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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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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): NOVEMBER 9, 1999
LEARN2.COM, INC.
(Exact name of registrant as specified in its charter)
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DELAWARE 0-24936 75-2480669
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(State or other jurisdiction (Commission File Number) (IRS Employer Identification
of incorporation) Number)
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1311 MAMARONECK AVENUE, SUITE 210, 10605
WHITE PLAINS, NEW YORK
(Address of principal executive offices) (Zip Code)
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Registrant's telephone number, including area code: (914) 682-4300
NOT APPLICABLE
(Former name or former address, if changed since last report.)
925 Westchester Avenue, Suite L-1
White Plains, NY 10604
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ITEM 5. OTHER EVENTS.
On August 23, 1999, the Registrant acquired all of the outstanding common
stock of ViaGrafix Corporation ("ViaGrafix"), a publicly traded company. The
Registrant issued approximately 10.7 million shares of its common stock to the
ViaGrafix stockholders in exchange for all the common stock of ViaGrafix. In
connection with its acquisition of ViaGrafix, the Registrant appointed Michael
A. Webster as a member of its Board of Directors. A copy of the Agreement and
Plan of Merger dated as of June 1, 1999 is included herein as Exhibit 99.6 and
is incorporated by reference into this Item 5.
ViaGrafix's training courses include interactive multimedia courses and
tutorials for IT training and other subjects for a variety of computer software.
ViaGrafix has an existing library of more than 1,000 titles. Its subsidiary,
eTracks.com, Inc., provides interactive email broadcast services for businesses
that rely on Web-based commerce and transactions.
The Registrant will file registration statements on Form S-3 and Form S-8
with the Securities and Exchange Commission.
Attached as Exhibit 99.7 are the supplementary consolidated financial
statements for the six and three months ended June 30, 1999 and 1998 and the
three years ended December 31, 1998, 1997 and 1996 and the accompanying notes
which reflect Learn2.com's financial position and the results of operations as
if ViaGrafix was a wholly-owned subsidiary of Learn2.com since inception.
In October 1999, the Chairman of the Board of Directors' received a letter
from Merv Adelson announcing his resignation from Learn2.com's Board of
Directors.
ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS.
(C) EXHIBITS.
23.1 Consent of KPMG LLP.
23.2 Consent of Arthur Andersen LLP.
23.3 Consent of Ernst & Young LLP.
99.6 Agreement and Plan of Merger dated as of June 1, 1999 by and among 7th
Level, Inc. (now known as Learn2.com, Inc.), 7th Level Merger Corporation
and ViaGrafix Corporation filed as an Exhibit to Learn2.com's Amendment
No. 1 to Form S-4 (Registration No. 333-82039) filed with the Securities
and Exchange Commission on July 19, 1999 and incorporated by reference
herein.
99.7 Supplementary Consolidated Financial Statements for the six and three
months ended June 30, 1999 and 1998 and the three years ended December 31,
1998, 1997, and 1996 and the accompanying notes.
99.8 Report of Independent Auditors.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned hereunto duly authorized.
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LEARN2.COM, INC.
By: /s/ MARC E. LANDY
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Marc E. Landy
VICE PRESIDENT, CHIEF FINANCIAL OFFICER
AND SECRETARY
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Date: November 11, 1999
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INDEX TO EXHIBITS
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EXHIBIT NO.
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23.1 Consent of KPMG LLP.
23.2 Consent of Arthur Andersen LLP.
23.3 Consent of Ernst & Young LLP.
99.6 Agreement and Plan of Merger dated as of June 1, 1999 by and
among 7th Level, Inc. (now known as Learn2.com, Inc.), 7th
Level Merger Corporation and ViaGrafix Corporation filed as
an Exhibit to Learn2.com's Amendment No. 1 to Form S-4
(Registration No. 333-82039) filed with the Securities and
Exchange Commission on July 19, 1999 and incorporated by
reference herein.
99.7 Supplementary Consolidated Financial Statements for the six
and three months ended June 30, 1999 and 1998 and the three
years ended December 31, 1998, 1997, and 1996 and the
accompanying notes.
99.8 Report of Independent Auditors
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EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in the registration statements
on Form S-3 (Nos. 333-64365, 333-69861 and 333-80357) and on Form S-8
(Nos. 333-83695, 333-65525, 333-10341 and 333-10339) of our report related to
the consolidated statements of operations, stockholders' equity and cash flows
of Learn2.com, Inc. (formerly known as 7th Level, Inc.) for the year ended
December 31, 1996, which report appears in this Current Report on Form 8-K of
Learn2.com, Inc. dated November 12, 1999.
KPMG LLP
Dallas, Texas
November 9, 1999
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EXHIBIT 23.2
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation by
reference of our report included in this Form 8-K into Learn2.com, Inc.'s
previously filed Registration Statements No. 333-64365, 333-69861 and 333-80357
on Form S-3 and Registration Statements No. 333-83695, 333-65525, 333-10341 and
333-10339 on Form S-8.
ARTHUR ANDERSEN LLP
New York, New York
November 9, 1999
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EXHIBIT 23.3
INDEPENDENT AUDITORS' CONSENT
We consent to the use of our report dated March 19, 1999, with respect to the
consolidated financial statements and schedule of ViaGrafix Corporation as of
December 31, 1998 and 1997 and for the three years ended December 31, 1998,
included in Learn2.com, Inc.'s Current Report on Form 8-K to be filed with the
Securities and Exchange Commission on or about November 9, 1999.
We also consent to the incorporation by reference in the following registration
statements on Form S-3 and related prospectuses and in the following
registration statements on Form S-8 of ViaGrafix Corporation and Learn2.com,
Inc. of our report dated March 19, 1999, with respect to the consolidated
financial statements and schedule of ViaGrafix Corporation, included in
Learn2.com, Inc.'s Current Report on Form 8-K to be filed with the Securities
and Exchange Commission on or about November 9, 1999.
ViaGrafix Registration Statement
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Form S-8: Registration No. 333-59591
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Learn2.com, Inc. Registration Statements
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Form S-3 Registration No. 333-64365
Registration No. 333-69861
Registration No. 333-80357
Form S-8 Registration No. 333-83695
Registration No. 333-10341
Registration No. 333-10339
Registration No. 333-65525
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/s/ ERNST & YOUNG LLP
Tulsa, Oklahoma
November 9, 1999
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EXHIBIT 99.7
LEARN2.COM, INC.
(FORMERLY KNOWN AS 7TH LEVEL, INC.)
SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS
TABLE OF CONTENTS
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Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 2
Report of Independent Public Accountants.................... 17
Independent Auditors' Report................................ 18
Supplementary Consolidated Financial Statements
Supplementary Consolidated Balance Sheets as of June 30,
1999, December 31, 1998 and 1997.......................... 19
Supplementary Consolidated Statements of Operations for the
three and six months ended June 30, 1999 and 1998 and the
years ended December 31, 1998, 1997 and 1996.............. 20
Supplementary Consolidated Statements of Stockholders'
Equity for the six months ended June 30, 1999 and the
years ended December 31, 1998, 1997, and 1996............. 21
Supplementary Consolidated Statements of Cash Flows for the
six months ended June 30, 1999 and 1998 and the years
ended December 31, 1998, 1997 and 1996.................... 22
Notes to Supplementary Consolidated Financial Statements.... 24
Notes to Unaudited Quarterly Financial Statements; Quarterly
Financial Information (unaudited)......................... 46
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following information should be read in conjunction with the
supplementary consolidated financial statements and the notes included thereto.
This Form 8-K Current Report contains or incorporates forward-looking
statements including statements regarding, among other things, our future plans,
objectives, performance, intentions, expectations and anticipated trends in our
business. We may make additional written or oral forward-looking statements from
time to time in filings with the Securities and Exchange Commission or
otherwise. When we use the words "believe," "expect," "anticipate," "project"
and similar expressions, this should alert you that this is a forward-looking
statement. Forward-looking statements speak only as of the date the statement is
made.
These forward-looking statements are based largely on our expectations. They
are subject to a number of known and unknown risks and uncertainties that could
cause our actual results, performance and achievements to differ materially from
those described or implied in the forward-looking statements. These factors
include among others, our ability to complete new products at planned costs and
on planned schedules, our ability to attract and retain strategic partners and
consummate acquisitions, our ability to leverage intangible assets in our
technology, and our ability to maintain a sufficient level of financing for our
business strategy. Additional factors that are beyond our control and could
influence results include market acceptance of our products and services and
adoption of the Internet as a medium of commerce and communications. See the
discussion of our business and a description of the various factors that could
materially affect our ability to achieve the anticipated results described in
the forward-looking statements which are included in Item 1 of our Annual Report
on Form 10-K/A for the year ended December 31, 1998.
OVERVIEW
On July 14, 1999, we changed our Company's name from 7th Level, Inc. to
Learn2.com, Inc. We made the change in order to create a single brand and to
more closely align our corporate identity with our product offerings.
Our company was founded in 1993 with the goal of becoming a leading
developer and publisher of interactive entertainment and educational products as
well as a creator of state of the art tools and technologies. In 1998, our
research and development activities were focused primarily on developing and
enhancing our Agent7-TM technology. We recognized that appropriate applications
of this technology were in the delivery of learning, training and enhanced
communications. To strengthen our position in the marketplace, we searched for a
viable and complementary partner with the appropriate technological assets,
distribution channel and management expertise and abandoned our interactive
entertainment business.
On February 16, 1999, we acquired all of the outstanding stock of Street
Technologies, Inc, a privately held company, and changed the name of Street
Technologies to Learn2, Inc. Learn2 markets and develops technology based
training solutions delivered over intranets and the Internet. The total value of
the transaction was approximately $40.3 million including $3.3 million of
assumed liabilities, which were primarily deferred revenue, and was accounted
for using the purchase method of accounting. Accordingly, the assets and
liabilities were recorded based upon their fair values at the date of
acquisition. We recorded approximately $13.4 million in goodwill and other
intangible assets, which are being amortized on a straight-line basis over
periods of seven to twenty years and wrote-off approximately $9.7 million of
acquired in-process technology.
On May 13, 1999, we acquired all of the outstanding stock of Panmedia
Corporation, a privately held company. Panmedia produces a website which offers
a wide spectrum of step by step instructions
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on skills, activities, and tasks. We exchanged 1,543,860 shares of our common
stock, $.01 par value per share for all of Panmedia's outstanding shares. The
total value of the transaction was approximately $9.7 million and was accounted
for as a pooling of interests. The supplementary consolidated financial
statements and footnotes for the two years ended December 31, 1998 and 1997 and
the accompanying notes reflect our financial position and the results of
operations as if Panmedia was a wholly-owned subsidiary since inception.
Panmedia's results of operations for 1996 are not material and therefore have
not been included. During June 1999, we recorded a one-time charge of $277,000
for acquisition-related costs. These costs consisted of legal and accounting
fees, and certain other expenses directly related to the acquisition.
On August 23, 1999, we acquired ViaGrafix Corporation, a publicly traded
company. ViaGrafix develops, produces and markets technology based training
products. We exchanged approximately 10.7 million shares of common stock for all
of ViaGrafix's outstanding common stock. The total value of the transaction was
approximately $40.5 million and was accounted for as a pooling of interests. The
supplementary consolidated financial statements do not include estimated
expenses of approximately $2.3 million relating to transaction costs incurred
with this transaction. These estimated costs include estimated investment
banking fees, professional services and financial advisory fees. These costs
will be recorded as expenses in the third quarter of 1999. The supplementary
consolidated financial statements and the accompanying notes reflect our
financial position and results of operations as if ViaGrafix was a wholly-owned
subsidiary of the Company since inception. As set forth on Note 3, our reported
results of operations for all periods prior to February 16, 1999 do not reflect
the results of Learn2, Inc. Consequently, the results prior to February 16, 1999
and our consolidated balance sheet at December 31, 1998 are not reflective of
our operations and financial position as presently constituted.
We plan to significantly increase our operating expenses to increase our
research and product development and sales and marketing operations to help
attain our goal of becoming the world's leading provider of Internet and network
delivered learning and training products and services. We may be unable to
adjust spending quickly enough to offset any unexpected revenue shortfall. If we
have a shortfall in revenues in relation to expenses, or if our expenses exceed
our revenues, then our business, results of operations and financial condition
would be materially and adversely affected. We expect to incur losses on a
quarterly and annual basis for the foreseeable future.
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
REVENUES
In August 1997, we announced a new strategy to leverage our existing core
technology and to transition from being a self-funded content developer and
publisher to position ourselves as a supplier of custom solutions and services,
tools and technology. Our strategy change in 1997 impacted our operations in
1998. Net revenues decreased 13% to $21.4 million for the year ended
December 31, 1998 compared to $24.5 million for the year ended December 31,
1997. The 13% decrease in net revenues reflects the shift in business strategy
as the first of the new products on the Agent7 platform was formally released
late in the third quarter of 1998 and accordingly, no significant revenues have
been realized. In 1998, product sales from ViaGrafix were $18.8 million or 88%
of total revenue. The remaining 12% of revenue came from various sources
including royalty streams from Learn2's discontinued game business, reversals of
prior period returns, price protection allowances in excess of actual returns,
price protections, and revenues related to Panmedia. In contrast, during 1997,
$6.0 million or 24% of our revenue came from product sales associated with game
business and $13.7 million or 56% came from product sales from ViaGrafix. The
remaining 20% was from other sources, including the sale of a title in the final
stages of development, Dominion, for $1.8 million, non-refundable advance
royalties of $1.5 million for Python titles, and approximately $1.2 million from
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Microsoft for development and initial royalties on the Barney Actimates titles.
Sales to customers outside of the United States were 2% and 8% of net revenue in
1998 and 1997, respectively.
The increase in ViaGrafix's 1998 sales are primarily from existing and
additional training products, along with sales of approximately $826,000 or 4%
of total ViaGrafix 1998 sales, from eTracks.com for the last five months of
1998. eTracks was purchased by ViaGrafix on July 31, 1998 and accounted for as a
purchase. Information technology training product sales for the year ended
December 31, 1998 increased 40% to approximately $15.5 million, or 83% of total
sales, compared to approximately $11.1 million, or 81% of total ViaGrafix sales,
in 1997. This increase was primarily attributable to increases in the number of
units of products sold rather than increases in prices. Graphics software sales
for the year ended December 31, 1998, decreased 8.5% to approximately
$2.4 million, or 13% of total ViaGrafix sales, compared to approximately
$2.6 million, or 19% of total ViaGrafix sales, in 1997. This decrease was
primarily due to lower than expected sales of ViaGrafix's DesignCAD upgrade,
DesignCAD Pro 2000, that was introduced in late August 1998.
Our strategy change in 1997 impacted our operations. Net revenues decreased
20% to $24.5 million for the year ended December 31, 1997 compared to
$30.6 million for the year ended December 31, 1996. In 1997, product sales from
our games business constituted approximately 24% of net revenue while product
sales from ViaGrafix constituted approximately 56% of revenues. The
remaining 20% was from other Learn2 sources, including the sale of a title in
the final stages of development, Dominion, for $1.8 million, non-refundable
advance royalties of $1.5 million for Python titles, and approximately
$1.2 million from Microsoft for development and initial royalties on the Barney
Actimates titles. In contrast, approximately 60% of 1996 net revenues came from
Learn2's product sales related to the games business, product sales from
ViaGrafix of 33% and the remaining 7% was from Learn2 licensing, OEM or Original
Equipment Manufacturer, and development contracts. Sales to customers outside of
the United States in 1997 were similar to 1996 and approximated 8% of net
revenue.
The increase in ViaGrafix's 1997 revenue reflects an increase in sales
primarily from existing and additional training products. Information technology
training product sales for the year ended December 31, 1997 increased 60% to
approximately $11.1 million, or 81% of total ViaGrafix sales, compared to
approximately $7.0 million, or 69% of total ViaGrafix sales, in 1996. This
increase was primarily attributable to increases in the number of units sold
rather than increases in prices. Graphics software sales for the year ended
December 31, 1997 decreased 17% to approximately $2.6 million, or 19% of total
ViaGrafix sales, compared to approximately $3.1 million, or 31% of total
ViaGrafix sales, in 1996. This decrease was primarily due to stronger sales of
DesignCAD upgrades for Windows 95 in 1996.
COST OF REVENUES
For the year ended December 31, 1998, costs of revenues were $5.0 million or
23% of net revenues. During 1998 cost of revenues consisted primarily of
$4.5 million related to ViaGrafix product sales, royalties and development. For
the year ended December 31, 1997, cost of revenues were $7.7 million or 31% of
net revenues whereby $3.0 million related to our product sales and $4.7 million
of product sales related to Learn2's product development, manufacturing, and
royalties and licensing. The increase in ViaGrafix's cost of revenues was
partially a result of a change in sales mix as ViaGrafix sales to major
retailers in 1998 were significantly higher than in 1997. Our "Teach Yourself"
product line makes up the majority of sales to major retailers and it generally
has a higher cost of revenues percentage. In addition, there was a higher cost
of revenues percentage (43.2%) from eTracks that affected our sales mix during
the last five months of 1998.
For the year ended December 31, 1997, costs of revenues were $7.7 million or
31% of net revenues. For the year ended December 31, 1996, cost of revenues were
$10.9 million or 36% of net
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revenues. During 1997 cost of revenues consisted primarily of $3.0 million
related to ViaGrafix product sales and $4.7 million of product sales related to
our product development, manufacturing, and royalties and licensing. During 1996
cost of revenues consisted primarily of $2.6 million related to ViaGrafix
product sales and $8.3 million of product sales related to Learn2's product
development, manufacturing, and royalties and licensing.
The decline in cost of revenues as a percent of sales was a result of
productivity improvements at ViaGrafix due to economies of scale as sales
increases were covered with a minimal increase in duplicating and packaging
personnel. Additionally, the 1997 revenues from the sale of Dominion and advance
royalties for Python referred to above had a very low cost which was offset by a
much higher relative cost of revenues associated with the development contracts.
RESEARCH AND PRODUCT DEVELOPMENT EXPENSES
Research and product development expenses were $4.1 million and
$15.6 million for the years ended December 31, 1998 and 1997, respectively. This
is comprised of $2.4 million and $14.4 million for Learn2 for 1998 and 1997,
respectively and $1.7 million and $1.2 million for ViaGrafix for 1998 and 1997,
respectively.
Learn2's research and product development costs decreased in 1998 as we
continued to reduce headcount and related expenditures in the games related
business. Approximately $700,000 related to the closing of the Learn2's
international localization studios is included in the 1997 amount. During 1998
we completed this process and reversed $250,000 in estimated over accruals
related to these closings. In 1998, research and product development expenses
primarily included $1.4 million for production expenses and $900,000 for
software research and development expenses. Research and product development
expenses for 1997 primarily included $5.2 million of production expenses,
$4.0 million for software research and development and $5.2 million for expenses
related to the Company's subsidiaries that were closed or sold during 1997.
