Exhibit 99.5
AUDITED FINANCIAL STATEMENTS
Classwell Learning Group Inc.
(A Development-Stage Company)
Period from July 27, 2000 (date of inception) through December 31, 2000
Classwell Learning Group Inc.
(A Development-Stage Company)
Audited Financial Statements
Period from July 27, 2000 (date of inception) through December 31, 2000
CONTENTS
Report of Independent Auditors.........................................................................1
Audited Financial Statements
Balance Sheet..........................................................................................2
Statement of Operations................................................................................3
Statement of Redeemable Convertible Common Stock and Stockholders' Deficit.............................4
Statement of Cash Flows................................................................................5
Notes to Financial Statements..........................................................................6
Report of Independent Auditors
To the Board of Directors and
Stockholders of Classwell Learning Group Inc.
We have audited the accompanying balance sheet of Classwell Learning Group Inc.
(a development-stage company) (the "Company") as of December 31, 2000, and the
related statements of operations, redeemable convertible common stock and
stockholders' deficit, and cash flows for the period from July 27, 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 financial statements referred to above present fairly, in
all material respects, the financial position of Classwell Learning Group Inc.
(a development-stage company) at December 31, 2000, and the results of its
operations and its cash flows for the period from July 27, 2000 (date of
inception) through December 31, 2000 in conformity with accounting principles
generally accepted in the United States.
The accompanying financial statements have been prepared assuming that Classwell
Learning Group Inc. will continue as a going concern. As more fully discussed in
Note 1, the Company has incurred operating losses since inception, and has not
achieved and does not expect to achieve sufficient revenues to support future
operations without additional financing. These conditions raise substantial
doubt about the Company's ability to continue as a going concern. Management's
plans in regards to these matters are also described in Note 1. The financial
statements do not include any adjustments to reflect the possible future effects
on the recoverability and classification of assets or the amounts and
classification of liabilities that may result from the outcome of this
uncertainty.
/s/ Ernst & Young LLP
Boston, Massachusetts
March 16, 2001
1
Classwell Learning Group Inc.
(A Development-Stage Company)
Balance Sheet
December 31, 2000
ASSETS
Current assets:
Cash and cash equivalents $ 2,319,937
Prepaid expenses and other current assets 174,678
-------------------
Total current assets 2,494,615
Property and equipment, net 1,513,889
Capitalized software costs 1,503,637
Electronic publishing and ancillary agreements, net 3,697,169
Goodwill, net 4,766,996
Prepaid royalties to shareholder 2,000,000
Investment 550,000
-------------------
Total assets $ 16,526,306
===================
LIABILITIES, REDEEMABLE CONVERTIBLE COMMON STOCK AND STOCKHOLDERS' DEFICIT
Current liabilities:
Royalties payable to stockholder $ 2,000,000
Accounts payable and accrued expenses 1,185,560
Accounts payable to stockholder 424,946
-------------------
Total current liabilities 3,610,506
Commitments
Redeemable convertible common stock:
Class A common stock, $0.001 par value; 11,000,000 shares authorized, 8,438,868 shares
issued and outstanding (stated at liquidation and redemption value) 39,650,534
Class D common stock, $0.001 par value; 7,800,000 shares authorized, no shares issued
and outstanding -
Common stock subscription receivables (Note 1 and 9) (20,404,417)
Stockholders' deficit:
Class B common stock, $0.001 par value; and 15,000,000 shares authorized, 159,253
share issued and outstanding 159
Class C common stock, $0.001 par value; and 2,018,744 shares authorized, issued and
outstanding 2,019
Additional paid-in capital 2,182,400
Accumulated deficit (6,990,292)
Deferred compensation (1,524,603)
-------------------
Total stockholders' deficit (6,330,317)
-------------------
Total liabilities, redeemable convertible common stock and
stockholders' deficit $ 16,526,306
===================
SEE ACCOMPANYING NOTES.
2
Classwell Learning Group Inc.
(A Development-Stage Company)
Statement of Operations
For the period from July 27, 2000 (date of inception)
through December 31, 2000
Operating expenses:
Research and development $ 3,639,899
Selling and marketing 1,756,394
General and administrative 1,504,973
-------------------
Loss from operations (6,901,266)
Interest income 118,989
-------------------
Loss before benefit from income taxes (6,782,277)
Income tax benefit 1,595,197
-------------------
Net loss $(5,187,080)
===================
SEE ACCOMPANYING NOTES.
3
Classwell Learning Group Inc.
