redemption value of
redeemable convertible preferred
stock........................... 276 350
Effect of beneficial conversion
feature of Series B Preferred
Stock........................... 1,840 --
------- -------
Net income (loss) applicable to
common stockholders............. $(5,499) $(6,169)
======= =======
(*) Allocation of stock
compensation expense
Cost of revenues--
professional services........... 73 347
Sales and marketing.............. 542 321
General and administrative....... 607 336
</TABLE>
27
<PAGE> 30
<TABLE>
<CAPTION>
QUARTER ENDED
---------------------------------------------------------------------------------------
MAR. 28, JUN. 27, SEPT. 26, DEC. 26, MAR. 27, JUN. 26, SEPT. 25, DEC. 25,
1998 1998 1998 1998 1999 1999 1999 1999
-------- -------- --------- -------- -------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
PERCENTAGE OF REVENUES:
Revenues............................... 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Expenses:
Cost of revenues -- professional
services (excluding stock
compensation)....................... 68.4 51.7 49.6 44.5 56.1 50.5 53.8 60.7
Cost of revenues -- AT&T warrant...... -- -- -- -- -- -- -- --
Sales and marketing (excluding stock
compensation)....................... 17.6 12.0 13.7 19.5 16.7 16.2 18.2 23.1
General and administrative (excluding
stock compensation)................. 32.7 22.1 27.4 27.5 39.2 34.9 38.8 49.2
Stock compensation.................... -- -- -- -- -- -- -- 0.2
----- ----- ----- ----- ----- ----- ----- -----
Total operating expenses........ 118.7 85.8 90.7 91.5 112.0 101.6 110.8 133.2
----- ----- ----- ----- ----- ----- ----- -----
Income (loss) from operations.......... (18.7) 14.2 9.3 8.5 (12.0) (1.6) (10.8) (33.2)
Interest income (expense), net......... -- (0.1) -- -- (0.2) 0.5 (0.2) (0.3)
----- ----- ----- ----- ----- ----- ----- -----
Income (loss) before income taxes...... (18.7) 14.1 9.3 8.5 (12.2) (1.1) (11.0) (33.5)
Income taxes........................... -- (0.5) 0.6 0.4 -- -- (0.4) --
----- ----- ----- ----- ----- ----- ----- -----
Net income (loss)...................... (18.7) 13.6 8.7 8.1 (12.2) (1.1) (10.6) (33.5)
Accretion of redemption value of
redeemable convertible preferred
stock................................. -- -- -- -- 1.2 2.5 2.1 2.0
Effect of beneficial conversion feature
of Series B Preferred Stock........... -- -- -- -- -- -- -- --
----- ----- ----- ----- ----- ----- ----- -----
Net income (loss) applicable to common
stockholders.......................... (18.7)% 13.6% 8.7% 8.1% (13.4)% (3.6)% (12.7)% (35.5)%
===== ===== ===== ===== ===== ===== ===== =====
<CAPTION>
QUARTER ENDED
-------------------
MAR. 25, JUN. 24,
2000 2000
-------- --------
<S> <C> <C>
PERCENTAGE OF REVENUES:
Revenues............................... 100.0% 100.0%
Expenses:
Cost of revenues -- professional
services (excluding stock
compensation)....................... 53.2 51.6
Cost of revenues -- AT&T warrant...... 0.5 3.5
Sales and marketing (excluding stock
compensation)....................... 20.5 25.2
General and administrative (excluding
stock compensation)................. 39.6 43.6
Stock compensation.................... 8.2 5.3
----- ------
Total operating expenses........ 122.0 129.2
----- ------
Income (loss) from operations.......... (22.0) (29.2)
Interest income (expense), net......... (.8) (1.2)
----- ------
Income (loss) before income taxes...... (22.8) (30.4)
Income taxes........................... -- --
----- ------
Net income (loss)...................... (22.8) (30.4)
Accretion of redemption value of
redeemable convertible preferred
stock................................. 1.9 1.8
Effect of beneficial conversion feature
of Series B Preferred Stock........... 12.4 --
----- ------
Net income (loss) applicable to common
stockholders.......................... (37.1)% (32.2)%
===== ======
</TABLE>
We believe that fluctuations in our quarterly operating results are caused
by many factors, some of which are outside of our control. The factors
influencing these fluctuations include the variability in market demand for our
services and the length of the sales cycle associated with our service
offerings. In addition, the number, size and scope of our projects and the
efficiency with which we utilize our employees can affect these fluctuations.
28
<PAGE> 31
LIQUIDITY AND CAPITAL RESOURCES
Since inception, we have funded our operations and investments in property
and equipment through private equity financings, bank borrowings and capital
lease financing arrangements. As of June 24, 2000, gross proceeds from the
private sales of our preferred stock totaled approximately $12 million. In July
2000, we received gross proceeds of $15 million from the sale of our Series C
Preferred Stock.
As of June 24, 2000 we had cash and cash equivalents of $350,000, a
decrease of approximately $1.4 million from cash and cash equivalents at
December 25, 1999. This decrease was due primarily to the $6.7 million used in
operations and $1.9 million used to acquire property and equipment, which is
partially offset by net cash provided by financing activities of $7.5 million.
Our cash and cash equivalents increased from approximately $303,000 at
December 26, 1998 to $1.7 million at December 25, 1999. This increase was from
net proceeds of $6.5 million from the sale of our Series A Preferred Stock in
March 1999. Cash used for operating activities was principally made up of
operating losses of $5.4 million for fiscal year 1999 and working capital used
to fund growth. The cash used in investing activities reflects our purchase of
$3.2 million in property and equipment. During the six months ending June 24,
2000, operating activities consumed $6.7 million of cash. We expect that
accounts receivable will continue to increase to the extent our revenues
continue to rise. Any such increase that occurs at the same or a greater rate
than increases in revenue can be expected to reduce cash and cash equivalents.
As of June 24, 2000, we had in place a revolving credit facility with
Imperial Bank, which provided for borrowings of up to the lesser of $7 million
or 85% of eligible accounts receivable and 50% of eligible unbilled accounts
receivable. Borrowings under this agreement accrue interest at Imperial Bank's
prime rate plus 1.75%. As of June 24, 2000, our borrowings under this credit
facility were $6.2 million. In July 2000, we amended this facility increasing
the amount available to borrow to $10 million or 85% of eligible accounts
receivable and 65% of eligible unbilled accounts receivable. A standby letter of
credit in the amount of $350,000 has also been issued against this facility as
security for leased office space. This facility is secured by substantially all
of our assets and we are required to comply with financial and restrictive
covenants related to, among other things, tangible net worth. The credit
agreement has a maturity date of March 29, 2001.
We have also financed our equipment purchases with the use of a $1.5
million capital lease facility with a leasing company that is secured by the
capital assets purchased with the borrowings. The credit facility was
substantially utilized as of June 24, 2000. In addition, we have operating
leases for our facilities requiring payments of over $11.8 million.
In connection with our acquisition of ZCom, we issued promissory notes to
two former ZCom employees of approximately $1.4 million, which we intend to
repay 10 days after completion of this offering.
In July 2000, related to our acquisition of Alliance, we paid cash
consideration, incurred acquisition costs, issued promissory notes and assumed
liabilities totaling approximately $8.8 million. We intend to repay the $1.1
million principal amount of a note after completion of this offering. In
addition, we amended a $650,000 employment-related liability to include payment
of terms of equal quarterly installments with accrued interest over the one-year
period beginning from the July 2000 date of acquisition.
Our Series A, Series B and Series C Preferred Stock, as described in Note 6
of Notes to the Financial Statements, carry certain redemption preferences. If
such redemption preferences
29
<PAGE> 32
were elected we would be obligated to pay the preferred stockholders an amount
equal to the original issue price per share, plus all declared and unpaid
dividends, plus an amount that will yield a 10% internal rate of return
calculated upon the original issue price and independent of all declared
dividends on such shares. At June 24, 2000, this redemption amount was
approximately $13.2 million. At July 25, 2000, the redemption amount for the
Series C Preferred Stock was $18.6 million. Upon automatic conversion of our
Series A, Series B and Series C Preferred Stock at the completion of the
offering, these redemption rights will terminate.
We anticipate that we will expend capital to develop the infrastructure to
support our anticipated future growth. As a result, we expect to use cash from
operations and the net proceeds from this offering to meet capital expenditures
and working capital requirements necessary to support this growth. We currently
have no material commitments for capital expenditures. We believe that our
current cash, cash equivalents, bank facility, short-term investments and the
net proceeds from this offering will be sufficient to meet our working capital
and capital expenditure requirements for at least the next 12 months. However,
we may require additional financing within this time frame and any additional
financing, if needed, may not be available on terms acceptable to us, if at all.
Our ability to grow, implement our business strategies and continue our
operations may be limited if we are not able to obtain additional financing when
necessary.
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RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board issued Statement No. 133,
Accounting for Derivative Instruments and Hedging Activities in June 1998. 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. If certain conditions are met, a derivative may
be specifically designated as a hedge. The accounting for changes in the fair
value of a derivative depends on the intended use of the derivative and the
resulting designation. SFAS No. 133, as amended by SFAS 137, is effective for
all fiscal quarters of fiscal years beginning after June 15, 2000. The adoption
of this statement is not expected to have a material impact on our financial
statements.
In December 1999, the Securities and Exchange Commission released Staff
Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements," which
we adopted December 26, 1999. SAB 101 provides guidance on revenue recognition
issues. While SAB 101 did not have a material impact on our financial
statements, there continue to be implementation questions and supplemental
issuances of interpretive guidance from the staff of the Securities and Exchange
Commission which may have future impact. Additionally, in June 2000, the
requirement for adoption of SAB 101 was deferred for calender year companies
until their fourth fiscal quarter.
In March 2000, the Financial Accounting Standards Board issued FASB
Interpretation No. 44, Accounting for Certain Transactions Involving Stock
Compensation, an Interpretation of APB Opinion No. 25. The Interpretation
clarifies the application of APB Opinion No. 25, Accounting for Stock Issued to
Employees for certain issues. The provisions of the Interpretation are effective
July 1, 2000. We do not expect the implementation of Interpretation No. 44 to
have a material impact on our financial statements.
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BUSINESS
OVERVIEW
We are a professional services firm that creates, transforms and integrates
digital business. Digital business is conducted by organizations that use the
Internet, information technology and new forms of electronic commerce to gain
competitive advantage, spur growth and enhance stockholder value. We design
digital business solutions that enable our clients to create new business
channels and markets, transform their culture and brand and integrate disparate
initiatives and communications. We provide these solutions to a client base of
Fortune 1000 and emerging high-growth companies seeking to capitalize on
Internet and other new digital technology opportunities.
We develop comprehensive digital business solutions that include business
strategy, creative design and technology engineering services. Our technology
engineering services include software development, web integration and
information technology planning. We deliver our solutions through our locally
based client management teams that draw upon the expertise of our national
practices, which focus on specific industries or possess specific solution
capabilities.
We believe that the depth of experience and background of our technology,
strategy and creative professionals provides us with a competitive advantage.
Our technology professionals average more than 10 years of industry experience.
Most of our strategy professionals have degrees from the nation's top-ranked
business schools and possess industry experience from leading strategy
consulting firms. Our creative professionals bring backgrounds and experiences
ranging from recognized art institutions to advertising agencies.
As of July 31, 2000, we employed 488 professionals in 13 offices across the
United States. During the six months ended June 24, 2000, we provided digital
business solutions for clients such as American Airlines Cargo, AT&T, Coca-Cola,
Disney, Dun & Bradstreet, Hasbro, Lucent Technologies, Lucy.com, Pfizer,
Priceline.com, Sabre and Warner Lambert.
In March 2000, we entered into a strategic alliance agreement with AT&T
Solutions to take advantage of both of our sales channels and our combined
business expertise to provide clients with digital business solutions. Under the
terms of the agreement, AT&T has incentives to direct $84 million of revenues to
us by March 31, 2002 through joint marketing efforts, but there is no assurance
that we will realize any future revenues as a result of this agreement. As part
of the agreement, we granted AT&T a warrant to purchase up to 600,000 shares of
our common stock. See Note 7(c) of Notes to our Financial Statements for further
discussion of this warrant.
INDUSTRY BACKGROUND
The Internet revolution has caused a dramatic shift in information
exchange, from static delivery of content to e-commerce transactions,
collaboration over the Internet and the sharing of production and supply chain
information. Today, increased use of the Internet and digital technologies
allows companies to increase revenue by enhancing their interactions with new
and existing customers. Businesses are using the Internet and digital
technologies to increase efficiency in their operations through improved
communication, both internally and with suppliers and business partners.
According to AMR Research Inc., the market for business-to-business
e-commerce is expected to grow to $5.7 trillion in 2004. To fully capitalize on
the new opportunities presented by the Internet, businesses demand digital
solutions that process transactions, deliver
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information more effectively and efficiently and open new revenue-generating
channels. For wireless technologies alone, International Data Corporation
forecasts that the total value of U.S. wireless Internet transactions should
increase from $4.3 billion in 1998 to more than $38 billion by 2003. Such new
channels for Internet-based applications will further increase demand for
digital business solutions and services.
Increasingly, large established organizations are using the Internet,
information technology and new forms of electronic commerce to create, transform
and integrate digital business. As a result, digital business applications and
solutions have become more complex and often difficult to manage and must keep
pace with constantly evolving business processes and technological innovations.
Internal IT departments often do not have the appropriate resources or breadth
of skills necessary to execute these initiatives. As a result, companies
increasingly turn to outside professionals to develop their business strategy
and then to design, integrate and implement their Internet or digital business
solutions. According to IDC, the worldwide market for e-business services is
projected to grow from $16.2 billion in 1999 to $99.1 billion in 2004. The U.S.
market for e-business services is forecasted by IDC to grow from $8.8 billion in
1999 to $44 billion in 2004, representing the largest e-business services market
by geographical region.
The rapidly growing demand for Internet professional services has attracted
many firms to this market, including strategy consulting firms, systems
integrators and Internet professional services providers. While these firms have
specific strengths, many are limited in their ability to deliver comprehensive,
complex digital business solutions. Some firms provide technology-based
solutions without giving appropriate consideration to their clients' business
strategy. Web design firms typically focus on user interfaces and front-end
design and do not offer a broad scope of expertise for rapid development and
deployment of innovative digital technologies, systems and capabilities.
Traditional IT services firms typically have been focused on enhancing existing
systems and implementing traditional business software applications. As a
result, companies often rely upon multiple firms to provide comprehensive
digital business solutions, resulting in additional expense, inefficiency and
discontinuity, as projects are transferred between multiple service providers.
Furthermore, companies lose the advantage of having a single service provider to
hold accountable for project execution and delivery.
We believe that as digital business projects become more complex, companies
seeking digital business solutions will place greater value on integrated
solution delivery across multiple disciplines. Without integrated solution
delivery, companies may face communications breakdowns, misaligned expectations
and inadequate project management. We believe an integrated solution delivery
model enables clients to avoid these problems and instead provides clients with
enhanced communication, speed, accountability and seamless integration between
different phases of a project. We believe there is a significant opportunity for
a digital business solution provider that can develop a company's initial
strategy, create interactive customer experiences and build the infrastructure
applications and business systems necessary to lead to measurable business
benefits.
OUR SOLUTION
We believe that the following key elements of our solution differentiate us
from most Internet professional service providers and enable us to effectively
meet the demand for Internet and digital business solutions.
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We deliver comprehensive digital business solutions
We offer comprehensive digital business solutions that include strategic,
creative and technical disciplines and deliver a unified approach to solving our
clients' business problems. Our full service approach provides a coherent
solution spanning multiple phases of a single project. As of July 31, 2000, we
had 39 strategic professionals who deliver a breadth of services, from
executive-level business consulting to Internet strategy consulting. Our 46
creative professionals provide services ranging from digital branding to user
experience design to Internet advertising. Our 403 technology professionals
deliver services ranging from web-based customer relationship systems to online
supply chain management systems to custom enterprise application software.
We focus on our clients' unique digital business issues rather than specific
technology trends
We are dedicated to creating competitive advantage and financial success
for our clients by providing valuable solutions that target their unique digital
business issues. These issues include:
- creating new digital businesses, new market opportunities and new
channels for additional revenue sources;
- transforming businesses into digital organizations with innovative
cultures and brands; and
- integrating current applications, processes and communications with newer
technologies without disrupting information flow.
To address these issues, our integrated teams focus on strategic business
objectives, challenges and opportunities prior to technical evaluations, and
then create a program tailored for our client. Our consultants typically analyze
a client's current business and industry practices, perform an extensive
customer and company profile and survey technology platforms. Once we understand
and analyze a client's business problem, we prescribe a program of action
targeted to result in measurable business benefit. We then execute this program,
creating opportunities to trace strategy through implementation and minimize the
amount of vital information that can be lost in large projects.
We have a geographic delivery model enhanced with specific industry expertise
and digital business capabilities
We have offices in 13 metropolitan areas across the United States. Our
dispersed geographic presence enables us to locally deliver our project, program
and account management resources. We believe our local delivery model enhances
communications, response time and client service. Our teams are led by
experienced, local project managers who are accountable for delivering our
solutions. Where appropriate, we supplement the core local delivery team with
professionals from other offices who possess specific expertise in certain
industries, including telecommunications, transportation, pharmaceuticals,
financial services and digital markets. These professionals enhance our ability
to understand the key business issues facing clients in specific industries. We
are able to supplement our core delivery teams with professionals who operate on
a national basis and possess expertise across digital business capabilities,
including strategy, digital branding and design, e-commerce, customer
relationship management and supply chain management. We share information and
best practices among our offices through our computer-based knowledge management
and quality system.
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OUR GROWTH STRATEGY
Our objective is to become the leading provider of comprehensive digital
business solutions. To achieve our objective, we are focused on the following
growth strategies:
Target clients with the potential for large, complex digital business needs
We target Fortune 1000 and emerging high-growth companies with complex
business needs that require our ability to provide comprehensive digital
business solutions. Generally, clients with these complex needs will enter into
long-term relationships with more predictable projects that enable us
efficiently to deploy our professionals and manage our business. Long-term
relationships allow us to become more familiar with our clients' businesses and
enable us to provide them with more successful solutions. In addition, the size
and visibility of these engagements help to establish our brand and credibility
within the Internet services marketplace.
Expand our capabilities through industry and solutions expertise
We continue to supplement our existing industry teams as well as add new
industry specialties. We currently focus on the telecommunications industry, the
transportation industry, the financial services industry, the pharmaceuticals
industry and digital markets. This industry focus allows us to stay abreast of
industry trends and issues and to apply this knowledge and expertise to our
client engagements. Industry teams are comprised of our consulting professionals
in the strategy, creative design and technology disciplines to ensure that all
client functional business areas and digital business issues are addressed. In
addition, we have teams dedicated to forming, developing and expanding our
service offerings in high-growth markets. These markets include wireless,
broadband, security and other emerging digital technologies.
Recruit, retain and motivate experienced professionals
To grow our business, we seek to attract, retain and motivate experienced
professionals who have demonstrated success and who will enable us to deliver
high-quality digital business solutions for our clients. Our local delivery
model reduces the need for travel, which we believe gives us a competitive
advantage in hiring and retaining professionals. As of July 31, 2000, we
employed a full-time staff of 22 recruiters. These recruiters are responsible
for hiring professionals who possess the necessary skills, experience and values
consistent with our culture. Additionally, we have established an employee
referral program that motivates our current professionals to bring new
professionals to work for us. During the last 12 months, we have hired
approximately 46% of our professionals through this program.
Expand our geographic presence
We manage and deliver our solutions from 13 offices throughout the United
States. We intend to expand our delivery capabilities through adding local
offices. Each of our offices is managed by a practice area leader, who is
responsible for the day-to-day operations of the local office as well as the
business development efforts, local project delivery and execution, resource
management and local recruiting. By maintaining a local office presence, we are
able to provide regional client support, manage the amount of travel time and
create local brand awareness. In addition, we are considering international
expansion in Europe to take advantage of local opportunities there, as well as
to deepen our relationships with our global client base.
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Increase brand awareness
We believe a recognizable brand results in a greater ability to maintain
our client base, attract new clients and employees and increase morale. We seek
increased brand awareness through the following activities:
- establishing a brand position as experienced, innovative leaders in the
digital business marketplace through representation at seminars,
conferences and recruiting fairs, as well as representation in the press;
- creating awareness of our company through targeted local and national
public relations and advertising programs;
- enhancing understanding of our service offerings and approach through
expanded web communications, event and direct marketing and partner
programs; and
- supporting the presence and sales capacity of our local delivery offices
through regional and field market development efforts.
OUR APPROACH
We have developed our delivery methodology to apply a disciplined,
practical and results-oriented approach to the development of digital business
solutions.
We have a comprehensive and efficient delivery system
We seamlessly deliver our solutions through the combination of broad
digital business capabilities, delivery methodologies, local accountability and
deep industry expertise. We follow a disciplined, but flexible delivery system
that allows us to provide fast, accurate and comprehensive digital business
solutions. Our delivery system is based upon the integration of business
strategy, creative design and technical engineering skills designed to ensure
continuity as a project moves between different phases.
We coordinate the delivery of our solution through our local account teams,
emphasizing accountability and quality assurance. Our local offices provide the
crucial roles of account management, program management and project management.
This provides our clients a responsive, local contact that is supported by the
diverse capabilities of our national practices. This model also provides for
team structures that can effectively deliver solutions on large, complex
engagements. These team structures permit concurrent projects to remain
connected and communicating with one another through a project management office
that is linked to the client as well as the disparate team members.
Digital Solutions Delivery Methodology
Our solutions delivery methodology comprises three core components: Vision,
Initiative and Iteration.
- Vision -- We believe successful business solutions are dependent on, and
shaped by, a sound business vision. Within the first component of our
methodology, we work with a client to develop an enterprise-wide vision
of the client's strategic business goals.
- Initiative -- Large and complex business solutions often demand that we
develop and integrate a number of disparate strategic programs, or
initiatives, to achieve a client's vision. Our step-by-step delivery
methodology allows us to deliver initiatives in series or in parallel
depending upon the client's objectives and requirements.
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- Iteration -- We deliver our solutions in discrete, incremental phases,
incorporating constant feedback from our client. This iterative delivery
methodology allows the client to benefit from each phase of an initiative
as it is implemented, rather than waiting until the entire business
solution is delivered. This iteration addresses a client's need for rapid
initial deployment and return on investment.
Together, these components yield a flexible framework that provides for
continual monitoring and reassessment of original strategic, creative and
technology assumptions in order to identify clients' changing business needs.
The flexibility of our methodology enables our consultants to create customized
business solutions that accommodate rapid growth and increased complexity, while
remaining aligned with client expectations and business needs. In addition, our
knowledge management and quality system contains a library of templates and
techniques designed to ensure that clients understand their solution,
communicate with the development team and have the opportunity to approve work.
Our Capabilities
The extensive experience of our professionals enables us to determine the
optimal solution for each client given their diverse business needs. Our
client-specific solution is then delivered by local consulting teams that are
supplemented by our national industry practices. This specialization brings
together strategic, creative and technical talent around a single focus to solve
industry-specific problems and execute the digital initiatives associated with
those solutions. Currently, we concentrate on the following five industries:
- Telecommunications;
- Transportation;
- Pharmaceuticals;
- Financial Services; and
- Digital Markets (companies that primarily market and distribute their
products and/or services electronically).
In addition to our industry teams, we also organize around digital business
capabilities. This approach allows our consultants to work together to develop
and share specific approaches ranging from strategic planning to user interface
design to detailed technical implementation tools. We offer six primary
capabilities:
- Business Strategy -- executive-level consulting that defines and shapes
our clients' growth opportunities, organizational alignment and financial
modeling.
- Digital Strategy -- consulting expertise designed to enable our clients
to use the Internet, information technology and electronic assets for
business benefit.
- Digital Branding and Design -- a program that develops our clients'
product or service image based upon customer interactions and
experiences, resulting in creative communications through various
electronic channels.
- Customer Interaction Engineering -- service offering focused on the
integration of all digital communications and interactions between a
company and its customers, including:
- e-Commerce -- integration and development of our clients' web sites,
Internet billing applications and business-to-business transaction
processing systems;
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- Customer Relationship Management -- enhancement of our clients'
marketing and sales force management capabilities and integration of
their call center and customer support functions;
- Business Intelligence -- centralized storage, analysis and strategic
use of business data, designed to enable personalized interactions
between our client and its customers; and
- Digital Communications -- adopts the latest in communications network
technology, including fixed and mobile wireless, broadband and mobile
applications, to provide immediate customer access.
- Supply Chain Engineering -- inventory, logistics, distribution and vendor
management strategies and applications.
- Systems Infrastructure and Security Engineering -- software and hardware
development programs necessary to create secure digital business
solutions able to accommodate the increasing demand on system
infrastructure.
Our Consulting Professionals
The strength of our delivery model is dependent upon the quality and
experience of our people. Our professionals have a diverse set of skills,
experience and credentials. We recruit from top strategic consulting firms and
top-ranked business schools. Our teams deliver executive officer-level business
strategy through an interactive and collaborative approach. Our creative
professionals bring a variety of experience ranging from national advertising to
fine arts to broadband and multimedia creative design. Their focus is on
creating effective customer experiences designed to infuse our clients' brand
into every interaction they have with their customers. Our technical engineering
professionals bring backgrounds from the most respected consulting and IT
organizations in the country and average over 10 years of experience. These
engineering professionals have experience developing large information
technology, Internet and broadband/wireless projects for a wide variety of
industries and clients. Our local delivery model reduces the need for travel,
which we believe gives us a competitive advantage in hiring and retaining
professionals.
OUR CLIENTS
We focus on providing digital business solutions to Fortune 1000 and
emerging high-growth companies. The following is a representative list of our
clients, each of which accounted for more than $300,000 of revenue for the
quarter ended June 24, 2000 and in the aggregate represented 47% of our total
revenues for that period.
<TABLE>
<S> <C>
AT&T Hawaiian Airlines
Buzzeo HealthAllies.com
Covance Priceline.com
Dun & Bradstreet Sabre
Emery Worldwide VirtualRelocation.com
Freightliner
</TABLE>
For the quarter ended June 24, 2000, AT&T accounted for 14.8% of our
revenues. Other than AT&T, no single client accounted for more than 10% of our
revenues in the six months ended June 24, 2000. The loss of any significant
client or a reduction or deferral in the work performed for any significant
client could significantly reduce our revenues.
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CASE STUDIES
AT&T -- An international telecommunications company.
<TABLE>
<S> <C>
Relationship: Our relationship with AT&T began in November 1997. From our
first project for AT&T, which involved custom Internet
software development, this relationship has expanded to
helping AT&T manage a broad series of Internet programs.
Challenge: Assist AT&T in integrating its business with client billing
systems to realize greater operational efficiencies and
provide a higher level of customer service.
Solution: We designed and implemented a web-based platform and suite
of software applications that enhance and extend various
AT&T customer service support software applications for
dispute management, collection, contract management and
customer satisfaction. By integrating its existing software
applications with a web-based platform, AT&T is able to:
- enable its customer service representatives to accurately
quantify and track accounts in review;
- automatically provide tools, information and techniques to
allow customer service representatives to efficiently
resolve client issues and prioritize collection
activities;
- track and coordinate customer contract management and
special offers; and
- utilize high volume electronic scanning hardware and
web-based software applications to create, search, and sort
customer service inquiry databases.
As a result, AT&T can improve the efficiency of its billing
operations and quickly identify priority business clients to
help them resolve billing issues in real-time.
</TABLE>
<TABLE>
<S> <C>
DUN & BRADSTREET -- A leading global provider of business credit,
marketing, purchasing, and supplier information.
Relationship: Dun and Bradstreet retained us in May 1999 to assist them in
the creation of a data store that serves as a centralized
point for data collected from businesses around the world.
Challenge: Enable Dun & Bradstreet to integrate an adaptable,
accessible and centralized global data warehouse for
business-to-business information.
Solution: We are working with Dun & Bradstreet to centralize the
collection, housing and dissemination of data from more than
58 million businesses in approximately 232 countries around
the world. Our solution includes analyzing, designing and
implementing a multi-lingual data store that contains up to
17 billion pieces of business information. We also are
working with Dun & Bradstreet to build an application that
will update information in the data store for more than
500,000 businesses daily. Also included is an Intranet
global error messaging system used to identify data
anomalies requiring investigation and data correction. Our
solution allows Dun & Bradstreet to provide its customer
base consistent, updated and easily accessible business
information.
</TABLE>
OUR PEOPLE AND CULTURE
We seek to attract, retain and motivate professionals who deliver the
highest quality solutions for our clients. We establish multi-disciplinary local
delivery teams of experienced
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professionals with the authority to make, and accountability for, decisions
regarding our delivery of professional services. We support our local delivery
teams with various industry and business functional experts as well as our
knowledge management and quality system that serves as a repository of our
company-wide capabilities, skills and experiences.
To achieve this objective, we hire professionals with a wide breadth of
skills and substantial depth of experience. We were ranked number two in
Interactive Week's survey of the "Top 10 Companies to Work For." To create and
maintain our positive culture, we seek to hire professionals whose values
closely align with our core values.
We continue to attract, retain and motivate our professionals by providing:
- the opportunity to work with leading-edge strategies and technologies to
create digital business solutions;
- a corporate culture that encourages innovation, creativity,
responsibility and a commitment to excellence;
- a work environment that promotes integrity, respect and open
communication;
- an atmosphere that encourages collegiality and fun in the workplace;
- a defined program for professional development, training and career
planning;
- a local delivery model that seeks to minimize travel; and
- stock options to every employee.
We refer to our methodology for people and performance management as
peopleCare. It is a fully integrated system of employee interactions aimed at
achieving maximum performance, retention and employee satisfaction. Our
peopleCare philosophy is based on the premise that the employee/manager
relationship is central to employee satisfaction and performance. The quality of
that relationship drives both our performance and the perception of our culture.
All peopleCare tools, roles and processes are focused on creating, facilitating
and improving the employee/manager relationship.
As of July 31, 2000, we had 687 employees. We typically hire experienced
professionals with diverse skill sets from companies such as the Big Five
accounting firms, systems integrators, leading strategy consulting firms,
creative and advertising agencies and Internet professional services firms. None
of our employees is represented by a labor union, and we have no collective
bargaining agreements. We consider our relations with our employees to be good.
In addition, we believe our culture provides us with excellent retention.
MARKETING AND STRATEGIC SALES PROCESS
As of July 31, 2000, we had a business development and marketing staff of
73 . Our marketing staff's efforts are dedicated to attracting new business,
market development and planning, service line offering creation, market
research, marketing communications and public relations. This combined team is
focused on generating new business opportunities, strengthening our brand name,
increasing market awareness and responding to market trends and opportunities.
This team manages client development from initial contact to point-of-sale
to actual implementation. Once we have established a lead with a prospective
client, we qualify the opportunity, define our ability to deliver the right
digital business solution, reach agreement and commence work. The next step in
our strategic sales process, after delivering successfully on the first project,
is to expand the relationship with our new client. Because of our capacity to
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deliver a wide variety of business solutions, we are able to establish
long-term, mutually beneficial relationships with our clients.