Because a large portion of the 1997 staffing cuts in connection with the change
in our strategic direction was implemented late in the year and continued into
1998 the benefit was not fully realized until 1998.
Research and development expense for ViaGrafix increased to $1.7 million or
42% for the year ended December 31, 1998 compared to $1.2 million in 1997. This
increase reflects ViaGrafix's commitment to expand the number of information
technology training courses offered, as it released 280 new computer-training
titles in 1998. Included in the research and development expense for 1998 are
costs associated with the initiation of the development of training libraries in
Spanish, French and German. ViaGrafix released DesignCAD Pro 2000 during the
third quarter of 1998 and DesignCAD LT 2000 in the fourth quarter of 1998.
ViaDraw, ViaGrafix's first entry in a line of graphics software products for the
consumer market, was released in late November 1998. Two additional graphics
software products for the consumer market, ViaCAD, a low cost CAD package, was
released in the first quarter of 1999, and ViaPage, a web-page editor, was
released in the second quarter of 1999. Research and development expenditures
also included development efforts on ViaGrafix's web site and on Internet online
delivery of training. ViaGrafix continued to increase its research and
development staff during 1998 and as of December 31, 1998 ViaGrafix had 62
employees in research and development compared to 44 on December 31, 1997.
Research and product development expenses were $15.6 million and
$20.1 million for the years ended December 31, 1997 and 1996, respectively. This
is comprised of $14.4 million and $19.6 million for Learn2 for 1997 and 1996,
respectively and $1.2 million and $467,000 for ViaGrafix for 1997 and 1996,
respectively. Learn2's research and product development costs decreased in 1997
as it reduced headcount and related expenditures. Approximately $700,000 related
to the closing of the international localization studios is included in the 1997
amount. Learn2's research and production development expenses decreased 27% in
1997, excluding the one-time closing expenses, compared to 1996. Learn2's
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research and product development expenses for 1997 included $5.2 million of
production expenses, $4.0 million for software research and development and
$5.2 million for expenses of the companies acquired in 1995 and 1996 to provide
expertise in the development of 3D technology and graphics design and to provide
the capabilities needed to expand into the Asia Pacific market. ViaGrafix's
higher level of research and development expense reflects an overall increase in
personnel for product development.
SALES AND MARKETING EXPENSES
Sales and marketing expenses were $9.0 million and $10.8 million for the
years ended December 31, 1998 and 1997, respectively. This is comprised of
$595,000 and $5.9 million for Learn2 for 1998 and 1997, respectively and
$8.4 million and $4.9 million for ViaGrafix for 1998 and 1997, respectively.
Sales and marketing expenses for Learn2 for 1998 included $14,200 of
expenses for advertising, marketing and public relations and $413,000 of
expenses related to internal staffing. Included in the 1997 amount is
approximately $965,000 related to the closing of Learn2's international sales
offices. The 1997 expenses included $2.4 million of expenses for advertising,
marketing and public relations and $3.7 million of expenses related to internal
staffing. Excluding costs for closing Learn2's international sales offices,
sales and marketing expenses decreased approximately $1.8 million or 17% in 1998
compared to 1997.
The increase in ViaGrafix sales and marketing expenses in 1998 was primarily
a result of increased staffing and commission expenditures. Staffing and
commission expenditures increased to $4.2 million in the year ended
December 31, 1998 from $2.7 million in 1997. Increased commission expenditures
were a result of increased sales. We believe these staff additions will provide
support for increased future sales. Included in ViaGrafix sales and marketing is
advertising expense totaling $4.4 million in the year ended December 31, 1998 as
compared to $2.0 million in 1997. Advertising expenses are for cooperative
advertising, advertising through the channels of distribution, direct
advertising and print media advertising.
Sales and marketing expenses were $10.8 million and $15.0 million for the
years ended December 31, 1997 and 1996, respectively. This is comprised of
$5.9 million and $11.3 million for Learn2 for 1997 and 1996, respectively and
$4.9 million and $3.7 million for ViaGrafix for 1997 and 1996, respectively.
Included in the 1997 amount for Learn2 is approximately $965,000 related to
the closing of its international sales offices. In addition, sales and marketing
expenses for 1997 included $2.4 million of expenses for advertising, marketing
and public relations and $3.7 million of expenses related to internal staffing.
For 1996, expenses of $6.3 million for advertising, marketing and public
relations and $5.0 million related to internal staffing were incurred. Excluding
costs for closing our international sales offices, Learn2's sales and marketing
expenses decreased approximately $5.4 million or 48% in 1997 compared to 1996.
Sales and marketing expenses for ViaGrafix increased to $4.9 million during
the year ended December 31, 1997, compared to $3.7 million in 1996. Included in
sales and marketing is advertising expense totaling $2.0 million in the year
ended December 31, 1997 as compared to $1.2 million in 1996. Advertising
expenses are for cooperative advertising, advertising through the channels of
distribution, direct advertising and print media advertising.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses for the year ended December 31, 1998
were $7.6 million compared with $6.6 million for the year ended December 31,
1997. This is comprised of $5.1 million
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and $5.3 million for Learn2 for 1998 and 1997, respectively and $2.3 million and
$1.2 million for ViaGrafix for 1998 and 1997, respectively. Approximately
$1.4 million of the 1998 combined company expenses is attributable to stock
grants to two of our directors. Additionally, Learn2 incurred higher legal and
professional fees in 1998 that also contributed to the increase in general and
administrative expenses compared to the 1997 amount. The increase in ViaGrafix's
general and administrative expenses was due primarily to planned increases in
staffing and expansion of its facilities.
General and administrative expenses for the year ended December 31, 1997
were $6.6 million compared with $5.5 million for the year ended December 31,
1996. This is comprised of $5.4 million and $4.3 million for Learn2 for 1997 and
1996, respectively and $1.2 million for ViaGrafix for 1997 and 1996.
Approximately $400,000 of the Learn2 increase of $1.0 million is associated with
expenses related to employee resignations in the first quarter of 1997.
Additionally, Learn2 incurred higher legal and professional fees in 1997 which
contributed to the increase in general and administrative expenses compared to
1996.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expenses were $2.6 million for the year ended
December 31, 1998 compared to $4.5 million for the year ended December 31, 1997.
Of the 1997 amount, approximately $450,000 represents the early write off of the
amortization of intangible assets acquired in the 1995 acquisition of Lanpro
Corporation and Lanpro Localization Center, Inc. These assets were acquired on
December 29, 1995 and were being amortized over periods up to seven years;
however, the assets were written off when we closed our offices in San Francisco
and Tokyo.
Depreciation and amortization expenses were $4.5 million for the year ended
December 31, 1997 compared to $3.3 million for the year ended December 31, 1996.
INTEREST AND OTHER INCOME
Interest income was $870,000 for the year ended December 31, 1998 compared
to $361,000 for the year ended December 31, 1997. A significant portion of the
net proceeds from ViaGrafix's initial public offering on March 4, 1998 was
invested in highly liquid investments with maturities of six months or less.
Interest expense was $1.8 million and $393,000 for the years ended December 31,
1998 and 1997, respectively. Approximately $1.7 million related to amortization
of debt issuance costs and accretion of debt discount was included in the amount
for 1998. The decrease in interest expense, excluding the amortization of debt
issuance cost and accretion of debt discount, is due to the reduction in
long-term debt.
Interest income was $361,000 for the year ended December 31, 1997 compared
with $1.4 million in the year ended December 31, 1996. This change was due to
lower average cash balances available for investment during 1997. Interest
expense was $393,000 and $402,000 for the years ended December 31, 1997 and
1996, respectively. Approximately $188,000 of interest expense was capitalized
as a cost of financing the acquisition of a tract of land and office building
construction during 1996.
Other expenses were $1.3 million for the year ended December 31, 1998
compared to other income of $1.1 million for the year ended December 31, 1997.
During 1998, we disposed of assets at a net loss of approximately $1.5 million
that was offset by reversals of accrued royalty expense in excess of actual
liabilities in the amount of $237,000. In November 1997, we sold our PyroTechnix
subsidiary which included the sale of the Return to Krondor game title and a
license to its TopGun technology and recognized a gain of approximately
$1.0 million which resulted in the significant increase over the 1996 amount.
For the year ended December 31, 1997, our PyroTechnix subsidiary recognized
revenues of approximately $320,000, cost of revenues of approximately $317,000
and operating expenses of approximately $1.5 million.
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INCOME TAXES
Income taxes represent actual taxes incurred by the Company's ViaGrafix
subsidiary. All deferred assets have been fully reserved for all periods
presented.
NET LOSS
The Company recorded net loss available to common shareholders of $15.1
million or $(0.53) per basic and diluted common share which includes
$5.8 million or $(0.21) per share related to dividends and a beneficial
conversion feature in association with Preferred Stock for the year ended
December 31, 1998 compared to net losses available to common shareholders of
$20.3 million and $23.7 million, or $(0.91), and $(1.16) per basic and diluted
common share for the years ended December 31, 1997 and 1996, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents increased $18.7 million during the year to
$21.4 million at December 31, 1998. Operating activities used $6.0 million of
cash in 1998. The primary factor related to the use of cash from operating
activities was the net loss of $9.3 million. The net loss was substantially
offset by non-cash charges of $7.7 million of which $2.6 million related to
depreciation and amortization, $3.2 million of non-cash compensation and
interest and $1.6 million relating to loss on disposal of assets.
The principal factors in the cash used in investing activities of
$5.6 million were the expenditures for fixed assets of $1.3 million, the
purchase of short term investments of $3.0 million, the acquisition of eTracks
for $682,000, net of cash acquired and prepaid royalties and licenses of
$620,000.
For the year ended December 31, 1998, cash provided by financing activities
of $30.3 million was due primarily to the sale of Common Stock of a private
placement in the amount of $4.7 million during May 1998, the issuance of Common
Stock as part of ViaGrafix's March 1998 initial public offering in the amount of
$20.5 million, the receipt of $5.3 million in connection with the December 1998
sale of Preferred Stock, and the proceeds from issuance of debt totaling
$4.3 million. This was offset by repayments of notes payable totaling
$3.7 million and the purchase and cancellation of common stock totaling
$1.5 million. For the year ended December 31, 1997, cash used by financing
activities of $6.7 million was due primarily to the repayment of $6.2 million in
connection with a bank line of credit and $358,000 related to the repayment of
notes payable to related parties and capital lease payments. For the year ended
December 31, 1996, cash provided by financing activities of $6.1 million was
primarily due to $6.8 million in proceeds from a line of credit with a bank and
proceeds from the excerise of warrants and stock options. This was offset by the
repayment of notes payable to related parties totaling $513,000.
In December 1998 the Company's ViaGrafix subsidiary purchased land in Pryor,
Oklahoma for expansion of its facilities for $115,000, and to accommodate the
seller, agreed to finance $103,500 of the purchase price at 5% interest until
June 1, 1999. The loan was repaid in the second quarter of 1999. The Company
does not currently have any other significant commitments for capital
expenditures. The Company anticipates that it will continue to expand its
facilities and purchase equipment as needed to support its product research and
development, production of its products, sales and marketing, product support,
and administrative staff.
In the normal course of business, we evaluate potential acquisitions, joint
ventures and strategic alliances that may complement our business. While we have
no present commitments or agreements with respect to any material business
combinations, we may in the future consummate transactions that may require us
to issue additional capital stock and this issuance may be significant.
To date, we continue to use cash and operate at a loss. Our ability to
achieve positive cash flow depends upon a variety of factors, including the
timely introduction and market success of our
8
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products, the costs of developing, producing and marketing these products,
adoption of the Internet as a medium of commerce and communications, and various
other factors, some of which may be beyond our control. Similar to other
Internet companies, we are making a substantial investment in our business and
may need to raise additional funds. If adequate funds are not available on
acceptable terms, we may not be able to realize our business plan.
THREE MONTHS ENDED JUNE 30, 1999 AND 1998 AND SIX MONTHS ENDED JUNE 30, 1999 AND
1998
REVENUES
Revenues increased 59% from $4.7 million to $7.5 million for the three
months ended June 30, 1999 compared to the three months ended June 30, 1998.
Excluding Learn2, Inc.'s revenue of $1.6 million for the quarter, revenues
increased $1.2 million to $5.9 million. The increase was primarily from our
ViaGrafix subsidiary. This reflects an increase in sales from existing and new
information technology training titles, and was primarily attributable to
increases in the volume of products sold rather than increases in prices. Net
sales of more than $1.0 million were contributed by eTracks, which was purchased
in July 1998.
Revenues increased $6.4 million from $9.4 million to $15.8 million for the
six months ended June 30, 1999. Excluding Learn2, Inc.'s revenue of
$2.2 million, revenues increased $4.2 million to $13.6 million from the period
subsequent to the Learn2, Inc. acquisition date. The increase was primarily from
our ViaGrafix subsidiary. During the six months ended June 30, 1999 ViaGrafix's
net sales were approximately $13.3 million, a 61% increase over net sales of
approximately $8.3 million during the same period in 1998. A significant portion
of the year-to-date increase in net sales was from sales to Internet resellers.
eTracks, generated approximately $1.7 million of our first half sales in 1999.
COST OF REVENUES
Cost of revenues for the three months ended June 30, 1999 was $2.0 million
or 27% of net revenues compared to $1.1 million or 23% of net revenues for the
three months ended June 30, 1998. The increase in cost of revenues as a
percentage of net sales for 1999's second quarter was primarily due to a higher
cost of revenues percentage realized by eTracks along with a lower overall mix
of high margin graphics software sales in the quarter.
Cost of revenues for the six months ended June 30, 1999 was $4.0 million or
25% of net revenues compared to $2.2 million or 23% of net revenues for the six
months ended June 30, 1998. The increase in the cost of revenues as a percentage
of net sales for the first half of 1999 was primarily due to a higher cost of
revenues percentage realized by eTracks.
RESEARCH AND PRODUCT DEVELOPMENT EXPENSES
Research and product development expenses were $1.6 million and
$1.1 million for the three months ended June 30, 1999 and 1998, respectively.
Research and product development costs increased $500,000 or 45% in 1999 and
reflects our increased headcount and related cost structure as a result of our
acquisition of Learn2, Inc.
Research and product development expenses were $2.7 million and
$2.2 million for the six months ended June 30, 1999 and 1998, respectively.
Research and product development costs increased $500,000 or 23% in 1999 and
reflects our increased headcount and related cost structure as a result of our
acquisition of Learn2, Inc.
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SALES AND MARKETING EXPENSES
Sales and marketing expenses were approximately $4.6 million and
$1.9 million for the three months ended June 30, 1999 and 1998, respectively.
Sales and marketing expenses increased $2.7 million or 142% for the three months
ended June 30, 1999 primarily due to the addition of sales and marketing staff
and increased commission expenditures.
Sales and marketing expenses were approximately $10.0 million and
$3.8 million for the six months ended June 30, 1999 and 1998, respectively.
Sales and marketing expenses increased $6.2 million or 163% for the six months
ended June 30, 1999 primarily due to the addition of sales and marketing staff
and increased commission expenditures.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were $2.0 million and $3.0 million for
the three months ended June 30, 1999 and 1998, respectively. General and
administrative expenses decreased $1.0 million or 33% for the three months ended
June 30, 1999. General and administrative expenses for the quarter ended
June 30, 1998 included approximately $1.4 million in non-cash compensation
related to stock granted to our Chairman and Vice Chairman and approximately
$44,000 in charges for certain stock options and stock warrants granted to
consultants. Excluding the one-time expenses, general and administrative
expenses increased approximately 25% between the two periods. The increase
resulted from changes in headcount and related cost structure as a result of our
merger with Learn2, Inc.
General and administrative expenses were $3.6 million and $4.4 million for
the six months ended June 30, 1999 and 1998, respectively. General and
administrative expenses decreased $800,000 or 19% for the six months ended
June 30, 1999. One time charges were recognized in the first half of 1998
totaling $1.8 million, which included approximately (i) $1.4 million in non-cash
compensation related to stock granted to our Chairman and Vice Chairman,
(ii) $44,000 in charges for certain stock options and stock warrants granted to
consultants and (iii) $400,000 related to professional fees associated with the
terminated merger with Pulse Entertainment, Inc. Excluding the one-time
expenses, general and administrative expenses increased approximately 38%
between the two periods. The increase resulted from changes in headcount and
related cost structure as a result of our merger with Learn2, Inc.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expenses were $905,000 and $594,000 for the
three months ended June 30, 1999 and 1998, respectively. Depreciation and
amortization expenses increased $311,000 or 52% for the three months ended
June 30, 1999. The 1999 expenses included $619,000 of depreciation on fixed
assets, $245,000 of amortization of computer software and $41,000 of
amortization on goodwill and intangible assets related to the Learn2, Inc.
merger. The 1998 expenses related primarily to depreciation and amortization on
fixed assets and intangible assets.
Depreciation and amortization expenses were $1.5 million and $1.2 million
for the six months ended June 30, 1999 and 1998, respectively. Depreciation and
amortization expenses increased $300,000 or 25% for the six months ended June
30, 1999. The 1999 expenses included approximately $700,000 of depreciation on
fixed assets, $500,000 of amortization of computer software and $300,000 of
amortization on goodwill and intangible assets related to the Learn2, Inc.
acquisition. The 1998 expenses related primarily to depreciation and
amortization on fixed and intangible assets.
RESTRUCTURING CHARGES
Restructuring charges related to our merger with Learn2, Inc. were
approximately $2.5 million for the six months ended June 30, 1999. The charges
were comprised of the following: $1.4 million to the
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write-off of redundant assets, $493,000 excess office space and other costs, and
$600,000 in employee severance costs.
NON-RECURRING COSTS
During the second quarter of 1999, we completed our merger with Panmedia
Corporation through the issuance of 1,543,860 shares of our common stock. We
recorded a non-recurring charge of $277,000 for transaction costs associated
with the merger.
ACQUIRED IN-PROCESS TECHNOLOGY
In connection with our merger with Learn2, Inc., we allocated $9.7 million
of the purchase price to acquired in-process technology. Accordingly, these
costs were expensed as of the acquisition date. The amount allocated to acquired
in-process technology relates to projects that had not yet reached technological
feasibility and that, until completion of development, had no alternative future
use. The technologies acquired in this merger will continue to require
substantial additional development.