(A Development-Stage Company)
Statement of Cash Flows
For the period from July 27, 2000 (date of inception)
through December 31, 2000
OPERATING ACTIVITIES
Net loss $ (5,187,080)
Adjustments to reconcile net loss to net cash used in operating activities:
Benefit from deferred tax liability (1,595,197)
Depreciation and amortization expense 728,216
Amortization of acquired prepaid license and market research 521,059
Stock-based compensation 286,897
Changes in operating assets and liabilities:
Prepaid expenses and other current assets (124,678)
Accounts payable and accrued expenses 1,185,560
Accounts payable to stockholder 424,946
---------------------
Net cash used in operating activities (3,760,277)
INVESTING ACTIVITIES
Purchases of property and equipment (1,206,914)
Capitalized software costs (1,321,477)
---------------------
Net cash used in investing activities (2,528,391)
FINANCING ACTIVITIES
Proceeds from sale of Class A and Class D common stock 8,606,586
Proceeds from sale of Class C common stock 2,019
---------------------
Net cash provided by financing activities 8,608,605
---------------------
Net increase in cash and cash equivalents 2,319,937
Cash and cash equivalents at July 27, 2000 (date of inception) -
---------------------
Cash and cash equivalents at December 31, 2000 $ 2,319,937
=====================
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Issuance of Class A, Class B and Class D common stock in conjunction with the
acquisition of certain noncash assets $ 9,207,378
=====================
Issuance of common stock subscription receivables in conjunction with issuance
of Class A and Class D common stock $20,404,417
=====================
Conversion of Class D common stock into Class A common stock $34,953,847
=====================
Accretion of Class A common stock to redemption value $ 1,803,212
=====================
Accrual of prepaid royalties to stockholder $ 2,000,000
=====================
SEE ACCOMPANYING NOTES.
4
Classwell Learning Group Inc.
(A Development-Stage Company)
Notes to Financial Statements
December 31, 2000
1. ORGANIZATION AND NATURE OF OPERATIONS
NATURE OF OPERATIONS
Classwell Learning Group Inc. (the "Company") was incorporated in the state of
Delaware on July 27, 2000 to provide online supplemental education services to
meet the educational needs of teachers, students, parents and administrators by
providing new teaching and learning resources. The Company's principal market is
the United States. The Company operates in a single segment: online education
services for pre-kindergarten through secondary education levels.
DEVELOPMENT STAGE REPORTING
The Company is considered to be in the development stage as no significant
revenues have been derived from operations. Accordingly, the financial
statements are presented in accordance with Statement of Financial Accounting
Standards ("SFAS") No. 7, ACCOUNTING AND REPORTING BY DEVELOPMENT STAGE
ENTERPRISES. The Company's ability to progress beyond the development stage is
subject to risks common to technology-based companies including, but not limited
to, the development of new technology, the ability to obtain adequate financing
to fund future operations, the successful development and marketing of
commercial products, expansion of markets and distribution channels, competition
from substitute products and larger companies, and dependence on key personnel.
GOING CONCERN
The Company has incurred significant operating losses since inception, and has
not achieved and does not expect to achieve sufficient revenues to support
future operations without additional financing. These conditions raise
substantial doubt about the Company's ability to continue as a going concern.
The financial statements have been prepared assuming that the Company will
continue as a going concern and, accordingly, do not include any adjustments to
reflect the possible future effects on the recoverability and classification of
assets or the amounts and classification of liabilities that may result from the
outcome of this uncertainty.
Management believes that the continued development of its products is the key
element to the Company's ability to secure adequate financing until the Company
is operating profitably. Management believes expected financing and current
operations will be sufficient to allow the Company to continue as a going
concern at least through 2001. Should revenues not materialize to planned
levels, or additional equity financing be unavailable to the Company, management
will restrict certain of the Company's planned activities and operations, as
necessary, to sustain operations and conserve cash resources.
5
Classwell Learning Group Inc.
(A Development-Stage Company)
Notes to Financial Statements (continued)
1. ORGANIZATION AND NATURE OF OPERATIONS (CONTINUED)
INITIAL CAPITALIZATION
On September 6, 2000, the Company entered into a stock purchase agreement with
Houghton Mifflin Company ("HMCo"), Sylvan Ventures, LLC (a subsidiary of Sylvan
Learning Systems, Inc.), Inception Capital, LLC and Event411.com, Inc.
(collectively the "Investors") whereby the Company issued shares of its Class A,
Class B, Class C and Class D common stock (collectively the "Common Stock") in
exchange for cash and stock subscription receivables from the Investors as well
as contributed assets from HMCo and Event411.com, Inc.
