MINDSURF, INC.
Audited Consolidated Financial Statements
For the Period October 25, 2000 (inception) through December 31, 2000 with
Report of Independent Auditors
MindSurf, Inc.
(a Development Stage Enterprise)
Audited Consolidated Financial Statements
For the period October 25, 2000 (date of inception) through December 31, 2000
Contents
Report of Independent Auditors.................................................2
Audited Consolidated Financial Statements
Consolidated Balance Sheet ....................................................3
Consolidated Statement of Operations ..........................................5
Consolidated Statement of Stockholders' Equity ................................6
Consolidated Statement of Cash Flows...........................................7
Notes to Consolidated Financial Statements.....................................8
Report of Independent Auditors
The Board of Directors and Stockholders
MindSurf, Inc.
We have audited the accompanying consolidated balance sheet of MindSurf, Inc., a
development stage company, as of December 31, 2000, and the related consolidated
statements of operations, stockholders' equity and cash flows for the period
October 25, 2000 (date of inception) through December 31, 2000. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of MindSurf, Inc. at
December 31, 2000, and the results of its operations and its cash flows for the
period October 25, 2000 (date of inception) through December 31, 2000, in
conformity with accounting principles generally accepted in the United States.
/s/Ernst & Young LLP
Baltimore, Maryland
February 22, 2001
2
MindSurf, Inc.
(a Development Stage Company)
Consolidated Balance Sheet
December 31, 2000
Assets
Current assets:
Cash $ 1,925,545
Restricted cash 160,215
Prepaid expenses 71,054
Other current assets 107,674
------------
Total current assets 2,264,488
Property and equipment:
Furniture and equipment 1,488,310
Software 970,020
Leasehold improvements 22,955
------------
2,481,285
Accumulated depreciation (139,182)
------------
2,342,103
Intangible assets:
Goodwill 20,481,386
Assembled workforce 4,868,500
------------
25,349,886
Accumulated amortization (1,170,113)
------------
24,179,773
Security deposits 513,156
------------
Total assets $ 29,299,520
============
3
MindSurf, Inc.
(a Development Stage Company)
Consolidated Balance Sheet (continued)
December 31, 2000
Liabilities and stockholders' equity
Current liabilities:
Accounts payable and accrued expenses $ 2,875,027
Accrued compensation 258,706
Due to related parties 1,333,266
Current portion of capital lease obligations 99,398
Dividends payable 43,397
------------
Total current liabilities 4,609,794
Capital lease obligations, less current portion 183,619
Commitments and contingent obligations --
Stockholders' equity:
Series Y Preferred Stock, par value $.01 per share -23,391,812 shares
authorized, issued and outstanding; aggregate liquidation value of
$ 16,000,000 233,918
Series B Convertible Preferred Stock, par value $.01 per share - 8,040,936
shares authorized, issued and outstanding; aggregate liquidation value of
$5,579,562 80,409
Series A Convertible Preferred Stock, par value $.01 per share
-28,500,000 shares authorized, 17,543,860 shares issued and outstanding;
aggregate liquidation value of $10,144,658 175,439
Series X Preferred Stock, par value $.01 per share -28,500,000 shares
authorized, no shares issued and outstanding --
Common stock , par value $.01 per share - 40,000,000 shares authorized,
no shares issued and outstanding --
Additional paid-in capital 31,946,136
Unearned compensation (291,891)
Deficit accumulated during the development stage (7,637,904)
------------
Total stockholders' equity 24,506,107
------------
Total liabilities and stockholders' equity $ 29,299,520
============
See accompanying notes.
4
MindSurf, Inc.
(a Development Stage Company)
Consolidated Statement of Operations
For the period October 25, 2000 (date of inception)
through December 31, 2000
Revenues $ --
Costs and expenses
Sales and marketing 1,330,731
General and administrative 2,673,018
Research and development 2,314,094
Services and other charges from related parties 1,333,266
-----------
Total operating costs and expenses 7,651,109
-----------
Loss from operations (7,651,109)
Interest income 13,205
-----------
Net loss accumulated during the development stage $(7,637,904)
===========
See accompanying notes.
