Exhibit 99.4
MINDSURF, INC.
Audited Consolidated Financial Statements
Year ended December 31, 2001 and the period October 25, 2000 (date of
inception) through December 31, 2000 with Report of Independent Auditors
Mindsurf, Inc.
Audited Consolidated Financial Statements
Year ended December 31, 2001 and the period October 25, 2000 (date of
inception) through December 31, 2000
CONTENTS
Report of Independent Auditors...........................................................................1
Audited Consolidated Financial Statements
Consolidated Balance Sheets..............................................................................2
Consolidated Statements of Operations....................................................................4
Consolidated Statements of Stockholders' Equity (Deficit)................................................5
Consolidated Statements 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 sheets of Mindsurf, Inc.,
as of December 31, 2001 and 2000, and the related consolidated statements of
operations, stockholders' equity (deficit) and cash flows for the year ended
December 31, 2001 and 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 audits.
We conducted our audits 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 audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Mindsurf, Inc. at
December 31, 2001 and 2000, and the results of its operations and its cash flows
for the year ended December 31, 2001 and the period October 25, 2000 (date of
inception) through December 31, 2000, in conformity with accounting principles
generally accepted in the United States.
The accompanying consolidated financial statements have been prepared assuming
that Mindsurf, Inc. will continue as a going concern. As more fully described in
Note 18, the Company's current and projected operating losses and limited
committed funding raise substantial doubt about its ability to continue as a
going concern. Management's plans to address this matter are also described in
Note 18. The consolidated 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
Baltimore, Maryland
March 22, 2002
Mindsurf, Inc.
Consolidated Balance Sheets
DECEMBER 31
2001 2000
------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 807,217 $ 1,925,545
Restricted cash - 160,215
Accounts receivable 782,809 -
Deferred costs 289,841 -
Prepaid expenses and other current assets 185,436 178,728
------------------------------------
Total current assets 2,065,303 2,264,488
Property and equipment:
Furniture and equipment 1,769,550 1,488,310
Software 1,067,349 970,020
Leasehold improvements - 22,955
------------------------------------
2,836,899 2,481,285
Accumulated depreciation (972,377) (139,182)
------------------------------------
1,864,522 2,342,103
Intangible assets:
Goodwill - 20,481,386
Purchased software development costs 2,822,779 -
Assembled workforce 323,780 4,868,500
------------------------------------
3,146,559 25,349,886
Accumulated amortization (409,909) (1,170,113)
------------------------------------
2,736,650 24,179,773
Deferred costs, less current portion 88,809 -
Security deposits 419,172 513,156
------------------------------------
Total assets $7,174,456 $29,299,520
====================================
2
Mindsurf, Inc.
Consolidated Balance Sheet (continued)
DECEMBER 31
2001 2000
------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable and accrued expenses $ 1,023,806 $ 2,875,027
Accrued compensation 259,648 258,706
Deferred revenue 545,644 -
Due to related parties for services and other charges 14,505 1,333,266
Current portion of capital lease obligations 104,321 99,398
Dividends payable 284,048 43,397
------------------------------------
Total current liabilities 2,231,972 4,609,794
Capital lease obligations, less current portion 74,865 183,619
Deferred revenue, less current portion 127,000 -
Convertible debt to related parties 13,200,000 -
Accrued interest on convertible debt to related parties 498,411 -
Stockholders' equity:
Series Y Preferred Stock, par value $.01 per share - 23,391,812 shares
authorized, issued and outstanding in 2001 and 2000; aggregate liquidation
value of $16,284,048 and $16,043,397 in
2001 and 2000, respectively 233,918 233,918
Series B Convertible Preferred Stock, par value $.01 per share -
8,040,936 shares authorized, issued and outstanding in 2001 and
2000; aggregate liquidation value of $6,027,004 and $5,579,562 in
2001 and 2000, respectively 80,409 80,409
Series A Convertible Preferred Stock, par value $.01 per share
-69,122,807 and 28,500,000 shares authorized in 2001 and 2000,
respectively; 42,807,017 and 17,543,860 shares issued and outstanding in
2001 and 2000, respectively; aggregate liquidation value of $11,923,897 and
$10,144,658 in 2001 and 2000,
respectively 428,071 175,439
Series C Convertible Preferred Stock, par value $.01 per share -
7,044,115 shares authorized, issued and outstanding in 2001;
aggregate liquidation value of $2,123,937 in 2001 70,441 -
Series X Preferred Stock, par value $.01 per share - 70,175,439 and
28,500,000 shares authorized in 2001 and 2000, respectively;
1,052,632 shares issued and outstanding in 2001; aggregate
liquidation value of $600,000 in 2001 10,526 -
Common stock, par value $.01 per share - 40,000,000 shares
authorized in 2001 and 2000; 99,093 shares issued and outstanding
in 2001 991 -
Additional paid-in capital 48,159,175 31,946,136
Unearned compensation (34,224) (291,891)
Accumulated deficit (57,907,099) (7,637,904)
------------------------------------
Total stockholders' equity (deficit) (8,957,792) 24,506,107
------------------------------------
Total liabilities and stockholders' equity (deficit) $ 7,174,456 $29,299,520
====================================
SEE ACCOMPANYING NOTES.
