<PAGE>
As filed with the Securities and Exchange Commission on May 5, 2000
Registration No. 333-
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------
FORM S-4
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
---------------
PRODIGY COMMUNICATIONS CORPORATION
(Exact name of registrant as specified in its charter)
7370 04-3323363
Delaware
(Primary Standard (I.R.S. Employer
(State or Other Industrial Identification Number)
Jurisdiction of Classifications Code
Number
Incorporation or ---------------
Organization
44 South Broadway, White Plains, New York 10601, (914) 448-8000
(Address, including zip code, and telephone number, including
area code, of registrant's principal executive offices)
---------------
Samer F. Salameh
Chairman of the Board and Chief Executive Officer
Prodigy Communications Corporation
44 South Broadway
White Plains, New York 10601
(914) 448-8000
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
---------------
Copies to:
David A. Westenberg, Esq. S. Michael Dunn, Esq.
Hale and Dorr LLP Brobeck, Phleger & Harrison LLP
60 State Street 301 Congress Avenue
Boston, Massachusetts 02109 Suite 1200
Telephone: (617) 526-6000 Austin, Texas 78701
Telecopy: (617) 526-5000 Telephone: (512) 477-5495
Telecopy: (512) 477-5813
---------------
Approximate date of commencement of proposed sale to the public: As soon as
practicable after this Registration Statement becomes effective and certain
other conditions under the Merger Agreement are met or waived.
If the securities being registered on this Form are being offered in
connection with the formation of a holding company and there is compliance with
General Instruction G, 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(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. [_]
---------------
CALCULATION OF REGISTRATION FEE
<TABLE>
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<CAPTION>
Proposed Proposed
Title of each class of maximum maximum
securities to be Amount to be offering price aggregate Amount of
registered registered(1) per share(2) offering price(2) registration fee (3)
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<S> <C> <C> <C> <C>
Common Stock, $.01 par
value per share 5,864,203 shares $11.66 $68,376,606 $18,046
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</TABLE>
(1) Based upon the estimated maximum number of shares of common stock of the
Registrant issuable in the merger described herein to stockholders of
FlashNet Communications, Inc.
(2) Estimated solely for the purpose of calculating the registration fee
pursuant to Rules 457(c) and 457(f) under the Securities Act of 1933, as
amended, and based upon the average of the high and low sale prices of the
Registrant's common stock as reported on the Nasdaq National Market on May
4, 2000.
(3) Pursuant to Rule 457(b) under the Securities Act, an amount ($24,376) in
excess of the registration fee was paid on December 23, 1999 in connection
with the filing of preliminary proxy materials.
---------------
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 thereafter 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 said Section 8(a),
may determine.
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<PAGE>
FlashNet Communications, Inc.
May 5, 2000
Dear FlashNet Communications, Inc. Shareholders:
I am writing to you today about our proposed merger with Prodigy
Communications Corporation. Proud of FlashNet's prior accomplishments, we are
looking forward at an industry increasingly dominated by companies that possess
size, strong brand names, broad service offerings and important strategic
alliances. We believe Prodigy possesses all of these strengths and we are
confident that this is the right transaction for FlashNet.
In the merger, each share of FlashNet common stock will be exchanged for 0.35
share of Prodigy common stock. Prodigy expects to issue approximately 5,000,000
shares of its common stock in the merger. Upon completion of the merger,
FlashNet shareholders will own approximately 7.4% of Prodigy's outstanding
common stock. Prodigy common stock is traded on the Nasdaq National Market
under the trading symbol "PRGY" and closed at a price of $11.6875 per share on
May 4, 2000. You will be asked to vote on the merger at a special meeting of
FlashNet shareholders.
Prodigy has a pending transaction with SBC Communications Inc. in which,
among other things, SBC will acquire an approximate 43% interest in Prodigy and
Prodigy will be the exclusive retail Internet service marketed by SBC to
consumers and small businesses in the United States. Completion of the SBC
transaction is not a condition to completion of FlashNet's merger with SBC. For
a description of the SBC transaction, please see "Pending SBC Transaction"
beginning on page 91. Following completion of the SBC transaction, FlashNet's
shareholders will own approximately 4.5% of Prodigy and SBC will own
approximately 39.5% of Prodigy.
We are very excited by the opportunities that we envision for the combined
company. Your board of directors has determined that the terms and conditions
of the merger are advisable and in the best interests of FlashNet and you and
unanimously recommends that you approve the merger agreement and the merger.
Your board of directors has obtained an opinion from its independent financial
advisor, Goldman, Sachs & Co., to the effect that the exchange ratio in the
merger is fair to you from a financial point of view.
The accompanying proxy statement/prospectus provides detailed information
about Prodigy, FlashNet and the merger. Please give all of this information
your careful attention. In particular, you should carefully consider the
discussion in the section entitled "Risk Factors" beginning on page 9 of the
proxy statement/prospectus.
Your vote is very important regardless of the number of shares you own. To
vote your shares, you may use the enclosed proxy card or attend the special
meeting. To approve the merger agreement, you MUST vote "FOR" the proposal by
following the instructions stated on the enclosed proxy card. If you do not
vote at all, it will, in effect, count as a vote against the merger.
Sincerely,
M. Scott Leslie
President and Chief Executive
Officer
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of this transaction or the securities of
Prodigy to be issued in the merger, or determined if this proxy
statement/prospectus is accurate or complete. Any representation to the
contrary is a criminal offense.
This proxy statement/prospectus is dated May 5, 2000, and was first mailed to
FlashNet shareholders on or about May 5, 2000.
<PAGE>
FlashNet Communications, Inc.
3001 Meacham Boulevard, Suite 100
Fort Worth, Texas 76137
(817) 820-0068
NOTICE OF SPECIAL MEETING OF SHAREHOLDERS
TO BE HELD ON MAY 30, 2000
We will hold a special meeting of the shareholders of FlashNet
Communications, Inc. at 9:00 a.m., local time, on Tuesday, May 30, 2000, at the
City Club in the City Center Tower II, located at 301 Commerce Street, Fort
Worth, Texas 76102:
1. To consider and vote on a proposal to approve and adopt the merger
agreement among Prodigy Communications Corporation, FlashNet and a wholly-
owned subsidiary of Prodigy, pursuant to which FlashNet will become a
wholly-owned subsidiary of Prodigy and each outstanding share of FlashNet
common stock will be converted into the right to receive 0.35 share of
Prodigy common stock; and
2. To transact any other business as may properly come before the special
meeting or any adjournment or postponement of the special meeting.
Your board of directors has determined that the merger is advisable and in
the best interests of FlashNet and you and unanimously recommends that you vote
to approve the merger agreement and the merger.
We describe the merger more fully in the accompanying proxy
statement/prospectus, which we urge you to read.
Only FlashNet shareholders of record at the close of business on April 7,
2000, are entitled to notice of and to vote at the special meeting or any
adjournment or postponement.
Your vote is important. To assure that your shares are represented at the
special meeting, you are urged to complete, date and sign the enclosed proxy
and mail it promptly in the postage-paid envelope provided, whether or not you
plan to attend the special meeting in person. You may revoke your proxy in the
manner described in the accompanying proxy statement/prospectus at any time
before it has been voted at the special meeting. You may vote in person at the
special meeting even if you have returned a proxy.
By Order of the Board of Directors
M. Scott Leslie
President and Chief Executive
Officer
Fort Worth, Texas
May 5, 2000
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
QUESTIONS AND ANSWERS ABOUT THE MERGER.................................... 1
SUMMARY................................................................... 3
RISK FACTORS.............................................................. 9
Risks Relating to the Merger............................................ 9
Risks Relating to Prodigy's Business.................................... 11
Risks Relating to FlashNet's Business................................... 18
Cautionary Statement Concerning Forward-Looking Statements.............. 24
SELECTED HISTORICAL CONDENSED CONSOLIDATED FINANCIAL INFORMATION.......... 26
SELECTED UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION..... 31
COMPARATIVE PER SHARE DATA................................................ 36
MARKET PRICE INFORMATION.................................................. 37
Prodigy Market Price Information........................................ 37
FlashNet Market Price Information....................................... 37
Recent Closing Prices................................................... 37
Dividends............................................................... 38
THE SPECIAL MEETING....................................................... 39
Date, Time and Place of Meeting......................................... 39
What Will Be Voted Upon................................................. 39
Record Date and Outstanding Shares...................................... 39
Vote Required to Approve the Merger..................................... 39
Share Ownership of Management and Shareholders.......................... 39
Quorum; Abstentions and Broker Non-Votes................................ 39
Voting and Revocation of Proxies........................................ 40
Solicitation of Proxies and Expenses.................................... 40
Board Recommendation.................................................... 40
THE MERGER................................................................ 41
Background of the Merger................................................ 41
Prodigy's Reasons for the Merger........................................ 44
FlashNet's Reasons for the Merger; Recommendation of the FlashNet Board
of Directors........................................................... 45
Opinion of FlashNet's Financial Advisor................................. 47
Interests of Executive Officers and Directors of FlashNet in the
Merger................................................................. 55
Treatment of FlashNet Common Stock...................................... 56
Accounting Treatment of the Merger...................................... 57
Regulatory Approvals.................................................... 57
Material United States Federal Income Tax Considerations................ 57
Resales of Prodigy Common Stock Issued in Connection with the Merger;
Affiliate Agreements................................................... 58
No Appraisal Rights..................................................... 59
Delisting and Deregistration of FlashNet's Common Stock Following the
Merger................................................................. 59
THE MERGER AGREEMENT...................................................... 60
General................................................................. 60
The Exchange Ratio and Treatment of FlashNet Common Stock............... 60
Treatment of FlashNet Stock Options..................................... 60
Treatment of FlashNet Warrants.......................................... 61
Termination of FlashNet Employee Stock Discount Purchase Plan and 401(k)
Plan................................................................... 61
Exchange of Certificates................................................ 61
Representations and Warranties.......................................... 62
Covenants of Prodigy and FlashNet....................................... 63
Conditions to Obligations to Complete the Merger........................ 66
</TABLE>
i
<PAGE>
<TABLE>
<CAPTION>
Page
----
<S> <C>
Termination; Expenses and Termination Fees............................. 67
Amendment.............................................................. 69
RELATED AGREEMENTS....................................................... 70
Stock Option Agreement................................................. 70
Stockholder Agreement.................................................. 71
PRODIGY BUSINESS......................................................... 73
PENDING SBC TRANSACTION.................................................. 91
PRODIGY'S MANAGEMENT..................................................... 96
PRODIGY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS................................................... 104
FLASHNET'S BUSINESS...................................................... 114
FLASHNET MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS................................................... 125
UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION............. 134
PRODIGY'S PRINCIPAL STOCKHOLDERS......................................... 146
FLASHNET'S PRINCIPAL SHAREHOLDERS........................................ 148
COMPARISON OF SHAREHOLDER RIGHTS......................................... 150
SHAREHOLDER PROPOSALS.................................................... 160
LEGAL MATTERS............................................................ 160
EXPERTS.................................................................. 160
WHERE YOU CAN FIND MORE INFORMATION...................................... 160
INDEX TO FINANCIAL STATEMENTS............................................ F-1
ANNEXES
Annex A--Opinion of Goldman, Sachs & Co................................ A-1
Annex B--Agreement and Plan of Merger.................................. B-1
Annex C--Stock Option Agreement........................................ C-1
Annex D--Stockholder Agreement......................................... D-1
</TABLE>
ii
<PAGE>
QUESTIONS AND ANSWERS ABOUT THE MERGER
Q: Why do the companies propose to merge?
A: Prodigy and FlashNet believe that the merger will provide several benefits
to both companies. In particular, Prodigy believes that the merger will,
among other things, strengthen its position in the market place by adding
approximately 235,000 subscribers to its subscriber base, by providing
Prodigy with a national network operations center and additional network
infrastructure and by providing Prodigy with a well-regarded in-house
customer service center and access to FlashNet's network marketing program
with its attendant low-cost acquisition sales channel. FlashNet believes
that the merger will provide its shareholders with the opportunity to
participate in the ownership of Prodigy, which FlashNet's management
believes possesses the size, strong national brand name, broad service
offerings and important strategic alliances that are necessary to compete in
an industry increasingly dominated by large national Internet service
providers. In addition, FlashNet's management believes that, absent the
merger, due to, among other factors, FlashNet's lack of size, strong brand
name and strategic relationships, FlashNet would not, at the present time,
be able to obtain financing on reasonable terms sufficient to enable it to
continue to fund its operations at their current levels.
Q: Are there any potential disadvantages to the proposed merger?
A: Prodigy has identified a number of potential negative factors that could
materialize as a result of the merger, including the risk that the potential
benefits sought in the merger might not be realized and the potential
adverse effect of the public announcement of the merger on FlashNet's
business, including its employees and customers. FlashNet also has
identified a number of disadvantages in the merger, including the risk that
the value to be received by FlashNet shareholders in the merger could
decline significantly from that determined as of the date of the merger
agreement due to the fixed exchange ratio used in the merger, the risk that
potential benefits sought to be achieved in the merger might not be fully
realized, the risk that FlashNet's management and technical personnel might
not continue with Prodigy after the merger, the loss of control over future
operations of FlashNet after the merger and the impact of the loss of
FlashNet's status as an independent company on its shareholders and
employees.
Q: What will I receive in the merger?
A: If the merger is completed, you will receive 0.35 share of Prodigy common
stock for each share of FlashNet common stock that you own and cash, without
interest, for any fractional shares.
Q: Prodigy has announced that it plans to establish a strategic relationship
with SBC Communications Inc. Is the proposed SBC transaction a condition to
Prodigy's proposed merger with FlashNet?
A: The completion of Prodigy's strategic relationship with SBC is not a
condition to the completion of Prodigy's merger with FlashNet, and the
completion of the FlashNet merger is not a condition to the completion of
Prodigy's strategic relationship with SBC.
Q: When do you expect to complete the merger of Prodigy and FlashNet?
A: We expect to complete the merger during the second calendar quarter of 2000.
We cannot predict the exact timing.
Q: Who must approve the merger?
A: In addition to the approvals of the board of directors of Prodigy and
FlashNet, which were already obtained, FlashNet shareholders must approve
the merger.
1
<PAGE>
Q: What shareholder vote is required to approve the merger agreement and the
merger?
A: The affirmative vote of the holders of at least two-thirds of the
outstanding shares of FlashNet common stock is required to approve the
merger agreement and the merger.
Q: Does the FlashNet Board of Directors recommend approval of the merger
agreement and the merger?
A: Yes. For a more complete description of the recommendation of the FlashNet
board of directors, see the section entitled "The Merger--FlashNet's Reasons
for the Merger; Recommendation of the FlashNet Board of Directors" on page
45.
Q: What do I need to do now?
A: We urge you to read this proxy statement/prospectus, including its annexes,
carefully, and to consider how the merger will affect you as a shareholder.
You also may want to review the documents referenced under "Where You Can
Find More Information" on page 160.
Q: How do I vote?
A: You may indicate how you want to vote on your proxy card. You may also
attend the special meeting and vote in person instead of submitting a proxy.
If you fail either to return your proxy card or to vote in person at the
special meeting, or if you mark your proxy "abstain," the effect will be a
vote against the merger agreement and the merger. If you fail to indicate
your vote on your proxy, your proxy will be counted as a vote for the
merger, unless your shares are held in a brokerage account.
Q: If my shares are held in a brokerage account, will my broker vote my shares
for me?
A: Your broker cannot vote your shares without instructions from you on how to
vote. Therefore, it is important that you follow the directions provided by
your broker regarding how to instruct your broker to vote your shares. If
you fail to provide your broker with instructions, it will have the same
effect as a vote against the merger agreement and the merger.
Q: May I change my vote after I have mailed in my signed proxy card?
A: You may change your vote at any time before the vote takes place at the
FlashNet special meeting. To change your vote, you may either submit a later
dated proxy card or send a written notice stating that you would like to
revoke your proxy. In addition, you may attend the special meeting and vote
in person. However, if you elect to vote in person at the special meeting
and your shares are held by a broker, bank or other nominee, you must bring
to the special meeting a legal proxy from the broker, bank or other nominee
authorizing you to vote the shares.
Q: When and where is the FlashNet special meeting?
A: The special meeting of FlashNet shareholders will be held at 9:00 a.m.,
local time, on Tuesday, May 30, 2000, at the City Club in the City Tower II
located at 301 Commerce Street, Fort Worth, Texas 76102.
Q: Should I send in my certificates now?
A: No. After we complete the merger, Prodigy's transfer agent will send
instructions to you regarding the exchange of your shares of FlashNet common
stock for Prodigy common stock.
Q: Whom may I contact with any additional questions?
A: You may call Charlotte Brown of Corporate Investor Communications, Inc., the
investor relations firm for FlashNet at (201) 896-5670.
2
<PAGE>
SUMMARY
This summary highlights selected information from this document and may not
contain all of the information that is important to you. To understand the
merger fully and for a more complete description of the legal terms of the
merger, you should read carefully this entire document and the documents to
which we have referred you. See "Where You Can Find More Information" on page
159. We have included page references parenthetically to direct you to a more
complete description of the topics in this summary.
The Companies
Prodigy Communications Corporation
44 South Broadway
White Plains, New York 10601
(914) 448-8000
Prodigy is a leading Internet service provider that provides Internet access
and other Internet-based services. Prodigy tailors its services to target the
consumer, small business and U.S. Hispanic markets. Prodigy's Internet strategy
is to strengthen its position as a leading Internet service provider and to
expand the range of services it offers and markets it serves. Prodigy's
strategy also envisions acquisitions that can complement its current or planned
business activities.
FlashNet Communications, Inc.
3001 Meacham Boulevard
Suite 100
Fort Worth, Texas 76137
(817) 820-0068
FlashNet is a nationwide provider of Internet access and related services.
FlashNet tailors its services to the specific demands of both consumer and
business customers. FlashNet's systems and network infrastructure are designed
to provide consumer and business customers with fast and reliable quality
service through state-of-the-art equipment and a trained support staff.
The Merger
Through the merger, FlashNet will become a wholly-owned subsidiary of
Prodigy. Its directors will not become directors of the board of Prodigy.
FlashNet shareholders will receive Prodigy common stock in exchange for their
shares of FlashNet common stock. The merger agreement is attached to this proxy
statement/prospectus as Annex B. We encourage you to read it.
Vote Required
(Page 39)
Approval of the merger agreement requires the vote of two-thirds of the
outstanding shares of FlashNet common stock. FlashNet's directors and executive
officers and their affiliates held approximately 28% of the outstanding shares
of FlashNet common stock on November 5, 1999. These holders of FlashNet common
stock have already agreed to vote in favor of the merger.
FlashNet Recommendation to Shareholders
(Page 40)
The FlashNet board of directors voted to approve the merger agreement and the
merger. The FlashNet board of directors believes that the merger is advisable
and in your best interest and recommends that you vote FOR the proposal to
approve the merger agreement and the merger.
What Holders of FlashNet Common Stock Will Receive
(Page 60)
Holders of FlashNet common stock can exchange each share for 0.35 share of
Prodigy common stock.
Prodigy will not issue fractional shares of Prodigy common stock in
connection with the merger. Instead, Prodigy will pay cash, without interest,
for any fractional shares.
Based on the 14,321,297 shares of FlashNet common stock outstanding on March
31, 2000, Prodigy estimates that FlashNet shareholders will receive
approximately 5,000,000 shares of Prodigy common stock in the merger.
3
<PAGE>
Conditions to the Merger
(Page 66)
The completion of the merger depends on a number of conditions, including:
. the approval of FlashNet shareholders;
. the approval of the listing on the Nasdaq National Market of Prodigy
common stock that Prodigy will issue to FlashNet shareholders in the
merger;
. the receipt of legal opinions regarding the treatment of the merger as a
tax-free reorganization; and
. other customary contractual conditions in the merger agreement.
The party entitled to assert any condition to the merger may waive it.
No Solicitation by FlashNet
(Page 65)
Subject to applicable fiduciary duties to shareholders of the FlashNet board
of directors to recommend a superior proposal to FlashNet shareholders,
FlashNet has agreed that neither it nor any of its subsidiaries will:
. solicit, initiate or encourage any proposal that might lead to an
alternative transaction;
. enter into discussions or negotiations concerning, or provide any non-
public information to a third party relating to an alternative
transaction; or
. agree to recommend an alternative transaction to the FlashNet
shareholders.
FlashNet has also agreed to cause each of its officers, directors, employees,
financial advisors, representatives and agents not to take any of these
actions.
In addition, FlashNet may comply with the Securities and Exchange
Commission's tender offer requirements with respect to an alternative
transaction.
Termination of the Merger Agreement
(Page 67)
Prodigy and FlashNet can mutually agree to terminate the merger agreement
without completing the merger, and either Prodigy or FlashNet can terminate the
merger agreement if:
. the other party breaches any material representation, warranty or
covenant in the merger agreement and fails to cure the breach within 10
days of receiving notice of the breach;
. the merger is not completed by May 31, 2000; or
. FlashNet shareholders do not approve the merger agreement and the merger
at a special meeting of FlashNet shareholders.
In addition, Prodigy can terminate the merger agreement if:
. the FlashNet board of directors fails to recommend approval of the
merger agreement and the merger to the FlashNet shareholders or
withdraws or modifies its recommendation;
. the FlashNet board of directors fails to reconfirm its recommendation of
the merger agreement and the merger to the FlashNet shareholders within
five business days after Prodigy requests that it do so;
. the FlashNet board of directors approves or recommends to the FlashNet
shareholders an alternative transaction with a third party meeting the
requirements set forth in the merger agreement;
. a third party, other than Prodigy or an affiliate of Prodigy, commences
a tender offer or exchange offer for the outstanding shares of FlashNet
common stock and the FlashNet board of directors recommends that the
FlashNet shareholders tender their shares in the tender or exchange
offer, or within ten days after the third party commences the tender or
exchange offer and the FlashNet board of directors fails to recommend
that the FlashNet shareholders reject the offer or takes no position
with respect to the offer; or
. for any reason, FlashNet fails to call and hold the special meeting by
May 30, 2000.
4
<PAGE>
Termination Fees and Expenses
(Page 67)
FlashNet must pay Prodigy a termination fee of $5,000,000 if Prodigy
terminates the merger agreement because:
. the FlashNet board of directors fails to recommend approval of the
merger agreement and the merger to the FlashNet shareholders or
withdraws or modifies its recommendation;
. the FlashNet board of directors fails to reconfirm its recommendation of
the merger agreement and the merger to the FlashNet shareholders within
five business days after Prodigy requests that it do so;
. the FlashNet board of directors approves or recommends to the FlashNet
shareholders an alternative transaction with a third party meeting the
requirements set forth in the merger agreement;
. a third party, other than Prodigy or an affiliate of Prodigy, commences
a tender offer or exchange offer for the outstanding shares of FlashNet
common stock and the FlashNet board of directors recommends that the
FlashNet shareholders tender their shares in the tender or exchange
offer, or within ten days after the third party commences the tender or
exchange offer and the FlashNet board of directors fails to recommend
that the FlashNet shareholders reject the offer or takes no position
with respect to the offer;
. FlashNet fails to call and hold the special meeting by May 30, 2000; or
. FlashNet breachs a representation, warranty or covenant of the merger
agreement, which excuses Prodigy from its obligation to effect the
merger and FlashNet fails to cure the breach within 10 days after it
receives a written notice of the breach from Prodigy.
FlashNet must also pay Prodigy a termination fee of $5,000,000 if FlashNet
fails to obtain the requisite vote of FlashNet shareholders to approve the
merger. In addition, FlashNet must pay Prodigy up to $500,000 as reimbursement
for the costs incurred by Prodigy related to the merger if Prodigy terminates
the merger agreement and the merger is not completed by May 31, 2000.
Prodigy must pay FlashNet a termination fee of $5,000,000 if Prodigy breaches
any representation, warranty or covenant of the merger agreement which Prodigy
fails to cure within 10 days after Prodigy receives a written notice of the
breach from FlashNet. In addition, Prodigy must pay FlashNet up to $500,000 as
reimbursement for the costs incurred by FlashNet related to the merger if
FlashNet terminates the merger agreement and the merger is not completed by May
31, 2000.
Stock Option Agreement
(Page 70)
In connection with the merger agreement, Prodigy and FlashNet entered into a
stock option agreement, dated as of November 5, 1999. The option agreement
grants Prodigy the right to purchase up to 2,837,475 shares of FlashNet common
stock, constituting approximately 19.9% of the outstanding shares of FlashNet
common stock, at a price of $8.6625 per share, subject to adjustment. However,
Prodigy may not exercise this option to acquire more than 19.9% of the
outstanding shares of FlashNet common stock. Prodigy may exercise the option
only after it terminates the merger agreement because:
. the FlashNet board of directors fails to recommend approval of the
merger agreement and the merger to the FlashNet shareholders or
withdraws or modifies its recommendation;
. the FlashNet board of directors fails to reconfirm its recommendation of
the merger agreement and the merger to the FlashNet shareholders within
five business days after Prodigy requests that it do so;
. the FlashNet board of directors approves or recommends to the FlashNet
shareholders an alternative transaction;
. a third party, other than Prodigy or an affiliate of Prodigy, commences
a tender offer or exchange offer for the outstanding
5
<PAGE>
shares of FlashNet common stock and the FlashNet board of directors
recommends that the FlashNet shareholders tender their shares in the
tender or exchange offer, or within ten days after the third party
commences the tender or exchange offer and FlashNet board of directors
fails to recommend that the FlashNet shareholders reject the offer or
takes no position with respect to the offer;
. FlashNet fails to call and hold the special meeting by May 30, 2000;
. FlashNet breachs a representation, warranty or covenant of the merger
agreement, which excuses Prodigy from its obligation to effect the
merger and FlashNet fails to cure the breach within 10 days after it
receives a written notice of the breach from Prodigy; or
. FlashNet fails to receive the requisite vote for approval of the merger
agreement at the special meeting of FlashNet shareholders.
Once the option is exercisable, Prodigy may exercise its option in whole or
in part, at any time or from time to time prior to its termination. The option
terminates at the earliest of:
. the time the merger becomes effective;
. termination of the merger agreement under circumstances that do not
allow Prodigy to receive a termination fee;
. the amount of cash received by Prodigy as a termination fee under the
merger agreement and from actual or potential sales of the shares of
FlashNet common stock issuable on exercise of the option exceeds
$5,000,000; and
. 90 days after the merger agreement is terminated. This period will be
extended by 30 days if either Prodigy cannot exercise its option or
FlashNet cannot deliver to Prodigy the shares of FlashNet common stock
purchased on exercise of the option because conditions to FlashNet's
obligation to deliver the shares have not been met.
Opinion of Financial Advisor
(Page 47)
In deciding to approve the merger, the FlashNet board of directors received
an opinion from its financial advisor, Goldman, Sachs & Co., that the exchange
ratio is fair, from a financial point of view, to the holders of FlashNet
common stock. The full text of Goldman Sachs' opinion is attached as Annex A to
this document.You should read it carefully and in its entirety. Goldman Sachs'
opinion is addressed to the FlashNet board of directors and does not constitute
a recommendation to any FlashNet shareholder as to how to vote on the merger.
Interests of Executive Officers and
Directors of FlashNet in the Merger
(Page 55)
In considering the recommendation of the FlashNet board of directors, you
should be aware of the interests that FlashNet executive officers and directors
have in the merger. These include:
. the executive officers of FlashNet will receive retention and severance
benefits;
. six FlashNet executive officers and directors who together hold a total
of 575,821 stock options granted or to be granted under FlashNet's stock
option plans, including 142,875 stock options which the FlashNet board
of directors has authorized for grant to M. Scott Leslie, have received
the benefit of accelerated vesting;
. FlashNet officers and directors have customary rights to indemnification
against liabilities; and
. one FlashNet director owns 1,000 shares of Prodigy common stock.
In considering the fairness of the merger to FlashNet shareholders, the
FlashNet board of directors took into account these interests. These interests
are different from and in addition to
6
<PAGE>
customary interests of shareholders. FlashNet executive officers and directors
have options to acquire FlashNet common stock that will be converted under the
terms of the merger agreement into options to acquire shares of Prodigy common
stock. As of March 31, 2000, the executive officers and directors of FlashNet
held options for an aggregate of 432,946 shares of FlashNet common stock, all
of which are currently vested. Assuming the last reported sales price of
FlashNet common stock on the Nasdaq National Market on the trading day
immediately prior to the effective date of the merger is in excess of $8.82,
FlashNet executive officers and directors will receive options to acquire
151,531 shares of Prodigy common stock in exchange for their FlashNet options.
A provision of the merger agreement requires FlashNet to cancel, on the
effective date of the merger, all options to acquire FlashNet's common stock
with an exercise price equal to or above the last reported sales price.
Consequently, if the last reported sales price is below $3.53, only Mr. Leslie
will receive an option to acquire Prodigy common stock in exchange for his
FlashNet options and such option will cover 50,006 shares of Prodigy common
stock. In addition, as of April 7, 2000, the record date, the executive
officers and directors of FlashNet and their affiliates held 4,013,813 shares
of FlashNet common stock. They will receive approximately 1,404,834 shares of
Prodigy common stock upon conversion of their shares of FlashNet common stock.
Subsequent to the November 5, 1999 meeting at which the merger was approved by
the FlashNet board of directors, Global Undervalued Securities Fund, L.P.,
which is controlled by a FlashNet director, acquired shares of Prodigy common
stock. As of April 18, 2000, Global Undervalued Securities Fund owned 266,700
shares of Prodigy common stock.
Accounting Treatment
(Page 57)
Prodigy will account for the merger using the purchase method of accounting.
Thus, Prodigy will record the assets and liabilities of FlashNet, including
intangible assets at their fair value and will include the results of
operations of FlashNet in its results from the date of acquisition.
Material United States Federal Income Tax
Considerations
(Page 57)
We have structured the merger to qualify as a tax-free reorganization under
the Internal Revenue Code. It is our intention that no gain or loss will be
generally recognized by FlashNet shareholders for federal income tax purposes
on the exchange of shares of FlashNet common stock solely for shares of Prodigy
common stock. Nevertheless, you should consult your tax advisor for a full
understanding of the tax consequences of the merger to you.
FlashNet Shareholders Have No Appraisal Rights
(Page 59)
Under Texas law, FlashNet shareholders do not have appraisal rights with
respect to the merger.
Prodigy Price Information
(Page 37)
Shares of Prodigy common stock are quoted on the Nasdaq National Market. On
November 5, 1999, the last full trading day prior to the public announcement of
the proposed merger, Prodigy common stock closed at $24.75 per share. On May 4,
2000, Prodigy common stock closed at $11.6875 per share.
FlashNet Price Information
(Page 37)
Shares of FlashNet common stock are also quoted on the Nasdaq National
Market. On November 5, 1999, the last full trading day prior to the public
announcement of the proposed merger, FlashNet common stock closed at $10.00 per
share. On May 4, 2000, FlashNet common stock closed at $3.75 per share.
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Pending SBC Transaction
(Page 91)
In considering whether to vote in favor of the merger, FlashNet shareholders
should consider the potential impacts of Prodigy's pending transaction with
SBC. Although the FlashNet merger and the SBC transaction are not conditioned
on each other, upon completion of the SBC transaction, SBC will have the right
to elect three directors of Prodigy. If the transaction is not completed,
however, Prodigy's board will remain unchanged.
Prodigy anticipates that it will complete the SBC transaction in the second
quarter of 2000.
The following table summarizes the ownership of Prodigy common stock
immediately following the FlashNet merger and Prodigy's pending strategic
transaction with SBC described under "Pending SBC Transaction." The table is
based on the shares, options and warrants outstanding as of March 31, 2000 and
assumes the exercise of all outstanding options and warrants as of that date.
<TABLE>
<CAPTION>
After
FlashNet
Merger and
As of After FlashNet SBC
March 31, 2000 Merger Transaction
-------------- -------------- -----------
<S> <C> <C> <C>
Current Prodigy stockholders.......... 100.0% 92.6% 56.0%
Former FlashNet shareholders.......... -- 7.4% 4.5%
SBC................................... -- -- 39.5%
Total................................. 100.0% 100.0% 100.0%
</TABLE>
8
<PAGE>
RISK FACTORS
You should carefully consider the following risk factors before you decide
whether to vote to approve and adopt the merger agreement. You should also
consider the other information in this document.
Risks Relating to the Merger
Prodigy's stock price is volatile and the value of the Prodigy common stock
issued in the merger will depend on its market price at the time of the merger,
and no adjustment will be made as a result of changes in the market price of
Prodigy's common stock.
The market price of Prodigy common stock, like that of the shares of many
other high technology and Internet companies, has been and may continue to be
volatile. For example, from February 11, 1999 to May 4, 2000, Prodigy common
stock traded as high as $50.625 per share and as low as $8.25 per share.
At the closing of the merger, holders of FlashNet common stock will exchange
each of their shares for 0.35 share of Prodigy common stock. This exchange
ratio will not be adjusted for changes in the market price of Prodigy common
stock or of FlashNet common stock. In addition, neither Prodigy nor FlashNet
may terminate or renegotiate the merger agreement, and FlashNet may not
resolicit the vote of its shareholders solely because of changes in the market
price of Prodigy common stock or of FlashNet common stock. Any reduction in
Prodigy common stock price will result in you receiving less value in the
merger at closing. You will not know the exact value of Prodigy common stock to
be issued to you in the merger at the time of the special meeting of FlashNet
shareholders.
The complex process of integrating Prodigy and FlashNet may disrupt the
business activities of Prodigy and affect employee morale, thus affecting
Prodigy's ability to retain key employees.
Integrating the operations and personnel of Prodigy and FlashNet will be a
complex process, and Prodigy is uncertain that the integration will be
completed rapidly or will achieve the anticipated benefits of the merger. Since
FlashNet is located in Texas, it will be more difficult to retain employees of
FlashNet if after the merger, some of the activities and management of FlashNet
move from Texas to New York. The successful integration of Prodigy and FlashNet
will require, among other things, integration of their finance, human resources
and sales and marketing groups and coordination of development efforts. The
diversion of the attention of Prodigy's management and any difficulties
encountered in the process of combining the companies could cause the
disruption of the business activities of Prodigy. Further, the process of
combining Prodigy and FlashNet could negatively affect employee morale and the
ability of Prodigy to retain some of its key employees after the merger.
If the merger's benefits do not meet the expectations of financial or industry
analysts, the market price of Prodigy common stock may decline.
The market price of Prodigy common stock may decline as a result of the
merger if:
. Prodigy does not achieve the perceived benefits of the merger as rapidly
as, or to the extent, anticipated by financial or industry analysts; or
. the effect of the merger on Prodigy's financial results is not
consistent with the expectations of financial or industry analysts.
Failure to complete the merger may impede alternative mergers or alternative
business combinations and may further result in FlashNet paying substantial
termination fees to Prodigy. This failure may also dilute the value of
FlashNet's stock, decrease its market price and cause FlashNet to nevertheless
incur legal and accounting fees.
If the merger is not completed for any reason, FlashNet may be subject to a
number of material risks, including:
. Prodigy may require FlashNet to pay a termination fee of $5,000,000
and/or reimburse Prodigy for expenses of up to $500,000;
9
<PAGE>
. FlashNet shareholders may experience dilutive effects to their stock
ownership because Prodigy may exercise an option to acquire up to 19.9%
of the outstanding shares of FlashNet common stock;
. the market price of FlashNet common stock may decline to the extent that
the current market price of FlashNet common stock reflects a market
assumption that the merger will be completed; and
. costs related to the merger, such as legal and accounting fees, must be
paid even if the merger is not completed.
If the merger is terminated and the FlashNet board of directors seeks another
merger or business combination, you cannot be certain that FlashNet will be
able to find a partner willing to pay an equivalent or more attractive price
than the price Prodigy will pay in the merger. In addition, Prodigy's option to
acquire up to 19.9% of the outstanding shares of FlashNet common stock, which
may become exercisable upon termination of the merger agreement, may impede an
alternative merger or business combination. You should read more about this
stock option under "Related Agreements--Stock Option Agreement" on page 70.
FlashNet's officers and directors may have been influenced to approve the
merger because of their ownership of options to purchase FlashNet stock, their
ownership as a group of a substantial interest in FlashNet, their possible
receipt of significant severance packages or employment agreements and
Prodigy's agreement to indemnify them against future liability. Also, two
FlashNet directors may have been influenced by their ownership interest in
Prodigy to support and approve the merger. There can be no assurance that
FlashNet's officers and directors would have supported the merger absent these
interests.
The directors and officers of FlashNet participate in arrangements and have
continuing indemnification against liabilities that provide them with interests
in the merger that are different from, or in addition to, yours, including the
following:
. as of the date of this prospectus, the executive officers and directors
of FlashNet owned stock options to purchase an aggregate of 432,946
shares of FlashNet common stock, all of which are vested;
. directors and officers and their affiliates, who together own
approximately 28% of the outstanding shares of FlashNet common stock as
of December 31, 1999, have agreed to vote in favor of the merger;
. several officers of FlashNet are entitled to benefits, including
substantial severance packages, under their employment agreements with
FlashNet if their employment is terminated upon FlashNet's change of
control, such as the merger;
. upon completion of the merger, Prodigy and FlashNet may enter into
employment agreements with some executive officers of FlashNet;
. Prodigy has agreed to cause the surviving corporation in the merger to
indemnify present and former FlashNet officers and directors against
liability arising out of their service as an officer or director.
Prodigy will cause the surviving corporation to maintain officers' and
directors' liability insurance to cover against this liability for the
next six years; and
. Mr. Thurburn, a FlashNet director, owns 1,000 shares of Prodigy common
stock. In addition, subsequent to the November 5, 1999 meeting at which
the merger was approved by the FlashNet board of directors, Global
Undervalued Securities Fund, L.P., which is controlled by Mr.
Kleinheinz, a FlashNet director, acquired Prodigy common stock. Global
Undervalued Securities Fund owned 87,800 shares of Prodigy common stock
on December 20, 1999 and 266,700 shares of Prodigy common stock on April
18, 2000.
It is possible that these interests may have influenced members of the
FlashNet board to vote to approve and support the merger agreement and the
merger when they would not have if they did not have these interests. No
committee of independent directors was appointed to consider the approval and
recommendation of the merger. FlashNet cannot determine whether an independent
board committee would have approved the merger. You should read more about
these interests under "The Merger--Interests of Executive Officers and
Directors of FlashNet in the Merger" on page 55.
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<PAGE>
The merger may cause FlashNet to lose key personnel which could materially
affect FlashNet's business and require FlashNet to incur substantial costs to
recruit replacements for lost personnel.
As a result of FlashNet's change in ownership, current and prospective
FlashNet employees may experience uncertainty about their future roles with
Prodigy. This uncertainty may adversely affect FlashNet's ability to attract
and retain key management, sales, marketing and technical personnel. Any
failure to attract and retain key personnel could have a material adverse
effect on the business of FlashNet and Prodigy.
Customers of Prodigy and FlashNet may terminate service as a result of
concerns over future service offerings and integration support of current
services following the merger.
The announcement and closing of the merger could cause customers and
potential customers of Prodigy and FlashNet to cancel service. In particular,
customers could be concerned about future service offerings and integration
support of current services. Subscriber cancellations could have a material
adverse effect on the future revenues and competitive portion of Prodigy and
FlashNet.
Risks Relating to Prodigy's Business
Prodigy has yet to generate positive cash flows and has incurred significant
losses and may incur losses in the future. If Prodigy does not achieve and
sustain profitability, Prodigy's financial condition and stock price could
decline.
Prodigy cannot assure that it will achieve or sustain profitability. Since
inception, Prodigy has incurred significant losses. The following table shows
Prodigy's revenues and net losses during the three years ended December 31,
1997, 1998 and 1999:
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------
1997 1998 1999
-------------- -------------- --------------
<S> <C> <C> <C> <C>
Revenues.................. $134.2 million $136.1 million $189.0 million
Net Losses................ $132.8 million $ 65.1 million $ 80.5 million
</TABLE>
At December 31, 1999, Prodigy had:
. an accumulated deficit of $373.3 million;
. a working capital deficit of $128.1 million;
. current liabilities of $179.9 million; and
. current assets of $51.8 million.
As a result of these losses, Prodigy has never generated positive cash flow
from operations and has relied on private and public sales of equity securities
and borrowings to fund its operations. The following table shows Prodigy's
negative cash flows from operations during the last three years.
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------
1997 1998 1999
-------------- ------------- -------------
<S> <C> <C> <C>
$114.0 million $68.0 million $40.1 million
</TABLE>
Prior to its acquisition by Prodigy on June 17, 1996, Prodigy's predecessor
incurred significant net losses and sustained negative cash flow from
operations that required continued funding by the predecessor's former owners,
IBM and Sears. The funding totaled $1.3 billion as of June 16, 1996.
11
<PAGE>
Prodigy operates in a highly competitive market and faces significant
competition from a variety of current and potential sources, including
EarthLink and America Online, as well as companies that provide broadband
services. Prodigy may also face additional competitive pressures from strategic
alliances or consolidations among other Internet service providers. Many of
Prodigy's current and future competitors have greater financial, marketing and
technical resources. Thus, Prodigy may fail to compete effectively in its
market.
Prodigy's industry is intensely competitive and some of Prodigy's current and
future competitors have substantially greater financial, marketing and
technical resources than Prodigy. Increased competition could also adversely
affect Prodigy's ability to develop new service offerings and interfere with
Prodigy's efforts to maintain or grow its subscriber base. Prodigy cannot
assure it will compete effectively. Increasing competition could have a
material adverse effect on Prodigy's future revenues and liquidity.
Prodigy's industry includes many significant participants, including:
. Internet service providers;
. proprietary online service providers;
. major international telecommunications companies;
. Internet-search services; and
. various other telecommunications companies.
Prodigy also faces competition from companies that provide broadband service
to households, including:
. local and long-distance telephone companies;
. cable television companies; and
. electric utility companies.
Among the larger Internet service providers that Prodigy competes with are
EarthLink, which has merged with MindSpring, Microsoft Network, AT&T WorldNet,
MCI Internet, IBM Internet Connection, PSINet Inc., GTE Internetworking, and
Concentric Network Corporation. Microsoft's ownership of the dominant PC
operating system and the Microsoft Internet Explorer browser may give Microsoft
Network competitive advantages, including distribution and marketing synergies.
Prodigy also competes with America Online, which offers the America Online and
CompuServe proprietary online services over closed networks and Internet
access.
Broadband technologies offer significantly faster Internet access than
conventional modems. Broadband companies could include Internet access in their
basic service packages, offer access for a nominal additional charge or prevent
Prodigy from delivering Internet access through the cable or wire connections
that these companies own.
The federal Telecommunications Act of 1996 contains provisions that remove,
or establish procedures for removing, restrictions on regional Bell operating
companies and others that may permit them to engage directly in the Internet
access business. This act also makes it possible for national long-distance
carriers, such as AT&T, to offer local telephone service, which would permit
these carriers to offer direct local Internet access. The federal
Telecommunications Act and strategic alliances or consolidation among Internet
service providers may result in additional competitive pressures.
Prodigy may be subject to increasing pricing pressures due to increasing
competition, the introduction of free service and unlimited usage plans and the
elimination of most hourly access charges in the industry, which could result
in lower revenues.
Because of Prodigy's historically low operating margins, any decrease in
revenues or increase in marketing expenses would diminish the likelihood of
Prodigy becoming profitable. The introduction of free service and unlimited
usage plans and the elimination of most hourly access charges by Internet
service providers, as well as increasing competition in Prodigy's industry,
have placed further pressure on Prodigy's revenues and profit margins.
12
<PAGE>
Subscriber cancellations are common in Prodigy's industry and the cost of
acquiring and retaining new subscribers is high. A high rate of customer
turnover may thus adversely affect future revenues.
The failure to attract and retain subscribers to Prodigy's services, or an
increase in or a failure to slow the rate of subscriber cancellations, would
have a material adverse effect on Prodigy's future revenues. Prodigy's industry
is characterized by a high rate of customer turnover. Customer acquisition
expenses and the administrative expenses of enrolling and assisting new
subscribers are substantial.
Prodigy relies on Splitrock's network to carry Prodigy's subscriber traffic.
Splitrock's failure to provide network servicer as required could damage
Prodigy's business.
Splitrock was formed in 1997 and has a limited operating history, and Prodigy
currently is Splitrock's principal customer. The failure by Splitrock for any
reason to provide network services as required, or any significant disruption
in these services, whether for technical, operational or financial reasons,
could adversely affect Prodigy's service quality, reputation and customer base.
Telecommunications networks are subject to security problems, such as break-
ins and viruses, and other network failures. The occurrence of a network
problem could result in breach of confidentiality lawsuits, the loss of
subscribers and substantial costs.
Security problems represent an ongoing threat to the telecommunications
networks used in Prodigy's business. Splitrock's network and Prodigy's data
hosting center are potentially vulnerable to computer viruses, break-ins and
similar disruptions that could lead to service interruptions. Break-ins could
jeopardize the confidentiality of information stored or transmitted by
Prodigy's customers. The security measures employed by Splitrock and Prodigy
cannot assure complete protection from security problems. The occurrence of
these problems may result in claims against Prodigy and could adversely affect
it or its ability to attract and retain customers.
Prodigy's operations are also dependent on the protection of Splitrock's
network and its data hosting center against damage from fire, power loss,
telecommunications failures and similar events. Technical problems and network
failures can occur from time to time in the ordinary course of operating a
telecommunications network. Prodigy's host configuration for Prodigy Internet
is unique and, for cost reasons, has not been replicated off site. The
occurrence of a natural disaster or other unanticipated problems in Splitrock's
network or Prodigy's data hosting center, or the failure of telecommunications
providers to provide required data communications capacity due to a natural
disaster or for any other reason, could cause interruptions in Prodigy's
services. These service interruptions could adversely affect Prodigy's
business.
Prodigy relies on third-party providers, including local phone companies, for
essential business services. The inability or unwillingness of these companies
to continue to provide telecommunications, customer service, billing and other
services to Prodigy or to provide the services at reasonable prices could
negatively affect Prodigy's business.
In addition to its network arrangements with Splitrock, Prodigy has
outsourced aspects of its content, customer service and billing functions to
several providers. Outsourcing makes Prodigy reliant on third-party providers
for critical functions. The failure of these providers to provide services as
required, or any significant disruption of or deterioration in services, could
require Prodigy to obtain alternative affiliates at a higher cost and result in
customer cancellations.
Prodigy also relies on local telephone and other companies to provide data
communications capacity via local telecommunications lines and leased long-
distance lines. The federal Telecommunications Act of 1996 is expected to lead
to increased competition in the provision of local and other telephone service.
However, Prodigy cannot predict the timing or extent of any developments or
their effect on pricing or supply. Prodigy's suppliers and telecommunications
carriers also sell or lease products and services to its competitors and
possibly current or future competitors. Prodigy's suppliers and
telecommunications carriers could enter into exclusive arrangements with its
competitors or stop selling or leasing their products or services to Prodigy at
commercially reasonable prices or at all.
13
<PAGE>
Carlos Slim Helu currently controls Prodigy. Mr. Slim can determine the
outcome of all matters submitted to shareholders irrespective of the votes of
other shareholders.
Carlos Slim Helu can control the management and affairs of Prodigy and can
currently determine the outcome of all matters submitted to a vote of Prodigy
shareholders, including the election of all members of Prodigy's board of
directors. Mr. Slim and members of his immediate family beneficially own a
majority of the voting equity securities of Carso Global Telecom. Carso Global
Telecom may be deemed to control Telmex through the shares of Telmex that it
owns directly and indirectly. Mr. Slim is also chairman of the board of Carso
Global Telecom and Telmex. Thus, Mr. Slim and members of his immediate family
may be deemed to control Prodigy. The voting control of Mr. Slim could be used
as a means or have the effect of delaying or preventing a change in control or
acquisition of Prodigy.
Carso Global Telecom, Telmex and Prodigy's directors have engaged in
transactions that were not necessarily arms' length. Prodigy cannot assure that
its directors will not act solely in the interest of Prodigy and its
shareholders.
Circumstances may arise in which the interests of Carso Global Telecom or
Telmex, as shareholders, could conflict with the interests of the other
shareholders of Prodigy. Carso Global Telecom and its affiliates have engaged
in numerous transactions with Prodigy in the past that were not necessarily a
result of arms'-length negotiations. For example, an affiliate of Carso Global
Telecom provides Prodigy with a $130,000,000 revolving line of credit, and
Telmex has committed to provide financing of up to $200,000,000 to fund
Prodigy's operations through February 2001. Prodigy has outsourced its network
operations to Splitrock, a company that is 30% owned by Carso Global Telecom.
Carso Global Telecom and its affiliates may engage in additional related-party
transactions with Prodigy in the future, and there can be no assurance these
transactions will be on arms'-length terms. Samer F. Salameh, Prodigy's
chairman of the board and chief executive officer, who formerly served on
Splitrock's board of directors, holds stock options to purchase shares of
Splitrock common stock. Mr. Salameh also serves as an advisor to the chief
executive officer of Telmex. In addition to Mr. Salameh, Alfredo Sanchez,
Arturo Elias and James M. Nakfoor, directors of Prodigy, are affiliated with
Carso Global Telecom or Telmex, and Allen Craft, an executive officer and
director of Prodigy, is employed by SBC. Mr. Salameh is married to Mr. Slim's
niece, and Mr. Elias is married to Mr. Slim's daughter.
The law requires Prodigy's directors to make all decisions in accordance with
their fiduciary duties and in the best interests of Prodigy and its
shareholders. Messrs. Salameh, Elias, Nakfoor and Sanchez, directors of
Prodigy, owe similar duties to the other companies for which they serve as
directors or officers or with which they are otherwise affiliated. Due to the
nature of the potential conflicts of interest presented on an ongoing basis by
these arrangements, and potential future arrangements, Prodigy cannot assure
that the directors involved have acted or will act in a manner that takes into
account solely the interests of Prodigy and its shareholders.
Prodigy cannot fund its operations with the cash generated from its business
and is seeking third-party financing to fund its operations. Additional
financing may result in dilution to existing stockholders and additional
operating restrictions.
Prodigy is currently experiencing substantial negative cash flow each month
and expects to continue to experience negative cash flow through 2000. Prodigy
has approximately $21,100,000 of cash available at March 31, 2000. Telmex has
committed to provide financing of up to $200,000,000 to fund Prodigy's
operations through February 2001. In addition, Prodigy is in the process of
seeking third party financing of $200,000,000 secured by the future service
fees payable by contract subscribers to the Prodigy Internet service. Any
additional equity financing may cause investors to experience dilution, and any
additional debt financing may result in restrictions on Prodigy's operations.
Enrollments from PC bundling are declining. If future enrollments from PC
bundling are not fully replaced by enrollments from contract acquisition
programs, Prodigy's financial condition may decline.
Prodigy's financial condition may decline if it does not continue to increase
its subscriber base. Historically, a majority of Prodigy Internet enrollments
have arisen from bundling arrangements with PC manufacturers. In
14
<PAGE>
1998, 44% of total enrollments to Prodigy Internet were obtained through PC
bundling, including 32% from Prodigy's PC bundling relationship with Packard
Bell/NEC. In 1999, the percentage of total enrollments to Prodigy Internet
obtained through PC bundling declined to 15% but the percentage obtained
through contract acquisition programs, in which Prodigy makes payments of up to
$400 to major PC retailers who enroll subscribers to term subscriptions of at
least one year, increased from zero in 1998 to 34%. Prodigy's contract
acquisition program with Best Buy accounted for approximately 33% of total
enrollments during 1999. Prodigy's contract acquisition program with Best Buy
terminated on November 30, 1999, except in 32 stores where the program is still
in effect. Prodigy has other, less significant, contract acquisition programs
with other retailers and entered into an additional contract acquisition
program in February 2000. Prodigy, however, cannot predict whether future
contract acquisition programs will generate as many enrollments as in the past.
The number of Prodigy Internet subscribers decreased from 1,138,000 at December
31, 1999 to 1,115,000 at March 31, 2000, primarily due to the termination of
Prodigy's contract acquisition program with Best Buy on November 30, 1999.
If Prodigy does not manage the integration of acquired companies successfully,
it may not achieve the desired results of the acquisitions and may experience
increased operating losses.
As a part of its business strategy, Prodigy has completed several
acquisitions to date and may enter into additional business combinations,
acquisitions and strategic relationships. These transactions are typically
accompanied by risks similar to those posed by the SBC transaction.
Prodigy may not succeed in addressing these risks or any other problems
encountered in connection with these potential business combinations and
acquisitions potentially disrupting Prodigy's business and causing increased
losses.
Risks associated with the pending SBC transaction.
Prodigy and SBC have agreed to establish the strategic relationship described
below under the caption "Pending SBC Transaction." Completion of the SBC
transaction is not a condition to completion of the FlashNet merger, and the
SBC transaction may not be completed. If the SBC transaction is completed:
. the dilution to existing investors may adversely affect the price of
Prodigy's stock;
. the change in ownership and management structure of Prodigy following
the SBC transaction could make it more difficult for Prodigy to attract
and retain key personnel and directors; and
. the price of Prodigy's stock could decline if the effect of the SBC
transaction on Prodigy's subscriber base and financial results does not
meet the expectations of financial or industry analysts.
Failure to complete the SBC transaction would adversely impact Prodigy's
ability to become a leading provider of high speed DSL Internet access services
and would adversely affect Prodigy's ability to increase its non-subscription
revenue.
Failure to complete the SBC transaction would mean that Prodigy would not
acquire access to SBC's existing subscribers and would not have the benefit of
the strategic and marketing agreement, under which SBC has committed to deliver
an additional 1,200,000 subscribers and to market Prodigy Internet as its
exclusive consumer service for the term of the agreement. As a result, the
failure to complete the SBC transaction would adversely affect Prodigy's
business and ability to become the leading provider of high speed DSL Internet
access service.
Prodigy's expansion strategy and future success depends on its ability to
anticipate and adapt to new services and markets.
Prodigy's business strategy includes the introduction of new services and
entry into new markets. Prodigy may be unsuccessful in offering new services
and entering new markets as planned. Prodigy's new services may not achieve
market acceptance. In particular, Prodigy is:
. expanding its Web hosting activities and other Internet-based services;
. expanding beyond its existing consumer market to include small and
medium-sized businesses; and
15
<PAGE>
. targeting Internet services to Spanish-speaking and Hispanic customers
in the United States.
Prodigy historically has focused on the consumer market and has only limited
experience in developing and marketing services in these markets.
Prodigy is subject to seasonality which causes Prodigy's quarterly results to
fluctuate. If Prodigy's quarterly results fail to meet the expectations of
public market analysts and investors, the market price of Prodigy's stock will
decline.
Although Prodigy's strategy of contracting with third parties to provide
services such as network access, billing and customer service enables it to tie
many variable costs to variable revenue sources, Prodigy bases its fixed
expenses, in part, on its expectations of future revenues. If revenues are
below expectations, Prodigy may be unable to reduce fixed costs
proportionately, which may adversely effect its operating results.
Prodigy experiences quarterly fluctuations in its operating results due to
many factors, including:
. pricing changes;
. changes in the level of consumer spending during business cycles;
. the timing of introduction of new and enhanced services by Prodigy; and
. competitive factors.
In addition, Prodigy historically has experienced seasonality in its
business, with:
. higher expenses during the last and first fiscal quarters, corresponding
to the Christmas and post-Christmas selling season
. lower timed usage revenues, meaning revenues from hourly usage charges,
typically occurring during Prodigy's second and third fiscal quarters
resulting from reduced usage of its services during the summer months.
Accordingly, Prodigy believes that quarter-to-quarter comparisons of
operating results may not be meaningful or indicative of future results.
The failure to protect Prodigy's proprietary technology adequately would
adversely affect Prodigy's competitive position.
Failure to protect Prodigy's proprietary technology could adversely affect
its competitive position. Prodigy attempts to protect its proprietary
technology through copyright and trade secrets laws, employee and third-party
confidentiality agreements and other methods. Prodigy grants customers a
license to use its services under agreements that contain terms and conditions
prohibiting unauthorized reproduction. Despite these precautions, unauthorized
third parties may be able to copy portions of Prodigy's services or reverse
engineer or obtain and use information Prodigy regards as proprietary.
Prodigy's business plan requires it to continue to grow its subscriber base.
If Prodigy is unable to manage growth effectively, its business could be
harmed.
Prodigy anticipates that the network assets and resources to be acquired upon
the consummation of the SBC transaction and the FlashNet merger will alleviate
the network performance deterioration which has accompanied the increase in
Prodigy's subscriber base. The failure to close either the SBC transaction or
the FlashNet merger in a timely fashion or at all or the failure to integrate
the network assets and resources acquired through the SBC transaction and the
FlashNet merger could adversely affect Prodigy's network performance, service
quality, reputation and customer base.
Prodigy's ability to exploit the market for its products and services and
increase its subscriber base requires an effective planning and management
process. Prodigy's ability to plan and manage effectively will require
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Prodigy to continue to implement and improve its operational, financial and
management information systems. Prodigy will also be required to attract and
retain skilled managers and other personnel, including its current executive
officers. These challenges are exacerbated during periods of rapid growth. For
example, as Prodigy increased the number of billable Prodigy Internet
subscribers by 87% from June 30, 1999 to December 31, 1999, network performance
deteriorated and customer service costs increased. The network performance
deterioration did not materially affect Prodigy's results of operations or
significantly alter the services offered by Prodigy.
If Prodigy is unable to attract and retain key personnel in an intensely
competitive environment, its operations could be adversely affected.
Competition for key personnel is intense, and there can be no assurance that
Prodigy will be successful in attracting and retaining necessary personnel to
maintain and support its business. Although Prodigy has entered into non-
competition agreements with some executive officers, the agreements may not be
enforceable. Prodigy does not maintain insurance on the lives of any of its
officers or directors.
Prodigy may not be able to complete proposed acquisitions, which could
adversely affect Prodigy's competitive position.
Prodigy's failure to expand its business through acquisitions may materially
adversely affect its competitive position. Prodigy may be unable to identify,
finance and complete acquisitions on acceptable terms. The Internet services
industry is highly fragmented, consisting of more than 5,000 Internet service
providers in the United States, and is expected to undergo substantial
consolidation over the next few years.
Prodigy depends on the continued use and expansion of the Internet.
Prodigy's business and revenues depend on the continued use and expansion of
the Internet. A decrease in the demand for Internet services or a reduction in
the currently anticipated growth for Internet services could adversely affect
Prodigy's future revenues and liquidity. Only recently has the commercial
sector begun significant use of the Internet and, more recently still, have
consumers begun using the Internet. Use of the Internet has grown dramatically,
but Prodigy cannot assure the continued use and expansion of the Internet as a
medium of communications and commerce.
Prodigy's attraction and retention of customers depends on its ability to
anticipate and adapt to rapidly changing technology and on the compatibility of
its technology with technology of others.
Prodigy's industry is characterized by rapid technological change resulting
in dynamic customer demands and frequent new product and service introductions.
As a result of these technological improvements, markets can change rapidly.
Prodigy's future results will depend in part on its ability to make timely and
cost-effective enhancements and additions to its services. For example,
competitors have introduced, or announced plans to introduce, high-speed
Internet access utilizing broadband technology through cable lines, integrated
services digital network, or ISDN, telephone service and digital subscriber
line, or DSL, telephone service. While Prodigy offers high-speed Internet
access through DSL, Prodigy may not have sufficient resources to provide DSL
access and to introduce new services that meet customer demands on a timely
basis. Prodigy's new service introductions may not achieve market acceptance.
Prodigy's ability to compete successfully is also dependent on the continued
compatibility of its services with the technologies of others. Although Prodigy
intends to support emerging standards in the market for Internet access, its
products may not conform to new standards in a timely fashion. Services or
technologies developed by others could render Prodigy's services or technology
noncompetitive or obsolete.
Changes in government regulation, which are likely in the rapidly evolving
Internet-related industries, could adversely affect Prodigy's business.
Internet access and online services are not subject to direct regulation in
the United States. Changes in the regulatory environment relating to the
telecommunications and media industry could adversely affect Prodigy's
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business, financial condition, results of operations or prospects. As the law
in this area develops, Prodigy's potential liability for information available
through its services could require Prodigy to implement measures to reduce its
exposure to this liability. Regulation of the Internet and online services
industry could result in increased telecommunications costs or competition for
participants in the Internet industry, including Prodigy. Prodigy cannot
predict whether, or to what extent, any new regulation will occur, or what
effect any new regulation would have on it. Due to the increasing use of the
Internet, additional laws may be adopted covering issues such as content, user
privacy, pricing, libel, intellectual property protection and infringement and
technology export and other controls.
Risks Relating to FlashNet's Business
FlashNet has a history of losses and expects continued losses. If FlashNet
does not achieve and sustain profitability, FlashNet's financial condition
would be adversely affected and its stock price could suffer.
FlashNet has incurred net losses of approximately $60.1 million from its
inception, September 25, 1995, through December 31, 1995, $6.1 million for the
year ended December 31, 1996, $11.7 million for the year ended December 31,
1997, $10.3 million for the year ended December 31, 1998 and $32.0 million for
the year ended December 31, 1999. FlashNet's inability to conduct its
operations on a profitable basis has contributed to declines in its stock price
and any continuing inability to attain profitability likely will further
depress its stock price. As of December 31, 1999, FlashNet had an accumulated
deficit of approximately $62.9 million representing, in large part, the sum of
its historical net losses. FlashNet has not achieved profitability in any
quarterly or annual period, and it expects to continue to incur net losses for
the foreseeable future. Although its revenues have grown in recent quarters,
FlashNet cannot assure that it will be able to sustain these growth rates or
that it will obtain sufficient revenues to achieve profitability. In addition,
FlashNet expects that all of its costs and expenses will continue to increase
in future periods, which could negatively affect its operating results. If
FlashNet does achieve profitability, it cannot assure that it can sustain or
increase profitability on a quarterly or annual basis in the future.
FlashNet is a new company with a limited operating history, which may
adversely affect FlashNet's ability to address the risks of its business and
successfully compete in the Internet access market.
FlashNet was incorporated in September 1995 and began offering Internet
access to the public in November 1995. When making your decision on how to vote
on the merger, you should consider the risks and difficulties FlashNet may
encounter competing in the new and rapidly evolving Internet access market,
especially given its limited operating history.
FlashNet is unable to forecast its operating expenses based on its historical
results. FlashNet's failure to accurately predict future revenues and adjust
its expenditures and capital commitments accordingly could adversely affect its
operating results and weaken its financial condition.
As a result of its limited operating history, FlashNet cannot forecast its
operating expenses based on its historical results. Accordingly, FlashNet
establishes its expense levels in advance based in part on its projections of
its future revenues. If FlashNet's actual revenues are less than its projected
revenues, it may be unable to reduce expenses proportionately, which will
negatively affect its operating results, cash flows and liquidity. FlashNet's
revenues currently depend heavily on its ability to attract and retain
subscribers who purchase Internet access on an annual basis. Its future
revenues will likely include more business services revenues, which will depend
on its ability to attract and retain business customers. Any failure to attract
and retain business customers will adversely affect its anticipated operating
results.
FlashNet may encounter pricing pressure due to intense competition in its
business, which may adversely affect its operating results and financial
condition and therefore depress its stock price.
FlashNet faces intense competition in conducting its business, and it expects
this competition to increase. This level of competition can require FlashNet to
reduce its prices, which in turn, decreases its revenues per customer.
FlashNet's competitors include various other Internet access providers with
much larger subscriber
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bases than FlashNet's. Furthermore, a number of its competitors offer a broader
variety of business services and may have done so for longer periods of time.
Every local market FlashNet has entered or intends to enter is served by
multiple Internet access providers. FlashNet's current and prospective
competitors include many large companies, some of which are better known than
FlashNet and may have greater financial, technical and marketing resources than
it does.
As a result of increased competition in its industry, FlashNet expects to
encounter significant pricing pressure. FlashNet cannot be certain that it will
be able to offset the effects of any required price reductions through an
increase in the number of its subscribers, higher revenues from its business
services, cost reductions or otherwise, or that it will have the resources to
continue to compete successfully. You should read "FlashNet's Business--
Competition" for a more complete discussion on the competitive factors and
competitors in FlashNet's industry.
Because FlashNet's business is new and rapidly evolving, FlashNet's financial
results are subject to significant fluctuations. If FlashNet's quarterly
results fail to meet expectations of public market analysts and investors, the
market price of FlashNet common stock will decline.
FlashNet expects that its revenues and operating results may fluctuate
significantly from quarter to quarter. These fluctuations can adversely affect
FlashNet's stock price. A number of factors are likely to cause these
fluctuations, including:
. the rate of new subscriber acquisitions;
. subscriber retention;
. changes in its pricing policies or those of its competitors;
. capital expenditures and other costs relating to the expansion of its
operations;
. the timing of new product and service announcements by it or its
competitors;
. market acceptance of new and enhanced versions of its products and
services;
. personnel changes;
. the introduction of alternative technologies;
. the effect of potential acquisitions; and
. increased competition in its markets.
If the merger does not occur, FlashNet must obtain additional capital to
continue to fund its operations and growth. FlashNet may not obtain this
additional capital on acceptable terms, or at all. Any failure to raise capital
for its business would render FlashNet unable to grow its business, and as a
result, adversely affect its stock price.
As of April 10, 2000, FlashNet had cash and cash equivalents of approximately
$1.0 million. During the past several months, FlashNet has, with the assistance
of financial advisors, explored various capital raising and strategic
partnering alternatives to fund its operations and growth. Based on these
activities, management of FlashNet believes that, at the present time, FlashNet
is unable to obtain, on reasonable terms, sufficient financing to achieve
continued revenue growth. If the merger does not occur and alternative sources
of financing are insufficient or do not become available on acceptable terms,
FlashNet must modify its growth and operating plans in accordance with the
extent of available financing, if any, and must attempt to attain profitability
in its existing geographic markets.
If FlashNet's third-party suppliers and telecommunications carriers
discontinue doing business with it, it may be unable to find adequate
replacements. The failure to maintain supplier relationships with
telecommunications carriers would significantly impair FlashNet's ability to
provide Internet access services and could lead to loss of customers.
FlashNet depends on third-party suppliers of hardware components and
telecommunications carriers to provide equipment and networking services.
FlashNet cannot assure that its suppliers and telecommunications
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carriers will continue to sell or lease their products and services to it at
commercially reasonable prices or at all. Difficulties in developing
alternative sources of supply, if required, could adversely affect FlashNet's
business, future financial condition or operating results. Moreover, failure of
FlashNet's telecommunications providers to provide the data communications
capacity required by it for any reason could cause interruptions in its ability
to provide access services to its customers, which may result in subscriber
cancellations and adversely affect its future revenues. It currently acquires
hardware components used in its network system from one or two sources,
including servers manufactured by Sun Microsystems, modems manufactured by
Ascend Communications and 3Com and high performance routers, which are devices
that receive and transmit data between different networks, manufactured by
Cisco Systems. FlashNet currently relies on a few local telephone companies and
others, such as PSINet and Level 3 Communications, to lease to it data
communications capacity via local telecommunications lines and leased long
distance lines. In addition, suppliers and telecommunications carriers also
sell or lease products and services to FlashNet's competitors and may be, or in
the future may become, competitors.
If FlashNet fails to continue to expand its network infrastructure to meet
additional demand or changing subscriber requirements, FlashNet's subscriber
base may decline, which would reduce its revenues and impair its financial
condition.
FlashNet's network infrastructure is composed of a complex system of routers,
switches, transmission lines and other hardware used to provide its subscribers
with Internet access and other services. Capacity constraints within FlashNet's
network and those of its suppliers have occurred in the past and will likely
occur in the future. If FlashNet fails to provide its customers with the
requisite network capacity to enable them to readily access the Internet, its
subscribers will experience a general slow-down in their Internet access which
may harm its relationships with them and may result in cancellations or non-
renewals of FlashNet Internet access service. Capacity constraints also may
prevent subscribers from gaining access to a particular point of presence or
may inhibit a subscriber from connecting to system-wide services such as e-mail
and news group services. FlashNet will have to expand its network
infrastructure as the number of subscribers and the amount and type of
information they wish to transmit over the Internet increases. This expansion
of its network infrastructure will require substantial resources. FlashNet
cannot assure that it will expand its network infrastructure to meet additional
demand or changing subscriber requirements on a timely basis and at a
commercially reasonable cost, or at all.
Disruptions of FlashNet's services due to system failure could result in
subscriber cancellations.
A significant portion of FlashNet's computer equipment, including critical
equipment dedicated to its Internet access services, is presently located at a
single facility in Fort Worth, Texas. The occurrence of a natural disaster, the
failure of one of its systems or the occurrence of other unanticipated problems
at its headquarters or at one of its primary points of presence could cause
interruptions in its services. Extensive or multiple interruptions in providing
customers with Internet access are a primary reason for customer decisions to
cancel the use of access services. Accordingly, any disruption of FlashNet's
services due to system failure could result in subscriber cancellations and
adversely affect its future revenues.
If FlashNet does not adapt to technology trends and evolving industry
standards, it will cease to remain competitive in its markets and will fail to
attract new customers or retain its existing customers.
FlashNet's market is susceptible to rapid changes due to technology
innovation, evolving industry standards, changes in subscriber needs and
frequent new service and product introductions. FlashNet must use leading
technologies effectively, continue to develop its technical expertise and
enhance its existing services on a timely basis to compete successfully in this
industry. Any inability to compete effectively likely would result in FlashNet
being unable to attract new customers or retain its existing customers.
Recently, several competitors have introduced, or announced plans to
introduce, high-speed Internet access utilizing broadband applications such as
cable modems, telephone service and digital subscriber line service.
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These devices transmit data at substantially faster speeds than the modems
currently used by FlashNet and its subscribers. FlashNet may need to develop
new technologies or modify its existing technology to accommodate these
developments and remain competitive. Its pursuit of these technological
advances may require substantial time and expense, and FlashNet cannot assure
that it will succeed in adapting its Internet access services business to
alternative access devices and conduits.
FlashNet's ability to compete successfully also depends on the continued
compatibility and interoperability of its services with products and systems
sold by various third parties. Although FlashNet intends to support emerging
standards in the market for Internet access and enhanced business services if
the merger does not occur, it cannot assure that industry standards will be
established or, if they become established, that FlashNet will conform to these
new standards in a timely fashion and maintain a competitive position in the
market.
If Internet usage does not continue to grow, FlashNet may not be able to
continue its business plan and grow its business.
Widespread use of the Internet is a relatively recent phenomenon. FlashNet's
future success substantially depends on continued growth in the use of the
Internet and the continued development of the Internet as a viable commercial
medium. FlashNet cannot assure that Internet usage will continue to grow as it
has in the past or that extensive Internet content will continue to be
developed and continue to be accessible for free or at nominal cost to Internet
users. If the use of the Internet does not continue to grow or if it evolves in
a way that FlashNet cannot address, FlashNet may be unable to continue the
execution of its business plan and grow its business which could materially and
adversely affect its future revenues and liquidity.
FlashNet faces the uncertainty of subscriber retention. Failure to retain
subscribers could reduce FlashNet's future revenues.
FlashNet's sales, marketing and other costs of acquiring new subscribers are
substantial relative to the monthly fees derived from these subscribers.
Accordingly, it believes that its long-term success depends largely on its
ability to retain its existing subscribers, while continuing to attract new
subscribers. Any decline in subscriber retention rates could have a material
adverse effect on FlashNet's business plan, future revenues and liquidity.
FlashNet believes that intense competition from its competitors, some of which
offer free service or other enticements for new subscribers, has caused, and
may continue to cause, some of its subscribers to switch to its competitors'
services. In addition, some new subscribers use the Internet only as a novelty
and do not become consistent users of Internet services and, therefore, may be
more likely to discontinue their service. These factors adversely affect
FlashNet's subscriber retention rates.
FlashNet's operating plans depend on the acceptance of its business services.
Any failure by FlashNet to increase sales of its business services could
materially reduce its anticipated future revenues.
FlashNet's operating plans are based in part on its strategy to increase
sales of its business services to corporate customers. This strategy will
depend significantly on the successful development, introduction, expansion and
market acceptance of its business services offerings. FlashNet cannot assure
that additional corporate customers will purchase its business services
offerings or that it will successfully meet customer needs or expectations.
If FlashNet is unable to attract and retain qualified sales personnel for its
corporate sales program, it may not attract or obtain new customers.
As part of its corporate sales program, FlashNet is beginning to deploy a
geographically dispersed sales force that will be primarily responsible for
attracting and retaining commercial customers for its business services. Any
failure by FlashNet to increase sales of its business services could materially
reduce its anticipated future revenues. FlashNet's future success in the
business services arena depends on its ability to market successfully to
corporate clients in an environment that is increasingly competitive. FlashNet
may not attract and retain qualified sales managers or other sales people,
which is necessary for this type of marketing approach.
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If FlashNet is unable to recruit independent sales representatives, it may not
continue its network marketing program to recruit subscribers.
FlashNet employs a network marketing program that uses independent
representatives to sell its Internet access services and to recruit other
independent representatives to sell these services. This program is an
important aspect of FlashNet's sales and marketing efforts to expand its
customer base and grow its revenues. Independent representatives are paid
commissions by FlashNet for their sales of access service plans, as well as for
sales made by those they recruit into the program. The success of its network
marketing program depends on its ability to attract, retain and motivate a
large base of independent representatives, who, in turn, are expected to
recruit both subscribers for its services as well as other independent sales
representatives. FlashNet has experienced significant turnover among
independent representatives. To date, this turnover has not materially impacted
FlashNet's results of operations. However, as the overall number of independent
representatives increases, FlashNet could become more dependent on these
representatives for its future growth. In order to maintain or increase the
overall number of its independent representatives, existing representatives
must continually recruit new independent representatives. The following could
adversely affect FlashNet's ability to attract and retain independent
representatives:
. the level of support services it provides to its independent
representatives;
. the availability of competing network marketing opportunities; and
. adverse trends regarding Internet usage.
State and federal government regulation could require FlashNet to change its
business, which could adversely affect its ability to compete or result in the
loss of subscribers for its services.
FlashNet provides Internet access and business services, in part, using
telecommunications services provided by carriers that are subject to the
jurisdiction of state and federal regulators. Due to the increasing popularity
and use of the Internet, state and federal regulators may adopt additional laws
and regulations relating to content, user privacy, pricing and copyright
infringement. The enactment of laws or regulations restricting the use of the
Internet could cause subscribers to cease their use of the Internet or
otherwise affect FlashNet's ability to compete. FlashNet cannot predict the
impact, if any, that future regulation or regulatory changes may have on its
business. You should read "FlashNet's Business--Government Regulation" for a
more detailed discussion of the government regulation to which FlashNet may be
subject.
FlashNet faces a potential cash shortfall if its growth rate slows which would
impair its financial condition and could depress its stock price.
The majority of FlashNet's sales are to customers who prepay for one year of
service. FlashNet applies all of the proceeds from these prepayments to acquire
more equipment, purchase advertising, meet current obligations and fund
operating deficits. It does not set aside proceeds as capital reserves to
reimburse subscribers who may decide to discontinue their service before their
prepaid term expires. As a result, FlashNet's financial condition is dependent
on an increasing number of new customers in the current year and beyond and any
slow down in its growth rate would impair its financial condition and could
depress its stock price. In 1997 and 1998, FlashNet raised capital through
third-party sources due in part to a decline in its rate of new subscriber
growth. Any continued or future decline in the rate of growth of new
subscribers, or any unanticipated increase in the rate of subscriber
reimbursements, could force FlashNet to raise additional capital to support its
operations by selling equity securities or incurring additional debt. Based on
its recent exploration of financing alternatives, FlashNet management believes
that, at the present time, FlashNet cannot raise sufficient capital on
reasonable terms to continue to finance its operations and grow its business.
Since September 30, 1999, FlashNet has curtailed aspects of its sales and
marketing efforts which has resulted in slowed customer growth and a decrease
in cash receipts. Accordingly, if the merger does not occur on a timely basis,
FlashNet will need to raise capital to support its operations. As of April 10,
2000, FlashNet had cash and cash equivalents of approximately $1.0 million.
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FlashNet depends on the protection of its proprietary rights. The failure to
protect its proprietary rights could compromise FlashNet's competitive
position.
FlashNet relies on a combination of copyright, trademark and trade secret
laws to protect its proprietary rights. FlashNet cannot assure that the steps
it has taken will be adequate to prevent the misappropriation of its technology
or that third parties, including competitors, will not independently develop
technologies that are substantially equivalent or superior to its proprietary
technology. The failure to protect its proprietary rights could compromise
FlashNet's competitive position.
FlashNet has obtained from various software manufacturers either licenses or
permission to use the software that it bundles in its client-side software
product for subscribers and for the software used internally in its Internet
services. Although it believes that these products do not infringe the
proprietary rights of any third parties, third parties could assert
infringement claims against FlashNet in the future. The defense of these claims
would require FlashNet to incur substantial costs and would divert management's
attention and resources to defend against any claims relating to proprietary
rights, which could materially and adversely affect FlashNet's liquidity and
operations. Parties making these claims could secure a judgment awarding them
substantial damages, as well as injunctive or equitable relief that could
effectively block FlashNet's ability to sell its services. This outcome could
adversely affect FlashNet's business, financial condition and operating
results. If a claim relating to proprietary technology or information is
asserted against FlashNet, it may seek licenses to use such intellectual
property. FlashNet cannot assure, however, that it can obtain licenses on
acceptable terms, if at all.
FlashNet could face losses and potential liability if intrusions, viruses or
similar disruptions to its network or computer systems impede its service or
jeopardize its confidential information or that of its subscribers.
Although FlashNet has implemented, and will continue to implement, security
measures, its network and computer systems are vulnerable to intrusions,
computer viruses or similar disruptive problems caused by, or transmitted
through, its subscribers or other Internet users. Computer viruses or similar
disruptions could lead to interruptions, delays or cessation in service to
FlashNet's subscribers. Inappropriate use of the Internet by third parties
could also potentially jeopardize the security of confidential information
stored in FlashNet's computer systems or those of its subscribers, which may
cause losses to either it or its subscribers. The potential that this can occur
may deter persons from subscribing to FlashNet's services. Alleviating problems
caused by computer viruses or other breaches of security likely would cause
interruptions, delays or cessation in service to FlashNet's subscribers, which
could have a material adverse effect on FlashNet's business and operations. In
addition, FlashNet expects that its subscribers will increasingly use the
Internet for commercial transactions. Any network malfunction or security
breach could cause these transactions to be delayed, not completed, or
completed with compromised security. It is possible that subscribers or others
could assert claims of liability against FlashNet as a result of this failure.
Furthermore, until more comprehensive security technologies are developed, the
security and privacy concerns of existing and potential subscribers may inhibit
the growth of the Internet service industry in general, and FlashNet's
subscriber base and revenues, in particular.
FlashNet faces potential liability for material transmitted through its
network or retrieved through its services which could cause it to pay damages
and thereby impair its financial condition.
The law relating to the liability of Internet access and business services
providers for information carried on or disseminated through their networks is
unsettled. As the law in this area develops, FlashNet may need to expend
substantial resources or discontinue services to reduce its exposure to the
potential imposition of liability for information carried on and disseminated
through its network. Any costs that FlashNet incurs as a result of contesting
these claims or the consequent imposition of liability could materially and
adversely affect its liquidity and impair its financial condition. In addition,
the federal Telecommunications Act of 1996 imposes fines on any entity that
knowingly permits any telecommunications facility under its control to be used
to make obscene or indecent material available to minors via an interactive
computer service. FlashNet cannot predict whether any claim under this statute
or other laws will be asserted against it, or if asserted, whether it will be
successful.
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In addition, because materials may be downloaded by users of FlashNet's
services and subsequently distributed to others, persons may potentially make
claims against FlashNet for defamation, negligence, copyright or trademark
infringement, personal injury or other causes of action based on the nature,
content, publication and distribution of these materials. FlashNet also could
be exposed to liability with respect to the offering of third-party content
that may be accessible through its services, including links to Web sites
maintained by its subscribers or other third parties, or posted directly to its
Web site, and subsequently retrieved by a third party through its services. It
is also possible that if any third-party content provided through FlashNet's
services contains errors, third parties who access this material could make
claims against FlashNet for losses incurred in reliance on the information.
FlashNet also offers e-mail services, which exposes it to other potential
risks, such as liabilities or claims resulting from unsolicited e-mail, lost or
misdirected messages, illegal or fraudulent use of e-mail or interruptions or
delays in e-mail service. These claims, with or without merit, likely would
divert management's time and attention and result in significant costs to
investigate and defend.
Residual Year 2000 problems may require FlashNet to incur significant
unanticipated expenses or expose FlashNet to claims of losses incurred by its
users.
Prior to January 1, 2000, there was a great deal of concern regarding the
ability of computers to adequately identify and distinguish 21st century dates
from 20th century dates. Confusion of dates may bring about system failures or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices or engage
in similar business activities. Most reports to date are that computer systems
are functioning properly and that compliance and remediation work effected
prior to January 1, 2000 was effective to prevent any problems. Computer
experts have warned, however, that there may be residual Year 2000 problems.
FlashNet currently believes that its computer systems are Year 2000 compliant.
Many of FlashNet's customers maintain their Internet operations on commercially
available operating systems, which may be impacted by Year 2000 complications.
In addition, FlashNet relies on third-party vendors for telecommunications and
information systems equipment and software included within its services.
Residual year 2000 problems with FlashNet's internal computer systems or of
third-party equipment or software could require FlashNet to incur significant
unanticipated expenses to remedy any problems and could expose FlashNet to
claims for losses incurred by its users due to Year 2000 complications. The
defense of these claims, with or without merit, could require FlashNet to incur
substantial costs and would divert management's time and attention, which could
have a material adverse effect on FlashNet's operations and financial
condition.
Cautionary Statement Concerning Forward-Looking Statements
Prodigy and FlashNet believe this proxy statement/prospectus contain
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. These statements are subject to risks and
uncertainties and are based on the beliefs and assumptions of management of
Prodigy and FlashNet, based on information currently available to each
company's management. When we use words such as "believes," "expects,"
"anticipates," "intends," "plans," "estimates," "should," "likely" or similar
expressions, we are making forward-looking statements. Forward-looking
statements include the information concerning possible or assumed future
results of operations of Prodigy or FlashNet set forth under:
"Summary," "Selected Historical Condensed and Unaudited Pro Forma
Financial Information," "Risk Factors," "The Merger--Background of the
Merger," "The Merger--Prodigy's Reasons for the Merger," "The Merger--
FlashNet's Reasons for the Merger; Recommendation of the FlashNet Board
of Directors," "The Merger--Opinion of FlashNet's Financial Advisor,"
"Prodigy's Business," "Pending SBC Transaction," "Prodigy Management's
Discussion and Analysis of Financial Condition and Results of
Operations," "FlashNet's Business," "FlashNet Management's Discussion
and Analysis of Financial Condition and Results of Operations" and
"Unaudited Pro Forma Condensed Combined Financial Statements."
24
<PAGE>
Forward-looking statements are not guarantees of performance. They involve
risks, uncertainties and assumptions. The future results and shareholder values
of Prodigy or FlashNet may differ materially from those expressed in the
forward-looking statements. Many of the factors that will determine these
results and values are beyond our ability to control or predict. Shareholders
are cautioned not to put undue reliance on any forward-looking statements. For
those statements, we claim the protection of the safe harbor for forward-
looking statements contained in the Private Securities Litigation Reform Act of
1995.
The factors discussed under "Risk Factors" that may affect future performance
and the accuracy of forward-looking statements is illustrative, but by no means
exhaustive. Accordingly, all forward-looking statements should be evaluated
with the understanding of their inherent uncertainty.
25
<PAGE>
SELECTED HISTORICAL CONDENSED CONSOLIDATED
FINANCIAL INFORMATION
The following data contains selected consolidated financial information and
other data for Prodigy and its predecessor business, Prodigy Services Company.
The selected consolidated financial data for Prodigy for each of the years
1995-1999 has been derived from Prodigy's annual consolidated financial
statements, including the consolidated balance sheets at December 31, 1998 and
1999 and the related consolidated statements of operations and of cash flows
for the three years ended December 31, 1999 and accompanying notes appearing
elsewhere in this document.
Please read this information in conjunction with "Prodigy Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
Prodigy's consolidated financial statements and accompanying notes included
elsewhere in this document.
Selected Historical Condensed Consolidated Financial Information of Prodigy
(in millions, except number of billable subscribers and per share information)
<TABLE>
<CAPTION>
Year Ended
December 31,
--------------------------------------------
1995(1)(4) 1996(4) 1997 1998 1999(2)
---------- ------- ------- ------ -------
<S> <C> <C> <C> <C> <C>
Consolidated Statement of
Operations Data:
Revenues
Internet and online service
revenues........................ $ 90.7 $ 128.3 $128.9 $169.8
Other............................ 8.2 5.9 7.2 19.2
------ ------ ------- ------ ------
Total Revenues................... 98.9 134.2 136.1 189.0
Operating costs and expenses
Costs of revenue................. $ 0.1 66.3 92.0 93.3 102.2
Sales and marketing.............. 20.7 59.6 41.7 58.9
Product development.............. 4.8 11.4 10.9 12.3
General and administrative....... 3.0 49.8 56.3 44.6 61.7
Depreciation and amortization.... 12.3 21.4 16.1 21.8
Amortization of subscriber
acquisition costs............... 20.4
Acquired incomplete technology... 20.9
Restructuring and other special
costs........................... 3.1 9.9
Write-down of assets held for
sale............................ 2.4
Loss on sale of cellular assets.. 0.8
------ ------ ------- ------ ------
Total operating costs and
expenses........................ 3.1 177.9 253.8 206.6 277.3
------ ------ ------- ------ ------
Operating loss.................. (3.1) (79.0) (119.6) (70.5) (88.3)
(Loss) on equity investment in
joint venture.................... (0.5) (12.1)
Gain on asset sale................ 5.2
(Write-down) recovery of equity
investments...................... (9.1) 0.3
Interest (expense) income, net.... (2.2) (1.4) 0.2 2.3
Gain on sale of equity
investment....................... 3.3
Gain on settlement of note
receivable....................... 0.5
Gain on settlement of note
payable.......................... 1.7
------ ------ ------- ------ ------
Net Loss........................ $ (3.1) $(90.8) $(132.8) $(65.1) $(80.5)
====== ====== ======= ====== ======
Net loss per common share:
Basic and diluted................ $(0.37) $(8.76) $ (7.66) $(1.60) $(1.34)
====== ====== ======= ====== ======
Weighted average number of common
and common equivalent shares
outstanding:
Basic and diluted................ 8.4 10.4 17.3 40.7 60.0
====== ====== ======= ====== ======
</TABLE>
26
<PAGE>
<TABLE>
<CAPTION>
Year Ended
December 31,
-----------------------------------------------
1995(1) 1996 1997 1998 1999(2)
---------- ------- ------- ------- ---------
<S> <C> <C> <C> <C> <C>
Other Data:
Prodigy Internet billable
subscribers at period end.... 7,000 221,000 505,000 1,138,000
Prodigy Classic billable
subscribers at period end.... 780,000 392,000 166,000 --
Internet subscribers managed.. 364,000
----- ------- ------- ------- ---------
Total managed subscribers at
period end................... 0 787,000 613,000 671,000 1,502,000
===== ======= ======= ======= =========
Prodigy Internet revenue...... $ 0.1 $ 29.5 $ 80.7 $ 154.2
Prodigy Classic revenue....... 90.6 98.8 48.2 15.6
EBITDA (3).................... $(3.1) (76.2) (110.0) (49.7) (40.5)
Other Cash Flow Data:
Net cash used in operating
activities................... (2.4) (35.3) (114.0) (68.0) (40.1)
Net cash used in investing
activities................... (1.4) (47.9) (15.3) 2.6 (212.6)
Net cash provided by financing
activities................... 4.0 104.1 120.4 65.2 276.0
<CAPTION>
December 31,
-----------------------------------------------
1995(1)(4) 1996(4) 1997 1998 1999(2)
---------- ------- ------- ------- ---------
<S> <C> <C> <C> <C> <C>
Consolidated Balance Sheet
Data:
Working capital .............. $(0.3) $ (54.8) $ (48.5) $ (33.6) $ (128.1)
Total assets.................. 2.5 126.6 93.5 78.3 346.0
Long-term debt................ 1.6 56.0 10.0 -- 1.0
Contingent Convertible Notes
(included in stockholders'
equity (deficit))............ -- 30.5 30.5 30.5 --
Stockholders' equity
(deficit).................... 0.0 (11.5) 17.7 29.8 165.1
</TABLE>
- --------
(1) International Wireless Incorporated was incorporated in May 1994 to
evaluate and develop cellular telephone systems and Internet access and
online services in Africa. In June 1996, Prodigy was formed under the name
Prodigy, Inc. as a new holding company to acquire Prodigy Services Company
and to hold International Wireless and the other communications interests
of International Wireless. On June 17, 1996, Prodigy completed the
acquisition of Prodigy Services Company. The acquisition was accounted for
under the purchase method of accounting. Accordingly, the results of
operations of Prodigy Services Company are included in Prodigy's
consolidated results of operations from the date of acquisition. In January
1997, Prodigy sold its cellular telephone assets and operations.
Subsequently, Prodigy decided to sell and wind-down its remaining
international operations in Africa and China.
(2) On October 5, 1999, Prodigy acquired the BizOnThe.Net Web hosting business
of U.S. Republic Communications, Inc., an indirect majority owned
subsidiary of VarTec, including the subscribers of the BizOnThe.Net Web
hosting business. At the closing, Prodigy repaid a $9 million loan from
VarTec to U.S. Republic and issued 2,840,993 shares of Prodigy common stock
to U.S. Republic.
The acquisition of BizOnThe.Net has been accounted for under the purchase
method of accounting and, accordingly, the results of operations of
BizOnThe.Net are included in Prodigy's consolidated results of operations
from the date of acquisition. The cost to acquire BizOnThe.Net was
allocated to the assets acquired and liabilities assumed based on their
respective fair values with the excess allocated to goodwill. Based on the
value of the 2,840,993 shares of common stock currently issued in
connection with the BizOnThe.Net acquisition and the $9 million cash used
to repay the loan, the total purchase price was approximately $58 million.
(3) Earnings before interest, taxes, depreciation and amortization is a
commonly used measure for operating performance of Internet service
providers, and also provides additional information to assist investors in
determining Prodigy's liquidity. Earnings before interest, taxes,
depreciation and amortization is not an accounting measure under generally
accepted accounting principles, is not necessarily indicative of operating
income or cash flows from operations as determined under these principles
and may not be comparable to similarly titled measures reported by other
companies.
27
<PAGE>
(4) Selected Historical Condensed Consolidated Financial Information of Prodigy
Services Company
(in millions)
<TABLE>
<CAPTION>
Period from
January 1,
Year Ended 1996 to
December 31, June 16,
1995 1996
------------ -----------
<S> <C> <C>
Consolidated Statement of Operations Data:
Online service revenues............................... $230.6 $ 98.2
Other................................................. 12.8 8.9
------ ------
Total revenues........................................ 243.4 107.1
------ ------
Net loss.............................................. $(34.6) $(62.9)
====== ======
</TABLE>
<TABLE>
<CAPTION>
December 31,
1995
------------
<S> <C>
Consolidated Balance Sheet Data:
Working capital (deficit)......................................... $(36.4)
Total assets...................................................... 84.7
Long-term debt.................................................... 16.4
Partners' capital (deficit)....................................... 9.8
</TABLE>
28
<PAGE>
Selected Historical Condensed Consolidated Financial Information Of FlashNet
(in thousands, except per share data)
Please read the following selected consolidated financial data of FlashNet in
conjunction with "FlashNet's Management's Discussion and Analysis of Financial
Condition and Results of Operations" and FlashNet's consolidated financial
statements and accompanying notes included elsewhere in this document. The
statement of operations data for the years ended December 31, 1997, 1998 and
1999, and the balance sheet data at December 31, 1998 and 1999 are derived from
FlashNet's audited consolidated financial statements included elsewhere in this
proxy statement/prospectus. The statement of operations data for the period
ended December 31, 1995 and the year ended December 31, 1996 and the balance
sheet data at December 31, 1995, 1996 and 1997 are derived from audited
financial statements not included in this document.
<TABLE>
<CAPTION>
Period from
September 25, 1995
(inception) Year Ended December 31,
through December -------------------------------------------
31, 1995 1996 1997 1998 1999
------------------ --------- --------- --------- ----------
<S> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Revenues:
Consumer access
services............... $ 19 $ 2,286 $ 11,942 $ 21,979 $ 31,104
Business services....... -- 53 571 1,597 2,079
Shipping revenues....... -- -- -- -- 2,374
Set-up fees and other... 15 1,315 5,024 3,316 4,694
--------- --------- --------- --------- ----------
Total revenues.......... 34 3,654 17,537 26,892 40,251
Operating costs and
expenses:
Cost of services........ 28 2,348 8,215 11,797 19,909
Cost of shipping........ -- -- -- -- 1,995
Cost of other revenues.. 4 473 799 349 1,973
Sales and marketing..... 32 4,329 10,300 8,202 20,967
General and
administrative......... 74 1,039 3,453 5,268 10,330
Operations and customer
support................ -- 830 3,683 6,016 10,453
Depreciation and
amortization........... 3 545 2,061 3,069 5,094
--------- --------- --------- --------- ----------
Total expenses.......... 141 9,564 28,511 34,701 70,721
--------- --------- --------- --------- ----------
Loss from operations.... (107) (5,910) (10,974) (7,809) (30,470)
Interest (expense)
income, net............ -- (144) (714) (2,456) 97
--------- --------- --------- --------- ----------
Loss before
extraordinary item..... (107) (6,054) (11,688) (10,265) (30,373)
Extraordinary item --
Loss on early
extinguishment of
debt................... -- -- -- -- (1,656)
--------- --------- --------- --------- ----------
Net loss................ (107) (6,054) (11,688) (10,265) (32,029)
Accretion on redeemable
preferred stock........ -- -- -- (2,741) (48)
--------- --------- --------- --------- ----------
Net loss attributable to
common shareholders.... $ (107) $ (6,054) $ (11,688) $ (13,006) $ (32,077)
========= ========= ========= ========= ==========
Net loss per common
share -- basic and
diluted
Loss before
extraordinary item..... $ (0.03) $ (1.15) $ (2.15) $ (2.36) $ (2.46)
Extraordinary item...... -- -- -- -- (0.13)
--------- --------- --------- --------- ----------
Basic and diluted net
loss per share......... $ (0.03) $ (1.15) $ (2.15) $ (2.36) $ (2.59)
========= ========= ========= ========= ==========
Shares used in computing
basic and diluted net
loss per share......... 3,527,000 5,266,000 5,449,000 5,505,000 12,370,000
</TABLE>
29
<PAGE>
<TABLE>
<CAPTION>
December 31,
--------------------------------------
1995 1996 1997 1998 1999
---- ------ ------- ------- ------
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash and cash equivalents.............. $25 $ 137 $ 1,570 $ 1,038 $7,045
Total assets........................... 175 5,887 11,000 9,733 39,585
Working capital........................ (41) (7,113) (16,835) (22,757) (8.816)
Total debt............................. -- 4,672 6,766 6,896 9,539
Redeemable preferred stock............. -- -- -- 7,911 --
Total shareholders' equity (deficit)... 51 (5,275) (13,436) (23,707) 9,656
</TABLE>
<TABLE>
<CAPTION>
Period from
September 25, 1995 Year Ended December 31,
(inception) through -------------------------------------
December 31, 1995 1996 1997 1998 1999
------------------- ------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Operating Data:
EBITDA(1)............... $(104) $(5,365) $ (8,913) $ (4,740) $(23,839)
Cash flow provided
(used) by:
Operating activities.... $ (38) $ 412 $ 1,342 $ (5,229) $(34,913)
Investing activities.... $ (82) $(1,038) $ (4,461) $ (1,445) $ (6,244)
Financing activities.... $ 145 $ 739 $ 4,551 $ 6,142 $ 47,164
Subscribers(2).......... 200 47,361 152,022 172,472 234,914
Independent sales
representatives in
FlashNet's network
marketing program(2)... -- -- 1,885 5,424 8,226
</TABLE>
- --------
(1) Earnings before interest, tax, depreciation and amortization (EBITDA)
consists of net loss before extraordinary item, provisions for net interest
expense/(income), income taxes, depreciation, amortization (including
amortization of customer hardware) and the deemed dividend on the preferred
stock. These earnings are not intended to represent cash flows from
operations in accordance with generally accepted accounting principles and
should not be considered as an alternative to net loss as an indicator of
FlashNet's operating performance or to cash flows as a measure of
liquidity. FlashNet believes that earnings before interest, tax,
depreciation and amortization is a standard measure commonly reported and
widely used by analysts, investors and other interested parties in the
Internet service provider industry to compare the operating performance of
companies within this industry. FlashNet has elected to include these
earnings in its financial presentation to provide investors with an
additional measurement of its operating performance, especially in view of
its continuing levels of net losses.
(2) Determined as of the end of the period.
30
<PAGE>
SELECTED UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION
On October 5, 1999, Prodigy acquired the BizOnThe.Net Web hosting business of
U.S. Republic Communications, Inc. an indirect majority owned subsidiary of
VarTec including the subscribers of the BizOnThe.Net Web hosting business. At
the closing, Prodigy repaid a $9 million loan from VarTec to U.S. Republic and
issued 2,840,993 shares of Prodigy common stock to U.S. Republic including
727,272 shares held in an escrow account to secure the indemnification
obligations of U.S. Republic and its shareholders. Some or all of the escrowed
shares will be released to U.S. Republic at various times over the two year
period following the closing. In addition to the shares and amounts paid at
closing, in 2001 Prodigy may be required to issue up to 727,272 additional
shares, contingent on the attainment by the acquired business of set earn-out
targets.
Under accounting principles generally accepted in the United States, the
acquisition of BizOnThe.Net was accounted for under the purchase method of
accounting and accordingly the cost to acquire BizOnThe.Net was allocated to
the assets acquired and liabilities assumed based on their respective fair
values with the excess allocated to goodwill. Based on the value of the
2,840,993 shares of Prodigy common stock currently issued in connection with
the BizOnThe.Net acquisition and the $9 million cash used to repay the loan,
the total purchase price is approximately $58 million, including transaction
costs of $829 thousand. The excess of the purchase price over the fair value of
net assets acquired is approximately $50 million.
On November 5, 1999, Prodigy, agreed to acquire FlashNet Communications, Inc.
In the merger, Prodigy will issue 0.35 share of Prodigy common stock for each
outstanding share of FlashNet common stock. Based on the number of FlashNet
shares outstanding on March 31, 2000, Prodigy will issue approximately
5,000,000 shares to complete the merger, representing approximately 7% of
Prodigy's then outstanding shares. In addition, Prodigy will assume all
FlashNet stock options and warrants outstanding as of the date of the merger.
Under accounting principles generally accepted in the United States, the
acquisition of FlashNet will be accounted for under the purchase method of
accounting. Accordingly, the cost to acquire FlashNet will be allocated to the
assets acquired and liabilities assumed based on their respective fair values,
with the excess to be allocated to goodwill. The valuations and other studies
required to determine the fair value of the FlashNet assets acquired and
liabilities assumed have not been performed and, accordingly, the related
adjustments reflected in the unaudited pro forma combined financial information
are preliminary and subject to further revisions and adjustments. Based on the
value of the estimated 5,000,000 shares of Prodigy common stock to be issued in
connection with the FlashNet acquisition, the total purchase price is
approximately $136 million including transaction costs incurred to date of $2.2
million. The goodwill and other intangibles acquired, based on the excess of
the purchase price over the net book value of net assets to be acquired, is
currently estimated to be $126 million.
On November 19, 1999, SBC and Prodigy agreed to establish a strategic
relationship in which:
. Prodigy will contribute substantially all of its assets and liabilities,
and transfer its employees to a new limited partnership, called the
operating partnership, that will operate Prodigy's business;
. SBC will acquire an approximately 43% indirect interest in Prodigy upon
completion of the SBC transaction and an approximate 39.5% indirect
interest after the FlashNet merger;
. SBC will contribute to the operating partnership routers, servers and
associated hardware used in connection with SBC's consumer and small
business Internet operations and that are selected by Prodigy because
Prodigy determines that they will be useful in connection with the
provision of services to SBC's customers and Prodigy's customers after
the closing;
. SBC will contribute to the operating partnership intangible assets
consisting primarily of royalty-free licenses to use SBC's trademarks in
connection with the marketing and operation of the Prodigy Internet
service and Prodigy's right to manage SBC's existing Internet customers;
. Prodigy will be the exclusive retail Internet service marketed by SBC to
consumers and small businesses;
31
<PAGE>
. SBC will purchase the Prodigy Internet service from Prodigy on wholesale
terms and provide it to SBC's approximately 690,000 existing Internet
subscribers--the wholesale price to be paid by SBC to Prodigy for the
Prodigy Internet service that SBC will resell to its existing Internet
subscribers will equal SBC's average retail price as of the closing less
reasonable and necessary expenses actually incurred by SBC in serving
its existing Internet subscribers;
. SBC has committed to obtain for Prodigy 1,200,000 additional Internet
subscribers over a three-year period in exchange for fees of $40 to $75
per subscriber--all new subscribers obtained for Prodigy by SBC will be
Prodigy subscribers;
. SBC has agreed to pay Prodigy a penalty, under a specified formula, if
SBC does not obtain 1,200,000 additional internet subscribers for
Prodigy over the three-year period, with the size of the penalty based
on the number of subscribers actually obtained by SBC who pay at least
one monthly bill from Prodigy -- for example, the penalty will range
from $165,000,000 if SBC acquires no new subscribers for Prodigy, to
$105,000,000 if SBC acquires 600,000 new subscribers for Prodigy, to no
penalty if SBC acquires 1,200,000 new subscribers for Prodigy;
. SBC will have the exclusive right to market its long-distance phone
service, local phone service, wireless phone services, paging services
and related calling services to Prodigy's subscribers, so long as SBC's
service offerings are competitive with service offerings from other
providers;
. SBC will be Prodigy's exclusive network provider so long as SBC offers
its network services to Prodigy at the most favorable rates that it
offers to other similar purchasers and so long as SBC's terms are
competitive with those offered by other providers;
. SBC will have the exclusive right to provide telecommunications,
advertising, telecommunications e-commerce and Internet telephony
applications in conjunction with the Prodigy Internet service to
Prodigy's subscribers, so long as SBC's terms are competitive with those
offered by other providers;
. SBC will be the exclusive provider of electronic yellow and white pages
and city guides to Prodigy's subscribers;
. Prodigy will convert all outstanding Prodigy common stock into Prodigy
Class A common stock; and
. Prodigy will issue to an SBC subsidiary one share of Prodigy Class B
common stock in consideration of $100.
The tangible and intangible assets received in conjunction with the SBC
transaction will be recorded at fair value on the date the assets are
contributed. Based on the following assumptions, the fair value of the assets
received has been estimated at $968.75 million:
. SBC will receive approximately 50,000,000 partnership units, which
assuming that SBC's book capital account equals its imputed capital
account and that the partnership interests will be equivalent in value
to the Prodigy Class A common stock, will be convertible into
approximately 50,000,000 shares of Prodigy Class A common stock based on
pro forma shares outstanding after giving effect to the BizOnThe.Net and
FlashNet acquisitions; and
. the value of one share of Prodigy common stock was approximately $19.38
on December 31, 1999, which when multiplied by 50,000,000 shares,
results in an estimated value of $968.75 million.
For purposes of the pro forma financial information, and pending preparation of
a valuation to allocate the purchase price, the tangible and intangible assets
to be received have been aggregated and presented in total in the SBC Assets
balance sheet caption. These assets, which are principally related to royalty-
free licenses to use the SBC trademarks, which will be amortized over the three
year term of the agreement, and the routers, servers and associated hardware,
which are also assumed to have a three year life. If the amortization period of
any of these assets is longer than the three year period assumed for purposes
of the pro forma financial information, the corresponding annual amortization
expense will be decreased.
32
<PAGE>
In addition to the equity investment, SBC will purchase from Prodigy the
Prodigy Internet service and resell these services to its existing 690,000
Internet service subscribers. Prodigy will charge SBC a fixed price per
subscriber for its services, to be fixed as of the closing date, and will incur
incremental costs associated with providing these services to SBC, principally
related to Prodigy's acquisition of additional network services and customer
service. Adjustments have not been made to revenue or cost of revenue included
in the pro forma statement of operations to reflect the services to be provided
to the existing SBC subscribers as contractual agreements have not been
finalized with respect to these services.
Additionally, the SBC agreement includes other services that Prodigy and SBC
will provide to each other. Impacts to revenue and expenses associated with
these services, however, cannot be estimated at this time and accordingly have
not been included in the pro forma statement of operations.
