Exhibit 99
Financial Statements
IdeaForest.com
Fiscal Year Ended January 31, 2001 (Audited)
Period From February 1, 2001 to December 31, 2001 (11-months Unaudited) and
Year Ended December 31, 2002 (Unaudited)
IdeaForest.com, Inc.
Index to Financial Statements
Page
----
Report of Independent Auditors...............................................1
Balance Sheets - Total Assets as of December 31, 2002, December 31, 2001
and January 31, 2001....................................................2
Balance Sheets - Total Liabilities and Shareholders' Deficit as of
December 31, 2002, December 31, 2001 and January 31, 2001...............3
Statements of Operations for the year ended December 31, 2002,
the period from February 1, 2001 to December 31, 2001 (11-months)
and the fiscal year ended January 31, 2001..............................4
Statements of Redeemable Preferred Stock and Shareholders' Deficit
for the year ended December 31, 2002, the period from
February 1, 2001 to December 31, 2001 (11-months) and the fiscal
year ended January 31, 2001.............................................5
Statements of Cash Flows for the year ended December 31, 2002,
the period from February 1, 2001 to December 31, 2001 (11-months)
and the fiscal year ended January 31, 2001..............................6
Notes to Financial Statements................................................7
Report of Independent Auditors
To the Shareholders and Board of Directors IdeaForest.com, Inc.:
We have audited the accompanying balance sheet of IdeaForest.com, Inc. as of
January 31, 2001, and the related statement of operations, redeemable preferred
stock and shareholders' deficit, and cash flows for the year then ended. 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 IdeaForest.com, Inc. at January
31, 2001, and the results of its operations and its cash flows for the year then
ended, in conformity with accounting principles generally accepted in the United
States.
We have not audited or reviewed the financial statements of IdeaForest.com, Inc.
as of December 31, 2002 and 2001 and for the year ended December 31, 2002 and
the period from February 1 to December 31, 2001. Accordingly, we do not express
an opinion or any other form of assurance on them.
/s/ Ernst & Young
Cleveland, Ohio,
August 8, 2003.
1
IdeaForest.com, Inc.
Balance Sheets
Total Assets
December 3l, January 31,
2002 2001 2001
-------------------------------------------------
Unaudited Unaudited
ASSETS
Current assets:
Cash and cash equivalents $ 1,537,185 $ 2,603,722 $ 6,745,097
Inventories 297,269 209 124,550
Deposits 215,645 - -
Prepaid expenses and other current assets 150,522 34,380 178,814
-------------------------------------------------
Total current assets 2,200,621 2,638,311 7,048,461
Property, equipment and website development:
Website development 4,704,408 4,704,408 4,704,408
Computer hardware 1,717,187 1,360,788 1,332,873
Computer software 1,377,518 1,357,255 1,354,662
Office equipment and other 408,430 436,968 459,046
-------------------------------------------------
8,207,543 7,859,419 7,850,989
Less accumulated depreciation and amortization 6,598,834 3,925,531 1,463,576
-------------------------------------------------
1,608,709 3,933,888 6,387,413
Other assets:
Licensing arrangements 468,750 2,338,738 2,593,457
Deposits and other long term assets - 172,512 202,950
-------------------------------------------------
Total assets $ 4,278,080 $ 9,083,449 $16,232,281
=================================================
See accompanying notes to financial statements.
2
IdeaForest.com, Inc.
Balance Sheets
Total Liabilities and Shareholders' Deficit
December 31, January 31,
2002 2001 2001
----------------------------------------------
Unaudited Unaudited
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Accounts payable $ 282,475 $ 127,436 $ 512,084
Accrued expenses and other current liabilities 380,273 227,016 417,133
Current portion of capital lease obligations - 206,694 358,779
Current portion of line of credit 143,447 - -
Amounts due to shareholder 516,301 159,003 27,218
----------------------------------------------
Total current liabilities 1,322,496 720,149 1,315,214
Capital lease obligations - - 174,969
Line of credit, net of current portion 73,088 - -
Note payable due to shareholder 100,000 100,000 100,000
Convertible redeemable preferred stock:
Convertible Redeemable Preferred Stock Series A--$0.001
par value (investment of $8,894,731 plus accretion to redemption value
of $0 for all periods) 8,894,731 8,894,731 8,894,731
Convertible Redeemable Preferred Stock, Series A-I--$0.001 par value 226 226 226
Convertible Redeemable Preferred Stock, Series B--$0.001
par value (investment of $21,466,667 plus accretion to redemption value of
$11,175,361, $6,564,511 and $2,470,579 and accrued and unpaid dividends
of $4,352,546, $2,590,956 and $998,468 in 2002, 2001 and 2000, respective 36,994,574 30,622,133 24,935,714
Less unamortized issuance costs for preferred stock (64,723) (90,371) (116,020)
----------------------------------------------
Total convertible redeemable preferred stock 45,824,808 39,426,719 33,714,651
Shareholders' deficit:
Common stock--$0.001 par value; 210,000,000 shares authorized at December 31,
2002, 2001 and January 31, 2001 and 19,188,897, 19,097,697 and
19,101,697 shares issued and outstanding at December 31, 2002, 2001
and January 31, 2001, respectively 19,188 19,097 19,101
Additional paid-in capital - - -
Unearned compensation (119,092) (153,428) (181,341)
Accumulated deficit (42,942,408) (31,029,088) (18,910,313
----------------------------------------------
Total shareholders' deficit (43,042,312) (31,163,419) (19,072,553)
----------------------------------------------
Total liabilities and shareholders' deficit $ 4,278,080 $ 9,083,449 $ 16,232,281
==============================================
See accompanying notes to financial statements.