Our marketing activities include the following initiatives:
- Business Development -- This team drives business development efforts,
including tele-research, requests for information and requests for
proposals, new business presentations, and deal closure.
- Market Development -- This team helps identify the top qualified
prospects and develops a highly focused marketing and sales effort to
bring the prospects through the sales cycle.
- Service Line Offerings -- This team develops service offering definitions
and services roadmaps, conduct market analysis and planning, white paper
development, business support and strategic partner management.
- Partner Marketing -- This team is responsible for the identification and
recruitment of strategic partners that align with our objectives and best
practices and drives co-marketing programs, including participation at
industry events, business development plans and go-to-market strategies.
- Brand and Awareness -- This team is responsible for all outbound and
inbound marketing communications activities, including advertising,
public relations, investor communications, employee communications, web
marketing, events and seminars and demand generation.
STRATEGIC PARTNERSHIPS
We have developed a series of partnerships in a variety of digital business
solution areas. In addition to providing shared sales opportunities, many of
these partnerships offer training, technical support, delivery services and the
opportunity to co-develop new digital business services. We have focused on
establishing criteria, best practices and relationship managers for these
partnerships to allow us to continue to work with the best companies and
technologies available. Our partners include:
Acta Technology
Active Software
Allaire Corporation
ATG
AT&T Solutions
BEA Systems
Blue Martini Software
Changepoint
Corio
IBM
Industri-Matematik International
Intel Online Services
Interwoven
Microsoft
Microstrategy
Onyx
Siebel
Sun Microsystems
The Management Network Group
Versata
Vitria Technology
Webridge
Yantra
We have formed strategic alliances with key partners to help us with our
new business development efforts and generate increased revenues. These include:
AT&T SOLUTIONS -- delivers enterprise application services focused
specifically on digital business integration initiatives for multiple
clients. We have a strategic alliance with AT&T Solutions to use joint
marketing efforts to take advantage of both of our sales channels and our
combined
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business expertise to provide clients with digital business solutions. Each
partner utilizes its extensive experience and capabilities to deliver
solutions to Fortune 1000 clients.
ATG -- provides next-generation e-commerce and personalization
software that helps digital businesses build online relationships with
customers, partners and suppliers. ATG's award-winning Dynamo product suite
is a complete software platform for building scalable, reliable and high
performance web solutions that use personalization as a foundation for
managing customer relationships online. We partner with ATG to deliver
digital customer relationship management and electronic commerce products
and services.
BLUE MARTINI -- provides enterprise-scale digital business
applications that build brands. With packaged solutions for digital
merchandising, digital marketing and digital service, Blue Martini helps
enable companies to engage their customers on the web, through call
centers, via e-mail, and over wireless devices. We partner with Blue
Martini to deliver customer interaction systems for e-commerce.
COMPETITION
We compete in the Internet and information technology professional services
market, which is relatively new and highly competitive. We expect competition to
intensify as the market continues to evolve. We believe that our competitors
fall into several categories, including the following:
- Internet services firms, such as Lante, Proxicom, Razorfish, Sapient,
Scient, Viant and Zefer;
- Strategic consulting firms, such as Bain & Company, Booz-Allen &
Hamilton, Boston Consulting Group, Diamond Technology Partners and
McKinsey & Company;
- Global IT service firms, such as the Big Five accounting firms, Computer
Sciences Corporation, EDS and IBM Global Services;
- Digital design agencies, such as Agency.com and Modem Media; and
- In-house information technology, marketing and design departments of our
potential and current clients.
We believe that only a few of these competitors offer an integrated package
of professional Internet and digital services. Several competitors, however,
have announced their intention to offer a broader range of services than they
currently provide. We believe that the principal competitive factors in the
Internet professional services industry are quality of service, timeliness of
delivery, reputation, responsiveness to client needs, availability of qualified
professionals, price, project management capability, technical expertise and
scale of operation. We intend to remain competitive due to the following:
- our ability to locate, recruit, motivate and retain professionals with
demonstrated performance capabilities and experience;
- our ability to deliver solutions on both a regional and national level;
and
- our ability to provide effective management of account relationships and
rapidly respond to our clients' ongoing business needs.
There are relatively low barriers to entry into the Internet professional
services market and, as a result, new competitors could emerge in the future.
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INTELLECTUAL PROPERTY
Our success is dependent, in part, upon our proprietary processes,
components and other intellectual property rights. We do not have any patents or
patent applications pending. We rely on a combination of nondisclosure and other
contractual agreements and trade secret, copyright and trademark laws to protect
our proprietary rights. Existing trade secret, copyright and trademark laws
afford us only limited protection. We enter into confidentiality agreements with
our employees, generally require that our consultants and clients enter into
similar agreements and limit access to, and distribution of, our proprietary
information. In addition, we have entered into non-competition agreements with
all of our employees. The steps we have taken in this regard may not be adequate
to deter misappropriation of our proprietary information and we may not be able
to detect unauthorized use or take appropriate steps to enforce our intellectual
property rights.
A portion of our business involves the development of software applications
for specific client projects. Ownership of client-specific software is generally
retained by the client, although we retain some rights to the applications,
processes and intellectual property developed in connection with client
projects.
FACILITIES
Our corporate headquarters facilities total approximately 25,883 square
feet. We lease these facilities, which are located in Portland, Oregon, pursuant
to a lease that expires in 2009, unless terminated earlier or extended pursuant
to our option to lease for one additional five-year period.
In addition to our headquarters, we have offices in or near Atlanta,
Georgia; Bellevue, Washington; Birmingham, Alabama; Boston, Massachusetts;
Dallas, Texas; Denver, Colorado; New York, New York; Phoenix, Arizona; San
Francisco, California; San Jose, California; Warren, New Jersey; and Washington,
D.C. We do not own any real estate. We do not consider any specific leased
location to be material to our operations, and we believe that equally suitable
alternative locations are available in all areas where we currently do business.
LITIGATION
We are not a party to any material litigation.
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MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The following table sets forth certain information with respect to our
executive officers and directors as of July 31, 2000.
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Martin Wright.......................... 38 President, Chief Executive Officer and Director
Jerry N. Grant......................... 37 Senior Vice President of Finance, Chief Financial
Officer and Director
Jim S. Gruher.......................... 39 Senior Vice President, Western U.S. Operations
Mark Markowitz......................... 44 Senior Vice President, Eastern U.S. Operations
Samuel C. Ellis........................ 44 Senior Vice President, Chief Technology Officer
and Chief Information Officer
David R. Stewart....................... 40 Senior Vice President, General Counsel, Chief
Administrative Officer and Secretary
Michael Norkus......................... 53 President of Strategy Group and Director
Martyn Etherington..................... 38 Vice President of Marketing
Michael W. Bealmear(1)(2).............. 52 Director
Charles Scott Gibson(1)(2)............. 47 Director
C. Toms Newby, III(1)(2)............... 33 Director
</TABLE>
-------------------------
(1) Member of the audit committee.
(2) Member of the compensation committee.
MARTIN WRIGHT is one of our co-founders and has been our President since
July 1998, our Chief Executive Officer since July 1999 and a member of our board
since February 1999. Mr. Wright also served as Vice President of our Portland
practice from January 1997 to December 1997 and as Senior Vice President of our
Western Region from January 1997 to June 1998. Before joining us, from March
1995 to November 1996, Mr. Wright was responsible for managing and developing
the West Coast consulting practice for MetaCorp Strategies, a company
specializing in computer consulting. From August 1990 to February 1995, Mr.
Wright was vice president of Claremont Technology Group, Inc. with
responsibility for developing and managing the information engineering
consulting practice. Mr. Wright attended the University of Capetown in South
Africa.
JERRY N. GRANT is one of our co-founders and has been Senior Vice President
of Finance and Chief Financial Officer since February 1997. He has been a member
of our board since March 1997. Prior to joining us, Mr. Grant was managing
director in the corporate finance group of KPMG LLP in Chicago, Illinois from
October 1993 to December 1996. Mr. Grant received an M.B.A. from Columbia
University and a B.A. in International Economics and Russian from the University
of Illinois.
JIM S. GRUHER has been Senior Vice President, Western U.S. Operations since
January 1999. Before joining us, he was vice president of Claremont Technology
Group, Inc., and Complete Business Solutions, Inc., from April 1992 through
January 1999, where he was responsible for directing the national manufacturing
industry practice. From April 1988 to April 1992, Mr. Gruher was a manager in
the systems integration practice at Andersen Consulting. Prior to that, he was
an industrial engineer at Ford Aerospace and Communications Company from July
1985 to February 1988 and at McDonnell Douglas Corporation from June 1983 to
July 1985. Mr. Gruher received an M.B.A. from the University of California,
Irvine and a B.S. in
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<PAGE> 47
Industrial Engineering from Oregon State University. He is certified at the CPIM
level by the American Production and Inventory Control Society.
MARK MARKOWITZ has been Senior Vice President, Eastern U.S. Operations
since July 1998. He served as Vice President of our New Jersey operations from
August 1997 to July 1998. Prior to joining us, he was vice president of
Claremont Technology Group, Inc. from February 1995 to August 1997, and
information systems executive of EDS, an information technology consulting
company, from December 1983 to January 1995. Mr. Markowitz received an M.A. from
American University and a B.S. from S.U.N.Y. College at Old Westbury.
SAMUEL C. ELLIS has been Senior Vice President and Chief Technology Officer
since December 1999 and Chief Information Officer since November 1999. Prior to
joining us, from July 1995 through November 1999, he was a senior principal
consultant at Hewlett-Packard Company. Mr. Ellis received a Ph.D. from the
University of Texas at Austin and an M.A.T. and a B.A. from Lewis and Clark
College.
DAVID R. STEWART has been General Counsel since August 1999, Senior Vice
President and Chief Administrative Officer since December 1999 and Secretary
since May 2000. Before joining us, he was a partner in the law firm of Sidley &
Austin from June 1994 through August 1999 and an associate with the firm from
June 1986 through June 1994. Mr. Stewart received a J.D. from the University of
California at Berkeley, an M.Sc. from the University of Edinburgh and an A.B.
from Harvard College.
MICHAEL NORKUS has been President of Emerald's Strategy Group and a member
of our board since July 2000. Before joining us, he was the founder and
president of Alliance Consulting Group Inc., a strategy consulting firm founded
in 1986. Prior to founding Alliance, Mr. Norkus was vice president and director
of the Boston Consulting Group, an international strategy and general management
consulting firm, where he worked for 11 years. Mr. Norkus holds a Ph.D. magna
cum laude in Law and Economics from the University of Hamburg, Germany, a Master
of Comparative Business Law from the University of Paris and an M.B.A. from
Harvard Business School.
MARTYN B. ETHERINGTON has been our Vice President of Marketing since March
2000. Before joining us, he was marketing director for the Americas for the web
server group of IBM from September 1999 through March 2000. From November 1997
through September 1999, he was senior director of global marketing for Sequent
Computer Systems, Inc. and chief of staff for the office of the chairman and
chief executive officer of Sequent from November 1996 through November 1997. Mr.
Etherington received a Higher National Diploma in Computer Science from
Northbrook College in Sussex, England.
MICHAEL W. BEALMEAR has been a member of our board since July 1999. Mr.
Bealmear is currently president and chief executive officer of Complete Business
Solutions, Inc. and serves as a director of CBSI, Inventa, ThruPoint, Spear
Technologies, Inc. and Business Engine Software. From September 1999 to May
2000, Mr. Bealmear served as chief executive officer of Spear Technologies.
Prior to that, he was executive vice president of Cadence Design Systems from
July 1997 to August 1998, and was senior vice president at Sybase from November
1994 to July 1997. From October 1984 to September 1990, he was worldwide
managing partner for information technology consulting at Coopers & Lybrand, and
from August 1973 to September 1984, he managed the Western United States
information technology consulting practice at KPMG LLP. He has also held
executive roles at SHL Systemhouse, now MCI Systemhouse, and Salomon Brothers.
Mr. Bealmear received a B.S. in Engineering from the University of Texas at
Austin.
CHARLES SCOTT GIBSON has been a member of our board since July 1999. Mr.
Gibson also serves as a director of TriQuint Semiconductor, Radisys Corporation,
Inference, IMS (Integrated
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<PAGE> 48
Measurement Systems), Egghead.com, CenQuest, Webridge, Telemark, iChristian.com
and etrieve, all high technology companies. He is also chairman of the board of
trustees of the Oregon Graduate Institute of Science and Technology. Mr. Gibson
was a general manager with Intel from June 1976 to January 1983 when he
cofounded Sequent Computer Systems. He was president of Sequent Computer Systems
until March 1992. Mr. Gibson holds a B.S. in electrical engineering and an
M.B.A. from the University of Illinois.
C. TOMS NEWBY, III has been a member of our board since March 1999. Mr.
Newby is currently a general partner of Technology Crossover Ventures, a
position he has held since July 1998, and serves as a director of eMachines,
Inc., mortgage.com, Total Sports and several other private companies. From April
1996 to July 1998, Mr. Newby was associated with Technology Crossover Ventures.
From 1994 through April 1996, Mr. Newby was a technology investment banker at
Montgomery Securities. Mr. Newby holds a B.S. from the University of North
Carolina and an M.B.A. from Stanford University.
BOARD OF DIRECTORS
We currently have authorized seven directors. Our directors are divided
into three classes whose terms expire at different times. In April 2000, our
stockholders elected the Class 1 Directors to three-year terms. Beginning with
our next annual meeting, the remaining classes of directors will 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. Any
additional directorships resulting from an increase in the number of directors
will be distributed among the three classes so that, as nearly as possible, each
class will consist of an equal number of directors.
Committees
Our board of directors has an audit committee and a compensation committee.
The audit committee consists of Messrs. Bealmear, Gibson and Newby. The audit
committee reviews our internal accounting procedures and consults with and
reviews the services provided by our independent accountants. The compensation
committee consists of Messrs. Bealmear, Gibson and Newby. The compensation
committee reviews the compensation and benefits of our employees and directors
and makes recommendations to our board of directors.
Compensation Committee Interlocks and Insider Participation
No member of our compensation committee has served as a member of the board
of directors or compensation committee of any entity that has one or more
executive officers serving as a member of our board of directors or compensation
committee.
Compensation
Directors are reimbursed for expenses incurred in attending any board or
committee meeting.
Our non-employee directors are eligible to participate in our 1999
Non-Employee Director Stock Option Plan. Each non-employee director will be
eligible to receive a grant of an option to purchase shares of common stock. The
shares subject to each of these options will vest and become fully exercisable
in equal three-month installments beginning three months after the date of grant
and continuing for the length of the director's term. The exercise price per
share for all options automatically granted to directors under our 1999
Non-Employee Director Stock Option Plan is equal to the market price of our
common stock on the date of grant. Employee
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<PAGE> 49
directors, including Messrs. Wright, Grant and Norkus, are eligible to receive
discretionary grants under our 1997 Stock Incentive Compensation Plan.
Required Number of Independent Directors
Under the rules of the Nasdaq National Market, we must have three
independent directors. For purposes of these rules, an independent director is a
director that is not an employee of ours and does not have other specified
relationships with us as described in the Nasdaq National Market's rules. We
believe that all of our directors, other than Messrs. Wright, Grant and Norkus,
are independent directors for these purposes.
EXECUTIVE OFFICERS
Our executive officers are appointed by our board of directors or president
and serve until their successors are elected or appointed.
Compensation
The following table contains information for fiscal year 1999 regarding the
compensation earned by our president and chief executive officer, and each of
our four other most highly compensated officers whose compensation exceeded
$100,000 for the period. In accordance with the rules of the Securities and
Exchange Commission, the compensation described in this table does not include
perquisites and other personal benefits received by the executive officers named
in the table below which do not exceed the lesser of $50,000 or 10% of the total
salary and bonus reported for these officers. Mr. Darrow received compensation
as our Chief Executive Officer between the beginning of fiscal year 1999 and
July 1999.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL
COMPENSATION LONG TERM COMPENSATION
------------------ ----------------------
SECURITIES UNDERLYING
NAME AND PRINCIPAL POSITIONS SALARY BONUS OPTIONS
---------------------------- -------- ------- ----------------------
<S> <C> <C> <C>
Martin Wright............................... $240,923 $37,620 90,000
President and Chief Executive Officer
Steven L. Darrow(1)......................... $196,163 $ 0 90,000
Former Chairman of the Board of Directors
Jerry N. Grant.............................. $220,062 $27,588 60,000
Senior Vice President of Finance, Chief
Financial Officer and Director
Mark Markowitz.............................. $210,000 $33,000 30,000
Senior Vice President, Eastern U.S.
Operations
Jim S. Gruher............................... $184,616 $27,000 170,000
Senior Vice President, Western U.S.
Operations
</TABLE>
---------------
(1) Resigned from our board of directors in May 2000.
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<PAGE> 50
Option Grants in Fiscal Year 1999
The following table sets forth information concerning grants of stock
options to each of the executive officers named in the table above during fiscal
year 1999.
Mr. Darrow's options were granted under our 1999 Non-Employee Director
Stock Option Plan. Mr. Darrow's options were to vest and become fully
exercisable quarterly over three years. Mr. Darrow resigned from our board of
directors on May 25, 2000. Mr. Darrow holds 45,000 vested stock options, all of
which expire on November 25, 2000. All other options granted to the named
executive officers in fiscal year 1999 were granted under our 1997 Stock
Incentive Compensation Plan. Twenty percent of the options vest and become
exercisable on the first anniversary of the date of grant, and the remaining
options vest each month over the remaining four years thereafter. The percentage
of total options granted in fiscal year 1999 is based on an aggregate of
2,541,014 options granted to employees, directors and consultants in the year
ended December 25, 1999. In general, options were granted at a fair market value
as determined by our board on the date of grant based on our financial results
and prospects. Amounts reported in the columns below represent amounts that may
be realized upon exercise of the options immediately prior to the expiration of
their term assuming the specified compound rates of appreciation (5% and 10%)
applied to an assumed initial public offering price of $12.00 per share over the
term of the options. These numbers are calculated based on rules promulgated by
the Securities and Exchange Commission and do not reflect our estimate of future
stock price growth. The gains shown are net of the option exercise price, but do
not include deductions for taxes or other expenses associated with the exercise
of the option or the sale of the underlying shares. The actual gains, if any, on
the exercises of stock options will depend on the future performance of our
common stock, the optionholders' continued employment through the option period,
and the date on which the options are exercised.
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
------------------------------------------------- POTENTIAL REALIZABLE
% OF TOTAL VALUE AT ASSUMED
NUMBER OF OPTIONS ANNUAL RATES OF
SECURITIES GRANTED TO STOCK APPRECIATION
UNDERLYING EMPLOYEES EXERCISE FOR OPTION TERM
OPTIONS IN FISCAL PRICE EXPIRATION -----------------------
NAME GRANTED 1999 PER SHARE DATE 5% 10%
---- ---------- ----------- --------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Steven L. Darrow..... 90,000 3.5% $1.50 08/25/09 $1,624,206 $2,666,242
Martin Wright........ 90,000 3.5 $4.00 12/18/09 1,399,206 2,441,242
Jerry N. Grant....... 60,000 2.4 $4.00 12/18/09 932,804 1,627,495
Mark Markowitz....... 30,000 1.2 $1.25 07/16/09 548,902 896,247
Jim S. Gruher........ 120,000 4.7 $0.88 02/01/09 2,240,608 3,629,989
40,000 1.6 $1.25 07/16/09 731,869 1,194,996
10,000 0.4 $1.50 08/27/09 180,467 296,249
</TABLE>
Aggregate Option Exercises in Fiscal Year 1999, and Option Values at December
25, 1999
None of the named executive officers exercised options during the fiscal
year ended December 25, 1999. The following table sets forth information
concerning exercisable and unexercisable stock options held by the executive
officers named in the summary compensation
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<PAGE> 51
table at December 25, 1999. The value of unexercised in-the-money options is
based on an assumed initial offering price of $12.00 per share minus the actual
exercise prices.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY
OPTIONS AT OPTIONS AT
DECEMBER 25, 1999 DECEMBER 25, 1999
--------------------------- ---------------------------
EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Steven L. Darrow........................ 7,500 82,500 $ 78,750 $ 866,250
Martin Wright........................... 374,998 815,002 4,320,602 8,911,898
Jerry N. Grant.......................... 306,666 553,334 3,553,326 6,076,675
Mark Markowitz.......................... 108,004 261,996 1,223,546 2,941,455
Jim S. Gruher........................... 0 170,000 0 1,870,000
</TABLE>
EMPLOYMENT AGREEMENTS
In January 1997, we entered into an employment agreement with Mr. Wright.
Mr. Wright serves as our President and Chief Executive Officer and is currently
paid a salary at the rate of $240,923 per year. Mr. Wright's employment
agreement provides that if Mr. Wright were terminated without cause by us, he
would receive his base salary for three months after the termination date.
In January 1997, we entered into an employment agreement with Mr. Grant.
Mr. Grant serves as our Senior Vice President of Finance and Chief Financial
Officer and is currently paid a salary at the rate of $220,062 per year. Mr.
Grant's employment agreement provides that if Mr. Grant were terminated without
cause by us, he would receive his base salary for three months after the
termination date.
In August 1997, we entered into an employment agreement with Mr. Markowitz.
Mr. Markowitz serves as our Senior Vice President, Eastern U.S. Operations and
is currently paid a salary at the rate of $210,000 per year. Mr. Markowitz's
employment agreement provides that if Mr. Markowitz were terminated without
cause by us during the first year of his employment, he would receive his base
salary, including health insurance, for three months after the termination date.
If Mr. Markowitz were terminated without cause by us after the first year of his
employment, he would receive his base salary, including health insurance and
life insurance, for three months after the termination date, plus an additional
month for each year of service after the first year of employment.
In January 1999, we entered into an employment agreement with Mr. Gruher.
Mr. Gruher serves as our Senior Vice President, Western U.S. Operations and is
currently paid a salary at the rate of $210,000 per year. Mr. Gruher's
employment agreement provides that if Mr. Gruher were terminated without cause
by us during the first year of his employment, he would receive his base salary,
including health insurance, for three months after the termination date. If Mr.
Gruher were terminated without cause by us after the first year of his
employment, he would receive his base salary, including health insurance and
life insurance, for three months after the termination date, plus an additional
month for each year of service after the first year of employment.
LIMITATIONS ON DIRECTORS' AND OFFICERS' LIABILITY AND INDEMNIFICATION
Our amended and restated certificate of incorporation to be filed upon
completion of this offering limits the liability of our directors to the maximum
extent permitted by Delaware law. Delaware law provides that directors of a
corporation will not be personally liable for monetary
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<PAGE> 52
damages for breach of their fiduciary duties as directors, except liability
associated with any of the following:
- any breach of their duty of loyalty to the corporation or its
stockholders;
- acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;
- unlawful payments of dividends or unlawful stock repurchases or
redemption; or
- any transaction from which the director derived an improper personal
benefit.
The limitation of a director's liability does not apply to liabilities
arising under the federal securities laws and does not affect the availability
of equitable remedies such as injunctive relief or rescission.
Our certificate of incorporation and bylaws also provide that we shall
indemnify our directors and executive officers and may indemnify our other
officers and employees and other agents to the fullest extent permitted by law.
We believe that indemnification under our bylaws covers at least negligence and
gross negligence on the part of indemnified parties. Our bylaws also permit us
to secure insurance on behalf of any officer, director, employee or other agent
for any liability arising out of his or her actions in such capacity, regardless
of whether our bylaws would permit indemnification.
We intend to enter into indemnification agreements with each of our
officers and directors containing provisions that require us to, among other
things, indemnify such officers and directors against liabilities that may arise
by reason of their status or service as directors or officers, other than
liabilities arising from willful misconduct of a culpable nature, to advance
their expenses incurred as a result of any proceeding against them as to which
they could be indemnified, and to cover our directors and officers under any of
our liability insurance policies applicable to our directors and officers. We
believe that these provisions and agreements are necessary to attract and retain
qualified persons as directors and executive officers.
STOCK PLANS
1997 Stock Incentive Compensation Plan
Our 1997 Stock Incentive Compensation Plan was originally approved by our
board of directors and stockholders in January 1997. In October 1999, the 1997
Stock Incentive Compensation Plan was amended to increase the number of shares
of common stock reserved for issuance thereunder to 7,600,000 shares. As of June
24, 2000, options to purchase an aggregate of 6,366,198 shares of common stock
were outstanding, 641,208 shares of common stock had been purchased pursuant to
exercises of stock options and stock purchase rights and 592,594 shares were
available for future grant.
Our 1997 Stock Incentive Compensation Plan provides for the grant of
incentive stock options within the meaning of Section 422 of the Internal
Revenue Code of 1986, as amended, to employees and nonstatutory stock options
and stock purchase rights to employees, including officers and directors, and to
non-employee directors and consultants. Unless terminated sooner, this plan will
terminate automatically in January 2007.
Our 1997 Stock Incentive Compensation Plan is administered by our board of
directors and, thus, the board of directors determines the terms of the options
or stock purchase rights granted, including the exercise price, the number of
shares subject to each option or stock purchase right, the vesting and the form
of consideration payable upon such exercise. In addition, the board has the
authority to amend, suspend or terminate the plan, provided that no
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<PAGE> 53
such action may affect any share of common stock previously issued and sold or
any option previously granted and then outstanding under the plan.
Options and stock purchase rights granted under our 1997 Stock Incentive
Compensation Plan are not generally transferable by the optionee; during the
lifetime of the optionee, each option and stock purchase right is exercisable
only by the optionee. The plan provides that options granted thereunder must
generally be exercised within three months of the end of optionee's status as
our employee or consultant, or within thirty-six months after his or her
termination by death or disability, but in no event later than the expiration of
the option's ten year term. However, in an exercise of its discretion, the board
has approved agreements under the plan that provide that options must generally
be exercised within twelve months after optionee's termination by death or
disability, but in no event later than the expiration of the option's ten year
term.
In the case of stock purchase rights, the agreement evidencing the grant
may provide that we have a repurchase option exercisable upon the voluntary or
involuntary termination of an employee's employment for any reason, including
death or disability. In the event of the exercise of the repurchase option, the
purchase price paid per share will equal or exceed the original price paid by
the employee and may be paid by cancellation of the employee's outstanding
indebtedness to us, if any. Our repurchase option shall lapse at a rate
determined by the board.
The exercise price of any incentive stock options granted under this plan
and any non-statutory stock options intended to qualify as "performance-based
compensation" within the meaning of Section 162(m) of the Code, must be at least
equal to the fair market value of our common stock on the date of grant. With
respect to any participant who owns stock possessing more than 10% of the voting
power of all classes of our outstanding capital stock, the exercise price of any
incentive stock option granted must equal at least 110% of the fair market value
on the grant date and the term of such incentive stock option must not exceed
five years. The term of all other options granted under the plan may not exceed
ten years.
Our 1997 Stock Incentive Compensation Plan provides that in the event of
our merger with or into another corporation or a sale of substantially all of
our assets, each option or right shall be assumed or an equivalent option or
right substituted by the successor corporation. If the outstanding options or
rights are not assumed or substituted, our board shall provide for the optionee
to have the right to exercise the option or stock purchase right as to all of
the optioned stock, including shares as to which it would not otherwise be
exercisable.
1999 Non-Employee Director Stock Option Plan
Our 1999 Non-Employee Director Stock Option Plan was originally approved by
our board of directors in August, 1999. A total of 400,000 shares of common
stock have been reserved for issuance under the plan. As of June 24, 2000,
options to purchase an aggregate of 210,000 shares of common stock were
outstanding, no shares of common stock had been purchased pursuant to exercises
of stock options and 190,000 shares were available for future grant.
Our 1999 Non-Employee Director Stock Option Plan provides for the grant of
non-statutory stock options to our non-employee directors. Unless terminated
sooner, this plan will terminate automatically in January 2009.
Our 1999 Non-Employee Director Stock Option Plan is administered by our
board of directors and, thus, the board of directors determines the terms of the
options granted, including the exercise price, the number of shares subject to
each option or stock purchase right, the vesting and the form of consideration
payable upon such exercise. In addition, the
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<PAGE> 54
board has the authority to amend, suspend or terminate the plan, provided that
no such action may affect any share of common stock previously issued and sold
or any option previously granted and then outstanding under the plan.
Options granted under our 1999 Non-Employee Director Stock Option Plan are
transferable by the optionee in a manner and to the extent acceptable to the
plan administrator. Options granted under the plan must generally be exercised
within three months of the end of optionee's status as one of our directors, or
within twelve months after his or her termination by death or disability, but in
no event later than the expiration of the option's ten year term. The exercise
price of any nonstatutory stock options intended to qualify as
"performance-based compensation" within the meaning of Section 162(m) of the
Code, must be at least equal to the fair market value of our common stock on the
date of grant. The term of all options granted under the plan may not exceed ten
years.
Our 1999 Non-Employee Director Stock Option Plan provides that in the event
of our merger with or into another corporation or a sale of substantially all of
our assets, each option shall be assumed or an equivalent option substituted by
the successor corporation. If the outstanding options are not assumed or
substituted, our board shall provide for the optionee to have the right to
exercise the remainder of the option as to two thirds of the total of unvested
shares of common stock subject to such option.
2000 Stock Incentive Plan
Our 2000 Stock Incentive Plan was approved by our board of directors and
stockholders in July 2000. A total of 360,000 shares of common stock have been
reserved for issuance under the plan. As of July 31, 2000, awards to purchase an
aggregate of 338,597 shares of common stock were outstanding, no shares of
common stock had been purchased pursuant to exercises of stock options and stock
purchase rights and 21,403 shares were available for future grant.
Our 2000 Stock Incentive Plan provides for the grant of incentive stock
options within the meaning of Section 422 of the Internal Revenue Code of 1986,
as amended, to employees and nonstatutory stock options and stock purchase
rights to employees, including officers and directors, and to non-employee
directors and consultants. Unless terminated sooner, this plan will terminate
automatically in July 2010.
Our 2000 Stock Incentive Plan is administered by our board of directors
and, thus, the board of directors determines the terms of the options or stock
purchase rights granted, including the exercise price, the number of shares
subject to each option or stock purchase right, the vesting and the form of
consideration payable upon such exercise. In addition, the board has the
authority to amend, suspend or terminate the plan, provided that no such action
may affect any share of common stock previously issued and sold or any option
previously granted and then outstanding under the plan.
Options and stock purchase rights granted under our 2000 Stock Incentive
Plan are not generally transferable by the recipient; during the lifetime of the
recipient, each option and stock purchase right is exercisable only the
recipient. The plan provides that options granted thereunder must generally be
exercised within three months of the end of recipient's status as our employee
or consultant, or within twelve months after his or her termination by death or
disability, but in no event later than the expiration of the option's ten year
term.
In the case of stock purchase rights or shares of common stock issued upon
exercise of options, the agreement evidencing the grant may provide that we have
a repurchase option exercisable upon the voluntary or involuntary termination of
an employee's employment for any reason, including death or disability. In the
event of the exercise of the repurchase option, the purchase price paid per
share will equal the original price paid by the recipient and may be paid
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by cancellation of the recipient's outstanding indebtedness to us, if any. This
repurchase option must be exercised within 90 days following termination.