The following is a summary of the Common Stock exchanged in the transaction:
Issuance of 645,162 shares of Class A common stock $ 3,000,003
Issuance of 159,253 shares of Class B common stock 371,059
Issuance of 2,018,744 shares of Class C common stock 2,019
Issuance of 7,793,706 shares of Class D common stock 36,240,733
Issuance costs (1,393,414)
--------------------
$ 38,220,400
====================
The following is a summary of the assets that the Company received in exchange
for the issuance of the Common Stock:
Cash proceeds ($10,002,019, net of issuance costs of $1,393,414) $ 8,608,605
Stock subscription receivables 20,404,417
Prepaid license fees and market research 571,059
Property and equipment 612,766
Investment in Event411.com, Inc. 550,000
Electronic publishing and ancillary agreements 3,961,253
Goodwill 5,107,497
Deferred tax liabilities for electronic publishing and ancillary agreements (1,595,197)
--------------------
$ 38,220,400
====================
The allocation of purchase price to intangible assets reflects preliminary
estimates.
6
Classwell Learning Group Inc.
(A Development-Stage Company)
Notes to Financial Statements (continued)
1. ORGANIZATION AND NATURE OF OPERATIONS (CONTINUED)
The stock subscription receivables are noninterest bearing promissory note
agreements payable in three quarterly installments on December 1, 2000, March 1,
2001 and June 1, 2001. However, the Company can request payment of unpaid
principal owed under these agreements in which payment will be due 10 days after
such request. The Company has been receiving payment upon its request.
Subsequent to December 31, 2000, Inception Capital, LLC informed the Company
that it would not fund all of its stock subscription receivable. Accordingly,
the agreement is in the process of being renegotiated (see Note 9).
The electronic publishing and ancillary agreements are comprised of value
assigned to a trademark license arrangement and an electronic publishing
agreement entered into between the Company and HMCo. These agreements are
described in greater detail in Note 8.
In accordance with the terms of the stock purchase agreement, the Company
reimbursed HMCo for operating costs incurred on behalf of the Company from July
1, 2000 through September 6, 2000 while the Company completed formation and
initiated operations. Accordingly, the Company has reimbursed HMCo approximately
$858,000, consisting of approximately $813,000 in operating expenses and
approximately $45,000 in property and equipment purchases. The operating
expenses have been charged to operations as the stock purchase agreement had
valued the initial capitalization transaction on or about July 1, 2000, although
the transaction was not completed until September 6, 2000.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying financial statements reflect the application of certain
significant accounting policies as described in this note and elsewhere in the
accompanying financial statements and notes.
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
footnotes thereto. Actual results could differ from those estimates.
CASH EQUIVALENTS
The Company invests its excess cash primarily in money market mutual funds.
Accordingly, these investments are subject to minimal credit and market risk.
For financial reporting purposes, the Company considers all highly liquid
investments purchased with an original maturity of three months or less to be
cash equivalents.
7
Classwell Learning Group Inc.
(A Development-Stage Company)
Notes to Financial Statements (continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Major replacements and improvements
are capitalized while general repairs and maintenance are charged to expense as
incurred. Depreciation is computed using the straight-line method based upon the
estimated useful lives of the assets.
INVESTMENT
The Company accounts for its investment under the cost method. The Company
obtained 18,333 shares of Class A preferred stock in Event 411.com valued at
$550,000 as part of the consideration received from the stock purchase agreement
dated September 6, 2000, as described in Note 1.
CAPITALIZED SOFTWARE COSTS
Capitalized software costs consist of costs incurred in the development of the
Company's internet-based technology. Such costs consist of salaries, consulting
fees, and software licenses for the design, deployment and enhancement of the
Company's technology . The Company capitalizes such costs under Statement of
Position ("SOP") 98-1, ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE DEVELOPED
OR OBTAINED FOR INTERNAL USE, and Financial Accounting Standards Board Emerging
Issues Task Force ("EITF") Issue No. 00-2, ACCOUNTING FOR WEBSITE DEVELOPMENT
COSTS. Under SOP 98-1 and EITF 00-2, costs of internal use software are expensed
during the preliminary project and post-implementation stages. Costs are
capitalized during the application development stage. Capitalization ends when
the project is substantially complete and the software is ready for its intended
use. The Company capitalized approximately $1,504,000 since inception. No
amortization expense was recognized during this period. Capitalized software
development costs will be amortized over three years from the point that the
software is ready for its intended use.
8
Classwell Learning Group Inc.
(A Development-Stage Company)
Notes to Financial Statements (continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
GOODWILL AND OTHER INTANGIBLE ASSETS
Amortization of goodwill and other intangible assets is provided using the
straight-line method over their estimated useful lives, five years. Other
intangible assets consist of electronic publishing and ancillary agreements, and
are being amortized over their estimated useful lives of five years. The Company
reviews the carrying value of goodwill and other intangible assets for
impairment whenever events in circumstances indicate that the carrying value may
not be recoverable. At December 31, 2000, accumulated amortization for goodwill
and other intangible assets was $340,501 and $264,084, respectively.