3
Mindsurf, Inc.
Consolidated Statements of Operations
PERIOD
OCTOBER 25, 2000
YEAR ENDED (DATE OF INCEPTION)
DECEMBER 31, THROUGH DECEMBER 31,
2001 2000
-----------------------------------------------
Revenues $ 327,483 $ -
Cost of sales 204,802 -
-----------------------------------------------
Gross margin 122,681 -
Costs and expenses:
Sales and marketing 5,893,937 1,330,731
General and administrative 11,002,370 2,673,018
Research and development 13,783,297 2,314,094
Services and other charges from related parties 1,468,120 1,333,266
Loss on write-off of intangible assets 17,842,301 -
-----------------------------------------------
Total operating costs and expenses 49,990,025 7,651,109
-----------------------------------------------
Loss from operations (49,867,344) (7,651,109)
Interest expense on convertible debt to related parties (498,411) -
Interest income 96,560 13,205
-----------------------------------------------
Net loss $(50,269,195) $(7,637,904)
===============================================
SEE ACCOMPANYING NOTES.
4
Mindsurf, Inc.
Consolidated Statements of Stockholders' Equity (Deficit)
SERIES B SERIES A SERIES C
SERIES Y CONVERTIBLE CONVERTIBLE CONVERTIBLE SERIES X
PREFERRED PREFERRED PREFERRED PREFERRED PREFERRED COMMON
STOCK STOCK 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 10) $ - $ - $ 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 3) - 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 3) 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 10) - - 32,456 - - -
Value of options to purchase
common stock to be issued in
connection with acquisition of
HiFusion (see Note 3) - - - - - -
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 - - -
------------ ------------ ------------ -------- -------- ------
ADDITIONAL
PAID-IN UNEARNED ACCUMULATED
CAPITAL COMPENSATION DEFICIT 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 10) $ 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 3) 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 3) 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 10) 1,817,544 - - 1,850,000
Value of options to purchase
common stock to be issued in
connection with acquisition of
HiFusion (see Note 3) 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
------------ ------------ ------------ ------------
5
Mindsurf, Inc.
Consolidated Statements of Stockholders' Equity (Deficit) (continued)
SERIES B SERIES A SERIES C
SERIES Y CONVERTIBLE CONVERTIBLE CONVERTIBLE SERIES X
PREFERRED PREFERRED PREFERRED PREFERRED PREFERRED COMMON
STOCK STOCK STOCK STOCK STOCK STOCK
--------------- -------------- --------------- ------------- ------------ ------------
Balance at December 31, 2000 $233,918 $80,409 $175,439 $ - $ - $ -
Issuance of 26,315,789 shares of
Series A Convertible Preferred
Stock for cash of $15,000,000
(see Note 10) - - 263,158 - - -
Conversion of 1,052,632 shares of
Series A Convertible Preferred
Stock to Series X Preferred
Stock (See Note 12) - - (10,526) - 10,526 -
Options exercised for purchase of
99,093 shares of common stock - - - - - 991
Issuance of 7,044,115 shares of
Series C Convertible Preferred
Stock valued at $2,042,225 in
connection with acquisition of
Discourse (see Note 2) - - - 70,441 - -
Amortization of unearned
compensation for the year ended
December 31, 2001, net of
forfeitures - - - - - -
Reduction of unearned compensation
related to forfeited options - - - - - -
Accrued dividends on Series Y
Preferred Stock - - - - - -
Net loss for the year ended
December 31, 2001 - - - - - -
---------- ------- -------- ------- ------- -----
$233,918 $80,409 $428,071 $70,441 $10,526 $991
========== ======= ======== ======= ======= =====
ADDITIONAL
PAID-IN UNEARNED ACCUMULATED
CAPITAL COMPENSATION DEFICIT TOTAL
