EX-99 11 l02819aexv99.txt EX-99 IDEAFOREST.COM FINANCIAL STATEMENTS 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