INCOME TAXES
The Company provides for income taxes under SFAS No. 109, ACCOUNTING FOR INCOME
TAXES. Under SFAS No. 109, the liability method is used in accounting for income
taxes. Under this method, deferred 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.
STOCK-BASED COMPENSATION
The Company accounts for stock-based compensation in accordance with Accounting
Principles Board Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES ("APB
25"), and related interpretations. Accordingly, compensation expense is recorded
for stock options awarded to employees and directors to the extent that the
option exercise prices are less than the common stock's fair market value on the
date of grant, where the number of shares and exercise price are fixed. The
difference between the fair value of the Company's common stock and the exercise
price of the stock option, if any, is recorded as deferred compensation and is
amortized to compensation expense over the vesting period of the underlying
stock option. The Company follows the disclosure requirements of SFAS No. 123,
ACCOUNTING FOR STOCK-BASED COMPENSATION. All stock-based awards to nonemployees
are accounted for at their fair value in accordance with SFAS No. 123 and
related interpretations.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development costs are charged to expense as incurred. These costs
totaled approximately $3,640,000 in 2000.
9
Classwell Learning Group Inc.
(A Development-Stage Company)
Notes to Financial Statements (continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value of the Company's financial instruments, which include cash
equivalents, accounts payable, and accrued expenses approximate their fair
values at December 31, 2000. The estimated fair values of the Company's notes
receivable approximate their carrying value based upon current rates offered to
the Company for similar type arrangements (see Note 1 and 9).
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, ACCOUNTING FOR DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES, which establishes accounting and reporting
standards for derivative instruments and hedging activities. It requires that an
entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value. The
Company, to date, has not engaged in derivative and hedging activities, and
therefore the adoption of SFAS No. 133 and related amendments in fiscal year
2001 is not expected to have a material impact on its financial reporting.
In March 2000, the Financial Accounting Standards Board issued Interpretation
No. 44 ("FIN 44"), ACCOUNTING FOR CERTAIN TRANSACTIONS INVOLVING STOCK
COMPENSATION AN INTERPRETATION OF APB 25. FIN 44 clarifies guidance for certain
issues that arose in the application of APB 25. Areas of focus within FIN 44
include repricings, modifications to extend the opinion term, change of grantee
status, modifications to accelerate vesting and options exchanged in a purchase
business combination. FIN 44 is generally effective prospectively to new awards,
modifications to outstanding awards, and changes in employee status on or after
July 1, 2000.
3. PROPERTY AND EQUIPMENT
At December 31, 2000, property and equipment consisted of the following:
ESTIMATED
USEFUL LIFE
(IN YEARS)
---------------
Computer equipment 3 $ 1,509,508
Furniture and fixtures 5 128,012
-------------------
1,637,520
Less accumulated depreciation 123,631
-------------------
Property and equipment, net $ 1,513,889
===================
10
Classwell Learning Group Inc.
(A Development-Stage Company)
Notes to Financial Statements (continued)
4. COMMON STOCK
The Company has four classes of common stock: Class A, Class B, Class C and
Class D. Class B and Class C common stock are considered junior stock to Class A
common stock. The Company has reserved 8,438,868 shares and 1,700,000 shares of
Class B common stock for the conversion of Class A common stock and issuance
under the Company's 2000 Stock Compensation Plan, respectively.
The Company's common stock have the following significant characteristics:
LIQUIDATION, DISSOLUTION AND WINDING-UP
In the event of any voluntary or involuntary liquidation, dissolution or
winding-up of the Company, the holders of Class A common stock are entitled to
be paid out of the assets available for distribution, the purchase price ($4.65)
of the respective shares, plus unpaid dividends (declared or undeclared). All
remaining assets after the initial distribution to Class A common stockholders
shall be distributed on a pro rata basis among the holders of Class A, Class B
and Class C common stock based upon the number shares held by each, assuming
conversion of Class A common stock into Class B common stock. If the assets of
the Company are insufficient to pay the full preferential amounts to the holders
of Class A common stock, the assets will be distributed ratably among the
holders of Class A common stock in proportion to their aggregate liquidation
preference amounts. The holders of Class D common stock have no special rights
in liquidation, dissolution or winding-up. At December 31, 2000, the liquidation
value of Class A common stock equals its redemption value.
DIVIDENDS
The holders of Class A common stock are entitled to receive, when and if
declared by the Board of Directors, quarterly dividends at the per annum rate of
5.0% of $4.65 per share. Dividends accrue, whether or not declared or paid, and
are cumulative for liquidation purposes. Cumulative unpaid and undeclared
dividends included in the value of Class A common stock at December 31, 2000 are
approximately $410,000. The holders of Class B and Class C common stock are
entitled to receive dividends, when and if declared by the Board of Directors.