------------ ------------ ------------ -----------
Balance at December 31, 2000 $31,946,136 $(291,891) $ (7,637,904) $24,506,107
Issuance of 26,315,789 shares of
Series A Convertible Preferred
Stock for cash of $15,000,000
(see Note 10) 14,736,842 - - 15,000,000
Conversion of 1,052,632 shares of
Series A Convertible Preferred
Stock to Series X Preferred
Stock (See Note 12) - - - -
Options exercised for purchase of
99,093 shares of common stock 2,950 - - 3,941
Issuance of 7,044,115 shares of
Series C Convertible Preferred
Stock valued at $2,042,225 in
connection with acquisition of
Discourse (see Note 2) 1,971,784 - - 2,042,225
Amortization of unearned
compensation for the year ended
December 31, 2001, net of
forfeitures - (219) - (219)
Reduction of unearned compensation
related to forfeited options (257,886) 257,886 - -
Accrued dividends on Series Y
Preferred Stock (240,651) - - (240,651)
Net loss for the year ended
December 31, 2001 - - (50,269,195) (50,269,195)
----------- ---------- ------------ ------------
$48,159,175 $ (34,224) $(57,907,099) $ (8,957,792)
=========== ========== ============ ============
6
Mindsurf, Inc.
Consolidated Statement of Cash Flows
PERIOD
OCTOBER 25, 2000
(DATE OF
INCEPTION)
YEAR ENDED THROUGH
DECEMBER 31, DECEMBER 31,
2001 2000
-------------- -----------------
OPERATING ACTIVITIES
Net loss $(50,269,195) $ (7,637,904)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation 869,010 138,182
Amortization of purchased software development costs 352,847 --
Amortization of other intangible assets 6,394,534 1,170,113
Amortization of unearned compensation (219) 18,530
Loss on disposal of fixed assets 50,391 --
Loss on write-off of intangible assets 17,842,301 --
Changes in operating assets and liabilities:
Restricted cash 160,215 --
Accounts receivable (603,940) --
Deferred costs (378,650) --
Prepaid expenses and other current assets 89,811 (77,273)
Accounts payable and accrued expenses (3,137,122) (896,000)
Accrued compensation 942 47,008
Due to related parties (1,318,761) 1,333,266
Deferred revenue 609,415 --
Accrued interest on convertible debt to related parties 498,411 --
------------ ------------
Net cash used in operating activities (28,840,010) (5,904,078)
INVESTING ACTIVITIES
Purchase of property and equipment (378,428) (146,090)
------------ ------------
Net cash used in investing activities (378,428) (146,090)
FINANCING ACTIVITIES
Payments of capital lease obligations (103,831) (34,286)
Proceeds from issuance of convertible debt 13,200,000 --
Issuance of Series A Convertible Preferred stock for cash 15,000,000 8,009,999
Issuance of common stock 3,941 --
------------ ------------
Net cash provided by financing activities 28,100,110 7,975,713
------------ ------------
Net change in cash and cash equivalents (1,118,328) 1,925,545
Cash and cash equivalents at the beginning of period 1,925,545 --
------------ ------------
Cash and cash equivalents at the end of period $ 807,217 $ 1,925,545
============ ============
SEE ACCOMPANYING NOTES.
7
Mindsurf, Inc.
Notes to Consolidated Financial Statements
December 31, 2001
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 one to one (one
computer to one student) computing solutions to the Kindergarten through 12th
grade sector (K-12) of the education community. The Company was established as a
strategic partnership between Sylvan Learning Systems, Inc. (Sylvan), Aether
Systems, Inc. (Aether) and Critical Path, Inc. (Critical Path). Prior to the
year ended December 31, 2001, the Company had been a development stage
enterprise.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Mindsurf, Inc. and
its wholly-owned subsidiaries. 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.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents.
