<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
Date of Report (date of earliest event reported): March 9, 2000
CMGI, Inc.
------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 000-23262 04-2921333
- -------------------------- ----------- -------------------
(State or other juris- (Commission (IRS Employer
diction of incorporation) File Number) Identification No.)
100 Brickstone Square, Andover, MA 01810
- ------------------------------------------- -----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (978) 684-3600
N/A
-------------------------------------------------------------
(Former name or former address, if changed since last report)
<PAGE>
Item 5. Other Events
------------
On December 14, 1999, CMGI, Inc. ("CMGI") entered into a merger
agreement (the "yesmail Merger Agreement") to acquire yesmail.com, inc. Pursuant
to the yesmail Merger Agreement, CMGI will issue 0.1252 shares of CMGI common
stock for each share of yesmail common stock issued and outstanding at the
closing of the merger. Total consideration for the yesmail merger is estimated
at approximately $671 million consisting of: (i) CMGI common stock valued at
$555 million, (ii) options and warrants to purchase CMGI common stock valued at
approximately $110 million and (iii) estimated direct acquisition costs of $6
million. The closing of this transaction will occur promptly following the
satisfaction of all closing conditions set forth in the yesmail Merger
Agreement, including the expiration or early termination of the applicable
waiting period under the Hart-Scott-Rodino Antitrust Improvement Act of 1976,
as amended (the "Hart-Scott-Rodino Act").
CMGI has entered into a Stock Purchase Agreement, dated
as of February 14, 2000, by and among itself, Bean Acquisition Corp., a
wholly-owned subsidiary of CMGI ("Acquisition Sub"), Tallan, Inc. ("Tallan") and
certain stockholders of Tallan (the "Stock Purchase Agreement"), providing for
the acquisition of an approximately 80% interest in Tallan on a fully diluted
basis. Total consideration for the acquisition is approximately $920 million and
is payable in cash, promissory notes and options to acquire CMGI stock. The
promissory notes have varying maturities and the principal and interest on the
promissory notes are generally payable, at CMGI's option, in cash or registered
shares of CMGI stock. The closing of the acquisition will occur promptly
following the satisfaction of all closing conditions set forth in the Stock
Purchase Agreement, which include the expiration or termination of the
applicable waiting period under the Hart-Scott-Rodino Act.
Item 7. Financial Statements, Pro Forma Financial Information and Exhibits
------------------------------------------------------------------
(a) Financial Statements of Business Acquired
-----------------------------------------
Audited consolidated balance sheets of yesmail.com, inc. as of December 31, 1998
and 1999, and the related consolidated statements of operations, common
stockholders' equity (deficit) and cash flows for each of the two years in the
period ended December 31, 1999.
Audited balance sheets of Tallan, Inc. as of December 31, 1998 and 1999, and the
related statements of operations, changes in stockholders' equity (deficit) and
cash flows for each of the three years in the period ended December 31, 1999.
(c) Exhibits:
--------
23.1 Consent of PricewaterhouseCoopers LLP
23.2 Consent of Arthur Andersen LLP
99.1 Audited consolidated balance sheets of yesmail.com, inc. as of
December 31, 1998 and 1999, and the related consolidated
statements of operations, common stockholders' equity
(deficit) and cash flows for each of the years in the period
ended December 31, 1999.
99.2 Audited balance sheets of Tallan, Inc. as of December 31,
1998 and 1999, and the related statements of operations,
changes in stockholders' equity (deficit) and cash flows for
each of the three years in the period ended December 31, 1999.
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
Date: March 8, 2000 CMGI, Inc.
------------
(Registrant)
By: /s/ William Williams II
----------------------------
William Williams II
Title: Vice President and
General Counsel
<PAGE>
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
23.1 Consent of PricewaterhouseCoopers LLP
23.2 Consent of Arthur Andersen LLP
99.1 Audited consolidated balance sheets of yesmail.com, inc. as of
December 31, 1998 and 1999, and the related consolidated
statements of operations, common stockholders' equity
(deficit) and cash flows for each of the years in the period
ended December 31, 1999.
99.2 Audited balance sheets of Tallan, Inc. as of December 31,
1998 and 1999, and the related statements of operations,
stockholders' equity (deficit) and cash flows for each of the
three years in the period ended December 31, 1999.
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
----------------------------------
We hereby consent to the incorporation by reference in the Registration
Statements on Forms S-3 (File Nos. 333-93005, 333-85047, 333-90587 and
333-71863), on Forms S-8 (Nos. 333-94645, 333-94479, 333-93189 and 333-91117)
and on Form S-4 (File No. 333-95977) of CMGI, Inc. of our report dated
January 25, 2000 relating to the financial statements of Tallan, Inc., which
appears in this Current Report on Form 8-K of CMGI, Inc.
PricewaterhouseCoopers LLP
Hartford, Connecticut
March 8, 2000
<PAGE>
EXHIBIT 23.2
[LOGO OF ARTHUR ANDERSEN]
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
As independent certified public accountants, we hereby consent to the
incorporation of our reports included or incorporated by reference in this Form
8-K, into CMGI's previously filed Registration Statements on Form S-8
(registration nos. 333-94645, 333-94479, 333-93189, 333-91117), previously filed
Registration Statements on Form S-3 (registration nos. 333-93005, 333-85047,
333-90587) and previously filed Registration Statement on Form S-4 (registration
no. 333-95977).
/s/ ARTHUR ANDERSEN LLP
ARTHUR ANDERSEN LLP
Chicago, Illinois
March 7, 2000
<PAGE>
EXHIBIT 99.1
yesmail.com, inc.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Public Accountants................................................................................... 2
Consolidated Financial Statements:
Consolidated Statements of Operations for the Years Ended December 31, 1998 and 1999..................................... 3
Consolidated Balance Sheets as of December 31, 1998 and 1999 ............................................................ 4
Consolidated Statements of Stockholders' (Deficit) Equity for the Years Ended December 31, 1998 and 1999................. 5
Consolidated Statements of Cash Flows for the Years Ended December 31, 1998 and 1999..................................... 6
Notes to Consolidated Financial Statements................................................................................. 7
</TABLE>
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of
yesmail.com, inc.:
We have audited the accompanying consolidated balance sheets of
yesmail.com, inc. (a Delaware corporation) as of December 31, 1998 and 1999, and
the related consolidated statements of operations, stockholders' (deficit)
equity and cash flows for each of the two years in the period ended December 31,
1999. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of yesmail.com,
inc. as of December 31, 1998 and 1999, and the results of their operations and
their cash flows for each of the two years in the period ended December 31,
1999, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Chicago, Illinois
February 4, 2000
2
<PAGE>
yesmail.com, inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
December 31,
--------------------------
1998 1999
---------- ----------
Revenues..................................... $ 4,583,354 $ 15,635,763
Cost of revenues............................. 2,702,872 10,351,995
---------- ----------
Gross profit.............................. 1,880,482 5,283,768
---------- ----------
Operating expenses:
Sales and marketing expenses............... 1,751,208 10,460,765
General and administrative expenses........ 929,209 4,252,508
Research and development costs............. 600,848 3,490,293
Merger costs............................... -- 1,175,000
Stock based compensation................... -- 1,121,717
---------- ----------
Total operating expenses.................. 3,281,265 20,500,283
---------- ----------
Operating loss............................... (1,400,783) (15,216,515)
Other expense:
Interest income (expense).................. (45,075) 520,418
Other...................................... (250,000) --
---------- ----------
Total other (expense) income.............. (295,075) 520,418
---------- ----------
Net loss before minority interest......... (1,695,858) (14,696,097)
Minority interest............................ (10,547) (34,356)
---------- ----------
Net loss.................................. $(1,706,405) $(14,730,453)
========== ==========
Net loss per share:
Basic and diluted.......................... $ (0.22) $ (1.15)
Weighted average shares--basic and
diluted................................ 7,636,099 12,826,932
========== ==========
The accompanying notes to consolidated financial statements
are an integral part of these statements.
3
<PAGE>
yesmail.com, inc.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
------------------------------
1998 1999
------------ ------------
<S> <C> <C>
Current assets:
Cash and cash equivalents .......................................................... $ 26,212 $ 12,771,312
Short term investments ................................... -- 15,793,921
Accounts receivable, net of allowance of $56,000 and $457,000 ...................... 242,757 6,081,564
Deposits and prepaid expenses ...................................................... 19,348 1,068,613
------------ ------------
Total current assets ....................................................... 288,317 35,715,410
------------ ------------
Property and equipment, net .......................................................... 353,871 2,757,981
------------ ------------
Intangibles, net and other assets .................................................... 750 1,118,734
------------ ------------
Total assets ............................................................... $ 642,938 $ 39,592,125
============ ============
Current liabilities:
Accounts payable ................................................................... $ 1,391,509 $ 5,219,473
Short-term debt .................................................................... 342,870 150,000
Due to related parties ............................................................. 56,788 --
Obligations under capital leases, current portion .................................. 87,165 825,003
Accrued liabilities and other ...................................................... 672,194 4,191,786
------------ ------------
Total current liabilities .................................................. 2,550,526 10,386,262
------------ ------------
Obligations under capital leases, less current portion ............................... 152,743 1,655,196
------------ ------------
Commitments and contingencies
Deferred Gain ........................................................................ -- 72,000
------------ ------------
Minority interest .................................................................... (6,990) --
Stockholders' (deficit) equity:
Series A convertible preferred stock, $.0001 par value; 5,000,000 shares authorized;
no shares issued and outstanding ............................................... -- --
Common stock, $.0001 par value; 60,000,000 shares authorized; 8,333,333 and
20,332,164 shares issued ........................................................ 833 2,033
Common stock in treasury, 833,333 and no shares, at cost ........................... (1,030) --
Notes receivable from stockholders ................................................. -- (3,947,936)
Additional paid-in capital ......................................................... 160,649 48,708,147
Deferred compensation .............................................................. -- (987,331)
Accumulated deficit ................................................................ (2,213,793) (16,944,246)
------------ ------------
Total stockholders' (deficit) equity ....................................... (2,053,341) 26,830,667
------------ ------------
Total liabilities and stockholders' equity ................................. $ 642,938 $ 39,592,125
============ ============
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these statements.