5
MindSurf, Inc.
(a Development Stage Company)
Consolidated Statement of Stockholders' Equity
For the period October 25, 2000 (date of inception)
through December 31, 2000
Series B Series A
Series Y Convertible Convertible Series X
Preferred Preferred Stock Preferred Preferred Common
Stock Stock Stock Stock
------------------------------------------------------------------------
Issuance of 14,298,246 shares of Series A
Convertible Preferred Stock at inception for cash
of $8,150,000, net of direct costs of
issuance of $140,001 (see Note 8) $ -- $ -- $ 142,983 $ -- $ --
Issuance of 8,040,936 shares of Series B
Convertible Preferred Stock on October 25, 2000
valued at $5,500,000 in connection with
acquisition of HiFusion (see Note 2) -- 80,409 -- -- --
Issuance of 23,391,812 shares of Series Y
Preferred Stock on October 25, 2000 valued at
$16,000,000 in connection with acquisition of
HiFusion (see Note 2) 233,918 -- -- -- --
Conversion of liabilities assumed in acquisition
of HiFusion to 3,245,614 shares of Series A
Convertible Preferred Stock at face value of
$1,850,000 (see Note 8) -- -- 32,456 -- --
Value of options to purchase common stock to be
issued in connection with acquisition of
HiFusion (see Note 2) -- -- -- -- --
Amortization of unearned compensation -- -- -- -- --
Accrued dividends on Series Y Preferred Stock -- -- -- -- --
Net loss for the period October 25, 2000 (date of
inception) through December 31, 2000 -- -- -- -- --
------------------------------------------------------------------------
Balance at December 31, 2000 $ 233,918 $ 80,409 $ 175,439 $ -- $ --
========================================================================
Deficit
Accumulated
Additional During
Paid-In Unearned Development
Capital Compensation Stage Total
---------------------------------------------------------------
Issuance of 14,298,246 shares of Series A
Convertible Preferred Stock at inception for cash
of $8,150,000, net of direct costs of
issuance of $140,001 (see Note 8) $ 7,867,016 $ -- $ -- $ 8,009,999
Issuance of 8,040,936 shares of Series B
Convertible Preferred Stock on October 25, 2000
valued at $5,500,000 in connection with
acquisition of HiFusion (see Note 2) 5,419,591 -- -- 5,500,000
Issuance of 23,391,812 shares of Series Y
Preferred Stock on October 25, 2000 valued at
$16,000,000 in connection with acquisition of
HiFusion (see Note 2) 15,766,082 -- -- 16,000,000
Conversion of liabilities assumed in acquisition
of HiFusion to 3,245,614 shares of Series A
Convertible Preferred Stock at face value of
$1,850,000 (see Note 8) 1,817,544 -- -- 1,850,000
Value of options to purchase common stock to be
issued in connection with acquisition of
HiFusion (see Note 2) 1,119,300 (310,421) -- 808,879
Amortization of unearned compensation -- 18,530 -- 18,530
Accrued dividends on Series Y Preferred Stock (43,397) -- -- (43,397)
Net loss for the period October 25, 2000 (date of
inception) through December 31, 2000 -- -- (7,637,904) (7,637,904)
---------------------------------------------------------------
Balance at December 31, 2000 $ 31,946,136 $ (291,891) $ (7,637,904) $ 24,506,107
===============================================================
6
MindSurf, Inc.
