ITEM 2. PROPERTIES
Our headquarters are located in Reston, Virginia. Our local operations lease space in their markets for their network points of presence or POPs and also for office space. We do not believe the locations of the properties in which we lease office or POP space or the terms of any of our leases, individually, are material. We anticipate that we will require additional space for POPs as we expand, and believe that we will be able to obtain suitable space as needed.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We are not a party to any pending legal proceeding that would have a material effect on our consolidated financial condition.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR OUR COMMON STOCK AND RELATED STOCKHOLDER MATTERS
MARKET PRICE OF COMMON STOCK
The following table sets forth the range of high and low sale prices for our common stock for the periods indicated as reported on the Nasdaq National Market:
We have not declared, nor have we paid, any dividends on our common stock and we do not intend to pay dividends on our common stock in the foreseeable future. Instead, we will retain our earnings to finance the expansion of our business and for general corporate purposes.
As of March 27, 2000 there were approximately 502 stockholders of record of our common stock. We do not have any outstanding shares of preferred stock.
EXCHANGE INFORMATION
Our common stock is traded on the Nasdaq National Market System under the symbol 'ONEM.'
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
SELECTED FINANCIAL DATA FOR ONEMAIN.COM, INC.
Presented below are selected financial data for the year ended December 31, 1999 and the period from August 19, 1998 (inception) through December 31, 1998, as well as the selected pro forma financial data for the years ended December 31, 1999 and 1998.
The selected historical statement of operations data for the year ended December 31, 1999 and the period from August 19, 1998 (inception) through December 31, 1998 and the selected historical balance sheet data at December 31, 1999 and 1998 have been derived from our consolidated financial statements which have been audited by Ernst & Young LLP, independent public accountants, whose report with respect to these financial statements is included elsewhere in this Annual Report on Form 10-K.
The selected pro forma financial income statement information includes (a) our historical consolidated results combined with the 17 ISPs as if the IPO Acquisitions had occurred on January 1, 1998; (b) the amortization of goodwill and customer lists resulting from the IPO Acquisitions; (c) the elimination of interest expense for the debt that was paid from the IPO proceeds; and (d) an income tax benefit at an appropriate rate. The selected pro forma financial information includes the results of operations of the Subsequent Acquisitions from the dates of acquisition only.
The pro forma combined financial information does not purport to represent what our results of operations would actually have been if such transactions and events in fact had occurred on those dates or to project our results of operations for any future period.
SELECTED FINANCIAL DATA FOR ONEMAIN.COM, INC. (IN THOUSANDS, EXCEPT PER SHARE AND SUBSCRIBER DATA)
- ------------------ (1) Consists of amortization expense of $96,930 and $77,910 for the years ended December 31, 1999 and 1998 recorded as a result of acquisitions. These amortization charges are attributable primarily to goodwill and subscriber lists and are amortized over three years.
(2) EBITDA represents earnings or losses before interest, taxes, depreciation and amortization. We have included EBITDA in these data because it is a measure commonly used by investors to analyze and compare companies on the basis of operating performance, EBITDA is not a measurement of financial performance under generally accepted accounting principles and should not be construed as a substitute for operating income (loss), net income (loss) or cash flows from operating activities for purposes of analyzing our operating performance, financial position or cash flows. Not all companies define EBITDA in the same way, and our EBITDA is not necessarily comparable to EBITDA reported by other companies.
SELECTED FINANCIAL DATA FOR ONEMAIN.COM, INC.--(CONTINUED) (IN THOUSANDS)
SELECTED HISTORICAL FINANCIAL DATA FOR OUR ISPS (IN THOUSANDS, EXCEPT SUBSCRIBER DATA)
The selected financial data of our initial predecessor 17 ISPs acquired upon the closing of our IPO have been presented below. The selected historical statement of operations data for the three months ended March 31, 1999 and for the years ended December 31, 1998 and 1997 and the selected historical balance sheet data at December 31, 1998 have been derived from the companies' audited financial statements included elsewhere in this Annual Report. The selected historical statement of operations data for the years ended December 31, 1996 and 1995 and the selected historical balance sheet data at December 31, 1997, 1996 and 1995 have been derived from the companies' audited financial statements not included elsewhere in this Annual Report on Form 10-K. All of our ISPs have fiscal years ending December 31. Subscriber information for December 31, 1995 is not available.
SELECTED HISTORICAL FINANCIAL DATA FOR OUR ISPS--(CONTINUED) (IN THOUSANDS, EXCEPT SUBSCRIBER DATA)
- ------------------ (1) Operating loss for the years ended December 31, 1998, 1997, 1996, and 1995 includes incentive compensation expense (benefit) of $3,341, $(599), $581, and $1,681, respectively. This expense (benefit) is attributable to compensation expense related to United States Internet's stock appreciation rights.
SELECTED HISTORICAL FINANCIAL DATA FOR OUR ISPS--(CONTINUED) (IN THOUSANDS, EXCEPT SUBSCRIBER DATA)
SELECTED HISTORICAL FINANCIAL DATA FOR OUR ISPS--(CONTINUED) (IN THOUSANDS, EXCEPT SUBSCRIBER DATA)
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (AMOUNTS IN THOUSANDS, EXCEPT SUBSCRIBER, SHARE AND PER SHARE DATA)
INTRODUCTION
The following discussion of our results of operations and of our liquidity and capital resources should be read in conjunction with our consolidated financial statements and the related notes thereto contained elsewhere in this Annual Report on Form 10-K.