3
IdeaForest.com, Inc.
Statements of Operations
Period From
Year Ended February 1 to Fiscal Year
December 31, December 31, Ended January
2002 2001 31, 2001
------------------------------------------------------
Unaudited Unaudited
Net revenues $ 8,362,143 $ 2,212,226 $ 635,727
Cost of goods sold 5,853,699 1,554,333 754,705
------------------------------------------------------
Gross profit (loss) 2,508,444 657,893 (118,978)
Operating expenses:
Selling, general and administrative 5,055,604 4,448,975 12,972,258
Depreciation and amortization 2,968,384 2,731,009 1,665,944
------------------------------------------------------
8,023,988 7,179,984 14,638,202
------------------------------------------------------
Loss from operations (5,515,544) (6,522,091) (14,757,180)
Interest income 34,629 161,186 494,574
Interest expense (39,247) (47,539) (401,843)
------------------------------------------------------
Net Loss $ (5,520,162) $ (6,408,444) $(14,664,449)
======================================================
See accompanying notes to financial statements.
4
IdeaForest.com, Inc.
Statements of Redeemable Preferred Stock and Shareholders' Deficit
CONVERTIBLE REDEEMABLE PREFERRED STOCK
------------------------------------------------------
SERIES A SERIES A-1
----------------------------- ----------------------
SHARES AMOUNT SHARES AMOUNT
------------------------------------------------------
Balance at February 1, 2000 18,817,556 $ 6,977,520 - $ -
Issuance of Series A Preferred Stock for License
Agreement 8,374,780 1,894,600
Issuance of Series A-1 Preferred Stock for License
Agreement 1,000 226
Issuance of Series B Preferred Stock
Issuance of warrant for License Agreement
Issuance of warrant in connection with bridge loan
Preferred stock dividends accretion
Accretion of preferred stock to redemption value 3,309
Exercise of stock options
Issuance of restricted stock
Issuance of stock options for services
Deferred compensation expense
Net loss
------------------------------------------------------
Balance at January 31, 2001 27,192,336 $ 8,875,429 1,000 $ 226
Preferred stock dividends
Accretion of preferred stock to redemption value 3,309
Issuance of stock options for services
Deferred compensation expense
Other
Net loss
------------------------------------------------------
Balance at December 31, 2001 (Unaudited) 27,192,336 $ 8,878,738 1,000 $ 226
Preferred stock dividends
Accretion of preferred stock to redemption value 3,309
Issuance of stock options for services
Exercise of stock options
Deferred compensation expense
Net loss
------------------------------------------------------
Balance at December 31, 2002 (Unaudited) 27,192,336 $ 8,882,047 1,000 $ 226
======================================================
SHAREHOLDERS' DEFICIT
----------------------------
CONVERTIBLE REDEEMABLE PREFERRED STOCK
----------------------------------------------
SERIES B
---------------------------- COMMON STOCK
SHARES AMOUNT TOTAL SHARES PAR AMOUNT
-----------------------------------------------------------------------------
Balance at February 1, 2000 - $ - $ 6,977,520 13,586,675 $ 13,586
Issuance of Series A Preferred Stock for License
Agreement 1,894,600
Issuance of Series A-1 Preferred Stock for License
Agreement 226
Issuance of Series B Preferred Stock 94,901,269 21,354,966 21,354,966
Issuance of warrant for License Agreement -
Issuance of warrant in connection with bridge loan -
Preferred stock dividends accretion 998,468 998,468
Accretion of preferred stock to redemption value 2,485,562 2,488,871
Exercise of stock options - 100,980 101
Issuance of restricted stock - 5,414,042 5,414
Issuance of stock options for services -
Deferred compensation expense -
Net loss -
-----------------------------------------------------------------------------
Balance at January 31, 2001 94,901,269 $ 24,838,996 $ 33,714,651 19,101,697 $ 19,101
Preferred stock dividends 1,592,487 1,592,487
Accretion of preferred stock to redemption value 4,116,272 4,119,581
Issuance of stock options for services -
Deferred compensation expense -
Other (4,000) (4)
Net loss -
-----------------------------------------------------------------------------
Balance at December 31, 2001 (Unaudited) 94,901,269 $ 30,547,755 $39,426,719 19,097,697 19,097
Preferred stock dividends 1,761,591 1,761,591
Accretion of preferred stock to redemption value 4,633,189 4,636,498
Issuance of stock options for services -
Exercise of stock options - 91,200 91
Deferred compensation expense -
Net loss -
-----------------------------------------------------------------------------
Balance at December 31, 2002 (Unaudited) 94,901,269 $ 36,942,535 $ 45,824,808 19,188,897 $ 19,188
=============================================================================
SHAREHOLDERS' DEFICIT
--------------------------------------------------------------
ADDITIONAL
PAID-IN UNEARNED ACCUMULATED
CAPITAL COMPENSATION DEFICIT TOTAL
----------------------------------------------------------------
Balance at February 1, 2000 $ 85,600 $ (64,467) $ (2,226,169) $ (2,191,450)
Issuance of Series A Preferred Stock for License
Agreement -
Issuance of Series A-1 Preferred Stock for License
Agreement -
Issuance of Series B Preferred Stock -
Issuance of warrant for License Agreement 883,689 883,689
Issuance of warrant in connection with bridge loan 353,670 353,670
Preferred stock dividends accretion (998,468) (998,468)
Accretion of preferred stock to redemption value (469,176) (2,019,695) (2,488,871)
Exercise of stock options 3,549 3,650
Issuance of restricted stock 138,609 (144,023) -
Issuance of stock options for services 2,527 2,527
Deferred compensation expense 27,149 27,149
Net loss (14,664,449) (14,664,449)
----------------------------------------------------------------
Balance at January 31, 2001 $ - $ (181,341) $ (18,910,313) $ (19,072,553)
Preferred stock dividends (1,592,487) (1,592,487)
Accretion of preferred stock to redemption value (1,737) (4,117,844) (4,119,581)
Issuance of stock options for services 1,737 1,737
Deferred compensation expense 27,913 27,913
Other (4)
Net loss (6,408,444) (6,408,444)
----------------------------------------------------------------
Balance at December 31, 2001 (Unaudited) $ - $ (153,428) $(31,029,088) $(31,163,419)
Preferred stock dividends (1,761,591) (1,761,591)
Accretion of preferred stock to redemption value (4,932) (4,631,567) (4,636,499)
Issuance of stock options for services 1,630 1,630
Exercise of stock options 3,302 3,393
Deferred compensation expense 34,336 34,336
Net loss (5,520,162) (5,520,162)
----------------------------------------------------------------
Balance at December 31, 2002 (Unaudited) $ - $ (119,092) $ (42,942,408) $ (43,042,312)
================================================================
See accompanying notes to financial statements.