(a Development Stage Company)
Consolidated Statement of Cash Flows
For the period October 25, 2000 (date of inception)
through December 31, 2000
Operating activities
Net loss accumulated during the development stage $ (7,637,904)
Adjustments to reconcile net loss accumulated during the development
stage to net cash used in operating activities:
Depreciation 138,182
Amortization of intangible assets 1,170,113
Amortization of unearned compensation 18,530
Changes in operating assets and liabilities:
Prepaid expenses 30,151
Other current assets (107,424)
Accounts payable and accrued expenses (896,000)
Accrued compensation 47,008
Due to related parties 1,333,266
------------
Net cash used in operating activities (5,904,078)
Investing activities
Purchase of property and equipment (146,090)
------------
Net cash used in investing activities (146,090)
Financing activities
Issuance of Series A Convertible Preferred Stock for cash 8,009,999
Payments of capital lease obligations (34,286)
------------
Net cash provided by financing activities 7,975,713
------------
Net change in cash and cash at end of period $ 1,925,545
============
Non-Cash Investing and Financing Activities
Issuance of Series B Convertible Preferred Stock in
connection with acquisition of HiFusion, Inc. $ 5,500,000
Issuance of Series Y Preferred Stock in connection
with acquisition of HiFusion, Inc. 16,000,000
Conversion of notes payable assumed in acquisition
of HiFusion to shares of Series A Convertible Preferred Stock 1,850,000
See accompanying notes.
7
MindSurf, Inc.
(a Development Stage Company)
Notes to Consolidated Financial Statements
December 31, 2000
1. Organization and Summary of Significant Accounting Policies
Organization
MindSurf, Inc., (the "Company") was incorporated on October 25, 2000 under the
laws of the state of Delaware for the purpose of providing an affordable mobile
wireless computing infrastructure that seamlessly links students, teachers and
parents, improving communication in the school community and enriching the K-12
learning experience. The Company was established as a strategic partnership
between Sylvan Learning Systems, Inc. ("Sylvan"), Aether Systems, Inc.
("Aether") and Critical Path, Inc. ("Critical Path").
Since inception, the Company's activities have consisted primarily of
organizational and research and development activities for its planned principal
operations. Accordingly, no revenue has been earned, and the Company is
considered a development stage company at December 31, 2000.
Principles of Consolidation
The consolidated financial statements include the accounts of Mindsurf, Inc. and
its wholly owned subsidiary, HiFusion, Inc. ("HiFusion"). All material
intercompany accounts and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Restricted Cash and Letter of Credit
Restricted cash consists of cash pledged as collateral on an outstanding letter
of credit expiring on November 30, 2001 that is required under the Company's
operating lease for office space. At December 31, 2000, restricted cash consists
of a certificate deposit bearing interest at 5.10% and maturing on November 19,
2002. Any amounts drawn under the letter of credit will bear interest at the
prime rate.
8
MindSurf, Inc.
(a Development Stage Company)
Notes to Consolidated Financial Statements (continued)
1. Organization and Summary of Significant Accounting Policies (continued)
Property and Equipment
Property and equipment is stated at cost and depreciated using the straight-line
method over estimated useful lives of three years. Assets held under capital
leases are stated at the lesser of the present value of future minimum lease
payments using the Company's incremental borrowing rate at the inception of the
lease or the fair value of the property at the inception of the lease. The
assets recorded under capital leases are generally amortized over the lesser of
the lease term or the estimated useful life of the assets in a manner consistent
with the Company's depreciation policy for owned assets. Amortization of assets
under capital leases is included in depreciation expense.
Intangible Assets
Intangible assets consist of goodwill and assembled workforce recorded in
connection with the acquisition of HiFusion on October 25, 2000. The Company
amortizes its goodwill and assembled workforce using the straight-line method
over estimated useful lives of four years.
Impairment of Long-Lived Assets
Long-lived assets, including intangible assets, are reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be fully recoverable. If an impairment indicator is present,
the Company evaluates whether an impairment exists on the basis of undiscounted
expected future cash flows from operations for the remaining amortization
period. If an impairment exists, the asset is reduced by the estimated shortfall
of discounted cash flows from the asset's carrying value.