4
<PAGE>
yesmail.com, inc.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' (DEFICIT) EQUITY
<TABLE>
<CAPTION>
Preferred Stock Common Stock Treasury Stock Notes
-------------------- -------------------- -------------------
Shares Amount Shares Amount Shares Amount Receivable
-------- -------- --------- -------- -------- -------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1997................... -- $ -- 8,333,333 $ 833 (497,685) $ (602) $ --
Treasury stock purchase....................... -- -- -- -- (335,648) (428) --
Net loss...................................... -- -- -- -- -- -- --
-------- -------- ---------- ------- -------- -------- -----------
Balance at December 31, 1998................... -- -- 8,333,333 833 (833,333) (1,030) --
Treasury stock cancelled...................... -- -- (833,333) (83) 833,333 1,030 --
Issuance of common stock in initial
Public offering, net....................... -- -- 3,400,000 340 -- -- --
Issuance of common stock...................... -- -- 1,875,469 188 -- -- --
Issuance of options and warrants.............. -- -- -- -- -- -- --
Exercise of warrants.......................... -- -- 7,601 1 -- -- --
Issuance of restricted common stock to
officers in exchange for notes receivable.. -- -- 2,394,546 239 -- -- (3,831,274)
Issuance of preferred stock................... 5,154,548 515 -- -- -- -- --
Conversion of Series A preferred stock
into Common stock.......................... (5,154,548) (515) 5,154,548 515 -- -- --
Interest on notes receivable.................. -- -- -- -- -- -- (116,662)
Deferred compensation......................... -- -- -- -- -- -- --
Amortization of deferred compensation, net.... -- -- -- -- -- -- --
Net loss...................................... -- -- -- -- -- -- --
---------- -------- ---------- ------- -------- -------- ----------
Balance at December 31, 1999................... -- $ -- 20,332,164 $ 2,033 -- -- $3,947,936)
========== ======== ========== ======= ======== ======== ==========
<CAPTION>
Additional
Paid In Deferred Accumulated
Capital Compensation Deficit Total
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Balance at December 31, 1997................... $ 160,649 $ -- $ (507,388) $ (346,508)
Treasury stock purchase....................... -- -- -- (428)
Net loss...................................... -- -- (1,706,405) (1,706,405)
------------ ------------ ------------ ------------
Balance at December 31, 1998................... 160,649 -- (2,213,793) (2,053,341)
Treasury stock cancelled...................... (947) -- -- --
Issuance of common stock in initial
Public offering, net....................... 33,142,832 -- -- 33,142,832
Issuance of common stock...................... 1,062 -- -- 1,250
Issuance of options and warrants.............. 1,496,782 -- -- 1,496,782
Exercise of warrants.......................... 20,295 -- -- 20,296
Issuance of restricted common stock to
officers in exchange for notes receivable.. 3,831,035 -- -- --
Issuance of preferred stock................... 8,949,485 -- -- 8,950,000
Conversion of Series A preferred stock into
Common stock............................... -- -- -- --
Interest on notes receivable.................. -- -- -- (116,662)
Deferred compensation......................... 1,120,420 (1,120,420) -- --
Amortization of deferred compensation, net.... (13,126) 133,089 -- 119,963
Net loss...................................... -- -- (14,730,453) (14,730,453)
------------ ------------ ------------ ------------
Balance at December 31, 1999................... $ 48,708.147 $ (987,331) $(16,944,246) $ 26,830,667
============ ============ ============ ============
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these statements.
5
<PAGE>
yesmail.com, inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
December 31,
-----------------------------
1998 1999
------------ -------------
<S> <C> <C>
Cash Flows from Operating Activities:
Net loss ...................................................... $ (1,706,405) $(14,730,453)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities--
Depreciation and Amortization.............................. 101,783 1,066,100
Stock based compensation .................................. -- 1,121,717
Minority interest ......................................... 10,547 34,356
Changes in operating assets and liabilities--
Accounts receivable .................................... (66,498) (5,838,807)
Deposits and prepaid expenses .......................... (15,562) (1,049,265)
Accounts payable, accrued liabilities and other ........ 1,677,070 7,347,556
------------ ------------
Net cash provided by (used in) operating activities .. 935 (12,048,796)
------------ ------------
Cash Flows from Investing Activities:
Purchases of property and equipment ......................... (102,232) (1,655,568)
Short term investments ...................................... -- (15,793,921)
Purchase of minority interest ............................... -- (150,000)
------------ ------------
Net cash used in investing activities ................ (102,232) (17,599,489)
------------ ------------
Cash Flows from Financing Activities:
Payment to related parties .................................. (19,933) (56,788)
Proceeds from short term debt ............................... 312,259 --
Payments of short term debt, net ............................ (118,630) (192,870)
Repurchase of stock ......................................... (428) --
Net proceeds from issuance of common stock .................. -- 33,144,082
Proceeds from issuance of preferred stock ................... -- 8,950,000
Proceeds from sale-leaseback ................................ -- 745,715
Principal payments under capital lease obligations .......... (47,600) (196,754)
------------ ------------
Net cash provided by financing activities ............ 125,668 42,393,385
------------ ------------
Net Increase in Cash .......................................... 24,371 12,745,100
Cash and cash equivalents, beginning of year .................. 1,841 26,212
------------ ------------
Cash and cash equivalents, end of year ........................ $ 26,212 $ 12,771,312
============ ============
Supplemental Disclosure of Cash Flow
Information:
Cash paid during the period for interest .................... $ 45,075 $ 158,047
============ ============
Noncash Transactions:
Equipment acquired under capital leases ..................... $ 251,782 $ 1,640,716
Securities received in exchange for sale of certain assets .. -- 720,000
Issuance of notes payable for purchase of minority interest . -- 150,000
Issuance of warrants to purchase common stock in connection
with lease agreement ..................................... -- 56,614
Issuance of options to purchase common stock in exchange for
purchase of minority interest ............................ -- 177,000
Issuance of restricted common stock to officer in exchange
for notes receivable ..................................... -- 3,831,274
============ ============
</TABLE>
The accompanying notes to consolidated financial statements
are an integral part of these statements.
6
<PAGE>
yesmail.com, inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. The company and description of business
yesmail.com, inc. (the "Company") provides Internet marketing services
which primarily consist of the delivery of targeted direct email campaigns to
specific members in the YesMail Network. The YesMail Network is a collection of
consumers who have given express permission to receive direct marketing messages
in specific categories of interest. These consumers join the YesMail Network
through relationships with Network Partners, and the Company shares a portion of
the revenue received from the delivery and execution of its email campaigns with
its Network Partners. Prior to 1999, the Company also offered a variety of
marketing services focused on delivering Internet users to a particular Web
site.
Superhighway Consulting, Inc. ("SCI", doing business as WebPromote) was
founded in 1995 and was merged with WP Holding, Inc. ("WP Holding") on March 29,
1999, in a stock-for-stock transaction (the "Merger"), with the SCI stockholders
receiving 80% of the outstanding shares of WP Holding. WP Holding was organized
as a Delaware corporation in October 1998 and five investors purchased 5 million
shares of common stock at par value on March 25, 1999. As the SCI stockholders
retained a controlling interest in the surviving entity and WP Holding had no
prior operations, the Company accounted for this merger as a recapitalization.
The shares of SCI have been retroactively adjusted as if there had been an 11.57
for one stock-split.
In connection with the Merger, SCI and the stockholders of WP Holding
entered into a Founders' Agreement, which, among other things, gives the former
SCI stockholders the right to retain the first $16 million in value of the
Company upon subsequent sale or merger or the WP Holding stockholders' interest
in the first $16 million in value of the Company upon the Company's initial
public offering. In the case of an initial public offering, such payment shall
be made with a transfer of shares among the stockholders. The $16 million
represented the negotiated value of SCI as of the date of the Merger.
The financial statements reflect the historical accounts of SCI, with the
number of SCI shares retroactively adjusted to reflect the stock split referred
to above. On May 10, 1999, WP Holding changed its name to yesmail.com, inc.
Starting Point, L.L.C. ("Starting Point"), was incorporated by the Company
as a wholly-owned subsidiary in February 1996. Starting Point manages and
operates an Internet directory and search resource. Starting Point owns a list
of permission e-mail addresses and sells Web site banner advertisements for its
Web site. In September 1996, the Company distributed a 30% interest to and
entered into an operating agreement with a third party retained to manage
Starting Point. This 30% ownership distribution resulted in a $16,000
compensation charge based on the fair market value of the 30% interest as
determined by the Board of Directors. In June 1999, the Company purchased the
30% minority ownership as further described in Note 12. On December 7, 1999, the
Company signed an agreement to sell certain assets of Starting Point as further
described in Note 12.
The Company signed a definitive agreement on December 14, 1999, to be
acquired by CMGI, Inc., in a stock-for-stock merger as further described in
Note 13.
2. Summary of significant accounting policies
Principles of consolidation
The consolidated financial statements include the accounts of the Company
and its subsidiary. All significant intercompany balances and transactions have
been eliminated in the consolidation process.
Cash and cash equivalents
The Company considers all highly liquid investments with a maturity of
three months or less at the time of purchase to be cash equivalents.
Short term investments
7
<PAGE>
The Company invests in investment-grade marketable securities with varying
maturities. These securities include government and agency securities, money
market funds, commercial paper and corporate bonds. The Company accounts for its
investments using Statement of Financial Accounting Standards No. 115,
"Accounting for Certain Investments in Debt and Equity Securities" ("SFAS No.
115"). Management determines the classification of investments under SFAS No.
115 at the time of purchase and reevaluates such classifications at each balance
sheet date.