INTEREST AND OTHER EXPENSES, NET
Interest and other expenses, net was $215,000 of income compared to
$1.1 million of expense for the three months ended June 30, 1999 and 1998,
respectively. Interest and other expenses, net changed $1.3 million. Interest
and other expenses, net in 1999 consisted primarily of interest income while in
1998 interest and other expenses consisted primarily of $1.4 million related to
the amortization of debt issuance costs and accretion of debt discount following
our May 1998 financing transactions.
Interest and other expenses, net was $288,000 of income compared to $1.3
million of expense for the six months ended June 30, 1999 and 1998,
respectively. Interest and other expenses, net changed $1.6 million. Interest
and other expenses, net in 1999 consisted primarily of interest income while in
1998 interest and other expenses, net consisted primarily of $1.4 million
related to the amortization of debt issuance costs and accretion of debt
discount following the May 1998 financing transactions.
INCOME TAXES
Income taxes represent actual taxes incurred by the Company's ViaGrafix
subsidiary. All deferred assets have been fully reserved for all periods
presented.
NET LOSS
The net loss for the three months ended June 30, 1999 was $3.3 million or
$(0.08) per basic and diluted common share, compared to $4.3 million or $(0.15)
per basic and diluted common share for the three months ended June 30, 1998. The
net loss was attributable to the factors discussed above.
The net loss for the six months ended June 30, 1999 was $17.4 million or
$(0.42) per basic and diluted common share, compared to $6.2 million or $(0.24)
per basic and diluted common share for the six months ended June 30, 1998. The
results for the six months ended June 30, 1999 include a non-recurring charge of
$277,000 incurred in connection with the May 1999 acquisition of Panmedia
Corporation, write-off of $9.7 million of acquired in-process technology
acquired in the Learn2, Inc. acquisition, and the $2.5 million restructuring
charge as a result of the Learn2, Inc. acquisition. Excluding these charges, our
net loss was $4.9 million or $(0.12) per basic and diluted common share. The net
loss was attributable to the factors discussed above.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents decreased $7.3 million during the first six months
of the year to $14.1 million at June 30, 1999. Operating activities used
$5.2 million of cash in the first six months of
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1999. The primary factor related to the use of cash from operating activities
was the net loss of $17.4 million. The net loss was substantially offset by
non-cash charges of $13.8 million (principally $1.5 million of depreciation and
amortization, $185,000 non-cash warrant expense, $2.5 million of restructuring
charges, and $9.7 million for the write-off of acquired in-process technology).
The principal factor in the cash used in investing activities of
$1.4 million were from capital expenditures.
In December 1998 the Company's ViaGrafix subsidiary purchased land in Pryor,
Oklahoma for expansion of its facilities for $115,000, and to accommodate the
seller, agreed to finance $103,500 of the purchase price at 5% interest until
June 1, 1999. The loan was repaid in the second quarter of 1999. The Company
does not currently have any other significant commitments for capital
expenditures. The Company anticipates that it will continue to expand its
facilities and purchase equipment as needed to support its product research and
development, production of its products, sales and marketing, product support,
and administrative staff.
Financing activities used $628,000 of cash. This was primarily due to the
purchase and cancellation of Common Stock totaling $808,000, dividends paid to
Stockholders of $185,000, repayments of debt of $103,000, payments on existing
capital leases totaling $128,000 offset by the issuance of Common Stock relating
to stock option exercises of $592,000.
In the normal course of business, we evaluate potential acquisitions, joint
ventures and strategic alliances that may complement our business. While we have
no present commitments or agreements with respect to any material business
combinations, we may in the future consummate transactions that may require us
to issue additional capital stock and this issuance may be significant.
To date, we continue to use cash and operate at a loss. Our ability to
achieve positive cash flow depends upon a variety of factors, including the
timely introduction and market success of our products, the costs of developing,
producing and marketing these products, adoption of the Internet as a medium of
commerce and communications, and various other factors, some of which may be
beyond our control. Similar to other internet companies, we are making a
substantial investment in our business and may need to raise additional funds.
If adequate funds are not available on acceptable terms, we may not be able to
realize our business plan.
YEAR 2000
Many currently installed computer systems and software products are coded to
accept only two-digit entries in the date code field and cannot distinguish
twenty-first century dates from twentieth century dates. To function properly,
these date-code fields must distinguish twenty-first century dates from
twentieth century dates and, as a result, many companies' software and computer
systems may need to be upgraded or replaced in order to comply with such "Year
2000" requirements.
STATE OF READINESS. We are dependent on the operation of numerous systems
that may be adversely affected by the Year 2000 problem, including:
- Internal systems.
- Equipment, software and content supplied to us by third-party vendors that
may not be Year 2000 compliant, including outside providers of web-hosting
and Internet access services on which we are currently dependent.
In addition, our future business depends on the successful operation of the
Internet following the commencement of the Year 2000. If the Internet is
inaccessible for an appreciable period of time, or if customers and users are
unable to access our site, our business and revenues could be materially
adversely affected. We are also subject to external forces that might generally
affect industry and commerce, such as telecommunications, utilities or
transportation companies' Year 2000 compliance
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failures, related service interruptions and the economic impact that such
failures have on our customers and advertisers.
YEAR 2000 COMPLIANCE ASSESSMENT PLANS. Unlike other businesses, we do not
have an installed base of legacy systems dating back many years. Nonetheless, in
order to reduce the risks of the Year 2000 compliance problem, we have
undertaken a two-phase process of analyzing the impact of the Year 2000 problem.
First, we have completed a formal assessment of our primary internal
systems. Based on such assessment and our knowledge of the specific software and
systems, we currently believe that our systems are Year 2000 compliant in all
material respects or can readily be brought into compliance with the application
of corrective software modifications. In many cases, we expect these
modifications to be provided by the vendors of the computer and software
products we have installed. We have not incurred material costs to date in this
informal phase of the assessment process, and currently do not believe that the
cost of additional actions will have a material effect on our results of
operations, cash flows or financial condition.
Second, we are in the process of performing a formal assessment of both our
internal systems and the vendor-supplied items and services we employ to
determine how the Year 2000 problem will affect all aspects of our operations.
We are in the final stages of completing this second phase of our assessment.
The formal process involves assessment of the following systems:
- Hardware systems, including servers and systems used for data storage.
- Software systems, including applications, development tools and
proprietary code.
- Infrastructure systems, including routers, hubs and networks.
- Facility systems, including general building functions, security, HVAC and
related operations.
- The systems of our business partners, including content providers and
ISPs.
We are conducting our formal assessment of Year 2000 compliance by gathering
information on each aspect of our systems, reviewing each component or
application for date usage, and examining date representations. As to our
systems, the preliminary results of this formal assessment are consistent with
the results of our informal assessment. With respect to vendor-supplied items
and services, we are conducting a review of product compliance information on
such items and services available online, in vendor literature and through trade
group information resources, contacting our vendors for compliance information,
and maintaining documentation of assessments that have been performed by such
vendors or outside sources.
Each department is involved in this formal assessment process. Once
complete, the formal assessment will lead to the creation of a formal
re-mediation and contingency plan for achieving Year 2000 compliance. We do not
anticipate, however, undertaking a formal assessment of the Year 2000 compliance
of the Internet or our underlying telecommunications infrastructure, and will
therefore be unable to predict the impact of Year 2000 issues that might affect
the broader Internet business community, including ours.
RESULTS OF COMPLIANCE EFFORTS TO DATE. Based on the completed informal
assessment and progress on the formal assessment, we currently believe that our
internal systems are or can readily be made Year 2000 compliant in all material
respects. However, it is possible that these current internal systems contain
undetected errors or defects with Year 2000 date functions. In addition,
although we do not anticipate problems, vendor-supplied items and services could
contain undetected errors or defects which, if not corrected, could result in
serious unanticipated negative consequences, including significant downtime for
one or more of our media properties.
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We could encounter some Year 2000 defects in the products and services we
produce and market. If Year 2000 defects are encountered, we could be liable for
substantial legal claims and litigation, and the adverse publicity could have a
material adverse effect on the future sales of our products and services, even
after any Year 2000 defects are resolved. However, any material adverse effect
on our financial position, results of operations and cash flows cannot be
currently estimated.
COSTS OF YEAR 2000 COMPLIANCE. Although we are not aware of any material
operational issues or costs associated with preparing our internal systems for
the Year 2000, and although we have not incurred material costs to date with
respect to the Year 2000 compliance of these internal systems, the occurrence of
any of the following events could materially and adversely affect our business,
results of operations, cash flows and financial condition:
- Errors and defects are detected after the formal assessment process is
complete.
- Third-party equipment, software or content fails to operate properly with
regard to the Year 2000.
- Web advertisers expend significant resources to correct their current
systems for Year 2000 compliance, resulting in reduced funds available for
web advertising or sponsorship of web services.
We believe our largest risk regarding the Year 2000 issue is from legal
claims and litigation. We expect that there will be a large number of lawsuits
filed over Year 2000 issues in the United States because of the great publicity
of the Year 2000 issue. Even small Year 2000 problems encountered could result
in substantial legal claims, lawsuits, and class action lawsuits against us,
which in turn could have a material adverse effect on our results of operations,
cash flows and financial position.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURES
As of January 15, 1999, we replaced our principal accountant KPMG LLP with
Arthur Andersen LLP. Our decision to change accountants was recommended by our
Board.
KPMG LLP's report on our consolidated financial statements as of
December 31, 1997 and 1996 and for each of the years in the three-year period
ended December 31, 1997 contained a separate paragraph stating that "the Company
has suffered recurring losses since inception and does not currently have
sufficient resources to meet its anticipated operating requirements during 1998,
which conditions raise substantial doubt about the Company's ability to continue
as a going concern. Management's plans in regard to these matters are also
described in Note 3 [in the notes to our 1997 financial statements]. The
consolidated financial statements and financial statement schedule do not
include any adjustments that might result from the outcome of these
uncertainties."
On April 20, 1998, we received commitments for an aggregate $10 million in
financing which was comprised of $4.5 million principal amount of senior secured
promissory notes and $5.5 million liquidation preference of non-convertible
preferred stock. The terms of the financing provided that upon stockholder
approval the non-convertible preferred stock would be automatically exchanged
into convertible preferred stock and the holders of the senior secured
promissory notes would have the option of exchanging their notes into
convertible preferred stock. On July 13, 1998, an aggregate of $10 million
liquidation preference of our Series B Convertible Preferred Stock was issued to
the holders of the senior secured promissory notes and non-convertible preferred
stock. Between April 20, 1998 and July 13, 1998, the market price of our common
stock increased such that the conversion price of the Series B Convertible
Preferred Stock was greater than the market price of our common stock on
April 20, 1998 but less than the market price of our common stock on July 13,
1998. Due to the beneficial conversion feature of the Series B Convertible
Preferred Stock, we were required to increase the loss attributable to common
stockholders for the quarter ended September 30, 1998. The one-time
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occurrence was accounted for similar to a non-cash dividend and had no effect on
our net loss or aggregate stockholders' equity.
KPMG LLP informed us about the accounting treatment of the beneficial
conversion feature. Management then requested KPMG LLP to look into alternative
accounting treatments. Management believes that its inquiries and discussions
regarding this matter did not constitute a disagreement. However, KPMG LLP has
informed us that in view of all the circumstances surrounding the discussions
about this issue this matter constitutes a disagreement as contemplated by Item
4 of Form 8-K and Item 304(a)(1) of Regulation S-K. Upon KPMG LLP informing us
that in KPMG's opinion there was no alternative accounting treatment, we
followed the advice of KPMG LLP and accounted for the Series B Convertible
Preferred Stock as described above to the satisfaction of KPMG LLP.
We have authorized KPMG LLP to respond fully to the inquiries of Arthur
Andersen LLP concerning the subject matter of the beneficial conversion feature.
The following is the response submitted to the SEC by KPMG LLP:
"We were previously principal accountants for 7th Level, Inc. and under the
date of January 30, 1998, we reported on the consolidated financial statements
of 7th Level, Inc. and subsidiaries as of December 31, 1997 and 1996 and for
each of the years in the three-year period ended December 31, 1997. On
January 15, 1999, our appointment as principal accountants was terminated. We
have read 7th Level, Inc.'s statements included under Item 4 of its Form 8-K
dated January 15, 1999, and agree with such statements, except that we are not
in a position to agree or disagree with 7th Level, Inc.'s statement that the
change in principal accountants was recommended by the Company's Board of
Directors."
After the change in accountants took place it came to our attention that at
the November 18, 1998 meeting of the Emerging Issues Task Force, the staff of
the SEC issued a statement regarding how issuers should account for convertible
securities. The minutes dealt with, among other things, the observation, by the
Task Force, that in certain circumstances, the intrinsic value of the beneficial
conversion feature may be greater than the proceeds received from the sale of
the convertible instrument. In those situations, the Task Force reached a
tentative conclusion that the amount of the discount assigned to the beneficial
conversion feature should be limited to the amount of proceeds received.
As a result of the foregoing, we have restated the financial statements
contained in the Quarterly Report on Form 10-Q/A for the three and nine month
periods ended September 30, 1998. We have reduced the beneficial conversion
feature originally recorded in the amount of approximately $15,000,000 to
approximately $5,500,000. The impact of such restatement on our Condensed
Consolidated Statement of Operations and Balance Sheet was as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 1998 SEPTEMBER 30, 1998
--------------------------- ----------------------------
AS ORIGINALLY AS ORIGINALLY
AS RESTATED REPORTED AS RESTATED REPORTED
----------- ------------- ------------ -------------
<S> <C> <C> <C> <C>
Net loss available to common
stockholders.......................... $(7,922,802) $(17,414,526) $(15,474,901) $(24,966,625)
Loss per common share................... $ (0.45) $ (1.00) $ (1.00) $ (1.62)
<CAPTION>
SEPTEMBER 30, 1998
----------------------------
AS ORIGINALLY
AS RESTATED REPORTED
------------ -------------
<S> <C> <C> <C> <C>
Additional capital................................................... $ 83,990,864 $ 93,482,588
Accumulated deficit.................................................. $(83,635,328) $(93,127,052)
</TABLE>
15
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QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to the impact of interest rate and foreign currency
fluctuations. Our objective in managing this exposure to interest rate changes
is to maximize our potential interest income without sacrificing cash equivalent
and short-term investment quality. We do not currently have interest rate
exposure from borrowing as we do not have a line of credit. We have only
$493,000 of notes payable.
In the first half of 1999 and 1998 sales to countries other than the United
States and Canada accounted for 3% and 4%, respectively, of total net sales.
These international net sales are denominated in foreign currencies.
Consequently a decrease in the value of a relevant foreign currency in relation
to the U.S. dollar could adversely affect our net sales. Our foreign currency
transactional exposures exist primarily with the United Kingdom Pound, the
French Franc, the German Mark and the Japanese Yen.
We do not utilize interest rate swaps or hedge exposures with foreign
currency forward contracts.
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REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Learn2.com, Inc.
We have audited the accompanying supplementary consolidated balance sheets
of Learn2.com, Inc. at December 31, 1998 and 1997, and the related supplementary
consolidated statements of operations, stockholders' equity and cash flows for
the years then ended. The supplementary consolidated statements give retroactive
effect to the merger with ViaGrafix Corporation on August 23, 1999, which has
been accounted for as a pooling of interests as described in Note 1. These
supplementary financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these supplementary
financial statements based on our audits. The consolidated financial statements
of the Company for the year ended December 31, 1996, were audited by other
auditors whose report dated February 7, 1997 (except for the second paragraph of
Note 5 which is as of March 14, 1997), expressed an unqualified opinion on those
statements. The opinion of such auditors, however, does not cover the
restatement for the pooling of interests transaction as discussed in Note 1. We
did not audit the consolidated financial statements of ViaGrafix included in the
supplementary consolidated financial statements of Learn2.com, Inc., which
statements reflect total assets and revenues constituting 66 and 88 percent,
respectively, in 1998 and 44 and 56 percent respectively, in 1997 of the related
supplementary consolidated totals. These statements were audited by other
auditors whose report thereon has been furnished to us, and our opinion
expressed herein, insofar as it relates to the amounts included for ViaGrafix
Corporation, is based solely upon the report of the other auditors.
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 and the report of other auditors provide a reasonable
basis for our opinion.
We have also audited the adjustments described in Note 1 that were applied
to restate the 1996 consolidated financial statements. In our opinion, such
adjustments are appropriate and have been properly applied.
In our opinion, based upon our audits and the report of the other auditors,
the supplementary consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Learn2.com, Inc. as
of December 31, 1998 and 1997, and the results of its operations and its cash
flows for the years then ended, after giving retroactive effect to the merger
with ViaGrafix as described in Note 1, all in conformity with generally accepted
accounting principles.
ARTHUR ANDERSEN LLP
New York, New York
November 2, 1999
17
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders of
Learn2.com, Inc. (Formerly Known as 7th Level, Inc.):
We have audited the consolidated statements of operations, stockholders'
equity and cash flows of Learn2.com, Inc. (formerly known as 7th Level, Inc.)
for the year ended December 31, 1996 before restatement for the pooling of
interests transaction discussed in note 1 to the supplementary financial
statements. These consolidated financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the results of operations and cash
flows of Learn2.com, Inc. (formerly known as 7th Level, Inc.) for the year ended
December 31, 1996 before restatement for the pooling of interests transaction
discussed in note 1 to the supplementary consolidated financial statements.
KPMG LLP
Dallas, Texas
February 7, 1997
18
<PAGE>
LEARN2.COM, INC.
(FORMERLY KNOWN AS 7TH LEVEL, INC.)