Security Deposits
Security deposits consist of amounts deposited with lessors to secure the
Company's obligations under certain capital lease obligations. These amounts
will be refunded to the Company upon the satisfaction of all payments under the
related leases that expire through 2003.
9
MindSurf, Inc.
(a Development Stage Company)
Notes to Consolidated Financial Statements (continued)
1. Organization and Summary of Significant Accounting Policies (continued)
Research and Development and Software Development Costs
Costs for the development of new software products are expensed as research and
development costs as incurred until technological feasibility is established, at
which time any additional development costs are capitalized until the product is
available for general release to customers. The Company defines technological
feasibility as the completion of a working model of the software product that
has been tested to be consistent with the product design specifications. As of
December 31, 2000, the Company has not established technological feasibility for
its software under development and therefore all costs have been expensed as
research and development costs.
Income Taxes
The Company uses the liability method in accounting for income taxes. Under this
method, deferred income tax assets and liabilities are determined based on
differences between financial reporting and tax bases of assets and liabilities
and are measured using the enacted tax rates and laws that will be in effect
when the differences are expected to reverse.
Advertising
The Company expenses advertising costs as incurred. Advertising expense totaled
approximately $142,000 for the period October 25, 2000 (date of inception)
through December 31, 2000.
Effect of Pending Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement No. 133,
Accounting for Derivative Instruments and Hedging Activities, as amended, which
is required to be adopted in years beginning after June 15, 2000. Because of the
Company's minimal use of derivatives, the adoption of the new Statement will not
have a significant effect on earnings or the financial position of the Company.
10
MindSurf, Inc.
(a Development Stage Company)
Notes to Consolidated Financial Statements (continued)
2. Acquisition of HiFusion
On October 25, 2000, the Company acquired all of the outstanding common stock of
HiFusion, Inc. ("HiFusion"), an Internet education portal developer and service
provider for teachers, parents and students. The purchase price consisted of
8,040,936 shares of Series B Convertible Preferred Stock valued at $5,500,000
and 23,391,812 shares of Series Y Preferred Stock valued at $16,000,000. The
securities issued in the acquisition were valued in good faith by the Company
based on contemporaneous cash transactions in its equity securities and other
pertinent factors. In addition, the Company agreed to exchange all of the
outstanding vested and unvested options to purchase an aggregate of 2,899,250
shares of common stock of HiFusion for options to purchase the same number of
shares of common stock of the Company at an exercise price of $0.57 per share.
The fair value of the options to be granted to the former HiFusion option
holders was estimated by the Company to be $1,119,300, determined using the
Black-Scholes option-pricing model. This amount has been included in the total
purchase price, reduced by the portion related to unearned employee compensation
of $310,421.
The acquisition was accounted for using the purchase method of accounting, and
the results of operations of HiFusion are included in the accompanying
consolidated statement of operations commencing October 25, 2000. The total
purchase price is summarized as follows:
Series B Convertible Preferred Stock $ 5,500,000
Series Y Preferred Stock 16,000,000
Options to purchase common stock 1,119,300
Less: unearned compensation (310,421)
------------
$ 22,308,879
============
The total purchase price was allocated as follows:
Current assets $ 699,655
Property and equipment 2,335,195
Notes payable (1,850,000)
Other liabilities assumed (4,225,857)
Goodwill 20,481,386
Assembled workforce 4,868,500
------------
$ 22,308,879
============
11
MindSurf, Inc.
(a Development Stage Company)
Notes to Consolidated Financial Statements (continued)
3. Services Agreements with Related Parties
Upon formation, the Company entered into service agreements with each of three
principal stockholders, as described below.
Under the master services agreement with Sylvan, Sylvan will provide certain
marketing, product development, sales, financial, and other management or
administrative services upon request. Under the agreement Sylvan will also
provide certain start up resources such as interim facilities, recruitment,
financial accounting, and temporary labor to help accelerate the Company's
business plan. Under the agreement, the Company is required to pay a quarterly
fee that is based on Sylvan's good faith estimate of the cost of such services.