The costs of the investments (which approximates fair market value) that are
held to maturity consist of the following as of December 31, 1999:
Corporate bonds .......................... $ 11,698,546
U.S. government and agency securities..... 4,095,375
------------
$ 15,793,921
Accounts receivable
A summary of activity in allowance for doubtful accounts is approximately
as follows:
December 31,
-------------------------
1998 1999
---------- ---------
Balance at beginning of the year ....... $ 26,000 $ 56,000
Charged to costs and expenses........... 30,000 406,000
Write-offs.............................. -- (5,000)
---------- ---------
Balance at the ending of the year $ 56,000 $ 457,000
Use of estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of expenses during the reporting period.
Actual results could differ from those estimates.
Property and equipment
Property and equipment are stated at cost. Depreciation is computed using
the straight-line method over the estimated useful lives of the assets or, for
leasehold improvements, the shorter of the lease term or the estimated useful
life of the asset, as follows:
Computer equipment and software.......... 1--3 years
Telephone equipment...................... 2--5 years
Furniture and fixtures................... 5--7 years
Leasehold improvements................... 1--5 years
Maintenance and repairs are charged to expense as incurred and improvements
and betterments are capitalized. When assets are retired or otherwise disposed
of, the cost and accumulated depreciation are removed from the accounts and any
resulting gain or loss is reflected in the consolidated statement of operations
for the period in which it is realized.
Income taxes
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards ("SFAS No.109"), "Accounting for Income Taxes."
Under SFAS No.109, deferred tax assets and liabilities are determined based on
temporary differences between the financial statement and tax bases of assets
and liabilities and net operating loss and credit carryforwards using enacted
tax rates in effect for the year in which the differences are expected to
reverse. Valuation allowances are established when necessary to reduce deferred
tax assets to the amounts expected to be realized. A provision for income tax
expense is recognized for income taxes payable for the current period, plus the
net changes in deferred tax amounts.
Revenue recognition
8
<PAGE>
The Company earns revenues from its customers by (i) charging fees for
sending targeted email to its owned and represented subscribers, (ii) placing
advertisements on Web sites and (iii) providing services to Web site owners.
Revenue is recognized when emails are transmitted to subscribers, as
advertisements are placed on Web sites, and when services are performed.
Deferred revenue represents liabilities for services not yet rendered or for
advertisements not yet placed.
The Company generally becomes obligated to make payments to it Network
Partners, which have contracted with the Company to be part of the YesMail
Network, in the period the email messages are delivered. Such expenses are
classified as cost of revenues in the consolidated statements of operations.
Research and development costs
Costs incurred in the development of its Web site, products, and related
applications to be used in connection with the Company's services have been
expensed to operations as incurred through the year ended December 31, 1998. In
March 1998, the American Institute of Certified Public Accountants issued
Statement of Position ("SOP") No. 98-1, "Software for Internal Use," which
provides guidance on accounting for the cost of computer software developed or
obtained for internal use. The Company adopted SOP No. 98-1 on January 1, 1999.
As a result, the Company has continued to expense its development costs as
incurred as the rapid pace of technological change results in an estimated
useful life of such software of one year or less.
Advertising costs
Costs of developing the advertisements are expensed as incurred. Costs of
placing the media are expensed as the advertisements are run. Such costs are
included in sales and marketing on the consolidated statement of operations and
totaled approximately $699,000 and $843,000 for the years ended December 31,
1998 and 1999, respectively.
Goodwill and other intangibles
Goodwill and other intangible assets are stated at cost and amortized using
the straight-line method over the estimated economic useful life of up to three
years. The Company continually evaluates whether subsequent events and
circumstances have occurred that indicate the remaining estimated useful life of
goodwill or an intangible asset may warrant revision, or that the remaining
balance of goodwill or an intangible asset may not be recoverable. The Company
evaluates the recoverability of goodwill and intangible assets by measuring the
carrying amount of the assets against the estimated undiscounted future cash
flows associated with them. At the time such evaluations indicate that the
future undiscounted cash flows of such assets are not sufficient to recover the
carrying value of such assets, the assets are adjusted to their fair values.
Based on these evaluations, there were no adjustments to the carrying value of
goodwill or intangible assets in 1998 and 1999.
Financial instruments and concentration of risk
Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of cash, accounts receivable,
accounts payable, short-term debt, obligations under capital leases and accrued
liabilities. At December 31, 1998 and 1999, the fair market value of these
instruments approximated their financial statement carrying amount because of
the short term maturity of these instruments. The Company does not require
collateral for accounts receivable, but does evaluate customer creditworthiness
and establish allowances as necessary based on management estimates of
collectibility. One customer represented 10.3% of revenues for the year ended
December 31, 1999, and 9.9% of the accounts receivable balance as of December
31, 1999.
Impairment of long-lived assets and long-lived assets to be disposed of
The Company reviews its long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. Recoverability of assets to be held and used is measured by
comparison of the carrying amount of an asset to future net cash flows expected
to be generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amount of the assets exceeds the fair value of the assets.
9
<PAGE>
Stock-based compensation
The Company accounts for stock-based compensation arrangements with
employees in accordance with provisions of Accounting Principles Board ("APB"),
Opinion No. 25, "Accounting for Stock Issued to Employees," and complies with
the disclosure provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation." Under APB No. 25, compensation expense is based on the
difference, if any, on the measurement date, between the estimated fair value of
the Company's stock and the exercise price of options to purchase that stock or
price paid for shares of stock. For directors and consultants receiving
stock-based compensation, the Company complies with the provisions of SFAS No.
123.
Net loss per share
The Company computes net loss per share in accordance with SFAS No. 128,
"Earnings per Share." Under the provisions of SFAS No. 128, basic net loss per
share is computed by dividing the net loss for the period by the weighted
average number of common shares outstanding during the period. Diluted net loss
per share is computed by dividing the net loss for the period by the weighted
average number of common and common equivalent shares outstanding during the
period. However, the Company had securities outstanding which could potentially
dilute basic earnings per share in the future, but were excluded in the
computation of diluted net loss per share in the periods presented, as their
effect would have been antidilutive. The Company has outstanding options to
purchase 1,966,924 shares of common stock as of December, 31, 1999.
Recently issued accounting pronouncements
In June 1997, the Financial Accounting Standard Board ("FASB") issued SFAS
No. 131, "Disclosures about Segments of an Enterprise and Related Information."
SFAS No. 131 establishes standards for the way companies report information
about operating segments in annual financial statements. It also establishes
standards for related disclosures about products and services, geographic areas
and major customers. The disclosures prescribed in SFAS No. 131 are effective
for the year ended December 31, 1998. The Company has determined that it does
not have any separately reportable business segments.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which defines derivatives, requires that
all derivatives be carried at fair value, and provides for hedge accounting when
certain conditions are met. SFAS No. 133 is effective for the Company in 2001.
Although the Company has not fully assessed the implications of SFAS No. 133,
the Company does not believe that the adoption of this statement will have a
material impact on the Company's financial position or results of operations.
Reclassifications
Certain prior year amounts have been reclassified to conform to the current
year's presentation.
3. Related-party transactions
The Company had amounts payable to certain stockholders for expenses
incurred on behalf of the Company in the amount of $133,509 as of December 31,
1998.
During 1999, the Company obtained advances from certain stockholders
totaling $600,000. All advances were converted to Series A preferred stock on
May 18, 1999.
Starting Point paid a management fee to its minority member for services
related to operating and managing the business. Management fees paid to the
minority member were $81,000 and $115,000 for the years ended December 31, 1998
and 1999, respectively.
Certain stockholders personally guarantee a portion of the Company's
short-term debt and certain equipment leases as further described in Notes 6 and
9.
10
<PAGE>
4. Property and equipment
Property and equipment are summarized as follows:
December 31,
-----------------------
1998 1999
---------- -----------
Computer equipment .................. $ 268,384 $ 2,834,294
Computer software ................... 126,147 728,251
Telephone equipment ................. 57,528 57,528
Furniture and fixtures .............. 10,878 91,157
Leasehold improvements .............. 60,628 108,619
---------- -----------
523,565 3,819,849
Accumulated depreciation............. (169,694) (1,061,868)
---------- -----------
$ 353,871 $ 2,757,981
========== ===========
5. Intangible and other assets
Intangible and other assets are summarized as follows:
December 31,
-----------------------
1998 1999
---------- ----------
Long-term investment ................ $ -- $ 720,000
Goodwill, net ....................... -- 374,695
Other................................ 750 24,039
---------- ----------
$ 750 $1,118,734
Accumulated amortization of goodwill as of December 31, 1999 is
approximately $75,000.
6. Short-term debt
As of December 31, 1998, the Company had two lines of credit for maximum
borrowings of $370,000. Interest rates ranged from 9.25% and 14.75%, with a
weighted average rate of 10% as of December 31, 1998. Outstanding borrowings
under the lines of credit were $298,955 as of December 31, 1998, and were
personally guaranteed by certain stockholders.
On March 12, 1998 the Company borrowed $50,000 from a bank at an interest
rate of 10.0% that matured and was paid in full in July 1999. The balance of the
note as of December 31, 1998, was $43,915. The loan was collateralized by all of
the assets and property of the Company.
In June 1999, the Company purchased the 30% ownership interest of Starting
Point from the minority interest shareholder for $477,000 as described in Note
12. The purchase price included the issuance of an $150,000 note, which accrues
interest at a rate of 10% and is to be repaid one year from the anniversary of
the acquisition date.
As of December 31, 1999, the Company has a line of credit with a bank
providing for maximum borrowing of $2,500,000 that expires on June 30, 2000.
Borrowings are collateralized by substantially all assets. Interest on
borrowings is at prime. There were no borrowings outstanding as of December 31,
1999.
7. 401(k) savings plan
In September 1997, the Company established a 401(k) Savings Plan (the
"Plan") that covers substantially all employees. Under the Plan, employees are
permitted to contribute a portion of gross compensation not to exceed standard
limitations provided by the Internal Revenue Service. The Company maintains the
right to match employee contributions, but for the years ended December 31, 1998
and 1999, no Company matching contributions were made.