The unaudited pro forma condensed combined balance sheets give effect to the
acquisition of FlashNet and the SBC transaction as if these had occurred on
December 31, 1999. The acquisition of BizOnThe.Net is reflected in the
historical balance sheet of Prodigy as of December 31, 1999.
The unaudited pro forma condensed combined statements of operations for the
year ended December 31, 1999 give effect to the acquisition of BizOnThe.Net and
FlashNet, and the SBC transaction as if these occurred on January 1, 1999 and
are based on the historical results of operations of Prodigy, BizOnThe.Net and
FlashNet and the amortization associated with the assets acquired in the SBC
transaction. The results of BizOnThe.Net for the fourth quarter of 1999 are
included in the results of operations of Prodigy for the year ended December
31, 1999.
The unaudited pro forma condensed combined financial statements are based on
the preliminary estimates and assumptions set forth in the notes to these
statements that have been made solely for purposes of developing this pro forma
information. The unaudited pro forma condensed combined financial statements
are not necessarily indicative of the results that would have been achieved had
these transactions been completed as of the dates indicated or that may be
achieved in the future.
These unaudited pro forma condensed combined financial statements should be
read in conjunction with the historical consolidated financial statements and
related notes and other financial information pertaining to Prodigy,
BizOnThe.Net and FlashNet, including the Prodigy and FlashNet "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Risk Factors" included elsewhere in this document.
33
<PAGE>
Selected Unaudited Pro Forma Condensed Combined Financial Information
Prodigy, BizOnThe.Net and FlashNet
Condensed Combined Pro Forma Financial Data
<TABLE>
<CAPTION>
Twelve Months
Ended
December 31,
1999
-------------
(In millions,
except share
and per share
information)
<S> <C>
Combined Statement of Operations Data
Revenues
Internet and online service revenues........................ $ 200.9
Web Hosting................................................. 19.0
Other....................................................... 28.4
----------
Total Revenues.......................................... 248.3
Operating costs and expenses
Costs of revenue............................................ 126.4
Amortization of subscriber acquisition costs................ 20.4
Sales and marketing......................................... 92.2
Product development......................................... 12.3
General and administrative.................................. 89.2
Depreciation and amortization............................... 83.3
----------
Total operating costs and expenses...................... 423.8
----------
Operating loss............................................ (175.5)
Interest (Expense) Income, net............................... 2.4
Gain on sale of equity investment............................ 3.3
Gain on settlement of note payable........................... 1.7
Gain on settlement of note receivable........................ 0.5
----------
Net loss before extraordinary item........................ $ (167.6)
==========
Net loss per common share:
Basic and diluted........................................... $ (2.50)
==========
Weighted average number of common and common equivalent
shares outstanding:
Basic and diluted........................................... 67,114,152
==========
<CAPTION>
December 31,
1999
-------------
<S> <C>
Combined Balance Sheet Data:
Working capital deficit...................................... $ (139.1)
Total assets................................................. 511.6
Stockholders' equity......................................... 298.5
</TABLE>
34
<PAGE>
Selected Unaudited Pro Forma Condensed Combined Financial Information
Prodigy, BizOnThe.Net, FlashNet
and SBC Transaction Condensed Combined Pro Forma Financial Data
<TABLE>
<CAPTION>
Twelve Months Ended
December 31,
1999
-------------------
(In millions,
except share and
per share
information)
<S> <C>
Combined Statement of Operations Data
Revenues
Internet and online service revenues....................... $ 200.9
Web Hosting................................................ 19.0
Other...................................................... 28.4
----------
Total Revenues......................................... 248.3
Operating costs and expenses
Costs of revenue........................................... 126.4
Amortization of subscriber acquisition costs............... 20.4
Sales and marketing........................................ 92.2
Product development........................................ 12.3
General and administrative................................. 89.2
Depreciation and amortization.............................. 406.2
----------
Total operating costs and expenses..................... 746.7
----------
Operating loss........................................... (498.4)
Interest (Expense) Income, net.............................. 2.4
Gain on sale of equity investment........................... 3.3
Gain on settlement of note payable.......................... 1.7
Gain on settlement of note receivable....................... 0.5
Minority interest in net loss............................... 193.2
----------
Net Loss before extraordinary item....................... $ (297.3)
==========
Net loss per common share:
Basic and diluted.......................................... $ (4.43)
==========
Weighted average number of common and
common equivalent shares outstanding:
Basic and diluted.......................................... 67,114,153
==========
<CAPTION>
December 31,
1999
-------------------
<S> <C>
Combined Balance Sheet Data:
Working capital deficit..................................... $ (139.1)
Total assets................................................ 1,480.3
Stockholders' equity........................................ 768.0
</TABLE>
35
<PAGE>
COMPARATIVE PER SHARE DATA
The following tables reflect:
. the historical net loss and book value per share of Prodigy common
stock;
. the historical net loss and book value per share of FlashNet common
stock;
. the unaudited pro forma net loss and book value per share after giving
effect to the purchase by Prodigy of BizOnThe.Net and the proposed
merger with FlashNet; and
. the unaudited pro forma net loss and book value per share after giving
effect to the purchase by Prodigy of BizOnThe.Net, the proposed merger
of Prodigy with FlashNet and the proposed transaction with SBC.
The information presented in the following table derived from and should be
read in conjunction with the unaudited pro forma condensed combined
financial statements and the historical consolidated financial statements
and related notes of Prodigy, BizOnThe.Net and FlashNet, which are included
in this document.
<TABLE>
<CAPTION>
Year Ended
December 31,
1999
------------
<S> <C>
Prodigy Historical
Net loss per common share-basic and diluted...................... $(1.34)
Book value per share............................................. $ 2.56
FlashNet Historical
Net loss per common share before extraordinary item and deemed
distributions-basic and diluted................................. $(2.46)
Book value per share............................................. $ 0.67
Prodigy, BizOnThe.Net and FlashNet Pro Forma Combined
Net loss per common share-basic and diluted...................... $(2.50)
Book value per share(1).......................................... $ 4.45
Equivalent net loss per share-basic and diluted (2).............. $(0.87)
Equivalent book value per share(2)............................... $ 1.56
Prodigy, BizOnThe.Net, FlashNet and SBC Transaction Pro Forma
Combined
Net loss per common share-basic and diluted...................... $(4.43)
Book value per share(1).......................................... $11.74
Equivalent net loss per share-basic and diluted(2)............... $(1.55)
Equivalent book value per share(2)............................... $ 4.00
</TABLE>
- --------
(1) Calculated by dividing total shareholders equity by shares issued and
outstanding at the respective dates and does not reflect the possible
exercise of stock options and warrants.
(2) The equivalent pro forma information reflects the pro forma information
presented in this document divided by the exchange ratio of .35 share of
Prodigy common stock for each share of FlashNet common stock.
36
<PAGE>
MARKET PRICE INFORMATION
Prodigy Market Price Information
Prodigy common stock has traded on the Nasdaq National Market under the
symbol "PRGY" since February 11, 1999.
The table below sets forth the range of high and low closing prices of
Prodigy common stock as reported on the Nasdaq National Market since February
11, 1999, the date of Prodigy's initial public offering.
<TABLE>
<CAPTION>
Prodigy
Common Stock
-----------------
High Low
-------- --------
<S> <C> <C>
Fiscal 1999
Quarter ended March 31, 1999............................... $ 50.625 $ 20.00
Quarter ended June 30, 1999................................ $ 41.25 $21.0625
Quarter ended September 30, 1999........................... $ 28.625 $ 14.00
Quarter ended December 31, 1999............................ $35.4375 $ 16.00
Fiscal 2000
Quarter ended March 31, 2000............................... $ 25.75 $ 12.00
Quarter ending June 30, 2000 (through May 4, 2000)......... $ 13.875 $ 9.8125
</TABLE>
As of April 7, 2000, Prodigy had 505 record holders. Prodigy believes that
there were more than 28,000 beneficial holders of its common stock at April 7,
2000.
FlashNet Market Price Information
FlashNet common stock has traded on the Nasdaq National Market under the
symbol "FLAS" since March 16, 1999.
The table below sets forth the range of high and low closing prices of
FlashNet common stock as reported on the Nasdaq National Market since March 16,
1999, the date of FlashNet's initial public offering.
<TABLE>
<CAPTION>
FlashNet
Common Stock
----------------
High Low
-------- -------
<S> <C> <C>
Fiscal 1999
Quarter ended March 31, 1999................................ $ 43.625 $33.375
Quarter ended June 30, 1999................................. $ 48.375 $ 17.50
Quarter ended September 30, 1999............................ $28.4375 $ 8.00
Quarter ended December 31, 1999............................. $ 10.875 $6.1875
Fiscal 2000
Quarter ended March 31, 2000................................ $ 8.7188 $ 4.625
Quarter ending June 30, 2000 (through May 4, 2000).......... $ 4.375 $2.7812
</TABLE>
As of April 7, 2000, FlashNet had 326 record holders.
Recent Closing Prices
The following table sets forth the closing prices per share of Prodigy common
stock and FlashNet common stock as reported on the Nasdaq National Market on
November 5, 1999, the last full trading day prior to the public announcement
that Prodigy and FlashNet had entered into the merger agreement and May 4,
2000, the last full trading day for which closing prices were available at the
time of the printing of this proxy statement/prospectus. This table also sets
forth the equivalent price per share of FlashNet common stock on
37
<PAGE>
those dates. The equivalent price per share is equal to the closing price of a
share of Prodigy common stock on that date multiplied by 0.35, the number of
shares of Prodigy common stock to be issued in the merger in exchange for each
share of FlashNet common stock.
<TABLE>
<CAPTION>
Prodigy FlashNet Equivalent
Common Common per
Date Stock Stock Share Price
- ---- -------- -------- -----------
<S> <C> <C> <C>
November 5, 1999.................................. $ 24.75 $10.00 $ 8.6625
May 4, 2000....................................... $11.6875 $ 3.75 $4.09063
</TABLE>
FlashNet and Prodigy believe that FlashNet common stock presently trades on
the basis of the value of Prodigy common stock expected to be issued in
exchange for the FlashNet common stock in the merger, discounted primarily for
the uncertainties associated with the merger.
FlashNet shareholders are advised to obtain current market quotations for
Prodigy common stock and FlashNet common stock. No assurance can be given as to
the market prices of Prodigy common stock or FlashNet common stock at any time
before completing the merger or as to the market price of Prodigy common stock
at any time after the merger. Because the exchange ratio is fixed, the exchange
ratio will not be adjusted to compensate FlashNet shareholders for decreases in
the market price of Prodigy common stock which could occur before the merger
becomes effective. In the event the market price of Prodigy common stock
decreases or increases prior to completing the merger, the value of the Prodigy
common stock to be received in the merger in exchange for FlashNet common stock
would correspondingly decrease or increase.
Dividends
Prodigy has never declared or paid cash dividends on Prodigy common stock.
Prodigy currently intends to retain earnings, if any, to support its growth
strategy and does not anticipate paying cash dividends in the foreseeable
future. Payment of future dividends, if any, will be at the discretion of the
Prodigy board of directors after taking into account various factors, including
Prodigy's financial condition, operating results, current and anticipated cash
needs and plans for expansion.
FlashNet has never paid cash dividends on its capital stock and does not
intend to pay any cash dividends on its common stock in the foreseeable future.
If the merger does not occur, FlashNet currently intends to retain earnings, if
any, to support its operations. Payment of future dividends, if any, will be at
the discretion of FlashNet's board of directors.
38
<PAGE>
THE SPECIAL MEETING
FlashNet is furnishing this document to holders of FlashNet common stock in
connection with the solicitation of proxies by the FlashNet board of directors
for use at the special meeting of FlashNet shareholders to be held on Tuesday,
May 30, 2000, and any adjournment of the meeting.
This document is first being furnished to FlashNet shareholders on or about
May 5, 2000. This document is also furnished to FlashNet shareholders as a
prospectus in connection with the issuance by Prodigy of shares of Prodigy
common stock as contemplated by the merger agreement.
Date, Time and Place of Meeting
The special meeting will be held on Tuesday, May 30, 2000, at 9:00 a.m.,
local time, at the City Club in the City Center Tower II located at 301
Commerce Street, Fort Worth, Texas 76102
What Will Be Voted Upon
At the special meeting, shareholders of FlashNet will be asked to approve the
merger agreement and the merger and to transact any other business that may
properly come before the special meeting or any postponements or adjournments
of that meeting.
Record Date and Outstanding Shares
Only shareholders of record of FlashNet common stock at the close of business
on the April 7, 2000 record date for the special meeting are entitled to notice
of and to vote at the special meeting. As of the close of business on the
record date, there were 14,321,297 shares of FlashNet common stock outstanding
and entitled to vote, held of record by 326 shareholders. Each FlashNet
shareholder is entitled to one vote for each share of FlashNet common stock
held as of the record date.
Vote Required to Approve the Merger
The affirmative vote of the holders of at least two-thirds of the shares of
FlashNet common stock outstanding on the record date is required to approve the
merger.
Share Ownership of Management and Shareholders
On the same day that the merger agreement was signed, directors and executive
officers of FlashNet and their affiliates entered into voting agreements with
Prodigy agreeing to vote all of their shares of FlashNet common stock for the
approval of the merger agreement and the merger. On the record date for the
special meeting, the same individuals and entities beneficially owned and were
entitled to vote 4,014,679 shares of FlashNet common stock, or approximately
28% of the outstanding shares of FlashNet common stock as of that date.
Quorum; Abstentions and Broker Non-Votes
A FlashNet shareholder may abstain from voting on the proposal to approve the
merger agreement and the merger by returning a proxy marked "ABSTAIN."
Under applicable rules, brokers who hold shares in street name for customers
have the authority to vote on some routine proposals when they have not
received instructions from beneficial owners. Under applicable rules, these
brokers are precluded from exercising their voting discretion with respect to
the approval and adoption of non-routine matters like the proposed merger and,
thus, absent specific instructions from the beneficial owner of shares held in
street name, brokers are not empowered to vote these shares with respect to the
approval and adoption of the merger agreement and the merger.
Abstentions and broker non-votes are not affirmative votes and, therefore,
will have the same effect as votes against approval of the merger agreement and
the merger. In addition, the required vote of the shareholders of FlashNet is
based on the number of the outstanding shares of FlashNet common stock rather
39
<PAGE>
than on the shares actually voted in person or by proxy at the special meeting.
Therefore, if the holders of any FlashNet shares fail to either submit a proxy
or vote in person at the special meeting, this failure will have the same
effect as a vote against approval of the merger.
Voting and Revocation of Proxies
The proxy accompanying this document is solicited on behalf of the FlashNet
board of directors. FlashNet shareholders are requested to complete, date and
sign the accompanying proxy and promptly return it in the accompanying envelope
or otherwise mail it to FlashNet. A number of brokerage firms and banks offer
telephone and Internet voting options. If your shares are registered in street
name, check the information forwarded by your bank or broker to see which
options are available to you. Please see the accompanying proxy for more
information.
All properly executed proxies received by FlashNet prior to the special
meeting that are not revoked will be voted at the special meeting in accordance
with the instructions indicated on the proxies, or, if no direction is
indicated, to approve the merger. FlashNet's board of directors does not
presently intend to bring any other business before the special meeting and, as
of the date of this document, the board knows of no other matters to be brought
before the special meeting. As to any other business that may properly come
before the special meeting, however, it is intended that proxies, in the form
enclosed, will be voted in accordance with the judgment of the persons voting
those proxies. A FlashNet shareholder who has given a proxy may revoke it at
any time before it is exercised at the special meeting by:
. delivering to the secretary of FlashNet a written notice, bearing a date
later than the date of the proxy, stating that the proxy is revoked;
. signing and delivering a proxy relating to the same shares and bearing a
later date than the date of the previous proxy prior to the vote at the
special meeting; or
. attending the special meeting and voting in person.
However, if you elect to vote in person at the special meeting and your
shares are held by a broker, bank or other nominee, you must bring to the
special meeting a legal proxy from your broker, bank or other nominee
authorizing you to vote the shares.
Solicitation of Proxies and Expenses
FlashNet will pay approximately $10,000 for the solicitation of proxies. In
addition to solicitation by mail, brokerage houses and other custodians,
nominees and fiduciaries will send beneficial owners the proxy materials.
FlashNet will, upon request, reimburse those brokerage houses and custodians
for their reasonable expenses. Moreover, FlashNet has retained Corporate
Investor Communications to aid in the solicitation of proxies and verify to
records related to the solicitations. To ensure sufficient representation at
its special meeting, FlashNet may request the return of proxy cards by
telephone or telegram. The necessity of this request depends entirely on how
promptly FlashNet receives the proxies. We urge shareholders to vote proxies
without delay.
Board Recommendation
FlashNet's board of directors has unanimously approved the merger agreement
and the merger and believes that the terms of the merger agreement are fair to,
and that the merger is in the best interest of, FlashNet and its shareholders
and therefore recommends that FlashNet's shareholders vote for approval of the
merger agreement and the merger.
The matters to be considered at the special meeting are of great importance
to the shareholders of FlashNet. Accordingly, FlashNet's shareholders are urged
to read and carefully consider the information presented in this document, and
to complete, date, sign and promptly return the enclosed proxy card in the
enclosed postage-paid envelope.
You should not send in any stock certificates with your proxy card. A
transmittal form with instructions for the surrender of certificates for
FlashNet common stock will be mailed to you as soon as practicable after
completion of the merger.
40
<PAGE>
THE MERGER
This section of the proxy statement/prospectus describes material aspects of
the proposed merger, including the merger agreement and the stock option
agreement. While we believe that the description covers the material terms of
the merger and the related transactions, this summary may not contain all of
the information that is important to FlashNet shareholders. FlashNet
shareholders should read the merger agreement, stock option agreement and other
documents we refer to carefully and in their entirety for a more complete
understanding of the merger.
Background of the Merger
On March 16, 1999, FlashNet sold 3,000,000 shares of its common stock to the
public in its initial public offering and concurrently sold an additional
175,000 shares to SBC. Shortly after FlashNet's initial public offering, a
number of major Internet service providers, including America Online, Microsoft
and Prodigy, began to offer a number of incentives to attract users. These
incentives included free Internet access and cash rebates to computer retailers
who enrolled purchasers of computers to subscription terms for Internet access
service. To attract new subscribers in the face of these incentives, FlashNet
began to sell refurbished computers bundled with Internet access. It quickly
found, however, that this program resulted in a rapid depletion of its cash
reserves without resulting in the increase in subscriber growth experienced by
the major Internet service providers with strong national brand names who were
providing similar incentives. To combat this rapid depletion of cash reserves
and to raise sufficient capital to fund the creation of its own national brand
recognition, FlashNet retained Goldman Sachs as an investment advisor to assist
it in capital raising efforts. Based on discussions with Goldman Sachs,
FlashNet realized that the changes taking place in its industry since its
initial public offering would make it difficult for FlashNet to raise
significant amounts of capital because it lacked a strong national brand
recognition, a large subscriber base and strong strategic financial and other
relationships. Accordingly, FlashNet explored strategic partnering efforts as
an alternative to raising capital to fund the growth of its business.
In early June 1999, FlashNet received an inquiry from Bear, Stearns & Co.
Inc., Prodigy's financial advisor, regarding FlashNet's interest in a potential
strategic relationship with Prodigy. FlashNet indicated that it might have an
interest because its management believed that Prodigy possessed many of the
characteristics that FlashNet's management had identified as necessary to
successfully compete in the Internet service provider industry. These
characteristics included a strong national brand recognition and a large
subscriber base and strategic alliances with strong financial and other
partners. On June 1, 1999, the approximate commencement date of discussions
between Prodigy and FlashNet, the closing price for Prodigy common stock on the
Nasdaq National Market was $24.0625 per share and the closing price for
FlashNet common stock on the Nasdaq National Market was $20.00 per share.
On June 10, 1999, Lee Thurburn, FlashNet's then chairman and chief executive
officer, Scott Leslie, FlashNet's president and chief operating officer, and
Andrew Jent, FlashNet's executive vice president and chief financial officer,
met in person with Samer Salameh, Prodigy's chairman and chief executive
officer, David Trachtenberg, Prodigy's president and chief operating officer,
Andrea Hirsch, Prodigy's executive vice president of business development and
general counsel, and David Henkel, Prodigy's then chief financial officer, at
the offices of Bear Stearns. At the meeting, FlashNet provided Prodigy with an
overview of its business. In addition, FlashNet and Prodigy talked in general
terms about a possible business combination between the two companies,
including the strategic fit of the two companies. This strategic fit included
the fact that a merger would provide Prodigy with access to FlashNet's company-
owned network infrastructure, customer service and call centers and independent
representative marketing network, benefits that Prodigy does not currently
have. A merger would also permit FlashNet to combine with Prodigy, which has
strong national brand recognition, a large existing subscriber base and strong
strategic relationships, benefits that FlashNet does not have.
On June 11, 1999, Ms. Hirsch advised the Prodigy board about the meeting with
FlashNet and that management was reviewing the advisability of the transaction.
41
<PAGE>
In the meantime, on June 14, 1999, FlashNet formally retained Goldman Sachs
to act as its financial advisor in connection with a possible business
combination with Prodigy. On June 16, 1999, Prodigy and FlashNet executed a
confidentiality and standstill agreement permitting more in-depth discussions.
Over the next several days, there were discussions between Prodigy and
FlashNet, including their respective financial advisors, on business and
technical issues regarding a possible business combination, including
opportunities to integrate their respective operations. Specific terms of a
proposed combination were not discussed at this meeting.
On June 22, 1999, Mr. Leslie, Mr. Jent and representatives from Goldman Sachs
met in person with Mr. Salameh, Ms. Hirsch, Mr. Henkel, Bill Kirkner, Prodigy's
chief technology officer, Linda Templeton, Prodigy's then vice president of
customer care, and representatives from Bear Stearns at Prodigy's offices. At
this meeting, Prodigy made management presentations regarding its business to
FlashNet and FlashNet toured Prodigy's data center and conducted other due
diligence on Prodigy. Neither party discussed specific terms of a proposed
combination at this meeting.
On June 24, 1999, Mr. Salameh, Ms. Hirsch, Mr. Henkel, Mr. Kirkner, Ms.
Templeton, Ken Domnitz, Prodigy's director of business development, and
representatives from Bear Stearns met in person with Mr. Thurburn, Mr. Leslie,
Mr. Jent, Russell Wiseman, FlashNet's then vice president of marketing, and
representatives of Goldman Sachs at FlashNet's offices for management
presentations by FlashNet and to conduct due diligence on FlashNet. At this
time, Mr. Salameh met separately with Mr. Thurburn to discuss FlashNet's
independent representative network marketing program. Neither party discussed
specific terms of a proposed combination at this meeting.
From June 25 until June 28, 1999, representatives of Prodigy and FlashNet,
including their respective financial advisors, continued with their due
diligence reviews and exchanged further information about the two companies.
On June 29, 1999, Bear Stearns, on behalf of Prodigy, had discussions with
Goldman Sachs regarding the possible terms of a merger between the two
companies. While no formal offer was made at this time, Bear Stearns indicated
that any transaction would have to take place at a discount to the current
trading price of FlashNet's common stock but would nonetheless be at a premium
to the recent historical trading prices of FlashNet's common stock. On June 28,
1999, the day prior to the date of these discussions, the closing price for
Prodigy common stock on the Nasdaq National Market was $22.25 per share and the
closing price of FlashNet common stock on the Nasdaq National Market was
$24.3125 per share.
FlashNet initially responded to these discussions through Goldman Sachs that
it felt that a valuation based on a discount to its current trading price was
inappropriate, but after further discussion a consensus could not be reached,
and the parties ceased further negotiations.
On July 8, 1999, Goldman Sachs made a presentation to FlashNet's board of
directors. The presentation included an industry overview and an analysis of
possible valuations of FlashNet. At that time, the FlashNet board concluded
that it was inappropriate to continue to try to pursue a transaction with
Prodigy. Accordingly, on July 9, 1999, FlashNet sent Prodigy a letter
terminating discussions and requesting the return of any confidential
information supplied by FlashNet to Prodigy. Prodigy then returned all the
information to FlashNet. At the time discussions were terminated, Prodigy had
not made any formal offer to FlashNet regarding the terms of a proposed merger.
From mid-July, when discussions broke down with Prodigy, through early
October, FlashNet continued to discuss capital raising and strategic
relationship alternatives with Goldman Sachs. In connection with these
discussions on October 11 and October 12, 1999, FlashNet's management
concluded, with Goldman Sachs' advice, that the industry conditions and trends
that it had identified prior to its discussions with Prodigy had worsened and
that FlashNet could not raise capital on reasonable terms at the levels
necessary to continue to fund its operations and growth. Accordingly, FlashNet
discussed possible strategic alternatives with Goldman Sachs at that time.
Those discussions included a possible sale or merger with several types of
companies. At FlashNet's direction, Goldman Sachs contacted eleven potential
strategic partners to gauge their interest in a
42
<PAGE>
strategic partnership with FlashNet, including other Internet service
providers, telephone companies and computer manufacturers. Prodigy was the only
one of these companies that expressed a serious interest in a possible
transaction with FlashNet.
On October 17, 1999, Mr. Leslie met with Mr. Salameh in Dallas to discuss re-
opening discussions. Neither party made any formal offer or proposal to the
other at this time, but Mr. Leslie and Mr. Salameh both agreed that Prodigy and
FlashNet had a strong interest in putting together a transaction.
On October 20, 1999, the Prodigy board held a telephonic meeting during which
it authorized management to proceed with discussions with FlashNet, subject to
board approval of the final terms of the transaction.
On October 21, 1999, Goldman Sachs made a presentation to FlashNet's board of
directors. At the meeting, Goldman Sachs discussed with the FlashNet board the
benefits of a possible business combination with Prodigy. These benefits
included Prodigy's strong national brand recognition, large subscriber base and
strategic relationships and increased access to capital. FlashNet's board
authorized management to proceed with discussions with Prodigy, subject to
board approval of the final terms of the transaction. Prodigy and FlashNet then
executed a new confidentiality and standstill agreement to continue with more
in-depth discussions.
On October 25, 1999, Bear Sterns submitted a draft term sheet on behalf of
Prodigy to Goldman Sachs outlining the proposed terms of a merger between the
two companies. This term sheet provided for an exchange ratio of 0.32 of a
share of Prodigy common stock for each outstanding share of FlashNet common
stock. The closing price of Prodigy's common stock on the Nasdaq National
Market on October 22, 1999, the business day prior to these discussions, was
$21.5625 per share and the closing price of FlashNet's common stock on the
Nasdaq National Market on that date was $6.75 per share.
For the next several days, FlashNet and Prodigy continued to discuss and
negotiate an exchange ratio for the merger. On October 26, 1999, FlashNet and
Prodigy agreed to an exchange ratio of 0.35 of a share of Prodigy common stock
for each outstanding share of FlashNet common stock. The closing price of
Prodigy common stock on the Nasdaq National Market on October 25, 1999, the day
prior to the date of this agreement, was $21.25 per share and the closing price
of FlashNet common stock on that date was $7.0625 per share.
On November 1, 1999, Mr. Henkel, Mr. Domnitz and Mr. Kirkner met in person
with Mr. Leslie and Mr. Jent, including their respective financial advisors, at
FlashNet's offices to update prior due diligence efforts and to conduct further
due diligence reviews. Prodigy's legal counsel, Hale and Dorr LLP, concurrently
delivered draft definitive merger agreement documents for review. Over the next
several days, representatives of Prodigy and FlashNet, including their
respective financial and legal advisors, negotiated the final terms of these
documents.
On November 5, 1999, the Prodigy board held a telephonic meeting during which
Mr. Salameh, Ms. Hirsch, Mr. Henkel, Mr. Domnitz and representatives of Hale
and Dorr reviewed the terms and conditions of the proposed merger and the
results of the due diligence investigations. Following a discussion, the
Prodigy board unanimously approved the merger and authorized management to
execute the merger agreement and related agreements.
On November 5, 1999, FlashNet held a board meeting during which Mr. Leslie,
Mr. Jent and representatives of Goldman Sachs and Brobeck, Phleger & Harrison
LLP, FlashNet's legal counsel, reviewed the terms and conditions of the
proposed merger with the FlashNet board. Goldman Sachs also made a presentation
to the board regarding the fairness of the proposed exchange ratio. Following a
discussion, the FlashNet board unanimously approved the merger and authorized
management to execute the merger agreement and related agreements.
On November 5, 1999, following the meeting of the Prodigy and FlashNet
boards, each party executed the merger agreement. The execution of the merger
agreement was announced on the morning of November 8, 1999, prior to the
commencement of trading on the Nasdaq National Market, by issuance of a joint
press release by Prodigy and FlashNet.
43
<PAGE>
On November 22, 1999, Prodigy and SBC issued a joint press release announcing
their strategic relationship.
On December 20, 1999, the FlashNet board reconvened to review the terms of
Prodigy's proposed strategic relationship with SBC and its effect on their
prior vote to recommend the approval of the merger to the FlashNet
shareholders. At the meeting, which was attended by representatives of Brobeck,
Mr. Leslie, Mr. Jent and representatives of Goldman Sachs reviewed the terms of
the SBC transaction with the FlashNet board. At this time Goldman Sachs made a
presentation to the board regarding the fairness of the exchange ratio in the
merger based on the assumption that the SBC transaction is closed and also
based on the assumption that the SBC transaction is not closed. Goldman Sachs
confirmed to the FlashNet board its opinion that the exchange ratio in the
merger is fair, from a financial point of view, to the shareholders of
FlashNet. Following a discussion, the FlashNet board unanimously confirmed its
prior determination that the merger is advisable and in the best interests of
the FlashNet shareholders and that it recommended the approval of the merger to
the FlashNet shareholders.
On March 15, 2000, Prodigy and FlashNet amended their merger agreement to
extend the closing deadline from April 30, 2000 to May 31, 2000.
On April 26, 2000, Prodigy agreed to loan up to $2,000,000 to FlashNet to
fund operations. Advances will be unsecured, bear interest at an annual rate of
12% and are due October 26, 2000. As of May 5, 2000, no advances had been made
under these arrangements.
Prodigy's Reasons for the Merger
The Prodigy board of directors unanimously concluded that the merger was fair
to, and in the best interest of, Prodigy and its stockholders.
The decision of the board of directors was based on several potential
benefits of the merger that it believes will contribute to Prodigy's success.
These potential benefits include:
. strengthening Prodigy's position in the Internet service provider
marketplace;
. increasing Prodigy's existing 1,200,000 managed subscribers by 235,000
new subscribers for a total managed subscriber base of approximately
1,500,000 members on a pro forma basis;
. bringing to Prodigy a national network operations center with state-of-
the-art disaster recovery capability;
. adding additional network infrastructure including 182 local points of
presence;
. acquiring a talented pool of dedicated FlashNet employees;
. adding a well-regarded in-house customer service operations and call
center; and
. leveraging FlashNet's independent agents/referral marketing program, a
proven, low-cost acquisition sales channel for FlashNet.
The Prodigy board of directors reviewed a number of factors in evaluating the
merger, including but not limited to the following:
. information concerning FlashNet's and Prodigy's respective businesses,
prospects, strategic business plans, financial performance and
condition, results of operations, technology positions, management and
competitive positions;
. results of the due diligence investigation conducted by Prodigy
management, financial advisors and legal advisors;
. Prodigy management's view of the positive results of combining the
operations and businesses of Prodigy and FlashNet;
. current financial market conditions and historical stock market prices,
volatility and trading information;
44
<PAGE>
. the impact of the merger on Prodigy's customers and employees; and
. the expectation that the merger will be accounted for as a purchase.
During the course of its deliberations concerning the merger, the Prodigy
board also identified and considered a variety of potentially negative factors
that could materialize as a result of the merger, including the following:
. the risk that the potential benefits sought in the merger might not be
fully realized;
. the possibility that the merger might not be completed;
. the effect of the public announcement of the merger on FlashNet's
business, including employees and customers; and
. the risks associated with obtaining the necessary approvals required to
complete the merger.
The board concluded that these factors were outweighed by the potential
benefits to be gained by the merger. In view of the wide variety of factors,
both positive and negative, considered by the Prodigy board, the directors did
not find it practical to, and did not, quantify or otherwise assign relative
weights to the specific factors discussed above.
FlashNet's Reasons for the Merger; Recommendation of the FlashNet Board of
Directors
The FlashNet board determined to enter into the merger agreement and to
recommend that FlashNet shareholders approve the merger to enable the
shareholders of FlashNet to realize future appreciation in the value of their
investments as shareholders of an Internet service provider with sufficient
size, national brand recognition and financial and other strategic
relationships to compete effectively in the Internet access services industry.
The decision of the FlashNet board was the result of its careful consideration
of FlashNet's business and operating results since the closing of its initial
public offering, the inability of FlashNet to raise significant amounts of
capital on reasonable terms to sustain its current level of operations and to
remain competitive in the industry and the range of strategic alternatives,
including business combinations and other relationships with companies in its
industry and complementary industries, to pursue its long-term growth
objectives.
The FlashNet board's primary concern was to identify and secure the strategic
alternative that would provide the best available opportunity for FlashNet to
provide long-term shareholder value to its shareholders. In considering its
alternatives, the FlashNet board concluded that the Prodigy merger met this
objective. In reaching this determination, the FlashNet board considered the
following factors:
. the need for FlashNet to raise significant amounts of capital to expand
its subscriber base to a size that would enable it to compete with the
leading Internet service providers, such as America Online,
Mindspring/EarthLink and Prodigy, and the conclusion by the FlashNet
board that FlashNet cannot at the present time raise capital on
reasonable terms to enable it to continue to fund its operations and
growth at their current levels;
. the opinions of Goldman Sachs, as delivered orally at the FlashNet board
meetings held on November 5, 1999 and December 20, 1999, and
subsequently provided in writing, that as of the dates of those
meetings, and subject to assumptions made, matters considered and
limitations on the review set forth in its opinion, the exchange ratio
in the merger is fair to FlashNet shareholders from a financial point of
view. Please see "Opinion of FlashNet's Financial Advisor";
. the FlashNet board's belief that the merger would provide the
opportunity to combine Prodigy's national brand name, large, national
subscriber base, and strong strategic relationships with FlashNet's
national and large Texas subscriber base and its unique network
marketing strategy, thus, enabling the combined company to compete more
effectively with the dominant U.S. Internet service providers, America
Online and Mindspring/EarthLink, as well as new entrants to the Internet
access services industry that have rapidly attained significant market
share, including Alta Vista, Dell Computer, Gateway and NetZero;
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<PAGE>
. the key strategic relationships that Prodigy has in place with Telmex,
which provide it more readily available access to capital than FlashNet
has, and the key distribution relationships that Prodigy has been able
to put in place with companies like CompUSA due to Prodigy's strong
national brand recognition; and
. the agreement reached by Prodigy with SBC to form a strategic
relationship, which in the view of the FlashNet board, strengthens
Prodigy's position in the market by, among other things, providing it
with the ability to market its Internet services to all of SBC's
residential subscribers and providing it with access to SBC's network
for the deployment of digital subscriber line high speed access.
In reviewing its alternatives and making its determination, the FlashNet
board also reviewed:
. the results of the due diligence review by FlashNet's management, legal
advisors and financial advisors regarding Prodigy's business, operations
and competitive position, which confirmed FlashNet's management's belief
that Prodigy has the national brand recognition, large subscriber base
and strategic financial and other relationships necessary to compete
effectively in the current industry environment;
. the possible synergistic effects of the combined company, including the
addition to Prodigy of FlashNet's company-owned national operation
center and network infrastructure, its in-house customer service
operation and call centers and its independent representative marketing
program;
. the current and prospective business environment in which FlashNet
operates, which requires strong national brand recognition, a large
subscriber base and strong strategic financial and other relationships,
attributes that the FlashNet board believes that FlashNet does not have,
to be competitive in the industry; and
. the increasing costs on a per-subscriber basis incurred by FlashNet to
expand its business, which have grown from approximately $59 per new
subscriber in the first calendar quarter of 1999 to approximately $148
per new subscriber at the end of the third calendar quarter of 1999, and
the resulting cash needs placed on FlashNet at a time when the board has
determined that FlashNet cannot raise capital on reasonable terms
sufficient to finance its operations and growth at their current levels.
The FlashNet board also reviewed with its legal advisors:
. the terms and conditions of the merger agreement, including provisions
enabling the board to change its recommendation to shareholders if
warranted to comply with its fiduciary duties;
. the following terms of the merger documents;
--the shareholder agreements under which shareholders holding 28% of
FlashNet common stock agreed to vote their shares in favor of the
Prodigy merger;
--the stock option covering shares of FlashNet granted to Prodigy in
connection with the merger agreement;
--the events that may trigger payment of the $5 million termination fee
to Prodigy; and
--the limitations on the ability of FlashNet to solicit or negotiate
with other companies regarding an alternative transaction;
including the potential deterring effect that these provisions might
have on parties that may have an interest in a business combination
with FlashNet and the potential limits that these provisions would
place on FlashNet's ability to pursue alternative proposals that could
be superior to the terms of the merger with Prodigy; and
. the interests of the FlashNet directors and officers in the merger that
are different from, or are in addition to, the interests of FlashNet
shareholders generally, and the potential that these differing interests
have to influence their decision with regard to the merger. Please see
"--Interests of Executive Officers and Directors of FlashNet in the
Merger."
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<PAGE>
The FlashNet board also considered a number of potentially negative factors
in its deliberations concerning the merger, including:
. the risk that, because the exchange ratio under the merger agreement
will not be adjusted for changes in the market price of either FlashNet
common stock or Prodigy common stock, the per share value of the
consideration to be received by FlashNet shareholders might be
significantly less than the price per share implied by the exchange
ratio immediately prior to the announcement of the merger;
. the risk that the merger might not be completed and the potential
adverse effects of the public announcement of the merger on FlashNet's
ability to attract and retain subscribers and employees and its overall
competitive position if the merger does not occur;
. the potential nonrenewal of current annual subscribers and loss of
business opportunities for FlashNet as a result of confusion in the
marketplace resulting from the announcement of the merger, and the
possible exploitation of this confusion by FlashNet's and Prodigy's
competitors;
. the possibility of management disruption associated with the merger and
integrating the operations of the companies, and the risk that, despite
the efforts of FlashNet and Prodigy, key management and technical
personnel of FlashNet might not continue with the combined company;
. the risk that the benefits sought to be achieved by the merger will not
be realized;
. the loss of control over the future operations of FlashNet following the
merger; and
. the impact of the loss of FlashNet's status as an independent company on
its shareholders and employees.
After carefully reviewing these factors, both positive and negative,
FlashNet's board of directors has unanimously approved the merger agreement and
has determined that the merger is advisable to, and in the best interests of,
FlashNet and its shareholders and unanimously recommends that FlashNet
shareholders vote FOR approval of the merger agreement and the merger.
The foregoing discussion of the information and factors considered by the
FlashNet board is not intended to be exhaustive but is believed to include all
material factors considered by the FlashNet board. In view of the complexity
and wide variety of information and factors, both positive and negative,
considered by the FlashNet board, the FlashNet board did not find it practical
to quantify, rank or otherwise assign relative or specific weights to the
factors considered. In addition, the FlashNet board did not reach any
conclusion with respect to each of the factors considered, or any aspect of any
particular factor, but, rather, conducted an overall analysis of the factors
described above, including thorough discussions with FlashNet's management and
legal, financial and accounting advisors. In considering the factors described
above, individual members of the FlashNet board may have given different weight
to different factors. The FlashNet board considered all these factors as a
whole and believed the factors supported its decision to approve the merger.
Opinion of FlashNet's Financial Advisor
On December 20, 1999, Goldman Sachs gave to the FlashNet board of directors
an oral opinion, subsequently confirmed in writing, that as of December 20,
1999, the exchange ratio was fair from a financial point of view to the
FlashNet shareholders.
The full text of the Goldman Sachs opinion is contained in Annex A. Goldman
Sachs provided the opinion to inform and assist the FlashNet board in
connection with its consideration of the merger. The opinion is not a
recommendation to any holder of FlashNet common stock as to how to vote at the
FlashNet special meeting. The summary of the Goldman Sachs opinion below is
qualified by its full text. FlashNet shareholders should read the Goldman Sachs
opinion carefully and in its entirety.
47
<PAGE>
In connection with its opinion, Goldman Sachs reviewed:
. the merger agreement;
. FlashNet's registration statement on Form S-1 relating to its initial
public offering, including the prospectus dated March 16, 1999 contained
in its registration statement;
. Prodigy's registration statement on Form S-1 relating to its initial
public offering, including the prospectus dated February 10, 1999
contained in its registration statement;
. the annual report on Form 10-K of Prodigy for the period ended December
31, 1998;
the quarterly reports on Form 10-Q of FlashNet;
. the quarterly reports on Form 10-Q of Prodigy;
. a number of other communications from FlashNet and Prodigy to their
respective shareholders;
. the investment, issuance, contribution and assumption agreement, dated
as of November 19, 1999, by and among SBC, an SBC subsidiary, Prodigy, a
Prodigy subsidiary and the operating partnership;
. the strategic and marketing agreement, dated as of November 19, 1999, by
and among SBC, an SBC subsidiary, Prodigy and the operating partnership;
. a number of internal financial analyses and forecasts for FlashNet and
Prodigy prepared by their respective managements; and
. a number of internal financial analyses and forecasts for the Internet
assets of SBC involved in the SBC transaction and the operating
partnership prepared by the management of Prodigy.
Goldman Sachs also held discussions with members of the senior managements of
FlashNet and Prodigy regarding the strategic rationale for, and the potential
benefits of, the merger and the past and current business operations, financial
condition and future prospects of their respective companies, including
FlashNet's recent inability to obtain additional financing necessary to achieve
continued revenue and subscriber growth on a standalone basis. In addition,
Goldman Sachs held discussions with members of senior management of Prodigy
regarding their assessment of the strategic rationale for, and the potential
benefits of, the SBC transaction and the past and current operations, financial
condition and future prospects of the Internet assets of SBC involved in the
SBC transaction. Goldman Sachs reviewed the reported price and trading activity
for FlashNet common stock and Prodigy common stock, which like many Internet
related stocks have been and are likely to continue to be subject to
significant short term price and trading volatility, compared some financial
and stock market information for FlashNet and Prodigy with similar information
for several other companies with publicly traded securities, and reviewed the
financial terms of other recent business combinations in the Internet service
provider industry specifically and in other industries generally. Goldman Sachs
also performed other studies and analyses which it considered appropriate.
Goldman Sachs assumed the accuracy and completeness of all of the financial
and other information reviewed by it for purposes of rendering its opinion. In
that regard, Goldman Sachs assumed, with the FlashNet board of directors'
consent, that the financial forecasts prepared by the managements of FlashNet
and Prodigy were reasonably prepared on a basis reflecting the best currently
available judgments and estimates of FlashNet and Prodigy. Goldman Sachs also
took into account, with the FlashNet board of directors' consent, the risks
inherent in FlashNet's standalone business plans, including the view of
management of FlashNet that FlashNet would be unable to obtain, on reasonable
terms, financing necessary to achieve continued revenue and subscriber growth
on a standalone basis. Goldman Sachs did not make an independent evaluation or
appraisal of the assets and liabilities of FlashNet or Prodigy or any of their
subsidiaries or the Internet assets of SBC involved in the SBC transaction nor
was it furnished with any evaluation or appraisal. Goldman Sachs provided its
opinion for the information and assistance of the FlashNet board of directors.
The Goldman Sachs opinion is not a recommendation as to how any FlashNet
shareholder should vote.
Goldman Sachs, as part of its investment banking business, is continually
engaged in the valuation of businesses and their securities in connection with
mergers and acquisitions, negotiated underwritings,
48
<PAGE>
competitive biddings, secondary distributions of listed and unlisted
securities, private placements and valuations for estate, corporate and other
purposes. Goldman Sachs is familiar with FlashNet, having extended a $5,000,000
loan to FlashNet on January 15, 1999 through its affiliate, Goldman Sachs
Credit Partners L.P., which loan was repaid in connection with FlashNet's
initial public offering, and having acted as its financial advisor in
connection with, and having participated in some of the negotiations leading
to, the merger agreement.
FlashNet engaged Goldman Sachs as financial advisor in connection with the
possible sale of all or a portion of FlashNet to Prodigy. FlashNet also
retained Goldman Sachs Real Estate (Texas) Inc., a licensed real estate broker
under the laws of the State of Texas, to provide services in the event the
transaction had been structured as an asset or other transfer covered by the
Texas Real Estate License Act. A fee of 1.125% of the aggregate consideration
paid by Prodigy in the merger, subject to a minimum fee of $4,500,000, is
payable on completion of the merger. In calculating the fee payable to Goldman
Sachs, debt of FlashNet prior to the merger is included in aggregate
consideration. In addition, for purposes of determining the aggregate
consideration, the value of Prodigy common stock is based on the average
closing price of Prodigy common stock over the five days prior to the
completion of the merger. Based on the current debt of FlashNet and the recent
closing prices of Prodigy common stock, the minimum fee would apply. The actual
fee payable to Goldman Sachs may be more. In addition, FlashNet has agreed to
reimburse Goldman Sachs for its reasonable out-of-pocket expenses, including
the fees and expenses of Goldman Sachs' attorneys, and to indemnify Goldman
Sachs against various liabilities to the full extent of the law, including
liabilities under the federal securities laws.
SBC engaged Goldman Sachs as financial advisor in connection with the SBC
transaction. The engagement with SBC is on customary terms and pursuant to the
engagement, Goldman Sachs will receive customary fees. Although no particular
conflict has been identified, the representation of both SBC and FlashNet by
Goldman Sachs could result in a conflict of interest. Goldman Sachs employs
internal compliance procedures to address potential conflicts of interest.
Financial analyses used by Goldman Sachs. The following is a summary of the
material financial analyses used by Goldman Sachs in connection with providing
its opinion to the FlashNet board of directors. Goldman Sachs performed some of
its analyses by using two separate scenarios for FlashNet's standalone
financial projections, with financing and without financing. FlashNet
management provided the without financing scenario. This scenario is intended
to reflect anticipated results assuming that FlashNet is unable to obtain
financing on commercially reasonable terms, thus forcing FlashNet to operate
relying on existing limited cash reserves and negatively affecting FlashNet's
ability to market itself to additional potential customers. FlashNet management
also provided the with financing scenario. This scenario is intended to reflect
anticipated results assuming that FlashNet is able to raise $30 million on
terms similar to previous FlashNet financings, thus allowing sustained
marketing expenditures to further grow the subscriber base. As described above,
Goldman Sachs held discussions with members of the senior management of
FlashNet regarding the financial condition and future prospects of FlashNet,
including its recent inability to obtain additional financing necessary to
achieve continued revenue and subscriber growth on a standalone basis. Goldman
Sachs also took into account, with the FlashNet board of directors' consent,
the risks inherent in FlashNet's standalone business plans, including the view
of management of FlashNet that FlashNet would be unable to obtain, on
reasonable terms, financing necessary to achieve continued revenue and
subscriber growth on a standalone basis. All projections regarding, SBC's
Internet assets involved in the SBC transaction were provided by Prodigy.
Some of the summaries of the financial analyses include information presented
in tabular format. The tables must be read together with the text accompanying
each summary.
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<PAGE>
Historical Stock Trading Analysis. Goldman Sachs compared the closing trading
prices for FlashNet common stock with the movements in the share prices of
America Online, Earthlink, MindSpring, Prodigy, OneMain.com and Internet
America from March 16, 1999 through December 16, 1999. Goldman Sachs noted that
while the share prices of the companies had declined in general, the leading
internet service providers showed less price decline and the stock price of the
largest internet service provider, America Online, increased. Goldman Sachs
also reviewed the relationship between movements of FlashNet common stock and
Prodigy common stock and movements in a composite index composed of the
following companies: America Online; Earthlink; Internet America; and
MindSpring. Goldman Sachs also noted that FlashNet's stock price has declined
more than its peers and noted that this might be attributable to any number of
factors including slowing subscriber growth for FlashNet, FlashNet's capital
constraints, selling pressure on FlashNet stock as a result of the expiration
of lock-up periods and, since November 5, 1999, the announcement of the merger.
Exchange ratio analysis. Goldman Sachs calculated the average of the
quotients of the closing prices per share of Prodigy common stock and the
closing prices per share of FlashNet common stock for the one month, three
month and six month periods ended November 5, 1999, the last full trading day
prior to announcement of the merger. The analysis indicated that for those
periods the average exchange ratios were .37, .60, and .77, respectively,
compared to .40 as of November 5, 1999 and .32 as of December 16, 1999.
Selected companies analysis. Goldman Sachs reviewed and compared publicly
available financial information relating to FlashNet to corresponding publicly
available financial information, ratios and public market multiples for nine
publicly traded corporations: America Online; Earthlink; Internet America; Juno
Online Services, Inc.; MindSpring; OneMain.com; Prodigy; NetZero; and
Voyager.net. The analysis of the selected companies were calculated using
closing stock prices as of December 16, 1999 and other publicly available
information, including estimates as reported by recent Wall Street research
reports and the Institutional Brokers Estimate System referred to in the table
below as "street estimates." Goldman Sachs also calculated these multiples and
ratios for FlashNet using the closing stock price as of October 25, 1999, and
using FlashNet management's projections and the closing stock price as of
December 16, 1999. None of the selected companies is directly comparable to
FlashNet.
The following table presents the ranges for FlashNet, Prodigy and the
selected companies:
<TABLE>
<CAPTION>
FlashNet--
FlashNet-- based on
Ranges for based on actual
selected FlashNet-- management price
companies based on estimates-- as of
(including street without October 25,
Prodigy) Prodigy estimates financing 1999
--------------- ------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Closing price December
16, 1999, except in the
last column, as a
percentage of 52 week
high................... 15% to 98% 40% 13% N.A. 14%
Enterprise value as a
multiple of 1999
revenue................ 3.8x to 37.6x 7.3x 1.9x 2.0x 2.1x
Enterprise value as a
multiple of latest
quarter annualized
revenue................ 3.0x to 78.5x 6.9x 1.6x N.A. 1.8x
Enterprise value divided
by 1999 Q2
subscribers............ $850 to $10,659 $1,707 $370 N.A. $408
Enterprise value divided
by 1999 Q3
subscribers............ $678 to $10,066 $1,059 $333 N.A. $368
1999 revenue divided by
1999 Q3 subscribers.... $63 to $268 $146 $172 $165 N.A.
IBES long-term projected
growth rates........... 35% to 118% 50% N.A. N.A. N.A.
</TABLE>
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<PAGE>
Selected transactions analysis. Goldman Sachs reviewed and analyzed selected
transactions involving other companies in the Internet service provider
industry that it deemed relevant, MindSpring/NETCOM On-Line Communications
Services, Incorporated, ICG Communications Inc./NETCOM, OneMain.com/various
targets, RCN Corporation/Erols Internet Inc., MindSpring/Spry, Inc.,
Prodigy/SBC, EarthLink/MindSpring, Verio Inc./TABNet, and Verio/Hiway
Technologies Inc. No company or transaction used in the analysis of the
selected transactions is directly comparable to FlashNet and Prodigy or the
merger. The number of subscribers for FlashNet used as a comparison was
244,000. Because no transaction reviewed was identical to the merger, an
assessment of the results of the following analysis involves considerations and
judgments concerning differences in financial and operating characteristics and
other factors.
The tables below summarize the results of this analysis.
<TABLE>
<CAPTION>
Transactions where
subscribers were
primarily consumers
--------------------
<S> <C>
Range of numbers of subscribers acquired................... 130,000 to 1,174,000
Range of enterprise value per subscriber acquired.......... $246 to $2,390
</TABLE>
<TABLE>
<CAPTION>
Transactions
where
subscribers were
primarily
businesses
----------------
<S> <C>
Range of numbers of subscribers acquired...................... 20,000 to 90,000
Range of enterprise value per subscriber acquired............. $3,650 to $4,435
</TABLE>
Contribution analysis. Goldman Sachs reviewed selected estimated future
operating and financial information for Prodigy, on a pro-forma basis assuming
completion of, and after giving effect to the SBC transaction, and for FlashNet
for the annual periods from 2000 through 2004. Goldman Sachs based this
information on estimates provided by Prodigy and FlashNet management and
included estimates of numbers of subscribers and revenues. Goldman Sachs then
determined implied exchange ratios based on the relative contributions. This
analysis was performed using the without financing scenario for FlashNet.
Goldman Sachs noted that the implied exchange ratios based on numbers of
subscribers decreased from .44x for the 2000 period to .15x for the 2004
period. Goldman Sachs also noted that the implied exchange ratios based on
revenues decreased from .47x for the 2000 period to .16x for the 2004 period.
The tables below sets forth the results of this analysis.
FlashNet--Without Financing vs. Prodigy after giving effect to the SBC
transaction
<TABLE>
<S> <C>
Implied Exchange Ratios based on Subscribers..................... 0.15x to 0.44x
Implied Exchange Ratios based on Revenue......................... 0.16x to 0.47x
</TABLE>
Goldman Sachs also reviewed selected historical and estimated future
operating and financial information, including numbers of subscribers and
revenues, for FlashNet and Prodigy, without assuming the completion of the SBC
transaction, based on actual results provided by their respective managements
for 1998 and the first three quarters of 1999 and on their respective
managements' estimates for the annual periods from 1999 through 2004. Goldman
Sachs then determined implied exchange ratios based on the relative
contributions. In the without financing scenario, Goldman Sachs noted that the
implied exchange ratios based on numbers of subscribers had decreased from
1.54x in 1998 to 1.46x, 1.24x and .86x for the first, second and third quarters
of 1999, respectively. Goldman Sachs also noted that the implied exchange
ratios based on numbers of subscribers decreased from .63x for the 1999 period
to .17x for the 2004 period. In addition, Goldman Sachs noted that the implied
exchange ratios based on revenues decreased from .96x for the 1999 period to
.25x for the 2004 period. In the with financing scenario, Goldman Sachs noted
that the implied exchange ratios based on numbers of subscribers had decreased
from 1.54x in 1998 to 1.46x, 1.24x and .86x for the first, second and third
quarters of 1999, respectively. Goldman Sachs also noted that the implied
exchange ratios based on numbers of subscribers decreased from .67x for the
1999 period to .36x for the 2004 period. In addition,
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<PAGE>
Goldman Sachs noted that the implied exchange ratios based on revenues
decreased from .97x for the 1999 period to .54x for the 2004 period. Goldman
Sachs performed these analyses using the with financing and without financing
scenarios for FlashNet.
The tables below sets forth the results of these analyses.
FlashNet--Without Financing vs. Prodigy
<TABLE>
<S> <C>
Implied Exchange Ratios based on Subscribers..................... 0.17x to 1.54x
Implied Exchange Ratios based on Revenue......................... 0.25x to 1.16x
</TABLE>
FlashNet--With Financing vs. Prodigy
<TABLE>
<S> <C>
Implied Exchange Ratios based on Subscribers..................... 0.36x to 1.54x
Implied Exchange Ratios based on Revenue......................... 0.54x to 1.16x
</TABLE>
Discounted cash flow analysis. Goldman Sachs performed a discounted cash flow
analysis of FlashNet alone as compared to Prodigy, on a pro-forma basis
assuming completion of, and after giving effect to, the SBC transaction and as
compared to FlashNet, for the annual periods form 2000 through 2004. Goldman
Sachs based this analysis on estimates provided by Prodigy and FlashNet
management. Goldman Sachs performed the FlashNet standalone analyses using the
with financing and without financing scenarios. Goldman Sachs performed these
analyses for FlashNet and Prodigy combined only using the without financing
scenario. Goldman Sachs calculated the net present value of various free cash
flows for the annual periods 2000 through 2004 using various discount rates.
Goldman Sachs calculated implied per share values in the year 2004 based on
multiples ranging from 8.0x to 12.0x of earnings before interest, tax,
depreciation and amortization and then discounted these terminal values using
the same discount rates. The discount rates Goldman Sachs used ranged from 14%
to 18% for FlashNet alone in the without financing scenario and 18% to 22% in
the with financing scenario. The discount rates Goldman Sachs used ranged from
12% to 16% for FlashNet and Prodigy combined.
The tables below sets forth the results of these analyses.
<TABLE>
<S> <C>
FlashNet standalone With Financing
Using discount rates from 18% to 22% and terminal multiples of 2004 earnings
before interest, tax, depreciation and amortization ranging from 8.0x to
12.0x
Implied enterprise value per 2004 subscriber................. $657 to $986
Implied per share value...................................... $7.63 to $11.76
FlashNet standalone Without Financing
Using discount rates from 14% to 18% and terminal multiples of 2004 earnings
before interest, tax, depreciation and amortization ranging from 8.0x to
12.0x
Implied enterprise value per 2004 subscriber................. $343 to $514
Implied per share value...................................... $2.65 to $3.88
FlashNet without financing and Prodigy after giving effect to
the SBC transaction
Using discount rates from 12% to 16% and terminal multiples of 2004 earnings
before interest, tax, depreciation and amortization ranging from 8.0x to
12.0x
Implied enterprise value per 2004 subscriber................. $522 to $728
Implied value per FlashNet share............................. $7.43 to $12.21
</TABLE>
Goldman Sachs also performed a discounted cash flow analysis of FlashNet and
Prodigy, without assuming the completion of the SBC transaction, combined using
projections provided by the managements of FlashNet and Prodigy for the years
1999 through 2004. These analyses were performed for FlashNet and Prodigy
combined only using the without financing scenario. Goldman Sachs calculated
the net present value of various free cash
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<PAGE>
flows for the years 1999 through 2004 using various discount rates. Goldman
Sachs calculated implied per share values in the year 2004 based on multiples
ranging from 8.0x to 12.0x of earnings before interest, tax, depreciation and
amortization and then discounted these terminal values using the same discount
rates. The discount rates used by Goldman Sachs ranged from 12% to 16% for
FlashNet and Prodigy combined.
The tables below sets forth the results of these analyses.
<TABLE>
<S> <C>
FlashNet--Without Financing and Prodigy Combined
Using discount rates from 12% to 16% and terminal multiples of 2004 earnings
before interest, tax, depreciation and amortization ranging from 8.0x to
12.0x
Implied enterprise value per 2004 subscriber.................. $452 to $678
Implied value per FlashNet share.............................. $5.83 to $9.37
</TABLE>
Future value analysis. Goldman Sachs performed an analysis in which it
calculated the implied present value per share of FlashNet alone as compared
Prodigy, on a pro-forma basis assuming completion of, and after giving effect
to, the SBC transaction and as compared to FlashNet, for the annual periods
from 2000 through 2004. Goldman Sachs based this analysis on estimates provided
by Prodigy and FlashNet management. Goldman Sachs calculated the net present
value of share prices determined by multiplying the projected number of
subscribers by fixed multiples of enterprise value per subscriber. The fixed
multiple used for FlashNet alone was $333 enterprise value per subscriber,
which is the enterprise value of FlashNet on December 16, 1999 divided by the
number of FlashNet subscribers at the end of the third quarter of 1999. The
fixed multiples used for FlashNet and Prodigy combined were $1,059 enterprise
value per subscriber, which is the enterprise value of Prodigy on December 16,
1999 divided by the number of Prodigy subscribers at the end of the third
quarter of 1999, and $1,007 enterprise value per subscriber, which is the
weighted average of $333 and $1,059 based on the relative market
capitalizations of FlashNet and Prodigy. This analysis was performed using the
without financing scenario described above. The discount rates used by Goldman
Sachs were 16% for FlashNet alone and 14% for FlashNet and Prodigy combined.
The table below sets forth the results of these analyses.
<TABLE>
<CAPTION>
Implied Present
Value
Per Share
------------------
1999 2000 2001
----- ----- ------
<S> <C> <C> <C>
FlashNet standalone without financing
Using a 16% discount rate.................................. $5.83 $4.32 $ 3.46
FlashNet without financing and Prodigy after giving effect
to the SBC transaction
Using a 14% discount rate and a multiple of $1,059
enterprise value per subscriber........................... N.A. $8.87 $10.45
Using a 14% discount rate and a multiple of $1,007
enterprise value per subscriber........................... N.A. $8.43 $ 9.94
</TABLE>
Goldman Sachs also performed an analysis in which it calculated the implied
present value per share of FlashNet alone as compared to FlashNet and Prodigy,
without assuming the completion of the SBC transaction, combined using
projections provided by the managements of FlashNet and Prodigy for the years
1999 through 2001. Goldman Sachs calculated the net present value of share
prices determined by multiplying the projected number of subscribers by fixed
multiples of enterprise value per subscriber. The fixed multiples used were the
same as in the prior analyses. Goldman Sachs performed these analyses using the
with financing and without financing scenarios for FlashNet. The discount rates
Goldman Sachs used were 16% for FlashNet alone and 14% for FlashNet and Prodigy
combined.
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<PAGE>
The table below sets forth the results of these analyses.
<TABLE>
<CAPTION>
Implied Present
Value Per Share
-------------------
1999 2000 2001
----- ------ ------
<S> <C> <C> <C>
FlashNet standalone
Without financing......................................... $5.83 $ 4.32 $ 3.46
With financing............................................ $6.10 $ 5.79 $ 5.35
FlashNet and Prodigy combined
Without financing and using a multiple of $1,059
enterprise value per subscriber.......................... $9.05 $10.03 $10.97
Without financing and using a multiple of $1,007
enterprise value per subscriber.......................... $8.60 $ 9.53 $10.43
With financing and using a multiple of $1,059 enterprise
value per subscriber..................................... $9.11 $10.39 $11.45
With financing and using a multiple of $1,007 enterprise
value per subscriber..................................... $8.66 $ 9.88 $10.89
</TABLE>
Analysis at various prices. Goldman Sachs assumed, for purposes of
illustration, various premiums and discounts to Prodigy's December 16, 1999
stock price and calculated the implied premium to the FlashNet stock price as
of October 25, 1999 and as of December 16, 1999, based on the exchange ratio in
the merger.
The table below sets forth the results of this analysis.
<TABLE>
<CAPTION>
Assumed Premium (Discount)
to Prodigy 12/16/99 Stock
Price (20)% (10)% 0% 10% 20% 30%
- -------------------------- ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
. Resulting Prodigy stock
price..................... $16.20 $18.23 $20.25 $22.28 $24.30 $26.33
. Implied premium to
FlashNet stock price as of
10/25/99.................. (19.7)% (9.7)% 0.4% 10.4% 20.4% 30.5%
. Implied premium to
FlashNet stock price as of
12/16/99.................. (13.2)% (2.3)% 8.5% 19.4% 30.2% 41.1%
</TABLE>
Goldman Sachs also calculated the implied enterprise value of FlashNet as a
multiple of subscribers and as a multiple of revenues, using the same premiums
and discounts to Prodigy's stock price as of December 16, 1999. These
calculations were for 1998 and the first through third quarters of 1999 using
actual results provided by the management of FlashNet and for the years 1999
through 2001 using projections provided by the management of FlashNet. Goldman
Sachs performed these analyses using the with financing and without financing
scenarios for FlashNet for the projected periods.
The table below sets forth the results of this analysis.
<TABLE>
<CAPTION>
Premium to Prodigy stock
price (20)% (10)% 0% 10% 20% 30%
- ------------------------ ------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
. Resulting Prodigy
stock prices.......... $16.20 $18.23 $20.25 $22.28 $24.30 $26.33
. With financing--
Implied enterprise
value as a multiple of
subscribers........... $223 to $372 $264 to $440 $304 to $509 $345 to $577 $386 to $645 $427 to $713
. Without financing--
Implied enterprise
value as a multiple of
subscribers........... $263 to $393 $312 to $465 $360 to $537 $408 to $609 $457 to $681 $505 to $753
. With financing--
Implied enterprise
value as a multiple of
revenue............... 0.9x to 2.4x 1.1x to 2.8x 1.3x to 3.3x 1.4x to 3.7x 1.6x to 4.1x 1.8x to 4.6x
. Without financing--
Implied enterprise
value as a multiple of
revenue............... 1.3x to 2.4x 1.5x to 2.8x 1.7x to 3.3x 2.0x to 3.7x 2.2x to 4.1x 2.4x to 4.6x
</TABLE>
In addition, Goldman Sachs calculated the implied enterprise value of
FlashNet as a multiple of subscribers and as a multiple of revenues, using the
same premiums and discounts to Prodigy's stock price as of December 16, 1999.
These calculations were for the years 2000 through 2004 using projections
provided by the managements of FlashNet and Prodigy. Goldman Sachs performed
these analyses using the without financing scenario.
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<PAGE>
The table below sets forth the results of this analysis.
<TABLE>
<CAPTION>
Premium to Prodigy stock
price (20)% (10)% 0% 10% 20% 30%
- ------------------------ ------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
. Resulting Prodigy
stock prices.......... $16.20 $18.23 $20.25 $22.28 $24.30 $26.33
. Implied enterprise
value as a multiple of
subscribers........... $232 to $570 $263 to $644 $293 to $719 $324 to $794 $354 to $869 $385 to $944
. Implied enterprise
value as a multiple of
revenue............... 0.8x to 2.9x 1.0x to 3.3x 1.1x to 3.6x 1.2x to 4.0x 1.3x to 4.4x 1.4x to 4.8x
</TABLE>
The preparation of a fairness opinion is a complex process and is not
necessarily susceptible to partial analysis or summary description. Selecting
portions of the analyses or of the summary set forth above, without considering
the analyses as a whole, could create an incomplete view of the processes
underlying Goldman Sachs' opinion. In arriving at its fairness determination,
Goldman Sachs considered the results of each of these analyses in their
totality. No company or transaction used in the above analyses as a comparison
is directly comparable to FlashNet, Prodigy or the merger. Goldman Sachs
prepared the analyses solely for the purpose of providing its opinion to the
FlashNet board of directors as to the fairness from a financial point of view
of the exchange ratio. The analyses are not appraisals and do not reflect
necessarily the prices at which businesses or securities actually may be sold.
Analyses based on forecasts of future results are not necessarily indicative of
actual future results, which may be significantly more or less favorable than
suggested by those analyses. Because these analyses are inherently subject to
uncertainty, being based on numerous factors or events beyond the control of
the parties or their respective advisors, none of FlashNet, Prodigy, Goldman
Sachs or any other person assumes responsibility if future results are
materially different from those forecast. As described above, Goldman Sachs'
opinion to the FlashNet board of directors was one of many factors taken into
consideration by the FlashNet board of directors in making its determination to
approve the merger agreement. This summary is not a complete description of the
analysis performed by Goldman Sachs. You should read the entire opinion of
Goldman Sachs in Annex A.
Interests of Executive Officers and Directors of FlashNet in the Merger
In considering the recommendation of the FlashNet board of directors with
respect to the merger, you should be aware that some executive officers and
directors of FlashNet have interests in the merger that are in addition to your
interests as a shareholder of FlashNet generally. The FlashNet board of
directors was aware of these potential conflicts and considered them in
approving the merger.
Stock Ownership and Voting
Each of the executive officers and directors of FlashNet and their respective
affiliates and one former executive officer who own FlashNet common stock have
entered into a stockholder agreement with Prodigy relating to the proposed
merger. As of the record date for the special meeting, these parties
collectively owned 4,014,679 shares of the outstanding shares of FlashNet
common stock, or approximately 28% of the outstanding shares of FlashNet common
stock. In the stockholder agreement, these parties agreed to vote all of the
shares of FlashNet common stock over which they exercise voting control in
favor of the merger against any competing merger proposal.
Acceleration of Stock Options
Executive officers and directors of FlashNet who hold options to purchase
FlashNet common stock will have their options converted to options to acquire
Prodigy common stock in connection with the merger. All unvested options issued
under FlashNet's 1997 stock incentive plan, including the options of executive
officers and directors, have fully vested as a result of notice given to the
option holders of the pending merger, including:
. options to purchase 270,868 shares of FlashNet common stock held by
Scott Leslie, the president, chief executive officer and a director of
FlashNet;
. options to purchase 15,000 shares of FlashNet common stock held by Lee
Thurburn, the chairman of the board of FlashNet;
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<PAGE>
. options to purchase 202,993 shares of FlashNet common stock held by
Andrew Jent, an executive vice president and the chief financial officer
of FlashNet;
. options to purchase 40,980 shares of FlashNet common stock held by James
Francis, a director of FlashNet;
. options to purchase 30,980 shares of FlashNet common stock held by Kevin
Stadtler, a director of FlashNet; and
. options to purchase 15,000 shares of FlashNet common stock held by John
Kleinheinz, a director of FlashNet.
Change in Control Agreements
Mr. Leslie and Mr. Jent each have agreements with FlashNet that require
FlashNet to pay them 12 months of salary if there is a material change in the
nature or scope of their duties of employment after a change in control.
Prodigy has reached agreements in principle with Mr. Leslie and Mr. Jent
modifying the severance arrangements for them. Under these agreements, each of
Mr. Leslie and Mr. Jent will agree to continue their full-time employment with
FlashNet for three months after the effective date of the merger and will
continue to work part-time on a consulting basis for another three months at
their current salary and bonus levels. After the expiration of their
employment, Mr. Leslie will receive 18 monthly severance payments of $18,750
and Mr. Jent will receive twelve monthly severance payments of $15,833. Each of
them also will receive fully-paid health care benefits through the end of their
respective severance periods.
Ownership of Prodigy Common Stock
On November 5, 1999, the date of the approval of the merger by the FlashNet
board of directors, Mr. Thurburn owned 1,000 shares of Prodigy common stock.
Mr. Thurburn continues to own these shares. In addition, subsequent to November
5, 1999, Global Undervalued Securities Fund, L.P., which is controlled by Mr.
Kleinheinz, acquired shares of Prodigy common stock. Global Undervalued
Securities Fund owned 87,800 shares of Prodigy common stock on December 20,
1999 and 266,700 shares of Prodigy common stock on April 18, 2000.
Indemnification Arrangements
Under the merger agreement, Prodigy has agreed, for a period of six years
after the effective date of the merger, to cause FlashNet, as the surviving
corporation in the merger, to indemnify each present and former officer and
director of FlashNet against liabilities incurred by any of them to the same
extent that the indemnification obligation existed on the date of the merger
agreement under FlashNet's restated articles of incorporation, its bylaws, the
Texas Business Corporations Act, any indemnification agreement between FlashNet
or its officer or director or otherwise.
Treatment of FlashNet Common Stock
In the merger, each share of FlashNet common stock will be exchanged for 0.35
share of Prodigy common stock.
Holders of FlashNet common stock should not send in any certificates
representing FlashNet common stock. Following the effective time of the merger,
holders of FlashNet common stock will receive instructions for the surrender
and exchange of their stock certificates.
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<PAGE>
Accounting Treatment of the Merger
Under Accounting Principles Board Opinion No. 16, the accounting for the
acquisition of FlashNet will follow the purchase method of accounting, where
the assets acquired and liabilities assumed are recorded at fair value by the
acquiring company. Any excess of purchase price over the fair market value of
the tangible and intangible assets acquired will be treated as goodwill.
Regulatory Approvals
Under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, Prodigy may
not complete the acquisition of shares of FlashNet common stock in the merger
until notifications have been furnished to the Federal Trade Commission and the
Antitrust Division of the Department of Justice and the required waiting period
has been satisfied. Prodigy and FlashNet each filed a pre-merger notification
and report form with the FTC and the Antitrust Division on December 15, 1999.
On January 14, 2000, the applicable waiting period under the Hart-Scott-Rodino
Act expired without comment from the FTC or the Antitrust Division. Therefore,
the merger is deemed to have received antitrust approval and may be
consummated, pending compliance with the other closing conditions.
At any time before the effective time of the merger, the Antitrust Division,
the FTC or a private person or entity could seek under antitrust laws, among
other things, to enjoin the merger and any time after the effective time of the
merger, to cause Prodigy to divest itself, in whole or in part, of the
surviving corporation of the merger or of businesses conducted by the surviving
corporation of the merger. There can be no assurance that a challenge to the
merger will not be made or that, if a challenge is made, Prodigy will prevail.
The obligations of Prodigy and FlashNet to complete the merger are subject to
the condition that any applicable waiting period under the Hart-Scott-Rodino
Act shall have expired without action by the Antitrust Division or the FTC to
prevent completion of the merger. See "The Merger Agreement--Conditions to
Obligations to Complete the Merger."
Material United States Federal Income Tax Considerations
The discussion below summarizes the material United States federal income tax
considerations generally applicable to United States holders of FlashNet common
stock who, pursuant to the merger, exchange their FlashNet common stock solely
for Prodigy common stock. Completion of the merger is conditioned on Prodigy's
receipt of an opinion from Hale and Dorr LLP or Brobeck, Phleger & Harrison
LLP, if Hale and Dorr does not provide the opinion, and FlashNet's receipt of
an opinion from Brobeck or Hale and Dorr, if Brobeck does not provide the
opinion, to the effect that the merger will qualify for federal income tax
purposes as a tax-free reorganization within the meaning of Section 368(a) of
the Internal Revenue Code. FlashNet will not waive this condition without
resoliciting shareholder approval. The discussion below assumes that the merger
will be treated in accordance with the opinions of Hale and Dorr and Brobeck
described in the preceding sentence which are included as exhibits 8.1 and 8.2
of the registration statement of which this proxy statement/prospectus forms a
part.
The discussion below and the opinions of Hale and Dorr and Brobeck are based
on current provisions of the Internal Revenue Code, currently applicable United
States Treasury regulations promulgated thereunder, and judicial and
administrative decisions and rulings. The opinions of Hale and Dorr and Brobeck
are based on the facts, representations and assumptions set forth or referred
to in the opinions, including representations contained in certificates
executed by officers of Prodigy and FlashNet. The opinions are not binding on
the Internal Revenue Service or the courts, and there can be no assurance that
the Internal Revenue Service or the courts will not take a contrary view. No
ruling from the Internal Revenue Service has been or will be sought. Future
legislative, judicial or administrative changes or interpretations could alter
the statements and conclusions in this document, and these changes or
interpretations could be retroactive and could affect the tax consequences of
the merger to Prodigy, FlashNet and the shareholders of FlashNet.
The discussion below does not purport to deal with all aspects of federal
income taxation that may affect particular shareholders in light of their
individual circumstances, and are not intended for shareholders subject
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<PAGE>
to special treatment under federal income tax law. Shareholders subject to
special treatment include insurance companies, tax-exempt organizations,
financial institutions, broker-dealers, foreign persons, shareholders who hold
their stock as part of a hedge, appreciated financial position, straddle or
conversion transaction, shareholders who do not hold their stock as capital
assets and shareholders who have acquired their stock by exercising employee
options or otherwise as compensation. In addition, the discussion below and the
opinions do not consider the effect of any applicable state, local or foreign
tax laws.
Holders of FlashNet common stock are urged to consult their tax advisors as
to the particular tax consequences to them as a result of the merger, including
the applicability and effect of any state, local or foreign tax laws, and of
changes in applicable tax laws.
In the opinion of Hale and Dorr, counsel to Prodigy, and in the opinion of
Brobeck counsel to FlashNet, the merger will constitute a reorganization within
the meaning of Section 368(a) of the Internal Revenue Code. Thus, the following
tax consequences will result:
. No gain or loss will be recognized by Prodigy, FlashNet or the
transitory subsidiary solely as a result of the merger.
. No gain or loss will be recognized by the holders of FlashNet common
stock on the receipt of Prodigy common stock solely in exchange for
FlashNet common stock in the merger, except to the extent of cash
received in lieu of fractional shares.
. Cash payments received by holders of FlashNet common stock in lieu of a
fractional share will be treated as capital gain or loss measured by the
difference between the cash payment received and the portion of the tax
basis in the shares of FlashNet common stock surrendered that is
allocable to the fractional share. Any gain or loss will be long-term
capital gain or loss if the fractional share of Prodigy common stock has
been held for more than one year at the effective time of the merger.
. FlashNet shareholders' aggregate tax basis of the Prodigy common stock
in the merger, including any fractional share of Prodigy common stock
not actually received, will be the same as the aggregate tax basis of
the FlashNet common stock surrendered in exchange.
. The holding period of the Prodigy common stock received by each FlashNet
shareholder in the merger will include the holding period for the
FlashNet common stock surrendered in exchange, provided that the
FlashNet common stock surrendered is held as a capital asset at the
effective time of the merger.
A successful Internal Revenue Service challenge to the "reorganization"
status of the merger would result in a FlashNet shareholder recognizing gain or
loss with respect to each share of FlashNet common stock surrendered in the
merger equal to the difference between the FlashNet shareholder's basis in the
share and the fair market value, as of the effective time of the merger, of the
Prodigy common stock received in exchange. In the event of a successful
challenge, a FlashNet shareholder's aggregate tax basis in the Prodigy common
stock received would equal its fair market value, and the FlashNet
shareholder's holding period for the stock would begin the day after the
merger.
Resales of Prodigy Common Stock Issued in Connection with the Merger; Affiliate
Agreements
Prodigy common stock issued in connection with the merger will be freely
transferable, except that shares of Prodigy common stock received by persons
who are deemed to be "affiliates," as the term is defined by Rule 144 under the
Securities Act, of FlashNet at the effective time of the merger may be resold
by them only in transactions permitted by the resale provisions of Rule 145
under the Securities Act or as otherwise permitted under the Securities Act.
Each executive officer and director and those who may be an affiliate of
FlashNet has executed a written affiliate agreement providing, among other
things, that the officer, director or affiliate will not offer, sell, transfer
or otherwise dispose of any of the shares of Prodigy common stock obtained as a
result of the merger except in compliance with the Securities Act and the
related rules and regulations.
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<PAGE>
No Appraisal Rights
Appraisal rights under the Texas Business Corporations Act are not available
to shareholders of a Texas corporation if:
. the securities of the corporation are listed on a national securities
exchange or designated as a national market system security on an
interdealer quotation system by the National Association of Securities
Dealers; and
. the shareholders of the corporation are not required to accept in
exchange for their stock anything other than stock in another
corporation listed on a national securities exchange or designated as a
national market system security on an interdealer quotation system by
the NASD and cash in lieu of fractional shares.
FlashNet shareholders will not have appraisal rights under the Texas Business
Corporations Act with respect to the merger because:
. FlashNet common stock is traded on the Nasdaq National Market;
. FlashNet shareholders are being offered only shares of Prodigy common
stock which is traded on the Nasdaq National Market and cash in lieu of
fractional shares.
Delisting and Deregistration of FlashNet Common Stock Following the Merger
If the merger is completed, FlashNet's common stock will be delisted from the
Nasdaq National Market and will be deregistered under the Securities Exchange
Act of 1934, as amended.
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THE MERGER AGREEMENT
The following is a brief summary of the material provisions of the merger
agreement, stock option agreement and stockholder agreement, copies of which
are attached as Annex B to this proxy statement/prospectus and are incorporated
by reference into this summary. While we believe that the summary covers the
material terms of the merger agreement, this summary may not contain all of the
information that is important to FlashNet shareholders. We urge all FlashNet
shareholders to read the merger agreement, stock option agreement and
stockholder agreement in their entirety for a more complete description of the
terms and conditions of the merger, the option granted to Prodigy and related
matters.
General
Following the adoption of the merger agreement and approval of the merger by
the FlashNet shareholders and the satisfaction or waiver of the other
conditions to the merger, the transitory subsidiary, a wholly owned subsidiary
of Prodigy, will merge into FlashNet. FlashNet will survive the merger as a
wholly owned subsidiary of Prodigy. Immediately thereafter, FlashNet's assets
and liabilities will be transferred to an operating partnership, along with
Prodigy's other assets and liabilities, as part of Prodigy's pending
transaction with SBC described below under "Pending SBC Transaction." If all
conditions to the merger are satisfied or waived, the merger will become
effective at the time of the filing by the surviving corporation of a
certificate of merger with the Secretary of State of the State of Delaware and
articles of merger with the Secretary of State of the State of Texas.
The Exchange Ratio and Treatment of FlashNet Common Stock
At the effective time of the merger, generally, each issued and outstanding
share of FlashNet common stock will be converted into 0.35 share of Prodigy
common stock. However, shares held in the treasury of FlashNet and shares held
by Prodigy or any of its wholly owned subsidiaries, will be canceled without
conversion. Prodigy will adjust the exchange ratio for any stock split, reverse
split, stock dividend, reorganization, recapitalization or other similar change
with respect to Prodigy common stock occurring before the effective time.
Based on the exchange ratio of 0.35 and the number of shares of FlashNet
common stock outstanding on March 31, 2000, a total of approximately 5,000,000
shares of Prodigy common stock will be issued in the merger.
Treatment of FlashNet Stock Options
At the effective time of the merger, FlashNet will terminate all FlashNet
stock options that have exercise prices equal to or higher than the market
price of FlashNet common stock at that time. Prodigy will assume each other
outstanding option to purchase shares of FlashNet common stock, which will have
become fully vested by virtue of the merger, previously granted by FlashNet
under its stock option plans and convert them into options to purchase shares
of Prodigy common stock on the same terms and conditions except for the vesting
schedule. The number of shares of Prodigy common stock issuable on the exercise
of FlashNet stock options assumed by Prodigy in the merger will be adjusted
based on the exchange ratio. Any fractional shares of Prodigy common stock
resulting from the adjustment will be rounded down to the nearest whole number.
The exercise price per share of Prodigy common stock issuable under each
FlashNet stock option will equal the aggregate exercise price of the FlashNet
common stock purchasable under the FlashNet stock option divided by the number
of shares of Prodigy common stock the FlashNet optionholder can purchase based
on the exchange ratio. The exercise price will be rounded up to the nearest
whole cent.
Prodigy will reserve for issuance a sufficient number of shares of its common
stock for delivery if a FlashNet optionholder exercises its options as
described above. Within 10 business days after the effective time of the
merger, Prodigy will file a registration statement on Form S-8 with respect to
the assumed FlashNet stock option. During the period that any options remain
outstanding, Prodigy will use its best efforts to maintain the effectiveness of
any registration statement on Form S-8.
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Treatment of FlashNet Warrants
To the extent it is not exercised prior to the merger, Prodigy will assume
the warrant held by Ascend Communications to purchase shares of FlashNet common
stock and convert it into a warrant to purchase shares of Prodigy common stock
on the same terms and conditions. The number of shares of Prodigy common stock
issuable on the exercise of the FlashNet warrant assumed by Prodigy in the
merger, and the exercise price, will be adjusted based on the exchange ratio.
The warrant currently covers 1,360,000 shares of FlashNet common stock at an
exercise price of $.003 per share. Assuming no portion of the warrant is
exercised prior to closing, after the merger, the warrant will cover 476,000
shares of Prodigy common stock at an exercise price of $.009 per share, and
Prodigy will reserve 476,000 shares of Prodigy common stock for issuance on
exercise of the warrant.
Termination of FlashNet Employee Stock Discount Purchase Plan and 401(k) Plan
As of or prior to the effective time of the merger, FlashNet will terminate
its employee stock discount purchase plan. If requested by Prodigy, FlashNet
will also terminate its 401(k) plan immediately prior to the effective time of
the merger.
Exchange of Certificates
Exchange Agent; Exchange Procedures; No Further Ownership Rights. As soon as
practicable after the effective time of the merger, Prodigy's exchange agent
will mail to each record holder of FlashNet common stock a letter of
transmittal and instructions for surrendering their certificates. Only those
holders who properly surrender their certificates in accordance with the
instructions will receive certificates representing shares of Prodigy common
stock, cash in lieu of any fractional shares of Prodigy common stock and any
dividends or distributions to which they are entitled. The surrendered
certificates representing shares of FlashNet common stock will be canceled.
After the effective time of the merger, under the merger agreement, each
certificate representing shares of FlashNet common stock that have not been
surrendered will only represent the right to receive:
. shares of Prodigy common stock;
. cash in lieu of any fractional shares of Prodigy common stock; and
. dividends or distributions. Following the effective time of the merger,
FlashNet will not register any transfers of shares of FlashNet common
stock on its stock transfer books.
No Fractional Shares. Prodigy will not issue any fractional shares of Prodigy
common stock in the merger. Instead, each holder of shares of FlashNet common
stock exchanged in connection with the merger who would otherwise be entitled
to receive a fraction of a share of Prodigy common stock will receive cash,
without interest, in an amount equal to the product of the fractional share
multiplied by the average closing price per share of Prodigy common stock on
the Nasdaq National Market during the ten consecutive trading days ending on
and including the last trading day immediately prior to the effective time of
the merger. As of the effective time of the merger, Prodigy will deposit with
its designated exchange agent the shares of Prodigy common stock issuable in
connection with the merger and cash in an amount sufficient to cover any
fractional shares.
Distributions With Respect to Unexchanged Shares. No dividends or other
distributions declared or made on or after the effective time of the merger
with respect to shares of Prodigy common stock will be paid to the holder of
any unsurrendered FlashNet certificate with respect to the shares of Prodigy
common stock that the holder is entitled to receive, and no cash payment in
lieu of fractional shares will be paid to the holder until the holder
surrenders its FlashNet certificate. Upon surrender, Prodigy will pay to record
holder of the certificate, without interest, any dividends or distributions
with respect to the shares of Prodigy common stock which have a record date on
or after the closing date of the merger and have become payable between the
effective time of the merger and the time of surrender.
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Lost Certificates. If any certificate representing shares of FlashNet common
stock are lost, stolen or destroyed, a FlashNet shareholder must provide an
appropriate affidavit of that fact. Prodigy may require the FlashNet
shareholder to deliver a bond as indemnity against any claim that may be made
against Prodigy with respect to any certificates alleged to have been lost,
stolen or destroyed.
Holders of FlashNet common stock should not send in their certificates until
they receive a letter of transmittal from the exchange agent.
Representations and Warranties
The merger agreement contains representations and warranties of Prodigy,
FlashNet and the transitory subsidiary. These relate to:
. their organization, existence, good standing, corporate power and
similar corporate matters;
. their capitalization;
. the authorization, execution, delivery, required filings and consents
and performance and the enforceability of the merger agreement and
related matters;
. any filings with the Securities and Exchange Commission;
. their financial statements;
. the absence of changes in their business;
. the absence of conflicts, violations and defaults under their corporate
charters and by-laws and other agreements and documents;
. brokers and related fees;
. litigation; and
. the accuracy of information provided in connection with this proxy
statement/prospectus.
FlashNet also represented and warranted as to:
. required governmental and third-party consents;
. subsidiaries;
. the absence of undisclosed liabilities;
. subscriber information;
. the absence of restrictions on its business activities;
. owned and leased real properties;
. taxes and tax returns;
. employee benefit plans;
. material contracts;
. licenses and permits;
. insurance;
. compliance with laws;
. intellectual property;
. labor matters;
. environmental matters;
. assets;
. customers;
. transactions with affiliates;
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. absence of existing discussions with other parties regarding an
acquisition proposal;
. the actions by its board of directors that make Part Thirteen of the
Texas Business Corporation Act statute inapplicable to this merger;
. year 2000 compliance;
. accounts receivable; and
. opinion of financial advisor.
Covenants of Prodigy and FlashNet
Conduct of FlashNet's Business Prior to the Merger. Except as contemplated by
the merger agreement, FlashNet has agreed that it and its subsidiaries will
carry on their business in the ordinary course in substantially the same manner
as previously conducted. Specifically, FlashNet has agreed that neither it nor
any of its subsidiaries will, without the prior written consent of Prodigy:
. declare, set aside or pay any dividends on or make any other
distributions in respect of its shares of capital stock;
. issue or split, combine or reclassify any of its capital stock or issue
or authorize the issuance of any other securities in substitution of its
shares of capital stock;
. purchase, redeem or otherwise acquire any shares of its capital stock or
rights to acquire these shares;
. issue, deliver, sell, grant, pledge or otherwise dispose of or encumber
any shares of capital stock or other securities, except pursuant to the
exercise of outstanding options or warrants;
. amend its charter or bylaws;
. acquire, either in whole or in part, any business, corporation,
partnership, association, joint venture, limited liability company or
other business organization;
. acquire any assets that are material, in the aggregate, to FlashNet and
any of its subsidiaries, taken as a whole, other than any assets
FlashNet purchases in the ordinary course of business and consistent
with past practice;
. sell, lease, license, pledge, or otherwise dispose of or encumber any
assets or property, other than in the ordinary course of business and
consistent with past practice;
. whether or not in the ordinary course of business or consistent with
past practice, sell or dispose of any assets material to FlashNet and
its subsidiaries, taken as a whole;
. adopt or implement any shareholder rights plan;
. enter into an agreement with respect to any merger, consolidation,
liquidation or business combination, or any acquisition or disposition
of all or substantially all of the assets or securities of FlashNet or
any of its subsidiaries;
. incur any indebtedness for borrowed money other than indebtedness which
existed on the unaudited balance sheet of FlashNet as of September 30,
1999;
. issue or sell any debt securities or warrants or other rights to acquire
any debt securities of FlashNet or any of its subsidiaries, guarantee
any debt securities of another person or enter into any agreement to
maintain any financial statement condition of another person;
. make any loans, advances not in the ordinary course of business and
inconsistent with past practice or capital contributions to, or
investment in, any other person;
. make any capital expenditure in excess of $500,000 in the aggregate for
FlashNet and its subsidiaries, taken as a whole;
. change its accounting methods or assumptions underlying these methods
except as required by generally accepted accounting principles;
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. pay, discharge, settle or satisfy any claim, liability or obligation
other than in the ordinary course of business and consistent with past
practice or as reserved against on FlashNet's consolidated financial
statements included in any reports or forms it had filed with the
Securities and Exchange Commission prior to November 5, 1999;
. waive any material benefits of any confidentiality, standstill or
similar agreements to which FlashNet or any of its subsidiaries is a
party;
. modify, amend or terminate any material contract or agreement or
knowingly waive, release or assign any material rights or claims;
. enter into any material contract or agreement except in the ordinary
course of business and consistent with past practice;
. license any material intellectual property rights to or from any third
party except in the ordinary course of business and consistent with past
practice;
. except as required to comply with applicable law, plans or agreements
existing as of November 5, 1999, take any action with regard to any
plans or agreements related to employee matters, including, adopting or
terminating any employee benefit plan or employment or severance
arrangement, materially increasing the compensation or fringe benefits
of, or pay any bonus to, any director, officer or key employee, or
accelerating the payment or vesting of any compensation or benefits;
. initiate, compromise or settle any material litigation or arbitration
proceeding;
. make or rescind any tax election or settle or compromise any tax
liability;
. close any facility or office;
. invest funds in debt securities or other investments maturing more than
90 days after the date of investment;
. fail to pay accounts payable and other obligations in the ordinary
course of business and consistent with past practice; or
. take or agree to take any action which would result in FlashNet's
representations and warranties being untrue or incorrect in any material
respect or that would result in the conditions of the merger set forth
in the merger agreement not being satisfied in a material way.
Prodigy and FlashNet have each agreed to use reasonable efforts to:
. take all appropriate action to complete the transactions contemplated by
the merger agreement as promptly as practical;
. obtain any consents, licenses, permits, waivers, approvals,
authorizations or orders from governmental entities or other third
parties required in connection with the transactions contemplated by the
merger agreement; and
. make all necessary filings and submissions with respect to the
transactions contemplated by the merger agreement under federal and
state securities laws, antitrust laws and other applicable laws.
Prodigy and FlashNet have also agreed to use reasonable efforts to obtain any
governmental clearances or approvals required under antitrust laws before the
closing of the merger. Prodigy has the right to direct any governmental
proceedings or negotiations relating to those governmental clearances, as long
as its allows FlashNet a reasonable opportunity to participate in the
proceedings. Prodigy is not required either to divest any of its businesses,
product lines or assets or take any other action that could reasonably be
expected to have a material adverse effect on Prodigy or, if the merger is
completed, Prodigy as combined with FlashNet, or to take any action with
respect to government clearances or approvals if the Department of Justice or
the FTC authorizes its staff to seek a preliminary injunction or restraining
order to enjoin completion of the merger.
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FlashNet is Restricted from Trying to Sell to Another Party. FlashNet has
agreed that neither it nor any of its subsidiaries will, directly or indirectly
through their officers, directors, employees, financial advisors,
representatives or agents:
. solicit, initiate, or encourage any proposal that could reasonably be
expected to lead to an alternative transaction;
. engage in discussions or negotiations concerning, or provide any non-
public information relating to, an alternative transaction; or
. agree to or recommend an alternative transaction to the FlashNet
shareholders.
The merger agreement defines an alternative transaction to mean:
. an acquisition by a third party of more than 20% of the outstanding
shares of FlashNet common stock by a tender offer, exchange offer,
merger or similar transaction;
. an acquisition of control by a third party of more than 20% of the fair
market value of all FlashNet's assets; or
. a public announcement by a third party of a proposal, plan, intention or
agreement to do any of the above.
However, FlashNet and the FlashNet board of directors may, if FlashNet has
not breached this covenant:
. furnish non-public information to, or enter into discussions or
negotiations with, a third party in connection with an unsolicited bona
fide written proposal for an alternative transaction or recommend any
unsolicited bona fide written proposal to the FlashNet shareholders, if
and only to the extent that:
. the FlashNet board of directors believes in good faith, after
consultation with its financial advisor, that the alternative
transaction is reasonably capable of being completed on the terms
proposed and constitutes a superior proposal to this merger, and the
FlashNet board of directors determines in good faith after
consultation with outside legal counsel that it must recommend the
proposal to the FlashNet shareholders to comply with applicable
fiduciary duties to shareholders;
. prior to furnishing the non-public information to, or entering into
discussions or negotiations with a third party, that third party
provides to the FlashNet board of directors an executed
confidentiality agreement no less favorable than the confidentiality
agreement between Prodigy and FlashNet; and
. prior to recommending a superior proposal, FlashNet gives Prodigy at
least five business days' prior notice of its intent to recommend
the superior proposal in order to provide Prodigy an opportunity to
make a counterproposal which FlashNet and its advisors must
negotiate in good faith with Prodigy during that period; or
. comply with Rule 14d-9 and Rule 14e-2 promulgated under the Exchange Act
with regard to an alternative transaction.
FlashNet has agreed to notify Prodigy in reasonable detail both orally and in
writing within 24 hours of receipt of any proposal for an alternative
transaction or request for non-public information. FlashNet has agreed to
continue to keep Prodigy informed on a current basis of the status of any
discussions or negotiations and all material terms being discussed or
negotiated.
Director and Officer Indemnification. The merger agreement provides that for
a period of six years after the effective time of the merger, Prodigy will
cause the surviving corporation to honor its obligations to indemnify each
present and former director and officer of FlashNet against any costs or
expenses pertaining to matters existing or occurring at or prior to the
effective time of the merger.
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Conditions to Obligations to Complete the Merger
The obligations of Prodigy and FlashNet to effect the merger are subject to
the satisfaction or waiver of the following conditions:
. the FlashNet shareholders must have approved and adopted the merger
agreement and the merger;
. all applicable waiting periods, and any extensions of these periods,
under the Hart-Scott-Rodino Act must have expired or been terminated;
. the parties must have obtained all government authorizations and
consents other than those the failure of which to obtain would not
result in a material adverse effect on FlashNet or Prodigy;
. the registration statement of which this proxy statement/prospectus is a
part must have become effective and not be the subject of a stop order
or other similar proceeding; and
. there must be no order, executive order, stay, decree, judgment or
injunction, or statute, rule or regulation in effect that makes the
merger illegal.
In addition, the obligations of Prodigy and the transitory subsidiary to
effect the merger are subject to the satisfaction or waiver of the following
conditions:
. the representations and warranties of FlashNet in the merger agreement
must be true and correct as of the date of the merger agreement and as
of the closing date, unless the representations and warranties are made
as of another date, in which case they must be true and correct as of
that date, except where the failure to be true and correct has not had
and is not reasonably likely to have a material adverse effect on
FlashNet;
. FlashNet must have performed in all material respects all obligations
required to be performed by it under the merger agreement at or prior to
the effective time of the merger;
. Prodigy receives an opinion from its counsel, or FlashNet's counsel if
Prodigy's counsel does not provide the opinion, to the effect that the
merger will be treated as a tax-free reorganization for federal income
tax purposes under Section 368(a) of the Internal Revenue Code;
. FlashNet obtains all material third-party consents; and
. Prodigy receives copies of the resignations of each FlashNet director
and officer, except as otherwise specified.
In addition, the obligation of FlashNet to effect the merger is subject to
the satisfaction or waiver of the following conditions:
. the representations and warranties of Prodigy and the transitory
subsidiary in the merger agreement must be true and correct as of the
date of the merger agreement and as of the closing date, unless the
representations and warranties are made as of another date, in which
case they must be true as of that date, except where the failure to be
true and correct has not had, and is not reasonably likely to have a
material adverse effect on Prodigy;
. Prodigy and the transitory subsidiary must have performed in all
material respects all obligations required to be performed by them under
the merger agreement at or prior to the effective time of the merger;
and
. FlashNet receives an opinion from its counsel, or from Prodigy's counsel
if FlashNet's counsel does not provide the opinion, to the effect that
the merger will be treated as a tax-free reorganization for federal
income tax purposes under Section 368(a) of the Internal Revenue Code.
FlashNet will not waive this condition without resoliciting shareholder
approval.
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Termination; Expenses and Termination Fees
Termination
The merger agreement may be terminated by written notice by the terminating
party under the following circumstances at any time prior to the effective time
of the merger:
. by mutual written consent of the parties;
. by either party if the merger has not closed by May 31, 2000, unless the
delay was due to the terminating party's failure to fulfill any
obligation under the merger agreement;
. by either Prodigy or FlashNet, if a governmental entity has issued a
nonappealable final order, decree or ruling or taken any other
nonappealable final action, which permanently restrains, enjoins or
otherwise prohibits the merger;
. by either Prodigy or FlashNet, if at the special meeting of FlashNet
shareholders the requisite vote of FlashNet's shareholders in favor of
the merger agreement and the merger is not obtained and the terminating
party is not in breach of the merger agreement;
. by Prodigy if:
. the FlashNet board of directors fails to recommend approval of the
merger agreement and the merger to the FlashNet shareholders or
withdraws or modifies its recommendation;
. the FlashNet board of directors fails to reconfirm its
recommendation of the merger agreement and the merger to the
FlashNet shareholders within five business days after Prodigy
requests that it do so;
. the FlashNet board of directors recommends to the FlashNet
shareholders an alternative transaction;
. a third party, other than Prodigy or an affiliate of Prodigy,
commences a tender offer or exchange offer for the outstanding
shares of FlashNet common stock and the FlashNet board of directors
recommends that the FlashNet shareholders tender their shares in the
tender or exchange offer, or within ten days after the tender or
exchange offer is commenced, the FlashNet board of directors fails
to recommend that the FlashNet shareholders reject the offer or
takes no position with respect to the offer; or
. for any reason FlashNet fails to call and hold the special meeting
by May 30, 2000; or
. by Prodigy or FlashNet, if there has been a breach of any
representation, warranty, covenant or agreement of the merger agreement
by the other party which is not cured within 10 days after the breaching
party receives a written notice of the breach.
If either Prodigy or FlashNet terminates the merger agreement because of any
of the reasons above, all obligations of the parties under the merger agreement
will terminate, except for the obligation to pay fees and expenses incurred by
either party in connection with the merger and the requirement to maintain a
confidentiality agreement. Furthermore, if Prodigy or FlashNet terminate the
merger agreement there will be no liability, except for any liability for
willful breaches of the merger agreement or the provisions of the stock option
agreement, on the part of Prodigy, FlashNet, the transitory subsidiary or their
respective officers, directors, shareholders or affiliates. In addition, the
representation regarding the scheduled broker fees of Goldman Sachs, as well as
the mutual confidentiality agreement dated October 21, 1999 between Prodigy and
FlashNet, will survive any termination of the merger agreement.
Expenses
Except as set forth in this section, Prodigy and FlashNet will bear their own
expenses incurred in connection with the merger. However, Prodigy and FlashNet
will share equally any expenses, other than attorney's fees, incurred with
respect to the printing and filing of this proxy statement/prospectus and the
registration statement.
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In addition to any termination fee described below, FlashNet has agreed to
pay up to a maximum of $500,000 to Prodigy as reimbursement for its fees and
expenses paid in connection with the merger if Prodigy terminates the merger
agreement because the merger is not completed by May 31, 2000, because:
. the representations and warranties of FlashNet fail to be true and
correct, except to the extent that the failure has not had and is not
reasonably likely to have a material adverse effect on FlashNet;
. the requisite vote of FlashNet's shareholders in favor of the merger
agreement and the merger is not obtained, except if Prodigy is in breach
of the merger agreement;
. the FlashNet board of directors fails to recommend approval of the
merger agreement and the merger to the FlashNet shareholders or
withdraws or modifies its recommendation;
. the FlashNet board of directors fails to reconfirm its recommendation of
the merger agreement and the merger to the FlashNet shareholders within
five business days after Prodigy requests that it do so;
. the FlashNet board of directors recommends to the FlashNet shareholders
an alternative transaction;
. a third party, other than Prodigy or an affiliate of Prodigy, commences
a tender offer or exchange offer for the outstanding shares of FlashNet
common stock and the FlashNet board of directors recommends that the
FlashNet shareholders tender their shares in the tender or exchange
offer, or within ten days after the tender or exchange offer is
commenced, the FlashNet board of directors fails to recommend that the
FlashNet shareholders reject the offer or takes no position with respect
to the offer; or
. for any reason FlashNet fails to call and hold the special meeting by
May 30, 2000; or
. there has been a breach of any representation, warranty or covenant of
the merger agreement by FlashNet which is not cured within 10 days after
FlashNet receives a written notice of the breach.
In addition to any termination fee described below, Prodigy has agreed to pay
up to a maximum of $500,000 to FlashNet as reimbursement for its fees and
expenses paid in connection with the merger if FlashNet terminates the merger
agreement because the merger is not completed by May 31, 2000, because:
. the representations and warranties of Prodigy fail to be true and
correct, except to the extent that the failure has not had and is not
reasonably likely to have a material adverse effect on Prodigy;
. there has been a breach of any representation, warranty or covenant of
the merger agreement by Prodigy which is not cured within 10 days after
Prodigy receives a written notice of the breach.
Termination Fees
FlashNet has agreed to pay Prodigy a $5 million termination fee if the merger
agreement is terminated under the following circumstances:
. by Prodigy, because:
. the FlashNet board of directors fails to recommend the merger
agreement and the merger to the FlashNet shareholders or withdraws
or modifies its recommendation;
. the FlashNet board of directors fails to reconfirm its
recommendation of the merger agreement and the merger to the
FlashNet shareholders within five business days after Prodigy
requests that it do so;
. the FlashNet board of directors recommends to the FlashNet
shareholders an alternative transaction;
. a third party, other than Prodigy or an affiliate of Prodigy,
commences a tender offer or exchange offer for the outstanding
shares of FlashNet common stock and the FlashNet board of directors
recommends that the FlashNet shareholders tender their shares in the
tender or exchange offer, or within ten days after the tender or
exchange offer is commenced, the FlashNet board of directors fails
to recommend that the FlashNet shareholders reject the offer or
takes no position with respect to the offer; or
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. for any reason FlashNet fails to call and hold the special meeting by
May 30, 2000;
. by Prodigy, because there has been a breach of any representation,
warranty or covenant of the merger agreement by FlashNet which is not
cured within 10 days after FlashNet receives a written notice of the
breach from Prodigy; or
. by Prodigy or FlashNet because FlashNet fails to obtain the requisite
vote of FlashNet shareholders to approve the merger agreement.
Prodigy has agreed to pay FlashNet a $5 million termination fee if FlashNet
terminates the merger agreement because of a breach of any representation,
warranty or covenant of the merger agreement by Prodigy which is not cured
within 10 days after Prodigy receives a written notice of the breach from
FlashNet.
If applicable, any expenses and fees payable as described above shall be paid
within one business day after demand for the payment is made following the
first to occur of the relevant termination events giving rise to the payment
obligation.
Amendment
Generally, the board of directors of each of Prodigy and FlashNet may amend
the merger agreement at any time prior to the effective time. However, after
the FlashNet shareholders approve the merger agreement, any amendment will be
restricted by the Texas Business Corporations Act. Amendments must be in
writing and signed by all parties.
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RELATED AGREEMENTS
Stock Option Agreement
In connection with the merger agreement, Prodigy and FlashNet entered into a
stock option agreement, dated as of November 5, 1999. The option agreement
grants Prodigy the right to purchase up to 2,837,475 shares of FlashNet common
stock, constituting approximately 19.9% of the outstanding shares of FlashNet
common stock, at an exercise price of $8.6625 per share, subject to adjustment.