This agreement has a five-year term, is renewable for one additional year, and
can be terminated by either party with 60 days notice. Sylvan charged the
Company $736,918 under this master services agreement for the period October 25,
2000 (date of inception) through December 31, 2000, principally related to
research and development activities, which is included in services and other
charges from related parties in the accompanying consolidated statement of
operations and due to related parties in the accompanying consolidated balance
sheet.
Under the master services agreement with Aether, Aether will provide wireless
systems integration technology, network implementation, and product support
services. Aether will charge an hourly rate for its personnel used during the
internal development and preparation of the network. The hourly rate will be
established and agreed upon in advance and will be invoiced on a monthly basis.
Any direct materials will be charged at Aether's cost. This agreement has a
five-year term, is renewable for one additional year, and can be terminated by
either party with 60 days notice. Aether charged the Company $580,959 under this
master services agreement for the period October 25, 2000 (date of inception)
through December 31, 2000, which is included in services and other charges from
related parties in the accompanying consolidated statement of operations and due
to related parties in the accompanying consolidated balance sheet.
12
MindSurf, Inc.
(a Development Stage Company)
Notes to Consolidated Financial Statements (continued)
3. Services Agreements with Related Parties (continued)
Under the master services agreement with Critical Path, Critical Path will
provide professional services to develop Internet-based messaging services to be
integrated into the Company's product offerings, and related customer support
services. The cost of these services will be determined based on terms that are
commercially favorable and will be invoiced on a monthly basis. This agreement
has a five-year term, is renewable for one additional year and is can be
terminated by either party with 60 days notice. Critical Path charged the
Company $15,389 under this master services agreement for the period October 25,
2000 (date of inception) through December 31, 2000, which is included in
services and other charges from related parties in the accompanying consolidated
statement of operations and due to related parties in the accompanying
consolidated balance sheet.
4. Income Taxes
The significant components of the Company's deferred tax assets and liabilities
as of December 31, 2000 are as follows:
Deferred tax assets:
Net operating loss carryforward $ 9,468,087
Contribution carryforward 614
Vacation pay accrual 76,045
-----------
Total deferred tax assets 9,544,746
Deferred tax liabilities:
Depreciation 73,003
-----------
Net deferred tax assets 9,471,743
Valuation allowance for deferred tax assets (9,471,743)
-----------
Net deferred tax assets $ --
===========
The Company has reported losses since inception. The losses have not resulted in
reported tax benefits because of increases in the valuation allowance for
deferred tax assets that result primarily from the inability to determine the
realizability of the net operating loss carryforwards. The Company paid no
income taxes during the period October 25, 2000 (date of inception) through
December 31, 2000.
13
MindSurf, Inc.
(a Development Stage Company)
Notes to Consolidated Financial Statements (continued)
4. Income Taxes (continued)
At December 31, 2000, the Company had net operating loss carryforwards of
approximately $24,516,000 which expire in 2020. Included in this amount is
approximately $18,172,000 of net operating loss carryforwards acquired from
HiFusion for which a full valuation allowance was applied on the date of the
acquisition. These net operating loss carryforwards begin to expire in 2019 and
are available only to offset future taxable income of HiFusion. Upon the
realization of the HiFusion net operating loss carryforwards, the benefit
realized from the elimination of the valuation allowance will be recorded as a
reduction of goodwill.
A reconciliation of the reported income tax expense to the amount that would
result by applying the U.S. federal statutory rate to the loss for the period
October 25, 2000 (date of inception) through December 31, 2000 is as follows:
Tax benefit at U.S. statutory rate of 34% $(2,596,887)
Effect of permanent differences 436,578
State income taxes, net of federal benefit (293,548)
Effect of change in valuation allowance for deferred tax assets 2,453,857
-----------
Total $ --
===========
5. Capital Lease Obligations
The Company has entered into capital lease agreements to acquire certain
equipment. Property and equipment in the accompanying balance sheet includes
this equipment, which has a cost of $350,979 and accumulated amortization of
$46,773. Amortization of the leased property is included in depreciation
expense.