11
<PAGE>
8. Accrued liabilities and other
Accrued liabilities and other are comprised of the following:
December 31,
------------------------
1998 1999
---------- -----------
Payroll and payroll related expenses ...... $ 213,291 $ 1,347,984
Deferred revenue .......................... 114,301 548,709
Legal settlement .......................... 250,000 --
Professional fees ......................... -- 1,756,093
Accrued marketing ......................... -- 539,000
Other ..................................... 94,602 --
---------- -----------
$ 672,194 $ 4,191,786
========== ===========
9. Commitments and contingencies
Leases
The Company leases office space and equipment under noncancelable operating
and capital leases with various expiration dates through the year 2004. Rent
expense amounted to approximately, $86,000, and $336,000 for the years ended
December 31, 1998 and 1999, respectively.
Future minimum lease payments under noncancelable capital leases and
operating leases as of December 31, 1999 are as follows:
Capital Operating
Leases Leases
---------- ----------
2000....................................... $1,093,624 $1,102,043
2001....................................... 1,038,780 1,189,975
2002....................................... 767,082 1,218,790
2003....................................... 28,395 1,210,945
2004....................................... -- 1,063,507
After 2004................................. -- 2,348,054
---------- ----------
Total minimum lease payments............... $2,927,881 $8,133,314
Less--Amount representing interest......... (447,682) ==========
----------
Present value of capital lease obligations. 2,480,199
Less--Current portion...................... (825,003)
----------
Long-term portion.......................... $1,655,196
==========
The Company received $745,715 as proceeds pursuant to an equipment and
furniture sale-leaseback transaction in August 1999. This capital lease
agreement expires in August 2002 and has any annual interest rate of 12.35%.
Interest rates under other noncancelable capital leases range from 10.43% to
28.11%.
Litigation
In connection with the termination of employment of a stockholder, the
Company exercised its right to repurchase the stockholder's shares in accordance
with the Shareholders' Agreement described in Note 11. The former stockholder
has filed a lawsuit contesting the repurchase amount. During 1998, the Company
recorded a reserve of $250,000 in other expense in the accompanying financial
statements. During 1999, the case was settled for approximately $250,000.
Additionally, the Company is, at times, subject to pending and threatened
legal actions and proceedings. After reviewing pending and threatened actions
and proceedings with counsel, management believes that the outcome of such
actions or proceedings is not expected to have a material adverse effect on the
financial position or results of operations of the Company.
Guarantees
The Company has commitments to certain third parties that guarantees quarterly
payments of approximately $300,000. These commitments expire in 2000.
Construction Commitments
12
<PAGE>
At December 31, 1999, the Company signed commitments to spend approximately
$2,000,000 relating to new office space. Management believes that the office
space will be completed by March 2000.
Letter of Credit
A letter of credit of $1,495,337 is outstanding that expires on February 28,
2001.
10. Income taxes
As of December 31, 1998 and 1999, the Company had net operating loss
carryforwards of approximately $1,423,000 and $10,213,000, which begin to expire
in the year 2010.
As a result of various equity transactions during 1999, the Company
believes that it may have undergone an "ownership change" as defined in Section
382 of the Internal Revenue Code. Accordingly, the utilization of a portion of
the net operating loss carryforwards may be limited. Due to the uncertainty
regarding the ultimate utilization of the net operating carryforwards, the
Company has not recorded any benefit for losses and a valuation allowance has
been recorded for the entire amount of the net deferred tax asset. In addition,
sales of the Company's stock, including shares sold in the Company's initial
public offering, may further restrict its ability to utilize its net operating
loss carryforwards.
The difference between the income tax benefit at the federal statutory rate
of 34% and the Company's effective tax rate is due primarily to recognition of a
full valuation allowance to offset the deferred tax assets.
The estimated tax effects of significant temporary difference and
carryforwards that give rise to deferred income tax assets are as follows:
December 31,
------------------------
1998 1999
----------- -----------
Deferred income tax assets--
Net operating loss carryforwards.......... $ 554,787 $ 3,983,195
Accrued liabilities and other............. 453,448 1,218,953
----------- -----------
Gross deferred income tax assets..... 1,008,235 5,202,148
Less: valuation allowance................. (839,316) (5,160,394)
----------- -----------
Deferred income tax liabilities--
Deferred revenue.......................... (156,629) --
Depreciation on property and equipment... (12,290) --
Prepaid insurance........................ -- (41,754)
----------- -----------
Gross deferred income tax liabilities.. (168,919) (41,754)
----------- -----------
Net deferred tax assets................ $ -- $ --
=========== ===========
The Company has recorded a valuation allowance against gross deferred tax
assets due to uncertainties surrounding their realization. The amount of net
deferred tax assets considered realizable, however, could be increased in the
future if estimates of future taxable income are increased.
11. Stockholders' (deficit) equity
Common stock
In January 1998, the Board of Directors authorized a five hundred for one
stock split. In connection with the Merger described in Note 1, the financial
statements reflect an 11.57 for one stock split on March 29, 1999. On July 13,
1999, the Company's Board of Directors approved a 3 for 8 reverse stock split of
the Company's outstanding shares of common stock and convertible preferred
stock. The reverse stock split became effective on September 21, 1999. The
consolidated financial statements have been restated to reflect these stock
splits.
The stock of SCI, prior to the Merger, was subject to a Shareholders'
Agreement which gave SCI the right to repurchase the stock, at a formula price,
from stockholders who terminated employment with SCI. The Shareholders'
Agreement also gave SCI the right of
13
<PAGE>
first refusal to repurchase shares offered to a third party. The Shareholders'
Agreement was terminated in connection with the Merger with WP Holding.
In 1998, the Company repurchased 335,648 shares of common stock in the
amount of $428 from terminated employees in accordance with a formula contained
in the then existing Shareholders' Agreement.
In February 1999, the Company retired all treasury shares outstanding.
In September 1999, the Company sold 3.4 million shares of common stock at
$11 per share in an initial public offering.
Common stock warrants
In August 1999, the Company issued a warrant to a financing company in
conjunction with a lease agreement. The warrant to purchase 7,601 shares of
common stock at $2.67 per share was exercisable immediately and expires on
August 24, 2004. In December this warrant was exercised.
In September 1999, the Company issued a warrant to a recruiting firm in
conjunction with the hiring of one of the Company's executives. The warrant to
purchase 17,969 shares of common stock at $8.99 per share was exercisable
immediately and expires on September 12, 2006.
In October 1999, the Company issued a warrant to a marketing firm for
marketing related services. The warrant to purchase 100,000 shares of common
stock at $11 per share and expires in September 2005. Subsequent to year-end the
warrant was exercised.
Bridge loan & warrant
On December 28, 1998, the Company agreed to issue a warrant to a
shareholder in connection with a loan of $1.0 million ("Bridge Loan"), which was
to be converted into Series A convertible preferred stock at the option of the
holder. The warrant was only exercisable upon an event of default. The bridge
loan which accrued interest at the prime rate (7.5%) matured upon the closing of
the private equity placement. No value was ascribed to the warrant. The proceeds
from the loan were received and the warrant was issued in January 1999. On May
18, 1999, the loan was converted into 572,727 shares of Series A convertible
preferred stock in connection with the Company's private equity placement and
the warrant was canceled.
Restricted common stock
In May, 1999, the Company issued an aggregate of 2,394,546 shares of
restricted common stock to officers for $1.60 per share. In the event of a
change of control (as defined in the Restricted Stock Purchase Agreement), 25%
of the shares purchased vest (in addition to any shares vested at such time). In
connection with such issuance, the officers paid for the stock by issuing notes
payable to the Company that are secured by the shares of the Company's common
stock purchased. The secured notes receivable bear interest at 5.22% per annum
with the entire principal balance of the note, together with all accrued and
unpaid interest, due and payable on the earlier of (a) the sale of the
underlying common stock, (b) May 10, 2008, or (c) termination of employment. The
Company has recourse against the signers of the notes for 75% of the principal
and all accrued interest. The notes receivable from the stockholders has been
classified as a reduction of equity. The shares generally vest over a four-year
period; however, 900,000 shares vest in April 2000, seven months from the
occurrence of the initial public offering. The stock is restricted in that any
unvested shares are subject to repurchase rights by the Company upon the
occurrence of certain events or conditions, such as employment termination, at
the original purchase price.
Stock option plan
On April 1, 1999, the Company adopted the 1999 Stock Plan (the "Stock Plan")
provides for the grant of up to 3,225,000 incentive or non-qualified stock
options or shares of restricted stock to employees, directors and consultants
("Optionee") of the Company. On May 17, 1999, the Board of Directors increased
the number of authorized options to 3,675,000 and on July 13, 1999, the Board of
Directors increased the number of authorized options to 4,425,000. Options
granted under the Stock Plan generally vest ratably over a period of four years
and expire ten years from the date of grant. If an Optionee ceases employment
with or service to the Company ("Termination"), the Optionee may exercise any
vested option at the time of Termination within such period of time specified in
the option agreement. In the absence of a specified time in the option
agreement, the option remains exercisable for three
14
<PAGE>
months following the Optionee's Termination. Unvested options revert to the
Stock Plan at the date of the Termination. If, after Termination, the Optionee
does not exercise the options within the time specified, the Option shall
terminate and the shares revert to the stock plan.
Stock option activity
During 1999, the Company granted approximately 460,000 of incentive stock
options and approximately 1,579,000 of non-qualified stock options. The stock
options vest over a two to four year period. Of these options issued, 30,000
options were issued to consultants in consideration for services rendered and
18,750 options were issued as consideration for the purchase of the minority
interest in Starting Point, as discussed in Note 12. These options vest on the
date of grant. In addition, the Company issued options to an employee which is
subject to performance and is forfeited if certain performance measures are not
met. The Company recorded an expense of approximately $245,000 for the issuance
of the performance options to the employee and the issuance of options to the
consultants. The performance options were valued using the intrinsic value
method at December 31, 1999. The options issued to consultants and options
issued as consideration for the purchase of minority interest were valued using
the Black-Scholes option pricing model at the date of grant as is described in
the additional stock plan information below.