The holders of Class D common stock have no dividend rights.
11
Classwell Learning Group Inc.
(A Development-Stage Company)
Notes to Financial Statements (continued)
4. COMMON STOCK (CONTINUED)
REGISTRATION RIGHTS
At any time more than six months after a qualified public offering, as defined,
by the Company, a majority of the holders of Class A and Class B common stock
(the Registrable Securities) may request the Company to register the shares,
provided that the anticipated aggregate offering price of the registration is at
least $5,000,000. The holders of Class C and Class D common stock have no
registration rights.
REDEMPTION
At any time after August 1, 2005, upon the written request of a majority of
Class A common stockholders, excluding Houghton Mifflin Company, the Company is
required to redeem all of the Class A common stock outstanding. The redemption
price for the Class A common stock is equal to the greater of the fair market
value of Class A common stock or the original purchase price ($4.65) plus any
accrued or unpaid dividends. The Company is required to immediately redeem Class
C common stock, at par value, upon the issuance of Class B common stock for the
conversion of other securities into Class B common stock, the issuance of Class
B common stock upon the exercise of options or the vesting of restricted shares
of Class B common stock. At December 31, 2000, the Class A common stock has been
accreted to its redemption value.
RIGHT OF FIRST REFUSAL
At December 31, 2000, all holders of the Company's common stock have the right
of first refusal to purchase any new securities offered by the Company. The
right of first refusal terminates immediately prior to the closing of a
qualified initial public offering, as defined, of the Company's common stock.
CONVERSION
Each share of Class A common stock is initially convertible at the option of the
holder into one share of Class B common stock. The conversion ratio is subject
to adjustment upon the occurrence of certain dilutive events, such as, but not
limited to, stock splits, dividends, issuances of other securities, and change
in conversion price. Upon the consummation of a qualified public offering with
gross proceeds to the Company of not less than $25,000,000, all shares of Class
A common stock are subject to mandatory conversion. All shares of Class D common
stock are automatically converted, on a one-for-one basis, into Class A common
stock upon the earlier of the expiration or
12
Classwell Learning Group Inc.
(A Development-Stage Company)
Notes to Financial Statements (continued)
4. COMMON STOCK (CONTINUED)
termination of the waiting period prescribed by the Hart-Scott-Rodino Antitrust
Improvements Act of 1976, as amended. All shares of Class D common stock were
converted into Class A common stock on October 19, 2000 upon the termination of
the waiting period. Class B and Class C common stock have no conversion rights.
VOTING RIGHTS
The holders of Class A common stock are entitled to the number of votes equal to
the number of Class B common stock shares into which they are convertible. The
holders of Class A and Class C common stock vote with the holders of Class B
common stock as a single class. The holders of Class D common stock do not have
any voting rights. The holders of Class A common stock are also entitled to
nominate directors. Furthermore, the Company is required to obtain the approval
of a majority of the holders of Class A common stock for the sale of
substantially all of the Company's assets or declare, or pay, dividends on
junior stock and at least 85% of the holders of Class A common stock to amend or
restate the Company's certificate of incorporation or change the number of seats
of the Company's Board of Directors.
5. STOCK COMPENSATION PLAN
In February 2001, the Company's Board of Directors approved the 2000 Stock
Compensation Plan (the "Plan") for which 1,700,000 shares of Class B common
stock have been reserved. Under the terms of the Plan, the Company may grant
incentive stock options to employees of the Company and nonqualified stock
options, awards of restricted stock, and direct stock purchase opportunities to
directors, officers, employees and consultants of the Company. The exercise
price, vesting provisions and duration of incentive stock options and
nonqualified stock options shall be determined for each grant by the Board of
Directors. The maximum term of the options is ten years. Incentive stock options
may not be granted at less than the fair market value of the Company's common
stock at the date of grant and for a term not to exceed ten years. For holders
of 10% or more of the Company's outstanding common stock, options may not be
granted at less than 110% of the fair market value of the common stock at the
date of grant and the option term may not exceed five years. Nonqualified
options may be granted at an exercise price less than, equal to or greater than
the fair market value on the date of grant, as determined by the Board of
Directors.
13
Classwell Learning Group Inc.
(A Development-Stage Company)
Notes to Financial Statements (continued)
5. STOCK COMPENSATION PLAN (CONTINUED)
Incentive stock options generally vest over a four-year period. The Company's
stock option activity from July 27, 2000 (date of inception) through December
31, 2000 is summarized as follows:
WEIGHTED-
AVERAGE
EXERCISE
OPTIONS PRICE
-----------------------------------
Granted (exercise price below fair value) 800,000 $ 0.10
Granted (exercise price equal to fair value) 321,500 2.33
Canceled (20,000) 2.33
------------------
Outstanding at end of year 1,101,500 0.71
===================================
Exercisable at end of year 50,000 $ 0.10
===================================
The fair value of the options granted during the period from July 27, 2000 (date
of inception) through December 31, 2000 is estimated to be $2.26 for options
granted with exercise prices below the Class B common stock fair value and $0.63
for options granted with exercise prices equal to the Class B common stock fair
value.