OVERVIEW
We successfully completed an initial public offering of 8,500,000 shares of our common stock on March 30, 1999, concurrently with the acquisitions of 17 ISPs (the 'IPO Acquisitions'). On April 9, 1999, the underwriters exercised their over-allotment option to purchase 1,275,000 shares of common stock at the initial public offering price of $22.00 per share. As of December 31, 1999, we acquired all of the outstanding common stock, limited liability company interests and partnership interests of nine additional ISPs and selected assets of various other ISPs (the 'Subsequent Acquisitions'). As of December 31, 1999, the total purchase price, comprised of cash and common stock, for all of our acquisitions was $340,300. For financial reporting purposes, the IPO Acquisitions have been accounted for under the purchase method of accounting from March 30, 1999 and the Subsequent Acquisitions from the dates of acquisition. The purchase of these companies, coupled with strategic, internal growth, has increased our subscribers to approximately 701,000 at December 31, 1999. Subsequent to December 31, 1999, we acquired all of the outstanding common stock of one other ISP for approximately $3,100 in cash.
REVENUE
We derive Internet access revenues primarily from subscriptions from individuals and small businesses for dial-up access to the Internet. Subscription fees vary among our ISPs and by billing plan within the subscriber base for a particular ISP. We also earn access revenues by providing dedicated Internet access and Web hosting services.
We earn other revenues by charging set-up and installation fees, providing Web page design and development and other technical services and by selling advertising, equipment and software. Revenues from the sale of these products and services have been classified as other revenues in the results of operations tables set forth below.
COSTS AND EXPENSES
Our costs and expenses include:
o cost of access revenues;
o cost of other revenues;
o operations and customer support;
o sales and marketing;
o general and administrative;
o amortization; and
o depreciation.
Cost of access revenues consists primarily of the costs of maintaining sufficient capacity to provide service to subscribers. For an ISP, capacity is a measurement of the ISP's ability to connect subscribers to the Internet. Capacity costs include:
o the cost of leased routers and access servers and recurring telecommunications costs, including the cost of local telephone lines to carry subscriber calls to our points of presence, or POPs;
o the costs associated with leased lines connecting our POPs directly to the Internet or to our operations centers and connecting the operations centers to the Internet; and
o Internet backbone costs, which are the amounts we pay to Internet backbone providers for bandwidth which allows us to transmit data from the Internet to our subscribers.
We expect the cost of access revenues to increase over time on an absolute basis, as our subscriber base grows. However, we expect to leverage the combined scale of our ISPs to lower the cost of access revenues as a percentage of revenues by:
o negotiating one or more relationships with national backbone providers to connect our ISPs to the Internet;
o negotiating favorable local loop contracts and establishing co-location arrangements with local exchange carriers;
o establishing relationships to reduce costs and improve access and reliability for our subscribers; and
o negotiating discounts with equipment vendors.
Cost of other revenues consists primarily of:
o the salaries and benefits of the personnel providing installation of equipment and software;
o Web development and technical services; and
o the cost of purchasing the equipment to provide these services. In the case of equipment and software sales, the cost of other revenues includes the cost of licensing software and purchasing equipment for resale.
Operations and customer support includes the expenses associated with customer service and technical support, and consists primarily of the salaries and employment costs of the employees responsible for those efforts. We expect operations and customer support expenses to increase over time to support new subscribers and expand existing subscribers' service. New subscribers tend to have particularly heavy customer service and technical support requirements. Because we anticipate rapid growth in our subscriber base to continue, these costs are expected to comprise an increasing percentage of expenses in the near term. In addition, we intend to implement a customer care center strategy which will provide customer service and technical support 24 hours a day, seven days a week in our markets. This strategy will also increase these expenses. In the longer term, as a percentage of revenues, we believe operations and customer support expenses should decline as we integrate our operations.
Sales and marketing includes the expenses associated with acquiring subscribers, including advertising, promotions, referral bonuses, salaries and sales commissions. On a percentage of revenue basis, sales and marketing expense is a relatively variable cost and will increase with our development of a common brand supported by a community-based marketing program. We expect that, over time, sales and marketing expense will decrease as a percent of revenues.
General and administrative expenses consist primarily of:
o the salaries and benefits of our management and administrative employees;
o the cost of travel, entertainment, rent, utilities and credit card processing; and
o the cost of consulting and professional fees related to integration.
We expect general and administrative costs to increase to support growth, particularly as we integrate our operations by establishing network operations centers and customer care centers, and by implementing common billing and financial reporting systems in the near term. Over time, we expect to leverage the combined scale of our ISPs to lower these expenses as a percentage of revenues as efficiencies from integration are realized.
Amortization expense primarily relates to the amortization of goodwill and customer lists resulting from the IPO Acquisitions and the Subsequent Acquisitions. Amortization expense is expected to increase as we acquire additional ISPs. Our policy is to amortize, on a straight-line basis, the portion of the acquisition purchase price attributable to customer lists and goodwill over a three-year period.
Depreciation primarily relates to hardware infrastructure and is calculated over the estimated useful lives of the assets ranging from two to five years using the straight-line method. We expect our capital expenditures to increase as we continue to expand our operations. We also anticipate that financial resources will be utilized to acquire additional communications equipment and improvements to technology that will allow our networks to grow to support new and acquired subscribers, build network operations and customer care centers and integrate common billing and financial reporting systems.