The exercise price of any incentive stock options granted under this plan
and any nonstatutory stock options intended to qualify as "performance-based
compensation" within the meaning of Section 162(m) of the Code, must be at least
equal to the fair market value of our common stock on the date of grant. With
respect to any participant who owns stock possessing more than 10% of the voting
power of all classes of our outstanding capital stock, the exercise price of any
incentive stock option granted must equal at least 110% of the fair market value
on the grant date and the terms of such incentive stock option must not exceed
five years. The term of all other options granted under the plan may not exceed
ten years.
Our 2000 Stock Incentive Plan provides that in the event of our merger with
or into another corporation or a sale of substantially all of our assets, each
option or right shall be assumed or an equivalent option or right substituted by
the successor corporation. If the outstanding options or rights are not assumed
or substituted, our board shall provide for the optionee to have the right to
exercise the option or stock purchase right as to all of the optioned stock,
including shares as to which it would not otherwise be exercisable.
2000 Employee Stock Purchase Plan
Our board of directors adopted our 2000 Employee Stock Purchase Plan in
April 2000. This purchase plan provides our employees with an opportunity to
purchase our common stock through accumulated payroll deductions.
A total of 1,000,000 shares of common stock has been reserved for issuance
under the purchase plan. In addition, the purchase plan provides for annual
increases in the number of shares available for issuance under the purchase plan
on January 1 of each year, beginning in 2001, equal to the lesser of 2,500,000
shares, or 5% of the outstanding shares of common stock on January 1, or a
lesser number of shares to be determined by the administrator of the purchase
plan.
Under the plan, the board of directors from time to time may resolve to
appoint the full board to administer the plan, or delegate the administration of
the plan to a committee. In either case, the administrator has full and
exclusive authority to interpret and apply the terms of the purchase plan and
determine who may be eligible to participate in it.
Employees are generally eligible to participate in the purchase plan if
they are customarily employed by us or any participating subsidiary for at least
20 hours per week and more than five months in any calendar year. However, an
employee may not be granted an option to purchase stock under the purchase plan
if, by participating in the plan, the employee would:
- own stock constituting five percent or more of the total combined voting
power or value of all classes of our capital stock; or
- obtain rights to purchase stock under all of our employee stock purchase
plans accruing at a rate in excess of $25,000 worth of stock per year.
The purchase plan, which is intended to qualify as an "Employee Stock
Purchase Plan" under Section 423 of the Internal Revenue Code of 1986, as
amended, contemplates consecutive, overlapping six-month offering periods. The
offering periods generally will start on the first trading day on or after
February 15 and August 15 of each year, except for the first such offering
period, which will commence on the first trading day on or after the effective
date of this offering and will end on the last trading day on or before February
14, 2001.
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<PAGE> 56
The purchase plan permits participants to purchase up to 750 shares of
common stock per offering period through payroll deductions of between 1% and
15% of the participant's compensation, which for purposes of the purchase plan
is comprised of the participant's base salary, overtime, commissions and cash
bonuses from the company. Amounts deducted and accumulated by the participant
are used to purchase shares of common stock at the end of each offering period,
at a price of 85% of the lower of the fair market value of the common stock at
the beginning or end of the offering period. Participants may end their
participation at any time during an offering period, whereupon they will receive
all amounts deducted pursuant to the plan in cash, their payroll deductions to
date. Participation ends automatically upon termination of employment with us.
A participant may not transfer rights granted under the purchase plan other
than by will, the laws of descent and distribution or as otherwise provided
under the purchase plan.
The purchase plan provides that, if we merge with or into another
corporation or sell substantially all of our assets, a successor corporation may
either assume or substitute for each outstanding purchase right. If the
successor corporation refuses to assume or substitute for the outstanding
purchase rights, the offering period then in progress may be shortened, and an
accelerated exercise date will be set, by the administrator in its sole
discretion.
The administrator may set and change all applicable offering periods,
exchange rates, and procedural rules of the purchase plan in its sole
discretion. The administrator may also amend any part of the purchase plan
provided that no optionholders would be adversely affected by such amendment.
Lastly, the administrator may terminate the purchase plan, provided that its
participants are allowed a final opportunity to exercise their remaining accrued
purchase rights. The purchase plan will terminate automatically in 2020 if not
sooner terminated by the administrator.
401(k) PLAN
In March 1997, our board of directors adopted a Retirement Savings and
Investment Plan covering our full-time employees located in the United States.
This plan is intended to qualify under Section 401(k) of the Internal Revenue
Code of 1986, as amended, so that contributions to this plan by employees, and
the investment earnings thereon, are not taxable to employees until withdrawn.
Pursuant to this plan, employees may elect to reduce their current compensation
by up to the lesser of 15% of their annual compensation or the statutorily
prescribed limit, which was $10,000 in 1999, and to have the amount of such
reduction contributed to this plan. We are not obligated to make additional
matching contributions on behalf of plan participants but may do so, at our
discretion.
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<PAGE> 57
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
SALES OF PREFERRED STOCK
In February 1999, we sold an aggregate of 13,333,334 shares of our Series A
Preferred Stock to the following investors, each a beneficial owner of more than
5% of our outstanding common stock, at a per share price of $0.525:
<TABLE>
<CAPTION>
NUMBER OF
SHARES OF
SERIES A AGGREGATE
NAME OF PURCHASER PREFERRED STOCK PURCHASE PRICE
----------------- --------------- --------------
<S> <C> <C>
Entities Associated with Technology Crossover Ventures.... 7,619,048 $4,000,000
Rho Management Trust I.................................... 5,714,286 3,000,000
</TABLE>
Each share of our Series A Preferred Stock is convertible into the number
of fully paid and nonassessable shares of common stock as is determined by
dividing the original issuance price of our Series A Preferred Stock by the
conversion price for the Series A Preferred Stock in effect at the time the
certificate is surrendered for conversion. Each share of our Series A Preferred
Stock is convertible into 0.4 shares of our common stock upon the closing of an
initial public offering.
The holders of our Series A Preferred Stock have entered into an agreement
with us under which they will have registration rights with respect to their
shares of common stock following this offering. See "Description of Capital
Stock -- Preferred Stock" for additional information regarding these
registration rights.
In February 2000, we sold an aggregate of 2,000,000 shares of our Series B
Preferred Stock to the following investors, each a beneficial owner of more than
5% of our outstanding common stock, at a per share price of $2.50:
<TABLE>
<CAPTION>
NUMBER OF
SHARES OF
SERIES B AGGREGATE
NAME OF PURCHASER PREFERRED STOCK PURCHASE PRICE
----------------- --------------- --------------
<S> <C> <C>
Entities Associated with Technology Crossover Ventures.... 1,142,857 $2,857,144
Rho Management Trust I.................................... 857,143 2,142,858
</TABLE>
Each share of our Series B Preferred Stock is convertible into the number
of fully paid and nonassessable shares of common stock as is determined by
dividing the original issuance price of our Series B Preferred Stock by the
conversion price for the Series B Preferred Stock in effect at the time the
certificate is surrendered for conversion. Each share of our Series B Preferred
Stock is convertible into 0.4 shares of our common stock upon the closing of an
initial public offering.
The holders of our Series B Preferred Stock have entered into an agreement
with us under which they will have registration rights with respect to their
shares of common stock following this offering. See "Description of Capital
Stock -- Preferred Stock" for additional information regarding these
registration rights.
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<PAGE> 58
In July 2000, we sold an aggregate of 2,318,392 shares of our Series C
Preferred Stock at a per share price of $6.47, 309,119 shares of which were sold
to entities associated with Technology Crossover Ventures, a beneficial owner of
more than 5% of our outstanding common stock.
Each share of our Series C Preferred Stock is convertible into the number
of fully paid and nonassessable shares of common stock as is determined by
dividing the original issuance price of our Series C Preferred Stock by the
conversion price for the Series C Preferred Stock in effect at the time the
certificate is surrendered for conversion. Each share of our Series C Preferred
is convertible into one share of our common stock upon the closing of an initial
public offering.
The holders of our Series C Preferred Stock have entered into an agreement
with us under which they will have registration rights with respect to their
shares of common stock following this offering. See "Description of Capital
Stock -- Preferred Stock" for additional information regarding these
registration rights.
EMPLOYMENT AGREEMENTS
We have entered into employment agreements with Mr. Wright, our President
and Chief Executive Officer, Mr. Grant, our Senior Vice President of Finance and
Chief Financial Officer, Mr. Gruher, our Senior Vice President, Western U.S.
Operations and Mr. Markowitz, our Senior Vice President, Eastern U.S.
Operations. See "Management -- Employment Agreements" for additional information
regarding these employment agreements.
OTHER AGREEMENTS
In September 1999, we entered into an agreement with Greens.com for the
provision of services relating to customer relationship management and
enterprise resource planning applications integration. During fiscal year 1999,
revenues from Greens.com represented 9.7% of our total revenues. We believe the
terms of our relationship with Greens.com were no less favorable than we could
have obtained from any unaffiliated third party. We terminated our agreement
with Greens.com in August 2000.
Steven L. Darrow, our former Chairman of the Board, was chairman of the
board and chief executive officer of Greens.com during 1999, and in 1999 owned
more than 40% of the outstanding stock of Greens.com. In November 1999, Mr.
Darrow entered into an agreement with us whereby Mr. Darrow personally
guarantees the payment of up to $4.5 million of our fees relating to
professional services we render to Greens.com. In February 2000, Mr. Darrow
contributed to the capital of Greens.com $4.0 million out of the proceeds from
his sale of 1,333,333 shares at $4.50 per share of his Emerald Solutions
founders' common stock to the following investors, each a beneficial owner of
more than 5% of our outstanding common stock:
<TABLE>
<CAPTION>
NUMBER OF
SHARES OF
COMMON STOCK AGGREGATE
PURCHASED FROM PURCHASE
NAME OF PURCHASER STEVEN L. DARROW PRICE
----------------- ---------------- ----------
<S> <C> <C>
Entities associated with Technology Crossover Ventures.... 888,889 3,992,739
Rho Management Trust I.................................... 444,444 2,000,000
</TABLE>
Also in February 2000, Greens.com paid to us approximately $2.7 million,
representing all monies Greens.com owed us as of January 30, 2000, and placed
approximately $1.3 million in
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<PAGE> 59
escrow to cover our anticipated professional services fees. There are no current
ongoing projects for Greens.com.
In July 1999, we loaned to Mr. Wright, our President, Chief Executive
Officer and director, an aggregate of $150,000 in order for Mr. Wright to
purchase 120,000 shares of our common stock. In connection with this loan, Mr.
Wright executed a full recourse promissory note in favor of us. The promissory
note bears interest at a rate of 5.82% per annum, matures in July 2004 and is
secured by a pledge of the common stock purchased by Mr. Wright for cash under
the terms of a stock pledge agreement between Mr. Wright and us. As of June 24,
2000, there was $150,000 plus interest outstanding on the promissory note.
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<PAGE> 60
PRINCIPAL STOCKHOLDERS
The following table sets forth information known to us with respect to the
beneficial ownership of our common stock as of July 31, 2000, by the following:
- each stockholder known by us to own beneficially more than 5% of our
common stock;
- each of our executive officers named in the compensation table above;
- each of our directors; and
- all directors and executive officers as a group.
This table lists applicable percentage ownership based on 31,713,304 shares
of common stock outstanding as of July 31, 2000, as adjusted to reflect the
conversion upon the closing of this offering of all outstanding shares of
redeemable convertible preferred stock and also lists applicable percentage
ownership based on 35,713,304 shares of common stock outstanding after
completion of this offering. Except as otherwise indicated, we believe that the
beneficial owners of the common stock listed below, on the information furnished
by such owners, have sole voting power and investment power with respect to such
shares subject to community property laws where applicable. The address for
those individuals for which an address is not otherwise indicated is
Emerald -- Delaware, Inc., 111 SW 5th Avenue, 27th Floor, Portland, OR 97204.
Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission. In computing the number of shares
beneficially owned by a person and the percentage ownership of that person,
shares of common stock subject to options or warrants held by that person that
are currently exercisable or will become exercisable within 60 days after July
31, 2000 are deemed outstanding.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED OWNED
PRIOR TO OFFERING AFTER OFFERING
NAME OR GROUP OF BENEFICIAL OWNERS ----------------------- -----------------------
AND ADDRESS NUMBER PERCENTAGE NUMBER PERCENTAGE
---------------------------------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Entities associated with Technology Crossover
Ventures(1)..................................... 10,210,009 32.2% 10,210,009 28.6%
Rho Management Trust I(2)......................... 5,246,928 16.5 5,246,928 14.7
Steven L. Darrow(3)............................... 3,300,908 10.4 3,300,908 9.2
Martin Wright(4).................................. 1,279,921 4.0 1,279,921 3.6
Jerry N. Grant(5)................................. 1,089,918 3.4 1,089,918 3.1
Michael Norkus.................................... 1,364,738 4.3 1,364,738 3.8
Mark Markowitz(6)................................. 290,266 * 290,266 *
Jim S. Gruher(7).................................. 206,646 * 206,646 *
Samuel C. Ellis................................... 33,333 * 33,333 *
David R. Stewart(8)............................... 64,483 * 64,483 *
Michael W. Bealmear(9)............................ 20,000 * 20,000
Charles Scott Gibson(10).......................... 20,000 * 20,000
C. Toms Newby(1).................................. 10,210,009 32.2 10,210,009 28.6
All directors and executive officers as a group
(10 persons)(11).............................. 14,579,315 46.0 14,579,315 40.8
</TABLE>
-------------------------
* Less than 1% of the outstanding shares of common stock.
(1) Includes 101,862 shares held by TCV II, V.O.F., 3,135,674 shares held by
Technology Crossover Ventures II, L.P., 2,410,750 shares held by TCV II
(Q), L.P., 427,823 shares held by TCV II Strategic Partners, L.P. and
478,755 shares held by Technology Crossover Ventures II, C.V. (the
foregoing five entities, collectively, the "TCV II Funds"); 26,540 shares
held by TCV III (GP),126,069 shares held by TCV III, L.P., 3,350,798 shares
held TCV III (Q), L.P., 151,740 shares held by TCV III Strategic Partners,
L.P. (the latter four
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<PAGE> 61
entities, collectively, the "TCV III Funds" and, together with the TCV II
Funds, the "TCV Funds"). Mr. Newby, a director of the Company, is a member
of Technology Crossover Management II, L.L.C. which is the General Partner
of each of the TCV II Funds and a member of Technology Crossover Management
III, L.L.C. which is the General Partner of each of the TCV III Funds. Mr.
Newby disclaims beneficial ownership of such shares except to the extent of
his pecuniary interest therein. The address for each of these persons and
entities is c/o Technology Crossover Ventures, 575 High Street, Suite 400,
Palo Alto, California 94301.
(2) Joshua Ruch controls Rho Management Company, Inc., an investment advisory
company exercising voting and investment power over all the shares held by
Rho Management Trust I. Mr. Ruch disclaims all beneficial ownership over
such shares, except to the extent of his pecuniary interest therein. The
address for Mr. Ruch and each of these entities is 765 Fifth Avenue, New
York, New York 10153.
(3) Mr. Darrow has agreed to sell 600,000 shares of our common stock upon
exercise of the underwriters' option to acquire additional shares to cover
over-allotments. The table assumes no exercise of the underwriters'
over-allotment option.
(4) Includes 546,665 shares issuable upon exercise of stock options held by Mr.
Wright exercisable within 60 days of July 31, 2000.
(5) Includes 99,863 shares held by the Grant II Trust and 10,000 shares held by
the Grant Irrevocable Trust and 137 shares held by Jerry and Carolyn Grant.
Also includes 433,331 shares issuable upon exercise of stock options held
by Mr. Grant exercisable within 60 days of July 31, 2000.
(6) Includes 123,604 shares held by the Markowitz Living Trust. Also includes
166,662 shares issuable upon exercise of stock options held by Mr.
Markowitz exercisable within 60 days of July 31, 2000.
(7) Includes 51,497 shares issuable upon exercise of stock options held by Mr.
Gruher exercisable within 60 days of July 31, 2000.
(8) Includes 13,000 shares issuable upon exercise of stock options held by Mr.
Stewart exercisable within 60 days of July 31, 2000.
(9) Includes 20,000 shares issuable upon exercise of stock options held by Mr.
Bealmear exercisable within 60 days of July 31, 2000.
(10) Includes 20,000 shares issuable upon exercise of stock options held by Mr.
Gibson exercisable within 60 days of July 31, 2000.
(11) Includes an aggregate of 1,251,155 shares issuable upon exercise of stock
options held by our directors and executive officers exercisable within 60
days of July 31, 2000.
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<PAGE> 62
DESCRIPTION OF CAPITAL STOCK
Upon the completion of this offering, we will be authorized to issue
80,000,000 shares, $0.001 par value per share, to be divided into two classes to
be designated common stock and preferred stock. Of the shares authorized,
78,000,000 shares shall be designated as common stock and 2,000,000 shares shall
be designated as preferred stock. The following description of our capital stock
is only a summary. You should refer to our certificate of incorporation and
bylaws as in effect upon the closing of this offering, material provisions of
which are summarized below, and, which are included as exhibits to the
registration statement of which this prospectus forms a part, and the provisions
of applicable Delaware law.
COMMON STOCK
As of July 31, 2000, there were 31,715,135 shares of common stock
outstanding on a pro forma basis, giving effect to the automatic conversion of
all outstanding shares of our preferred stock into 8,451,724 shares of common
stock upon completion of this offering, which were held of record by
approximately 271 stockholders. There will be 35,715,135 shares of common stock
outstanding assuming no exercise of outstanding options after July 31, 2000
after giving effect to the sale of our common stock in this offering. There are
6,366,198 shares of common stock issuable upon exercise of outstanding options
under our 1997 Stock Incentive Compensation Plan and 210,000 shares of common
stock issuable upon exercise of outstanding options under our 1999 Non-Employee
Director Stock Option Plan. Our outstanding shares of common stock include
338,597 shares of restricted common stock issued in July 2000 to Alliance
employees pursuant to our 2000 Stock Incentive Plan. See "Management -- Stock
Plans" for a description of our stock plans.
The holders of our common stock are entitled to one vote per share held of
record on all matters submitted to a vote of the stockholders. Our amended and
restated certificate of incorporation, to be filed concurrently with completion
of this offering, does not provide for cumulative voting in the election of
directors. Subject to preferences that may be applicable to any outstanding
preferred stock, the holders of common stock are entitled to receive ratably
such dividends, if any, as may be declared from time to time by our board of
directors out of funds legally available for that purpose. In the event of our
liquidation, dissolution or winding up, holders of our common stock are entitled
to share ratably in all assets remaining after payment of liabilities, subject
to prior distribution rights of preferred stock, if any, then outstanding.
Holders of our common stock have no preemptive or other subscription or
conversion rights. There are no redemption or sinking fund provisions applicable
to our common stock. All outstanding shares of common stock are fully paid and
non-assessable, and the shares of common stock to be issued upon the completion
of this offering will be fully paid and non-assessable.
The current holders of our common stock are subject to the terms of a
stockholders' agreement and a rights and restrictions agreement.
PREFERRED STOCK
As of July 31, 2000, there were 13,333,334 shares of redeemable convertible
Series A Preferred Stock outstanding which were held of record by six
stockholders. All outstanding shares of our Series A Preferred Stock will be
converted into an aggregate of 5,333,332 shares of common stock automatically
upon completion of this offering.
Each share of Series A Preferred Stock can be converted at the option of
the holder at any time after issuance according to a conversion ratio, subject
to adjustment for dilution. In addition, each share of Series A Preferred Stock
shall automatically convert into shares of
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<PAGE> 63
common stock upon the date specified by vote or written consent or agreement of
holders of a majority of the outstanding shares of Series A Preferred Stock.
At the election of the holders of at least a majority of the outstanding
shares of Series A Preferred Stock on or any time after November 1, 2002, the
corporation will redeem the Series A Preferred Stock in two equal consecutive
installments.
Each share of Series A Preferred Stock has voting rights equal to common
stock into which it is convertible on the record date of the vote. Holders of
common stock are entitled to vote as a separate class for any remaining
directors.
Holders of Series A Preferred Stock are entitled to receive noncumulative
dividends at the per annum rate of 8% of the original issue price per share when
and if declared by the board of directors. The board of directors has not
declared any dividends as of December 25, 1999. In the event of a conversion of
the Series A Preferred Stock, any declared and unpaid dividends shall be paid at
the election of the holder in cash or common stock at its then fair market
value. If dividends or other distributions are paid on the common stock, the
holders of Series A Preferred Stock are entitled to the preferential dividends
above and are entitled to per share dividends equal to those declared or paid to
holders of common stock.
In the event of liquidation, dissolution or winding up of the corporation,
either voluntary or involuntary, holders of Series A Preferred Stock are
entitled to receive, prior to the distribution of any corporation assets, an
amount of $0.525 per share in addition to any declared but unpaid dividends. If
the assets of the corporation are insufficient to permit payment to the holders
of Series A Preferred Stock, then the entire assets and funds of the corporation
legally available for distribution shall be distributed between holders of
Series A Preferred Stock in proportion to the product of the liquidation
preference of each such share and the number of such shares owned by each
holder. After the original liquidation distribution has been paid to the holders
of Series A Preferred Stock, the remaining assets of the corporation shall be
distributed among the holders of the common stock and Series A Preferred Stock
on an as-converted basis, until the holders of Series A Preferred Stock receive
assets valued at 4.5 times the original Series A Preferred Stock price per
share. Any remaining assets will be distributed pro-rata solely to holders of
common stock.
As of July 31, 2000, there were 2,000,000 shares of redeemable convertible
Series B Preferred Stock outstanding which were held of record by five
stockholders. All outstanding shares of our Series B Preferred Stock will be
converted into an aggregate of 800,000 shares of common stock automatically upon
completion of this offering.
The shares of Series B Preferred Stock have similar rights and preferences
as the shares of Series A Preferred Stock except they are non-voting, have a
different conversion ratio and have a liquidation price of $3.50 per share for
the first twelve months after issuance and $4.50 per share thereafter. In
addition, the holders of Series B Preferred Stock will have the right to convert
their shares into Series B-1 voting preferred stock upon certain regulatory
approvals. The Series B-1 preferred stock will have identical rights as the
Series B Preferred Stock except it will also have voting rights.
As of July 31, 2000, there were 2,318,392 shares of redeemable convertible
Series C Preferred Stock outstanding which were held of record by ten
stockholders. All outstanding shares of our Series C Preferred Stock will be
converted into an aggregate of 2,318,392 shares of common stock automatically
upon completion of this offering.
The shares of Series C Preferred Stock have similar rights and preferences
as the shares of Series A and B Preferred Stock except they have a different
conversion ratio and a liquidation price of $8.09 per share for the first six
months after issuance and $9.71 per share thereafter.
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<PAGE> 64
Upon the completion of this offering and the filing of our amended and
restated certificate of incorporation, our board will be authorized, without
action by the stockholders, to issue shares of preferred stock in one or more
series and to fix the rights, preferences, privileges and restrictions of these
shares of preferred stock. These rights, preferences and privileges include
dividend rights, conversion rights, voting rights, terms of redemption,
liquidation preferences, sinking fund terms and the number of shares
constituting any series or the designation of any series, all or any of which
may be greater than the rights of the common stock.
The issuance of preferred stock could adversely affect the voting power of
holders of common stock and the likelihood that the holders of common stock will
receive dividend payments and payments upon liquidation. In addition, the
issuance of preferred stock could have the effect of delaying or preventing a
change in our control without further action by the stockholders. We have no
present plans to issue any shares of preferred stock.
REGISTRATION RIGHTS
Pursuant to a Second Amended and Restated Investors Rights Agreement we
entered into with the holders of our preferred stock, the holders of 8,451,624
shares of common stock on an as converted basis are entitled to registration
rights. The holders of these shares may also require us to file a registration
statement under the Securities Act at our expense with respect to their shares
of common stock. We are required to use our best efforts to effect this
registration, subject to conditions and limitations. Furthermore, the holders of
these shares may require us to file additional registration statements on Form
S-3, when and if we are qualified to use such form, and subject to further
conditions and limitations.
We have also granted registration rights to the former stockholders of
Alliance in connection with the acquisition of Alliance, and to Deutsche Bank
Securities Inc. in connection with the warrant that we issued to them. These
registration rights provide that if we propose to register any securities under
the Securities Act, either for our own account or for the account of other
security holders exercising registration rights, the above holders would be
entitled to notice and may include shares of their common stock in the
registration. This right is subject to conditions and limitations, including the
right of the underwriters to limit the number of shares included in the
registration.
DELAWARE ANTI-TAKEOVER LAW AND CERTAIN CHARTER AND BYLAW PROVISIONS
Upon the closing of this offering, some provisions of Delaware law and our
certificate of incorporation and bylaws could make the following more difficult:
- acquisition of us by means of a tender offer;
- acquisition of us by means of a proxy contest or otherwise; or
- removal of our incumbent officers and directors.
These provisions, summarized below, are expected to discourage certain types of
coercive takeover practices and inadequate takeover bids and to encourage
persons seeking to acquire control of us to first negotiate with us. We believe
that the benefits of increased protection of our potential ability to negotiate
with the proponent of an unfriendly or unsolicited proposal to acquire or
restructure us outweighs the disadvantages of discouraging such proposals
because, among other things, negotiation of such proposals could result in an
improvement of their terms. The amendment of any of the following provisions
would require approval by holders of at least 66 2/3% of our outstanding common
stock.
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<PAGE> 65
Board of Directors
Effective with the first annual meeting of stockholders following
completion of this offering, our restated bylaws provide for the division of our
board of directors into three classes, as nearly equal in number as possible,
with the directors in each class serving for a three-term, and one class being
elected each year by our stockholders. This system of electing and removing
directors may tend to discourage a third party from making a tender offer or
otherwise attempting to obtain control of us and may maintain the incumbency of
the board of directors, as it generally makes it more difficult for stockholders
to replace a majority of the directors. Further, our amended and restated
certificate of incorporation filed in connection with this offering and restated
bylaws do not provide for cumulative voting in the election of directors.
Stockholder Meetings
Under our amended and restated certificate of incorporation and restated
bylaws, the stockholders may call a special meeting only upon the request of the
holders of at least 51% of the outstanding shares. Additionally, our board of
directors, chairman of the board or president may call special meetings of
stockholders. Our restated bylaws establish advance notice procedures with
respect to stockholder proposals and the nomination of candidates for election
as directors, other than nominations made by or at the direction of the board of
directors or a committee thereof. In addition, our amended and restated
certificate of incorporation eliminates the right of stockholders to act by
written consent without a meeting.
Delaware Anti-Takeover Law
We are subject to Section 203 of the Delaware General Corporation Law, an
anti-takeover law. In general, Section 203 prohibits a publicly held Delaware
corporation from engaging in a business combination with an interested
stockholder for a period of three years following the date the person became an
interested stockholder, unless the business combination or the transaction in
which the person became an interested stockholder is approved in a prescribed
manner. Generally, a business combination includes a merger, asset or stock
sale, or other transaction resulting in a financial benefit to the interested
stockholder. Generally, an interested stockholder is a person who, together with
affiliates and associates, owns or within three years prior to the determination
of interested stockholder status, did own 15% or more of a corporation's voting
stock. The existence of this provision would be expected to have an anti-
takeover effect with respect to transactions not approved in advance by the
board of directors, including discouraging attempts that might result in a
premium over the market price for the shares of common stock held by
stockholders.
Undesignated Preferred Stock
The authorization of undesignated preferred stock makes it possible for the
board of directors to issue preferred stock with voting or other rights or
preferences that could impede the success of any attempt to change control of
us. These and other provisions may have the effect of deferring hostile
takeovers or delaying changes in control or management.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the common stock is American Stock
Transfer & Trust Co., Inc.
NASDAQ STOCK MARKET NATIONAL MARKET LISTING
We have applied to list our common stock on the Nasdaq National Market
under the symbol "EMSO."
63
<PAGE> 66
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this offering, we will have 35,715,135 shares of common
stock outstanding. Of these shares, the 4,000,000 shares sold in this offering
will be freely transferable without restriction under the Securities Act, unless
they are held by "affiliates" as that term is defined in Rule 144 of the
Securities Act.
Of these shares, the remaining 31,715,135 shares were sold by us in
reliance on exemptions from the registration requirements of the Securities Act,
are restricted securities within the meaning of Rule 144 under the Securities
Act and become eligible for sale in the public market as follows:
- beginning 90 days after the effective date, no shares will become
eligible for sale;
- beginning 181 days after the effective date, 27,564,665 shares will
become eligible for sale, subject to the provisions of Rules 144, 144(k)
or 701, upon the expiration of agreements not to sell such shares entered
into between the underwriters and such stockholders;
- thereafter, the remaining 4,150,470 shares held for one year or more will
become eligible for sale, subject to the provisions of Rule 144.
Beginning 181 days after the date of this prospectus, approximately
2,693,003 additional shares subject to vested options as of the date of
completion of this offering will be available for sale subject to compliance
with Rule 701 and upon the expiration of agreements not to sell such shares
entered into between the underwriters and such stockholders. Any shares subject
to lock-up agreements may be released at any time without notice by the
underwriters.
In general, under Rule 144 as currently in effect, a person or persons
whose shares are aggregated, including an affiliate, who has beneficially owned
restricted shares for at least one year is entitled to sell, within any
three-month period commencing 90 days after the date of completion of this
offering, a number of shares that does not exceed the greater of 1% of the then
outstanding shares of common stock, or approximately 357,151 shares immediately
after this offering, or the average weekly trading volume in the common stock
during the four calendar weeks preceding such sale, subject to the filing of a
Form 144 with respect to such sale and certain other limitations and
restrictions. In addition, a person who is not deemed to have been our affiliate
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, would be entitled to sell
such shares under Rule 144(k) without regard to the requirements described
above.
Any of our employees, officers or directors of or consultant who purchased
his or her shares prior to the date of completion of this offering or who holds
vested options as of that date pursuant to a written compensatory plan or
contract is entitled to rely on the resale provisions of Rule 701, which permits
non-affiliates to sell their Rule 701 shares without having to comply with the
public-information, holding-period, volume-limitation or notice provisions of
Rule 144 and permits affiliates to sell their Rule 701 shares without having to
comply with Rule 144's holding-period restrictions, in each case commencing 90
days after the date of completion of this offering. However, we and our
officers, directors and stockholders have agreed not to sell or otherwise
dispose of any shares of our common stock for the 180-day period after the date
of this prospectus without the prior written consent of the underwriters. See
"Underwriting" for additional information regarding limitations on the sale of
our common stock.
As soon as practicable after the date of completion of this offering, we
intend to file a registration statement on Form S-8 under the Securities Act to
register shares of common stock reserved for issuance under our 1997 Stock
Incentive Compensation Plan, our 1999 Non-Employee Director Stock Option Plan
and our 2000 Stock Incentive Plan, thus permitting the resale of such shares by
non-affiliates in the public market without restriction under the Securities
Act. Such registration statements will become effective immediately upon filing.
64
<PAGE> 67
UNDERWRITING
Subject to the terms and conditions of the underwriting agreement dated as
of the date of this prospectus, the underwriters named below, through their
representatives Deutsche Bank Securities Inc., FleetBoston Robertson Stephens
Inc., Adams, Harkness & Hill, Inc. and Pacific Crest Inc. have severally agreed
to purchase from us the following respective number of shares of common stock at
the initial public offering price less the underwriting discounts and
commissions set forth on the cover page of this prospectus:
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITER SHARES
----------- ----------
<S> <C>
Deutsche Bank Securities Inc. ..............................