The following table summarizes information about stock options outstanding and
exercisable at December 31, 2000:
WEIGHTED-
AVERAGE
REMAINING
OPTIONS CONTRACTUAL OPTIONS
EXERCISE PRICE OUTSTANDING LIFE (IN YEARS) EXERCISABLE
- ----------------------------------------------------------------------------------------------------
$ 0.10 800,000 9.7 50,000
2.33 301,500 9.8 -
--------------------- ---------------------
1,101,500 50,000
===================== =====================
14
Classwell Learning Group Inc.
(A Development-Stage Company)
Notes to Financial Statements (continued)
5. STOCK COMPENSATION PLAN (CONTINUED)
SFAS No. 123 encourages but does not require companies to record compensation
cost for stock-based employee compensation at fair value. The Company has chosen
to account for stock-based compensation granted to employees using the intrinsic
value method prescribed in APB 25 and related interpretations. Accordingly,
deferred compensation cost for restricted stock awards and stock options granted
to employees is measured as the excess, if any, of the fair value of the
Company's stock at the date of the grant over the amount that must be paid to
acquire the stock. For the period from July 27, 2000 (date of inception) through
December 31, 2000, the Company recorded $1,784,000 in deferred compensation for
options to purchase common stock granted at exercise prices determined to be
below the fair value of the common stock on the date of grant. The Company
recognized compensation expense of $278,187 during this period related to these
arrangements. Furthermore, during the same period, the Company recorded deferred
compensation and compensation expense of $27,500 and $8,710, respectively, for
options granted to nonemployees.
Option valuation models have been developed to estimate the fair value of traded
options, which have no vesting restrictions and are fully transferable. Such
models require the input of highly subjective assumptions. Because the Company's
employee stock options have characteristics significantly different from those
of traded options and because changes in the subjective input assumptions can
materially affect the fair value estimate, in management's opinion, the existing
models do not necessarily provide a reliable single measure of the fair value of
its employee stock options. The fair value of each option grant is estimated on
the date of grant using the minimum value method.
The following assumptions were made for grants in 2000:
Dividend yield 0%
Expected lives of options (in years) 5
Risk-free interest rate 5.33%-6.08%
Had the Company accounted for stock options to employees under the fair value
method prescribed under SFAS No. 123, pro forma net losses would have been as
follows (the effects of applying SFAS No. 123 in this pro forma disclosure are
not indicative of future amounts):
Net loss (as reported) $(5,187,080)
Incremental stock compensation expense (9,039)
---------------------
Pro forma net loss $(5,196,119)
=====================
15
Classwell Learning Group Inc.
(A Development-Stage Company)
Notes to Financial Statements (continued)
6. INCOME TAXES
A reconciliation of the Company's income tax provision to the statutory federal
and state provision is as follows:
Statutory federal income tax provision $ (2,306,000)
State income taxes, net of federal tax benefit (425,000)
Change in deferred tax asset valuation allowance 989,000
Amortization of goodwill 116,000
Other items 31,000
-------------------
Net income tax expense / (benefit) $ (1,595,000)
===================
Significant components of the Company's deferred tax liabilities and assets at
December 31, 2000 consist of the following:
Deferred tax liabilities:
Electronic publishing and ancillary agreements $ 1,489,000
Capitalized software costs 606,000
-------------------
Total deferred tax liabilities 2,095,000
Deferred tax assets:
Net operating loss carryforwards 1,899,000
Startup costs 1,166,000
Property and equipment 19,000
-------------------
Total deferred tax assets 3,084,000
Valuation allowance for deferred tax assets (989,000)
-------------------
Net deferred tax assets 2,095,000
-------------------
Net deferred tax liabilities / (assets) $ -
===================
The Company has net operating loss carryforwards for both federal and state of
approximately $4,716,000 available at December 31, 2000 to offset future taxable
income. The above net operating loss carryforwards expire at various times
through fiscal year 2020. Net operating loss carryforwards are subject to review
and possible adjustment by the Internal Revenue Service. Under the provisions of
the Internal Revenue Code, certain substantial changes in the Company's
ownership may limit the amount of net operating loss carryforwards which could
be utilized annually to offset future taxable income. Subsequent significant
ownership changes could further effect the limitation in future years.
16
Classwell Learning Group Inc.