However, Prodigy may not exercise this option to acquire more than 19.9% of the
outstanding shares of FlashNet common stock. The option becomes exercisable
after the earliest to occur of the following:
. Prodigy terminates the merger agreement because:
. the FlashNet board of directors fails to recommend the merger
agreement and the merger to the FlashNet shareholders or withdraws
or modifies its recommendation;
. the FlashNet board of directors fails to reconfirm its
recommendation of the merger agreement and the merger to the
FlashNet shareholders within five business days after Prodigy
requests that it do so;
. the FlashNet board of directors approves or recommends to the
FlashNet shareholders an alternative transaction;
. a third party, other than Prodigy or an affiliate of Prodigy,
commences a tender offer or exchange offer for the outstanding
shares of FlashNet common stock and the FlashNet board of directors
recommends that the FlashNet shareholders tender their shares in the
tender or exchange offer, or within ten days after the tender or
exchange offer is commenced, the FlashNet board of directors fails
to recommend that the FlashNet shareholders reject the offer or
takes no position with respect to the offer; or
. for any reason FlashNet fails to call and hold the special meeting
by May 30, 2000;
. Prodigy terminates the merger agreement because FlashNet breaches a
representation, warranty or covenant of the merger agreement, which
excuses Prodigy from its obligation to effect the merger, such as the
condition relating to FlashNet being year 2000 compliant, and is not
cured within ten days after FlashNet receives a written notice of the
breach from Prodigy; and
. an alternative transaction has been proposed or completed prior to the
special meeting of FlashNet shareholders, and the termination fee of $5
million becomes payable to Prodigy because FlashNet fails to receive the
requisite shareholder vote for approval of the merger agreement and the
merger, in which event Prodigy may exercise its option immediately prior
to the occurrence of any event causing the termination fee to become
payable.
Once the option is exercisable, Prodigy may exercise its option in whole or
in part, at any time or from time to time, prior to its termination. The option
will terminate upon the earliest of:
. the effective time of the merger;
. termination of the merger agreement under circumstances that do not
entitle Prodigy to receive a termination fee;
. the date on which Prodigy realizes a total profit of $5 million based on
the sum of the amount of cash received by Prodigy as a result of the
termination of the merger agreement plus cash amounts available to
Prodigy from actual or potential sales of the shares of FlashNet common
stock issuable to Prodigy on exercise of its option less Prodigy's
purchase price for FlashNet's shares; and
. 90 days after the date on which the merger agreement is terminated,
unless Prodigy cannot exercise its option or FlashNet cannot deliver to
Prodigy the shares of FlashNet common stock purchased on exercise of the
option because conditions to FlashNet's obligation to deliver the shares
have not been met, in which case the option will not expire until 30
days after the impediment to exercise has been removed.
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At any time during which Prodigy's option is exercisable, Prodigy has the
right to cause FlashNet to repurchase from Prodigy all or any portion of
Prodigy's option, to the extent not previously exercised, and the shares of
FlashNet common stock that Prodigy purchased by exercising its option. Prodigy
must give written notice to FlashNet of its demand for repurchase.
The repurchase price for Prodigy's option is the difference between the
market/tender offer price and the purchase price, if the market/tender offer
price is greater. The market/tender offer price is the greater of:
. the price per share of FlashNet common stock offered pursuant to a
tender or exchange offer or an acquisition proposal that was made prior
to and not terminated or withdrawn as of the date on which Prodigy gave
notice of its repurchase demand to FlashNet; and
. the average of the closing price per share of FlashNet common stock on
the Nasdaq National Market for the ten trading days immediately
preceding the notice date.
The purchase price is the product of the exercise price per share of FlashNet
common stock and the number of shares of FlashNet common stock purchasable
pursuant to the option for which Prodigy is demanding repurchase.
The repurchase price for the shares of FlashNet common stock that Prodigy had
acquired by exercising its option is the product of:
. the number of shares of FlashNet common stock for which Prodigy is
demanding repurchase; and
. the purchase price per share plus the difference between the
market/tender offer price and the purchase price, if the market/tender
offer price paid by Prodigy for the shares of FlashNet common stock is
greater.
In the event that FlashNet is prohibited under applicable law or regulation,
or as a consequence of administrative policy, from repurchasing in full the
option or shares of FlashNet common stock as demanded by Prodigy, then FlashNet
must immediately notify Prodigy of the prohibition. In addition, within five
business days after each date on which FlashNet is no longer so prohibited,
FlashNet must deliver to Prodigy that portion of the repurchase price. However,
during the prohibition period and if FlashNet is using its best efforts to
obtain all required regulatory and legal approvals and to file any required
notices as promptly as practicable to accomplish the repurchase, Prodigy may
revoke its notice demanding repurchase, in whole or to the extent of the
prohibition. If Prodigy revokes its notice, FlashNet must promptly deliver to
Prodigy the portion of the repurchase price which FlashNet is not prohibited
from delivering and, as appropriate:
. a new stock option agreement evidencing Prodigy's right to purchase that
number of shares of FlashNet common stock obtained by multiplying the
number of shares of FlashNet common stock for which the surrendered
stock option agreement was exercisable at the time of delivery of the
notice by a fraction, the numerator of which is the repurchase price
less the portion of the repurchase price previously delivered to
Prodigy, and the denominator of which is the repurchase price; and
. a certificate for the shares of FlashNet common stock that FlashNet is
then so prohibited from repurchasing.
FlashNet has agreed to file up to two registration statements within two
years following any purchase by Prodigy of shares of FlashNet common stock
under the option to register the resale by Prodigy of those shares under
applicable federal and state securities laws.
Stockholder Agreement
As an inducement to Prodigy to enter into the merger agreement, some of the
FlashNet shareholders, who now beneficially own an aggregate of 4,014,679
shares of FlashNet common stock, entered into a stockholder agreement with
Prodigy, dated as of November 5, 1999, agreeing to vote their shares in favor
of the merger agreement and the merger and against any alternative
transactions. The shareholders retain the right to vote their shares on all
other matters.
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The shareholders also agreed to execute a proxy, which would give Prodigy, or
any nominee of Prodigy, the limited right to vote each of the 4,014,679 shares
of FlashNet common stock as lawful attorney and proxy, at every FlashNet
shareholders meeting and every written consent in lieu of a meeting, in favor
of approval of the merger and the merger agreement. The stockholder agreement
terminates upon the earlier of the merger becoming effective in accordance with
the terms and provisions of the merger agreement and the termination of the
merger agreement.
Advances from Prodigy
On April 26, 2000, Prodigy agreed to loan FlashNet up to $2,000,000 to fund
operations. Advances will be unsecured, bear interest at an annual rate of 12%
and are due October 26, 2000. As of May 5, 2000, no advances had been made
under these arrangements.
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PRODIGY'S BUSINESS
Prodigy is a leading nationwide Internet service provider that provides fast
and reliable Internet access and other Internet-based services. Prodigy's
nationwide Internet service offering, customer base and well recognized brand
name have made it a leading national Internet service provider. Prodigy tailors
its services to target the consumer, small business and U.S. Hispanic markets.
Prodigy has nationwide brand recognition and customer acquisition not available
to regional and local Internet service providers. Prodigy utilizes a nationwide
network covering over 850 cities in all 50 states. This network allows
approximately 90% of the United States population to access Prodigy's services
with a local telephone call. Prodigy believes its scalable technology allows it
to grow cost-effectively without significant capital expenditures. The number
of billable subscribers to Prodigy Internet, including subscribers who switched
from Prodigy's original Prodigy Classic online service, increased from 221,000
at December 31, 1997 to 1,138,000 at December 31, 1999.
Prodigy Internet enables subscribers to use the Internet as a productivity
tool by allowing subscribers to obtain and communicate desired information
quickly and efficiently in an easy and personalized manner. Prodigy Internet
users receive fast and reliable access to the Internet, Prodigy-branded and
partner-branded content and other member services. Prodigy is expanding its Web
hosting and electronic commerce services for business customers. Prodigy
believes that its extensive experience in operating a large data center with
electronic commerce applications positions it well for growth in these areas.
Prodigy has introduced or is introducing various Internet-based services, such
as Web-based email, chat, personal Web pages, instant messaging, long-distance
telephone services, Internet-based telephone and fax services and online
customer billing.
Prodigy has been an online pioneer since its inception in 1984. Prodigy
launched Prodigy Classic as the world's first consumer-focused online service
in 1988. Prodigy Classic featured custom content, e-mail and chat rooms and was
based on technologies owned by Prodigy. In October 1996, Prodigy launched
Prodigy Internet, a service allowing consumers with any computer operating
system to access the Internet. Prodigy Classic was discontinued in October 1999
as Prodigy completed the transition to Prodigy Internet. Since the autumn of
1997, Prodigy has focused on expanding the Prodigy Internet subscriber base and
introducing additional Internet-based services. Prodigy has also used outside
companies for network coverage, customer support and content. Due to these
initiatives, Prodigy has substantially reduced its fixed operating costs and
number of employees. Prodigy believes it can accommodate sustained subscriber
growth cost-effectively without significant capital expenditures.
Industry Background
Growth of the Internet and Electronic Commerce
The Internet is a collection of computer networks that links millions of
public and private computers to form the largest computer network in the world.
It has become an important global communications medium, enabling millions of
people to obtain and share information and conduct business electronically, and
a critical tool for information and communications for many users. The Internet
has grown rapidly in recent years, both in the number of Web users and Web
sites. Many factors are driving the growth in the number of Web users and Web
sites, including:
. the large and growing number of personal computers;
. the declining cost of computers;
. advances in the performance and speed of personal computers and modems;
. easier and alternative access to the Internet; and
. the increasing importance of the Internet for communications,
information and commerce.
For many businesses, the Internet has created a new communications and sales
channel enabling large numbers of geographically dispersed organizations and
consumers to be reached quickly and cost-effectively.
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Evolution of the Internet Services Market
Today, the Internet services market consists primarily of Internet access.
Access services include dial-up access for individuals and small businesses and
high-speed dedicated access primarily for larger organizations. The rapid
development and growth of the Internet have resulted in a highly fragmented
industry, consisting of more than 5,000 Internet service providers in the
United States, most of which operate as small, local businesses. The Internet
services industry is expected to undergo substantial consolidation, especially
among mid-sized Internet service providers, over the next few years.
Internet service providers vary widely in geographic coverage, customer focus
and the nature and quality of services provided to subscribers. Few Internet
service providers offer nationwide coverage, have a brand name with nationwide
recognition or can grow significantly without additional investment in
infrastructure. Internet service providers may concentrate on specific types of
customers that differ from the target markets of other Internet service
providers. Services offered by Internet service providers can range from simple
dial-up access to highly organized, personalized access coupled with value-
added services. Prodigy believes that consumers generally focus on speed and
reliability of access, ease of use, customer service and price as they evaluate
an Internet service provider. In addition, Prodigy believes many business
customers want all their Internet-based requirements, such as Internet access,
Web hosting and electronic commerce applications, met by a single provider.
Internet operations, including Web hosting and electronic commerce, are
increasingly becoming critical to businesses. However, many businesses lack the
resources and expertise to develop, maintain and enhance, on a cost-effective
basis, successful Internet operations. As a result, businesses increasingly use
outside companies to enhance Web site reliability and performance, provide
continuous operation of their Internet-based functions and reduce operating
expenses. By outsourcing these services, companies can focus on their business
rather than using their resources to support Internet operations.
As a result, there is increasing demand for Internet service providers to
offer electronic commerce services that businesses can establish quickly and
easily. An increasing number of Internet service providers supplement their
basic Internet access services with a variety of commercial services that
facilitate electronic commerce, such as hosting web sites, online customer
billing, co-location and other value-added services. These services expand an
Internet service provider's potential revenue sources from basic monthly access
fees to other fees such as set-up and maintenance charges. In addition, some
larger and more sophisticated Internet service providers market other Internet-
based services, such as paging, long-distance and cellular telephone services,
to both consumers and business customers nationwide.
The Prodigy Solution
Prodigy provides fast and reliable Internet access and other Internet-based
services. Prodigy intends to meet the rapidly changing needs of its customers
by offering new products and additional Internet-based services as demand
arises. Prodigy believes the following competitive strengths positions it to
meet this goal:
Nationwide Brand Name Recognition. Since the introduction of its original
service in 1988, Prodigy has established substantial nationwide brand
recognition it believes offers a significant competitive advantage in
attracting new subscribers. Prodigy uses a variety of advertising, promotional
and distribution channels to leverage its brand name, one of the oldest and
best-known in the Internet industry. Prodigy launched the Prodigy Internet
service in October 1996 as a productivity tool dedicated to the Internet and
designed to make a user's experience simpler and more rewarding. Prodigy
believes the strength of the Prodigy brand has enhanced its Prodigy Internet
marketing efforts and facilitated the rapid growth in the number of Prodigy
Internet subscribers.
Nationwide Customer Acquisition Channels. Prodigy has a variety of
arrangements to acquire customers, including:
. contract acquisition programs with selected major PC manufacturers and
retailers;
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. bundling with PCs shipped by leading PC manufacturers;
. its relationship with Microsoft;
. Web-based marketing;
. retail channels;
. direct mail and telemarketing; and
. television, radio and print advertising.
Prodigy believes many of these customer acquisition channels are not
available to regional and local Internet service providers who lack a
nationwide presence. Prodigy Internet software is included on PCs shipped by
many leading PC manufacturers. This software is also included in the online
services folder of every copy of Windows 98 and Windows 2000 shipped by
Microsoft for sale in retail channels or for loading on new PCs. The Prodigy
Internet service is also included in Microsoft's Internet service providers
Internet Referral Service Program.
Scalable Business Model. Prodigy has created a business and operating model
that it believes can accommodate sustained subscriber growth cost-effectively
without significant capital expenditures. Prodigy outsources major capital- and
labor- intensive functions to companies that it believes can provide scalable
and dependable network coverage, customer service and organized content.
Prodigy's outsourcing arrangements enable it to rely on the resources of other
companies while drawing on its own experience to manage these services. As a
result, the principal costs of servicing new subscribers, network usage and
telephone customer service are variable and generally increase only as the
subscriber base increases. In addition, Prodigy's e-mail and customer
authentication systems have been developed in-house to support a large number
of customers. Prodigy's existing data hosting facilities have the capacity to
support millions of additional subscribers.
Fast and Reliable Service. Prodigy Internet offers fast and reliable Internet
connections. Prodigy Internet subscribers have direct Internet access at speeds
of up to 56 kilobits per second.
Nationwide Network Coverage. The networks used to offer the Prodigy Internet
service cover over 850 cities in all 50 states. The networks can provide dial-
up access, with a local telephone call, to approximately 90% of the households
in the United States. Prodigy also offers network access via an 800 telephone
number for $.10 per minute without an additional enrollment charge. Prodigy
also offers DSL access in seven states and is negotiating agreements expected
to provide nationwide DSL coverage by the end of 2000.
Superior Customer Experience. In addition to being easy to use and
personalize, Prodigy believes Prodigy Internet offers a productive and
rewarding customer experience. Prodigy's customer services include toll-free
telephone support, various online support options and an online "members
helping members" program. Prodigy distributes its customer service calls over
multiple outsourcing partners to reduce call waiting times. Prodigy has
developed proprietary filters to limit unsolicited commercial email, or "spam,"
sent by or addressed to subscribers. Prodigy accepts banner advertisements and
sponsorships but does not generate pop-up advertisements which appear on
smaller screens that automatically overlay the user's PC screen. Prodigy also
offers a program that rewards subscribers for their loyalty with points that
can be redeemed for gift certificates at selected retail stores.
Business Strategy
Prodigy's objectives are to strengthen its position as a leading nationwide
Internet service provider and to expand the range of services it offers and
markets it serves. Key elements of Prodigy's business strategy include:
Leverage Strong Brand Name. Prodigy intends to increase its brand equity by
promoting the Prodigy brand through increased marketing and advertising
activities. Prodigy is leveraging the Prodigy brand name to expand its customer
acquisition activities, offer new services and enter new markets.
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Introduce New Services. Prodigy is expanding its Web hosting business and
introducing additional Internet-based services. In October 1999, Prodigy
acquired BizOnThe.Net, a Web hosting business which sells Web sites to
customers. The designs of these sites are based on standardized forms and
artwork, which are customized for specific lines of business. Prodigy is
enhancing its ability to obtain and organize customer data to enable targeted
sales and marketing of Internet-based services to existing subscribers. In
addition, Prodigy plans to expand its electronic commerce activities and has
introduced broadband services with Bell Atlantic and Covad.
Enter New Markets. Prodigy is leveraging its brand recognition to expand
beyond its existing consumer market to include the small business and U.S.
Hispanic markets. Prodigy's services for small businesses include dial-up
Internet access, Web hosting, communications provisioning and related services.
Since January 1999, Prodigy has managed Telmex's Prodigy Internet de Telmex
subscribers in exchange for a management fee. In April 1999, Prodigy introduced
its bilingual Prodigy en Espanol service for U.S. Hispanic consumers.
Evaluate Acquisition Opportunities. Prodigy evaluates acquisition
opportunities on an ongoing basis. At any given time Prodigy may be engaged in
discussions with respect to possible acquisitions or other business
combinations. Prodigy may seek strategic acquisitions that can complement its
current or planned business activities. The Internet services industry is
expected to undergo substantial consolidation over the next few years, and
Prodigy may also seek to acquire other Internet service providers as an
additional means of customer acquisition or to enter into new markets.
Products and Services
Prodigy Internet
Prodigy Internet is an open standards-based Internet access service, allowing
consumers with any computer operating system to access the Internet. The
Prodigy Internet service combines the depth and breadth of the Internet with
the ease of use and organization of a traditional online service. Prodigy
Internet users receive fast and reliable access to the Internet, Prodigy-
branded and partner-branded content and other Prodigy member services.
The Prodigy Internet service provides subscribers with, among other services:
. direct, high-speed Internet access;
. an electronic mailbox enabling subscribers to send and receive an
unlimited number of text, graphics and multimedia messages;
. instant messaging;
. space on Prodigy's servers to host a personal Web page; and
. Web-based email.
Prodigy Internet also offers for most Prodigy Internet subscribers:
. a personalized home page for each subscriber which includes personalized
news services through MSNBC, stock portfolios, weather through
Accuweather, local TV listings and sports scores;
. customer service and online member support, including help files,
tutorials and other online educational tools;
. content generated by community members using communication tools such as
chat, message boards, news groups, bulletin boards and personal Web
pages; and
. access to online transactions on the Web through the Prodigy home page
and other e-commerce platforms.
The Prodigy Internet service is compatible with Internet standards and
protocols, allowing use of industry-standard client/server software. Unlike
some online services that use proprietary technologies, Prodigy Internet merges
seamlessly with Web content and can be regularly updated to incorporate
advances in Internet
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technologies, such as new browsers, RealAudio players and security devices for
electronic commerce. Prodigy Internet is compatible with the Microsoft Internet
Explorer and Netscape Navigator browsers on the Windows 98, Windows 95 and
Windows 3.1 operating systems and on Macintosh computers. Microsoft Internet
Explorer is the primary browser shipped on disks that contain the Prodigy
Internet software.
As of December 31, 1999, there were 1,138,000 billable subscribers to the
Prodigy Internet service.
The price plans for the Prodigy Internet service vary and are subject to
change. Prodigy Internet's principal price plans currently are:
. $19.95 per month for unlimited usage with a 30-day money back guarantee;
. a discounted prepaid annual plan of $198 for one year of unlimited
usage, equivalent to $16.50 per month;
. $9.95 per month for three months of unlimited usage, and $19.95 per
month thereafter;
. a free trial for 30 days with unlimited usage, and $19.95 per month
thereafter;
. $21.95 per month for unlimited usage plus five mailboxes; and
. $21.95 or $19.95 per month for new customers acquired under contract
acquisition programs with major PC retailers.
Other Internet-Based Services
Prodigy's other Internet-based services include the following:
. The shopping tab on Prodigy Internet currently provides links to over
100 Web-based stores and retailers, including Amazon.com, Reel.com,
PETsMART, Godiva Chocolate, eToys, uBid, Outpost.com and Omaha Steaks.
. In September 1998, Prodigy began offering paging services in partnership
with SkyTel.
. In February 1999, Prodigy announced the launch of Prodigy MailLink, a
new Web-based e-mail program that allows Prodigy Internet members to
access their Prodigy e-mail from any PC connected to the Web.
. In June 1999, Prodigy rolled out the co-branded marketing of long-
distance telephone services through Talk.com.
. In December 1999, Prodigy announced a relationship with Metris and
Mastercard to offer a Prodigy Internet Mastercard to Prodigy members.
The program is scheduled to launch in the second quarter of 2000.
. In January 2000, Prodigy announced a relationship with AnyDay.com to
provide free calendaring and invitation services to its members.
. In March 2000, Prodigy announced a relationship with LookSmart to
provide the LookSmart search engine to its members.
Business Services
In October 1999, Prodigy acquired BizOnThe.Net, a Web hosting business, and
combined it with Prodigy's existing Web hosting business. The combined
operation is called Prodigy Biz. The majority of the Prodigy Biz business is
the sale of Web sites with standardized forms and artwork to customers. These
hosting services are sold through telemarketing and offer a simple, easy to use
and understandable Web site to small businesses. A small part of the Prodigy
Biz business is the sale of more complex and sophisticated shared Web hosting
services to small businesses, as developed by the Prodigy Business Solutions
Group before the purchase of BizOnThe.Net. This more sophisticated offering
allows Web hosting customers the ability to design their own Web sites. Prodigy
also offers these Web-hosting customers e-commerce capabilities, which permit
the customer to set up an online store to promote, sell, bill for and collect
payments relating to its products and services.
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Spanish-Speaking and Hispanic Market
Prodigy markets Internet services to Spanish-speaking and Hispanic customers
in the United States. According to U.S. census data, there are approximately 17
million persons in the United States age 5 or older who speak Spanish at home,
and a total of approximately 28 million U.S. residents are identified as
Hispanic.
In April 1999, Prodigy launched Prodigy en Espanol, the first completely
bilingual Spanish-English Internet access service offered nationwide in the
United States. Prodigy en Espanol is tailored to meet the needs of the large
and growing Hispanic community in the United States. Prodigy en Espanol
provides the same fast and reliable access to the Internet as Prodigy Internet.
Bilingual options for the customer include enrollment software, the customer
interface, customer service and technical service, allowing Prodigy en Espanol
subscribers the option using either Spanish or English. Content of interest to
the Hispanic community in the United States, and links to web sites with
Spanish language content, are featured on the home page of Prodigy en Espanol.
Prodigy en Espanol subscribers also have access to all of the English content
offered to Prodigy Internet subscribers.
In April 2000, Prodigy became the exclusive co-branded preferred Internet
service provider for Hispanic Broadcasting Company, a large Spanish-language
radio broadcasting company in the United States, and Prodigy en Espanol will be
the preferred Internet access service featured on Hispanic Broadcasting
Company's radio stations, Web sites and special events. The agreement between
Prodigy and Hispanic Broadcasting Company includes on-air and off-air
promotional time as well as a provision for Prodigy to provide hosting services
for Hispanic Broadcasting Company's corporate Internet activities.
As of December 31, 1999, Prodigy managed approximately 364,000 Prodigy
Internet de Telmex subscribers. See "Transactions with Related Parties." Telmex
is the leading provider of local and long-distance telephone services in Mexico
and is the principal full-service telecommunications provider in Mexico. Telmex
owns the nationwide network of local telephone lines and the principal public
long-distance telephone transmission facilities in Mexico, and has built a
nationwide data transmission network. Carso Global Telecom currently controls
Telmex. Carso Global Telecom and Telmex are Prodigy's principal shareholders.
Electronic Commerce
Prodigy was a pioneer in electronic commerce through its establishment of
standards and creation of applications that facilitated online shopping and
transacting, such as online banking and securities trading. Prodigy currently
has the capability to provide the fundamental elements of electronic commerce--
Web hosting, hosting of intranets/extranets and high-speed dial access, meaning
using the quickest modem available to send and to receive information to and
from the Internet. Prodigy's strategy is to provide its customers with a bundle
of products and services containing everything needed to access the web and to
set up online stores to promote, sell, bill for and collect payments relating
to its products and services. Although e-commerce applications have not to date
generated a material portion of Prodigy's revenues, e-commerce applications
that Prodigy plans to roll out include:
. electronic shopping carts;
. order processing and tracking;
. online billing and payment processing; and
. in conjunction with partners, consulting and integration services for
complex and large electronic commerce sites.
Broadband Services
Prodigy's broadband strategy is designed to provide customers with a suite of
Internet access and other Internet-based services in conjunction with selected
technology and marketing partners. Prodigy has entered into agreements with
Bell Atlantic, Southwestern Bell and Covad Communications for the provisioning
of DSL services and is in discussions with others to support various broadband
applications.
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Customer Acquisition and Marketing
Prodigy uses a variety of methods to acquire customers. Prodigy believes that
the strong national brand recognition of the Prodigy name and the nationwide
network used by Prodigy provide it with access to customer acquisition methods
not available to local and regional Internet service providers.
The Prodigy Internet service is marketed through a variety of media outlets,
including television, radio and outdoor advertising. The target audiences for
Prodigy Internet are:
. purchasers of new desktop consumer PCs;
. existing subscribers to online services who may be interested in moving
to an Internet service provider; and
. existing Internet service subscribers who are dissatisfied with their
current service or attracted to the performance and features of Prodigy
Internet.
Prodigy believes that the purchasers of new desktop consumer PCs give Prodigy
effective access to both first-time Internet users, who may be attracted by
Prodigy Internet's ease-of-use, personalized home page customer service and
online assistance, and existing Internet access subscribers who, in conjunction
with the purchase of a new PC, may be willing to switch to Prodigy Internet.
Prodigy believes that consumers in the other target segments listed above are
less likely to switch back from Prodigy Internet to another Internet service
providers, are less price-sensitive and are more receptive to value-added
services.
Prodigy's marketing efforts position the Prodigy Internet service as the
right Internet choice and as a productivity tool to help users obtain and
communicate information quickly and efficiently. Marketing themes emphasize
that the Prodigy Internet service is superior in terms of:
. availability and reliability;
. speed--up to 56 kilobits;
. technology--a network architecture that places asynchronous transfer
mode switching devices at local phone access sites instead of
backhauling the data to a central location;
. navigation; and
. personalization.
Contract Acquisition Programs. Prodigy has relationships with selected major
PC retailers which enable the retailers to offer rebates to consumers who
purchase new PCs. Under these agreements, Prodigy makes a payment to the
retailer in exchange for the retailer enrolling a customer onto Prodigy
Internet and obtaining a signed contractual commitment from the customer to a
term subscription to Prodigy Internet. These payments range up to $400 for a
term subscription of up to three years.
PC Bundling. The Prodigy Internet service is bundled with PCs under
arrangements where Prodigy pays a negotiated fee to the PC manufacturer only if
a subscriber enrolls from the PC and continues as a service customer beyond an
introductory period. PC bundling is attractive to Prodigy because the supplier
bears the distribution cost and bundling reaches many more potential
subscribers than through most other acquisition channels. The Prodigy Internet
software is pre-loaded on selected PC models shipped by Hewlett Packard, IBM,
Gateway 2000, Sony and Toshiba.
Microsoft Relationship. Microsoft includes the Prodigy Internet service in
the online services folder of every copy of the Windows 98 shipped by Microsoft
for sale in retail channels or for loading on new PCs. Prodigy Internet,
Microsoft Network, America Online, CompuServe and AT&T WorldNet are the only
services in the online services folders of Windows 98. Microsoft also includes
Prodigy Internet in Microsoft's Internet service providers Internet Referral
Service Program. Prodigy believes that these arrangements enhance Prodigy's
nationwide brand presence.
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Web-Based. Prodigy maintains a Web site--www.prodigy.com--that provides
Internet users with the opportunity to learn about and enroll in the Prodigy
Internet service. Prodigy believes its television advertising and other
programs help target consumers interested in switching providers.
Retail. Prodigy has relationships with major retailers in the computer,
software and consumer electronics areas, including Best Buy, Office Depot and
Electronics Boutique. The Prodigy Internet software is currently available at
approximately 6,000 retail stores nationwide. These relationships typically
entitle Prodigy to establish displays containing free software in prime
locations, such as next to cash registers. Prodigy supports these relationships
through the use of bounty programs, cooperative advertising, joint promotional
events and manufacturer development funds.
Direct. Prodigy pursues targeted audiences in its direct mailing and
telemarketing efforts. Prodigy targets its direct mail to highly-qualified
prospects, such as known Internet users and new PC purchasers. Prodigy's
inbound telemarketing program fulfills customer orders, 24 hours a day, 7 days
a week, 365 days a year, via toll-free telephone numbers--1-800-PRODIGY and 1-
888-PRODIGY--that it promotes widely. Prodigy's outbound telemarketing programs
focus on the reacquisition of recently disconnected members and highly-
qualified prospects. Prodigy outsources its telemarketing services. Prodigy
maintains an online, member-assisted referral program in which existing
subscribers receive cash payments for signing up new members.
Retention Programs. Prodigy also develops programs to encourage trial
customers to subscribe and improve customer retention. Prodigy designs these
promotions to increase usage, which results in a higher likelihood of
subscribing. In January 1999, Prodigy introduced the Prodigy Points program, a
member loyalty program designed to increase knowledge and usage of the Web for
transactions and other services. Through the Prodigy Points program, Prodigy
members can earn "points" based on usage and redeem points for gift
certificates at selected retail stores. Prodigy plans to extend this program to
travel services and other merchandise, including a free month of Prodigy
Internet service. Prodigy also uses incentives to retain subscribers who might
otherwise cancel service.
Customer Service
Prodigy designs its customer service programs to increase member satisfaction
and retention, while controlling costs by combining outsourcing with in-house
services. Prodigy believes that its customer service programs, coupled with a
new-release strategy that is sensitive to the concerns of existing members and
responsive to market trends, have positioned Prodigy to provide customer
support that is cost-effective and that it can expand to accommodate future
growth.
Telephone Support. Prodigy outsources its telephone support for initial
questions from users to various vendors. Telephone technical support is toll-
free and available twenty-four hours per day, 365 days per year. Customers are
assisted with Prodigy software installation, enrollment questions, account
management concerns, service access problems and disconnect requests. Prodigy
can direct customer calls between vendors on short notice, which Prodigy
believes creates a competitive environment between vendors, resulting in
enhanced quality, performance and pricing. Geographic distribution of call
centers allows for uninterrupted service in the event of regional disasters.
Administrative and billing support is available weekdays from 9:00 a.m. to
9:00 p.m., eastern time.
In-House Customer Support and Systems. Prodigy maintains an online member
services area that provides a variety of support options to all members,
including real-time chat, instant messaging, news groups, message boards and
email. Prodigy has integrated comprehensive help, tutorials, advisories,
frequently asked questions and tips online. Prodigy also has an online "members
helping members" program, in which selected subscribers receive nominal monthly
compensation in exchange for providing personalized responses to members
posting inquiries on news groups, message boards and chat. Prodigy's customer
service organization monitors customer service vendor performance with
quantitative metrics such as average wait time, first call resolution rate and
abandon rate, and qualitative controls such as call monitoring. Prodigy also
has technically-trained customer service representatives to call subscribers
with unresolved problems.
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Prodigy maintains detailed customer records and documents each customer
support request in a problem tracking system. This system allows recurring
problems to be identified and escalated for resolution. Prodigy maintains a
Web-based database that is accessible by all vendor and employee customer
service representatives on a real-time basis. This database helps ensure
accurate and consistent delivery of customer service regardless of where the
contact is handled.
Billing. Prodigy outsources its customer billing system and services to CSG
Systems, CSG Systems' billing system is highly customized and flexible and
supports prompt pricing changes. CSG Systems provides credit card and paper
billing, transaction processing and check handling. Prodigy bills a substantial
majority of its current subscribers through pre-authorized credit card charges.
Other subscribers receive invoices.
Technology
Prodigy has been a technology pioneer in the online industry since its
formation in 1984 and introduced many concepts that would later be adopted for
the Web. Continuing this pioneering heritage in the Internet industry, the
Prodigy Internet service utilizes a standards-based, proprietary service
provider platform and mail server developed by Prodigy.
Service Provider Platform. The service provider platform is a suite of
functions that creates the infrastructure of a large-scale Internet service
provider. Capabilities include customer profile management, access control,
authentication, billing and customer care interfaces and other functions
necessary to offer large-scale Internet services. The service provider platform
is scalable to millions of subscribers. It is compatible with industry standard
products, such as Netscape and Apache Web servers and Oracle databases. The
service provider platform also interfaces effectively with Prodigy's mail
server. The platform is built to open standards to enable the use of
applications from other suppliers.
Portal. Highly scalable Web platform for delivery of a personalized
Internet experience. The platform is compatible with various content feeds.
Personalization is based on member preference and geographical data.
Instant Message/Chat. High function system that enables interactive and
real-time communication between members.
Community Platform. Various tools and systems that enable and promote
communities on the Prodigy Internet service, including a bulletin board
platform and an email-list platform. The email-list platform is capable of
supporting custom domains, and delegated administration making it possible
for Prodigy to leverage it not only for communities, but also for the small
business Web hosting line of business.
Alerts. A real-time notification system that is capable of alerting
Prodigy members to various interesting events, such as arrival of certain
emails, stock and Usenet alerts. The system is highly scalable and
extensible to various content and alert feeds.
Web-Hosting Platform. High scalable and functional system for hosting
small business Web sites. The system is compatible with e-commerce
applications and various Web publishing tools. The system also provides
small business users with custom email domains and mailboxes, as well 56
kilobits dial capabilities.
Mail Server. The Prodigy Internet service uses a scalable, reliable Internet
mail server. The mail server draws on the fault-tolerance and scalability
provided by the underlying Oracle database to offer flexibility, ease of
operation and scalability. Prodigy's mail server supports standard Internet
protocols. The mail system also provides:
Tools for Administrators. Welcome messages; bulk mailers; quota controls
by realm, domain, household, small business or individual account; tools to
manage spam; and operational scripts and tools.
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Tools for Users. User-configured filters for prioritization and spam
removal. Messages can contain any number of attachments through technology
which allows the user to send and receive graphics, audio and video files
via the Internet, up to a size limitation of 10 megabytes per mailbox. The
mail system delivers messages without promotional tag lines.
Features for Business Customers. Support for multiple domains, which
enables Prodigy Internet to operate multiple Internet services under
different brands on the same system base and an off-site administrator to
control enterprise mailboxes.
Configuration and Provisioning Interfaces. The system supports a standard
administrative interface that provides configuration and control of the
mail system from external systems or via a hypertext markup language
screen. Standard application programming interfaces, interface the system
to external databases for user authentication and mailbox provisioning.
Scaling Ability. The system is designed to scale to millions of mailboxes
with an architecture that supports hardware and data redundancy.
Network and Related Infrastructure
Subscribers access Prodigy's services by connecting to a network with their
PCs using local, toll-free or long distance telephone service. The network
connects subscribers' PCs to the Internet and to Prodigy's hosting servers. The
hosting servers store some of the data accessed during subscriber sessions.
Network connections are made through communications hardware, such as telephone
lines, routers, switches and modems. These direct data and enable communication
among a variety of computer operating systems. The network used for the Prodigy
Internet service is built to Internet standards. Prodigy outsources its
consumer dialup network functions to Splitrock, Navinet and AT&T.
Network Architecture
The network infrastructure used by Prodigy Internet consists of three primary
tiers: local phone access sites; a middle tier, which connects local phone
access sites to regional hubs; and a backbone tier, which connects the regional
hubs to the Internet or Prodigy's data hosting center. The network currently
includes over 750 local phone access sites nationwide and has the capability to
provide dial-up access, with a local telephone call, to approximately 90% of
the households in the United States. Prodigy also offers access to the
Splitrock network via an 800 telephone number for $.10 per minute without an
additional enrollment charge. Over 750 local phone access sites currently
provide 56 kilobits access to Prodigy Internet subscribers having modems of
that speed. All of the local phone access sites that provide 56 kilobits access
are V.90 supported.
Data Hosting Center
Prodigy's data hosting center, located in Yorktown Heights, New York, houses
approximately 400 high-capacity servers to store content and other data. The
data center contains a mainframe complex that supports business support systems
such as subscriber session accounting and reporting and high-capacity servers
for customer service support systems and business accounting. Prodigy's data
center hosts a variety of applications that are scalable to millions of users.
The use of standard interfaces allows integration of products offered by a
broad spectrum of vendors, including IBM, Microsoft and Netscape. Supported
operating system platforms include UNIX/AIX, Windows(R) NT and OS/390, and
installed database products include Oracle and DB2.
Prodigy has equipped its data hosting center with triple redundant power
systems and housed it in a climate and humidity controlled environment. Prodigy
has installed both battery and diesel power backup systems to preclude outages.
All production host systems have backup processors or are designed to be fault
tolerant, and all critical data is backed up to tape daily. Prodigy physically
secures facilities and data by incrementally restrictive card key locks. Built-
in operating system security features provide logical data security. The
facility uses firewall technology to protect critical systems. Prodigy has
installed servers that are open directly to the Internet on a separate network.
In addition, the facility uses anti-hacking measures.
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Reliability and Availability
Reliability and availability are key objectives of Prodigy's network and
hosting configurations. Prodigy accumulates and analyzes statistics on each
access line. Lines exhibiting quality problems are removed from service and
referred for repair. When possible, problem lines are immediately replaced with
lines from other vendors. In addition, Prodigy has integrated Inverse's IP
Insight product into the Prodigy Internet software, allowing Prodigy to gather
data on the actual connection experiences of subscribers who have agreed to
have their connection experiences measured. Prodigy reports problem sites to
the network provider for action.
At Prodigy's data hosting center, Prodigy operates a 24x7 operations control
center. Where feasible, Prodigy distributes the telephone lines among multiple
modem subsystems and access servers to provide diversity. The hosting center
connects to the backbone via diversely routed, multi-vendor DS3 lines.
Principal Outsourcing Arrangements
Splitrock
Prodigy owned and operated its own network in the United States until July 1,
1997. Effective July 1, 1997, Prodigy conveyed its network assets to Splitrock
in exchange for Splitrock's agreement to build and operate a network, hire all
Prodigy employees engaged in Prodigy's network operations and assume various
local phone access site leases and other liabilities. Splitrock is required to
provide dial-up network access in all locations in which Prodigy provided dial-
up service as of June 30, 1997. Prodigy may require additional sites to be
added if it meets designated coverage and usage parameters. Splitrock may also
provide access to the network to other customers. Splitrock is required to
provide a backbone network based on technology and is required to support
transmission via Serial Line Internet Protocol, Point-to-Point Protocol and
TCP/IP.
Splitrock is required to meet specified service levels. Splitrock's failure
to meet the specified service level objectives will result in financial
penalties. If Splitrock fails to meet specified service levels for an extended
period, Prodigy may terminate the agreement. In addition, if there is a system-
wide failure, Prodigy will have the right to terminate the agreement or assume
responsibility for operating the network at Splitrock's expense.
Splitrock charges Prodigy a monthly fee per subscriber for usage by Prodigy's
subscribers. If the average hourly usage by Prodigy's subscribers in any month
exceeds a set threshold, Prodigy must pay Splitrock an additional amount per
hour in excess of the threshold. The agreement includes minimum monthly
charges. Prodigy may terminate the agreement at any time upon payment of an
early termination charge.
The agreement, as amended, will expire on December 31, 2001 and is subject to
automatic renewal for successive one-year terms unless terminated by either
party on 12 months' notice. Until termination of the agreement, Prodigy has
agreed that Splitrock will be Prodigy's primary provider of network services.
During this period, Prodigy must give Splitrock advance notice of, and the
opportunity to discuss with Prodigy, any forms of service access, other than
network access, that Prodigy wishes to pursue in the United States.
CSG Systems
Prodigy outsources its customer billing to CSG Systems. CSG Systems is a
leading provider of customer care and billing services for telecommunications
providers, including many of the largest cable television and direct broadcast
satellite providers. Prodigy and CSG Systems have agreed that CSG Systems is
Prodigy's exclusive provider of billing services for the Prodigy Internet
service, but not for premium or other billing services. CSG Systems charges
Prodigy a monthly fee based on the number of subscribers, subject to a minimum
charge, and a monthly minimum fee for ongoing development and support. The
agreement between Prodigy and CSG Systems expires June 30, 2001.
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Competition
The industry in which Prodigy competes is intensely competitive and includes
many significant participants. These participants include:
. Internet service providers;
. proprietary online service providers;
. ultra high-speed service providers;
. major international telecommunications companies;
. wireless communications companies;
. Internet-search services; and
. various other telecommunications companies.
There are more than 5,000 Internet service providers in the United States,
most of which operate small, local businesses. Additional regional telephone
operating companies, long-distance carriers and cable companies may also enter
the market. Internet-search service companies and major telecommunications
companies have established various partnering arrangements, which could result
in increased competition for Prodigy. Moreover, Prodigy faces competition from
companies that provide broadband connections to households, including local and
long-distance telephone companies, cable television companies and electric
utility companies. Broadband technologies offer significantly faster Internet
access than conventional modems, and the above-listed companies could include
Internet access in their basic service packages, could offer access for a
nominal additional charge or could prevent Prodigy from delivering Internet
access through the cable or wire connections that they own. Some competitors,
such as NetZero, even offer free Internet access services.
Among the larger providers of Internet service providers services are
EarthLink, which has merged with MindSpring, Microsoft Network, AT&T WorldNet,
MCI Internet, IBM Internet Connection, PSINet, GTE Internetworking and
Concentric Network Corporation. Microsoft's ownership of the dominant PC
operating system and the Microsoft Internet Explorer browser may give Microsoft
Network certain competitive advantages, including distribution and marketing
synergies. Prodigy also competes with America Online, which offers the America
Online and CompuServe proprietary online services over closed networks and
Internet access.
Prodigy believes that the principal competitive factors in the Internet
service provider industry are speed and reliability of access, ease of use,
brand name recognition, network coverage, customer service and price. Prodigy
believes that it competes effectively on the basis of these factors.
Government Regulation
Internet access and online services are not subject to direct regulation in
the United States. Changes in the laws and regulations relating to the
telecommunications and media industry, however, could impact Prodigy's
business. For example, the Federal Communications Commission could begin to
regulate the Internet and online services industry, which could result in
increased costs for Prodigy.
The federal Child Online Protection Act, enacted in October 1998, creates
criminal penalties for content on the Internet that may be deemed harmful to
minors. Prodigy has not changed any of its plans or policies as a result of
this statute, and does not believe its current plans or policies violate this
statute. In February 1999, a federal judge enjoined this statute. The federal
Children's Online Privacy Act, also enacted in October 1998 and effective no
earlier than April 2000, will regulate the collection of personal information
from children by commercial Web site operators. Prodigy believes its plans and
policies will enable it to comply with the statute. There also are laws that
make it illegal to traffic in obscene or child pornographic materials,
including by a computer.
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In addition, the applicability to Prodigy of existing laws governing issues,
such as intellectual property ownership, defamation, access to the Internet for
the disabled and personal privacy is uncertain. Courts have indicated that
online service providers and Internet service providers could be held
responsible for the publication of defamatory material or for failure to
prevent the distribution of material that infringes copyrights. Further, the
applicability to Prodigy of international laws and regulations governing the
Internet is also uncertain.
Prodigy does not edit or otherwise monitor the content accessed by
subscribers to Prodigy Internet. In addition, Prodigy blocks access to news
groups that carry child pornography.
In March 1997, Prodigy entered into a consent order with the Federal Trade
Commission, which became effective in March 1998, regarding use of the word
"free" and similar words in advertising, disclosure of the financial terms and
conditions of services, including method of cancellation, practices with
respect to electronic funds transfers and related matters. The consent order
has a duration of twenty years and imposes various record keeping requirements.
Prodigy believes that it is in compliance with the consent order and that its
continuing compliance with the order will not have a negative affect on
Prodigy. America Online is subject to a similar consent order that governs its
marketing of services under both the American Online and CompuServe brands.
In connection with the acquisition of BizOnThe.Net from U.S. Republic,
Prodigy became subject to an agreement between U.S. Republic and the Federal
Trade Commission that became final through a court order in November 1999. The
agreement requires full disclosure of "free" trial offers and cancellation
obligations, the verification of direct-to-phone-bill orders, clear
communication of the submission process and probable placement of customer Web
sites on search engines and various record keeping requirements. Prodigy
believes that it is in compliance with the agreement and that its continuing
compliance will not negatively affect Prodigy's business.
Proprietary Rights
Prodigy owns a variety of trademarks, including "Prodigy(R)", the Prodigy
globe logo, the Prodigy Internet logo, "Prodigy Internet", "Are you a
Prodigy?", "Prodigy MailLink" and others, many of which are the subject of
existing or pending registrations in the United States and various foreign
countries. Prodigy also owns other intellectual property rights, including
proprietary software used in its business. Prodigy protects its proprietary
technology through copyright and trade secrets laws, employee and third-party
confidentiality agreements and other methods.
Prodigy and IBM have licensed each other's entire patent portfolios existing
as of June 17, 1996 and all additional patents issued with respect to patent
applications filed prior to June 1, 1999. Until June 17, 2001, Prodigy is
required to grant IBM most favored nation status with respect to Prodigy's
software that it makes generally available to the public, meaning IBM can
obtain the software on terms no less favorable than any other company.
Employees
At March 31, 2000, Prodigy had 438 full-time employees, of whom 63 were in
sales and marketing, 166 were in technology and product development, 123 were
in customer service, and 86 were in management, finance and administration. As
necessary, Prodigy supplements its regular employees with temporary and
contract personnel, which totaled 130 persons at March 31, 2000.
None of Prodigy's employees is represented by a labor union. Prodigy believes
that its employee relations are good.
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Facilities
Prodigy leases 97,000 square feet of office space in White Plains, New York.
The lease expires December 31, 2004 and Prodigy has the right to offer to
extend the lease on expiration. The current annual base rent is $2,330,000 and
Prodigy is required to pay an allocated portion of taxes and operating
expenses. Prodigy has established a letter of credit in the initial amount of
$3,930,000 to secure the rent payments.
Prodigy also leases 80,000 square feet in Yorktown Heights. The lease expires
February 28, 2001 with two five-year renewal options in Prodigy's favor. The
current annual base rent is $764,000 and Prodigy is required to pay associated
taxes and operating expenses.
Prodigy leases approximately 20,000 square feet of office space in Stafford,
Texas under a lease expiring on September 14, 2003. The current annual base
rent is $69,000.
Prodigy believes that its existing facilities are adequate for its current
needs and that suitable additional space will be available as needed.
Legal Proceedings
In September 1998, Prodigy received a letter from the Office of the Attorney
General of New York notifying Prodigy that the Attorneys General of New York
and 19 other states were investigating the "advertising and certain other
practices" of Prodigy and other unnamed Internet service providers. The letter
stated that the inquiry was a follow-up to the settlement between America
Online and many states in May 1998 concerning the following issues:
.disclosures for free offers;
.representations concerning pricing;
.disclosures concerning premium areas;
.disclosures for communications charges;
.advertising to minors;
.cancellation procedures; and
.unauthorized charges to credit cards or bank accounts and changes to the
service agreement.
The letter requested that Prodigy voluntarily supply various documents and
other information relating to the marketing and provision of its services.
Prodigy has submitted all requested materials. Since July 1999, Prodigy has
allowed the State of New York to share the documents and information submitted
in response to this inquiry with a number of additional states. No legal action
has been initiated against Prodigy as a result of the investigation.
On March 31, 2000, Giovanni R. Viana filed a class action lawsuit against
Prodigy in the 11th Judicial Circuit Court for Dade County, Florida. This class
action lawsuit arises out of the Best Buy mail-in rebate program. The plaintiff
alleges Prodigy violated Florida's Unfair Trade Practices Act when it
represented it would provide rebates and failed to do so. In addition, the
complaint contains a breach of contract claim for failure to pay the rebates.
The plaintiff seeks damages under the breach of contract claim not to exceed
$75,000 per member of the class, as well as actual damages plus attorneys' fees
and litigation costs. Given the early stage of this litigation, no prediction
as to its outcome can be made.
On February 24, 2000, Prodigy was served with a summons and complaint by
Carroll Wesley Chance in a class action lawsuit brought against Best Buy,
Prodigy and Young America in the State Court of Richmond County, State of
Georgia. The case was brought on behalf of the class of similarly situated
consumers who purchased a computer at Best Buy, enrolled in the Prodigy
Internet service under the rebate program and did not receive a rebate check.
The complaint alleges breach of contract, unjust enrichment, conversion and
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negligence. The plaintiffs seek damages not to exceed $74,900 per member of the
class, including actual damages, rebates, interest, punitive damages, court
costs and litigation expenses. Given the early stage of this litigation, no
prediction as to its outcome can be made.
On January 10, 2000, Christa Roberts filed a class action lawsuit in the
Superior Court of the State of California, County of Los Angeles, against
Prodigy, America Online, Circuit City Stores, Fry's Electronic, Microsoft and
other unnamed parties. On February 7, 2000, the plaintiff filed an amended
complaint naming Young H. Kim as the named plaintiff in place of Christa
Roberts. Prodigy has received a copy of the summons and complaint but has not
been properly served in the lawsuit. The lawsuit alleges that Prodigy and the
other defendants offered rebates to consumers and entered into retail sales
contracts with consumers which violated California law and engaged in false
advertising. Ms. Roberts is seeking restitution from the defendants of all sums
related to this conduct. Given the early stage of this litigation, no
prediction as to its outcome can be made.
On October 2, 1999, Irwin Sales filed a lawsuit against Prodigy in the United
States District Court of the Southern District of New York. The lawsuit alleges
that Prodigy breached an independent contractor agreement with the plaintiff
and engaged in fraud arising out of it. The plaintiff seeks $25,000,000 in
damages for the contract claim and $50,000,000 in damages for the fraud claim.
On January 5, 2000 Prodigy served its answer. On February 1, 2000, the
plaintiff filed an amended complaint and, on February 25, 2000, Prodigy filed a
motion to dismiss the plaintiff's fraud claim. Prodigy believes it has
meritorious defenses to the claims and intends to vigorously contest them.
Transactions with Related Parties
Transactions with IBM and Sears
On June 17, 1996, Prodigy's predecessor business, Prodigy Services Company,
was acquired from IBM and Sears for $46,950,000 in cash plus the issuance of
convertible promissory notes valued at $30,500,000. In connection with the
acquisition:
. IBM and Sears assumed Prodigy Services Company's four existing
retirement plans and all obligations thereunder;
. IBM received sole ownership of six patents jointly-owned with Prodigy
Services Company, Prodigy received sole ownership of two other jointly-
owned patents, and IBM and Prodigy entered into patent cross-license
agreements; and
. Prodigy is obligated to indemnify IBM and Sears for claims and
liabilities arising out of Prodigy Services Company's business, whether
arising before or after the closing of the acquisition of Prodigy
Services Company, except with respect to the retirement plans assumed by
IBM and Sears.
Upon the closing of Prodigy's initial public offering in February 1999, IBM
and Sears each surrendered its convertible promissory note and received:
. 2,127,633 shares of common stock, and
. a warrant to purchase 2,409,145 shares of common stock at an exercise
price of $19.50 per share at any time prior to February 16, 2002.
IBM and Sears have customary piggyback and demand registration rights for
their shares. IBM and Sears have agreed to vote their shares of common stock in
accordance with the voting recommendations of Prodigy's board of directors.
In October 1998, Prodigy sold to IBM a version of Prodigy's service provider
platform software enabling an Internet service provider to manage subscriber
data. IBM paid Prodigy $2,000,000, and Prodigy retained a perpetual, royalty-
free license to use and upgrade the software for its own use. Prodigy does not
use this software to manage its own subscriber data.
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Between June 1996 and October 1997, IBM and Sears paid the State of New York
$3.4 million for sales and use taxes assessed against Prodigy Services Company
for periods ended prior to the acquisition of Prodigy Services Company. In
October 1997, Prodigy, IBM and Sears agreed that each of them would be liable
for one-third of all sales and use taxes assessed against Prodigy Services
Company for periods ended prior to the acquisition of Prodigy Services Company,
and Carso Global Telecom paid $567,000 to each of IBM and Sears in light of
prior payments of these taxes by IBM and Sears.
Prior to outsourcing its network to Splitrock, Prodigy utilized a network
backbone and local phone access sites provided by Advantis and subsequently by
IBM Global Services after IBM acquired Sears' interest in Advantis during 1997.
Prodigy also purchases computer equipment from IBM on normal commercial terms.
For network services and equipment purchases, Prodigy paid IBM/Advantis
$15,091,000 during 1996, $33,244,000 during 1997, $8,742,000 during 1998 and
$6,770,000 during 1999.
At the time of outsourcing its network to Splitrock, Prodigy had non-
cancelable commitments to purchase network services from Advantis/IBM Global
Services. In December 1998, to satisfy these commitments, Prodigy agreed to
purchase from IBM, on normal commercial terms, maintenance and voice-related
network services in the amount of $7,500,000 prior to December 31, 2000. If the
amount of these purchases does not equal $7,500,000 by December 31, 2000,
Prodigy must pay the balance in cash on or before December 31, 2000.
Transactions with Carso Global Telecom and Telmex
Stock Purchases by Carso Global Telecom. Pursuant to a funding agreement
entered into in connection with the acquisition of Prodigy Services Company,
Carso Global Telecom granted Prodigy a stock put giving Prodigy the right to
require Carso Global Telecom to purchase up to $125,000,000 of common stock at
a price of $24.00 per share. The dollar amount of the stock put was subject to
reductions. On October 31, 1996, the exercise price of the stock put was
reduced to $12.00 per share.
Carso Global Telecom purchased the following shares of Prodigy in private
transactions prior to Prodigy's initial public offering in February 1999:
<TABLE>
<CAPTION>
Total
Number of Purchase
Date Shares Price Type of Transaction
- ---- ---------- ------------ ---------------------------
<S> <C> <C> <C>
February 1996-September
1996..................... 1,007,750 $ 12,057,750 Purchases from stockholders
March 1996-September
1996..................... 1,750,000 $ 21,000,000 Purchases from Prodigy
October 1996.............. 291,667 $ 3,500,000 Purchase from Prodigy
December 1996............. 675,000 $ 8,100,000 Warrant exercise
March 1997-October 1997... 8,661,538 $103,938,467 Purchases from Prodigy
December 1997............. 12,385,956 $ 49,543,822 Purchase from Prodigy
April 1998................ 3,250,000 $ 13,000,000 Warrant exercise
July 1998................. 1,375,000 $ 11,000,000 Purchase from Prodigy
</TABLE>
The warrants reflected in the above table were granted by Prodigy to Carso
Global Telecom in connection with its financing commitments to Prodigy.
Private Stock Purchases by Telmex. In August 1998, Telmex purchased 6,125,000
shares of common stock from Prodigy for $8.00 per share for a purchase price of
$49,000,000. Pending regulatory approval of the investment, Telmex made an
unsecured, interest-free loan of $49,000,000 to Prodigy. In August 1998, Telmex
also purchased 3,287,500 shares of common stock from two stockholders of
Prodigy for $8.00 per share for a total purchase price of $26,300,000. In
February 1999, Telmex purchased 2,000,000 shares of common stock from Prodigy
for $15.00 per share for a purchase price of $30,000,000.
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Subscriber Management Agreement With Telmex. In January 1999, Prodigy and
Telmex signed an agreement under which Prodigy manages Telmex's Prodigy
Internet de Telmex subscribers in Mexico for a monthly management fee. The fee
is equal to 15% of the invoiced sales price minus discounts, excise taxes and
credits for returns on the first 200,000 subscribers and 10% on additional
subscribers. The agreement expires in January 2004 and may be terminated by
Telmex if Prodigy undergoes a change of control.
Loans from Carso Global Telecom, Telmex and Banco Inbursa. In June 1996,
Prodigy borrowed $48,000,000 from Banco Inbursa, an affiliate of Carso Global
Telecom, in order to pay the cash portion of the purchase price for the
acquisition of Prodigy Services Company and related expenses and subsequently
borrowed an additional $2,000,000. These loans bore interest at the prime rate
plus one-half percentage point. In March 1997, Prodigy repaid $40,000,000 to
Banco Inbursa. Between February 1998 and July 1998, Banco Inbursa loaned
$22,100,000 to Prodigy to fund operations. These loans bore 9% interest and
were due December 31, 1999. In July 1998, Prodigy repaid the $32,100,000 then
owed to Banco Inbursa. Pending regulatory approval of some of the stock put
exercises described above, Carso Global Telecom loaned $71,500,000 to Prodigy
on an interest-free basis, and Banco Inbursa loaned Prodigy $13,650,000 at 9%
interest. These loans were unsecured, and the proceeds were used to finance
Prodigy's operations.
In August 1999, Carso Global Telecom agreed to provide Prodigy with a $130
million revolving line of credit. Advances are due 30 days after borrowing, but
Prodigy is permitted to roll over advances into new advances at its election.
Advances are uncollateralized and bear interest at the LIBOR rate plus between
one and five percentage points as negotiated on a case-by-case basis. As of
February 29, 2000, $96.4 million was outstanding under this line of credit.
In February 2000, Telmex committed to provide Prodigy with financing of up to
$200 million to fund its operations through February 2001.
Transactions with SBC
On March 16, 2000, Prodigy and Citibank signed a letter agreement which
contemplates that Citibank will structure and arrange financing of $200 million
secured by the future service fees payable by contract subscribers to the
Prodigy Internet service. The letter agreement includes a preliminary summary
of principal terms and conditions, estimated expenses and the structuring fee
due Citibank at closing. The letter agreement does not constitute a firm
financing commitment from Citibank, and Prodigy cannot assure that the Citibank
financing will be completed. The Citibank financing is subject to the issuance
by SBC of a performance guarantee and satisfaction of the following conditions:
. satisfactory completion of Citibank's due diligence review of Prodigy;
. in Citibank's determination, the absence of any material adverse change
in the financial markets or in the financial condition or operations of
Prodigy;
. negotiation and execution of mutually satisfactory documentation for the
financing;
. the receipt of specified ratings from ratings agencies; and
. the receipt of internal Citibank credit approval and any other approvals
and legal opinions as Citibank may deem necessary or advisable.
In connection with this financing, SBC has agreed in principle to guarantee
Prodigy's ongoing performance obligations under its customer contracts. Prodigy
and SBC have not fully negotiated the terms of the guarantee. In exchange for
this guarantee, Prodigy and SBC have agreed in principle that SBC will receive
a contingent warrant to purchase 537,924 shares of Prodigy common stock for
$1.00 per share, expiring 3.5 years after the closing date of the Citibank
financing and exercisable only if:
. SBC's performance guarantee is triggered;
. Prodigy's chief executive officer is not then an SBC appointee; and
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. SBC, Carso Global Telecom and Telmex then collectively own, on a fully-
diluted basis, securities representing less than 50% of the voting power
of Prodigy's then outstanding securities.
If the financing were to close on the date hereof, the condition specified in
the last bullet point above would not be satisfied, and Prodigy cannot predict
when, or if, the SBC warrant would become exercisable. See "Prodigy
Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
Allen Craft, an executive officer and director of Prodigy, is employed by
SBC. SBC pays the salary of and provides employee benefits to Mr. Craft. See
"Prodigy's Management--Executive Officers and Directors."
Splitrock Transaction
Prodigy has outsourced its network operations to Splitrock. Carso Global
Telecom owns 30% of Splitrock. Samer F. Salameh, Prodigy's chairman and chief
executive officer, is a former director of Splitrock and holds stock options to
purchase Splitrock common stock. During the years ended December 31, 1997, 1998
and 1999, Prodigy incurred network charges to Splitrock of $22,700,000,
$64,100,000 and $76,600,000 respectively.
Pending Transaction with SBC
Prodigy has a material pending transaction with SBC. See "Pending SBC
Transaction."
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PENDING SBC TRANSACTION
In considering whether to vote in favor of the merger, FlashNet shareholders
should consider the potential impacts of the pending transaction between
Prodigy and SBC Communications Inc. Completion of the merger is not conditioned
on completion of the SBC transaction and completion of the SBC transaction is
not conditioned on completion of the merger. Prodigy anticipates that the SBC
transaction will be completed contemporaneously with the completion of the
FlashNet merger. Prodigy's principal shareholders, who collectively own a
majority of the outstanding shares of Prodigy common stock, have agreed to vote
in favor of the SBC transaction and therefore Prodigy stockholder approval of
the SBC transaction is assured. However, it is possible that the SBC
transaction will not be completed.
Prodigy's current principal stockholders are Carso Global Telecom and Telmex.
Carlos Slim Helu controls Prodigy and Carso Global Telecom and is a director of
SBC. Carso Global Telecom controls Telmex, and SBC owns an equity interest of
approximately 8.9% in Telmex. Carso Global Telecom and SBC have formed other
joint ventures in the past and may do so in the future. Allen Craft, an
executive officer and director of Prodigy, is employed by SBC.
Prodigy has filed a proxy statement with the Securities and Exchange
Commission relating to the SBC transaction. The following summary of the SBC
transaction may not contain all information that is important to FlashNet
shareholders. For a more complete understanding of the SBC transaction,
FlashNet shareholders may read the proxy statement for the SBC transaction. To
learn how you can obtain a copy of that proxy statement from the Securities and
Exchange Commission, please see "Where You Can Find More Information."
Overview and Structure of the SBC Transaction
On November 22, 1999, Prodigy and SBC announced that they had agreed to
establish a strategic relationship in which:
. SBC will acquire an approximate 43% indirect interest in Prodigy;
. Prodigy will be the exclusive retail Internet service marketed by SBC to
consumers and small businesses in the United States;
. SBC will purchase the Prodigy Internet service from Prodigy on wholesale
terms and provide it to SBC's approximately 690,000 existing Internet
subscribers--the wholesale price to be paid by SBC to Prodigy for the
Prodigy Internet service that SBC will resell to its existing Internet
subscribers will equal SBC's average retail price as of the closing less
reasonable and necessary expenses actually incurred by SBC in serving
its existing Internet subscribers;
. SBC has committed to obtain for Prodigy 1,200,000 additional Internet
subscribers over a three-year period--all new subscribers obtained for
Prodigy by SBC will be Prodigy subscribers;
. Prodigy has agreed to pay SBC a fee of between $40 and $75 for each
subscriber obtained by SBC;
. SBC has agreed to pay Prodigy a penalty, under a specified formula, if
SBC does not obtain 1,200,000 additional Internet subscribers for
Prodigy over the three-year period, with the size of the penalty based
on the number of subscribers actually obtained by SBC who pay at least
one monthly bill from Prodigy--for example, the penalty will range from
$165,000,000 if SBC acquires no new subscribers for Prodigy, to
$105,000,000 if SBC acquires 600,000 new subscribers for Prodigy, to no
penalty if SBC acquires 1,200,000 new subscribers for Prodigy;
. SBC will have the exclusive right to market its long-distance phone
service, local phone service, wireless phone services, paging services
and related calling services to Prodigy's subscribers, so long as SBC's
service offerings are competitive with service offerings from other
providers;
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. SBC will be Prodigy's exclusive network provider so long as SBC offers
its network services to Prodigy at the most favorable rates that it
offers to other similar purchasers, so long as SBC's terms are
competitive with those offered by other providers;
. SBC will have the exclusive right to provide telecommunications,
advertising, telecommunications e-commerce and Internet telephony
applications in conjunction with the Prodigy Internet service to
Prodigy's subscribers, so long as SBC's terms are competitive with those
offered by other providers; and
. SBC will be the exclusive provider of electronic yellow and white pages
and city guides to Prodigy's subscribers.
SBC's exclusive rights described in the three preceding bullet points will be
subject to Prodigy's existing agreements with other providers. Prodigy
currently has agreements with other providers of network, telecommunications
and related services. These agreements will not be affected by the SBC's
transaction. When these agreements terminate, SBC's exclusive rights described
above will apply.
In order to implement our strategic relationship with SBC:
. Prodigy will contribute substantially all of its assets and liabilities
and transfer its employees to the operating partnership;
. SBC will contribute to the operating partnership routers, servers and
associated hardware used in connection with SBC's consumer and small
business Internet operations and that are selected by Prodigy because
Prodigy determines that they will be useful in connection with the
provision of services to SBC's customers and Prodigy's customers after
the closing;
. SBC will contribute to the operating partnership intangible assets
consisting primarily of royalty-free licenses to use SBC's trademarks in
connection with the marketing and operation of the Prodigy Internet
service and Prodigy's right to manage SBC's existing Internet customers;
. Prodigy will receive an initial interest in the operating partnership of
approximately 57%;
. SBC will receive an initial interest in the operating partnership of
approximately 43%; and
. SBC may convert its interest in the operating partnership into a direct
equity interest in Prodigy at any time, or may require the operating
partnership to be merged into Prodigy at any time.
As a result of this structure, Prodigy will become a holding company and its
principal asset will be its interest in the operating partnership. Upon the
liquidation of the operating partnership, the assets contributed by Prodigy and
SBC will be distributed to them after payment of the operating partnership's
liabilities.
Following the SBC transaction, Prodigy will:
. provide the Prodigy Internet service to SBC's existing Internet
subscribers;
. continue to provide the Prodigy Internet service to Prodigy's current
subscribers;
. obtain additional Prodigy Internet subscribers through SBC's marketing
efforts; and
. continue to obtain new Prodigy Internet subscribers through Prodigy's
existing and new channels on a nationwide basis.
At the closing, Prodigy will also issue to the SBC subsidiary one share of
Prodigy Class B common stock in consideration of $100. Prodigy Class B common
stock will be convertible at any time, on a one-for-one basis, into the same
number of shares of Prodigy Class A common stock. When transferred to any
person or entity not affiliated with SBC, Prodigy Class B common stock will
automatically convert into Prodigy Class A common stock. Only one share of
Class B common stock will be authorized for issuance and Prodigy does not
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anticipate issuing any additional shares of Class B common stock to SBC or
anyone else. As part of its strategic relationship with SBC, Prodigy will also
amend its certificate of incorporation and by-laws to implement the following
corporate governance arrangements:
. SBC will have the right to appoint three Prodigy directors;
. Carso Global Telecom and Telmex, Prodigy's current principal
stockholders, will have the right to appoint three Prodigy directors;
. Prodigy's other three directors will be its chief executive officer and
two independent directors;
. Prodigy's board will establish a new executive steering committee, which
must approve all major corporate actions prior to being submitted to the
board for consideration; and
. SBC will have the right to appoint two members of the executive steering
committee and Carso Global Telecom an Telmex will have the right to
appoint the other two members of the executive steering committee.
The structure of the SBC transaction is depicted below:
[FLOW CHART APPEARS HERE]
As a result of the SBC transaction:
. Prodigy will be a holding company;
. Prodigy's sole assets will consist of the approximate 57% interest in
the operating partnership and rights under stock-related agreements and
plans;
. Prodigy's sole business will be to act as the general partner of the
operating partnership;
. Prodigy will become an affiliate of SBC and will become subject to the
restrictions imposed on affiliates of Bell operating companies under the
federal Communications Act.
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Rights of Prodigy Stockholders Following the SBC Transaction
Prodigy's stockholders, including FlashNet's former shareholders if the
FlashNet merger is completed, will exchange their Prodigy common stock for
Prodigy Class A common stock. Prodigy Class A common stock will be listed on
the Nasdaq National Market and will be freely tradeable to the same extent as
Prodigy common stock formerly was. Holders of Prodigy Class A common stock will
generally have rights identical to holders of Prodigy Class B common stock,
except that:
. each holder of Prodigy Class A common stock will be entitled to one vote
per share; and
. the SBC subsidiary that holds Prodigy Class B common stock will be
entitled to one vote for the share of Prodigy Class B common stock held
by it and one vote for each unit in the operating partnership not held
by Prodigy.
SBC will have the right to directly elect three of Prodigy's nine directors.
Otherwise, holders of Prodigy Class A common stock and Prodigy Class B common
stock generally will vote together as a single class on all matters, including
the election of the directors who are not elected directly by SBC. SBC, as
holder of Prodigy Class B common stock, may approve a merger of the operating
partnership into Prodigy by a vote of at least 75% of Prodigy Class B common
stock without a vote of the holders of Prodigy Class A common stock.
Governance of Prodigy and the Operating Partnership Following the SBC
Transaction
As sole general partner of the operating partnership, Prodigy will have
unilateral control over all of the affairs and decision making of the operating
partnership. As the sole general partner, Prodigy will be responsible for
nearly all operational and administrative decisions of the operating
partnership and the day-to-day management of the operating partnership's
business. With some exceptions, Prodigy cannot be removed as the sole general
partner of the operating partnership and the operating partnership cannot be
dissolved without Prodigy's approval.
Upon issuance of the units and Prodigy Class B common stock to the SBC
subsidiary, the number of units owned by Prodigy will equal the number of
outstanding shares of Prodigy common stock. After the closing, the number of
units owned by Prodigy is intended to be at all times equal to the number of
shares of outstanding common stock of Prodigy. The net cash proceeds received
by Prodigy from any issuance of shares of common stock, such as from the
exercise of options and warrants, will be concurrently transferred to the
operating partnership in exchange for units equal in number to the number of
shares of Prodigy common stock issued by Prodigy.
Following the SBC transaction, Prodigy's board of directors will consist of
nine members:
. three directors elected by SBC;
. three directors designated by Carso Global Telecom and Telmex;
. Prodigy's chief executive officer; and
. two independent directors.
Following the SBC transaction, Prodigy will establish an executive steering
committee of the board of directors. This committee will consist of four
members, two of whom will be selected by the directors elected by SBC and two
of whom will be selected by the directors designated by Carso Global Telecom
and Telmex. The purpose of the committee will be to evaluate all major
corporate actions of Prodigy and its subsidiaries, such as mergers,
acquisitions, capital expenditures or borrowings in excess of $20,000,000. The
executive steering committee must approve major corporate actions before it
submits them to the board of directors of Prodigy for approval.
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Please see "Prodigy's Management" to learn about Prodigy's current
management.
Directors of Prodigy Following the SBC Transaction
Samer F. Salameh, as Prodigy's current chief executive officer, will remain a
director upon completion of the SBC transaction. Carso Global Telecom and
Telmex have indicated to Prodigy that two of their designees to Prodigy's board
will be James M. Nakfoor and Jaime Chico Pardo, whose biography appears below,
but that they have not yet selected their third designee. SBC has indicated to
Prodigy that its three designees to Prodigy's board will be James D. Gallemore,
James S. Kahan and Charles J. Roesslein, whose biographies appear below. Carso
Global Telecom, Telmex and SBC have not yet indicated to Prodigy who their
representatives on the executive steering committee will be. Prodigy expects
that Allen Craft, Arturo Elias and Alfredo Sanchez will resign as directors
upon completion of the SBC transaction. Prodigy intends to appoint two
independent directors within ninety days after completion of the SBC
transaction. As a result, FlashNet stockholders should understand that the
composition of the Prodigy board of directors following completion of the SBC
transaction will be significantly different than the directors elected at the
annual meeting.
Jaime Chico Pardo, age 50, currently serves as vice chairman and chief
executive officer of Telmex, which he joined as chief executive officer in
1995. From 1993 to 1995, Mr. Chico Pardo was president and chief executive
officer of Grupo Condumex, S.A. de C.V., a manufacturer of products for the
construction, automobile and telecommunications industries. Mr. Chico Pardo is
also vice chairman of Carso Global Telecom and a director of Grupo Carso and
Grupo Financiero Inbursa, both of which are affiliated with Carso Global
Telecom. He also serves as a director of Honeywell International Inc., a
diversified technology and manufacturing company.
James D. Gallemore, age 48, has served as executive vice president--SBC
Strategic Marketing & Planning of SBC Operations, Inc. since April 1997.
Previously, he was vice president--marketing for Southwestern Bell Operations
from 1995 until April 1997. He served as vice president--marketing of
Southwestern Bell Telephone from 1994 to 1995 and as its assistant vice
president--marketing from 1992 to 1994. From 1973 to 1992, he held various
marketing and sales positions with SBC companies.
James S. Kahan, age 52, has been employed by various SBC affiliates since
1983. He has served as SBC's senior executive vice president--corporate
development since October 1999. He was SBC's senior vice president--corporate
development from 1992 to October 1999. Previously, he was managing director--
corporate development from 1988 to 1992. Mr. Kahan is also a director of Bell
Canada and Amdocs Ltd., a leading provider of product-driven information system
solutions to major telecommunications companies.
Charles J. Roesslein, age 51, has served as a senior vice president of SBC
since March 2000. From October 1999 to March 2000, he was president-SBC CATV,
responsible for SBC's cable television operations at Ameritech and Southern New
England Telephone. From 1997 to 1999, Mr. Roesslein was president and chief
executive officer of SBC Technology Resources, responsible for the development
of SBC's long-term technology strategies. He was vice president-information
services of Southwestern Bell Telephone Company and vice president-chief
information officer for SBC Services, Inc. from 1995 to 1997, except for the
period from October 1996 to August, 1997, when he served as SBC's vice
president-strategic planning. From 1990 to 1994, Mr. Roesslein served as vice
president-chief financial officer and treasurer for Southwestern Bell Telephone
Company. Previously he held a variety of network, strategic planning, corporate
development and finance positions with SBC companies, dating back to 1970.
Impact of Failure to Complete SBC Transaction
If the SBC transaction is not completed, Prodigy's business would be
significantly different. Failure to complete the SBC transactions would mean
that Prodigy would not acquire access to SBC's existing subscribers and would
not have the benefit of the strategic and marketing agreement, under which SBC
has committed to deliver an additional 1,200,000 subscribers and to market
Prodigy Internet as its exclusive consumer service for the term of the
agreement. As a result, the failure to complete the SBC transaction would
adversely impact Prodigy's ability to become a leading provider of high speed
DSL Internet access services and would also adversely affect Prodigy's ability
to increase its non-subscription revenue. Please see "Prodigy's Principal
Stockholders" for a comparison of the ownership of Prodigy if the SBC
transaction is not completed.
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PRODIGY'S MANAGEMENT
Executive Officers and Directors
The executive officers and directors of Prodigy and their ages and positions
with Prodigy are as follows:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Samer F. Salameh........ 35 Chairman of the Board and Chief Executive Officer
Alfredo Sanchez......... 44 Vice Chairman of the Board
David C. Trachtenberg... 37 President and Chief Operating Officer
Allen Craft............. 44 Executive Vice President of Finance, Chief Financial Officer,
Treasurer and Director
Andrea S. Hirsch........ 42 Executive Vice President, Business Development, General Counsel
James R. Adams(1)(2).... 60 Director
Arturo Elias(1)......... 33 Director
James M. Nakfoor(1)(2).. 36 Director
</TABLE>
- --------
(1) Member of the Compensation Committee
(2) Member of the Audit Committee
Mr. Salameh has served as chief executive officer and a director of Prodigy
since September 1997, as chairman of the board since August 1998, and served as
president from September 1997 to December 1998. From July 1994 until joining
Prodigy, Mr. Salameh served as director, long distance division of SBC,
responsible for marketing, strategy, positioning, product management and
product development with respect to Telmex. Mr. Salameh was employed by MCI
Telecommunications as a product manager in 1994 and as a strategic marketing
manager from 1991 to 1993. Mr. Salameh holds a Master's degree from the
Fletcher School of Law and Diplomacy, a B.S. degree in Management and
Technology Transfer from Polytechnic University of New York and a Baccalaureate
degree with a concentration in Math and Physics from Lycee Fenelon in Paris. He
also serves as an advisor to the chief executive officer of Telmex.
Mr. Sanchez joined Prodigy's board of directors in June 1996 and became vice
chairman in August 1998. Mr. Sanchez has served as president of Uninet, S.A. de
C.V., a wholly-owned subsidiary of Telmex through which Telmex provides data
transmission services and Internet access to customers, since January 1996. He
has also served as president of Consorcio Red Uno, S.A. de C.V., a network
company founded by Mr. Sanchez and now owned by Telmex, since March 1991. From
1985 to March 1991, he was president of Onyx Systems, a Unix microcomputer
manufacturer with operations in the United States, Europe and Mexico. Mr.
Sanchez previously held various communications and transportation positions in
the Mexican government. Mr. Sanchez holds a degree in Electronics Engineering
from the Metropolitan Autonomous University of Mexico.
Mr. Trachtenberg joined Prodigy as president and chief operating officer in
December 1998. Prior to joining Prodigy, Mr. Trachtenberg was employed for more
than eight years by MCI Communications Corporation and then MCI WorldCom, Inc.
From September 1997 to December 1998, Mr. Trachtenberg was executive director
of online marketing, responsible for residential and small business Internet
operations, and from January 1997 to September 1997, he served as executive
director of Brand Marketing, responsible for the MCI One brand portfolio,
including domestic and international long distance products, calling card
services and advanced services for the consumer and small business segments.
Between March 1990 and January 1997, he held various other marketing and
business development positions, including director of Customer Marketing and
director of International Marketing. Prior to joining MCI, Mr. Trachtenberg was
employed for four years by Bain & Company, an international consulting firm.
Mr. Trachtenberg received a B.A. degree, summa cum laude, from Tufts
University, and received an M.B.A degree from the Wharton School of Business at
the University of Pennsylvania, where he also received a Masters in
International Affairs and was a Fellow at the Lauder Institute.
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Mr. Craft joined Prodigy as executive vice president of finance, chief
financial officer, treasurer and a director in March 2000. He has been employed
by SBC since 1993, serving as director of finance of SBC International from
March 1998 until March 2000, director of corporate financial planning from
August 1996 to February 1998 and manager of financial planning from June 1993
to August 1996. Previously, Mr. Craft was manager of financial planning at the
Permea division of Air Products from April 1990 to May 1993 and a plant
controller for Monsanto from December 1986 to March 1990. He holds a B.B.A.
degree from the University of Central Florida and an M.B.A. degree from the
University of Texas.
Ms. Hirsch joined Prodigy in September 1998 as executive vice president,
business development and general counsel. Prior to joining Prodigy, Ms. Hirsch
served as vice president, corporate development counsel for Simon & Schuster,
Inc., a publishing company, from March 1994 to September 1998, and as Assistant
General Counsel for Macmillan, Inc., a publishing company, from June 1991 to
January 1994. Ms. Hirsch holds a B.A. degree from Queens College and a J.D.
degree from Washington College of Law at American University.
Mr. Adams joined Prodigy's board of directors in May 1999. Mr. Adams served
as chairman of the board of Texas Instruments Inc. from July 1996 to May 1998.
From November 1989 to August 1995, he served as president and chief executive
officer of Southwestern Bell Telephone Company, before becoming group president
of SBC. He currently serves as a director of Texas Instruments, Inet
Technologies and Storage Tek Corp.
Mr. Elias joined Prodigy's board of directors in September 1997. He served as
consulting advisor to the president of Telmex from September 1996 to May 1998
and has since served as head of commercial new technologies and regulation for
Telmex. Since 1994, he has also been a private investor in Mexican real estate,
textile and retail businesses. Mr. Elias is also a director of Carso Global
Telecom, Telmex, Sears Roebuck de Mexico and several privately-held companies.
Mr. Elias studied Business Administration at Anahuac University and received a
Master in Business Management degree from the Instituto Panamericano de Alta
Direccion de Empresa.
Mr. Nakfoor joined Prodigy's board of directors in September 1997. Since
1991, Mr. Nakfoor has served as vice president of securities trading for
Inversora Bursatil, S.A. de C.V., a wholly-owned subsidiary of Grupo Financiero
Inbursa, S.A. de C.V., which is engaged in the securities brokerage, investment
banking and money management businesses in Mexico. Grupo Financiero, which is
affiliated with Carso Global Telecom, is a Mexican financial group whose
businesses include banking, brokerage, insurance, leasing, factoring and other
financial services. Mr. Nakfoor holds a B.A. degree in Economics and an M.B.A.
degree from the University of Texas at Austin.
Messrs. Salameh, Sanchez, Elias and Nakfoor were elected directors of Prodigy
pursuant to a voting agreement between Carso Global Telecom and a former
principal stockholder of Prodigy. The voting agreement was terminated in August
1998.
Officers of Prodigy serve at the discretion of the board of directors and
hold office until their successors are duly elected and qualified or until
their earlier resignation or removal.
Carlos Slim Helu, a Mexican citizen, and members of his immediate family,
beneficially own a majority of the outstanding voting equity securities of
Carso Global Telecom. Carso Global Telecom may be deemed to control Telmex
through the regular-voting shares of Telmex that it owns directly and its
interest in a trust which owns a majority of Telmex's outstanding regular-
voting shares. Thus, Mr. Slim and members of his immediate family may be deemed
to control Carso Global Telecom, Telmex and Prodigy. Mr. Salameh is married to
Mr. Slim's niece, and Mr. Elias is married to Mr. Slim's daughter. There are no
other family relationships among Prodigy's directors, executive officers and
principal shareholders and their affiliates.
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Committees of the Board of Directors
The board of directors has an audit committee and compensation committee.
There is no standing nominating committee of the board of directors. The audit
committee, which is composed of Messrs. Adams and Nakfoor:
. reviews the annual financial statements of Prodigy prior to their
submission to the board;
. consults with Prodigy's independent accountants to review financial
results, internal financial controls and procedures, audit plans and
recommendations; and
. recommends to the board the selection, retention or termination of
independent accountants and approve services provided by independent
accountants.
The compensation committee, composed of Messrs. Adams, Elias and Nakfoor,
makes recommendations to the board regarding the compensation of executive
officers, key managers and directors and administers Prodigy's stock plans.
Director Compensation
All directors are reimbursed for their expenses in attending board and
committee meetings in accordance with Prodigy's expense reimbursement policies.
Directors who are also employees of Prodigy do not receive additional
compensation for serving as directors.
In January 1999, Prodigy's board of directors and stockholders adopted
Prodigy's 1999 outside director stock option plan. The director plan permits
the issuance of up to 250,000 shares of common stock on the exercise of options
granted under the director plan. All options granted under the director plan
are non-statutory stock options. Pursuant to the director plan, each director
of Prodigy who was not then employed by Prodigy received on the closing of
Prodigy's initial public offering an option to purchase 30,000 shares of common
stock at an exercise price equal to the price per share at which shares were
sold in the initial public offering. Accordingly, Messrs. Sanchez, Elias and
Nakfoor each received 30,000 options on the closing of the initial public
offering at an exercise price of $15.00 per share. Thereafter, each new non-
employee director will receive, on his or her initial election to the board of
directors, an option to purchase an option to purchase 30,000 shares of common
stock at an exercise price equal to the fair market value of the common stock
on the date of grant. As a result, Mr. Adams received an option to purchase
30,000 shares at an exercise price of $25.625 on his initial election to the
board of directors on May 17, 1999. All options granted under the director plan
vest in four equal annual installments, based on continued service as a
director, and expire three months after termination of service as a director.
In the event of an acquisition of Prodigy, 50% of all then unvested options
will accelerate and become exercisable.
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Executive Compensation
The following lists the total compensation earned in the years ended December
31, 1997, 1998 and 1999 for Prodigy's chief executive officer, its two other
most highly compensated executive officers in 1999 who were serving as
executive officers on December 31, 1999, and four former executive officers who
were not serving as executive officers on December 31, 1999. These current and
former executive officers are sometimes referred to as the named executive
officers.
Summary Compensation Table
<TABLE>
<CAPTION>
Annual Compensation Long-Term Compensation
-------------------------------------- --------------------------
Securities
Other Annual Underlying All Other
Name and Principal Position Year Salary Bonus Compensation Options(1) Compensation(2)
- --------------------------- ---- -------- -------- ------------ ---------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Current Executive
Officers:
Samer F. Salameh......... 1999 $241,667 $127,250 -- -- $4,800
Chairman of the Board 1998 $200,000 $ 65,084(3) -- -- $6,000
and
Chief Executive Officer 1997 $ 50,000 $ 90,000 -- 156,250 $1,250
David C. 1999
Trachtenberg(4)......... $224,000 $115,828(3) -- -- $4,200
President and Chief 1998 $ 11,056 -- -- 125,000 --
Operating
Officer 1997 -- -- -- -- --
Andrea S. Hirsch(5)...... 1999 $201,083 -- -- -- $4,800
Executive Vice 1998 $ 56,878 $180,000 -- 93,750 --
President, Business 1997 -- -- -- -- --
Development, General
Counsel and Acting Chief
Financial Officer
Former Executive
Officers:
James P. Dougherty(6).... 1999 $126,667 $ 49,876 $148,346(7) -- $3,978
Former General Manager, 1998 $171,138 $ 44,904 -- -- $4,404
Business
Services 1997 $ 15,385 -- -- 93,750 $ 462
David R. Henkel(8)....... 1999 $201,083 $ 80,898 -- -- $4,800
Former Executive Vice 1998 $ 79,167 -- -- 187,500 $2,375
President,
Finance and Chief 1997 -- -- -- -- --
Financial
Officer
James L'Heureux(9)....... 1999 $149,686 $ 60,000 $ 12,423(7) -- --
Former Executive Vice 1998 $190,000 $ 11,756 -- 43,750 --
President,
Consumer Services 1997 $ 86,474 $ 40,000 -- 50,090 --
Carena M. Pooth(10)...... 1999 $174,167 $ 87,875 -- -- $4,800
Former Executive Vice 1998 $181,250 $ 26,250 -- 68,750 $4,313
President,
Technology 1997 $161,458 $ 22,500 -- -- $4,800
</TABLE>
- --------
(1) Represents the number of shares covered by options to purchase shares of
Prodigy's common stock. Prodigy has never granted any stock appreciation
rights.
(2) Represents company matching contributions under Prodigy's 401(k) plan.
(3) Includes payments for car and housing expenses.
(4) Commenced employment with Prodigy in December 1998.
(5) Commenced employment with Prodigy in September 1998.
(6) Ceased employment with Prodigy in August 1999.
(7) Represents severance payments and vacation payouts.
(8) Resigned as an executive officer of Prodigy in December 1999.
(9) Ceased employment with Prodigy in January 1999.
(10) Ceased employment with Prodigy in February 1999.
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<PAGE>
Option Grants During 1999
Prodigy did not grant stock options to any of the named executive officers
during the year ended December 31, 1999.
1999 Year-End Option Values
The following table sets forth information about option exercises during 1999
by the named executive officers and the number and value of unexercised options
held by each of the named executive officers on December 31, 1999. No named
executive officer exercised a stock option during 1999.
Aggregated Option Exercises In Last Fiscal Year And Fiscal Year-end Option
Values
<TABLE>
<CAPTION>
Number of Securities Value of Unexercised
Underlying Unexercised In-The-Money Options
Value Options at Fiscal Year End at Fiscal Year End(2)
Shares Acquired Realized ------------------------------- -------------------------
Name on Exercise (1) Exercisable Unexercisable Exercisable Unexercisable
---- --------------- -------- ----------- -------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Current Executive
Officers:
Samer F. Salameh........ 68,750 $1,489,844 43,750 43,750 $672,656 $ 672,656
David C. Trachtenberg... -- $ -- 41,666 83,334 $592,701 $1,185,424
Andrea S. Hirsch........ 5,000 $ 109,998 26,250 62,500 $298,594 $ 710,938
Former Executive
Officers:
James P. Dougherty...... 68,750 $1,561,792 -- -- $ -- $ --
David R. Henkel......... 84,085 $1,486,052 9,323 94,092 $106,049 $1,070,296
James L'Heureux......... 27,083 $ 706,241 -- -- $ -- $ --
Carena M. Pooth......... 93,750 $1,577,475 -- -- $ -- $ --
</TABLE>
- --------
(1) Represents the difference between the exercise price and the fair market
value of Prodigy common stock on the date of exercise.
(2) Represents the difference between the fair market value of Prodigy common
stock at December 31, 1999 ($19.375) and the option exercise price.
Employment Agreements
Current Executive Officers
Mr. Salameh is employed under an employment agreement that expires on
December 31, 2000 under which he currently receives an annual base salary of
$200,000. Mr. Salameh received a sign-on bonus of $90,000 and is eligible to
receive an annual performance bonus of up to 50% of his base salary, contingent
on the successful completion of mutually established personal and corporate
goals. Mr. Salameh is also eligible to participate in all of Prodigy's fringe
benefit programs. Prodigy has agreed to provide Mr. Salameh with a monthly
housing allowance of $4,000, a monthly car allowance of $1,050 and monthly
round-trip airfare between New York and Mexico City. Mr. Salameh was also
entitled to accelerated vesting of stock options as a result of the closing of
Prodigy's initial public offering in February 1999. In the event Prodigy
terminates Mr. Salameh's employment other than for cause, or does not offer by
November 1, 2000 to renew his employment agreement for at least one year, Mr.
Salameh will continue to receive his base salary and fringe benefits for a
period of 12 months and will receive a severance payment equal to one week's
base salary for each six months of completed service with Prodigy. If Mr.
Salameh is terminated for any reason, Prodigy is required to pay up to $40,000
of Mr. Salameh's expenses to relocate out of the New York City area.
Mr. Trachtenberg is employed under an employment agreement that expires on
December 31, 2001 under which he currently receives an annual base salary of
$224,000. Mr. Trachtenberg received a sign-on bonus of $74,000 and is eligible
to receive an annual performance bonus of up to 50% of his base salary,
contingent on the successful completion of personal and corporate goals as
mutually established. Mr. Trachtenberg is also eligible to participate in all
of Prodigy's fringe benefit programs. Prodigy has agreed to provide
Mr. Trachtenberg with a
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monthly car allowance of $2,166 and up to $5,000 to terminate his previous car
lease. For the first six months of employment, Prodigy agreed to reimburse his
reasonable temporary housing expenses and weekly commuting expenses between New
York and Washington, D.C., and thereafter Prodigy will reimburse his relocation
expenses and provide a monthly housing allowance of $3,500. Prodigy has also
agreed to reimburse Mr. Trachtenberg's reasonable legal fees for review of his
employment agreement. In the event Prodigy terminates Mr. Trachtenberg's
employment other than for cause, he will continue to receive his base salary
for a length of time based on his length of service and will receive
accelerated vesting of options.
Ms. Hirsch is employed under an employment agreement that expires on
September 13, 2001 and under which she currently receives an annual base salary
of $203,000. Prodigy paid Ms. Hirsch a sign-on bonus of $180,000. Ms. Hirsch is
eligible to receive an annual performance bonus of up to 50% of her base
salary, contingent on the successful completion of personal and corporate goals
as mutually established. Ms. Hirsch is also eligible to participate in all of
Prodigy's fringe benefit programs. In the event Prodigy terminates Ms. Hirsch's
employment other than for cause after Ms. Hirsch's third month of service with
Prodigy, Ms. Hirsch will continue to receive her base salary and fringe
benefits for six months and will be entitled to accelerated vesting of stock
options. In the event that Prodigy has not offered to renew her employment
agreement prior to its expiration, Ms. Hirsch will continue to receive her base
salary and fringe benefits for six months and will be entitled to receive a
performance bonus for the six-month period. In the event Prodigy terminates
Ms.Hirsch's employment other than for cause, she will continue to receive her
base salary for a length of time based on her length of service and will
receive accelerated vesting of options.
Mr. Craft is employed by SBC but serves as executive vice president of
finance, chief financial officer, treasurer and a director of Prodigy. SBC pays
the salary of and provides employee benefits to Mr. Craft. Prodigy provides Mr.
Craft with a monthly housing allowance, a monthly car allowance and the use of
a cellular phone.
Former Executive Officers
Mr. Dougherty was employed under an employment agreement scheduled to expire
on November 24, 2001 providing for an annual base salary of $190,000, a sign-on
bonus of $20,000 and an annual performance bonus of up to 50% of his base
salary, customary fringe benefits and other customary provisions. Effective
August 31, 1999, Mr. Dougherty resigned, and Prodigy agreed to pay him a lump
sum severance payment equal to nine months of base salary. Prodigy also agreed
that 25,000 of Mr. Dougherty's options would vest on termination of employment.
Mr. Henkel was employed under an employment agreement providing for an annual
base salary off $190,000 subject to annual review and increase, an annual
performance bonus of up to 50% of his base salary, a monthly housing allowance
of $3,000, allowances for airfare between New York City and Dallas for
Mr. Henkel and members of his family during the first year of his employment,
relocation expenses of up to $3,000, customary fringe benefits and other
customary provisions. Effective December 31, 1999, Mr. Henkel resigned as a
director and officer but agreed to work as a part time employee of Prodigy for
one fifth of his annual base salary until February 28, 2000. Prodigy agreed to
pay him an annual performance bonus of up to 50% of his annual base salary for
1999 and continued fringe benefits through the end of his part time employment.
Prodigy also agreed that 93,408 of his stock options would remain vested and
exercisable through June 30, 2000 and that an additional 47,046 of his options
would vest upon the closing of the SBC transaction and would remain vested and
exercisable for three months from the closing of the SBC transaction.
Mr. L'Heureux was employed under an employment agreement scheduled to expire
on May 31, 2000 providing for an annual base salary of $190,000 subject to
annual review and increase, a sign-on bonus of $40,000, an annual performance
bonus of up to 50% of his base salary, customary fringe benefits and other
customary provisions. Effective January 13, 1999, Mr. L'Heureux resigned, and
Prodigy agreed to pay him a performance bonus of $60,000 for 1998 and severance
consisting of a lump sum payment of $11,000 and continued salary and fringe
benefits for nine months. Prodigy also agreed that 27,083 of Mr. L'Heureux's
options would remain vested and exercisable through September 30, 1999.
Ms. Pooth was employed under an employment agreement scheduled to expire on
May 31, 2000 providing for an annual base salary of $190,000. Ms. Pooth was
eligible to receive an annual performance bonus of up to
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50% of her base salary, contingent on the successful completion of personal and
corporate goals as mutually established. Ms. Pooth was eligible to participate
in all of Prodigy's fringe benefit programs, and was entitled to accelerated
vesting of stock options on a change in control of Prodigy. Effective February
28, 1999, Ms. Pooth resigned from Prodigy, and pursuant to her employment
agreement, she is entitled to salary continuation for nine months and all of
her options accelerated and will remain exercisable through December 31, 1999.
Stock Plans
1996 Stock Option Plan
Prodigy's 1996 stock option plan permits the issuance of up to 3,125,000
shares of Prodigy common stock on the exercise of options granted under the
option plan. The option plan is currently administered by the compensation
committee of the board of directors. Under the option plan, the board or
compensation committee may grant incentive stock options within the meaning of
Section 422 of the Internal Revenue Code and non-statutory stock options not
intended to qualify as incentive stock options. Stock options may be granted
under the option plan to employees, directors, consultants and advisors of
Prodigy. Only employees of Prodigy and its subsidiaries are eligible to receive
incentive stock options. The option plan expires in June 2006.
Subject to the provisions of the option plan, the board and compensation
committee have the authority to determine:
. to whom options will be granted;
. the time when options my be granted;
. the number of shares to be covered by each option;
. when the option becomes exercisable; and
. the exercise price of the option.
In the case of incentive stock options, the exercise price may not be less
than the fair market value of Prodigy common stock on the date of grant, or in
the case of incentive stock options granted to employees who own, directly or
indirectly, more than 10% of the total combined voting power of all classes of
stock of Prodigy, 110% of the fair market value of Prodigy common stock on the
date of the grant. Prodigy's chief executive officer has authority, without
prior board or compensation committee approval, to grant options under the
option plan and to determine the terms of these options, provided that no
grants may be made to executive officers and options may not exceed 25,000
shares per employee per year.
As of March 31, 2000:
. there were outstanding options to purchase an aggregate of 1,600,371
shares at a weighted-average price of $11.23 per share;
. an aggregate of 1,243,537 shares had been issued on exercises; and
. 281,092 additional shares were reserved for future option grants.
1999 Stock Option Plan
At its 2000 annual meeting of stockholders, Prodigy is also requesting
stockholder approval of a 1999 stock option plan covering 5,600,000 shares of
Prodigy common stock.
As of March 31, 2000, under the 1999 stock option plan:
. there were outstanding options to purchase an aggregate of 2,181,290
shares at a weighted-average price of $19.11 per share;
. no shares had been issued on exercises; and
. 3,418,710 additional shares were reserved for future option grants.
1999 Employee Stock Purchase Plan
In January 1999, Prodigy's board of directors and stockholders adopted the
1999 employee stock purchase plan. The purchase plan authorizes the issuance of
up to 500,000 shares of Prodigy common stock to eligible
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employees of Prodigy and its subsidiaries. Employees are eligible to join the
purchase plan if their customary employment is more than 20 hours per week and
for more than five months in any calendar year. Employees who own directly or
indirectly, taking into account the shares subject to purchase under the
purchase plan, 5% or more of the total combined voting power or value of all
classes of stock of Prodigy are not eligible to participate.
The purchase plan permits shares to be purchased at the end of purchase
periods occurring during each offering periods. Unless otherwise provided by
the board prior to commencement, an offering period will begin on each May 16
and November 16, and continue for a period of 24 months. A purchase period will
begin on each May 16 and November 16, and will continue for a period of six
months, ending on the following November 15 or May 15, respectively. The first
offering period and the first purchase period commenced on Prodigy's initial
public offering. The last day of each purchase period is the date on which
shares are actually purchased.
Each eligible employee may enroll in an offering period by filing an election
by the first payroll date occurring during the offering period or up to 45 days
after the start of the offering period if approved in advance by the board,
provided that the eligible employee is not already participating in an offering
period which began earlier. When enrolling in an offering period, the employee
must specify the amount to be withheld from pay on each payroll date during the
offering period, which cannot exceed 10% of the employee's basic rate of pay,
determined at the beginning of the offering period.
The amount withheld from a participating employee's pay is credited to his or
her account under the purchase plan. Unless the electing employee withdraws
from participation, in which case the employee will be refunded the amount in
his account, without interest, the funds in his or her account will be used on
each purchase date to purchase that number of shares which can be purchased at
a price equal to the lower of 85% of the fair market value of the shares on the
first date of the offering period and 85% of the fair market value of the
shares on the purchase date. Fair market value means the last sale price of
Prodigy common stock on the Nasdaq National Market on the applicable day.
The number of shares otherwise subject to purchase by an employee on a
purchase date will be reduced proportionately if the number of shares available
under the purchase plan, or available with respect to the offering period, is
not sufficient to satisfy the purchase rights of all employees on that date. In
addition, the number of shares otherwise subject to purchase on a purchase date
will be reduced to the extent necessary to insure that the employee's right to
acquire shares under the purchase plan does not accrue at a rate which exceeds
$25,000 in fair market value, as determined on the first day of the offering
period of reference, for each calendar year during which the employee was an
active participant in the purchase plan.
If an employee terminates employment for any reason, including death or
disability, or withdraws from an offering period, the employee will not be
entitled to acquire shares on any succeeding purchase date occurring with
respect to the offering period, and the amount in his or her account will be
refunded without interest. An employee withdrawing from an offering period will
not be entitled to rejoin the purchase plan with respect to the offering period
but may, if the employee otherwise qualifies, rejoin the purchase plan with
respect to any subsequent offering period.
The purchase plan is administered by the compensation committee of the board.
The amounts paid to Prodigy with respect to the purchase of shares may be used
for any corporate purpose. The employees participating in the purchase plan
will have no interest, voting rights or other privileges with respect to the
shares until they receive a certificate representing the shares.
Compensation Committee Interlocks and Insider Participation
The current members of the compensation committee of the board of directors
are Messrs. Adams, Elias and Nakfoor. Mr. Salameh makes recommendations and
participates in discussions regarding executive compensation but he does not
participate directly in discussions regarding his own compensation. No
executive officer of Prodigy has served as a director or member of the
compensation committee or other committee serving an equivalent function of any
other entity, whose executive officers served as a director of or member of the
compensation committee of the board of directors.
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PRODIGY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the risk factors,
selected financial information, pro forma financial statements and historical
financial statements.
Prodigy is a leading national Internet service provider. In October 1996,
Prodigy launched Prodigy Internet, an open standards-based Internet access
service. Since the autumn of 1997, Prodigy has focused on expanding the Prodigy
Internet subscriber base and introducing additional value-added services.
Prodigy has also made strategic decisions to outsource its network and use
multiple vendors for outsourced customer services functions. As a result of
these initiatives, Prodigy has substantially reduced its fixed operating costs
and headcount.
In conjunction with the launch of Prodigy Internet in October 1996, Prodigy
began offering a plan allowing subscribers unlimited usage of Prodigy Internet
for a flat monthly fee without hourly usage charges. In December 1996, Prodigy
introduced a similar plan for Prodigy Classic. Since the introduction of
Prodigy's unlimited usage plans, the portion of revenues generated from hourly
usage charges has decreased substantially.
The results of operations of Internet service providers, including those of
Prodigy, are significantly affected by subscriber cancellations. Subscriber
acquisition expenses and the administrative expenses of enrolling and assisting
new subscribers are substantial, and in the past Prodigy typically offered free
service for one or two months to new subscribers. In selected distribution
channels, Prodigy has replaced free trial programs with prepaid term plans and
subscriber contract acquisition programs in order to attract enrollees who are
less likely to terminate service.
Prodigy historically has experienced better retention for subscribers under
prepaid term plans than subscribers under month-to-month plans. Under prepaid
term plans, subscribers choose to prepay for longer terms at reduced monthly
rates. Additionally, under subscriber contract acquisition programs, Prodigy
makes payments to computer retailers in return for, among other things, the
retailers enrolling a customer onto Prodigy Internet, obtaining a signed
contractual commitment from the customer to a term subscription of one, two or
three years, and committed marketing of Prodigy Internet by the retailer in
connection with the retailers' other product advertisements. Prodigy's recent
experience has been that subscribers obtained through subscriber contract
acquisition programs have lower rates of cancellation than those obtained
through other channels. As a result of these lower rates of cancellation,
Prodigy has made the strategic decision to focus its marketing efforts towards
these subscriber acquisition programs.
Prodigy historically has experienced seasonality in its business, with:
. higher expense during the last and first fiscal quarters, corresponding
to the Christmas and post-Christmas selling season; and
. lower timed usage revenues (revenues from hourly usage charges) during
its second and third fiscal quarters resulting from reduced usage of its
services during the summer months.
Prodigy believes that the seasonal reductions in timed usage revenues
historically experienced by Prodigy will be mitigated by the movement from
timed usage plans to unlimited usage plans as well as growth in Prodigy's
subscriber base, although Prodigy expects to continue to have higher expenses
during its first and fourth quarters. Due to the seasonality of its business,
as well as to other factors, Prodigy experiences quarterly fluctuations in its
operating results.
On October 5, 1999, Prodigy acquired the BizOnThe.Net Web hosting business of
U.S. Republic Communications, Inc., an indirect majority owned subsidiary of
VarTec, including the subscribers of the BizOnThe.Net Web hosting business. In
consideration for BizOnThe.Net, Prodigy paid a $9 million loan from VarTec to
U.S. Republic and issued 2,840,993 shares of Prodigy common stock to U.S.
Republic including 727,272 shares held in an escrow account to secure the
indemnification obligations of U.S. Republic and its
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shareholders. Some or all of the escrowed shares will be released to U.S.
Republic at various times over the two year period following the closing. In
addition to the shares and amounts paid at closing, in 2001 Prodigy may be
required to issue up to 727,272 additional shares, contingent on the attainment
by the acquired business of set earn-out targets.
Based on the value of the 2,840,993 shares of common stock currently issued
in connection with the BizOnThe.Net acquisition and the $9 million cash used to
repay the loan, the total purchase price is approximately $58 million. The
excess of the purchase price over the fair value of the assets acquired and
liabilities assumed of $49.6 million has been allocated to goodwill and will be
amortized on a straight line basis over three years.
Results of Operations
Prodigy's total revenues have two components: Internet and online service
revenues, consisting of subscription revenues from subscribers to Prodigy
Internet and Prodigy Classic, and other revenues, consisting of small business
Web hosting fees from Prodigy's ProdigyBiz division, fees from a management
contract with Telmex under which Prodigy provides certain management and
consulting services to Telmex's Internet subsidiary Prodigy Internet de Telmex,
and advertising and transaction fees. Subscription revenues include revenues
from hourly usage charges ("timed usage revenues").
Prodigy defines billable subscribers as subscribers who remain enrolled
beyond completion of the applicable trial period or who enroll in a money-back
guarantee program. Prodigy defines "Internet subscribers managed" to include
billable Prodigy Internet subscribers and billable Prodigy Internet de Telmex
subscribers but excluding subscribers to the Prodigy Classic service which was
discontinued in October 1999.