SUPPLEMENTARY CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
JUNE 30, -------------------
1999 1998 1997
----------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 14,092 $ 21,359 $ 2,697
Short-term investments.................................... 3,100 3,000 --
Accounts receivable, net of allowances of $319 (unaudited)
$149 and $1,187, respectively........................... 5,077 4,887 3,633
Income tax receivable..................................... 1,038 205 --
Inventories............................................... 2,757 1,909 1,429
Prepaid expenses and other current assets................. 1,947 885 1,070
--------- -------- --------
Total current assets.................................. 28,011 32,245 8,829
Fixed assets, net........................................... 3,911 4,542 7,274
Capitalized software (net of accumulated amortization of
$645 (unaudited) and $64 in 1999 and 1998,
respectively)............................................. 15,422 169 --
Prepaid royalties and licenses (net of accumulated
amortization of $155 and $78 in 1999 and 1998,
respectively)............................................. 388 543 --
Intangible assets (net of accumulated amortization of $413
(unaudited) and $154 and $7 in 1999, 1998, and 1997,
respectively)............................................. 3,461 214 13
Goodwill (net of accumulated amortization of $233
(unaudited) and $45 and $31 in 1999, 1998 and 1997,
respectively)............................................. 9,795 88 101
Other assets................................................ 334 268 533
--------- -------- --------
Total assets.......................................... $ 61,322 $ 38,069 $ 16,750
========= ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 1,664 $ 1,965 $ 1,960
Accrued expenses.......................................... 3,386 2,694 4,803
Current portion of deferred revenue....................... 2,120 50 --
Current portion of notes payable.......................... 493 590 82
Current portion of long-term debt......................... -- -- 789
Current portion of capital lease obligations.............. -- 148 172
Other current liabilities................................. -- 183 631
Income taxes payable...................................... -- -- 209
--------- -------- --------
Total current liabilities............................. 7,663 5,630 8,646
Notes payable............................................... -- 2 3,208
Notes payable to related parties............................ -- -- 108
Deferred revenue............................................ 933 -- --
Other....................................................... 858 46 365
--------- -------- --------
Total liabilities..................................... 9,454 5,678 12,327
Minority interest in subsidiary............................. 25 -- --
Commitments and contingencies (Note 14)
Stockholders' equity:
Series A Convertible Preferred Stock par value $0.01 per
share, 10,000,000 shares authorized 0 (unaudited), 0,
and 855,000 issued and outstanding in 1999, 1998 and
1997, respectively...................................... -- -- 9
Series B Convertible Preferred Stock, par value $0.01 per
share, 15,000 shares authorized; 1,395 shares issued and
outstanding, in 1998 ($1,395 liquidation value)......... -- 629 --
Series D Convertible Preferred Stock, par value $0.01 per
share, 35,000 shares authorized; 21,661 (unaudited),
shares issued and outstanding in 1999
($21,661 liquidation value)............................. -- -- --
Common stock, par value $0.01 per share, 100,000,000
shares authorized; 43,330,054 (unaudited), 36,136,746
and 22,456,628 shares issued and outstanding in 1999,
1998 and 1997, respectively............................. 433 361 225
Additional paid-in capital................................ 153,745 114,419 72,094
Notes and accounts receivable from directors (Notes 9 and
13)..................................................... (1,687) -- --
Accumulated deficit....................................... (100,558) (82,914) (67,769)
Unearned compensation..................................... (90) (104) (149)
Cumulative translation adjustment......................... -- -- 13
--------- -------- --------
Total stockholders' equity............................ 51,843 32,391 4,423
--------- -------- --------
Total liabilities and stockholders' equity............ $ 61,322 $ 38,069 $ 16,750
========= ======== ========
</TABLE>
The accompanying notes are an integral part of these supplementary consolidated
financial statements.
19
<PAGE>
LEARN2.COM, INC.
(FORMERLY KNOWN AS 7TH LEVEL, INC.)
SUPPLEMENTARY CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
SIX MONTHS THREE MONTHS
ENDED ENDED YEAR ENDED
JUNE 30, JUNE 30, DECEMBER 31,
------------------- ------------------- ------------------------------
1999 1998 1999 1998 1998 1997 1996
-------- -------- -------- -------- -------- -------- --------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
Net revenues......................................... $ 15,764 $ 9,364 $ 7,466 $ 4,689 $ 21,424 $ 24,501 $ 30,626
Cost of revenues..................................... 4,002 2,180 2,003 1,097 5,017 7,692 10,913
-------- ------- ------- ------- -------- -------- --------
Gross profit....................................... 11,762 7,184 5,463 3,592 16,407 16,809 19,713
Operating expenses:
Research and product development................... 2,710 2,248 1,588 1,052 4,093 15,632 20,108
Sales and marketing................................ 10,013 3,825 4,625 1,907 8,956 10,759 14,968
General and administrative......................... 3,579 4,419 2,037 2,972 7,620 6,573 5,495
Depreciation and amortization...................... 1,542 1,245 905 594 2,556 4,500 3,250
Restructuring charges.............................. 2,493 -- -- -- -- -- --
Non-recurring costs................................ 277 -- 277 -- -- -- --
Acquired in-process technology..................... 9,677 -- -- -- -- -- --
-------- ------- ------- ------- -------- -------- --------
Total operating expenses....................... 30,291 11,737 9,432 6,525 23,225 37,464 43,821
-------- ------- ------- ------- -------- -------- --------
Operating loss................................. (18,529) (4,553) (3,969) (2,933) (6,818) (20,655) (24,108)
Interest expense..................................... (78) (1,428) (8) (1,357) (1,786) (393) (402)
Interest income...................................... 481 324 224 246 870 361 1,395
Other (expense) income............................... (115) (156) (1) 6 (1,277) 1,114 --
-------- ------- ------- ------- -------- -------- --------
Net loss before income taxes................... (18,241) (5,813) (3,754) (4,038) (9,011) (19,573) (23,115)
(Benefit) provision for income taxes................. (856) 398 (469) 227 306 629 601
-------- ------- ------- ------- -------- -------- --------
Net loss....................................... (17,385) (6,211) (3,285) (4,265) (9,317) (20,202) (23,716)
Dividends on Preferred Stock......................... -- -- -- -- 338 57 --
Beneficial conversion feature in association with
preferred stock (Note 3)........................... -- -- -- -- 5,479 -- --
-------- ------- ------- ------- -------- -------- --------
Net loss available to common shareholders............ $(17,385) $(6,211) $(3,285) $(4,265) $(15,134) $(20,259) $(23,716)
======== ======= ======= ======= ======== ======== ========
Basic and diluted loss per common share.............. $ (0.42) $ (0.24) $ (0.08) $ (0.15) $ (0.53) $ (0.91) $ (1.16)
======== ======= ======= ======= ======== ======== ========
Weighted average basic and diluted shares
outstanding........................................ 41,448 25,687 43,327 27,917 28,310 22,365 20,514
======== ======= ======= ======= ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these supplementary consolidated
financial statements.
20
<PAGE>
LEARN2.COM, INC.
(FORMERLY KNOWN AS 7TH LEVEL, INC.)
SUPPLEMENTARY CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON STOCK CONVERTIBLE CONVERTIBLE CONVERTIBLE
------------------- PREFERRED PREFERRED PREFERRED ADDITIONAL
SHARES AMOUNT SERIES A SERIES B SERIES D CAPITAL
-------- -------- ----------- ----------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1995.............. 25,074 $251 $ 9 $ -- $ -- $ 70,657
Common Stock issued under Stock Option
Plan and Stock Purchase Plan.......... 185 2 -- -- -- 779
Common Stock issued for acquisitions.... 281 3 -- -- -- 331
Common Stock issued for conversion of
debt.................................. 23 -- -- -- -- 80
Common Stock issued on exercise of
warrants.............................. 13 -- -- -- -- 3
Purchase of treasury stock, at cost..... -- -- -- -- -- --
Foreign currency translation
adjustment............................ -- -- -- -- -- --
Unrealized loss on investments.......... -- -- -- -- -- --
Accumulated earnings--Panmedia.......... -- -- -- -- -- --
Net loss................................ -- -- -- -- -- --
------ ---- ------ ------ --------- --------
BALANCE AT DECEMBER 31, 1996.............. 25,576 256 9 -- -- 71,850
Common Stock issued under Stock Option
Plan and Stock Purchase Plan.......... 198 2 -- -- -- 346
Common Stock issued on exercise of
warrants.............................. 6 -- -- -- -- 1
Common Stock issued for consulting
services.............................. 40 -- -- -- -- 75
Purchase of treasury stock, at cost..... -- -- -- -- -- --
Stock options granted below fair market
value................................. -- -- -- -- -- 181
Amortization of unearned compensation... -- -- -- -- -- --
Cancellation of unearned Common Stock
issued as contingent purchase
consideration......................... (40) -- -- -- -- (107)
Cancellation of treasury stock, at
cost.................................. (3,323) (33) -- -- -- (219)
Foreign currency translation
adjustment............................ -- -- -- -- -- --
Unrealized gain on investments.......... -- -- -- -- -- --
Accumulated earnings--Panmedia.......... -- -- -- -- -- --
Dividend distribution................... -- -- -- -- -- (33)
Net loss................................ -- -- -- -- -- --
------ ---- ------ ------ --------- --------
BALANCE AT DECEMBER 31, 1997.............. 22,457 225 9 -- -- 72,094
Issuance of Series A Preferred Stock
(net of issuance costs of $3,021)..... -- -- 2,479 -- -- 2,790
Issuance costs in connection with
Notes................................. -- -- -- -- -- 1,467
Beneficial Conversion Feature........... -- -- -- -- -- 5,479
Conversion of Series A Preferred Stock
to Series B Preferred Stock........... -- -- (2,479) 2,479 -- --
Conversion of Notes to Series B
Preferred Stock....................... -- -- -- 3,000 -- 1,500
Conversion of Series A Preferred Stock
to Common Stock....................... 923 9 (9) -- -- 4
Common Stock issued on conversion of
Series B Preferred Stock.............. 4,303 43 -- (4,850) -- 4,807
Common Stock dividends.................. 107 1 -- -- -- 278
Common Stock issued in private
placement............................. 1,667 17 -- -- -- 4,683
Amortization of unearned compensation... -- -- -- -- -- --
Cancellation of stock options granted
below fair market value............... -- -- -- -- -- (13)
Issuance of common stock pursuant to
ViaGrafix initial public offering..... 3,323 33 -- -- -- 20,464
Purchase and cancellation of Common
Stock................................. (754) (8) -- -- -- (1,491)
Warrants issued to non-employees........ -- -- -- -- -- 32
Common Stock issued on exercise of
warrants.............................. 2,813 28 -- -- -- --
Common Stock granted to officers........ 765 8 -- -- -- 1,379
Common Stock issued under Stock Option
Plan and Stock Purchase Plan.......... 533 5 -- -- -- 920
Compensation expense issued to non-
employees............................. -- -- -- -- -- 41
Foreign currency translation
adjustment............................ -- -- -- -- -- --
Accumulated earnings--Panmedia.......... -- -- -- -- -- --
Dividend distribution................... -- -- -- -- -- (15)
Net loss................................ -- -- -- -- -- --
------ ---- ------ ------ --------- --------
BALANCE AT DECEMBER 31, 1998.............. 36,137 361 -- 629 -- 114,419
Common Stock issued on conversion of
Series B Preferred Stock.............. 698 7 -- (629) -- 622
Stock issued in connection with Street
Technologies, Inc. acquisition........ 4,948 49 -- -- -- 36,439
Series B dividends paid in Common
Stock................................. 24 1 -- -- -- 73
Common Stock issued on exercise of
warrants.............................. 375 4 -- -- -- --
Common Stock issued upon conversion of
notes payable......................... 187 2 -- -- -- 571
Warrants and options issued to non-
employees............................. -- -- -- -- -- 301
Notes and accounts receivable from
directors from the exercise of stock
options............................... -- -- -- -- -- --
Repayment of notes and accounts
receivable from directors from the
exercise of stock options............. -- -- -- -- -- --
Common Stock issued under Stock Option
Plan and Stock Purchase Plan.......... 1,146 11 -- -- -- 2,254
Purchase and cancellation of Common
Stock................................. (185) (2) -- -- -- (804)
Amortization of unearned compensation... -- -- -- -- -- --
Series D Preferred Stock issued under
Stock Option Plan..................... -- -- -- -- -- 18
Dividend distribution................... -- -- -- -- -- (1)
Financing costs......................... -- -- -- -- -- (147)
Net loss................................ -- -- -- -- -- --
------ ---- ------ ------ --------- --------
BALANCE AT JUNE 30, 1999 (UNAUDITED)...... 43,330 $433 $ -- $ -- $ -- $153,745
====== ==== ====== ====== ========= ========
<CAPTION>
NOTES AND
ACCOUNTS
UNREALIZED RECEIVABLE
CUMULATIVE GAIN (LOSS) FROM ACCUMULATED COMMON
UNEARNED TRANSLATION ON DIRECTORS (DEFICIT) SHARES IN
COMPENSATION ADJUSTMENT INVESTMENTS NOTE 9 EARNINGS TREASURY
------------- ----------- ----------- ---------- ------------ ---------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1995.............. $ -- $(15) $ 22 $ -- $ (21,069) $(1,996)
Common Stock issued under Stock Option
Plan and Stock Purchase Plan.......... -- -- -- -- -- 10
Common Stock issued for acquisitions.... -- -- -- -- (583) --
Common Stock issued for conversion of
debt.................................. -- -- -- -- -- --
Common Stock issued on exercise of
warrants.............................. -- -- -- -- -- --
Purchase of treasury stock, at cost..... -- -- -- -- -- (5)
Foreign currency translation
adjustment............................ -- 66 -- -- -- --
Unrealized loss on investments.......... -- -- (28) -- -- --
Accumulated earnings--Panmedia.......... -- -- -- -- 14 --
Net loss................................ -- -- -- -- (23,716) --
---- ---- ---- ------- --------- -------
BALANCE AT DECEMBER 31, 1996.............. -- 51 (6) -- (45,354) (1,991)
Common Stock issued under Stock Option
Plan and Stock Purchase Plan.......... -- -- -- -- -- 10
Common Stock issued on exercise of
warrants.............................. -- -- -- -- -- --
Common Stock issued for consulting
services.............................. -- -- -- -- -- --
Purchase of treasury stock, at cost..... -- -- -- -- -- (2)
Stock options granted below fair market
value................................. (181) -- -- -- -- --
Amortization of unearned compensation... 32 -- -- -- -- --
Cancellation of unearned Common Stock
issued as contingent purchase
consideration......................... -- -- -- -- -- --
Cancellation of treasury stock, at
cost.................................. -- -- -- -- (1,746) 1,983
Foreign currency translation
adjustment............................ -- (38) -- -- -- --
Unrealized gain on investments.......... -- -- 6 -- -- --
Accumulated earnings--Panmedia.......... -- -- -- -- 46 --
Dividend distribution................... -- -- -- -- (513) --
Net loss................................ -- -- -- -- (20,202) --
---- ---- ---- ------- --------- -------
BALANCE AT DECEMBER 31, 1997.............. (149) 13 -- -- (67,769) --
Issuance of Series A Preferred Stock
(net of issuance costs of $3,021)..... -- -- -- -- -- --
Issuance costs in connection with
Notes................................. -- -- -- -- -- --
Beneficial Conversion Feature........... -- -- -- -- (5,479) --
Conversion of Series A Preferred Stock
to Series B Preferred Stock........... -- -- -- -- -- --
Conversion of Notes to Series B
Preferred Stock....................... -- -- -- -- -- --
Conversion of Series A Preferred Stock
to Common Stock....................... -- -- -- -- -- --
Common Stock issued on conversion of
Series B Preferred Stock.............. -- -- -- -- -- --
Common Stock dividends.................. -- -- -- -- (279) --
Common Stock issued in private
placement............................. -- -- -- -- -- --
Amortization of unearned compensation... 32 -- -- -- -- --
Cancellation of stock options granted
below fair market value............... 13 -- -- -- -- --
Issuance of common stock pursuant to
ViaGrafix initial public offering..... -- -- -- -- -- --
Purchase and cancellation of Common
Stock................................. -- -- -- -- -- --
Warrants issued to non-employees........ -- -- -- -- -- --
Common Stock issued on exercise of
warrants.............................. -- -- -- -- -- --
Common Stock granted to officers........ -- -- -- -- -- --
Common Stock issued under Stock Option
Plan and Stock Purchase Plan.......... -- -- -- -- -- --
Compensation expense issued to non-
employees............................. -- -- -- -- -- --
Foreign currency translation
adjustment............................ -- (13) -- -- -- --
Accumulated earnings--Panmedia.......... -- -- -- -- 347 --
Dividend distribution................... -- -- -- -- (417) --
Net loss................................ -- -- -- -- (9,317) --
---- ---- ---- ------- --------- -------
BALANCE AT DECEMBER 31, 1998.............. (104) -- -- -- (82,914) --
Common Stock issued on conversion of
Series B Preferred Stock.............. -- -- -- -- -- --
Stock issued in connection with Street
Technologies, Inc. acquisition........ -- -- -- -- -- --
Series B dividends paid in Common
Stock................................. -- -- -- -- (73) --
Common Stock issued on exercise of
warrants.............................. -- -- -- -- -- --
Common Stock issued upon conversion of
notes payable......................... -- -- -- -- -- --
Warrants and options issued to non-
employees............................. -- -- -- -- -- --
Notes and accounts receivable from
directors from the exercise of stock
options............................... -- -- -- (1,934) -- --
Repayment of notes and accounts
receivable from directors from the
exercise of stock options............. -- -- -- 247 -- --
Common Stock issued under Stock Option
Plan and Stock Purchase Plan.......... -- -- -- -- -- --
Purchase and cancellation of Common
Stock................................. -- -- -- -- -- --
Amortization of unearned compensation... 14 -- -- -- -- --
Series D Preferred Stock issued under
Stock Option Plan..................... -- -- -- -- -- --
Dividend distribution................... -- -- -- -- (186) --
Financing costs......................... -- -- -- -- -- --
Net loss................................ -- -- -- -- (17,385) --
---- ---- ---- ------- --------- -------
BALANCE AT JUNE 30, 1999 (UNAUDITED)...... $(90) $ -- $ -- $(1,687) $(100,558) $ --
==== ==== ==== ======= ========= =======
<CAPTION>
TOTAL
STOCKHOLDERS'
EQUITY
-------------
<S> <C>
BALANCE AT DECEMBER 31, 1995.............. $ 47,859
Common Stock issued under Stock Option
Plan and Stock Purchase Plan.......... 791
Common Stock issued for acquisitions.... (249)
Common Stock issued for conversion of
debt.................................. 80
Common Stock issued on exercise of
warrants.............................. 3
Purchase of treasury stock, at cost..... (5)
Foreign currency translation
adjustment............................ 66
Unrealized loss on investments.......... (28)
Accumulated earnings--Panmedia.......... 14
Net loss................................ (23,716)
--------
BALANCE AT DECEMBER 31, 1996.............. 24,815
Common Stock issued under Stock Option
Plan and Stock Purchase Plan.......... 358
Common Stock issued on exercise of
warrants.............................. 1
Common Stock issued for consulting
services.............................. 75
Purchase of treasury stock, at cost..... (2)
Stock options granted below fair market
value................................. --
Amortization of unearned compensation... 32
Cancellation of unearned Common Stock
issued as contingent purchase
consideration......................... (107)
Cancellation of treasury stock, at
cost.................................. (15)
Foreign currency translation
adjustment............................ (38)
Unrealized gain on investments.......... 6
Accumulated earnings--Panmedia.......... 46
Dividend distribution................... (546)
Net loss................................ (20,202)
--------
BALANCE AT DECEMBER 31, 1997.............. 4,423
Issuance of Series A Preferred Stock
(net of issuance costs of $3,021)..... 5,269
Issuance costs in connection with
Notes................................. 1,467
Beneficial Conversion Feature........... --
Conversion of Series A Preferred Stock
to Series B Preferred Stock........... --
Conversion of Notes to Series B
Preferred Stock....................... 4,500
Conversion of Series A Preferred Stock
to Common Stock....................... 4
Common Stock issued on conversion of
Series B Preferred Stock.............. --
Common Stock dividends.................. --
Common Stock issued in private
placement............................. 4,700
Amortization of unearned compensation... 32
Cancellation of stock options granted
below fair market value............... --
Issuance of common stock pursuant to
ViaGrafix initial public offering..... 20,497
Purchase and cancellation of Common
Stock................................. (1,499)
Warrants issued to non-employees........ 32
Common Stock issued on exercise of
warrants.............................. 28
Common Stock granted to officers........ 1,387
Common Stock issued under Stock Option
Plan and Stock Purchase Plan.......... 925
Compensation expense issued to non-
employees............................. 41
Foreign currency translation
adjustment............................ (13)
Accumulated earnings--Panmedia.......... 347
Dividend distribution................... (432)
Net loss................................ (9,317)
--------
BALANCE AT DECEMBER 31, 1998.............. 32,391
Common Stock issued on conversion of
Series B Preferred Stock.............. --
Stock issued in connection with Street
Technologies, Inc. acquisition........ 36,488
Series B dividends paid in Common
Stock................................. 1
Common Stock issued on exercise of
warrants.............................. 4
Common Stock issued upon conversion of
notes payable......................... 573
Warrants and options issued to non-
employees............................. 301
Notes and accounts receivable from
directors from the exercise of stock
options............................... (1,934)
Repayment of notes and accounts
receivable from directors from the
exercise of stock options............. 247
Common Stock issued under Stock Option
Plan and Stock Purchase Plan.......... 2,265
Purchase and cancellation of Common
Stock................................. (806)
Amortization of unearned compensation... 14
Series D Preferred Stock issued under
Stock Option Plan..................... 18
Dividend distribution................... (187)
Financing costs......................... (147)
Net loss................................ (17,385)
--------
BALANCE AT JUNE 30, 1999 (UNAUDITED)...... $ 51,843
========
</TABLE>
21
<PAGE>
LEARN2.COM, INC.