FleetBoston Robertson Stephens Inc. ........................
Adams, Harkness & Hill, Inc.................................
Pacific Crest Inc...........................................
----------
Total.............................................
==========
</TABLE>
The underwriting agreement provides that the obligations of the several
underwriters to purchase the shares of common stock being sold in this offering
are subject to certain conditions precedent and that the underwriters will
purchase all shares of the common stock offered hereby, other than those covered
by the over-allotment option described below, if any of these shares are
purchased. The underwriting agreement provides that, in the event of a default
by an underwriter, in certain circumstances the purchase commitments of
non-defaulting underwriters may be increased or the underwriting agreement may
be terminated.
We have been advised by the representatives that the underwriters propose
to offer the shares of common stock to the public initially at the public
offering price set forth on the cover page of this prospectus and, through the
representatives, to selling group members at such price less a concession of
$ . per share and the underwriters and such selling group members may allow a
discount of $ . per share on sales to certain other brokers-dealers. After the
offering, the public offering price and concession and discount to dealers may
be changed by the representatives.
The selling stockholder has granted to the underwriters an option,
exercisable not later than 30 days after the date of this prospectus, to
purchase up to 600,000 additional shares of common stock at the public offering
price less underwriting discounts and commissions. Such option may be exercised
only to cover over-allotments in the sale of shares of common stock being sold
in this offering. To the extent such option is exercised, each underwriter will
become obligated, subject to certain conditions, to purchase approximately the
same percentage of such additional shares of common stock as the number of
shares of common stock to be purchased by it in the above table bears to
.
The underwriting discounts and commissions are equal to the public offering
price per share of common stock less the amount paid by the underwriters to us
per share of common stock. We and the selling stockholder have agreed to pay the
underwriters the following discounts and
65
<PAGE> 68
commissions, assuming either no exercise or full exercise by the underwriters of
the underwriters' over-allotment option:
<TABLE>
<CAPTION>
TOTAL
-------------------------------
PER WITHOUT WITH FULL
SHARE OVER-ALLOTMENT OVER-ALLOTMENT
----- -------------- --------------
<S> <C> <C> <C>
Underwriting discounts and commissions paid by
Emerald Solutions................................. $ $ $
Underwriting discounts and commissions paid by the
selling stockholder............................... $ $ $
</TABLE>
In addition, we estimate that the total expenses of this offering,
excluding underwriting discounts and commissions, will be approximately $1.1
million. The selling stockholder will pay a pro rata share of this amount based
on the percentage of the number of shares sold by the selling stockholder to the
total number of shares sold in this offering.
We and the selling stockholder have agreed to indemnify the underwriters
against liabilities in connection with this offering, including liabilities
under the Securities Act and to contribute to payments the underwriters may be
required to make in respect of any of these liabilities.
Each of our officers and directors and substantially all of our
stockholders and holders of options and warrants to purchase our stock, has
agreed not to offer, sell, contract to sell or otherwise dispose of, or enter
into any transaction that is designed to, or could be expected to, result in the
disposition of any portion of our common stock held by these persons prior to
this offering or common stock issuable upon exercise of options or warrants held
by these persons for a period of 180 days after the effective date of the
registration statement of which this prospectus is a part without the prior
written consent of Deutsche Bank Securities Inc. This consent may be given at
any time without public notice. We have entered into a similar agreement with
the representatives of the underwriters, except that we may grant options and
sell shares pursuant to our 1997 Stock Incentive Compensation Plan and our 1999
Non-Employee Director Stock Option Plan without such consent.
A prospectus in electronic format may be made available on the websites
maintained by one or more of the underwriters of this offering. The underwriters
may agree to allocate a number of shares to underwriters for sale to their
online brokerage account holders. Internet distributions will be allocated by
the representatives to underwriters that may make Internet distributions on the
same basis as other allocations. Any underwriters making such Internet
distributions will either clear such procedures with the Securities and Exchange
Commission or will follow procedures for online distributions previously cleared
with the Securities and Exchange Commission.
The representatives have advised us that they do not expect discretionary
sales by the underwriters to exceed 5% of the shares being offered hereby.
In order to facilitate the offering of our common stock, the underwriters
may engage in transactions that stabilize, maintain or otherwise affect the
market price of our common stock. Specifically, the underwriters may over-allot
shares of our common stock in connection with this offering, thus creating a
short position in our common stock for their own account. A short position
results when an underwriter sells more shares of common stock than the
underwriter is committed to purchase. Additionally, to cover these
over-allotments or to stabilize the market price of our common stock, the
underwriters may bid for, and purchase, shares of our common stock in the open
market. Finally, the representatives, on behalf of the underwriters, may also
reclaim selling concessions allowed to an underwriter or dealer if the
underwriting syndicate repurchases shares distributed by that underwriter or
dealer. Any of these activities may
66
<PAGE> 69
stabilize or maintain the market price of our common stock at a level above that
which might otherwise prevail in the open market. The underwriters are not
required to engage in these activities and, if commenced, may end any of these
activities at any time.
At our request, the underwriters have reserved for sale, at the initial
public offering price, up to 400,000 of the shares of common stock offered in
this offering for friends and family members of our executive officers and other
persons that are affiliated with companies with whom we have a business
relationship, such as executives of companies that market, sell or otherwise
promote our products. None of these shares will be subject to lock-up
agreements. The number of shares of our common stock available for sale to the
general public will be reduced to the extent these reserved shares are
purchased. Any reserved shares that are not purchased by these persons will be
offered by the underwriters to the general public on the same basis as the other
shares in this offering.
Deutsche Bank Securities Inc. acted as a placement agent for us in
connection with the private placement of shares of our Series C Preferred Stock
in July 2000. We incurred customary placement fees to Deutsche Banc Alex. Brown
for such services, including a cash placement fee of $500,000 and a warrant to
purchase 38,639 shares of common stock at the private placement price of $6.47
per share. In addition, DB Alex. Brown Venture Investors Portfolio, LLC, an
affiliate of Deutsche Banc Alex. Brown, purchased 154,559 shares of our Series C
Preferred Stock in connection with the Series C private placement. Each of
Deutsche Banc Alex. Brown and DB Alex. Brown Venture Investors Portfolio, LLC
has agreed with us not to sell, transfer, assign, pledge or hypothecate any such
shares for at least one year from the date of our initial public offering.
PRICING OF THIS OFFERING
Prior to this offering, there has been no public market for our common
stock. Consequently, the initial public offering price for our common stock will
be determined by negotiation among us and the representatives of the
underwriters. Among the primary factors that will be considered in determining
the public offering price are:
- prevailing market conditions;
- our results of operations in recent periods;
- the assessment of our management;
- the market capitalizations and stages of development of other companies
that we and the representatives of the underwriters believe to be
comparable to our business; and
- estimates of our business potential.
LEGAL MATTERS
The validity of the common stock being sold in this offering will be passed
upon for us by Morrison & Foerster LLP, Palo Alto, California. Legal matters
will be passed upon for the underwriters by Ropes & Gray, Boston, Massachusetts.
EXPERTS
The financial statements of (i) Emerald-Delaware, Inc. as of December 26,
1998 and December 25, 1999, and for each of the years in the three-year period
ended December 25, 1999, (ii) ZCom Incorporated as of December 31, 1998 and
1999, and for each of the years
67
<PAGE> 70
then ended and (iii) Alliance Consulting Group, Inc. as of December 31, 1998 and
1999, and for each of the years then ended, have been included in this
prospectus and in the registration statement in reliance upon the reports of
KPMG LLP, independent auditors, and upon the authority of that firm as experts
in accounting and auditing.
ADDITIONAL INFORMATION
We have filed with the Securities and Exchange Commission, Washington,
D.C., a registration statement on Form S-1 under the Securities Act with respect
to the shares of common stock being sold in this offering. This prospectus does
not contain all the information set forth in the registration statement and the
exhibits and schedules to the registration statement. For further information
with respect to us and our common stock, reference is made to the registration
statement and to the exhibits and schedules to the registration statement.
Statements contained in this prospectus as to the contents of any contract or
other document referred to are not necessarily complete, and in each instance
reference is made to the copy of the contract or other document filed as an
exhibit to the registration statement, each statement being qualified in all
respects by this reference. A copy of the registration statement may be
inspected by anyone without charge at the Public Reference Section of the
Commission at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington,
D.C. 20549. Copies of all or any portion of the registration statement may be
obtained from the Public Reference Section of the Commission, 450 Fifth Street,
N.W., Washington, D.C. 20549, upon payment of prescribed fees. The Commission
maintains a web site at www.sec.gov that contains reports, proxy and information
statements and other information regarding registrants that file electronically
with the Commission.
------------------------------------
"Emerald Solutions" is our registered trademark and "E-Business
Engineering" is our registered service mark, in addition, we have applied for
registration of our Emerald Solutions "ES" logo, "E-Business Engineering,"
"E-Business Engineering at Work" and "Business Agility Index." All other
trademarks or service marks appearing in this prospectus are trademarks or
service marks of the respective companies that use them.
68
<PAGE> 71
EMERALD -- DELAWARE, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
EMERALD -- DELAWARE, INC.
Independent Auditors' Report................................ F-2
Balance Sheets.............................................. F-3
Statements of Operations.................................... F-4
Statement of Stockholders' Equity (Deficit)................. F-5
Statements of Cash Flows.................................... F-6
Notes to Financial Statements............................... F-8
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL
INFORMATION
Overview.................................................... F-29
Unaudited Pro Forma Condensed Consolidated Balance Sheet.... F-31
Unaudited Pro Forma Condensed Consolidated Statements of
Operations................................................ F-32
Notes to Unaudited Pro Forma Condensed Consolidated
Financial Statements...................................... F-34
ZCOM INCORPORATED
Independent Auditors' Report................................ F-36
Balance Sheets.............................................. F-37
Statements of Operations.................................... F-38
Statements of Stockholders' Deficiency...................... F-39
Statements of Cash Flows.................................... F-40
Notes to Financial Statements............................... F-41
ALLIANCE CONSULTING GROUP, INC.
Independent Auditors' Report................................ F-45
Balance Sheets.............................................. F-46
Statements of Operations.................................... F-47
Statements of Stockholders' Equity (Deficit)................ F-48
Statements of Cash Flows.................................... F-49
Notes to Financial Statements............................... F-50
</TABLE>
F-1
<PAGE> 72
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders of Emerald -- Delaware, Inc.:
We have audited the accompanying balance sheets of Emerald -- Delaware,
Inc. (formerly Emerald Solutions, Inc.) as of December 26, 1998 and December 25,
1999, and the related statements of operations, stockholders' equity (deficit)
and cash flows for each of the years in the three-year period ended December 25,
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 Emerald -- Delaware, Inc. as
of December 26, 1998 and December 25, 1999, and the results of its operations
and its cash flows for each of the years in the three-year period ended December
25, 1999 in conformity with generally accepted accounting principles.
/s/ KPMG LLP
Seattle, Washington
February 15, 2000, except for note 14, which is as of April 3, 2000.
F-2
<PAGE> 73
EMERALD -- DELAWARE, INC.
BALANCE SHEETS
DECEMBER 26, 1998, DECEMBER 25, 1999 AND JUNE 24, 2000
<TABLE>
<CAPTION>
JUNE 24,
2000
DECEMBER 26, DECEMBER 25, JUNE 24, PRO
1998 1999 2000 FORMA
------------ ------------ ------------ -----------
(UNAUDITED)
<S> <C> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.................................. $ 302,733 $ 1,708,355 $ 350,274 $ 9,567,632
Trade accounts receivable, net of allowance for doubtful
accounts of $50,000 in 1998, $249,999 in 1999 and
$517,704 in 2000......................................... 2,167,626 6,234,715 13,974,289 15,648,194
Receivable from related party.............................. 54,947 1,774,140 28,645 28,645
Prepaid expenses........................................... 261,135 392,297 450,238 471,119
----------- ----------- ------------ -----------
Total current assets................................. 2,786,441 10,109,507 14,803,446 25,715,590
----------- ----------- ------------ -----------
Property and equipment, net................................. 1,688,089 4,453,632 7,508,693 7,947,004
Intangibles................................................. -- -- 6,731,964 24,641,746
Other assets................................................ 171,188 321,691 1,085,673 701,089
----------- ----------- ------------ -----------
$ 4,645,718 $14,884,830 $ 30,129,776 $59,005,429
=========== =========== ============ ===========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable........................................... $ 652,960 $ 1,661,043 $ 4,721,097 $ 4,804,037
Accrued compensation....................................... 626,918 2,864,762 4,904,727 5,560,597
Other accrued liabilities.................................. 169,126 828,302 1,911,445 2,306,314
Line of credit............................................. -- 5,000,000 6,195,108 6,920,108
Deferred revenue........................................... 375,322 374,415 867,203 1,171,238
Notes payable.............................................. -- -- 1,350,000 2,405,000
Current portion of capital lease obligations............... 69,438 163,882 660,837 660,837
----------- ----------- ------------ -----------
Total current liabilities............................ 1,893,764 10,892,404 20,610,417 23,828,131
----------- ----------- ------------ -----------
Capital lease obligations, excluding current portion........ 74,328 210,717 1,330,835 1,330,835
Other long-term liabilities................................. 31,416 31,416 436,144 706,821
Series A redeemable convertible preferred stock, $.001 par
value, 13,333,334 shares authorized, issued, and
outstanding at December 25, 1999 and June 24, 2000.
Aggregate liquidation preference of $7,000,000 at December
25, 1999 and June 24, 2000. Aggregate redemption value of
$7,583,333 and $7,989,626 at December 25, 1999 and June 24,
2000 (no shares issued and outstanding, pro forma)......... -- 7,207,422 7,646,673 --
Series B redeemable convertible preferred stock, $.001 par
value, 2,000,000 shares authorized, issued and outstanding
at June 24, 2000. Aggregate liquidation preference of
$7,000,000 at June 24, 2000. Aggregate redemption value of
$5,187,000 at June 24, 2000 (no shares issued and
outstanding, pro forma).................................... -- -- 5,187,501 --
Series C redeemable convertible preferred stock, $0.001 par
value, 2,318,392 shares authorized pro forma; no shares
issued or outstanding at June 24, 2000 (no shares issued
and outstanding pro forma)................................. -- -- -- --
Stockholders' equity (deficit):
Common stock, $.001 par value. 40,000,000 shares authorized
at December 25, 1999 and 73,666,666 shares authorized at
June 24, 2000, 19,805,200, 20,016,966 and 20,675,800
shares issued and outstanding at December 26, 1998,
December 25, 1999 and June 24, 2000, respectively,
(78,000,000 shares authorized, 31,713,304 shares issued
and outstanding pro forma)............................... 19,805 20,017 20,676 31,713
Additional paid-in capital................................. 5,867,611 5,400,614 21,218,802 64,303,064
Deferred compensation...................................... -- (86,259) (8,332,728) (13,206,591)
Accumulated deficit........................................ (3,145,036) (8,570,219) (17,771,800) (17,771,800)
----------- ----------- ------------ -----------
2,742,380 (3,235,847) (4,865,050) 33,356,386
Less stock subscriptions receivable........................ 96,170 221,282 216,744 216,744
----------- ----------- ------------ -----------
Total stockholders' equity (deficit)................. 2,646,210 (3,457,129) (5,081,794) 33,139,642
Commitments, contingencies and subsequent events
----------- ----------- ------------ -----------
$ 4,645,718 $14,884,830 $ 30,129,776 $59,005,429
=========== =========== ============ ===========
</TABLE>
See accompanying Notes to Financial Statements.
F-3
<PAGE> 74
EMERALD -- DELAWARE, INC.
STATEMENTS OF OPERATIONS
FISCAL YEARS ENDED DECEMBER 27, 1997, DECEMBER 26, 1998 AND DECEMBER 25, 1999
AND
SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000
<TABLE>
<CAPTION>
FISCAL YEAR ENDED SIX MONTHS ENDED
------------------------------------------ --------------------------
DECEMBER 27, DECEMBER 26, DECEMBER 25, JUNE 26, JUNE 24,
1997 1998 1999 1999 2000
------------ ------------ ------------ ----------- ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues (includes related party
revenues of $55,000 and $3,384,000
during fiscal years 1998 and 1999,
respectively, and $1,110,000 and
$2,234,000 during the six months
ended June 26, 1999 and June 24,
2000, respectively)................. $ 2,720,750 $15,010,608 $34,710,594 $14,285,779 $ 33,966,433
Expenses:
Cost of revenues -- professional
services (excluding stock
compensation)..................... 2,417,697 7,742,208 19,280,517 7,552,303 17,759,611
Cost of revenues -- AT&T warrant.... -- -- -- -- 753,902
Sales and marketing (excluding stock
compensation)..................... 406,561 2,400,561 6,589,529 2,344,614 7,861,854
General and administrative
(excluding stock compensation).... 3,473,581 4,091,416 14,261,204 5,234,663 14,228,007
Stock compensation*................. -- -- 18,921 -- 2,226,360
Loss on investment in subsidiary
held for disposal................. 238,650 -- -- -- --
----------- ----------- ----------- ----------- ------------
Total operating expenses.............. 6,536,489 14,234,185 40,150,171 15,131,580 42,829,734
----------- ----------- ----------- ----------- ------------
Income (loss) from operations......... (3,815,739) 776,423 (5,439,577) (845,801) (8,863,301)
Other income (expense):
Interest income..................... -- 3,514 103,588 49,154 63,067
Interest expense.................... (37,306) (12,221) (123,594) (17,411) (401,347)
----------- ----------- ----------- ----------- ------------
Interest income (expense), net........ (37,306) (8,707) (20,006) 31,743 (338,280)
----------- ----------- ----------- ----------- ------------
Income (loss) before income taxes..... (3,853,045) 767,716 (5,459,583) (814,058) (9,201,581)
Income taxes.......................... -- 59,707 (34,400) -- --
----------- ----------- ----------- ----------- ------------
Net income (loss)................... (3,853,045) 708,009 (5,425,183) (814,058) (9,201,581)
Accretion of redemption value of
redeemable convertible preferred
stock............................. -- -- 691,535 276,608 626,752
Effect of beneficial conversion
feature of Series B Preferred
Stock............................. -- -- -- -- 1,840,000
----------- ----------- ----------- ----------- ------------
Net income (loss) applicable to
common stockholders............... $(3,853,045) $ 708,009 $(6,116,718) $(1,090,666) $(11,668,333)
=========== =========== =========== =========== ============
Net earnings (loss) per share
applicable to common stockholders:
Basic earnings (loss) per share..... $ (0.23) $ 0.04 $ (0.31) $ (0.05) $ (0.57)
=========== =========== =========== =========== ============
Diluted earnings (loss) per share... $ (0.23) $ 0.03 $ (0.31) $ (0.05) $ (0.57)
=========== =========== =========== =========== ============
Shares used to calculate:
Basic earnings (loss) per share... 16,739,028 19,488,361 19,930,206 19,904,397 20,404,828
Diluted earnings (loss) per
share........................... 16,739,028 20,364,229 19,930,206 19,904,397 20,404,828
(*)Allocation of stock compensation
expense
Cost of revenues -- professional
services.......................... -- -- -- -- 420,617
Sales and marketing................. -- -- -- -- 862,821
General and administrative.......... -- -- 18,921 -- 942,922
</TABLE>
See accompanying Notes to Financial Statements.
F-4
<PAGE> 75
EMERALD -- DELAWARE, INC.
STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
FISCAL YEARS ENDED DECEMBER 27, 1997, DECEMBER 26, 1998 AND DECEMBER 25, 1999
AND
SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000
<TABLE>
<CAPTION>
TOTAL
COMMON STOCK ADDITIONAL STOCK STOCKHOLDERS'
-------------------- PAID-IN DEFERRED SUBSCRIPTIONS ACCUMULATED EQUITY
SHARES AMOUNT CAPITAL COMPENSATION RECEIVABLE DEFICIT (DEFICIT)
---------- ------- ----------- ------------ ------------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balances at beginning of
period........................ 10,300,000 $10,300 $ 2,049,700 $ -- $(2,060,000) $ -- $ --
Sale of common stock........... 7,786,957 7,787 2,746,697 -- (2,754,484) -- --
Payment of stock subscriptions
receivable.................... -- -- -- -- 4,618,899 -- 4,618,899
Stock issued in acquisitions... 615,883 616 384,312 -- -- -- 384,928
Net loss....................... -- -- -- -- -- (3,853,045) (3,853,045)
---------- ------- ----------- ----------- ----------- ------------ -----------
Balances at December 27,
1997.......................... 18,702,840 18,703 5,180,709 -- (195,585) (3,853,045) 1,150,782
Sale of common stock........... 1,176,000 1,176 733,825 -- (95,250) -- 639,751
Payment of stock subscriptions
receivable.................... -- -- -- -- 194,665 -- 194,665
Stock repurchased.............. (432,000) (432) (270,788) -- -- -- (271,220)
Options exercised.............. 207,350 207 129,635 -- -- -- 129,842
Settlement of a liability with
common stock.................. 151,010 151 94,230 -- -- -- 94,381
Net income..................... -- -- -- -- -- 708,009 708,009
---------- ------- ----------- ----------- ----------- ------------ -----------
Balances at December 26,
1998.......................... 19,805,200 19,805 5,867,611 -- (96,170) (3,145,036) 2,646,210
Payment of stock subscriptions
receivable.................... -- -- -- -- 74,888 -- 74,888
Issuance of note receivable to
finance common stock
acquisitions.................. -- -- -- -- (200,000) -- (200,000)
Issuance of stock options...... -- -- 105,180 (105,180) -- -- --
Amortization of deferred
compensation.................. -- -- -- 18,921 -- -- 18,921
Options exercised.............. 206,766 207 99,363 -- -- -- 99,570
Stock issued for services
rendered...................... 5,000 5 19,995 -- -- -- 20,000
Accretion of redemption value
of redeemable convertible
preferred stock............... -- -- (691,535) -- -- -- (691,535)
Net loss....................... -- -- -- -- -- (5,425,183) (5,425,183)
---------- ------- ----------- ----------- ----------- ------------ -----------
Balances at December 25,
1999.......................... 20,016,966 20,017 5,400,614 (86,259) (221,282) (8,570,219) (3,457,129)
Sale of stock by principal
stockholder(unaudited)........ -- -- 949,825 -- -- -- 949,825
Issuance and modifications of
stock options (unaudited)..... -- -- 4,470,048 (4,600,581) -- -- (130,533)
Payment of stock subscriptions
receivable (unaudited)........ -- -- -- -- 4,538 -- 4,538
Amortization of deferred
compensation (unaudited)...... -- -- -- 1,049,210 -- -- 1,049,210
Options exercised
(unaudited)................... 227,092 227 179,729 -- -- -- 179,956
Stock issued in acquisition
(unaudited)................... 431,742 432 5,396,338 -- -- 5,396,770
Accretion of redemption value
of redeemable convertible
preferred stock (unaudited)... -- -- (626,752) -- -- -- (626,752)
Beneficial conversion feature
of Series B redeemable
convertible preferred stock
(unaudited)................... -- -- 1,840,000 -- -- -- 1,840,000
Recognition of beneficial
conversion feature of Series B
redeemable convertible
preferred stock (unaudited)... -- -- (1,840,000) -- -- -- (1,840,000)
Issuance of warrant to
AT&T (unaudited).............. -- -- 5,449,000 (5,449,000) -- -- --
Amortization of
AT&T warrant(unaudited)....... -- -- -- 753,902 -- -- 753,902
Net loss (unaudited)........... -- -- -- -- -- (9,201,581) (9,201,581)
---------- ------- ----------- ----------- ----------- ------------ -----------
Balances at June 24, 2000
(unaudited)................... 20,675,800 $20,676 $21,218,802 $(8,332,728) $ (216,744) $(17,771,800) $(5,081,794)
========== ======= =========== =========== =========== ============ ===========
</TABLE>
See accompanying Notes to Financial Statements.
F-5
<PAGE> 76
EMERALD -- DELAWARE, INC.
STATEMENTS OF CASH FLOWS
FISCAL YEARS ENDED DECEMBER 27, 1997, DECEMBER 26, 1998 AND DECEMBER 25, 1999
AND SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000
<TABLE>
<CAPTION>
FISCAL YEAR ENDED SIX MONTHS ENDED
------------------------------------------ -------------------------
DECEMBER 27, DECEMBER 26, DECEMBER 25, JUNE 26, JUNE 24,
1997 1998 1999 1999 2000
------------ ------------ ------------ ----------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating
activities:
Net income (loss)................. $(3,853,045) $ 708,009 $(5,425,183) $ (814,058) $(9,201,581)
Adjustments to reconcile net
income (loss) to net cash used
in operating activities:
Depreciation and amortization... 106,610 296,867 819,871 257,435 1,311,150
Loss on disposal of equipment... -- -- 40,013 -- --
Stock compensation expense...... -- -- 38,921 -- 2,980,262
Loss on investment in subsidiary
held for disposal............. 238,650 -- -- -- --
Changes in certain assets and
liabilities, net of
acquisition:
Accounts receivable........... (566,482) (1,409,480) (4,067,089) (2,671,365) (7,592,909)
Receivable from related
party....................... -- (54,947) (1,719,193) (645,069) 1,745,495
Prepaid expenses.............. (97,828) (143,672) (131,162) (1,815) (55,438)
Other assets.................. (80,577) (5,280) (233,684) (134,774) (730,408)
Accounts payable, accrued
compensation and other
accrued liabilities......... 1,271,255 40,592 3,905,103 1,620,270 4,384,245
Deferred revenue.............. 71,768 292,860 (907) (102,285) 492,788
----------- ----------- ----------- ----------- -----------
Net cash used in operating
activities................ (2,909,649) (275,051) (6,773,310) (2,491,661) (6,666,396)
----------- ----------- ----------- ----------- -----------
Cash flows from investing
activities:
Purchases of property and
equipment....................... (755,925) (1,028,939) (3,220,316) (1,481,283) (1,930,425)
Proceeds from disposition of
subsidiary...................... -- 472,413 -- -- --
Cash paid for acquisition......... (911,493) -- -- -- --
Cash obtained through
acquisition..................... 174,930 -- -- -- 103,595
----------- ----------- ----------- ----------- -----------
Net cash used in investing
activities.................. (1,492,488) (556,526) (3,220,316) (1,481,283) (1,826,830)
----------- ----------- ----------- ----------- -----------
Cash provided by financing
activities:
Bank overdrafts................... -- -- -- -- 914,664
Proceeds from issuance of common
stock........................... 4,618,899 639,751 -- -- --
Payment of stock subscriptions
receivable...................... -- 194,665 74,888 65,860 4,538
Proceeds from issuance of
preferred stock................. -- -- 6,515,887 6,515,887 5,000,000
Exercise of stock options......... -- 129,842 99,570 33,344 179,956
Proceeds from line of credit,
net............................. -- -- 5,000,000 300,000 1,195,108
Increase in other long-term
liabilities..................... -- 31,416 -- -- 47,228
Repayment of capital lease
obligations..................... (13,229) (64,897) (91,097) (34,156) (206,349)
Issuance of notes receivable to
finance common stock
acquisitions.................... -- -- (200,000) -- --
----------- ----------- ----------- ----------- -----------
Net cash provided by financing
activities.................. 4,605,670 930,777 11,399,248 6,880,935 7,135,145
----------- ----------- ----------- ----------- -----------
</TABLE>
F-6
<PAGE> 77
<TABLE>
<CAPTION>
FISCAL YEAR ENDED SIX MONTHS ENDED
------------------------------------------ -------------------------
DECEMBER 27, DECEMBER 26, DECEMBER 25, JUNE 26, JUNE 24,
1997 1998 1999 1999 2000
------------ ------------ ------------ ----------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net increase (decrease) in
cash and cash equivalents... 203,533 99,200 1,405,622 2,907,991 (1,358,081)
Cash and cash equivalents at
beginning of period............... -- 203,533 302,733 302,733 1,708,355
----------- ----------- ----------- ----------- -----------
Cash and cash equivalents at end of
period............................ $ 203,533 $ 302,733 $ 1,708,355 $ 3,210,724 $ 350,274
=========== =========== =========== =========== ===========
Supplemental disclosures of cash
flow information:
Cash paid during the period for
income taxes.................... $ -- $ 59,707 $ -- $ -- $ --
Cash paid during the period for
interest........................ -- -- 80,017 17,411 374,347
Supplemental schedule of noncash
investing and financing
activities:
Equipment acquired through capital
lease obligations............... 221,892 -- 321,930 -- 1,763,322
Common stock issued in
acquisitions.................... 384,928 -- -- -- 5,396,770
Notes payable issued in
acquisition..................... -- -- -- -- 1,350,000
Reacquisition of common stock in
conjunction with sale of
subsidiary...................... -- 271,220 -- -- --
Liability in connection with
restricted stock to be issued to
employees....................... -- -- -- -- 357,500
Recognition of beneficial
conversion feature of Series B
redeemable convertible preferred
stock........................... -- -- -- -- 1,840,000
Stock subscriptions receivable.... 195,585 95,250 -- -- --
Stock issued in settlement of a
liability....................... -- 94,381 -- -- --
Accretion of redemption value of
redeemable convertible preferred
stock........................... $ -- $ -- $ 691,535 $ 276,608 $ 626,752
</TABLE>
See accompanying Notes to Financial Statements.
F-7
<PAGE> 78
EMERALD -- DELAWARE, INC.
NOTES TO FINANCIAL STATEMENTS
FISCAL YEARS ENDED DECEMBER 27, 1997, DECEMBER 26, 1998 AND DECEMBER 25, 1999
AND SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 (INFORMATION AS OF AND FOR
THE SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 IS UNAUDITED)
(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) DESCRIPTION OF BUSINESS
Emerald -- Delaware, Inc. (formerly Emerald Solutions, Inc.) (the
"Company") was incorporated in Washington State in November 1996, with
substantive operations beginning in January 1997. During 1999, the Company was
reincorporated in the State of Delaware. The Company is a professional services
firm that delivers comprehensive digital solutions that may include strategic
consulting, creative design, software development, web integration, and
information technology planning. The Company delivers solutions through locally
based client management teams that can draw upon the expertise of national
practices which specialize in specific industries or specific solution
capabilities.
(b) BASIS OF PRESENTATION
The Company's fiscal year ends on the last Saturday in December. Fiscal
years 1997, 1998 and 1999 included 52 weeks.
Fiscal year 1997 includes the accounts of the Company and its subsidiary,
ServerLogic Corporation ("ServerLogic"), which was disposed of in 1998.
The six months ended June 26, 1999 and June 24, 2000 included 26 weeks. On
March 25, 2000, the Company completed its acquisition of ZCom Incorporated
("ZCom"). The balances at June 24, 2000 include the accounts of the Company and
ZCom.
(c) REVENUE RECOGNITION
The Company delivers services under fixed-fee and time-and-materials
contracts. Revenues earned under fixed-fee contracts are generally recognized as
services are rendered, using the percentage-of-completion method of accounting
(measured as the ratio of hours worked to date to the estimated total hours at
completion). Any estimated losses on projects in progress are recognized in
their entirety in the period such losses become known. Revenues earned under
time-and-materials contracts are generally recognized as services are provided.