Recent Results
On April 25, 2000, Prodigy reported the following results for the quarter
ended March 31, 2000:
. total revenues of $65.0 million in the quarter ended March 31, 2000,
consisting of Prodigy Internet revenues of $56.9 million and other revenues
of $8.0 million, compared to total revenues of $35.9 million in the quarter
ended March 31, 1999, consisting of Prodigy Internet revenues of $27.9
million, Prodigy Classic revenues of $6.7 million and other revenues of $1.3
million;
. total operating expenses of $97.3 million in the quarter ended March 31,
2000, including amortization of subscriber acquisition costs of $15.3
million, compared to total operating expenses of $54.4 million in the
quarter ended March 31, 1999;
. an operating loss of $32.3 million in the quarter ended March 31, 2000,
compared to an operating loss of $18.5 million in the quarter ended March
31, 1999;
. interest expense of $2.6 million in the quarter ended March 31, 2000,
compared to interest income of $1.0 million in the quarter ended March 31,
1999;
. $1.7 million in non-recurring costs related to planning for the integration
of the FlashNet and SBC subscriber bases, which was included in general and
administrative expense for the quarter endedMarch 31, 2000;
. a net loss of $34.9 million in the quarter ended March 31, 2000, compared to
a net loss of $15.7 million in the quarter ended March 31, 1999, with the
increase due to amortization of subscriber acquisition costs resulting from
Prodigy's contract subscriber acquisition programs and its Cable & Wireless
consumer Internet subscriber acquisition in July 1999 as well as
amortization of goodwill and other intangibles resulting from Prodigy's
acquisition of BizOnThe.Net in October 1999;
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. net loss per share (basic and diluted) of $0.54 per share in the quarter
ended March 31, 2000, compared to $0.29 per share in the quarter ended March
31, 1999;
. an increase in the number of Internet subscribers managed from 731,000 at
March 31, 1999 to 1,526,000 at March 31, 2000;
. an increase in the number of Internet subscribers managed from 1,502,000 at
December 31, 1999, consisting of 1,138,000 Prodigy Internet subscribers and
364,000 Prodigy Internet de Mexico subscribers to 1,526,000 at March 31,
2000, consisting of 1,115,000 Prodigy Internet subscribers and 411,000
Prodigy Internet de Mexico subscribers; and
. a decrease in the number of Prodigy Internet subscribers from 1,138,000 at
December 31, 1999 to 1,115,000 at March 31, 2000, primarily due to the
termination of Prodigy's contract acquisition program with Best Buy on
November 30, 1999.
Year Ended December 31, 1999 Compared to Year Ended December 31, 1998
Subscribers
The number of Prodigy Internet billable subscribers increased 633,000, or
125%, from 505,000 billable subscribers at December 31, 1998 to 1,138,000 at
December 31, 1999. Prodigy Classic subscribers decreased from 166,000 at
December 31, 1998 to 70,000 on October 1, 1999, the date Prodigy Classic was
discontinued, and zero thereafter. Total Internet subscribers managed increased
by 997,000, or 197%, from 505,000 at December 31, 1998 to 1,502,000 at December
31, 1999. Billable subscribers of Prodigy Internet de Telmex accounted for
approximately 364,000 of the number of Internet subscribers managed at December
31, 1999.
Internet revenues
Subscription revenues from Prodigy Internet increased $73.5 million, or 91%,
from $80.7 million in 1998 to $154.2 million in 1999 due to the increase in
billable subscribers discussed above. Subscription revenues from Prodigy
Classic decreased $32.6 million, or 68%, from $48.2 million in 1998 to $15.6
million in 1999 due to the discontinuation of service as of October 1999. Timed
usage revenues decreased $2.7 million, or 64%, from $4.2 million in 1998 to
$1.5 million in 1999. The decrease in timed usage revenues was primarily
attributable to the decrease in Prodigy Classic subscribers during 1999.
Other revenues
Other revenues increased by $12.0 million, or 166%, from $7.2 million in 1998
to $19.2 million in 1999. The increase in other revenues consisted of $6.8
million in management fees relating to Prodigy's January 1999 agreement with
Telmex to manage the Prodigy Internet de Telmex's Internet subscribers, $3.0
million from Prodigy's Web hosting business including revenues from
BizOnThe.Net, which was acquired in October 1999, $5.4 million attributable to
transition services revenue related to Prodigy's July 1999 acquisition of
Internet subscribers of Cable & Wireless USA, Inc., and a $1.0 million increase
in advertising display revenues primarily due to Prodigy's successful program
of re-establishing control over advertising content displayed on Prodigy
Internet's home page. These increases were offset, in part, by a decrease of
$4.4 million from Prodigy's African Internet operations that were sold in
October 1998.
Cost of revenues
Cost of revenues includes network and content expenses. Network expense
includes costs associated with Prodigy's hosting operations center in Yorktown,
New York as well as the costs of outsourced network provider services. Content
expenses consist of the costs of developing, or obtaining from third parties,
content for inclusion in Prodigy's service offerings. Cost of revenues
increased $8.8 million, or 9%, from $93.4 million in 1998 to $102.2 million in
1999 primarily related to increased network charges incurred by Prodigy in
1999. Network usage increased 65% in 1999 compared to 1998 primarily due to the
shift of the subscriber base from timed usage to unlimited usage plans which
result in higher hourly usage. However, network expense increased only 11%, or
$10.3 million, primarily due to a monthly "cap" (based on average hourly usage
by subscribers)
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contained in the network agreement between Prodigy and Splitrock. The increase
in network charges was offset, in part, by a decrease of $1.5 million, or 40%,
in content expense attributable to the discontinuation of the Prodigy Classic
service.
Sales and marketing
Sales and marketing expense includes advertising, salaries of sales and
marketing personnel and other general sales and marketing costs. Sales and
marketing expense increased $17.2 million, or 41%, from $41.7 million in 1998
to $58.9 million in 1999. The increase in marketing costs was primarily
attributable to an increase of $5.6 million in production and media costs
associated with Prodigy's "There is a Choice" and "Are you a Prodigy?"
advertising campaigns that appeared during 1999. In early 1998, Prodigy
postponed certain of its marketing programs in response to network performance
issues encountered during the transition period accompanying the initial
rollout of the Splitrock network. Additionally, Prodigy spent $4.4 million in
establishing Prodigy's Business Solutions division and marketing its product
offerings, and $1.4 million in marketing Prodigy's Hispanic Internet offering.
Sales and marketing expense also reflects increased bad debt provisions of $2.8
million related to amounts due from subscribers for contractual early
termination penalties. As a result of the significant increase in contract
subscribers during the period, Prodigy experienced a corresponding increase in
accounts receivable and the related provision for doubtful accounts associated
with the penalty fees charged on terminated subscriber contracts.
Product development
Product development expense includes research and development costs and other
product development costs. Product development expense increased $1.4 million,
or 13%, from $10.9 million in 1998 to $12.3 million in 1999. Product
development activities in 1999 centered on implementing the billing,
provisioning and customer service infrastructure to support Prodigy's small
business Web hosting business, improving the system infrastructure supporting
the Prodigy Internet de Telmex subscriber base, including Year 2000 remediation
efforts, developing a new home page for Prodigy Internet and developing future
Prodigy Internet product offerings and service enhancements.
General and administrative
General and administrative expense increased $17.1 million, or 38%, from
$44.6 million in 1998 to $61.7 million in 1999. The increase was primarily
attributable to substantially higher customer service charges incurred in
connection with the 125% increase of billable Prodigy Internet subscribers
achieved in the year, especially the heavy volume of enrollments emanating from
the contract subscriber acquisition program during the second half of 1999.
This increase primarily reflected a $10.2 million increase in customer service
charges, a $2.7 million increase in 800 number charges, and a $2.1 million
increase in billing and credit card interchange fees. General and
administrative expense also increased in 1999 due to increased charges for
accounting and legal fees, recruiting, office temporary workers and
compensation expense resulting from the issuance of stock options priced below
market.
Depreciation and amortization
Depreciation and amortization expense increased $5.7 million, or 35%, from
$16.1 million in 1998 to $21.8 million in 1999. The increase was primarily due
to $4.0 million of goodwill, tradename and other intangibles' amortization
incurred in connection with the BizOnThe.Net acquisition. In addition, the 1999
period reflects depreciation attributable to a new accounting system as well as
and subscriber management software implemented during 1999.
Amortization of subscriber acquisition costs
In May 1999, Prodigy entered into an agreement with Cable & Wireless to
purchase the dial-up access Internet subscriber base of that entity. At the
closing on July 20, 1999, Prodigy paid Cable & Wireless $40.9 million in cash.
Upon settlement of the transaction during the first quarter of 2000, Prodigy
received a purchase
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price reduction of $10.1 million from the original payment due to fewer
subscribers transitioning to the Prodigy Internet service than originally
projected. During 1999, Prodigy also entered into agreements with major
retailers of personal computers for the purpose of stimulating Prodigy Internet
enrollments. Under these agreements, Prodigy made payments to the retailers in
exchange for the retailers enrolling a customer onto Prodigy Internet,
obtaining a signed contractual commitment from the customer to a term
subscription of one, two or three years, and committed marketing of Prodigy
Internet by the retailers in connection with the retailers' other product
advertisements. These payments amounted to $100, $250, or $400, respectively,
for a term subscription of one, two or three years at Prodigy's standard
monthly rates. Payments pursuant to these agreements amounted to $161.7 million
through December 31, 1999. Prodigy has accounted for these payments, and the
purchase price paid for the acquired Cable & Wireless subscribers that migrated
to Prodigy Internet, as subscriber acquisition costs and amortizes these costs
over the term of the underlying subscriber contract or 36 months, respectively.
During 1999, Prodigy incurred amortization of subscriber acquisition costs of
$20.4 million consisting of $15.6 million related to subscriber acquisition
contracts and $4.8 million related to the acquired Cable & Wireless
subscribers.
Interest and other income
Interest income increased $3.6 million, from $1.5 million in 1998 to $5.1
million in 1999. The increase is primarily due to the investment of the cash
proceeds of Prodigy's initial public offering in February 1999 in short-term
money market instruments. These increases were offset by interest expense of
$2.9 million incurred to service notes payable during 1999.
During the year ended December 31, 1999, Prodigy recognized a gain of $3.3
million upon the sale of an equity investment. In addition, Prodigy recognized
a gain of $1.7 million when it paid $.75 million in full settlement of a
promissory note in the principal amount of $2.0 million plus all accrued
interest.
Income Taxes
Prodigy has evaluated the positive and negative evidence bearing on the
realizability of its deferred tax assets, which are comprised principally of
net operating loss carry forwards. Under the applicable accounting standards,
Prodigy has considered its history of losses and concluded that it is more
likely than not that Prodigy will not realize these favorable tax attributes.
Accordingly, the related deferred tax assets have been fully reserved.
Operating Loss
As a result of the foregoing factors, Prodigy's operating loss increased
$17.8 million, or 25%, from $70.5 million in 1998 to $88.2 million in 1999 and
its net loss increased $15.4 million, or 24%, from $65.1 million in 1998 to
$80.5 million in 1999.
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
Revenue
Subscription revenues from Prodigy Internet increased $51.2 million, or 174%,
from $29.5 million in 1997 to $80.7 million in 1998. The number of Prodigy
Internet billable subscribers increased 284,000, or 129%, from 221,000 at
December 31, 1997 to 505,000 billable subscribers at December 31, 1998,
representing 36% and 75% of total billable subscribers at December 31, 1997 and
December 31, 1998, respectively. Prodigy Internet subscribers accounted for 44%
and 80% of total network usage during 1997 and 1998, respectively. Subscription
revenues from Prodigy Classic decreased $50.6 million, or 51%, from $98.8
million in 1997 to $48.2 million in 1998 as the number of Prodigy Classic
billable subscribers decreased from 392,000 at December 31, 1997 to 166,000 at
December 31, 1998. Total billable subscribers increased by 58,000, or 9%, from
613,000 at December 31, 1997 to 671,000 at December 31, 1998. Timed usage
revenues decreased $7.8 million, or 65%, from $12.0 million in 1997 to $4.2
million in 1998. The decrease in revenues attributable to
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decreases in the total number of billable subscribers and in timed usage
revenues associated with Prodigy Classic was offset, in part, by an increase in
average revenue per billable subscriber primarily due to the higher-priced
plans for unlimited usage associated with Prodigy Internet. Other revenues
increased by $1.3 million, or 22%, from $5.9 million in 1997 to $7.2 million in
1998 primarily due to increased sales by Prodigy's African Internet operations
which were sold on October 1, 1998. For the years 1997 and 1998, the other
revenues derived from Prodigy's former international operations consisted
primarily of fees for Internet access and online services provided primarily to
businesses in Africa and China. As a result of the foregoing factors, total
revenues increased by $1.9 million from $134.2 million in 1997 to $136.1
million in 1998.
Cost of Revenue
Cost of revenues increased from $92.0 million in 1997 to $93.4 million in
1998. This increase was primarily attributable to increased network charges
incurred by Prodigy in 1998. Network usage increased 74% in 1998 compared to
1997 primarily due to the shift of the subscriber base from timed usage to
unlimited usage plans, but network charges increased only 40% because of a
monthly cap, based on average hourly usage by subscribers, contained in the
network agreement between Prodigy and Splitrock. This increase was offset in
part by a reduction in content expense, which declined as a result of the
renegotiation and/or termination of content contracts associated with Prodigy
Classic and Prodigy's content outsourcing agreement with Excite.
Sales and Marketing
Sales and marketing expense decreased from $59.6 million in 1997 to $41.7
million in 1998, a decrease of $17.9 million, or 30%. The 1997 period reflected
spending related to the launch of Prodigy Internet in October 1996 which
continued through the post-Christmas selling season. In addition, in early
1998, Prodigy temporarily deferred sales and marketing programs in response to
network performance issues encountered during the transition period
accompanying the initial roll-out of the new Splitrock network.
Product and Development
Product development expense decreased from $11.4 million in 1997 to $10.9
million in 1998, a decrease of $.5 million, or 4%. During 1997, product
development efforts were primarily focused on stabilization and enhancement of
Prodigy Internet and on migration of Prodigy Classic content to the Prodigy
Internet platform. As a result of the completion of these activities in 1997,
product development activities and spending were subsequently reduced. In 1998,
product development activities centered on integration and stabilization of the
Splitrock network, transition to the co-branded Prodigy/Excite content platform
for Prodigy Internet, and development of commercial application and value-added
services.
General and Administrative
General and administrative expense decreased from $56.3 million in 1997 to
$44.6 million in 1998, a decrease of $11.7 million, or 21%. The decrease in
general and administrative expense was attributable to significantly lower
personnel costs resulting from a decrease in average headcount and lower
incentive compensation expense combined with lower occupancy expense due to the
relocation to a new headquarters facility in White Plains, New York as of
January 1, 1998. As a result of the grant of employee stock options with
exercise prices deemed to be below fair market value, Prodigy recorded
compensation expense of $.7 million in 1998.
Depreciation and Amortization
Depreciation and amortization expense decreased $5.3 million, or 25%, from
$21.4 million in 1997 to $16.1 million in 1998. During the second half of 1997,
Prodigy entered into a third party network agreement realizing the cash
benefits of reduced capital expenditures for telecommunications equipment.
Moreover, during 1997 the remaining Prodigy Internet capitalized product
development costs were amortized whereas 1998 was a year of product
stabilization and integration into the new network.
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Interest and other income
Interest income/expense, net improved from an expense of $1.3 million in 1997
to income of $.2 million in 1998. This improvement was due to higher cash
balances and reduced levels of borrowing during 1998.
In 1997, Prodigy recorded a loss of $12.1 million on an equity investment in
a joint venture, restructuring and other special costs of $9.9 million, a $2.4
million write-down of its investment in its African Internet operations to the
net realizable value, and an $.8 million loss on the sale of its African
cellular telephone operations. In 1998, Prodigy recognized a gain of $2.9
million from the sale of its African Internet operations and a gain of $2.3
million from the sale of internally developed customer service and content
applications.
Operating Loss
As a result of the foregoing factors, Prodigy's operating loss decreased from
$119.6 million in 1997 to $70.5 million in 1998. Its net loss decreased from
$132.8 million in 1997 to $65.1 million in 1998.
Restructuring Charges
In response to changes in its business environment, and to decrease cash
outflows and more efficiently manage its business, Prodigy has incurred
restructuring and other special costs. The table below presents restructuring
and other special costs incurred and/or expended by Prodigy from January 1,
1997 through December 31, 1999:
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------
1997 1998 1999
-------- ------- -------
(in millions)
<S> <C> <C> <C>
Accrued restructuring costs at beginning of
period: ......................................... $ 11.5 $ 7.9 $ 4.7
-------- ------- -------
Restructuring accruals:
Network termination costs (A)..................... 4.7 -- --
Reductions-in-force (B)........................... 2.9 -- --
Content production (C)............................ 0.6 -- --
Facility closing (D).............................. 1.6 -- --
Headquarters lease termination.................... -- -- --
Idle leased space at former headquarters'
location......................................... -- -- --
-------- ------- -------
Subtotal, period accruals......................... 9.8 -- --
-------- ------- -------
<CAPTION>
Year Ended December 31,
--------------------------
1997 1998 1999
-------- ------- -------
(in millions)
<S> <C> <C> <C>
Restructuring expenditures:
Network termination costs......................... -- (0.8) (0.1)
Reductions-in-force............................... (3.1) (1.0) --
Content production................................ -- (0.6) --
Facility closing.................................. -- (0.8) (0.8)
Headquarters lease termination.................... (7.8) -- --
Idle leased space at former headquarters'
location......................................... (2.5) -- --
-------- ------- -------
Subtotal, period expenditures..................... (13.4) (3.2) (0.9)
-------- ------- -------
Accrued restructuring costs at period end......... $ 7.9 $ 4.7 $ 3.8
======== ======= =======
</TABLE>
- --------
(A) In connection with the sale of its network, Prodigy incurred liabilities
related primarily to early termination payments and other contractual
obligations for certain non-cancelable network related agreements. Prodigy
expects to use this reserve in full during the year ending December 31,
2001.
(B) In 1997, Prodigy implemented a restructuring plan to reduce costs through
job elimination and, as a result, recorded a charge of $2.9 million.
Approximately 80 employees were terminated. The entire reserve was used in
1997 and 1998 to make severance payments to employees identified as part of
the original plan.
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(C) Prodigy decided to discontinue the production of its own content and, as a
result, recorded a charge of $.6 million to account for the employee
termination costs and the costs to settle content related contractual
obligations. Approximately 25 employees were terminated. The entire reserve
was used in 1997 and 1998 to make severance payments to employees
identified as part of the original plan.
(D) Prodigy's Medford, Massachusetts facility has been closed and a charge of
$1.6 million recorded in 1997 to account for the costs of employee
terminations and lease cancellation. This reserve was fully utilized at
December 31, 1999.
Former International Operations
The historical results discussed above include the operating results of
Prodigy's African and Chinese operations, which began in late-1995 and mid-
1996, respectively. The revenue and net loss from Prodigy's Africa and China
operations were as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------
1997 1998 1999
-------- -------- -------
(in millions)
<S> <C> <C> <C>
Revenue........................................... $ 3.2 $ 4.4 --
Net loss.......................................... (8.5) 0.2 --
</TABLE>
Prodigy sold its African cellular telephone operations in January 1997,
determined to terminate its Chinese operations in December 1997, terminated its
Chinese operations in March 1998 and sold its African Internet operations in
October 1998. In 1997, Prodigy recorded a $0.8 million loss on the sale of its
African cellular telephone operations and a $2.4 million write-down of its
investment in its African Internet operations to the estimated net realizable
value.
Liquidity and Capital Resources
Since formation, Prodigy has relied on private sales of equity securities
(totaling $294.1 million through December 31, 1999), borrowings and its initial
public offering in February 1999 with net proceeds of $157.2 million to fund
its operations. Prodigy has incurred significant losses since inception and, at
December 31, 1999, had an accumulated deficit of $373.3 million and a working
capital deficit of $128.1 million comprised of current liabilities of $179.9
million offset by current assets of $51.8 million. For the years ended December
31, 1997, 1998 and 1999, Prodigy incurred negative cash flow from operations of
$114.0 million, $68.0 million and $40.1 million, respectively.
The decrease in cash used in operating activities from 1997 to 1998 resulted
from decreased net losses partially offset by the timing of payable
settlements. The increase in cash used in operating activities from 1998 to
1999 resulted from timing of payable settlements and increased amortization
expense which offset the increased net losses.
Net cash from investing activities increased to $2.6 million provided from
investing activities in 1998 from $15.3 million used in 1997 due to the cash
proceeds of $5.2 million from the sale of assets and equity investments
combined with decreased capital expenditures. Net cash from investing
activities decreased in 1999 to $212.6 million used in investing activities due
to cash payments related to the acquisition of BizOnThe.Net, the acquisition of
subscribers from Cable & Wireless USA subscriber contract acquisition programs
and increased capital expenditures.
In May 1999, Prodigy entered into an agreement with Cable & Wireless USA,
Inc. to purchase the dial-up Internet access subscriber base of that entity for
a purchase price of approximately $41.6 million in cash as determined by the
number of qualified Cable & Wireless subscribers who transitioned to Prodigy
Internet.
Commencing in July 1999 through the end of the year Prodigy paid
approximately $154.6 million in consideration for subscribers obtained through
its subscriber contract acquisition programs. Prodigy has $7.1 million accrued
related to these programs as of December 31, 1999. Prodigy has capitalized
these costs and will amortize these costs over the underlying subscriber
contracts (one, two or three years). At December 31, 1999, Prodigy had
capitalized related subscriber contract acquisition costs of $161.7 million and
had
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recognized amortization expense of $15.6 million. In February 2000, Prodigy
entered into a similar program with another retailer. Total amounts to be paid
under this program will depend on the number of subscriber contracts received
and could be material.
Prodigy's capital expenditures for the year ended December 31, 1999 were
$11.3 million, primarily for the purchase of data processing equipment,
compared to capital expenditures of $2.6 million in 1998. Prodigy anticipates
that its capital expenditures will approximately $25 million in 2000.
Net cash from financing activities in 1998 and 1999 and future financing
requirements are discussed in the following paragraphs.
To fund operations, Prodigy borrowed $16.4 million from Banco Inbursa, S.A.,
an affiliate of Carso Global Telecom, in February 1998 and $5.7 million from
Banco Inbursa in July 1998. The Banco Inbursa loans bore 9% interest and were
due December 31, 1999. In July 1998, Prodigy borrowed $30.0 million from Bank
of America National Trust and Savings Association and used the proceeds to
repay $30.0 million of the $32.1 million then owed to Banco Inbursa. The Bank
of America loan bore 6.5% interest, was guaranteed by Carso Global Telecom and
was due August 14, 1998. The Bank of America loan was repaid with interest with
a portion of the proceeds from the sales of common stock described below.
In August 1998, Telmex purchased 6,125,000 shares of common stock from
Prodigy for gross proceeds of $49.0 million, and in July 1998 Carso Global
Telecom purchased 1,375,000 shares of Common Stock from Prodigy for gross
proceeds of $11.0 million. Prodigy used a portion of the proceeds to repay
amounts owed to Banco Inbursa and Bank of America in the aggregate amount of
$32.1 million.
In August 1998, Prodigy obtained a $35.6 million line of credit commitment
from Carso Global Telecom. This credit facility, originally due to expire on
December 31, 1999, was cancelled in August 1999 when it was replaced by the
larger credit facility described below.
In February 1999, Prodigy sold 11,200,000 shares of common stock in its
initial public offering, including 2,000,000 shares of Common Stock sold to
Telmex, for aggregate net proceeds of $157.2 million.
In August 1999, Prodigy obtained a $130 million revolving line of credit from
Carso Global Telecom to fund its subscriber contract acquisition programs
during the third and fourth quarter of 1999. The terms of this line of credit
allow Prodigy to borrow, repay and reborrow amounts in minimum increments of $1
million. Advances are due 30 days after borrowing, but Prodigy is permitted to
rollover advances into new advances at its election. Advances are
uncollateralized, and during the third and fourth quarters of 1999, bore
interest of 9% and 12%, respectively. During the fourth quarter, Prodigy
borrowed the maximum amount permitted under this line of credit. At December
31, 1999, the line of credit had been paid down to $110.2 million. Prodigy
repaid $13.8 million of these notes in January 2000 and the remaining $96.4
million is due on April 7, 2000.
At December 31, 1999, Prodigy had available cash and cash equivalents of
$35.5 million ($21.1 million at March 31, 2000). Prodigy is currently
experiencing substantial negative cash flow each month and expects to continue
to experience negative cash flows through 2000. Telmex has unconditionally
committed to provide financing, either through capital and/or debt financing of
up to $200 million to fund Prodigy's operations through February 2001. The
terms of this financing will be determined at the time such financing, if any,
is provided.
On March 16, 2000, Prodigy and Citibank signed a letter agreement which
contemplates that Citibank will structure and arrange financing of $200 million
secured by the future service fees payable by contract subscribers to the
Prodigy Internet service. The letter agreement includes a preliminary summary
of principal terms and conditions, estimated expenses and the structuring fee
due Citibank at closing. The letter agreement does not constitute a firm
financing commitment from Citibank, and Prodigy cannot assure that the Citibank
financing will be completed. The Citibank financing is subject to the issuance
by SBC of a performance guarantee and satisfaction of the following conditions:
. satisfactory completion of Citibank's due diligence review of Prodigy;
. in Citibank's determination, the absence of any material adverse change
in the financial markets or in the financial condition or operations of
Prodigy;
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. negotiation and execution of mutually satisfactory documentation for the
financing;
. the receipt of specified ratings from ratings agencies; and
. the receipt of internal Citibank credit approval and any other approvals
and legal opinions as Citibank may deem necessary or advisable.
In connection with the Citibank financing, Prodigy and SBC have agreed in
principle that SBC will provide a contingent performance guarantee in exchange
for which Prodigy will grant SBC a contingent warrant to purchase 537,924
shares of Prodigy common stock for $1.00 per share. The performance guarantee
to be provided by SBC requires that, in the event Prodigy becomes unable to
continue to perform its service obligations under the subscriber contracts, SBC
will either perform Prodigy's service obligations directly or replace Prodigy
with a substitute Internet service provider. Management believes that the
Citibank financing or, if not completed, the Telmex financing will be
sufficient to enable Prodigy to meet its planned expenditures through at least
February 2001. Prodigy cannot assure that the Citibank financing will be
completed. If the Citibank financing or other comparable third party financing
is completed, Prodigy does not expect to obtain financing through the Telmex
commitment.
Prodigy's future financing requirements will depend on a number of factors,
including Prodigy's operating performance and increases in operating expenses
associated with growth in Prodigy's business. Based upon its current operating
plan, Prodigy believes that it will require significant external financing in
order to continue to expand its consumer business. Prodigy is considering a
number of alternatives to raise additional financing, including public or
private equity or debt financing, bank loans, strategic partner and joint
venture arrangements, vendor financing, leasing arrangements or a combination
of these sources. There can be no assurance that Prodigy will be able to obtain
sufficient financing on acceptable terms.
Year 2000 Compliance
The year 2000 issue was the cause of great concern before January 1, 2000.
The concern was that computer programs that have time-sensitive software may
not recognize the date "00" as the year 2000 but rather as the year 1900.
Currently, most computer systems are functioning properly and the compliance
and remediation work effected prior to January 1, 2000 was effective in
preventing Year 2000 problems. Computer experts still warn, however, of
residual consequences from the year 2000 issue. Although Prodigy currently
believes that its computer systems are Year 2000 compliant, its operations and
financial condition could suffer if Prodigy experiences any residual Year 2000
problems.
Prodigy maintains its Internet operations and internal operating systems.
Furthermore, Prodigy relies on third party vendors for the provision of
computerized billing and network operations and services. Residual Year 2000
problems experienced by Prodigy and its third party vendors could negatively
impact Prodigy's internal operating systems, as well as the computer systems of
the third party vendors and ultimately affect Prodigy's ability to provide
customer and business services.
Prodigy has evaluated its internal systems and programs related to both the
delivery of the Prodigy Internet service and the daily operations of the
business and has made any necessary changes. In addition, Prodigy has contacted
all vendors to verify Year 2000 compliance. Any application that was not
compliant by December 1999 was deactivated and removed.
Recently Issued Accounting Pronouncements
In November 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin ("SAB") No. 100, "Restructuring and Impairment Charges." In
December 1999, the SEC issued SAB No. 101, "Revenue Recognition in Financial
Statements." SAB No. 100 expresses the views of the SEC staff regarding the
accounting for and disclosure of certain expenses not commonly reported in
connection with exit activities and business combinations. This includes the
accrual of exit and employee termination costs and the recognition of
impairment charges. SAB No. 101 expresses the views of the SEC staff in
applying generally accepted accounting principles to certain revenue
recognition issues. Prodigy has concluded that these SABs do not have a
material impact on its financial position or its results of operations.
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FLASHNET'S BUSINESS
Overview
FlashNet is a nationwide provider of consumer Internet access and business
services. FlashNet provides its Internet access services in approximately
900 cities, covering approximately 90% of the United States population, through
both its proprietary network and strategic network arrangements with Golden
Harbor, PSINet and Level 3 Communications. As of December 31, 1999, FlashNet
had approximately 235,000 customers, including approximately 3,200 business
customers. FlashNet's services offerings are tailored to the specific demands
of both its consumer and business customers and include dial-up access, high
speed access and other value-added services.
Industry Background
Growth of the Internet and Electronic Commerce
The Internet is a collection of computer networks that links millions of
public and private computers to form the largest computer network in the world.
It has become an important global communications medium, enabling millions of
people to obtain and share information and conduct business electronically, and
a critical tool for information and communications for many users. The Internet
has grown rapidly in recent years, both in the number of Web users and Web
sites. Many factors are driving the growth in the number of Web users and Web
sites, including the large and growing number of personal computers, advances
in the performance and speed of personal computers and modems, easier access to
the Internet and the increasing importance of the Internet for communications,
information and commerce. For many businesses, the Internet has created a new
communications and sales channel enabling large numbers of geographically
dispersed organizations and consumers to be reached quickly and cost-
effectively.
Evolution of the Internet Services Market
Today, the Internet services market consists primarily of Internet access.
Access services include dial-up access for individuals and small businesses and
high-speed dedicated access primarily for larger organizations. The rapid
development and growth of the Internet have resulted in a highly fragmented
industry, consisting of more than 5,000 Internet service providers in the
United States, most of which operate as small, local businesses. The Internet
services industry is expected to undergo substantial consolidation, especially
among mid-sized Internet service providers, over the next few years.
Internet service providers vary widely in geographic coverage, customer focus
and the nature and quality of services provided to subscribers. Few Internet
service providers offer nationwide coverage, have a brand name with nationwide
recognition or can grow significantly without additional investment in
infrastructure. Internet service providers may concentrate on specific types of
customers that differ from the target markets of other Internet service
providers. Services offered by Internet service providers can range from simple
dial-up access to highly organized, personalized access coupled with value-
added services. FlashNet believes that consumers generally focus on speed and
reliability of access, ease of use, customer service and price as they evaluate
an Internet service providers. In addition, FlashNet believes many business
customers want all their Internet-based requirements, such as Internet access,
Web hosting and electronic commerce applications, met by a single provider.
Internet operations, including Web hosting and electronic commerce, are
increasingly becoming critical to businesses. However, many businesses lack the
resources and expertise to develop, maintain and enhance, on a cost-effective
basis, successful Internet operations. As a result, businesses increasingly use
outside companies to enhance Web site reliability and performance, provide
continuous operation of their Internet-based functions and reduce operating
expenses. By outsourcing these services, companies can focus on their business
rather than using their resources to support Internet operations.
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As a result, there is increasing demand for Internet service providers to
offer electronic commerce services that businesses can establish quickly and
easily. An increasing number of Internet service providers supplement their
basic Internet access services with a variety of commercial services that
facilitate electronic commerce, such as hosting web sites, online customer
billing, co-location and other value-added services. These services expand an
Internet service provider's potential revenue sources from basic monthly access
fees to other fees such as set-up and maintenance charges. In addition, some
larger and more sophisticated Internet service providers market other Internet-
based services, such as paging, long-distance and cellular telephone services,
to both consumers and business customers nationwide.
The FlashNet Solution
FlashNet offers a full range of consumer Internet access services and a broad
selection of business services, both of which are offered nationwide at
competitive prices. FlashNet believes that its services provide customers with
the following benefits:
Fast and Reliable Quality Service. FlashNet's systems and network
infrastructure are designed to provide consumer and business customers with
fast and reliable quality service through its state-of-the-art equipment, its
network operations center that is monitored on a 24 hours-a-day, seven days-a-
week basis by its technicians and third-party network providers.
Cost-Effective Access. FlashNet offers high quality Internet connectivity and
enhanced business services at price points that are generally lower than those
charged by other Internet service providers with national coverage. It offers
pre-bundled access services packages under monthly or prepaid plans.
Enhanced Business Services. FlashNet offers a broad selection of enhanced
business services that are focused on the practical needs of businesses to
support their Internet operations. These services are further described in
"Consumer Access and Business Services."
Nationwide Network Coverage. Through its proprietary network and agreements
with third party providers, including Golden Harbor, PSINet, MCIWorldCom and
Level 3 Communications, its access services cover approximately 900 cities and
approximately 90% of the population of the United States.
Superior Customer Support. FlashNet provides superior customer service and
support, with customer care and technical personnel available by telephone and
on-line on a 24 hours-a-day, seven days-a-week basis and additional support
resources available at its Web site.
Brand Name Recognition. FlashNet has made significant investments in, and has
applied a creative approach to, high visibility advertising, which has included
radio spots and prominent radio host endorsements, television commercials,
targeted direct mail campaigns and billboard placements. As a result, it has
achieved brand name recognition in its core markets that enhances its
customers' comfort and familiarity with having it as their Internet access
provider.
Consumer Access and Business Services
Consumer Access Services
FlashNet's consumer access services are designed to provide subscribers with
simplified access to the Internet through a dial-up modem. All of its Internet
access accounts include:
. unlimited access to the Internet;
. at least one e-mail account, which facilitates the subscriber's ability
to send and receive e-mail messages across the Internet;
. news group access for reading and posting of messages and other
information among Internet users;
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. file transfer Internet protocol privileges which enable its customers to
place a file on its servers for public or private use or to retrieve
files placed on its servers by others; and
. an intuitive interface for viewing of pictures and graphics.
FlashNet also offers advanced filtering capabilities to reduce access to
material that may be unsuitable for family, business and institutional users.
All consumer access services include, for no additional charge, Netscape
Communicator or Microsoft Internet Explorer, and other Internet software, as
well as technical assistance and customer support on a 24 hours-a-day, seven
days-a-week basis, including Web-based support for many products and services.
See the subsection entitled "Customer Service and Support."
FlashNet currently offers a variety of options for providing customers with
Internet access, as described in the following table:
<TABLE>
<CAPTION>
Target Current Pricing
Access Service Description Customers Information
-------------- ----------- --------- ---------------
<C> <C> <C> <S>
Basic Account Basic Account service Consumer $17.95/month with a $25
that includes two e-mail Internet users set-up fee ($16.95 in some
accounts and sufficient markets)(1)(2)
Web space to support
traditional dial up
access speeds in most
markets.
Daytime Account(3) Basic Account service Small $6.95 per month with a $35
with access from 7:00am businesses set-up fee; $1.95 per hour
to 5:00pm, Monday for off-hours usage
through Friday.
Premium Account Basic Account service Consumers and $19.95/month with a $25
plus four additional e- small set-up fee(1)(2)
mail accounts and businesses
additional Web space.
Clean Internet Premium Account service Consumers, $19.95/month with a $25
Account plus client-side and businesses and set-up fee
server-side filtering institutional
software. users
ISDN Dial Up Basic Account with Consumers and $17.95/month with a $25
Account(3) digital service which small set-up fee ($16.95 in some
provides faster access-- businesses markets)(1)(2)
also known as integrated
services digital network
access.
High Speed Dial Up Basic Account with Small $35.90/month with a $100
ISDN Account(3) higher speed integrated businesses set-up fee(1)
services digital network
access.
</TABLE>
- --------
(1) Discounts available in some markets if prepaid on an annual basis.
(2) $25 set-up fee does not apply if prepaid on an annual basis.
(3) Not available in all markets.
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Business Services
FlashNet has introduced to market a variety of enhanced business services
that enable its business customers to obtain high speed Internet access,
outsource their Internet facilities and systems needs and undertake electronic
commerce initiatives. Information concerning its current offering of business
services is summarized in the following table:
<TABLE>
<CAPTION>
Target
Business Service Description Customers Pricing Information
- ---------------- ----------- --------- -------------------
<S> <C> <C> <C>
Dedicated ISDN Basic Account access Small to $144/month with a $50 set-
Account(1) service with dedicated medium-sized up fee(2)
integrated services businesses
digital network access
in addition to six
separate Internet
addresses.
High Speed Dedicated Basic Account with Small to $288/month with a $250
ISDN Account(1) dedicated integrated medium-sized set-up fee(2)
services digital network businesses
access in addition to 12
separate Internet
addresses.
Broadband Access A variety of services Medium to Monthly fees start at
Solutions(1) that provide access to large-sized $1,295 and vary depending
the Internet at speeds businesses on bandwidth; Set-up fees
greater than regular seeking high apply
phone lines or bandwidth
integrated services access
digital network service. solutions.
Web Hosting Services that provide Consumers and Prices start at
Services(1) space on our servers for small to $29.95/month with a $45
customer Web pages and medium-sized set-up fee(2)
e-mail accounts. businesses
Co-Location Services Services to enable Small to Monthly pricing based on
customers to locate medium-sized 1/4 rack increments and
equipment within businesses bandwidth usage; Set-up
FlashNet's network with business- fees apply
operations center which critical Web
provides 24 hours-a-day, sites or
seven day-a-week electronic
monitoring, commerce
uninterrupted power systems.
support, environment
management,
electromagnetic surge
protection, radio
frequency protection and
disaster recovery
systems.
Electronic Commerce Provides business Small to Prices range from $19.95
Solutions customers with the medium-sized to $99.95/month; Set-up
ability to sell businesses fees apply
merchandise from the seeking easy-
Internet, including to-use, fully
reporting and payment functional
processing capabilities, electronic
catalogs, extra e-mail commerce
accounts, extra Web solutions.
space, database
management
functionality, high
speed data transfer
rates, secure payment
mechanisms and technical
support.
</TABLE>
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<TABLE>
<CAPTION>
Target
Business Service Description Customers Pricing Information
- ---------------- ----------- --------- -------------------
<S> <C> <C> <C>
Managed IP Services Various services to Small to Quote basis
support an medium-sized
organization's Internet businesses
operations, including with IP
the purchase of network
telephone lines, outsourcing
managing portions of the needs
Internet for private
purposes, notifying
other Internet providers
and their customers
where to find our
customers' sites and
managing site addresses
on the Internet.
</TABLE>
- --------
(1) Not available in all markets.
(2) Selected business accounts are discounted if prepaid on an annual basis.
Customers and Markets
FlashNet's subscriber base currently consists of approximately 235,000
subscribers for its access services. As a result of its concentrated sales and
marketing efforts within its core markets, approximately 63% of subscribers
reside in Texas, 9% in California and 10% in the metropolitan areas of Chicago,
Illinois and Detroit, Michigan, with the remaining subscriber base spread
through other markets across the nation.
Customers for FlashNet's business services consist of small and medium-sized
businesses and include professional organizations such as law firms, accounting
firms and medical offices with two to 50 employees. Since its inception,
FlashNet has accumulated approximately 3,200 customers for its business
services. To date, its business services customers have been located primarily
in Texas.
Sales and Marketing
FlashNet's sales and marketing strategy consists of three components: direct
response marketing, a network marketing program and corporate direct sales.
Historically, FlashNet's direct response and network marketing activities have
led to growth in its subscriber base. Moreover, FlashNet developed a corporate
direct sales force to focus specifically on sales of dedicated and high
bandwidth access services and other business services to business customers.
These strategies are designed to build brand name recognition and generate high
levels of subscriber growth while minimizing subscriber acquisition costs and
customer turnover.
Direct Response Marketing
FlashNet is engaged in a variety of direct response marketing and various
promotional activities to stimulate consumer awareness of the value proposition
offered by its access services. These efforts are directed both to consumers
who have not previously subscribed to Internet access services and to Internet
users who may switch to FlashNet's services after learning of their
affordability and reliability. FlashNet principally employs targeted high
visibility media, including radio advertising, television, direct mail
distribution and billboards, to solicit new subscribers. FlashNet advertises on
television through nationally distributed channels and on a regional, spot
market basis.
In addition, FlashNet believes that a consumer's selection of an Internet
service provider often is strongly influenced by a personal referral.
Accordingly, FlashNet believes that its delivery of superior customer service
and support and its associated high levels of customer satisfaction have led to
positive customer referrals. These referrals, combined with its consumer
marketing efforts geared toward expanding its brand name identity, have
attracted significant numbers of new customers for its access services.
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Network Marketing--The FlashNet Opportunity
In June 1997, FlashNet instituted a network marketing program, referred to as
the "FlashNet Opportunity," as a novel approach within the Internet service
provider industry to expand rapidly its subscriber base. The program is
designed to establish and expand a network of independent representatives to
sell its access services. Independent representatives in the network act as
independent contractors and are not employees of FlashNet. An individual or
business entity may become an independent representative of FlashNet generally
by paying a non-refundable fee of $199 for a starting kit package that includes
marketing materials and personal training by FlashNet's personnel or seasoned
independent representatives. In general, each independent representative is
paid a commission for signing up new customers to subscriptions for FlashNet's
services and is paid residual commissions as those customers renew their
subscriptions. FlashNet believes that the FlashNet Opportunity assists in
lowering its cost of customer acquisition, reducing variable technical support
costs by utilizing independent representatives to aid in the set-up and
maintenance of new customers and reducing customer turnover. Customer turnover
associated with subscribers acquired through this sales channel tends to occur
at a lower rate than turnover experienced with subscribers acquired through
other sales channels. FlashNet believes that this is a result of the nature of
direct selling as opposed to mass advertising. As of December 31, 1999, the
FlashNet Opportunity included 6,875 independent representatives and has been
responsible for the acquisition of 49,665 new subscribers since its inception.
The FlashNet Opportunity is particularly well suited for individuals who
possess strong sales skills and are motivated by the prospect of supplementing
their sources of income under a flexible work schedule without the drawbacks
associated with other network marketing programs, such as:
. the need to purchase inventory;
. requirements to meet monthly sales quotas; and
. poorly defined commission credit systems resulting in commission
disputes.
The commission structure of the FlashNet Opportunity also creates incentives
for independent representatives to recruit other independent representatives to
the program. For each sale of an access services subscription to a new customer
that is made by an independent representative who has been recruited to the
program by an existing independent representative, and for each renewal of that
subscription, a commission is paid to the existing independent representative
in addition to the commission paid to the independent representative who was
responsible for the new subscription or renewal. Additional commissions also
are paid to the existing independent representative as independent
representatives that were recruited into the program by the existing
independent representative recruit other independent representatives who, in
turn, effect sales or renewals of FlashNet's access services. The commission
tree extends as these recruited independent representatives recruit other
representatives and those representatives recruit other representatives. Thus,
a new subscription sale or renewal may result in the payment of six separate
commissions. The amount of the commission paid to the existing independent
representative in connection with the sale or renewal will vary according to
the level of the existing independent representative within the chain of
representatives above the representative who received direct credit for the
sale or renewal. As the program continues to mature, the total amount of
commissions paid to independent representatives per new subscriber will
increase; however, FlashNet believes that these commissions will be less than
the costs for new subscriber acquisitions through traditional sales and
marketing activities.
Corporate and Commercial Sales
FlashNet's Corporate Sales Department is responsible for all sales of
dedicated analog and digital access service accounts, as well as sales of
higher speed broadband connections. The Corporate Sales Department also has
responsibility for sales of other enhanced business services. The department
currently is based within FlashNet's Fort Worth headquarters. As of December
31, 1999, the Corporate Sales Department consisted of one sales director, one
sales channel manager and approximately 15 sales representatives.
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Customer Service and Support
A key competitive factor that differentiates FlashNet from other Internet
service providers is its strong commitment to customer satisfaction, which is
evidenced by the quality of its customer service and support. FlashNet
continually reviews network utilization rates, and refines and expands its
network as necessary, to ensure high levels of network performance and
reliability, which, in turn, minimizes many customer service related issues.
FlashNet maintains 24 hours-a-day, seven days-a-week customer support for
telephone inquiries, with technical personnel available at all times to address
customer questions and concerns. Customers also can access customer support
services through FlashNet's e-mail or access trouble-shooting tips and
configuration information, as well as network status and performance reports,
at its Web site. In addition, FlashNet has produced a series of videocassettes
to assist customers with Web site development and related subjects and have
published user guides to provide customers with useful information about the
Internet and its vast resources. FlashNet believes that its emphasis on
customer service and support was the primary contributor to its ranking as the
third best provider of overall quality service based on a 1998 survey of 13
leading Internet service providers conducted by an independent research firm.
Consumer and business customers have very different support needs, especially
as to technical requirements and the sophistication of the user who makes the
customer service inquiry. FlashNet employs a tiered support system designed to
direct incoming calls to specialized support personnel as needed for efficient
problem resolution. As a result, customer care personnel generally field
relatively simple technical issues, miscellaneous account questions and similar
customer issues. Customer problems or issues that are more complex or that
affect a customer's business-critical operations are referred to FlashNet's
technical support department for high-level resolution. In addition, FlashNet
offers premium support, which, for a per-minute charge, enables customers to
speak to its technical personnel to resolve questions or issues pertaining to
any non-connectivity related matter, such as techniques for Web page design or
support for products that were not sold by it.
Network Infrastructure
FlashNet has designed its network and related systems to provide fast and
reliable, high-quality access services, while minimizing the capital investment
needed for infrastructure. FlashNet frequently re-evaluates its network's
structure and design to leverage available resources in order to maintain or
improve network performance and cost. FlashNet's strategy is to remain
indifferent to building its own network versus leasing network from third-party
providers, which will enable it to maintain flexibility and scalability.
Because it is not committed to leasing or building its own network, it can take
rapid advantage of the market opportunities that develop due to technological
advances or regulatory changes. These opportunities may include, among other
things, high speed access through a cable network or access for Internet-
enabled devices such as cell phones, pagers and other appliances. FlashNet will
modify its network over time to enhance its performance, to provide access
demanded by the market and to allow it to serve a larger subscriber base.
FlashNet's goal is to minimize both network costs and exposure to technological
obsolescence of equipment.
FlashNet's current network consists of a state-of-the-art network operations
center in Fort Worth, Texas, which is interconnected to 28 FlashNet-owned
remote facilities. These facilities also are connected to the networks of
third-party providers, including Golden Harbor, PSINet and Level 3
Communications. Through its own network and the networks of these third party
providers, FlashNet provides local exchange access and remote switched access
in most major metropolitan areas in the continental United States, as well as
smaller communities. The combined coverage area encompasses over 900 cities and
approximately 90% of the United States population.
FlashNet continuously monitors capacity demands on its network so that
network resources grow ahead of market demands. Generally, when 70% utilization
of its network occurs at peak hours in any given market, FlashNet orders new
capacity from its third-party vendors or orders the required new equipment to
increase its
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capacity to levels acceptable with forecasted demand. FlashNet has designed an
intelligent network management procedure to proactively provide system status
information in order to maintain 99.999% network availability.
Network Operations Center
FlashNet's Fort Worth network operations center monitors network traffic,
quality of services and security issues, as well as the performance of the
equipment located at each of its physical locations to ensure reliable service.
This facility also serves as the primary site for its delivery of business
services. FlashNet maintains state-of-the-art equipment and an uninterruptible
power supply within its network operations center. FlashNet staffs its network
operations center on a 24 hour-a-day, seven days-a-week basis and maintain
responsibility for communications between its internal departments as well as
with external providers of services. FlashNet continues to enhance the
capabilities of the network operations center as its customer base grows.
Network Design
Each of the 28 remote FlashNet-owned facilities include modern hardware along
with routing equipment and associated leased-telephone line interface devices.
Modems are interconnected to switched telephone networks serving the local
area, and high speed telephone lines connect the point of presence router to
other sites within FlashNet's network. The hardware and software deployed at
each physical facility allows FlashNet to analyze the performance of the
network and perform limited maintenance remotely. From time to time FlashNet
will lease new high speed telephone lines and install hardware into the network
that will allow more data traffic to travel over its network in a more
efficient fashion. Overall, its network separates physical and logical
resources for greater redundancy in case of catastrophic failures. FlashNet
designed its network to increase reliability by means of establishing
redundancy of mission-critical systems to minimize single points of failure.
Competition
The market for the provision of Internet access services is extremely
competitive and highly fragmented. As there are no significant barriers to
entry, FlashNet expects that competition will intensify. FlashNet believes that
the primary competitive factors determining success as an Internet service
provider are:
. a reputation for reliability and high-quality service;
. effective customer support;
. access speed;
. pricing;
. effective marketing techniques for customer acquisition;
. ease of use; and
. scope of geographic coverage.
FlashNet believes that it has competed favorably based on these factors,
particularly due to:
. its emphasis on providing fast and reliable, high quality services and
superior customer service and support;
. its policy of pricing services at prices lower than or competitive to
those of other national Internet service providers; and
. its three-pronged marketing strategy which includes a novel network
marketing approach to the sale of access services plans.
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However, FlashNet cannot assure you that, if the merger does not occur, it
will be able to continue to compete successfully against current or future
competitors or that competitive pressures faced by it will not materially and
adversely affect its business, operating results or financial condition.
FlashNet's current and prospective competitors include many large companies
that have substantially greater market presence, brand name recognition and
financial, technical, marketing and other resources than FlashNet. With respect
to its access and business services, it currently competes, or expects to
compete in the foreseeable future, with the following:
. national Internet service providers, including Prodigy and
EarthLink/MindSpring;
. numerous regional and local Internet service providers, some of which
have significant market share in their particular market area;
. established on-line information service providers, which provide basic
Internet access as well as proprietary information not available through
public Internet access, such as AOL;
. providers of Web hosting, co-location and other Internet-based business
services, including AOL, Exodus and Verio;
. computer hardware and software and other technology companies that
provide Internet connectivity with their products, including Gateway,
IBM, Dell and Microsoft;
. telecommunications companies, including long distance carriers such as
AT&T, MCIWorIdCom and Sprint, regional Bell operating companies and
local telephone companies;
. operators that provide Internet access through television cable lines,
including TCI, Time Warner Cable and AT&T;
. electric utility companies;
. communications companies;
. companies that provide television or telecommunications through
participation in satellite systems; and
. nonprofit or educational Internet access providers.
With respect to its potential competitors, FlashNet believes that
manufacturers of computer hardware and software products, media and
telecommunications companies and others will continue to enter the Internet
services market, which will intensify competition. In addition, as consumers
and businesses increasingly move on-line in greater numbers, FlashNet expects
existing competitors to increase further their emphasis on Internet access and
electronic commerce initiatives, resulting in even greater competition for it
in its markets. The ability of competitors or others to enter into business
combinations, strategic alliances or joint ventures, or to bundle their
services and products with Internet access, could place FlashNet at a
significant competitive disadvantage.
Moreover, FlashNet expects to face competition in the future from companies
that provide connections to consumers' homes, such as telecommunications
providers, cable companies and electrical utility companies. For example,
recent advances in technology have enabled cable television operators to offer
Internet access through their cable facilities at significantly faster rates
than existing analog modem speeds. These companies could include Internet
access in their basic bundle of services, offer this access for a nominal
additional charge or deny FlashNet access to their proprietary wire and cable
connections for purposes of providing Internet access services to FlashNet's
customers and prospective customers. Any of these developments could materially
and adversely affect FlashNet's business, operating results and financial
condition. See the section entitled "Risks Relating to FlashNet's Business--If
FlashNet does not adapt to technology trends and evolving industry standards,
it will cease to remain competitive in its markets and will fail to attract new
customers or retain its existing customers."
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Government Regulation
Regulation of the Internet and Internet Access Services
Internet access and online services are not subject to direct regulation in
the United States. Changes in the laws and regulations relating to the
telecommunications and media industry, however, could impact FlashNet's
business. For example, the Federal Communications Commission could begin to
regulate the Internet and online services industry, which could result in
increased costs for FlashNet.
The federal Child Online Protection Act, enacted in October 1998, creates
criminal penalties for content on the Internet that may be deemed harmful to
minors. FlashNet has not changed any of its plans or policies as a result of
this statute, and does not believe its current plans or policies violate this
statute. In February 1999, a federal judge enjoined this statute. The federal
Children's Online Privacy Act, also enacted in October 1998 and effective no
earlier than April 2000, will regulate the collection of personal information
from children by commercial Web site operators. FlashNet believes its plans and
policies will enable it to comply with the statute. There also are laws that
make it illegal to traffic in obscene or child pornographic materials,
including by a computer.
In addition, the applicability to FlashNet of existing laws governing issues
such as intellectual property ownership, defamation, access to the Internet for
the disabled and personal privacy is uncertain. Courts have indicated that,
online service providers and Internet service providers could be held
responsible for the publication of defamatory material or for failure to
prevent the distribution of material that infringes copyrights.
Intellectual Property
Although FlashNet believes that its success is more dependent on its
technical, marketing and customer service expertise and capabilities than its
proprietary rights, its success and ability to compete effectively are
dependent in part on its proprietary rights. FlashNet relies on a combination
of copyright, trademark and trade secret laws to protect its proprietary
rights. "FlashNet" and its logo are service marks for which service mark
applications are pending. Additional service mark applications are pending for
the registration of other service marks used by FlashNet in its business.
FlashNet cannot assure you that the steps taken by it will be adequate to
prevent misappropriation of its technology or that third parties, including
competitors, will not independently develop technologies that are substantially
equivalent or superior to its proprietary technology. See "Risk Factors
Relating to FlashNet's Business--FlashNet depends on the protection of its
proprietary rights."
FlashNet has received authorization to use the products of each manufacturer
of software that is bundled in its software for users with personal computers
operating on the Windows or Macintosh platforms. FlashNet has obtained
permission and licenses, where necessary, for applications in its start-up kit.
FlashNet currently intends to maintain or negotiate renewals of all existing
software licenses and authorizations as necessary, although it cannot be
certain that these renewals will be available to it on acceptable terms, if at
all. FlashNet may also enter into licensing arrangements in the future for
other applications.
Employees
As of December 31, 1999, FlashNet had 344 employees, including 97 in sales
and marketing, 221 in customer care and technical services and 24 in general
and administrative functions. FlashNet's employees are not covered by any
collective bargaining agreement, and it has never experienced a work stoppage.
FlashNet believes that its employee relations are good. FlashNet believes its
future success will depend in large part on its continuing ability to attract
and retain highly skilled technical, sales, marketing and customer support
personnel.
Properties
FlashNet's corporate offices are located at 3001 Meacham Boulevard, Fort
Worth, Texas where all executive, systems, sales, finance and accounting
functions are housed. This facility, together with two
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additional Fort Worth facilities, provides FlashNet with approximately 75,000
square feet under leases, 45,000 square feet of which expire in July 2002 and
the remaining 30,000 square feet of which expire in September 2009. The
aggregate monthly rental under the leases is approximately $54,000. FlashNet
also leases space, which is typically less than 100 square feet, to house
equipment in 28 remote facilities in various locations in its core markets.
FlashNet does not own any real estate. FlashNet believes that all of its
facilities are adequately maintained and suitable for their present use.
Legal Proceedings
FlashNet is subject to certain claims and legal proceedings that arise in the
ordinary course of its business activities. Each of these matters is subject to
various uncertainties, and it is possible that some of these matters may be
decided unfavorably to Flashnet. Management believes that any liability that
may ultimately result from the resolution of these matters will not have a
material adverse effect on the financial condition, operating results or cash
flows of FlashNet.
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FLASHNET MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the risk factors,
selected financial information and other financial statements and related notes
of FlashNet included elsewhere in this document.
Overview
FlashNet is a nationwide provider of consumer Internet access services and
business services. FlashNet provides its Internet access in approximately 900
cities throughout the United States. As of December 31, 1999, FlashNet had
accumulated a subscriber base of approximately 235,000 users, including
approximately 3,200 customers for its business services.
In addition to access services as a national Internet service provider,
FlashNet offers a broad range of business services that enable businesses to
outsource their Internet and electronic commerce activities. FlashNet believes
that attracting additional business customers will result in a more stable,
higher quality customer base. FlashNet further believes that its business
services enable it to acquire new corporate customers more effectively and
provide many cross-selling opportunities.
During the quarter ended June 30, 1999, FlashNet contracted with several
vendors for the purchase of both new and refurbished personal computers.
FlashNet began reselling the personal computers through a bundled service
offering combining Internet access with a computer in exchange for a two or
three year contractual commitment for Internet service. In addition, FlashNet
also resold personal computers without Internet access. On September 30, 1999,
FlashNet discontinued its program of reselling refurbished personal computers
with bundled Internet service due to operational and cash considerations.
However, FlashNet expects to continue to sell new personal computers with
bundled Internet service on a limited basis.
Revenues
FlashNet's revenues generally are composed of:
. consumer access services;
. business services;
. shipping revenues; and
. set-up fees and other revenues.
Consumer access services revenues are composed of annual prepaid and monthly
subscriptions for consumer dial-up access to the Internet. FlashNet offers
prepaid and monthly subscribers a full money-back guarantee on cancellation of
their service if made within 30 days of initiating service. Amounts received on
the sale or renewal of prepaid annual and monthly subscriptions are recorded as
deferred revenue through the 30-day money-back cancellation period and then
amortized over the remaining period in which service is provided. Subscribers
may cancel their subscriptions at any time following the initial 30-day period,
in which case FlashNet charges the subscriber a $50 cancellation fee and
refunds any remaining prepaid amounts after the charge. Cash received from
subscribers is applied to working capital when received, and no cash reserves
are maintained for potential refund obligations.
Business services consisting of dedicated access services also are offered on
a prepaid annual and monthly subscription basis. The revenue recognition
policies and customer guarantee practices described above for consumer access
services also apply to dedicated access business services. Revenues from the
sale of business services involve set-up fees, which are included in set-up
fees and other revenues in the consolidated statement of operations, and a
service contract that provides for monthly billing. These business services
revenues are recognized as services are provided.
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Shipping revenues are derived primarily from the shipment of refurbished or
new personal computers issued in connection with FlashNet's bundled service
offering. The fees are non-refundable and are recognized as the personal
computers are shipped.
FlashNet derives set-up fees and other revenues through a variety of sources,
including set-up fees for subscribers to its consumer access services and
business services, sales of merchandise and hardware, sign-up and renewal fees
for independent representatives in its network marketing program and
advertising revenues. Set-up fees are charged to all new customers of consumer
access and to business services customers. These one-time set-up fees are non-
refundable and are deferred and amortized over a one-year period. Sales of
merchandise and hardware without bundled internet access and associated non-
refundable shipping fees are recognized as earned. Consulting services have
been provided from time to time on a limited basis by FlashNet on both a fixed
fee and a time-and-materials basis and are recognized as the services are
performed. Non-refundable fees are paid by representatives in FlashNet's
network marketing program at the commencement of participation in the program
and for renewal of participation on each anniversary of the representative's
commencement date. These fees are deferred and amortized over a one-year period
following the month of initial sign-up or renewal, as the case may be.
Advertising revenues are recognized as advertising services are provided.
Costs And Expenses
FlashNet's costs include:
. cost of services that are primarily related to the number of
subscribers;
. costs related to merchandise and hardware sold and cost of material for
FlashNet's network marketing program;
. amortization of and loss on personal computers issued to customers;
. selling, customer support and general and administrative expenses that
are associated more generally with operations; and
. depreciation and amortization, which are related to the size of
FlashNet's network and capital lease obligations.
Cost of services is comprised of the costs incurred in providing consumer
access services and business services. These costs include costs for providing
local telephone lines into each company-owned point of presence, the use of
third-party networks and the use of leased lines to connect each company-owned
point of presence and third-party point of presence to its hub and to connect
its hub to the Internet backbone.
Cost of other revenues consists of costs of installation software, premium
support costs, cost of merchandise and hardware sold and the cost of user
guides and other materials for representatives and distributors involved in
FlashNet's network marketing program.
Amortization of customer hardware is the result of amortizing the cost of
capitalized personal computers issued to customers, over the life of the
subscriber contract, with the amortization rate adjusted for estimates for non-
recoverability of equipment and uncollectible balances on cancelled contracts.
Loss on customer hardware resulted from personal computers returned by
customers which FlashNet was unable to recover from its vendors.
Cost of shipping is related primarily to the cost incurred by FlashNet to
have personal computers shipped by a third-party distributor, in connection
with FlashNet's bundled service offering.
Selling, general and administrative costs are incurred in the areas of sales
and marketing, customer support, network operations and maintenance,
engineering, accounting and administration. Sales and marketing
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expenses consist primarily of media and production costs, commissions and
expenses related to FlashNet's network marketing program, sales and marketing
overhead, and personnel costs. General and administrative expenses consist of
personnel and related costs associated with FlashNet's executive and
administrative functions and other miscellaneous expenses. Operations and
customer support expenses consist primarily of expenses associated with daily
support of FlashNet's subscriber base, including customer service and technical
support.
FlashNet has experienced operating losses since its inception as a result of
efforts to build its network infrastructure, customer base and internal
staffing, develop its systems and expand into new markets.
Results of Operations
The following table sets forth the percentage of total revenues represented
by items on FlashNet's consolidated statements of operations for the periods
indicated. Operating results for any period are not necessarily indicative of
results for any future period.
<TABLE>
<CAPTION>
Years Ended
December 31,
----------------------
1996 1997 1998 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues:
Consumer access services................................ 63% 68% 82% 77%
Business services....................................... 1 3 6 5
Shipping revenues....................................... -- -- -- 6
Set-up fees and other................................... 36 29 12 12
---- --- --- ---
Total revenues........................................ 100 100 100 100
---- --- --- ---
Operating costs and expenses:
Cost of services (includes amortization of and loss on
customer hardware)..................................... 64 47 44 50
Cost of shipping........................................ -- -- -- 5
Cost of other revenues.................................. 13 5 1 5
Sales and marketing..................................... 118 59 31 52
General and administrative.............................. 28 20 20 26
Operations and customer support......................... 23 21 22 26
Depreciation and amortization........................... 15 12 11 12
---- --- --- ---
Total expenses........................................ 261 164 129 176
---- --- --- ---
Loss from operations...................................... (161) (64) (29) (76)
Interest expense (net).................................... (4) (4) (9) --
---- --- --- ---
Loss before extraordinary item............................ (165) (68) (38) (76)
Extraordinary item--Loss on early extinguishment of debt.. -- -- -- (4)
---- --- --- ---
Net loss.................................................. (165) (68) (38) (80)
==== === === ===
</TABLE>
Year Ended December 31, 1999 Compared to Year Ended December 31, 1998
Revenues
FlashNet experienced substantial growth in revenues in 1999 as compared to
1998. Total revenues increased 50% to $40.3 million in 1999 from $26.9 million
in 1998.
As reflected by the increase in consumer access and business services
revenues, subscriptions and renewals increased 42% to $31.1 million in 1999
from $22.0 million in 1998. The increase in access service revenues was
primarily due to an increase in FlashNet's subscriber base of 37% to 235,000 at
December 31, 1999 from 172,000 at December 31, 1998.
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Shipping revenues of $2.4 million in 1999, were the result of FlashNet's
personal computer offer which began in June. Shipping fees are non-refundable
and are recognized as the personal computers are shipped. On September 30,
1999, FlashNet discontinued its program of reselling refurbished personal
computers with bundled Internet service due to operational and cash
considerations. FlashNet expects to continue to resell new computers with
bundled Internet service but anticipates less volume under this product
offering.
Subscriber set-up fees and other revenues increased 42% to $4.7 million in
1999 from $3.3 million in 1998. The increase was primarily the result of a $1.3
million increase in revenues from computer hardware and related add-on sales
such as upgraded processors and CD Roms.
Cost of Services
Cost of services increased 69% to $19.9 million in 1999 from $11.8 million in
1998, primarily due to a $4.1 million increase in dial tone costs and an
increase in Internet access charges of $700,000 resulting from the larger
subscriber base and greater usage per subscriber as subscribers spent more time
online, and amortization of and loss on customer hardware of $3.1 million, as
described below. Cost of services as a percentage of total revenues increased
to 50% from 44% during 1999 and 1998, respectively, primarily due to
amortization of and loss on customer hardware partially offset by the increases
in total revenues leveraging fixed costs and greater network efficiencies.
Cost of Other Revenues
Cost of other revenues increased to $2.0 million in 1999 from $0.3 million in
1998, respectively. Cost of other revenues as a percentage of total revenues
increased to 5% in 1999 from 1% in 1998. This increase was mainly due to the
costs associated with FlashNet's sales of computer hardware and various add-ons
such as upgraded processors and CD Roms.
Cost of Shipping, Amortization of and Loss on Customer Hardware
In June 1999, FlashNet began reselling personal computers through a bundled
service offering combining Internet access with a computer in exchange for a
two or three year contractual commitment. The costs of the personal computers
have been capitalized and are being amortized over the life of the subscriber
contract with the amortization term adjusted for estimates for the non-
recoverability of equipment and uncollectible balances on cancelled contracts.
Amortization expense for 1999 was approximately $1.5 million. On September 30,
1999, FlashNet discontinued its program of reselling refurbished personal
computers with bundled Internet service due to operational and cash
considerations. FlashNet expects to continue to resell new computers with
bundled Internet service but anticipates less volume under this product
offering. Loss of customer hardware resulted from personal computers returned
by customers which FlashNet was unable to recover from its vendor. See Note 12
to the consolidated financial statements for further discussion. Both the
amortization of, and loss on, customer hardware have been included in cost of
services.
Sales and Marketing Expenses
Sales and marketing expenses increased 156% to $21.0 million in 1999 from
$8.2 million in 1998. Sales and marketing expenses as a percentage of total
revenues increased to 52% from 31% during 1999 and 1998, respectively. The
increases, both in absolute dollars and as a percentage of total revenues, were
primarily due to increased advertising and labor costs associated with
FlashNet's "Free Web PC" offer which began in June 1999 and was discontinued on
September 30, 1999 with respect to the refurbished PCs. FlashNet aggressively
marketed the "Free Web PC" offer during the third quarter, resulting in an
increase in advertising and promotion expense of $8.1 million including $1.0
million in agency fees in 1999 versus 1998. As a result of the tremendous
response to the offer, FlashNet increased the number of full-time and contract
employees in the sales department. Labor costs increased $2.9 million in 1999
versus 1998, which included $1.2 million spent on
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outsourcing the excess call volume to third party call centers. In addition,
commissions paid to FlashNet's network marketing representatives increased $1.8
million in 1999 versus 1998 due to increases in subscribers obtained by such
representatives. FlashNet suspended much of its advertising efforts in 1998 to
conserve cash resources.
General and Administrative Expenses
General and administrative expenses increased 94% to $10.3 million in 1999
from $5.3 million in 1998. General and administrative expenses as a percentage
of total revenues increased to 26% from 20% during 1999 and 1998, respectively.
The increases were primarily due to increases in payroll, credit card fees and
spending on facilities. Payroll costs increased $0.9 million in 1999 versus
1998, primarily due to growth in headcount as a result of FlashNet's continued
growth. Credit card processing fees increased $0.9 million in 1999 versus 1998,
due to the increase in sales as a result of the growth in FlashNet's subscriber
base. Facility costs increased $1.5 million in 1999 versus 1998, as a result of
FlashNet relocating to new office facilities. Professional fees increased $1.2
million in 1999 versus 1998, primarily as a result of costs associated with
FlashNet's financing activities and consulting fees.
Operations and Customer Support Expenses
Operations and customer support expenses increased 74% to $10.5 million in
1999 from $6.0 million in 1998. Operations and customer support expenses as a
percentage of total revenues increased to 26% from 22% during 1999 and 1998,
respectively. The increases, both in absolute dollars and as a percentage of
total revenues, were primarily due to increased labor costs and increased
telephone charges associated with FlashNet's "Free Web PC" offer. Due to the
significant increase in call volume as a result of the offer, FlashNet's
telephone charges increased $0.7 million in 1999 versus 1998. In addition, the
number of full-time and contract employees in the customer support department
increased by approximately 80 personnel during 1999. FlashNet also added
additional technical personnel to support the larger subscriber base. As a
result, labor costs increased $3.8 million in 1999 versus 1998.
Depreciation and Amortization
Depreciation and amortization expense increased 66% to $5.1 million in 1999
from $3.1 million in 1998. The increase primarily resulted from additional
purchases of equipment and software and equipment acquired under capital leases
needed to support FlashNet's expanding network. Depreciation and amortization
expense as a percentage of total revenues increased to 13% for 1999 from 11% in
1998.
Net Interest Expense
Net interest expense decreased 100% to $0 from $2.5 million in 1998. Interest
expense decreased to $1.3 million in 1999 from $2.5 million in 1999 due to
lower average debt levels throughout 1999. Interest and other income increased
to $1.4 million from $.1 million during 1999 and 1998, respectively, offsetting
interest expense recorded during the twelve month period. The increase is due
to interest earned on the net proceeds from FlashNet's initial public offering
effected March 16, 1999, which FlashNet has used for working capital and the
purchase of temporary investments consisting of cash, cash equivalents, and
short-term investments with original maturity dates of three months or less at
the date of purchase.
Extraordinary Loss
The extraordinary loss on early extinguishment of debt represents the write-
off of unamortized debt discount costs of $1.4 million related to the repayment
of the $6.5 million Ascend note and $0.3 million of unamortized debt discount
and other costs related to the repayment of a $5.0 million term loan from
Goldman Sachs.
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Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
Revenues
FlashNet's total revenues increased $9.4 million, or 53%, to $26.9 million in
1998 from $17.5 million in 1997. Subscriptions and renewals increased $10.0
million, as reflected by the increase in consumer access services revenues, and
approximately $1.0 million was attributable to increased sales of business
services. These increases were offset by a $1.7 million decrease in subscriber
set-up fees and other revenues, resulting primarily from the elimination of
set-up fees applicable to annual prepaid consumer accounts made in connection
with a price increase for all consumer access and business access services in
the fourth quarter of 1997. New subscriptions increased in large part from the
expansion of FlashNet's network marketing program, which accounted for 27,521
new subscriber acquisitions in 1998 as compared to 10,050 new subscriber
acquisitions in 1997. Consumer access services revenues increased 84% in 1998
over 1997, primarily as a result of increases in FlashNet's subscriber base and
in average revenues per subscriber due to the price increase in the fourth
quarter of 1997. Business services revenues increased 180% in 1998 from 1997 as
FlashNet expanded its offerings of dedicated and broadband access and other
business services in response to escalating customer demand. Revenues from set-
up fees and other revenues decreased 34% in 1998 from 1997, primarily as a
result of FlashNet's decision in the fourth quarter of 1997 to discontinue
charging set-up fees for prepaid subscriptions and due to the receipt in 1997
of consulting fees of $1.0 million for a project that was completed in that
year.
Cost of Services
Cost of services increased $3.6 million, or 44%, to $11.8 million in 1998
from $8.2 million in 1997. Of this increase, $3.1 million was attributable to
an increase in dial tone costs associated with a higher level of subscribers on
FlashNet's network. As a percentage of total revenues, cost of services
decreased to 44% in 1998 from 47% in 1997 primarily due to the increases in
consumer access and business services partially offset by a decline in set-up
fees and other revenues in 1998. As a percentage of revenues derived from
consumer access services and business services, cost of recurring revenues
decreased to 50% in 1998 from 66% in 1997. This decrease resulted from the
price increase in the fourth quarter of 1997 and greater network efficiencies.
Cost of Other Revenues
Cost of other revenues decreased $450,000, or 56%, to $349,000 in 1998 from
$799,000 in 1997. As a percentage of total revenues, cost of other revenues
decreased to 1% in 1998 from 5% in 1997. The decrease in cost of other
revenues, both in absolute dollars and as a percentage of total revenues, was
primarily the result of cost savings of $315,000 attributable to FlashNet's
obtaining a royalty-free license for Netscape software in the fourth quarter of
1997 that was previously purchased by it and resold to customers.
Sales and Marketing Expenses
Sales and marketing expenses decreased $2.1 million, or 20%, to $8.2 million
in 1998 from $10.3 million in 1997. As a percentage of total revenues, sales
and marketing expenses decreased to 31% in 1998 from 59% in 1997. This
decrease, both in absolute dollars and as a percentage of total revenues, was
attributable to a $3.8 million decline in media expenses offset by an $1.5
million increase in expenses associated with FlashNet's network marketing
program. FlashNet's reduction in media expenditures in 1998 was primarily due
to its decision to conserve cash resources and, to a lesser extent, to its
decision to purchase national media spots rather than local media spots, with
the latter being generally more expensive on a per-impression basis. See the
subsection entitled "Overview."
General and Administrative Expenses
General and administrative expenses increased $1.8 million, or 53%, to $5.3
million in 1998 from $3.5 million in 1997. General and administrative expenses
increased primarily due to an increase in the number of
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<PAGE>
staff members and increased spending on facilities and supplies, due primarily
to FlashNet's expansion of its network marketing program. Facility costs
increased $0.6 million in 1998 versus 1997, as FlashNet expanded its office
space for the additional employees. Labor costs increased $0.5 million in 1998
versus 1997. In addition, credit card fees increased $0.4 million as a result
of increased sales. As a percentage of total revenues, general and
administrative expenses remained constant at 20%.
Operations and Customer Support Expenses
Operations and customer support expenses increased $2.3 million, or 63%, to
$6.0 million in 1998 from $3.7 million in 1997. As a percentage of total
revenues, operations and customer support expenses increased to 22% in 1998
from 21% in 1997. These increases were primarily due to the addition of new
customer care and technical personnel to support a larger subscriber base.
Depreciation and Amortization
Depreciation and amortization expense increased $1.0 million, or 49%, to $3.1
million in 1998 from $2.1 million in 1997. This increase primarily resulted
from additional purchases of equipment and software that were needed to support
FlashNet's expanding network. As a percentage of total revenues, depreciation
and amortization expense decreased slightly to 11% in 1998 from 12% in 1997.
Net Interest Expense
Net interest expense increased $1.8 million to $2.5 million in 1998 from
$714,000 in 1997. This increase was primarily attributable to interest paid on
borrowings of $6.5 million from Ascend in the fourth quarter of 1997 and, to a
lesser extent, capitalized leases for the acquisition of additional networking
equipment.
Net Loss
Net loss decreased $1.4 million to $10.3 million in 1998 from $11.7 million
in 1997. As a percentage of total revenues, net loss decreased to 38% in 1998
from 68% in 1997. In 1998, the net loss attributable to common shareholders
included $2.7 million related to preferred stock deemed distributions and
accretion.
Liquidity and Capital Resources
FlashNet's principal capital and liquidity needs historically have related to
its sales and marketing activities, the development and expansion of its
network infrastructure, the establishment of its customer service and support
operations and general working capital needs. The capital needs of FlashNet
have historically been met by receipts from its prepaid subscriber customer
base, additional capital from outside sources, including vendor capital leases
and other vendor financing arrangements and through private placements of its
securities. FlashNet's initial public offering, completed in March 1999,
provided FlashNet with additional capital of $56.3 million.
FlashNet's operating activities used net cash of approximately $34.9 million
during 1999. Net cash used in operations resulted primarily from net losses,
adjusted for depreciation and amortization expense, the purchase of personal
computers included in FlashNet's new bundled service offering, the increase in
accounts receivable and the decrease in deferred revenue. In addition, FlashNet
funded a $700,000 note receivable bearing interest at 12% per annum maturing in
April 2000, which is convertible, at the option of FlashNet, into common stock
of a public company focused on developing communication services.
Cash used by investing activities has consisted primarily of equipment
purchases for point of presence and network expansion. For 1999, capital
expenditures amounted to approximately $8.5 million. Additionally, FlashNet
received approximately $2.9 million in proceeds from sale/leasebacks of data
communication equipment. At December 31, 1999, FlashNet does not have any
material commitments for capital expenditures.
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<PAGE>
Cash provided by financing activities was approximately $47.2 million during
1999. During January 1999, FlashNet received proceeds of a $5.0 million term
loan from Goldman Sachs. During March 1999, FlashNet effected its initial
public offering. Net proceeds to FlashNet were approximately $56.3 million.
Cash used for financing activities included $6.5 million and $5.0 million for
the early repayment of the Ascend note and the Goldman Sachs term loan,
respectively, during March 1999. Principal payments under capital lease
obligations were $3.1 million for 1999.
Cash used in operating activities of $5.2 million during 1998 primarily was
attributable to a $10.3 million net loss, partially offset by $3.0 million in
depreciation expense and $1.9 million in non-cash interest expense. Cash used
in investing activities during 1998 was $1.4 million, principally as a result
of the purchase of property, plant and equipment to support increases in
FlashNet's subscriber base. Cash provided from financing activities during 1998
was $6.1 million, which consisted primarily of $7.8 million, after transaction
fees, raised in a private placement of convertible preferred stock offset by
debt principal payments.
During the quarter ended June 30, 1999, Flashnet began reselling personal
computers, or PCs, through a bundled service offering combining Internet access
with a computer in exchange for a two or three year contractual commitment for
Internet service. The initial response to this "Free PC" program was much
greater than anticipated and Flashnet's vendors could not service the demand
for refurbished computers thus causing significant delays in the fulfillment of
these customers orders. These delays caused the customers to place a
significant number of calls into Flashnet's call center. To handle this demand,
Flashnet increased the number of its telephone representatives by approximately
75%. The resulting increased costs, coupled with the actual cost of the
computers, resulted in a significant decrease in Flashnet's cash balance.
Although Flashnet discontinued the "Free PC" program after September 30, 1999,
it continued to receive a significant number of calls into its call center
throughout the fourth quarter. Additionally, the delays in the fulfillment of
the customer orders caused a larger number of customers to cancel their service
contracts, which in turn caused Flashnet to incur a loss on its computer
hardware. Due to the operational and cash requirements of the "Free PC"
program, Flashnet was forced to make reductions in its cash expenditures in
other operational areas and discontinued the "Free PC" program to preserve its
cash resources. Flashnet identified its sales and marketing efforts as the
primary area to reduce its expenditures. The reduction in these efforts, which
was mainly accomplished by reducing its advertising and media expenditures, has
resulted in a decrease in new subscribers and cash receipts from revenue-
generating activities. The selling of new personal computers with bundled
Internet service could require additional cash commitments. However, sales of
new computers with bundled Internet service have not been and are not expected
to be significant. Because the pending merger with Prodigy requires FlashNet to
maintain its basic infrastructure, FlashNet continues to conduct its operations
in a manner generally consistent with its historical practices (except
curtailing certain aspects of its sales and marketing as described above) and
has not sought additional financing nor has any commitments for financing at
December 31, 1999. FlashNet will be required to seek additional financing
sufficient to meet its working capital needs for fiscal 2000 if the merger with
Prodigy is not consummated. Based on FlashNet's recent efforts to raise
capital, management has determined that it most likely cannot raise additional
capital or financing on reasonable terms. The Report of Independent Auditors
dated March 3, 2000 with respect to FlashNet's consolidated financial
statements for the year ended December 31, 1999, contains an explanatory
paragraph regarding FlashNet's ability to continue as a going concern.
FlashNet's only plan at this time with respect to the going concern is the
merger with Prodigy and FlashNet has no contingency plans presently in place
should the merger with Prodigy fail to occur. If the merger is not consummated,
management could be forced to make significant reductions in its headcount and
expenditure levels, and would most likely be forced to raise capital, if
obtainable, on unfavorable terms. FlashNet does not believe that its current
cash and cash equivalents are sufficient to meet its working capital needs for
the next 12 months.
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On April 26, 2000, Prodigy agreed to loan FlashNet up to $2,000,000 to fund
operations. Advances will be unsecured, bear interest at an annual rate of 12%
and are due October 26, 2000. As of May 5, 2000, no advance had been made under
these arrangements. As of April 10, 2000, FlashNet had cash and cash
equivalents of approximately $1 million. However, in the judgment of FlashNet's
management, Prodigy's loan commitment coupled with FlashNet's cash on hand,
should be sufficient to finance its operations until the closing of the merger.
Impact of Year 2000
In prior years, FlashNet discussed the nature and progress of its plans to
become Year 2000 ready. In late 1999, FlashNet completed its remediation and
testing of systems. As a result of those planning and implementation efforts,
FlashNet experienced no significant disruptions in mission critical information
technology and non-information technology systems and believes those systems
successfully responded to the Year 2000 date change. FlashNet expensed
approximately $200,000 during 1999 in connection with remediating its systems.
FlashNet is not aware of any material problems resulting from Year 2000 issues,
either with its products, its internal systems, or the products and services of
third parties. FlashNet will continue to monitor its mission critical computer
applications and those of its suppliers and vendors throughout the Year 2000 to
ensure that any latent Year 2000 matters that may arise are addressed promptly.
Changes in and Disagreement with Independent Accountants
On August 20, 1999, FlashNet dismissed Deloitte & Touche LLP as its
independent accountants and appointed Ernst & Young LLP as its auditors for the
year ending December 31, 1999. The audit committee of FlashNet's board of
directors recommended the change in independent accountants and the change was
approved by the board of directors. Deloitte & Touche LLP's reports on
FlashNet's financial statements for the two most recent fiscal years ended
December 31, 1997 and 1998, did not contain an adverse opinion, disclaimer of
opinion, qualification or modification as to audit scope or accounting
principles. In addition, during the two most recent years and through August
20, 1999 there were no disagreements with Deloitte & Touche LLP on any matter
of accounting principles or practices, financial statement disclosure or
auditing scope and procedures, which disagreements, if not resolved to the
satisfaction of Deloitte & Touche LLP, would have caused Deloitte & Touche LLP
to make reference to the subject matter of the disagreements in connection with
their reports on the financial statements of FlashNet.
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UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION
On October 5, 1999, Prodigy acquired the BizOnThe.Net Web hosting business of
U.S. Republic Communications, Inc. an indirect majority owned subsidiary of
VarTec including the subscribers of the BizOnThe.Net Web hosting business. At
the closing, Prodigy repaid a $9 million loan from VarTec to U.S. Republic and
issued 2,840,993 shares of Prodigy common stock to U.S. Republic including
727,272 shares held in an escrow account to secure the indemnification
obligations of U.S. Republic and its shareholders. Some or all of the escrowed
shares will be released to U.S. Republic at various times over the two year
period following the closing. In addition to the shares and amounts paid at
closing, in 2001 Prodigy may be required to issue up to 727,272 additional
shares, contingent on the attainment by the acquired business of set earn-out
targets.
Under accounting principles generally accepted in the United States, the
acquisition of BizOnThe.Net was accounted for under the purchase method of
accounting and accordingly the cost to acquire BizOnThe.Net was allocated to
the assets acquired and liabilities assumed based on their respective fair
values with the excess allocated to goodwill. The valuations and other studies
required to determine the fair value of the BizOnThe.Net assets acquired and
liabilities assumed were substantially completed and the respective adjustments
to the historical values are included in the balance sheet of Prodigy as of
December 31, 1999. The total purchase price is subject to change based on the
calculation of the amount by which the net book value of the acquired assets
and assumed liabilities as of October 5, 1999 exceeded or was less than the net
book value as of July 31, 1999, which is expected to be finalized in the second
quarter of 2000, and earn-out adjustments and other contractual terms to be
finalized over the next two years. Changes in the purchase price based on these
adjustments will be recorded as corresponding increases or decreases in
goodwill at the time the related items are resolved and are not expected to
exceed $10 million. Based on the value of the 2,840,993 shares of common stock
currently issued in connection with the BizOnThe.Net acquisition and the $9
million cash used to repay the loan, the total purchase price is approximately
$58 million, including transaction costs of $829 thousand. The excess of the
purchase price over the fair value of net assets acquired is approximately $50
million.
On November 5, 1999, Prodigy agreed to acquire FlashNet Communications, Inc.
In the merger, Prodigy will issue 0.35 share of Prodigy common stock for each
outstanding share of FlashNet common stock. Based on the number of FlashNet
shares outstanding on March 31, 2000, Prodigy will issue approximately
5,000,000 shares to complete the merger, representing approximately 7% of
Prodigy's then outstanding shares. In addition, Prodigy will assume all
FlashNet stock options and warrants outstanding as of the date of the merger.
Under accounting principles generally accepted in the United States, the
acquisition of FlashNet will be accounted for under the purchase method of
accounting. Accordingly, the cost to acquire FlashNet will be allocated to the
assets acquired and liabilities assumed based on their respective fair values,
with the excess to be allocated to goodwill. The valuations and other studies
required to determine the fair value of the FlashNet assets acquired and
liabilities assumed have not been performed and, accordingly, the related
adjustments reflected in the unaudited pro forma combined financial information
are preliminary and subject to further revisions and adjustments. For purposes
of this presentation, the carrying amounts of the FlashNet tangible net assets
acquired was assumed to approximate fair value. In addition, Prodigy expects to
recognize intangible assets such as subscriber relationships and trade name.
Therefore, the excess of purchase price over the historical net book value of
the net assets of FlashNet has been classified on the pro forma balance sheet
as "Goodwill and Other Intangibles." After the completion of the FlashNet
merger, Prodigy will arrange for an independent appraisal of significant assets
and liabilities of FlashNet. Upon completion of the determination of fair
value, the purchase price will be allocated to specific assets and liabilities
of FlashNet. It is anticipated that there will be reductions to and increases
in the carrying amounts of assets. Accordingly, the final valuation could
result in materially different allocations of the purchase price compared to
the amounts presented in the following pro forma information, resulting in
corresponding changes in depreciation and amortization amounts. Based on the
value of the estimated 5,000,000 shares of Prodigy common stock to be issued in
connection with
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the FlashNet acquisition, the total purchase price is approximately $135.6
million including transaction costs incurred to date of $2.2 million. The
goodwill and other intangibles acquired, based on the excess of the purchase
price over the net book value of net assets to be acquired is currently
estimated to be $126 million.
On November 19, 1999, SBC and Prodigy agreed to establish a strategic
relationship in which:
. Prodigy will contribute substantially all of its assets and liabilities,
and transfer its employees to a new limited partnership, called the
operating partnership, that will operate Prodigy's business;
. SBC will acquire an approximately 43% indirect interest in Prodigy upon
completion of the SBC transaction and approximately 39.5% indirect
interest after the FlashNet merger;
. SBC will contribute to the operating partnership routers, servers and
associated hardware used in connection with SBC's consumer and small
business Internet operations and that are selected by Prodigy because
Prodigy determines that they will be useful in connection with the
provision of services to SBC's customers and Prodigy's customers after
the closing;
. SBC will contribute to the operating partnership intangible assets
consisting primarily of royalty-free licenses to use SBC's trademarks in
connection with the marketing and operation of the Prodigy Internet
service and Prodigy's right to manage SBC's existing Internet customers;
. Prodigy will be the exclusive retail Internet service marketed by SBC to
consumers and small businesses;
. SBC will purchase the Prodigy Internet service from Prodigy on wholesale
terms and provide it to SBC's approximately 690,000 existing Internet
subscribers--the wholesale price to be paid by SBC to Prodigy for the
Prodigy Internet service that SBC will resell to its existing Internet
subscribers will equal SBC's average retail price as of the closing less
reasonable and necessary expenses actually incurred by SBC in serving
its existing Internet subscribers;
. SBC has committed to obtain for Prodigy 1,200,000 additional Internet
subscribers over a three-year period in exchange for fees of $40 to $75
per subscriber--all new subscribers obtained for Prodigy by SBC will be
Prodigy subscribers;
. SBC has agreed to pay Prodigy a penalty if SBC does not obtain 1,200,000
additional internet subscribers for Prodigy over the three-year period,
with the size of the penalty based on the number of subscribers actually
obtained by SBC who pay at least one monthly bill from Prodigy--for
example, the penalty will range from $165,000,000 if SBC acquires no new
subscribers for Prodigy, to $105,000,000 if SBC acquires 600,000 new
subscribers for Prodigy, to no penalty if SBC acquires 1,200,000 new
subscribers for Prodigy;
. SBC will have the exclusive right to market its long-distance phone
service, local phone service, wireless phone services, paging services
and related calling services to Prodigy's subscribers, so long as SBC's
service offerings are competitive with service offerings from other
providers;
. SBC will be Prodigy's exclusive network provider so long as SBC offers
its network services to Prodigy at the most favorable rates that it
offers to other similar purchasers, so long as SBC's terms are
competitive with those offered by other providers;
. SBC will have the exclusive right to provide telecommunications,
advertising, telecommunications e-commerce and Internet telephony
applications in conjunction with the Prodigy Internet service to
Prodigy's subscribers so long as SBC's terms are competitive with those
offered by other providers;
. SBC will be the exclusive provider of electronic yellow and white pages
and city guides Prodigy's subscribers;
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. Prodigy will convert all outstanding common stock into Prodigy Class A
common stock; and
. Prodigy will issue to an SBC subsidiary one share of Prodigy Class B
common stock in consideration of $100.
The tangible and intangible assets received in conjunction with the SBC
transaction will be recorded at fair value on the date the assets are
contributed. Based on the following assumptions, the fair value of the assets
received has been estimated at $968.75 million:
. SBC will receive approximately 50,000,000 partnership units, which
assuming that SBC's book capital account equals its imputed capital
account and that the partnership interests will be equivalent in value
to the Prodigy Class A common stock, will be convertible into
approximately 50,000,000 shares of Prodigy Class A common stock based on
pro forma shares outstanding after giving effect to the BizOnThe.Net and
FlashNet acquisitions; and
. the value of one share of Prodigy common stock was approximately $19.38
on December 31, 1999, which when multiplied by 50,000,000 shares,
results in an estimated value of $968.75 million.
For purposes of the pro forma financial information, and pending preparation of
a valuation to allocate the purchase price, the tangible and intangible assets
to be received have been aggregated and presented in total in the SBC Assets
balance sheet caption. These assets which are principally related to the
royalty-free license to use the SBC trademarks, which will be amortized over
the three year term of the agreement, and the routers, servers and associated
hardware, which are also assumed to have a three year life. If the amortization
period of any of these assets is longer than the three year period assumed for
purposes of the pro forma financial information, the corresponding annual
amortization expense will be decreased.
In addition to the equity investment, SBC will purchase from Prodigy the
Prodigy Internet service and resell these services to its existing Internet
service subscribers. Prodigy will charge SBC a fixed price per subscriber for
its services, to be fixed as of the closing date, and will incur incremental
costs associated with providing these services to SBC, principally related to
Prodigy's acquisition of additional network services and customer service.
Adjustments have not been made to revenue or cost of revenue included in the
pro forma statement of operations to reflect the services to be provided to the
existing SBC subscribers as contractual agreements have not been finalized with
respect to these services. Prodigy currently estimates that the revenue from
the sale of the subscribers services will approximate $16.61 per subscriber per
month, the costs of revenue associated with each subscriber will be
approximately $7.00 per month and customer service costs will approximate $1.70
per subscriber per month. Actual amounts ultimately incurred could differ
materially from these estimated amounts.
Additionally, the SBC agreement includes other services that Prodigy and SBC
will provide to each other. Impacts to revenue and expenses associated with
these services, however, cannot be estimated at this time and accordingly have
not been included in the pro forma statement of operations.
The unaudited pro forma condensed combined balance sheets give effect to the
acquisition of FlashNet and the SBC transaction as if these had occurred on
December 31, 1999. The acquisition of BizOnThe.Net is reflected in the
historical balance sheet of Prodigy as of December 31, 1999.
The unaudited pro forma condensed combined statements of operations for the
year ended December 31, 1999 give effect to the acquisition of BizOnThe.Net and
FlashNet, and the SBC transaction as if these occurred on January 1, 1999 and
are based on the historical results of operations of Prodigy, BizOnThe.Net and
FlashNet and the amortization associated with the assets acquired in the SBC
transaction. The results of BizOnThe.Net for the fourth quarter of 1999 are
included in the results of operations of Prodigy for the year ended
December 31, 1999.
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The unaudited pro forma condensed combined financial statements are based on
the preliminary estimates and assumptions set forth in the notes to these
statements that have been made solely for purposes of developing this pro forma
information. The unaudited pro forma condensed combined financial statements
are not necessarily indicative of the results that would have been achieved had
these transactions been completed as of the dates indicated or that may be
achieved in the future.
These unaudited pro forma condensed combined financial statements should be
read in conjunction with the historical consolidated financial statements and
related notes and other financial information pertaining to Prodigy,
BizOnThe.Net and FlashNet, including the Prodigy and FlashNet "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Risk Factors" included elsewhere in this document.
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Unaudited Pro Forma Condensed Consolidated Statement of Operations
Prodigy and BizOnThe.Net
For the Year Ended December 31, 1999
(In thousands, except per share amounts and shares outstanding)
<TABLE>
<CAPTION>
January 1, 1999
Year Ended through Pro Forma
December 31, 1999 September 30, 1999 Adjust- Prodigy and
Prodigy BizOnThe.Net ments BizOnThe.Net
----------------- ------------------ --------- ------------
<S> <C> <C> <C> <C>
Revenues:
Internet and online
service revenues...... $ 169,810 $ 169,810
Web hosting............ $19,069 19,069
Other.................. 19,228 19,228
----------- ------- --------- ----------
189,038 19,069 208,107
Operating costs and ex-
penses:
Costs of revenue....... 102,199 249 102,448
Amortization of
subscriber acquisition
costs................. 20,448 20,448
Sales and marketing.... 58,854 12,418 71,272
Product development.... 12,341 12,341
General and
administrative........ 61,652 6,720 68,372
Depreciation and
amortization.......... 21,792 277 $ 14,153 1(a) 36,222
----------- ------- --------- ----------
277,286 19,664 14,153 311,103
----------- ------- --------- ----------
Operating income
(loss)................. (88,248) (595) (14,153) (102,996)
Interest income / (ex-
pense), net............ 2,262 (473) 473 1(b) 2,262
Gain on sale of equity
investment............. 3,319 3,319
Gain on settlement of
note payable........... 1,714 1,714
Gain on settlement of
note receivable........ 500 500
Other................... (35) (35)
----------- ------- --------- ----------
Net loss................ $ (80,488) $(1,068) $ (13,680) $ (95,236)
=========== ======= ========= ==========
Basic and diluted loss
per share.............. ($1.34) ($1.53)
=========== ==========
Weighted average number
of common and
common equivalent
shares outstanding..... 59,958,111 2,156,041 1(c) 62,114,152
=========== ========= ==========
</TABLE>
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Notes to the Unaudited Pro Forma Condensed Combined Financial Information
(in thousands except subscriber, share and per share information)
BizOnThe.Net
1. (a) Adjustment of amortization and depreciation to reflect the
amortization of goodwill and other intangible assets which will be amortized
over a period of three years, the expected period of benefit. The goodwill has
been calculated and the purchase price allocated based on the fair value of the
BizOnThe.Net net assets acquired, including other intangible assets acquired,
as follows:
<TABLE>
<S> <C>
Cash portion of purchase price..................................... $ 9,000
Value of stock portion of purchase price........................... 48,439
Transaction costs.................................................. 829
--------
Purchase price..................................................... 58,268
Add: fair value of liabilities assumed............................. 621
Less: fair value of tangible assets acquired....................... (3,091)
Less: fair value of intangible assets acquired
Developed software................................................. (700)
Subscriber relationships........................................... (1,900)
Tradename.......................................................... (3,600)
--------
Goodwill........................................................... $ 49,598
========
The amortization of intangible assets was calculated as follows:
Total Goodwill and Intangible Assets............................... $ 55,798
Average life of intangible assets.................................. 3 years
Annual amortization................................................ $ 18,599
--------
278 days of amortization........................................... $ 14,153
--------
</TABLE>
The BizOnThe.Net liabilities, which were assumed by Prodigy, exclude
liabilities included in the September 30, 1999 financial statements on an
allocated basis as those amounts were paid by VarTec/U.S. Republic prior to
closing.
The 2,840,993 shares of common stock issued in connection with the
BizOnThe.Net acquisition were valued at $17.05 per share which represents the
average market value of a Prodigy share immediately before and after the terms
of the acquisition were announced. This amount excludes the 727,272 shares to
be issued in 2001 pending resolution of the related contingencies.
(b) Adjustment to remove interest expense on VarTec note payable to reflect
the repayment of the note in connection with the acquisition of BizOnThe.Net.
(c) Adjustment of the weighted average shares of common stock outstanding
used in computing basic and diluted net loss per share to reflect issuance of
2,840,993 shares of common stock as of January 1, 1999 including the 727,272
shares held in escrow. The 727,272 shares which are issuable contingent upon
attainment of certain earnings targets have been excluded from the weighted
average shares as the effect would be anti-dilutive.
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UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
Unaudited Pro Forma Condensed Consolidated Balance Sheets
Prodigy and FlashNet
As of December 31, 1999
(In thousands)
<TABLE>
<CAPTION>
Pro Forma
Prodigy
Prodigy FlashNet Adjustments and FlashNet
-------- -------- ----------- ------------
<S> <C> <C> <C> <C>
Assets
Current assets:..............
Cash........................ $ 35,473 $ 7,045 $ 42,518
Accounts receivable, net.... 10,314 4,393 14,707
Note receivable............. 700 700
Due from affiliate.......... 1,801 1,801
Prepaid expense............. 2,793 2,661 5,454
Other current assets........ 1,437 904 2,341
-------- ------- -------- ---------
Total current assets....... 51,818 15,703 67,521
-------- ------- -------- ---------
Restricted cash.............. 4,692 4,692
Property and equipment, net.. 18,201 17,783 35,984
Customer hardware............ 5,579 5,579
Subscriber Acquistion Costs.. 182,838 182,838
Goodwill and other
intangibles................. 87,321 $125,982 2(a) 213,303
Software Licenses............ 338 338
Other assets................. 1,118 182 1,300
-------- ------- -------- ---------
Total assets................. 345,988 39,585 $125,982 $ 511,555
======== ======= ======== =========
Liabilities and Stockholders'
Equity
Current liabilities..........
Notes payable............... $110,154 $ 110,154
Lease obligations--current
portion.................... 412 $ 4,129 4,541
Accounts payable and other
accrued expenses........... 48,342 9,262 $ 2,215 2(a) 59,819
Accrued compensation........ 3,095 913 4,008
Unearned revenue............ 14,062 10,215 24,277
Accrued purchase and
restructuring costs........ 3,849 3,849
-------- ------- -------- ---------
Total current liabilities.. 179,914 24,519 2,215 206,648
Lease obligations--long-term
portion..................... 983 5,410 6,393
-------- ------- -------- ---------
Total Liabilities............ 180,897 29,929 2,215 213,041
Stockholders' equity
Common stock................ 645 68,776 (68,726)2(b) 695
Warrants to purchase common
stock...................... 3,330 10,893 2(c) 14,223
Additional paid-in capital--
common stock............... 539,054 1,909 119,150 2(b) 658,204
(1,909)2(b)
Accumulated deficit......... (373,275) (62,932) 62,932 2(b) (373,275)
Unearned compensation....... (1,427) 1,427 2(b)
-------- ------- -------- ---------
166,424 9,656 123,767 299,847
Less note receivable from
stockholder................ (1,333) (1,333)
-------- ------- -------- ---------
Total stockholders'
equity.................... 165,091 9,656 123,767 298,514
-------- ------- -------- ---------
Total liabilities and
stockholders' equity...... $345,988 $39,585 $125,982 $ 511,555
======== ======= ======== =========
</TABLE>
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Unaudited Pro Forma Condensed Consolidated Statement of Operations
Prodigy, BizOnThe.Net and FlashNet
For the Year Ended December 31, 1999
(In thousands, except per share amounts and shares outstanding)
<TABLE>
<CAPTION>
Pro Forma
Pro Forma Prodigy,
Prodigy and BizOnThe.Net
BizOnThe.Net FlashNet Adjustments and FlashNet
------------ -------- ----------- ------------
<S> <C> <C> <C> <C>
Revenues:
Internet and online
service revenues......... $ 169,810 $ 31,104 $ 200,914
Web hosting............... 19,069 19,069
Other..................... 19,228 9,147 28,375
----------- -------- ---------- -----------
208,107 40,251 248,358
Operating costs and
expenses:
Costs of revenue.......... 102,448 23,877 126,325
Amortization of
subscriber acquisition
costs.................... 20,448 20,448
Sales and marketing....... 71,272 20,967 92,239
Product development....... 12,341 12,341
General and
administrative........... 68,372 20,783 89,155
Depreciation and
amortization............. 36,222 5,094 41,994 3(a) 83,310
----------- -------- ---------- -----------
311,103 70,721 41,994 423,818
----------- -------- ---------- -----------
Operating loss............. (102,996) (30,470) (41,994) (175,460)
Interest income/(expense),
net....................... 2,262 97 2,359
Gain on sale of equity
investment................ 3,319 3,319
Gain on settlement of note
payable................... 1,714 1,714
Gain on settlement of note
receivable................ 500 500
Other...................... (35) (35)
----------- -------- ---------- -----------
Net loss before
extraordinary item........ ($ 95,236) ($30,373) ($ 41,994) ($ 167,603)
=========== ======== ========== ===========
Basic and diluted loss per
share..................... ($ 1.53) ($ 2.50)
=========== ===========
Weighted average number of
common and common equiva-
lent shares
outstanding............... 62,114,152 5,000,000 3(b) 67,114,152
=========== ========== ===========
</TABLE>
141
<PAGE>
FlashNet
2. (a) Adjustment to calculate goodwill and other intangible assets and to
allocate the purchase price over the estimated fair value of the FlashNet net
assets acquired calculated as follows:
<TABLE>
<S> <C>
Value of stock portion of purchase price........................ $119,200
Fair value of converted options and warrants.................... 14,223
Transaction costs............................................... 2,215
--------
Purchase price.................................................. 135,638
Less: estimated fair value of net assets acquired............... (9,656)
--------
Goodwill and other intangibles.................................. $125,982
========
</TABLE>
The value of the common stock to be issued to FlashNet is $23.84 a share which
represents the average market value of a share of Prodigy common stock
immediately before and after the terms of the acquisition were announced.
(b) Adjustment to eliminate the stockholders equity of FlashNet and reflect
the issuance of approximately 5,000,000 shares of common stock based on the
exchange ratio of .35 share of Prodigy common stock for each share of FlashNet
common stock valued at $23.84 per share. This results in common stock of $50
and $119,150 of additional paid in capital.
(c) Adjustment to recognize the fair value of FlashNet warrants and vested
options converted to Prodigy warrants and options based on the exchange ratio
of .35 share of Prodigy common stock for each share of FlashNet common stock.
All options and warrants that Prodigy assumes in the acquisition will be
fully vested. Additionally, prior to the acquisition, FlashNet will terminate
all FlashNet stock options that have exercise prices equal to or higher than
the market price of FlashNet common stock. Assuming the merger occurred on
December 31, 1999, approximately 210,000 options to purchase Prodigy common
stock would be issued on a fully-vested basis at the time of the merger.
Additionally, Prodigy will assume the warrant held by Ascend Communications,
Inc. to purchase 1,360,000 shares of FlashNet common stock at an exercise price
of $.003 and convert it into a warrant to purchase 476,000 shares of Prodigy
common stock at an exercise price of $.009 based on the exchange ratio.
A Black-Scholes option pricing model was utilized to determine the value of
these options and the warrant using the following assumptions:
<TABLE>
<S> <C>
Dividend Yield: None
Volatility: 60%
Risk free rate: 5.76% for the options; 6.12% for the warrant
Expected Option Life: 2 years for the options; 8.2 years for the warrant
Fair Value of Underlying
Common Stock $23.84 per share
</TABLE>
There will be no unvested options or warrants assumed.
3. (a) Adjustment to amortization to reflect amortization of the FlashNet
goodwill and intangible assets based on an estimated three year useful life.
(b) Adjustment of the weighted average shares of common stock outstanding
used in computing basic and diluted net loss per share to reflect the issuance
of approximately 5,000,000 shares of common stock as of January 1, 1999.
142
<PAGE>
UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
Unaudited Pro Forma Condensed Consolidated Balance Sheets
Prodigy, FlashNet and SBC
As of December 31, 1999
(In thousands)
<TABLE>
<CAPTION>
Pro Forma
Pro Forma Prodigy,
Prodigy SBC FlashNet
and FlashNet Adjustments and SBC
------------ ----------- ----------
<S> <C> <C> <C>
Assets
Current assets:......................
Cash................................ $ 42,518 $ 42,518
Accounts receivable, net............ 14,707 14,707
Note receivable..................... 700 700
Due from affiliate.................. 1,801 1,801
Prepaid expense..................... 5,454 5,454
Other current assets................ 2,341 2,341
-------- -------- ----------
Total current assets............... 67,521 67,521
-------- -------- ----------
Restricted cash...................... 4,692 4,692
Property and equipment, net.......... 35,984 35,984
Customer hardware.................... 5,579 5,579
Subscriber Acquisition costs......... 182,838 182,838
Goodwill and other intangibles....... 213,303 213,303
Software Licenses.................... 338 338
SBC assets........................... $968,750 4(a) 968,750
Other assets......................... 1,300 1,300
-------- -------- ----------
Total assets......................... $511,555 $968,750 $1,480,305
======== ======== ==========
Liabilities and Stockholders' Equity
Current liabilities..................