5
IdeaForest.com, Inc.
Statements of Cash Flows
Period From
Year Ended February 1 to Fiscal Year
December 31, December 31, Ended January
2002 2001 31, 2001
------------------------------------------------------
Unaudited Unaudited
OPERATING ACTIVITIES
Net loss $ (5,520,162) $ (6,408,444) $(14,664,449)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 2,968,384 2,731,009 1,665,944
Stock compensation expense 35,966 29,650 29,676
Amortization of discount on bridge loan - - 353,670
Loss on asset sales and disposals 26,059 161,186 143,396
Impairment loss on intangible asset 1,592,112 - -
Changes in operating assets and liabilities:
Inventories (297,060) 124,341 (124,550)
Prepaid expenses and other assets (159,272) 174,868 (107,159)
Accounts payable 155,039 (384,648) (212,134)
Due to shareholder 357,298 131,785 127,218
Accrued expenses and other current liabilities 153,257 (190,117) 367,236
------------------------------------------------------
Net cash used in operating activities (688,379) (3,630,370) (12,421,152)
INVESTING ACTIVITIES
Proceeds from sale of assets 1,486 59,340 11,514
Capital expenditures, net of capital leases (392,878) (243,291) (2,198,442)
Website development costs - - (4,550,161)
------------------------------------------------------
Net cash used in investing activities (391,392) (183,951) (6,737,089)
FINANCING ACTIVITIES
Proceeds from issuance of preferred stock - - 20,354,966
Proceeds from bridge loan - - 646,330
Proceeds from issuance of warrant - - 353,670
Proceeds from line of credit 216,535 - -
Proceeds from the exercise of options 3,393 - 3,650
Payments on capital lease obligations (206,694) (327,054) (322,870)
------------------------------------------------------
Net cash provided (used) by financing activities 13,234 (327,054) 21,035,746
------------------------------------------------------
Net (decrease) increase in cash (1,066,537) (4,141,375) 1,877,505
Cash and cash equivalents at beginning of year 2,603,722 6,745,097 4,867,592
------------------------------------------------------
Cash and cash equivalents at end of year $ 1,537,185 2,603,722 $ 6,745,097
======================================================
See accompanying notes to financial statements.
6
IdeaForest.com, Inc.
Notes to Financial Statements
December 31, 2002
1. ORGANIZATION AND BUSINESS
IdeaForest.com, Inc. (IdeaForest.com or the Company) is an online specialty
retailer focused on the sale of high quality arts and crafts and related
products. The Company was incorporated on September 7, 1999 as Craft Legend,
Inc., which changed its name to IdeaForest.com, Inc. on June 1, 2000. The
Company hosts and maintains its websites through the url's ideaforest.com and
joann.com. The Company completed the initial design and launched its website in
May 2000. In September 2000 the Company entered into a trademark license,
marketing, merchandising and procurement agreements with Jo-Ann Stores, Inc.
(Jo-Ann) to leverage the Jo-Ann brand through the Company's website (See Note
2). Jo-Ann (a significant shareholder of the Company) has over 900 stores
throughout the United States and is publicly traded on the New York Stock
Exchange (JASA and JASB). The Company's website also provides chat rooms as an
outlet for customers to exchange ideas for various arts and crafts.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
FISCAL YEAR
The Company's fiscal periods are as follows:
Fiscal 2000 - February 1, 2000 through January 31, 2001
Fiscal 2001 (Unaudited) - February 1, 2001 through December 31, 2001 (Eleven-months)
Fiscal 2002 (Unaudited) - January 1, 2002 through December 31, 2002
The Company changed its year-end from January 31 to December 31 in 2001. The
statements of operations, redeemable preferred stock and shareholders' deficit,
and cash flows as of December 31, 2001 is for the period from February 1, 2001
through December 31, 2001 (eleven-months).