(FORMERLY KNOWN AS 7TH LEVEL, INC.)
SUPPLEMENTARY CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEAR ENDED
JUNE 30, DECEMBER 31,
------------------- ------------------------------
1999 1998 1998 1997 1996
-------- -------- -------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net loss.................................................. $(17,385) $(6,211) $(9,317) $(20,202) $(23,716)
Adjustments to reconcile net loss to net cash used in
operating activities:
Non-cash compensation, compensation expense for sale of
minority interest in subsidiary and interest.......... 49 2,830 3,185 32 142
Depreciation and amortization........................... 1,542 1,245 2,556 4,500 3,250
Non-cash common stock warrant and option expense........ 185 -- -- -- --
Loss (gain) on sale of assets........................... 2 163 1,598 (1,107) --
Minority interest in loss of subsidiary................. (9) -- -- -- --
Gain on early retirement of debt........................ -- -- -- (10) --
Restructuring charges................................... 2,493 -- -- -- --
Acquired in-process technology.......................... 9,677 -- 37 -- --
Bad debt expense........................................ 166 66 119 107 --
Other................................................... 79 141 187 74 --
Changes in assets and liabilities, net of acquisitions:
Accounts receivable................................... 357 (40) (1,362) 3,738 654
Inventories........................................... (848) (81) (479) (28) (187)
Income tax receivable................................. (833) (169) (205) -- --
Other current assets.................................. (741) 555 185 830 (706)
Other assets.......................................... (73) -- 452 533 (367)
Accounts payable...................................... (559) (482) (6) (526) 483
Income taxes payable.................................. -- (209) (209) (250) 428
Other current liabilities............................. (232) (796) (2,745) 18 1,656
Other liabilities..................................... 930 (14) -- -- --
-------- ------- ------- -------- --------
Net cash used in operating activities............... (5,200) (3,002) (6,004) (12,291) (18,363)
Cash flows from investing activities:
Proceeds from sale of assets.............................. 32 -- 126 6,593 --
Purchase of short-term investments........................ (3,100) -- (3,000) -- (7,965)
Proceeds from sales of short-term investments............. 3,000 -- 4,491 13,158
Issuance of note receivable--officer...................... 3 -- (188) -- --
Prepaid royalties and licenses............................ -- -- (620) -- --
Equity investment......................................... -- -- -- -- (400)
Acquisitions, net of cash acquired (paid)................. (8) -- (682) -- (772)
Capital expenditures...................................... (1,366) (870) (1,279) (1,183) (9,928)
-------- ------- ------- -------- --------
Net cash (used in) provided by investing
activities........................................ (1,439) (870) (5,643) 9,901 (5,907)
Cash flows from financing activities:
Public offering of common stock........................... -- 20,491 20,497 -- --
Net proceeds from private placement of common stock....... -- -- 4,700 -- --
Net proceeds from issuance of preferred stock............. -- 5,269 5,269 -- --
Net proceeds from debt issuance........................... -- 4,515 4,311 -- --
Purchase and cancellation of common stock................. (806) -- (1,499) -- --
Proceeds from bank line of credit......................... -- -- -- -- 6,000
Repayment of debt......................................... (103) (3,661) (3,661) (6,247) (513)
Repayment of notes payable to related parties............. -- -- -- (125) --
Principal payments under capital lease obligations........ (128) -- (187) (233) (163)
Proceeds from exercise of warrants........................ 4 21 -- -- --
Issuance of common stock under stock option and stock
purchase plan........................................... 578 699 925 358 791
Dividend to common and preferred shareholders............. (187) (38) -- (546) --
Purchase of treasury stock................................ -- -- -- (2) (5)
Other..................................................... 14 -- (46) 47 4
-------- ------- ------- -------- --------
Net cash (used in) provided by financing activities......... (628) 27,296 30,309 (6,748) 6,114
Effect of exchange rate changes on cash and cash
equivalents............................................... -- -- -- 25 (12)
-------- ------- ------- -------- --------
Net (decrease) increase in cash and cash equivalents........ (7,267) 23,424 18,662 (9,113) (18,168)
Cash and cash equivalents, beginning of period.............. 21,359 2,697 2,697 11,810 29,978
-------- ------- ------- -------- --------
Cash and cash equivalents, end of period.................... $ 14,092 $26,121 $21,359 $ 2,697 $ 11,810
======== ======= ======= ======== ========
Supplemental disclosure of cash flow information
Cash paid for interest.................................... $ 9 $ 9 $ 84 $ 506 $ 522
======== ======= ======= ======== ========
Cash paid for income taxes................................ $ -- $ 635 $ 720 $ 479 $ 173
======== ======= ======= ======== ========
</TABLE>
22
<PAGE>
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEAR ENDED
JUNE 30, DECEMBER 31,
------------------- ------------------------------
1999 1998 1998 1997 1996
-------- -------- -------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Schedule of noncash financing activities:
Conversion of notes payable into common stock............. $ 573 -- -- -- --
Notes and accounts receivable received upon exercise of
stock options........................................... 1,687 -- -- -- --
Detail of acqusition:
Fair value of assets acquired........................... 39,630 -- -- -- --
Liabilities assumed..................................... (3,133) -- -- -- --
Common stock issued..................................... (14,845) -- -- -- --
Preferred stock issued.................................. (21,644) -- -- -- --
-------- ------- ------- -------- --------
Acquisition costs, net of cash acquired................. 8 -- -- -- --
Cash acquired in acquisition............................ 774 -- -- -- --
-------- ------- ------- -------- --------
Total acqusition costs................................ $ 782 $ -- $ -- $ -- $ --
======== ======= ======= ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
23
<PAGE>
LEARN2.COM, INC.
(FORMERLY KNOWN AS 7TH LEVEL, INC.)
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
1. INCORPORATION AND NATURE OF BUSINESS
Learn2.com, Inc. (formerly known as 7th Level, Inc.) (the "Company") was
incorporated under the laws of the State of Delaware on April 28, 1993. The
Company has been engaged in the business of developing entertainment and
educational software. In April 1998, the Company announced a strategy to become
a leading developer of Internet media preparation tools and technologies. In
February 1999, 7th Level.com Merger Corporation, a wholly-owned subsidiary of
the Company, merged with Street Technologies, Inc. (the "Merger").
VIAGRAFIX ACQUISITION
In August 1999, 7th Level, Inc. Merger Corporation, a wholly-owned
subsidiary of the Company, merged with ViaGrafix Corporation ("ViaGrafix") in
which ViaGrafix became a wholly-owned subsidiary of the Company. The Company
exchanged 10,684,988 shares of common stock for all the outstanding common stock
of ViaGrafix. The merger was accounted for as a pooling-of-interests and,
accordingly, the accompanying supplementary consolidated financial statements
and footnotes have been restated to include the operations of ViaGrafix for
1998, 1997, and 1996.
ViaGrafix is engaged primarily in the business of developing, producing and
selling, directly to end-users and through resellers and distributors, a wide
range of computer software training videos and interactive CD-ROM software
training products ("training products") as well as Computer-Aided Design ("CAD")
software, which is primarily used in the engineering and architectural fields.
Beginning in August 1998, ViaGrafix entered the business of providing e-mail
list management and Internet marketing services through its new wholly-owned
subsidiary, eTracks.com (formerly known as Make-It-So, Inc.)
PANMEDIA ACQUISITION
In May 1999, 7th Level, Inc. Acquisition Corporation, a wholly-owned
subsidiary of the Company, merged with Panmedia Corporation ("Panmedia") in
which Panmedia became a wholly-owned subsidiary of the Company. The Company
exchanged 1,543,860 shares of common stock for all the outstanding common stock
of Panmedia. The merger was accounted for as a pooling-of-interests and,
accordingly, the accompanying supplementary consolidated financial statements
and footnotes have been restated to include the operations of Panmedia for 1998
and 1997. Panmedia's results of operations for 1996 were not material and have
therefore not been included.
24
<PAGE>
LEARN2.COM, INC.
(FORMERLY KNOWN AS 7TH LEVEL, INC.)
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
1. INCORPORATION AND NATURE OF BUSINESS (CONTINUED)
Components of the consolidated results of operation of Learn2.com and of
ViaGrafix and Panmedia prior to their acquisitions by the Company, are as
follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
NET REVENUES
Learn2.com.................................................. $ 1,571 $ 10,499 $ 20,549
ViaGrafix................................................... 18,750 13,694 10,077
Panmedia.................................................... 1,103 308 --
-------- -------- --------
Total....................................................... $ 21,424 $ 24,501 $ 30,626
======== ======== ========
NET INCOME (LOSS)
Learn2.com.................................................. $(10,958) $(22,458) $(24,253)
ViaGrafix................................................... 1,294 2,210 537
Panmedia.................................................... 347 46 --
-------- -------- --------
Total....................................................... $ (9,317) $(20,202) $(23,716)
======== ======== ========
</TABLE>
The Company has incurred significant losses since inception including
operating losses of approximately $6,818,000, $20,655,000 and $24,108,000 for
the years ended December 31, 1998, 1997 and 1996, respectively.
In August 1997 the Company announced a new strategy, by leveraging its
existing core technology, to transition from being a self-funded content
developer and publisher to position itself as a supplier of custom solutions and
services, tools and technologies. As part of that shift in strategy, the Company
divested itself of its games development groups and new titles under
development. The Company also closed its international localization and sales
offices including those in San Francisco, Tokyo and Munich and sold its
PyroTechnix, Inc. subsidiary during 1997. In fourth quarter 1998 the production
facilities located in Glendale, California were closed. Research and product
development and sales and marketing expenses in 1998 include approximately,
$700,000 and $965,000, respectively, related to the closing of the international
localization and sales offices. In the year ended December 31, 1998, the Company
was able to reverse into income certain reserves established in 1997 as it was
able to settle certain liabilities and commitments for approximately $523,000
less than anticipated.
During fiscal 1998, the Company raised over $14.3 million, net of offering
expenses, in connection with private placements (See Note 3) to fund operations.
Furthermore, at the Company's election, as defined, the Company has the right to
sell shares of Common Stock under a Subscription Agreement in exchange for an
additional $5,000,000, as defined (See Note 3).
25
<PAGE>
LEARN2.COM, INC.
(FORMERLY KNOWN AS 7TH LEVEL, INC.)
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The accompanying supplementary consolidated financial statements include the
accounts of the Company and its wholly-owned subsidiaries. All significant
intercompany transactions and accounts have been eliminated.
USE OF ESTIMATES
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
The Company's estimates and future results could be affected adversely by a
number of uncertainties related to its new software products. Such factors
include, but are not limited to market acceptance; ability to obtain sales
volumes and adequate prices; the Company's sustained commitment of resources to
further develop and market the technology; and the technological competitive
advantage of these new products.
REVENUE RECOGNITION
The Company generates revenue primarily from computer software training
videos, interactive CD-ROM software training products and interactive software
product sales, licensing agreements and product development agreements. The
Company recognizes revenue from software license agreements in accordance with
the provisions of Statement of Position ("SOP") No. 97-2, "Software Revenue
Recognition". Software product sales under such license agreements are
recognized as revenue upon shipment of the products to customers, provided that
there are no significant vendor obligations and collection of the related
receivable is probable. The Company accounts for insignificant vendor
obligations and post-contract support at the time of product delivery by
accruing such estimated costs or recognizing them ratably as the obligations are
fulfilled.
Revenue from product sales are recognized on all products at the time of
delivery. Computer software training videos and interactive CD-ROM software
training products can be returned within 30 days or, for certain retailers,
under a stock return policy. The Company records an estimate of the amount, when
significant, of returns expected in the next 30 days or under each stock return
policy at the time of the initial delivery of the products. The Company sells
its CAD software with no obligations beyond the delivery date of the software.
The Company's price for its products is fixed at the date of sale, and the sale
is not contingent upon resale of the products or affected by damage or theft of
the products.
Revenues from development contracts are recognized as the services are
performed under the terms of the respective contracts. The Company had deferred
revenues of approximately $3,000 and $385,000 included in other current
liabilities associated with development and licensing contracts at December 31,
1998 and 1997, respectively.
26
<PAGE>
LEARN2.COM, INC.
(FORMERLY KNOWN AS 7TH LEVEL, INC.)
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Revenue from website design and implementation services for corporate
clients is recognized based on either time and materials charges incurred during
the period, the achievement of project milestones as defined by customer
contracts or percentage of completion for fixed fee contracts. The Company also
derives revenue from website advertisements. The Company offers numerous sizes
and types of advertising placement, including banner advertisements, text links
and sponsorship programs. Revenues from advertising sales are recognized ratably
in the period in which the advertisement is displayed, provided that no
significant Company obligations remain and collection of the resulting
receivable is probable. Payments received from advertisers are deferred until
displayed.
Company obligations typically include guarantees of minimum number of
"impressions," or times that an advertisement appears in pages viewed by users
of the Company's online properties. To the extent minimum guaranteed impressions
are not met, the Company defers recognition of the corresponding revenues until
the remaining guaranteed impression levels are achieved. Payments received from
advertisers prior to displaying their website advertisements are recorded as
deferred revenue and are recognized ratably as the advertisements are displayed.
RESEARCH AND PRODUCT DEVELOPMENT EXPENDITURES
Statement of Financial Accounting Standards ("SFAS") No. 86 "Accounting for
the Costs of Computer Software to be Sold, Leased or Otherwise Marketed",
provides for the capitalization of certain software development costs once
technological feasibility has been established and until such time as the
product is available for general release. In addition, the Company evaluates the
recoverability of any capitalized costs as provided by generally accepted
accounting principles. All costs incurred prior to technological feasibility are
expensed as research and development costs when incurred. Due to the method
employed by the Company to develop software, an insignificant amount of costs
are incurred between the date technological feasibility is established, and when
the products are ready for general release.
As described in Note 3, the Company allocates a portion of the cost of
acquired enterprises to intangible assets based upon the estimated fair value of
the intangibles, including software in various stages of development. The fair
value of software development projects which have not yet reached technological
feasibility and which have no alternative use are expensed as research and
development in the period acquired. The fair values of all other developed
software products are included in capitalized software and amortized over the
expected remaining life of the specific software products. Capitalized software
amortization expense was $64,000, $6,000 and $322,000 for the years ended
December 31, 1998, 1997 and 1996, respectively.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying values of cash, cash equivalents, accounts receivable and
accounts payable approximate fair value due to their short maturities.
27
<PAGE>
LEARN2.COM, INC.
(FORMERLY KNOWN AS 7TH LEVEL, INC.)
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ADVERTISING COSTS
Advertising costs, included in sales and marketing expenses, are charged as
an expense when they are incurred. Advertising costs were $4,585,000, $4,361,000
and $7,507,000 for the years ended December 31, 1998, 1997 and 1996,
respectively.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with original maturities
of three months or less to be cash equivalents. Cash and cash equivalents
consist of money market funds, commercial paper, U.S. Treasury securities and
other debt securities. The Company had cash equivalents of approximately
$21.0 million and $2.7 million at December 31, 1998 and 1997, respectively.
SHORT-TERM INVESTMENTS
Short-term investments are comprised of an investment in a municipal
security with an original maturity of six months.
OTHER CURRENT ASSETS AND PREPAID EXPENSES
Other current assets include prepaid insurance, prepaid royalties, interest
receivable, other receivables, and other miscellaneous prepaid expenses.
INVENTORIES
Inventories are carried at the lower of cost or market, determined on a
first-in first-out basis. Cost is determined using the average cost method.
FIXED ASSETS
Fixed assets are recorded at cost and are depreciated using accelerated and
straight-line methods over the following estimated useful lives:
<TABLE>
<CAPTION>
YEARS
--------
<S> <C>
Building and building improvements.......................... 10-39
Equipment................................................... 3-7
Automobiles................................................. 5-7
Furniture and Fixtures...................................... 3-7
</TABLE>
INTANGIBLE ASSETS
At December 31, 1998 intangible assets consisted of various patents,
copyrights, and trademarks, technological know-how, customer lists and assembled
workforce. Intangible assets are being amortized on a straight line basis over
estimated useful lives of one to seven years. The Company assesses the
recoverability of intangible assets in accordance with SFAS No. 121 "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of," by determining whether the
28
<PAGE>
LEARN2.COM, INC.