Notes payable....................... $110,154 $ 110,154
Lease obligations--current portion.. 4,541 4,541
Accounts payable and other accrued
expenses........................... 59,819 59,819
Accrued compensation................ 4,008 4,008
Unearned revenue.................... 24,277 24,277
Accrued purchase and restructuring
costs.............................. 3,849 3,849
-------- -------- ----------
Total current liabilities.......... 206,648 206,648
Lease obligations--long-term
portion............................. 6,393 6,393
-------- -------- ----------
Total Liabilities.................... 213,041 213,041
Minority Interest in Operating
Partnership......................... 499,302 4(b) 499,302
Stockholders' equity
Common stock........................ $ 695 (695)4(c)
Class A common stock................ 695 4(c) 695
Class B common stock................
Warrants to purchase common stock... 14,223 14,223
Additional paid-in capital--common
stock.............................. 658,204 469,448 4(b) 1,127,652
Accumulated deficit................. (373,275) (373,275)
-------- -------- ----------
299,847 469,448 769,295
Less note receivable from
stockholder........................ (1,333) (1,333)
-------- -------- ----------
Total stockholders' equity......... 298,514 469,448 767,962
-------- -------- ----------
Total liabilities and stockholders'
equity............................ $511,555 $968,750 $1,480,305
======== ======== ==========
</TABLE>
143
<PAGE>
Unaudited Pro Forma Condensed Consolidated Statement of Operations
Prodigy, BizOnThe.Net, FlashNet and SBC
For the Year Ended December 31, 1999
(In thousands, except per share amounts and shares outstanding)
<TABLE>
<CAPTION>
Pro Forma Prodigy,
Prodigy, SBC BizOnThe.Net
BizOnThe.Net Adjust- FlashNet
and FlashNet ments and SBC
------------ --------- ------------
<S> <C> <C> <C>
Revenues:
Internet and online
service revenues.................... $ 200,914 $ 200,914
Web hosting.......................... 19,069 19,069
Other................................ 28,375 28,375
----------- --------- ----------
248,358 248,358
Operating costs and
expenses:
Costs of revenue..................... 126,325 126,325
Amortization of
subscriber acquisition costs........ 20,448 20,448
Sales and marketing.................. 92,239 92,239
Product development.................. 12,341 12,341
General and
administrative...................... 89,155 89,155
Depreciation and
amortization........................ 83,310 $322,917 5(a) 406,227
----------- --------- ----------
423,818 322,917 5(a) 746,735
----------- --------- ----------
Operating loss........................ (175,460) (322,917) (498,377)
Interest income / (expense), net...... 2,359 2,359
Gain on sale of equity
investment........................... 3,319 3,319
Gain on settlement of note payable.... 1,714 1,714
Gain on settlement of note receiv-
able................................. 500 500
Other................................. (35) (35)
Minority interest in net loss......... 193,265 5(b) 193,265
----------- --------- ----------
Net loss before
extraordinary item................... ($167,603) ($129,652) ($297,255)
=========== ========= ==========
Basic and diluted loss per share...... ($2.50) ($4.43)
=========== ==========
Weighted average number of common and
common equivalent shares
outstanding.......................... 67,114,152 1 5(c) 67,114,153
=========== ========= ==========
</TABLE>
144
<PAGE>
SBC Transaction
4. (a) Adjustment to recognize the fair value of the assets to be received
pursuant to the investment, issuance, contribution and assumption agreement
between Prodigy and SBC.
(b) The SBC interest in the operating partnership is reflected as minority
interest in the Prodigy pro forma combined balance sheet calculated as follows:
<TABLE>
<S> <C>
Pro Forma Prodigy, FlashNet net assets........................ $ 298,514
Contributed SBC Assets........................................ 968,750
----------
Partnership net assets........................................ 1,267,264
SBC Interest.................................................. 39.5%
----------
SBC Minority Interest....................................... $ 499,302
==========
</TABLE>
As a result of this transaction, Prodigy's interest in the partnership net
assets exceeds Prodigy's carrying value by $469,448 which has been reflected as
additional paid in capital.
(c) Reflects conversion of shares of Prodigy common stock into shares of
Prodigy Class A common stock and issuance of one share of Prodigy Class B
common stock.
5. (a) Adjustment to reflect amortization of the SBC Assets, primarily
related to the SBC brand assets and subscriber relationships, over the three
year life of the agreements. Tangible assets received from SBC may have longer
lives which would result in a decrease in the amortization expense presented in
this document, however, management does not expect this result to have a
significant impact.
(b) Adjustment to reflect SBC's minority interest in the net loss of the
operating partnership.
(c) Adjustment of the weighted average shares of Prodigy common stock
outstanding used in computing basic and diluted net loss per share to reflect
issuance of one share of Prodigy Class B common stock as of January 1, 1999.
145
<PAGE>
PRODIGY'S PRINCIPAL STOCKHOLDERS
The following table illustrates the beneficial ownership of the Prodigy
common stock as of March 31, 2000 by:
. each person or entity known to Prodigy to own beneficially more than 5%
of Prodigy common stock;
. each of the directors of Prodigy;
. each of the named executive officers of Prodigy; and
. all current executive officers and directors of Prodigy as a group.
In addition, the table depicts the shares beneficially owned if the SBC
transaction is not completed, as illustrated in the first column, and the
shares beneficially owned if the SBC transaction is completed, as illustrated
in the second column. If the pending FlashNet merger is completed, all
percentages will be diluted by approximately 4.5%.
<TABLE>
<CAPTION>
Shares beneficially Shares beneficially
owned prior to the owned after the SBC
SBC transaction(1) transaction(1)
--------------------- ---------------------
Name Number Percentage Number Percentage
---- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Current directors, executive
officers and 5% stockholders:
Carlos Slim Helu(2) 41,413,111 64.1 41,413,111 35.6
Carso Global Telecom(3) 29,396,911 45.5 29,396,911 25.3
Telmex(4) 12,016,200 18.6 12,016,200 10.3
Samer F. Salameh(5) 112,500 * 134,375 *
James R. Adams -- * 15,000 *
Allen Craft(6) -- * -- *
Arturo Elias(5) 45,000 * 60,000 *
James M. Nakfoor(5) 10,000 * 25,000 *
Alfredo Sanchez(5) 47,000 * 62,000 *
David C. Trachtenberg 41,666 * 83,333 *
Andrea S. Hirsch 26,250 * 57,500 *
All current executive officers
and directors as a group
(8 persons)(5)(7) 282,416 * 437,208 *
Other 5% stockholders:
SBC(8) -- -- 51,821,505 44.5
Sears(9) 4,536,778 7.0 4,536,778 3.8
Former executive officers:
James P. Dougherty 43,750 * 43,750 *
David R. Henkel 323 * 47,369 *
James L'Heureux -- -- -- --
Carena M. Pooth -- -- -- --
</TABLE>
- --------
* Denotes ownership of less than 1% of the outstanding shares of Prodigy
common stock.
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission, and is not necessarily indicative of
beneficial ownership for any other purpose. Under these rules, beneficial
ownership includes any shares as to which the individual or entity has
sole or shared voting power or investment power and any shares which the
individual or entity has the right to acquire within 60 days after March
31, 2000 through the exercise of any stock option, warrant or other right.
Beneficial ownership also includes the shares subject to options held by
current executive officers and directors that will accelerate and become
exercisable upon completion of the SBC transaction. However, these shares
are not deemed outstanding for purposes of calculating the percentage
ownership of any other person. The inclusion in this table of any shares
does not constitute an admission that the named stockholder is a direct or
indirect beneficial owner of the shares. Unless otherwise indicated, each
person or entity named in the table has sole voting power and investment
power with respect to all shares of capital stock listed as owned by the
person or entity.
146
<PAGE>
(2) Consists of the listed shares held by Carso Global Telecom and Telmex. Mr.
Slim and members of his immediate family, beneficially own a majority of
the outstanding voting equity securities of Carso Global Telecom. Thus,
Mr. Slim and members of his immediate family may be deemed to control
Carso Global Telecom, Telmex and Prodigy. The business address of Carso
Global Telecom and Mr. Slim is Paseo de las Palmas, #736, Col. Lomas de
Chapultepec, Mexico City, Mexico 11000.
(3) Excludes the listed shares held by Telmex. Carso Global Telecom may be
deemed to control Telmex though the regular-voting shares of Telmex that
it owns directly and its interest in a trust which owns a majority of
Telmex's outstanding regular-voting shares. Carso Global Telecom is a
Mexican holding company.
(4) Telmex's business address is Parque Via 190, Oficina 1016, Colonia
Cuauhtemoc, Mexico City, Mexico 06599.
(5) Excludes the listed shares held by Carso Global Telecom, and Telmex and
SBC.
(6) Excludes the shares held by SBC.
(7) Includes 169,792 shares that are subject to options that will become
exercisable on completion of the SBC transaction.
(8) Consists of shares issuable on conversion of Prodigy Class B common stock
and units in the operating partnership to be issued to SBC on completion
of the SBC transaction. Does not include a contingent warrant to purchase
537,924 shares of Prodigy common stock for $1.00 per share which Prodigy
and SBC have agreed in principle SBC will receive in exchange for
guaranteeing Prodigy's ongoing performance obligations under its customer
contracts in connection with a proposed third party financing. See
"Prodigy Management's Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity and Capital Resources." SBC's business
address is 175 East Houston, San Antonio, Texas 78205.
(9) Ownership is based on a Schedule 13G/A filed by Sears with the Securities
and Exchange Commission on February 10, 2000. Includes 2,409,145 shares
issuable on exercise of a warrant. Sears' business address is 3333 Beverly
Road, Hoffman Estates, Illinois 60179.
147
<PAGE>
FLASHNET'S PRINCIPAL SHAREHOLDERS
The following table sets forth the beneficial ownership of FlashNet common
stock as of March 31, 2000, by:
. each person who is known by FlashNet to own beneficially more than five
percent of its common stock;
. each of FlashNet's directors;
. each of FlashNet's executive officers; and
. all of FlashNet's executive officers and directors as a group.
This table is based on information provided to FlashNet or filed with the
Securities and Exchange Commission by FlashNet's directors, executive officers
and principal shareholders. Beneficial ownership is determined in accordance
with the rules and regulations 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
held by that person that are currently exercisable or exercisable within 60
days of March 31, 2000, are deemed outstanding. These shares, however, are not
deemed outstanding for the purposes of computing the percentage ownership of
any other person. Except as indicated in the footnotes to this table and
pursuant to applicable community property laws, each shareholder named in the
table has sole voting and investment power with respect to the shares set forth
opposite the shareholder's name. Unless otherwise indicated, the address for
the following shareholders is c/o FlashNet Communications, Inc., 3001 Meacham
Boulevard, Suite 100, Fort Worth, Texas 76137.
<TABLE>
<CAPTION>
Percentage of
Number of Shares Outstanding FlashNet
Name of Beneficial Owner Beneficially Owned Common Stock
------------------------ ------------------ --------------------
<S> <C> <C>
Ascend Communications, Inc.(1)........ 1,360,000 8.7%
Global Undervalued Securities Fund,
L.P.(2).............................. 1,081,973 7.6%
James B. Francis, Jr.(3).............. 45,980 *
Andrew N. Jent(4)..................... 202,993 1.4%
John B. Kleinheinz(5)................. 1,928,516 13.5%
Michael Scott Leslie(6)............... 1,059,188 7.3%
James A. Ryffel(7).................... 748,000 5.2%
Kevin A. Stadtler(8).................. 591,113 4.1%
Albert Lee Thurburn(9)................ 761,844 5.3%
All directors and executive officers
as a group (6 persons)(10)........... 4,718,493 30.8%
</TABLE>
- --------
* Represents less than 1% of the outstanding shares of common stock.
(1) Includes a warrant immediately exercisable for 1,360,000 shares of common
stock. The address for Ascend Communications, Inc. is 1701 Harbor Bay
Parkway, Alameda, California 94502. Ascend Communications, Inc. is a
wholly owned subsidiary of Lucent Technologies Inc.
(2) The address for Global Undervalued Securities Fund, L.P. is 201 Main
Street, Suite 2001, Fort Worth, Texas 76102. Global Undervalued Securities
Fund, L.P. is controlled by John B. Kleinheinz, one of FlashNet's
directors.
(3) Includes 40,980 shares of common stock subject to stock options held by
Mr. Francis. The address for Mr. Francis is 2911 Turtle Creek, Suite 925,
Dallas, Texas 75219.
(4) Includes 202,993 shares of common stock subject to stock options held by
Mr. Jent.
(5) Includes 15,000 shares of common stock subject to stock options held by
Mr. Kleinheinz, 1,081,973 shares held by Global Undervalued Securities
Fund, L.P. and 16,664 shares held by Kleinheinz Capital Partners LDC. Mr.
Kleinheinz, one of FlashNet's directors, controls both Global Undervalued
Securities Fund, L.P. and Kleinheinz Capital Partners LDC. He disclaims
beneficial ownership of the shares held by
148
<PAGE>
Global Undervalued Securities Fund, L.P. and Kleinheinz Capital Partners
LDC except to the extent of his pecuniary interest in them arising from
his direct and/or indirect ownership interests in the entities. Mr.
Keinheinz's address is the same as the address of Global Undervalued
Securities Fund, L.P.
(6) Includes 127,993 shares of common stock subject to stock options held by
Mr. Leslie and 142,875 shares of common stock subject to a stock option
to be issued to Mr. Leslie immediately prior to the effective date of the
merger.
(7) Includes 34,000 shares of common stock held by Mr. Ryffel as custodian
for one of his children. Mr. Ryffel disclaims beneficial ownership of
these shares. The address for Mr. Ryffel is 3113 South University Drive
#600, Fort Worth, Texas 76109.
(8) Includes 30,980 shares of common stock subject to stock options held by
Mr. Stadtler and 560,133 shares held by Applied Telecommunications
Technologies, Inc. Mr. Stadtler, one of FlashNet's directors, is a vice
president of Applied Telecommunications Technologies. He disclaims
beneficial ownership of the shares held by Applied Telecommunications
Technologies. Mr. Stadtler's address is c/o Applied Telecommunications
Technologies, Inc., 20 William Street, Wellesley, Massachusetts 02481.
(9) Includes 15,000 shares of common stock subject to stock options held by
Mr. Thurburn.
(10) Includes 575,821 shares of common stock issuable on exercise of options,
1,081,973 shares held by Global Undervalued Securities Fund, L.P., 16,664
shares held by Kleinheinz Capital Partners LDC and 560,133 shares held by
Applied Telecommunications Technologies, Inc.
149
<PAGE>
COMPARISON OF SHAREHOLDER RIGHTS
The rights of FlashNet shareholders are governed by FlashNet's restated
articles of incorporation and bylaws, each as amended, and the laws of the
State of Texas, and the rights of Prodigy stockholders are governed by
Prodigy's certificate of incorporation and bylaws and the laws of the State of
Delaware. After the merger, the FlashNet shareholders will become stockholders
of Prodigy and accordingly their rights will be governed by Prodigy's
certificate of incorporation and bylaws, each as amended, and the laws of the
State of Delaware.
While the rights and privileges of FlashNet shareholders are, in many
instances, comparable to those of the stockholders of Prodigy, there are some
differences. The following is a summary of the material differences as of the
date of this document between the rights of the FlashNet shareholders and the
rights of the Prodigy stockholders. These differences arise from differences
between the respective charters and bylaws of FlashNet and Prodigy and the
differences between Texas and Delaware law. The following discussion of these
differences is only a summary of the material differences and does not purport
to be a complete description of all the differences. Please consult the
following references to the Texas Business Corporations Act, Delaware General
Corporation Law and the respective revised charters and bylaws of FlashNet and
Prodigy for a more complete understanding of these differences.
Required Vote for Mergers and Other Transactions--Shareholder Approval of
Business Combinations
Under the Texas Business Corporations Act, a merger or consolidation, or a
sale, lease, exchange or other disposition of all or substantially all of the
property of the corporation that is not in the usual and regular course of the
corporation's business, or a dissolution of the corporation, must be approved
by at least two-thirds of the shares entitled to vote on the matter, unless the
corporation's charter requires the vote of a different number of shares. The
restated articles of incorporation of FlashNet do not require a different
number. If the holders of any class of shares are entitled to vote as a class
on the matter, then two-thirds of the outstanding shares of a class and at
least two-thirds of the outstanding shares otherwise entitled to vote on the
matter must approve the transaction.
Under the Delaware General Corporation Law, a merger or consolidation, or a
sale, lease or exchange of all or substantially all of the property of the
corporation, or a dissolution of the corporation, must be approved by the
holders of a majority of the shares entitled to vote on the matter unless the
charter provides for a greater vote. The certificate of incorporation of
Prodigy does not provide otherwise. In addition, under the Delaware General
Corporation Law, class voting rights exist with respect to amendments to the
charter that adversely affect the terms of the shares of a class or the number
of shares or par value of shares of a class. The class voting rights do not
exist as to other extraordinary matters, unless the charter provides otherwise.
The certificate of incorporation of Prodigy does not provide otherwise.
Absence of Required Vote for Mergers
Under the Texas Business Corporations Act, no vote of the shareholders of a
corporation surviving a merger is required to approve the merger if:
. the corporation is the sole surviving corporation in the merger;
. the articles of incorporation of the corporation will not differ from
its articles of incorporation before the merger;
. each shareholder of the corporation whose shares were outstanding
immediately before the effective date of the merger will hold the same
number of shares, with identical preferences, limitations and relative
rights, immediately after the effective date of the merger;
. the voting power of the number of voting shares outstanding immediately
after the merger, plus the voting power of the number of voting shares
of the corporation to be issued in the merger, if any,
150
<PAGE>
does not exceed by more than 20% the voting power of the total number of
voting shares outstanding immediately before the merger; and
. the number of participating shares of the corporation to be issued in
the merger, if any, does not exceed 20% of the number of the shares
outstanding immediately before the merger and the board of directors of
the corporation adopts a resolution approving the plan of merger.
Under the Delaware General Corporation Law, no vote of the stockholders of a
corporation surviving a merger is required to approve a merger if:
. the agreement of merger does not amend the charter of the corporation;
. each share of stock of the corporation outstanding immediately before
the merger will be an identical outstanding or treasury share of the
surviving corporation after the merger; and
. the number of shares of common stock of the corporation to be issued in
the merger, if any, does not exceed 20% of the number of shares
outstanding immediately before the merger.
Appraisal Rights
Under the Texas Business Corporations Act, in general, a shareholder has (1)
the right to dissent from any plan of merger or consolidation to which the
corporation is a party, or the sale, lease, exchange or other disposition of
substantially all of the assets of the corporation where a shareholder vote is
required; and (2) the right, sometimes called an appraisal right, to demand
payment of the fair value of his shares upon compliance with the statutory
procedures. However, under the Texas Business Corporations Act, a shareholder
of a corporation does not have the right to dissent or to assert appraisal
rights if the following two requirements are satisfied. First, the shares held
by the shareholder must be part of a class or series of shares which are
listed on a national securities exchange, listed on the Nasdaq National
Market, or held of record by not less than 2,000 holders, on the record date
fixed to determine the shareholders entitled to vote on the plan of merger or
consolidation or sale, lease, exchange or other disposition. Second, the
shareholder must not be required by the terms of the plan of merger or
consolidation or sale, lease, exchange or other disposition to accept for his
shares any consideration other than:
. shares of the corporation that, immediately after the effective date of
the merger are, or will be, part of a class the shares of which are
listed or authorized for listing upon official notice of issuance, on a
national securities exchange, or approved for quotation as a national
market security on an interdealer quotation system by the National
Association of Securities Dealers, or held of record by not less than
2,000 holders; or
. cash in lieu of fractional shares otherwise entitled to be received; or
. any combination of the foregoing.
Under the Delaware General Corporation Law, appraisal rights exist only as
to mergers and consolidations, but a stockholder of a corporation generally
does not have appraisal rights in connection with a merger or consolidation
if:
. the shares of the corporation are listed on a national securities
exchange, designated as a national market security on an interdealer
quotation system by the National Association of Securities Dealers, or
held of record by more than 2,000 shareholders;
However, in any event, a stockholder is entitled to appraisal rights in the
case of a merger or consolidation, if the shareholder is required by the terms
of an agreement of merger or consolidation to accept in exchange for his
shares anything other than:
. shares of stock of the corporation surviving or resulting from the
merger or consolidation;
151
<PAGE>
. shares of any other corporation that at the effective date of the merger
or consolidation will be either listed on a national securities
exchange, designated as a national market security on an interdealer
quotation system by the National Association of Securities Dealers, or
held of record by more than 2,000 stockholders;
. cash in lieu of fractional shares of the corporation described in the
foregoing clauses; or
. any combination of the foregoing.
Shareholder Consent to Action Without Meeting
Under the Texas Business Corporations Act, if the articles of incorporation
allow, any action that may be taken at a meeting of the shareholders may be
taken without a meeting if a written consent is signed by the holders of that
number of shares who would be required to approve the action which is the
subject of the consent as set forth in the articles of incorporation.
FlashNet's restated articles of incorporation permit actions to be taken by its
shareholders by written consent and without a meeting.
Under the Delaware General Corporation Law, unless otherwise provided in the
corporation's charter, any action that can be taken at a meeting of
stockholders of the corporation can be taken without a meeting if a written
consent is signed by the holders of outstanding stock having the minimum number
of votes necessary to authorize or to take action at a meeting of the
stockholders. Prodigy's certificate of incorporation does not provide
otherwise.
Special Meetings of Shareholders
Under the Texas Business Corporations Act, the president, the board of
directors or any person or persons authorized by the charter or the bylaws may
call special meetings. In addition, the act permits special meetings to be
called by shareholders who own at least 10% of the outstanding voting shares
unless the corporation's charter provides for a lesser or greater number, which
may not exceed 50%. Under FlashNet's restated articles of incorporation, a
special meeting of its shareholders may be called by its President or board of
directors or the holders of not less than 25% of its outstanding voting shares
or by persons authorized in the bylaws.
Under the Delaware General Corporation Law, a special meeting of stockholders
may be called only by the board of directors or by persons authorized in the
charter or the bylaws. The certificate of incorporation and bylaws of Prodigy
do not provide for the call of a special meeting of stockholders by anyone
other than the President or the board of directors of Prodigy.
Cumulative Voting
Under the Texas Business Corporations Act, unless expressly prohibited by the
corporation's charter, shareholders of the corporation have the right to
cumulate their votes in the election of directors if they notify the
corporation at least one day before the meeting of their intent to do so.
FlashNet's restated articles of incorporation prohibit cumulative voting. Under
the Delaware General Corporation Law, stockholders do not have any cumulative
voting rights unless provided in the corporation's charter. Prodigy's
certificate of incorporation does not provide for cumulative voting.
Advance Notice of Shareholder Proposals
The FlashNet bylaws provide that written notice of an annual meeting of
shareholders must be given to each FlashNet shareholder entitled to vote at the
meeting within ten days but not more than 60 days before the date of the
meeting. The notice must state the place, date and hour of the meeting.
For business to be properly before a meeting, the business must be:
. specified in the notice of the meetings or any supplement to the notice,
given to the appropriate shareholders;
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. properly brought by the FlashNet board of directors; or
. properly brought by a FlashNet shareholder.
For business to be properly brought by a FlashNet shareholder, the FlashNet
shareholder must comply with applicable laws and must have given timely notice
of the business in writing to the Secretary of FlashNet. To be timely, this
notice must be delivered to or mailed and received at the principal place of
business of FlashNet not less than 30 days nor more than 60 days prior to the
meeting. However, if less than 40 days notice or prior public disclosure of the
date of the meeting was given or made to FlashNet shareholders, the notice, to
be timely, must be received not later than the close of business on the tenth
day following the day on which the notice of the date of the meeting was mailed
or public disclosure was made.
Distributions and Dividends; Redemptions
Under the Texas Business Corporations Act, a distribution is defined as a
transfer of money or other property, except a corporation's shares or rights to
acquire its shares, or an issuance of indebtedness, by a corporation to its
shareholders in the form of a dividend on any class or series of the
corporation's outstanding shares, a purchase or redemption of its shares or a
payment in liquidation of all or a portion of its assets. Under the Texas
Business Corporations Act, a corporation may make a distribution, subject to
restrictions in its charter, if it does not render the corporation unable to
pay its debts as they become due in the usual course of its business, and if it
does not exceed the corporation's surplus. Surplus is defined in the Texas
Business Corporations Act as the excess of net assets over stated capital,
which the board may adjust. This limitation does not apply to distributions
involving a purchase or redemption of shares to eliminate fractional shares,
collect indebtedness, pay dissenting shareholders or redeem shares if net
assets exceed the proposed distribution.
Under the Delaware General Corporation Law, a corporation may pay dividends
out of surplus and, if there is no surplus, out of net profits for the current
and/or the preceding fiscal year, unless the net assets of the corporation are
less than the capital represented by issued and outstanding stock having a
preference on asset distributions. Surplus is defined in the Delaware General
Corporation Law as the excess of the net assets over capital, which the board
may adjust. A corporation may purchase or redeem shares of any class except
when its capital is impaired or would be impaired by a purchase or redemption.
A corporation may, however, purchase or redeem out of capital shares that are
entitled on any distribution of its assets to a preference over another class
or series of its stock, or if no shares entitled to such a preference are
outstanding, any of its shares, if the shares are to be retired and the capital
reduced.
Proxies
Under the Texas Business Corporations Act, proxies are valid for 11 months,
and under the Delaware General Corporation Law, proxies are valid for three
years, in both cases, unless the proxies provide for a different period.
Size of Board of Directors
Pursuant to FlashNet's bylaws, its board of directors consists of seven
members divided into three separate classes serving staggered three-year terms.
Prodigy does not have a classified board of directors.
Vacancies on Board of Directors
Under the Texas Business Corporations Act, a vacancy on the board may be
filled by the vote of a majority of directors then in office, although less
than a quorum, or by election at a meeting of shareholders. A newly created
directorship resulting from an increase in the number of directors may be
filled by election at a meeting of shareholders or may be filled by the board
for a term continuing only until the next election of directors by
shareholders, but not more than two of the directorships may be filled during
the period between any two successive annual meetings. FlashNet's bylaws
require the affirmative vote of at least 60% of the directors remaining in
office to fill any vacancy on its board of directors.
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Under the Delaware General Corporation Law, a vacancy and newly created
directorship may be filled by a majority of the remaining directors, although
less than a quorum, unless otherwise provided in the charter or bylaws. Neither
the certificate of incorporation nor the bylaws of Prodigy provide otherwise.
Removal of Directors
Under the Texas Business Corporations Act, the bylaws or charter of a
corporation may provide that at any meeting of shareholders called expressly
for that purpose, any director or the entire board may be removed, with or
without cause, by vote of the holders of a majority of the shares then entitled
to vote at an election of directors, subject to further restrictions on removal
which may be contained in the bylaws, except in the case of a corporation with
a classified board.
Under the Delaware General Corporation Law, any director or the entire board
may be removed, with or without cause, by the holders of a majority of the
shares entitled to vote at an election of directors, or in the case of class
voting, the holders of a majority of the shares of that class and entitled to
vote, except in the case of a corporation with a classified board.
If a Texas corporation has a classified board, shareholders may remove a
director or directors only for cause unless the charter otherwise provides.
FlashNet has a classified board and its charter does permit shareholders to
remove a director or directors other than for cause.
Inspection of Books and Records
Under the Texas Business Corporations Act, a shareholder may, for a proper
purpose, inspect the books and records of a corporation if the shareholder
holds at least five percent of the outstanding shares of stock of the
corporation or has been a holder of shares for at least six months prior to the
demand.
Under the Delaware General Corporation Law, any stockholder may inspect the
corporation's books and records for a proper purpose.
Amendment of Charter
Under the Texas Business Corporations Act, a corporation's charter may be
amended if the board sets forth the proposed amendment in a resolution and
directs that it be submitted to a vote at a meeting of shareholders and the
holders of at least two-thirds of the outstanding shares entitled to vote on
the amendment approve it by affirmative vote. However, a corporation's charter
may require the vote of a different number of shares, which if lesser, must be
at least a majority. In addition, if the holders of any class or series of
shares are entitled to vote as a class or series on an amendment to the
charter, the amendment must be approved by the affirmative vote of the holders
of at least two-thirds of the shares within each class or series of outstanding
shares entitled to vote thereon, unless the charter otherwise requires the vote
of a different number of shares, which, if lesser, must be at least a majority.
FlashNet's charter does not provide for a different vote.
Under the Delaware General Corporation Law, a corporation's charter may be
amended if the board sets forth the proposed amendment in a resolution,
declares the advisability of the amendment and directs that it be submitted to
a vote at the meeting of shareholders and the holders of at least a majority of
shares of stock entitled to vote on the amendment approve the amendment, unless
the charter requires the vote of a greater number of shares. Prodigy's charter
does not provide for a greater vote. If the holders of the outstanding shares
of a class are entitled to vote as a class on a proposed amendment, the holders
of a majority of the outstanding shares of this class must also vote in favor
of the amendment.
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Preemptive Rights
Shareholders of a Texas corporation generally have a preemptive right to
acquire from the corporation additional unissued or treasury shares of the
corporation, except to the extent limited or denied by Article 2.22-1 of the
Texas Business Corporations Act or the articles of incorporation of the subject
corporation. The restated articles of incorporation of FlashNet deny the
statutory preemptive rights afforded to shareholders under the act. The
Delaware General Corporation Law denies shareholders with preemptive rights
except to the extent set forth in the certificate of incorporation or bylaws of
the corporation. Prodigy's certificate of incorporation and bylaws do not
authorize preemptive rights in favor of its shareholders.
Amendment of Bylaws
Under the Texas Business Corporations Act, the board may amend or repeal a
corporation's bylaws, or adopt new bylaws, unless the charter reserves this
power exclusively to shareholders or the shareholders in amending, repealing or
adopting a particular bylaw provision expressly provide that the board may not
amend or repeal that bylaw. In addition, unless the charter or a bylaw adopted
by the shareholders provides otherwise as to all or some portion of a
corporation's bylaws, shareholders may amend the bylaws even though the board
may also amend them. FlashNet's restated articles of incorporation reserve the
power to amend its bylaws exclusively to its board of directors. In addition,
no particular provision of FlashNet's bylaws expressly provides that the board
may not amend or repeal it.
Under the Delaware General Corporation Law, the board may amend bylaws if it
is authorized by the charter. The stockholders of a Delaware corporation also
have the power to amend bylaws. The certificate of incorporation of Prodigy
authorizes the board to amend its bylaws.
Indemnification of Directors and Officers
The Texas Business Corporations Act and the Delaware General Corporation Law
have different provisions and limitations regarding indemnification by a
corporation of its officers, directors, employees and agents. The following is
a summary comparison of the laws' indemnification provisions:
Scope. Under the Texas Business Corporations Act, a corporation is permitted
to provide indemnification or advancement of expenses by a bylaw provision,
agreement, security arrangement or otherwise. Under the Delaware General
Corporation Law, indemnification rights are expressly non-exclusive. A
corporation is permitted to provide indemnification or advancement of expenses
by a bylaw provision, agreement or otherwise.
Advancement of Expenses. Under the Texas Business Corporations Act,
reasonable court costs and attorneys' fees incurred by a director who was, is,
or is threatened to be made a named defendant or respondent in a proceeding
because the person is or was a director of a corporation may be paid or
reimbursed by the corporation in advance of the final disposition of the
proceeding. However, payment or reimbursement can be made only after the
corporation receives a written affirmation by the director of his good faith
belief that he has met the standard of conduct necessary for indemnification
under the Texas Business Corporations Act and a written undertaking by or on
behalf of the director to repay the amount paid or reimbursed if it is
ultimately determined that he has not met those requirements or indemnification
for the expenses is precluded under the act.
The Delaware General Corporation Law provides for the advancement of expenses
for proceedings against a director of a company on receipt of a similar
undertaking. The undertaking, however, need not be in writing. The law does not
require that such director give an affirmation regarding his conduct in order
to receive an advance of expenses.
Reimbursement of Expenses. Under the Texas Business Corporations Act, a
reimbursement of expenses may only be made after the required determination of
the appropriateness of the reimbursement has been made pursuant to the
procedures set out in the act. Thus, there cannot be automatic reimbursement of
expenses.
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Under the Delaware General Corporation Law, there is no express provision
that allows for the automatic reimbursement of expenses, but a Delaware
corporation, through a bylaw provision or a contract, may make reimbursement of
expenses automatic.
Mandatory Indemnification. Under the Texas Business Corporations Act,
indemnification by the corporation is mandatory only if the director is wholly
successful on the merits or otherwise, in the defense of the proceeding. The
Delaware General Corporation Law provides for mandatory indemnification to the
extent that the director or officer is successful on the merits or otherwise.
Insurance. The Texas Business Corporations Act and the Delaware General
Corporation Law both allow a corporation to purchase and to maintain insurance
on behalf of any person who is or was a director, officer, employee or agent of
the corporation against any liability asserted against and incurred by the
person because of the person's role in the company even if the corporation
could indemnify the person. Under the Texas Business Corporations Act, a
corporation may also establish and maintain arrangements, other than insurance,
to protect these individuals, including a trust fund or surety arrangement. As
noted above, indemnification rights under the Delaware General Corporation Law
are expressly non-exclusive.
Persons Covered. The Texas Business Corporations Act expressly and separately
deals with the protection available for officers, employees and agent. This
protection is similar to those provided to directors. The Delaware General
Corporation Law permits the same indemnification rights to officers, employees
and agents as it provides for directors.
Standard of Care. The standard of care required under both the Texas Business
Corporations Act and Delaware General Corporation Law is substantially the
same. In general, directors are charged with the duty in their decision-making
process and oversight responsibilities to act as a reasonably prudent person
would.
Continuity of Indemnification. The Texas Business Corporations Act does not
have a provision that expressly provides indemnification after a directorship
has terminated for acts or omissions which took place prior to the termination.
The Delaware General Corporation Law contains a provision that expressly
provides that the statutory indemnification provisions apply to a director
after he leaves the corporation for acts he performed while a director and
apply to the estate and personal representatives of the director.
Shareholder Report. The Texas Business Corporations Act requires a report to
the shareholders upon indemnification or advancement of expenses. The Delaware
General Corporation Law does not have a similar reporting requirement.
Limited Liability of Directors
Under the Texas Miscellaneous Corporation Laws Act, a corporation's charter
may eliminate all monetary liability of each director to the corporation or its
shareholders for conduct in the performance of the director's duties other than
conduct specifically excluded from protection. No limitation is permitted on
the liability of a director for the following actions:
. breaching the duty of loyalty to the corporation or its shareholders;
. failing to act in good faith;
. engaging in intentional misconduct or a known violation of law;
. obtaining an improper personal benefit from the corporation; or
. violating applicable statutes which expressly provide for the liability
of a director.
FlashNet's restated articles of incorporation eliminate the monetary
liability of a director to the full extent permitted by applicable law. It is
likely that any amendment to a charter would have no effect on the availability
of equitable remedies, such as an injunction or a rescission, based on a
director's breach of the duty of care.
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The Delaware General Corporation Law permits the adoption of a charter
provision limiting or eliminating the monetary liability of a director to a
corporation or its stockholders by reason of a director's breach of fiduciary
duty. The Delaware General Corporation Law does not permit any limitation of
the liability of a director for the following actions:
. breaching the duty of loyalty to the corporation or its stockholders;
. acts or omissions not in good faith;
. engaging in intentional misconduct or a knowing violation of law;
. obtaining an improper personal benefit from the corporation; or
. paying a dividend or approving a stock repurchase that was illegal under
the Delaware General Corporation Law.
The certificate of incorporation of Prodigy eliminates the monetary liability
of a director to the full extent permitted by applicable law.
Anti-Takeover Statutes
The Texas Business Corporations Act contains provisions that make it more
difficult to effect transactions between a Texas corporation or its majority
owned subsidiaries and an affiliated shareholder. An affiliated shareholder is
any person or associate of the person who is or was, within the three preceding
years, the owner of 20% or more of the outstanding voting stock of a Texas
corporation. An affiliated shareholder is also a person or an associate of the
person who is affiliate of a Texas corporation. Under the Texas Business
Corporations Act, for a period of three years following the date that a
shareholder becomes an affiliated shareholder, the following types of business
combinations between a Texas corporation and the affiliated shareholder are
prohibited unless the conditions described below are met:
. mergers, share exchanges or conversions;
. sales, leases, exchanges, mortgages, pledges, transfers or other
dispositions of 10% or more of:
. the aggregate market value of assets of the corporation;
. the aggregate market value of all the outstanding stock of the
corporation; or
. 10% or more of the earning power or net income of the corporation;
. issuances or transfers by the corporation of shares of its stock that
would have the effect of increasing the affiliate shareholder's
proportionate share of stock of the corporation;
. receipt by the affiliated shareholder of the benefit of loans, advances,
guarantees, pledges or other financial assistance provided by the
corporation;
. adoption of a plan of liquidation or dissolution proposed by or pursuant
to an agreement with the affiliated shareholder; and
. any other transaction that has the effect of increasing the
proportionate share of the stock of the corporation owned by the
affiliated shareholder.
The three-year ban does not apply if:
. prior to the date on which the person becomes an affiliated shareholder,
the board approves either the proposed business combination or the
transaction which would result in the shareholder becoming an affiliated
shareholder;
. a business combination is approved by the corporation's board of
directors and by the holders of at least two-thirds of the outstanding
voting stock not owned by the affiliated shareholder at a meeting called
for that purpose not less than six months after the affiliated
shareholder became an affiliated shareholder;
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. the business combination is with an affiliated shareholder that became
an affiliated shareholder inadvertently, the affiliated shareholder
divests itself as soon as is practicable of a sufficient number of
shares so that it no longer is an affiliated shareholder and the
affiliated shareholder would not be an affiliated shareholder at any
time within the three-year period preceding the announcement date of the
business combination but for the inadvertent acquisition;
. the affiliated shareholder was the beneficial owner of 20% or more of
the outstanding voting shares of the corporation on December 31, 1996
and continuously until the date of the announcement date of the business
combination;
. the affiliated shareholder became an affiliated shareholder through a
transfer of stock by will or intestate succession and continuously was
an affiliated shareholder until the announcement date of the business
combination; or
. the business combination is with a domestic, wholly-owned subsidiary and
the subsidiary is not an affiliate or associate of the affiliated
shareholder other than by reason of the affiliated shareholder's
beneficial ownership of voting shares in the corporation.
Under the Texas Business Corporations Act, a corporation can exclude itself
from the coverage of this anti-takeover provision by a provision in its
original charter or bylaws or an amendment to its charter or bylaws adopted
prior to December 31, 1997. However, any amendment adopted after December 31,
1997 must be approved by the affirmative vote of not less than two-thirds of
the outstanding voting shares and will not be effective until eighteen months
after its adoption and will not apply to any business combination with a person
who became an affiliated shareholder prior to the adoption of the amendment.
The Delaware General Corporation Law also contains provisions that make it
more difficult to effect transactions between a Delaware corporation or its
majority owned subsidiaries and an interested shareholder. An interested
shareholder includes any person and any affiliate or associate of the person
owning 15% or more of the outstanding voting stock of a Delaware corporation.
An interested shareholder is also a person who is an affiliate or an associate
of a Delaware corporation and who was the owner of 15% or more of its
outstanding voting stock at any time during the preceding three years, and
affiliates and associates of such person. Under the Delaware General
Corporation Law for a period of three years following the time that a
shareholder becomes an interested shareholder, the following types of business
combinations between a Delaware corporation and the interested shareholder are
prohibited unless the conditions described below are met:
. mergers or consolidations;
. sales, leases, exchanges or other disposition of assets with a value of
10% or more of the aggregate assets of the corporation or the aggregate
market value of all the outstanding stock of the corporation;
. issuances or transfers by the corporation of shares of its stock that
would have the effect of increasing the interested stockholder's
proportionate share of any class or series of stock of the corporation;
. receipt by the interested stockholder of the benefit of loans, advances,
guarantees, pledges or other financial benefits provided by the
corporation; and
. any other transaction that has the effect of increasing the
proportionate share any class or series of the stock of the corporation
owned by the interested stockholder.
The three-year ban does not apply if:
. prior to the time on which the person becomes an interested stockholder,
the board approves either the proposed business combination or the
transaction which would result in the stockholder becoming an interested
stockholder;
. upon completion of the transaction that results in a shareholder
becoming an interested shareholder, the shareholder will own at least
85% of the voting stock of the corporation which was outstanding on the
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date the transaction commenced, excluding those shares owned by its
directors who are also officers and employee stock plans in which
participants do not have the right to determine confidentially whether
shares will be tendered in a tender or exchange offer; or
. the business combination is approved by the corporation's board of
directors and, at a meeting, by the holders of at least 66 2/3% of the
outstanding voting stock not owned by the interested stockholder.
Under the Delaware General Corporation Law, a corporation can exclude itself
from the coverage of this anti-takeover provision by a provision in its
original charter, an amendment to its bylaws adopted by stockholders, which
amendment may not be further amended by the board, or an amendment to its
charter. However, any exclusion effected by amendment to the charter or bylaws
must be approved by the affirmative vote of not less than a majority of the
outstanding shares entitled to vote on the amendment. In addition, the
amendment will not be effective until twelve months after its adoption and
will not apply to any business combination with a person who became an
interested shareholder prior to the adoption of the amendment.
Share Exchanges
The Texas Business Corporations Act permits a transaction known as a "share
exchange." A share exchange is a transaction in which share interests of a
corporation are acquired by another corporation or entity without the
necessity of a merger of the two entities. A share exchange possesses
advantages over a traditional merger transaction in that it permits the
acquisition of all of the share interests of one or more classes or series of
stock of a corporation without the acquired entity going out of existence and
with the acquiring entity becoming a subsidiary of the acquiring entity. The
Delaware General Corporation Law does not permit this exchange.
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SHAREHOLDER PROPOSALS
If completion of the merger does not occur and FlashNet holds an annual
meeting of its shareholders in 2000, FlashNet will include information in its
Form 10-Q for the quarter ended June 30, 2000 regarding the deadline for
receipt by FlashNet of shareholder proposals intended to be presented at the
meeting and included in FlashNet's proxy materials for the meeting.
LEGAL MATTERS
The validity of the shares of Prodigy common stock to be issued in connection
with the merger will be passed on for Prodigy by Hale and Dorr LLP.
EXPERTS
The consolidated financial statements of Prodigy as of December 31, 1998 and
1999 and for each of the three years in the period ended December 31, 1999
included in this proxy statement/prospectus have been so included in reliance
on the report of PricewaterhouseCoopers LLP, independent accountants, given on
the authority of said firm as experts in auditing and accounting.
The consolidated financial statements of FlashNet as of December 31, 1998 and
for each of the two years in the period ended December 31, 1998, included in
this proxy statement, have been audited by Deloitte & Touche LLP, independent
accountants, as set forth in their report appearing herein and have been so
included in reliance on the report of such firm given on their authority as
experts in accounting and auditing.
The consolidated financial statements of FlashNet Communications, Inc. at
December 31, 1999 and for the year then ended and the financial statements of
the Web Hosting Business of U.S. Republic Communications, Inc. at December 31,
1998, and for the period from January 6, 1998 (inception) to December 31, 1998,
appearing in this proxy statement/prospectus have been audited by Ernst & Young
LLP, independent auditors, as set forth in their reports thereon appearing
elsewhere herein, and are included in reliance upon such reports given on the
authority of such firm as experts in accounting and auditing.
WHERE YOU CAN FIND MORE INFORMATION
Prodigy and FlashNet each file annual, quarterly and special reports, proxy
statements and other information with the Securities and Exchange Commission.
You may read and copy any reports, statements or other information that Prodigy
or FlashNet files at the Securities Exchange Commission's public reference
rooms in Washington, D.C., New York, New York and Chicago, Illinois. Please
call the Securities Exchange Commission at 1-800-SEC-0330 for further
information on the public reference rooms. Securities and Exchange Commission
filings are also available to the public from commercial document retrieval
services and at the web site maintained by the Securities and Exchange
Commission at http://www.sec.gov.
Prodigy filed with the Securities and Exchange Commission a registration
statement on Form S-4 under the Securities Act of 1933 to register with the
Securities and Exchange Commission the Prodigy common stock issuable pursuant
to the merger agreement. This proxy statement/prospectus does not contain all
the information you can find in the registration statement or the exhibits and
schedules to the registration statement. For further information with respect
to Prodigy, FlashNet and the Prodigy common stock, please refer to the
registration statement, including the exhibits and schedules. You may inspect
and copy the registration statement, including the exhibits and schedules, as
described above. Statements contained in this proxy statement/prospectus about
the contents of any contract or other document are not necessarily complete,
and Prodigy refers you, in each case, to the copy of the contract or other
document filed as an exhibit to the registration statement.
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Prodigy has supplied all information contained in this proxy
statement/prospectus relating to Prodigy, and FlashNet has supplied all
information contained in this proxy statement/prospectus relating to FlashNet.
You should rely only on the information contained in this proxy
statement/prospectus to vote on the merger. Prodigy and FlashNet have not
authorized anyone to provide you with information that is different from what
is contained in this proxy statement/prospectus. This proxy
statement/prospectus is dated May 5, 2000. You should not assume that the
information contained in this proxy statement/prospectus is accurate as of any
date other than May 5, 2000, and neither the mailing of the proxy
statement/prospectus to FlashNet shareholders nor the issuance of Prodigy
common stock in the merger shall create any implication to the contrary.
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INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
PRODIGY COMMUNICATIONS CORPORATION
Three years ended December 31, 1999, 1998 and 1997
Report of Independent Accountants....................................... F-2
Consolidated Balance Sheets............................................. F-3
Consolidated Statement of Operations.................................... F-4
Consolidated Statements of Stockholders' Equity (Deficit)............... F-5
Consolidated Statements of Cash Flows................................... F-7
Notes to Consolidated Financial Statements.............................. F-9
FLASHNET COMMUNICATIONS, INC.
Three years ended December 31, 1999, 1998 and 1997
Report of Independent Auditors.......................................... F-28
Independent Auditor's Report............................................ F-29
Consolidated Balance Sheets............................................. F-30
Consolidated Statements of Operations................................... F-31
Consolidated Statements of Cash Flows................................... F-32
Consolidated Statements of Shareholders' Equity (Deficit)............... F-33
Notes to Financial Statements........................................... F-34
WEB HOSTING BUSINESS OF U.S. REPUBLIC COMMUNICATIONS, INC.
January 6, 1998 (inception) to December 31, 1998 and unaudited nine
months ended
September 30, 1999
Report of Independent Auditors.......................................... F-46
Statement of Assets to Be Acquired and Liabilities to be Assumed........ F-47
Statement of Operations................................................. F-48
Statement of Cash Flows................................................. F-49
Notes to Financial Statements........................................... F-50
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
Prodigy Communications Corporation:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, stockholders' equity (deficit) and cash
flows present fairly, in all material respects, the financial position of
Prodigy Communications Corporation and its subsidiaries (the "Company") at
December 31, 1998 and 1999, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1999 in
conformity with accounting principles generally accepted in the United States
of America. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with auditing standards generally accepted in the United States of
America, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
New York, New York
March 3, 2000
F-2
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands except share and per share amounts)
<TABLE>
<CAPTION>
December 31,
--------------------
1998 1999
--------- ---------
<S> <C> <C>
ASSETS:
Current assets:
Cash and cash equivalents.............................. $ 12,180 $ 35,473
Trade accounts receivable, net of allowances for
doubtful accounts of $367 and $3,380 at December 31,
1998 and 1999, respectively........................... 966 10,314
Due from affiliate..................................... -- 1,801
Prepaid expenses....................................... 1,691 2,793
Other current assets................................... 106 1,437
--------- ---------
Total current assets................................. 14,943 51,818
Restricted cash.......................................... 5,420 4,692
Property and equipment, net.............................. 12,998 18,201
Other intangibles, net................................... -- 1,748
Tradename, net........................................... 26,579 26,330
Goodwill, net............................................ 11,587 55,680
Deferred network costs, net.............................. 5,939 3,563
Subscriber acquisition costs, net........................ -- 182,838
Other assets............................................. 866 1,118
--------- ---------
Total assets......................................... $ 78,332 $ 345,988
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current liabilities:
Notes payable.......................................... $ 2,000 $ 110,154
Accounts payable....................................... 10,442 24,351
Accrued compensation................................... 3,000 3,095
Accrued restructuring and other special costs.......... 4,705 3,849
Other accrued expenses................................. 18,193 16,847
Accrued subscriber acquisition costs................... -- 7,144
Unearned revenue....................................... 10,200 14,062
Capital lease obligation--short term................... -- 412
--------- ---------
Total current liabilities............................ 48,540 179,914
Capital lease obligation--long term...................... -- 983
--------- ---------
Total liabilities.................................... 48,540 180,897
--------- ---------
Commitments and contingencies (Note 14)
Stockholders' equity:
Preferred stock, $.01 par value; 10,000,000 shares
authorized; none issued or outstanding................ -- --
Contingent convertible notes........................... 30,500 --
Common stock, $.01 par value; 150,000,000 shares
authorized; 45,034,297 and 64,502,608 shares issued
and outstanding at December 31, 1998 and 1999,
respectively.......................................... 450 645
Additional paid-in capital............................. 294,296 539,054
Accumulated deficit.................................... (292,787) (373,275)
Note receivable from stockholder....................... (2,667) (1,333)
--------- ---------
Total stockholders' equity........................... 29,792 165,091
--------- ---------
Total liabilities and stockholders' equity........... $ 78,332 $ 345,988
========= =========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-3
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands except per share amounts)
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------
1997 1998 1999
--------- -------- --------
<S> <C> <C> <C>
Revenues:
Internet and online service revenues:
Prodigy Internet............................ $ 29,459 $ 80,696 $154,211
Prodigy Classic............................. 98,793 48,212 15,599
--------- -------- --------
128,252 128,908 169,810
Other......................................... 5,940 7,232 19,228
--------- -------- --------
Total revenues.............................. 134,192 136,140 189,038
--------- -------- --------
Operating costs and expenses:
Costs of revenue.............................. 91,998 93,355 102,199
Sales and marketing........................... 59,624 41,678 58,854
Product development........................... 11,407 10,880 12,341
General and administrative.................... 56,254 44,640 61,652
Depreciation and amortization................. 21,444 16,072 21,792
Amortization of subscriber acquisition costs.. -- -- 20,448
Restructuring and other special costs......... 9,854 -- --
Write-down of assets held for sale............ 2,400 -- --
Loss on sale of cellular assets............... 848 -- --
--------- -------- --------
Total operating costs and expenses.......... 253,829 206,625 277,286
--------- -------- --------
Operating loss.................................. (119,637) (70,485) (88,248)
Gain on sale of assets/equity investments..... 250 5,176 3,319
Gain on settlement of note payable............ -- -- 1,714
Gain on settlement of note receivable......... -- -- 500
(Loss) on equity investment in joint venture.. (12,101) -- --
Interest income............................... 272 1,541 5,121
Interest expense.............................. (1,559) (1,315) (2,859)
Other......................................... -- -- (35)
--------- -------- --------
Net loss.................................... $(132,775) $(65,083) $(80,488)
========= ======== ========
Basic and diluted loss per share................ $ (7.66) $ (1.60) $ (1.34)
========= ======== ========
Weighted average number of common shares
outstanding used in computing basic and diluted
net loss per share............................. 17,337 40,746 59,958
========= ======== ========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-4
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(in thousands except per share amounts)
<TABLE>
<CAPTION>
Contingent Common Stock Additional
Convertible -------------- Paid-in Accumulated
Notes Shares Amount Capital Deficit
----------- ------ ------ ---------- -----------
<S> <C> <C> <C> <C> <C>
Balance at December 31,
1996........................ $30,500 12,310 $123 $ 52,883 $ (94,929)
Issuance of common stock for
cash........................ 14,913 149 71,890
Issuance of common stock on
conversion of advances from
stockholders................ 8,547 86 102,565
Acquisition and retirement of
treasury shares............. (1,966) (20) (8,602)
Comprehensive loss:
Net loss.................... (132,775)
Other comprehensive losses:
Translation adjustment......
Comprehensive loss..........
------- ------ ---- -------- ---------
Balance at December 31,
1997........................ 30,500 33,804 338 218,736 (227,704)
------- ------ ---- -------- ---------
Issuance of common stock for
cash........................ 11,254 112 74,926
Issuance of common stock on
conversion of advances from
stockholders
Options granted below fair
market value................ 730
Acquisition and retirement of
treasury shares............. (24) (96)
Comprehensive loss:
Net loss.................... (65,083)
Comprehensive loss..........
------- ------ ---- -------- ---------
Balance at December 31,
1998........................ 30,500 45,034 450 294,296 (292,787)
------- ------ ---- -------- ---------
Issuance of common stock for
cash........................ 12,373 124 164,409
Issuance of common stock in
connection with the
acquisition of
BizOnThe.Net................ 2,841 28 48,411
Convertible securities
redemption.................. (30,500) 4,255 43 30,457
Options granted below fair
market value................ 1,481
Comprehensive loss:
Net loss.................... (80,488)
Comprehensive loss..........
------- ------ ---- -------- ---------
Balance at December 31,
1999........................ $ -- 64,503 $645 $539,054 $(373,275)
======= ====== ==== ======== =========
</TABLE>
F-5
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)--(Continued)
(in thousands except per share amounts)
<TABLE>
<CAPTION>
Accumulated Note
Other Receivable
Comprehensive From Comprehensive
(Loss) Profit Stockholder Total Loss
------------- ----------- --------- -------------
<S> <C> <C> <C> <C>
Balance at December 31,
1996....................... $ (30) $ (11,453)
Issuance of common stock for
cash....................... $(4,000) 68,039
Issuance of common stock on
conversion of advances from
stockholders............... 102,651
Acquisition and retirement
of treasury shares......... (8,622)
Comprehensive loss:
Net loss................... (132,775) $(132,775)
Other comprehensive losses:
Translation adjustment..... (159) (159) (159)
---------
Comprehensive loss......... $(132,934)
----- ------- --------- =========
Balance at December 31,
1997....................... (189) (4,000) 17,681
----- ------- ---------
Issuance of common stock for
cash....................... 75,038
Issuance of common stock on
conversion of advances from
stockholders............... 1,333 1,333
Options granted at below
fair market value.......... 730
Acquisition and retirement
of treasury shares......... (96)
Comprehensive loss:
Net loss................... (65,083) $ (65,083)
Other comprehensive losses:
Translation adjustment..... 189 189 189
---------
Comprehensive loss......... $ (64,894)
----- ------- --------- =========
Balance at December 31,
1998....................... $ -- (2,667) 29,792
----- ------- ---------
Issuance of common stock for
cash....................... 1,334 165,867
Issuance of common stock on
acquisition of
BizOnThe.Net............... 48,439
Convertible securities
redemption
Options granted below fair
market value............... 1,481
Comprehensive loss:
Net loss................... (80,488) $ (80,488)
---------
Comprehensive loss......... $ (80,488)
----- ------- --------- =========
Balance at December 31,
1999....................... $ -- $(1,333) $ 165,091
===== ======= =========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-6
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands except share and per share amounts)
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------
1997 1998 1999
--------- -------- ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss....................................... $(132,775) $(65,083) $ (80,488)
Adjustments to reconcile net loss to net cash
used in operating activities:
Loss on equity investment in joint venture.... 12,101 -- --
Recovery of equity investments................ (250) -- --
Write-down of assets held for sale............ 2,400 -- --
Gain on sale of assets........................ -- (5,176) (3,319)
Gain on settlement of note payable............ -- -- (1,714)
Gain on settlement of note receivable......... -- -- (500)
Option grants at below fair value............. -- 730 1,481
Loss on sale of cellular assets............... 848 -- --
Depreciation and amortization of property and
equipment.................................... 11,997 7,896 8,429
Amortization of goodwill...................... 1,551 1,551 5,505
Amortization of tradename..................... 3,455 3,667 3,849
Amortization of other intangibles............. -- -- 152
Amortization of deferred network asset........ 1,335 2,228 2,376
Amortization of subscriber acquisition costs.. -- -- 20,448
Amortization of deferred software development
costs........................................ 1,159 -- --
Write-down of deferred software development
costs to net realizable value................ 1,946 -- --
Provision for doubtful accounts............... (342) (49) (3,200)
Change in operating assets and liabilities,
net of effects of acquisitions and disposals:
Trade accounts receivable..................... 1,935 823 (4,711)
Due from affiliate............................ -- -- (1,801)
Prepaid expenses.............................. 1,340 (312) (1,078)
Other assets.................................. (1,690) 1,320 (1,083)
Assets held for sale.......................... (5,325) 1,650 --
Accounts payable and other accrued expenses... (11,650) (20,359) 12,997
Accrued compensation.......................... (1,089) 652 95
Accrued restructuring and other special
costs........................................ (2,178) (3,170) (856)
Unearned revenue.............................. 1,193 5,648 3,271
--------- -------- ---------
Net cash used in operating activities........ (114,039) (67,984) (40,147)
--------- -------- ---------
Cash flows from investing activities:
Acquisition of property and equipment......... (8,556) (2,567) (9,907)
Acquisition of subscribers.................... -- -- (196,142)
Acquisition of Web hosting business........... -- -- (9,829)
Proceeds from sale of assets/equity
investments.................................. -- 5,176 3,319
Investment in joint venture................... (7,006) -- --
Increase in other assets...................... 308 -- --
--------- -------- ---------
Net cash used in investing activities........ (15,254) 2,609 (212,559)
--------- -------- ---------
Cash flows from financing activities:
Proceeds from issuance of common stock........ 68,039 74,942 164,533
Repayment of notes payable to related
parties...................................... (46,000) (32,100) (19,846)
Proceeds from notes payable to related
parties...................................... -- 22,100 130,000
Repayment of borrowings....................... -- (30,000) (750)
Proceeds from borrowings...................... 102,651 30,000 --
Payment of note receivable from stockholder... -- 1,333 1,334
(Increase)/decrease in restricted cash........ (4,148) (1,272) 728
Other......................................... (161) 189 --
--------- -------- ---------
Net cash provided by financing activities.... 120,381 65,192 275,999
--------- -------- ---------
Net increase (decrease) in cash and cash
equivalents................................... (8,912) (183) 23,293
--------- -------- ---------
Cash and cash equivalents, beginning of
period........................................ 21,275 12,363 12,180
--------- -------- ---------
Cash and cash equivalents, end of period....... $ 12,363 $ 12,180 $ 35,473
========= ======== =========
</TABLE>
F-7
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS--(continued)
(in thousands except share and per share amounts)
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1997 1998 1999
-------- ------ --------
<S> <C> <C> <C>
Supplementary Cash Flow Information:
Cash paid for interest.............................. $ 1,177 $1,164 $ 1,823
Noncash investing and financing activities:
Conversion of advances from stockholder to common
stock.............................................. 102,651 -- --
Contingent convertible notes and contingent warrants
issued in exchange for contingent convertible
note............................................... 30,500 -- --
Conversion of contingent convertible notes into
common stock....................................... -- (30,500)
Sale of network assets in exchange for service
agreement.......................................... 9,502 -- --
Issuance of common stock in connection with
acquisition of Web hosting business................ -- -- (48,439)
Contingent convertible note received as settlement
for sale of International Wireless cellular
communications business............................ -- -- (875)
Capital lease obligations........................... -- -- 1,395
Option grants at below fair value................... -- 730 1,481
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-8
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands except share and per share amounts)
1. Organization and Basis of Presentation
Prodigy Communications Corporation (the "Company") is a leading nationwide
Internet Service Provider ("ISP"). The Company is controlled by Carso Global
Telecom, S.A. de C.V. ("Carso Global Telecom") through a 64.1% direct and
indirect majority voting equity interest in the Company's common stock. The
Company was formed in June 1996, under the name Prodigy, Inc., to acquire
Prodigy Services Company ("PSC") and to hold International Wireless
Incorporated ("IW") and other communications interests. IW was incorporated on
May 23, 1994, to develop and operate cellular telephone systems in Africa. IW's
other communications interests consisted of Africa Online, Inc., a wholly-owned
subsidiary engaged in Internet access and online services in Africa, and an
equity investment in a start-up joint venture in China.
Since the acquisition of PSC, the Company has been in the midst of a major
transformation, both domestically and internationally. In the United States,
the Company launched its open standards based Internet access service ("Prodigy
Internet") in October 1996. The Company's cellular telephone assets and
operations were sold in January 1997. In 1997, the Company determined that its
primary focus would be as an ISP and decided to discontinue the production of
its own content for Prodigy Internet. In 1998, the Company sold its African
operations and negotiated a settlement of its liabilities in connection with
the closing of its Asian operations (see Note 5-Dispositions).
Since formation, Prodigy has relied on private sales of equity securities
(totaling $294,100 through December 31, 1999), borrowings and the initial
public offering in February 1999 (with net proceeds of $157,200) to fund its
operations. Prodigy has incurred significant losses since inception and, at
December 31, 1999, had an accumulated deficit of $373,275 and a working capital
deficit of $128,096 comprised of current liabilities of $179,914 offset by
current assets of $51,818. For the years ended December 31, 1997, 1998 and
1999, Prodigy incurred negative cash flow from operations of $114,039, $67,984
and $40,147, respectively. To the extent the Company is unable to fund its
current obligations as they become due from its operating cash flows, Carso
Global Telecom, through its subsidiary Telmex, has committed to provide
additional financing, either through capital and/or debt financing, of up to
$200,000 through February, 2001. Specific terms of this financing will be
determined at the time such financing, if any, is provided. Management believes
that this additional funding will be sufficient to enable the Company to meet
its planned expenditures through at least December 31, 2000.
2. Acquisitions
Acquisition of BizOnThe.Net
On October 5, 1999, Prodigy acquired the BizOnThe.Net Web hosting business of
U.S. Republic Communications, Inc. an indirect majority owned subsidiary of
VarTec including the subscribers of the BizOnThe.Net Web hosting business. At
the closing, Prodigy repaid a $9,000 loan from VarTec to U.S. Republic and
issued 2,840,993 shares of Prodigy common stock to U.S. Republic including
727,272 shares held in an escrow account to secure the indemnification
obligations of U.S. Republic and its shareholders. Some or all of the escrowed
shares will be released to U.S. Republic at various times over the two year
period following the closing. In addition to the shares and amounts paid at
closing, in 2001 Prodigy may be required to issue up to 727,272 additional
shares, contingent on the attainment by the acquired business of set earn-out
targets.
The acquisition of BizOnThe.Net has been accounted for under the purchase
method of accounting and accordingly the cost to acquire BizOnThe.Net was
allocated to the assets acquired and liabilities assumed based on their
respective fair values with the excess allocated to goodwill. The total
purchase price is subject to change based on the calculation of the amount by
which the net book value of the acquired assets and assumed liabilities as of
October 5, 1999 exceeded or was less than the net book value as of July 31,
1999, which is expected to be finalized in the second quarter of 2000, and
earn-out adjustments to be finalized over the next two years. Changes in the
purchase price based on these adjustments will be recorded as corresponding
increases or decreases in goodwill at the time the related items are resolved
and are not expected to exceed
F-9
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands except share and per share amounts)
$10,000. Based on the value of the 2,840,993 shares of common stock currently
issued in connection with the BizOnThe.Net acquisition and the $9,000 cash used
to repay the loan, the total purchase price is approximately $58,000. The
excess of the purchase price over the fair value of tangible and intangible
assets acquired and liabilities assumed of $49,598 has been allocated to
goodwill and will be amortized on a straight-line basis over 3 years.
Pro Forma (Unaudited)
The unaudited condensed pro forma results of operations presented below
assume that the Combination occurred at the beginning of each period presented.
The pro forma information is not necessarily indicative of the combined results
of operations of Prodigy and BizOnThe.Net that would have resulted if the
transaction had occurred on the dates indicated and they are not necessarily
indicative of the future operating results of the combined company.
<TABLE>
<CAPTION>
Twelve Months Ended
December 31,
--------------------
1999 1998
--------- ---------
<S> <C> <C>
Revenues.............................................. $ 208,107 $ 143,246
Net loss.............................................. $ (95,236) $ (91,385)
Pro forma net loss per common share................... $ (1.53) $ (2.10)
</TABLE>
3. Significant Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
the Company and its subsidiaries. All significant intercompany accounts and
transactions have been eliminated.
Estimates and Assumptions
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 revenue and expenses during the reporting periods.
Actual results could differ from those estimates.
Foreign Currency Translation
The functional currencies of the Company's foreign subsidiaries, which were
disposed of in 1998, were the local currencies. Accordingly, assets and
liabilities of foreign subsidiaries were translated to U.S. dollars at period-
end exchange rates and revenues and expenses were translated using the average
rates during the period. The effects of foreign currency translation
adjustments have been accumulated and are included as a separate component of
stockholders' equity. Foreign currency transaction gains and losses, arising
from exchange rate fluctuations on transactions denominated in currencies other
than the functional currencies, were immaterial for all periods presented.
Revenue Recognition
Internet and on-line service revenues encompass subscription and usage fees
and are earned over the period services are provided. Other revenues,
consisting principally of subscriber management fees, Web hosting fees and
marketing services, are recognized as fees are earned or services are provided.
Unearned revenue consists primarily of subscription fees billed in advance.
F-10
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands except share and per share amounts)
Subscriber Acquisition Costs
Costs of acquisition programs which result in subscriber enrollments without
further effort required by the Company are capitalized and amortized over the
estimated life of the acquired subscriber (See Note 8-Subscriber Acquisition
Costs). General marketing costs, as well as all other costs related to the
acquisition of subscribers, are expensed as incurred.
Advertising Costs
Advertising costs are included in marketing expenses and are expensed as
incurred.
Research and Development
Research and development costs are expensed as incurred.
Cash and Cash Equivalents
The Company considers all highly liquid investments with original maturities
at date of purchase of three months or less to be cash equivalents. Cash and
cash equivalents are stated at cost, which approximates fair value because of
the short maturity of these instruments.
Restricted Cash
Restricted cash represents collateral for outstanding letters of credit, the
escrow portion of proceeds related to the Company's sale of a subsidiary and
collateral for a surety bond filed with a state government.
Property and Equipment
Property and equipment are recorded at cost and depreciated using the
straight-line method over the estimated useful lives of the assets.
Expenditures for major renewals and betterments that extend the useful lives of
property and equipment are capitalized. Expenditures for maintenance and
repairs are charged to expense as incurred. When assets are sold or otherwise
disposed of, the cost and related accumulated depreciation are relieved and any
resulting gain or loss is recognized.
Internal Use Software
The Company capitalizes the cost of acquiring internal use software once the
application development stage has begun and ceases to capitalize costs once the
software is put into use. Training, maintenance and data conversion costs are
expensed as incurred.
Equipment Under Capital Leases
The Company leases certain computer equipment under capital lease agreements.
The assets and liabilities under capital leases are recorded at the lower of
the present value of the minimum lease payments or the fair value of the asset.
The assets are being depreciated over their related lease terms. Depreciation
of assets under capital leases is included in depreciation expense.
Intangible Assets
Intangible assets consist principally of tradenames and goodwill.
Amortization of these assets is computed on a straight-line basis over
estimated useful lives. Tradenames are amortized over a period of 3 to 10 years
and goodwill, which represents the excess of the purchase price over the
estimated fair values of net assets acquired, is amortized over a period of 3
to 10 years.
F-11
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands except share and per share amounts)
Long-Lived Assets
The Company periodically reviews the recoverability of the carrying value of
these assets using the methodology prescribed in SFAS No. 121, Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
of. The Company reviews long-lived assets and the related intangible assets for
impairment whenever events or changes in circumstances indicate the carrying
amounts of such assets may not be recoverable. Recoverability of these assets
is determined by comparing the forecasted undiscounted net cash flows of the
operation to which the assets relate, to the carrying amount, including
associated intangible assets, of such operation. If the operation is determined
to be unable to recover the carrying amount of its assets, then intangible
assets are written down first, followed by the other long-lived assets of the
operation, to fair value. Fair value is determined based on discounted cash
flows or appraised values, depending upon the nature of the assets.
Income Taxes
Deferred tax liabilities and assets are recognized based on temporary
differences between the financial statement and tax bases of assets and
liabilities using current statutory rates. A valuation allowance is applied
against net deferred tax assets if, based on the weighted available evidence,
it is more likely than not that some or all of the deferred tax assets will not
be realized.
Accounting for Stock-Based Compensation
The Company adopted Statement of Financial Accounting Standards No. 123 (SFAS
No. 123), "Accounting for Stock-Based Compensation," in 1996. As permitted by
SFAS No. 123, the Company has elected to continue to apply the intrinsic value
methodology provisions of Accounting Principles Board Opinion No. 25 (APB 25),
"Accounting for Stock Issued to Employees," for the grants or awards of equity
instruments to employees. In accordance with APB 25 no expense was recorded
during 1997. During 1998 and 1999 approximately $730 and $1,481 of compensation
expense was recorded. As required by SFAS No. 123, the Company has disclosed
the pro forma effect on net loss of using a fair value approach to measure
compensation for grants or awards of equity instruments (see Note 12-Stock
Option and Purchase Plan).
Net Loss Per Share
The Company computes basic and diluted earnings per share in accordance with
Statement of Financial Accounting Standards No. 128 ("SFAS 128"), "Earnings per
Share." SFAS 128 requires the Company to report both basic earnings per share,
which is based on the weighted average number of common shares outstanding, and
diluted earnings per share, which is based on the weighted average number of
common shares outstanding and all dilutive potential common shares outstanding.
As the Company incurred losses for all periods presented, there is no
difference between basic and diluted earnings per share.
Concentrations of Credit Risk
Financial instruments which potentially subject the Company to concentrations
of credit risk consist principally of cash and trade receivables. Concentration
of credit risk with respect to cash is limited as the Company invests its cash
in deposits with several financial institutions. Concentration of credit risk
with respect to trade receivables is limited as the outstanding total
represents a large number of customers with individually small balances. The
Company does not require collateral or other security against trade receivable
balances; however, it does maintain reserves for potential credit losses and
such losses have been within management's expectations.
F-12
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands except share and per share amounts)
Reclassifications
Certain amounts from prior periods have been reclassified to conform with the
current year presentation.
Recent Accounting Pronouncements
In November 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin ("SAB") No. 100, "Restructuring and Impairment Charges." In
December 1999, the SEC issued SAB No. 101, "Revenue Recognition in Financial
Statements." SAB No. 100 express the views of the SEC staff regarding the
accounting for and disclosure of certain expenses not commonly reported in
connection with exit activities and business combinations. This includes the
accrual of exit and employee termination costs and the recognition of
impairment charges. SAB No. 101 expresses the views of SEC staff in applying
generally accepted accounting principles to certain revenue recognition issues.
Prodigy has concluded that these SABs do not have a material impact on its
financial position or its results of operations.
4. Restructuring and Other Special Costs
During 1997, in an effort to decrease cash outflows and more efficiently
manage its business, the Company decided to restructure its operations and
outsource its network and content production functions. The Company's
provisions, expenditures and remaining balances to be paid are detailed below:
<TABLE>
<CAPTION>
Accrued Accrued Accrued
Costs at Costs at Costs at
1997 1997 December 31, 1998 December 31, 1999 December 31,
Cost Payments 1997 Payments 1998 Payments 1999
------ -------- ------------ -------- ------------ -------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
(A) Network termination
costs.............. $4,740 $4,740 $ 849 $3,891 $ 42 $3,849
(B) Employee
severance.......... 2,900 $1,979 921 921
(C) Discontinuance of
content
production......... 585 585 585
(D) Medford, MA
Facility Closing... 1,629 1,629 815 814 814
------ ------ ------ ------ ------ ---- ------
$9,854 $1,979 $7,875 $3,170 $4,705 $856 $3,849
====== ====== ====== ====== ====== ==== ======
</TABLE>
- --------
(A) In connection with the sale of its network (see Note 5--Dispositions, Sale
of Network), the Company incurred liabilities related primarily to early
termination payments and other contractual obligations for certain non-
cancelable network related agreements. Management expects to use this
reserve in full by the year ending December 31, 2001.
(B) The Company implemented a restructuring plan to reduce costs through job
elimination and as a result recorded a charge of $2,900. Approximately 80
employees throughout the Company were terminated. The entire reserve was
used in 1997 and 1998 to make severance payments to employees identified as
part of the original plan.
(C) The Company decided to discontinue the production of its own content and as
a result recorded a charge of $585 to account for the employee termination
costs and the costs to settle content related contractual obligations.
Approximately 25 employees were terminated. The entire reserve was used in
1997 and 1998 to make severance payments to employees identified as part of
the original plan.
(D) The Company's Medford, Massachusetts location has been closed and a charge
of $1,629 was recorded to account for the costs of employee terminations
and lease cancellation. The entire reserve has been utilized by December
31, 1999. The terminated employees were involved with the Company's
international operations and/or former headquarters management.
Approximately 20 employees were terminated.
F-13
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands except share and per share amounts)
5. Dispositions
Sale of International Wireless
Effective January 1997, the Company sold all issued outstanding capital stock
of IW to a company (the "Buyer") formed by a former executive and shareholder
of the Company (the "Executive"). The selling price consisted of (i) the
surrender of 1,392,857 shares of common stock of the Company, (ii) a Promissory
Note (the "Note") in the amount of $21,500 due in full on July 27, 1997,
including $1,500 in reimbursement of capital expenditures made by the Company
for the benefit of IW, secured by a pledge of 67% of the shares of IW purchased
from the Company, and bearing interest at 9% until April 27, 1997 and 12%
thereafter, and (iii) the termination of the Executive's fully vested options
to purchase 125,000 shares of common stock for $1.00 per share and 125,000
shares of common stock for $8.00 per share.
In October 1997, the Company and the Buyer modified the Note including the
following: (i) the due date was extended to January 31, 1999, (ii) the Note was
changed to make it unsecured, (iii) the interest rate was reduced to 8%, (iv)
the Note was subject to mandatory repayment out of the net proceeds from an
acquisition of IW. The Buyer also surrendered an additional 573,580 shares of
common stock of the Company in exchange for a reduction in IW's unpaid
obligations at October 31, 1997 to $16,148. As a result of the restructuring of
the Note and revaluation of the Company's stock from $12.00 to $4.00 per share,
a loss on the sale of IW of $848,000 was recorded in 1997.
In October 1999 the note was restructured for a cash settlement of $500,000
and an 8% convertible note for $875,000 due in October 2006. The Note is
convertible into 1 million shares of common stock of Wireless Communications
Technology, which purchased the cellular division of IW. At December 31, 1997,
1998 and 1999 the respective notes receivable were valued at zero.
Sale of Network
Prodigy owned and operated its own network in the United States until July 1,
1997. Effective July 1, 1997, the Company sold to Splitrock Services, Inc.
("Splitrock"), an affiliate of Carso Global Telecom, certain of its network
assets. Splitrock agreed to: (i) assume equipment leases, maintenance and
license liabilities related to network assets, and (ii) enter into a Full
Service Agreement whereby Splitrock will provide certain network services to
the Company, including commitments to meet certain capacity and performance
requirements.
As a result of the sale of the network effective July 1, 1997, the Company
sold property and equipment with a net book value of approximately $9,500 and
did not record any gain or loss upon the sale of these assets. The net book
value of the equipment was removed from property and equipment on the balance
sheet and classified as a "Deferred Network Asset" and is being amortized over
the four year term of the Splitrock contract on a straight-line basis.
Exit of International Operations
In December 1997, management decided to exit its international operations in
order to focus on its domestic internet service business. The Company recorded
a charge of $2,400 in 1997 to reduce the carrying value of Africa Online, Inc.
long lived assets, including goodwill, to their estimated net realizable value.
In March 1998, the Company terminated its Chinese joint ventures and
operations. On October 1, 1998, Africa Online, Inc. was sold for gross cash
proceeds of $2,815, of which $750 was placed in escrow to collateralize certain
indemnification obligations of the Company for a six month period. The sale
resulted in a gain to the Company of approximately $2,900.
F-14
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands except share and per share amounts)
Sale of Equity Investment
During 1997 the Company sold a subsidiary which eventually became part of TCI
Music. As a result of the sale, the Company acquired shares of TCI Music.
During April of 1999, TCI Music announced its merger with Liberty Media. As a
result, the value of the Company's investment increased and was sold for
$3,325, generating a gain of $3,319 which was recognized in 1999.
6. Property and Equipment
Property and equipment consisted of the following at December 31:
<TABLE>
<CAPTION>
Useful Life 1998 1999
----------- ------- -------
<S> <C> <C> <C>
Computer equipment................................. 3-5 years $24,711 $33,109
Capitalized software............................... 3-5 years 2,126 5,862
Leasehold improvements............................. 5-7 years 4,778 4,836
Furniture and equipment............................ 5-8 years 1,590 1,696
Property under capital lease....................... 39 months 1,538
------- -------
33,205 47,041
Less accumulated depreciation and amortization..... 20,207 28,840
------- -------
$12,998 $18,201
======= =======
</TABLE>
Depreciation and amortization of fixed assets was approximately $11,997,
$7,896 and $8,429 for the years ended December 31, 1997, 1998 and 1999,
respectively.
7. Intangible Assets
The cost and accumulated amortization of intangible assets was as follows at
December 31:
<TABLE>
<CAPTION>
1998 1999
------- -------
<S> <C> <C>
Tradename:
Cost...................................................... $35,668 $39,217
Less: accumulated amortization............................ 9,089 12,887
------- -------
$26,579 $26,330
======= =======
Goodwill:
Cost...................................................... $15,529 $65,127
Less: accumulated amortization............................ 3,942 9,447
------- -------
$11,587 $55,680
======= =======
Deferred network costs:
Cost...................................................... $ 9,502 $ 9,502
Less: accumulated amortization............................ 3,563 5,939
------- -------
$ 5,939 $ 3,563
======= =======
Other Intangibles:
Cost...................................................... $ -- $ 1,900
Less: accumulated amortization............................ -- 152
------- -------
$ -- $ 1,748
======= =======
</TABLE>
F-15
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands except share and per share amounts)
8. Subscriber Acquisition Costs
In May 1999, the Company entered into an agreement with Cable & Wireless USA,
Inc. to purchase the dial-up access Internet subscriber base of that entity. At
the closing on July 20, 1999, the Company paid Cable & Wireless USA, Inc.
$40,900 in cash and anticipates finalizing the purchase price in the first
quarter of 2000. The purchase price is expected to decrease by approximately
$10 million from the original payment due to fewer subscribers transitioning to
the Prodigy service than originally projected. The Company has capitalized the
costs of the subscribers purchased under this agreement and is amortizing these
costs over 36 months representing the estimated weighted average term of the
subscribers acquired.
During 1999, the Company entered into agreements with major retailers of
personal computers (the "Retailers") to make specified payments to the
Retailers in exchange for the Retailers enrolling customers onto Prodigy
Internet and obtaining a signed contractual commitment from these customers to
term subscriptions to Prodigy Internet of one, two or three years at the
Company's standard monthly rates. The Company has capitalized these payments
and is amortizing them over the term of the individual subscriber contract. The
company reviews subscriber terminations on a quarterly basis and any
unamortized acquisition costs related to such terminations are written off.
Capitalized subscriber acquisition costs at December 31, 1999 are as follows:
<TABLE>
<CAPTION>
1999
--------
<S> <C>
Cable & Wireless
Cost............................................................. $ 41,612
Less: accumulated amortization................................... (4,818)
--------
$ 36,794
========
Subscriber Contract Acquisition
Cost............................................................. $161,674
Less: accumulated amortization................................... (15,630)
--------
$146,044
========
</TABLE>
The amortization expense for subscriber acquisition costs for the year ended
December 31, 1999 is $20,448.
9. Notes Payable
Notes payable consisted of the following at December 31:
<TABLE>
<CAPTION>
1998 1999
------ --------
<S> <C> <C>
Notes payable to related party.............................. $ 0 $110,154
------ --------
Loan payable to corporate lender............................ $2,000 $ 0
------ --------
</TABLE>
In March 1996, the Company borrowed $2,000 from a network company (the
"Corporate Lender") pursuant to an 8.25% convertible note. Principal and
interest were due on March 31, 1997. The note had not been formally extended.
The Corporate Lender had the right within 30 days after the completion of a
private placement and prior to March 31, 1997 to convert the principal and
interest into common stock at the price per share at which the Company's common
stock is issued in the private placement. In January 1999, the Company paid the
Corporate Lender $750 in full settlement of its 8.25% convertible note in the
principal amount of $2,000 and all accrued interest. As a result the Company
recognized a gain of $1,714 in 1999.
F-16
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands except share and per share amounts)
In August 1998, the Company obtained a $35,600 line of credit from Carso
Global Telecom. This credit facility expired on December 31, 1999 and bore
interest at the LIBOR rate plus between one and five percentage points. There
were no outstanding amounts on this facility as of December 31, 1998 or 1999.
In August 1999, the Company obtained a $130,000 line of credit from Banco
Inbursa to fund its various subscriber acquisition programs during the third
and fourth quarter of 1999. The interest rate on this facility fluctuates based
on market conditions at the time of each drawdown. These borrowings reached a
maximum of $130,000 during 1999 at interest rates between 9% and 12%. At
December 31, 1999 the line had been paid down to $110,154. In January 2000,
Prodigy repaid $13,800 of these notes. The remaining $96,400 is due April 7,
2000.
10. Contingent Convertible Notes and Warrants
The Contingent Convertible Notes ("Contingent Notes") valued at $30,500, were
issued to International Business Machines Corporation ("IBM") and Sears Roebuck
and Co. ("Sears") in 1996 in connection with the acquisition of PSC and had an
interest rate of 8% annually commencing on December 17, 1997.
In November 1997, IBM and Sears (i) agreed that the consideration receivable
upon conversion of the Contingent Notes would be based on the valuation of the
Company in excess of $250,000 (with the aggregate consideration payable to IBM
and Sears still limited to $200,000 plus interest from June 17, 1996) and (ii)
were granted Contingent Stock Purchase Warrants (the "Contingent Warrants") to
purchase shares of Common Stock of the Company at 130% of the fair market value
thereof at the time of conversion of the Contingent Notes. The aggregate number
of shares of Common Stock issuable to IBM and Sears upon conversion of the
Contingent Notes and exercise of the Contingent Warrants could not exceed 15%
of the number of shares outstanding upon completion of the IPO. As a condition
to these arrangements, Carso Global Telecom prepaid (on behalf of and as an
advance to the Company) the balance due on the Company's former White Plains
lease ($5,831) and established a $4,000 letter of credit, declining quarterly
over three years, to collateralize certain payment obligations of the Company
under PSC contracts for which IBM and Sears remain liable.
Upon the completion of the Company's initial public offering both IBM and
Sears acquired an interest in the Company's outstanding common stock in
accordance with the terms of the Contingent Convertible Notes. IBM and Sears
each received approximately 2,127,500 shares for a combined total of
approximately 4,255,000. Additionally, IBM and Sears each received warrants
which allow them to purchase 2,409,145 additional shares each at $19.50 per
share. Those warrants are exercisable for three years from the conversion date.
11. Income Taxes
The Company had no income tax expense for the years ended December 31, 1997,
1998 and 1999 as a result of net losses. As of December 31, 1998 and 1999, the
Company's deferred tax assets were as follows:
<TABLE>
<CAPTION>
1998 1999
-------- ---------
<S> <C> <C>
Domestic net operating loss carryforwards............... $ 84,991 $ 114,840
Intangible assets....................................... 6,382 6,133
Restructuring and other nonrecurring reserves........... 3,838 1,844
Other................................................... 979 5,026
Valuation allowance..................................... (96,190) (127,843)
-------- ---------
Net deferred tax asset.................................. $ -- $ --
======== =========
</TABLE>
F-17
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands except share and per share amounts)
At December 31, 1999, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $280,098 which may be used to
offset future taxable income, beginning to expire in 2010. The utilization of
the federal income tax loss carryforwards is subject to limitation as a result
of a change of ownership.
Management of the Company has evaluated the positive and negative evidence
bearing upon the realizability of its deferred tax assets, which are comprised
principally of net operating loss carryforwards. Under the applicable
accounting standards, management has considered the Company's history of losses
and concluded that it is more likely than not that the Company will not realize
these deferred tax assets.
12. Stockholders' Equity
Authorized Shares of Common Stock
In 1997, the Board of Directors and the stockholders approved an increase in
the authorized shares of common stock to 280,000,000 shares.
Reverse Stock Split
On January 25, 1999, the Board of Directors effected a one-for-four reverse
common stock split. The share information in the accompanying consolidated
financial statements has been retroactively restated to reflect the effect of
the reverse stock split.
Reduction in Authorized Shares
On January 25, 1999, the Company effected a reduction in the number of
authorized shares from 280,000,000 to 150,000,000.
Private Placements
In October 1996, the Company offered up to 2,000,000 shares of its common
stock in a private placement, resulting in net proceeds to the Company from
investors of approximately $1,843. In February 1997, the Company increased the
size of the offering from 2,000,000 shares to 4,000,000 shares of common stock
and reduced the offering price to $12.00 per share from $28.00 per share. As a
result of the reduction in the offering price, the Company offered to each
investor the choice of either (i) receiving additional shares to reduce their
average purchase price to $12.00 or (ii) rescinding their subscriptions and
receiving refunds without interest upon the closing. The Company received
aggregate gross proceeds of $88,843 and issued 7,403,603 shares of common
stock.
In November 1997, the Company made a Rights Offering whereby each eligible
stockholder was entitled to purchase at a price of $4.00 per share, one share
of the Company's common stock for each share held. The Company issued
12,640,478 additional shares and received $46,554 in cash and a $4,000 note
receivable from Carso Global Telecom for the issuance of the IBM/Sears letter
of credit (see Note 10--Contingent Convertible Notes and Warrants). On a
quarterly basis, Carso Global Telecom will contribute $333 less any draws on
the letter of credit until the $4,000 has been paid to the Company.
In August 1998, the Company sold 6,125,000 shares of common stock at a price
of $8.00 per share to Telefonos de Mexico, S.A. de C.V. ("Telmex"), an
affiliate of Carso Global Telecom, resulting in proceeds of $49,000 to the
Company. At the same time Carso Global Telecom purchased an additional
1,375,000 shares of
F-18
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands except share and per share amounts)
common stock at a price of $8.00 per share, resulting in proceeds of $11,000 to
the Company. These proceeds were used to repay a $30,000 note payable to Bank
of America and a remaining $2,100 in notes payable to Banco Inbursa, with the
balance used for general corporate purposes.
Initial Public Offering
On February 11, 1999, the Company completed an initial public offering
("IPO") under the Securities Act of 1933. This resulted in the sale of 11.2
million shares of common stock for gross proceeds of approximately $168,000 and
net proceeds of approximately $157,200.
IBM and Sears Conversion of Contingent Notes
Upon the completion of the Company's IPO both IBM and Sears acquired 7.5% of
the Company's outstanding common stock in accordance with the Contingent Notes
Conversion feature (see Note 10 --Contingent and Convertible Notes and
Warrants). IBM and Sears each received approximately 2,127,500 shares for a
combined total of approximately 4,255,000 or 15% of the Company.
Additionally, IBM and Sears each received warrants which allow them to
purchase up to 15% of the Company at 130% of the fair market value at the date
of conversion of the Contingent Notes. Those warrants are exercisable for three
years from the conversion date. IBM and Sears each received approximately
2,409,000 warrants or approximately 4,818,000 in total.
Stock Warrants
A warrant to purchase 250,000 shares issued to Carso Global Telecom in 1996
was canceled in March 1997, at which time the Company granted Carso Global
Telecom and another shareholder warrants to purchase 3,250,000 shares and
500,000 shares, respectively, of common stock for $12.00 per share, exercisable
prior to or on November 12, 1997. In October 1997, in consideration for
arranging interim financing for the Company, the exercise price was reduced
from $12.00 per share to $4.00 per share.
At December 31, 1997, the Company had warrants outstanding with various
shareholders, including Carso Global Telecom, to purchase 3,859,347 shares of
the Company's common stock at an average price of $4.20 per share. During 1998,
3,750,000 warrants were exercised at $4.00 per share. At December 31, 1998, the
Company had warrants outstanding with various shareholders to purchase 122,402
shares of the Company's common stock at an average price of $11.09 per share.
All the outstanding warrants were exercisable as of December 31, 1998. At
December 31, 1999 the Company had warrants outstanding with various
shareholders to purchase 117,402 shares of the Company's common stock at an
average price of $11.05 per share. During 1999, 5,000 warrants were exercised
at a price of $12.00 per share.
13. Stock Option and Purchase Plans
In 1996, the Board of Directors and the stockholders approved a Stock Option
Plan (the "1996 Plan"). Under the 1996 Plan, options to purchase up to
2,375,000 shares of common stock may be granted to employees, directors,
consultants and advisors of the Company. Options granted may be either
"incentive stock options" or "nonqualified options." All options issued under
the 1996 Plan are exercisable over periods determined by the Board of
Directors, not to exceed 10 years from the date of grant. Options generally
vest over periods ranging from 3-5 years. In September 1997, the Board of
Directors and the stockholders approved an increase of 750,000 to the number of
shares of common stock available for future grants. These options have the same
terms and conditions as the shares initially authorized under the 1996 Plan.
F-19
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands except share and per share amounts)
1999 Outside Directors Stock Option Plan
In January 1999, Prodigy's Board of Directors and stockholders adopted
Prodigy's 1999 outside director stock option plan. The director plan permits
the issuance of up to 250,000 shares of common stock on the exercise of options
granted under the director plan. All options granted under the director plan
are non-statutory stock options. Pursuant to the director plan, each director
of Prodigy who was not then employed by Prodigy received on the closing of
Prodigy's initial public offering an option to purchase 30,000 shares of common
stock at an exercise price equal to the price per share at which shares were
sold in the initial public offering. Thereafter, each new non-employee director
will receive, on his or her initial election to the board of directors, an
option to purchase 30,000 shares of common stock at an exercise price equal to
the fair market value of the common stock on the date of grant. All options
granted under the director plan vest in four equal annual installments, based
on continued service as a director, and expire three months after termination
of service as a director.
1999 Stock Option Plan
The Board of Directors has adopted, subject to shareholder approval, the 1999
Stock Option Plan (the "1999 Plan"). Under the 1999 Plan, options to purchase
up to 5,600,000 shares of common stock, subject to adjustment in the event of
stock splits, may be granted to employees, directors, consultants and advisors
of the Company. Options granted may be either incentive stock options or
nonqualified options. All options issued under the 1999 Plan are exercisable
over periods determined by the Board of Directors, not to exceed 10 years from
the date of grant. No options were granted under the 1999 Plan as of December
31, 1999.
The Company's stock option plans are administered by the Board of Directors.
Repricing of Stock Options
In June 1997, the Board approved a plan to reprice employee stock options
under the 1996 Plan to restore the long-term employee retention and performance
incentives of the stock options outstanding. In accordance with the repricing
plan, all stock options held by then current, active full-time employees, with
exercise prices above $12.00 per share, were canceled and replaced by the same
number of options exercisable at $12.00 per share, the fair value of the
Company's common stock as determined by the Board on the date of the repricing.
In May 1998, the Board approved a plan to reprice employee stock options
under the 1996 Plan to restore the long-term employee retention and performance
incentives of the stock options outstanding. In accordance with the repricing
plan, all stock options held by then current, active full-time employees, with
exercise prices above $4.00 per share, were canceled and replaced by the same
number of options exercisable at $4.00 per share. The Company records
compensation expense for these repriced options over the vesting periods based
upon a fair value of $7.00 per share. The deferred compensation expense
amounted to $3,123 at December 31, 1998.
The exercise and vesting periods of the outstanding options were not altered
by the repricings.
F-20
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands except share and per share amounts)
Stock option plan activity for the years ended December 31, 1997, 1998 and
1999 follows (in thousands):
<TABLE>
<CAPTION>
1997 1998 1999
----- ------ ------
<S> <C> <C> <C>
Outstanding at January 1.............................. 2,286 2,299 2,370
Options granted..................................... 828 1,441 1,093
Options exercised................................... (3) (1,092)
Options canceled/forfeited.......................... (815) (1,367) (464)
----- ------ ------
Outstanding at December 31............................ 2,299 2,370 1,907
===== ====== ======
Exercisable at December 31.......................... 867 691 413
===== ====== ======
Available for grant at December 31.................. 825 752 373
===== ====== ======
</TABLE>
Weighted average option exercise price information for the years ended
December 31, 1997, 1998 and 1999 follows:
<TABLE>
<CAPTION>
1997 1998 1999
------ ------ ------
<S> <C> <C> <C>
Outstanding at January 1............................... $12.48 $10.72 $ 5.83
Options granted...................................... $10.04 $ 5.84 $16.63
Options exercised.................................... $ 0 $11.46 $ 6.24
Options canceled..................................... $ 9.32 $10.64 $ 8.06
Outstanding at December 31............................. $10.72 $ 5.83 $11.17
====== ====== ======
Exercisable at December 31........................... $10.96 $ 6.87 $ 5.83
====== ====== ======
</TABLE>
The following table summarizes information about stock options outstanding at
December 31, 1999:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
-----------------------------------------------------------------------------
Weighted-
Average Weighted-
Number Remaining Average Number Average
Range of Outstanding Contractual Exercise Exercisable Exercise
Exercise Prices (In Thousands) Life Price (In Thousands) Price
--------------- -------------- ----------- --------- -------------- --------
<S> <C> <C> <C> <C> <C>
$4.00 596 8.0 years $ 4.00 272 $ 4.00
$8.00-$8.60 336 8.6 years $ 8.06 95 $ 8.07
$9.00-$12.00 286 8.8 years $11.21 41 $ 9.30
$15.00-$25.63 689 9.6 years $18.87 5 $21.72
----- --------- ------ --- ------
$4.00 to 25.63 1,907 8.4 years $11.17 413 $ 5.83
===== ========= ====== === ======
</TABLE>
F-21
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands except share and per share amounts)
Had compensation cost for the Company been determined based upon the fair
value at the grant date for awards under the plan consistent with the
methodology prescribed under SFAS No. 123, the Company's net losses for the
years ended December 31, 1997, 1998, and 1999 would have been approximately
$136,921, $65,872 and $83,977, respectively, and basic and diluted net loss per
share would have been approximately $7.90, $1.62 and $1.40, respectively. The
weighted average fair value of the options granted during the years ended
December 31, 1997, 1998, and 1999 was estimated at $1.12, $4.15, and $8.18 per
share, respectively, on the date of grant using the Black-Scholes option-
pricing model and the following assumptions:
<TABLE>
<CAPTION>
1997 1998 1999
--------- ------- ----------
<S> <C> <C> <C>
Dividend yield............................... 0 0 0
Volatility................................... 55% 60% 60%
Risk free rate............................... 5.99% 5.4% 5.34%
Expected option life......................... 4.6 years 3 years 3.35 years
</TABLE>
In determining the fair value of the common stock at the date of grant, the
Board considered a broad range of factors including the liquid nature of an
investment in the Company's common stock, transactions in the Company's common
stock, the Company's historical financial performance relative to that of
comparable companies and its future prospects.
1999 Employee Stock Purchase Plan
In January 1999, Prodigy's Board of Directors and stockholders adopted the
1999 Employee Stock Purchase Plan (the "purchase plan"). The purchase plan
authorizes the issuance of up to 500,000 shares of Prodigy's common stock to
eligible employees of Prodigy and its subsidiaries. Under the purchase plan,
eligible employees may purchase shares of the Company's common stock, subject
to certain limitations, at a price equal to the lower of 85% of the fair market
value of the shares on the first date of the offering period and 85% of the
fair market value of the shares on the purchase date. The purchase plan permits
shares to be purchased at the end of the purchase periods occurring during each
offering period. Unless otherwise provided by the Board prior to commencement,
an offering period will begin on each May 16 and November 16, and continue for
a period of 24 months. A purchase period will begin on each May 16 and November
16, and will continue for a period of six months, ending on the following
November 15 or May 15, respectively. The first offering period and the first
purchase period commenced on Prodigy's initial public offering. The last day of
each purchase period is the date on which shares are actually purchased.
Purchases are limited to 10% of an employee's eligible compensation up to a
maximum of $25 per year. During 1999 Prodigy issued 83,880 new shares to its
employees at an average price of $12.75 per share under the purchase plan.
14. Commitments and Contingencies
Commitments
At December 31, 1999, the Company's minimum rental commitments under
noncancelable operating leases with initial or remaining terms of more than one
year were as follows:
<TABLE>
<S> <C>
Year ended December 31,
2000............................................................... $ 3,432
2001............................................................... 2,710
2002............................................................... 2,727
2003............................................................... 2,529
2004 and thereafter................................................ 2,490
-------
$13,888
=======
</TABLE>
F-22
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands except share and per share amounts)
The Company's rent expense in the years ended December 31, 1997, 1998, and
1999 was approximately $9,192, $2,302 and $2,970, respectively.
During 1999 the Company entered into capital leases for certain computer
equipment. Minimum future lease payments under the capital leases as of
December 31, 1999 are:
<TABLE>
<S> <C>
2000................................................................. $ 569
2001................................................................. 585
2002................................................................. 526
------
Total minimum lease payments......................................... 1,680
Less--amounts representing interest.................................. (285)
------
Present value of minimum lease payments.............................. $1,395
======
</TABLE>
In December 1993, PSC entered into a noncancelable agreement with a telephone
company to provide certain services at the Company's White Plains, NY and
Yorktown, NY facilities. The agreement has a term ("service period") of ten
years. The agreement calls for line charges totaling $510 per year. The Company
has the right to terminate the agreement for certain services at any time at a
cost of 80% of the line charges over the remaining services period.
The Company is party to a contract for a subscription management system
through June 2001. This contract requires minimum annual payment of processing
fees of $1,116. For the years ended 1997, 1998 and 1999, the Company paid
$3,628, $3,039 and $3,723, respectively.
Under the Company's four-year agreement with Splitrock, the Company is
obligated to minimum annual payments of $45,000 in 1999, $51,000 in 2000 and
$54,000 in 2001 and maximum monthly charges based on the number of the
Company's subscribers for the month. The agreement provides for early
termination charges of $7,000 in the first year, declining thereafter on an
annual basis. The agreement is automatically renewed for successive 12-month
periods unless terminated by either party upon 12-months notice.
In August 1999, the Company entered into an agreement with a vendor to
provide network licensing and technical support. This agreement requires an
annual payment of $730 in 2000. Upon 30-day prior written notice, the Company
can terminate the agreement without penalty. The agreement can be extended for
an additional 12 months.
As of December 31, 1997, the Company was contractually obligated to pay IBM a
network termination penalty of $7,500 resulting from the sale of the Company's
network. The Company has negotiated with IBM to settle this liability through a
defined purchasing plan, whereby the Company will be obliged to purchase
services from IBM through December 31, 2000, up to $7,500 in value, with any
shortfall being paid as a penalty. The Company has accrued $3,849 as of
December 31, 1999, representing management's best estimate of the amount of the
purchase commitment that will not be used as of December 31, 2000. This amount
is included in the Company's accrued network termination cost (see Note 4--
Restructuring and Other Special Costs).
In February 1998 the Company contracted with a vendor to provide various data
communications services. The contract has a term of 36 months and requires
minimum annual payments to the vendor of $7,300. If the minimum annual payment
is not reached, the Company is subject to an underutilization charge equal to
50% of the difference between the minimum annual payment and the actual usage.
The Company can terminate the agreement upon written notice to the vendor and
the payment of a penalty equal to 50% of the minimum annual payment due for the
remaining term.
F-23
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands except share and per share amounts)
In May 1998 the Company contracted with a vendor to provide customer service
and technical support to its members. The contract is for 12 months expiring
April 1999. In March 1999 the Company extended this contract for an additional
12 months through April 2000. The agreement requires minimum monthly payments
to the vendor of $91.
In October 1999, the Company entered into an agreement with a telephone
company to provide certain network services for the Yorktown data center. These
services are due to commence during the first quarter of 2000. This agreement
has an initial term of seven years and requires minimum payments of $1,225 per
year. The agreement has termination and cancellation charges which would be
defined by New York's FCC Tariffs in effect at the time of cancellation.
In February 2000, the Company entered into an agreement with another major
electronics retailer to make specified payments to the retailer in exchange for
the retailer enrolling customers and obtaining a signed contractual commitment
from these customers to term subscriptions to Prodigy Internet at the Company's
standard monthly rates. The payments, amounting to $100, $225 or $400 per
subscriber (in whole dollars) for a one-year, two-year, or three-year Prodigy
Internet service contract, respectively, are required at the time the contract
is received and will be capitalized and amortized over the respective
contractual terms.
Contingencies
The Company is a defendant in various lawsuits arising in the ordinary course
of business. It is the opinion of management that any liability to the Company
which may arise as a result of these matters will not have a material adverse
effect on the Company's financial condition or results of operations.
15. Defined Contribution Plan
On June 17, 1996, as part of the Company's acquisition of PSC, the Company
took on responsibility for the administration and sponsorship of the Prodigy
Services Corporation Capital Accumulation Plan (the "Plan").
The Plan is a defined contribution plan covering all employees of the
Company. Employees can participate in the Plan from their first day of
employment.
Each year, active participants may contribute up to 12 percent of their pre-
tax base salaries, up to the maximum amount allowed by the Plan. The Company
contributes a matching contribution equal to 100 percent of an employee's pre-
tax contributions, limited to a maximum of 3 percent of a participant's
compensation. The Plan also has an after-tax savings feature that permits
employees to contribute from 1 percent to 10 percent of their base salaries
subject to Internal Revenue Code limitations.
The Company's contributions were $569, $469 and $698 in 1997, 1998 and 1999,
respectively.
16. Valuation and Qualifying Accounts
The following table sets forth activity in the Company's allowance for
doubtful accounts:
<TABLE>
<CAPTION>
Balance At Balance at
Beginning Charges to End of
of Period Operations Deductions Period
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Year ended:
December 31, 1997.............. $930 $ 342 $587 $ 685
December 31, 1998.............. 685 49 367 367
December 31, 1999.............. 367 3,200 187 3,380
</TABLE>
F-24
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands except share and per share amounts)
17. Related Party Transactions
Telmex Agreement
On January 25, 1999, Prodigy and Telmex, a subsidiary of Carso Global
Telecom, executed an agreement under which: (i) Prodigy will assist Telmex in
the negotiation of agreements with service providers for Telmex's IDP service
in Mexico pertaining to network/Internet access, Web hosting, customer service,
content hosting, billing, marketing, sales and data collection services; (ii)
Prodigy will advise Telmex on customer service, administrative functions and
technical operations, including marketing, Internet connection and other
network services, content, customer support, pricing and service composition,
billing and collection, inbound telemarketing and other aspects of the ISP
business; (iii) the parties will discuss the potential migration of certain IDP
infrastructure functions, including email, subscriber management and
authentication systems, for Telmex's IDP subscriber to the Prodigy
infrastructure platform, and the advisability of offering a co-branded
IDP/Prodigy service in Mexico; and (iv) the parties will pursue additional
opportunities, such as providing services to one another and the joint
acquisitions of subscribers. In exchange for Prodigy's services, Telmex will
pay Prodigy a management fee, on a monthly basis, equal to 15% of the net
subscriber revenue (defined as the invoiced sales price less discounts, excise
taxes and credits for returns) on the first 200,000 IDP subscribers and 10% of
the net subscriber revenue (as defined above) on additional IDP subscribers.
The agreement has a term of five years and may be terminated by Telmex if
Prodigy undergoes a change of control. The Company earned subscriber management
fees from Telmex of $6,833 during 1999, of which $1,801 was receivable at
December 31, 1999.
SplitRock Agreement
Carso Global Telecom owns a minority interest in Splitrock. As part of the
sale of its network operations, the Company also entered into a Sublease
Agreement pursuant to which Splitrock subleases a portion of the Company's
leased space in Yorktown Heights, New York, effective July 1, 1997 through
February 28, 2001.
Pursuant to the Full Service Agreement with Splitrock, effective July 1,
1997, Splitrock provides to the Company network services consisting primarily
of end-to-end connection services from subscriber dial-up lines to the
Company's data center. Splitrock charges Prodigy at a fixed rate per
subscriber, subject to a monthly maximum usage limit, after which an
incremental hourly rate is charged, and certain minimum charges (see Note 14--
Commitments and Contingencies). The Company incurred network charges to
Splitrock of approximately $22,700, $64,100 and $76,600 for the years ended
December 31, 1997, 1998 and 1999, respectively.
Additionally, the Company's accounts payable to Splitrock for the years ended
December 31, 1998 and December 31, 1999 was approximately $2,500 and $8,800,
respectively.