The financial statements and financial information in the notes to the financial
statements presented as of December 31, 2002 and 2001 and for the year ended
December 31, 2002 and the eleven-month period from February 1, 2001 to December
31, 2001 have not been audited. These unaudited financial statements have been
prepared pursuant to the rules and regulations of the Securities and Exchange
Commission in accordance with accounting principles generally accepted in the
United States.
7
IdeaForest.com, Inc.
Notes to Financial Statements
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REVENUE RECOGNITION
Product Sales
The Company recognizes revenues from product sales, net of discounts, coupon
redemptions and promotional allowances when products are shipped to customers.
Shipping and handling revenues and expenses are included in sales and cost of
sales, respectively.
For the fiscal periods ended 2002, 2001, and 2000 shipping and handling revenues
and expenses were as follows:
UNAUDITED
-----------------------------
2002 2001 2000
----------- -------------- -------------
Shipping Revenue $810,717 $303,110 $ 78,562
Shipping Expense $972,696 $263,222 $127,983
The Company allows for merchandise to be returned under most circumstances,
however the Company does not provide a reserve as the amounts of returns have
not historically had a material impact on the financial statements. The Company
is the principal in its transactions with customers. Specifically, the Company
takes title to all products sold to its customers prior to shipment.
Furthermore, the Company bears credit risk and inventory risk; however, these
risks are mitigated through relationships with credit card issuers and shippers.
Advertising Revenue
The Company provides advertising to certain manufacturers on its website.
Advertising revenue is recorded when the advertising commitment is completed
which is on a monthly basis. Total advertising revenues for fiscal periods 2002,
2001 and 2000 were $413,089 (unaudited), $107,319 (unaudited) and $25,820,
respectively.
8
IdeaForest.com, Inc.
Notes to Financial Statements
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SOFTWARE COSTS
The cost of internally developed software is capitalized and included in
property, equipment and website development. The costs to develop such software
are capitalized in accordance with Statement of Position 98-1, Accounting for
the Costs of Computer Software Developed or Obtained for Internal Use, and
begins when management authorizes and commits to funding a project it believes
will be completed and used to perform the functions intended and the conceptual
formulation, design and testing of possible software project alternatives have
been completed. Pilot projects and projects where expected future economic
benefits are less than probable are not capitalized. Internally developed
software costs include the cost of software tools and licenses used in the
development of the Company's systems, the cost of the design and programming of
the Company's website and customization costs. Completed projects are
transferred to property, equipment and website development at cost and are
amortized on a straight-line basis over their estimated useful lives of three
years.
STOCK COMPENSATION
The Company has elected to follow Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations in
accounting for its employee stock options. As such, compensation is recorded on
the date of issuance or grant as the excess of the current estimated fair value
of the underlying stock over the purchase or exercise price of the stock option.
Any deferred compensation is amortized over the respective vesting periods of
the equity instruments.
In December 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standard (SFAS) No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure", an amendment of SFAS No.
123. SFAS No. 148 provides alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, SFAS No. 148 amends the disclosure requirements of
SFAS No. 123 to require more prominent and more frequent disclosures in
financial statements about the effects of stock-based compensation. This
statement is effective for financial statements for fiscal years ending after
December 15, 2002. SFAS No. 148 will not have any impact on the Company's
financial statements as management does not have any current intention to change
to the fair value method.
9
IdeaForest.com, Inc.
Notes to Financial Statements
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SFAS No. 123, Accounting for Stock-Based Compensation, encourages but does not
require companies to record compensation cost for stock-based employee
compensation at fair value. The fair value of the option grant was estimated on
the date of grant using the Black Scholes method with the following assumptions
for all years presented: risk free rate of 4.92% - 6.75%; no expected dividends;
an expected life of 10 years; and no volatility.
If the Company had determined compensation cost for stock options based on the
fair value at the grant dates for awards under the stock plans consistent with
SFAS No. 123, the Company's net loss would have increased to the pro forma
amounts shown in the table below:
FISCAL PERIODS
-------------------------------------------------
UNAUDITED
-------------------------------
2002 2001 2000
-------------------------------------------------
Net loss as reported $5,520,162 $6,408,444 $14,644,449
Less: Stock-based compensation determined
under the fair value method 32,580 29,865 24,376
---------- ---------- -----------
Pro forma net loss $5,552,742 $6,438,309 $14,668,825
========== ========== ===========
ADVERTISING EXPENSE
The Company expenses advertising costs as incurred. For fiscal periods 2002,
2001 and 2000 advertising expense amounted to $340,000 (unaudited), $449,454
(unaudited) and $1,917,766, respectively.
CASH AND CASH EQUIVALENTS
Cash equivalents consist of highly liquid investments primarily with maturity of
three months or less at the time of purchase. At December 31, 2002, cash
equivalents consist primarily of short-term debt instruments, certificates of
deposit and money market funds.
10
IdeaForest.com, Inc.
Notes to Financial Statements
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INVENTORIES
Inventory purchases by the Company consist primarily of finished goods items.
Inventory is accounted for at lower of cost or market using the first in first
out method.
PROPERTY, EQUIPMENT AND WEBSITE DEVELOPMENT
Property, equipment and website development, including capital leases are
carried at cost less accumulated depreciation and amortization. The provision
for depreciation and amortization has been computed using the straight-line
method over the following estimated useful lives of the assets:
Website development 3 years
Computer hardware 3 - 7 years
Computer software 3 years
Office equipment and other 3-10 years
For fiscal periods 2002, 2001 and 2000 depreciation and amortization expense for
property, equipment and website development was $2,690,509 (unaudited),
$2,476,294 (unaudited), and $1,480,820, respectively.