Deferred stock compensation
During 1999, certain employees were granted options to purchase an
aggregate of approximately 970,000 shares of common stock. Giving effect to the
Company's proposed initial public offering, the deemed fair market value of the
Company's common stock exceeded the exercise price of the options granted. Total
non-cash compensation of approximately $1,120,000 related to these grants will
be charged to operations over the four-year vesting period. Non cash
compensation expense totaling approximately $119,000 has been recorded for the
year ended December 31, 1999 related to these employee options.
A summary of the Company's stock option activity follows:
Weighted
Average
Shares Exercise Price
--------- --------------
Balance, January 1, 1999.............. -- --
Granted.............................. 2,040,518 $ 6.48
Forfeited............................. (73,594) 4.09
--------- ------
Balance, December 31, 1999............ 1,966,924 $ 6.40
=========
Available for grant at
December 31, 1999.................... 2,458,076
15
<PAGE>
The following table summarizes information about currently outstanding and
vested stock options at December 31, 1999:
<TABLE>
<CAPTION>
Options Outstanding Options Vested
------------------------------------------------ -------------------------------
Weighted
Average
Remaining Weighted Vested at Weighted
Range of Outstanding at Contractual Average December 31, Average
Exercise Price December 31, 1999 Life Exercise Price 1999 Exercise Price
-------------- ----------------- ------------- -------------- ------------- ---------------
<S> <C> <C> <C> <C> <C>
$ 1.60 667,734 9.75 $ 1.60 132,422 $ 1.60
1.79 -- -- -- 18,750 1.79
3.20 52,500 9.75 3.20 7,500 3.20
8.99 215,625 9.75 8.99 -- --
9.87 730,224 9.75 9.87 4,219 9.87
$10.25 - $20 137,950 9.75 14.93 -- --
1,804,033 $ 6.90 162,891 $ 1.91
============ ========== ======= ======
</TABLE>
Additional stock plan information
As discussed in Note 2, the Company accounts for its stock-based awards to
employees using the intrinsic value method in accordance with APB Opinion No.
25, "Accounting for Stock Issued to Employees" and its related interpretations.
SFAS No. 123 "Accounting for Stock-Based Compensation," requires the
disclosure of pro forma net loss and loss per share had the Company adopted the
fair value method since the Company's inception. Under SFAS No. 123, the fair
value of stock-based awards to employees is calculated through the use of option
pricing models, even though such models were developed to estimate the fair
value of freely tradable, fully transferable options without vesting
restrictions, which significantly differ from the Company's stock option awards.
The Company's calculations for employee grants were made using the
Black-Scholes option pricing model with the following weighted average
assumptions:
Year Ended
December 31, 1999
-----------------
Dividend yield............... None
Expected volatility.......... 90%
Risk free interest rate...... 5.0%
Expected term, in years...... 9.75
The weighted average fair value per option as of the date of grant for
options granted during 1999 was $ 6.48.
Had the Company determined compensation cost based on the fair value at the
grant date for its stock options under SFAS No. 123, the Company's net loss
would have been reduced to the pro forma amounts indicated below:
Year Ended
December 31, 1999
-----------------
Loss attributable to common stockholders (in thousands):
As reported............................................ $(14,730)
Pro forma............................................. $(16,152)
Basic and diluted net loss per share:
As reported........................................... $ (1.15)
Pro forma............................................. $ (1.26)
Convertible preferred stock
On May 18, 1999, the Company issued the 5,154,548 shares of $.0001 par
value series A convertible preferred stock at $1.75 per share ("Subscription
Price") for gross proceeds of approximately $9.0 million, including the $1
million Bridge Loan and the $600,000 of stockholder advances previously
received. The Bridge Loan and stockholder advances were converted to
approximately 916,000 shares of preferred stock.
Upon closing of the initial public offering, 5,154,548 preferred shares
were converted to common stock.
16
<PAGE>
Employee stock purchase plan
In July 1999, the Company adopted an employee stock purchase plan (the
"Purchase Plan") which provides employees with an opportunity to purchase common
stock through accumulated payroll deductions up to a maximum of $25,000 for all
purchases within the same calendar year and up to a maximum of 2,000 shares for
the first purchase period and a maximum of 1,000 shares for each purchase period
thereafter. Under the Purchase Plan, employees may purchase the common stock at
a price equal to 85% of the fair market value of the common stock on the first
or last day of the offering period, whichever is lower. This Plan became
effective on September 22, 1999. 200,000 shares of common stock have been
reserved for issuance under the Purchase Plan (subject to an annual increase),
of which approximately 30,000 shares were issued subsequent to year end (See
Note 14).
12. Acquisition and sale of minority interest
In June 1999, the Company purchased the 30% ownership interest of Starting
Point from the minority interest shareholder for $477,000. The purchase price
included an initial cash payment of $150,000, an issuance of an $150,000 note
which accrues interest at a rate of 10% and is to be repaid one year from the
anniversary of the acquisition date and a grant of 18,750 options at an exercise
price of $1.79 which are fully vested on the date of grant. In addition, the
Company is required to make a contingency payment of a maximum of $200,000 in
the event that the options do not have a value of an amount specified per the
LLC Interest Purchase Agreement, no later than 180 days from the acquisition
date or upon sale of the Company. The Company recorded goodwill of approximately
$450,000 for the acquisition based on the difference between the purchase price
and the value of the 30% interest in the net assets acquired at the time of the
acquisition. The goodwill is being amortized over three years. If a contingency
payment becomes due, the Company intends to increase goodwill for this amount
and amortize it over the balance of the original amortization period.
On December 8, 1999, the Company sold certain assets of Starting Point to
Techlabs, Inc. ("Techlabs") in exchange for 250,000 shares of common stock in
Techlabs. The Company has recorded $720,000 as a long term investment and as a
long term deferred gain to account for this transaction. Techlabs' stock is
thinly traded over the counter . Techlabs is also a development stage company
that was incorporated in May 1998. Techlabs has guaranteed value of the shares
would be $1.5 million on December 8, 2000. If the shares are not worth $1.5
million on December 8, 2000, then Techlabs has agreed to deliver additional
shares of Techlabs common stock so that the Company receives $1.5 million in
value (as defined).
13. Merger Agreement
On December 14, 1999, the Company announced that it had signed a definitive
agreement to be acquired by CMGI, Inc. ("CMGI"), in a stock -for-stock merger.
Under the terms of the agreement, CMGI will issue .2504 (post CMGI's 2-for-1
common stock split on January 12, 2000) CMGI common stock shares for every
common stock share of the Company. Closing of the merger is subject to customary
conditions, including formal approval by the Company's shareholders. It is
anticipated that the transaction will close in March 2000. A significant
percentage of the Company's shareholders have agreed to the vote in favor of the
merger. The Company expects to incur additional financial advisor accounting and
legal fees estimated to be between $500,000 and $800,000 contingent upon
completion of the acquisition. The Company will also be responsible for paying a
transaction fee to Deutsche Banc Alex. Brown of 1% of closing price which is
estimated to be approximately $5,000,000. These estimates are preliminary and
are therefore, subject to change.
14. Subsequent Events
The Company completed its SEC and Hart-Scott-Rodino filings in February
2000 related to the CMGI and yesmail.com, inc. merger. A special shareholders
meeting to vote on the merger is scheduled for March 10, 2000.
In February 2000, the Company issued approximately 30,000 shares of common
stock that were purchased by eligible employees under the Company's employee
stock purchase plan. These shares were purchased at $11.10 per share which
represented to 85% of the fair market value of the common stock on September 22,
1999, which was the first day of the offering period.
17
<PAGE>
EXHIBIT 99.2
Tallan, Inc.
Index to Financial Statements
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Page
<S> <C>
Report of Independent Accountants 2
Financial Statements
Balance Sheets at December 31, 1999 and 1998 3
Statements of Operations for each of the three years in the
period ended December 31, 1999 4
Statements of Changes in Stockholders' Equity (Deficit) for each
of the three years in the period ended December 31, 1999 5
Statements of Cash Flows for each of the three years in the
period ended December 31, 1999 6
Notes to Financial Statements 7
</TABLE>
<PAGE>
Report of Independent Accountants
To the Board of Directors and
Stockholders of Tallan, Inc.
In our opinion, the accompanying balance sheets and the related statements of
operations, changes in stockholders' equity (deficit) and of cash flows present
fairly, in all material respects, the financial position of Tallan, Inc. at
December 31, 1999 and 1998, 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. 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, 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
January 25, 2000
Hartford, Connecticut
2
<PAGE>
Tallan, Inc.
Balance Sheets
December 31, 1999 and 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
Assets
Current assets
Cash and cash equivalents $ 9,788,891 $ 39,015
Investments 302,681 100,000
Accounts receivable (net of allowance for doubtful
accounts of $300,000 and $100,000, respectively) 10,602,380 3,479,776
Prepaid expenses and other current assets 463,907 130,148
---------- ---------
Total current assets 21,157,859 3,748,939
Property and equipment, net (Note 4) 2,332,485 749,211
Other assets 661,016 72,867
---------- ---------
Total assets $24,151,360 $4,571,017
========== =========
Liabilities, Mandatorily Redeemable Preferred Stock
and Stockholders' Equity
Current liabilities
Line of credit $ - $ 881,566
Accounts payable 385,496 182,709
Current taxes payable 780,299 16,702
Accrued payroll 1,257,518 861,272
Deferred revenue 484,608 -
Accrued other expenses 1,359,330 484,369
Deferred income taxes - 114,910
---------- ---------
Total current liabilities 4,267,251 2,541,528
---------- ---------
Long-term liabilities
Deferred income taxes (Note 6) 181,457 345,643
Deferred compensation 154,282 -
Commitments and Contingencies (Note 5)
Mandatorily Redeemable Preferred Stock (Note 8)
Series A Redeemable Preferred Stock, $0.01 par value, 3,412,969 shares
authorized; 3,412,969 and 0
shares issued and outstanding, respectively 10,479,354 -
Series B Convertible Preferred Stock, $0.01 par value,
1,706,485 shares authorized; 1,706,485 and 0
shares issued and outstanding, respectively 6,183,676 -
Stockholders' equity (Note 9)
Common stock, $0.01 par value, 32,000,000 and 21,000,000 shares authorized;
19,240,555 and 15,820,000 shares issued;
16,321,568 and 15,820,000 shares outstanding, respectively 192,406 -
Additional paid-in capital 16,038,638 266,600
Treasury stock at cost (2,918,987 shares) (17,105,264) -
Retained earnings 3,666,879 1,417,246
Other comprehensive income 92,681 -
---------- ---------
Total stockholders' equity 2,885,340 1,683,846
---------- ---------
Total liabilities, mandatorily redeemable preferred stock
and stockholders' equity $24,151,360 $4,571,017
========== =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE>
Tallan, Inc.