RESTRICTED CASH AND LETTER OF CREDIT
Restricted cash at December 31, 2000 consisted of cash pledged as collateral on
an outstanding letter of credit that was required under the Company's operating
lease for office space. Restricted cash consisted of a certificate deposit
bearing interest at 5.10%. During 2001, the outstanding letter of credit
expired, the Company's operating lease was terminated and the cash became
unrestricted. As of December 31, 2001, the Company does not have any outstanding
letters of credit or restrictions of cash.
8
Mindsurf, Inc.
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 at December 31, 2001 consist of purchased software development
costs and assembled workforce recorded in connection with the acquisition of
Discourse on June 21, 2001. The Company amortizes its purchased software
development costs and assembled workforce using the straight-line method over
estimated useful lives of four and three years, respectively.
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 shortfall of the
asset's estimated fair value from the 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.
Notes to Consolidated Financial Statements (continued)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REVENUE RECOGNITION
The Company derives revenue from arrangements that include software licenses,
postcontract customer support (PCS), and services. In addition, the Company for
the convenience of its customers, sells hardware and software purchased from
third parties. Postcontract customer support includes telephone support, bug
fixes, and rights to upgrades on a when-and-if available basis. Services
primarily include installation and training.
The Company allocates the total arrangement fee among each deliverable based on
the fair value of each of the deliverables determined based on vendor-specific
objective evidence. If vendor-specific objective evidence of fair value does not
exist for each of the deliverables, all revenue from the arrangement is deferred
until the earlier of the point at which sufficient vendor-specific objective
evidence of fair value or all elements of the arrangement have been delivered.
However, if the only undelivered element is PCS, the entire fee is recognized
ratably over the term of the PCS arrangement. All amounts billed or received in
excess of the revenue recognized is included in deferred revenue. In addition,
the Company defers all direct costs associated with revenue that has been
deferred. These amounts are classified as deferred costs in the accompanying
consolidated balance sheet.
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, 2001, with the exception of purchased software development costs,
the Company has not established technological feasibility for its software under
development and therefore all costs have been expensed as research and
development costs.
10
Mindsurf, Inc.
Notes to Consolidated Financial Statements (continued)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 $61,000 and $142,000 for year ended December 31, 2001 and the
period October 25, 2000 (date of inception ) to December 31, 2000, respectively.
RECLASSIFICATIONS
Certain amounts in the 2000 consolidated financial statements have been
reclassified to conform with the 2001 presentation.
NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 141, BUSINESS COMBINATIONS, and No. 142,
GOODWILL AND OTHER INTANGIBLE ASSETS. Statement 141 requires that the purchase
method of accounting be used for all business combinations initiated after June
30, 2001. Statement 141 also includes guidance on the initial recognition and
measurement of goodwill and other intangible assets arising from business
combinations completed after June 30, 2001. Statement 142 prohibits the
amortization of goodwill and intangible assets with indefinite useful lives.
Statement 142 requires that these assets be reviewed for impairment at least
annually. Intangible assets with finite lives will continue to be amortized over
their estimated useful lives. Additionally, Statement 142 requires that goodwill
included in the carrying value of equity method investments no longer be
amortized. The Company will apply Statement 142 beginning in fiscal year 2002.
Application of the nonamortization and impairment provisions of Statement 142 is
not anticipated to be significant.
11
Mindsurf, Inc.
Notes to Consolidated Financial Statements (continued)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
NEW ACCOUNTING PRONOUNCEMENTS (CONTINUED)
In August 2001, the Financial Accounting Standards Board issued Statement of
Financial Standards No. 144, ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF
LONG-LIVED ASSETS, which addresses financial accounting and reporting for the
impairment or disposal of long-lived assets and supersedes Statement No. 121,
ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO
BE DISPOSED OF, and the accounting and reporting provisions of APB Opinion No.
30, REPORTING THE RESULTS OF OPERATIONS for a disposal of a segment of business.
Statement 144 is effective for fiscal years beginning after December 15, 2001,
with earlier application encouraged. The Company expects to adopt Statement 144
in fiscal year 2002 and it does not expect that the adoption of the Statement
will have a significant impact on the Company's financial position and results
of operations.
2. ACQUISITION OF DISCOURSE TECHNOLOGIES, INC.
On June 21, 2001, the Company acquired all of the outstanding common stock of
Discourse Technologies, Inc. (Discourse), a technology company whose primary
product was a one to one teaching application for use in the K-12 classroom
environment. The purchase price consisted of 7,044,115 shares of Series C
Convertible Preferred Stock (Series C) valued at $2,042,225. The securities
issued in connection with the acquisition were valued in good faith by the
Company based on an independent appraisal of the business acquired and other
pertinent factors.