(A Development-Stage Company)
Notes to Financial Statements (continued)
6. INCOME TAXES (CONTINUED)
The Company has incurred losses since inception and has provided a full
valuation allowance on its deferred tax assets at December 31, 2000 since
realization of these future benefits is uncertain.
No income taxes were paid in the period from July 27, 2000 (date of inception)
through December 31, 2000.
7. EMPLOYEE BENEFIT PLAN
In 2000, the Company established the Classwell 401(k) Plan (the "Plan") for its
employees, which is designed to be qualified under Section 401(k) of the
Internal Revenue Code. Eligible employees are permitted to contribute to the
Plan within statutory and plan limits. The Company has not contributed to the
Plan during 2000.
8. RELATED PARTY TRANSACTIONS
In accordance with the stock purchase agreement dated September 6, 2000, the
Company entered into the following arrangements with Houghton Mifflin Company
("HMCo"), a shareholder:
REIMBURSEMENT OF OPERATING EXPENSES
The Company reimbursed HMCo for operating costs incurred on behalf of the
Company from July 1, 2000 through September 6, 2000 while the Company completed
formation and initiated operations. Accordingly, the Company has reimbursed HMCo
approximately $858,000, consisting of approximately $813,000 in operating
expenses and approximately $45,000 in property and equipment purchases. The
operating expenses have been charged to operations as the stock purchase
agreement had valued the initial capitalization transaction on or about July 1,
2000, although the transaction was not completed until September 6, 2000.
ADMINISTRATIVE AND SERVICES AGREEMENT
The Company entered into an agreement with HMCo that provides administrative
support services including payroll processing, use of a general ledger system,
use of an accounts payable and check processing system, and access to consulting
and or other support services. The monthly cost for these administrative support
services is $1,000 plus time and materials costs for consulting or other
support. The agreements is scheduled to terminate on May 31, 2001. During 2000,
the Company charged administrative support expenses to operations of
approximately $12,000 related to this agreement.
17
Classwell Learning Group Inc.
(A Development-Stage Company)
Notes to Financial Statements (continued)
8. RELATED PARTY TRANSACTIONS (CONTINUED)
USE AND OCCUPANCY AGREEMENT
The Company has an agreement with HMCo that grants the Company a license to
occupy certain leased space and use certain furniture and equipment for a
monthly cost of approximately $49,000. The agreement was scheduled to terminate
on May 31, 2001. The Company has made arrangements to extend the license of the
leased space and equipment with minimum lease payments totaling approximately
$592,000 for 2001. During 2000, the Company charged rent expense to operations
of approximately $222,000. The Company also paid approximately $33,000 to HMCo
for utilization of property and equipment under this agreement.
TRADEMARK LICENSE ARRANGEMENT
The Trademark License Agreement ("TLA") allows the Company to use HMCo licensed
trademarks, including HMCo's trade name and as defined, for approximately ten
years through December 31, 2010 on a royalty free, nonexclusive basis. Through
August 1, 2003, HMCo cannot grant the use of its licensed trademarks to any of
the Company's competitors. Furthermore, for a two-year period, the TLA requires
that HMCo will not establish a new business until after December 31, 2002 that
is substantially equivalent in scope and nature to the Company.
ELECTRONIC PUBLISHING AGREEMENT
The Electronic Publishing Agreement ("EPA") provides the Company with electronic
revision and electronic distribution rights of HMCo copyrighted materials, as
defined. The EPA includes provisions for a royalty payment equal to 5% of net
revenues earned until December 31, 2003, 4% in 2004, 3% in 2005 and 1%
thereafter until December 31, 2010. The EPA includes terms for a minimum royalty
payment of $8 million payable in cash and/or stock. A maximum of $4 million can
be paid with voting stock, at the Company's option. The fair value of the stock
is valued at $4.65 for the purposes of this agreement.
Minimum royalty payments are scheduled as follows:
OBLIGATION DATE PAYMENT DUE DATE
-------------------------- -------------------------
$2.0 million payable in cash September 6, 2000 October 31, 2001
$2.0 million payable in cash October 31, 2001 October 31, 2001
$1.3 million payable in cash or stock October 31, 2001 October 31, 2001
$1.35 million payable in cash or stock October 31, 2002 October 31, 2002
$1.35 million payable in cash or stock October 31, 2003 October 31, 2003
18
Classwell Learning Group Inc.
(A Development-Stage Company)
Notes to Financial Statements (continued)
8. RELATED PARTY TRANSACTIONS (CONTINUED)
Each minimum royalty payment shall be used to offset percentage royalties due
HMCo by crediting such minimum payments against royalties owed HMCo during the
term of the ten-year agreement. As of December 31, 2000, the Company has
recorded $2.0 million of prepaid royalties and $2.0 million in accrued royalties
to recognize the minimum royalty obligation due as of October 31, 2001. HMCo
may, in its sole discretion, extend the payment due dates, but not the
obligation dates, for any, or all, of the royalty payments due as of October 31,
2001 to the earlier to occur of (a) January 30, 2002, or (b) to the date of
closing of a next round of equity financing by the Company.