INTANGIBLE ASSETS
In June 2000, the Company entered into a ten year trademark license, website,
marketing, merchandising and procurement agreement (the Licensing Agreement)
with Jo-Ann. Among other things, the Licensing Agreement allows the Company to
purchase inventory from Jo-Ann and use the joann.com url and name on its
website. The Company is dependent upon this agreement with Jo-Ann to operate
under its current economic model. The Licensing Agreement was consummated
through the issuance of 8,374,780 shares of Series A Preferred Stock (Series A),
1,000 shares of Series A-1 Preferred Stock (Series A-1) and a warrant to
purchase 44,193,898 common stock shares of the Company. The warrant had an
exercise period of ten years, commencing on June 2, 2000, with an exercise price
of $0.02262. The value assigned to the License Agreement was based on the fair
market value of the equity instruments exchanged with Jo-Ann and the Company.
The total value assigned to the Licensing Agreement was $2,778,515.
11
IdeaForest.com, Inc.
Notes to Financial Statements
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The Company is amortizing the value of the intangible asset over the life of the
related contract (i.e. ten years). Total amortization expense for fiscal periods
2002, 2001 and 2000 was approximately $278,000 (unaudited), $255,000 (unaudited)
and $185,000, respectively. Amortization expense for each of the five succeeding
years is expected to be approximately $62,500 (unaudited) per year.
IMPAIRMENT OF LONG-LIVED ASSETS
Effective January 1, 2002, the Company adopted SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets (SFAS No. 144). SFAS No. 144
supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed Of, to supply a single accounting approach
for measuring impairment of long-lived assets, including definite lived
intangible assets, businesses accounting for as a discontinued operation, assets
to be sold and assets to be disposed of other than by sale. The initial
adoptions of SFAS No. 144 did not have a significant impact on the Company's
results of operations or financial position.
Under SFAS No. 144, long-lived assets, except for goodwill and indefinite lived
intangible assets, are reviewed for impairment when circumstances indicate the
carrying value of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by a comparison of the carrying amount of the
assets to future net cash flows estimated by the Company to be generated by such
assets. If such assets are considered to be impaired, the impairment to be
recognized is the amount by which the carrying amount of the assets exceeds the
fair value of the assets. Assets to be disposed of are recorded at the lower of
carrying value or estimated net realizable value.
12
IdeaForest.com, Inc.
Notes to Financial Statements
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In connection with fiscal 2002 year end reporting and based on the results of
operations from 2002 and the completion of the Company's updated 2003 - 2005
strategic plan, the Company determined that an indication of impairment existed
at December 31, 2002 in connection with the Licensing Agreement. Accordingly, an
evaluation of the License Agreement asset under SFAS No. 144 was completed and
the Company determined that the Licensing Agreement asset was impaired. As a
result of this impairment, the Company reduced the net value of the License
Agreement by $1,592,112 (unaudited) to approximately $500,000 (unaudited) in
fiscal 2002. The impairment loss of $1,592,112 (unaudited) was recorded in the
statement of operations in fiscal 2002 in general and administrative expense.
INCOME TAXES
The Company uses the liability method in measuring the provision for income
taxes and recognizing deferred tax assets and liabilities in the balance sheet.
The liability method requires that deferred income taxes reflect the tax
consequences of currently enacted rates for differences between tax and
financial reporting basis of assets and liabilities.
CONCENTRATIONS
In fiscal 2002, 2001 and 2000, the Company purchased approximately 28%
(unaudited), 29% (unaudited) and 15%, respectively, of its inventory sold from
Jo-Ann.
The Company performs ongoing credit evaluations of its customers; however, the
majority of its sales do not require collateral and are paid by credit card.
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.
13
IdeaForest.com, Inc.
Notes to Financial Statements
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
NEW ACCOUNTING PRONOUNCEMENTS
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
establishes standards for how an issuer classifies and measures in its statement
of financial position certain financial instruments with characteristics of both
liabilities and equity. In accordance with the standard, financial instruments
that embody obligations for the issuer are required to be classified as
liabilities. SFAS No. 150 will be effective in fiscal 2003. The Company is
currently assessing the impact of the provisions of SFAS No. 150.
3. LEASES
The Company leases its corporate office facility under an operating lease that
expired on December 31, 2002. On January 1, 2003 the Company signed a three-year
lease for this facility. For fiscal periods 2002, 2001 and 2000 rental expense
under this operating lease amounted to $97,042 (unaudited), $139,725 (unaudited)
and $282,533, respectively.
Future minimum lease payments under the non-cancelable operating lease signed on
January 1, 2003 are as follows:
(unaudited)
2003 $ 89,232
2004 91,462
2005 93,694
2006 --
2007 --
-----------
Total minimum lease payments $ 274,388
===========
For fiscal periods ended 2001 and 2000 the Company had capital leases for
computer equipment of $206,694 (unaudited) and $360,529, respectively. The
Company fulfilled all of its capital lease obligations in fiscal 2002.
14
IdeaForest.com, Inc.