Statements of Operations
For the Years Ended December 31, 1999, 1998 and 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Revenues $ 53,940,686 $ 22,869,596 $ 13,453,472
------------- ------------- ------------
Operating expenses
Project personnel costs 30,573,791 13,150,562 8,514,755
General and administrative 8,559,155 5,020,290 3,442,982
Selling and marketing 1,785,313 918,854 909,489
Research and development - 222,599 623,024
Depreciation and amortization 795,772 297,952 187,415
------------- ------------- ------------
41,714,031 19,610,257 13,677,665
------------- ------------- ------------
Income (loss) from operations 12,226,655 3,259,339 (224,193)
------------- ------------- ------------
Other income (expense)
Interest income 144,164 20,689 20
Loss on disposal of assets (39,478) (19,889) (83,057)
Interest expense (135,920) (157,736) (205,943)
------------- ------------- ------------
(31,234) (156,936) (288,980)
------------- ------------- ------------
Income (loss) before provision (benefit) for
income taxes 12,195,421 3,102,403 (513,173)
Provision (benefit) for income taxes (Note 6) 5,122,981 1,396,026 (96,506)
------------- ------------- ------------
Net income (loss) 7,072,440 1,706,377 (416,667)
Deemed preferred dividends and accretion (Note 8) (4,822,807) - -
------------- ------------- ------------
Net income (loss) available for common shareholders $ 2,249,633 $ 1,706,377 $ (416,667)
============= ============= ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE>
- -------------------------------------------------------------------------------
Tallan Inc.
Statements of Changes in Stockholders Equity (Deficit)
For the Years Ended December 31, 1999, 1998 and 1997.
<TABLE>
<CAPTION>
Class B
Common Stock Common Stock Additional Retained
----------------------- ------------------- Paid-In Earnings
Shares Amount Shares Amount Capital (Deficit)
---------- --------- ------- -------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996 12,600,000 $ - 3,500,000 $ - $ 1,000 $ 127,536
Net loss - - - - - (416,667)
---------- -------- ---------- --------- ---------- -----------
Balance at December 31, 1997 12,600,000 - 3,500,000 - 1,000 (289,131)
Conversion of shares 2,100,000 - (3,500,000) - - -
Issuance of common stock 1,120,000 - - - 265,600 -
Net income - - - - - 1,706,377
---------- -------- ---------- --------- ---------- ----------
Balance at December 31, 1998 15,820,000 - - - 266,600 1,417,246
Exchange of shares - 158,200 - - (158,200) -
Issuance of common stock 3,412,969 34,130 - - 12,206,591 -
Purchase of treasury shares - - - - - -
Exercise of options 7,586 76 - - 9,710 -
Unrealized gain - - - - - -
Deemed preferred dividends
and accretion - - - - 3,713,937 (4,822,807)
Net income - - - - - 7,072,440
---------- --------- ---------- --------- ---------- -----------
Balance at December 31, 1999 19,240,555 $ 192,406 $ - $ - $16,038,638 $ 3,666,879
========== ========= ========== ========= =========== ===========
<CAPTION>
Treasury Stock
------------------------- Other Total
Number Comprehensive Stockholders'
of Shares Amount Income Equity (Deficit)
----------- ------------ --------------- ------------------
<S> <C> <C> <C> <C>
Balance at December 31, 1996 - $ - $ - $ 128,536
Net loss - - - (416,667)
----------- ------------ -------------- ----------------
Balance at December 31, 1997 - - - (288,131)
Conversion of shares - - - -
Issuance of common stock - - - 265,600
Net income - - - 1,706,377
----------- ------------ -------------- ----------------
Balance at December 31, 1998 - - - 1,683,846
Exchange of shares - - - -
Issuance of common stock - - - 12,240,721
Purchase of treasury shares 2,918,987 (17,105,264) - (17,105,264)
Exercise of options - - - 9,786
Unrealized gain - - 92,681 92,681
Deemed preferred dividends
and accretion - - - (1,108,870)
Net income - - - 7,072,440
----------- ------------ -------------- ----------------
Balance at December 31, 1999 2,918,987 $(17,105,264) $ 92,681 $ 2,885,340
=========== ============ ============== ================
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE>
Tallan, Inc.
Statements of Cash Flows
For the Years Ended December 31, 1999, 1998 and 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Cash flows from operating activities
Net income (loss) $ 7,072,440 $ 1,706,377 $ (416,667)
---------- ----------- ----------
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities
Depreciation and amortization 795,772 297,952 187,415
Provision for doubtful accounts 200,000 - 100,000
Loss on disposition of assets 39,478 19,889 83,057
Deferred income taxes (390,683) 416,000 (99,567)
Change in assets and liabilities
Accounts receivable (7,322,604) (695,987) (1,871,553)
Prepaid expenses and other assets (118,075) (114,290) 55,605
Accounts payable 202,787 (352,077) 246,247
Current taxes payable 763,597 16,702 -
Other assets (588,149) 12,187 (28,621)
Deferred revenue 484,608 - -
Accrued expenses 874,961 (120,112) 622,155
Deferred compensation 154,282
Accrued payroll 396,246 598,115 -
---------- ----------- ----------
Net cash provided by (used in) operating activities 2,564,660 1,784,756 (1,121,929)
---------- ----------- ----------
Cash flows from investing activities
Purchase of assets (2,450,775) (562,243) (107,037)
Proceeds from disposal of assets 32,251 19,125 -
Purchase of investment (110,000) (100,000) -
---------- ----------- ----------
Net cash used in investing activities (2,528,524) (643,118) (107,037)
---------- ----------- ----------
Cash flows from financing activities
(Repayments) proceeds from line of credit, net (881,566) (933,538) 1,285,064
Proceeds from note payable - 250,000 -
Repayment of note payable - (250,000) -
Proceeds from employee and stockholder loans - - 188,272
Repayment of loans to employees and stockholders - (177,896) -
Deferred financing costs (104,097) (42,563) -
Proceeds from exercise of options 9,786 - -
Proceeds from issuance of stock, net 27,794,881 265,600 -
Repayment of capital lease obligations - (342,933) (118,913)
Purchase of treasury stock (17,105,264) - -
---------- ----------- ----------
Net cash provided by (used in) financing activities 9,713,740 (1,231,330) 1,354,423
---------- ----------- ----------
Net increase (decrease) in cash 9,749,876 (89,692) 125,457
Cash at beginning of year 39,015 128,707 3,250
------------ ----------- ----------
Cash at end of year $ 9,788,891 $ 39,015 $ 128,707
------------ ----------- ----------
Supplemental disclosures of cash flow information
Cash paid during the year for:
Interest $ 150,751 $ 171,971 $ 189,401
Income taxes 4,760,146 963,323 508
Additional non-cash transactions disclosed in Notes 2, 4 and 8.
</TABLE>
The accompanying notes are an integral part of these financial statements.
6
<PAGE>
Tallan, Inc.
Notes to Financial Statements
December 31, 1999, 1998 and 1997
- --------------------------------------------------------------------------------
1. Organization and Nature of Operations
Business
Tallan, Inc. ("Tallan" or the "Company") was initially incorporated in
Connecticut in 1985 under the name BDS Business Center, Inc. ("BDS"). In
August 1999, BDS completed a migratory merger to reincorporate in Delaware.
In December 1999, BDS changed its name to Tallan.
Tallan is an Internet professional services firm that creates technically
advanced Internet and e-Business solutions that improve commerce between
businesses and consumers as well as among businesses and their trading
partners. The Company focuses on providing solutions for their customers
that will allow them to maximize the opportunities presented by the
Internet, particularly projects that create new revenue opportunities. The
Company's customers are located primarily in the United States.
2. Summary of Significant Accounting Policies
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, and
the disclosure of contingent assets and liabilities at the date of the
financial statements, and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
Cash and Cash Equivalents
Cash and Cash Equivalents include cash on deposit with banks, as well as
short-term investments with original maturities of 90 days or less.
Investments
The Company's investment balance consists of equity securities and are
categorized as available-for-sale securities. Unrealized holding gains and
losses are reflected as a net amount in accumulated other comprehensive
income until realized. For the purpose of computing realized gains and
losses, cost is identified on a specific identification basis.
Additionally, during 1999, the Company received a warrant to purchase
666,667 shares of common stock of one of its customers in exchange for
services rendered to that customer. Also in 1999, the Company received
252,227 unregistered equity securities of another customer in exchange for
services rendered to that customer. The combined carrying value of the
warrants and unregistered securities of $415,657 approximates the value of
the services performed and is included within other assets at December 31,
1999.
Property and Equipment
Property and equipment is recorded at cost, less accumulated depreciation.
Expenditures for repairs and maintenance are charged to expense as incurred
while those relating to major improvements are treated as capital additions
and depreciated over the remaining useful life of the related asset. For
assets sold or otherwise disposed of, the cost and related accumulated
depreciation are removed from the accounts and any resulting gain or loss
is reflected in income for the period.
7
<PAGE>
Tallan, Inc.