Under a transition services agreement, Prodigy agreed to pay for certain of
Splitrock's operating expenses and to provide temporary network-related
services to Splitrock, including accounting, human resources and purchasing
functions. Splitrock agreed to reimburse Prodigy for expenses incurred and the
cost of providing these support services (excluding termination penalties under
existing network contracts). The total of the reimbursed expenses and service
costs in 1997 was $27,532. The reimbursed amounts have been offset against the
corresponding expenses and costs in the statements of operations. The
transition services agreement terminated on December 31, 1997, although the
Company continued to provide certain incidental services and make payments on
behalf of Splitrock through June 30, 1998.
Under the Full Service Agreement, Splitrock is required to meet specified
service level objectives. Splitrock's failure to meet the service level
objectives results in financial penalties. If Splitrock fails to meet the
F-25
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands except share and per share amounts)
service level objectives for an extended period of time, Prodigy may terminate
the Full Service Agreement. In addition, if there is a system-wide failure, or
Splitrock breaches specified financial covenants, Prodigy has the right to
terminate the Full Service Agreement or assume responsibility for operating the
network at Splitrock's expense.
18. Subsequent Events
Pending Acquisition of FlashNet Communications
On November 5, 1999, the Company announced a definitive agreement to acquire
FlashNet Communications, Inc. in a stock-for-stock merger. Under the terms of
the merger agreement, Prodigy will issue 0.35 shares of Prodigy common stock
for each share of FlashNet common stock outstanding on the closing date of the
transaction. Based on the number of shares of FlashNet currently outstanding,
Prodigy will issue approximately 5,000,000 shares to complete the acquisition.
The acquisition is expected to be completed in the second quarter of 2000,
subject to FlashNet shareholder approval. The acquisition will be accounted for
under the purchase method of accounting.
Pending Transaction with SBC Communications
During November 1999, Prodigy announced a proposed transaction with SBC
Communications Inc. ("SBC"). In the proposed transaction, SBC will acquire an
approximate 43% indirect interest in Prodigy. Prodigy will be the exclusive
retail Internet service marketed by SBC in the United States and SBC will
purchase the Prodigy Internet service from Prodigy on wholesale terms and
provide it to SBC's approximately 690,000 existing Internet subscribers. SBC
has committed to obtain for Prodigy an additional 1,200,000 Internet
subscribers over a three year period in exchange for a fee of $40 to $75 (in
whole dollars) for each subscriber obtained. SBC will pay Prodigy a penalty for
shortfalls in the number of subscribers delivered over the three year period,
with the size of the penalty based on the number of subscribers actually
obtained. The agreement also includes provisions under which SBC and Prodigy
can purchase other services from each other, including telecommunications and
network services.
In order to implement the transaction with SBC: (i) Prodigy will contribute
substantially all its assets and liabilities and transfer its employees to the
operating partnership; (ii) SBC will contribute to the operating partnership
routers, servers and associated hardware used in connection with its consumer
and small business Internet operations that are selected by Prodigy and
intangible assets consisting primarily of brand assets and subscriber
relationships; (iii) Prodigy will receive an initial interest in the operating
partnership of approximately 57%; (iv) SBC will receive an initial interest in
the operating partnership of approximately 43% and (v) SBC may convert its
interest in the operating partnership into a direct equity interest in Prodigy
at any time, or may require the operating partnership to be merged into Prodigy
at any time.
Prodigy will recognize the contribution of the assets by SBC to the operating
partnership at fair value in exchange for the partnership units issued. As a
result of the partnership units issued, Prodigy will consolidate the operating
partnership and will recognize the SBC minority interest in the operating
partnership. The contribution of the intangible assets at fair value will
result in a substantial amount of amortization which will reduce Prodigy's
future earnings or increase its future losses.
(Unaudited)
On March 16, 2000, Prodigy and Citibank signed a letter agreement which
contemplates that Citibank will structure and arrange financing of $200 million
secured by the future service fees payable by contract subscribers to the
Prodigy Internet service. The letter agreement includes a preliminary summary
of principal terms and
F-26
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands except share and per share amounts)
conditions, estimated expenses and the structuring fee due Citibank at closing.
The letter agreement does not constitute a firm financing commitment from
Citibank, and Prodigy cannot assure that the Citibank financing will be
completed. The Citibank financing is subject to the issuance by SBC of a
performance guarantee and satisfaction of the following conditions:
. satisfactory completion of Citibank's due diligence review of Prodigy;
. in Citibank's determination, the absence of any material adverse change
in the financial markets or in the financial condition or operations of
Prodigy;
. negotiation and execution of mutually satisfactory documentation for the
financing;
. the receipt of specified ratings from ratings agencies; and
. the receipt of internal Citibank credit approval and any other approvals
and legal opinions as Citibank may deem necessary or advisable.
In connection with the Citibank financing, Prodigy and SBC have agreed in
principle that SBC will provide a contingent performance guarantee in exchange
for which Prodigy will grant SBC a contingent warrant to purchase 537,924
shares of Prodigy common stock for $1.00 per share. The performance guarantee
to be provided by SBC requires that, in the event Prodigy becomes unable to
continue to perform its service obligations under the subscriber contracts, SBC
shall either perform Prodigy's service obligations directly or replace Prodigy
with a substitute Internet service provider.
F-27
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
FlashNet Communications, Inc.
We have audited the accompanying consolidated balance sheet of FlashNet
Communications, Inc. as of December 31, 1999, and the related consolidated
statements of operations, cash flows, and shareholders' equity/(deficit) for
the year 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 audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of FlashNet
Communications, Inc. at December 31, 1999, and the consolidated results of its
operations and its cash flows for the year then ended, in conformity with
accounting principles generally accepted in the United States.
The accompanying financial statements have been prepared assuming that FlashNet
Communications, Inc. will continue as a going concern. As more fully described
in Note 1, the Company has incurred significant operating losses and has a
working capital deficiency. These conditions raise substantial doubt about the
Company's ability to continue as a going concern. The financial statements do
not include any adjustments to reflect the possible future effects on the
recoverability and classification of assets or the amounts and classification
of liabilities that may result from the outcome of this uncertainty.
Ernst & Young LLP
Fort Worth, Texas
March 3, 2000
F-28
<PAGE>
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors and Shareholders of
FlashNet Communications, Inc.
We have audited the accompanying consolidated balance sheet of FlashNet
Communications, Inc. (the "Company") and subsidiaries as of December 31, 1998,
and the related consolidated statements of operations, shareholders' deficit
and cash flows for the years ended December 31, 1997 and 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our 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
statements presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements present fairly, in all
material respects, the financial position of the Company and subsidiaries at
December 31, 1998, and the results of their operations and their cash flows for
the years ended December 31, 1997 and 1998 in conformity with generally
accepted accounting principles.
Deloitte & Touche LLP
Fort Worth, Texas
February 23, 1999 (March 11,
1999 as to the last
paragraph in Note 12)
F-29
<PAGE>
FLASHNET COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31, December 31,
1998 1999
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.......................... $1,038,000 $ 7,045,000
Note receivable.................................... -- 700,000
Accounts receivable, net of allowance for doubtful
accounts of $28,000 and $181,000 in 1998 and 1999,
respectively...................................... 391,000 4,393,000
Prepaid expenses................................... 740,000 2,661,000
Other current assets............................... 551,000 904,000
---------- -----------
Total current assets............................. 2,720,000 15,703,000
Property and equipment, net.......................... 6,821,000 17,783,000
Software licenses, net of accumulated amortization of
$68,000 and $270,000 in 1998 and 1999,
respectively........................................ 6,000 338,000
Customer hardware, net of accumulated amortization of
$1,458,000.......................................... -- 5,579,000
Other assets......................................... 186,000 182,000
---------- -----------
Total............................................ $9,733,000 $39,585,000
========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Note payable....................................... $4,834,000 $ --
Trade accounts payable............................. 5,335,000 8,162,000
Accrued payroll and related expenses............... 535,000 913,000
Other accrued expenses............................. 438,000 1,100,000
Current portion of capital lease obligations....... 1,824,000 4,129,000
Current portion of convertible notes payable....... 186,000 --
Deferred revenue................................... 12,325,000 10,215,000
---------- -----------
Total current liabilities........................ 25,477,000 24,519,000
Capital lease obligations, net of current portion.... 52,000 5,410,000
---------- -----------
Total liabilities................................ 25,529,000 29,929,000
Commitments and contingencies (Note 7)
</TABLE>
<TABLE>
<S> <C> <C>
Redeemable Series A Preferred Stock, $1.00 par
value; 1,375,000 shares authorized, 1,364,085 and
none issued and outstanding, respectively......... 7,911,000 --
Shareholders' equity (deficit):
Common stock, no par value, 50,000,000 shares
authorized, 5,528,868 and 14,307,694 issued and
outstanding, respectively....................... 3,444,000 68,776,000
Additional paid-in capital, stock options........ -- 1,909,000
Unearned compensation............................ -- (1,427,000)
Warrants to purchase common stock................ 3,704,000 3,330,000
Accumulated deficit.............................. (30,855,000) (62,932,000)
------------ ------------
Total shareholders' equity (deficit)........... (23,707,000) 9,656,000
------------ ------------
Total.......................................... $ 9,733,000 $ 39,585,000
============ ============
</TABLE>
See notes to consolidated financial statements
F-30
<PAGE>
FLASHNET COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------
1997 1998 1999
------------ ------------ ------------
<S> <C> <C> <C>
Revenues:
Consumer access services........... $ 11,942,000 $ 21,979,000 $ 31,104,000
Business services.................. 571,000 1,597,000 2,079,000
Shipping revenues.................. -- -- 2,374,000
Set-up fees and other.............. 5,024,000 3,316,000 4,694,000
------------ ------------ ------------
Total............................ 17,537,000 26,892,000 40,251,000
------------ ------------ ------------
Operating costs and expenses:
Cost of services (includes
amortization of and loss on
customer hardware of $1,537,000
and $1,581,000, respectively, for
the year ended December 31,
1999)............................. 8,215,000 11,797,000 19,909,000
Cost of shipping................... -- -- 1,995,000
Cost of other revenues............. 799,000 349,000 1,973,000
Sales and marketing................ 10,300,000 8,202,000 20,967,000
General and administrative......... 3,453,000 5,268,000 10,330,000
Operations and customer support.... 3,683,000 6,016,000 10,453,000
Depreciation and amortization...... 2,061,000 3,069,000 5,094,000
------------ ------------ ------------
Total............................ 28,511,000 34,701,000 70,721,000
------------ ------------ ------------
Loss from operations................. (10,974,000) (7,809,000) (30,470,000)
Interest expense..................... (735,000) (2,529,000) (1,274,000)
Interest and other income............ 21,000 73,000 1,371,000
------------ ------------ ------------
Loss before extraordinary item....... (11,688,000) (10,265,000) (30,373,000)
Extraordinary item--loss on early
extinguishment of debt.............. -- -- (1,656,000)
------------ ------------ ------------
Net loss............................. (11,688,000) (10,265,000) (32,029,000)
Deemed distributions and accretion on
redeemable preferred stock.......... -- (2,741,000) (48,000)
------------ ------------ ------------
Net loss attributable to common
shareholders........................ $(11,688,000) $(13,006,000) $(32,077,000)
============ ============ ============
Net loss per share, basic and
diluted:
Loss before extraordinary item..... $ (2.15) $ (2.36) $ (2.46)
Extraordinary item................. -- -- (0.13)
------------ ------------ ------------
Net loss............................. $ (2.15) $ (2.36) $ (2.59)
============ ============ ============
Weighted average shares, basic and
diluted............................. 5,449,000 5,505,000 12,370,000
============ ============ ============
</TABLE>
See notes to consolidated financial statements
F-31
<PAGE>
FLASHNET COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------
1997 1998 1999
------------ ------------ ------------
<S> <C> <C> <C>
Operating activities:
Net loss............................ $(11,688,000) $(10,265,000) $(32,029,000)
Adjustments to reconcile net loss to
net cash provided (used) by
operating activities:
Extraordinary loss................. -- -- 1,656,000
Depreciation....................... 2,040,000 3,010,000 4,796,000
Loss on customer hardware.......... -- -- 1,581,000
Amortization of customer hardware.. -- -- 1,537,000
Amortization of debt discount and
other............................. 236,000 1,951,000 650,000
Stock based compensation expense... -- -- 381,000
Provision for allowance for
doubtful accounts................. 100,000 21,000 197,000
(Gain) loss on sale of equipment... 12,000 -- (66,000)
Changes in assets and liabilities:
(Increase) decrease in accounts
receivable....................... (283,000) 82,000 (4,199,000)
Increase in prepaid expenses and
other current assets............. (254,000) (991,000) (2,500,000)
Increase in customer hardware..... -- -- (8,571,000)
Increase (decrease) in accounts
payable and and accrued
liabilities...................... 4,827,000 (816,000) 3,764,000
Increase (decrease) in deferred
revenue.......................... 6,352,000 1,779,000 (2,110,000)
------------ ------------ ------------
Net cash provided (used) by
operating activities............ 1,342,000 (5,229,000) (34,913,000)
------------ ------------ ------------
Investing activities:
Increase in note receivable......... -- -- (700,000)
Purchases of property and
equipment.......................... (4,664,000) (1,435,000) (7,829,000)
Purchases of software and other
assets............................. -- (10,000) (625,000)
Proceeds from sale of equipment..... 203,000 -- 2,910,000
------------ ------------ ------------
Net cash used in investing
activities...................... (4,461,000) (1,445,000) (6,244,000)
------------ ------------ ------------
Financing activities:
Proceeds from initial public
offering, net...................... -- -- 56,302,000
Proceeds from issuances of notes
payable............................ 6,500,000 -- 5,000,000
Proceeds from issuance of preferred
stock.............................. -- 7,802,000 --
Proceeds from employee stock
purchase plan and exercise of stock
options............................ -- -- 496,000
Principal payments under notes
payable............................ (27,000) (109,000) (11,500,000)
Principal payments under capital
lease obligations.................. (1,921,000) (1,551,000) (3,134,000)
------------ ------------ ------------
Net cash provided by financing
activities...................... 4,552,000 6,142,000 47,164,000
------------ ------------ ------------
Net increase (decrease) in cash and
cash equivalents.................... 1,433,000 (532,000) 6,007,000
Cash and cash equivalents, beginning
of period........................... 137,000 1,570,000 1,038,000
------------ ------------ ------------
Cash and cash equivalents, end of
period.............................. $ 1,570,000 $ 1,038,000 $ 7,045,000
============ ============ ============
</TABLE>
See notes to consolidated financial statements
F-32
<PAGE>
FLASHNET COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
Additional
Paid in Warrants to Total
Common Stock Capital- Purchase Shareholders'
---------------------- Stock Unearned Common Accumulated Equity
Shares Amount Options Compensation Stock Deficit (Deficit)
---------- ----------- ---------- ------------ ----------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31,
1996................... 5,420,919 $ 462,000 $ -- $ -- $ 424,000 $ (6,161,000) $ (5,275,000)
Conversion of notes
payable................ 66,300 195,000 -- -- -- -- 195,000
Warrants retired........ -- 45,000 -- -- (45,000) -- --
Issuance of warrants.... -- -- -- -- 3,332,000 -- 3,332,000
Net loss................ -- -- -- -- -- (11,688,000) (11,688,000)
---------- ----------- ---------- ----------- ---------- ------------ ------------
Balance, December 31,
1997................... 5,487,219 702,000 -- -- 3,711,000 (17,849,000) (13,436,000)
Conversion of notes
payable................ 34,679 102,000 -- -- -- -- 102,000
Exercise of warrants.... 6,970 7,000 -- -- (7,000) -- --
Deemed distribution
related to issuance of
redeemable preferred
stock.................. -- 2,633,000 -- -- -- (2,633,000) --
Accretion of discount
related to redeemable
preferred stock........ -- -- -- -- -- (108,000) (108,000)
Net loss................ -- -- -- -- -- (10,265,000) (10,265,000)
---------- ----------- ---------- ----------- ---------- ------------ ------------
Balance, December 31,
1998................... 5,528,868 3,444,000 -- -- 3,704,000 (30,855,000) (23,707,000)
Shares issued with
initial public
offering............... 3,625,000 56,302,000 -- -- -- -- 56,302,000
Conversion of Redeemable
Series A preferred
stock.................. 4,637,889 7,959,000 -- -- -- -- 7,959,000
Conversion of notes
payable................ 68,235 201,000 -- -- -- -- 201,000
Exercise of warrants.... 349,877 374,000 -- -- (374,000) -- --
Employee stock purchase
plan and exercise of
stock options.......... 97,825 496,000 -- -- -- -- 496,000
Accretion of discount
related to redeemable
preferred stock........ -- -- -- -- -- (48,000) (48,000)
Compensatory stock
option grants and
amortization........... -- -- 1,909,000 (1,427,000) -- -- 482,000
Net loss................ -- -- -- -- -- (32,029,000) (32,029,000)
---------- ----------- ---------- ----------- ---------- ------------ ------------
Balance, December 31,
1999................... 14,307,694 $68,776,000 $1,909,000 $(1,427,000) $3,330,000 $(62,932,000) $ 9,656,000
========== =========== ========== =========== ========== ============ ============
</TABLE>
See notes to consolidated financial statements
F-33
<PAGE>
FLASHNET COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS
1. Nature of Operations and Summary of Significant Accounting Policies
General
FlashNet Communications, Inc. and its wholly-owned subsidiary, FlashNet
Marketing, Inc. ("FlashNet Marketing") (collectively referred to as the
"Company") were organized on September 25, 1995 and June 16, 1997,
respectively. The Company is a nationwide provider of consumer internet access
services and business services through a national network. FlashNet Marketing
is a marketing organization designed to increase utilization of the Company's
services through customer incentive marketing programs.
Going Concern
The Company has experienced significant operating losses since inception, a
working capital deficiency exists and it expects that it will continue to incur
net losses. The Company's operations are subject to certain risks and
uncertainties including, among others: (i) risks associated with technology and
regulatory trends; (ii) evolving industry standards; (iii) dependence on its
network infrastructure and suppliers; (iv) growth and acquisitions; (v) actual
and prospective competition by entities with greater financial and other
resources; and (vi) the development of the Internet market. There can be no
assurance that the Company will be successful in achieving or sustaining
profitability and positive cash flow in the future.
The merger agreement with Prodigy Communications Corporation (see Note 13 for
further discussion) requires the Company to maintain its basic infrastructure.
As a result, the Company has conducted its operations in a manner generally
consistent with its historical practices (except curtailing certain aspects of
its sales and marketing efforts) and has not sought additional financing. The
Company will be required to seek additional financing sufficient to meet its
working capital needs for fiscal 2000 if the merger with Prodigy is not
consummated. Based on the Company's recent efforts to raise capital, management
has determined that it most likely cannot raise additional capital or financing
on reasonable terms. If the merger is not consummated, management could be
forced to make significant reductions in its headcount and expenditure levels,
and would most likely be forced to raise capital, if obtainable, on unfavorable
terms. The Company has no contingency plans presently in place should the
merger with Prodigy fail to occur. Given that no assurance can be made that the
merger with Prodigy will be consummated or additional financing can be
obtained, substantial doubt exists about the Company's ability to continue as a
going concern. The financial statements do not include any adjustments to
reflect the possible future effects on the recoverability and classification of
assets or liabilities that may result from the outcome of these uncertainties.
Stock Split
During February 1999, the Company's Board of Directors and shareholders
approved a change in the number of authorized shares of common stock to
50,000,000, and approved a 3.4-to-1 stock split. Such change in authorized
shares and stock split became effective March 11, 1999.
Management Estimates
In preparing the financial statements, management is required to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities as of the date
of the financial statements and revenues and expenses for the period. Actual
results could differ significantly from those estimates.
Consolidation
All significant intercompany balances and transactions have been eliminated
in consolidation.
F-34
<PAGE>
FLASHNET COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Cash and Cash Equivalents
The Company considers all short-term, highly liquid investments with an
original maturity date of three months or less at date of purchase to be cash
equivalents. Cash and cash equivalents are stated at cost, which approximates
fair value.
Credit Risk
The Company's accounts receivable potentially subject the Company to credit
risk, as collateral is generally not required. The Company's risk of loss is
limited due to advance billings to customers for services, the use of
preapproved charges to customer credit cards (approximately $4 million is due
from one credit card processor at December 31, 1999) and the ability to
terminate access on delinquent accounts. The large number of customers
comprising the customer base mitigates the concentration of credit risk.
Note Receivable
During the third quarter of 1999, the Company funded a $0.7 million note
receivable to a public telecommunications service company. The note bears
interest at 12% per annum and matures in April 2000. The note receivable is
convertible, at the option of the Company, into common stock of the
telecommunications service company.
Property and Equipment
Property and equipment are recorded at cost and depreciated using the
straight-line method over the estimated useful life of five years for customer
network equipment, three years for internal network equipment and two years for
software. Leasehold improvements are amortized over the shorter of the term of
the related lease or the estimated useful lives of the assets.
Equipment Under Capital Lease
The Company leases certain of its data communications equipment and other
fixed assets under capital lease agreements. The assets and liabilities under
capital leases are recorded at the lesser of the present value of aggregate
future minimum lease payments, or the fair value of the assets under lease.
Assets under these capital leases are depreciated over the shorter of the term
of the related lease (generally 36 to 48 months) or the useful life of the
asset.
Supplemental Disclosure Of Cash Flow Information
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------
1997 1998 1999
-------- ---------- -----------
<S> <C> <C> <C>
Cash paid for interest..................... $512,000 $ 637,000 $ 926,000
Equipment acquired under capital leases.... 859,000 -- 10,771,000
Deemed distributions and accretion on
redeemable preferred stock................ -- 2,741,000 48,000
</TABLE>
Long-Lived Assets
The Company periodically evaluates the recoverability of its long-lived
assets and would recognize impairment of long-lived assets in the event the net
book value of such assets exceeds the estimated fair value of such assets. No
such impairments have been identified to date. The Company assesses the
impairment of long-lived assets when events or changes in circumstances
indicate that the carrying value of an asset may not be recoverable.
F-35
<PAGE>
FLASHNET COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Revenue Recognition
Amounts received upon the sale or renewal of prepaid annual and monthly
business and consumer subscriptions are recorded as deferred revenue through a
30-day money back cancellation period and then amortized over the remaining
period in which service is provided. Annual business and consumer subscribers
canceling after the initial 30-day period are assessed a $50 cancellation fee.
Distributor sign-up and renewal fees are also recorded as deferred revenue and
amortized over the life of the related agreements. Revenue from the sale of
merchandise and hardware without bundled internet access is recognized
immediately upon the shipment of the merchandise. Consulting services have been
provided from time to time on a limited basis by the Company on both a fixed
fee and a time-and-materials basis and are recognized as the services are
performed. Consulting revenue for the years ended December 31, 1997, 1998 and
1999 was $1.0 million, $0 and $0, respectively. Advertising revenues, all of
which must be paid in cash by the customer, are recognized as advertising
services are provided. During the quarter ended June 30, 1999, the Company
began providing subscribers a bundled service offering combining Internet
access with a computer in exchange for a 2 or 3 year contractual commitment
payable on a monthly basis. Related revenue is recognized on a monthly basis
subject to deferral through a 30-day money back cancellation period. Shipping
revenues are derived primarily from the shipment of refurbished or new personal
computers issued in connection with the Company's new bundled service offering.
Shipping fees are non-refundable and are recognized as the personal computers
are shipped.
Cost of Revenues
Cost of services consist primarily of expenses related to customer hardware
and the monthly costs of telecommunications facilities necessary to provide
subscriber services which are recognized as incurred. Cost of other revenues
include costs of installation, software, premium support costs, cost of
merchandise sold and hardware without bundled internet access and the cost of
user guides and other materials for representatives and distributors and are
recognized as incurred. New customer bonuses paid to distributors and
continuing residual commission expenses are expensed as incurred.
Customer Hardware
In connection with the bundled service offering, the Company contracted with
vendors for the purchase of both new and refurbished personal computers
("PCs"). The costs of the PCs are capitalized as customer hardware and
amortized over the term of the contracts, with the amortization rate adjusted
for estimates for non-recoverability of equipment and uncollectible balances on
cancelled contracts. Amortization expense for the year ended December 31, 1999
was approximately $1.5 million. Net capitalized costs are reviewed periodically
for recoverability of balances on cancelled contracts.
Advertising Costs
The Company expenses all advertising costs as incurred. Advertising expense
for the years ended December 31, 1997, 1998 and 1999 was $7.5 million, $5.8
million and $12.0 million, respectively.
Common Stock-Based Compensation
The Company accounts for its employee stock-based compensation in accordance
with the provisions of Accounting Principles Board Opinion No. 25 ("APB No.
25") and provides pro forma disclosures in the notes to the financial
statements, as if the measurement provisions of Statement of Financial
Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation," had been adopted. The Company has adopted SFAS No. 123 for stock
based compensation related to nonemployees.
F-36
<PAGE>
FLASHNET COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Net Loss Per Share
Share and per share amounts have been adjusted retroactively for the 3.4-to-1
stock split which was approved in February 1999 and became effective March 11,
1999. Basic loss per share is computed using the weighted average number of
common shares outstanding. Options, warrants and convertible securities, as
applicable at December 31, 1997, 1998 and 1999 are not included in the
computation of diluted loss per share as the effects would be antidilutive.
Source of Supplies
The Company relies on local telephone companies and other companies to
provide data communications capacity. Although management believes alternative
telecommunications facilities could be found in a timely manner, any disruption
of these services could have an adverse effect on operating results.
The Company attempts to maintain multiple vendors for its modems, terminal
servers and high-performance routers, which are important components of its
network. If the suppliers are unable to meet the Company's needs as it expands
its network infrastructure, the Company may experience delays and increased
costs, which would adversely affect operating results.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board (the "FASB") issued
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities,"
which is required to be adopted in years beginning after June 15, 1999. In June
1999, the FASB issued Statement No. 137, "Accounting for Derivative Instruments
and Hedging Activities-Deferral of Effective Date of FASB Statement No. 133".
The Statement defers for one year the effective date of SFAS No. 133. As the
Company does not have any derivative instruments or hedging transactions,
adoption of SFAS No. 133 is not anticipated to have any effect on the
consolidated financial statements.
Reclassification
Certain reclassifications have been made to prior period amounts to conform
to the 1999 presentation.
2. Property and Equipment
Property and equipment consist of the following:
<TABLE>
<CAPTION>
December 31,
------------------------
1998 1999
----------- -----------
<S> <C> <C>
Data communications equipment..................... $10,922,000 $19,741,000
Office and other equipment........................ 1,090,000 4,914,000
Purchased software................................ 361,000 2,969,000
----------- -----------
12,373,000 27,624,000
Less accumulated depreciation and amortization.... (5,552,000) (9,841,000)
----------- -----------
$ 6,821,000 $17,783,000
=========== ===========
</TABLE>
Property and equipment includes $4.7 million and $15.5 million of data
communications equipment under capital leases at December 31, 1998 and 1999,
respectively. Depreciation expense charged to operations was $2.0 million, $3.0
million and $4.8 million in the years ended December 31, 1997, 1998 and 1999,
respectively, including amortization of property under capital leases.
F-37
<PAGE>
FLASHNET COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
3. Capital Lease Obligations
The Company has entered into capital leases for new data communications
equipment and software. The Company's capital lease obligations are generally
payable in 36 to 48 monthly installments from the dates of purchase and include
bargain purchase options at the end of the lease term.
Future minimum lease payments under capital leases at December 31, 1999 are
as follows:
<TABLE>
<S> <C>
2000............................................................ $ 5,025,000
2001............................................................ 3,395,000
2002............................................................ 2,460,000
2003............................................................ 156,000
-----------
Total minimum lease payments.................................... 11,036,000
Less amounts representing interest and approximately $68,000 of
unamortized value attributed to warrants (see Note 6).......... 1,497,000
-----------
Present value of future minimum lease payments.................. 9,539,000
Less current portion............................................ 4,129,000
-----------
$ 5,410,000
===========
</TABLE>
In October 1999, the Company sold data communications equipment for $5.5
million. Such equipment was then leased back from a major financial services
company with a stated period of 36 months. The resulting leases are being
accounted for as capital leases. No gains or losses resulted from these
sale/leaseback transactions. Future minimum lease payments under these
sale/leasebacks are as follows (such amounts are included in minimum lease
payments in the table above):
<TABLE>
<S> <C>
2000............................................................. $2,259,000
2001............................................................. 2,303,000
2002............................................................. 1,778,000
----------
Total minimum lease payments..................................... $6,340,000
==========
</TABLE>
4. Convertible Notes Payable
During 1996, the Company issued units of convertible notes payable totaling
$0.6 million which were convertible into 215,900 shares of common stock. In
addition, the Company issued stock warrants exercisable at $0.003 per share for
177,038 shares of common stock, which were assigned a value of $0.2 million.
The remaining principal balance of the notes was due in July 1999 and bore 12%
annual interest, payable quarterly. At December 31, 1998, the notes payable
were presented net of approximately $16,000 in unamortized discount. During
1999, the outstanding balance of the notes payable was converted at $2.94 per
share, into an aggregate of 68,235 shares of the Company's common stock. The
outstanding stock warrants representing 170,068 shares of common stock were
also exercised during 1999.
5. Notes Payable
In January 1999, the Company entered into a $5.0 million term loan agreement
with Goldman Sachs Credit Partners L. P. ("Goldman Sachs"). The term loan's
stated maturity was January 15, 2000, bore interest at 13%, was subject to a
repayment fee of 1.13% to 4.50% of the repaid principal and was secured by a
second lien on the Company's assets. As part of this financing, a Goldman Sachs
affiliate obtained the right to acquire
F-38
<PAGE>
FLASHNET COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
within 180 days of the consummation of an initial public offering up to $5.0
million of the Company's common stock at the initial public offering price.
Goldman Sachs did not exercise its right to acquire the Company's common stock.
In December 1997, the Company issued a $6.5 million Secured Promisory Note to
Ascend Communications, Inc. ("Ascend Note"). Warrants initially exercisable at
$0.003 per share for 1,360,000 shares of the Company's common stock were issued
as part of the agreement and were assigned a value of $3.3 million (see Note
6). Substantially all of the Company's assets served as collateral for the
Ascend Note. The principal balance of the Ascend Note was due and payable at
the earlier of December 28, 1999 or the effective date of a defined initial
public offering by the Company providing gross proceeds in excess of $12.0
million or a change of control. Interest accrued at 6.0% per annum and was
payable monthly. At December 31, 1998, the principal balance outstanding was
$6.5 million and was presented net of approximately $1.7 million in unamortized
discount.
The Company repaid both the Goldman Sachs note and Ascend Note in March 1999
with proceeds from the initial public offering. As a result, the Company
recognized an extraordinary loss from early extinguishment of debt of $1.7
million comprised primarily of unamortized discount at the time of
extinguishment.
6. Capital Stock
At December 31, 1999, the Company has reserved shares of common stock for
issuance as follows:
<TABLE>
<CAPTION>
Shares
---------
<S> <C>
Warrants........................................................... 1,360,000
Stock options...................................................... 4,164,705
---------
5,524,705
=========
</TABLE>
Initial Public Offering
On March 16, 1999, the Company effected its initial public offering ("IPO").
The IPO consisted of 3,450,000 shares of Common Stock issued at $17.00 per
share. Concurrently with the IPO, the Company sold an additional 175,000 shares
of Common Stock to SBC Communications Inc. at $17.00 per share. Net proceeds to
the Company were approximately $56.3 million.
Redeemable Convertible Preferred Stock
In May and August 1998, the Company issued a total of 1,364,085 shares of its
redeemable Series A Convertible Preferred Stock to investors including among
others, affiliates of certain directors, for $8.3 million and incurred stock
issuance costs of $0.5 million. Each share of Preferred Stock was convertible
into 3.4 shares of the Company's common stock. The Company has recorded
dividends in 1998 of $2.6 million for the deemed difference on the date of
issuance between the issuance price of the Preferred Stock and the fair value
of the common stock into which the Preferred Stock was convertible. Accretion
of stock issuance costs was $107,000 and $48,000 for the years ended December
31, 1998 and 1999, respectively. Effective with the IPO in March 1999, the
outstanding preferred stock was automatically converted into 4,637,889 shares
of the Company's common stock.
Warrants
During 1996, the Company entered into an agreement to issue warrants to
purchase shares of common stock at $0.003 per share in connection with a lease
line for equipment. The 179,809 warrants were assigned a value of $249,000. The
warrants were exercised in July 1999. Warrants issued with the Ascend Note are
currently exercisable at $0.003 per share for 1,360,000 shares through March
16, 2004.
F-39
<PAGE>
FLASHNET COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Stock Options
During 1997, the Company adopted a Stock Incentive Plan (the "Plan"). The
Plan provides for the issuance of incentive and non-qualified stock options to
key employees and directors of the Company. The Board of Directors increased
the number of shares of common stock authorized and reserved for issuance under
the 1997 Stock Incentive Plan to 1,327,230 shares in 1999. As of December 31,
1999, options to purchase 368,062 shares of common stock remained available for
grant under the Plan. Options vest over periods ranging from 1 to 5 years and
generally expire 10 years from date of grant. Stock option activity from
January 1, 1997 through December 31, 1999 is summarized by the following
(adjusted for the 3.4-to-1 stock split occurring in February 1999):
<TABLE>
<CAPTION>
Exercisable
----------------
Weighted Weighted
Number Average Number Average
of Exercise of Exercise
Options Price Options Price
-------- -------- ------- --------
<S> <C> <C> <C> <C>
January 1, 1997.......................... 53,550 $ 0.97 17,000 $0.79
Granted................................ 88,230 1.81 -- --
Cancelled.............................. (20,400) 0.90 -- --
--------
December 31, 1997........................ 121,380 1.59 64,090 1.16
Granted................................ 657,424 5.41 -- --
Cancelled.............................. (160,820) 1.87 -- --
--------
December 31, 1998........................ 617,984 5.58 74,970 3.11
Granted................................ 662,442 11.26 -- --
Exercised.............................. (81,320) 3.21 -- --
Cancelled.............................. (239,938) 11.53 -- --
--------
December 31, 1999........................ 959,168 8.41 18,928 2.35
========
</TABLE>
Options outstanding as of December 31, 1999 are as follows:
<TABLE>
<CAPTION>
Weighted Weighted
Ranges of Average Average
Exercise Options Years to Exercise Currently
Price Outstanding Expiration Price Exercisable
------------ ----------- ---------- -------- -----------
<S> <C> <C> <C> <C> <C>
Options issued at market
price.................. $2.35-8.82 595,241 9.34 $ 5.87 18,928
$17.00-30.00 197,004 9.45 18.01 --
Options issued below
market price........... $5.88-8.82 166,923 9.18 6.16 --
------- ------
959,168 18,928
======= ======
</TABLE>
During January 1999, options to purchase 150,943 and 15,980 shares of common
stock at $5.88 per share and $8.82 per share, respectively, were granted to
officers, directors, and employees under the Plan. In conjunction with these
grants, the Company recognized unearned compensation expense of $1.8 million
for the difference between the total exercise price and fair market value of
the common stock. This expense is being amortized over the vesting periods
ranging from 3 to 5 years from the date of grant. Compensation expense for the
year ended December 31, 1999 related to these grants was $0.4 million.
F-40
<PAGE>
FLASHNET COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
The Company applies the provisions of APB No. 25 and related interpretations
in accounting for its stock options. Accordingly, compensation cost has been
recognized only to the extent the exercise price assigned to the options at the
dates of grant were less than the estimated fair market value of the common
stock at the grant dates. Had compensation cost for the Company's stock options
been determined based on the fair value at the grant dates for awards
consistent with the method prescribed by SFAS No. 123, the Company's pro-forma
net loss and net loss per share would have been as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------
1997 1998 1999
------------ ------------ ------------
<S> <C> <C> <C>
Net loss attributable to common
shareholders:
Actual........................ $(11,688,000) $(13,006,000) $(32,077,000)
Pro-forma..................... $(11,710,000) $(13,034,000) $(32,807,000)
Basic and diluted loss per
share:
Actual........................ $ (2.15) $ (2.36) $ (2.59)
Pro-forma..................... $ (2.15) $ (2.37) $ (2.65)
</TABLE>
The weighted average fair value of options granted at market price during
1997, 1998 and 1999 was estimated at $0.56, $2.62 and $8.63 per share,
respectively. The weighted average fair value of options granted below market
price during 1999 was estimated at $14.11 per share. The fair value of each
option grant is estimated on the date of grant using the Black-Scholes option-
pricing model with the following weighted average assumptions used for the
grants: risk-free interest rates of 6.00% in 1997, 5.00% in 1998 and 6.00% in
1999, dividend yield of 0%, expected lives of three years in 1997, 1998 and
1999 and expected volatility of 1.1 in 1999. There was no expected volatility
in 1998 and 1997 because the Company's stock was not publicly traded.
Black-Scholes option valuation models are used in estimating the fair value
of traded options that have no vesting restrictions and are fully transferable.
In addition, option valuation models require the input of highly subjective
assumptions including the expected stock-price volatility. Because the
Company's employee stock options have characteristics significantly different
from those of traded options, and because changes in the subjective input
assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
Employee Stock Discount Purchase Plan
Effective with the IPO, the Company adopted an Employee Stock Discount
Purchase Plan (the "Stock Purchase Plan"). The Stock Purchase Plan is intended
to give employees a convenient means of purchasing shares of Common Stock
through payroll deductions. The Stock Purchase Plan is open to all employees of
the Company. Each participating employee's contributions will be used to
purchase shares for the employee's share account as promptly as practicable
after each calendar quarter. The cost per share will be 85% of the lower of the
closing price of the Company's Common Stock on the Nasdaq National Market on
the first or the last day of the calendar quarter. The Company has reserved
340,000 shares of Common Stock for issuance under the Stock Purchase Plan.
F-41
<PAGE>
FLASHNET COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
7. Commitments and Contingencies
Commitments
Guaranteed monthly levels of telecommunication services with certain of the
Company's telecommunication vendors at December 31, 1999 aggregate to the
following annual amounts:
<TABLE>
<CAPTION>
Year Ending
December 31,
------------
<S> <C>
2000............................................................ $1,141,000
2001............................................................ 1,051,000
2002............................................................ 676,000
----------
$2,868,000
==========
</TABLE>
The Company leases certain of its facilities under non-cancelable operating
leases expiring in various years through 2009. Total rent expense for all
operating leases amounted to $1,806,000, $1,560,000 and $2,268,000 in the years
ended December 31, 1997, 1998 and 1999, respectively.
Future minimum lease payments under non-cancelable operating leases as of
December 31, 1999 are as follows:
<TABLE>
<CAPTION>
Year Ending
December 31,
------------
<S> <C>
2000............................................................ $1,707,000
2001............................................................ 925,000
2002............................................................ 657,000
2003............................................................ 540,000
2004............................................................ 540,000
Thereafter...................................................... 2,010,000
----------
$6,379,000
==========
</TABLE>
Contingencies
The Company is subject to certain claims and legal proceedings that arise in
the ordinary course of its business activities. Each of these matters is
subject to various uncertainties, and it is possible that some of these matters
may be decided unfavorably to the Company. Management believes that any
liability that may ultimately result from the resolution of these matters will
not have a material adverse effect on the financial condition, operating
results or cash flows of the Company.
F-42
<PAGE>
FLASHNET COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
8. Income Taxes
No provision for income taxes has been recognized as the Company incurred net
operating losses for income tax purposes.
Deferred tax assets and liabilities consist of:
<TABLE>
<CAPTION>
December 31,
-----------------------
1998 1999
---------- -----------
<S> <C> <C>
Net operating loss carryforwards.................... $8,100,000 $18,662,000
Deferred revenue.................................... -- 518,000
Book depreciation in excess of tax.................. 450,000 148,000
Other............................................... 100,000 410,000
---------- -----------
Total deferred tax assets......................... 8,650,000 19,738,000
Deferred tax liabilities............................ -- --
---------- -----------
Net deferred tax asset.............................. 8,650,000 19,738,000
Valuation allowance................................. (8,650,000) (19,738,000)
---------- -----------
$ -- $ --
========== ===========
</TABLE>
The Company has provided a valuation allowance for net deferred tax assets,
as it is more likely than not that these assets will not be realized.
At December 31, 1999, the Company has net operating loss carryforwards of
approximately $50.4 million for income tax purposes. These net operating loss
carryforwards begin to expire in 2013 and may be limited in their use due to
significant changes in the Company's ownership in prior years. The differences
between the Company's effective tax rate and the federal statutory rate of 34%
are as follows:
<TABLE>
<CAPTION>
Years Ended
December 31,
------------------
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
Income tax benefit at statutory rate.................... (34)% (34)% (34)%
State tax benefit, net of federal benefit............... (3) (3) (3)
Valuation allowance..................................... 37 37 35
Other................................................... -- -- 2
--- --- ---
Total income tax expense................................ --% --% --%
=== === ===
</TABLE>
9. Employee Savings Plan
During 1997, the Company began sponsoring an employee savings plan under
Section 401(k) of the Internal Revenue Code. The plan does not provide for
Company contributions.
10. Fair Value of Instruments
The Company has estimated the fair value of financial instruments as of
December 31, 1998 and 1999. The estimated fair value amounts are determined by
using available market information and appropriate valuation methodologies.
However, considerable judgment is required to interpret market data to develop
the estimates of fair value. Accordingly, the estimates presented herein are
not necessarily indicative of the amounts the Company could realize in a
current market exchange. The use of different market assumptions and/or
estimation methodologies may have a material effect on the estimated fair value
amounts.
F-43
<PAGE>
FLASHNET COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
The Company's financial instruments include accounts receivable, note
receivable, accounts payable, notes payable and capital lease obligations. The
Company has estimated that the carrying amount of accounts receivable, note
receivable and accounts payable approximates fair value due to the short-term
maturities of these instruments.
The Company's notes payable and capital lease obligations bear fixed interest
rates and are privately placed with unique terms and no active market. The fair
value of such financial instruments was determined by discounting future cash
flows at current market yields, which were determined based on the market
yields for similar instruments with similar terms. The following is a summary
of both the carrying values and estimated fair values of such instruments.
<TABLE>
<CAPTION>
December 31,
-------------------------------------------
1998 1999
--------------------- ---------------------
Historical Historical
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Convertible note payable........ $ 186,000 $ 217,000 $ -- $ --
Note payable.................... 4,834,000 5,092,000 -- --
Capital lease obligations....... 1,876,000 1,876,000 9,539,000 9,266,000
</TABLE>
11. Valuation and Qualifying Accounts
The following table sets forth activity in the Company's reserve accounts:
<TABLE>
<CAPTION>
Beginning Charges to End of
Allowance for Doubtful Accounts of Period Operations Deductions Period
------------------------------- --------- ---------- ---------- -------
<S> <C> <C> <C> <C>
Year ended December 31, 1997........ $28,000 $100,000 $93,000 $35,000
Year ended December 31, 1998........ 35,000 21,000 28,000 28,000
Year ended December 31, 1999........ 28,000 197,000 44,000 181,000
</TABLE>
12. Loss on Customer Hardware
During the fourth quarter, the Company filed a lawsuit against one of its
providers of refurbished computers due to a dispute regarding the magnitude of
reimbursement for returned computers. The Company believed that returns of
computers related to cancelled service agreements were the financial
responsibility of the provider and that all returns of refurbished computers
would be credited against amounts previously billed. In lieu of costly
litigation, the Company settled the claim with the vendor. Under the terms of
the settlement agreement, the Company agreed to pay this vendor $2.9 million
for an option to purchase 5,000 new PC's at substantially discounted levels
(approximately $1.9 million related to PC purchases is included in prepaid
expenses at December 31, 1999) and for the satisfaction of all billed and
unbilled invoices. Additionally, the Company agreed to bear the financial
burden of all future returns unrelated to warranty issues. Subsequent to the
date of the settlement agreement, the Company experienced actual returns in
excess of its estimate at the time of settlement. These excess returns resulted
in a charge in the fourth quarter of approximately $1.6 million as the Company
had no additional recourse to the vendor based on the terms of the settlement
agreement.
13. Pending Merger with Prodigy Communications Corporation
On November 5, 1999, the Company and Prodigy Communications Corporation
("Prodigy") entered into a definitive agreement whereby Prodigy will acquire
the Company in a stock-for-stock merger. Under the terms of the merger
agreement, Prodigy will issue 0.35 shares of Prodigy common stock for each
share of the Company's common stock outstanding on the closing date of the
transaction.
F-44
<PAGE>
FLASHNET COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
The Boards of Directors of both Prodigy and the Company unanimously approved
the merger; however, the merger is also subject to approval by the Company's
shareholders and to customary regulatory approvals. Closing of the merger is
expected to occur in the second quarter of 2000. In connection with the merger
agreement, the Company has granted Prodigy an option to purchase up to 19.9% of
the outstanding shares of the Company's common stock at $8.66 per share, which
may be exercised in certain circumstances. Based on the number of shares of the
Company and Prodigy currently outstanding, Prodigy will issue approximately 5.0
million shares to complete the merger.
F-45
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
U.S. Republic Communications, Inc.
We have audited the accompanying statement of assets to be acquired and
liabilities to be assumed of the Web Hosting Business of U.S. Republic
Communications, Inc. (the Web Hosting Business as defined in Note 1 to the
financial statements), as of December 31, 1998, and the related statements of
operations and cash flows for the period from January 6, 1998 (inception) to
December 31, 1998. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe our audit provides a reasonable basis for
our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the assets to be acquired and liabilities to be assumed
of the Web Hosting Business as of December 31, 1998, and the results of its
operations and its cash flows for the period January 6, 1998 (inception) to
December 31, 1998, in conformity with generally accepted accounting principles.
Ernst & Young LLP
Dallas, Texas
July 8, 1999,
Except for the first paragraph of Note 1, as to which the date is September 7,
1999
F-46
<PAGE>
WEB HOSTING BUSINESS
OF U.S. REPUBLIC COMMUNICATIONS, INC.
STATEMENTS OF ASSETS TO BE ACQUIRED AND LIABILITIES TO BE ASSUMED
(in thousands)
<TABLE>
<CAPTION>
September 30,
December 31, 1999
1998 (Unaudited)
------------ -------------
<S> <C> <C>
ASSETS
Current assets:
Accounts receivable, net of allowance for doubtful
accounts and adjustments of $2,729 and $4,824 at
December 31, 1998 and September 30, 1999,
respectively..................................... $3,495 $1,622
Prepaid expense................................... 24
------ ------
Total current assets............................ 3,495 1,646
Property and equipment:
Computer equipment................................ 566 1,311
Furniture and fixtures............................ 681 982
Leasehold improvements............................ 26 52
------ ------
1,273 2,345
Less accumulated depreciation and amortization.... 258 715
------ ------
Net property and equipment........................ 1,015 1,630
------ ------
Total assets.................................... $4,510 $3,276
====== ======
LIABILITIES
Current liabilities:
Demand note payable due to VarTec Telecom, Inc.... $9,000 $9,000
Accounts payable.................................. 308 1,802
Accrued taxes..................................... 412 --
Accrued payroll and benefits...................... 126 46
Accrued billing and collection costs.............. 374 26
Marketing costs payable........................... 1,310 113
Accrued liabilities............................... 76 43
Deferred revenue.................................. 790 591
------ ------
Total liabilities............................... 12,396 11,621
------ ------
Net liabilities................................. $7,886 $8,345
====== ======
Commitments and contingencies (Notes 3 and 4)
</TABLE>
See accompanying notes.
F-47
<PAGE>
WEB HOSTING BUSINESS
OF U.S. REPUBLIC COMMUNICATIONS, INC.
STATEMENTS OF OPERATIONS
(in thousands)
<TABLE>
<CAPTION>
Period from
January 6, 1998 Nine Months Ended
(inception) to September 30, 1999
December 31, 1998 (Unaudited)
----------------- ------------------
<S> <C> <C>
Net revenues............................... $ 7,106 $19,069
------- -------
Operating costs and expenses:
Cost of revenue.......................... 32 249
Marketing................................ 11,402 12,418
Billing and collection................... 710 2,165
Depreciation and amortization............ 114 277
Bad debts................................ 186 386
Other general and administrative......... 2,365 4,169
------- -------
14,809 19,664
------- -------
Operating loss............................. (7,703) (595)
Interest expense......................... 260 473
------- -------
Net loss............................... $(7,963) $(1,068)
======= =======
</TABLE>
See accompanying notes.
F-48
<PAGE>
WEB HOSTING BUSINESS
OF U.S. REPUBLIC COMMUNICATIONS, INC.
STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Period from
January 6, 1998 Nine Months Ended
(inception) to September 30, 1999
December 31, 1998 (Unaudited)
----------------- ------------------
<S> <C> <C>
Cash flows from operating activities:
Net loss................................ $(7,785) $ (821)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization......... 116 289
Bad debt expense...................... 186 386
Changes in operating assets and
liabilities:
Accounts receivable, net............ (3,680) 1,487
Prepaid expense..................... -- (24)
Accounts payable.................... 308 1,494
Accrued taxes....................... 412 (412)
Accrued payroll and benefits........ 126 (80)
Accrued billing and collection
costs.............................. 374 (348)
Marketing costs payable............. 1,310 (1,197)
Accrued liabilities................. 76 (33)
Deferred revenue.................... 790 (199)
------- -------
Net cash used in operating activities..... (7,767) 542
Cash flows from investing activities:
Purchase of property and equipment...... (1,124) (1,073)
------- -------
Net cash used in investing activities..... (1,124) (1,073)
Cash flows from financing activities:
Net transfers from USRC................. 8,891 531
------- -------
Net cash provided by financing
activities............................... 8,891 531
------- -------
Net increase in cash...................... -- --
Cash at beginning of period............... -- --
------- -------
Cash at end of period..................... $ -- $ --
======= =======
Cash paid during the period for interest.. $ 82 $ 227
======= =======
</TABLE>
See accompanying notes.
F-49
<PAGE>
WEB HOSTING BUSINESS
OF U.S. REPUBLIC COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS
December 31, 1998
1. Summary of Significant Accounting Policies
Basis of Financial Statement Presentation
VarTec Telecom, Inc. (VTI), Vartec Telecom Holding Company (VTH), U.S.
Republic Communications, Inc. (USRC), the minority stockholders of USRC and
Prodigy Communications Corporation (the Buyer) entered into an Asset Purchase
Agreement dated as of September 7, 1999 (the Agreement). As specified in the
Agreement on the contractually designated closing date, the Buyer will acquire
certain assets and assume certain liabilities of the Web Hosting Business of
USRC (the Business). The financial statements present the assets to be acquired
and liabilities to be assumed and the related results of operations and cash
flows of the Business based upon the transaction as set forth in the Agreement.
This transaction is herein referred to as the Acquisition.
The Business provides server-based hosting of Internet Web pages for small to
medium sized businesses within the continental United States. The Business
offers these services through its BizOnThe.Net Web site. The Business began
operations on January 6, 1998 (inception). Since inception, the Business has
been in the start-up phase of its operations and is still in the process of
developing its business. As a result, the Business has incurred operating
losses and is dependent upon USRC and VTI for funding of its operations.
The Business is an operating division of USRC, a majority-owned subsidiary of
VTH which, in turn, is a wholly owned subsidiary of VTI. VTI is a majority-
owned subsidiary of CommuniGroup, Inc., which is a wholly owned subsidiary of
Telephone Electronics Corporation (TEC). USRC also operates a long distance
resell business with which the Business shares resources and certain costs and
expenses. Assets and liabilities of USRC have been included in the accompanying
Statement of Assets to be Acquired and Liabilities to be Assumed if the items
are to be acquired or assumed by the Buyer as specified in the Agreement.
The financial statements have been prepared in accordance with generally
accepted accounting principles which require management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates. The
accompanying unaudited condensed consolidated financial statements for the
period ended September 30, 1999, have been prepared in accordance with
generally accepted accounting principles for interim financial information.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
Operating costs and expenses presented in the accompanying financial
statements reflect allocations based on management's best estimates as to what
the operating results of the Business would have been as if it had operated as
a stand-alone company. However, these estimates could differ from actual costs
and expenses incurred had the Business operated as a stand-alone company.
Accounts Receivable
Accounts receivable consist of amounts due from local exchange carriers
(LECs) that purchase USRC's customer billings for monthly service fees and
associated taxes on a full-recourse basis. The LECs purchase the accounts
receivable net of billing adjustments and estimates of bad debts. Unbillable
amounts that the LECs cannot bill to the customer due to incorrect or
incomplete billing information are excluded from gross revenues and related
receivables. Billing adjustments consist of amounts credited to customer
accounts by the LECs or USRC resulting from disputed charges. Bad debts are
estimated by the LECs either based on historical data or on a predetermined
percentage. These estimates are trued-up on periodic basis by the LECs based on
the actual uncollectible accounts.
F-50
<PAGE>
WEB HOSTING BUSINESS
OF U.S. REPUBLIC COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
The allowance for doubtful accounts and adjustments at December 31, 1998
represents an estimate of the future adjustments to be reported by the LECs
which relate to billings through such date. This estimate is based on the
history of adjustments reported by the LECs to the Business.
Property and Equipment
Property and equipment are recorded at cost. All property and equipment of
USRC is to be acquired by the Buyer under the Agreement and, accordingly, is
included in the accompanying Statement of Assets to be Acquired and Liabilities
to be Assumed at its historical carrying value when transferred to the
Business. Maintenance and repairs are charged against operations as incurred,
while renewals and major replacements are capitalized.
The Business provides depreciation on fixed assets using the straight-line
method over the estimated useful lives of the respective assets as follows:
<TABLE>
<CAPTION>
Estimated Useful Life Years
---------------------------
<S> <C>
Office furniture and equipment................... 1 to 4 years
Leasehold improvements........................... 5 years
</TABLE>
Total depreciation and amortization expense recorded by USRC was $191,000 for
the year ended December 31, 1998. Depreciation and amortization expense was
allocated to the Business as follows: (1) assets identified as used only by the
Business were allocated the total depreciation and amortization for each asset
and (2) for assets that were utilized in both the Business and long distance
business, depreciation and amortization expense was allocated based on monthly
gross revenues generated by each business.
Accounts Payable
Accounts payable consist primarily of trade payables for equipment and
general and administrative costs. Total USRC accounts payable at December 31,
1998, was $466,000. Accounts payable which relates to both the Business and
long distance business have been allocated to the Business based on the ratio
of revenues to total gross revenues of USRC for the month of December 1998.
Accrued Taxes
Accrued taxes consist of state and local sales taxes and federal excise tax
payable. State and local taxes are calculated by the LECs for USRC and billed
to the customers. The LECs remit back the amount of sales and excise taxes
collected from customers to USRC. The total USRC accrued tax liability as of
December 31, 1998 was $916,000. The Business was allocated accrued taxes based
on the ratio of the Business' gross revenues to total gross revenues of USRC
for the month of December 1998.
Revenue Recognition
Revenues consist of monthly service fees for providing Web hosting services
on the Company's server and providing Internet users access to customers' Web
pages. Revenues are recognized as services are provided. Deferred revenues
represent the amount of gross revenues billed but not earned as of December 31,
1998.
Marketing Costs
Marketing costs are fees due to independent sales agents for obtaining
customers and are expensed as incurred.
F-51
<PAGE>
WEB HOSTING BUSINESS
OF U.S. REPUBLIC COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Billing and Collection Costs
Billing and collection costs consist of the LECs service charges to the
Business for performing the billing and collection functions for USRC. Total
billing and collection expense for USRC was $3,094,000 for the year ended
December 31, 1998. Billing and collection expense has been allocated to the
Business based on the ratio of the Business' monthly gross revenues to total
monthly gross revenues of USRC.
Accrued billing and collection costs represent amounts charged by the LECs to
provide billing and collection services on USRC's behalf. The total billings
and collections costs accrued as of December 31, 1998, for USRC was $832,000.
The Business has been allocated accrued billing and collection costs based on
the ratio of the Business' gross revenues to total gross revenues of USRC for
the month of December 1998.
Other General and Administrative Expenses
Other general and administrative expenses include payroll and benefits,
facilities charges, call rating, verification services and other general and
administrative expenses incurred by USRC. The total costs incurred by USRC for
general and administrative costs in 1998 were $5,920,000. General and
administrative expenses allocated to the Business, excluding call rating and
verification services represent the incremental increase over the historical
general and administrative expenses incurred by USRC's long distance resell
business since the inception of the Business. Call rating costs included in
general and administrative expense were allocated to the Business based on the
ratio of the Business' gross revenues to the total gross revenues of USRC for
the year ended December 31, 1998. Verification services included in general and
administrative costs represent actual costs incurred by the Business.
All facilities and personnel are to be assigned to the Buyer as a part of the
Acquisition. Therefore, all facility related accruals and payroll accruals have
been included in the statement of assets to be acquired and liabilities to be
assumed.
Software Development Costs
The Business expenses all internal costs related to the development and
implementation of internal-use software. Purchased software costs are
capitalized if the Business will realize future benefits. These costs are
amortized over a period of twelve months. Beginning in 1999, the Business will
adopt Statement of Position 98-1, Accounting for Costs of Computer Software
Developed or Obtained For Internal Use. The Business is currently reviewing the
impact that SOP 98-1 and does not believe it will have a material effect on its
financial statements.
Income Taxes
The results of operations of the Business are included in the consolidated
income tax returns of TEC. Pursuant to the Agreement, TEC will retain
substantially all income tax liabilities and rights to all tax refunds relating
to operations prior to the closing date of the Acquisition. Accordingly, the
statements of assets to be acquired and liabilities to be assumed do not
reflect income tax receivables or payables. The Business has incurred losses
for both financial reporting and income tax reporting purposes since its
inception. No benefit for income taxes, as if the Business were liable for
federal and state income taxes as a separate legal entity for the period from
January 6, 1998 (inception) through December 31, 1998, has been recorded as the
deferred tax asset resulting from such losses would have been offset by a
valuation allowance as future realization of such asset is uncertain.
F-52
<PAGE>
WEB HOSTING BUSINESS
OF U.S. REPUBLIC COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
2. Related Party Transactions
In the normal course of operations, USRC receives certain services or engages
in transactions with VTI, VTH, and TEC. The significant services and
transactions with affiliated companies and related parties not discussed
elsewhere are summarized below.
USRC received charges for interest and insurance expense from VTI, VTH, and
TEC which totaled $310,000 and $72,000, respectively, for the year ended
December 31, 1998. Such costs allocated to the Business represent the
incremental increase in these costs incurred by USRC since the inception of the
Business.
Commissions expense incurred by the Business for telemarketing services to
companies which an officer of USRC has an ownership interest was approximately
$896,000 for the period from January 6, 1998 (inception) to December 31, 1998.
As of December 31, 1998, USRC has a demand note payable to VTH in the amount
of $9,103,000. USRC also has a short-term payable to VTH in the amount of
$127,000. The Buyer has agreed to assume $9,000,000 of these payables as part
of the Acquisition and, therefore, only $9,000,000 of the total $9,230,000
payable to VTH has been included in the accompanying Statement of Assets to be
Acquired and Liabilities to be Assumed. Interest expense related to these notes
was allocated to the Business based on the increase in the level of borrowings
by USRC during 1998 to fund the start-up operations of the Business.
3. Commitments
The Company leases office space under three operating leases expiring in
2003. Total rental expense of USRC amounted to $243,000 for the year ended
December 31, 1998. Rental expense has been included in other general and
administrative expense allocated to the Business in the Statement of
Operations. The operating leases have escalation clauses with respect to
monthly rent. Rent may be adjusted each annual period by a proportionate share
of the landlord's operating and maintenance costs pertaining to the premises as
compared to a predetermined base.
At December 31, 1998, future minimum lease payments under the above
noncancelable lease are as follows:
<TABLE>
<S> <C>
1999.............................................................. $ 338,000
2000.............................................................. 344,000
2001.............................................................. 353,000
2002.............................................................. 356,000
2003.............................................................. 255,000
----------
Total........................................................... $1,646,000
==========
</TABLE>
4. Contingencies
The Federal Trade Commission (FTC) has conducted an inquiry into the
marketing and billing practices (especially the LECs billings) of USRC. A
settlement agreement has been reached whereby USRC will modify certain internal
procedures and offer potential refunds to customers who have been LECs billed
and who may have incurred unauthorized billings resulting from the actions of
telemarketers, without the actual knowledge of USRC. The number of customers
which could be eligible for refunds and the related amount of refunds which may
result from this proposed settlement cannot be estimated at this time.
F-53
<PAGE>
WEB HOSTING BUSINESS
OF U.S. REPUBLIC COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
In June 1999, the Attorney General for the State of Arkansas filed a
complaint against USRC alleging violations of the Arkansas Deceptive Trade
Practices Act seeking various forms of restitution to affected customers, civil
penalties, and revocation of the right to do business within the state. USRC
has responded to this initial complaint. However, the ultimate outcome of this
matter cannot be determined at this time.
In June 1999, the Attorney General for the State of North Carolina filed a
complaint against USRC alleging violations of the North Carolina Unfair and
Deceptive Trade Practices Act seeking various forms of restitution to affected
customers, civil penalties, and revocation of the right to do business within
the state. The Attorney General has also filed a temporary restraining order
prohibiting USRC or its agents from engaging in telephonic sales activities or
solicitations in North Carolina and barring all collection activity. On July 8,
1999, this original temporary restraining order was superseded by a consent
order agreed to by both USRC and the Attorney General which permits collection
activity on accounts billed through the LECs. The ultimate outcome of this
matter cannot be determined at this time.
USRC is currently responding to inquiries from various other states
concerning USRC's trade practices. However, no formal complaints have been
filed by these other states. The Business is also subject to other legal
proceedings and claims which have arisen in the ordinary course of its
business.
Losses and related obligations, if any, which may result from these matters
and proceedings will remain the obligation of USRC and are not being assumed by
the Buyer.
5. Employee Stock Ownership Plan (ESOP)
TEC has established an ESOP that covers substantially all employees with one
year or more of service with a participating company. Participating companies
include TEC and its subsidiaries (including USRC). This plan is funded by
participating company contributions determined annually by TEC's Board of
Directors. USRC contributed $255,000 to the ESOP during 1998. ESOP expense has
been included in other general and administrative expense allocated to the
Business in the Statement of Operations. The employees of the Business will no
longer participate in this plan effective with the closing date of the
Acquisition.
6. Year 2000 Issue--Unaudited
The Business operates numerous date-sensitive computer applications and
systems throughout their businesses. Management of the Business believes all of
its internal systems are Year 2000 compliant. Through December 31, 1998, the
Business has relied on the LECs for its billing and collection functions and
has no knowledge as to the compliance of these companies with the Year 2000
issue. Subsequent to December 31, 1998, the Business has begun to transition
the billing and collection functions in-house through the use of a direct-
billing system. No costs have been incurred in order to make the Business'
systems Year 2000 compliant. No contingency plans and back-up systems are
currently being written.
F-54
<PAGE>
ANNEX A
PERSONAL AND CONFIDENTIAL
December 20, 1999
Board of Directors
FlashNet Communications, Inc.
3001 Meacham Blvd.
Suite 100
Fort Worth, Texas 76137
Gentlemen:
You have requested our opinion as to the fairness from a financial point of
view to the holders of the outstanding shares of Common Stock, no par value
(the "Shares"), of FlashNet Communications, Inc. (the "Company") of the
exchange ratio of 0.35 shares of Common Stock, par value $.01 per share
("Prodigy Common Stock"), of Prodigy Communications Corporation ("Prodigy") to
be received for each Share (the "Exchange Ratio"), pursuant to the Agreement
and Plan of Merger, dated as of November 5, 1999, among Prodigy, PUCKnut
Corporation, a wholly-owned subsidiary of Prodigy, and the Company (the
"Agreement"). On November 19, 1999, Prodigy and SBC Communications Inc. ("SBC")
entered into various agreements pursuant to which they will combine certain
business operations (the "SBC Transaction").
Goldman, Sachs & Co., as part of its investment banking business, is
continually engaged in the valuation of businesses and their securities in
connection with mergers and acquisitions, negotiated underwritings, competitive
biddings, secondary distributions of listed and unlisted securities, private
placements and valuations for estate, corporate and other purposes. We are
familiar with the Company, having extended a $5 million loan to the Company on
January 15, 1999 through our affiliate, Goldman Sachs Credit Partners L.P.,
which loan was repaid in connection with the Company's initial public offering,
and having acted as its financial advisor in connection with, and having
participated in certain of the negotiations leading to, the Agreement. We also
have provided various investment banking services to SBC from time to time,
including having acted as financial advisor to SBC in connection with the SBC
Transaction for which Goldman, Sachs & Co. will receive customary fees.
In connection with this opinion, we have reviewed, among other things, the
Agreement; the Company's Registration Statement on Form S-1 relating to its
initial public offering, including the Prospectus therein dated March 16, 1999;
Prodigy's Registration Statement on Form S-1 relating to its initial public
offering, including the Prospectus therein dated February 10, 1999; the Annual
Report on Form 10-K of Prodigy for the fiscal year ended December 31, 1998;
certain interim reports to stockholders and Quarterly Reports on Form 10-Q of
the Company and Prodigy; certain other communications from the Company and
Prodigy to their respective stockholders; the Investment, Issuance,
Contribution and Assumption Agreement, dated as of November 19, 1999, by and
among SBC, SBC Internet Communications, Inc., Prodigy, Prodigy Transition
Corporation, and Prodigy Communications Limited Partnership; the Strategic and
Marketing Agreement, dated as of November 19, 1999, by and among SBC, SBC
Internet Communications, Inc., Prodigy, and Prodigy Communications Limited
Partnership; and certain internal financial analyses and forecasts for the
Company and Prodigy prepared by their respective managements and for the
business operations of SBC involved in the SBC Transaction, including certain
operating synergies projected by the management of Prodigy to result from the
SBC Transaction (the "Forecasts"). In addition, we have held discussions with
members of the senior management of the Company and Prodigy regarding their
assessment of the strategic rationale for, and the
A-1
<PAGE>
potential benefits of, the transaction contemplated by the Agreement and the
past and current business operations, financial condition and future prospects
of their respective companies, including the Company's recent inability to
obtain additional financing necessary to achieve continued revenue and
subscriber growth on a standalone basis. We have held discussions with members
of senior management of Prodigy regarding their assessment of the strategic
rationale for, and the potential benefits of, the SBC Transaction and the past
and current business operations, financial condition and future prospects of
the business operations of SBC involved in the SBC Transaction. We have
reviewed the reported price and trading activity for the Shares and Prodigy
Common Stock, which like many Internet related stocks have been and are likely
to continue to be subject to significant short term price and trading
volatility, compared certain financial and stock market information for the
Company and Prodigy with similar information for certain other companies the
securities of which are publicly traded, reviewed the financial terms of
certain recent business combinations in the Internet service provider industry
specifically and in other industries generally and performed such other studies
and analyses as we considered appropriate.
We have relied upon the accuracy and completeness of all of the financial and
other information discussed with or reviewed by us and have assumed such
accuracy and completeness for purposes of rendering this opinion. In that
regard, we have assumed with your consent that the Forecasts have been
reasonably prepared on a basis reflecting the best currently available
judgments and estimates of the Company and Prodigy. We have also taken into
account, with your consent, the risks inherent in the Company's standalone
business plans, including the view of management of the Company that the
Company would be unable to obtain, on reasonable terms, financing necessary to
achieve continued revenue and subscriber growth on a standalone basis. In
addition, we have not made an independent evaluation or appraisal of the assets
and liabilities of the Company or Prodigy or any of their subsidiaries or the
business operations of SBC involved in the SBC Transaction and we have not been
furnished with any such evaluation or appraisal. Our advisory services and the
opinion expressed herein are provided for the information and assistance of the
Board of Directors of the Company in connection with its consideration of the
transaction contemplated by the Agreement and such opinion does not constitute
a recommendation as to how any holder of Shares should vote with respect to
such transaction.
Based upon and subject to the foregoing and based upon such other matters as
we consider relevant, it is our opinion that as of the date hereof the Exchange
Ratio pursuant to the Agreement is fair from a financial point of view to the
holders of the Shares.
Very truly yours,
/s/ Goldman, Sachs & Co.
A-2
<PAGE>
ANNEX B
COMPOSITE COPY
AGREEMENT AND PLAN OF MERGER
by and among
PRODIGY COMMUNICATIONS CORPORATION,
PUCKNUT CORPORATION
and
FLASHNET COMMUNICATIONS, INC.
Dated as of November 5, 1999
and amended as of March 15, 2000
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<C> <S> <C>
ARTICLE I THE MERGER................................................. B-1
1.1 Effective Time of the Merger............................... B-1
1.2 Closing.................................................... B-1
1.3 Effects of the Merger...................................... B-2
1.4 Directors and Officers..................................... B-2
ARTICLE II CONVERSION OF SECURITIES................................... B-2
2.1 Conversion of Capital Stock................................ B-2
2.2 Exchange of Certificates................................... B-3
ARTICLE III REPRESENTATIONS AND WARRANTIES OF THE COMPANY.............. B-5
3.1 Organization, Standing and Power; Subsidiaries............. B-5
3.2 Capitalization............................................. B-6
3.3 Authority; No Conflict; Required Filings and Consents...... B-7
3.4 SEC Filings; Financial Statements.......................... B-8
3.5 No Undisclosed Liabilities................................. B-9
3.6 Absence of Certain Changes or Events....................... B-9
3.7 Taxes...................................................... B-9
3.8 Owned and Leased Real Properties........................... B-11
3.9 Intellectual Property...................................... B-11
3.10 Agreements, Contracts and Commitments...................... B-11
3.11 Litigation................................................. B-12
3.12 Environmental Matters...................................... B-12
3.13 Employee Benefit Plans..................................... B-13
3.14 Compliance With Laws....................................... B-14
3.15 Permits.................................................... B-14
3.16 Registration Statement; Proxy Statement/Prospectus......... B-14
3.17 Labor Matters.............................................. B-15
3.18 Insurance.................................................. B-15
3.19 Business Activity Restrictions............................. B-15
3.20 Year 2000 Compliance....................................... B-15
3.21 Assets..................................................... B-16
3.22 Subscribers................................................ B-17
3.23 Accounts Receivable........................................ B-17
3.24 No Existing Discussions.................................... B-17
3.25 Opinion of Financial Advisor............................... B-17
3.26 Part Thirteen of the TBCA Not Applicable................... B-17
3.27 Tax Matters................................................ B-17
3.28 Transactions with Affiliate................................ B-17
3.29 Brokers; Schedule of Fees and Expenses..................... B-17
3.30 Disclosure................................................. B-17
ARTICLE IV REPRESENTATIONS AND WARRANTIES OF THE BUYER AND THE
TRANSITORY SUBSIDIARY...................................... B-18
4.1 Organization, Standing and Power........................... B-18
4.2 Capitalization............................................. B-18
4.3 Authority; No Conflict; Required Filings and Consents...... B-18
4.4 SEC Filings; Financial Statements.......................... B-19
4.5 Absence of Certain Changes or Events....................... B-19
4.6 Tax Matters................................................ B-20
4.7 Litigation................................................. B-20
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
Page
----
<C> <S> <C>
4.8 Compliance with Laws...................................... B-20
4.9 Registration Statement; Proxy Statement/Prospectus........ B-20
4.10 Operations of the Transitory Subsidiary................... B-20
4.11 Brokers................................................... B-20
4.12 Disclosure................................................ B-20
ARTICLE V CONDUCT OF BUSINESS....................................... B-20
5.1 Covenants of the Company.................................. B-20
5.2 Cooperation............................................... B-23
5.3 Confidentiality........................................... B-23
ARTICLE VI ADDITIONAL AGREEMENTS..................................... B-23
6.1 No Solicitation........................................... B-23
6.2 Proxy Statement/Prospectus; Registration Statement........ B-24
6.3 Nasdaq Quotation.......................................... B-25
6.4 Access to Information..................................... B-25
6.5 Stockholders Meeting...................................... B-25
6.6 Legal Conditions to the Merger............................ B-26
6.7 Public Disclosure......................................... B-27
6.8 Tax-Free Reorganization................................... B-27
6.9 Affiliate Agreements...................................... B-27
6.10 Nasdaq National Market Listing............................ B-27
6.11 Company Stock Options, Warrants and Plans................. B-27
6.12 Stockholder Litigation.................................... B-28
6.13 Indemnification........................................... B-28
6.14 Notification of Certain Matters........................... B-29
ARTICLE VII CONDITIONS TO MERGER...................................... B-29
Conditions to Each Party's Obligation To Effect the
7.1 Merger.................................................... B-29
7.2 Additional Conditions to Obligations of the Buyer and the
Transitory Subsidiary..................................... B-30
7.3 Additional Conditions to Obligations of the Company....... B-30
ARTICLE VIII TERMINATION AND AMENDMENT................................. B-31
8.1 Termination............................................... B-31
8.2 Effect of Termination..................................... B-32
8.3 Fees and Expenses......................................... B-32
8.4 Amendment................................................. B-33
8.5 Extension; Waiver......................................... B-33
ARTICLE IX MISCELLANEOUS............................................. B-33
9.1 Nonsurvival of Representations and Warranties............. B-33
9.2 Notices................................................... B-34
9.3 Entire Agreement.......................................... B-34
9.4 No Third Party Beneficiaries.............................. B-34
9.5 Assignment................................................ B-35
9.6 Severability.............................................. B-35
9.7 Counterparts and Signature................................ B-35
9.8 Interpretation............................................ B-35
9.9 Governing Law............................................. B-35
9.10 Remedies.................................................. B-35
9.11 Waiver of Jury Trial...................................... B-36
</TABLE>
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<PAGE>
TABLE OF DEFINED TERMS
<TABLE>
<CAPTION>
Cross Reference
Terms in Agreement
- ----- ---------------
<S> <C>
Affiliate....................................................... Section 6.9
Affiliate Agreement............................................. Section 6.9
Agreement....................................................... Preamble
Alternative Transaction......................................... Section 8.3(g)
Antitrust Laws.................................................. Section 6.6(b)
Antitrust Order................................................. Section 6.6(b)
Articles of Merger.............................................. Section 1.1
Buyer........................................................... Preamble
Buyer Balance Sheet............................................. Section 4.4(b)
Buyer Common Stock.............................................. Section 2.1(c)
Buyer Disclosure Schedule....................................... Article IV
Buyer Material Adverse Effect................................... Section 4.1
Buyer Preferred Stock........................................... Section 4.2
Buyer SEC Reports............................................... Section 4.4(a)
Certificates.................................................... Section 2.2(b)
Certificate of Merger........................................... Section 1.1
Closing......................................................... Section 1.2
Closing Date.................................................... Section 1.2
Code............................................................ Preamble
Company......................................................... Preamble
Company Balance Sheet........................................... Section 3.4(b)
Company Common Stock............................................ Section 2.1(b)
Company Disclosure Schedule..................................... Article III
Company Employee Plans.......................................... Section 3.13(a)
Company Intellectual Property Rights............................ Section 3.9(a)
Company Leases.................................................. Section 3.8(b)
Company Material Adverse Effect................................. Section 3.1(a)
Company Material Contracts...................................... Section 3.10
Company Meeting................................................. Section 3.16
Company Permits................................................. Section 3.15
Company Preferred Stock......................................... Section 3.2(a)
Company SEC Reports............................................. Section 3.4(a)
Company Stock Options........................................... Section 3.2(b)
Company Stock Option Agreement.................................. Preamble
Company Stock Plans............................................. Section 3.2(b)
Company Voting Proposal......................................... Section 6.5(a)
Company Warrants................................................ Section 3.2(b)
Confidentiality Agreement....................................... Section 5.3
Constituent Corporations........................................ Section 1.3
DGCL............................................................ Section 1.1
Effective Time.................................................. Section 1.1
Employee Benefit Plan........................................... Section 3.13(a)
Environmental Law............................................... Section 3.12(b)
ERISA Affiliate................................................. Section 3.13(a)
ERISA........................................................... Section 3.13(a)
Exchange Agent.................................................. Section 2.2(a)
Exchange Fund................................................... Section 2.2(a)
Exchange Act.................................................... Section 3.3(c)
</TABLE>
B-iii
<PAGE>
<TABLE>
<CAPTION>
Cross Reference
Terms in Agreement
- ----- --------------------
<S> <C>
Exchange Ratio............................................ Section 2.1(c)
Governmental Entity....................................... Section 3.3(c)
Hazardous Substance....................................... Section 3.12(c)
HSR Act................................................... Section 3.3(c)
Indemnified Parties....................................... Section 6.13
Insurance Policies........................................ Section 3.18
Liens..................................................... Section 3.21
Merger.................................................... Preamble
Outside Date.............................................. Section 8.1(b)
Proxy Statement........................................... Section 3.16
Registration Statement.................................... Section 3.16
Rule 145.................................................. Section 6.9
SEC....................................................... Section 3.3(c)
Securities Act............................................ Section 3.4(a)
Stockholder Agreement..................................... Preamble
Subsidiary................................................ Section 3.1(b)
Superior Proposal......................................... Section 6.1(a)(A)(1)
Surviving Corporation..................................... Section 1.3
Tax Returns............................................... Section 3.7(a)
Taxes..................................................... Section 3.7(a)
TBCA...................................................... Section 1.1
Third Party............................................... Section 8.3(g)
Transitory Subsidiary..................................... Preamble
Year 2000 Compliant....................................... Section 3.20(d)
</TABLE>
B-iv
<PAGE>
AGREEMENT AND PLAN OF MERGER
THIS AGREEMENT AND PLAN OF MERGER (this "Agreement"), dated as of November 5,
1999 and as amended as of March 15, 2000, is by and among Prodigy
Communications Corporation, a Delaware corporation (the "Buyer"), PUCKnut
Corporation, a Delaware corporation and a wholly owned subsidiary of Buyer (the
"Transitory Subsidiary"), and FlashNet Communications, Inc., a Texas
corporation (the "Company").
WHEREAS, the Boards of Directors of the Buyer and the Company deem it
advisable and in the best interests of each corporation and its respective
stockholders that the Buyer and the Company combine in order to advance the
long-term business interests of the Buyer and the Company;
WHEREAS, the combination of the Buyer and the Company shall be effected by
the terms of this Agreement through a merger of the Transitory Subsidiary into
the Company, as a result of which the stockholders of the Company will become
stockholders of the Buyer (the "Merger");
WHEREAS, concurrently with the execution and delivery of this Agreement and
as a condition and inducement to the Buyer's willingness to enter into this
Agreement, the Company has entered into a Stock Option Agreement dated as of
the date of this Agreement and attached hereto as Exhibit A (the "Company Stock
Option Agreement"), pursuant to which the Company granted the Buyer an option
to purchase shares of common stock of the Company under certain circumstances;
WHEREAS, concurrently with the execution and delivery of this Agreement and
as a condition and inducement to the Buyer's willingness to enter into this
Agreement, the stockholders of the Company specified in Section 6.5(c) of this
Agreement have entered into a Stockholder Agreement dated as of the date of
this Agreement in the form attached as Exhibit B (the "Stockholder Agreement"),
pursuant to which such stockholders agreed to give the Buyer a proxy to vote
all of the shares of capital stock of the Company that such stockholders own;
and
WHEREAS, for federal income tax purposes, it is intended that the Merger
shall qualify as a reorganization within the meaning of Section 368(a) of the
Internal Revenue Code of 1986, as amended (the "Code").
NOW, THEREFORE, in consideration of the foregoing and the respective
representations, warranties, covenants and agreements set forth below, the
Buyer, the Transitory Subsidiary and the Company agree as follows:
ARTICLE I
THE MERGER
1.1 Effective Time of the Merger. Subject to the provisions of this
Agreement, prior to the Closing (as defined in Section 1.2), the Buyer shall
prepare, and on the Closing Date (as defined in Section 1.2) or as soon as
practicable thereafter the Buyer shall cause to be filed (i) with the Secretary
of State of the State of Delaware, a certificate of merger (the "Certificate of
Merger") in such form as is required by, and executed by the Surviving
Corporation (as defined in Section 1.3) in accordance with, the relevant
provisions of the Delaware General Corporation Law ("DGCL"), (ii) with the
Secretary of State of the State of Texas, articles of merger ("Articles of
Merger") in such form as required by, and executed by the Constituent
Corporations (as defined in Section 1.3) in accordance with the relevant
provisions of the Texas Business Corporation Act ("TBCA"), and shall make all
other filings or recordings required under the DGCL and TBCA. The Merger shall
become effective upon the filing of the Certificate of Merger with the
Secretary of State of the State of Delaware and the Articles of Merger with the
Secretary of State of the State of Texas or at such later time as is
established by the Buyer and the Company and set forth in the Certificate of
Merger and Articles of Merger (the "Effective Time").
1.2 Closing. The closing of the Merger (the "Closing") shall take place at
10:00 a.m., Boston time, on a date to be specified by the Buyer and the Company
(the "Closing Date"), which shall be no later than the
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<PAGE>
second business day after satisfaction or waiver of the conditions set forth in
Article VII (other than delivery of items to be delivered at the Closing), at
the offices of Hale and Dorr LLP, 60 State Street, Boston, Massachusetts,
unless another date, place or time is agreed to in writing by the Buyer and the
Company.
1.3 Effects of the Merger. At the Effective Time (i) the separate existence
of the Transitory Subsidiary shall cease and the Transitory Subsidiary shall be
merged with and into the Company (the Transitory Subsidiary and the Company are
sometimes referred to below as the "Constituent Corporations" and the Company
following the Merger is sometimes referred to below as the "Surviving
Corporation"), (ii) the Restated Articles of Incorporation of the Company shall
be amended so that the third paragarph of ARTICLE TWO of such Restated Articles
of Incorporation reads in its entirety as follows: "The total number of shares
of all classes of stock which the Corporation shall have authority to issue is
1,000, all of which shall consist of common stock, $.01 par value per share,"
and, as so amended, such Restated Articles of Incorporation shall be the
Restated Articles of Incorporation of the Surviving Corporation, and (iii) the
By-laws of the Company as of the date hereof, with such changes as are
specified by the Buyer prior to the Effective Time, shall be the By-laws of the
Surviving Corporation. The Merger shall have the effects set forth in Section
259 of the DGCL and Article 5.06 of the TBCA.
1.4 Directors and Officers. Except as specified in Section 1.4 of the Company
Disclosure Schedule, the directors and officers of the Transitory Subsidiary
immediately prior to the Effective Time shall be the initial directors and
officers of the Surviving Corporation, each to hold office in accordance with
the Restated Articles of Incorporation and By-laws of the Surviving
Corporation.
ARTICLE II
CONVERSION OF SECURITIES
2.1 Conversion of Capital Stock. As of the Effective Time, by virtue of the
Merger and without any action on the part of the holder of any shares of the
capital stock of the Company or capital stock of the Transitory Subsidiary:
(a) Capital Stock of the Transitory Subsidiary. Each issued and
outstanding share of the capital stock of the Transitory Subsidiary shall
be converted into and become one fully paid and nonassessable share of
common stock, $.01 par value per share, of the Surviving Corporation.
(b) Cancellation of Treasury Stock and Buyer-Owned Stock. All shares of
common stock, no par value, of the Company ("Company Common Stock") that
are owned by the Company as treasury stock or by any wholly owned
Subsidiary (as defined in Section 3.1) of the Company and any shares of
Company Common Stock owned by the Buyer, the Transitory Subsidiary or any
other wholly owned Subsidiary of the Buyer shall be canceled and retired
and shall cease to exist and no stock of the Buyer or other consideration
shall be delivered in exchange therefor.
(c) Exchange Ratio for Company Common Stock. Subject to Section 2.2, each
share of Company Common Stock (other than shares to be canceled in
accordance with Section 2.1(b)) issued and outstanding immediately before
the Effective Time, and all rights in respect thereof, shall be
automatically converted into 0.35 share (the "Exchange Ratio ") of common
stock, $.01 par value per share, of the Buyer ("Buyer Common Stock"). As of
the Effective Time, all such shares of Company Common Stock shall no longer
be outstanding and shall automatically be canceled and retired and shall
cease to exist, and each holder of a certificate representing any such
shares of Company Common Stock shall cease to have any rights with respect
thereto, except the right to receive the shares of Buyer Common Stock and
any cash in lieu of fractional shares of Buyer Common Stock to be issued or
paid in consideration therefor upon surrender of such certificate in
accordance with Section 2.2, without interest.
B-2
<PAGE>
(d) Adjustments to Exchange Ratio. The Exchange Ratio shall be adjusted
to reflect fully the effect of any stock split, reverse split, stock
dividend (including any dividend or distribution of securities convertible
into Buyer Common Stock or Company Common Stock), reorganization,
recapitalization or other like change with respect to Buyer Common Stock or
Company Common Stock occurring after the date hereof and prior to the
Effective Time.
(e) Unvested Stock. At the Effective Time, any unvested shares of Company
Common Stock awarded to employees, directors or consultants pursuant to any
of the Company's plans or arrangements and outstanding immediately prior to
the Effective Time shall be converted to unvested shares of Buyer Common
Stock in accordance with the Exchange Ratio and shall remain subject to the
same terms, restrictions and vesting schedule as in effect immediately
prior to the Effective Time, except to the extent by their terms such
unvested shares of Company Common Stock vest at the Effective Time. All
outstanding rights which the Company may hold immediately prior to the
Effective Time to repurchase unvested shares of Company Common Stock shall
be assigned to in the Merger and shall thereafter be exercisable by Buyer
by Buyer upon the same terms and conditions in effect immediately prior to
the Effective Time, except that the shares purchasable pursuant to such
rights and the purchase price payable per share shall be adjusted to
reflect the Exchange Ratio.
(f) Treatment of Company Options and Company Warrants. Outstanding
Company Options and Company Warrants (in each case as defined in Section
3.2(b)) shall be treated following the Effective Time in the manner set
forth in Section 6.11.
2.2 Exchange of Certificates. The procedures for exchanging outstanding
shares of Company Common Stock for Buyer Common Stock pursuant to the Merger
are as follows:
(a) Exchange Agent. As of the Effective Time, the Buyer shall deposit
with a bank or trust company designated by the Buyer (the "Exchange
Agent"), for the benefit of the holders of shares of the Company Common
Stock, for exchange in accordance with this Section 2.2, through the
Exchange Agent, (i) certificates representing the shares of Buyer Common
Stock (such shares of Buyer Common Stock, together with any dividends or
distributions with respect thereto, being hereinafter referred to as the
"Exchange Fund") issuable pursuant to Section 2.1 in exchange for
outstanding shares of the Company Common Stock, (ii) cash in an amount
sufficient to make payments required pursuant to Section 2.2(e), and (iii)
any dividends or distributions to which holders of Certificates (as defined
below) may be entitled pursuant to Section 2.2(c)
(b) Exchange Procedures. As soon as reasonably practicable after the
Effective Time, the Exchange Agent shall mail to each holder of record of a
certificate or certificates which immediately prior to the Effective Time
represented outstanding shares of the Company Common Stock (the
"Certificates") whose shares were converted pursuant to Section 2.1 into
the right to receive shares of Buyer Common Stock (i) a letter of
transmittal (which shall specify that delivery shall be effected, and risk
of loss and title to the Certificates shall pass, only upon delivery of the
Certificates to the Exchange Agent and shall be in such form and have such
other provisions as the Buyer may reasonably specify) and (ii) instructions
for effecting the surrender of the Certificates in exchange for
certificates representing shares of Buyer Common Stock (plus cash in lieu
of fractional shares, if any, of Buyer Common Stock and any dividends or
distributions as provided below). Upon surrender of a Certificate for
cancellation to the Exchange Agent or to such other agent or agents as may
be appointed by the Buyer, together with such letter of transmittal, duly
executed, and such other documents as may reasonably be required by the
Exchange Agent, the holder of such Certificate shall be entitled to receive
in exchange therefor a certificate representing that number of whole shares
of Buyer Common Stock which such holder has the right to receive pursuant
to the provisions of this Article II plus cash in lieu of fractional shares
pursuant to Section 2.2(e) and any dividends or distributions pursuant to
Section 2.2(c), and the Certificate so surrendered shall immediately be
canceled. In the event of a transfer of ownership of Company Common Stock
which is not registered in
B-3
<PAGE>
the transfer records of the Company, a certificate representing the proper
number of shares of Buyer Common Stock plus cash in lieu of fractional
shares pursuant to Section 2.2(e) and any dividends or distributions
pursuant to Section 2.2(c) may be issued and paid to a person other than
the person in whose name the Certificate so surrender is registered, if
such Certificate is presented to the Exchange Agent, accompanied by all
documents required to evidence and effect such transfer and by evidence
that any applicable stock transfer taxes have been paid. Until surrendered
as contemplated by this Section 2.2, each Certificate shall be deemed at
any time after the Effective Time to represent only the right to receive
upon such surrender the certificate representing shares of Buyer Common
Stock plus cash in lieu of fractional shares pursuant to Section 2.2(e) and
any dividends or distributions pursuant to Section 2.2(c) as contemplated
by this Section 2.2.
(c) Distributions with Respect to Unexchanged Shares. No dividends or
other distributions declared or made after the Effective Time with respect
to Buyer Common Stock with a record date after the Effective Time shall be
paid to the holder of any unsurrendered Certificate with respect to the
shares of Buyer Common Stock represented thereby and no cash payment in
lieu of fractional shares shall be paid to any such holder pursuant to
Section 2.2(e) until the holder of record of such Certificate shall
surrender such Certificate. Subject to the effect of applicable laws,
following surrender of any such Certificate, there shall be issued and paid
to the record holder of the Certificate, (i) certificates representing
whole shares of Buyer Common Stock issued in exchange therefor, without
interest, (ii) at the time of such surrender, the amount of any cash
payable in lieu of a fractional share of Buyer Common Stock to which such
holder is entitled pursuant to Section 2.2(e) and the amount of dividends
or other distributions with a record date after the Effective Time
previously paid with respect to such whole shares of Buyer Common Stock,
and (iii) at the appropriate payment date, the amount of dividends or other
distributions with a record date after the Effective Time but prior to
surrender and a payment date subsequent to surrender payable with respect
to such whole shares of Buyer Common Stock.
(d) No Further Ownership Rights in Company Common Stock. All shares of
Buyer Common Stock issued upon the surrender for exchange of Certificates
in accordance with the terms hereof (including any cash or other
distributions paid pursuant to Sections 2.2(c) or 2.2(e)) shall be deemed
to have been issued in full satisfaction of all rights pertaining to such
shares of Company Common Stock, and from and after the Effective Time there
shall be no further registration of transfers on the stock transfer books
of the Surviving Corporation of the shares of Company Common Stock which
were outstanding immediately prior to the Effective Time. If, after the
Effective Time, Certificates are presented to the Surviving Corporation or
the Exchange Agent for any reason, they shall be canceled and exchanged as
provided in this Article II.
(e) No Fractional Shares. No certificate or scrip representing fractional
shares of Buyer Common Stock shall be issued upon the surrender for
exchange of Certificates, and such fractional share interests will not
entitle the owner thereof to vote or to any other rights of a stockholder
of the Buyer. Notwithstanding any other provision of this Agreement, each
holder of shares of Company Common Stock exchanged pursuant to the Merger
who would otherwise have been entitled to receive a fraction of a share of
Buyer Common Stock (after taking into account all Certificates delivered by
such holder) shall receive, in lieu thereof, cash (without interest) in an
amount equal to such fractional part of a share of Buyer Common Stock
multiplied by the average of the last reported sales prices of the Buyer
Common Stock on the Nasdaq National Market during the ten (10) consecutive
trading days ending on and including the last trading day prior to the
Effective Time.
(f) Termination of Exchange Fund. Any portion of the Exchange Fund which
remains undistributed to the holders of Company Common Stock for 180 days
after the Effective Time shall be delivered to the Buyer, upon demand, and
any holder of Company Common Stock who has not previously complied with
this Section 2.2 shall thereafter look only to the Buyer for payment of its
claim for Buyer Common Stock, any cash in lieu of fractional shares of
Buyer Common Stock and any dividends or distributions with respect to Buyer
Common Stock.
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<PAGE>
(g) No Liability. To the extent permitted by applicable law, none of the
Buyer, the Transitory Subsidiary, the Company, the Surviving Corporation or
the Exchange Agent shall be liable to any holder of shares of Company
Common Stock or Buyer Common Stock, as the case may be, for such shares (or
dividends or distributions with respect thereto) delivered to a public
official pursuant to any applicable abandoned property, escheat or similar
law. If any Certificate shall not have been surrendered prior to one year
after the Effective Time (or immediately prior to such earlier date on
which any shares of Buyer Common Stock, and any cash payable to the holder
of such Certificate pursuant to this Article II or any dividends or
distributions payable to the holder of such Certificate would otherwise
escheat to or become the property of any Governmental Entity (as defined in
Section 3.3(c))), any such shares of Buyer Common Stock or cash, dividends
or distributions in respect of such Certificate shall, to the extent
permitted by applicable law, become the property of the Surviving
Corporation, free and clear of all claims or interest of any person
previously entitled thereto.
(h) Withholding Rights. Each of the Buyer and the Surviving Corporation
shall be entitled to deduct and withhold from the consideration otherwise
payable pursuant to this Agreement to any holder of shares of Company
Common Stock such amounts as it is required to deduct and withhold with
respect to the making of such payment under the Code, or any other
applicable provision of law. To the extent that amounts are so withheld by
the Surviving Corporation or the Buyer, as the case may be, such withheld
amounts shall be treated for all purposes of this Agreement as having been
paid to the holder of the shares of Company Common Stock in respect of
which such deduction and withholding was made by the Surviving Corporation
or the Buyer, as the case may be.
(i) Lost Certificates. If any Certificate shall have been lost, stolen or
destroyed, upon the making of an affidavit of that fact by the person
claiming such Certificate to be lost, stolen or destroyed and, if required
by the Surviving Corporation, the posting by such person of a bond in such
reasonable amount as the Surviving Corporation may direct as indemnity
against any claim that may be made against it with respect to such
Certificate, the Exchange Agent will issue in exchange for such lost,
stolen or destroyed Certificate the shares of Buyer Common Stock and any
cash in lieu of fractional shares, and unpaid dividends and distributions
on shares of Buyer Common Stock deliverable in respect thereof pursuant to
this Agreement.
ARTICLE III
REPRESENTATIONS AND WARRANTIES OF THE COMPANY
The Company represents and warrants to the Buyer and the Transitory
Subsidiary that the statements contained in this Article III are true and
correct, except as set forth herein or in the disclosure schedule delivered by
the Company to the Buyer on or before the date of this Agreement (the "Company
Disclosure Schedule"). The Company Disclosure Schedule shall be arranged in
paragraphs corresponding to the numbered and lettered paragraphs contained in
this Article III and the disclosure in any paragraph shall qualify other
paragraphs in this Article III only to the extent that it is reasonably
apparent from a reading of such disclosure that it also qualifies or applies to
such other paragraphs.
3.1 Organization, Standing and Power; Subsidiaries.
(a) Each of the Company and its Subsidiaries (as defined below) is a
corporation duly organized, validly existing and in good standing under the
laws of the jurisdiction of its incorporation, has all requisite corporate
power and authority to own, lease and operate its properties and assets and
to carry on its business as now being conducted and as proposed to be
conducted, and is duly qualified to do business and is in good standing as
a foreign corporation in each jurisdiction in which the failure to be so
qualified, individually or in the aggregate, would be reasonably likely to
have a material adverse effect on the
B-5
<PAGE>
business, properties, financial condition, results of operations or
prospects of the Company and its Subsidiaries, taken as a whole, or to have
a material adverse effect on the ability of the Company to consummate the
transactions contemplated by this Agreement or the Company Stock Option
Agreement (a "Company Material Adverse Effect"); provided, however, that
"Company Material Adverse Effect" shall not include any adverse change,
effect or event that (i) is demonstrably shown to have been proximately
caused by the announcement or pendency of the Merger, (ii) is caused by any
breach of any representation, warranty or covenant by the Buyer or the
Transitory Subsidiary, or (iii) applies generally to any entity engaged in
the same business in which the Company is engaged.
(b) Except as set forth in the Company SEC Reports (as defined in Section
3.4) filed prior to the date of this Agreement, neither the Company nor any
of its Subsidiaries directly or indirectly owns any equity, membership,
partnership or similar interest in, or any interest convertible into or
exchangeable or exercisable for any equity, membership, partnership or
similar interest in, any corporation, partnership, joint venture, limited
liability company or other business association or entity, whether
incorporated or unincorporated. As used in this Agreement, the word
"Subsidiary" means, with respect to a party, any corporation, partnership,
joint venture, limited liability company or other business association or
entity, whether incorporated or unincorporated, of which (i) such party or
any other Subsidiary of such party is a general partner (excluding
partnerships, the general partnership interests of which held by such party
and/or one or more of its Subsidiaries do not have a majority of the voting
interest in such partnership), (ii) such party and/or one or more of its
Subsidiaries holds voting power to elect a majority of the board of
directors or other governing body performing similar functions, or (iii)
such party and/or one or more of its Subsidiaries, directly or indirectly,
owns or controls more than 50% of the equity, membership, partnership or
similar interests.
(c) The Company has delivered to the Buyer complete and accurate copies
of the Restated Articles of Incorporation and By-laws of the Company and of
the charter, by-laws or other organization documents of each Subsidiary of
the Company.
3.2 Capitalization.
(a) The authorized capital stock of the Company consists of 50,000,000
shares of Company Common Stock and 5,000,000 shares of preferred stock,
$1.00 par value per share ("Company Preferred Stock"). As of the close of
business on the date immediately preceding the date of this Agreement, (i)
14,258,690 shares of Company Common Stock were issued and outstanding, (ii)
no shares of Company Common Stock were held in the treasury of the Company
or by Subsidiaries of the Company, and (iii) no shares of the Company
Preferred Stock were issued and outstanding.
(b) Section 3.2(b) of Company Disclosure Schedule lists the number of
shares of Company Common Stock reserved for future issuance pursuant to
stock options granted and outstanding as of the date of this Agreement and
the plans under which such options were granted (collectively, the "Company
Stock Plans") and sets forth a complete and accurate list of all holders of
outstanding options to purchase shares of Company Common Stock (such
outstanding options, the "Company Stock Options") under the Company Stock
Plans, indicating the number of shares of Company Common Stock subject to
each Company Stock Option, and the exercise price, the date of grant,
vesting schedule and the expiration date thereof. Section 3.2(b) of the
Company Disclosure Schedule shows the number of shares of Company Common
Stock reserved for future issuance pursuant to warrants or other
outstanding rights to purchase shares of Company Common Stock outstanding
as of the date of this Agreement (such outstanding warrants or other
rights, the "Company Warrants") and the agreement or other document under
which such Company Warrants were granted and sets forth a complete and
accurate list of all holders of Company Warrants indicating the number and
type of shares of Company Common Stock subject to each Company Warrant, and
the exercise price, the date of grant and the expiration date thereof.
Except (x) as
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set forth in this Section 3.2(b) of the Company Disclosure Schedule and (y)
as reserved for future grants under Company Stock Plans, (i) there are no
equity securities of any class of the Company or any of its Subsidiaries,
or any security exchangeable into or exercisable for such equity
securities, issued, reserved for issuance or outstanding and (ii) there are
no options, warrants, equity securities, calls, rights, commitments or
agreements of any character to which the Company or any of its Subsidiaries
is a party or by which the Company or any of its Subsidiaries is bound
obligating the Company or any of its Subsidiaries to issue, transfer,
deliver or sell, or cause to be issued, transferred, delivered or sold,
additional shares of capital stock of the Company or any of its
Subsidiaries or any security or rights convertible into or exchangeable or
exercisable for any such shares, or obligating the Company or any of its
Subsidiaries to grant, extend, accelerate the vesting of, otherwise modify
or amend or enter into any such option, warrant, equity security, call,
right, commitment or agreement. Neither the Company nor any of its
Subsidiaries has issued and outstanding any stock appreciation rights,
phantom stock, performance based rights or similar rights or obligations.
To the knowledge of the Company, other than the Stockholders Agreements,
there are no agreements or understandings with respect to the voting
(including voting trusts and proxies) or sale or transfer (including
agreements imposing transfer restrictions) of any shares of capital stock
of the Company or any of its Subsidiaries.
(c) All outstanding shares of Company Common Stock are, and all shares of
Company Common Stock subject to issuance as specified above, upon issuance
on the terms and conditions specified in the instruments pursuant to which
they are issuable, will be, duly authorized, validly issued, fully paid and
nonassessable and not subject to or issued in violation of any purchase
option, call option, right of first refusal, preemptive right, subscription
right or any similar right under any provision of the TBCA, the Company's
Restated Articles of Incorporation or By-laws or any agreement to which the
Company is a party or is otherwise bound. There are no obligations,
contingent or otherwise, of Company or any of its Subsidiaries to
repurchase, redeem or otherwise acquire any shares of the Company Common
Stock or the capital stock of the Company or any of its Subsidiaries or to
provide funds to or make any material investment (in the form of a loan,
capital contribution or otherwise) in the Company or any Subsidiary of the
Company or any other entity, other than guarantees of bank obligations of
Subsidiaries of the Company entered into in the ordinary course of
business.
(d) All of the outstanding shares of capital stock of each of the
Company's Subsidiaries are duly authorized, validly issued, fully paid,
nonassessable and free of preemptive rights and all such shares are owned,
of record and beneficially, by the Company or another Subsidiary of the
Company free and clear of all security interests, liens, claims, pledges,
agreements, limitations in the Company's voting rights, charges or other
encumbrances of any nature.
(e) No consent of the holders of Company Stock Options is required in
connection with the conversion of such options contemplated by Section
6.11.
3.3 Authority; No Conflict; Required Filings and Consents.
(a) The Company has all requisite corporate power and authority to enter
into this Agreement and the Company Stock Option Agreement and to
consummate the transactions contemplated by this Agreement and the Company
Stock Option Agreement. The execution and delivery of this Agreement and
the Company Stock Option Agreement and the consummation of the transactions
contemplated by this Agreement and the Company Stock Option Agreement by
the Company have been duly authorized by all necessary corporate action on
the part of the Company, subject only to the approval of the Merger by the
Company's stockholders under the TBCA. This Agreement and the Company Stock
Option Agreement have been duly executed and delivered by the Company and
constitute the valid and binding obligations of the Company, enforceable in
accordance with their respective terms, except as such enforceability may
be limited by principles of public policy and subject to bankruptcy,
insolvency and other laws relating to or affecting creditors' rights
generally and to general equitable principles.
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(b) The execution and delivery of this Agreement and the Company Stock
Option Agreement by the Company does not, and the consummation of the
transactions contemplated by this Agreement and the Company Stock Option
Agreement will not, (i) conflict with, or result in any violation or breach
of, any provision of the Restated Articles of Incorporation or By-laws of
the Company or the charter, by-laws, or other organizational document of
any Subsidiary of the Company, (ii) conflict with, or result in any
violation or breach of, or constitute (with or without notice or lapse of
time, or both) a default (or give rise to a right of termination,
cancellation or acceleration of any obligation or loss of any material
benefit) under, or require a consent or waiver under, any of the terms,
conditions or provisions of any note, bond, mortgage, indenture, lease,
license, contract or other agreement, instrument or obligation to which the
Company or any of its Subsidiaries is a party or by which any of them or
any of their properties or assets may be bound, or (iii) subject to
compliance with the requirements specified in clauses (i), (ii), (iii),
(iv) and (v) of Section 3.3(c), conflict with or violate any permit,
concession, franchise, license, judgment, injunction, order, decree,
statute, law, ordinance, rule or regulation applicable to the Company or
any of its Subsidiaries or any of its or their properties or assets, except
in the case of (ii) and (iii) for any such conflicts, violations, breaches,
defaults, terminations, cancellations or accelerations which, individually
or in the aggregate, are not reasonably likely to have a Company Material
Adverse Effect.
(c) No consent, approval, license, permit, order or authorization of, or,
registration, declaration, notice or filing with, any court, arbitrational
tribunal, administrative agency or commission or other governmental or
regulatory authority or agency (a "Governmental Entity") is required by or
with respect to the Company or any of its Subsidiaries in connection with
the execution and delivery of this Agreement and the Company Stock Option
Agreement by the Company or the consummation of the transactions
contemplated by this Agreement or the Company Stock Option Agreement,
except for (i) the filing of a pre-merger notification report under the
Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the "HSR
Act"), (ii) the filing of the Certificate of Merger with the Secretary of
State of the States of Delaware and the filing of Articles of Merger with
the Secretary of State of the State of Texas, (iii) the filing of the Proxy
Statement (as defined in Section 3.16 below) with the Securities and
Exchange Commission (the "SEC") in accordance with the Securities Exchange
Act of 1934, as amended (the "Exchange Act"), (iv) the filing of such
reports or schedules under Section 13 of the Exchange Act as may be
required in connection with this Agreement and the transactions
contemplated hereby and (v) such consents, approvals, orders,
authorizations, registrations, declarations and filings as may be required
under applicable state securities laws.