Notes to Financial Statements
4. RELATED PARTY TRANSACTIONS
The Company purchased inventory and marketing services from Jo-Ann in fiscal
2002, 2001 and 2000. Total inventory and advertising services purchased by the
Company is as follows:
Inventory Advertising
--------------- ----------------
Fiscal 2002 (unaudited) $1,730,000 $ 340,000
Fiscal 2001 (unaudited) 470,000 --
Fiscal 2000 130,000 --
For fiscal year 2002, 2001 and 2000, the Company had outstanding obligations
with Jo-Ann of $616,301 (unaudited), $259,003 (unaudited) and $127,218,
respectively. For debt owed to Jo-Ann, see Note 5.
5. DEBT
The Company has a line of credit with a brokerage firm. The credit limit for
this line is tied to the available cash the Company has with the brokerage firm.
As of December 31, 2002 the Company had available on this line of credit
approximately $650,000 (unaudited). Interest is accrued at 5.16% per annum. The
Company intends to pay the remaining amount on the line by June 30, 2004 by
remitting monthly payments of $12,547 (unaudited).
The following represents a line of credit maturity for the next five years for
the debt noted above:
(unaudited)
2003 $ 143,447
2004 73,088
2005 --
2006 --
2007 --
---------
216,535
Less current portion (143,447)
---------
$ 73,088
=========
The Company also has a $100,000 interest-free note payable with Jo-Ann, which is
due on February 1, 2004.
15
IdeaForest.com, Inc.
Notes to Financial Statements
6. EMPLOYEE 401(k) PLAN
The Company sponsors a defined contribution 401(k) plan in which substantially
all employees are eligible to participate. Under this plan, eligible employees
can contribute up to 15% of salary up to the legal limit. The Company does not
provide a matching contribution. For fiscal periods 2002, 2001 and 2000, the
Company paid administrative expenses on behalf of the plan of approximately
$6,800 (unaudited), $6,800 (unaudited) and $0, respectively.
7. CONVERTIBLE REDEEMABLE PREFERRED STOCK
The Company has three classes of convertible redeemable preferred stock, Series
A, Series A-1 and Series B. During November 1999, the Company issued 18,817,556
shares of Series A Preferred Stock (Series A) for $0.372 per share and received
gross proceeds of $7,000,131. Additionally, during June 2000, the Company issued
8,374,780 shares of Series A and 1,000 shares of Series A-1 Preferred Stock
(Series A-1) in connection with the Jo-Ann License Agreement (See Note 2). Also
during June 2000, the Company issued 93,059,240 of Series B for $0.2262 per
share and together with an additional 1,842,029 shares of Series B issued on
September 1, 2000 for $0.2262 per share, received gross proceeds of $21,466,667.
Costs associated with these offerings were $134,864 and have been netted against
the proceeds.
Dividends
Series A issues dividends at 8% of the original Series A purchase price of
$0.372. Such dividends shall be payable only when declared by the Board of
Directors and shall be non-cumulative. No dividend shall be paid on the Series A
unless all accrued dividends on the Series B have been paid in full. Series B
issues dividends at 8% of the purchase price of $0.2262. Such dividends shall be
payable only if declared by the Board of Directors or upon liquidation or
redemption and shall be cumulative annually. No dividends maybe declared on
common stock as long as the Series Preferred stock is outstanding.
Voting Rights
Series A and B Preferred Stockholders shall be voted equally with the shares of
common stock of the Company, and not as a separate class.
For as long as 5,000,000 shares of Series A remain outstanding, the vote or
written consent of a majority of the Series A holders shall be necessary to (i)
amend the Company's Certificate of Incorporation or Bylaws, (ii) increase or
decrease the authorized number of shares of Series A
16
IdeaForest.com, Inc.
Notes to Financial Statements
Preferred, (iii) redeem common stock, (iv) pay of common or preferred dividends,
(v) asset acquisition or (vi) transfer and voluntarily dissolve or liquidate the
Company.
In addition, for as long as 23,000,000 shares of Series B remain outstanding,
the vote or written consent of at least two-thirds of the Series B holders shall
be necessary to (i) amend the Company's Certificate of Incorporation or Bylaws,
(ii) increase or decrease the authorized number of shares of Series B Preferred,
(iii) authorize any new class or series of stock convertible into equity of the
Company ranking on a parity with or senior to the Series B Preferred stock, (iv)
redeem or repurchase with respect to any equity security ranking junior to or on
parity with the Series B Preferred, except for certain acquisitions of common
stock, (v) pay as common or preferred dividends, (vi) effect an asset
acquisition or transfer, (vii) enter into any reclassification or
recapitalization of the outstanding capital stock of the Company, or (viii)
voluntary dissolve or liquidate the Company, (ix) incur additional debt or liens
in excess of $1.0 million other than accounts receivables or inventory financing
in the ordinary course of business or (x) increase or decrease the authorized
number of members of the Company's Board of Directors.
Liquidation
The Series B shall rank, upon liquidation, senior and prior to the Series A, A-1
and common stock and to all other classes or series of shares issued by the
Company. In the event of any voluntary or involuntary liquidation, dissolution
or winding up of the Company, the holders of shares of Series B then outstanding
shall be entitled to be paid out an amount per share equal to two times the
Series B original issuance price plus, any cumulative dividends whether or not
such dividends were declared.
After the payment of the full liquidation preference of the Series B, if the
value of the cash, securities, and other property to be distributed to the
stockholders of the Company (the Liquidation Value) is less than or equal to
$50.0 million, then before any distribution or payment shall be made to the
holders of any Common Stock, the holders of Series A Preferred and Series A-1
Preferred shall be entitled to receive a per share amount equal to the Original
Series A Issue price plus all declared and unpaid dividends on the Series A
Preferred and Series A-1 Preferred. Once the payment of the full amount of the
liquidation preference to the holders of Series A Preferred, Series A-1
Preferred and Series B Preferred has been made these holders will be entitled to
receive, on an as-if-converted basis, together with the holders of Common Stock
a ratable portion of the assets of the Company legally available for
distribution or if the Liquidation Value is greater than $50 million, the
holders of Series A, A-1 and B preferred shares
17
IdeaForest.com, Inc.