RESULTS OF OPERATIONS
The following pro forma financial information includes (a) our historical consolidated results combined with the 17 ISPs as if the IPO Acquisitions had occurred on January 1, 1997; (b) the amortization of goodwill and customer lists resulting from the IPO Acquisitions; (c) the elimination of interest expense for the debt that was paid from the IPO proceeds; and (d) an income tax benefit at an appropriate rate. The selected pro forma financial information includes the results of operations of the Subsequent Acquisitions from the dates of acquisition only.
The pro forma combined financial information does not purport to represent what our results of operations would actually have been if such transactions and events in fact had occurred on those dates or to project our results of operations for any future period.
The following table, which is based on the preceding table, shows a comparison of costs of revenues, operations and customer support, sales and marketing and general and administrative expenses as a percentage of total revenues:
PRO FORMA YEAR ENDED DECEMBER 31, 1999 COMPARED TO PRO FORMA YEAR ENDED DECEMBER 31, 1998
We incurred a pro forma operating loss of $114,734 for the year ended December 31, 1999 compared to a pro forma operating loss of $84,193 for the year ended December 31, 1998.
Total Revenues. Total revenues for the year ended December 31, 1999 were $102,266, compared to $56,687 for the year ended December 31, 1998, an increase of 80.4%. The increase was primarily attributable to an increase in the number of subscribers as a result of internal growth and strategic acquisitions during 1999. Revenues related to the Subsequent Acquisitions totaled $13,698, or 13.4% of total revenues. Total subscribers at December 31, 1999 were approximately 701,000 compared to approximately 332,000 at December 31, 1998, an increase of 111.1%. Of this increase, approximately 216,000 subscribers were a result of the Subsequent Acquisitions.
Access revenues for the year ended December 31, 1999 were $96,263, compared to $51,814 for the year ended December 31, 1998, an increase of 85.8%. The increase was primarily attributable to the increase in subscribers discussed above, offset by the effects of promotional discounts during 1999.
Other revenues for the year ended December 31, 1999 totaled $6,003 compared to $4,873 for the year ended December 31, 1998, an increase of 23.2%. The increase was primarily attributable to set-up fees and equipment sales. The growth in set-up fees does not track with the growth in access revenues because not all access subscribers pay a set-up fee.
Costs of access and other revenues. Total costs of access and other revenues for the year ended December 31, 1999 were $40,581, a 78.1% increase over $22,787 for the year ended December 31, 1998. Stated as a percentage of revenues, the total costs of access and other revenues remained relatively consistent at 39.7% and 40.2% for the years ended December 31, 1999 and 1998, respectively. We expect that cost of access and other revenues, as a percentage of revenues, will decline in future periods as we begin to achieve the benefits of network integration. Any decrease, however, may be partially offset by network improvements and expansion projects.
Operations and customer support. Operations and customer support expenses for the year ended December 31, 1999 increased to $14,908, a 68.8% increase from $8,834 for the year ended December 31, 1998. As a percentage of revenues, operations and customer support expenses for the year ended December 31, 1999 decreased to 14.6% from 15.6% for the year ended December 31, 1998. The decrease is a result of our ability to leverage this relatively fixed cost over a larger subscriber base.
Sales and marketing. Sales and marketing expenses for the year ended December 31, 1999 increased to $16,466, or 131.4%, from $7,115, for the year ended December 31, 1998. Sales and marketing expense as a percentage of revenues for the year ended December 31, 1999 increased to 16.1% from 12.6% for the year ended December 31, 1998. The increase is the result of increased marketing promotions during 1999. We expect sales and marketing expense to increase with our development of a common brand supported by a community-based marketing program. However, over time, we expect sales and marketing expense to decrease as a percent of revenues.
General and administrative. General and administrative costs (exclusive of non-cash compensation expense) increased to $35,937, or 94.9%, for the year ended December 31, 1999, from $18,439 for the year ended December 31, 1998. General and administrative expense as a percentage of revenues (exclusive of non-cash compensation expense) for the year ended December 31, 1999 increased to 35.1% from 32.5% for the year ended December 31, 1998. The increase was attributable to costs associated with our various integration efforts during 1999.
Amortization. Amortization expense for the year ended December 31, 1999 totaled $97,774 compared to $79,105 for the year ended December 31, 1998. This increase is primarily attributable to the amortization from additional goodwill and customer lists relating to the Subsequent Acquisitions and from adjustments related to the definitive purchase agreements and contingent payments made to former owners of the IPO Acquisitions.
Depreciation. Depreciation expense for the year ended December 31, 1999 totaled $8,889 compared to $4,281 for the year ended December 31, 1998. The increase is a direct result of increased capital expenditures resulting from our continuing effort to improve our infrastructure in order to enhance existing services and support continued growth.
PRO FORMA YEAR ENDED DECEMBER 31, 1998 COMPARED TO PRO FORMA YEAR ENDED DECEMBER 31, 1997
Total Revenues. Total revenues for the year ended December 31, 1998 were $56,687, an 86.2% increase from $30,439 for the same period in 1997. The increase was primarily attributable to an increase in the number of subscribers.
Cost of access and other revenues. Cost of access and other revenues increased to $22,787 for the year ended December 31, 1998 from $13,404 for the year ended December 31, 1997. This 70.0% increase was primarily the result of the increased costs associated with adding capacity to service new subscribers. Cost of access and other revenues as a percentage of revenues decreased to 40.2% in 1998 from 44.0% in 1997, primarily as a result of existing excess capacity being used to service new subscribers.