Notes to Financial Statements
December 31, 1999, 1998 and 1997
- --------------------------------------------------------------------------------
Depreciation is computed using an accelerated method over the following
estimated useful lives:
Computer software 3 years
Computer equipment 5 years
Office equipment and furniture 7 years
Income Taxes
An asset and liability approach is used to recognize deferred tax assets
and liabilities for the future tax consequences of items that have already
been recognized in its financial statements and tax return. A valuation
allowance is established against net deferred tax assets if, based on the
weight of available evidence, it is more likely than not that some or all
of the net deferred tax assets will not be realized.
Revenue Recognition
The Company provides services on a time and materials basis. Revenues are
recognized at agreed-upon rates as services are performed. The Company
records an allowance for doubtful accounts based on individual customer
analyses. The Company did not write-off any material accounts receivable
balances during the years ended December 31, 1999, 1998 and 1997. Deferred
revenue reflects amounts received in advance of providing services.
Project Personnel Costs
Project personnel costs consists primarily of salaries and employee
benefits for personnel dedicated to client projects, and non-reimbursed
direct expenses incurred to complete projects.
Research and Development Costs
Research and development costs are charged to expense when incurred. There
were no research and development projects ongoing during 1999.
Concentrations of Credit Risk
Concentrations of credit risk exist with respect to cash and cash
equivalents and accounts receivable. The Company maintains its cash and
cash equivalents with one financial institution. A significant portion of
the Company's receivables are attributable to a limited number of clients.
At December 31, 1999, two clients accounted for 16% and 13%, respectively,
of the accounts receivable balance. Revenues for the year ended December
31, 1999 from three clients were approximately $8.6 million, $6.5 million
and $5.5 million, respectively. At December 31, 1998, two clients accounted
for 26% and 12%, respectively, of the accounts receivable balance. Revenues
for the year ended December 31, 1998 from three clients were approximately
$6.8 million, $2.8 million and $2.3 million, respectively. For the year
ended December 31, 1997, two customers accounted for 43% and 16%,
respectively, of total revenues.
8
<PAGE>
Tallan, Inc.
Notes to Financial Statements
December 31, 1999, 1998 and 1997
- --------------------------------------------------------------------------------
Comprehensive Income
The Company adopted Statement of Financial Accounting Standards No.130,
"Reporting Comprehensive Income" ("SFAS 130"), effective January 1, 1998.
SFAS 130 requires that items defined as comprehensive income, such as
foreign currency translation adjustments and unrealized gains (losses) on
marketable securities, be separately classified in the financial statements
and that the accumulated balance of other comprehensive income be reported
separately from retained earnings and additional paid-in capital in the
equity section of the balance sheet. Total comprehensive income is
comprised of net income and other accumulated comprehensive income
disclosed in the equity section of the balance sheet.
For the year ended December 31, 1999, total comprehensive income was
$2,342,314, which was not materially different from net income. There were
no differences between net income and comprehensive income for the years
ended December 31, 1998 and 1997.
Recent Accounting Pronouncements
In November 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin ("SAB") No. 100, Restructuring and Impairment
Charges ("SAB 100"). In December 1999, the SEC issued SAB No. 101, Revenue
Recognition in Financial Statements ("SAB 101"). 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. The Company does not expect the provisions of
SAB No. 100 to have a material impact on its financial statements. SAB No.
101 expresses the views of the SEC staff in applying generally accepted
accounting principles to certain revenue recognition issues. The Company
does not expect the provisions of SAB No. 101 to have a material impact on
its financial statements.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities. This statement establishes accounting
and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging
activities. As issued, this statement is effective for all fiscal quarters
of all fiscal years beginning after June 15, 1999, with earlier application
encouraged. In May 1999, the Financial Accounting Standards Board delayed
the effective date of this statement for one year, to all fiscal quarters
of all fiscal years beginning after June 15, 2000. The Company does not
currently, nor do they intend in the future to, use derivative instruments
and therefore do not expect that the adoption of Statement of Accounting
Standards No. 133 will have any impact on their financial position or
results of operations.
9
<PAGE>
Tallan, Inc.
Notes to Financial Statements
December 31, 1999, 1998 and 1997
- --------------------------------------------------------------------------------
3. Stock Splits
During 1999, in connection with the migratory merger and reincorporation in
Delaware, each share of no par value Common Stock converted into seven
shares of $0.01 par value per share Common Stock. During 1998, the Company
executed a 1,000-for-1 stock split of the Common Stock with no par value.
All shares, options and par values have been restated in the financial
statements and footnotes to reflect the effects of these splits of the
Company's Common Stock.
4. Property and Equipment
1999 1998
Computer equipment $2,906,657 $ 844,554
Computer software 271,658 139,535
Office equipment and furniture 405,774 282,725
--------- ---------
3,584,089 1,266,814
Less - accumulated depreciation
and amortization (1,251,604) (517,603)
--------- ---------
Property and equipment, net $2,332,485 $ 749,211
--------- ---------
Depreciation expense for the years ended December 31, 1999, 1998 and 1997
was $795,772, $251,860 and $187,415, respectively.
In 1997, the Company acquired certain equipment through capital leases
totaling $296,175. Obligations under all capital leases were paid in full
in 1998.
10
<PAGE>
Tallan, Inc.
Notes to Financial Statements
December 31, 1999, 1998 and 1997
- --------------------------------------------------------------------------------
5. Commitments and Contingencies
Operating Leases
The Company leases office space, apartments for use by employees who work
on client assignments away from their homes, equipment and vehicles under
various noncancelable operating lease agreements.
Future minimum lease payments required over the next five years under
operating lease agreements are as follows:
2000 $1,191,311
2001 364,544
2002 350,589
2003 339,762
2004 and thereafter 311,449
---------
$2,557,655
---------
Rent expense for the years ended December 31, 1999, 1998 and 1997 was
approximately $3,267,000, $1,282,000 and $670,000, respectively.
6. Income Taxes
The income tax provision for the years ended December 31, 1999, 1998 and
1997 is as follows:
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Current
Federal $ 4,151,002 $ 661,597 $ -
State 1,362,662 318,429 3,061
---------- --------- -------
Total 5,513,664 980,026 3,061
---------- --------- -------
Deferred
Federal (273,392) 297,053 (67,316)
State (117,291) 118,947 (32,251)
---------- --------- -------
Total (390,683) 416,000 (99,567)
---------- --------- -------
Total income tax provision (benefit) $ 5,122,981 $ 1,396,026 $(96,506)
========== ========== =======
</TABLE>
11
<PAGE>
Tallan, Inc.
Notes to Financial Statements
December 31, 1999, 1998 and 1997
- --------------------------------------------------------------------------------
The difference between the statutory U.S. federal income tax rate at 34%
and the Company's effective tax rate is as follows:
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Provision (benefit) at statutory rate $ 4,146,443 $ 1,054,817 $ (174,479)
State and city income tax, net 821,944 288,667 (19,265)
Other 154,594 52,542 97,238
---------- ---------- ---------
Provision (benefit) for income taxes $ 5,122,981 $ 1,396,026 $ (96,506)
---------- ---------- ---------
</TABLE>
The significant components of the Company's deferred income tax assets and
liabilities are as follows:
December 31,
1999 1998
Gross deferred tax assets:
Reserves $ 208,213 $ 42,172
Accrued expenses 64,266 -
Other - 5,381
------- -------
272,479 47,553
------- -------
Gross deferred tax liabilities:
Change from cash to accrual 320,651 487,392
Other 21,698 20,714
------- -------
342,349 508,106
------- -------
Net deferred tax liability $ 69,870 $ 460,553
======= =======
7. Debt
At December 31, 1998, the Company had $881,566 outstanding under a
revolving line of credit. Interest was at the bank's prime rate plus 1%
(8.75% at December 31, 1998). The line of credit was terminated during
1999.
8. Mandatorily Redeemable Preferred Stock
Pursuant to a private placement in August 1999, the Company sold (i)
3,412,969 shares of Series A Redeemable Preferred Stock ("Series A
Preferred Stock") for $5.86 per share, (ii) 1,706,485 shares of Series B
Convertible Preferred Stock ("Series B Preferred Stock") for $5.86 per
share, and (iii) 3,412,969 shares of Common Stock at $.01 per share. Gross
proceeds from the private placement were approximately $30.0 million. The
per share proceeds were allocated to the Series A Preferred Stock, Series B
Preferred Stock and the Common Stock based on the fair value of the
individual securities.
12
<PAGE>
Tallan, Inc.
Notes to Financial Statements
December 31, 1999, 1998 and 1997
- --------------------------------------------------------------------------------
Series A Redeemable and Series B Convertible Preferred Stock
The Series A Preferred Stock may be redeemed at the option of the Company,
in whole or in part, at any time after August 20, 1999. The redemption is
mandatory (i) upon the closing of an underwritten public offering in which
the aggregate gross proceeds to the Company are at least $30 million and
the pre-public market capitalization of the Company is at least $250
million, or (ii) on August 20, 2006. Upon redemption, the Company shall
redeem all remaining shares of the Series A Preferred Stock by paying in
cash a sum equal to $5.86 per share plus any accrued and unpaid dividends.
In the event the Series A Preferred Stock is not redeemed prior to August
20, 2005, a dividend shall be declared and paid on that date as a one-time,
cumulative dividend with respect to the Series A Preferred Stock in an
amount equivalent to the annual rate of 8% per share (as adjusted for any
stock dividends, combinations or splits with respect to these shares), as
if the dividend had begun to accrue on August 20, 1999. Beginning August
13, 2005 a cash dividend of 8% will accrue if the Series A Preferred Stock
has not been redeemed. Management does not consider any events that would
trigger a deemed liquidation of the Series B Preferred Stock to be probable
events. Management has determined that a reliable estimate of when the
circumstances that would result in a deemed liquidation cannot be made and,
therefore, does not accrue for any accretion of the difference between the
carrying and redemption values.
The difference between the Series A Preferred Stock's initial assigned
carrying value of approximately $9.4 million at August 20, 1999 and the
redemption value of approximately $20.0 million at August 20, 2006, plus
any dividends, is being periodically adjusted to increase the carrying
value to the redemption value. Accretion and dividends for 1999 totaled
$1,108,870 and has been reflected as a charge to net income applicable to
common shareholders.