Future minimum payments under capital lease obligations consist of the following
at December 31, 2000:
2001 $ 122,058
2002 121,575
2003 77,508
---------
Total minimum lease payments 321,141
Amounts representing interest (38,124)
---------
Present value of net minimum lease payments
(including current portion of $99,398) $ 283,017
=========
14
MindSurf, Inc.
(a Development Stage Company)
Notes to Consolidated Financial Statements (continued)
6. Series Y Preferred Stock
As of December 31, 2000, the Company has authorized the issuance of up to
88,432,748 shares of preferred stock, par value $0.01 per share, of which
23,391,812 has been designated Series Y Preferred Stock ("Series Y"). On October
25, 2000, in connection with the acquisition of HiFusion (see Note 2), the
Company issued 23,391,812 shares of Series Y that were valued at $16,000,000.
Dividends
The holders of the Series Y are entitled to receive cumulative dividends at the
annual rate of $0.0103 per share out of assets of the Company legally available
for distribution, payable annually on each October 1. In the event of
non-payment, the dividends will accrue at the annual rate of $0.0239 per share
until paid. After the third anniversary of the issuance date, the holders of the
Series Y are entitled to receive cumulative dividends at the annual rate of
$0.041 per share out of assets of the Company legally available for
distribution, payable annually on each October 1. In the event of non-payment,
the dividends will accrue at the annual rate of $0.0547 per share until paid.
The dividend rights of the Series Y holders are superior to all other classes of
securities. As of December 31, 2000, the Company has accrued dividends payable
to the Series Y holders of $43,397.
The Series Y was recorded at estimated fair value on the date of issuance,
assuming a constant dividend yield of 6% per annum. The excess of the redemption
value over the fair value of $1,918,610 is being accreted by periodic charges to
additional paid-in capital during the period from the date of issuance through
the commencement of the perpetual dividend payments using the interest method.
Liquidation
Each share of Series Y has a preference on liquidation equal to $0.684 per share
plus all accrued and unpaid dividends. The liquidation preference of the Series
Y is senior to the holders of all other securities.
Voting Rights
The holders of the Series Y are not entitled to vote.
15
MindSurf, Inc.
(a Development Stage Company)
Notes to Consolidated Financial Statements (continued)
6. Series Y Preferred Stock (continued)
Redemption
At any time beginning immediately prior to the closing of an underwritten public
offering with at least $35 million of gross proceeds to the Company or the
change of control of the Company (a "redemption event"), the Company may redeem
all of part of the issued and outstanding shares of Series Y at a price equal to
$0.684 per share plus all accrued and unpaid dividends. If the Company does not
redeem all of the issued and outstanding shares of Series Y within 30 days of a
redemption event, the holders of the Series Y will be entitled to cash dividends
at an annual rate of $0.137 per share.
7. Series B Convertible Preferred Stock
The Company has authorized the issuance of up to 8,040,936 shares of Series B
Convertible Preferred Stock ("Series B"), par value $0.01 per share. On October
25, 2000, in connection with the acquisition of HiFusion (see Note 2), the
Company issued 8,040,936 shares of Series B that was valued at $5,500,000.
Conversion Rights
The Series B is convertible into common stock, at the option of the holder,
beginning 18 months after the date of issuance. In addition, the Series B will
convert automatically into shares of common stock upon the closing of an
underwritten public offering with at least $35 million of gross proceeds to the
Company, upon the change of control of the Company, or upon the affirmative vote
of two-thirds of the Series B holders. Each share of Series B is initially
convertible into one share of common stock. This conversion ratio is subject to
adjustment upon the occurrence of certain specified dilutive events.