Revenues earned in excess of billings represent revenue recognized in advance of
amounts billed and are included in trade accounts receivable. Billings in excess
of revenues earned are classified as deferred revenues. Revenue excludes
reimbursed expenses charged to and collected from clients.
(d) CASH EQUIVALENTS
The Company considers all highly liquid investments with an original
maturity of three months or less when purchased to be cash equivalents. Cash
equivalents primarily consist of amounts held in money market funds.
F-8
<PAGE> 79
EMERALD -- DELAWARE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FISCAL YEARS ENDED DECEMBER 27, 1997, DECEMBER 26, 1998 AND DECEMBER 25, 1999
AND SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 (INFORMATION AS OF AND FOR
THE SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 IS UNAUDITED)
(e) PROPERTY AND EQUIPMENT
Property and equipment are stated at cost and are depreciated using the
straight-line method over estimated useful lives of 3 to 10 years. Leasehold
improvements are amortized over the lesser of the lease term or estimated useful
lives.
The Company periodically assesses the recoverability of long-lived assets.
Recoverability of assets to be held and used is measured by a comparison of the
carrying amount of an asset to net cash flows expected to be generated by the
asset. If such assets are considered to be impaired, the impairment to be
recognized is measured as the amount by which the carrying amount of the assets
exceeds their fair value. Assets to be disposed of are reported at the lower of
the carrying amount or the fair value less costs to sell.
(f) INCOME TAXES
Income taxes are stated using the asset and liability method. The asset and
liability method requires recognition of deferred tax assets and liabilities,
for differences between the financial statement and tax basis of existing assets
and liabilities and tax carryforwards and tax credits measured using the enacted
tax rates and laws expected to apply in the years in which those differences are
expected to be recovered or settled. Valuation allowances are established when
necessary to reduce deferred tax assets to the amount expected to be realized.
The effect on deferred tax assets and liabilities of a change in tax rate is
recognized in results of operations in the period that includes the enactment
date.
(g) STOCK-BASED COMPENSATION
The Company has elected to follow Accounting Principles Board Opinion No.
25, Accounting for Stock Issued to Employees (APB 25), and related
interpretations, in accounting for its employee stock options rather than the
alternative fair value accounting allowed by Statement of Financial Accounting
Standards No. 123, Accounting for Stock Based Compensation (SFAS No. 123).
Compensation cost for stock options issued to employees is measured as the
excess, if any, of the fair market price of the Company's stock at the date of
grant over the amount an employee must pay to acquire the stock. Pro forma
results are presented as if compensation cost for stock options issued to
employees had been determined pursuant to SFAS No. 123.
(h) NET EARNINGS (LOSS) PER SHARE
Basic net earnings (loss) per share is computed by dividing net income
(loss) applicable to common stockholders by the weighted average number of
common shares outstanding for the period. Diluted net earnings (loss) per share
is computed by dividing net income (loss) applicable to common stockholders by
the weighted average number of common and dilutive common equivalent shares
deemed to be outstanding during the period. Net income (loss) applicable to
common stockholders consists of net income (loss) as adjusted for the impact of
accretion of redeemable convertible preferred stock to its redemption value and
for the effect of the beneficial conversion feature of redeemable convertible
preferred stock. The calculation of
F-9
<PAGE> 80
EMERALD -- DELAWARE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FISCAL YEARS ENDED DECEMBER 27, 1997, DECEMBER 26, 1998 AND DECEMBER 25, 1999
AND SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 (INFORMATION AS OF AND FOR
THE SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 IS UNAUDITED)
diluted net income (loss) per share excludes potential common shares if the
effect is antidilutive.
(i) INTANGIBLE AND OTHER ASSETS
Intangible assets consist of goodwill, which represents costs in excess of
the fair value of the net assets acquired and other identifiable intangibles.
Other intangibles include acquired workforce and customer lists and are valued
principally using the replacement cost method or income method. Other assets
include professional fees in connection with the Alliance Consulting Group, Inc.
acquisition which was completed in July 2000, and deferred costs related to the
Company's July 2000 Series C financing and its proposed Initial Public Offering
("IPO"). Intangible assets are amortized on a straight-line basis generally
ranging from two to four years. The Company assesses the recoverability of
intangible assets by determining whether the amortization of the intangible
balance over its remaining life can be recovered through undiscounted future
cash flows. The amount of intangible asset impairment, if any, is measured based
on projected discounted future operating cash flows using a discount rate
reflecting the Company's average cost of funds. The assessment of the
recoverability of the intangible assets will be impacted if estimated future
operating cash flows are not achieved.
(j) RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current
year presentation.
(k) 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.
(l) SEGMENT INFORMATION
Revenues consist almost entirely of fees received for professional
services. The Company organizes its information reporting by geographical
location and by management responsibility for client projects. Since inception,
the Company has operated in a single business segment providing comprehensive
digital solutions within the United States. Expenses incurred are reported
according to their expense category. No further segment segregation is
considered meaningful at this time.
(m) FINANCIAL INSTRUMENTS AND CONCENTRATIONS OF CREDIT RISK
Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of cash equivalents and accounts
receivable. The fair value of the Company's financial instruments approximates
their financial statement carrying amount. The financial
F-10
<PAGE> 81
EMERALD -- DELAWARE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FISCAL YEARS ENDED DECEMBER 27, 1997, DECEMBER 26, 1998 AND DECEMBER 25, 1999
AND SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 (INFORMATION AS OF AND FOR
THE SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 IS UNAUDITED)
instruments have a short term until maturity or settlement in cash and therefore
the carrying value approximates fair value. Accounts receivable are typically
unsecured and are derived from revenue earned from clients located in the United
States. The Company's customers include, in part, emerging high-growth and
Internet companies. Some of these companies may be subject to evolving, volatile
market conditions that can lead to financial instability. The Company mitigates
credit risk from these and other companies by initial and ongoing credit
evaluation procedures however, given the inherent nature of the underlying
markets these emerging companies operate within, the Company may be subject to
credit losses and, in the event of customer bankruptcy, issues relating to
regulatory and legal proceedings outside of the Company's control.
The Company records an allowance for potential credit losses based on
ongoing credit evaluations of its clients' financial condition and records
potential credit losses based upon the expected collectibility of total accounts
receivable.
Through 1999, the Company had not experienced any material credit losses.
The Company increased its provision for doubtful accounts to approximately 4% of
revenue for the six months ended June 24, 2000.
The Company derives a significant portion of its revenues from projects with a
limited number of clients. The following customers represent 10% or more of the
Company's revenues during the years ended December 27, 1997, December 26, 1998
and December 25, 1999 and the six months ended June 26, 1999 and June 24, 2000:
<TABLE>
<CAPTION>
CUSTOMER ACCOUNTS
CUSTOMER AS A % OF RECEIVABLE AS A % OF TRADE
CUSTOMER REVENUE ACCOUNTS RECEIVABLE
-------- ------------------ ---------------------------
<S> <C> <C>
FISCAL YEAR
1997:
A.......................... 71% 25%
B.......................... 10 23
1998:
A.......................... 18 8
C.......................... 25 23
D.......................... 13 22
E.......................... 13 13
1999:
C.......................... 35 22
SIX MONTHS ENDED JUNE 26,
1999:
C.......................... 41 47
SIX MONTHS ENDED JUNE 24,
2000:
C.......................... 15 1
</TABLE>
F-11
<PAGE> 82
EMERALD -- DELAWARE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FISCAL YEARS ENDED DECEMBER 27, 1997, DECEMBER 26, 1998 AND DECEMBER 25, 1999
AND SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 (INFORMATION AS OF AND FOR
THE SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 IS UNAUDITED)
(n) RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board issued Statement No. 133,
Accounting for Derivative Instruments and Hedging Activities in June 1998. 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. If certain conditions are met, a derivative may
be specifically designated as a hedge. The accounting for changes in the fair
value of a derivative depends on the intended use of the derivative and the
resulting designation. SFAS No. 133, as amended by SFAS 137, is effective for
all fiscal quarters of fiscal years beginning after June 15, 2000. The adoption
of this statement is not expected to have a material impact on our financial
statements.
In December 1999, the SEC released Staff Accounting Bulletin No. 101
"Revenue Recognition in Financial Statements," which we adopted December 26,
1999. SAB 101 provides guidance on revenue recognition issues. While SAB 101 did
not have a material impact on our financial statements, there continue to be
implementation questions and supplemental issuances of interpretive guidance by
the staff of the Securities and Exchange Commission which may have future
impact.
In March 2000, the Financial Accounting Standards Board issued FASB
Interpretation No. 44, Accounting for Certain Transactions Involving Stock
Compensation, an Interpretation of APB opinion No. 25. The Interpretation
clarifies the application of APB opinion No. 25, Accounting for Stock Issued to
Employees for certain issues. The provisions of the Interpretation are effective
July 1, 2000. The Company does not expect implementation of Interpretation No.
44 will have a material impact on its financial statements.
(o) INITIAL PUBLIC OFFERING AND UNAUDITED PRO FORMA BALANCE SHEET
In January 2000, the board of directors authorized the filing of a
registration statement with the SEC that would permit the Company to sell shares
of the Company's common stock in connection with a proposed IPO.
If the offering is consummated under the terms presently anticipated, each
of the outstanding shares of the Company's Series A and Series B redeemable
convertible preferred stock will automatically convert into 0.4 shares of common
stock and each share of Series C redeemable convertible preferred stock will
automatically convert into one share of common stock upon closing of the
proposed IPO. The following has been reflected in the accompanying unaudited pro
forma balance sheet as if it had occurred as of June 24, 2000:
- The issuance of 2,318,392 shares of Series C redeemable convertible
preferred stock in July 2000;
- The automatic conversion of the Series A, B, and C redeemable convertible
preferred stock upon completion of the proposed IPO; and
F-12
<PAGE> 83
EMERALD -- DELAWARE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FISCAL YEARS ENDED DECEMBER 27, 1997, DECEMBER 26, 1998 AND DECEMBER 25, 1999
AND SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 (INFORMATION AS OF AND FOR
THE SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 IS UNAUDITED)
- The effect of the acquisition of Alliance, which includes the issuance of
2,585,780 shares of common stock, as well as cash consideration,
acquisition costs, issuance of a promissory note and the assumption of
liabilities totaling $8,800,000.
(p) UNAUDITED INTERIM FINANCIAL STATEMENTS
In the opinion of the Company's management, the June 26, 1999 and June 24,
2000 unaudited interim financial statements include all adjustments, consisting
of normal recurring adjustments, necessary for a fair presentation.
(2) ACCOUNTS RECEIVABLE
Trade accounts receivable at December 26, 1998, December 25, 1999 and June
24, 2000 consist of the following:
<TABLE>
<CAPTION>
1998 1999 2000
---------- ---------- -----------
<S> <C> <C> <C>
Trade accounts receivable..... $1,673,398 $4,649,471 $ 7,887,468
Revenues earned in excess of
billings.................... 544,228 1,835,243 6,604,525
---------- ---------- -----------
2,217,626 6,484,714 14,491,993
Less allowance for doubtful
accounts.................... 50,000 249,999 517,704
---------- ---------- -----------
Trade accounts
receivable, net... $2,167,626 $6,234,715 $13,974,289
========== ========== ===========
</TABLE>
At December 26, 1998, the Company had $42,391 in accounts receivable and
$12,556 in revenues earned in excess of billings related to Greens.com. At
December 25, 1999, the Company had $857,545 in accounts receivable and $916,595
in revenues earned in excess of billings related to Greens.com. At June 24,
2000, the Company had $28,645 in accounts receivable and $0 in revenues in
excess of billings related to Greens.com. Steven Darrow, former Chairman of the
Company, was chairman of Greens.com during 1999. Mr. Darrow has signed a
personal guaranty on the repayment of all Greens.com accounts receivable and
revenues earned in excess of billings up to $4,500,000. The Company's board of
directors approved the contracts with Greens.com prior to their execution. All
balances due from Greens.com as of December 25, 1999 were collected in February
2000.
Included in revenues for the years ended December 27, 1997, December 26,
1998 and December 25, 1999 is approximately $0, $55,000 and $3,384,000,
respectively, and for the six months ended June 26, 1999 and June 24, 2000 is
approximately $1,110,000 and $2,234,000, respectively, of services fees charged
to Greens.com.
F-13
<PAGE> 84
EMERALD -- DELAWARE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FISCAL YEARS ENDED DECEMBER 27, 1997, DECEMBER 26, 1998 AND DECEMBER 25, 1999
AND SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 (INFORMATION AS OF AND FOR
THE SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 IS UNAUDITED)
(3) PROPERTY AND EQUIPMENT AND INTANGIBLES
Property and equipment, net, at December 26, 1998, December 25, 1999 and
June 24, 2000 consists of the following:
<TABLE>
<CAPTION>
1998 1999 2000
---------- ---------- -----------
<S> <C> <C> <C>
Office furniture.................................. $ 352,863 $ 706,102 $ 1,304,816
Computer equipment................................ 1,061,244 3,034,879 4,888,616
Computer software................................. 364,272 1,027,163 2,176,931
Leasehold improvements............................ 228,378 718,116 1,027,497
---------- ---------- -----------
2,006,757 5,486,260 9,397,860
Less accumulated depreciation and amortization.... 318,668 1,032,628 1,889,167
---------- ---------- -----------
Property and equipment, net............. $1,688,089 $4,453,632 $ 7,508,693
========== ========== ===========
</TABLE>
Depreciation and amortization of property and equipment was $45,015,
$273,653 and $736,690 for the years ended December 27, 1997, December 26, 1998
and December 25, 1999, respectively, and $257,435 and $858,686 for the six
months ended June 26, 1999 and June 24, 2000, respectively.
Included in office furniture and computer equipment is the gross amount of
furniture, computer equipment and related accumulated amortization recorded
under capital leases at December 26, 1998, December 25, 1999, and June 24, 2000
as follows:
<TABLE>
<CAPTION>
1998 1999 2000
-------- -------- ----------
<S> <C> <C> <C>
Office furniture....................................... $221,892 $208,662 $ 433,662
Computer equipment..................................... -- 321,930 1,860,252
-------- -------- ----------
221,892 530,592 2,293,914
Less accumulated amortization.......................... 69,554 147,601 423,571
-------- -------- ----------
$152,338 $382,991 $1,870,343
======== ======== ==========
</TABLE>
Intangibles, net at December 26, 1998, December 25, 1999 and June 24, 2000
consist of the following:
<TABLE>
<CAPTION>
1998 1999 2000
------- ------- ----------
<S> <C> <C> <C>
Workforce in place.................................... $ -- $ -- $ 148,000
Customer value........................................ -- -- 92,000
Goodwill.............................................. -- -- 6,944,428
------- ------- ----------
-- -- 7,184,428]
Less accumulated amortization......................... -- -- (452,464)
------- ------- ----------
Intangibles, net............................ $ -- $ -- $6,731,964
======= ======= ==========
</TABLE>
Amortization expense excluding other assets totaled $40,339 for the year
ended December 27, 1997 and $452,464 for the six months ended June 24, 2000.
There was no amortization expense for the years ended December 26, 1998 and
December 25, 1999 nor for the six months ended June 26, 1999.
F-14
<PAGE> 85
EMERALD -- DELAWARE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FISCAL YEARS ENDED DECEMBER 27, 1997, DECEMBER 26, 1998 AND DECEMBER 25, 1999
AND SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 (INFORMATION AS OF AND FOR
THE SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 IS UNAUDITED)
(4) LINE OF CREDIT
At December 26, 1998 the Company had an operating line of credit with a
bank, which provided for up to the lesser of $2,000,000 or 70% of eligible
accounts receivable at a borrowing rate of 0.65% above the bank's prime rate.
During fiscal year 1999, the line of credit was replaced with a revolving credit
facility with the same bank which provides for borrowings of up to the lesser of
$5,000,000 or 85% of eligible accounts receivable. Borrowings under this credit
facility bear interest at the bank's prime rate plus 2.25% (10.75% at December
25, 1999 and 10% at June 26, 1999) and are secured by substantially all Company
assets. At December 25, 1999 amounts borrowed under this facility were
$5,000,000. In connection with the facility, the bank requires the maintenance
of certain financial covenants. The Company cancelled this facility in March,
2000 and replaced it with a new line of credit arrangement with a different
bank.
The new line of credit agreement provides for borrowings of up to the
lesser of $7,000,000 or 85% of eligible accounts receivable and 50% of eligible
unbilled accounts receivable. Borrowings under this credit facility bear
interest at the bank's prime rate plus 1.75% (11.75% at June 24, 2000) and are
secured by substantially all Company assets. In connection with the facility,
the bank requires the maintenance of certain financial covenants. The credit
arrangement has a maturity date of March 29, 2001. The Company may not pay
dividends without the consent of the bank.
(5) LEASES
The Company leases office space and equipment under long-term
non-cancelable operating and capital leases. Future minimum lease payments under
non-cancelable operating and capital leases at December 25, 1999 are as follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
-------- -----------
<S> <C> <C>
2000................................................... $194,856 $ 2,375,890
2001................................................... 117,454 2,393,691
2002................................................... 107,667 1,841,855
2003................................................... -- 1,003,327
2004................................................... -- 976,177
Thereafter............................................. -- 2,432,407
-------- -----------
Total minimum lease payments................. 419,977 $11,023,347
===========
Amounts due under non-cancelable subleases............. $ 401,476
===========
Less amounts representing interest at 9% to 10%........ 45,378
--------
Present value of future minimum lease
payments................................... 374,599
Less current portion of capital lease obligations...... 163,882
--------
Long-term capital lease obligations,
excluding current portion.................. $210,717
========
</TABLE>
Total rent expense for operating leases during the years ended December 27,
1997, December 26, 1998 and December 25, 1999 amounted to approximately
$155,000, $774,000
F-15
<PAGE> 86
EMERALD -- DELAWARE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FISCAL YEARS ENDED DECEMBER 27, 1997, DECEMBER 26, 1998 AND DECEMBER 25, 1999
AND SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 (INFORMATION AS OF AND FOR
THE SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 IS UNAUDITED)
and $1,379,661, respectively, and $437,366 and $1,395,520 for the six months
ended June 26, 1999 and June 24, 2000, respectively.
(6) REDEEMABLE CONVERTIBLE PREFERRED STOCK
(a) In February 1999, the Company issued 13,333,334 shares of redeemable
convertible preferred stock (Series A Preferred Stock) at $0.525 per share for
net proceeds totaling $6,515,887, net of issuance costs of $484,113.
A summary of the significant terms of the Series A Preferred Stock is as
follows:
Conversion
Each share of Series A Preferred Stock can be converted at the option of
the holder at any time after issuance according to a conversion ratio, subject
to adjustment for dilution. The initial conversion ratio is determined by
dividing the original issue price of $0.525 by the conversion price in effect at
the time the shares are converted. The conversion price is the original issue
price adjusted for subsequent equity adjustments. Each share of Series A
Preferred Stock automatically converts into the number of shares of common stock
into which such shares are convertible at the then effective conversion ratio,
upon the closing of a public offering of common stock at a per share price of at
least $3.94 per share with gross proceeds of at least $20,000,000. In addition,
each share of Series A Preferred Stock shall automatically convert into shares
of common stock upon the date specified by vote or written consent or agreement
of holders of a majority of the outstanding shares of Series A Preferred Stock.
Redemption
At the election of the holders of at least a majority of the outstanding
shares of Series A Preferred Stock on or any time after November 1, 2002, the
Company will redeem the Series A Preferred Stock in two equal consecutive
installments. The first redemption date shall be within 120 days following the
date of the redemption election, and the second redemption date shall occur on
the first anniversary of the first redemption date. The redemption price shall
equal the original issue price per share, plus all declared but unpaid
dividends, plus an amount that will return a 10% internal rate of return
calculated upon the original issue price over and above all declared dividends
on such shares.
The Company accounts for the difference between the carrying amount of
redeemable preferred stock and the redemption amount by increasing the carrying
amount for periodic accretion using the interest method, so that the carrying
amount will equal the redemption amount at the redemption date.
Voting
Each share of Series A Preferred Stock has voting rights equal to common
stock into which it is convertible on the record date of the vote. Holders of
common stock are entitled to vote as a separate class for any remaining
directors.
F-16
<PAGE> 87
EMERALD -- DELAWARE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FISCAL YEARS ENDED DECEMBER 27, 1997, DECEMBER 26, 1998 AND DECEMBER 25, 1999
AND SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 (INFORMATION AS OF AND FOR
THE SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 IS UNAUDITED)
Dividends
Holders of Series A Preferred Stock are entitled to receive noncumulative
dividends at the per annum rate of 8% of the original issue price per share when
and if declared by the board of directors. The board of directors has not
declared any dividends as of December 25, 1999. In the event of a conversion of
the Series A Preferred Stock, any declared and unpaid dividends shall be paid at
the election of the holder in cash or common stock at its then fair market
value. If dividends or other distributions are paid on the common stock, the
holders of Series A Preferred Stock are entitled to the preferential dividends
above and are entitled to per share dividends equal to those declared or paid to
holders of common stock.
Liquidation
In the event of liquidation, dissolution or winding up of the Company,
either voluntary or involuntary, holders of Series A Preferred Stock are
entitled to receive, prior to the distribution of any Company assets, an amount
of $0.525 per share in addition to any declared but unpaid dividends. If the
assets of the Company are insufficient to permit payment to the holders of
Series A Preferred Stock, then the entire assets and funds of the Company
legally available for distribution shall be distributed ratably between holders
of Series A Preferred Stock in proportion to the product of the liquidation
preference of each such share and the number of such shares owned by each
holder.
After the original liquidation distribution has been paid to the holders of
Series A Preferred Stock, the remaining assets of the corporation shall be
distributed among the holders of the common stock and Series A Preferred Stock
on an as-converted basis, until the holders of Series A Preferred Stock receive
assets valued at 4.5 times the original Series A Preferred Stock price per
share. Any remaining assets will be distributed pro-rata solely to holders of
common stock.
(b) In February 2000, the Company amended its articles of incorporation and
designated 2,000,000 of its preferred shares as Series B redeemable convertible
preferred stock (Series B Preferred Stock). Also, in February 2000, the Company
entered into agreements to sell 2,000,000 shares of Series B Preferred Stock for
$5.0 million. The shares of Series B Preferred Stock have similar rights and
preferences as the shares of Series A Preferred Stock except they are
non-voting, the initial conversion ratio is based on the original issue price of
$2.50 per share, and the liquidation price is $3.50 per share for the first
twelve months after issuance and $4.50 per share thereafter. In addition, the
Series B Preferred Stockholders will have the right to convert their shares into
Series B-1 voting preferred stock upon certain regulatory approvals. The Series
B-1 preferred stock will have identical rights as the Series B Preferred Stock
except it will also have voting rights. The 2,000,000 shares of Series B
Preferred Stock were issued with a beneficial conversion feature, which was
valued at approximately $1.8 million. In accordance with EITF 95-8, the
beneficial conversion feature was based on the intrinsic value and calculated as
the difference between the conversion price and the fair value of the common
stock into which the preferred stock is convertible. It was recognized at the
time of issuance because the preferred stock was immediately convertible into
common stock. This amount is accounted for as an increase in additional paid-in
capital and preferred stock and an in substance dividend to the preferred
stockholders in the first quarter of 2000 and, accordingly, increases the loss
applicable to common stockholders by approximately $1.8 million.
F-17
<PAGE> 88
EMERALD -- DELAWARE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FISCAL YEARS ENDED DECEMBER 27, 1997, DECEMBER 26, 1998 AND DECEMBER 25, 1999
AND SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 (INFORMATION AS OF AND FOR
THE SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 IS UNAUDITED)
(7) STOCKHOLDERS' EQUITY (DEFICIT)
(a) STOCK SUBSCRIPTIONS RECEIVABLE
The Company had common stock subscriptions receivable totaling $96,170,
$221,282 and $216,744 at December 26, 1998, December 25, 1999 and June 24, 2000,
respectively. The receivables at December 25, 1999 and June 24, 2000 primarily
are collateralized by the stock, bear interest at 5.82% and are due in 2004.
Additionally, the agreements provide for full recourse against the holder.
On July 30, 1999, a principal stockholder of the Company sold 133,333
shares of common stock to two executives at fair market value. The purchase of
the common stock was facilitated through two loans by the Company to the
employees totaling $200,000. The notes are due on July 30, 2004, and are secured
by the 133,333 shares of stock sold to the employees. The notes are full
recourse and bear interest at a rate of 5.82%. The balance of the receivables at
December 25, 1999 and June 24, 2000 was $200,000 and is recorded under stock
subscriptions receivable.
(b) EARNINGS (LOSS) PER SHARE
The following table reconciles the Company's reported net income (loss) to
net income (loss) applicable to common stockholders used to compute basic and
diluted earnings (loss) per share for the years ended December 27, 1997,
December 26, 1998 and December 25, 1999 and the six months ended June 26, 1999
and June 24, 2000:
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS ENDED
--------------------------------------- ---------------------------
1997 1998 1999 1999 2000
----------- ----------- ----------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Net income (loss)................................. $(3,853,045) $ 708,009 $(5,425,183) $ (814,058) $ (9,201,581)
Accretion of redemption value of redeemable
convertible preferred stock...................... -- -- 691,535 276,608 626,752
Effect of beneficial conversion feature of Series
B Preferred Stock................................ -- -- -- -- 1,840,000
----------- ----------- ----------- ------------ ------------
Net income (loss) applicable to common
stockholders..................................... $(3,853,045) $ 708,009 $(6,116,718) $ (1,090,666) $(11,668,333)
=========== =========== =========== ============ ============
Shares used to calculate basic earnings (loss) per
share............................................ 16,739,028 19,488,361 19,930,206 19,904,397 20,404,828
Basic earnings (loss) per share................... $ (0.23) $ 0.04 $ (0.31) $ (0.05) $ (0.57)
=========== =========== =========== ============ ============
Dilutive effect of stock options.................. -- 875,868 -- -- --
Shares used to calculate dilutive earnings (loss)
per share........................................ 16,739,028 20,364,229 19,930,206 19,904,397 20,404,828
Diluted earnings (loss) per share................. $ (0.23) $ 0.03 $ (0.31) $ (0.05) $ (0.57)
=========== =========== =========== ============ ============
</TABLE>
F-18
<PAGE> 89
EMERALD -- DELAWARE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FISCAL YEARS ENDED DECEMBER 27, 1997, DECEMBER 26, 1998 AND DECEMBER 25, 1999
AND SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 (INFORMATION AS OF AND FOR
THE SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 IS UNAUDITED)
The computation of diluted earnings (loss) per share excludes the following
options to acquire shares of common stock for the years ended December 27, 1997,
December 26, 1998 and December 25, 1999 and the six months ended June 26, 1999
and June 24, 2000 because the effect would be antidilutive:
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS ENDED
--------------------------------------- -------------------------
1997 1998 1999 1999 2000
----------- ----------- ----------- ---------- ------------
<S> <C> <C> <C> <C> <C>
Shares of common stock............................... 1,960,280 1,540,280 5,646,744 4,491,389 6,576,198
----------- ----------- ----------- ---------- ------------
Weighted average exercise price per share............ $ 0.38 $ 0.88 $ 1.10 $ 0.71 $ 2.08
</TABLE>
The computation of diluted earnings (loss) per share during the year ended
December 25, 1999 and the six months ended June 24, 2000 excluded 5,333,332 and
6,133,332 shares issuable upon conversion of redeemable convertible preferred
stock, respectively, because the effect would be antidilutive. In addition, the
computation of diluted loss per share during the six months ended June 24, 2000,
excludes a warrant to acquire 600,000 shares of common stock because the effect
would be antidilutive.
(c) AT&T STRATEGIC ALLIANCE
In March 2000, the Company entered into a strategic alliance with AT&T
Solutions to take advantage of both companies' sales channels and combined
business expertise in the area of e-business solutions. As part of the
agreement, the Company granted AT&T a warrant to purchase up to 600,000 shares
of common stock, 40,000 of which were immediately exercisable at a price of
$6.25 and the remainder of which are exercisable at the fair market value of our
common stock on August 1, 2000. The warrant was immediately vested on the date
of grant in that it is not subject to forfeiture for any reason. 560,000 shares
subject to the warrant will become exercisable after seven years or, upon
achievement of certain performance thresholds, on the first and second
anniversary of the grant. In order to accelerate the exercisability of its
warrant, AT&T must direct a minimum of $12 million of revenues to the Company
prior to the first anniversary of the grant or $30 million prior to the second
anniversary. Once a threshold has been met, then the AT&T warrant becomes
exercisable ratably based on the proportion the revenue generated by this
relationship within the two-year period ended March 14, 2002, bears to $84
million. The examples below are for illustrative purposes only:
<TABLE>
<CAPTION>
THEN THE AGGREGATE NUMBER OF
SHARES SUBJECT TO THE
IF REVENUES DIRECTED AT&T WARRANT
TO THE COMPANY BY AT&T ARE THAT WOULD ACCELERATE WOULD BE
-------------------------- -----------------------------------
<C> <S> <C>
$12 million ................... 80,000
30 million ................... 200,000
48 million ................... 320,000
66 million ................... 440,000
84 million ................... 560,000
</TABLE>
Although the agreement does not require AT&T to make any performance
commitments and the warrants are not subject to forfeiture for any reason, the
Company expects to recognize a non-cash expense equal to the fair value of the
warrant of approximately $5.4 million ratably
F-19
<PAGE> 90
EMERALD -- DELAWARE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FISCAL YEARS ENDED DECEMBER 27, 1997, DECEMBER 26, 1998 AND DECEMBER 25, 1999
AND SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 (INFORMATION AS OF AND FOR
THE SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 IS UNAUDITED)
over the two-year period of the arrangement. Approximately $754,000 has been
included in cost of revenues -- AT&T warrant for the six months ended June 24,
2000.