(d) The affirmative vote of the holders of two-thirds of the outstanding
shares of Company Common Stock on the record date for the Company Meeting
(as defined below) is the only vote of the holders of any class or series
of the Company's capital stock or other securities necessary to approve the
Merger. There are no bonds, debentures, notes or other indebtedness of the
Company having the right to vote (or convertible into, or exchangeable for,
securities having the right to vote) on any matters on which stockholders
of the Company may vote.
3.4 SEC Filings; Financial Statements.
(a) The Company has filed and made available to the Buyer all forms,
reports and other documents required to be filed by the Company with the
SEC since December 18, 1998. All such required forms, reports and other
documents (including those that the Company may file after the date hereof
until the Closing) are referred to herein as the "Company SEC Reports." The
Company SEC Reports (i) were or will be filed on a timely basis, (ii) were
or will be prepared in compliance in all material respects with the
applicable requirements of the Securities Act of 1933, as amended (the
"Securities Act"), and the Exchange Act, as the case may be, and the rules
and regulations of the SEC thereunder applicable to such Company SEC
Reports, and (iii) did not or will not at the time they were or are filed
contain any untrue statement of a material fact or omit to state a material
fact required to be stated in such Company SEC
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Reports or necessary in order to make the statements in such Company SEC
Reports, in the light of the circumstances under which they were made, not
misleading. No Subsidiary of the Company is required to file any forms,
reports or other documents with the SEC.
(b) Each of the consolidated financial statements (including, in each
case, any related notes and schedules) contained or to be contained in the
Company SEC Reports (i) complied or will comply as to form in all material
respects with applicable accounting requirements and the published rules
and regulations of the SEC with respect thereto, (ii) were or will be
prepared in accordance with generally accepted accounting principles
applied on a consistent basis throughout the periods involved (except as
may be indicated in the notes to such financial statements or, in the case
of unaudited statements, as permitted by the SEC on Form 10-Q under the
Exchange Act) and (iii) fairly presented or will fairly present the
consolidated financial position of Company and its Subsidiaries as of the
dates and the consolidated results of its operations and cash flows for the
periods indicated, consistent with the books and records of the Company and
its Subsidiaries, except that the unaudited interim financial statements
were or are subject to normal and recurring year-end adjustments which were
not or are not expected to be material in amount. The unaudited balance
sheet of the Company as of September 30, 1999 is referred to herein as the
"Company Balance Sheet."
3.5 No Undisclosed Liabilities. Except as disclosed in the Company SEC
Reports filed prior to the date of this Agreement, and except for normal or
recurring liabilities incurred since the date of the Company Balance Sheet in
the ordinary course of business consistent with past practices, the Company and
its Subsidiaries do not have any liabilities, either accrued, contingent or
otherwise (whether or not required to be reflected in financial statements in
accordance with generally accepted accounting principles), and whether due or
to become due, which, individually or in the aggregate, are reasonably likely
to have a Company Material Adverse Effect.
3.6 Absence of Certain Changes or Events. Except as disclosed in the Company
SEC Reports filed prior to the date of this Agreement, since the date of the
Company Balance Sheet, the Company and its Subsidiaries have conducted their
respective businesses only in the ordinary course and in a manner consistent
with past practice and, since such date, there has not been (i) any event,
change or development in the business, properties, financial condition, results
of operations or prospects of the Company and its Subsidiaries, taken as a
whole, which, individually or in the aggregate, has had, or is reasonably
likely to have, a Company Material Adverse Effect; (ii) any damage, destruction
or loss (whether or not covered by insurance) with respect to the Company or
any of its Subsidiaries which, individually or in the aggregate, has had, or is
reasonably likely to have, a Company Material Adverse Effect; or (iii) any
other action or event that would have required the consent of the Buyer
pursuant to Section 5.1 of this Agreement had such action or event occurred
after the date of this Agreement.
3.7 Taxes.
(a) The Company and each of its Subsidiaries has filed all Tax Returns
(as defined below) that it was required to file, and all such Tax Returns
were correct and complete except for any errors or omissions which are not,
individually or in the aggregate, reasonably likely to have a Company
Material Adverse Effect. The Company and each of its Subsidiaries has paid
on a timely basis all Taxes (as defined below) that are shown to be due on
any such Tax Returns. The unpaid Taxes of the Company and its Subsidiaries
for Tax periods through the date of the Company Balance Sheet do not exceed
in any material respect the accruals and reserves for Taxes set forth on
the Company Balance Sheet exclusive of any accruals and reserves for
"deferred taxes" or similar items that reflect timing differences between
Tax and financial accounting principles. All Taxes that the Company or any
of its Subsidiaries is or was required by law to withhold or collect have
been duly withheld or collected and, to the extent required, have been paid
to the proper Governmental Entity. For purposes of this Agreement, (i)
"Taxes" means all taxes, charges, fees, levies or other similar assessments
or liabilities, including income, gross receipts, ad valorem, premium,
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<PAGE>
value-added, excise, real property, personal property, sales, use,
services, transfer, withholding, employment, payroll and franchise taxes
imposed by the United States of America or any state, local or foreign
government, or any agency thereof, or other political subdivision of the
United States or any such government, and any interest, fines, penalties,
assessments or additions to tax resulting from, attributable to or incurred
in connection with any tax or any contest or dispute thereof and (ii) "Tax
Returns" means all reports, returns, declarations, statements or other
information required to be supplied to a taxing authority in connection
with Taxes.
(b) The Company has delivered or otherwise made available to the Buyer
correct and complete copies of all federal income Tax Returns, examination
reports and statements of deficiencies assessed against or agreed to by the
Company or any of its Subsidiaries since inception. The federal income Tax
Returns of the Company and each of its Subsidiaries have not been audited
by the Internal Revenue Service or are closed by the applicable statute of
limitations for all taxable years through the taxable year specified in
Section 3.7(b) of the Company Disclosure Schedule. The Company has made
available to the Buyer correct and complete copies of all other Tax Returns
of the Company and its Subsidiaries together with all related examination
reports and statements of deficiency for all periods from and after January
1, 1996. No examination or audit of any Tax Return of the Company or any of
its Subsidiaries by any Governmental Entity is currently in progress or, to
the knowledge of the Company, threatened or contemplated. Neither the
Company nor any of its Subsidiaries has been informed by any Governmental
Entity that the Governmental Entity believes that the Company or any of its
Subsidiaries was required to file any Tax Return that was not filed.
Neither the Company nor any of its Subsidiaries has waived any statute of
limitations with respect to Taxes or agreed to an extension of time with
respect to a Tax assessment or deficiency.
(c) Neither the Company nor any of its Subsidiaries: (i) is a "consenting
corporation" within the meaning of Section 341(f) of the Code, and none of
the assets of the Company or its Subsidiaries are subject to an election
under Section 341(f) of the Code; (ii) has been a United States real
property holding corporation within the meaning of Section 897(c)(2) of the
Code during the applicable period specified in Section 897(c)(l)(A)(ii) of
the Code; (iii) has made any payments, is obligated to make any payments,
or is a party to any agreement that could obligate it to make any payments
that may be treated as an "excess parachute payment" under Section 280G of
the Code; (iv) has any actual or potential liability for any Taxes of any
person (other than the Company and its Subsidiaries) under Treasury
Regulation Section 1.1502-6 (or any similar provision of law in any
jurisdiction), or as a transferee or successor, by contract, or otherwise;
or (v) is or has been required to make a basis reduction pursuant to
Treasury Regulation Section 1.1502-20(b) or Treasury Regulation Section
1.337(d)-2(b).
(d) None of the assets of the Company or any of its Subsidiaries: (i) is
property that is required to be treated as being owned by any other person
pursuant to the provisions of former Section 168(f)(8) of the Code; (ii) is
"tax-exempt use property" within the meaning of Section 168(h) of the Code;
or (iii) directly or indirectly secures any debt the interest on which is
tax exempt under Section 103(a) of the Code.
(e) Neither the Company nor any of its Subsidiaries has undergone, or
will undergo as a result of the transactions contemplated by the Agreement,
a change in its method of accounting resulting in an adjustment to its
taxable income pursuant to Section 481(h) of the Code.
(f) No state or federal "net operating loss" of the Company determined as
of the Closing Date is subject to limitation on its use pursuant to Section
382 of the Code or comparable provisions of state law as a result of any
"ownership change" within the meaning of Section 382(g) of the Code or
comparable provisions of any state law occurring prior to the Closing Date.
(g) Neither the Company nor any of its Subsidiaries (i) is or has ever
been a member of a group of corporations with which it has filed (or been
required to file) consolidated, combined or unitary Tax
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Returns, other than a group of which only the Company and its Subsidiaries
are or were members or (ii) is a party to or bound by any Tax indemnity,
Tax sharing or Tax allocation agreement.
3.8 Owned and Leased Real Properties.
(a) The Company does not and has never owned any real property.
(b) The Company has provided or otherwise made available to the Buyer a
complete and accurate list of all real property leased by the Company or
its Subsidiaries (collectively "Company Leases") and the location of the
premises. The Company is not in default under any of the Company Leases.
Each of the Company Leases is in full force and effect and will not cease
to be in full force and effect as a result of the transactions contemplated
by this Agreement.
3.9 Intellectual Property.
(a) The Company and its Subsidiaries exclusively own, or are licensed or
otherwise possess legally enforceable rights to use on an exclusive basis,
without any obligation to make any fixed or contingent payments, including
any royalty payments, all patents, trademarks, trade names, domain names,
service marks and copyrights, any applications for and registrations of
such patents, trademarks, trade names, domain names, service marks and
copyrights, and all processes, formulae, methods, schematics, technology,
know-how, computer software programs or applications and tangible or
intangible proprietary information or material that are used or necessary
to conduct the business of the Company and its Subsidiaries as currently
conducted (the "Company Intellectual Property Rights").
(b) The execution and delivery of this Agreement and consummation of the
Merger will not result in the breach of, or create on behalf of any third
party the right to terminate or modify, any material license, sublicense or
other agreement relating to the Company Intellectual Property Rights, or
any license, sublicense and other agreement as to which the Company or any
of its Subsidiaries is a party and pursuant to which the Company or any of
its Subsidiaries is authorized to use any third party patents, trademarks,
copyrights or trade secrets (the "Company Third Party Intellectual Property
Rights"), including software that is used in the manufacture of,
incorporated in, or forms a part of any product or service sold by or
expected to be sold by a Company or any of its Subsidiaries.
(c) All patents, registered trademarks, service marks and copyrights
which are held by the Company or any of its Subsidiaries and which are
material to the business of the Company and its Subsidiaries, taken as a
whole, are valid and subsisting. The Company and its Subsidiaries have
taken commercially reasonable measures to protect the proprietary nature of
the Company Intellectual Property Rights that are material to the business
of the Company and its Subsidiaries, taken as a whole, and to maintain in
confidence all trade secrets and confidential information owned or used by
the Company or any of its Subsidiaries and that are material to the
business of the Company and its Subsidiaries, taken as a whole. To the
knowledge of the Company, no other person or entity is infringing,
violating or misappropriating any of the Company Intellectual Property
Rights. None of the activities or business previously or currently
conducted by the Company or any of the Subsidiaries infringes, violates or
constitutes a misappropriation of, any patents, trademarks, trade names,
service marks and copyrights, any applications for and registrations of
such patents, trademarks, trade names, service marks and copyrights, and
all processes, formulae, methods, schematics, technology, know-how,
computer software programs or applications and tangible or intangible
proprietary information or material of any other person or entity. Neither
the Company nor any of its Subsidiaries has received any complaint, claim
or notice alleging any such infringement, violation or misappropriation.
3.10 Agreements, Contracts and Commitments.
(a) There are no contracts or agreements that are material contracts (as
defined in Item 601(b)(10) of Regulation S-K) with respect to the Company
and its Subsidiaries (the "Company Material Contracts"),
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other than the Company Material Contracts identified on the exhibit indices
of the Company SEC Reports filed prior to the date of this Agreement. Each
Company Material Contract has not expired by its terms and is in full force
and effect. Neither the Company nor any of its Subsidiaries is in violation
of or in default under (nor does there exist any condition which, upon the
passage of time or the giving of notice or both, would cause such a
violation of or default under) any loan or credit agreement, note, bond,
mortgage, indenture, lease, permit, concession, franchise, license or other
contract, arrangement or understanding to which it is a party or by which
it or any of its properties or assets is bound, except for violations or
defaults which, individually or in the aggregate, have not resulted in, and
are not reasonably likely to result in, a Company Material Adverse Effect.
(b) Section 3.10(b) of the Company Disclosure Schedule sets forth a
complete list of each contract or agreement to which the Company or any of
its Subsidiaries is a party or bound with any Affiliate of the Company
(other than any Subsidiary which is a direct or indirect wholly owned
Subsidiary of the Company).
3.11 Litigation. Except as disclosed in the Company SEC Reports filed prior
to the date of this Agreement, there is no action, suit, proceeding, claim,
arbitration or investigation pending or, to the knowledge of the Company,
threatened against or affecting the Company or any of its Subsidiaries which,
individually or in the aggregate, has had, or is reasonably likely to have, a
Company Material Adverse Effect. There are no judgments, orders or decrees
outstanding against the Company.
3.12 Environmental Matters.
(a) Except as disclosed in the Company SEC Reports filed prior to the
date of this Agreement and except for such matters which, individually or
in the aggregate, have not had, and are not reasonably likely to have a
Company Material Adverse Effect: (i) the Company and each of its
Subsidiaries has complied with, and is not in violation of, any applicable
Environmental Laws (as defined in Section 3.12(b)); (ii) the properties
currently owned or operated by the Company and its Subsidiaries (including
soils, groundwater, surface water, buildings or other structures) are not
contaminated with any Hazardous Substances (as defined in Section 3.12(c));
(iii) the properties formerly owned or operated by the Company or any of
its Subsidiaries were not contaminated with Hazardous Substances prior to
or during the period of ownership or operation by the Company or any of its
Subsidiaries; (iv) neither the Company nor its Subsidiaries are subject to
liability for any Hazardous Substance disposal or contamination on the
property of any third party; (v) neither the Company nor any of its
Subsidiaries have released any Hazardous Substance to the environment; (vi)
neither the Company nor any of its Subsidiaries has received any notice,
demand, letter, claim or request for information alleging that the Company
or any of its Subsidiaries may be in violation of, liable under or have
obligations under any Environmental Law; (vii) neither the Company nor any
of its Subsidiaries is subject to any orders, decrees, injunctions or other
arrangements with any Governmental Entity or is subject to any indemnity or
other agreement with any third party relating to liability under any
Environmental Law or relating to Hazardous Substances; and (viii) there are
no circumstances or conditions involving the Company or any of its
Subsidiaries that could reasonably be expected to result in any claims,
liability, obligations, investigations, costs or restrictions on the
ownership, use or transfer of any property of the Company or any of its
Subsidiaries pursuant to any Environmental Law.
(b) For purposes of this Agreement, "Environmental Law" means any law,
regulation, order, decree, permit, authorization, opinion, common law or
agency requirement of any jurisdiction relating to: (A) the protection,
investigation or restoration of the environment, human health and safety,
or natural resources, (B) the handling, use, presence, disposal, release or
threatened release of any Hazardous Substance or (C) noise, odor, wetlands,
pollution, contamination or any injury or threat of injury to persons or
property.
(c) For purposes of this Agreement, "Hazardous Substance" means any
substance that is: (A) listed, classified, regulated or which falls within
the definition of a "hazardous substance" or "hazardous
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material" pursuant to any Environmental Law; (B) any petroleum product or
by-product, asbestos-containing material, lead-containing paint or
plumbing, polychlorinated biphenyls, radioactive materials or radon; or (C)
any other substance which is the subject of regulatory action by any
Governmental Entity pursuant to any Environmental Law.
(d) Section 3.12(d) of the Company Disclosure Schedule sets forth a
complete and accurate list of all documents (whether in hard copy or
electronic form) that contain any environmental reports, investigations and
audits relating to premises currently or previously owned or operated by
the Company or any of its Subsidiaries (whether conducted by or on behalf
of the Company or one of its Subsidiaries or a third party, and whether
done at the initiative of the Company or one of its Subsidiaries or
directed by a Governmental Entity or other third party) which were issued
or conducted during the past five years and which the Company has
possession of or access to. A complete and accurate copy of each such
document has been provided to the Buyer.
3.13 Employee Benefit Plans.
(a) Section 3.13(a) of the Company Disclosure Schedule sets forth a
complete and accurate list of all Employee Benefit Plans (as defined below)
maintained, or contributed to, by the Company, any Subsidiary of the
Company or any ERISA Affiliate (as defined below) (together, the "Company
Employee Plans"). For purposes of this Agreement, the following terms shall
have the following meanings: (i) "Employee Benefit Plan" means any
"employee pension benefit plan" (as defined in Section 3(2) of ERISA), any
"employee welfare benefit plan" (as defined in Section 3(1) of ERISA), and
any other written or oral plan, agreement or arrangement involving direct
or indirect compensation, including insurance coverage, severance benefits,
disability benefits, deferred compensation, bonuses, stock options, stock
purchase, phantom stock, stock appreciation or other forms of incentive
compensation or post-retirement compensation; (ii) "ERISA" means the
Employee Retirement Income Security Act of 1974, as amended; and (iii)
"ERISA Affiliate" means any entity which is, or at any applicable time was,
a member of (1) a controlled group of corporations (as defined in Section
414(b) of the Code), (2) a group of trades or businesses under common
control (as defined in Section 414(c) of the Code), or (3) an affiliated
service group (as defined under Section 414(m) of the Code or the
regulations under Section 414(o) of the Code), any of which includes or
included the Company or a Subsidiary.
(b) With respect to each Company Employee Plan, the Company has furnished
or otherwise made available to the Buyer, a complete and accurate copy of
(i) such Company Employee Plan (or a written summary of any unwritten
plan), (ii) the most recent annual report (Form 5500) filed with the IRS,
(iii) each trust agreement, group annuity contract and summary plan
description, if any, relating to such Company Employee Plan and (iv) all
reports regarding the satisfaction of the nondiscrimination requirements of
Sections 410(b), 401(k) and 401(m) of the Code.
(c) Each Company Employee Plan has been administered in all material
respects in accordance with its terms and each of the Company, the
Company's Subsidiaries and their ERISA Affiliates has in all material
respects met its obligations with respect to such Company Employee Plan and
has made in all material respects all required contributions thereto. With
respect to the Company Employee Plans, no event has occurred, and to the
knowledge of the Company, there exists no condition or set of circumstances
in connection with which the Company or any of its Subsidiaries could be
subject to any liability under ERISA, the Code or any other applicable law
which, individually or in the aggregate, is reasonably likely to have a
Company Material Adverse Effect.
(d) With respect to the Company Employee Plans, there are no material
funded benefit obligations for which contributions have not been made or
properly accrued and there are no material unfunded benefit obligations
which have not been accounted for by reserves, or otherwise properly
footnoted in accordance with generally accepted accounting principles, on
the financial statements of the Company.
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(e) All the Company Benefit Plans that are intended to be qualified under
Section 401(a) of the Code have received determination letters from the
Internal Revenue Service to the effect that such Company Benefit Plans are
qualified and the plans and trusts related thereto are exempt from federal
income taxes under Sections 401(a) and 501(a), respectively, of the Code,
no such determination letter has been revoked and revocation has not been
threatened, and no such Employee Benefit Plan has been amended or operated
since the date of its most recent determination letter or application
therefor in any respect, and no act or omission has occurred, that would
adversely affect its qualification or materially increase its cost.
(f) Neither the Company, any Subsidiary of the Company nor any ERISA
Affiliate has (i) ever maintained a Company Employee Plan which was ever
subject to Section 412 of the Code or Title IV of ERISA or (ii) ever been
obligated to contribute to a "multiemployer plan" (as defined in Section
4001(a)(3) of ERISA). No Company Benefit Plan is funded by, associated with
or related to a "voluntary employee's beneficiary association" within the
meaning of Section 501(c)(9) of the Code.
(g) Each Company Benefit Plan is amendable and terminable unilaterally by
the Company at any time without liability to the Company as a result
thereof and no Company Benefit Plan, plan documentation or agreement,
summary plan description or other written communication distributed
generally to employees by its terms prohibits the Company from amending or
terminating any such Company Benefit Plan.
(h) Except as disclosed in the Company SEC Reports filed prior to the
date of this Agreement, neither the Company nor any of its Subsidiaries is
a party to any oral or written (i) agreement with any stockholders,
director, executive officer or other key employee of the Company or any of
its Subsidiaries (A) the benefits of which are contingent, or the terms of
which are materially altered, upon the occurrence of a transaction
involving the Company or any of its Subsidiaries of the nature of any of
the transactions contemplated by this Agreement, (B) providing any term of
employment or compensation guarantee or (C) providing severance benefits or
other benefits after the termination of employment of such director,
executive officer or key employee; (ii) agreement, plan or arrangement
under which any person may receive payments from the Company or any of its
Subsidiaries that may be subject to the tax imposed by Section 4999 of the
Code or included in the determination of such person's "parachute payment"
under Section 280G of the Code; and (iii) agreement or plan binding the
Company or any of its Subsidiaries, including any stock option plan, stock
appreciation right plan, restricted stock plan, stock purchase plan or
severance benefit plan, any of the benefits of which will be increased, or
the vesting of the benefits of which will be accelerated, by the occurrence
of any of the transactions contemplated by this Agreement or the value of
any of the benefits of which will be calculated on the basis of any of the
transactions contemplated by this Agreement.
3.14 Compliance With Laws. The Company and each of its Subsidiaries has
complied with, is not in violation of, and has not received any notice alleging
any violation with respect to, any applicable provisions of any statute, law or
regulation with respect to the conduct of its business, or the ownership or
operation of its properties or assets, except for failures to comply or
violations which, individually or in the aggregate, have not had, and are not
reasonably likely to have, a Company Material Adverse Effect.
3.15 Permits. The Company and each of its Subsidiaries have all permits,
licenses and franchises from Governmental Entities required to conduct their
businesses as now being conducted or as presently contemplated to be conducted
(the "Company Permits"), except for such permits, licenses and franchises the
absence of which, individually or in the aggregate, have not resulted in, and
are not reasonably likely to result in, a Company Material Adverse Effect. The
Company and its Subsidiaries are in compliance with the terms of the Company
Permits, except for failures to comply which, individually or in the aggregate,
have not had and are not reasonably likely to have, a Company Material Adverse
Effect.
3.16 Registration Statement; Proxy Statement/Prospectus. The information to
be supplied by the Company for inclusion in the registration statement on Form
S-4 pursuant to which shares of Buyer Common Stock issued in the Merger will be
registered under the Securities Act (the "Registration Statement"), shall not
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at the time the Registration Statement is declared effective by the SEC contain
any untrue statement of a material fact or omit to state any material fact
required to be stated in the Registration Statement or necessary in order to
make the statements in the Registration Statement, in light of the
circumstances under which they were made, not misleading. The information to be
supplied by the Company for inclusion in the proxy statement/prospectus (the
"Proxy Statement") to be sent to the stockholders of the Company in connection
with the meeting of the Company's stockholders to consider this Agreement and
the Merger (the "Company Meeting") shall not, on the date the Proxy Statement
is first mailed to stockholders of the Company, at the time of the Company
Meeting and at the Effective Time, contain any statement which, at such time
and in light of the circumstances under which it shall be made, is false or
misleading with respect to any material fact, or omit to state any material
fact necessary in order to make the statements made in the Proxy Statement not
false or misleading; or omit to state any material fact necessary to correct
any statement in any earlier communication with respect to the solicitation of
proxies for the Company Meeting which has become false or misleading. If at any
time prior to the Effective Time any event relating to the Company or any of
its Affiliates, officers or directors should be discovered by the Company which
should be set forth in an amendment to the Registration Statement or a
supplement to the Proxy Statement, the Company shall promptly inform the Buyer.
3.17 Labor Matters. Neither the Company nor any of its Subsidiaries is a
party to or otherwise bound by any collective bargaining agreement, contract or
other agreement or understanding with a labor union or labor organization.
Neither the Company nor any of its Subsidiaries is the subject of any
proceeding asserting that the Company or any of its Subsidiaries has committed
an unfair labor practice or is seeking to compel it to bargain with any labor
union or labor organization, nor is there pending or, to the knowledge of the
Company, threatened, any labor strike, dispute, walkout, work stoppage, slow-
down or lockout involving the Company or any of its Subsidiaries.
3.18 Insurance. Each of the Company and its Subsidiaries maintains insurance
policies (the "Insurance Policies") with reputable insurance carriers against
all risks of a character and in such amounts as are usually insured against by
similarly situated companies in the same or similar businesses. Each Insurance
Policy is in full force and effect and is valid, outstanding and enforceable,
and all premiums due thereon have been paid in full. None of the Insurance
Policies will terminate or lapse (or be affected in any other materially
adverse manner) by reason of the transactions contemplated by this Agreement.
The Company and its Subsidiaries have complied in all material respects with
the provisions of each Insurance Policy under which it is the insured party. No
insurer under any Insurance Policy has canceled or generally disclaimed
liability under any such policy or indicated any intent to do so or not to
renew any such policy. All material claims under the Insurance Policies have
been filed in a timely fashion.
3.19 Business Activity Restrictions. There is no non-competition or other
similar agreement, commitment, judgment, injunction, order to create to which
the Company or any Subsidiary of the Company is a party or subject to that has
or could reasonably be expected to have the effect of prohibiting or impairing
the conduct of the business by the Company in any material respect. The Company
has not entered into any agreement under which it is restricted in any material
respect from selling, licensing or otherwise distributing any of its technology
or products, or providing services to, customers or potential customers or any
class of customers, in any geographic area, during any period of time or any
segment of the market or line of business.
3.20 Year 2000 Compliance.
(a) The Company has conducted "year 2000" audits with respect to (i) all
of the internal systems of the Company and each of its Subsidiaries used in
the business or operations of the Company or any of its Subsidiaries,
including, without limitation, computer hardware systems, software
applications, firmware, equipment firmware and other embedded systems, and
(ii) the software, hardware, firmware and other technology which constitute
part of the products and services marketed or sold by the Company or any of
its Subsidiaries or licensed by the Company or any of its Subsidiaries to
third parties. The Company has requested in writing "year 2000" compliance
certificates with respect to all material third-party systems used in
connection with the business or operations of the Company and its
Subsidiaries. Communications
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to date with the Company's major telecommunications, information systems
and software vendors indicate that these third parties expect, at this
time, to be compliant by the year 2000 based on their progress to date.
(b) All of (i) the material internal systems of the Company and each of
its Subsidiaries used in the business or operations of the Company or any
of its Subsidiaries, as the case may be, including, without limitation,
computer hardware systems, software applications, firmware, equipment
containing embedded microchips and other embedded systems (collectively,
the "Company Systems"), and (ii) the software, hardware, firmware and other
technology which constitute part of the products and services marketed or
sold by the Company or any of its Subsidiaries or licensed by the Company
or any of its Subsidiaries to third parties (collectively, the "Company
Products") will be Year 2000 Compliant by the end of November 1999.
(c) The Company has no knowledge of any failure to be Year 2000 Compliant
of any material third-party system used in connection with the business or
operations of the Company and its Subsidiaries.
(d) For purposes of this Agreement, "Year 2000 Compliant" means that the
applicable system or item:
(i) accurately receives, records, stores, provides, recognizes and
processes all date and time data from, during, into and between the
twentieth and twenty-first centuries, the years 1999 and 2000 and all
leap years;
(ii) accurately performs all date-dependent calculations and
operations (including, without limitation, mathematical operations,
sorting, comparing and reporting) from, during, into and between the
twentieth and twenty-first centuries, the years 1999 and 2000 and all
leap years; and
(iii) does not malfunction, cease to function or provide invalid or
incorrect results as a result of (x) the change of years from 1999 to
2000 or from 2000 to 2001, (y) date data, including date data which
represents or references different centuries, different dates during
1999 and 2000, or more than one century or (z) the occurrence of any
particular date;
in each case without human intervention, other than original data entry;
provided, in each case, that all applications, hardware and other systems
used in conjunction with such system or item which are not owned or
licensed by the Company or any of its Subsidiaries correctly exchange date
data with or provide data to such system or item.
(e) Neither the Company nor any of its Subsidiaries has provided any
guarantee or warranty for any product sold or licensed, or service
provided, by the Company or any Subsidiary to the effect that such product
or service (i) complies with or accounts for the fact of the arrival of the
year 2000, (ii) will not be adversely affected with respect to
functionality, interoperability, performance or volume capacity (including,
without limitation, the processing and reporting of data) by virtue of the
arrival of the year 2000 or (iii) is otherwise Year 2000 Compliant.
3.21 Assets. Each of the Company and its Subsidiaries owns or leases all
tangible assets necessary for the conduct of its businesses as presently
conducted. All of such tangible assets which are owned, are owned free and
clear of all mortgages, security interest, pledges, liens and encumbrances
("Liens") except for (i) Liens which are disclosed in the Company SEC Reports
filed prior to the date of this Agreement and (ii) other Liens which,
individually and in the aggregate, do not materially interfere with the ability
of the Company and its Subsidiaries to conduct their business as currently
conducted and have not resulted in, and are not reasonably likely to result in,
a Company Material Adverse Effect. The tangible assets of the Company and its
Subsidiaries, taken as a whole, are free from material defects, have been
maintained in accordance with normal industry practice, are in good operating
condition and repair (subject to normal wear and tear) and are suitable for the
purpose for which they are presently used.
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3.22 Subscribers. Section 3.22 of the Company Disclosure Schedule sets forth
the total number of the Company's subscribers as of October 31, 1999 who, as of
such date, had paid at least one monthly bill for the Company's services.
3.23 Accounts Receivable. All accounts receivable of the Company reflected on
the Company Balance Sheet are valid receivables, arose from bona fide sales of
goods and services in the ordinary course of business, and are not subject to
any material setoffs or counterclaims.
3.24 No Existing Discussions. As of the date of this Agreement, neither the
Company nor any of its Subsidiaries is engaged, directly or indirectly, in any
discussions or negotiations with any other party with respect to an Alternative
Transaction (as defined in Section 8.3(g)).
3.25 Opinion of Financial Advisor. The financial advisor of the Company,
Goldman, Sachs & Co., has delivered to the Company an opinion dated the date of
this Agreement to the effect, as of such date, that the Exchange Ratio is fair
to the holders of the Company Common Stock from a financial point of view, a
signed copy of which opinion will be delivered to the Buyer promptly after the
date hereof.
3.26 Part Thirteen of the TBCA Not Applicable. The Board of Directors of the
Company has taken all actions necessary so that the restrictions contained in
Part Thirteen of the TBCA applicable to a "business combination" (as defined
therein) will not apply to the execution, delivery or performance of this
Agreement, the Company Stock Option Agreement, the Stockholder Agreements or
the consummation of the Merger or the other transactions contemplated by this
Agreement, the Company Stock Option Agreement or the Stockholder Agreements.
3.27 Tax Matters. To the Company's knowledge, after consulting with its
independent auditors, neither the Company nor any of its Affiliates has taken
or agreed to take any action which would prevent the Merger from constituting a
transaction qualifying as a reorganization under Section 368(a) of the Code.
3.28 Transactions with Affiliates. Except as disclosed in the Company SEC
Reports filed prior to the date of this Agreement, neither the Company nor any
of its Subsidiaries has entered into any transaction with any director, officer
or other affiliate of the Company or any of its Subsidiaries or any transaction
that would be subject to proxy statement disclosure pursuant to Item 404 of
Regulation S-K.
3.29 Brokers; Schedule of Fees and Expenses.
(a) No agent, broker, investment banker, financial advisor or other firm
or person is or will be entitled to any broker's, finder's, financial
advisor's or other similar fee or commission in connection with any of the
transactions contemplated by this Agreement, except Goldman, Sachs & Co.,
whose fees and expense will be paid by the Company. The Company has
delivered to the Buyer a complete and accurate copy of all agreements
pursuant to which Goldman, Sachs & Co. is entitled to any fees and expenses
in connection with any of the transactions contemplated by this Agreement.
(b) Section 3.29(b) of the Company Disclosure Schedule sets forth a
complete and accurate list of the estimated fees and expenses incurred and
to be incurred by the Company and any of its Subsidiaries in connection
with this Agreement and the transactions contemplated by this Agreement
(including the fees and expenses of Goldman, Sachs & Co. and of the
Company's legal counsel and accountants).
3.30 Disclosure. No representation or warranty by the Company contained in
this Agreement, and no statement contained in the Company Disclosure Schedule
or any other document, certificate or other instrument delivered to or to be
delivered by or on behalf of the Company pursuant to this Agreement, contains
or will contain any untrue statement of a material fact or omits or will omit
to state any material fact necessary, in light of the circumstances under which
it was or will be made, in order to make the statements herein or therein not
misleading.
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ARTICLE IV
REPRESENTATIONS AND WARRANTIES OF THE BUYER AND
THE TRANSITORY SUBSIDIARY
The Buyer and the Transitory Subsidiary represent and warrant to the Company
that the statements contained in this Article IV are true and correct, except
as set forth herein or in the disclosure schedule delivered by the Buyer to the
Company on or before the date of this Agreement (the "Buyer Disclosure
Schedule"). The Buyer Disclosure Schedule shall be arranged in paragraphs
corresponding to the numbered and lettered paragraphs contained in this Article
IV and the disclosure in any paragraph shall qualify other paragraphs in this
Article IV only to the extent that it is reasonably apparent from a reading of
such document that it also qualifies or applies to such other paragraphs.
4.1 Organization, Standing and Power. Each of the Buyer and the Transitory
Subsidiary and the Buyer's other Subsidiaries is a corporation duly organized,
validly existing and in good standing under the laws of the jurisdiction of its
incorporation, has all requisite corporate power and authority to own, lease
and operate its properties and assets and to carry on its business as now being
conducted and as proposed to be conducted, and is duly qualified to do business
and is in good standing as a foreign corporation in each jurisdiction in which
the failure to be so qualified, individually or in the aggregate, would be
reasonably likely to have a material adverse effect on the business,
properties, financial condition, results of operations or prospects of the
Buyer and its Subsidiaries, taken as a whole, or to have a material adverse
effect on the ability of the Buyer to consummate the transactions contemplated
by this Agreement (a "Buyer Material Adverse Effect").
4.2 Capitalization. The authorized capital stock of the Buyer consists of
150,000,000 shares of Buyer Common Stock and 10,000,000 shares of preferred
stock, $.01 par value per share (the "Buyer Preferred Stock"). As of the close
of business on the date immediately preceding the date of this Agreement,
64,152,028 shares of Buyer Common Stock were issued and outstanding and no
shares of Buyer Preferred Stock were issued and outstanding. All outstanding
shares of Buyer Common Stock are, and all shares of Buyer Common Stock subject
to issuance as specified above, upon issuance on the terms and conditions
specified in the instruments pursuant to which they are issuable, will be, duly
authorized, validly issued, fully paid and nonassessable. All of the shares of
Buyer Common Stock issuable pursuant to Section 2.1(c) in connection with the
Merger, when issued in accordance with this Agreement, will be duly authorized,
validly issued, fully paid and nonassessable.
4.3 Authority; No Conflict; Required Filings and Consents.
(a) Each of the Buyer and the Transitory Subsidiary has all requisite
corporate power and authority to enter into this Agreement and to
consummate the transactions contemplated by this Agreement. The execution
and delivery of this Agreement and the consummation of the transactions
contemplated by this Agreement by the Buyer and the Transitory Subsidiary
have been duly authorized by all necessary corporate action on the part of
each of the Buyer and the Transitory Subsidiary (including the approval of
the Merger by the Buyer as the sole stockholder of the Transitory
Subsidiary). This Agreement and has been duly executed and delivered by
each of the Buyer and the Transitory Subsidiary and constitutes the valid
and binding obligation of each of the Buyer and the Transitory Subsidiary,
enforceable in accordance with its terms.
(b) The execution and delivery of this Agreement by each of the Buyer and
the Transitory Subsidiary does not, and the consummation of the
transactions contemplated by this Agreement will not, (i) conflict with, or
result in any violation or breach of, any provision of the Certificate of
Incorporation or By-laws of the Buyer or the Transitory Subsidiary, (ii)
conflict with, or result in any violation or breach of, or constitute (with
or without notice or lapse of time, or both) a default (or give rise to a
right of termination, cancellation or acceleration of any obligation or
loss of any material benefit) under, or require a consent or
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waiver under, any of the terms, conditions or provisions of any note, bond,
mortgage, indenture, lease, license, contract or other agreement,
instrument or obligation to which the Buyer or any of its Subsidiaries is a
party or by which any of them or any of their properties or assets may be
bound, or (iii) subject to compliance with the requirements specified in
clause (i), (ii), (iii), (iv), (v) and (vi) of Section 4.3(c), conflict
with or violate any permit, concession, franchise, license, judgment,
injunction, order, decree, statute, law, ordinance, rule or regulation
applicable to the Buyer or any of its Subsidiaries or any of its or their
properties or assets, except in the case of (ii) and (iii) for any such
conflicts, violations, breaches, defaults, terminations, cancellations or
accelerations which, individually or in the aggregate, are not reasonably
likely to have a Buyer Material Adverse Effect.
(c) No consent, approval, license, permit, order or authorization of, or
registration, declaration, notice or filing with, any Governmental Entity
is required by or with respect to the Buyer or any of its Subsidiaries in
connection with the execution and delivery of this Agreement by the Buyer
or the Transitory Subsidiary or the consummation of the transactions
contemplated by this Agreement, except for (i) the filing of a pre-merger
notification report under the HSR Act, (ii) the filing of the Certificate
of Merger with the Secretary of State of the States of Delaware and Texas,
(iii) the filing of the Registration Statement with the SEC in accordance
with the Securities Act, (iv) the filings of such reports or schedules
under Section 13 of the Exchange Act as may be required in connection with
this Agreement and the transactions contemplated hereby, (v) such consents,
approvals, orders, authorizations, registrations, declarations and filings
as may be required under applicable state securities laws and (vi) the
filing with the Nasdaq National Market of a Notification Form for Listing
of Additional Shares with respect to the Buyer Common Stock issuable in
connection with the Merger.
4.4 SEC Filings; Financial Statements.
(a) The Buyer has filed and made available to the Company all forms,
reports and other documents required to be filed by the Buyer with the SEC
since September 25, 1998. All such required forms, reports and other
documents (including those that the Buyer may file after the date hereof
until the Closing) are referred to herein as the "Buyer SEC Reports." The
Buyer SEC Reports (i) were or will be filed on a timely basis, (ii) were or
will be prepared in compliance in all material respects with the applicable
requirements of the Securities Act and the Exchange Act, as the case may
be, and the rules and regulations of the SEC thereunder applicable to such
Buyer SEC Reports, and (iii) did not or will not at the time they were or
are filed contain any untrue statement of a material fact or omit to state
a material fact required to be stated in such Buyer SEC Reports or
necessary in order to make the statements in such Buyer SEC Reports, in the
light of the circumstances under which they were made, not misleading.
(b) Each of the consolidated financial statements (including, in each
case, any related notes and schedules) contained or to be contained in the
Buyer SEC Reports (i) complied or will comply as to form in all material
respects with applicable accounting requirements and the published rules
and regulations of the SEC with respect thereto, (ii) were or will be
prepared in accordance with generally accepted accounting principles
applied on a consistent basis throughout the periods involved (except as
may be indicated in the notes to such financial statements or, in the case
of unaudited statements, as permitted by the SEC on Form 10-Q under the
Exchange Act) and (iii) fairly presented or will fairly present the
consolidated financial position of the Buyer and its Subsidiaries as of the
dates and the consolidated results of its operations and cash flows for the
periods indicated, consistent with the books and records of the Buyer and
its Subsidiaries, except that the unaudited interim financial statements
were or are subject to normal and recurring year-end adjustments which were
not or are not expected to be material in amount. The unaudited balance
sheet of the Buyer as of September 30, 1999 is referred to herein as the
"Buyer Balance Sheet."
4.5 Absence of Certain Changes or Events. Except as disclosed in the Buyer
SEC Reports filed prior to the date of this Agreement, since the date of the
Buyer Balance Sheet, there has not been any event, change or
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development in the business, properties, financial condition, results of
operations or prospects of the Buyer and its Subsidiaries, taken as a whole,
which has had, or is reasonably likely to have, a Buyer Material Adverse
Effect.
4.6 Tax Matters. To the Buyer's knowledge, after consulting with its
independent auditors, neither the Buyer nor any of its Affiliates has taken or
agreed to take any action which would prevent the Merger from constituting a
transaction qualifying as a reorganization under Section 368(a) of the Code.
4.7 Litigation. Except as disclosed in the Buyer SEC Reports filed prior to
the date of this Agreement, there is no action, suit, proceeding, claim,
arbitration or investigation pending or, to the knowledge of the Buyer,
threatened against or affecting the Buyer or any of its Subsidiaries which,
individually or in the aggregate, has had, or is reasonably likely to have, a
Buyer Material Adverse Effect. There are no judgments, orders or decrees
outstanding against the Buyer.
4.8 Compliance with Laws. Each of the Buyer and the Transitory Subsidiary has
complied with, is not in violation of, and has not received any notice alleging
any violation with respect to, any applicable provisions of any statute, law or
regulation with respect to the conduct of its business, or the ownership or
operation of its properties or assets, except for failures to comply or
violations which, individually or in the aggregate, have not had, and would not
have, a Buyer Material Adverse Effect.
4.9 Registration Statement; Proxy Statement/Prospectus. The information in
the Registration Statement (except for information supplied by the Company for
inclusion in the Registration Statement, as to which the Buyer makes no
representation and which shall not constitute part of the Buyer SEC Report for
purposes of this Agreement) shall not at the time the Registration Statement is
declared effective by the SEC contain any untrue statement of a material fact
or omit to state any material fact required to be stated in the Registration
Statement or necessary in order to make the statements in the Registration
Statement, in light of the circumstances under which they were made, not
misleading. If at any time prior to the Effective Time any event relating to
the Buyer or any of its Affiliates, officers or directors should be discovered
by the Buyer which should be set forth in an amendment to the Registration
Statement, the Buyer shall promptly inform the Company.
4.10 Operations of the Transitory Subsidiary. The Transitory Subsidiary was
formed solely for the purpose of engaging in the transactions contemplated by
this Agreement, has engaged in no other business activities and has conducted
its operations only as contemplated by this Agreement.
4.11 Brokers. The Buyer has not retained or incurred any liability to any
agent, broker, investment banker, financial advisor or similar firm or person
in connection with any of the transactions contemplated by this Agreement,
except Bear, Stearns & Co. Inc., whose fees and expenses will be paid by the
Buyer.
4.12 Disclosure. No representation or warranty by the Buyer contained in this
Agreement, and no statement contained in any document, certificate or other
instrument delivered to or to be delivered by or on behalf of the Buyer
pursuant to this Agreement, contains or will contain any untrue statement of a
material fact or omits or will omit to state any material fact necessary, in
light of the circumstances under which it was or will be made, in order to make
the statements herein or therein not misleading.
ARTICLE V
CONDUCT OF BUSINESS
5.1 Covenants of the Company. Except as expressly provided herein or as
consented to in writing by the Buyer, from and after the date of this Agreement
until the earlier of the termination of this Agreement in accordance with its
terms or the Effective Time, the Company shall, and shall cause each of its
Subsidiaries to, act and carry on its business in the usual, regular and
ordinary course in substantially the same manner as
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previously conducted, pay its debts and Taxes and perform its other obligations
when due (subject to good faith disputes over such debts, Taxes or
obligations), and use all reasonable efforts, consistent with past practices,
to maintain and preserve its and each Subsidiary's business organization,
assets and properties, keep available the services of its present officers and
employees and preserve its advantageous business relationships with customers,
suppliers, distributors and others having business dealings with it to the end
that its goodwill and ongoing business shall be unimpaired at the Effective
Time. Without limiting the generality of the foregoing, from and after the date
of this Agreement until the earlier of the termination of this Agreement in
accordance with its terms or the Effective Time, the Company shall not, and
shall not permit any of its Subsidiaries to, directly or indirectly, do any of
the following without the prior written consent of the Buyer:
(a) (A) declare, set aside or pay any dividends on, or make any other
distributions (whether in cash, securities or other property) in respect
of, any of its capital stock (other than dividends and distributions by a
direct or indirect wholly owned subsidiary of the company to its parent);
(B) split, combine or reclassify any of its capital stock or issue or
authorize the issuance of any other securities in respect of, in lieu of or
in substitution of shares of its capital stock; or (C) purchase, redeem or
otherwise acquire any shares of its capital stock or any other securities
thereof or any rights, warrants or options to acquire any such shares or
other securities;
(b) issue, deliver, sell, grant, pledge or otherwise dispose of or
encumber any shares of its capital stock, any other voting securities or
any securities convertible into or exchangeable for, or any rights,
warrants or options to acquire, any such shares, voting securities or
convertible or exchangeable securities (other than the issuance of shares
of Company Common Stock upon the exercise of Company Options or Company
Warrants outstanding on the date of this Agreement in accordance with their
present terms);
(c) amend its Restated Articles of Incorporation, by-laws or other
comparable charter or organizational documents, except as expressly
provided by this Agreement;
(d) except as permitted by Section 6.1, acquire (A) by merging or
consolidating with, or by purchasing a substantial portion of the assets or
any stock of, or by any other manner, any business or any corporation,
partnership, joint venture, limited liability company, association or other
business organization or division thereof or (B) any assets that are
material, in the aggregate, to the Company and the Subsidiaries, taken as a
whole, except purchases of inventory in the ordinary course of business
consistent with past practice;
(e) except in the ordinary course of business consistent with past
practice, sell, lease, license, pledge, or otherwise dispose of or encumber
any properties or assets of the Company or of any of its Subsidiaries;
(f) whether or not in the ordinary course of business or consistent with
past practice, sell or dispose of any assets material to the Company and
its Subsidiaries, taken as a whole (including any accounts, leases,
contracts or intellectual property or any assets or the stock of any
Subsidiaries, but excluding the sale of products in the ordinary course of
business consistent with past practice);
(g) adopt or implement any stockholder rights plan;
(h) except as permitted by Section 6.1, enter into an agreement with
respect to any merger, consolidation, liquidation or business combination,
or any acquisition or disposition of all or substantially all of the assets
or securities of the Company or any of its Subsidiaries;
(i) (A) incur or suffer to exist any indebtedness for borrowed money
other than such indebtedness which existed as of September 30, 1999 as
reflected on the Company Balance Sheet or guarantee any such indebtedness
of another person, (B) issue or sell any debt securities or warrants or
other rights to acquire any debt securities of the Company or any of its
Subsidiaries, guarantee any debt securities of another
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person, enter into any "keep well" or other agreement to maintain any
financial statement condition of another person or enter into any
arrangement having the economic effect of any of the foregoing, or (C) make
any loans, advances (other than routine advances to employees of the
Company in the ordinary course of business consistent with past practice)
or capital contributions to, or investment in, any other person;
(j) make any capital expenditures or expenditures with respect to
property, plant or equipment in excess of $500,000 in the aggregate for the
Company and its Subsidiaries, taken as a whole;
(k) make any changes in accounting methods, principles or practices,
except insofar as may have been required by a change in generally accepted
accounting principles or, except as so required, change any assumption
underlying, or method of calculating, any bad debt, contingency or other
reserve;
(l) (A) pay, discharge, settle or satisfy any claims, liabilities or
obligations (absolute, accrued, asserted or unasserted, contingent or
otherwise), other than the payment, discharge or satisfaction, in the
ordinary course of business consistent with past practice or in accordance
with their terms, of liabilities reflected or reserved against in, or
contemplated by, the most recent consolidated financial statements (or the
notes thereto) of the Company included in the Company SEC Reports filed
prior to the date of this Agreement (to the extent so reflected or reserved
against) or incurred thereafter in the ordinary course of business
consistent with past practice, or (B) waive any material benefits of any
confidentiality, standstill or similar agreements to which the Company or
any of its Subsidiaries is a party;
(m) modify, amend or terminate any material contract or agreement to
which the Company or any of its Subsidiaries is party, or knowingly waive,
release or assign any material rights or claims (including any write-off or
other compromise of any accounts receivable of the Company of any of its
Subsidiaries);
(n) except in the ordinary course of business consistent with past
practice (A) enter into any material contract or agreement or (B) license
any material intellectual property rights to or from any third party;
(o) except as required to comply with applicable law or agreements, plans
or arrangements existing on the date hereof or as otherwise disclosed in
Section 5.1(o) of the Company Disclosure Schedule, (A) adopt, enter into,
terminate or amend any employment, severance or similar agreement or
benefit plan for the benefit or welfare of any current or former director,
officer or employee or any collective bargaining agreement, (B) increase in
any material respect the compensation or fringe benefits of, or pay any
bonus to, any director, officer or key employee, (C) accelerate the
payment, right to payment or vesting of any compensation or benefits,
including any outstanding options or restricted stock awards, (D) pay any
material benefit not provided for as of the date of this Agreement under
any benefit plan, (E) grant any awards under any bonus, incentive,
performance or other compensation plan or arrangement or benefit plan
(including the grant of stock options, stock appreciation rights, stock
based or stock related wards, performance units or restricted stock, or the
removal of existing restrictions in any benefit plans or agreements or
awards made thereunder), or (F) take any action other than in the ordinary
course of business consistent with past practice to fund or in any other
way secure the payment of compensation or benefits under any employee plan,
agreement, contract or arrangement or benefit plan;
(p) make or rescind any Tax election, settle or compromise any Tax
liability or amend any Tax return;
(q) initiate, compromise or settle any material litigation or arbitration
proceeding;
(r) close any facility or office;
(s) invest funds in debt securities or other instruments maturing more
than 90 days after the date of investment;
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(t) fail to pay accounts payable and other obligations in the ordinary
course of business consistent with past practice; or
(u) authorize any of, or commit or agree, in writing or otherwise, to
take any of, the foregoing actions or any action which would make any
representation or warranty in Artilce III untrue or incorrect in any
material respect, or would materially impair or prevent the occurrence of
any conditions Article VII hereof.
5.2 Cooperation. Subject to compliance with applicable law, from and after
the date of this Agreement and continuing until the earlier of the termination
of this Agreement in accordance with its terms of the Effective Time, the
Company and each of its Subsidiaries shall make its officers available to
confer on a regular and frequent basis with one or more representatives of the
Buyer to report on the general status of ongoing operations and shall promptly
provide the Buyer or its counsel with copies of all filings made by such party
with any Governmental Entity in connection with this Agreement, the Merger and
the transactions contemplated hereby.
5.3 Confidentiality. The parties acknowledge that the Buyer and the Company
have previously executed a Confidentiality Agreement, dated as of October 21,
1999 (the "Confidentiality Agreement"), which Confidentiality Agreement will
continue in full force and effect in accordance with its terms, except as
expressly modified herein.
ARTICLE VI
ADDITIONAL AGREEMENTS
6.1 No Solicitation.
(a) From and after the date of this Agreement until the earlier of the
termination of this Agreement in accordance with its terms or the Effective
Time, the Company and its Subsidiaries shall not, directly or indirectly,
through any officer, director, employee, financial advisor, representative
or agent (i) solicit, initiate, or encourage any inquiries or proposals
that constitute, or could reasonably be expected to lead to, a proposal or
offer for an Alternative Transaction (as defined Section 8.3(g)), other
than the transactions contemplated by this Agreement, (ii) engage in
negotiations or discussions concerning, or provide any non-public
information to any person or entity relating to, any Alternative
Transaction, or (iii) agree to or recommend any Alternative Transaction;
provided, however, that, if the Company has not breached this Section 6.1,
nothing contained in this Agreement shall prevent the Company or its Board
of Directors, from:
(A) furnishing non-public information to, or entering into
discussions or negotiations with, any person or entity in connection
with an unsolicited bona fide written Alternative Transaction by such
person or entity or recommending an unsolicited bona fide written
Alternative Transaction to the stockholders of the Company, if and only
to the extent that
(1) the Board of Directors of the Company believes in good faith
(after consultation with its financial advisor) that such
Alternative Transaction is reasonably capable of being completed on
the terms proposed and would, if consummated, result in a
transaction more favorable than the transaction contemplated by this
Agreement (any such more favorable Alternative Transaction being
referred to in this Agreement as a "Superior Proposal") and the
Company's Board of Directors determines in good faith after
consultation with outside legal counsel that such action is
necessary for such Board of Directors to comply with its fiduciary
duties to stockholders under applicable law,
(2) prior to furnishing such non-public information to, or
entering into discussions or negotiations with, such person or
entity, such Board of Directors receives from such person or entity
an executed confidentiality agreement with terms no less favorable
to such party than those contained in the Confidentiality Agreement,
and
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(3) prior to recommending a Superior Proposal, the Company shall
provide the Buyer with at least five business days' prior notice of
its proposal to do so, during which time the Buyer may make, and in
such event the Company shall consider, a counterproposal to such
Superior Proposal, and the Company shall itself and shall cause its
financial and legal advisors to negotiate in good faith on its
behalf with the Buyer with respect to the terms and conditions of
such counterproposal; or
(B) complying with Rule 14d-9 and 14e-2 promulgated under the
Exchange Act with regard to an Alternative Transaction.
(b) The Company will immediately cease any and all existing activities,
discussions or negotiations with any parties conducted heretofore of the
nature described in Section 6.1(a) and will use reasonable efforts to
obtain the return of any confidential information furnished to any such
parties.
(c) The Company shall notify the Buyer immediately (but in any event,
within 24 hours) after receipt by the Company (or its advisors) of any
Alternative Transaction or any request for nonpublic information in
connection with an Alternative Transaction or for access to the properties,
books or records of the Company by any person or entity that informs the
Company that it is considering making, or has made, an Alternative
Transaction. Such notice shall be made orally and in writing and shall
indicate in reasonable detail the identity of the offer or and the terms
and conditions of such proposal, inquiry or contact. The Company shall
continue to keep the Buyer informed, on a current basis, of the status of
any such discussions or negotiations and the terms being discussed or
negotiated.
(d) Nothing in this Section 6.1 shall (i) permit the Company to terminate
this Agreement (except as specifically provided in Section 8.1 hereof),
(ii) permit the Company to enter into any agreement with respect to an
Alternative Transaction during the term of this Agreement (it being agreed
that during the term of this Agreement, the Company shall not enter into
any agreement with any person that provides for, or in any way facilitates,
an Alternative Transaction (other than a confidentiality agreement of the
type referred to in Section 6.1(a) above)) or (iii) affect any other
obligation of the Company under this Agreement.
6.2 Proxy Statement/Prospectus; Registration Statement.
(a) As promptly as practicable after the execution of this Agreement, the
Buyer and the Company shall prepare and the Company shall file with the SEC
the Proxy Statement, and the Buyer shall prepare and file with the SEC the
Registration Statement, in which the Proxy Statement will be included as a
prospectus, provided that the Buyer may delay the filing of the
Registration Statement until approval of the Proxy Statement by the SEC.
The Buyer and the Company shall use reasonable efforts to cause the
Registration Statement to become effective as soon after such filing as
practicable. Each of the Buyer and the Company will respond to any comments
of the SEC and will use its respective reasonable efforts to have the Proxy
Statement cleared by the SEC and the Registration Statement declared
effective under the Securities Act as promptly as practicable after such
filings and the Company will cause the Proxy Statement and the prospectus
contained within the Registration Statement to be mailed to its
stockholders at the earliest practicable time after both the Proxy
Statement is cleared by the SEC and the Registration Statement is declared
effective under the Securities Act. Each of the Buyer and the Company will
notify the other promptly upon the receipt of any comments from the SEC or
its staff or any other government officials and of any request by the SEC
or its staff or any other government officials for amendments or
supplements to the Registration Statement, the Proxy Statement or any
filing pursuant to Section 6.2(b) or for additional information and will
supply the other with copies of all correspondence between such party or
any of its representatives, on the one hand, and the SEC, or its staff or
any other government officials, on the other hand, with respect to the
Registration Statement, the Proxy Statement, the Merger or any filing
pursuant to Section 6.2(b). Each of the Buyer and the Company will cause
all documents that it is responsible for filing with the SEC or other
regulatory authorities under this Section 6.2 to comply in all
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material respects with all applicable requirements of law and the rules and
regulations promulgated thereunder. Whenever any event occurs which is
required to be set forth in an amendment or supplement to the Proxy
Statement, the Registration Statement or any filing pursuant to Section
6.2(b), the Buyer or the Company, as the case may be, will promptly inform
the other of such occurrence and cooperate in filing with the SEC or its
staff or any other government officials, and/or mailing to stockholders of
the Company, such amendment or supplement.
(b) The Company shall use its best efforts to cause to be delivered to
the Buyer two letters from Deloitte & Touche LLP and/or Ernst & Young LLP,
as appropriate, the Company's former and current independent accountants,
respectively, one letter dated a date within two business days before the
date on which the Registration Statement shall become effective and one
letter dated a date within two business days before the Closing Date, each
addressed to the Buyer, in form and substance reasonably satisfactory to
the Buyer and customary in scope and substance for comfort letters
delivered by independent public accountants in connection with registration
statements similar to the Registration Statement.
(c) Each of the Buyer and the Company shall make all filings required of
it with respect to the Merger under the Securities Act, the Exchange Act,
applicable state blue sky laws and the rules and regulations thereunder.
6.3 Nasdaq Quotation. The Company agrees to continue the quotation of the
Company Common Stock on the Nasdaq National Market during the term of this
Agreement.
6.4 Access to Information. The Company shall (and shall cause each of its
Subsidiaries to) afford to the Buyer's officers, employees, accountants,
counsel and other representatives, reasonable access, during normal business
hours during the period prior to the Effective Time, to all its properties,
books, contracts, commitments, personnel and records and, during such period,
the Company shall (and shall cause each of its Subsidiaries to) furnish
promptly to the Buyer (a) a copy of each report, schedule, registration
statement and other document filed or received by it during such period
pursuant to the requirements of federal or state securities laws and (b) all
other information concerning its business, properties, assets and personnel as
the Buyer may reasonably request. Unless otherwise required by law, the Buyer
will hold any such information which is nonpublic in confidence in accordance
with the Confidentiality Agreement. No information or knowledge obtained in any
investigation pursuant to this Section or otherwise shall affect or be deemed
to modify any representation or warranty contained in this Agreement or the
conditions to the obligations of the parties to consummate the Merger.
6.5 Stockholders Meeting.
(a) The Company, acting through its Board of Directors, shall, subject to
and according to applicable law and its Restated Articles of Incorporation
and Bylaws, promptly and duly call, give notice of, convene and hold as
soon as practicable following the date on which the Registration Statement
becomes effective the Company Meeting for the purpose of voting to approve
and adopt this Agreement and the Merger (the "Company Voting Proposal").
The Board of Directors of the Company shall (i) recommend approval and
adoption of the Company Voting Proposal by the stockholders of the Company
and include in the Proxy Statement such recommendation and (ii) take all
reasonable and lawful action to solicit and obtain such approval; provided,
however, that in response to an Alternative Transaction the Board of
Directors of the Company may withdraw such recommendation if (but only if)
(i) the Board of Directors of the Company has received a Superior Proposal,
(ii) such Board of Directors upon advice of its outside legal counsel
determines that it is required, in order to comply with its fiduciary
duties under applicable law, to recommend such Superior Proposal to the
stockholders of the Company and (iii) the Company has complied with the
provisions of Section 6.1.
(b) The Company shall call and hold the Company Meeting for the purpose
of voting upon the approval of this Agreement and the Merger regardless of
whether its Board of Directors at any time
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subsequent to the date hereof determines that this Agreement is no longer
advisable or recommends that the Company's stockholders reject it.
(c) Applied Telecommunications Technologies, Inc., James B. Francis, Jr.,
Global Undervalued Securities Fund, L.P., Andrew N. Jent, John B.
Kleinheinz, Kleinheinz Capital Partners, Inc., Michael Scott Leslie, Kevin
A. Stadtler, Albert Lee Thurburn and Russell A. Wiseman have each executed
and delivered a Stockholder Agreement to the Buyer concurrently with the
signing of this Agreement.
(d) Andrew N. Jent, Michael Scott Leslie and Russell A. Wiseman have each
executed and delivered to the Buyer a Non-Compete Agreement in a form
agreed upon by the Buyer and the Company.
6.6 Legal Conditions to the Merger.
(a) Subject to the terms hereof, the Company and the Buyer shall each use
its reasonable efforts to (i) take, or cause to be taken, all actions, and
do, or cause to be done, and to assist and cooperate with the other parties
in doing, all things necessary, proper or advisable to consummate and make
effective the transactions contemplated hereby as promptly as practicable,
(ii) obtain from any Governmental Entity or any other third party any
consents, licenses, permits, waivers, approvals, authorizations, or orders
required to be obtained or made by the Company or the Buyer or any of their
Subsidiaries in connection with the authorization, execution and delivery
of this Agreement and the consummation of the transactions contemplated
hereby, (iii) as promptly as practicable, make all necessary filings, and
thereafter make any other required submissions, with respect to this
Agreement and the Merger required under (A) the Securities Act and the
Exchange Act, and any other applicable federal or state securities laws,
(B) the HSR Act and any related governmental request thereunder (provided
that the initial filings under the HSR Act shall be made on or after such
date as is designated by the Buyer), and (C) any other applicable law and
(iv) execute or deliver any additional instruments necessary to consummate
the transactions contemplated by, and to fully carry out the purposes of,
this Agreement. The Company and the Buyer shall cooperate with each other
in connection with the making of all such filings, including providing
copies of all such documents to the non-filing party and its advisors prior
to filing and, if requested, to accept all reasonable additions, deletions
or changes suggested in connection therewith. The Company and the Buyer
shall use their respective reasonable efforts to furnish to each other all
information required for any application or other filing to be made
pursuant to the rules and regulations of any applicable law (including all
information required to be included in the Proxy Statement and the
Registration Statement) in connection with the transactions contemplated by
this Agreement.
(b) Subject to the terms hereof, the Buyer and the Company agree, and
shall cause each of their respective Subsidiaries, to cooperate and to use
their respective reasonable efforts to obtain any government clearances or
approvals required for Closing under the HSR Act, the Sherman Act, as
amended, the Clayton Act, as amended, the Federal Trade Commission Act, as
amended, and any other federal, state or foreign law or, regulation or
decree designed to prohibit, restrict or regulate actions for the purpose
or effect of monopolization or restraint of trade (collectively "Antitrust
Laws"), to respond to any government requests for information under any
Antitrust Law, and to contest and resist any action, including any
legislative, administrative or judicial action, and to have vacated,
lifted, reversed or overturned any decree, judgment, injunction or other
order (whether temporary, preliminary or permanent) (an "Antitrust Order")
that restricts, prevents or prohibits the consummation of the Merger or any
other transactions contemplated by this Agreement under any Antitrust Law.
The parties hereto will consult and cooperate with one another, and
consider in good faith the views of one another, in connection with any
analyses, appearances, presentations, memoranda, briefs, arguments,
opinions and proposals made or submitted by or on behalf of any party
hereto in connection with proceedings under or relating to any Antitrust
Law. The Buyer shall be entitled to direct any proceedings or negotiations
with any
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Governmental Entity relating to any of the foregoing, provided that it
shall afford the Company a reasonable opportunity to participate therein.
Notwithstanding anything to the contrary in this Section, neither the Buyer
nor any of its Subsidiaries shall be required to (i) divest any of their
respective businesses, product lines or assets, or to take or agree to take
any other action or agree to any limitation, that could reasonably be
expected to have a material adverse effect on the Buyer or on the Buyer
combined with the Company after the Effective Time or (ii) take any action
under this Section if the United States Department of Justice or the United
States Federal Trade Commission authorizes its staff to seek a preliminary
injunction or restraining order to enjoin consummation of the Merger.
(c) Each of the Company and the Buyer shall give (or shall cause their
respective Subsidiaries to give) any notices to third parties, and use, and
cause their respective Subsidiaries to use, their reasonable efforts to
obtain any third party consents related to or required in connection with
the Merger that are (A) necessary to consummate the transactions
contemplated hereby, (B) disclosed or required to be disclosed in the
Company Disclosure Schedule or the Buyer Disclosure Schedule, as the case
may be, or (C) required to prevent a Company Material Adverse Effect or a
Buyer Material Adverse Effect from occurring prior to or after the
Effective Time.
6.7 Public Disclosure. The Buyer and the Company shall each use its
reasonable efforts to consult with the other before issuing any press release
or otherwise making any public statement with respect to the Merger or this
Agreement and shall not issue any such press release or make any such public
statement prior to using such efforts, except as may be required by law.
6.8 Tax-Free Reorganization. The Buyer and the Company shall each use its
reasonable efforts to cause the Merger to be treated as a reorganization within
the meaning of Section 368(a) of the Code. The parties hereto hereby adopt this
Agreement as a plan of reorganization.
6.9 Affiliate Agreements. Upon the execution of this Agreement, the Company
will provide the Buyer with a list of those persons who are, in the Company's
reasonable judgment, "affiliates" of the Company, within the meaning of Rule
145 (each such person who is an "affiliate" of the Company within the meaning
of Rule 145 is referred to as an "Affiliate") promulgated under the Securities
Act ("Rule 145"). The Company shall provide to the Buyer such information and
documents as the Buyer shall reasonably request for purposes of reviewing such
list and shall notify the Buyer in writing regarding any change in the identity
of its Affiliates prior to the Closing Date. The Company shall use its
reasonable efforts to deliver or cause to be delivered to the Buyer by November
19, 1999 (and in any case prior to the mailing of the Proxy Statement) from
each of its Affiliates, an executed Company Affiliate Agreement, in
substantially the form appended hereto as Exhibit C (the "Affiliate
Agreement"). The Buyer shall be entitled to place appropriate legends on the
certificates evidencing any shares of Buyer Common Stock to be received by Rule
145 Affiliates of the Company pursuant to the terms of this Agreement, and to
issue appropriate stop transfer instructions to the transfer agent for the
Buyer Common Stock (provided that such legends or stop transfer instructions
shall be removed, two years after the Effective Date, upon the request of any
stockholder that is not then an Affiliate of the Buyer).
6.10 Nasdaq National Market Listing. The Buyer shall file with the Nasdaq
National Market a Notification Form for Listing of Additional Shares with
respect to the Buyer Common Stock issuable in connection with the Merger.
6.11 Company Stock Options, Warrants and Plans.
(a) At the Effective Time, the Buyer shall assume each outstanding
Company Stock Option under Company Stock Plans, whether vested or unvested,
shall be deemed to constitute an option to acquire, on the same terms and
conditions as were applicable under the Company Stock Option immediately
prior to
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the Effective Time, the same number of shares of Buyer Common Stock as the
holder of the Company Stock Option would have been entitled to receive
pursuant to the Merger had such holder exercised such option in full
immediately prior to the Effective Time (rounded down to the nearest whole
number), at a price per share (rounded up to the nearest whole cent) equal
to (y) the aggregate exercise price for the shares of Company Common Stock
purchasable pursuant to the Company Stock Option immediately prior to the
Effective Time divided by (z) the number of full shares of Buyer Common
Stock deemed purchasable pursuant to the Company Stock Option in accordance
with the foregoing.
(b) As soon as practicable after the Effective Time, the Buyer shall
deliver to the participants in the Company Stock Plans appropriate notice
setting forth such participants' rights pursuant thereto and the grants
pursuant to the Company Stock Plans shall continue in effect on the same
terms and conditions (subject to the adjustments required by this Section
after giving effect to the Merger).
(c) The Buyer shall take all corporate action necessary to reserve for
issuance a sufficient number of shares of Buyer Common Stock for delivery
under the Company Stock Plans assumed in accordance with this Section.
Prior to or as soon as practicable after the Effective Time, and in any
event within 10 business days after the Effective Time, the Buyer shall
file a registration statement on Form S-8 (or any successor form) or
another appropriate form with respect to the shares of Buyer Common Stock
subject to such options and shall use its best efforts to maintain the
effectiveness of such registration statement or registration statements
(and maintain the current status of the prospectus or prospectuses
contained therein) for so long as such options remain outstanding.
(d) The Board of Directors of the Company shall, prior to or as of the
Effective Time, take all necessary actions, pursuant to and in accordance
with the terms of Company Stock Plans and the instruments evidencing the
Company Stock Options, to provide for the conversion of the Company Stock
Options into options to acquire Buyer Common Stock in accordance with this
Section, and that no consent of the holders of the Company Stock Options is
required in connection with such conversion.
(e) As of or prior to the Effective Time, the Company shall terminate its
Employee Stock Discount Purchase Plan in accordance with its terms.
(f) As of the Effective Time, the Company shall terminate (with the
consent of the holders of the applicable Company Stock Options, if
necessary) all Company Stock Options with an exercise price equal to or
higher than the last reported sales price of the Company Common Stock on
the Nasdaq National Market on the trading day immediately prior to the
Effective Time.
(g) If requested by the Buyer in writing, the Company shall, immediately
prior to the Effective Time, terminate the Company's 401(k) Plan.
6.12 Stockholder Litigation. Until the earlier of the termination of this
Agreement in accordance with its terms or the Effective Time, the Company shall
give the Buyer the opportunity to participate in the defense or settlement of
any stockholder litigation against the Company or its Board of Directors
relating to this Agreement or any of the transactions contemplated by this
Agreement, and shall not settle any such litigation without the Buyer's prior
written consent, which will not be unreasonably withheld or delayed.
6.13 Indemnification. From and after the Effective Time, the Buyer shall, to
the fullest extent permitted by law, cause the Surviving Corporation, for a
period of six years from the Effective Time, to honor all of the Company's
obligations to indemnify and hold harmless, and to advance expenses with
respect to, each present and former director and officer of the Company (the
"Indemnified Parties"), against any costs or expenses (including attorneys'
fees), judgments, fines, losses, claims, damages, liabilities or amounts paid
in settlement incurred in connection with any claim, action, suit, proceeding
or investigation, whether civil, criminal,
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administrative or investigative, arising out of or pertaining to matters
existing or occurring at or prior to the Effective Time, whether asserted or
claimed prior to, at or after the Effective Time, to the extent that such
obligations to indemnify and hold harmless exist on the date of this Agreement
under the Company's Restated Articles of Incorporation, By-laws, the TBCA, any
agreement between such person and the Company listed on Section 6.13 of the
Company Disclosure Schedule, or otherwise; provided, further, that in the event
any claim or claims are asserted or made within such six year period, all
rights to indemnification in respect of any such claim or claims shall continue
until the disposition of any and all such claims.
6.14 Notification of Certain Matters. The Buyer will give prompt notice to
the Company, and the Company will give prompt notice to the Buyer, of the
occurrence, or failure to occur, of any event, which occurrence or failure to
occur would be reasonably likely to cause (a) (i) any representation or
warranty of such party contained in this Agreement that is qualified as to
materiality to be untrue or inaccurate in any respect or (ii) any other
representation or warranty of such party contained in this Agreement to be
untrue or inaccurate in any material respect, in each case at any time from and
after the date of this Agreement until the Effective Time, or (b) any material
failure of the Buyer and the Transitory Subsidiary or the Company, as the case
may be, or of any officer, director, employee or agent thereof, to comply with
or satisfy any covenant, condition or agreement to be complied with or
satisfied by it under this Agreement. Notwithstanding the above, the delivery
of any notice pursuant to this Section will not limit or otherwise affect the
remedies available hereunder to the party receiving such notice or the
conditions to such party's obligation to consummate the Merger.
ARTICLE VII
CONDITIONS TO MERGER
7.1 Conditions to Each Party's Obligation To Effect the Merger. The
respective obligations of each party to this Agreement to effect the Merger
shall be subject to the satisfaction prior to the Closing Date of the following
conditions:
(a) Stockholder Approval. The Company Voting Proposal shall have been
approved and adopted at the Company Meeting, at which a quorum is present,
by the affirmative vote of the holders of two-thirds of the shares of the
Company Common Stock outstanding on the record date for the Company
Meeting.
(b) HSR Act. The waiting period applicable to the consummation of the
Merger under the HSR Act shall have expired or been terminated.
(c) Governmental Approvals. Other than the filings provided for by
Section 1.1, all authorizations, consents, orders or approvals of, or
declarations or filings with, or expirations of waiting periods imposed by,
any Governmental Entity, the failure of which to file, obtain or occur is
reasonably likely to have a Buyer Material Adverse Effect or a Company
Material Adverse Effect shall have been filed, been obtained or occurred.
(d) Registration Statement. The Registration Statement shall have become
effective under the Securities Act and shall not be the subject of any stop
order or proceedings seeking a stop order and no similar proceeding in
respect of the Proxy Statement shall have been initiated or threatened by
the SEC.
(e) No Injunctions. No Governmental Entity of competent jurisdiction
shall have enacted, issued, promulgated, enforced or entered any order,
executive order, stay, decree, judgment or injunction (each an "Order") or
statute, rule or regulation which is in effect and which has the effect of
making the Merger illegal or otherwise prohibiting consummation of the
Merger.
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7.2 Additional Conditions to Obligations of the Buyer and the Transitory
Subsidiary. The obligations of the Buyer and the Transitory Subsidiary to
effect the Merger are subject to the satisfaction of each of the following
additional conditions, any of which may be waived in writing exclusively by the
Buyer and the Transitory Subsidiary:
(a) Representations and Warranties. The representations and warranties of
the Company set forth in this Agreement shall be true and correct (i) as of
the date of this Agreement (except to the extent such representations and
warranties are specifically made as of a particular date, in which case
such representations and warranties shall be true and correct as of such
date) and (ii) as of the Closing Date as though made on and as of the
Closing Date (except (x) to the extent such representations and warranties
are specifically made as of a particular date, in which case such
representations and warranties shall be true and correct as of such date,
(y) for changes contemplated by this Agreement and (z) where the failures
to be true and correct (without regard to any materiality, Company Material
Adverse Effect or knowledge qualifications contained therein), individually
or in the aggregate, have not had, and are not reasonably likely to have, a
Company Material Adverse Effect); and the Buyer shall have received a
certificate signed on behalf of the Company by the chief executive officer
and the chief financial officer of the Company to such effect.
(b) Performance of Obligations of the Company. The Company shall have
performed in all material respects all obligations required to be performed
by it under this Agreement at or prior to the Closing Date; and the Buyer
shall have received a certificate signed on behalf of the Company by the
chief executive officer and the chief financial officer of the Company to
such effect.
(c) Tax Opinion. The Buyer shall have received a written opinion from
Hale and Dorr LLP, counsel to the Buyer, to the effect that the Merger will
be treated for federal income tax purposes as a tax-free reorganization
within the meaning of Section 368(a) of the Code; provided that if Hale and
Dorr LLP does not render such opinion, this condition shall nonetheless be
deemed satisfied if Brobeck, Phleger & Harrison LLP renders such opinion to
the Buyer (it being agreed that the Buyer and the Company shall each
provide reasonable cooperation, including making reasonable
representations, to Hale and Dorr LLP or Brobeck, Phleger & Harrison LLP,
as the case may be, to enable them to render such opinion).
(d) Third Party Consents. The Company shall have obtained (i) all
consents and approvals of third parties referred to in Section 3.3(b) of
the Company Disclosure Schedule and (ii) any other consent or approval of
any third party (other than a Governmental Entity) the failure of which to
obtain, individually or in the aggregate, is reasonably likely to have a
Company Material Adverse Effect.
(e) Resignations. The Buyer shall have received copies of the
resignations, effective as of the Effective Time, of each director and
officer of the Company and its Subsidiaries, except as listed on Section
7.2(e) of the Company Disclosure Schedule.
7.3 Additional Conditions to Obligations of the Company. The obligation of
the Company to effect the Merger is subject to the satisfaction of each of the
following additional conditions, any of which may be waived, in writing,
exclusively by the Company:
(a) Representations and Warranties. The representations and warranties of
the Buyer and the Transitory Subsidiary set forth in this Agreement shall
be true and correct (i) as of the date of this Agreement (except to the
extent such representations are specifically made as of a particular date,
in which case such representations and warranties shall be true and correct
as of such date) and (ii) as of the Closing Date as though made on and as
of the Closing Date (except (x) to the extent such representations and
warranties are specifically made as of a particular date, in which case
such representations and
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warranties shall be true and correct as of such date, (y) for changes
contemplated by this Agreement and (z) where the failures to be true and
correct (without regard to any materiality, Buyer Material Adverse Effect
or knowledge qualifications contained therein), individually or in the
aggregate, have not had, and are not reasonably likely to have, a Buyer
Material Adverse Effect); and the Company shall have received a certificate
signed on behalf of the Buyer by the chief executive officer or the chief
financial officer of the Buyer to such effect.
(b) Performance of Obligations of the Buyer and the Transitory
Subsidiary. The Buyer and Sub shall have performed in all material respects
all obligations required to be performed by them under this Agreement at or
prior to the Closing Date, and the Company shall have received a
certificate signed on behalf of the Buyer by the chief executive officer or
the chief financial officer of the Buyer to such effect.
(c) Tax Opinion. The Company shall have received the opinion of Brobeck,
Phleger & Harrison LLP, counsel to the Company, to the effect that the
Merger will be treated for federal income tax purposes as a tax-free
reorganization within the meaning of Section 368(a) of the Code; provided
that if Brobeck, Phleger & Harrison LLP does not render such opinion, this
condition shall nonetheless be deemed satisfied if Hale and Dorr LLP
renders such opinion to the Company (it being agreed that the Buyer and the
Company shall each provide reasonable cooperation, including making
reasonable representations, to Brobeck, Phleger & Harrison LLP or Hale and
Dorr LLP, as the case may be, to enable them to render such opinion).
ARTICLE VIII
TERMINATION AND AMENDMENT
8.1 Termination. This Agreement may be terminated at any time prior to the
Effective Time (with respect to Sections 8.1(b) through 8.1(f), by written
notice by the terminating party to the other party), whether before or after
approval of the Merger by the stockholders of the Company:
(a) by mutual written consent of the Buyer and the Company; or
(b) by either the Buyer or the Company if the Merger shall not have been
consummated by May 31, 2000 (the "Outside Date") (provided that the right
to terminate this Agreement under this Section 8.1(b) shall not be
available to any party whose failure to fulfill any obligation under this
Agreement has been a principal cause of or resulted in the failure of the
Merger to occur on or before such date); or
(c) by either the Buyer or the Company if a Governmental Entity of
competent jurisdiction shall have issued a nonappealable final order,
decree or ruling or taken any other nonappealable final action, in each
case having the effect of permanently restraining, enjoining or otherwise
prohibiting the Merger; or
(d) by either the Buyer or the Company if at the Company Meeting
(including any adjournment or postponement), the requisite vote of the
stockholders of the Company in favor of the Company Voting Proposal shall
not have been obtained (provided that the right to terminate this Agreement
under this Section 8.1(d) shall not be available to any party seeking
termination who at the time is in breach of or has failed to fulfill its
obligations under this Agreement); or
(e) by the Buyer, if: (i) the Board of Directors of the Company shall
have failed to recommend approval of the Company Voting Proposal in the
Proxy Statement or shall have withdrawn or modified its recommendation of
the Company Voting Proposal; (ii) the Board of Directors of the Company
fails to reconfirm its recommendation of this Agreement or the Merger
within five business days after the Buyer requests in writing that the
Board of Directors of the Company do so; (iii) the Board of Directors of
the Company shall have approved or recommended to the stockholders of the
Company an Alternative Transaction (as defined in Section 8.3(g)); or (iv)
a tender offer or exchange offer for outstanding shares of
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the Company Common Stock is commenced (other than by the Buyer or an
Affiliate of the Buyer) and the Board of Directors of the Company
recommends that the stockholders of the Company tender their shares in such
tender or exchange offer or, within 10 days after such tender or exchange
offer, fails to recommend against acceptance of such offer or takes no
position with respect to the acceptance thereof; or (v) for any reason the
Company fails to call and hold the Company Meeting by the date which is one
business day prior to the Outside Date; or
(f) by either the Buyer or the Company, if there has been a breach of, or
material inaccuracy or omission with respect to, any representation,
warranty, covenant or agreement on the part of the other party set forth in
this Agreement, which breach, inaccuracy or omission (i) causes the
conditions set forth in Section 7.2(a) or 7.2(b) (in the case of
termination by the Buyer) or Section 7.3(a) or 7.3(b) (in the case of
termination by the Company) not to be satisfied, and (ii) shall not have
been cured within 10 days following receipt by the breaching party of
written notice of such breach from the other party.
8.2 Effect of Termination. In the event of termination of this Agreement as
provided in Section 8.1, this Agreement shall immediately become void and there
shall be no liability or obligation on the part of the Buyer, the Company, the
Transitory Subsidiary or their respective officers, directors, stockholders or
Affiliates, except as set forth in Sections 3.29, 5.3, 8.3 and Article IX;
provided that any such termination shall not relieve any party from liability
for any willful breach of this Agreement (which includes without limitation the
making of any representation or warranty by a party in this Agreement that the
party knew was not true and accurate when made) and the provisions of the
Company Stock Option Agreement, Sections 3.29, 5.3, 8.3 and Article IX of this
Agreement and the Confidentiality Agreement shall remain in full force and
effect and survive any termination of this Agreement.
8.3 Fees and Expenses.
(a) Except as set forth in this Section 8.3, all fees and expenses
incurred in connection with this Agreement and the transactions
contemplated hereby shall be paid by the party incurring such fees and
expenses, whether or not the Merger is consummated; provided however, that
the Company and the Buyer shall share equally all fees and expenses, other
than attorneys' fees, incurred with respect to the printing and filing of
the Proxy Statement (including any related preliminary materials) and the
Registration Statement and any amendments or supplements thereto.
(b) The Company shall pay the Buyer up to $500,000 as reimbursement for
expenses of the Buyer actually incurred relating to the transactions
contemplated by this Agreement prior to termination (including, but not
limited to, fees and expenses of the Buyer's counsel, accountants and
financial advisors, but excluding any discretionary fees paid to such
financial advisors), upon the termination of this Agreement by the Buyer
pursuant to (i) Section 8.1(b) as a result of the failure to satisfy the
condition set forth in Section 7.2(a); (ii) Section 8.1(e); or (iii)
Section 8.1(f) or by the Buyer or the Company pursuant to Section 8.1(d).
(c) The Company shall pay the Buyer a termination fee of $5,000,000 upon
the earliest to occur of the following events:
(i) the termination of this Agreement by the Buyer pursuant to
Section 8.1(e); or
(ii) the termination of this Agreement by the Buyer pursuant to
Section 8.1(f) after a breach by the Company of this Agreement; or
(iii) the termination of the Agreement by the Buyer or the Company
pursuant to Section 8.1(d) as a result of the failure to receive the
requisite vote for approval of the Company Voting Proposal by the
stockholders of the Company at the Company Meeting.
(d) The Buyer shall pay the Company up to $500,000 as reimbursement for
expenses of the Company actually incurred relating to the transactions
contemplated by this Agreement prior to
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termination (including, but not limited to, but excluding any discretionary
fees paid to such financial advisors), upon the termination of this
Agreement by the Company pursuant to (i) Section 8.1(b) as a result of the
failure to satisfy the condition set forth in Section 7.3(a) or (ii)
Section 8.1(f).
(e) The Buyer shall pay the Company a termination fee of $5,000,000 upon
the termination of this Agreement by the Company pursuant to Section 8.1(f)
after a breach by the Buyer of this Agreement.
(f) The expenses and fees, if applicable, payable pursuant to Section
8.3(b), 8.3(c), 8.3(d) and 8.3(e) shall be paid within one business day
after demand therefor following the first to occur of the events giving
rise to the payment obligation described in Section 8.3(b), 8.3(c)(i), (ii)
or (iii), 8.3(d) or 8.3(e). If one party fails to promptly pay to the other
any expense reimbursement or fee due hereunder, the defaulting party shall
pay the costs and expenses (including legal fees and expenses) in
connection with any action, including the filing of any lawsuit or other
legal action, taken to collect payment, together with interest on the
amount of any unpaid fee at the publicly announced prime rate of Bank of
New York plus five percent per annum, compounded quarterly, from the date
such expense reimbursement or fee was required to be paid.
(g) As used in this Agreement, "Alternative Transaction" means either (i)
a transaction pursuant to which any person (or group of persons) other than
the Buyer or its affiliates (a "Third Party"), acquires more than 20% of
the outstanding shares of the Company Common Stock pursuant to a tender
offer or exchange offer or otherwise, (ii) a merger or other business
combination involving the Company pursuant to which any Third Party
acquires more than 20% of the outstanding shares of Company Common Stock or
of the entity surviving such merger or business combination, (iii) any
other transaction pursuant to which any Third Party acquires control of
assets (including for this purpose the outstanding equity securities of
Subsidiaries of the Company, and the entity surviving any merger or
business combination including any of them) of the Company having a fair
market value equal to more than 20% of the fair market value of all the
assets of the Company immediately prior to such transaction, or (iv) any
public announcement by a Third Party of a proposal, plan or intention to do
any of the foregoing or any agreement to engage in any of the foregoing.
8.4 Amendment. This Agreement may be amended by the parties hereto, by action
taken or authorized by their respective Boards of Directors, at any time before
or after approval of the matters presented in connection with the Merger by the
stockholders of the Company, but, after any such approval, no amendment shall
be made which by law requires further approval by such stockholders without
such further approval. This Agreement may not be amended except by an
instrument in writing signed on behalf of each of the parties hereto.
8.5 Extension; Waiver. At any time prior to the Effective Time, the parties
hereto, by action taken or authorized by their respective Boards of Directors,
may, to the extent legally allowed, (i) extend the time for the performance of
any of the obligations or other acts of the other parties hereto, (ii) waive
any inaccuracies in the representations and warranties contained herein or in
any document delivered pursuant hereto and (iii) waive compliance with any of
the agreements or conditions contained herein. Any agreement on the part of a
party hereto to any such extension or waiver shall be valid only if set forth
in a written instrument signed on behalf of such party.
ARTICLE IX
MISCELLANEOUS
9.1 Nonsurvival of Representations and Warranties. The respective
representations and warranties of the Company, the Buyer and the Transitory
Subsidiary contained in this Agreement or in any instrument delivered pursuant
to this Agreement shall expire with, and be terminated and extinguished upon,
the Effective Time. No party hereto makes any representation or warranty to the
other party other than those expressly set forth herein.
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9.2 Notices. All notices and other communications hereunder shall be in
writing and shall be deemed duly delivered (i) four business days after being
sent by registered or certified mail, return receipt requested, postage
prepaid, or (ii) one business day after being sent for next business day
delivery, fees prepaid, via a reputable nationwide overnight courier service,
in each case to the intended recipient as set forth below:
(a) if to the Buyer or Transitory Subsidiary, to
Prodigy Communications Corporation
44 South Broadway
White Plains, New York 10601
Attn: General Counsel
Telecopy: (914) 448-8198
with a copy to:
Hale and Dorr LLP
60 State Street
Boston, Massachusetts 02109
Attn: David A. Westenberg, Esq.
Telecopy: (617) 526-5000
(b) if to the Company, to
FlashNet Communications, Inc.
1812 North Forest Park Blvd.
Fort Worth, Texas 76102
Attn: President
Telecopy: (817) 870-0296
with a copy to:
Brobeck, Phleger & Harrison LLP
301 Congress Avenue, Suite 1200
Austin, Texas 78701
Attn: S. Michael Dunn, Esq.
Telecopy: (512) 477-5813
Any party may give any notice or other communication hereunder using any
other means (including personal delivery, messenger service, telecopy, telex,
ordinary mail or electronic mail), but no such notice or other communication
shall be deemed to have been duly given unless and until it actually is
received by the party for whom it is intended. Any party may change the address
to which notices and other communications hereunder are to be delivered by
giving the other parties notice in the manner herein set forth.
9.3 Entire Agreement. This Agreement (including the Schedules and Exhibits
hereto and the documents and instruments referred to herein that are to be
delivered at the Closing) constitutes the entire agreement among the parties
hereto and supersedes any prior understandings, agreements or representations
by or among the parties hereto, or any of them, written or oral, with respect
to the subject matter hereof; provided that the Confidentiality Agreement shall
remain in effect in accordance with its terms.
9.4 No Third Party Beneficiaries. Except as provided in Section 6.13, this
Agreement is not intended, and shall not be deemed, to confer any rights or
remedies upon any person other than the parties hereto and their respective
successors and permitted assigns, to create any agreement of employment with
any person or to otherwise create any third-party beneficiary hereto.
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9.5 Assignment. Neither this Agreement nor any of the rights, interests or
obligations under this Agreement may be assigned or delegated, in whole or in
part, by operation of law or otherwise by any of the parties hereto without the
prior written consent of the other parties, and any such assignment without
such prior written consent shall be null and void, except that the Buyer and/or
the Transitory Subsidiary may assign this Agreement to any direct or indirect
wholly owned Subsidiary of the Buyer without consent of the Company, provided
that the Buyer and/or the Transitory Subsidiary, as the case may be, shall
remain liable for all of its obligations under this Agreement. Subject to the
preceding sentence, this Agreement shall be binding upon, inure to the benefit
of, and be enforceable by, the parties hereto and their respective successors
and permitted assigns.
9.6 Severability. Any term or provision of this Agreement that is invalid or
unenforceable in any situation in any jurisdiction shall not affect the
validity or enforceability of the remaining terms and provisions hereof or the
validity or enforceability of the offending term or provision in any other
situation or in any other jurisdiction. If the final judgment of a court of
competent jurisdiction declares that any term or provision hereof is invalid or
unenforceable, the parties agree hereto that the court making such
determination shall have the power to limit the term or provision, to delete
specific words or phrases, or to replace any invalid or unenforceable term or
provision with a term or provision that is valid and enforceable and that comes
closest to expressing the intention of the invalid or unenforceable term or
provision, and this Agreement shall be enforceable as so modified. In the event
such court does not exercise the power granted to it in the prior sentence, the
parties hereto agree to replace such invalid or unenforceable term or provision
with a valid and enforceable term or provision that will achieve, to the extent
possible, the economic, business and other purposes of such invalid or
unenforceable term.
9.7 Counterparts and Signature. This Agreement may be executed in two or more
counterparts, each of which shall be deemed an original but all of which
together shall be considered one and the same agreement and shall become
effective when counterparts have been signed by each of the parties hereto and
delivered to the other parties, it being understood that all parties need not
sign the same counterpart. This Agreement may be executed and delivered by
facsimile transmission.
9.8 Interpretation. When reference is made in this Agreement to an Article or
a Section, such reference shall be to an Article or Section of this Agreement,
unless otherwise indicated. The table of contents, table of defined terms and
headings contained in this Agreement are for convenience of reference only and
shall not affect in any way the meaning or interpretation of this Agreement.
The language used in this Agreement shall be deemed to be the language chosen
by the parties hereto to express their mutual intent, and no rule of strict
construction shall be applied against any party. Whenever the context may
require, any pronouns used in this Agreement shall include the corresponding
masculine, feminine or neuter forms, and the singular form of nouns and
pronouns shall include the plural, and vice versa. Any reference to any
federal, state, local or foreign statute or law shall be deemed also to refer
to all rules and regulations promulgated thereunder, unless the context
requires otherwise. Whenever the words "include", "includes" or "including" are
used in this Agreement, they shall be deemed to be followed by the words
"without limitation".
9.9 Governing Law. This Agreement shall be governed by and construed in
accordance with the internal laws of the State of New York without giving
effect to any choice or conflict of law provision or rule (whether of the State
of New York or any other jurisdiction) that would cause the application of laws
of any jurisdictions other than those of the State of New York.
9.10 Remedies. Except as otherwise provided herein, any and all remedies
herein expressly conferred upon a party will be deemed cumulative with and not
exclusive of any other remedy conferred hereby, or by law or equity upon such
party, and the exercise by a party of any one remedy will not preclude the
exercise of any other remedy. The parties hereto agree that irreparable damage
would occur in the event that any of the provisions of this Agreement were not
performed in accordance with their specific terms or were otherwise
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breached. It is accordingly agreed that the parties shall be entitled to an
injunction or injunctions to prevent breaches of this Agreement and to enforce
specifically the terms and provisions hereof this being in addition to any
other remedy to which they are entitled at law or in equity.
9.11 Waiver of Jury Trial. EACH OF THE BUYER, THE TRANSITORY SUBSIDIARY AND
THE COMPANY HEREBY IRREVOCABLY WAIVES ALL RIGHTS TO TRIAL BY JURY IN ANY
ACTION, PROCEEDING OR COUNTERCLAIM (WHETHER BASED ON CONTRACT, TORT OR
OTHERWISE) ARISING OUT OF OR RELATING TO THIS AGREEMENT OR THE TRANSACTIONS
CONTEMPLATED HEREBY OR THE ACTIONS OF THE BUYER, THE TRANSITORY SUBSIDIARY OR
THE COMPANY IN THE NEGOTIATION, ADMINISTRATION, PERFORMANCE AND ENFORCEMENT OF
THIS AGREEMENT.
[Signature Page to follow]
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IN WITNESS WHEREOF, the Buyer, the Transitory Subsidiary and the Company have
caused this Agreement to be signed by their respective officers thereunto duly
authorized as of the date first written above.
PRODIGY COMMUNICATIONS CORPORATION
/s/ Andrea S. Hirsch
By: _________________________________
Name: Andrea S. Hirsch
Title: Executive Vice President
and General Counsel
PUCKNUT CORPORATION
/s/ Andrea S. Hirsch
By: _________________________________
Name: Andrea S. Hirsch
Title: Vice President, General
Counsel and Secretary
FLASHNET COMMUNICATIONS, INC.
/s/ Michael Scott Leslie
By: _________________________________
Name: Michael Scott Leslie
Title: Chief Executive Officer
and President
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ANNEX C
STOCK OPTION AGREEMENT
STOCK OPTION AGREEMENT, dated as of November 5, 1999 (the "Agreement"),
between Prodigy Communications Corporation, a Delaware corporation (the
"Grantee"), and FlashNet Communications, Inc., a Texas corporation (the
"Grantor").
WHEREAS, the Grantee, the Grantor and PUCKnut Corporation, a wholly owned
subsidiary of the Grantee ("Newco"), are entering into an Agreement and Plan of
Merger, dated as of the date hereof (the "Merger Agreement"), which provides,
among other things, for the merger (the "Merger") of Newco with and into the
Grantor;
WHEREAS, as a condition to its willingness to enter into the Merger
Agreement, the Grantee has requested that the Grantor grant to the Grantee an
option to purchase the shares of Common Stock of the Grantor (the "Common
Stock") covered hereby, upon the terms and subject to the conditions hereof;
and
WHEREAS, in order to induce the Grantee to enter into the Merger Agreement,
the Grantor is willing to grant the Grantee the requested option.
NOW, THEREFORE, in consideration of the premises and the mutual covenants and
agreements set forth herein, the parties hereto agree as follows:
1. The Option; Exercise; Adjustments; Termination.
(a) Contemporaneously herewith the Grantee, Newco and the Grantor are
entering into the Merger Agreement. Subject to the other terms and conditions
set forth herein, the Grantor hereby grants to the Grantee an irrevocable
option (the "Option") to purchase up to 2,837,475 shares of Common Stock (the
"Shares") at a cash purchase price equal to $8.6625 per Share (the "Purchase
Price"); provided, however, that the number of shares issuable to Buyer
pursuant hereto shall not exceed 19.9% of the outstanding shares of Common
Stock. The Option may be exercised by the Grantee, in whole or in part, at any
time, or from time to time, after the earlier of (i) the occurrence of any
event which would permit the Buyer to terminate the Merger Agreement under
Section 8.1(e) or Section 8.1(f) of the Merger Agreement, or (ii) immediately
prior to the occurrence of any event causing the termination fee to become
payable to Buyer pursuant to Section 8.3(c)(iii) of the Merger Agreement,
provided that, in the case of clause (ii), an Alternative Transaction involving
the Company has been proposed or consummated prior to the Company Meeting.
(b) In the event of any change in the number of issued and outstanding shares
of Common Stock by reason of any stock dividend, stock split, split-up,
recapitalization, merger or other change in the corporate or capital structure
of the Grantor, the number of Shares subject to the Option and the purchase
price per Share shall be appropriately adjusted to restore to the Grantee its
rights hereunder.
(c) In the event the Grantee wishes to exercise the Option, the Grantee shall
send a written notice to the Grantor (the "Exercise Notice") specifying a date
(subject to the requirements of the Hart-Scott-Rodino Antitrust Improvements
Act of 1976, as amended (the "HSR Act")) not later than 10 business days and
not earlier than the next business day following the date such notice is given
for the closing of such purchase.
(d) The right to exercise the Option shall terminate at the earliest of (i)
the Effective Time (as defined in the Merger Agreement), (ii) the termination
of the Merger Agreement pursuant to circumstances under which the Grantee is
not entitled to receive the termination fee pursuant to Section 8.3 of the
Merger Agreement, (iii) the date on which Grantee realizes a Total Profit equal
to the Profit Limit (as such terms are defined in Section 8) and (iv) 90 days
after the date (the "Merger Termination Date") on which the Merger Agreement is
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terminated (the date referred to in clause (iv) being hereinafter referred to
as the "Option Expiration Date"); provided that if the Option cannot be
exercised or the Shares cannot be delivered to Grantee upon such exercise
because the conditions set forth in Section 2(a) or Section 2(b) hereof have
not yet been satisfied, the Option Expiration Date shall be extended until 30
days after such impediment to exercise has been removed.
2. Conditions to Delivery of Shares. The Grantor's obligation to deliver
Shares upon exercise of the Option is subject only to the conditions that:
(a) No preliminary or permanent injunction or other order issued by any
federal or state court of competent jurisdiction in the United States
prohibiting the delivery of the Shares shall be in effect; and
(b) Any applicable waiting periods under the HSR Act shall have expired
or been terminated.
3. The Closing.
(a) Any closing hereunder shall take place on the date specified by the
Grantee in its Exercise Notice at 10:00 a.m., local time, at the offices of
Hale and Dorr LLP, 60 State Street, Boston, Massachusetts, or, if the
conditions set forth in Section 2(a) or 2(b) have not then been satisfied, on
the second business day following the satisfaction of such conditions, or at
such other time and place as the parties hereto may agree (the "Closing Date").
On the Closing Date, the Grantor will deliver to the Grantee a certificate or
certificates, duly endorsed (or accompanied by duly executed stock powers),
representing the Shares in the denominations designated by the Grantee in its
Exercise Notice and the Grantee will purchase such Shares from the Grantor at
the price per Share equal to the Purchase Price. Any payment made by the
Grantee to the Grantor, or by the Grantor to the Grantee, pursuant to this
Agreement shall be made by certified or official bank check or by wire transfer
of federal funds to a bank designated by the party receiving such funds.
(b) The certificates representing the Shares may bear an appropriate legend
relating to the fact that such Shares have not been registered under the
Securities Act of 1933, as amended (the "Securities Act").
4. Representations and Warranties of the Grantor. The Grantor represents and
warrants to the Grantee that:
(a) the Grantor is a corporation duly organized, validly existing and in
good standing under the laws of the State of Texas and has the requisite
corporate power and authority to enter into and perform this Agreement;
(b) the execution and delivery of this Agreement by the Grantor and the
consummation by it of the transactions contemplated hereby have been duly
authorized by the Board of Directors of the Grantor and this Agreement has
been duly executed and delivered by a duly authorized officer of the
Grantor and constitutes a valid and binding obligation of the Grantor,
enforceable in accordance with its terms, subject to bankruptcy,
insolvency, fraudulent transfer, reorganization, moratorium and similar
laws of general applicability relating to or affecting creditors' rights
and to general equity principles;
(c) the Grantor has taken all necessary corporate action to authorize and
reserve the Shares issuable upon exercise of the Option and the Shares,
when issued and delivered by the Grantor upon exercise of the Option, will
be duly authorized, validly issued, fully paid and non-assessable and free
of any lien, security interest or other adverse claim and free of any
preemptive rights;
(d) except as otherwise required by the HSR Act, the execution and
delivery of this Agreement by the Grantor and the consummation by it of the
transactions contemplated hereby do not require the consent, waiver,
approval or authorization of or any filing with any person or public
authority and will not violate, require a consent or waiver under, result
in a breach of or the acceleration of any obligation under, or constitute a
default under, any provision of any charter or by-law, indenture, mortgage,
lien, lease, agreement, contract, instrument, order, law, rule, regulation,
stock market rule, judgment, ordinance, decree or restriction by which the
Grantor or any of its subsidiaries or any of their respective properties or
assets is bound; and
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(e) no "fair price", "moratorium", "control share acquisition" or other
form of anti-takeover statute or regulation is or shall be applicable to
the acquisition of Shares pursuant to this Agreement.
5. Representations and Warranties of the Grantee. The Grantee represents and
warrants to the Grantor that:
(a) the execution and delivery of this Agreement by the Grantee and the
consummation by it of the transactions contemplated hereby have been duly
authorized by all necessary corporate action on the part of the Grantee and
this Agreement has been duly executed and delivered by a duly authorized
officer of the Grantee and will constitute a valid and binding obligation
of Grantee; and
(b) the Grantee is acquiring the Option and, if and when it exercises the
Option, will be acquiring the Shares issuable upon the exercise thereof for
its own account and not with a view to distribution or resale in any manner
which would be in violation of the Securities Act.
6. Listing of Shares; HSR Act Filings; Governmental Consents. Subject to
applicable law and the rules and regulations of the Nasdaq National Market, the
Grantor shall (i) promptly file a notice to list the Shares on the Nasdaq
National Market and (ii) make, as promptly as practicable, all necessary
filings by the Grantor under the HSR Act and use its best efforts to obtain all
necessary approvals thereunder as promptly as practicable; provided, however,
that if the Grantor is unable to effect such listing on the Nasdaq National
Market by the Closing Date, the Grantor will nevertheless be obligated to
deliver the Shares upon the Closing Date. Each of the parties hereto will use
its best efforts to obtain consents of all third parties and governmental
authorities, if any, necessary to the consummation of the transactions
contemplated.
7. Registration Rights.
(a) In the event that the Grantee shall desire to sell any of the Shares
within two years after the purchase of such Shares pursuant hereto, and such
sale requires, in the opinion of counsel to the Grantee, which opinion shall be
reasonably satisfactory to the Grantor and its counsel, registration of such
Shares under the Securities Act, the Grantor will cooperate with the Grantee
and any underwriters in registering such Shares for resale, including, without
limitation, promptly filing a registration statement which complies with the
requirements of applicable federal and state securities laws and entering into
an underwriting agreement with such underwriters upon such terms and conditions
as are customarily contained in underwriting agreements with respect to
secondary distributions; provided that the Grantor shall not be required to
have declared effective more than two registration statements hereunder and
shall be entitled to delay the filing or effectiveness of any registration
statement for up to 120 days if the offering would, in the judgment of the
Board of Directors of the Grantor, require premature disclosure of any material
corporate development or otherwise interfere with or adversely affect any
pending or proposed offering of securities of the Grantor or any other material
transaction involving the Grantor.
(b) If the Common Stock is registered pursuant to the provisions of this
Section 7, the Grantor agrees (i) to furnish copies of the registration
statement and the prospectus relating to the Shares covered thereby in such
numbers as the Grantee may from time to time reasonably request and (ii) if any
event shall occur as a result of which it becomes necessary to amend or
supplement any registration statement or prospectus, to prepare and file under
the applicable securities laws such amendments and supplements as may be
necessary to keep available for at least 90 days a prospectus covering the
Common Stock meeting the requirements of such securities laws, and to furnish
to the Grantee such numbers of copies of the registration statement and
prospectus as amended or supplemented as may reasonably be requested. The
Grantor shall bear the cost of the registration, including, but not limited to,
all registration and filing fees, printing expenses, and fees and disbursements
of counsel and accountants for the Grantor, except that the Grantee shall pay
the fees and disbursements of its counsel and the underwriting fees and selling
commissions applicable to the Shares sold by the Grantee. The Grantor shall
indemnify and hold harmless Grantee, its affiliates and its officers and
directors from and against any and all losses, claims, damages, liabilities and
expenses arising out of or based upon any statements contained in, omissions or
alleged omissions from, each registration statement filed pursuant to this
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paragraph; provided, however, that this provision does not apply to any loss,
liability, claim, damage or expense to the extent it arises out of any
statement or omission made in reliance upon and in conformity with written
information furnished to the Grantor by the Grantee, its affiliates or its
officers expressly for use in any registration statement (or any amendment
thereto) or any preliminary prospectus filed pursuant to this paragraph. The
Grantor shall also indemnify and hold harmless each underwriter and each person
who controls any underwriter within the meaning of either the Securities Act or
the Securities Exchange Act of 1934 against any and all losses, claims,
damages, liabilities and expenses arising out of or based upon any statements
contained in, omissions or alleged omissions from, each registration statement
filed pursuant to this paragraph; provided, however, that this provision does
not apply to any loss, liability, claim, damage or expense to the extent it
arises out of any statement or omission made in reliance upon and in conformity
with written information furnished to the Grantor by the underwriters expressly
for use in any registration statement (or any amendment thereto) or any
preliminary prospectus filed pursuant to this paragraph.