Operating expenses. Operating expenses, which include operations and customer support, sales and marketing and general and administrative expenses, increased 65.4% to $34,388 for the year ended December 31, 1998 from $20,791 for the year ended December 31, 1997. This increase is primarily a result of hiring additional customer support, technical support and administrative personnel. Operating expenses as a percentage of revenues decreased to 60.7% in 1998 from 68.3% in 1997, primarily as a result of spreading the cost of existing personnel over a growing subscriber base.
EFFECTS OF INFLATION
We do not believe that inflation has had a material impact on our results of operations during the year ended December 31, 1999.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 1999, our combined cash and cash equivalents balance was $27,099 compared with $172 at December 31, 1998. This increase is mainly attributable to the receipt of $190,622 of net proceeds from our IPO, the payment of the aggregate cash portion of the purchase price of the IPO Acquisitions and Subsequent Acquisitions of $129,755, net of cash acquired and the purchase price payable of $7,097 at December 31, 1999, the repayment of $7,324 of debt assumed in the IPO Acquisitions and the Subsequent Acquisitions and the net investment of $15,789 in marketable securities. In addition, we earned interest income of $3,225 in 1999. At closing of each acquisition, we retired substantially all of the acquired company's debt obligations except to the extent such obligations related to capitalized leases.
Net cash provided by operating activities was $2,553 for the year ended December 31, 1999.
Net cash used in investing activities was $156,613 for the year ended December 31, 1999, representing the payment of the cash portion of the purchase prices for the acquisitions, net of cash acquired and the purchase price payable of $7,097 at December 31, 1999, the net investment in marketable securities and the purchases of property, plant and equipment.
Net cash provided by financing activities was $180,987 for the year ended December 31, 1999. We received net proceeds from the IPO of $190,622 and $1,941 from exercises of common stock options. We repaid $7,324 of debt assumed in the acquisitions. Additionally, during the three months ended March 31, 1999 we issued a second promissory note in the amount of $500 to one of our founders to fund the payment of offering costs. During the year ended December 31, 1999, we repaid the founders notes and accrued interest in full, in the aggregate of $1,021.
We expect our capital expenditures to increase as we continue to expand our operations. We anticipate that financial resources will be utilized in acquiring additional communications equipment and improvements to technology that will allow our networks to grow to support new and acquired subscribers, build a network operations center and integrate billing and financial reporting systems. At December 31, 1999, we owe $7,097 in purchase price payable relating to the acquisition of two companies and other customer lists. Of this amount, $6,829 was paid in January 2000. We expect to pay additional consideration pursuant to earn-out arrangements included in the definitive agreements for the IPO Acquisitions and the Subsequent Acquisitions. The payment of additional consideration is contingent upon certain operational and earnings margin requirements being met by the ISPs. The amount of the additional consideration will be payable in either cash or stock. We also expect to pay additional consideration and to recover amounts previously paid relating to the final purchase price adjustments for certain of the acquisitions. As of December 31, 1999, we estimate the amount of additional consideration to be approximately $2,608, net of purchase price adjustments related to the definitive agreements. Such amounts may be adjusted further in future periods.
In the year 2000, we plan to continue our integration efforts and anticipate that we will take a restructuring charge for severance and exit costs relating to the consolidation of our facilities and operating agreements.
We anticipate that our current cash on hand and cash flow from operations will be sufficient to meet our liquidity requirements for operations through the remainder of 2000. However, we are currently pursuing, and intend to continue to pursue, additional acquisitions which we expect to be funded through a combination of cash and the issuance of shares of our common stock. To the extent we elect to pursue acquisitions involving the payment of significant amounts of cash to fund the purchase price of such acquisitions and the repayment of assumed indebtedness, we are likely to require additional sources of financing to fund such non-operating cash needs. We may determine to raise additional debt or equity capital to finance potential acquisitions and/or to fund accelerated growth. Any significant acquisitions or increases in our growth rate could materially affect our operating and financial expectations and results, liquidity and capital resources.
EFFECTS OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In December 1999, the SEC issued Staff Accounting Bulletin No. 101, 'Revenue Recognition in Financial Statements' ('SAB 101'), which is effective for fiscal years beginning after December 15, 1999. We are in the process of reviewing our revenue recognition policies to determine that they are in accordance
with SAB 101. We anticipate that the adoption of SAB 101 will require us to change the way in which we account for set-up fees associated with Internet access service. Our historical practice has been to recognize the revenue associated with the fees when charged. Under SAB 101, revenue for set-up fees generally should be recognized on a straight-line basis over the contractual period or longer if the relationship with the customer is expected to extend beyond the initial term and the customer continues to benefit from the payment of the set-up fee. We anticipate that we will account for the change in accounting principle as a cumulative effect adjustment in the year 2000 and that the adjustment will not be material.
In January 2000, the EITF released Issue 99-17, 'Accounting for Advertising Barter Transactions' ('EITF 99-17'). EITF 99-17 provides guidance on the revenue and expense recognition for advertising barter transactions. We will adopt the provisions of EITF 99-17 beginning January 1, 2000 and do not expect that it will have a material effect on our revenues and earnings.
FORWARD-LOOKING STATEMENTS
Some of the statements contained in this Annual Report are 'forward-looking statements.' These statements can sometimes be identified by our use of forward-looking words such as 'may,' 'will,' 'anticipate,' 'continue,' 'believe,' 'pro forma,' 'estimate,' 'expect' or 'intend' or the negative thereof or other variations thereon or comparable terminology. These forward-looking statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. These risks and uncertainties include our ability to:
o retain and grow our subscriber base;
o sustain our projected growth;
o successfully integrate new subscribers and/or assets obtained through acquisitions;
o succeed in the highly competitive markets in which we operate;
o obtain required financing on favorable terms;
o reduce operating costs resulting from the integration and optimization of our acquisitions;
o respond to technological developments affecting the Internet; and
o protect our intellectual property.