The acquisition was accounted for using the purchase method of accounting, and
the results of operations of Discourse are included in the accompanying
consolidated statement of operations commencing June 21, 2001. The total
purchase price was allocated as follows:
Current assets $ 207,356
Property and equipment 63,393
Current liabilities assumed (1,375,083)
Purchased software 2,822,779
Assembled workforce 323,780
----------
$2,042,225
==========
12
Mindsurf, Inc.
Notes to Consolidated Financial Statements (continued)
3. ACQUISITION OF HIFUSION AND LOSS ON WRITE-OFF OF INTANGIBLE ASSETS
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,
all of which were granted during 2001. The fair value of the options 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
was 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 have been 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
===========
13
Mindsurf, Inc.
Notes to Consolidated Financial Statements (continued)
3. ACQUISITION OF HIFUSION AND LOSS ON WRITE-OFF OF INTANGIBLE ASSETS
(CONTINUED)
In December 2001, the Company determined that certain long-lived assets acquired
as part of the HiFusion acquisition should be written-off as a result of
strategic changes in its business. The identified assets, consisting of goodwill
and assembled workforce, were impaired as a result of changes in the business to
focus primarily on selling the Discourse software product as well as the
termination of substantially all of the employees obtained in the acquisition of
HiFusion. All other long-lived assets have been integrated into the ongoing
business are expected to be realized through future operations.
The changes in the goodwill and assembled workforce related to the HiFusion
acquisition are summarized as follows:
ASSEMBLED
GOODWILL WORKFORCE
------------ ------------
Balance at December 31, 2000 $ 19,528,433 $ 4,651,340
Amortization of goodwill (5,120,347) (1,217,125)
Write-off of intangible assets (14,408,086) (3,434,215)
------------ ------------
Balanced at December 31, 2001 $ -- $ --
============ ============
Therefore, the accompanying consolidated statement of operations for the year
ended December 31, 2001 includes a loss on the write-off of intangible assets
totaling $17,842,301.
4. 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 $346,176 and $736,918 under this master services agreement for the year
ended
14
Mindsurf, Inc.
Notes to Consolidated Financial Statements (continued)
4. SERVICES AGREEMENTS WITH RELATED PARTIES (CONTINUED)
December 31, 2001 and the period October 25, 2000 (date of inception) through
December 31, 2000, respectively, principally related to administrative and
research and development activities, which is included in services and other
charges from related parties in the accompanying consolidated statements of
operations.
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 $1,093,640 and
$580,959 under this master services agreement for the year ended December 31,
2001 and the period October 25, 2000 (date of inception) through December 31,
2000, respectively, which is included in services and other charges from related
parties in the accompanying consolidated statements of operations.
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 $28,304 and $15,389 under this master services agreement for the year
ended December 31, 2001 and the period October 25, 2000 (date of inception)
through December 31, 2000, respectively, which is included in services and other
charges from related parties in the accompanying consolidated statements of
operations.
5. CONVERTIBLE DEBT TO RELATED PARTIES
During 2001, the Company issued convertible promissory notes with an aggregate
face value of $13,200,000 to Sylvan and Aether. The promissory notes bear
interest at a fixed rate of 12% per annum which is payable at the maturity date
of the notes. The notes mature five years from the date of issuance and are
convertible at any time at the option of the holders into Series A Convertible
Preferred Stock (Series A) at a conversion rate of $0.57 per share, subject to
adjustment upon the occurrence of certain specified dilutive events. The notes
will automatically convert into shares of Series A immediately prior to the
automatic conversion of the Series A into common stock as described in Note 10.
15
Mindsurf, Inc.
Notes to Consolidated Financial Statements (continued)
5. CONVERTIBLE DEBT TO RELATED PARTIES (CONTINUED)
During 2001, the Company accrued interest expense totaling $498,411, which is
included in accrued interest on convertible debt to related parties in the
accompanying consolidated balance sheet.