The fair value of the warrant was based on an option pricing model and the
following assumptions:
<TABLE>
<S> <C>
Stock price............................................... $12.50
Exercise price............................................ $6.25 - $12.50
Volatility................................................ 60%
Term...................................................... 2 - 9 years
Risk-free rate............................................ 6.5%
</TABLE>
(8) INTEREST INCOME AND EXPENSE, NET
Net other expense for the years ended December 27, 1997, December 26, 1998
and December 25, 1999 and the six months ended June 26, 1999 and June 24, 2000
consists of the following:
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS ENDED
------------------------------------ --------------------
1997 1998 1999 1999 2000
-------- ----------- ----------- -------- ---------
<S> <C> <C> <C> <C> <C>
Interest income............................................. $ -- $ 3,514 $ 103,588 $ 49,154 $ 63,067
Interest expense............................................ (37,306) (12,221) (123,594) (17,411) (401,347)
-------- ----------- ----------- -------- ---------
Net other (expense) income........................... $(37,306) $ (8,707) $ (20,006) $ 31,743 $(338,280)
======== =========== =========== ======== =========
</TABLE>
(9) INCOME TAXES
The Company had federal net operating loss carryforwards available to
offset future taxable income of approximately $2,855,000 and $7,129,000 at
December 26, 1998 and December 25, 1999, respectively. These operating loss
carryforwards expire in varying amounts beginning in 2017. The amount of
benefits from net operating loss carryforwards may be impaired or limited in
certain circumstances. Events which cause limitations in the amount of net
operating losses that the Company may utilize in any one year include, but are
not limited to, a cumulative ownership change of more than 50%, as defined, over
a three year period. Income tax expense (benefit) differs from "expected" income
tax expense (benefit) (computed by applying the U.S. federal income tax rate of
35%) as follows for the years ended December 27, 1997, December 26, 1998 and
December 25, 1999:
<TABLE>
<CAPTION>
1997 1998 1999
----------- --------- -----------
<S> <C> <C> <C>
Computed "expected" tax expense (benefit).... $(1,348,566) $ 268,701 $(1,910,854)
Meals and entertainment...................... 9,415 32,742 123,271
Other........................................ (27,376) 57,882 (5,246)
State income taxes........................... 527 29,902 (21,710)
Increase (decrease) in valuation allowance... 1,366,000 (329,520) 1,780,139
----------- --------- -----------
Tax expense (benefit).............. $ -- $ 59,707 $ (34,400)
=========== ========= ===========
</TABLE>
F-20
<PAGE> 91
EMERALD -- DELAWARE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FISCAL YEARS ENDED DECEMBER 27, 1997, DECEMBER 26, 1998 AND DECEMBER 25, 1999
AND SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 (INFORMATION AS OF AND FOR
THE SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 IS UNAUDITED)
There was no tax expense (benefit) for the six months ended June 26, 1999
and June 24, 2000.
The tax effects of temporary differences and operating loss carryforwards
that give rise to significant portions of deferred tax assets and liabilities at
December 26, 1998 and December 25, 1999 are as follows:
<TABLE>
<CAPTION>
1998 1999
----------- -----------
<S> <C> <C>
Deferred tax assets:
Deferred revenue.......................................... $ 131,363 $ 160,254
Capital loss carryforward................................. 143,101 143,101
Net operating loss carryforwards.......................... 999,126 2,495,296
Accrued liabilities....................................... 64,438 250,799
Other..................................................... 31,204 106,815
----------- -----------
Total gross deferred tax assets................... 1,369,232 3,156,265
Valuation allowance......................................... (1,036,480) (2,816,619)
----------- -----------
Net deferred tax assets........................... 332,752 339,646
----------- -----------
Deferred tax liabilities:
Depreciation and amortization............................. (137,878) (339,646)
Other..................................................... (194,874) --
----------- -----------
Total gross deferred tax liabilities.............. (332,752) (339,646)
----------- -----------
Net deferred taxes................................ $ -- $ --
=========== ===========
</TABLE>
Realization of deferred tax assets is contingent upon the generation of
future taxable income. Due to the uncertainty of realization of these deferred
tax assets, the Company has provided a valuation allowance to the extent its
deferred tax assets exceed its deferred tax liabilities.
(10) ACQUISITIONS
(a) ACQUISITION OF SERVERLOGIC CORPORATION
On September 8, 1997, the Company acquired from third parties all the
outstanding shares of common stock of ServerLogic, a Washington based provider
of PowerBuilder add-on products and client/server consulting solutions. The
Company was interested in ServerLogic's strategy and relationships focused on
certain industries that were complementary to the Company's. The purchase price
consisted of $900,000 in cash and 430,176 shares of common stock valued at
$268,861. The acquisition was recorded using the purchase method of accounting.
The purchase price of $1,168,861 was allocated to assets acquired and
liabilities assumed based on the fair value at the date of acquisition. The
excess of the purchase price over the fair value of the net identifiable assets
was recorded as goodwill in the amount of $920,000, and was being amortized on
the straight-line basis over ten years.
The Company advanced $60,000 to ServerLogic in September 1997. As a result,
in part, of the inability to expeditiously leverage and integrate ServerLogic's
industry relationships, the Company committed to a plan of action prior to
December 27, 1997, wherein they would sell
F-21
<PAGE> 92
EMERALD -- DELAWARE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FISCAL YEARS ENDED DECEMBER 27, 1997, DECEMBER 26, 1998 AND DECEMBER 25, 1999
AND SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 (INFORMATION AS OF AND FOR
THE SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 IS UNAUDITED)
all of the outstanding common stock of ServerLogic to three of the Company's
employee stockholders in exchange for $550,000 in cash, forgiveness of the
$60,000 advance, and 432,000 shares of Company stock, valued at $270,000, held
by such stockholders. The loss on investment in subsidiary held for disposal
includes the write-off of the unamortized goodwill acquired in the original
purchase transaction. The transaction was consummated on December 31, 1997.
The results of ServerLogic's operations from September 8, 1997 through
December 27, 1997, consisting of revenues of $483,909 and net loss of $170,211
are included in the Company's financial statements.
(b) ACQUISITION OF ZCom, INCORPORATED
On March 25, 2000, the Company completed the acquisition of ZCom,
Incorporated ("ZCom"), a consulting business offering Internet marketing
solutions, branding strategies, digital advertising and web design services.
Under terms of the acquisition, the Company issued 431,742 shares of its common
stock and notes payable totaling $1,350,000 in exchange for all outstanding
shares of ZCom's common stock. The notes bear interest at 8% per annum and are
due upon the earlier of March 25, 2001 or ten business days after the closing of
an IPO of the Company's common stock. The acquisition was accounted for using
the purchase method of accounting, and, accordingly, the results of ZCom's
operations are included in the Company's financial statements beginning March
25, 2000. The purchase price excludes performance-based contingent payments that
depend on achievement of minimum revenue thresholds and gross margin ratios. In
the year ending December 2000, if ZCom achieves:
-- a 45% gross margin and
-- revenues greater than $3,000,000,
then for each $100,000 of incremental revenue above $3,000,000, payments of
$90,000 will become due up to a maximum payout of $900,000, payable in common
stock or cash at the election of the former stockholders of ZCom. The contingent
amounts will be accounted for as compensation if paid because, to receive any
amounts, the stockholders must remain employees through December 2000.
A summary of the consideration paid for the acquisition and liabilities
assumed is as follows:
<TABLE>
<S> <C>
Stock issued................................................ $5,396,770
Notes payable issued........................................ 1,350,000
Direct acquisition costs.................................... 235,000
Accrued liabilities assumed................................. 790,953
----------
Total............................................. $7,772,723
==========
</TABLE>
F-22
<PAGE> 93
EMERALD -- DELAWARE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FISCAL YEARS ENDED DECEMBER 27, 1997, DECEMBER 26, 1998 AND DECEMBER 25, 1999
AND SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 (INFORMATION AS OF AND FOR
THE SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 IS UNAUDITED)
Such amounts were allocated as follows:
<TABLE>
<S> <C>
Cash acquired............................................... $ 103,595
Other current assets acquired............................... 149,526
Property and equipment and other non-current assets......... 335,174
Goodwill and other intangibles.............................. 7,184,428
----------
Total............................................. $7,772,723
==========
</TABLE>
Goodwill represents the excess of the purchase price over the fair value of
identifiable tangible and intangible assets acquired. Goodwill and identifiable
intangible assets are being amortized using the straight-line method over their
estimated lives of 2 to 4 years.
As part of employment agreements signed March 25, 2000 with employees of
ZCom, a deferred non-cash stock compensation charge of $358,000 was recorded in
association with 28,600 shares subject to repurchase rights. As of June 24,
2000, the shares had not been issued and the Company therefore has recorded a
liability for the value of the shares to be issued. The Company expects to
recognize compensation costs for the value of the shares over the associated two
year employment periods over which those shares vest.
In connection with the acquisition, 67,200 shares of common stock valued at
$840,000 were issued and placed in escrow to secure indemnification obligations
of former shareholders of ZCom. The shares can be released after 1 year.
Portions of the shares may be released earlier if certain share value thresholds
are met. The escrowed share amounts are included as part of the purchase price
consideration and will ultimately be released to the ZCom shareholders in the
event no indemnification obligations are identified.
(c) ACQUISITION OF ALLIANCE CONSULTING GROUP, INC. (UNAUDITED)
On July 26, 2000, the Company completed the acquisition of Alliance
Consulting Group, Inc. ("Alliance"), a consulting business with 36 employees
that provides strategy and management consulting services to large and small
businesses. Under the terms of the acquisition, the Company paid cash
consideration, incurred acquisition costs, issued a promissory note and assumed
liabilities totaling $8,800,000 and issued 1,364,738 shares of common stock and
441,224 vested shares of common stock under restricted stock agreements to
shareholders of Alliance. The Company also issued 779,818 unvested shares of
common stock under restricted stock plans for employees of Alliance. $1,055,000
in a promissory note that bears interest at 10% per annum is due upon the
earlier of December 26, 2001 or upon the closing of an IPO of the Company's
common stock. The acquisition was accounted for using the purchase method of
accounting. The Company is also obligated to pay up to $5.0 million in earn-out
payments to employees of Alliance in the event certain minimum revenue and gross
profit targets are met during the twelve month period following the closing of
the merger. The contingent amounts will be accounted for as compensation expense
as and to the extent the performance measures are met since continued employment
as well as the achievement of performance targets are required to be eligible to
earn the contingent payments.
F-23
<PAGE> 94
EMERALD -- DELAWARE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FISCAL YEARS ENDED DECEMBER 27, 1997, DECEMBER 26, 1998 AND DECEMBER 25, 1999
AND SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 (INFORMATION AS OF AND FOR
THE SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 IS UNAUDITED)
The results of Alliance's operations are included in the pro forma exhibit
and note 10(d) below.
(d) PRO FORMA RESULTS OF OPERATIONS -- ZCom AND ALLIANCE (UNAUDITED)
The following table presents pro forma results of operations as if the
acquisition of ZCom and Alliance had occurred as of the beginning of each of the
periods presented. The pro forma information is not necessarily indicative of
the combined results that would have occurred had the acquisitions taken place
at the beginning of 1999 or at the beginning of 2000, nor is it necessarily
indicative of results that may occur in the future.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED -------------------------
DECEMBER 25, JUNE 26, JUNE 24,
1999 1999 2000
------------ ----------- -----------
<S> <C> <C> <C>
Total net revenues............................. $41,722,548 $17,928,240 $38,219,074
Net income (loss).............................. (16,794,496) (6,925,547) (14,826,419)
Net income (loss) applicable to common (17,486,031)( (7,202,155) (17,293,171)
stockholders.................................
Net income (loss) per share applicable to
common stockholders:
Basic and diluted earnings (loss) per $ (0.78) $ (0.32) $ (0.77)
share.....................................
</TABLE>
(11) STOCK OPTION AND PURCHASE PLAN
(a) In 1997, the Company's board of directors and stockholders adopted and
approved the Emerald -- Delaware, Inc. 1997 Stock Incentive Compensation Plan
(the "1997 Plan"), which provides for the issuance of nonqualified and incentive
stock options to officers, directors, employees and consultants to acquire
shares of common stock. The exercise price for incentive stock options shall not
be less than the fair market value of the Company's common stock on the date of
grant and generally the options vest at 20% after the end of the first year and
ratably each month for the next four years.
In 1999, the Company's board of directors adopted and approved the 1999
Non-Employee Director Stock Option Plan (the "1999 Plan"), which provides for
the issuance of nonqualified stock options to non-employee directors to acquire
shares of common stock. The exercise price for stock options shall be 100% of
the fair market value of the Company's common stock on the date of grant and the
options generally vest ratably over the one to three year term of the
non-employee director.
All options under the 1997 and 1999 Plans expire 10 years from the date of
grant and revert back to the option pool if cancelled. The Company has reserved
7,600,000 shares of common stock for issuance under the 1997 Plan and 400,000
shares of common stock for issuance under the 1999 Plan.
F-24
<PAGE> 95
EMERALD -- DELAWARE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FISCAL YEARS ENDED DECEMBER 27, 1997, DECEMBER 26, 1998 AND DECEMBER 25, 1999
AND SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 (INFORMATION AS OF AND FOR
THE SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 IS UNAUDITED)
A summary of the Company's stock option activity is as follows:
<TABLE>
<CAPTION>
OUTSTANDING OPTIONS
-------------------------------------------
SHARES WEIGHTED
AVAILABLE NUMBER OF AVERAGE
FOR GRANT SHARES EXERCISE PRICE
----------- ---------- --------------
<S> <C> <C> <C>
Plan introduction............................ 6,000,000 -- $ --
Options granted.............................. (2,655,360) 2,655,360 0.35
Options forfeited............................ 695,080 (695,080) 0.28
----------- ----------
Balances at December 27, 1997................ 4,039,720 1,960,280 0.38
Options granted.............................. (2,721,790) 2,721,790 0.80
Options forfeited............................ 633,443 (633,443) 0.63
Options exercised............................ -- (207,350) 0.63
----------- ----------
Balances at December 26, 1998................ 1,951,373 3,841,277 0.63
Plan amendment and adoption.................. 2,000,000 -- --
Options granted.............................. (2,541,014) 2,541,014 1.70
Options forfeited............................ 528,781 (528,781) 0.88
Options exercised............................ -- (206,766) 0.48
----------- ----------
Balances at December 25, 1999................ 1,939,140 5,646,744 1.10
=========== ==========
Options granted.............................. (1,642,492) 1,642,492 5.39
Options forfeited............................ 485,946 (485,946) 2.52
Options exercised............................ -- (227,092) 0.79
----------- ----------
Balances at June 24, 2000.................... 782,594 6,576,198 $2.08
=========== ========== =====
</TABLE>
Options exercisable at December 27, 1997, December 26, 1998, December 25,
1999 and June 24, 2000 were 61,854, 698,424, 1,237,307 and 1,627,225
respectively.
Those individuals who purchased the outstanding stock of ServerLogic in
1997 became immediately vested in 180,000 employee stock options. No
compensation charge was recognized as the intrinsic value of the options was $0
at the time of this modification. Such individuals remain common stockholders of
the Company.
The following table summarizes information concerning currently outstanding
and exercisable options at December 25, 1999:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
EXERCISE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
PRICE OUTSTANDING LIFE PRICE EXERCISABLE PRICE
------------ ----------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$0.25 940,000 6.4 years $0.25 593,392 $0.25
0.63 - 0.88 3,039,784 8.7 years 0.80 621,415 0.73
1.25 - 1.88 1,199,930 9.6 years 1.40 22,500 1.50
3.68 - 4.00 467,030 9.9 years 3.93 -- --
---------- ---------
5,646,744 $1.10 1,237,307 $0.53
========== =========
</TABLE>
F-25
<PAGE> 96
EMERALD -- DELAWARE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FISCAL YEARS ENDED DECEMBER 27, 1997, DECEMBER 26, 1998 AND DECEMBER 25, 1999
AND SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 (INFORMATION AS OF AND FOR
THE SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 IS UNAUDITED)
Had compensation expense for the Company's stock option plans been
determined based on the fair value methodology under SFAS No. 123, the Company's
net income (loss) as reported for the years ended December 27, 1997, December
26, 1998 and December 25, 1999 would have been changed to the pro forma amounts
indicated in the table below.
<TABLE>
<CAPTION>
1997 1998 1999
----------- -------- -----------
<S> <C> <C> <C>
Net income (loss):
As reported............................. $(3,853,045) $708,009 $(5,425,183)
Pro forma............................... (3,959,565) 567,968 (5,866,046)
Net income (loss) applicable to common
stockholders:
As reported............................. $(3,853,045) $708,009 $(6,116,718)
Pro forma............................... (3,959,565) 567,968 (6,557,581)
Basic earnings (loss) per share:
As reported............................. $ (0.23) $ 0.04 $ (0.31)
Pro forma............................... $ (0.24) $ 0.03 $ (0.33)
Diluted earnings (loss) per share:
As reported............................. $ (0.23) $ 0.03 $ (0.31)
Pro forma............................... $ (0.24) $ 0.03 $ (0.33)
</TABLE>
The fair value of options granted was estimated using the minimum value
method. As a public entity, future fair value calculations for purposes of
disclosing SFAS No. 123 pro forma results are anticipated to be based on an
option valuation method that takes into account expected volatility. The
weighted average fair value of stock options granted where the exercise price
equaled the fair market value of the Common stock at time of grant was $0.08,
$0.18 and $0.35 per share during 1997, 1998 and 1999, respectively, using the
following assumptions:
<TABLE>
<CAPTION>
1997 1998 1999
------- ------- ---------
<S> <C> <C> <C>
Risk-free interest rate............................ 5.50% 5.25% 5.35%
Expected option lives.............................. 5 years 5 years 4.5 years
Assumed dividend rate.............................. 0% 0% 0%
</TABLE>
During 1999 and the six months ended June 24, 2000, the Company granted
certain options with exercise prices less than the then current fair market
value. The Company recorded deferred compensation of $105,180 in 1999 and an
additional $4,243,081 in the six months ended June 24, 2000 for the intrinsic
value of the options and will recognize the amount as compensation expense over
the vesting period of the options. Additionally, during February 2000 one of the
Company's principal stockholders sold 417,547 shares at prices less than the
current fair market value to employees or directors for which the Company
recorded $949,825 in non-cash stock compensation.
(B) In April 2000, the board of directors approved the 2000 Employee Stock
Purchase Plan which provides employees the opportunity to purchase stock at 85%
of the lower of the fair value at the beginning or end of a six-month offering
period. 1,000,000 shares have been initially reserved under the plan.
F-26
<PAGE> 97
EMERALD -- DELAWARE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FISCAL YEARS ENDED DECEMBER 27, 1997, DECEMBER 26, 1998 AND DECEMBER 25, 1999
AND SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 (INFORMATION AS OF AND FOR
THE SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 IS UNAUDITED)
(12) 401(k) SAVINGS PLAN
The Company's Retirement/Savings Plan ("401(k) Plan") under Section 401(k)
of the Internal Revenue Code covers those employees that meet eligibility
requirements. Eligible employees may contribute up to 15% of their compensation
subject to Internal Revenue Code provisions. Under the 401(k) Plan, management
may, but is not obligated to, match a portion of the employee contributions up
to a defined maximum.
The Company contributed $0, $121,011 and $523,782 during the years ended
December 27, 1997, December 26, 1998 and December 25, 1999, and $201,282 and
$520,366 during the six months ended June 26, 1999 and June 24, 2000,
respectively.
(13) CONTINGENCIES
The Company is involved in legal and administrative proceedings and claims
of various types from time to time. While any litigation contains an element of
uncertainty, management presently believes that the outcome of each such
proceeding or claim which is pending or known to be threatened, or all of them
combined, will not have a material adverse effect on the Company.
(14) REVERSE STOCK SPLIT
In April 2000, the board of directors and stockholders approved, a 2.5 for
1 reverse split of its common stock and approved a change in the authorized
number of shares of common stock to 73,666,666 shares.
The financial statements, including all shares and per share amounts, have
been restated to reflect the reverse stock split.
Additionally, the Company approved an amendment to the certificate of
incorporation that will become effective upon the IPO. Provisions include
changing the authorized number of shares of common stock to 78,000,000 and
preferred shares to 2,000,000 and eliminating the Series A, B and C Preferred
Stock designations and preferences.
(15) SUBSEQUENT EVENTS (UNAUDITED)
In July 2000, the Company authorized and issued 2,318,392 shares for $6.47
per share of redeemable convertible Series C Preferred Stock. The shares of
Series C Preferred Stock have similar rights and preferences as the shares of
Series A and B Preferred Stock except they have a different conversion ratio and
a liquidation price of $8.09 per share for the first twelve months after
issuance and $9.71 per share thereafter. Additionally, the Company paid $500,000
and issued a warrant for 38,639 shares of common stock at an exercise price of
$6.47 per share to Deutsche Bank Securities, Inc. in connection with the Series
C financing.
In July 2000, the Company amended its borrowing facility increasing the
amount available to borrow to $10 million or 85% of eligible accounts receivable
and 65% of eligible unbilled accounts receivable. A standby letter of credit in
the amount of $350,000 was also issued
F-27
<PAGE> 98
EMERALD -- DELAWARE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FISCAL YEARS ENDED DECEMBER 27, 1997, DECEMBER 26, 1998 AND DECEMBER 25, 1999
AND SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 (INFORMATION AS OF AND FOR
THE SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 24, 2000 IS UNAUDITED)
against this facility as security for leased office space. In connection with
the amendment, the bank was issued a warrant to purchase 15,000 shares of common
stock at $6.47 per share.
In July 2000, the board of directors and stockholders approved the adoption
of the 2000 Stock Incentive Compensation Plan under which a total of 360,000
shares of common stock have been reserved for issuance under the option plan.
F-28
<PAGE> 99
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION
OVERVIEW OF ZCom ACQUISITION
On March 25, 2000, Emerald-Delaware, Inc. ("Emerald" or the "Company")
acquired ZCom, Incorporated ("ZCom") by issuing notes payable totaling
$1,350,000 and 431,742 shares of Common Stock valued at $5,396,770 in exchange
for all of ZCom's outstanding common stock. The promissory notes bear interest
at 8% and are due upon the earlier of March 25, 2001 or ten business days after
the closing of an initial public offering of the Company's Common Stock. The
acquisition is being accounted for using the purchase method of accounting
whereby the purchase price is allocated to the assets acquired and liabilities
assumed based on the their fair values at the acquisition date.
The fair value of the Common Stock issued in the acquisition was estimated
to be $12.50 per share. The amount of the total consideration paid to the former
shareholders of ZCom was determined by arms-length negotiation between the
parties. The purchase price excludes performance-based contingent payments of up
to $900,000, payable in stock or cash at the election of the former stockholders
of ZCom. The former stockholders must continue employment to be eligible to
receive the contingent payments and therefore the amounts will be accounted for
as compensation expense as the performance measures are met. The company
additionally agreed to issue 28,600 shares of common stock to employees of ZCom
valued at $358,000 which will be recorded as compensation expense over the
associated employment period in which these shares vest.
OVERVIEW OF ALLIANCE ACQUISITION
On July 26, 2000, Emerald acquired Alliance Consulting Group, Inc.
("Alliance") by paying $5,329,129 in cash at closing, assuming liabilities and
issuing a note payable totaling $3,188,391 and issuing 1,805,962 shares of
Common Stock valued at $11,287,262 in exchange for all of Alliances' outstanding
common and preferred stock. The promissory note bears interest at 10% and is
payable over an 18 month period. The due date for a portion of the note will be
accelerated after the closing of an initial public offering of the Company's
Common Stock. The acquisition is being accounted for using the purchase method
of accounting whereby the purchase price is allocated to the assets acquired and
liabilities assumed based on the their fair values at the acquisition date.
The fair value of the Common Stock issued in the acquisition was estimated
to be $6.25 per share. The amount of the total consideration paid to the former
shareholders of Alliance was determined by arms-length negotiation between the
parties. The purchase price excludes performance-based contingent payments of up
to $5,000,000 to former shareholders and employees. The former shareholders and
employees must continue employment to be eligible to receive the contingent
payments and therefore the amounts will be accounted for as compensation expense
as and to the extent the performance measures are met. Additionally, the Company
issued 779,818 shares of common stock to employees of Alliance valued at
$4,873,863 which will be recorded as compensation expense over the associated
employment period in which these shares vest.
PRO FORMA STATEMENTS
The following unaudited pro forma condensed consolidated balance sheet as
of June 24, 2000 gives effect to the acquisition of Alliance as if it had
occurred on June 24, 2000. The unaudited pro forma condensed consolidated
balance sheet is based on historical balances of Emerald as of June 24, 2000,
and historical balances of Alliance as of June 30, 2000. The
F-29
<PAGE> 100
following unaudited pro forma condensed consolidated statements of operations
for the year ended December 25, 1999 and the six months ended June 24, 2000 give
effect to the acquisitions of ZCom and Alliance as if they had occurred on
December 27, 1998. The unaudited pro forma condensed consolidated statements of
operations are based on historical results of operations of Emerald for the year
ended December 25, 1999 and the six months ended June 24, 2000, historical
results of operations of ZCom for the year-ended December 31, 1999 and the
period from January 1, 2000 through March 25, 2000 and historical results of
operations of Alliance for the year-ended December 31, 1999 and the six months
ended June 30, 2000. No adjustments have been made to conform ZCom's and
Alliance's fiscal periods to Emerald's fiscal periods as the impact would not be
significant to the unaudited pro forma condensed consolidated financial
information. The unaudited pro forma condensed consolidated financial statements
and the accompanying notes should be read in conjunction with and are qualified
by the historical financial statements and notes thereto of Emerald, ZCom, and
Alliance.
The unaudited pro forma condensed consolidated balance sheet as of June 24,
2000 also gives effect to the Company's issuance of 2,318,392 shares of Series C
redeemable convertible preferred stock in July 2000, net of issuance costs of
approximately $900,000.
The unaudited pro forma condensed consolidated financial information is
intended for illustrative purposes only and is not necessarily indicative of the
combined results that would have occurred had the acquisitions taken place on
December 27, 1998, nor is it necessarily indicative of results that may occur in
the future.
F-30
<PAGE> 101
EMERALD -- DELAWARE, INC.
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED
BALANCE SHEET
AS OF JUNE 24, 2000
<TABLE>
<CAPTION>
ALLIANCE
EMERALD- CONSULTING PRO FORMA PRO FORMA
DELAWARE, INC. GROUP, INC. ADJUSTMENTS COMBINED
-------------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents............... $ 350,274 $ 46,487 $(5,329,129)(a) $ 9,567,632
14,500,000(d)
Trade accounts receivable, net of
allowance for doubtful accounts....... 13,974,289 1,673,905 -- 15,648,194
Receivable from related party........... 28,645 -- -- 28,645
Prepaid expenses........................ 450,238 20,881 -- 471,119
----------- ---------- ----------- -----------
Total current assets.............. 14,803,446 1,741,273 9,170,871 25,715,590
----------- ---------- ----------- -----------
Property and equipment, net............... 7,508,693 438,311 -- 7,947,004
Intangibles............................... 6,731,964 -- 17,909,782(a) 24,641,746
Other assets.............................. 1,085,673 15,416 (400,000)(d) 701,089
----------- ---------- ----------- -----------
3$0,129,776.. $2,195,000 $26,680,653 $59,005,429
=========== ========== =========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
(DEFICIT)
Current Liabilities:
Accounts payable........................ $ 4,721,097 $ 82,940 $ -- $ 4,804,037
Accrued compensation.................... 4,904,727 655,870 -- 5,560,597
Other accrued liabilities............... 1,911,445 94,869 300,000(a) 2,306,314
Line of credit.......................... 6,195,108 725,000 -- 6,920,108
Deferred revenue........................ 867,203 304,035 -- 1,171,238
Notes payable........................... 1,350,000 -- 1,055,000(a) 2,405,000
Current portion of capital lease
obligations........................... 660,837 -- -- 660,837
Deferred taxes.......................... -- 40,408 (40,408)(a) --
----------- ---------- ----------- -----------
Total current liabilities......... 20,610,417 1,903,122 1,314,592 23,828,131
----------- ---------- ----------- -----------
Capital lease obligations, excluding
current portion......................... 1,330,835 -- -- 1,330,835
Other long-term liabilities............... 436,144 270,677 -- 706,821
Series A redeemable convertible preferred
stock................................... 7,646,673 -- -- 7,646,673
Series B redeemable convertible preferred
stock................................... 5,187,501 -- -- 5,187,501
Series C redeemable convertible preferred
stock................................... -- -- 14,100,000(d) 14,100,000
Stockholders' equity (deficit):
Common stock............................ 20,676 1,000 (1,000)(b) 23,262
1,806(a)
780(c)
Additional paid-in capital.............. 21,218,802 -- 11,285,456(a) 37,377,341
4,873,083(c)
Deferred compensation................... (8,332,728) -- (4,873,863)(c) (13,206,591)
Retained earnings (accumulated
deficit).............................. (17,771,800) 20,201 (20,201)(b) (17,771,800)
----------- ---------- ----------- -----------
(4,865,050) 21,201 11,266,061 6,422,212
Less stock subscriptions receivable..... 216,744 -- -- 216,744
----------- ---------- ----------- -----------
Total stockholders' equity
(deficit)....................... (5,081,794) 21,201 11,266,061 6,205,468
Commitments, contingencies, and subsequent
events
----------- ---------- ----------- -----------
$30,129,776 $2,195,000 $26,680,653 $59,005,429
=========== ========== =========== ===========
</TABLE>
See notes to unaudited pro forma condensed consolidated financial statements.
F-31
<PAGE> 102
EMERALD -- DELAWARE, INC.
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED
STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 25, 1999
<TABLE>
<CAPTION>
ALLIANCE
EMERALD- ZCOM, CONSULTING PRO FORMA PRO FORMA
DELAWARE, INC. INCORPORATED GROUP, INC. ADJUSTMENTS COMBINED
-------------- ------------ ----------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Revenues....................................... $34,710,594 $1,579,710 $ 5,432,244 $ -- $ 41,722,548
Expenses:
Cost of revenues -- professional services
(excluding stock compensation)............. 19,280,517 829,848 4,252,038 701,500(i) 25,063,903
Sales and marketing (excluding stock
compensation).............................. 6,589,529 149,384 227,342 -- 6,966,255
General and administrative (excluding stock
compensation).............................. 14,261,204 539,462 1,400,510 -- 16,201,176
Intangible amortization...................... -- -- -- 1,856,107(e) 6,758,545
4,902,438(f)
Stock compensation *......................... 18,921 -- -- 292,171(g) 3,852,332
3,541,240(h)
----------- ---------- ----------- ------------ ------------
Total operating expenses....................... 40,150,171 1,518,694 5,879,890 11,293,456 58,842,211
----------- ---------- ----------- ------------ ------------
Income (loss) from operations.................. (5,439,577) 61,016 (447,646) (11,293,456) (17,119,663)
Net other income (expense)..................... (20,006) (65,943) 547,616 (170,900)(j) 290,767
----------- ---------- ----------- ------------ ------------
Income (loss) before income taxes............ (5,459,583) (4,927) 99,970 (11,464,356) (16,828,896)
Income taxes................................... (34,400) -- -- -- (34,400)
----------- ---------- ----------- ------------ ------------
Net income (loss)............................ (5,425,183) (4,927) 99,970 (11,464,356) (16,794,496)
Accretion of redemption value of redeemable
convertible preferred stock.................. (691,535) -- -- -- (691,535)
----------- ---------- ----------- ------------ ------------
Net income (loss) applicable to common
stockholders............................. $(6,116,718) $ (4,927) $ 99,970 $(11,464,356) $(17,486,031)
=========== ========== =========== ============ ============
Basic and diluted net loss per share........... $ (0.31) $ (0.78)
=========== ============
Shares used to compute basic and diluted net
loss per share............................... 19,930,206 2,505,500(k) 22,435,706
(*) Allocation of stock compensation expense
Cost of revenues -- professional services.... -- -- -- 3,833,411 3,833,411
Sales and marketing.......................... -- -- -- -- --
General and administrative................... 18,921 -- -- -- 18,921
</TABLE>
See notes to unaudited pro forma condensed consolidated financial statements.
F-32
<PAGE> 103
EMERALD -- DELAWARE, INC.