(FORMERLY KNOWN AS 7TH LEVEL, INC.)
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
amortization of the intangible assets over their remaining lives can be
recovered through projected undiscounted future cash flows. During 1997, in
connection with the sale of a 3D game and the closure of its Asia Pacific
localization and sales offices, the Company wrote off the remaining intangible
assets and the related accumulated amortization acquired in certain prior
business combinations. Combined, these totaled approximately $610,000.
GOODWILL
Goodwill, which represents the excess of the purchase price and liabilities
assumed over the fair value of tangible and specifically identified intangible
assets acquired, is being amortized over 10 years.
Amortization of goodwill was $13,000 in 1998, 1997 and 1996.
FOREIGN CURRENCY TRANSLATION
For the Company's subsidiaries outside the United States, the functional
currency is the local currency of the country in which the subsidiary is
domiciled. The Company applies SFAS No. 52 "Accounting for the Translation of
Foreign Currency Transactions and Foreign Currency Financial Statements".
Accordingly, assets and liabilities of the subsidiaries outside of the United
States are translated into U.S. dollars at year end exchange rates. Income and
expense items are translated at average rates of exchange prevailing during the
year. The adjustments resulting from translating the financial statements of
these subsidiaries are reflected as cumulative translation adjustments and
included in stockholders' equity. Foreign currency transaction gains and losses
are recognized when they occur. Such amounts are not material in any of the
periods presented. During 1998 the Company closed down its foreign operations
and accordingly the adjustment was removed from the separate component of equity
and reported as a part of the loss on cessation of these operations.
ROYALTIES
Royalties are accrued based on net revenues, pursuant to contractual
agreements with talent for various products published by the Company. Royalty
expense is included in the cost of revenues.
LOSS PER SHARE
In 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 128, "Earnings Per Share". This statement established standards for
computing and presenting earnings per share. This statement is effective for
periods ending after December 15, 1997. In February 1998, the Securities and
Exchange Commission ("SEC") issued Staff Accounting Bulletin ("SAB") No. 98.
This bulletin revised the SEC's guidance for calculating earnings per share with
respect to equity security issuances before an initial public offering ("IPO")
and is effective for fiscal years ending after December 15, 1997. The prior
years' earnings per share have been retroactively restated to reflect the
adoption of SFAS No. 128 and SAB No. 98.
Basic earnings per share was determined by dividing net loss by the weighted
average common shares outstanding during the period. Diluted earnings per share
was determined by dividing net loss by diluted weighted average shares
outstanding. Diluted weighted average shares reflects the dilutive
29
<PAGE>
LEARN2.COM, INC.
(FORMERLY KNOWN AS 7TH LEVEL, INC.)
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
effect, if any, of common equivalent shares and nominal issuances. Common
equivalent shares include common stock options and warrants to the extent their
effect is dilutive, based on the treasury stock method. Nominal issuances arise
when a company issues common stock, options or warrants to purchase common stock
or other potentially dilutive instruments for nominal consideration, as defined
by SAB No. 98, in the periods preceding an IPO. During the period preceding the
Company's IPO, the Company did not have any nominal issuances.
The calculations of basic and dilutive weighted average shares outstanding
are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1998 1997 1996
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Basic weighted average Common shares outstanding............ 28,310 22,365 20,514
Weighted average Common equivalent shares................... -- -- --
Diluted weighted average shares outstanding................. 28,310 22,365 20,514
</TABLE>
Diluted weighted average shares outstanding do not include 4,276,571 and
2,584,703 common equivalent shares at December 31, 1998 and 1997, respectively,
as their effect would be anti-dilutive.
TREASURY STOCK
Treasury stock purchases were accounted for under the cost method whereby
the entire cost of the acquired stock was recorded as treasury stock. Gains and
losses on the subsequent reissuance of shares were credited or charged to
additional paid-in capital or retained earnings, respectively, using the
specific identification method. All treasury stock was canceled in December
1997.
INCOME TAXES
The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes". SFAS No. 109 requires recognition of deferred tax
assets and liabilities for the future tax consequences of temporary differences
between the financial statement carrying amounts and the tax bases of assets and
liabilities.
RECLASSIFICATIONS
Certain prior year balances have been reclassified to conform to the current
year presentation.
RECENT ACCOUNTING PRONOUNCEMENTS
In Fiscal 1998, the Company, as required, adopted SFAS No. 130, "Reporting
Comprehensive Income." SFAS No. 130 requires disclosure of all components of
comprehensive income on an annual and interim basis. Comprehensive income is
defined as the change in equity of a business enterprise during a period from
transactions and other events and circumstances from nonowner sources. The
effect of the adoption of SFAS 130 is immaterial and has had no effect on the
Company's reporting.
30
<PAGE>
LEARN2.COM, INC.
(FORMERLY KNOWN AS 7TH LEVEL, INC.)
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In March 1998, the American Institute of Certified Public Accountants issued
"SOP" 98-1, "Accounting for the Costs of Computer Software Developed or Obtained
for Internal Use". SOP 98-1 requires computer software costs associated with
internal use software to be charged to operations as incurred until certain
capitalization criteria are met. SOP 98-1 is effective beginning January 1,
1999. The Company does not expect adoption of this statement to have a material
impact on its consolidated financial position, results of operations or cash
flows.
3. BUSINESS COMBINATIONS AND PRIVATE PLACEMENTS
PYROTECHNIX ACQUISITION
On March 1, 1996, the Company acquired all of the outstanding capital stock
of PyroTechnix, Inc. ("PyroTechnix") for 300,000 shares of the Company's Common
Stock. The acquisition was accounted for as a pooling of interests. The
operating results for PyroTechnix were not material to the combined results of
the two companies for all periods prior to the acquisition and therefore results
for those periods have not been restated.
The Company sold its PyroTechnix subsidiary in November 1997 and recognized
a gain of approximately $1,033,000, which is included as non-operating income in
the accompanying consolidated statement of operations for the year ended
December 31, 1997. Included in the supplemental consolidated statements of
operations are losses from operations of PyroTechnix of approximately $1,524,000
and $307,000, respectively, for the years ended December 31, 1997 and 1996.
ETRACKS.COM
On July 31, 1998, the Company's ViaGrafix subsidiary acquired certain assets
of eTracks.com (formerly known as Make-It-So, Inc.), a privately held company
based in San Mateo, California, that provides e-mail list management and
Internet marketing services. The purchase consideration totaled $682,000 and was
financed with existing cash. The acquisition was accounted for as a purchase.
The purchase price was allocated to the tangible and specifically identified
intangible assets acquired based upon the estimated fair value of such assets.
The fair value of software development projects and customer lists was computed
based upon the future cash flows expected to be generated by such projects. The
costs assigned to software development projects related to products that had not
yet reached technological feasibility and for which the technology had no future
alternative uses were expensed immediately as in-process research and
development. The costs assigned to projects for which technological feasibility
had been achieved is being amortized over the remaining life of the respective
product, which was estimated at 18 months. Customer lists are being amortized
over their estimated life of 12 months.
31
<PAGE>
LEARN2.COM, INC.
(FORMERLY KNOWN AS 7TH LEVEL, INC.)
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
3. BUSINESS COMBINATIONS AND PRIVATE PLACEMENTS (CONTINUED)
The following table presents the allocation of the purchase price to the
assets acquired (in thousands):
<TABLE>
<S> <C>
Customer lists.............................................. $354
Software development........................................ 230
Property, plant and equipment............................... 44
In-process research and development......................... 37
Accounts receivable......................................... 16
Prepaid expenses............................................ 1
----
$682
====
</TABLE>
The operating results of eTracks.com, Inc. are included in the statements of
operations from the acquisition date forward. The capitalized customer lists
amortization expense was $148,000 for the year ended December 31, 1998. Research
and development expense includes $37,000 of acquired in-process research and
development which was expensed as the associated products were not
technologically feasible. The pro forma effect of the transaction on the
Company's revenues and net income if the transaction had occurred on January 1,
1996 is not significant.
PRIVATE PLACEMENT
In May 1998, the Company sold, pursuant to a private placement, Secured
Promissory Notes ("Notes") in the aggregate principal amount of $4,500,000 and
warrants for 675,000 shares of Common Stock at an exercise price of $0.01 per
share. The Company allocated approximately $1,200,000 of the proceeds from the
Notes to the warrants based on the relative fair values of the Notes and the
warrants. Accordingly, the Company amortized the related debt discount to
interest expense over the period from May 6, 1998 (date of issuance) to
July 13, 1998 (date of exchange--see below). All of such warrants were exercised
in June 1998. On July 9, 1998, the Company obtained stockholder approval for,
among other things, an increase in its authorized Common Stock (the "Certificate
of Amendment") at its 1998 Annual Meeting of Stockholders. The Certificate of
Amendment was filed on July 10, 1998. On July 13, 1998, the holders of the Notes
exchanged the Notes for 4,500 shares of the Company's Series B Convertible
Preferred Stock, $0.01 par value per share and warrants to purchase 1,125,000
shares of Common Stock at an exercise price of $0.01 per share. The Company
allocated $3,000,000 to Series B Convertible Preferred Stock and $1,500,000 to
warrants in accounting for the exchange.
In May 1998, the Company also sold, pursuant to a private placement, shares
of Series A Preferred Stock in the aggregate amount of $5,500,000 and warrants
for 1,375,000 shares of Common Stock at an exercise price of $0.01 per share.
The Company allocated approximately $2,500,000 of the proceeds from the
Series A Preferred Stock to the warrants based on the relative fair values of
the Series A Preferred Stock and the warrants. All of such warrants were
exercised in June 1998. On July 13, 1998, after the Certificate of Amendment was
approved by the Company's stockholders and was filed with the Secretary of State
of the State of Delaware, the exchange of 5,500 shares of Series A Preferred
Stock for 5,500 shares of Series B Convertible Preferred Stock was effected.
32
<PAGE>
LEARN2.COM, INC.
(FORMERLY KNOWN AS 7TH LEVEL, INC.)
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
3. BUSINESS COMBINATIONS AND PRIVATE PLACEMENTS (CONTINUED)
The Certificate of Designations, Preferences and Rights of Series B
Convertible Preferred Stock (the "Certificate of Designations") provides that on
the original issue date of the Series B Convertible Preferred Stock, the holders
of the Series B Convertible Preferred Stock will have the right to nominate two
members of the Board of Directors of the Company. The Series B Convertible
Preferred Stock ranks senior and prior to the Common Stock and to all other
classes or series of stock issued by the Company. Dividends accrue on the shares
of Series B Convertible Preferred Stock at the rate of 8% per annum; provided,
however, that in the event the Company fails to redeem the Series B Convertible
Preferred Stock on or before April 30, 2005 (the "Anniversary Redemption Date"),
pursuant to the Certificate of Designations, the dividend rate on the Series B
Convertible Preferred Stock shall increase 2% per annum on each anniversary of
the Anniversary Redemption Date. Annual dividends are cumulative and are payable
quarterly in arrears when and as declared by the Company's Board of Directors.
These shares have a liquidation preference of $1,000 per share. The Series B
Convertible Preferred Stock is convertible immediately into Common Stock,
initially at a conversion price of $2.00 per share, subject to adjustment. The
shares of Series B Convertible Preferred Stock may be redeemed, at the option of
the Company, at $1,000 per share on or after the Anniversary Redemption Date.
Upon a change of control, the Company may offer to redeem such shares at $2,000
per share or the Company may issue to each holder of Series B Convertible
Preferred Stock warrants exercisable for 250,000 shares of Common Stock for each
1,000 shares of Series B Convertible Preferred Stock owned by such holder at an
exercise price of $0.01 per share. The Company also has optional redemption
rights at any time after i) completion of an underwritten public offering by the
Company with gross proceeds to the Company of at least $20,000,000 and a price
per share of Common Stock of at least $4.00 per share, subject to adjustment, or
ii) after the Company's Common Stock shall have traded at an average price in
excess of $4.00 per share, subject to adjustment, for 20 consecutive trading
days and the aggregate market value of the Common Stock held by non-Affiliates
of the Company is at least $35,000,000. The holders of Series B Convertible
Preferred Stock also are entitled to certain preemptive rights, co-sale rights
and registration rights.
For the year ended December 31, 1998, the Company was required to increase
the loss attributable to common stockholders, as a result of the beneficial
conversion feature which arose due to the increase in the market price of the
Company's Common Stock from the date the Company received commitments with
respect to the $10,000,000 financing (April 20, 1998) to the date of issuance of
the Series B Convertible Preferred Stock (July 13, 1998). The beneficial
conversion feature is based upon the difference between the market price of the
5,000,000 shares of Common Stock into which the Series B Convertible Preferred
Stock is convertible and the carrying value of the Series B Convertible
Preferred Stock on the date of authorized issuance, but is limited (as discussed
above) to the proceeds received with respect to each security issued. As the
Company allocated $3,000,000 of proceeds to the Series B Convertible Preferred
Stock, and approximately $2,500,000 of proceeds to the Series A Preferred Stock,
the amount of the beneficial conversion feature is approximately $5,500,000. The
one-time occurrence was accounted for similar to a non-cash dividend and had no
effect on the Company's net loss or aggregate stockholders' equity.
In December 1998, the Company sold, pursuant to a subscription agreement,
1,666,667 shares of Common Stock for $5,000,000, or $3.00 per share, and rights
to purchase an additional 100,000 and 650,000 shares of Common Stock for $.01
and $4.50, respectively, to Fletcher International Limited
33
<PAGE>
LEARN2.COM, INC.
(FORMERLY KNOWN AS 7TH LEVEL, INC.)
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
3. BUSINESS COMBINATIONS AND PRIVATE PLACEMENTS (CONTINUED)
("Fletcher"). The Subscription Agreement provides that, at the Company's
election, and as long as the market price of the Company's Common Stock is
greater than $3.00 per share and the Company has an effective registration
statement for the resale of Fletcher's shares, Fletcher is obligated to purchase
up to an additional $5,000,000 of Common Stock at market prices when the Company
elects to exercise its right to sell shares to Fletcher. In addition, Fletcher
may receive additional shares of Common Stock if the Company's Common Stock does
not meet certain price targets or if the Company does not register the resale of
Fletcher's shares by certain dates, as defined.
4. INVENTORIES
Inventories as of December 31 consist of the following (in thousands):
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
Finished goods.............................................. $ 996 $ 739
Raw materials............................................... 913 690
------ ------
$1,909 $1,429
====== ======
</TABLE>
5. FIXED ASSETS, NET
Fixed assets, at cost, as of December 31, 1998 and 1997 consisted of the
following (in thousands):
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
Land....................................................... $ 215 $ 100
Building and improvements.................................. 2,147 4,518
Equipment.................................................. 6,188 8,464
Furniture and fixtures..................................... 381 466
------ -------
8,931 13,548
Less: accumulated depreciation............................. 4,389 6,274
------ -------
$4,542 $ 7,274
====== =======
</TABLE>
The Company leases certain office equipment under capital lease agreements.
At December 31, 1998 and 1997, respectively, the carrying value of capital
assets was $193,000 and $389,000, net of accumulated amortization of $317,000
and $209,000.
34
<PAGE>
LEARN2.COM, INC.
(FORMERLY KNOWN AS 7TH LEVEL, INC.)
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
5. FIXED ASSETS, NET (CONTINUED)
During 1998 the Company disposed of approximately $1.8 million of net
capital assets as a result of a reduction in capacity and recognized a loss in
the December 31, 1998 consolidated financial statements related to this
disposition of these assets of approximately $1.5 million.
In April 1997 the Company sold its office building, which was under
construction, for $5.6 million, and as a result, recognized a gain of
approximately $95,000.
6. ACCRUED EXPENSES
Accrued expenses consist of the following at December 31, 1998 and 1997 (in
thousands):
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
Accrued office closing costs................................ $ 265 $1,065
Accrued royalties........................................... 346 859
Accrued discounts and allowances............................ 678 807
Accrued legal and corporate expenses........................ 296 361
Accrued compensation........................................ 433 755
Accrued interest and taxes.................................. 55 191
Other....................................................... 621 765
------ ------
$2,694 $4,803
====== ======
</TABLE>
7. INCOME TAXES
The components of the provision for income taxes for the years ended
December 31 are as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Current:
Federal............................................... $202 $492 $535
State................................................. 104 137 66
---- ---- ----
306 629 601
==== ==== ====
</TABLE>
Provision for federal and state income taxes for 1998, 1997, and 1996 were
recorded on the Company's ViaGrafix subsidiary.
35
<PAGE>
LEARN2.COM, INC.
(FORMERLY KNOWN AS 7TH LEVEL, INC.)
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
7. INCOME TAXES (CONTINUED)
A reconciliation of the statutory federal income tax rate to the provision
for income taxes for the year ended December 31 is as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Expected provision for federal income taxes at the
statutory rate.................................. $(3,064) $(6,655) $(7,859)
State income taxes--net of federal benefit........ 63 112 45
S corporation income--not taxable................. (118) (16) --
Foreign income not subject to U.S. taxes.......... (616) 521 994
Income tax credits................................ (153) (283) --
Interest from tax-exempt municipal securities..... (130) -- --
Other............................................. 10 56 110
------- ------- -------
Total............................................. (4,008) (6,265) (6,710)
Change in valuation allowance..................... 4,314 6,894 7,311
------- ------- -------
Provision for taxes............................... $ 306 $ 629 $ 601
======= ======= =======
</TABLE>
Significant components of the Company's deferred income tax assets and
liabilities as of December 31 are as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
Deferred Income Tax Assets
Net operating loss.................................... 23,515 18,097
Fixed assets and intangibles.......................... 390 766
Accrued liabilities not deductible for tax............ 584 1,123
Other................................................. 85 275
-------- --------
Net deferred income tax assets.......................... 24,574 20,261
Valuation allowance..................................... (24,574) (20,261)
-------- --------
Net Asset............................................... -- --
======== ========
</TABLE>
At December 31, 1998, the Company had operating loss carryforwards available
to offset future federal taxable income of approximately $80.0 million. These
operating loss carryforwards expire at various dates through 2018 and under
Section 382 of the Internal Revenue Code may be limited due to ownership
changes.
Prior to being acquired by the Company, Panmedia elected S Corporation
status for federal and state income tax reporting purposes. As a result, the
Company's earnings are taxable directly to the shareholder. We remain liable,
however, for the State of California taxes. Pro forma income tax information is
not material.
In connection with the ViaGrafix acquisition, all years presented have been
restated to reflect what the changes in the valuation allowance would have been
if the companies had been combined as of January 1, 1996.
36
<PAGE>
LEARN2.COM, INC.