6. INCOME TAXES
The significant components of the Company's deferred tax assets and liabilities
as of December 31, 2001 and 2000 are as follows:
DECEMBER 31
2001 2000
------------ ------------
Deferred tax assets:
Net operating loss carryforwards $ 22,893,430 $ 9,468,087
Contribution carryforward 614 614
Vacation pay accrual 60,277 76,045
Deferred revenue 70,211 --
Depreciation 34,146 --
------------ ------------
Total deferred tax assets 23,058,678 9,544,746
Deferred tax liabilities:
Depreciation -- 73,003
------------ ------------
Net deferred tax assets 23,058,678 9,471,743
Valuation allowance for deferred tax
assets (23,058,678) (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 year ended December 31, 2001 and the period October 25,
2000 (date of inception ) to December 31, 2000.
At December 31, 2001, the Company had net operating loss carryforwards of
approximately $59.3 million that begin to expire in 2020. Included in this
amount is approximately $18.2 million and $9.6 million of net operating loss
carryforwards acquired from HiFusion and Discourse, respectively, for which a
full valuation allowance was applied on the dates of the acquisition. These net
operating loss carryforwards begin to expire in 2018 and are available only to
offset certain types of future taxable income.
16
Mindsurf, Inc.
Notes to Consolidated Financial Statements (continued)
6. INCOME TAXES (CONTINUED)
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 is as follows:
PERIOD
OCTOBER 25, 2000
(DATE OF INCEPTION)
YEAR ENDED THROUGH
DECEMBER 31, DECEMBER 31,
2001 2000
-------------- -------------------
Tax benefit at U.S. statutory rate of 34% $(17,091,526) $ (2,596,887)
Effect of permanent differences 8,393,958 436,578
State income taxes, net of federal benefit (1,181,847) (293,548)
Effect of change in valuation allowance for
deferred tax assets 9,879,415 2,453,857
------------ ------------
Total $ -- $ --
============ ============
7. CAPITAL LEASE OBLIGATIONS
The Company has entered into capital lease agreements to acquire certain
equipment. Property and equipment in the accompanying consolidated balance
sheets includes the following balances with respect to equipment under capital
lease:
DECEMBER 31
2001 2000
-------- --------
Furniture and equipment $336,763 $350,979
Accumulated depreciation (159,027) (46,773)
-------- --------
$177,736 $304,206
======== ========
Amortization of the leased property is included in depreciation expense.
17
Mindsurf, Inc.
Notes to Consolidated Financial Statements (continued)
7. CAPITAL LEASE OBLIGATIONS (CONTINUED)
Future minimum payments under capital lease obligations consist of the following
at December 31, 2001:
2002 $121,575
2003 77,508
--------
Total minimum lease payments 199,083
Amounts representing interest (19,897)
--------
Present value of net minimum lease payments
(including current portion of $104,321) $179,186
========
8. SERIES Y PREFERRED STOCK
The Company has authorized the issuance of up to 177,775,109 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 3), 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
nonpayment, 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 nonpayment,
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, 2001 and 2000, the Company has accrued dividends
payable to the Series Y holders of $284,048 and $43,397, respectively.
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.
18
Mindsurf, Inc.
Notes to Consolidated Financial Statements (continued)
8. SERIES Y PREFERRED STOCK (CONTINUED)
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.
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.
9. 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 3), 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.
19
Mindsurf, Inc.
Notes to Consolidated Financial Statements (continued)
9. 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 nonpayment, 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 and Series C
stockholders. Dividends in arrears on the Series B were $519,372 and $79,562 at
December 31, 2001 and 2000, respectively.
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 and Series C but subordinate to the
holders of the Series Y.
VOTING RIGHTS
The holders of the Series B are not entitled to vote.
10. SERIES A CONVERTIBLE PREFERRED STOCK
The Company has authorized the issuance of up to 69,122,807 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 up to 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. During
2001, an additional 26,315,789 shares of Series A were issued to Sylvan and
Aether for gross proceeds of $15,000,000.
20
Mindsurf, Inc.
Notes to Consolidated Financial Statements (continued)
10. 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 Series C and common stockholders. Dividends in arrears on the
Series A were $1,912,234 and $144,658 at December 31, 2001 and 2000,
respectively.
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 and Series C in the aggregate are
entitled to appoint all seven members of the Board of Directors.
21
Mindsurf, Inc.