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED
STATEMENTS OF OPERATIONS
SIX MONTHS ENDED JUNE 24, 2000
<TABLE>
<CAPTION>
ALLIANCE
EMERALD- ZCOM, CONSULTING PRO FORMA PRO FORMA
DELAWARE, INC. INCORPORATED GROUP, INC. ADJUSTMENTS COMBINED
-------------- ------------ ----------- ----------- ------------
<S> <C> <C> <C> <C> <C>
Revenues........................ $ 33,966,433 $ 439,894 $3,812,747 $ -- $ 38,219,074
Expenses:
Cost of revenues --
professional services
(excluding stock
compensation)............... 17,759,611 261,140 2,530,687 350,750(i) 20,902,188
Cost of revenues -- AT&T
warrant..................... 753,902 -- -- -- 753,902
Sales and marketing (excluding
stock compensation)......... 7,861,854 81,546 144,323 -- 8,087,723
General and administrative
(excluding stock
compensation)............... 14,228,007 157,510 896,141 -- 15,281,658
Intangible amortization....... -- -- -- 475,589(e) 2,926,808
2,451,219(f)
Stock compensation *............ 2,226,360 -- -- 73,043(g) 2,987,272
687,869(h)
------------ --------- ---------- ----------- ------------
Total operating expenses........ 42,829,734 500,196 3,571,151 4,038,470 50,939,551
------------ --------- ---------- ----------- ------------
Income (loss) from operations... (8,863,301) (60,302) 241,596 (4,038,470) (12,720,477)
Net other income (expense)...... (338,280) (42,977) 1,746 (85,450)(j) (464,961)
------------ --------- ---------- ----------- ------------
Income (loss) before income
taxes......................... (9,201,581) (103,279) 243,342 (4,123,920) (13,185,438)
Income taxes -- -- 57,091 -- 57,091
------------ --------- ---------- ----------- ------------
Net income (loss)............. (9,201,581) (103,279) 186,251 (4,123,920) (13,242,529)
Accretion of redemption value of
redeemable convertible
preferred stock............... 626,752 -- -- -- 626,752
Effect of beneficial conversion
feature of Series B preferred
stock......................... 1,840,000 -- -- -- 1,840,000
------------ --------- ---------- ----------- ------------
Net income (loss) applicable
to common stockholders...... $(11,668,333) $(103,279) $ 186,251 $(4,123,920) $(15,709,281)
============ ========= ========== =========== ============
Basic and diluted net loss per
share......................... $ (0.57) $ (0.69)
============ ============
Shares used to compute basic and
diluted net loss per share.... 20,404,828 2,470,711(k) 22,875,539
(*) Allocation of stock
compensation expense
Cost of revenues -- professional
services...................... 420,617 -- -- 760,912 1,181,529
Sales and marketing 862,821 -- -- -- 862,821
General and administrative 942,922 -- -- -- 942,922
</TABLE>
See notes to unaudited pro forma condensed consolidated financial statements.
F-33
<PAGE> 104
EMERALD -- DELAWARE, INC.
NOTES TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
PRO FORMA ADJUSTMENTS.
The following adjustments were applied to the historical financial
statements of the Company, ZCom and Alliance to arrive at the unaudited pro
forma condensed consolidated financial information:
(a) To allocate the purchase price, including $300,000 of transaction costs
incurred in the acquisition, to assets and liabilities of Alliance. The excess
of the purchase price over the fair value of net assets acquired is reflected as
goodwill and is amortized using the straight-line method over 4 years. The
estimated fair values of assets acquired and liabilities assumed are based upon
preliminary estimates and may not be indicative of the final allocation of
purchase price consideration.
A summary of the purchase price for the acquisition is as follows:
<TABLE>
<S> <C>
Cash..................................................... $ 5,329,129
Note payable to stockholder.............................. 1,055,000
Stock issued............................................. 11,287,262
Direct acquisition costs................................. 300,000
Liabilities assumed...................................... 2,133,391
-----------
Total.......................................... $20,104,782
===========
Cash acquired............................................ $ 46,487
Other current assets..................................... 1,694,786
Equipment................................................ 438,311
Identifiable intangibles................................. 5,099,918
Goodwill................................................. 12,809,864
Other assets............................................. 15,416
-----------
Total.......................................... $20,104,782
===========
</TABLE>
As part of the Alliance acquisition arrangement, payment terms on accrued
liability amounts totaling $654,000 were modified such that the amount will
accrue interest at 10% and be paid in 4 equal quarterly installments over the
next 12 months.
(b) Represents the elimination of the historical shareholders' equity
accounts of Alliance.
(c) To record the issuance of restricted stock to certain Alliance
employees.
(d) Represents the receipt of $14,500,000 the Company received in July
2000, from the issuance of 2,318,392 shares of Series C redeemable convertible
preferred stock, net of offering costs of $500,000, and the reclassification of
$400,000 in deferred offering costs.
(e) Represents the amortization of goodwill and intangibles associated with
the Company's acquisition of ZCom which are amortized over their estimated
useful lives of two to four years.
(f) Represents the amortization of goodwill and other intangibles
associated with the Company's acquisition of Alliance which are amortized over
their useful lives of three to four years.
F-34
<PAGE> 105
EMERALD -- DELAWARE, INC.
NOTES TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS -- (CONTINUED)
(g) Represents non-cash stock compensation charges associated with shares
of common stock issued to employees of ZCom valued at $358,000 at the
transaction date. The Company is recognizing compensation expense for the value
of these shares over the associated employment period in which these shares
vest.
(h) Represents non-cash stock compensation charges associated with shares
of common stock issued to employees of Alliance valued at $4,873,863 at the
transaction date. The Company is recognizing compensation expense for the value
of these shares over the associated employment period in which these shares
vest.
(i) Represents compensation expense related to stay bonuses for employees
of Alliance. The stay bonuses will be recorded as compensation expense over the
period earned by the employees.
(j) Represents interest expense at 10% on the note issued to a former
stockholder of Alliance, and the modification of terms on $654,000 of
employment-related liabilities to accrue interest.
(k) Unaudited pro forma basic and diluted net loss per share are computed
by dividing the unaudited pro forma net loss applicable to common shareholders
by the unaudited pro forma weighted average number of common shares outstanding.
Potentially dilutive securities were not included in the computation of pro
forma basic and diluted net loss per share because their effects would be
antidilutive. A reconciliation of shares used to computed historical basic and
diluted net loss per share to shares used to compute pro forma basic and diluted
net loss per share is as follows:
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS ENDED
DECEMBER 25, JUNE 24,
1999 2000
------------ ----------------
<S> <C> <C>
Shares used to compute historical
basic and diluted net loss per
share............................... 19,930,206 20,404,828
Shares issued in ZCom acquisition..... 431,742 215,871
Shares issued in Alliance
acquisition......................... 1,805,962 1,805,962
Weighted average restricted stock plan
shares expected to vest during
period.............................. 267,796 448,878
---------- ----------
Shares used to compute pro forma basic
and diluted net loss per share...... 22,435,706 22,875,539
========== ==========
</TABLE>
(l) Other Information
The purchase price for ZCom excludes performance based contingent payments
of up to $900,000 payable in stock or cash at the election of the former
stockholders of ZCom. The purchase price for Alliance excludes performance based
contingent payments of up to $5,000,000. The contingent amounts will be
accounted for as compensation expense as and to the extent the performance
measures are met since continued employment as well as the achievement of
performance targets are required to be eligible to earn the contingent payments.
The contingent payments may be earned over the year following the acquisition.
F-35
<PAGE> 106
INDEPENDENT AUDITORS' REPORT
The Board of Directors
ZCom Incorporated:
We have audited the accompanying balance sheets of ZCom Incorporated as of
December 31, 1999 and 1998, and the related statements of operations,
stockholders' deficiency 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 ZCom Incorporated as of
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.
/s/ KPMG LLP
Portland, Oregon
March 29, 2000
F-36
<PAGE> 107
ZCOM INCORPORATED
BALANCE SHEETS
DECEMBER 31, 1999 AND 1998
<TABLE>
<CAPTION>
1999 1998
--------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 24,415 $ --
Trade accounts receivable, net of allowance for doubtful
accounts of $62,000 and $6,000 in 1999 and 1998,
respectively (note 4).................................. 158,411 117,540
Revenue in excess of billings............................. 130,262 24,823
Prepaid expenses.......................................... 17,140 228
--------- ---------
Total current assets.............................. 330,228 142,591
Property and equipment, net (note 2)........................ 171,929 82,763
Other assets................................................ 14,146 2,763
--------- ---------
$ 516,303 $ 228,117
========= =========
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities:
Accounts payable.......................................... $ 108,920 $ 81,827
Accrued compensation...................................... 105,159 46,195
Other liabilities (note 4)................................ 198,000 117,483
Payable to related parties (note 5)....................... 88,562 88,662
Deferred revenue.......................................... 62,910 --
Current portion of capital lease obligations (note 3)..... 47,563 6,703
--------- ---------
Total current liabilities......................... 611,114 340,870
--------- ---------
Capital lease obligations, excluding current portion (note
3)........................................................ 23,803 --
Stockholders' deficiency:
Common stock, no par value. Authorized 1,000 shares;
issued and outstanding 500 shares...................... 7,000 7,000
Accumulated deficit....................................... (113,218) (108,291)
--------- ---------
(106,218) (101,291)
Less stockholder receivable (note 5)...................... (12,396) (11,462)
--------- ---------
Total stockholders' deficiency.................... (118,614) (112,753)
Commitments and subsequent event (notes 3 and 6)
--------- ---------
$ 516,303 $ 228,117
========= =========
</TABLE>
See accompanying notes to financial statements.
F-37
<PAGE> 108
ZCOM INCORPORATED
STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1999 AND 1998
<TABLE>
<CAPTION>
1999 1998
---------- ----------
<S> <C> <C>
Revenues:
Professional services..................................... $1,532,190 $1,019,044
Product sales............................................. 47,520 --
---------- ----------
1,579,710 1,019,044
---------- ----------
Expenses:
Cost of professional services revenue..................... 798,948 512,530
Cost of products.......................................... 30,900 --
Sales and marketing....................................... 149,384 91,867
General and administrative................................ 539,462 402,603
---------- ----------
1,518,694 1,007,000
---------- ----------
Other income (expense):
Interest income -- stockholder............................ 934 790
Other interest income..................................... 344 293
Interest expense.......................................... (71,284) (55,436)
Other income.............................................. 4,063 --
---------- ----------
Net other expense................................. (65,943) (54,353)
---------- ----------
Net loss.......................................... $ (4,927) $ (42,309)
========== ==========
</TABLE>
See accompanying notes to financial statements.
F-38
<PAGE> 109
ZCOM INCORPORATED
STATEMENTS OF STOCKHOLDERS' DEFICIENCY
YEARS ENDED DECEMBER 31, 1999 AND 1998
<TABLE>
<CAPTION>
COMMON STOCK TOTAL
--------------- STOCKHOLDER ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT RECEIVABLE DEFICIT DEFICIENCY
------ ------ ----------- ----------- -------------
<S> <C> <C> <C> <C> <C>
Balances at December 31, 1997.... 500 $7,000 $(10,672) $ (65,982) $ (69,654)
Net loss......................... -- -- -- (42,309) (42,309)
Increase in note receivable...... -- -- (790) -- (790)
--- ------ -------- --------- ---------
Balances at December 31, 1998.... 500 7,000 (11,462) (108,291) (112,753)
Net loss......................... -- -- -- (4,927) (4,927)
Increase in note receivable...... -- -- (934) -- (934)
--- ------ -------- --------- ---------
Balances at December 31, 1999.... 500 $7,000 $(12,396) $(113,218) $(118,614)
=== ====== ======== ========= =========
</TABLE>
See accompanying notes to financial statements.
F-39
<PAGE> 110
ZCOM INCORPORATED
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1999 AND 1998
<TABLE>
<CAPTION>
1999 1998
--------- --------
<S> <C> <C>
Cash flows from operating activities:
Net loss.................................................. $ (4,927) $(42,309)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation and amortization.......................... 47,732 48,468
Interest earned on stockholder receivable.............. (934) (790)
Related party interest expense......................... 2,336 2,252
Changes in certain assets and liabilities:
Accounts receivable.................................. (40,871) 18,068
Revenue in excess of billings........................ (105,439) (24,823)
Prepaid expenses..................................... (43,212) 812
Other assets......................................... (11,383) 1,291
Accounts payable and accrued liabilities............. 86,057 (14,959)
Payable to related parties........................... (2,436) 58,260
Increase in deferred revenue......................... 89,210 --
--------- --------
Net cash provided by operating activities......... 16,133 46,270
--------- --------
Cash flows from investing activities:
Purchases of property and equipment....................... (29,032) (13,883)
--------- --------
Net cash used in investing activities............. (29,032) (13,883)
--------- --------
Cash provided by financing activities:
Repayment of capital lease obligations.................... (43,203) (64,320)
Proceeds from secured borrowings, net..................... 80,517 2,252
--------- --------
Net cash provided by (used in) financing
activities...................................... 37,314 (62,068)
--------- --------
Net increase (decrease) in cash and cash
equivalents..................................... 24,415 (29,681)
Cash and cash equivalents at beginning of year.............. -- 29,681
--------- --------
Cash and cash equivalents at end of year.................... $ 24,415 $ --
========= ========
Supplemental disclosures of cash flow information:
Cash paid during the year for interest.................... $ 69,948 $ 53,184
========= ========
Supplemental schedule of noncash investing and financing
activities:
Equipment acquired through capital lease obligations...... $ 107,866 $ --
========= ========
</TABLE>
See accompanying notes to financial statements.
F-40
<PAGE> 111
ZCOM INCORPORATED
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) DESCRIPTION OF BUSINESS
ZCom Incorporated (the "Company") is a consulting agency in the business of
developing corporate web pages. The Company offers Internet marketing solutions,
branding strategies, digital advertising and Internet web design services to
commercial customers. The Company is focused on the west coast market although
at present its customers are predominately based in the greater Portland area.
The Company was incorporated in the State of Oregon in 1991. The Company is
headquartered in Portland, Oregon.
(b) REVENUE RECOGNITION
Revenues from fixed-price contracts are recognized on the
percentage-of-completion method, measured by the percentage of hours incurred to
date in relation to the estimated total hours of completion. This method is used
because management considers hours to be the best available measure of progress
on these contracts. Billings in excess of earnings are classified as deferred
revenues. Revenues recognized prior to billing are classified as revenue in
excess of billings.
Revenues from time and materials contracts are recognized during the period
in which the services are provided.
The cumulative impact of any revision in estimates in the percentage of
completion is reflected in the period in which the change becomes known. Losses
on projects in progress are recognized when known.
(c) PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Equipment under capital leases
are stated at fair value at the inception of the lease. Depreciation is provided
using the straight-line method over the assets' estimated useful lives of three
to five years. Equipment held under capital leases are amortized using the
straight-line method over the shorter of the lease term or estimated useful
lives of the assets. Leasehold improvements are amortized over the shorter of
estimated useful lives or the respective lease term. Depreciation expense
includes amortization on capitalized leases.
(d) OTHER ASSETS
Other assets are stated at cost. The balance is comprised of security
deposits required on operating leases.
(e) INCOME TAXES
No provision has been made for federal and state income taxes. Under
Subchapter S of the Internal Revenue Code, the Company has elected not to be
taxed as a corporation and the stockholders have consented to include the
Company's income or loss in their individual returns.
F-41
<PAGE> 112
ZCOM INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999 AND 1998
(f) ADVERTISING
Advertising costs are expensed as incurred and are included in sales and
marketing expense. Advertising expense was $26,167 and $10,804 for the years
ended December 31, 1999 and 1998, respectively.
(g) USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions affecting 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 in future periods could differ from those estimates used.
(h) FINANCIAL INSTRUMENTS AND CONCENTRATIONS OF CREDIT RISK
Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of accounts receivable. The fair
value of the Company's financial instruments approximates their carrying amount
due to their short-term nature. Accounts receivable are typically unsecured and
are derived from revenue earned from clients located in the United States. The
Company performs ongoing credit evaluations of its clients' financial condition
and records an allowance for potential credit losses based upon the expected
collectibility of total accounts receivable. To date, the Company has not
experienced any material credit losses.
The Company derives a significant portion of its revenues from projects
with a limited number of clients. In 1999, two customers represented 22% and
16%, respectively, of the Company's sales and accounted for 27% and 20% of the
total of accounts receivable and revenue in excess of billings. In 1998, two
customers represented 35% and 12% of sales and 52% and 26% of total accounts
receivable and revenue in excess of billings.
(2) PROPERTY AND EQUIPMENT
Property and equipment, net at December 31, 1999 and 1998 consists of the
following:
<TABLE>
<CAPTION>
1999 1998
--------- ---------
<S> <C> <C>
Computer equipment.......................................... $ 351,905 $ 220,448
Office furniture and other equipment........................ 39,398 37,560
Computer software........................................... 25,778 16,189
Leasehold improvements...................................... 8,029 28,872
--------- ---------
425,110 303,069
Less accumulated depreciation and amortization.............. (253,181) (220,306)
--------- ---------
Property and equipment, net............................... $ 171,929 $ 82,763
========= =========
</TABLE>
Depreciation expense, including amortization of capitalized leases, was
$47,732 and $48,468 for the years ended December 31, 1999 and 1998,
respectively.
F-42
<PAGE> 113
ZCOM INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999 AND 1998
Included in property and equipment is the gross amount of computer
equipment and related accumulated amortization recorded under capital leases at
December 31, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
1999 1998
-------- --------
<S> <C> <C>
Computer equipment................................ $107,863 $ 71,509
Less accumulated amortization..................... (17,194) (35,714)
-------- --------
$ 90,669 $ 35,795
======== ========
</TABLE>
(3) COMMITMENTS
(a) LEASES
The Company leases office space and equipment under long-term
non-cancelable operating and capital leases with various expirations through
2005. Future minimum lease payments under operating and capital leases at
December 31, 1999 are as follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
------- ---------
<S> <C> <C>
2000................................................ $56,412 $130,206
2001................................................ 20,472 148,165
2002................................................ 7,020 143,534
2003................................................ -- 140,088
2004................................................ -- 143,081
Thereafter.......................................... -- 26,947
------- --------
Total minimum lease payments.............. 83,904 $732,021
========
Less amounts representing interest at 11% to 23%.... 12,538
-------
Present value of future minimum lease payments.... 71,366
Less current portion of capital lease obligations... 47,563
-------
Long-term capital lease obligations, excluding
current portion................................ $23,803
=======
</TABLE>
Total rent expense for operating leases during the years ended December 31,
1999 and 1998 amounted to approximately $56,506 and $27,691, respectively.
(b) PROFIT-SHARING PLANS
The Company sponsors a 401(k) profit-sharing plan that covers all employees
that meet a minimum service requirement. The Company is required to contribute
an employee match up to 3% of the employee's salary. The Company contributed
$11,767 and $8,432 during the years ended December 31, 1999 and 1998,
respectively.
(c) PRODUCT WARRANTY
The Company provides a standard 30-day warranty for any errors, omissions
or functionality not matching specifications outlined in the contract. There
were no significant warranty claims by customers at December 31, 1999 and 1998.
F-43
<PAGE> 114
ZCOM INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999 AND 1998
(4) OTHER LIABILITIES
The Company has a financing agreement with an unrelated third party under
which the Company transfers its accounts receivables to the third party for
cash. The obligation is secured by the underlying accounts receivable. The third
party acts as servicer for collection of the accounts receivable. The third
party will advance 90% of the unpaid balance of the receivables. The third party
has the right to require repayment of amounts advanced prior to collection of
amounts from the related receivables and charges interest and service fees equal
to 1/10 of 1% per calendar day for the average total of all outstanding gross
receivables for each settlement period. At December 31, 1999 and 1998, the
receivables subject to this arrangement were included in trade accounts
receivables of $158,411 and $117,540. The interest and service fees charged for
the services were $46,876 in 1999 and $35,054 in 1998.
(5) RELATED PARTY TRANSACTIONS
(a) PAYABLE TO STOCKHOLDER
At December 31, 1999 and 1998, the Company owed $55,824 and $58,260 to a
stockholder for expenses incurred on behalf of the Company. Such amounts are
non-interest bearing. The Company also has a note payable to a relative of a
stockholder with no maturity date that bears interest at 8% per annum. Interest
expense on this note was $2,336 and $2,252 during 1999 and 1998, respectively.
(b) NOTE RECEIVABLE FROM STOCKHOLDER
At December 31, 1999 and 1998, the Company had a note receivable in the
amount of $12,396 and $11,462, respectively, from a stockholder with no stated
maturity date that bears interest at 5.77% per annum. The note has been
classified as a component of stockholders' deficiency. Interest income was $934
and $790 during 1999 and 1998, respectively.
(6) SUBSEQUENT EVENT
On March 25, 2000, the Company entered into an Agreement and Plan of Merger
with Emerald -- Delaware, Inc. ("Emerald"). The consideration will be in the
form of cash and promissory notes to the principals of the Company totaling
$1,350,000 and 1,079,354 shares of Emerald common stock. The shares issued by
Emerald have not been adjusted to reflect any stock splits.
F-44
<PAGE> 115
INDEPENDENT AUDITORS' REPORT
The Stockholder
Alliance Consulting Group, Inc.:
We have audited the accompanying balance sheets of Alliance Consulting
Group, Inc. as of December 31, 1998 and 1999, and the related statements of
operations, stockholder's 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 Alliance Consulting Group,
Inc. as of December 31, 1998 and 1999, and the results of its operations and its
cash flows for the years then ended, in conformity with generally accepted
accounting principles.
/s/ KPMG LLP
Boston, Massachusetts
June 16, 2000
F-45
<PAGE> 116
ALLIANCE CONSULTING GROUP, INC.
BALANCE SHEETS
DECEMBER 31, 1998 AND 1999 AND JUNE 30, 2000
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------ JUNE 30,
1998 1999 2000
---------- ---------- -----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.................... $ 2,867 $ 3,012 $ 46,487
Trade accounts receivable:
Billed, less allowance for doubtful
accounts of $0 at December 31, 1998,
$75,000 at December 31, 1999 and $75,000
at June 30, 2000........................ 1,466,795 1,395,359 1,536,869
Unbilled revenues......................... 249,948 -- --
Other..................................... 40,000 143,666 137,036
Prepaid expenses............................. 37,229 66,050 20,881
---------- ---------- ----------
Total current assets................. 1,796,839 1,608,087 1,741,273
Property and equipment, net.................. 223,273 437,486 438,311
Deposits..................................... 400 15,416 15,416
---------- ---------- ----------
Total assets......................... $2,020,512 $2,060,989 $2,195,000
========== ========== ==========
LIABILITIES AND STOCKHOLDER'S EQUITY (DEFICIT)
Current liabilities:
Bank overdraft............................... $ 165,116 $ 35,668 $ --
Line of credit............................... 61,000 461,100 725,000
Accounts payable............................. 129,564 50,866 82,940
Current portion of accrued incentive
compensation.............................. 325,436 740,650 655,870
Other accrued expenses....................... 165,953 198,085 94,869
Deferred revenues............................ 530,000 468,993 304,035
Deferred taxes............................... -- -- 40,408
Loan payable, stockholder.................... 167,813 -- --
---------- ---------- ----------
Total current liabilities............ 1,544,882 1,955,362 1,903,122
Accrued incentive compensation................. 740,650 270,677 270,677
---------- ---------- ----------
Total liabilities.................... 2,285,532 2,226,039 2,173,799
---------- ---------- ----------
Commitments and contingencies
Stockholder's equity (deficit):
Common stock, $1 par value:
Authorized 300,000 shares, issued and
outstanding 1,000 shares................ 1,000 1,000 1,000
Retained earnings (deficit).................. (266,020) (166,050) 20,201
---------- ---------- ----------
Total stockholder's equity
(deficit).......................... (265,020) (165,050) 21,201
---------- ---------- ----------
Total liabilities and stockholder's
equity (deficit)................... $2,020,512 $2,060,989 $2,195,000
========== ========== ==========
</TABLE>
See accompanying notes to financial statements.
F-46
<PAGE> 117
ALLIANCE CONSULTING GROUP, INC.
STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1998 AND 1999
AND THE SIX MONTHS ENDED JUNE 30, 1999 AND 2000
<TABLE>
<CAPTION>
YEARS ENDED SIX MONTHS ENDED
DECEMBER 31, JUNE 30,
----------------------- -----------------------
1998 1999 1999 2000
---------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C>
Revenues:
Consulting services................. $6,215,145 $5,432,244 $2,984,497 $3,812,747
---------- ---------- ---------- ----------
Operating expenses:
Professional services............... 2,773,207 3,828,606 1,741,482 2,530,687
Incentive compensation.............. 1,867,045 423,432 185,338 --
Sales development................... 833,554 227,342 35,013 144,323
General and administrative.......... 1,036,431 1,400,510 608,917 896,141
---------- ---------- ---------- ----------
Total operating expenses.... 6,510,237 5,879,890 2,570,750 3,571,151
---------- ---------- ---------- ----------
Income (loss) from operations......... (295,092) (447,646) 413,747 241,596
Other income:
Interest and dividends.............. 11,593 15,348 8,992 1,746
Gain from investment securities..... -- 518,626 -- --
Other............................... 4,939 13,642 19,204 --
---------- ---------- ---------- ----------
Income (loss) before income taxes..... (278,560) 99,970 441,943 243,342
Income tax expense (benefit).......... (42,600) -- -- 57,091
---------- ---------- ---------- ----------
Net income (loss)..................... $ (235,960) $ 99,970 $ 441,943 $ 186,251
========== ========== ========== ==========
Basic net income (loss) per share..... $ (235.96) $ 99.97 $ 441.94 $ 186.25
========== ========== ========== ==========
Basic weighted average common shares
outstanding......................... 1,000 1,000 1,000 1,000
</TABLE>
See accompanying notes to financial statements.
F-47
<PAGE> 118
ALLIANCE CONSULTING GROUP, INC.
STATEMENTS OF STOCKHOLDER'S EQUITY (DEFICIT)
YEARS ENDED DECEMBER 31, 1998 AND 1999
AND THE SIX MONTHS ENDED JUNE 30, 2000
<TABLE>
<CAPTION>
TOTAL
COMMON STOCK RETAINED STOCKHOLDER'S
---------------- EARNINGS EQUITY
SHARES AMOUNT (DEFICIT) (DEFICIT)
------ ------ --------- -------------
<S> <C> <C> <C> <C>
Balance at December 31, 1997.............. 1,000 $1,000 $ (30,060) $ (29,060)
Net loss................................ -- -- (235,960) (235,960)
----- ------ --------- ---------
Balance at December 31, 1998.............. 1,000 1,000 (266,020) (265,020)
Net income.............................. -- -- 99,970 99,970
----- ------ --------- ---------
Balance at December 31, 1999.............. 1,000 1,000 (166,050) (165,050)
Net income (unaudited).................. -- -- 186,251 186,251
----- ------ --------- ---------
Balance at June 30, 2000 (unaudited)...... 1,000 $1,000 $ 20,201 $ 21,201
===== ====== ========= =========
</TABLE>
See accompanying notes to financial statements.
F-48
<PAGE> 119
ALLIANCE CONSULTING GROUP, INC.
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998 AND 1999
AND THE SIX MONTHS ENDED JUNE 30, 1999 AND 2000
<TABLE>
<CAPTION>
YEARS ENDED SIX MONTHS ENDED
DECEMBER 31, JUNE 30,
---------------------- ----------------------
1998 1999 1999 2000
--------- --------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)..................................... $(235,960) $ 99,970 $ 441,943 $ 186,251
Adjustments to reconcile net income (loss) to net cash
flows provided (used) by operating activities:
Deferred income taxes............................... (44,000) -- -- 40,408
Gain on sale of marketable security................. -- (224,103) -- --
Gain on distribution of customer equity............. -- (294,523) -- --
Revenue recognized from customer equity received.... (40,000) (20,000) (20,000) (84,780)
Distribution of incentive compensation satisfied
through distribution of customer equity........... -- 294,523 -- 84,780
Depreciation and amortization....................... 85,842 141,774 70,886 89,705
Provision for doubtful accounts..................... -- 75,000 -- --
Changes in operating assets and liabilities:
Trade receivables................................. (719,634) 246,384 424,140 (141,510)
Prepaid expenses.................................. (6,443) (28,821) 34,968 45,169
Bank overdraft.................................... 165,116 (129,448) (165,116) (35,668)
Accounts payable.................................. 68,684 (78,698) 61,518 32,074
Accrued incentive compensation.................... 230,318 (54,759) 199,590 --
Other accrued expenses............................ 64,152 32,132 (28,851) (103,216)
Deferred revenue.................................. 530,000 (204,673) (327,740) (243,108)
--------- --------- --------- ---------
Net cash flows provided (used) by operating
activities..................................... 98,075 (145,242) 691,338 (129,895)
--------- --------- --------- ---------
Cash flows from investing activities:
Property and equipment purchases...................... (141,207) (355,987) (218,417) (90,530)
Proceeds from sale of marketable security............. -- 284,103 -- --
--------- --------- --------- ---------
Net cash flows used by investing activities....... (141,207) (71,884) (218,417) (90,530)
--------- --------- --------- ---------
Cash flows from financing activities:
Proceeds from line of credit, net..................... 61,000 400,100 (61,000) 263,900
Loan payments to stockholder, net..................... (21,234) (167,813) (167,813) --
(Increase) decrease in deposits....................... 4,088 (15,016) -- --
--------- --------- --------- ---------
Net cash flows provided (used) by financing
activities..................................... 43,854 217,271 (228,813) 263,900
--------- --------- --------- ---------
Net increase in cash and cash equivalents............... 722 145 244,108 43,475
Cash and cash equivalents, beginning of period.......... 2,145 2,867 2,867 3,012
--------- --------- --------- ---------
Cash and cash equivalents, end of period................ $ 2,867 $ 3,012 $ 246,975 $ 46,487
========= ========= ========= =========
Supplemental disclosures of cash flow information:
Cash paid during the period for interest.............. $ 3,181 $ 950 $ 900 $ 8,207
========= ========= ========= =========
Cash paid for income taxes............................ $ -- -- -- --
========= ========= ========= =========
Supplemental disclosures of non-cash transactions:
Receivables arising from equity instruments promised
from customers...................................... $ 40,000 $ 143,666 $ -- $ 78,150
========= ========= ========= =========
</TABLE>
See accompanying notes to financial statements.
F-49
<PAGE> 120
ALLIANCE CONSULTING GROUP, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1999 AND THE
SIX MONTHS ENDED JUNE 30, 1999 AND 2000
(INFORMATION AS OF AND FOR THE SIX MONTHS ENDED
JUNE 30, 1999 AND 2000 IS UNAUDITED)
(1) THE COMPANY
Alliance Consulting Group, Inc. (the "Company") is a strategy consulting
firm focused on e-commerce strategy development offering business-to-business
and business-to-consumer solutions. The Company provides services to Fortune 500
companies and Internet start-ups. The Company operates out of two offices
located in Boston, Massachusetts and San Jose, California.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect certain 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 periods. Actual results could differ from those estimates.
(b) CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investment securities with maturity
at purchase of three months or less to be cash equivalents.
(c) DISCLOSURES ABOUT THE FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company has determined that the fair market values of its financial
assets and liabilities at December 31, 1998 and 1999 and June 30, 2000
approximate their carrying amounts.