Notes to Financial Statements
shall be entitled to receive, on an as-if-converted basis, together with the
holders of Common Stock a ratable portion of the assets of the Company legally
available for distribution.
If upon any such liquidation, distribution or wind up, the assets of the Company
shall be insufficient to make payment in full to all holders of Series A
Preferred and Series A-1 Preferred then such assets shall be distributed among
the holders of Series A and Series A-1 Preferred at the time outstanding,
ratably in proportion to the full amount.
Conversion Rights
Each share of the Series A, A-1 and B is convertible, at the option of the
holder, into shares of common stock. The number of shares of common stock to
which a holder of Series A, A-1 and B Preferred shall be entitled upon
conversion is the product obtained by multiplying the applicable "Conversion
Rate" then in effect by the number of shares of Series A, A-1, or B preferred
shares being converted. The Conversion Rate is defined as the quotient obtained
by dividing the Original Series A, A-1 and B Issue Price by the applicable
Conversion Price. The Conversion Price is the Original Series Issue price which
is defined as $.372 for Series A and A-1 and $.2262 for Series B. As of December
31, 2002 the Series A, A-1, and B Preferred shares are convertible on a
one-for-one basis, subject to adjustment (as defined in the Amended and Restated
Certificate of Incorporation).
Each share of Series A, A-1 and B Preferred shall automatically be converted
into shares of common stock upon a 2/3 majority vote of the respective Series
Preferred holders. In addition, Series A-1 preferred shares will automatically
convert to common at such time as Jo-Ann and its affiliates hold less than 10%
of the Company's common stock on a fully diluted basis. Each share of the Series
A, A-1 and B Preferred Stock is automatically converted into shares of common
stock at a specified conversion price upon the closing of a qualified initial
public offering of the Company's common stock (as defined in the Amended and
Restated Certificate of Incorporation).
Redemption
The Series A and A-1 Preferred Shares are redeemable, if 2/3 of the Series A
(and A-1) holders affirms redemption on the seventh anniversary of the date that
the first share of Series A preferred was issued. The seventh anniversary date
is November 17, 2006. The Company would have to redeem the Series A and A-1
Preferred shares in eight quarterly installments. The Company would be required
to pay cash, equivalent to the original issue purchase price plus declared and
undeclared dividends with respect to such shares. Further, no shares of Series A
or
18
IdeaForest.com, Inc.
Notes to Financial Statements
A-1 Preferred may be redeemed prior to the redemption of all outstanding shares
of the Series B Preferred.
The Series B Preferred Shares are redeemable, if 2/3 of the Series B holders
affirms redemption on the fifth anniversary of the date that the first share of
Series B preferred was issued. The fifth anniversary date is June 2, 2005. The
Company would be required to pay cash equivalent to two times the original issue
purchase price plus declared and undeclared dividends with respect to such
shares.
8. WARRANTS
In June 2000, the Company issued warrants to purchase 44,193,898 shares of
common stock in conjunction with its Licensing Agreement with Jo-Ann. The
warrants expire in June 2010 and have an exercise price of $0.02 per share. The
warrants had a fair value of $883,689 at the date of issuance and were recorded
as an addition to the value of the intangible licensing arrangement asset (see
Note 2). The fair value of the warrants was determined using an option pricing
model with the following assumptions: expected volatility of 84.0%, expected
life of 10 years, expected dividend yield rate of 0.00% and a risk free interest
rate of 6.3%. See Note 2 for details regarding the intangible license agreement
asset.
In May 2000, the Company obtained a $1,000,000 bridge loan from Media Technology
Ventures, LP (a shareholder of the Company). The bridge loan was used in
connection with the issuance of Series B Preferred Stock and had a term of one
month. In exchange for this loan the Company issued a warrant to purchase
2,210,432 shares of Series B Preferred Shares at $.2262. These warrants expire
in 2010 and had a fair value of $353,670. The fair value of these warrants was
determined using an option pricing model and was recognized as interest expense
during fiscal 2000. The assumptions used to determine the fair value of these
warrants included: expected volatility of 84.0%, expected life of 5 years,
expected dividend yield rate of 0.00% and a risk free interest rate of 6.3%.
9. STOCK-BASED COMPENSATION PLAN
On October 20, 1999, the Company adopted the 1999 IdeaForest.com, Inc. Equity
Incentive Plan (Stock Plan) for the issuance of stock options and stock grants
(i.e., restricted stock). The Stock Plan provides for an aggregate of 24,887,461
shares of the Company's common stock to be awarded under the Plan. These common
shares may be granted to selected officers, key employees, the Company's Board
of Directors and consultants at prices generally equal to the fair market value
of a share of common stock on the date of grant. Options generally vest ratably
19
IdeaForest.com, Inc.
Notes to Financial Statements
over a period commencing with the grant date and expire no later than ten years
from the date of grant.