This list is intended to identify some of the principal factors that could cause actual results to differ materially from those described in the forward-looking statements included elsewhere in this Annual Report. These risks and uncertainties are not intended to represent a complete list of all risks and uncertainties inherent in our business, and no assurance can be given that future results indicated, whether expressed or implied, will be achieved. These forward-looking statements are based on current expectations, and we assume no obligation to update this information. Therefore, our actual experience and results achieved during the period covered by any forward-looking statement may differ substantially from those stated or implied. The forward-looking statements should be read together with the information presented in this Annual Report and included elsewhere in recent SEC filings.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We are exposed to changes in interest rates primarily from our investments in cash and cash equivalents and marketable securities. We believe that the market risk associated with our cash and cash equivalents and marketable securities is not material to our results of operations.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the financial statements listed under the heading '(a) (1) Consolidated Financial Statements' of Item 14 hereof, which financial statements and quarterly information included in Note 11 to the financial statements are incorporated herein by reference in response to this Item 8.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The response to this item is incorporated by reference from the sections titled 'Election of Director,' 'Executive Officers' and 'Section 16(a) Beneficial Ownership Reporting Compliance' in our Proxy Statement for our 2000 Annual Meeting of Stockholders.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The response to this item is incorporated by reference from the section titled 'Executive Compensation' in our Proxy Statement for our 2000 Annual Meeting of Stockholders.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The response to this item is incorporated by reference from the section titled 'Stock Ownership' in our Proxy Statement for our 2000 Annual Meeting of Stockholders.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The response to this item is incorporated by reference from the section titled 'Related Party Transactions' in our Proxy Statement for our 2000 Annual Meeting of Stockholders.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 10-K
(a)(1) Financial Statements. The following financial statements of OneMain.com, Inc. and the IPO Acquisitions are filed with this Form 10-K:
The consolidated financial statements of OneMain.com, Inc. as of December 31, 1999 and 1998 and for the year ended December 31, 1999 and for the period August 19, 1998 (inception) through December 31, 1998 as audited by Ernst & Young LLP.
The Balance Sheets of the 17 IPO Acquisitions (except TGF Technologies, Inc.) as of December 31, 1998 and the Statements of Operations, Cash Flows and Stockholders' Equity or Members' Equity of the 17 IPO Acquisitions for the three months ended March 31, 1999, the year ended December 31, 1998 (except TGF Technologies, Inc.), and the year ended December 31, 1997 (except Southwind Internet Access, Inc., United States Internet, Inc., Internet Solutions, LLC, TGF Technologies, Inc., and JPS.Net Corporation) as audited by Ernst & Young LLP.
The Statements of Operations, Cash Flows, and Stockholders' Equity of JPS.Net Corporation for the period January 31, 1997 (inception) through December 31, 1997 as audited by Ernst & Young LLP.
The Balance Sheet of TGF Technologies, Inc. as of December 31, 1998 and the Statements of Operations, Cash Flows and Stockholders' Equity for the years ended December 31, 1998 and 1997 as audited by KPMG LLP.
The Statements of Operations, Cash Flows, and Stockholders' Equity of Southwind Internet Access, Inc. for the year ended December 31, 1997 as audited by Grant Thornton LLP.
The Statements of Operations, Cash Flows, and Stockholders' Equity of United States Internet, Inc. for the year ended December 31, 1997 as audited by Coulter & Justus, P.C.
The Statements of Operations, Cash Flows, and Members' Equity of Internet Solutions, LLC for the year ended December 31, 1997 as audited by Kevin J. Tochtrop, Certified Public Accountant.
(a)(2) Financial Statement Schedules
All financial statement schedules required by Item 14(a)(2) have been omitted because they are inapplicable or because the required information have been included in the Consolidated Financial Statements of Notes thereto.
(a)(3) Exhibits
The following Exhibits are incorporated herein by reference or are filed with this Form 10-K as indicated below.
- ------------------
* Incorporated by reference
(b) Reports on Form 8-K
We filed a Current Report on Form 8-K on December 13, 1999, under Item 5 relating to supplemental information provided to investors and analysts at our Investor and Media Day.
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, ON THE 30TH DAY OF MARCH, 2000.
ONEMAIN.COM, INC.
By: /S/ STEPHEN E. SMITH ----------------------------------- Stephen E. Smith Chief Executive Officer and Chairman of the Board
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES INDICATED ON THE 30TH DAY OF MARCH, 2000.
ONEMAIN.COM, INC.
ONEMAIN.COM, INC. INDEX TO FINANCIAL STATEMENTS--(CONTINUED)
ONEMAIN.COM, INC. INDEX TO FINANCIAL STATEMENTS--(CONTINUED)
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
To the Board of Directors and Stockholders of OneMain.com, Inc.
We have audited the accompanying consolidated balance sheets of OneMain.com, Inc. as of December 31, 1999 and 1998 and the related consolidated statements of operations, stockholders' equity (deficit), and cash flows for the year ended December 31, 1999 and for the period from August 19, 1998 (inception) through December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of OneMain.com, Inc. at December 31, 1999 and 1998 and the consolidated results of its operations and its cash flows for the year ended December 31, 1999 and for the period from August 19, 1998 (inception) through December 31, 1998 in conformity with accounting principles generally accepted in the United States.