(d) CONCENTRATION OF CREDIT RISK
Accounts receivable potentially subject the Company to a concentration of
credit risk. At December 31, 1998 and 1999 and June 30, 2000, three, four and
three individual customer receivables exceeded ten percent of gross billed and
unbilled accounts receivable totaling $998,555, $860,544 and $779,047,
respectively.
The Company performs ongoing credit evaluations of its customers and
generally does not require collateral on accounts receivable. The Company
maintains allowances for potential credit losses and such losses have been
within management's expectations. Write-offs of accounts receivable have not
been material for the any of the periods presented.
(e) PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Depreciation is recorded on a
straight-line basis over the estimated useful lives of the related assets, which
range from five to seven years. Leasehold improvements are amortized over the
lesser of the lease term or the life of the asset. Maintenance and repairs are
charged to operations when incurred.
F-50
<PAGE> 121
ALLIANCE CONSULTING GROUP, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1999 AND THE
SIX MONTHS ENDED JUNE 30, 1999 AND 2000
(INFORMATION AS OF AND FOR THE SIX MONTHS ENDED
JUNE 30, 1999 AND 2000 IS UNAUDITED)
(f) REVENUE RECOGNITION
The Company derives its revenues from service contracts. Revenues pursuant
to fixed-price contracts are recognized as services are rendered on the
percentage-of-completion method of accounting (based on the ratio of labor hours
incurred to total estimated labor hours). Revenues pursuant to time and
materials contracts are recognized as services are provided.
Unbilled revenues on contracts are comprised of costs plus earned fees in
excess of billings on such contracts. Advanced billings and billings in excess
of costs plus earned fees are classified as deferred revenues until the period
such services are provided. Revenues exclude reimbursed expenses charged to and
collected from clients.
Provisions for estimated losses on uncompleted contracts are made on a
contract-by-contract basis and are recognized in the period in which such losses
become probable and can be reasonably estimated.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin ("SAB") No. 101, Revenue Recognition in Financial
Statements. SAB No. 101 summarizes certain of the staff's views in applying
generally accepted accounting principles to revenue recognition in financial
statements. Management believes the Company has complied with the provisions of
SAB No. 101.
(g) EQUITY INSTRUMENTS RECEIVED FROM CUSTOMERS
In accordance with Emerging Issues Task Force Issue No. 00-8, Accounting by
a Grantee for an Equity Instrument to be Received in Conjunction with Providing
Goods or Services, the Company records publicly traded equity instruments
received from customers in exchange for services rendered based upon the fair
value of the asset received as of the earlier of the date the parties come to a
mutual understanding of the terms of the equity-based compensation arrangement
and a commitment for performance by the Company to earn the equity instrument is
reached or the date at which the Company's performance necessary to earn the
equity instrument is complete.
When the Company receives equity securities which are not publicly traded
and the fair value of such securities are not clearly evident, the Company
records the fair value of such securities based upon the fair value of the
services provided measured at the cost of services provided. The associated
revenue is deferred until the Company receives the promised equity securities.
(h) PROFESSIONAL SERVICES
Professional services costs consist of payroll and payroll-related costs
dedicated to client assignments.
F-51
<PAGE> 122
ALLIANCE CONSULTING GROUP, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1999 AND THE
SIX MONTHS ENDED JUNE 30, 1999 AND 2000
(INFORMATION AS OF AND FOR THE SIX MONTHS ENDED
JUNE 30, 1999 AND 2000 IS UNAUDITED)
(i) INCOME TAXES
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
(j) IMPAIRMENT OF LONG-LIVED ASSETS
The Company records impairment losses on long-lived assets used in
operations when indicators of impairment are present and the undiscounted cash
flows estimated to be generated by those assets are less than the assets'
carrying amount.
(k) SEGMENT REPORTING
Statement of Financial Accounting Standards ("SFAS") No. 131, Disclosures
about Segments of an Enterprise and Related Information, establishes standards
for the way that public business enterprises report selected information about
operating segments in annual and interim financial statements. It also
establishes standards for related disclosures about products and services,
geographic areas and major customers. SFAS No. 131 requires the use of the
"management approach" in disclosing segment information, based largely on how
senior management generally analyzes the business operations. The Company
currently operates in only one segment and, as such, no additional disclosures
are required.
(l) HISTORICAL NET INCOME (LOSS) PER SHARE
SFAS No. 128, Earnings per Share, requires entities with simple capital
structures to present basic earnings per share for all periods presented.
Pursuant to SAB No. 98, common stock issued for nominal consideration,
prior to the anticipated effective date of an initial public offering, are
required to be included in the calculation of basic and diluted net income per
share as if they were outstanding for all periods presented. To date, the
Company has not had any issuances or grants for nominal consideration.
(m) UNAUDITED INTERIM FINANCIAL STATEMENTS
In the opinion of the Company's management, the unaudited financial
statements as of June 30, 2000 and for the six months ended June 30, 1999 and
2000 include all adjustments, consisting of normal recurring adjustments,
necessary for a fair presentation.
F-52
<PAGE> 123
ALLIANCE CONSULTING GROUP, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1999 AND THE
SIX MONTHS ENDED JUNE 30, 1999 AND 2000
(INFORMATION AS OF AND FOR THE SIX MONTHS ENDED
JUNE 30, 1999 AND 2000 IS UNAUDITED)
(3) EQUITY INSTRUMENTS RECEIVED FROM CUSTOMERS
For transactions involving the receipt of equity positions in non-publicly
traded entities in exchange for services rendered, the Company has recorded the
equity instruments based upon the fair value of services surrendered measured at
the cost of services provided. At December 31, 1999 and June 30, 2000, the
Company recorded approximately $144,000 and $137,000, respectively, of other
accounts receivable related to such transactions all of which have been deferred
until such time as the underlying equity investments are received. For the six
months ended June 30, 2000, the Company recognized $84,780 of consulting revenue
related to the receipt of underlying equity instruments.
For the transaction involving the exchange of an equity investment in a
publicly traded entity for services rendered, the Company recorded the equity
investment based upon the fair value of the asset received. At December 31,
1998, the Company recorded $40,000 of other accounts receivable related to this
transaction. For the years ended December 31, 1998 and 1999, the Company
recognized $40,000 and $20,000, respectively, of consulting services revenue
related to this transaction. For the year ended December 31, 1999, the Company
recognized a gain on the disposition through sale and distribution of this
investment of $518,626 related to the 1998 transaction.
(4) PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------- JUNE 30,
1998 1999 2000
-------- -------- ----------
<S> <C> <C> <C>
Office and computer equipment...................... $363,970 $556,350 $ 610,598
Furniture and fixtures............................. 275,313 425,300 461,582
Leasehold improvements............................. -- 3,907 3,907
-------- -------- ----------
639,283 985,557 1,076,087
Less: accumulated depreciation and amortization.... 416,010 548,071 637,776
-------- -------- ----------
$223,273 $437,486 $ 438,311
======== ======== ==========
</TABLE>
(5) LINE OF CREDIT
The maximum borrowing limit of the Company's line of credit was $200,000,
$600,000 and $938,900 as of December 31, 1998, 1999 and June 30, 2000,
respectively. For the years ended December 31, 1998 and 1999, outstanding
amounts bore interest at 1.5% over the lending institution's base rate.
Effective April 27, 2000, outstanding amounts bear interest at 1.0% over the
lending institution's base rate. At December 1998, 1999 and June 30, 2000, the
amount outstanding under the line of credit was $61,000, $461,000 and $725,000,
respectively. The maximum amount outstanding during the years ended December 31,
1998 and 1999, and for the six months ended June 30, 2000, was $200,000,
$461,000 and $725,000, respectively. For the years ended December 31, 1998 and
1999, and the six months ended June 30, 1999, interest expense on the line of
credit was less than $3,200,
F-53
<PAGE> 124
ALLIANCE CONSULTING GROUP, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1999 AND THE
SIX MONTHS ENDED JUNE 30, 1999 AND 2000
(INFORMATION AS OF AND FOR THE SIX MONTHS ENDED
JUNE 30, 1999 AND 2000 IS UNAUDITED)
$1,000 and $1,000, respectively. For the six months ended June 30, 2000,
interest expense on the line of credit was approximately $8,200.
(6) LOAN PAYABLE, STOCKHOLDER
The Company periodically borrows money from its stockholder. Payment is due
on demand. The interest rate associated with this loan was 8.5% annually for the
years ended December 31, 1998 and 1999. At December 31, 1998, the amount due to
the stockholder was $167,813. The loan to the stockholder was repaid in 1999.
For the years ended December 31, 1998 and 1999, interest expense on the loan
payable to the stockholder was less than $3,200 and $1,000, respectively.
(7) DEFERRED COMPENSATION PLAN
The Company sponsors a qualified 401(k) profit sharing plan (the "Plan"),
which covers substantially all of its employees. Participants are permitted, in
accordance with the provisions of Section 401(k) of the Internal Revenue Code,
to contribute up to 15% of their earnings into the Plan. According to the
provisions of the Plan, the Company may make discretionary matching
contributions. For the years ended December 31, 1998 and 1999, the Company
recorded discretionary matching contributions of $75,000 and $110,000,
respectively, to the Plan.
(8) INCENTIVE COMPENSATION PLAN
The stockholder and certain members of senior management participate in an
incentive compensation plan, which consists of a contingent bonus pool and a
profit sharing pool. For the years ended December 31, 1998 and 1999, and the six
months ended June 30, 1999, total compensation earned under the incentive
compensation plan was $1,867,045 and $423,432 and $185,338, respectively. The
Company is not required to pay out the incentive compensation by any specific
date. In addition, the Company may from time to time distribute customer equity
received arising from non-monetary transactions to satisfy the amount earned.
(9) COMMITMENTS
The Company leases office space under operating leases, which expire
through October 31, 2004. In addition to base rent, the Company is responsible
for a share of operating expenses and real estate taxes on the premises. The
Company also leases motor vehicles under operating leases, which expire through
2001.
F-54
<PAGE> 125
ALLIANCE CONSULTING GROUP, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1999 AND THE
SIX MONTHS ENDED JUNE 30, 1999 AND 2000
(INFORMATION AS OF AND FOR THE SIX MONTHS ENDED
JUNE 30, 1999 AND 2000 IS UNAUDITED)
Minimum future annual rental commitments under non-cancelable operating
leases are as follows at December 31:
<TABLE>
<S> <C>
2000.......................................... $ 482,442
2001.......................................... 497,719
2002.......................................... 484,367
2003.......................................... 478,964
2004.......................................... 241,470
----------
Total............................... $2,184,962
==========
</TABLE>
Rental expense was approximately $144,400 and $297,800 for the years ended
December 31, 1998 and 1999, respectively, and approximately $134,255 and
$223,596 for the six-month periods ended June 30, 1999 and 2000, respectively.
(10) INCOME TAXES
Income tax expense (benefit) consists of the following:
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
------------------
1998 1999
-------- ------
<S> <C> <C>
Current:
Federal............................................ $ -- $ --
State.............................................. 1,400 527
-------- ------
1,400 527
-------- ------
Deferred:
Federal............................................ (31,162) (3,337)
State.............................................. (12,838) 2,810
-------- ------
(44,000) (527)
-------- ------
$(42,600) $ --
======== ======
</TABLE>
The following is a reconciliation between the statutory federal income tax
rate and the Company's effective rate:
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
----------------
1998 1999
----- -----
<S> <C> <C>
Statutory federal income tax rate....................... (34.0)% 34.0%
State income taxes, net of federal income tax benefit... (5.1) 6.4
Change in valuation allowance........................... 24.6 (42.1)
Permanent items and other............................... (0.8) 1.7
----- -----
(15.3)% 0.0%
===== =====
</TABLE>
F-55
<PAGE> 126
ALLIANCE CONSULTING GROUP, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1999 AND THE
SIX MONTHS ENDED JUNE 30, 1999 AND 2000
(INFORMATION AS OF AND FOR THE SIX MONTHS ENDED
JUNE 30, 1999 AND 2000 IS UNAUDITED)
The following is a summary of the significant components of the Company's
deferred tax assets and liabilities as of:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1998 1999
-------- --------
<S> <C> <C>
Deferred tax assets:
Allowance for doubtful accounts................. $ -- $ 30,113
Cash to accrual adjustments..................... 11,028 --
Net operating loss carryforwards................ 57,420 13,910
-------- --------
Total gross deferred tax assets................. 68,448 44,023
Less: valuation allowance....................... (68,448) (26,928)
-------- --------
Net deferred tax assets......................... -- 17,095
Deferred tax liabilities:
Cash to accrual adjustment...................... -- (17,095)
-------- --------
Total gross deferred tax liabilities............ -- (17,095)
-------- --------
Net deferred taxes.............................. $ -- $ --
======== ========
</TABLE>
Due to the uncertainty of realization of these deferred tax assets, the
Company has provided a valuation allowance to the extent its deferred tax assets
exceed its deferred tax liabilities. The net change in the total valuation
allowance for the years ended December 31, 1998 and 1999 was an increase of
$68,448 and a decrease of $41,520, respectively. No income tax benefit has been
recorded for 1999 because of the valuation allowance.
The Company had federal net operating loss carryovers of approximately
$40,000 at December 31, 1999 that may be used to offset future taxable income,
if any, through 2020. Net operating loss carryforwards and other tax attributes
may be limited in the event of certain changes in ownership interests.
(11) SIGNIFICANT CUSTOMERS
The following table summarizes sales to major customers (consulting
services in excess of 10%) as a percentage of total consulting services:
<TABLE>
<CAPTION>
SIX MONTHS
YEARS ENDED ENDED
DECEMBER 31, JUNE 30,
------------ ------------
1998 1999 1999 2000
---- ---- ---- ----
<S> <C> <C> <C> <C>
Customer A................................................. 54% 11% 16% --%
Customer B................................................. 11 6 14 16
Customer C................................................. -- 14 18 --
Customer D................................................. -- 10 10 1
Customer E................................................. 10 8 14 14
Customer F................................................. -- 2 -- 11
</TABLE>
F-56
<PAGE> 127
ALLIANCE CONSULTING GROUP, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1999 AND THE
SIX MONTHS ENDED JUNE 30, 1999 AND 2000
(INFORMATION AS OF AND FOR THE SIX MONTHS ENDED
JUNE 30, 1999 AND 2000 IS UNAUDITED)
(12) SUBSEQUENT EVENTS (UNAUDITED)
On July 11, 2000, the Company reincorporated in the state of Delaware by
effecting a tax-free reorganization with its newly formed wholly owned
subsidiary Alliance Consulting Group, Inc. ("Alliance Delaware"). Pursuant to
the reorganization, the outstanding shares of capital stock of the Company were
converted into 1,000,000 shares of preferred stock, $0.01 par value per share of
Alliance Delaware.
On July 12, 2000, Alliance Delaware issued 8,000,000 shares of restricted
common stock, $.01 par value per share to certain of its employees in exchange
for $2,000,000 of promissory notes. The promissory notes, including interest at
the rate of 6.62% per annum, are due and payable on July 12, 2004.
On July 26, 2000, Alliance Delaware entered an Agreement and Plan of Merger
(the "Agreement") with Emerald -- Delaware, Inc. ("Emerald"). The consideration
will be in the form of cash and promissory notes to the principals of Alliance
Delaware totaling approximately $6,400,000 and 2,247,183 shares of Emerald
common stock.
In accordance with the terms of the Agreement, the Company discontinued its
incentive compensation plan effective January 1, 2000. As a result, no
additional incentive compensation expense was recognized for the six months
ended June 30, 2000.
F-57
<PAGE> 128
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS DOCUMENT OR TO WHICH
WE HAVE REFERRED YOU. WE HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH
INFORMATION THAT IS DIFFERENT. THIS DOCUMENT MAY ONLY BE USED WHERE IT IS LEGAL
TO SELL THESE SECURITIES. THE INFORMATION IN THIS DOCUMENT MAY ONLY BE ACCURATE
ON THE DATE OF THIS DOCUMENT.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary.................... 1
Risk Factors.......................... 5
Special Note Regarding Forward-
Looking Statements.................. 14
Use of Proceeds....................... 15
Dividend Policy....................... 15
Capitalization........................ 16
Dilution.............................. 17
Selected Financial Data............... 18
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 20
Business.............................. 32
Management............................ 44
Certain Relationships and Related
Transactions........................ 55
Principal Stockholders................ 58
Description of Capital Stock.......... 60
Shares Eligible for Future Sale....... 64
Underwriting.......................... 65
Legal Matters......................... 67
Experts............................... 67
Additional Information................ 68
Index to Financial Statements......... F-1
</TABLE>
DEALER PROSPECTUS DELIVERY OBLIGATION: UNTIL , 2000 (25 DAYS AFTER
THE COMMENCEMENT OF THIS OFFERING), ALL DEALERS THAT EFFECT TRANSACTIONS IN
THESE SECURITIES, WHETHER OR NOT PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED
TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE DEALER'S OBLIGATION TO
DELIVER A PROSPECTUS WHEN ACTING AS AN UNDERWRITER AND WITH RESPECT TO UNSOLD
ALLOTMENTS OR SUBSCRIPTIONS.
EMERALD LOGO
4,000,000 SHARES
COMMON STOCK
DEUTSCHE BANC ALEX. BROWN
ROBERTSON STEPHENS
ADAMS, HARKNESS & HILL, INC.
PACIFIC CREST SECURITIES
PROSPECTUS
, 2000
<PAGE> 129
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the costs and expenses, other than
underwriting discounts and commissions, payable by us in connection with the
sale of Common Stock being registered. All amounts are estimates except the SEC
registration fee, the NASD filing fee and the Nasdaq National Market listing
fee.
<TABLE>
<S> <C>
SEC registration fee........................................ $ 15,788
NASD filing fee............................................. 6,480
Nasdaq National Market listing fee.......................... 5,000
Printing and engraving costs................................ 250,000
Legal fees and expenses..................................... 350,000
Accounting fees and expenses................................ 450,000
Blue Sky fees and expenses.................................. 5,000
Transfer Agent and Registrar fees........................... 5,000
Miscellaneous expenses...................................... 22,632
----------
Total............................................. $1,100,000
==========
</TABLE>
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145 of the Delaware General Corporation Law permits a corporation
to include in its charter documents, and in agreements between the corporation
and its directors and officers, provisions expanding the scope of
indemnification beyond that specifically provided by the current law.
Our Restated Certificate of Incorporation provides for the indemnification
of directors to the fullest extent permissible under Delaware law.
Our Bylaws provide for the indemnification of officers, directors and third
parties acting on our behalf if such person acted in good faith and in a manner
reasonably believed to be in and not opposed to our best interest, and, with
respect to any criminal action or proceeding, the indemnified party had no
reason to believe his or her conduct was unlawful.
We have entered into indemnification agreements with our directors and
executive officers, in addition to indemnification provided for in our Bylaws,
and intend to enter into indemnification agreements with any new directors and
executive officers in the future.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
(a) Within the last three years, we have issued and sold the following
unregistered securities described below.
(1) In September 1997, we issued and sold an aggregate of 108,567
shares of our common stock to an employee in exchange for cash in the
aggregate amount of $54,284.
(2) In September 1997, we issued 430,176 shares of our common stock
valued at $268,861 in exchange for all outstanding shares of the common
stock of ServerLogic Corporation.
II-1
<PAGE> 130
(3) In October 1997, we issued and sold an aggregate of 524,000 shares
of our common stock to officers, directors and employees in exchange for
cash in the aggregate amount of $327,500.
(4) In December 1997, we issued and sold an aggregate of 1,311,575
shares of our common stock to officers and directors in exchange for cash
in the aggregate amount of $819,735.
(5) In February 1998, we issued and sold an aggregate of 981,545
shares of our common stock to officers, directors and employees in exchange
for cash in the aggregate amount of $613,466.
(6) In March 1998, we issued and sold an aggregate of 363,115 shares
of our common stock to officers, directors and employees in exchange for
cash in the aggregate amount of $453,894.
(7) In April 1998, we issued and sold an aggregate of 2,494 shares of
our common stock to an employee in exchange for cash in the aggregate
amount of $1,559.
(8) In June 1998, we issued and sold an aggregate of 320,000 shares of
our common stock to a director and an employee in exchange for cash in the
aggregate amount of $400,000.
(9) In July 1998, we issued and sold an aggregate of 240,000 shares of
our common stock to an officer and a director in exchange for cash in the
aggregate amount of $300,000.
(10) In August 1998, we issued and sold an aggregate of 5,000 shares
of our common stock to an employee in exchange for cash in the aggregate
amount of $8,000.
(11) In December 1999, we issued and sold an aggregate of 5,000 shares
of our common stock to a vendor in payment of an invoice in the amount of
$8,000.
(12) In February 1999, we issued and sold an aggregate of 13,333,334
shares of our Series A Preferred Stock in exchange for cash in the
aggregate amount of $7.0 million to six investors each of whom is a
beneficial owner of more than 5% of our outstanding common stock.
(13) In February 2000, we issued and sold an aggregate of 2,000,000
shares of our Series B Preferred Stock in exchange for cash in the
aggregate amount of $5.0 million to five investors each of whom is a
beneficial owner of more than 5% of our outstanding common stock.
(14) In March 2000, we issued a warrant for an aggregate of 600,000
shares of our common stock to AT&T Solutions for an exercise price per
share equal to one of the following: (i) if the common stock is listed on a
national securities exchange, the average of the daily closing sale prices
of our common stock on a national securities exchange, subject to certain
events, (ii) if the common stock is not listed on a national securities
exchange, the average of the closing sales price on the Nasdaq National
Market, subject to certain events, or (iii) if the common stock is not
listed on a national securities exchange or quoted on the Nasdaq National
Market, the fair market value of our common stock as determined by our
board of directors, subject to certain events.
(15) In March 2000, we issued 431,742 shares of our common stock and
notes payable totaling $1,350,000 in exchange for all outstanding shares of
the common stock of ZCom Incorporated.
II-2
<PAGE> 131
(16) In July 2000, we issued and sold an aggregate of 2,009,273 shares
of our Series C Preferred Stock in exchange for cash in the aggregate
amount of $15.0 million to three "qualified institutional buyers," as
defined in Rule 144A of the Securities Act of 1933, as amended. In
addition, in connection with the sale of these shares, we sold an aggregate
of 309,119 shares of our Series C Preferred Stock to funds controlled by an
exisiting holder of our Series A Preferred Stock, Series B Preferred Stock
and Common Stock who has pre-emptive rights.
(17) In July 2000, we issued a warrant for 38,639 shares of our common
stock to Deutsche Bank Securities, Inc., with an exercise price of $6.47
per share.
(18) In July 2000, we issued a warrant for 15,000 shares of our common
stock to Imperial Bank, with an exercise price of $6.47 per share.
(19) In July 2000, we issued and sold an aggregate of 1,364,738 shares
of our common stock and 1,221,042 shares of our restricted common stock to
23 employees of Alliance Consulting Group, Inc.
(20) Since our inception and through June 24, 2000, we have granted
options to purchase an aggregate of 8,746,182 shares of common stock to
employees, directors and consultants under our 1997 Stock Incentive
Compensation Plan and the 1999 Non-Employee Director Stock Option Plan at
exercise prices ranging from $0.25 to $6.25 per share.
(21) Since our inception and through June 24, 2000, we have granted
options to purchase an aggregate of 270,000 shares of common stock to
non-employee directors under our 1999 Non-Employee Director Stock Option
Plan at an exercise price of $1.50 per share. All of these options remain
outstanding, and no shares of our common stock have been issued pursuant to
the exercise of these stock options.
None of the foregoing transactions involved any underwriters, underwriting
discounts or commissions, or any public offering, and we believe that each
transaction was exempt from the registration requirements of the Securities Act
by virtue of Section 4(2) thereof, Regulation D promulgated thereunder and/ or
Rule 701 pursuant to compensatory benefit plans and contracts relating to
compensation as provided under such Rule 701. The recipients in such
transactions represented their intention to acquire the securities for
investment only and not with a view to or for sale in connection with any
distribution thereof, and appropriate legends were affixed to the share
certificates and instruments issued in such transactions. All recipients had
adequate access, through their relationships with us, to information about us.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) EXHIBITS
The Exhibits are as set forth on the Exhibit Index hereto.
(b) FINANCIAL STATEMENT SCHEDULES
<TABLE>
<CAPTION>
SCHEDULE PAGE
-------- ----
<S> <C>
II -- Valuation and Qualifying Accounts..................... S-1
</TABLE>
Schedules not listed above have been omitted because the information
required to be set forth therein is not applicable or is shown in the Financial
Statements or Notes thereto.
II-3
<PAGE> 132
ITEM 17. UNDERTAKINGS
We hereby undertake to provide to the Underwriters at the closing specified
in the Underwriting Agreement certificates in such denominations and registered
in such names as required by the Underwriters to permit prompt delivery to each
purchaser.
Insofar as indemnification by us for liabilities arising under the
Securities Act may be permitted to our directors, officers and controlling
persons pursuant to the provisions referenced in Item 14 of this Registration
Statement, or otherwise, we have been advised that, in the opinion of the
Securities and Exchange Commission such indemnification is against public policy
as expressed in the Securities Act and is, therefore, unenforceable. In the
event that a claim for indemnification against such liabilities (other than the
payment by us of expenses incurred or paid by one of our directors, officers or
controlling persons in the successful defense of any action, suit or proceeding)
is asserted by a director, officer or controlling person in connection with the
securities being registered, we will, unless in the opinion of our counsel the
matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by us is
against public policy as expressed in the Securities Act and we will be governed
by the final adjudication of such issue.
We hereby undertake that:
(1) For purposes of determining any liability under the Securities Act, the
information omitted from the form of Prospectus filed as part of this
Registration Statement in reliance upon Rule 430A and contained in a form of
Prospectus filed by us pursuant to Rule 424(b)(1) or (4) or 497(h) under the
Securities Act shall be deemed to be part of this Registration Statement as of
the time it was declared effective.
(2) For the purpose of determining any liability under the Securities Act,
each post-effective amendment that contains a form of Prospectus shall be deemed
to be a new registration statement relating to the securities offered therein,
and the offering of such securities at that time shall be deemed to be the
initial bona fide offering thereof.
II-4
<PAGE> 133
SIGNATURES
Pursuant to the requirements of the Securities Act of 1993, as amended,
Emerald -- Delaware, Inc. has duly caused this amendment to the Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Portland, State of Oregon, on the 17th day of August,
2000.
Emerald -- Delaware, Inc.
By /s/ MARTIN WRIGHT
------------------------------------
Martin Wright
President and Chief Executive
Officer
POWER OF ATTORNEY
Pursuant to the requirements of the Securities Act of 1933, as amended,
this amendment to the Registration Statement has been signed by the following
persons in the capacities and on the dates indicated:
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ MARTIN WRIGHT President and Chief Executive August 17, 2000
------------------------------------------------ Officer and Director (Principal
(Martin Wright) Executive Officer)
JERRY N. GRANT* Senior Vice President of August 17, 2000
------------------------------------------------ Finance, Chief Financial
(Jerry N. Grant) Officer and Director (Principal
Financial Officer)
NOGI ASP* Vice President -- Finance August 17, 2000
------------------------------------------------ (Principal Accounting Officer)
(Nogi Asp)
MICHAEL W. BEALMEAR* Director August 17, 2000
------------------------------------------------
(Michael W. Bealmear)
CHARLES SCOTT GIBSON* Director August 17, 2000
------------------------------------------------
(Charles Scott Gibson)
/s/ MICHAEL NORKUS President of Strategy Group August 17, 2000
------------------------------------------------ Director
(Michael Norkus)
C. TOMS NEWBY, III* Director August 17, 2000
------------------------------------------------
(C. Toms Newby, III)
/s/ MARTIN WRIGHT* August 17, 2000
------------------------------------------------
Attorney-in-Fact
</TABLE>
II-5
<PAGE> 134
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
EMERALD SOLUTIONS, INC.
FOR THE YEARS ENDED DECEMBER 27, 1997, DECEMBER 26, 1998, AND DECEMBER 25, 1999
<TABLE>
<CAPTION>
BALANCE AT CHARGED TO BALANCE
BEGINNING OF COSTS AND DEDUCTIONS AT END OF
DESCRIPTION YEAR EXPENSES (1) YEAR
----------- ------------ ---------- ---------- ---------
<S> <C> <C> <C> <C>
YEAR ENDED DECEMBER 27, 1997:
Valuation accounts deducted from assets:
Allowance for doubtful accounts
receivable......................... $ -- $ 50,000 $ -- $ 50,000
YEAR ENDED DECEMBER 26, 1998:
Valuation accounts deducted from assets:
Allowance for doubtful accounts
receivable......................... 50,000 30,105 (30,105) 50,000
YEAR ENDED DECEMBER 25, 1999:
Valuation accounts deducted from assets:
Allowance for doubtful accounts
receivable......................... 50,000 229,084 (29,085) 249,999
</TABLE>
-------------------------
(1) Represents amounts written off.
S-1
<PAGE> 135
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
-------
<S> <C>
1.1* Form of Underwriting Agreement
3.1 Amended and Restated Certificate of Incorporation of the
Registrant as currently in effect
3.2** Form of Amended and Restated Certificate of Incorporation of
the Registrant to be filed upon completion of the offering
3.3 Bylaws of the Registrant as currently in effect
3.4** Bylaws of the Registrant as in effect upon completion of the
offering
4.1 Reference is made to Exhibits 3.1, 3.2, 3.3 and 3.4
4.2** Specimen certificate for common stock
5.1 Opinion of Morrison & Foerster LLP
10.1* Form of Indemnification Agreement between the Registrant and
each of its directors and officers
10.2* Employment Agreement dated January 27, 1997 between the
Registrant and Martin Wright
10.3* Employment Agreement dated January 7, 1997 between the
Registrant and Jerry Grant
10.4* Employment Agreement dated August 21, 1997 between the
Registrant and Mark Markowitz
10.5* Employment Agreement dated January 18, 1999 between the
Registrant and Jim Gruher
10.6+ Professional Services Agreement between the Registrant and
golfgateway.com (n/k/a Greens.com) dated as of September 15,
1999
10.7* 1997 Stock Incentive Compensation Plan and forms of
agreements thereunder
10.8* 1999 Non-Employee Director Stock Option Plan and form of
agreements thereunder
10.9 2000 Employee Stock Purchase Plan
10.10+ General Agreement for Information Technology Projects
between AT&T Corp. and the Registrant effective as of April
15, 1998
10.11+ Strategic Alliance Agreement by and between the Registrant
and AT&T Solutions Inc., effective as of March 15, 2000
10.12 2000 Stock Incentive Plan
23.1 Consent and report on schedule of KPMG LLP, independent
auditors
23.2 Consent of Counsel (see Exhibit 5.1)
23.3 Consent of KPMG LLP, independent auditors
23.4 Consent of KPMG LLP, independent auditors
24.1 Power of Attorney (Registration Statement signature page)
27.1 Financial Data Schedules
</TABLE>
-------------------------
+ We have requested confidential treatment by the Commission of those portions
of the exhibit omitted and marked with an asterisk. The omitted portions have
been separately filed with the Commission.
* Previously filed.
** To be filed by amendment.