16
MindSurf, Inc.
(a Development Stage Company)
Notes to Consolidated Financial Statements (continued)
7. Series B Convertible Preferred Stock (continued)
Dividends
The holders of the Series B are entitled to receive cumulative dividends at the
annual rate of $0.0547 per share commencing on the date of issuance and
continuing until the third anniversary of issuance, when and if declared by the
Board of Directors, and regardless of whether there are actual profits or other
funds available for dividend payment. These dividend rights of the Series B
holders are superior to those of the common stockholders and equal to the rights
of the holders of the Series A Convertible Preferred Stock ("Series A"). After
the third anniversary of the issuance date, the holders of the Series B are
entitled to receive cumulative dividends at the annual rate of $0.041 per share
out of assets of the Company legally available for distribution, payable
annually on each October 1. In the event of non-payment, the dividends will
accrue at the annual rate of $0.0547 per share until paid. These dividend rights
of the Series B holders are superior to both the common and Series A
stockholders. Dividends in arrears on the Series B were $79,562 at December 31,
2000.
Liquidation
Each share of Series B has a preference on liquidation equal to $0.684 per share
plus all accrued and unpaid dividends. The liquidation preference of the Series
B is senior to the holders of the Series A but subordinate to the holders of the
Series Y.
Voting Rights
The holders of the Series B are not entitled to vote.
8. Series A Convertible Preferred Stock
The Company has authorized the issuance of up to 28,500,000 shares of Series A,
par value $0.01 per share. On October 25, 2000, the Company entered into a stock
purchase agreement with Sylvan, Aether, and Critical Path under which it has
agreed to sell an aggregate of 122,807,017 shares of Series A for gross proceeds
of $70,000,000. In connection with the execution of this agreement, the Company
issued 17,543,860 shares of Series A in exchange for cash of $8,150,000 and the
termination of certain notes payable to Aether (assumed in the acquisition of
HiFusion) with an aggregate face value of $1,850,000. The Company can call the
remaining $60,000,000 at any time after certain funding targets set forth in the
stock purchase agreement are met (see Note 14).
17
MindSurf, Inc.
(a Development Stage Company)
Notes to Consolidated Financial Statements (continued)
8. Series A Convertible Preferred Stock (continued)
Conversion Rights
The Series A is convertible into common stock at the option of the holder at any
time. In addition, the Series A will convert automatically into shares of common
stock upon the closing of an underwritten public offering with at least $35
million of gross proceeds to the Company, upon the change of control of the
Company, or upon the affirmative vote of two-thirds of the Series A holders.
Each share of Series A is initially convertible into one share of common stock.
This conversion ratio is subject to adjustment upon the occurrence of certain
specified dilutive events.
Dividends
The holders of Series A are entitled to receive cumulative dividends at the
annual rate of $0.0456 per share when and if declared by the Board of Directors,
and regardless of whether there are actual profits or other funds available for
dividend payment. The dividend rights of the Series A holders are superior to
those of the common stockholders. Dividends in arrears on the Series A were
$144,658 at December 31, 2000.
Liquidation
Each share of Series A has a preference on liquidation equal to $0.57 per share
plus all accrued and unpaid dividends. The liquidation preference of the Series
A is subordinate to the holders of the Series B and the Series Y.
Voting Rights
Each share of Series A has substantially the same voting rights as the number of
shares of common stock into which it can be converted. In addition, certain
corporate actions require the consent of two-thirds of the outstanding shares of
Series A and the holders of the Series A in the aggregate are entitled to
appoint all seven members of the Board of Directors.
18
MindSurf, Inc.
(a Development Stage Company)
Notes to Consolidated Financial Statements (continued)
9. Series X Preferred Stock
The Company has authorized the issuance of up to 28,500,000 shares of Series X
Preferred Stock ("Series X"), par value $0.01 per share. As of December 31,
2000, the Company has not issued any Series X.