/S/ ERNST & YOUNG LLP
McLean, Virginia February 7, 2000
ONEMAIN.COM, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
See accompanying notes.
ONEMAIN.COM, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
See accompanying notes.
ONEMAIN.COM, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT) (IN THOUSANDS)
See accompanying notes.
ONEMAIN.COM, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
See accompanying notes.
ONEMAIN.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 1--ORGANIZATION
OneMain.com, Inc., a Delaware Corporation (the 'Company') was founded in August 1998 as a provider of Internet access and related services to individuals and businesses located predominately in smaller metropolitan markets and rural communities throughout the United States. Simultaneously with the completion of an initial public offering of its common stock on March 30, 1999, the Company acquired the outstanding capital stock and limited liability interests of 17 Internet service providers ('IPO Acquisitions'). Throughout the remainder of 1999, the Company acquired the outstanding capital stock, limited liability interests and partnership interests of nine additional ISPs as well as certain assets of various other ISPs ('Subsequent Acquisitions'). The Company is currently one of the ten largest independent Internet service providers in the United States.
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates. The preparation of financial statements in conformity with generally accepted accounting principles 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.
Principles of Consolidation. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
Business Combinations. Business combinations have been accounted for under the purchase method of accounting. As a result, the consolidated financial statements include the results of operations of the acquired ISPs from the dates of acquisition. Net assets of the ISPs acquired are recorded at fair value at the dates of acquisition.
Cash and Cash Equivalents. For purposes of the statement of cash flows, the Company considers all highly liquid investments with maturities of three months or less at the time of purchase to be cash equivalents.
Marketable Securities. The Company's marketable securities are classified as 'held to maturity'. Marketable securities consist of $13,743 in commercial paper, $1,198 in mortgage-backed securities, $800 in certificates of deposit and $48 in other securities, all maturing within one year.
Accounts Receivable. The Company recorded a provision for doubtful accounts of $2,010 and write-offs of $1,604 for the year ended December 31, 1999.
Property and Equipment. Computer equipment, internal software, furniture and equipment are recorded at cost and depreciated using the straight-line method over estimated useful lives which range from two to five years. Leasehold improvements are recorded at cost and depreciated over the lesser of the related lease term or the useful life of the asset. The Company leases certain of its equipment under capital lease agreements. The assets and liabilities under capital leases are recorded at the lesser of the present value of aggregate future minimum lease payments or the fair value of the assets under the lease. Assets under capital leases are depreciated over their estimated useful lives or the lease term as applicable.
The Company accounts for the costs associated with the development of internal use software under the provisions of Statement of Position (SOP) 98-1, 'Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.' The pronouncement requires that certain costs for the development of internal use software should be capitalized, including the costs of coding, software configuration, upgrades and enhancements. During the year ended December 31, 1999, the Company capitalized $1,700 of costs related to the development of internal use software.
ONEMAIN.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Goodwill and Customer Lists. Goodwill represents the costs in excess of the fair market value of identifiable net assets acquired and is being amortized using the straight-line method over three years. The costs of customer lists acquired are being amortized over three years using the straight line method.
Impairment of Long-Lived Assets. The Company reviews the recoverability of long-lived assets whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. If the expected future cash flows from the use of such assets (undiscounted without interest charges) are less than the carrying value, the Company's policy is to record a write-down that is determined based on the difference between the carrying value of the asset and its estimated fair value.
Financial Instruments. The carrying amounts of the Company's financial assets and liabilities approximate fair value.
Revenue Recognition. The Company recognizes Internet access revenue when the services are provided. The Company offers contracts for Internet access that are generally paid in advance by customers. The Company has deferred recognizing revenue on these advance payments and amortizes the amounts to revenue on a straight-line basis as the services are provided.
Other revenues include set-up fees, network installation, maintenance and consulting services. Other than set-up fees, these services are provided on a time-and-material basis and revenue is recognized based upon time (at established rates) and other direct costs as incurred.
Advertising Costs. The Company expenses advertising costs as incurred. The Company incurred $6,766 in advertising costs for the year ended December 31, 1999.
Sources of Supplies. The Company relies on local telephone companies to provide data communications. Although management feels alternative telecommunication facilities could be found in a timely manner, any disruption of these services could have an adverse effect on operating results.
The Company attempts to maintain alternative vendors for required products. Its modems, terminal servers and high-performance routers, which are important components of its network, are currently acquired from three sources. Some of the Company's suppliers have limited resources and production capacity. If the suppliers are unable to meet the Company's needs as it is building out its network infrastructure and the Company is unable to obtain this equipment from other sources, then delays and increased costs in the expansion of the Company's network infrastructure could result, having an adverse effect on operating results.
Stock Based Compensation. The Company grants options for a fixed number of shares to employees with an exercise price equal to the fair value of the shares on the date of grant. The Company accounts for stock option grants in accordance with APB Opinion No. 25, 'Accounting for Stock Issued to Employees' ('APB 25') and related Interpretations because the Company believes the alternative fair value accounting provided for under FASB Statement No. 123, 'Accounting for Stock-Based Compensation,' requires the use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized.
Basic and Diluted Loss Per Share. Basic and diluted loss per share is calculated by dividing the net loss by the weighted average number of shares of common stock outstanding during each period. Stock options have been excluded from the calculation of diluted loss per share as their effect would have been antidilutive.