Notes to Consolidated Financial Statements (continued)
11. SERIES C CONVERTIBLE PREFERRED STOCK
As of December 31, 2001, the Company has authorized the issuance of up to
7,044,115 shares of Series C Convertible Preferred Stock (Series C), par value
$0.01 per share. On June 21, 2001, in connection with the acquisition of
Discourse (see Note 2), the Company issued 7,044,115 shares of Series C that was
valued at $2,042,225.
CONVERSION RIGHTS
The Series C is convertible into common stock at the option of the holder at any
time. In addition, the Series C 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 and Series C
holders. Each share of Series C 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 C are entitled to receive cumulative dividends at the
annual rate of $0.0232 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 C holders are superior to
those of the common stockholders. Dividends in arrears on the Series C were
$81,712 at December 31, 2001.
LIQUIDATION
Each share of Series C has a preference on liquidation equal to $0.57 per share
plus all accrued and unpaid dividends. The liquidation preference of the Series
C is subordinate to the holders of the Series A, Series B and the Series Y.
VOTING RIGHTS
Each share of Series C has substantially the same voting rights as the number of
shares of common stock into which it can be converted. In addition, the holders
of the Series A and C voting together as a class in the aggregate are entitled
to appoint all seven members of the Board of Directors.
22
Mindsurf, Inc.
Notes to Consolidated Financial Statements (continued)
12. SERIES X PREFERRED STOCK
As of December 31, 2001, the Company has authorized the issuance of up to
70,175,439 shares of Series X Preferred Stock (Series X), par value $0.01 per
share. During 2001, 1,052,632 shares of Series A automatically converted into an
equal number of shares of Series X as a result of Critical Path's default under
the initial stock purchase agreement.
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, Series C and Series Y.
13. 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 nonqualified 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, 2001, options to purchase
9,158,927 shares of common stock may be granted under the plan.
All options have a 10-year term and vest over periods of up to a four years.
With the exception of the options granted to in connection with the acquisition
of HiFusion (see Note 3), all options outstanding under the plan have been
granted at prices that equal or exceed the estimated fair market value of the
stock on the date of grant. Options to purchase 2,899,250 shares of common stock
were granted to the former HiFusion option holders, many with an exercise price
that was below the market value of the stock on the date of grant. The fair
value of these options was estimated by the Company to be $1,119,300, determined
using the Black-Scholes option-pricing model with the following weighted average
assumptions: risk-free interest rate of 6%, dividend yield of 0%, volatility
factor of 0.70, and an expected life of granted options of five years.
23
Mindsurf, Inc.
Notes to Consolidated Financial Statements (continued)
13. STOCK OPTIONS (CONTINUED)
The following table summarizes the stock option activity attributable to the
Company for the year ended December 31, 2001.
WEIGHTED
AVERAGE
EXERCISE
OPTIONS PRICE
---------- --------
Outstanding - beginning of year -- $ --
Granted 8,216,250 0.52
Exercised (99,093) 0.04
Forfeited (3,370,221) 0.48
---------- -----
Outstanding - end of year 4,746,936 $0.56
========== =====
Exercisable at end of year 1,824,850 $0.55
========== =====
Weighted-average fair value of options granted
during the year $0.22
=====
Exercise prices for options outstanding as of December 31, 2001 ranged from
$0.01 to $1.00 as follows:
WEIGHTED
WEIGHTED AVERAGE WEIGHTED
AVERAGE REMAINING AVERAGE
EXERCISE CONTRACTUAL EXERCISE
RANGE OF PRICES OF LIFE OF PRICES OF
EXERCISE OUTSTANDING OUTSTANDING OUTSTANDING EXERCISABLE EXERCISABLE
PRICES OPTIONS OPTIONS OPTIONS OPTIONS OPTIONS
- --------------------------------------------------------------------------------------
$0.01-$0.56 157,083 $0.01 8.02 years 106,417 $0.01
$0.57-$0.61 4,553,228 0.57 9.00 years 1,681,808 0.58
$0.62-$1.00 36,625 1.00 8.69 years 36,625 1.00
24
Mindsurf, Inc.
Notes to Consolidated Financial Statements (continued)
13. STOCK OPTIONS (CONTINUED)
For the year ended December 31, 2001, pro forma net loss required by Statement
123 has been determined using the minimum value method for all grants other than
the previously described grants made in connection with the acquisition of
HiFusion. The minimum value method calculates the fair value of options as the
excess of the estimated fair value of the underlying stock at the date of grant
over the present value of both the exercise price and the expected dividend
payments, each discounted at the risk-free rate, over the expected life of the
option. In determining the estimated fair value of granted stock options under
the minimum value method, the following weighted-average assumptions were used:
risk free rate of 5%; dividend yield of 0%; and, expected life of the granted
options of five years.