(FORMERLY KNOWN AS 7TH LEVEL, INC.)
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
8. LONG-TERM DEBT AND NOTES PAYABLE
As of December 31, 1998 and 1997 the Company's long-term debt and notes
payable were as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
7% Convertible Notes Payable, dated February 11, 1994;
annual interest payments; notes are convertible, in whole
but not in part, at the option of the holder at
approximately 283 shares of Common Stock for each $1,000
principal amount outstanding. Remaining principal balance
due February 11, 1999 and satisfied (See Note 16 b).
Included in this amount is $108,000 due to related
parties................................................... $485 $ 485
7.5% Promissory notes dated August 15, 1995; payable in
equal monthly installments over five years with remaining
unpaid principal and interest due August 15, 2000 (repaid
in March, 1998)........................................... -- 3,616
5% Promissory note dated December 18, 1998; proceeds used to
purchase land, note and interest payable in June 1999;
note issued in exchange for land.......................... 103 --
Other....................................................... 4 86
---- ------
Total..................................................... 592 4,187
Less current portion........................................ 590 871
---- ------
Long term payables.......................................... $ 2 $3,316
==== ======
</TABLE>
Interest expense to related parties on the above debt was $61,000, $308,000
and $325,000 for 1998, 1997, and 1996, respectively. Included in the principal
of the 7.5% promissory note is $44,760 and $142,342 of interest which was
reclassified as additional principal in 1998 and 1996, respectively as per the
debt agreement.
9. STOCKHOLDERS' EQUITY
COMMON STOCK
On July 9, 1998 the shareholders of the Company authorized an increase in
the number of shares of Common Stock from 20,000,000 to 100,000,000, par value
$0.01 per share (the "Common Stock").
Prior to the merger between Learn2.com and ViaGrafix, in May 1998, ViaGrafix
completed an initial public offering in which it sold 1,750,000 shares of
ViaGrafix common stock (equivalent to 3,230,500 shares of the Company's common
stock for total proceeds of approximately $20.5 million).
PREFERRED STOCK
There are 100,000 shares of Preferred Stock, par value of $0.01 per share,
authorized and 1,395 shares were outstanding as of December 31, 1998. The Board
of Directors is authorized to provide for the issuance of the shares of
Preferred Stock in one or more series and to establish the number of shares
included in any such series and to fix the designation, powers, preferences and
rights of the shares of any such series.
37
<PAGE>
LEARN2.COM, INC.
(FORMERLY KNOWN AS 7TH LEVEL, INC.)
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
9. STOCKHOLDERS' EQUITY (CONTINUED)
In May 1998, the Company sold, pursuant to a private placement, 5,500 shares
of Series A Preferred Stock. On July 13, 1998 the Notes were exchanged for 4,500
shares of the Series B Convertible Preferred Stock (See Note 3). In a separate
transaction the Series A Preferred Stock was exchanged for 5,500 shares of
Series B Convertible Preferred Stock. During the fourth quarter of 1998, 8,605
shares of the Series B Convertible Preferred Stock were converted into 4,302,500
shares of Common Stock.
SERIES A CONVERTIBLE PREFERRED STOCK
Prior to March 1998, there were 855,000 shares of ViaGrafix Series A
convertible preferred stock outstanding. In March 1998, all 855,000 shares of
preferred stock outstanding were converted to 901,902 shares of common stock in
accordance with the Series A Convertible Preferred Stock Purchase Agreement as a
result of the ViaGrafix's initial public offering.
STOCK COMPENSATION PLANS
Pursuant to the consummation of the acquisition of ViaGrafix, the Company
had two stock-based compensation plans which are described below.
The Learn2.com, Inc. Amended and Restated Incentive Stock Option Plan (the
"Incentive Stock Option Plan") and the ViaGrafix Plan (collectively the "Plans")
allow the Company to grant options to certain employees, directors and outside
consultants to purchase Common Stock under an incentive stock option plan. The
option price represents estimated fair value at the date of grant. Under the
plans, the Company may grant options to its employees for up to 5,046,000 shares
of Common Stock. As of December 31, 1998 the Plans had 1,811,510 option shares
outstanding and 1,840,277 shares available to grant. Of the 1,811,510 shares
outstanding, 45,500 shares are subject to the Option Share Repurchase Agreement
with certain stockholders and no new shares will be issued upon the exercise of
grants.
Pursuant to the Option Share Repurchase Agreement, the Company had the right
to purchase up to 948,000 shares of Common Stock from certain stockholders at
$0.003 per share. The Company may invoke this right in the event certain
outstanding options (exercisable for an identical number of shares) are
exercised. The Company intends to satisfy its obligations to issue shares of
Common Stock upon any exercise of such associated options by delivering to the
exercising optionee(s) shares of treasury stock, thereby resulting in no change
in the number of outstanding shares of Common Stock. At December 31, 1998,
545,500 options associated with the Option Share Repurchase Agreement had been
exercised at a weighted average exercise price of $0.163 per share (and an
identical number of shares of Common Stock had been purchased by the Company
pursuant to the Option Share Repurchase Agreement).
At December 31, 1998, 469,500 options subject to the Option Share Repurchase
Agreement with a weighted average exercise price of $0.253 per share had been
cancelled. Notwithstanding the cancellation of certain options, the stockholders
who are party to the Option Share Repurchase Agreement agreed that 112,500
shares of Common Stock underlying such cancelled options would remain subject to
the agreement. During 1998, 69,000 shares were assigned to outstanding options.
38
<PAGE>
LEARN2.COM, INC.
(FORMERLY KNOWN AS 7TH LEVEL, INC.)
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
9. STOCKHOLDERS' EQUITY (CONTINUED)
Accordingly, all the 45,500 shares remaining under the Option Share Repurchase
Agreement have corresponding option grants.
Transactions in stock options under the Plans are summarized as follows:
<TABLE>
<CAPTION>
OPTION SHARE WEIGHTED AVERAGE
REPURCHASE EXERCISE WEIGHTED AVERAGE
AGREEMENT PRICE STOCK OPTIONS EXERCISE PRICE
------------ ---------------- ------------- ----------------
<S> <C> <C> <C> <C>
Balance at December 31, 1995.......... 222,000 $0.715 1,816,740 $ 7.15
Granted............................... -- -- 2,662,750 7.27
Exercised............................. (85,250) 0.450 (156,229) 1.60
Canceled.............................. (15,000) 0.003 (1,887,964) 10.77
------- ------ ---------- ------
Balance at December 31, 1996.......... 121,750 $0.990 2,435,297 $ 4.83
Granted............................... -- -- 1,241,924 5.40
Exercised............................. (69,250) 0.083 (149,624) 0.93
Canceled.............................. (1,500) 0.003 (1,356,622) 5.31
------- ------ ---------- ------
Balance at December 31, 1997.......... 51,000 $2.244 2,170,975 $ 5.12
Granted............................... -- -- 1,107,545 2.72
Exercised............................. (41,500) 0.634 (390,784) 2.23
Reassigned............................ 69,000 1.250 (69,000) 1.25
Canceled.............................. (33,000) 3.561 (1,052,725) 4.89
------- ------ ---------- ------
Balance at December 31, 1998.......... 45,500 $1.250 1,766,010 $ 4.55
======= ====== ========== ======
</TABLE>
Transactions in stock options to employees, directors and consultants
outside either of the formal plans mentioned above are summarized as follows:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
STOCK OPTIONS EXERCISE PRICE
------------- ----------------
<S> <C> <C>
Balance at December 31, 1996..................... -- $ --
Granted.......................................... 737,500 3.76
Exercised........................................ -- --
Canceled......................................... -- --
--------- -----
Balance at December 31, 1997..................... 737,500 $3.76
Granted.......................................... 3,056,500 1.98
Exercised........................................ (11,000) 1.32
Canceled......................................... (956,000) 3.26
--------- -----
Balance at December 31, 1998..................... 2,827,000 $2.02
========= =====
</TABLE>
The Company has granted to directors options to purchase Common Stock under
a non-employee directors' stock option plan with vesting over four years. Under
the Learn2.com Inc. Amended and Restated 1994 Non-Employee Directors' Stock
Option Plan (the "Directors' Plan"), the Company may grant options to its
non-employee directors for up to 125,000 shares of Common Stock. In 1998, 65,000
39
<PAGE>
LEARN2.COM, INC.
(FORMERLY KNOWN AS 7TH LEVEL, INC.)
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
9. STOCKHOLDERS' EQUITY (CONTINUED)
shares outstanding under the Directors' Plan were cancelled in exchange for new
options granted outside this plan. All of the 125,000 shares authorized under
the Directors' Plan were deregistered. At December 31, 1998, no options were
outstanding.
In May 1998, the Company exchanged with two board members their options to
purchase 715,000 shares of Common Stock for 765,000 shares of Common Stock for
$0.01 per share. The Company recognized a compensation charge of $1,377,000
related to this stock issuance.
On May 13, 1999, options to purchase 600,000 shares of the Company's common
stock were granted to certain employees of Panmedia as an inducement to retain
the services of these employees. These options were all granted at fair market
value on the date of grant and vest over a period of three to four years.
On August 23, 1999, options to purchase 1,925,000 shares of the Company's
common stock were granted to certain employees of ViaGrafix as an inducement to
retain the services of these employees. These options were all granted at fair
market value on the date of acquisition by Learn2 and vest over a period of four
years.
Subsequent to year end, three members of the Board of Directors exercised
options to purchase 960,000 shares of Common Stock for the aggregate amount of
approximately $1.9 million. In connection with these exercises, the Company
received promissory notes from these individuals in the approximate amount of
$1.7 million.
The following table summarizes information about the Plans and non-plan
stock options outstanding at December 31, 1998:
<TABLE>
<CAPTION>
TOTAL OPTIONS OUTSTANDING
------------------------------------------------- TOTAL OPTIONS EXERCISABLE
WEIGHTED AVERAGE ------------------------------
NUMBER REMAINING WEIGHTED AVERAGE NUMBER WEIGHTED AVERAGE
RANGE OF EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
- ------------------------ ----------- ---------------- ---------------- ----------- ----------------
<S> <C> <C> <C> <C> <C>
$0.003-2.990............... 3,360,308 9.13 years $ 1.90 791,457 $ 1.62
3.000-4.990............... 489,190 10.00 years 3.84 -- --
5.000-11.50............... 789,012 9.97 years 7.10 160,802 7.18
--------- -------
4,638,510 952,259
</TABLE>
Options vest over varying time periods ranging from zero to five years.
During 1998 and 1996 respectively, 527,500 and 1,217,250 outstanding options
were repriced at the then current market value. Such options are included in
both the granted and canceled options reported in the above schedule.
The Company's Employee Stock Purchase Plan allows eligible employees to
authorize the Company to withhold from 1% to 10% of gross earnings to purchase
shares of the Company's Common Stock. Shares are purchased by participants at
the lower of 85% of fair market value at either the beginning or purchase date
of each 24 month offering period. Purchase dates are every six months. As of
December 31, 1998, 300,000 shares were authorized for purchase pursuant to the
plan and 223,436 shares had been issued.
40
<PAGE>
LEARN2.COM, INC.
(FORMERLY KNOWN AS 7TH LEVEL, INC.)
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
9. STOCKHOLDERS' EQUITY (CONTINUED)
The Company adopted SFAS No. 123, "Accounting for Stock Based Compensation",
during 1996 and elected to continue to apply the intrinsic value method provided
under Accounting Principles Board ("APB") Opinion No. 25 and related
interpretations in accounting for its stock based compensation plans described
above. If compensation costs for the Company's stock-based compensation plans
had been determined under the fair value method, the Company's net loss
available to common shareholders per share would have been increased to the pro
forma amounts indicated below:
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C> <C>
Net loss (in thousands).......................... As Reported $(15,134) $(20,202) $(23,716)
Pro forma (18,623) (23,273) (28,482)
Basic and diluted loss per Common share.......... As Reported $ (0.53) $ (0.91) $ (1.16)
Pro forma (0.66) (1.04) (1.39)
</TABLE>
The fair value of each option grant and employee purchase rights are
estimated on the date of grant using the Black-Scholes option-pricing model with
the following weighted-average assumptions: no dividend yield; expected
volatility of 67 to 211 percent; risk free interest rates of 5.2 to
6.5 percent; and variable expected lives of zero, two and one-half and five
years, depending on the characteristics of the individual grants. The pro forma
amounts are based upon assumptions that the Company's management believes are
reasonable; however, the Company has a relatively short history on which to base
these estimates. The assumptions used in option pricing models significantly
affect the estimated value of stock benefits and, accordingly, the pro forma
amounts do not purport to represent the Company's results of operations for any
future period.
As a result of negotiations with underwriters in connection with ViaGrafix's
initial public stock offering in March 1998, management, for financial statement
purposes, reassessed the fair value of its common stock as of each option grant
date prior to March 1998 for the purpose of determining the amount of unearned
compensation expense, if any, under APB No. 25. Based upon management's revised
estimates, unearned compensation of $181,000 related to the January 1997,
ViaGrafix stock option grants was recognized in 1997 and is being amortized over
the five-year vesting period.
WARRANTS
In connection with a $2,000,000 bridge loan agreement entered into in 1994
between the Company and certain existing stockholders prior to the initial
public offering, the Company issued warrants to purchase 350,000 shares of
Common Stock at $7.50 per share. The warrants expired October 11, 1999. At
December 31, 1998, 278,195 of these warrants were outstanding.
In connection with the acquisition of PyroTechnix, the Company assumed the
liability for outstanding warrants of PyroTechnix. There were warrants for 5,000
shares of PyroTechnix common stock and as of December 31, 1997, 19,268 shares of
the Company's Common Stock had been issued to cover the exercise of all of these
warrants.
In May 1998, in connection with the private placements (See Note 3), the
Company issued warrants to purchase 675,000 and 1,375,000 shares of Common Stock
at an exercise price of $0.01 per
41
<PAGE>
LEARN2.COM, INC.
(FORMERLY KNOWN AS 7TH LEVEL, INC.)
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
9. STOCKHOLDERS' EQUITY (CONTINUED)
share. The Company allocated approximately $1,200,000 and $2,500,000,
respectively, of the total proceeds of $10,000,000 to these warrants. All of the
warrants were exercised in June 1998. In connection with the exchange of the
Notes issued in the above mentioned private placement the Company issued
additional warrants to purchase 1,125,000 shares of Common Stock at an exercise
price of $0.01 per share. During 1998, 750,000 shares of Common Stock were
issued upon the exercise of the warrants and warrants for 375,000 shares
remained outstanding at December 31, 1998. Subsequent to year end all of these
warrants were exercised.
In December 1998, as part of the stock subscription agreement between the
Company and Fletcher, the Company issued rights to purchase an additional
100,000 and 650,000 shares of Common Stock for $.01 and $4.50, respectively (See
Note 3). As of December 31, 1998, all of these rights remain outstanding.
10. LEASES
The Company leases office facilities in California and Texas and certain
office equipment under operating leases that expire at various dates through
2002. Rental expense for operating leases amounted to $522,000, $966,000 and
$936,000 for 1998, 1997 and 1996, respectively.
Minimum payments under leases expiring subsequent to December 31, 1998 are
as follows (in thousands):
<TABLE>
<CAPTION>
CAPITAL OPERATING
YEAR LEASES LEASES
- ---- -------- ---------
<S> <C> <C>
1999....................................................... $161 $ 522
2000....................................................... 48 384
2001....................................................... 3 391
2002....................................................... -- 265
---- ------
Total.................................................. $212 $1,562
Less amount representing interest.......................... (18)
----
Present value of minimum lease payments.................. $194
====
</TABLE>
11. MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK
SFAS No. 105, "Disclosure of Information About Financial Instruments with
Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit
Risk", requires disclosure of any significant off balance sheet and credit risk
concentration. The Company has no significant off-balance-sheet concentration of
credit risk such as foreign currency exchange contracts or other hedging
arrangements. Financial instruments that subject the Company to credit risk
consist of cash and cash equivalents and accounts receivable. The Company places
its temporary cash in financial institutions. For the years ended December 31,
1998 and 1997, one customer represented approximately 26% and 11% of the
Company's total net revenues, respectively. The Company did not have any
customers which individually accounted for more than 10% of total sales for the
year ended December 31, 1996.
42
<PAGE>
LEARN2.COM, INC.
(FORMERLY KNOWN AS 7TH LEVEL, INC.)
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
11. MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK (CONTINUED)
The Company sells and markets, primarily in the United States and Canada,
its training products and software directly and through resellers and
distributors. Training product sales for the years ended December 31, 1998,
1997, and 1996 were 73%, 45% and 23%, respectively, of total net sales. During
the year ended December 31, 1998, approximately 38% of the Company's net sales
were through direct sales and 62% through resellers, major retailers and
distributors.
The Company does not require collateral from its customers. Its credit
policy is in accordance with normal industry trade and credit terms. Credit
losses relating to the Company's customers have not been significant.
12. RELATED PARTY TRANSACTIONS
In January 1997, ViaGrafix entered into an agreement with Street
Technologies, Inc., now known as Learn2, Inc. pursuant to which Learn2, Inc.
agreed to pay royalties for sales of ViaGrafix networkable multimedia products
and ViaGrafix agreed to pay royalties to Learn2, Inc. on licenses sold for
networkable multimedia training products developed using Learn2, Inc. products.
For the years ended December 31, 1998 and 1997, Learn2, Inc. paid net royalties
excluding the $620,000 prepayment discussed below of $292,000 and $315,000,
respectively, to ViaGrafix. The president and chief executive officer of
Learn2, Inc. was a director of ViaGrafix.
In 1998, ViaGrafix rented an airplane from an affiliate for use in traveling
to trade shows and other marketing activities. Total costs charged by the
affiliate during the year ended December 31, 1998 was $37,000.
In September 1998, ViaGrafix paid $620,000 to amend the agreement with
Learn2, Inc. whereby the royalty paid to Learn2, Inc. on licenses sold for
networkable multimedia training products developed using Learn2, Inc. products
was reduced through September 30, 2000. At that time, ViaGrafix has the option
to pay an additional $250,000 to reduce the royalty paid on Learn2, Inc.'s
products for the life of their products. The $620,000 payment was capitalized as
prepaid royalty and license and is being amortized over 24 months. Prepaid
royalty and license amortization expense was $78,000 for the year ended
December 31, 1998.
In July 1998, the Company issued a $188,000 note receivable to an officer as
part of an employment agreement. The note receivable is secured by a first
mortgage on his residence, earns interest at 8% per annum and is payable monthly
with a balloon payment in July 2000.