A summary of stock option activity under the Company's Stock Plan for the period
from February 1, 2000 to December 31, 2002 is presented below:
WEIGHTED
AVERAGE
OPTION EXERCISE SHARES
OPTIONS PRICE PRICE EXERCISABLE
-------------------------------------------------------------
Outstanding at February 1, 2000 1,903,000 $0.0186 - $0.0372 $0.0351 -
Granted 7,007,150 $0.0186 - $0.0372 $0.0292 5,730
Forfeited -3,404,720 $0.0226 - $0.0372 $0.0285 -
Exercised -5,730 $0.0266 $0.0266 -
Vested 118,635
-------------------------------------------------------------
Outstanding at January 31, 2001 5,499,700 $0.0186 - $0.0372 $0.0316 124,365
Forfeited -4,899,700 $0.0226 - $0.0372 $0.0318 -
Vested 86,374
-------------------------------------------------------------
Outstanding at December 31, 2001 600,000 $0.0226 - $0.0372 $0.0303 210,739
(unaudited)
-------------------------------------------------------------
Forfeited -2,500 $0.0226 $0.0226
Vested 153,177
-------------------------------------------------------------
Outstanding at December 31, 2002 597,500 $0.0226 - $0.0372 $0.0301 363,916
(unaudited)
=============================================================
Options outstanding at December 31, 2002 had a weighted average remaining
contractual life of 8.5 years. At December 31, 2002, approximately 15,000,000
(unaudited) options remained available for grant.
In addition, the Company issued options to non-employee consultants for services
performed during fiscal periods 1999 and 2000 amounting to 510,400 shares (See
Note 11). The fair value of these options totaled $10,208. The assumptions used
to determine the fair value of these options included: expected volatility of
84.0%, expected life of 3 years, expected dividend yield rate of 0.00% and a
risk free interest rate of 6.58%. The Company is amortizing the fair value of
these options over their respective vesting period as a charge to compensation
expense. Compensation expense related to the issuance of these options totaled
$1,630 (unaudited), $1,737 (unaudited) and $2,527 in fiscal 2002, 2001 and 2000,
respectively.
During fiscal years 1999 and 2000, the Company issued 8,886,517 stock grants to
officers and
20
IdeaForest.com, Inc.
Notes to Financial Statements
directors. The stock grants were value at the estimated fair value of common
shares, which ranged between $.0186 and $.0372 during 1999 and 2000. These stock
grants vest over a period ranging from one to three years. Accordingly, the
Company has recorded the grants as unearned compensation to be recognized as
compensation expense over the respective vesting period. Total cumulative common
stock vested under these grants for fiscal year 2002, 2001 and 2000 are
6,104,913 (unaudited), 3,898,556 (unaudited) and 1,542,507, respectively. The
Company recognized compensation expense related to these stock grants of $34,336
(unaudited), $27,913 (unaudited) and $27,149 during fiscal years 2002, 2001 and
2000, respectively.
10. COMMON STOCK
At December 31, 2002, approximately 5,000,000 shares of common stock were
reserved for future issuance of outstanding stock options and for the granting
of future stock under the 1999 IdeaForest.com, Inc. Stock Incentive Plan. In
addition, approximately 122,000,000 common shares were reserved for the
conversion of Series A, A-1 and B Preferred Stock. The Company has also reserved
44,193,898 common shares for conversion of stock warrants.
11. INCOME TAXES
Deferred income taxes reflect the net tax effect of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax liabilities and assets as of the fiscal periods ended
2002, 2001 and 2000 are as follows:
UNAUDITED
------------------------------------------
2002 2001 2000
---------------------------------------------------------------
Accrued expenses $ 192,410 $ 123,285 $ 192,413
Depreciation and amortization (263,220) (1,160,354) (1,677,433)
Net operating loss carryforwards 10,870,006 10,229,162 8,086,108
Valuation allowance (10,799,196) (9,192,093) (6,601,088)
---------------------------------------------------------------
Net deferred taxes $ - $ - $ -
===============================================================
As of December 31, 2002, the Company had Federal net operating loss
carryforwards of approximately $27.2 million (unaudited), which will expire in
fiscal years from 2019 to 2022. For financial reporting purposes, the entire
deferred tax benefit has been offset by a valuation allowance. In the Company's
judgement, the ultimate realization of the benefit is uncertain.
21
IdeaForest.com, Inc.
Notes to Financial Statements
The Company has tax attributes that may be subject to limitation by Internal
Revenue Code Sections 382 or 383 as a result of an equity shift during 2001. The
Company has not utilized any of these attributes. The Company will perform an
appropriate analysis before filing a federal income tax return for which any of
these tax attributes are utilized.
The Company's effective tax rate differs from the expected benefit at the
federal statutory tax rate as follows:
UNAUDITED
-----------------------------------------
2002 2001 2000
----------------------------------------------------------
Federal statutory tax rate 34.0% 34.0% 34.0%
Valuation allowance (34.0) (34.0) (34.0)
----------------------------------------------------------
Effective tax rate 0.0% 0.0% 0.0%
==========================================================
12. COMMITMENTS AND CONTINGENCIES
The Company currently collects sales or other similar taxes in respect of goods
sold in states where it believes nexus exists. One or more states or the federal
government may seek to impose sales tax collection obligations on out-of-state
companies (such as IdeaForest.com) that engage in or facilitate online commerce.
A number of proposals have been made at the state and local level that would
impose additional taxes on the sale of goods and services through the Internet.
A successful assertion by one or more states, or the federal government, that
the Company should collect further sales or other taxes on the sales of products
through IdeaForest.com could negatively affect the revenues and business of the
Company.
22