Concentrations of Risk. The Company provides Internet access and related services to individuals and businesses located predominately in smaller metropolitan markets and rural communities throughout the
ONEMAIN.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
United States. The Company generally does not perform credit evaluations of its customers' financial condition. The Company maintains reserves to provide for estimated credit losses. Actual credit losses could differ from such estimates.
Recent Pronouncements. In December 1999, the SEC issued Staff Accounting Bulletin No. 101, 'Revenue Recognition in Financial Statements' ('SAB 101'), which is effective for fiscal years beginning after December 15, 1999. Under SAB 101, revenue for set-up fees generally should be recognized on a straight-line basis over the contractual period or longer if the relationship with the customer is expected to extend beyond the initial term and the customer continues to benefit from the payment of the set-up fee. The Company will account for the change in accounting principle as a cumulative effect adjustment in the year 2000 and does not believe that the adjustment will be material.
In January 2000, the EITF released Issue 99-17, 'Accounting for Advertising Barter Transactions' ('EITF 99-17'). EITF 99-17 provides guidance on the revenue and expense recognition for advertising barter transactions. The Company will adopt the provisions of EITF 99-17 beginning January 1, 2000 and does not expect that it will have a material effect on the Company's revenues and earnings.
NOTE 3--BUSINESS COMBINATIONS
The following table sets forth the consideration paid (a) in cash and (b) in shares of common stock for each of the acquisitions in 1999, the fair value of the net assets acquired, the value of customer lists acquired and goodwill. For purposes of computing the purchase price, the value of shares for the IPO Acquisitions is based upon a 10% discount from the initial public offering price of $22.00 because those shares have trading restrictions. The value of shares for the Subsequent Acquisitions was determined based on the average market price of the Company's common stock.
The total consideration below also reflects the payment of $1,765 of contingent consideration related to earn out arrangements included in the definitive agreements for certain of the companies, as well as adjustments to the purchase prices of certain ISPs. The payment of additional consideration is contingent upon certain operational and earnings margin requirements being met. The amount of the additional consideration is payable in either cash or stock. At December 31, 1999, the Company has estimated and accrued $2,608 in additional earn out consideration, net of purchase price adjustments related to the definitive agreements, which is not reflected in the total consideration below. The Company has not accrued any liability related to earn out arrangements with performance measurement dates subsequent to December 31, 1999.
ONEMAIN.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 3--BUSINESS COMBINATIONS--(CONTINUED)
- ------------------
(1) Includes $52,984 of deferred tax liabilities associated with purchase accounting.
At December 31, 1999, the Company has recorded $6,269 in purchase price payable related to the acquisitions of Rural Connections and Radiks. In addition, the Company has recorded $828 in purchase price payable related to the acquisitions of other customer lists. Such amounts are included in other current liabilities. The purchase prices of Rural Connections and Radiks are subject to adjustment, upward or downward, based on closing balance sheet audits.
The following pro forma financial information includes the effects of (a) the IPO Acquisitions and Subsequent Acquisitions; (b) the amortization of goodwill and customer lists resulting from the IPO Acquisitions and Subsequent Acquisitions; (c) the elimination of interest expense for the debt that was paid from the IPO proceeds; and (d) an income tax benefit at an appropriate rate. The pro forma combined financial information does not purport to represent what the Company's results of operations would actually have been if such IPO
ONEMAIN.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 3--BUSINESS COMBINATIONS--(CONTINUED)
Acquisitions and Subsequent Acquisitions had occurred on those dates or to project the Company's results of operations for any future period.
On February 22, 2000, the Company acquired all of the outstanding capital stock of DataStream Networks, Inc. for approximately $3,100 in cash.
NOTE 4--PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
Depreciation expense for the year ended December 31, 1999 totaled $7,587.
NOTE 5--DEBT
On December 1, 1999, the Company entered into a note payable for $5,480 for the purchase of equipment. The note is collateralized by the equipment and bears interest at 10.825% annually. At December 31, 1999, the principal amount outstanding on this note was $5,274. Effective February 1, 2000, the note amortizes on a straight-line basis through November 1, 2004 at a monthly rate of $80, including interest. A final lump sum payment of $2,740, including interest, is due on November 1, 2004.
On December 31, 1999, the Company assumed certain bank notes payable in the amount of $744 in connection with the acquisition of Rural Connections. This debt, including accrued interest, was repaid in January 2000. Also at December 31, 1999, the Company assumed $1,187 in notes payable to the shareholders of Rural Connections and Radiks. These notes, plus accrued interest, were repaid in January 2000.
ONEMAIN.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 5--DEBT--(CONTINUED)
The principal payments under the Company's debt agreements were as follows at December 31, 1999:
On November 25, 1998 and February 4, 1999, the Company issued two promissory notes to one of its founders (the 'founders notes') for $500 each. Interest was payable at the prime rate. The proceeds of these loans were used to pay offering costs. During the first quarter of 1999, the loans were paid in full.