13. EMPLOYEE BENEFIT PLANS
The Company sponsors 401(k) plans for its employees whereby employees that
qualify for participation under the plan can contribute up to 15% of their
salary, on a before tax basis, subject to a maximum contribution limit as
determined by the Internal Revenue Service. The Company matched participant
contributions 50% up to a maximum of 6% of a participant's salary. For the years
ended December 31, 1998, 1997 and 1996, the Company made contributions to the
plan of approximately $131,000, $231,000 and $280,000, respectively. The Company
does not provide any post-retirement benefits other than the 401(k) plans.
43
<PAGE>
LEARN2.COM, INC.
(FORMERLY KNOWN AS 7TH LEVEL, INC.)
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
14. COMMITMENTS AND CONTINGENCIES
On May 22, 1998, a lawsuit was filed as a putative class action against the
Company's ViaGrafix subsidiary and certain of its officers and directors
claiming violations of the Securities Act of 1933 for alleged misrepresentations
and omissions in the prospectus issued in connection with ViaGrafix's initial
public offering made in March 1998. The Company believes the lawsuit is without
merit.
The Company is involved in other claims and lawsuits that are generally
incidental to its business. The Company is vigorously contesting all such
matters and believes that their ultimate resolution will not have a material
adverse effect on the Company's consolidated financial position, results of
operations or cash flows.
15. INDUSTRY SEGMENTS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" (SFAS No. 131). SFAS NO. 131 superseded SFAS
No. 14, "Financial Reporting for Segments of a Business Enterprise". SFAS
No. 131 establishes standards for the way that public business enterprises
report information about operating segments in annual financial statements and
requires that those enterprises report selected information about operating
segments in interim financial reports. SFAS No. 131 also establishes standards
for related disclosures about products and services, geographic areas, and major
customers. In the initial year of application, comparative information for
earlier years must be restated. Management has determined that it does not have
any separately reportable business segments.
16. SUBSEQUENT EVENTS
A. STREET TECHNOLOGIES, INC. ACQUISITION
In February 1999, the Company acquired Learn2, Inc., a company that uses
streaming technology to market and sell its extensive catalog of online training
course products. Effective as of the date of the merger, Street
Technologies, Inc. changed its name to Learn2, Inc. To consummate the
transaction, the Company issued 4,948,182 shares of Common Stock and 21,644
shares of Series D 8% Preferred Stock (the "Series D Stock") with an aggregate
liquidation preference of $21,643,970. Upon the receipt of Common Stockholders
approval to convert, the Series D Stock will convert into Common Stock at $3.00
per share. The Series D 8% Preferred Stockholders are entitled to participate
with the Common Stockholders in dividends and distributions and to vote on most
matters on an "as converted" basis with the Common stockholders and as a
separate class, except for the vote on whether to convert the Series D Stock.
The total value of the transaction is approximately $36 million and will be
accounted for using the purchase method of accounting.
B. CONVERSION OF 7% CONVERTIBLE NOTES PAYABLE
The 7% Convertible Notes Payable were due and payable on February 11, 1999
(See Note 8). To induce the holders to convert the notes into Common Stock, the
Company on February 10, 1999, offered the holders the right to convert at a
price equal to 85% of the then current market rate of the stock. During
February 1999, the Company issued 186,982 shares of Common Stock in exchange for
$458,000 of current notes payable. Accordingly, the Company recognized interest
expense in the
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LEARN2.COM, INC.
(FORMERLY KNOWN AS 7TH LEVEL, INC.)
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
16. SUBSEQUENT EVENTS (CONTINUED)
amount of $115,000. As of June 30, 1999 the remaining balance of $27,000 has not
been paid to the one remaining holder.
C. SETTLEMENT OF LAWSUIT
Subsequent to December 31, 1998, ViaGrafix settled a lawsuit filed in
December 1998, arising out of operations. The amount of the settlement was
$172,000 and it is reflected in 1998, general and administrative expenses.
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17. NOTES TO UNAUDITED QUARTERLY FINANCIAL STATEMENTS FOR THE THREE MONTHS AND
SIX MONTHS ENDED JUNE 30, 1999 AND 1998
A. BASIS OF PRESENTATION
In the opinion of management, the accompanying unaudited condensed
supplementary consolidated financial statements contain all adjustments
necessary to present fairly the financial position of Learn2.com, Inc. (formerly
known as 7th Level, Inc.) and subsidiaries (the "Company") as of June 30, 1999
and the results of operations for the three and six month periods ended
June 30, 1999 and June 30, 1998 and statement of cash flows for the six months
ended June 30, 1999 and June 30, 1998. These condensed supplementary
consolidated financial statements should be read in conjunction with the
consolidated financial statements of the Company contained herein.
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
disclosures 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. The results
of operations for any interim period are not necessarily indicative of the
results to be expected for the entire year ending December 31, 1999. The
condensed supplementary consolidated financial statements for the periods ended
June 30, 1999 and 1998 have been restated to reflect the May 1999 acquisition of
Panmedia Corporation ("Panmedia") and the August 1999 acquisition of ViaGrafix
Corporation ("ViaGrafix"), which were accounted for as a pooling of interests.
Certain amounts in the prior periods' condensed consolidated financial
statements have been reclassified for comparative purposes to conform to the
current period presentation.
B. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REVENUE RECOGNITION
The Company recognizes revenue in accordance with the provisions of
Statement of Position ("SOP") No. 97-2, "Software Revenue Recognition." Revenues
from software license agreements are recognized upon delivery and acceptance of
the software if there are no significant post-delivery and acceptance
obligations, and payment is fixed and determinable. Revenues for post-contract
customer support are recognized ratably over the term of the support period.
Revenues from development and consulting services are recognized in the period
in which services are provided and the revenues are fixed and determinable.
For direct and indirect sales to organizations, the Company recognizes
revenue for the software license at the time of sale. In most instances, the
Company provides web hosting services. The Company recognizes revenue for this
post-contract support ratably over the hosting period, which is generally one
year.
The Company recognizes revenue from the sale to resellers during the year as
product is delivered and payment is made. In most instances, the Company
provides web hosting services and therefore recognizes revenue for this
post-contract support ratably over the hosting period.
Revenue from web site design and implementation services for corporate
clients is recognized based on either time and materials charges incurred during
the period, the acheivement of project milestones as defined by customer
contracts or percentage of completion for fixed fee contracts.
SOFTWARE DEVELOPMENT COSTS
The Company capitalizes software development costs in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 86, "Accounting for the
Costs of Computer Software to Be Sold,
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<PAGE>
Leased or Otherwise Marketed." SFAS 86 requires the capitalization of certain
software development costs once technological feasibility is established and
until such time as the product is available for general release. The capitalized
cost is then amortized on a straight-line basis over the estimated product life,
or on the ratio of current revenues to total projected product revenues,
whichever is greater.
C. RECENT DEVELOPMENTS AND BUSINESS COMBINATIONS
On July 14, 1999, the Company changed its name from 7th Level, Inc. to
Learn2.com, Inc. The change was made in order to create a single brand and to
more closely align the Company's identity with its product offerings.
VIAGRAFIX ACQUISITION
In August 1999, the Company acquired ViaGrafix ("ViaGrafix") Corporation.
Under the terms of the agreement, the Company issued 10,684,988 shares of its
common stock. This represents 1.846 shares for each share of ViaGrafix common
stock outstanding. The acquisition was accounted for as a pooling-of-interests
and, accordingly, the accompanying financial statements and footnotes have been
restated to include the operations of ViaGrafix for all periods presented.
PANMEDIA ACQUISITION
In May 1999, the Company merged with Panmedia Corporation ("Panmedia"). The
Company exchanged 1,543,860 shares of common stock for all the outstanding
common shares of Panmedia. The merger was accounted for as a
pooling-of-interests, and, accordingly, the accompanying financial statements
and footnotes have been restated to include the operations of Panmedia for all
periods presented.
Components of the condensed supplementary consolidated results of operations
of Learn2.com and of ViaGrafix and Panmedia prior to their acquisitions by
Learn2.com are as follows (in thousands):
<TABLE>
<CAPTION>
SIX MONTHS ENDED THREE MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -------------------
1999 1998 1999 1998
-------- -------- -------- --------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
NET REVENUES
Learn2.com.............................................. $ 1,829 $ 534 $ 1,238 $ 366
ViaGrafix............................................... 13,304 8,264 5,959 4,187
Panmedia................................................ 631 566 269 136
-------- ------- ------- -------
Total................................................... 15,764 9,364 7,466 4,689
======== ======= ======= =======
NET INCOME (LOSS)
Learn2.com.............................................. (16,141) (7,552) (2,621) (4,825)
ViaGrafix............................................... (1,261) 1,039 (710) 502
Panmedia................................................ 17 302 46 58
-------- ------- ------- -------
Total................................................... $(17,385) $(6,211) $(3,285) $(4,265)
======== ======= ======= =======
</TABLE>
STREET TECHNOLOGIES ACQUISITION
In February 1999, the Company acquired all of the outstanding stock of
Street Technologies, Inc., a privately held company, and renamed the subsidiary
Learn2, Inc. The Company began marketing and developing training solutions
delivered over intranets and the Internet. To consummate the transaction, the
Company issued 4,948,182 shares of common stock and 21,644 shares of Series D 8%
Preferred
47
<PAGE>
Stock (the "Series D Stock") with an aggregate liquidation preference of
$21.6 million. On July 29, 1999, the Series D Stock automatically converted into
7,214,666 shares of common stock, the day after stockholder approval of the
conversion. The total value of the transaction was approximately $40.4 million
including $3.1 million of assumed liabilities, which consisted primarily of
deferred revenue. The transaction was accounted for using the purchase method of
accounting. The results of Street Technologies, Inc. subsequent to the
acquisition are included in the Company's condensed supplmentary consolidated
statement of operations.
The aggregate purchase price consisted of the following (in thousands):
<TABLE>
<CAPTION>
DESCRIPTION AMOUNT
- ----------- --------
<S> <C>
Common stock................................................ $14,845
Preferred stock............................................. 21,644
-------
Subtotal.................................................. 36,489
Assumed liabilities......................................... 3,133
Acquisition costs........................................... 782
-------
Total................................................... $40,404
=======
</TABLE>
The purchase price was allocated to the net assets acquired based upon their
fair values. The fair values were determined by an independent appraisal. The
appraisal incorporated proven valuation procedures and techniques. The purchase
price has been allocated as follows (in thousands):
<TABLE>
<CAPTION>
DESCRIPTION AMOUNT
- ----------- --------
<S> <C>
Current assets.............................................. $ 1,763
Fixed assets................................................ 343
Other assets................................................ 490
Capitalized software........................................ 14,717
Intangible assets........................................... 3,519
Acquired in-process technology (written-off)................ 9,677
Goodwill.................................................... 9,895
-------
Total................................................... $40,404
=======
</TABLE>
The acquired in-process technology has been expensed as a charge against
operations and is included in the accompanying condensed consolidated statement
of operations for the six months ended June 30, 1999. The amount allocated to
acquired in-process technology relates to projects that had not yet reached
technological feasibility and that, until completion of development, had no
alternative future use. These projects require substantial development and
testing prior to reaching technological feasibility. However, these projects may
not reach technological feasibility and may not develop into products that may
be sold by the Company. The acquired in-process technology has required, and may
require substantial development by the Company. The intangible assets are being
amortized over seven to twenty years. The Company recorded approximately
$427,000 and $630,000 in amortization expense relating to these intangible
assets during the three and six months ended June 30, 1999, respectively.
The accompanying condensed supplmentary consolidated statement of operations
for the six months ended June 30, 1999 includes charges of approximately
$9.7 million associated with the write-off of acquired in-process technology and
approximately $2.5 million associated with a restructuring charge which includes
the write-off of redundant assets, excess office space and employee severance.
The following unaudited pro forma information has been prepared assuming that
this acquisition had taken place at the beginning of the period; it is not
necessarily indicative of results that may occur in the future.
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<PAGE>
PRO FORMA
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
----------------------------- -----------------------------
JUNE 30, 1999 JUNE 30, 1998 JUNE 30, 1999 JUNE 30, 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Revenue..................................... $ 7,750 $6,779 $ 16,095 $11,595
(Loss) income from operations............... (3,988) 2,078 (19,316) (369)
Net (loss) income........................... (3,304) 2,019 (18,095) (585)
(Loss) income per share..................... $ (.08) $ .06 $ (.42) $ (.02)
</TABLE>
ETRACKS.COM ACQUISITION
On July 31, 1998 ViaGrafix acquired certain assets of eTracks.com, Inc.
(formally known as Make It So, Inc.), a privately held company based in San
Mateo, California, that provides interactive email broadcast services for
businesses that rely on web-based commerce and transactions and operates
eTracks.com, an online community of currently more than 550,000 members, for
approximately $682,000. The transaction was financed with existing cash and was
accounted for as a purchase. The purchase price and related direct expenses
associated with the acquisition have been allocated based on the fair value of
the assets purchased. The results of operations for this acquisition have been
included in the Company's consolidated results of operations since the
acquisition date. Pro forma operating results are not presented, as they would
not differ materially from actual results for 1998. In January 1999, ViaGrafix
issued common shares equal to a 5% ownership in eTracks.com to a key employee of
eTracks.com. The value per share of the issued shares equaled the fair value per
share paid by ViaGrafix in July 1998.
D. INVENTORIES
Inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
----------- ------------
(UNAUDITED)
<S> <C> <C>
Finished goods....................................... $1,728 $ 996
Raw materials........................................ 1,029 913
------ ------
$2,757 $1,909
====== ======
</TABLE>
E. LOSS PER COMMON SHARE
Basic and diluted loss per share was determined by dividing the net loss by
the weighted average common shares outstanding during the period. Common stock
equivalents are excluded from the loss per share calculation, as their effect
would be anti-dilutive.
F. CONVERSION OF 7% CONVERTIBLE NOTES PAYABLE
The Company's 7% Convertible Notes Payable (the "Notes") were due and
payable on February 11, 1999. To induce the holders to convert the Notes into
common stock, the Company on February 10, 1999 agreed with the holders of the
Notes to amend the Notes to provide that the conversion price should be reduced
to a price equal to 80% of the then current market price of the common stock.
During February 1999, the Company issued 186,982 shares of common stock in
exchange for approximately $458,000 of the Notes. The difference between the
stated conversion price and the actual conversion price was approximately
$115,000 and is included as interest expense in the
49
<PAGE>
accompanying condensed supplementary consolidated statement of operations. As of
June 30, 1999 the remaining balance of $27,000 is still owed to one remaining
holder.
G. STOCKHOLDERS' EQUITY
In the first quarter of 1999, three members of the Board of Directors
exercised their options to purchase an aggregate of 960,000 shares of Common
Stock for an aggregate exercise price of $1,934,000. The outstanding balance of
$1,687,000 is included as notes and accounts receivable from directors in the
stockholders' equity section of the condensed supplementary consolidated balance
sheet. Under the terms of the promissory notes, interest accrues at a rate of 6%
per annum payable quarterly, or at the option of the holders, will accrue at a
rate of 7% per annum payable upon the maturity of the loan. The notes mature at
various dates in 2004.
As of June 30, 1999, all shares of the Company's Series B Convertible
Preferred Stock had been converted into shares of Common Stock.
H. COMMITMENTS AND CONTINGENCIES
LEGAL CONTINGENCIES
On May 22, 1998 a lawsuit was filed in the United States District Court for
the Northern District of Texas by Jonathan L. Gordon, as a putative class action
against ViaGrafix and certain of its officers and directors claiming violations
of the Securities Act of 1933 for alleged misrepresentations and omissions in
the Prospectus issued in connection with ViaGrafix's initial public offering
made in March 1998. Mr. Gordon and certain others have sought designation as
lead plaintiffs in the action. We believe the lawsuit is without merit. Our
response is not yet due.
The Company is involved in various claims and lawsuits that are generally
incidental to its business. The Company is vigorously contesting all such
matters and believes that their ultimate resolution will not have a material
adverse effect on the Company's consolidated financial position, results of
operations or cash flows.
I. RESTRUCTURING CHARGES
During the first quarter, the Company recorded a charge of approximately
$2.5 million of incurred direct costs primarily related to the merger with
Street Technologies, Inc. and the Company's reorganization plans to integrate
the operations of Street Technologies, Inc. and the Company. The charges were
comprised of the following: $1.4 million to write-off redundant assets, $493,000
excess office space and other costs, and $600,000 in employee severance costs.
The following table summarizes the activity in the accruals during the
period ended June 30, 1999. The balance of the restructuring accrual at
June 30, 1999 is included in accrued expenses on the condensed supplementary
consolidated balance sheet and is anticipated to be paid within the next three
years (in thousands);
<TABLE>
<CAPTION>
BALANCE AT
JUNE 30,
RESTRUCTURING NON-CASH CASH ----------
CHARGES CHARGES PAYMENTS PAYMENTS 1999
- ------- ------------- -------- -------- ----------
<S> <C> <C> <C> <C>
Write-off of redundant assets....... $1,400 $(1,385) $ (15) $ --
Office space and other costs........ 493 86 (164) 415
Employee severance costs............ 600 (34) (537) 29
------ ------- ----- -----
Total............................. $2,493 $(1,333) $(716) $ 444
====== ======= ===== =====
</TABLE>
50
<PAGE>
J. INDUSTRY SEGMENTS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" (SFAS No. 131). SFAS No. 131 superseded SFAS
No. 14, "Financial Reporting for Segments of a Business Enterprise". SFAS
No. 131 establishes standards for the way that public business enterprises
report information about operating segments in annual financial statements and
requires that those enterprises report selected information about operating
segments in interim financial reports. SFAS No. 131 also establishes standards
for related disclosures about products and services, geographic areas, and major
customers. In the initial year of application, comparative information for
earlier years must be restated. Management has determined that it does not have
any separately reportable business segments.
51
<PAGE>
EXHIBIT 99.8
REPORT OF INDEPENDENT AUDITORS
To Board of Directors and Shareholders
ViaGrafix Corporation
We have audited the consolidated balance sheets of ViaGrafix Corporation as
of December 31, 1998 and 1997, and the related statements of operations, changes
in stockholders' equity, and cash flows for each of the three years in the
period ended December 31, 1998 (not presented separately herein). Our audits
also included the financial statement schedule included in the Index to
Consolidated Financial Statements (not presented separately herein). These
financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule 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 consolidated financial position of
ViaGrafix Corporation at December 31, 1998 and 1997, and the consolidated
results of operations and cash flows for each of the three years in the period
ended December 31, 1998, in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
ERNST & YOUNG LLP
/s/ Ernst & Young LLP
(Original Manually Signed)
Tulsa, Oklahoma
March 19, 1999