8. Profit Limitation.
(a) Notwithstanding any other provision of this Agreement, in no event shall
the Grantee's Total Profit (as hereinafter defined) exceed $5 million (the
"Profit Limit") and, if it otherwise would exceed such amount, the Grantee, at
its sole election, shall either (i) deliver to the Grantor for cancellation
Shares previously purchased by Grantee, (ii) pay cash to the Grantor, (iii)
receive a smaller termination fee under Section 8.3 of the Merger Agreement or
(iv) undertake any combination thereof, so that Grantee's Total Profit shall
not exceed the Profit Limit after taking into account the foregoing actions.
(b) Notwithstanding any other provision of this Agreement, the Option may not
be exercised for a number of Shares as would, as of the date of the Exercise
Notice, result in a Notional Total Profit (as defined below) of more than the
Profit Limit and, if exercise of the Option otherwise would exceed the Profit
Limit, the Grantee, at its discretion, may increase the Purchase Price for that
number of Shares set forth in the Exercise Notice so that the Notional Total
Profit shall not exceed the Profit Limit; provided, that nothing in this
sentence shall restrict any exercise of the Option permitted hereby on any
subsequent date at the Purchase Price set forth in Section 1(a) hereof.
(c) As used herein, the term "Total Profit" shall mean the aggregate amount
(before taxes) of the following: (i) the amount of cash received by Grantee
pursuant to Section 8.3(c) of the Merger Agreement, and (ii) (x) the cash
amounts (net of customary brokerage commissions paid in connection with the
transaction) received by Grantee pursuant to the sale of Shares (or any other
securities into which such Shares are converted or exchanged) to any
unaffiliated party, less (y) the Grantee's purchase price for such Shares.
(d) As used herein, the term "Notional Total Profit" with respect to any
number of Shares as to which Grantee may propose to exercise the Option shall
be the Total Profit determined as of the date of the Exercise Notice assuming
that the Option were exercised on such date for such number of Shares and
assuming that such Shares, together with all other Shares held by Grantee and
its affiliates as of such date, were sold for cash at the closing market price
for the Common Stock as of the close of business on the preceding trading day
(less customary brokerage commissions).
9. Put.
(a) At any time during which the Option is exercisable under this Agreement
(the "Repurchase Period"), upon demand by the Grantee, the Grantee shall have
the right to sell to the Grantor (or any successor entity thereof) and Grantor
(or such successor entity, shall be obligated to repurchase from the Grantee
(the "Put"), all or any portion of the Option, to the extent not previously
exercised, at the price set forth in subparagraph (i) below, and/or all or any
portion of the Shares purchased by the Grantee pursuant thereto, at a price set
forth in subparagraph (ii) below:
(i) the difference between the "Market/Tender Offer Price" for shares of
Common Stock as of the date (the "Notice Date") notice of exercise of the
Put is given to the other party (defined as the greater of
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(A) the price per share offered as of the Notice Date pursuant to any
tender or exchange offer or other Acquisition Proposal which was made prior
to the Notice Date and not terminated or withdrawn as of the Notice Date
(the "Tender Price") or (B) the average of the closing prices of shares of
Common Stock on the Nasdaq National Market for the ten (10) trading days
immediately preceding the Notice Date (the "Market Price")), and the
Purchase Price multiplied by the number of Shares purchasable pursuant to
the Option (or portion thereof with respect to which the Grantee is
exercising its rights under this Section 9), but only if the Market/Tender
Offer Price is greater than the Purchase Price;
(ii) the Purchase Price paid by the Grantee for the Shares acquired
pursuant to the Option plus the difference between the Market/Tender Offer
Price and the Purchase Price, but only if the Market/Tender Offer Price is
greater than the Purchase Price, multiplied by the number of Shares so
purchased;
(b) In the event Grantee exercises its rights under this Section 9, the
Grantor shall, within ten business days of the Notice Date, pay the required
amount (the "Repurchase Price") to the Grantee in immediately available funds
and the Grantee shall surrender to the Grantor the Option or the certificates
evidencing the Shares purchased by the Grantee pursuant thereto, and the
Grantee shall represent and warrant that it owns such shares and that such
shares are then free and clear of all liens, claims, charges and encumbrances
of any kind or nature whatsoever, other than any of the same created by the
Grantor or its affiliates.
(c) To the extent that the Grantor is prohibited under applicable law or
regulation, or as a consequence of administrative policy, from repurchasing the
Option and/or Shares in full, the Grantor shall immediately so notify the
Grantee and thereafter deliver or cause to be delivered, from time to time, to
the Grantee the portion of the Repurchase Price that it is no longer prohibited
from delivering within five business days after the date on which the Grantor
is no longer so prohibited; provided that, if the Grantor at any time after
delivery of a notice of exercise of the Put pursuant to Section 9(a) is
prohibited under applicable law or regulation, or as a consequence of
administrative policy, from delivering to the Grantee the Repurchase Price in
full (and the Grantor hereby undertakes to use its best efforts to obtain all
required regulatory and legal approvals and to file any required notices as
promptly as practicable in order to accomplish such repurchase), the Grantee
may revoke its notice of the exercise of the Put whether in whole or to the
extent of the prohibition, whereupon, in the latter case, the Grantor shall
promptly (1) deliver to the Grantee that portion of the Repurchase Price that
the Grantor is not prohibited from delivering and (2) deliver to the Grantee as
appropriate, (A) a new Agreement evidencing the right of the Grantee to
purchase that number of shares of Common Stock obtained by multiplying the
number of shares of Common Stock for which the surrendered Agreement was
exercisable at the time of delivery of the notice of exercise of the Put by a
fraction, the numerator of which is the Repurchase Price less the portion of
the Repurchase Price previously delivered to the Grantee and the denominator of
which is the Repurchase Price, and/or (B), a certificate for the Shares the
Grantor is then so prohibited from repurchasing.
10. Expenses. Each party hereto shall pay its own expenses incurred in
connection with this Agreement, except as otherwise specifically provided
herein.
11. Specific Performance. The Grantor acknowledges that if the Grantor fails
to perform any of its obligations under this Agreement, immediate and
irreparable harm or injury would be caused to the Grantee for which money
damages would not be an adequate remedy. In such event, the Grantor agrees that
the Grantee shall have the right, in addition to any other rights it may have,
to specific performance of this Agreement. Accordingly, if the Grantee should
institute an action or proceeding seeking specific enforcement of the
provisions hereof, the Grantor hereby waives the claim or defense that the
Grantee has an adequate remedy at law and hereby agrees not to assert in any
such action or proceeding the claim or defense that such a remedy at law
exists. The Grantor further agrees to waive any requirements for the securing
or posting of any bond in connection with obtaining any such equitable relief.
12. Notice. All notices, requests, demands and other communications hereunder
shall be deemed to have been duly given and made if in writing and if served by
personal delivery upon the party for whom it is
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intended or delivered by registered or certified mail, return receipt
requested, or if sent by facsimile transmission, upon receipt of oral
confirmation that such transmission has been received, to the person at the
address set forth below, or such other address as may be designated in writing
hereafter, in the same manner, by such person:
If to the Grantor:
FlashNet Communications, Inc.
1812 North Forest Park Blvd.
Fort Worth, Texas 76102
Attn: President
Telecopy: (817) 870-0296
With a copy to:
Brobeck, Phleger & Harrison LLP
301 Congress Avenue, Suite 1200
Austin, Texas 78701
Attn: S. Michael Dunn, Esq.
Telecopy: (512) 477-5813
If to the Grantee:
Prodigy Communications Corporation
44 South Broadway
White Plains, New York 10601
Attn: General Counsel
Telecopy: (914) 448-8198
With a copy to:
Hale and Dorr LLP
60 State Street
Boston, Massachusetts 02109
Attn: David A. Westenberg, Esq.
Telecopy: (617) 526-5000
13. Parties in Interest. Nothing in this Agreement, express or implied, is
intended to confer upon any person other than the Grantor or the Grantee, or
their successors or assigns, any rights or remedies under or by reason of this
Agreement.
14. Entire Agreement; Amendments. This Agreement, together with the Merger
Agreement and the other documents referred to therein, contains the entire
agreement between the parties hereto with respect to the subject matter hereof
and supersedes all prior and contemporaneous agreements and understandings,
oral or written, with respect to such transactions. The terms of this Agreement
may be amended, modified or waived only by an agreement in writing signed by
the party against whom such amendment, modification or waiver is sought to be
enforced.
15. Assignment. No party to this Agreement may assign any of its rights or
obligations under this Agreement without the prior written consent of the other
party hereto, except that the Grantee may assign its rights and obligations
hereunder to any direct or indirect wholly-owned subsidiary of the Grantee
(provided that such assignment shall not relieve the Grantee of its obligations
hereunder if such transferee does not perform such obligations).
16. Headings. The section headings herein are for convenience only and shall
not affect the construction of this Agreement.
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17. Counterparts. This Agreement may be executed in any number of
counterparts, each of which, when executed, shall be deemed to be an original
and all of which together shall constitute one and the same document.
18. Governing Law. This Agreement shall be governed by and construed in
accordance with the laws of the State of New York (regardless of the laws that
might otherwise govern under applicable New York principles of conflicts of
law).
19. Survival. All representations and warranties contained in this Agreement
shall survive delivery of and payment for the Shares.
20. Severability. If any term, provision, covenant or restriction of this
Agreement is held by a court of competent jurisdiction to be invalid, void or
unenforceable, the remainder of the terms, provisions, covenants and
restrictions of this Agreement shall remain in full force and effect and shall
in no way be affected, impaired or invalidated.
IN WITNESS WHEREOF, the Grantee and the Grantor have caused this Agreement to
be duly executed and delivered on the day and year first above written.
FLASHNET COMMUNICATIONS, INC.
/s/ Michael Scott Leslie
By___________________________________
Name: Michael Scott Leslie
Title: Chief Executive Officer and
President
PRODIGY COMMUNICATIONS CORPORATION
/s/ Andrea S. Hirsch
By___________________________________
Name: Andrea S. Hirsch
Title: Executive Vice President
and General Counsel
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<PAGE>
ANNEX D
STOCKHOLDER AGREEMENT
STOCKHOLDER AGREEMENT, dated as of November 5, 1999 (this "Agreement"), by
the stockholders listed on the signature page(s) hereto (collectively,
"Stockholders" and each individually, a "Stockholder") to and for the benefit
of Prodigy Communications Corporation, a Delaware corporation ("Acquiror").
Capitalized terms used and not otherwise defined herein shall have the
respective meanings assigned to them in the Merger Agreement referred to below.
WHEREAS, as of the date hereof, the Stockholders collectively own of record
and beneficially shares of capital stock of FlashNet Communications, Inc., a
Texas corporation (the "Company"), as set forth on Schedule I hereto (such
shares or any other voting or equity of securities of the Company, hereafter
acquired by any Stockholder prior to the termination of this Agreement, being
referred to herein collectively as the "Shares");
WHEREAS, concurrently with the execution of this Agreement, Acquiror and the
Company are entering into an Agreement and Plan of Merger, dated as of the date
hereof (the "Merger Agreement"), pursuant to which, upon the terms and subject
to the conditions thereof, a subsidiary of Buyer will be merged with and into
the Company, and the Company will be the surviving corporation (the "Merger");
and
WHEREAS, as a condition to the willingness of the Company and Acquiror to
enter into the Merger Agreement, Acquiror has requested that the Stockholders
agree, and in order to induce Acquiror to enter into the Merger Agreement, the
Stockholders are willing to agree to vote in favor of adopting the Merger
Agreement and approving the Merger, upon the terms and subject to the
conditions set forth herein.
NOW, THEREFORE, in consideration of the foregoing and the mutual covenants
and agreements contained herein, and intending to be legally bound hereby, the
parties hereby agree, severally and not jointly, as follows:
Section 1. Voting of Shares. Each Stockholder covenants and agrees that until
the termination of this Agreement in accordance with the terms hereof, at the
Company Meeting or any other meeting of the stockholders of the Company,
however called, and in any action by written consent of the stockholders of the
Company, such Stockholder will vote, or cause to be voted, all of his, her or
its respective Shares (a) in favor of adoption of the Merger Agreement and
approval of the Merger contemplated by the Merger Agreement, as the Merger
Agreement may be modified or amended from time to time in a manner not adverse
to the Stockholders, and (b) against any other Alternative Transaction. In
addition, such Stockholder agrees that it will, upon request by Acquiror,
furnish written confirmation, in form and substance reasonably acceptable to
Acquiror, of such Stockholder's vote in favor of the Merger Agreement and the
Merger. Each Stockholder covenants and agrees to deliver to Acquiror upon
request prior to any vote contemplated by the first sentence of this Section 1,
a proxy substantially in the form attached hereto as Annex A (a "Proxy"), which
Proxy shall be irrevocable during the term of this Agreement to the extent
permitted under Texas law, and Acquiror agrees to vote the Shares subject to
such Proxy in favor of the approval and adoption of the Merger Agreement and
the Merger. Each Stockholder acknowledges receipt and review of a copy of the
Merger Agreement. Each Stockholder acknowledges and agrees that this proxy, if
and when given, shall be coupled with an interest, shall constitute, among
other things, an inducement for Acquiror to enter into the Merger Agreement,
shall be irrevocable and shall not be terminated by operation of law or
otherwise upon the occurrence of any event and that no subsequent proxies with
respect to such Shares shall be given (and if given shall not be effective);
provided however that any such proxy shall terminate automatically and without
further action on behalf of the Stockholders upon the termination of this
Agreement. In the event that a Stockholder does not provide the Proxy upon
request of Acquiror, such Stockholder hereby grants Buyer a power of attorney
to execute and deliver such Proxy for and behalf of such Stockholder, which
power of attorney is coupled with an interest and shall survive any death,
disability, bankruptcy or any other such impediment of such Stockholder. Upon
the execution of this Agreement by each Stockholder, such Stockholder hereby
revokes any and all prior proxies or powers of attorney given by such
Stockholder with respect to the Shares.
D-1
<PAGE>
Section 2. Transfer of Shares. Each Stockholder covenants and agrees that
such Stockholder will not directly or indirectly, (a) sell, assign, transfer
(including by merger, testamentary disposition, interspousal disposition
pursuant to a domestic relations proceeding or otherwise by operation of law),
pledge, encumber or otherwise dispose of any of the Shares, (b) deposit any of
the Shares into a voting trust or enter into a voting agreement or arrangement
with respect to the Shares or grant any proxy or power of attorney with respect
thereto which is inconsistent with this Agreement or (c) enter into any
contract, option or other arrangement or undertaking with respect to the direct
or indirect sale, assignment, transfer (including by merger, testamentary
disposition, interspousal disposition pursuant to a domestic relations
proceeding or otherwise by operation of law) or other disposition of any
Shares; provided, however, that a Stockholder may transfer Shares to an entity
controlled by the Stockholder, and Applied Telecommunications Technologies,
Inc. may transfer Shares to its stockholders, in each case on the condition
that each such transferee enter into this agreement and agree unconditionally
to bound by the terms hereof.
Section 3. Representations and Warranties of the Stockholders. Each
Stockholder on its own behalf hereby severally represents and warrants to
Acquiror with respect to itself and its or her ownership of the Shares as
follows:
(a) Ownership of Shares. On the date hereof, the Shares are owned
beneficially by Stockholder or its nominee. Stockholder has sole voting
power, without restrictions, with respect to all of the Shares.
(b) Power, Binding Agreement. Stockholder has the legal capacity, power
and authority to enter into and perform all of its obligations, under this
Agreement. The execution, delivery and performance of this Agreement by
Stockholder will not violate any material agreement to which Stockholder is
a party, including, without limitation, any voting agreement, stockholders'
agreement, partnership agreement or voting trust. This Agreement has been
duly and validly executed and delivered by Stockholder and constitutes a
valid and binding obligation of Stockholder, enforceable against
Stockholder in accordance with its terms, subject to applicable bankruptcy,
insolvency, fraudulent conveyance, reorganization, moratorium and similar
laws affecting creditors' rights and remedies generally and subject, as to
enforceability, to general principles of equity (regardless of whether
enforcement is sought in a proceeding at law or in equity).
(c) No Conflicts. The execution and delivery of this Agreement do not,
and the consummation of the transactions contemplated hereby will not,
conflict with or result in any violation of, or default (with or without
notice or lapse of time, or both) under, or give rise to a right of
termination, cancellation or acceleration of any obligation or to loss of a
material benefit under, any provision of any loan or credit agreement,
note, bond, mortgage, indenture, lease, or other agreement, instrument,
permit, concession, franchise, license, judgment, order, decree, statute,
law, ordinance, rule or regulation applicable to Stockholder or any of its
properties or assets, other than such conflicts, violations or defaults or
terminations, cancellations or accelerations which individually or in the
aggregate do not materially impair the ability of Stockholder to perform
its obligations hereunder.
Section 4. No Solicitation. Prior to the termination of this Agreement in
accordance with its terms, each Stockholder agrees, in its individual capacity
as a stockholder of the Company that (i) it will not, nor will it authorize or
permit any of its employees, agents and representatives to, directly or
indirectly, (a) initiate, solicit or encourage any inquiries or the making of
any Acquisition Proposal (as defined in the Merger Agreement), (b) enter into
any agreement with respect to any Acquisition Proposal, or (c) participate in
any discussions or negotiations regarding, or furnish to any person any
information with respect to, or take any other action to facilitate any
inquiries or the making of any proposal that constitutes, or may reasonably be
expected to lead to, any Acquisition Proposal, and (ii) it will notify Acquiror
as soon as possible if any such inquiries or proposals are received by, any
information or documents is requested from, or any negotiations or discussions
are sought to be initiated or continued with, it or any of its affiliates in
its individual capacity; provided, that, notwithstanding the foregoing, each
Stockholder shall not be prohibited from taking any such actions to the extent
that the Company or its Board of Directors is permitted to take such actions
under the Merger Agreement.
D-2
<PAGE>
Section 5. Termination. This Agreement shall terminate upon the earliest to
occur of (i) the Effective Time (as such term is defined in the Merger
Agreement) or (ii) any termination of the Merger Agreement in accordance with
the terms thereof; provided that no such termination shall relieve any party of
liability for a willful breach hereof prior to termination.
Section 6. Specific Performance. The parties hereto agree that irreparable
damage would occur in the event any provision of this Agreement was not
performed in accordance with the terms hereof and that the parties shall be
entitled to specific performance of the terms hereof, in addition to any other
remedy at law or in equity.
Section 7. Fiduciary Duties. Each Stockholder is signing this Agreement
solely in such Stockholder's capacity as an owner of his, her or its respective
Shares, and nothing herein shall prohibit, prevent or preclude such Stockholder
from taking or not taking any action in his or her capacity as an officer or
director of the Company, to the extent permitted by the Merger Agreement.
Section 8. Legend on Certificate. Each Stockholder agrees to present the
certificates representing the Shares presently owned or hereafter acquired by
such Stockholder to the Secretary of the Company and to cause the Secretary to
stamp on the certificate in a prominent manner the following legend:
"The shares represented by this certificate are subject to transfer
restrictions and an irrevocable proxy pursuant to a Stockholder
Agreement and Irrevocable Proxy, each dated as of November 5, 1999 (the
"Agreements"). Copies of the Agreements are available for inspection
during normal business hours at the principal executive office of this
corporation."
Section 9. Miscellaneous.
(a) This Agreement constitutes the entire agreement between the parties
hereto with respect to the subject matter hereof and supersedes all prior
agreements and understandings, both written and oral, between the parties with
respect thereto. This Agreement may not be amended, modified or rescinded
except by an instrument in writing signed by each of the parties hereto.
(b) If any term or other provision of this Agreement is invalid, illegal or
incapable of being enforced by any rule of law, or public policy, all other
conditions and provisions of this Agreement shall nevertheless remain in full
force and effect. Upon such determination that any term or other provision is
invalid, illegal or incapable of being enforced, the parties hereto shall
negotiate in good faith to modify this Agreement so as to effect the original
intent of the parties as closely as possible to the fullest extent permitted by
applicable law in a mutually acceptable manner in order that the terms of this
Agreement remain as originally contemplated to the fullest extent possible.
(c) This Agreement shall be governed by and construed in accordance with the
laws of the State of New York without regard to the principles of conflicts of
law thereof.
(d) This Agreement may be executed in counterparts, each of which shall be
deemed an original and all of which together shall constitute one and the same
instrument.
[Signature Page to follow]
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<PAGE>
IN WITNESS WHEREOF, each of the parties hereto has caused this Agreement to
be signed individually or by its respective duly authorized officer as of the
date first written above.
PRODIGY COMMUNICATIONS CORPORATION
/s/ Andrea S. Hirsch
By: _________________________________
Name: Andrea S. Hirsch
Title: Executive Vice President
and General Counsel
STOCKHOLDERS:
APPLIED TELECOMMUNICATIONS
TECHNOLOGIES, INC.
/s/ Dennis P. Cameron
By: _________________________________
Name: Dennis P. Cameron
Title: President
D-4
<PAGE>
IN WITNESS WHEREOF, each of the parties hereto has caused this Agreement to
be signed individually or by its respective duly authorized officer as of the
date first written above.
PRODIGY COMMUNICATIONS CORPORATION
/s/ Andrea S. Hirsch
By: _________________________________
Name: Andrea S. Hirsch
Title: Executive Vice President
and General Counsel
STOCKHOLDERS:
/s/ James B. Francis, Jr.
By: _________________________________
Name: James B. Francis, Jr.
D-5
<PAGE>
IN WITNESS WHEREOF, each of the parties hereto has caused this Agreement to
be signed individually or by its respective duly authorized officer as of the
date first written above.
PRODIGY COMMUNICATIONS CORPORATION
/s/ Andrea S. Hirsch
By: _________________________________
Name: Andrea S. Hirsch
Title: Executive Vice President
and General Counsel
STOCKHOLDERS:
GLOBAL UNDERVALUED SECURITIES
FUND, L.P.
By: KLEINHEINZ CAPITAL PARTNERS LDC
its general partner
/s/ John B. Kleinheinz
By: _________________________________
Name: John B. Kleinheinz
Title: President
D-6
<PAGE>
IN WITNESS WHEREOF, each of the parties hereto has caused this Agreement to
be signed individually or by its respective duly authorized officer as of the
date first written
PRODIGY COMMUNICATIONS CORPORATION
/s/ Andrea S. Hirsch
By: _________________________________
Name: Andrea S. Hirsch
Title: Executive Vice President
and General Counsel
STOCKHOLDERS:
/s/ Andrew N. Jent
By: _________________________________
Name: Andrew N. Jent
D-7
<PAGE>
IN WITNESS WHEREOF, each of the parties hereto has caused this Agreement to
be signed individually or by its respective duly authorized officer as of the
date first written above.
PRODIGY COMMUNICATIONS CORPORATION
/s/ Andrea S. Hirsch
By: _________________________________
Name: Andrea S. Hirsch
Title: Executive Vice President
and General Counsel
STOCKHOLDERS:
/s/ John B. Kleinheinz
By: _________________________________
Name: John B. Kleinheinz
D-8
<PAGE>
IN WITNESS WHEREOF, each of the parties hereto has caused this Agreement to
be signed individually or by its respective duly authorized officer as of the
date first written above.
PRODIGY COMMUNICATIONS CORPORATION
/s/ Andrea S. Hirsch
By: _________________________________
Name: Andrea S. Hirsch
Title: Executive Vice President
and General Counsel
STOCKHOLDERS:
KLEINHEINZ CAPITAL PARTNERS LDC
/s/ John B. Kleinheinz
By: _________________________________
Name: John B. Kleinheinz
Title: President
D-9
<PAGE>
IN WITNESS WHEREOF, each of the parties hereto has caused this Agreement to
be signed individually or by its respective duly authorized officer as of the
date first written above.
PRODIGY COMMUNICATIONS CORPORATION
/s/ Andrea S. Hirsch
By: _________________________________
Name: Andrea S. Hirsch
Title: Executive Vice President
and General Counsel
STOCKHOLDERS:
/s/ Michael Scott Leslie
By: _________________________________
Name: Michael Scott Leslie
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<PAGE>
IN WITNESS WHEREOF, each of the parties hereto has caused this Agreement to
be signed individually or by its respective duly authorized officer as of the
date first written above.
PRODIGY COMMUNICATIONS CORPORATION
/s/ Andrea S. Hirsch
By: _________________________________
Name: Andrea S. Hirsch
Title: Executive Vice President
and General Counsel
STOCKHOLDERS:
/s/ Kevin A. Stadtler
By: _________________________________
Name: Kevin A. Stadtler
D-11
<PAGE>
IN WITNESS WHEREOF, each of the parties hereto has caused this Agreement to
be signed individually or by its respective duly authorized officer as of the
date first written above.
PRODIGY COMMUNICATIONS CORPORATION
/s/ Andrea S. Hirsch
By: _________________________________
Name: Andrea S. Hirsch
Title: Executive Vice President
and General Counsel
STOCKHOLDERS:
/s/ Albert Lee Thurburn
By: _________________________________
Name: Albert Lee Thurburn
D-12
<PAGE>
IN WITNESS WHEREOF, each of the parties hereto has caused this Agreement to
be signed individually or by its respective duly authorized officer as of the
date first written above.
PRODIGY COMMUNICATIONS CORPORATION
/s/ Andrea S. Hirsch
By: _________________________________
Name: Andrea S. Hirsch
Title: Executive Vice President
and General Counsel
STOCKHOLDERS:
/s/ Russell A. Wiseman
By: _________________________________
Name: Russell A. Wiseman
D-13
<PAGE>
SCHEDULE I
<TABLE>
<CAPTION>
Number of
Name Shares
- ---- ---------
<S> <C>
Applied Telecommunications Technologies, Inc.......................... 560,133
James B. Francis, Jr.................................................. 5,000
Global Undervalued Securities Fund, L.P............................... 1,041,973
Andrew N. Jent*....................................................... 0
John B. Kleinheinz.................................................... 814,879
Kleinheinz Capital Partners LDC....................................... 16,664
Michael Scott Leslie.................................................. 798,320
Kevin A. Stadtler*.................................................... 0
Albert Lee Thurburn................................................... 746,844
Russell A. Wiseman.................................................... 866
</TABLE>
- --------
* option holder
D-14
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 20. Indemnification of Directors and Officers.
Article EIGHTH of the Registrant's Certificate of Incorporation, as amended
(the "Certificate of Incorporation"), provides that no director of the
Registrant shall be personally liable for any monetary damages for any breach
of fiduciary duty as a director, except to the extent that the Delaware General
Corporation Law prohibits the elimination or limitation of liability of
directors for breach of fiduciary duty.
Article NINTH of the Registrant's Certificate of Incorporation provides that
a director or officer of the Registrant (a) shall be indemnified by the
Registrant against all expenses (including attorneys' fees), judgments, fines
and amounts paid in settlement incurred in connection with any litigation or
other legal proceeding (other than an action by or in the right of the
Registrant) brought against him by virtue of his position as a director or
officer of the Registrant if he acted in good faith and in a manner he
reasonably believed to be in, or not opposed to, the best interests of the
Registrant, and, with respect to any criminal action or proceeding, had no
reasonable cause to believe his conduct was unlawful and (b) shall be
indemnified by the Registrant against all expenses (including attorneys' fees)
and amounts paid in settlement incurred in connection with any action by or in
the right of the Registrant brought against him by virtue of his position as a
director or officer of the Registrant if he acted in good faith and in a manner
he reasonably believed to be in, or not opposed to, the best interests of the
Registrant, except that no indemnification shall be made with respect to any
matter as to which such person shall have been adjudged to be liable to the
Registrant, unless a court determines that, despite such adjudication but in
view of all of the circumstances, he is entitled to indemnification of such
expenses. Notwithstanding the foregoing, to the extent that a director or
officer has been successful, on the merits or otherwise, including, without
limitation, the dismissal of an action without prejudice, he is required to be
indemnified by the Registrant against all expenses (including attorneys' fees)
incurred in connection therewith. Expenses shall be advanced to a director or
officer at his request, provided that he undertakes to repay the amount
advanced if it is ultimately determined that he is not entitled to
indemnification for such expenses.
Indemnification is required to be made unless the Registrant determines that
the applicable standard of conduct required for indemnification has not been
met. In the event of a determination by the Registrant that the director or
officer did not meet the applicable standard of conduct required for
indemnification, or if the Registrant fails to make an indemnification payment
within 60 days after such payment is claimed by such person, such person is
permitted to petition the court to make an independent determination as to
whether such person is entitled to indemnification. As a condition precedent to
the right of indemnification, the director or officer must give the Registrant
notice of the action for which indemnity is sought and the Registrant has the
right to participate in such action or assume the defense thereof.
Article NINTH of the Registrant's Certificate of Incorporation further
provides that the indemnification provided therein is not exclusive, and
provides that in the event that the Delaware General Corporation Law is amended
to expand the indemnification permitted to directors or officers the Registrant
must indemnify those persons to the fullest extent permitted by such law as so
amended.
Section 145 of the Delaware General Corporation Law provides that a
corporation has the power to indemnify a director, officer, employee or agent
of the corporation and certain other persons serving at the request of the
corporation in related capacities against amounts paid and expenses incurred in
connection with an action or proceeding to which he is or is threatened to be
made a party by reason of such position, if such person shall have acted in
good faith and in a manner he reasonably believed to be in or not opposed to
the best interests of the corporation, and, in any criminal proceeding, if such
person had no reasonable cause to believe his conduct was unlawful; provided
that, in the case of actions brought by or in the right of the corporation, no
indemnification shall be made with respect to any matter as to which such
person shall have been adjudged to be liable to the corporation unless and only
to the extent that the adjudicating court determines that such indemnification
is proper under the circumstances.
II-1
<PAGE>
The Registrant has an insurance policy with coverage of $20,000,000 that
insures the directors and officers of the Registrant (with entity coverage)
against certain liabilities which might be incurred by such directors and
officers in connection with the performance of their duties.
Item 21. Exhibits and Financial Statement Schedules.
(a) Exhibits
<TABLE>
<C> <S>
2.1(1)+ Asset Purchase Agreement, dated as of May 26, 1999, by and among
Cable & Wireless USA, Inc., Cable & Wireless USA Internet, L.L.C.
and the Registrant.
2.2(2) Asset Purchase Agreement, dated as of September 7, 1999, by and
among the Registrant, U.S. Republic Communications, Inc., VarTec
Telecom, Inc., VarTec Telecom Holding Company, T. Gary Remy and Tom
D. Johnson.
2.3* Agreement and Plan of Merger, dated as of November 5, 1999 and as
amended as of March 15, 2000, among the Registrant, PUCKnut
Corporation and FlashNet Communications, Inc. (included as Annex B
to the Proxy Statement/Prospectus, which is a part of this
Registration Statement).
2.4 Stock Option Agreement, dated as of November 5, 1999, among the
Registrant and FlashNet Communications, Inc. (included as Annex C to
the Proxy Statement/Prospectus, which is a part of this Registration
Statement).
2.5 Stockholder Agreement, dated as of November 5, 1999, among the
Registrant, Applied Telecommunications Technologies, Inc., James B.
Francis, Jr., Global Undervalued Securities Fund, L.P., Andrew N.
Jent, John B. Kleinheinz, Kleinheinz Capital Partners LDC, Michael
Scott Leslie, Kevin A. Stadtler, Albert Lee Thurburn and Russell A.
Wiseman (included as Annex D to the Proxy Statement/Prospectus,
which is a part of this Registration Statement).
3.1(3) Certificate of Incorporation of the Registrant, as amended.
3.2(3) By-laws of the Registrant, as amended.
3.3(4) Form of Amended and Restated Certificate of Incorporation of the
Registrant, to be effective following the closing of the SBC
transaction.
3.4(4) Form of Amended and Restated By-laws of the Registrant, to be
effective following the closing of the SBC transaction.
3.5(4) Form of Amended and Restated Limited Partnership Agreement for
Prodigy Communications Limited Partnership by and among the
Registrant, SBC Internet Communications, Inc. and Prodigy Transition
Corporation, to be effective following the closing of the SBC
transaction.
4.1(3) Specimen certificate for shares of Common Stock.
8.1 Opinion of Hale and Dorr LLP Regarding Tax Matters.
8.2 Opinion of Brobeck, Phleger & Harrison LLP Regarding Tax Matters.
8.3 Opinion of Goldman, Sachs & Co. (included as Annex A to the Proxy
Statement/Prospectus, which is a part of this Registration
Statement).
10.1(3) 1996 Stock Option Plan of the Registrant, as amended.
10.2(3) 1999 Employee Stock Purchase Plan of the Registrant.
10.3(5) 1999 Stock Option Plan of the Registrant.
10.4(3) 1999 Outside Director Stock Option Plan of the Registrant.
10.5(3)+ Software License and Services Agreement, dated April 16, 1997,
between Prodigy Services Corporation and ORACLE Worldwide Tech
Support.
10.6(5)++ Amended and Restated Splitrock Full Service Agreement, dated
February 16, 2000, between Splitrock Services, Inc. and Prodigy
Services Corporation.
</TABLE>
II-2
<PAGE>
<TABLE>
<C> <S>
10.7(3) Agreement of Sublease, dated June 24, 1997, between Splitrock
Services, Inc. and Prodigy Services Corporation.
10.8(3) Employment Agreement, dated September 1, 1998, between the
Registrant and Samer F. Salameh.
10.9(3) Employment Agreement, dated September 14, 1998, between the
Registrant and Andrea S. Hirsch.
10.10(3) Employment Agreement, dated December 14, 1998, between the
Registrant and David C. Trachtenberg.
10.11(3) Lease, dated August 14, 1997, between Prodigy Services Corporation
and Westchester One LLC, as amended.
10.12(3)+ Promotion & Distribution Agreement, effective October 7, 1996,
between Microsoft Corporation and Prodigy Services Corporation, as
amended.
10.13(3)+ Distribution and Licensing Agreement, effective October 1, 1996,
between Packard Bell NEC, Inc. and Prodigy Services Corporation.
10.14(3)+ Excite Services Distribution and Co-Branded Area Agreement, dated
January 20, 1998, between Excite, Inc. and Prodigy Services
Corporation.
10.15(3) Lease Agreement, dated June 6, 1998, between Prodigy Services
Company and Crow-Kelly#1, as amended.
10.16(6)+ Microsoft Windows 98 "Get Connected" Co-Marketing Agreement, dated
July 2, 1998, between Prodigy Services Corporation and Microsoft
Corporation.
10.17(5) Amendment No. 1 to Microsoft Windows 98 "Get Connected" Co-
Marketing Agreement, dated October 1, 1998, by and between
Microsoft Corporation and Prodigy Services Corporation.
10.18(5)++ Renewal and Amendment to that certain Microsoft Windows 98 "Get
Connected" Co-Marketing Agreement, dated June 1, 1999, by and
between Microsoft Corporation and Prodigy Services Corporation.
10.19(5) Amendment No. 3 to that certain Microsoft Windows 98 "Get
Connected" Co-Marketing Agreement, dated January 19, 2000, by and
between Microsoft Corporation and Prodigy Services Corporation.
10.20(3)+ Software Development and processing Services Agreement, dated
January 1, 1992, between Prodigy Services Company and CSG Systems,
Inc., as amended.
10.21(3) Form of Prodigy Service Member Agreement.
10.22(3) Agreement, dated January 25, 2999, among the Registrant, Telefonos
de Mexico, S.A. de C.V. and others.
10.23(6) Microsoft Internet Explorer Logo License Agreement, dated July 2,
1998, by and between Prodigy Services Corporation and Microsoft
Corporation.
10.24(6) Microsoft Internet Explorer License and Distribution Agreement,
dated July 2, 1998, by and between Prodigy Services Corporation and
Microsoft Corporation.
10.25(4)* Investment, Issuance, Contribution and Assumption Agreement, dated
as of November 19, 1999 and as amended as of April 19, 2000, by and
among SBC Communications Inc., SBC Internet Communications, Inc.,
the Registrant, Prodigy Transition Corporation and Prodigy
Communications Limited Partnership.
10.26(4) Strategic and Marketing Agreement, dated as of November 19, 1999,
by and among SBC Communications Inc., SBC Internet Communications,
Inc., the Registrant and Prodigy Communications Limited
Partnership.
10.27(7) Voting Agreement, dated as of November 19, 1999, by and among SBC
Communications Inc., Carso Global Telecom, S.A. de C.V. and
Telefonos de Mexico, S.A. de C.V.
10.28(7) Form of Registration Rights Agreement by and among the Registrant,
SBC Communications Inc. and SBC Internet Communications, Inc., to
be effective following the closing of the SBC transaction.
</TABLE>
II-3
<PAGE>
<TABLE>
<C> <S>
10.29 Letter, dated February 28, 2000, from Telefonos de Mexico, S.A. de C.V.,
committing to provide up to $200 million in financing to Prodigy.
10.30 Promissory Note of FlashNet Communications, Inc., dated April 26, 2000,
in favor of the Registrant.
10.31 Letter Agreement, dated March 13, 2000, by and between the Registrant
and Citibank, N.A.
21(5) Subsidiaries of the Registrant.
23.1 Consent of Hale and Dorr LLP (included in Exhibit 8.1).
23.2 Consent of Brobeck, Phleger & Harrison LLP (included in Exhibit 8.2).
23.3 Consent of PricewaterhouseCoopers LLP.
23.4 Consent of Ernst & Young LLP.
23.5 Consent of Deloitte & Touche LLP.
24.1 Power of Attorney (included in the signature page of this Registration
Statement).
27(5) Financial Data Schedule.
99.2 Form of Proxy Card of FlashNet Communications, Inc.
</TABLE>
- --------
(1) Incorporated by reference to the Registrant's Current Report on Form 8-K
filed on August 3, 1999.
(2) Incorporated by reference to the Registrant's Current Report on Form 8-K
filed on October 20, 1999.
(3) Incorporated herein by reference to the Registrant's Registration
Statement on Form S-1, as amended (File No. 333-64233).
(4) Incorporated by reference to the Registrant's Definitive Proxy Statement
on Schedule 14A filed on the date hereof.
(5) Incorporated by reference to the Registrant's Annual Report on Form 10-K
filed on March 30, 2000.
(6) Incorporated by reference to the Registrant's Annual Report on Form 10-
K405 filed on March 31, 1999.
(7) Incorporated by reference to the Schedule 13D/A filed on March 9, 2000 by
Carlos Slim Helu, Carlos Slim Domit, Marco Antonio Slim Domit, Patrick
Slim Domit, Maria Soumaya Slim Domit, Vanessa Paula Slim Domit, Johanna
Monique Slim Domit, Carso Global Telecom, S.A. de C.V. and Telefonos de
Mexico, S.A. de C.V.
+ Confidential treatment granted as to certain portions.
++ Confidential treatment requested as to certain portions.
* The exhibits and schedules to this agreement were omitted from the
agreement by the Registrant. The Registrant agrees to furnish any exhibit
or schedule to this agreement supplementally to the Securities and Exchange
Commission upon written request.
(b) Financial Statement Schedules
All schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required under
the related instructions or are not applicable, and, therefore, have been
omitted.
Item 22. Undertakings.
A. The undersigned registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being made, a
post-effective amendment to this registration statement:
(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933;
(ii) To reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth
in the registration statement. Notwithstanding the foregoing, any
increase or decrease in volume of securities offered (if the total
dollar value of securities offered would not exceed that which was
registered) and any deviation from the low or high end of the estimated
maximum offering range may be reflected in the form of prospectus filed
with the Commission pursuant to Rule 424(b) if, in the aggregate, the
changes in volume and price represent no more than 20 percent change in
the maximum aggregate offering price set forth in the "Calculation of
Registration Fee" table in the effective registration statement.
(iii) To include any material information with respect to the plan of
distribution not previously disclosed in the registration statement or
any material change to such information in the registration statement.
II-4
<PAGE>
(2) That, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment 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.
(3) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering.
B. The undersigned registrant hereby undertakes that, for purposes of
determining any liability under the Securities Act of 1933, each filing of the
registrant's annual report pursuant to Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 (and, where applicable, each filing of an employee benefit
plan's annual report pursuant to Section 15(d) of the Securities Exchange Act
of 1934) that is incorporated by reference in this registration statement 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.
C. The undersigned registrant hereby undertakes as follows:
(1) That prior to any public reoffering of the securities registered
hereunder through use of a prospectus which is a part of this registration
statement, by any person or party who is deemed to be an underwriter within
the meaning of Rule 145(c), the issuer undertakes that such reoffering
prospectus will contain the information called for by the applicable
registration form with respect to reofferings by persons who may be deemed
underwriters, in addition to the information called for by the other items
of the applicable form.
(2) That every prospectus (i) that is filed pursuant to paragraph (1)
immediately preceding, or (ii) that purports to meet the requirements of
Section 10(a)(3) of the Act and is used in connection with an offering of
securities subject to Rule 415, will be filed as a part of an amendment to
the registration statement and will not be used until such amendment is
effective, and that, for purposes of determining any liability under the
Securities Act of 1933, each such post-effective amendment 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.
D. Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
the registrant pursuant to the foregoing provisions, or otherwise, the
registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the Act and
will be governed by the final adjudication of such issue.
E. The undersigned registrant hereby undertakes to respond to requests for
information that is incorporated by reference into the prospectus pursuant to
Item 4, 10(b), 11, or 13 of this form, within one business day of receipt of
such request, and to send the incorporated documents by first class mail or
other equally prompt means. This included information contained in documents
filed subsequent to the effective date of this registration statement through
the date of responding to the request.
F. The undersigned registrant hereby undertakes to supply by means of a post-
effective amendment all information concerning a transaction, and the company
being acquired involved herein, that was not the subject of and included in the
registration statement when it became effective.
II-5
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act, the registrant has duly
caused this registration statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the city of White Plains, state of
New York, on the 5th day of May, 2000.
PRODIGY COMMUNICATIONS CORPORATION
/s/ Samer F. Salameh
By___________________________________
Samer F. Salameh
Chairman of the Board and
Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below on this registration statement hereby constitutes and appoints Samer F.
Salameh, Andrea S. Hirsch and David A. Westenberg, their true and lawful
attorneys-in-fact and agents, with full power of substitution and
resubstitution, for them and in their name, place and stead, in any and all
capacities (unless revoked in writing) to sign any and all amendments to this
registration statement to which this power of attorney is attached, including
any post-effective amendments as well as any related registration statement (or
amendment thereto) filed in reliance upon Rule 462(b) under the Securities Act
of 1933, as amended, and to file the same, with all exhibits thereto, and other
documents in connection therewith, with the Securities and Exchange Commission,
granting to such attorneys-in-fact and agents, and each of them, full power and
authority to do and perform each and every act and thing requisite or necessary
to be done in connection therewith, as fully to all intents and purposes as
they might and could do in person, hereby ratifying and confirming all that
said attorneys-in-fact and agents or any of them, or their substitute or
substitutes, may lawfully do or cause to be done by virtue thereof.
Pursuant to the requirements of the Securities Act of 1933, as amended, this
registration statement has been signed by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Samer F. Salameh May 5, 2000
- ------------------------------------
Samer F. Salameh Chairman of the Board and
Chief Executive Officer
(Principal Executive
Officer)
- ------------------------------------
Alfredo Sanchez Vice Chairman of the Board
/s/ Allen Craft May 5, 2000
- ------------------------------------
Allen Craft Executive Vice President,
Finance, Chief Financial
Officer and Director
(Principal Financial and
Accounting Officer)
/s/ James R. Adams May 5, 2000
- ------------------------------------
James R. Adams Director
/s/ Arturo Elias May 5, 2000
- ------------------------------------
Arturo Elias Director
/s/ James M. Nakfoor May 5, 2000
- ------------------------------------
James M. Nakfoor Director
</TABLE>
II-6
<PAGE>
EXHIBIT INDEX
<TABLE>
<C> <S>
2.1(1)+ Asset Purchase Agreement, dated as of May 26, 1999, by and among
Cable & Wireless USA, Inc., Cable & Wireless USA Internet, L.L.C.
and the Registrant.
2.2(2) Asset Purchase Agreement, dated as of September 7, 1999, by and
among the Registrant, U.S. Republic Communications, Inc., VarTec
Telecom, Inc., VarTec Telecom Holding Company, T. Gary Remy and Tom
D. Johnson.
2.3* Agreement and Plan of Merger, dated as of November 5, 1999 and as
amended as of March 15, 2000, among the Registrant, PUCKnut
Corporation and FlashNet Communications, Inc. (included as Annex B
to the Proxy Statement/Prospectus, which is a part of this
Registration Statement).
2.4 Stock Option Agreement, dated as of November 5, 1999, among the
Registrant and FlashNet Communications, Inc. (included as Annex C to
the Proxy Statement/Prospectus, which is a part of this Registration
Statement).
2.5 Stockholder Agreement, dated as of November 5, 1999, among the
Registrant, Applied Telecommunications Technologies, Inc., James B.
Francis, Jr., Global Undervalued Securities Fund, L.P., Andrew N.
Jent, John B. Kleinheinz, Kleinheinz Capital Partners LDC, Michael
Scott Leslie, Kevin A. Stadtler, Albert Lee Thurburn and Russell A.
Wiseman (included as Annex D to the Proxy Statement/Prospectus,
which is a part of this Registration Statement).
3.1(3) Certificate of Incorporation of the Registrant, as amended.
3.2(3) By-laws of the Registrant, as amended.
3.3(4) Form of Amended and Restated Certificate of Incorporation of the
Registrant, to be effective following the closing of the SBC
transaction.
3.4(4) Form of Amended and Restated By-laws of the Registrant, to be
effective following the closing of the SBC transaction.
3.5(4) Form of Amended and Restated Limited Partnership Agreement for
Prodigy Communications Limited Partnership by and among the
Registrant, SBC Internet Communications, Inc. and Prodigy Transition
Corporation, to be effective following the closing of the SBC
transaction.
4.1(3) Specimen certificate for shares of Common Stock.
8.1 Opinion of Hale and Dorr LLP Regarding Tax Matters.
8.2 Opinion of Brobeck, Phleger & Harrison LLP Regarding Tax Matters.
8.3 Opinion of Goldman, Sachs & Co. (included as Annex A to the Proxy
Statement/Prospectus, which is a part of this Registration
Statement).
10.1(3) 1996 Stock Option Plan of the Registrant, as amended.
10.2(3) 1999 Employee Stock Purchase Plan of the Registrant.
10.3(5) 1999 Stock Option Plan of the Registrant.
10.4(3) 1999 Outside Director Stock Option Plan of the Registrant.
10.5(3)+ Software License and Services Agreement, dated April 16, 1997,
between Prodigy Services Corporation and ORACLE Worldwide Tech
Support.
10.6(5)++ Amended and Restated Splitrock Full Service Agreement, dated
February 16, 2000, between Splitrock Services, Inc. and Prodigy
Services Corporation.
10.7(3) Agreement of Sublease, dated June 24, 1997, between Splitrock
Services, Inc. and Prodigy Services Corporation.
10.8(3) Employment Agreement, dated September 1, 1998, between the
Registrant and Samer F. Salameh.
10.9(3) Employment Agreement, dated September 14, 1998, between the
Registrant and Andrea S. Hirsch.
</TABLE>
<PAGE>
<TABLE>
<C> <S>
10.10(3) Employment Agreement, dated December 14, 1998, between the
Registrant and David C. Trachtenberg.
10.11(3) Lease, dated August 14, 1997, between Prodigy Services Corporation
and Westchester One LLC, as amended.
10.12(3)+ Promotion & Distribution Agreement, effective October 7, 1996,
between Microsoft Corporation and Prodigy Services Corporation, as
amended.
10.13(3)+ Distribution and Licensing Agreement, effective October 1, 1996,
between Packard Bell NEC, Inc. and Prodigy Services Corporation.
10.14(3)+ Excite Services Distribution and Co-Branded Area Agreement, dated
January 20, 1998, between Excite, Inc. and Prodigy Services
Corporation.
10.15(3) Lease Agreement, dated June 6, 1998, between Prodigy Services
Company and Crow-Kelly#1, as amended.
10.16(6)+ Microsoft Windows 98 "Get Connected" Co-Marketing Agreement, dated
July 2, 1998, between Prodigy Services Corporation and Microsoft
Corporation.
10.17(5) Amendment No. 1 to Microsoft Windows 98 "Get Connected" Co-
Marketing Agreement, dated October 1, 1998, by and between
Microsoft Corporation and Prodigy Services Corporation.
10.18(5)++ Renewal and Amendment to that certain Microsoft Windows 98 "Get
Connected" Co-Marketing Agreement, dated June 1, 1999, by and
between Microsoft Corporation and Prodigy Services Corporation.
10.19(5) Amendment No. 3 to that certain Microsoft Windows 98 "Get
Connected" Co-Marketing Agreement, dated January 19, 2000, by and
between Microsoft Corporation and Prodigy Services Corporation.
10.20(3)+ Software Development and processing Services Agreement, dated
January 1, 1992, between Prodigy Services Company and CSG Systems,
Inc., as amended.
10.21(3) Form of Prodigy Service Member Agreement.
10.22(3) Agreement, dated January 25, 2999, among the Registrant, Telefonos
de Mexico, S.A. de C.V. and others.
10.23(6) Microsoft Internet Explorer Logo License Agreement, dated July 2,
1998, by and between Prodigy Services Corporation and Microsoft
Corporation.
10.24(6) Microsoft Internet Explorer License and Distribution Agreement,
dated July 2, 1998, by and between Prodigy Services Corporation and
Microsoft Corporation.
10.25(4)* Investment, Issuance, Contribution and Assumption Agreement, dated
as of November 19, 1999 and as amended as of April 19, 2000, by and
among SBC Communications Inc., SBC Internet Communications, Inc.,
the Registrant, Prodigy Transition Corporation and Prodigy
Communications Limited Partnership.
10.26(4) Strategic and Marketing Agreement, dated as of November 19, 1999,
by and among SBC Communications Inc., SBC Internet Communications,
Inc., the Registrant and Prodigy Communications Limited
Partnership.
10.27(7) Voting Agreement, dated as of November 19, 1999, by and among SBC
Communications Inc., Carso Global Telecom, S.A. de C.V. and
Telefonos de Mexico, S.A. de C.V.
10.28(7) Form of Registration Rights Agreement by and among the Registrant,
SBC Communications Inc. and SBC Internet Communications, Inc., to
be effective following the closing of the SBC transaction.
10.29 Letter, dated February 28, 2000, from Telefonos de Mexico, S.A. de
C.V., committing to provide up to $200 million in financing to
Prodigy.
10.30 Promissory Note of FlashNet Communications, Inc., dated April 26,
2000, issued in favor of the Registrant.
</TABLE>
<PAGE>
<TABLE>
<C> <S>
10.31 Letter Agreement, dated March 13, 2000, by and between the Registrant
and Citibank, N.A.
21(5) Subsidiaries of the Registrant.
23.1 Consent of Hale and Dorr LLP (included in Exhibit 8.1).
23.2 Consent of Brobeck, Phleger & Harrison LLP (included in Exhibit 8.2).
23.3 Consent of PricewaterhouseCoopers LLP.
23.4 Consent of Ernst & Young LLP.
23.5 Consent of Deloitte & Touche LLP.
24.1 Power of Attorney (included in the signature page of this Registration
Statement).
27(5) Financial Data Schedule.
99.2 Form of Proxy Card of FlashNet Communications, Inc.
</TABLE>
- --------
(1) Incorporated by reference to the Registrant's Current Report on Form 8-K
filed on August 3, 1999.
(2) Incorporated by reference to the Registrant's Current Report on Form 8-K
filed on October 20, 1999.
(3) Incorporated herein by reference to the Registrant's Registration
Statement on Form S-1, as amended (File No. 333-64233).
(4) Incorporated herein by reference to the Registrant's Definitive Proxy
Statement on Schedule 14A filed on the date hereof.
(5) Incorporated by reference to the Registrant's Annual Report on Form 10-K
filed on March 30, 2000.
(6) Incorporated by reference to the Registrant's Annual Report on Form 10-
K405 filed on March 31, 1999.
(7) Incorporated by reference to the Schedule 13D/A filed on March 9, 2000 by
Carlos Slim Helu, Carlos Slim Domit, Marco Antonio Slim Domit, Patrick
Slim Domit, Maria Soumaya Slim Domit, Vanessa Paula Slim Domit, Johanna
Monique Slim Domit, Carso Global Telecom, S.A. de C.V. and Telefonos de
Mexico, S.A. de C.V.
+ Confidential treatment granted as to certain portions.
++ Confidential treatment requested as to certain portions.
* The exhibits and schedules to this agreement were omitted from the
agreement by the Registrant. The Registrant agrees to furnish any exhibit
or schedule to this agreement supplementally to the Securities and Exchange
Commission upon written request.
<PAGE>
EXHIBIT 8.1
Hale and Dorr LLP
Counsellors at Law
60 State Street
Boston, MA 02109
May 4, 2000
Prodigy Communications Corporation
44 South Broadway
White Plains, NY 10601
Re: Merger Pursuant to Agreement and Plan of Merger By and Among Prodigy
Communications Corporation, PUCKnut Corporation, and Flashnet
Communications, Inc.
Ladies and Gentlemen:
This opinion is being delivered to you in connection with the filing of a
registration statement (the "Registration Statement") on Form S-4, which
includes the Proxy Statement and Prospectus relating to the Agreement and Plan
of Merger dated as of November 5, 1999 and amended as of March 15, 2000 (the
"Merger Agreement"), by and among Prodigy Communications Corporation, a Delaware
corporation ("Buyer"), PUCKnut Corporation, a Delaware corporation and wholly
owned subsidiary of Buyer ("Transitory Subsidiary"), and Flashnet
Communications, Inc., a Texas corporation ("Company"). Pursuant to the Merger
Agreement, Transitory Subsidiary will merge with and into Company (the
"Merger"). Except as otherwise provided, capitalized terms not defined herein
have the meanings set forth in the Merger Agreement and the exhibits thereto or
in the letters delivered to Hale and Dorr LLP by Buyer and Company containing
certain representations of Buyer and Company relevant to this opinion (the
"Representation Letters"). All section references, unless otherwise indicated,
are to the United States Internal Revenue Code of 1986, as amended (the "Code").
In our capacity as counsel to Buyer in the Merger, and for purposes of
rendering this opinion, we have examined and relied upon the Registration
Statement, the Merger Agreement and the exhibits thereto, the Representation
Letters, and such other documents as we considered relevant to our analysis. In
our examination of documents, we have assumed the authenticity of original
documents, the accuracy of copies, the genuineness of signatures, and the legal
capacity of signatories.
We have assumed that all parties to the Merger Agreement and to any other
documents examined by us have acted, and will act, in accordance with the terms
of such Merger Agreement
<PAGE>
Prodigy Communications Corporation
May 4, 2000
Page 2
and documents and that the Merger will be consummated at the Effective Time
pursuant to the terms and conditions set forth in the Merger Agreement without
the waiver or modification of any such terms and conditions. Furthermore, we
have assumed that all representations contained in the Merger Agreement, as well
as those representations contained in the Representation Letters, are, and at
the Effective Time will be, true and complete in all material respects, and that
any representation made in any of the documents referred to herein "to the best
of the knowledge and belief" (or similar qualification) of any person or party
is correct without such qualification. We have also assumed that as to all
matters for which a person or entity has represented that such person or entity
is not a party to, does not have, or is not aware of, any plan, intention,
understanding, or agreement, there is no such plan, intention, understanding, or
agreement. We have not attempted to verify independently such representations,
but in the course of our representation, nothing has come to our attention that
would cause us to question the accuracy thereof.
The conclusions expressed herein represent our judgment as to the proper
treatment of certain aspects of the Merger under the income tax laws of the
United States based upon the Code, Treasury Regulations, case law, and rulings
and other pronouncements of the Internal Revenue Service (the "IRS") as in
effect on the date of this opinion. No assurances can be given that such laws
will not be amended or otherwise changed prior to the Effective Time, or at any
other time, or that such changes will not affect the conclusions expressed
herein. Nevertheless, we undertake no responsibility to advise you of any
developments after the Effective Time in the application or interpretation of
the income tax laws of the United States.
Our opinion represents our best judgment of how a court would decide if
presented with the issues addressed herein and is not binding upon either the
IRS or any court. Thus, no assurances can be given that a position taken in
reliance on our opinion will not be challenged by the IRS or rejected by a
court.
This opinion addresses only the specific United States federal income tax
consequence of the Merger set forth below, and does not address any other
federal, state, local, or foreign income, estate, gift, transfer, sales, use, or
other tax consequences that may result from the Merger or any other transaction
(including any transaction undertaken in connection with the Merger).
On the basis of, and subject to, the foregoing, and in reliance upon the
representations and assumptions described above, we are of the opinion that the
Merger will constitute a reorganization within the meaning of Section 368(a).
No opinion is expressed as to any federal income tax consequence of the
Merger except as specifically set forth herein, and this opinion may not be
relied upon except with respect to the consequence specifically discussed
herein. No opinion is expressed as to any transaction other than the Merger as
described in the Merger Agreement or to any transaction whatsoever (including
the Merger) if all the transactions described in the Merger Agreement are not
consummated in accordance with the terms thereof. In the event that any one of
the statements,
<PAGE>
Prodigy Communications Corporation
May 4, 2000
Page 3
representations, warranties, or assumptions upon which we have relied to issue
this opinion is incorrect, our opinion might be adversely affected and may not
be relied upon.
This opinion is intended solely for the purpose of inclusion as an exhibit
to the Registration Statement. It may not be relied upon for any other purpose
or by any other person or entity, other than you, and may not be made available
to any other person or entity without our prior written consent. We hereby
consent to the filing of this opinion as an exhibit to the Registration
Statement and further consent to the use of our name in the Registration
Statement in connection with references to this opinion and the tax consequences
of the Merger. In giving this consent, however, we do not hereby admit that we
are in the category of persons whose consent is required under Section 7 of the
Securities Act of 1933, as amended.
Very truly yours,
/s/ Hale and Dorr LLP
<PAGE>
EXHIBIT 8.2
----------------
BROBECK
PHLEGER & Spear Street Tower
HARRISON One Market
Telephone: (415) 442-0900 LLP San Francisco
Facsimile: (415) 442-1010 ATTORNEYS AT LAW California 94105
---------------- www.brobeck.com
May 4, 2000
FlashNet Communications, Inc.
3001 Meacham Boulevard, Suite 100
Fort Worth, Texas 76137
Ladies and Gentlemen:
This opinion is being delivered to you in connection with (i) the
Agreement and Plan of Merger (the "Agreement") dated as of November 5, 1999 and
amended as of March 15, 2000, between Prodigy Communications Corporation., a
Delaware corporation ("Parent"), PUCKnut Corporation, a Delaware corporation and
a wholly owned subsidiary of Parent ("Merger Sub"), and FlashNet Communications,
Inc., a Texas corporation ("Target"), and (ii) the preparation and filing with
the Securities and Exchange Commission of a Form S-4 Registration Statement
relating to the Merger (the "Registration Statement"). Pursuant to the
Agreement, Merger Sub will merge with and into Target (the "Merger"), and Target
will become a wholly owned subsidiary of Parent.
Except as otherwise provided, capitalized terms referred to herein
have the meanings set forth in the Agreement. All section references, unless
otherwise indicated, are to the Internal Revenue Code of 1986, as amended (the
"Code").
We have acted as legal counsel to Target in connection with the
Merger. As such, and for the purpose of rendering this opinion, we have
examined and are relying upon (without any independent investigation or review
thereof) the truth and accuracy, at all relevant times, of the statements,
covenants, representations and warranties contained in the following documents
(including all schedules and exhibits thereto):
1. The Agreement;
2. The Registration Statement; and
3. Such other instruments and documents related to Parent, Target,
Merger Sub and the Merger as we have deemed necessary or appropriate.
Austin Denver Irvine London Los Angeles New York Palo Alto San
Diego San Francisco, Washington, D.C.
<PAGE>
-----------------
BROBECK
PHLEGER &
HARRISON
FlashNet Communications, Inc. LLP May 4, 2000
ATTORNEYS AT LAW Page 2
-----------------
In connection with rendering this opinion, we have assumed or obtained
representations (and are relying thereon, without any independent investigation
or review thereof) that:
A. Original documents submitted to us (including signatures) are
authentic, documents submitted to us as copies conform to the original
documents, and there has been (or will be by the Effective Time) due execution
and delivery of all documents where due execution and delivery are prerequisites
to the effectiveness thereof; and
B. The Merger will be consummated in accordance with the Agreement
without any waiver or breach of any material provision thereof, and the Merger
will be effective under applicable state law.
On the basis of, and subject to, the foregoing, and in reliance upon
the representations and assumptions described above, we are of the opinion that
the Merger will constitute a reorganization within the meaning of Section
368(a).
In addition to the assumptions and representations described above,
this opinion is subject to the exceptions, limitations and qualifications set
forth below.
(1) This opinion represents and is based upon our best judgment
regarding the application of federal income tax laws arising under the Code,
existing judicial decisions, administrative regulations and published rulings
and procedures. Our opinion is not binding upon the Internal Revenue Service or
the courts, and there is no assurance that the Internal Revenue Service will not
successfully assert a contrary position. Furthermore, no assurance can be given
that future legislative, judicial or administrative changes, on either a
prospective or retroactive basis, will not adversely affect the accuracy of the
conclusions stated herein. Nevertheless, we undertake no responsibility to
advise you of any new developments in the application or interpretation of the
federal income tax laws.
(2) No opinion is expressed as to any transaction other than the
Merger (whether or not undertaken in connection with the Merger) or as to any
transaction whatsoever, including the Merger, if all the transactions described
in the Agreement are not consummated in accordance with the terms of such
Agreement and without waiver or breach of any material provision thereof or if
all of the statements, representations, warranties and assumptions upon which we
relied are not true and accurate at all relevant times. In the event any one of
the statements, representations, warranties or assumptions upon which we have
relied to issue this opinion is incorrect, our opinion might be adversely
affected and may not be relied upon.
This opinion is rendered to you solely in connection with the filing
of the Registration Statement. We hereby consent to the filing of this opinion
as an exhibit to the Registration Statement. We also consent to the references
to our firm name wherever appearing
<PAGE>
-----------------
BROBECK
PHLEGER &
HARRISON
FlashNet Communications, Inc. LLP May 4, 2000
ATTORNEYS AT LAW Page 3
-----------------
in the Registration Statement with respect to the discussion of the federal
income tax consequences of the Merger, including any amendments to the
Registration Statement. This opinion may not be relied upon for any other
purpose, and may not be made available to any other person, without our prior
written consent.
Very truly yours,
/s/ BROBECK, PHLEGER & HARRISON LLP
<PAGE>
EXHIBIT 10.29
TELEFONOS DE MEXICO, S.A. DE C.V.
February 28, 2000
Mr. Samer Salameh
Prodigy Communications Corporation
Chairman and
Chief Executive Officer
44 South Broadway
White Plains, NY 10601
Ladies and Gentlemen:
At December 31, 1999, current liabilities of Prodigy Communications Corporation
("Prodigy") exceeded current assets by $128.1 million. Included in this amount
are loans payable to Banco Inbursa, S.A. which were arranged under the auspices
of Carso Global Telecom in the amount of $110.2 million.
This letter serves to confirm the following:
1. Telefonos de Mexico, S.A. de C.V. or any of its subsidiaries (TELMEX) will
provide additional funding up to $200.0 million, either through capital
and/or debt financing, to allow Prodigy to continue as a going concern for
one year from the date of this letter.
2. TELMEX has available capital and/or debt financing facilities necessary to
support Prodigy's funding requirements for one year from the date of this
letter.
Sincerely,
/s/ Adolfo Cerezo
Adolfo Cerezo
Chief Financial Officer
<PAGE>
EXHIBIT 10.30
PROMISSORY NOTE
$2,000,000.00 Fort Worth, Texas
April 26, 2000
FOR VALUE RECEIVED, on or before October 26, 2000 (the "Maturity Date"),
FlashNet Communications, Inc., a Texas corporation (the "Borrower"), hereby
promises to pay to the order of Prodigy Communications Corporation, a Delaware
corporation (the "Lender"), the lesser of the principal sum of Two Million
Dollars ($2,000,000) or the aggregate unpaid principal amount of all Advances
(defined below) made by the Lender to the Borrower, in immediately available
funds at its principal offices located at 44 South Broadway, White Plains, New
York 10601 (or such other place as Lender may designate), together with interest
on the unpaid principal amount hereof at the rates and on the dates set forth
herein. The Lender hereby agrees, so long as no Event of Default exists, to
make all Advances as may be requested by the Borrower hereunder prior to the
Maturity Date, provided that the aggregate sum of the principal amount of all
Advances outstanding hereunder from time to time does not exceed $2,000,000.
The outstanding principal of each Advance hereunder shall accrue interest
at a per annum rate equal to twelve percent.
Each request for an Advance shall be in writing and shall be made by the
Borrower at least three (3) Business Days prior the requested date of such
Advance. Each Advance shall be in the minimum amount of $250,000 (and in
integral multiples of $100,000 if in excess thereof). Each request for an
advance hereunder shall specify the date of such Advance, and the amount of such
Advance. The Lender shall, and is hereby authorized to, record on the schedule
attached hereto, or to otherwise record in accordance with its usual practice,
the date and amount of each Advance and the date and amount of each principal
payment hereunder.
The Borrower may prepay any Advance without premium or penalty subject to
the Borrower giving at least one (1) Business Day prior written notice to the
Lender. Any Advances that are repaid may not be reborrowed.
For the purpose of this Note, the following terms shall have the following
meanings:
"ADVANCE" shall mean a borrowing under this Note.
"BUSINESS DAY" shall mean any day other than a Saturday, Sunday, or other
day on which commercial banks in the State of New York are authorized or
required to close under the laws of the State of New York.
"TERMINATION DATE" means the earlier of (1) the Maturity Date and (2) the
date on which the Lender declares an Event of Default pursuant to the terms
hereof.
Interest shall be payable hereunder on each Advance on the Maturity Date.
Interest shall be computed on the basis of a three hundred sixty-five (365) day
year and actual days elapsed. Upon default or after maturity or after judgment
has been rendered on this Note, each Advance shall bear interest at a rate per
annum equal to fourteen percent (14.0%) per annum. In addition to, and not in
limitation of, the foregoing, during the continuance of a default hereunder, to
the extent permitted by law, overdue interest, fees (including reasonable
attorney's fees and the
<PAGE>
commitment fee) and other charges payable hereunder shall bear interest from and
including the due date hereof until paid at a rate per annum equal to fourteen
percent (14.0%) per annum. Such rate shall be in effect until all the
obligations of the Borrower to the Lender are paid in full. In no event shall
any interest be at a rate in excess of the maximum rate permitted by law.
At the option of the holder, this Note shall become immediately due and
payable upon the occurrence and during the continuance at any time of any of the
following events of default (each an "Event of Default"): (1) default in the
payment or performance of this or any other liability or obligation of the
maker, including the payment of any installment hereunder, or of any endorser or
guarantor of any obligation or liability of the maker, to the holder; (2) the
liquidation, termination, dissolution or the appointment of a receiver for the
maker or its property as a whole; (3) the institution by the maker of any
proceedings under the United States Bankruptcy Code or any other federal or
state law in which the maker is alleged to be insolvent or unable to pay his
debts as they mature or the making by the undersigned of an assignment or trust
mortgage for the benefit of creditors; or (4)(a) the institution against the
maker of any proceedings under the United States Bankruptcy Code or of any other
federal or state law in which the maker is alleged to be insolvent or unable to
pay his debts as they mature, and (b) the failure of the maker to cause such
proceedings to be dismissed or stayed within 30 days; whereupon the holder shall
have then, or at any time thereafter, all of the rights and remedies afforded by
the Uniform Commercial Code as from time to time in effect in the State of New
York or afforded by other applicable law.
Any expenses incurred in connection with the enforcement or collection of
the Advances or the Lender's rights hereunder, including reasonable attorney's
fees, shall be paid by the Borrower.
This Note and the rights as described herein are not assignable in whole or
in part by the Borrower, and are personal to the Borrower and may not be relied
upon by any other party.
No delay or omission on the part of the holder in exercising any right
hereunder shall operate as a waiver of such right or of any other right of such
holder, nor shall any delay, omission or waiver on any one occasion be deemed a
bar to or waiver of the same or any other right on any future occasion. The
maker and every indorser or guarantor of this Note regardless of the time, order
or place of signing waives presentment, demand, protest and notices of every
kind and assents to any extension or postponement of the time of payment or any
other indulgence, to any substitution, exchange or release of collateral, and to
the addition or release of any other party or person primarily or secondarily
liable.
None of the terms or provisions of this Note may be excluded, modified, or
amended except by a written instrument duly executed on behalf of the holder
expressly referring hereto and setting forth the provision so excluded, modified
or amended.
ALL RIGHTS AND OBLIGATIONS HEREUNDER SHALL BE GOVERNED BY THE LAWS OF THE
STATE OF NEW YORK AND THIS NOTE SHALL BE DEEMED TO BE UNDER SEAL.
2
<PAGE>
EXECUTED as of this 25th day of April, 2000 as an instrument under seal.
FLASHNET COMMUNICATIONS, INC.
By: /s/Andy Jent
-------------------------------
Name: Andy Jent
Title: Executive Vice President and
Chief Financial Officer
AGREED:
PRODIGY COMMUNICATIONS CORPORATION
By: /s/ Andrea S. Hirsch
-------------------------------------
Name: Andrea S. Hirsch
Title: Executive Vice President, General Counsel
3
<PAGE>
SCHEDULE OF LOAN AND PAYMENTS OF PRINCIPAL
TO
PROMISSORY NOTE OF
FLASHNET COMMUNICATIONS, INC.
DATED: April 26, 2000
<TABLE>
<CAPTION>
Principal Principal
Date Amount of Amount Unpaid
Advance Paid Balance
<S> <C> <C> <C>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
</TABLE>
4
<PAGE>
EXHIBIT 10.31
[Citibank LOGO]
Citibank, N.A.
399 Park Avenue
6th Floor
New York, NY 10043
Date: March 13, 2000
Andrea Hirsch
Executive Vice President
Prodigy Communications Corp.
44 South Broadway
White Plains, NY 10601
Dear Ms. Hirsch:
On behalf of ourselves and our affiliates (collectively, "Citibank"), we are
pleased to submit this proposal to Prodigy Communication Corp. ("Prodigy"), to
structure and arrange the up to $200,000,000 financing (the "Financing")
described in this letter agreement and in the "Indicative Summary of Terms and
Conditions" attached hereto as Annex A (the "Term Sheet") which is incorporated
by reference herein.
Description of Transaction
- --------------------------
We would recommend that Prodigy establish a special-purpose, bankruptcy-remote
wholly owned subsidiary [Prodigy Funding Corporation] ("Prodigy Funding").
Prodigy shall initially sell the Contracts, originated over the past 12 months
under the retailer rebate programs, on a true sale basis to Prodigy Funding.
Prodigy Funding will be the issuer of a Variable Funding Note (the "Note"). The
Note will represent an undivided interest in the Receivables generated by the
assets of Prodigy Funding. We would anticipate that the Note would, initially,
be in an amount of up to US$ 200 million. As part of this transaction, we
intend to pursue a financial guarantee (the "Financial Guarantee") to wrap the
performance of the Note to achieve a rating of at least AA/Aa2. The Financial
Guarantee and overall financing will be contingent upon, among other factors, a
performance guarantee provided by SBC Communications, Inc. ("SBC") as detailed
in Annex A. The target market for this issuance would be one of the Citicorp
administered commercial paper conduits supported by a syndicated liquidity
facility. We believe this structure would provide Prodigy with unique
structural benefits, as well as attractive pricing and execution.
<PAGE>
Note: It is understood by the parties undertaking this letter agreement
----
that Prodigy is currently negotiating the establishment of an operating
partnership with SBC Communications, Inc. ("SBC"). The proposed purpose of
this partnership is to join SBC and Prodigy's Consumer and Small Business
Internet operations. It is contemplated that Prodigy will act as the
General Partner within the proposed partnership structure. The parties
understand and agree that following the completion of the establishment of
the proposed partnership, it is Prodigy's intention to transfer all of its
rights and obligations under the agreement to the operating partnership,
including but not limited to the ownership of Prodigy Funding. It is
further acknowledged that during the establishment of the financing
structure, all necessary steps will be taken to ensure that the program
documents will permit the transfer to the operating company and that the
operating company will be able to comply with such documents.
Indicative Terms
- ----------------
To meet your initial objective of financing the three-year contract subscribers,
we would recommend that the Note be structured with a 3-year final maturity. A
Credit Enhancer would be available at this tenor and would allow a placement
into one of the Citicorp administered commercial paper conduits. Under current
market conditions, we believe that the Note could be placed within one of the
Citicorp administered conduits at an effective spread of 100 bps over one month
LIBOR. Below is a breakdown of the indicative spread calculation as of
March 10, 2000:
<TABLE>
<S> <C> <C>
Conduit Base Cost versus LIBOR(1) (8) bps
Ongoing Annual Costs
Program Fee 40
Liquidity Fee(2) 30
Dealer Commission(3) 5
Ratings Agencies(4) 1
Administration Fee 2
Surety Cost(5) 30
--------------------------------------------------------------
Average Ongoing Costs 100 bps
</TABLE>
(1) Based on Charta Inc. commercial paper issuance cost compared to the 30-day
LIBOR average.
(2) Assumes 1-year backstop facility. Liquidity fee will depend on market
conditions at the time of issuance and be subject to re-pricing at eat 364-
day renewal.
(3) Distribution fee paid by Charta to distribute the CP in the market.
(4) To monitor the transaction.
(5) Surety Cost estimate based on initial negotiation with two independent
surety providers.
Prodigy acknowledges that Citibank's representative are not tax, accounting,
legal or regulatory experts and accordingly can make no representation as to any
2
<PAGE>
tax, accounting, legal or regulatory result. Prodigy will seek separate advice
regarding such matters from its own qualified advisors.
Not a Commitment
- ----------------
This letter does not constitute a commitment by Citibank to lend money, to
underwrite the Financing, to purchase securities or otherwise assets, or to
provide financing to Prodigy or obtain financing for Prodigy from others. The
delivery of such a commitment will be subject to, among other things;
satisfaction of the conditions precedent set forth below.
Conditions Precedent
- --------------------
Citibank's obligations hereby and its ability to consummate the Financing
described herein, are expressly subject to the satisfaction of the following:
(i) completion of such due diligence review as Citibank deems advisable,
the results of which are satisfactory to Citibank;
(ii)in Citibank's determination, the absence of any material adverse change
in the financial markets or in the financial condition or operations of
Prodigy;
(iii)negotiation and execution of mutually satisfactory documentation of the
Financing (collectively, the "Program Documents"), including, without
limitation, note purchaser agreement, credit agreement, Financial
Guarantee documentation and the receivables contribution and sale
agreement;
(iv) the receipt of a structure shadow rating of at least investment grade
and an overall transaction rating of at least AA/Aa2 from S&P and
Moody's respectively;
(v) the receipt of internal credit approval and such other approvals and
legal opinion as Citibank may deem necessary or advisable, in form and
substance satisfactory to Citibank; and
(vi) any other condition precedent set forth in the Term Sheet.
Fees and Expenses
- -----------------
In consideration of the services to be provided by the Arranger hereunder,
Prodigy shall pay the Arranger a structuring fee equal to 0.75% of the aggregate
principal amount of the Note with a minimum structuring fee equal to $1.250
million. Such fee shall be due and payable only at and upon closing and shall
be deducted from the proceeds of the transaction.
3
<PAGE>
The following are estimates of key expenses for the potential transaction.
<TABLE>
<S> <C>
Arranger Legal Counsel US$ 100,000-150,000 (plus disbursements)
Citicorp out-of-pocket US$ 15,000
Information Memorandum
Production (Syndication) US$ 7,500
Collection Agent Gees US$ 10,000 per annum
Trustee Legal Expenses US$ 15,000 (plus disbursements)
Rating Agency Expenses US$ 50,000-100,000
Surety Upfront Fees US$ 50,000-75,000
</TABLE>
All payments to the Arranger under this Proposal Letter shall be payable in U.S.
dollars in New York free and clear of any set-off, claims and all applicable
withholding, stamp and other similar taxes and of all other governmental charges
of any nature whatsoever.
Recognizing that Citibank is incurring substantial costs and expenses in
connection with the proposal described herein, Prodigy also agrees to reimburse
Citibank on demand for any out-of-pocket expenses incurred by it in performing
its obligations hereunder, including, without limitation, all reasonable fees
and disbursements listed above and counsel for the surety provider, whether or
not the Program Documents are executed or the Financing is consummated or
Citibank's engagement hereunder is terminated, up to $750,000. Such expenses
will be in addition to any direct expenses incurred by Prodigy in connection
with the Financing, including without limitation, fees and disbursements of
counsel to Prodigy, rating agency fees, and agency and trustees fees. Prodigy
also agrees to pay o demand all out-of-pocket 3rd party costs and expenses of
Citibank (including, without limitation fees and disbursements of counsel)
incurred in connect with the enforcement of any of its rights and remedies
hereunder.
Termination
- -----------
Citibank's engagement hereunder shall terminate on the earlier of (i) the
execution of mutually satisfactory Program Documents, and (ii) the written
notice of Prodigy to Citibank, or of Citibank to Prodigy, that the engagement is
terminated (such date, the "Termination Date"). The obligations of Prodigy
under "Fees and Expenses", "Indemnification" and "Confidentiality" shall survive
termination of Citibank's engagement hereunder, except to the extent, and only
to the extent, such matters are explicitly covered in such Program Documents.
Indemnification
- ---------------
Prodigy shall indemnify and hold harmless and release each indemnified Party
from and against any losses, claims, damages, liabilities or expenses (including
fees and expenses of counsel), joint and several, resulting from or arising out
of, or in connection with or relating to (i) the Financing or the use of
proceeds therefrom, or (ii) Citibank's engagement hereunder, whether or not the
4
<PAGE>
transactions contemplated hereby are consummated, except to the extent such
loss, claim, damage, liability or expense is found in a final, non-appealable
judgment of a court of competent jurisdiction to have resulted from such
Indemnified Party's gross negligence or willful misconduct or breach of the
obligations of the Indemnified Party under this agreement. Prodigy further
agrees that no Indemnified Party shall have any liability (whether direct or
indirect, in contract, tort or otherwise) to Prodigy or any of their
shareholders or creditors for or in connection with the transactions
contemplated hereby, except to the extent such liability is found in a final,
non-appealable judgment of a court of competent jurisdiction to have resulted
from such Indemnified Party's gross negligence or willful misconduct or breach
of the obligations of the Indemnified Party under this agreement. An
"Indemnified Party" means Citibank, each of its affiliates and each special
purpose or receivable securitization company for which Citibank acts as
administrative agent, servicing agent, servicer or in a similar capacity, and
each of the respective officers, director, agents and employees of such
Indemnified Parties.
Confidentiality
- ---------------
The proposal and structure of the Financing, any related structures developed by
Citibank for Prodigy, any related analyses, computer models, information or
documents, this Agreement, the Term Sheet, the Program Documents, Citibank's
written and oral reports to Prodigy and any related written information
(collectively, "Product Information") constitutes proprietary information of
Citibank. Prodigy agrees:
(i) to keep all Product Information confidential and to disclose Product
Information only to those of its officers, employees, agents, accountants, legal
counsel and other representatives (collectively "Representatives") who have a
need to know such Product Information for the purpose of assisting in the
negotiation and completion of the Financing:
(ii) to use the Product Information only in connection with the Financing
and not for any other purpose;
(iii) to cause its Representatives to comply with these provisions and to
be responsible for any failure of any Representative to so comply.
All information provided to Citibank which, under the circumstances of its
provisions and receipt, would ordinarily be considered confidential shall
similarly be subject to the provisions set forth in subparagraphs (i) through
(iii) and the obligations of non-disclosure contained therein by Citibank and
its representatives.
The provisions of this section shall not apply to Product Information or to
information provided by Prodigy to Citibank that is a matter of general public
knowledge or that has heretofore been or is hereafter published in any source
5
<PAGE>
generally available to the public or that is required to be disclosed by law or
in requested by any regulatory body with jurisdiction over Citibank.
Potential Conflicts; Principal Transactions
- -------------------------------------------
Prodigy acknowledges that:
(i) Citibank may be providing financing or other services to parties whose
interests may conflict with Prodigy; it being understood that consistent with
its long-standing policy to hold in confidence the affairs of its customers,
Citibank will not furnish confidential information obtained from Prodigy to any
of its other customers and will not make available to Prodigy confidential
information that it has obtained or may obtain from any other customers;
(ii) Citibank is not acting as an agent or fiduciary for Prodigy in
connection with the Financing and Prodigy has the capacity to evaluate and
negotiate the terms of the Financing on an arm's length basis; and
(iii) Citibank may act as principal in various aspects of the Financing.
Prodigy waives any claim against Citibank based upon any conflict of interest
that Citibank may have with regard to acting under this Agreement and as a
principal in the Financing, except to the extent that such conflict of interest
results in a breach of Citibank's obligations to Prodigy under this letter
agreement.
Exclusivity
- -----------
Prodigy agrees that, during the terms of this agreement, no other person is or
will be appointed, authorized or retained by Prodigy or any of their affiliates
to perform substantially similar services on behalf of Prodigy that the
Arrangers has been engaged to perform hereunder for the proposed securitization
of the ISP contract receivables. Furthermore, during the period from the date
hereof through the date which is 6 months after the date hereof, Prodigy will
not, and will cause its affiliates not to, initiate, solicit or enter into any
dissuasions or negotiations looking toward the issuance, offering, or sale of
the Notes, or any other substantially similar security, to any third parties,
except through the Arrangers. In the event Prodigy receives any inquiry
concerning the Financing during such period, Prodigy will promptly inform the
Arranger of such inquiry.
Additionally, for a period of one year from the date of this agreement, Prodigy
agrees that Citibank shall have the right of first refusal to act as sole agent
for the next substantially similar financing transaction undertaken by Prodigy.
6
<PAGE>
Cooperation
- -----------
It is understood that Prodigy will furnish Citibank with all information and
data that Citibank shall reasonably deem appropriate in connection with its
engagement hereunder. Prodigy agrees to do those things that are reasonable and
necessary to assist Citibank to facilitate the consummation of the Financing.
Prodigy recognizes and confirms that Citibank, in acting pursuant hereto, will
be using information in public reports and other information provided by others,
including information provided by Prodigy and that Citibank does not assume
responsibility for the accuracy or completeness of such information.
Complete Agreement; Amendments; Governing Law
- ---------------------------------------------
This Agreement sets forth the entire understanding of the parties relating to
the subject matter hereof and supersedes and cancels any prior communications,
understandings and agreements between the parties relating to the subject matter
hereof. This Agreement may not be amended or modified except in writing. The
terms of this Agreement shall be governed by and construed in accordance with
the laws of the State of New York, without reference to the conflicts of laws
provisions thereof.
If the foregoing terms meet with your approval, please indicate your acceptance
by signing and returning the attached copy of this letter to us no later than
March 20, 2000.
Sincerely,
CITIBANK N.A. NEW YORK
By: /s/ Michael Fey
---------------
Title: Michael Fey-Vice President
Date:
ACCEPTED AND AGREED
PRODIGY COMMUNICATIONS CORP.
By: /s/ Andrea S. Hirsch
---------------------------
Andrea Hirsch
Title: EVP General Counsel
Date: 3/16/00
cc: Ken Domnitz, Prodigy
7
<PAGE>
March 13, 2000
Prodigy Communications Corporation, Inc.
Receivables Securitization Program
Preliminary Summary of Principal Terms and Conditions
(Not a Commitment - For discussion purposes only)
<TABLE>
<S> <C>
Program: Revolving transfer of an undivided
interest in receivables (the
"Receivables") arising under certain
contracts (the "Contracts") between
Prodigy Communications Corp.
("Prodigy") and various consumer
obligators (the "Subscribers") in
connection with Prodigy's computer
purchase rebate program. Payments by
the Subscribers under the Contracts
will be due monthly over a period of
one, two, or three years unless sooner
terminated. The maximum tenor of the
Contracts is three years.
Originator: Prodigy shall initially transfer all of
the contracts originated under the Best
Buy rebate program, which meet the
eligibility criteria, on a true sale
basis to the Issuer.
Issuer: [Prodigy Funding Corp.] ("Prodigy
Funding"); Prodigy Funding will be
established as a special-purpose,
bankruptcy-remote wholly-owned
subsidiary of Prodigy or its
successors. The Issuer will issue the
Variable Funding Note (the "Note"),
representing an undivided interest in
the Receivables generated by the assets
of Prodigy Funding, to the Purchaser
pursuant to the Note Sale Agreement.
Opinions of law will be provided to
conform the separateness of Prodigy
from the Issuer, the true sale nature
of the transfer, and that the assets
transferred to the Issuer would not be
consolidated with the estate of Prodigy
in the case of a bankruptcy or
insolvency event with respect to
prodigy.
Credit Enhancement: To be in the form of:
. Overcollateralization of anticipated
future receipts at a level to be
determined following due diligence
and of sufficient debt service
coverage to meet
</TABLE>
A-1
<PAGE>
<TABLE>
<S> <C>
. both S&P's and Moody's minimum
investment grade standards on a stand
alone basis;
. A performance guarantee provided by
SBC Communications Corp. ("SBC")
that, in the event Prodigy becomes
unable to continue to provide its
service obligations under the
Contracts, SBC shall either (a)
provide prodigy's service obligations
directly, or (b) replace Prodigy with
a substitute ISP, as allowed by the
Contracts, acceptable to the program
agent or its assignees;
. A financial guarantee provided by
either a monoline insurer or a re-
insurance company whose rating shall
be at least AA/A12 by S&P and Moody's
respectively.
. Additional credit enhancement in the
form of an affirmative pledge by
Prodigy and its successors to replace
defaulted Receivables with "month to
month" subscriber cash flows to the
extent necessary to maintain the
minimum investment grade shadow or
ratings required by from S&P and
Moody's.
Purchaser: A multi-seller receivables
securitization company (each, an "RSC")
administered by Citicorp North America,
Inc., and/or its eligible assignees,
including the Liquidity Provider.
Program Agent: Citicorp North America, Inc. will act
as the Purchaser's agent ("Program
Agent") to administer the Program.
Receivables: The Receivables represent either (i)
scheduled payments, cancellation fees,
late fees and other amounts due
(collectively, the "Contractual
Payments") under the Contracts from the
Subscribers who, as a result of
receiving a $400, $250, or $100
computer purchase rebate, subscribe to
"Prodigy", an ISP service provided by
Prodigy for a period of three, two or
one years respectively, with a regular
monthly payment of [either $19.95 or
$21.95], (ii) payments [less
interchange fees] due from various
credit card companies (e.g. MasterCard,
VISA etc.) approved by the Program
Agent (the "Credit Card Companies") who
bill and collect all or a part of the
Contractual
</TABLE>
A-2
<PAGE>
<TABLE>
<S> <C>
Payments from the Subscribers, or (iii)
Payments due from all other "month to
month" Prodigy subscribers.
Facility Size: Up to $200 million, subject to due
diligence. The collection of
Receivables will be used to repay the
Program.
Revolving Period: The period commencing on the closing
date and ending on the date (the
"Termination Date") which occurs six
months thereafter, or sooner if agreed
to by all parties to the Program
documents.
Maturity Date: Three years from the Termination Date.
Transfer Date: With regard to any Receivable, the date
such Receivable is transferred under
the Program. The Initial transfer is
anticipated to occur on or before
[May 31, 2000].
Servicer: Prodigy. The duties of the Servicer
will include billing, collecting, re-
billing, enforcement and pursuit of
past due payments on any Receivables,
funds disbursement, and periodic
reporting. Prodigy may sub-contract all
or part of its servicing obligations if
it remains primarily liable therefore.
The Program Agent may, under certain
circumstances, terminate Prodigy as
Servicer and appoint a new Servicer.
Servicer Fee: As Servicer, Prodigy will receive a fee
of [$ ] per month per Subscriber
payable by the Issuer unless an Event
of Termination has occurred. If Prodigy
is not the Servicer, a market rate for
such Servicer, capped at [ %] of such
successor Servicer's actual cost of
collection, will be deducted from cash
proceeds from the Receivables. The
Servicer Fee will be set following
rating agency review and negotiation
with a financial guarantor.
Security Interest: The Purchaser will be conveyed, in
connection with the purchaser of the
Variable Funding Note, a first priority
perfected ownership/security interest
in the Receivables, the proceeds
thereof, and any security related
thereto.
Settlement Procedures: Provided no Event of Termination has
occurred, monthly collections are
allocated as follows: (i) to the
Purchaser for interest and fees, (ii)
to the Servicer for
</TABLE>
A-3
<PAGE>
<TABLE>
<S> <C>
the Servicer Fee and (iii) (1) prior to
the Termination Date, to the Originator
to reinvest in new Eligible Receivables
to the extent such Eligible Receivables
exist, otherwise to the Purchaser for
repayment of outstanding capital or (2)
after the Termination Date, to the
Purchase for repayment of the aggregate
amount of outstanding Capital and other
amounts owed to the purchaser.
Upon the occurrence, and following an
Event of Termination or a "SBC Event"
(to be defined following the
negotiation of the SBC Performance
Guarantee), monthly collections are
allocated as follows: (i) to the
Purchaser for interest and fees, (ii)
to the Purchaser for repayment of the
aggregate amount of outstanding Capital
and other amounts owned to the
purchaser, and (iii) after Capital is
paid in full, to the Servicer for the
Servicer Fee.
Eligible Receivables Due Any Receivables:
from Subscribers:
. Which arise under a valid and binding
Contract and which at the time of the
transfer of such Receivable conveyed
good and marketable title thereto
free and clear of all liens.
. With regard to which the related
Subscriber is not affiliated with the
Issuer or Prodigy.
. Which will at all times be the legal
and assignable payment obligation of
the Subscriber of such Receivable,
enforceable against such Subscriber
in accordance with its terms.
. Which arises under a Contract which
(I) is fully payable no later than
[35] months after its related
Transfer Date and (ii) requires
payments to be made no less
frequently than monthly.
. Which, on the Transfer Date, is not a
Defaulted Receivable.
. Which, together with the contract
related thereto, does violate any
law or regulation.
</TABLE>
A-4
<PAGE>
<TABLE>
<S> <C>
. Which is (a) freely transferable and
(b) arises under a Contract which is
(i) a legal, valid and binding
obligation of the Issuer and the
Subscriber enforceable in accordance
with its terms, (ii) in form and
substance satisfactory to the Program
Agent.
. Which is an "account" as defined
within the UCC.
. Which is denominated and payable by
approved Credit Card Companies in
United States dollars in the United
States to Prodigy who in turn
deposits into Purchaser's Accounts.
. Which is not the subject of any
dispute, offset, counterclaim or
defense.
. Which complies with Prodigy's credit
and collection policy.
. Which Represents the sale of goods or
services per Section 3(c)(5) of the
Investment Company Act of 1940 and
which arises out of a current
transaction per Section 3(a)(3) of
the Securities Act of 1933.
. Other, as applicable.
Eligible Receivables Due To be determined after due diligence
from Credit Card Companies:
Defaulted Subscriber Receivable: All Receivables outstanding (whether or
not then due) under any Contract (i)
that has Receivables or part thereof
which remain unpaid for more than [60]
days (subject to due diligence) from
the original due date, (ii) the
Subscriber under whish is in bankruptcy
or similar proceedings, (iii) which,
consistent with Prodigy's credit and
collection policy, has been or should
have been written off as uncollectable,
or (iv) as to which there is a breach
in the underlying contract.
Defaulted Credit Card Company To be determined after due diligence
Receivable:
</TABLE>
A-5
<PAGE>
<TABLE>
<S> <C>
Delinquent Subscriber Receivable: All Receivables outstanding (whether or
not then due) that are not Defaulted
Receivables under any Contract (i) that
has Receivables or part thereof which
remain unpaid for more than [30] days
from the original due date or (ii)
which, consistent with Prodigy's credit
and collection policy, has been or
should be classified as delinquent.
Delinquent Credit Card Company To be determined after due diligence
Receivable:
Covenants: Customary covenants with respect to the
issuer and Prodigy, including:
. Issuer will furnish to Program Agent
a monthly report which will include,
without limitation, information with
regard to agings, defaults,
collections, deemed collections,
Subscriber volumes and Subscriber and
Credit Card Company cancellations;
etc.
. Issuer and Prodigy will maintain all
documents and records necessary with
respect to the collection of the
Receivables.
. Issuer and Prodigy will provide
certified quarterly and annual
financial statements. Prodigy will
provide certified quarterly and
audited annual financial statements.
Prodigy and Issuer will provide such
other information as Program Agent
may reasonably request.
. Issuer and Prodigy will permit audits
of information related to the
Program.
. Issuer will maintain its separate
existence from Prodigy.
. Issuer will only accept transfers of
Receivables from Prodigy or its
successors.
</TABLE>
A-6
<PAGE>
<TABLE>
<S> <C>
. Prodigy and Issuer will perform and
comply with the terms and conditions
specified in the Program documents,
and shall maintain such documents in
full force and effect.
. Issuers and Prodigy or successors
will not modify its organizational
documents in such a way as to have an
adverse effect on Purchaser.
. Issuer will not incur debt, except as
permitted under the Program
documents.
. Issuer will not make distributions,
except as permitted under the Program
documents.
. Issuer will not enter into
transactions with affiliates or third
parties, except as permitted under
the Program documents.
. Neither Issuer nor Prodigy will sell,
assign or otherwise encumber any
Receivable except as contemplated
under the Program documents.
. Prodigy and the Issuer will each
comply with its credit and collection
policy and will not materially change
its credit and collection policy,
except as specifically permitted by
the Program Agent.
. Prodigy and the Issuer will comply
with all terms of the Contracts.
. Neither Prodigy nor the Issuer will
cancel, terminate, amend, modify or
waive any term or condition of any
Contract related to the receivables,
except as specifically permitted by
the Program Agent.
. Prodigy will offer to the Subscribers
the same upgrades to their level of
service that Prodigy provides to
their other on-line customers at no
higher price.
. Prodigy, or its successor, must
either (a) directly provide the
Prodigy service or (b) wholly own the
entity which provides the Prodigy
service, in each case for the
duration of the Contracts and at
least at the level of service
presently provided.
</TABLE>
A-7
<PAGE>
<TABLE>
<S> <C>
. Prodigy, or its successor, must own,
directly or indirectly, 100% of the
capital stock of the Issuer and
maintain control of them.
. Other, as applicable.
Events of Termination: Events of Termination shall result in
acceleration of the transaction via a
100% trapping of cash to be used to pay
down the facility in advance of
scheduled amortization. Upon the
occurrence of an Event of Termination
the revolving nature of the facility
shall cease a no new contract
purchasers shall occur. The Events of
Termination shall include:
. Servicer fails to make payments when
due (a cure period will be negotiated
within the program documents).
. Any representation or warranty or
Issuer Report or any information is
materially false or incorrect.
. Issuer fails to perform or observe
any other term or covenant.
. The parent fails to pay other debt
with a principal balance in excess of
[ ] million or defaults under any
other debt agreement or instrument
with a principal balance in excess of
[ ] million.
. The Note purchased by Purchaser
ceases to create a valid and
perfected first priority ownership
interest in the Pool Receivables.
. Bankruptcy or insolvency of Issuer or
the Parent.
. 3 month rolling average Default Ratio
exceeds [ ]; 3 month rolling average
Dilution Ratio exceeds [ ]; 3 month
rolling average Loss-to-Liquidation
Ratio exceeds [ ]; and 3 month
rolling average Delinquency Ratio
exceeds [ ]. These triggers will be
set as part of the negotiation of the
program documents.
. Material adverse change in financial
condition or operations of Issuer or
in the collectibility of Pool
Receivables.
</TABLE>
A-8
<PAGE>
<TABLE>
<S> <C>
. SBC senior unsecured long term debt
rating falls below either, BBB by
S&P, or Baa2 by Moody's.
. Others to be determined in the course
of due diligence including a minimum
debt service coverage factor to be
set based upon rating agency
requirements.
Conditions Precedent: Completion and execution of all
documentation delivered and
satisfactory to the Program Agent,
including filing of UCC-1 financing
statements plus:
. Representations and warranties are
true.
. No event of Termination has occurred.
. The Program Agent has received such
other approvals as reasonably
requested.
. Satisfactory reviewed by the Program
Agent of Servicer's billing,
collection and reporting systems and
Pool Receivables.
. Tue sale, enforceability, and other
necessary opinions.
. Consents of third parties as
appropriate.
. Other, as applicable
Representations and Customary representations and
Warranties: warranties of the Issuer and Prodigy
found in similar rated bank or
securitization transactions,
including:
. Due organization, qualification, etc.
of Issuer and Prodigy.
. Due authorization, execution,
delivery and performance of the
Program documents by the Issuer and
Prodigy, respectively, which
establishes legal, valid, and binding
obligations of Issuer and Prodigy
respectively, with respect thereto.
</TABLE>
A-9
<PAGE>
<TABLE>
<S> <C>
. The Note Purchase Agreement will
evidence the transfer of a first
priority perfected ownership interest
in the Receivables to the Purchaser.
. All filings and recordings required
to perfect the Interest of the
transferor and the Purchaser in the
Receivables, including the Contracts
sold to the issuer, and any related
security shall have been accomplished
and are in full force and effect.
. Each Receivable is an Eligible
Receivable and is free of adverse
claims.
. Transfer of the Receivables by
Prodigy to issuer is for reasonably
equivalent value.
. Invoices and/or credit card billing
statements with respect to each
Receivable will be sent in accordance
with the Receivables Transfer
Agreement.
. All information furnished by Transfer
or Prodigy to the Program Agent (and
other transaction parties), whether
on or before the closing date, (i) is
true and accurate in all material
respects, (ii) does not contain any
materially misleading statements, and
(iii) does not omit material facts.
. No material adverse change in the (i)
collectibility of Receivables or (ii)
operations or ability to perform its
obligations under the program
documents, of Issuer or Prodigy.
. Prodigy has complied with their
credit and collection policy and such
policy has not changed.
. Neither the Issuer nor Prodigy will
cause a voluntary bankruptcy of
Issuer so long as Issuer is solvent.
. Issuer and Prodigy are solvent.
. Issuer is not an "investment company"
within the meaning of the Investment
Company Act of 1940, as amended.
. Other, as applicable.
</TABLE>
A-10
<PAGE>
<TABLE>
<S> <C>
Indemnities: Prodigy shall jointly and severally
indemnify the parties to the
transaction, (each an "Indemnified
Party") against all third party
liabilities, expenses, damages or
losses ("Losses") associated with the
Program, excluding however, (i) Losses
to the extent resulting from the gross
negligence or willful misconduct of the
Indemnified Party, (ii) income,
franchise or similar taxes or (iii)
recourse (except as herein
contemplated) for uncollectible
Receivables.
Without limiting the foregoing, Prodigy
shall indemnify the Indemnified Parties
for all Losses resulting from:
. Misrepresentations and omissions.
. Any reduction or offset in the amount
owed by a Subscriber or a Credit Card
Company.
. Failure to vest in the Purchaser for
a first priority perfected ownership
interest in the Receivables.
. Failure by Prodigy or the Servicer to
perform the servicing duties or other
obligations under the Program
documents or to comply with any term
or condition thereunder.
. Any increase in the fees (including
without limitation, intercharge fees)
payable by Prodigy to the Credit Card
Companies.
. Commingling of funds.
. Others as may be required upon
completion of due diligence.
Assignability: The Purchaser and its assignees may
each assign, in whole or in part, its
interest in the Notes pursuant to the
Program documents. Neither Prodigy, nor
the issuer shall be permitted to assign
any of its rights or obligations
pursuant to the Program documents
without the prior written consent of
the Program Agent.
Governing Law: The laws of State of New York.
</TABLE>
A-11
<PAGE>
<TABLE>
<S> <C>
Costs and Expenses: All out-of-pocket costs and expenses of
Citibank and its affiliates associated
with the preparation, execution and
delivery, waivers and amendments,
administration and enforcement of the
Program including fees and expenses of
counsel and auditing fees are to be
paid by Prodigy regardless of whether
the Program closes.
</TABLE>
A-12
<PAGE>
EXHIBIT 23.3
CONSENT OF INDEPENDENT ACCOUNTANTS
----------------------------------
We hereby consent to the use in this Registration Statement on Form S-4 of
Prodigy Communications Corporation of our report dated March 3, 2000 relating to
the financial statements of Prodigy Communications Corporation, which appears in
such Registration Statement. We also consent to the references to us under the
heading "Experts" in such Registration Statement.
PricewaterhouseCoopers LLP
New York, New York
May 1, 2000
<PAGE>
EXHIBIT 23.4
CONSENT OF INDEPENDENT AUDITORS
We consent to the reference to our firm under the caption "Experts" and to the
use of our report dated March 3, 2000, included in the Proxy Statement of
FlashNet Communications, Inc. that is made a part of the Registration Statement
(Form S-4 No. 333- ) and Prospectus of Prodigy Communications Corporation
for the registration of 5,864,203 shares of its common stock.
/s/ Ernst & Young LLP
Fort Worth, Texas
May 1, 2000
<PAGE>
EXHIBIT 23.5
INDEPENDENT AUDITORS' CONSENT
We consent to the use in this Registration Statement of Prodigy Communications
Corporation on Form S-4 of our report dated February 23, 1999 (March 11, 1999
as to the last paragraph in Note 12) relating to the consolidated balance sheet
of FlashNet Communications, Inc. and subsidiaries as of December 31, 1998, and
the related statements of operations, shareholders' deficit, and cash flows for
the years ended December 31, 1998 and 1997, appearing in the Prospectus, which
is part of this Registration Statement. We also consent to the reference to us
under the heading "Experts" in such Prospectus.
DELOITTE & TOUCHE LLP
Fort Worth, Texas
May 1, 2000
<PAGE>
EXHIBIT 99.2
PROXY
FLASHNET COMMUNICATIONS, INC.
SPECIAL MEETING OF SHAREHOLDERS
TO BE HELD ON TUESDAY, MAY 30, 2000
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS OF THE COMPANY
The undersigned hereby appoints M. Scott Leslie and Andrew
Jent, and each of them as proxies, each with the power of
substitution, and hereby authorizes them to vote all
shares of Common Stock which the undersigned is entitled
to vote at the Special Meeting of the Company's sharehold-
ers, to be held at the City Club in the City Center Tower
II, located at 301 Commerce Street, Fort Worth, Texas
76102 on Tuesday, May 30, 2000 at 9:00 a.m. local time,
and at any adjournments or postponements thereof (1) as
hereinafter specified upon the proposal listed on the re-
verse side and as more particularly described in the
Company's Proxy Statement and (2) in their discretion upon
such other matters as may properly come before the meet-
ing.
WHETHER OR NOT YOU PLAN TO ATTEND THE MEETING IN PERSON,
YOU ARE URGED TO SIGN AND PROMPTLY MAIL THIS PROXY IN THE
RETURN ENVELOPE SO THAT YOUR STOCK MAY BE PRESENTED AT THE
MEETING.
CONTINUED AND TO BE SIGNED ON REVERSE SIDE
P
R
O
X
Y
<PAGE>
Please mark your votes as in this example.
This proxy will be voted as directed. If no direction is given, this
proxy will be voted FOR the following proposal.
The board of directors recommends a vote FOR the proposal.
1. To approve and adopt
the merger agreement
among the Company,
Prodigy Communication
Corporation and PUCKnut
Corporation, including
the first amendment to
the merger agreement,
and the related merger
pursuant to which the
Company will become a
wholly-owned subsidiary
of Prodigy and each
outstanding share of
FlashNet common stock
will be converted into
the right to receive
0.35 share of Prodigy
common stock.
Sign exactly as your name(s) appear(s) on
your stock certificate. If shares of
stock stand of record in the names of two
or more or in the name of husband and
wife, whether as joint tenants or other-
wise, both or all of such persons should
sign the above Proxy. If shares of stock
are held of record by a corporation, the
Proxy should be executed by the President
or Vice President and the Secretary or
Assistant Secretary, and the corporate
seal should be affixed thereto. Executors
or administrators or other fiduciaries
who execute the above Proxy for a de-
ceased shareholder should give their full
title. Please date the Proxy.
Signature: Date: Signature: Date:
X
FOR AGAINST ABSTAIN
MARK HERE IF YOU PLAN TO
ATTEND THE MEETING
MARK HERE FOR ADDRESS
CHANGEAND NOTE BELOW