Because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the minimum value method and other
methods prescribed by Statement 123 do not necessarily provide a single measure
of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting periods. The Company's pro
forma net loss does not differ materially from the Company's historical net loss
for the year ended December 31, 2001.
14. SHARES RESERVED FOR FUTURE ISSUANCE
As of December 31, 2001 and 2000, the Company has reserved shares of common
stock for issuance as follows:
DECEMBER 31
2001 2000
---------- ----------
Conversion of Series A 42,807,017 17,543,860
Conversion of Series B 8,040,936 8,040,936
Conversion of Series C 7,044,115 --
Exercise of stock options granted and available for
granting under 2000 Equity Incentive Plan
9,158,927 4,514,964
---------- ----------
67,050,995 30,099,760
========== ==========
25
Mindsurf, Inc.
Notes to Consolidated Financial Statements (continued)
15. NON-CASH INVESTING AND FINANCING ACTIVITIES
DECEMBER 31
2001 2000
------------ ----------------
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
Issuance of Series C Convertible Preferred Stock in
connection with acquisition of Discourse Technologies, Inc. 2,042,225 -
16. OPERATING LEASES
The Company leases office space and certain computer equipment under
noncancelable operating leases. Future minimum lease payments under
noncancelable operating leases consisted of the following at December 31, 2001:
2002 $181,520
2003 169,858
2004 39,341
--------
$390,719
========
Rent expense under all operating leases for the years ended December 31, 2001
and 2000 was $1,031,633 and $542,217, respectively.
17. 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. For
the year ended December 31, 2001 and the period October 25, 2000 (date of
inception) through December 31, 2000, no discretionary contributions have been
made to the plan.
Mindsurf, Inc.
Notes to Consolidated Financial Statements (continued)
18. LIQUIDITY AND CAPITAL RESOURCES
For the period October 25, 2000 (date of inception) through December 31, 2001,
the Company incurred a net loss of $57.9 million and has used $34.7 million of
cash in its operations. A working capital deficit of $0.2 exists at December 31,
2001.
During 2000, the Company entered into an agreement with Sylvan, Aether and
Critical Path (the Investors) under which it agreed to sell up to 122,807,017
shares of Series A for gross proceeds of $70 million. To date, the Company has
issued 43,859,649 shares of Series A for aggregate proceeds of $25 million.
During 2001, Critical Path defaulted under this agreement and, as a result,
1,052,632 shares of previously issued Series A were converted to Series X at
which time Critical Path ceased to be eligible for future participation under
the agreement. Under the terms of agreements among the various investors and the
Company, once the Investors acquired a total of $25 million of Series A, they
were allowed to make subsequent investments in the Company in the form of debt.
During 2001, after the Company had received $25 million of gross proceeds from
the Investors, the Investors elected to make additional investments in the form
of convertible debt. During 2002, Sylvan and Aether each provided $6.6 million
of funding in the form of convertible debt (see Note 5).
Under the terms of the agreement, in order for the Company to request that the
Investors acquire additional debt or equity securities from the Company, the
Company must meet certain milestones. As of December 31, 2001, the Company has
requested and received all of the capital that it is eligible to request based
on the milestones achieved to date. In the event the Company reaches future
milestones and requests that the Investors acquire additional securities, the
Investors have the right to decline to make an additional investment. In the
event that one of the Investors agrees to make such an investment and the other
Investor declines to do so, the Company has the right to convert all of the
securities held by the declining Investor to Series X. In the event that both of
the Investors agree not to fund, the Investors may decline to make the requested
investments without impact to the Investors previously purchased securities.
The Company's operating losses incurred since inception, in conjunction with
forecasted operating losses and limited committed funding sources raise
substantial doubt about the Company's ability to continue as a going concern.
Management is actively pursuing additional sources of financing including
negotiations with the Investors as well as other potential investors. However,
there can be no assurance that the Company will be able to generate sufficient
cash flow from operations or additional financing to meet its development and
operating needs, or that such financing would be available on terms acceptable
to the Company.
27