The Series X is not convertible into common stock, does not accrue dividends and
the holders are not entitled to vote. Each share of Series X has a preference on
liquidation equal to $0.57 per share. The liquidation preference of the Series X
is subordinate to the holders of the Series A, Series B and Series Y.
10. Stock Options
On October 25, 2000, the Company adopted the Mindsurf Inc. 2000 Equity Incentive
Plan. The plan allows for the grant of options to purchase common stock to
employees, officers, directors and consultants of the Company in the form of
incentive and non-qualified stock options. The aggregate number of shares of
common stock that may be issued under the plan may not exceed 15% of the total
number of shares of common stock issued and outstanding, assuming the conversion
of all convertible securities. As of December 31, 2000, options to purchase
4,514,964 shares of common stock may be granted under the plan.
No awards have been granted as of December 31, 2000; however, the Company has
agreed to grant options to purchase 2,899,250 shares common stock to the former
option holders of HiFusion at an exercise price of $0.57 per share as required
under the purchase agreement (see Note 2).
11. Shares Reserved for Future Issuance
As of December 31, 2000, the Company has reserved shares of common stock for
issuance as follows:
Conversion of Series A 17,543,860
Conversion of Series B 8,040,936
Exercise of stock options available for granting
under 2000 Equity Incentive Plan 4,514,964
----------
30,099,760
==========
19
MindSurf, Inc.
(a Development Stage Company)
Notes to Consolidated Financial Statements (continued)
12. Operating Leases
The Company leases office space and certain computer equipment under
non-cancelable operating leases. Future minimum lease payments under
non-cancelable operating leases consisted of the following at December 31, 2000:
2001 $1,160,460
2002 383,261
2003 320,964
----------
$1,864,685
==========
Rent expense under all operating leases for the period October 25, 2000 (date of
inception) through December 31, 2000 was $542,217.
13. Employee Benefit Plan
Effective October 25, 2000, the Company adopted the defined contribution
retirement plan previously established by HiFusion, Inc. The plan covers
substantially all employees of the Company. Participants may contribute from 1%
to 15% of their annual compensation to the plan. In addition, the Company may
make discretionary matching and profit-sharing contributions to the plan. As of
December 31, 2000, no discretionary contributions have been made to the plan.
20
MindSurf, Inc.
(a Development Stage Company)
Notes to Consolidated Financial Statements (continued)
14. Liquidity and Capital Resources
For the period October 25, 2000 (date of inception) through December 31, 2000,
the Company incurred a net loss of $7.6 million and used $5.9 million of cash in
its operations. A working capital deficit of $2.3 million exists at December 31,
2000. To provide needed capital, the Company's agreement with Sylvan, Aether,
and Critical Path provides for the sale of an aggregate of 122,807,017 shares of
Series A for gross proceeds of $70 million. As of December 31, 2000, the Company
has issued 17,543,860 shares of Series A for total consideration of $10 million.
The Company can call the remaining $60 million at any time after certain funding
targets set forth in the stock purchase agreement are met. These funding targets
are summarized as follows:
1. Successful installation and initiation of prototype testing in one
class in the selected target school allows the Company to call $10
million.
2. Successful installation and initiation of demonstration system
testing more than one class in the selected target school allows the
Company to call an additional $20 million.
3. The sale of the first 100 units allows the Company to call the final
$30 million.
In November 2000, the Company met the first funding target and in January 2001
called $10 million from the investors. On February 16, 2001, $9.4 million was
received from Sylvan and Aether in addition to $2.3 million of additional
voluntary funding. As a result of not participating in this capital call, the
1,052,632 shares of Series A held by Critical Path have been converted into
Series X.
In addition, in February 2001, the Company met the second funding target, but
has not yet called the $20 million available under that target. Management
believes that the amounts received to date and the amounts currently callable
provide sufficient capital in the near term to meet the Company's obligations in
the normal course of business.
21