The Series B Preferred Stock is convertible, at the option of the holder,
at any time into 1,706,485 shares of Common Stock of the Company. Each
share of the Series B Preferred Stock shall be automatically converted into
shares of Common Stock upon the earlier of (i) the closing of a qualified
underwritten public offering, as defined, or (ii) upon the approval of the
holders of greater than 50% of the then outstanding shares of Series B
Preferred Stock. In the event that the Company shall pay a dividend (other
than a dividend payable solely in shares of Common Stock or other
securities or rights convertible into, or entitling the holder thereof to
receive additional shares of Common Stock) on Common Stock, it shall pay to
the holders of shares of Series B Preferred Stock a dividend equal to such
dividend on the Common Stock.
In the event of any liquidation, dissolution or winding up of the Company,
either voluntary or involuntary, or a change in control which is deemed to
be a liquidation, the holders of the Series A and Series B Preferred Stock
shall be entitled to receive, prior and in preference to any distribution
of any assets of the Company to the holders of Common Stock or any other
class or series of stock ranking in liquidation junior to the Series A and
Series B Preferred Stock, an amount per share equal to the sum of (i) $5.86
for each outstanding share (as adjusted for any stock dividends,
combinations or splits with respect to the Series A and Series B Preferred
Stock) and (ii) an amount equal to all declared but unpaid dividends, plus
accrued dividends, if any.
13
<PAGE>
Tallan, Inc.
Notes to Financial Statements
December 31, 1999, 1998 and 1997
- --------------------------------------------------------------------------------
The holder of each share of Series B Preferred Stock shall have the right
to one vote for each share of Common Stock into which such Preferred Stock
could then be converted, and with respect to such vote, such holder shall
have full voting rights and powers equal to the voting rights and powers of
the holders of Common Stock. The Series A Preferred Stock is non-voting
except that the holders of the Series A Preferred Stock are entitled to a
class vote with the holders of the Series B Preferred Stock with respect to
certain protective provisions.
Beneficial Conversion Feature In August 1999, the Company recorded a
beneficial conversion charge concurrent with the issuance of the Series B
Preferred Stock. The beneficial conversion feature was calculated as the
difference between the assigned value of the Series B Preferred Shares and
the fair market value of the related Common Stock as of August 20, 1999,
into which the Series B Preferred Shares were immediately convertible.
Accordingly, a deemed preferred dividend of approximately $3.7 million as
of the issuance date has been recognized as a charge to retained earnings
and net income applicable to common shareholders, and as an increase to
additional paid-in capital.
9. Stockholder's Equity
Common Stock
As discussed in Note 8, the Company issued 3,412,969 shares of Common Stock
at $0.01 per share, pursuant to a private placement.
On March 30, 1998, the Company's stockholders approved a resolution to
exchange all the outstanding shares of Class B non-voting common stock (the
"Class B Common Stock") for 2,100,000 shares of Class A common stock
("Class A Common Stock"). The Class B non-voting stock was then eliminated
as a class. Also on March 30, 1998, the Company's stockholders approved a
resolution to sell up to 15 investment units. Each unit was comprised of
140,000 shares of Class A Common Stock, at a price per Class A Common Stock
pursuant to the Company's 1998 Stock Plan at an exercise price of $0.24. In
April 1998, pursuant to this resolution, the Company sold 8 units and
raised $265,600 of additional capital. In January 1999, the Class A
distinction was eliminated and all outstanding stock became known as Common
Stock.
Treasury Stock Purchase
Concurrent with the August 1999 private placement described in Note 8, the
Company repurchased 2,918,987 shares of Common Stock at $5.86 per share
from various major shareholders. These shares are carried at cost within
Treasury Stock.
14
<PAGE>
Tallan, Inc.
Notes to Financial Statements
December 31, 1999, 1998 and 1997
- --------------------------------------------------------------------------------
10. Stock Option Plan
In March 1998, the Company instituted the 1998 Employee Stock Option and
Performance Incentive Plan (the "1998 Plan"). The Company has reserved
8,750,000 shares of Common Stock for issuance under this plan, pursuant to
nonqualified and incentive stock options, stock appreciation rights and tax
offset payments, to its employees, officers, directors and consultants. In
general, options granted under the 1998 Plan were granted at fair market
value and vest ratably over a three or four year period. Options under the
1998 Plan expire no later than ten years from the date of grant. In
addition, certain options granted under the 1998 Plan accelerate
automatically upon a change in control. The 1998 Plan was terminated in May
1999 and the number of shares of Common Stock reserved under this plan was
fixed at 7,672,000, the number of then outstanding options.
In May 1999, the Company adopted the 1999 Stock Option and Incentive Plan
(the "1999 Plan"), under which employees, officers, directors and
consultants may be granted various stock based awards. A total of 2,478,000
shares of Common Stock have been reserved for issuance under this plan.
Generally, options that have been issued under this plan have been granted
at an exercise price equal to the fair market value of the Common Stock on
the date of grant, vest over a four year period and expire ten years from
the date of grant.
In January 2000, the Company adopted the 2000 Non-Employee Director Stock
Option Plan, which provides for non-employee directors to receive options
to purchase Common Stock of the Company at an exercise price equal to the
fair market value of the common stock on the date of grant. The Company has
reserved a total of 250,000 shares of Common Stock for issuance under this
plan. This plan is expected to be effective upon the closing of an initial
public offering of the Company.
In January 2000, the Company adopted the 2000 Employee Stock Purchase Plan,
which permits eligible employees of the Company to purchase shares of
Common Stock pursuant to payroll deductions at a price equal to 85% of the
fair market value of the Company's stock. The Company has reserved an
aggregate of 600,000 shares of Common Stock for issuance under this plan.
This plan is expected to be effective upon the closing of an initial public
offering of the Company.
A summary of stock option activity for the years ended December 31, 1999
and 1998 is as follows:
<TABLE>
<CAPTION>
1999 1998
---------------------------- -------------------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
<S> <C> <C> <C> <C>
Outstanding at beginning of period 1,820,000 $ 0.24 $ - $ -
Granted 7,164,500 2.17 1,820,000 0.24
Exercised (7,586) 1.29 - -
Canceled or forfeited (161,220) 1.79 - -
---------- ---------
Outstanding at period end 8,815,694 1.78 1,820,000 0.24
========== =========
Options exercisable at period end 1,882,845 0.95 - -
========== =========
Weighted average fair value of
options granted during the period $ 0.54 $ 0.40
========== =========
</TABLE>
15
<PAGE>
Tallan, Inc.
Notes to Financial Statements
December 31, 1999, 1998 and 1997
- --------------------------------------------------------------------------------
The following table summarizes information about stock options outstanding
at December 31, 1999:
<TABLE>
<CAPTION>
Options Outstanding Options Excercisable
------------------------------------------------ ------------------------------
Number Weighted Weighted Number Weighted
Outstanding Average Average Outstanding Average
Range of at December 31, Remaining Exercise at December 31, Exercise
Exercise Prices 1999 Life Price 1999 Price
----------------- ----------------- ----------- ------------ --------------- -----------
<S> <C> <C> <C> <C> <C>
$ 0.24 - $ 0.24 1,820,000 8.25 $ .24 606,666 $ .24
0.25 - 1.29 5,697,194 9.08 1.29 1,276,179 1.29
1.30 - 5.86 1,235,500 9.68 5.86 - -
5.87 - 10.50 63,000 9.88 10.50 - -
----------------- ----------- ------------ --------------- -----------
8,815,694 9.00 $ 1.78 1,882,845 $ .95
----------------- ----------- ------------ --------------- -----------
</TABLE>
The Company follows Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees", and the related Interpretations in
accounting for the plans.
Had compensation expense for the plans been determined based on the fair
value at the grant dates for awards under the plan consistent with the
method of SFAS 123, "Accounting for Stock-Based Compensation", the
Company's pro forma net income (loss) would have been as follows:
1999 1998 1997
Net income (loss):
As reported $ 2,249,633 $ 1,706,377 $ (416,667)
Pro forma 1,721,971 1,680,415 (416,667)
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 grants in 1999 and 1998: dividend yield of 0%;
expected volatility of 0%; weighted average risk-free interest rate of
4.78% and 5.68% in 1999 and 1998, respectively, and expected lives of 5
years.
Compensation expense of $299,250 has been attributed to those common stock
options granted to employees during 1999, with an exercise price below
estimated fair value. This compensation expense is being recognized over
the four year vesting period and totaled $9,282 during 1999. Compensation
expense of $145,000 was recognized in 1999 and was attributable to options
issued to advisory board members.
11. 401(k) Profit-Sharing Plan
The Company has a defined contribution 401(k) profit sharing plan covering
substantially all employees. The Plan allows eligible employees to
contribute up to 15% of their eligible earnings, subject to a statutorily
prescribed annual limit. The Company matches 50% of eligible employees'
contributions up to a maximum of 6% of their earnings. The Company may make
additional discretionary profit sharing contributions of up to 15% of
participants' compensation annually. For the years ended December 31, 1999,
1998 and 1997, the Company contributed $330,237, $ 221,009 and $145,909,
respectively.
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Tallan, Inc.
Notes to Financial Statements
December 31, 1999, 1998 and 1997
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12. Related Party Transactions
In February 1999, the Company made a $21,684 loan with interest at 6% per
annum, to its Chief Executive Officer, who is also a member of the Board of
Directors. In May 1999, the Company granted two additional loans to its
Chief Executive Officer totaling $40,180. All three loans were repaid in
August 1999.
In March 1999, the Company granted a $170,000 loan with interest at 6% per
annum to a different member of its Board of Directors. This loan was also
repaid in August 1999.
13. Subsequent Events (unaudited)
On January 31, 2000, the Company completed a group hire of substantially
all of the employees of Citation Systems, Inc. for a purchase price of
approximately $1.1 million in cash. In addition, options for 340,000 shares
of Common Stock were issued to the employees of Citation in connection with
their employment at Tallan.
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