9. SUBSEQUENT EVENTS
INCEPTION CAPITAL, LLC STOCK SUBSCRIPTION RECEIVABLE
In conjunction with the Company's stock purchase transaction on September 6,
2000, the Company issued a stock subscription receivable to Inception Capital,
LLC. The stock subscription receivable is a noninterest bearing promissory note
agreement payable in three quarterly installments of $2,220,492, $1,973,770 and
$839,942 on December 1, 2000, March 1, 2001 and June 1, 2001, respectively.
However, the Company can request payment of unpaid principal owed under the
agreement in which payment will be due 10 days after such request. Subsequent to
December 31, 2000, Inception Capital, LLC informed the Company that it would not
fund the total amount of its stock subscription receivable. Accordingly, the
Company and Inception Capital, LLC are currently renegotiating this agreement.
EDTOPIA.COM ASSET PURCHASE AND SALE AGREEMENT
On February 2, 2001, the Company entered into an Asset Purchase and Sale
Agreement with Edtopia.com (d/b/a GlobaLearn) ("Edtopia") whereby the Company,
for a purchase price of $206,500, agreed to purchase certain intellectual
property and miscellaneous property and equipment from Edtopia. The payment of
$206,500 is comprised of $81,500 paid at the closing and issuance of a
noninterest bearing note for $125,000 due February 2, 2002.
19
Classwell Learning Group Inc.
(A Development-Stage Company)
Statement of Redeemable Convertible Common Stock and Stockholders' Deficit
For the period from July 27, 2000 (date of inception) through December 31, 2000
Class A Common Stock Class D Common Stock Common Stock
---------------------------- -------------------------- Subscription
Shares Amount Shares Amount Receivable
------------ ------------- ----------- ------------- --------------
Issuance of Class A, Class B, Class C and Class D
common stock for cash, subscription receivable,
fixed assets and intangible assets, net of
issuance costs of $1,393,414, on September 6, 2000 645,162 $ 2,893,475 7,793,706 $ 34,953,847 $(20,404,417)
Conversion of Class D common stock into Class A
common stock on October 19, 2000 ................. 7,793,706 34,953,847 (7,793,706) (34,953,847)
Deferred compensation related to stock options
grants to employees and nonemployees .............
Amortization of deferred compensation ..............
Accretion of Class A common stock to
redemption value ................................. 1,803,212
Net loss ...........................................
------------ ------------- ----------- ------------- --------------
Balance at December 31, 2000 ....................... 8,438,868 $39,650,534 -- $ - $(20,404,417)
============ ============= =========== ============= ==============
Class B Common Stock Class C Common Stock Additional
----------------------- ------------------------ Paid-in Accumulated
Shares Par Value Shares Par Value Capital Deficit
---------- ------------ ----------- ----------- ---------- -------------
Issuance of Class A, Class B, Class C and Class D
common stock for cash, subscription receivable,
fixed assets and intangible assets, net of
issuance costs of $1,393,414, on September 6, 2000 159,253 $ 159 2,018,744 $ 2,019 $ 370,900
Conversion of Class D common stock into Class A
common stock on October 19, 2000 .................
Deferred compensation related to stock options
grants to employees and nonemployees ............. 1,811,500
Amortization of deferred compensation ..............
Accretion of Class A common stock to
redemption value ................................. $ (1,803,212)
Net loss ........................................... (5,187,080)
---------- ------------ ----------- ----------- ---------- -------------
Balance at December 31, 2000 ....................... 159,253 $ 159 2,018,744 $ 2,019 $2,182,400 $ (6,990,292)
========== ============ =========== =========== ========== =============
Total
Deferred Stockholders'
Compensation Deficit
------------ -------------
Issuance of Class A, Class B, Class C and Class D
common stock for cash, subscription receivable,
fixed assets and intangible assets, net of
issuance costs of $1,393,414, on September 6, 2000 $ 373,078
Conversion of Class D common stock into Class A
common stock on October 19, 2000 .................
Deferred compensation related to stock options
grants to employees and nonemployees ............. $(1,811,500) --
Amortization of deferred compensation .............. 286,897 286,897
Accretion of Class A common stock to
redemption value ................................. (1,803,212)
Net loss ........................................... (5,187,080)
------------ -------------
Balance at December 31, 2000 ....................... $(1,524,603) $(6,330,317)
============ =============
See accompanying notes.