NOTE 6--INCOME TAXES
The composition of the Company's benefit for income taxes is as follows:
The differences between amounts computed by applying the statutory federal income tax rates to the net loss and the total income tax benefit were as follows:
ONEMAIN.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 6--INCOME TAXES--(CONTINUED)
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The significant components of deferred tax assets and liabilities are as follows at December 31:
At December 31, 1999 and 1998, the Company had net operating loss carryforwards ('NOLs') of approximately $33,800 and $99, respectively. Included in the 1999 amount are approximately $16,100 of NOLs that were generated by C Corporations prior to the Company's acquisition of the entities. Under the tax law, the Company retains the tax attributes of the acquired corporations upon acquisition, including any NOL carryforwards, however, the Company's ability to utilize these acquired operating loss carryovers will be limited under Internal Revenue Code Section 382. Therefore, the acquired NOL carryforwards were not recorded as deferred tax assets at the acquisition dates, and will be reflected if and when they are actually utilized by the Company. The NOL carryover generated by the Company through 1999 was approximately $17,700 and was recorded as a deferred tax asset at December 31, 1999. The Company's NOL carryovers will expire in various years through 2019.
At December 31, 1999 and 1998, the Company was uncertain whether it will realize any future tax benefit of its deferred tax assets. Accordingly, a full valuation allowance has been recorded against the deferred tax assets.
NOTE 7--STOCKHOLDERS' EQUITY
Common Stock
In connection with the organization and initial capitalization on August 19, 1998, the Company issued 4,552,500 shares of Common Stock ('Common Stock'), at $0.01 per share. The Company subsequently issued 230,000 shares at $0.05 per share to members of senior management. During 1999, the Company issued 100,000 shares to another member of its senior management for $0.05 per share.
On March 30, 1999, in connection with its IPO, the Company issued 8,500,000 shares for $22.00 per share, before costs and expenses of the offering. On April 9, 1999, the underwriters exercised their over-allotment option to purchase an additional 1,275,000 shares of Common Stock at the initial public offering price of $22.00 per share. The gross proceeds from the Offering were $215,050. The net proceeds after underwriter discounts and commissions and offering costs were approximately $190,622. The net proceeds have been used as follows: (1) approximately $129,755 to pay the cash portion of the purchase prices for acquisitions,
ONEMAIN.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 7--STOCKHOLDERS' EQUITY--(CONTINUED)
net of cash acquired and the purchase price payable of $7,097 at December 31, 1999, (2) $1,021 to repay founders notes and accrued interest and (3) approximately $7,324 to retire debt assumed in acquisitions. The remaining net proceeds are being used for general corporate purposes, which include additional acquisitions, working capital and the payment of any additional amounts payable to former owners of the ISPs under the earn-out provisions of the acquisition agreements.
Stock Based Compensation
Options to purchase the Company's common stock under various stock option plans have been granted to employees, directors, and consultants of the Company at fair market value at the date of grant. The options become exercisable over periods of up to eight years and expire ten years from the date of grant. There are 8,000,000 shares of stock available for issuance pursuant to the stock option plans.
Option activity is as follows:
The following table summarizes information about stock options outstanding at December 31, 1999:
A member of senior management purchased 100,000 shares of common stock for $5, or $0.05 per share during January 1999. In addition, the Company issued options to purchase shares of the Company's common stock to certain outside consultants during 1999. The Company recognized one-time, non-cash compensation charges of $2,594 in connection with these transactions during the year ended December 31, 1999. The Company does not anticipate incurring similar equity compensation charges in the future.
The effect of applying SFAS 123 on the 1999 net loss as stated below is not necessarily representative of the effects on reported net income (loss) for future years due to, among other things, (1) the vesting period of the stock options and the (2) fair value of additional stock options in future years. Had compensation cost for the Company's stock option plans been determined based upon the fair value at the grant date for awards under the plans consistent with the methodology prescribed under SFAS 123, the Company's net loss in 1999 would have been approximately $89,806, or $(4.84) per share.
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions: volatility of 75%; dividend yield of 0%; risk-free interest rate of 5.25% and expected life of the option term of 3-4 years.
ONEMAIN.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 7--STOCKHOLDERS' EQUITY--(CONTINUED)
RESERVE FOR ISSUANCE
The Company has 9,544,046 shares of common stock at December 31, 1999 reserved for issuance upon exercise of outstanding and unissued stock options, in connection with the Employee Stock Purchase Plan ('ESPP') and for future business combinations.
NOTE 8--EMPLOYEE BENEFIT PLANS
401(K) PLAN
In 1998, the Company's Board of Directors adopted a defined contribution 401(k) retirement plan. The Company's plan allows employees of the Company and its subsidiaries to make pre-tax contributions to the plan, subject to a statutorily prescribed annual limit. Each participant is fully vested in his or her contributions and the investment earnings. The plan also provides for the Company to match the employees' contributions, up to a stated limit. The Company contributions vest over four years. Employees began contributing to the plan effective January 1, 2000.
During 1999, certain of the Company's subsidiaries maintained their own 401(k) plans. Effective January 1, 2000, the plans were merged into the Company's plan.
EMPLOYEE STOCK PURCHASE PLAN
In 1998, the Company's Board of Directors adopted a non-compensatory ESPP under Section 423 of the Internal Revenue Code. The ESPP permits an enrolled employee to make contributions to purchase shares of common stock by having amounts ranging from 1 to 15 percent withheld from his or her pay. There are 500,000 shares of stock available for issuance pursuant to the ESPP. Employees began contributing to the ESPP effective January 1, 2000.
NOTE 9--COMMITMENTS AND CONTINGENCIES
The Company entered into a seven-year lease agreement to occupy 14,352 square feet of office space for its executive offices commencing June 15, 1999. The monthly lease payments are $29 and will increase 3% per annum commencing June 15, 2000 through the end of the lease term. The lease includes one five-year renewal option.
The Company leases additional office space and equipment under operating leases, which expire on various dates through 2004. Certain leases provide for escalations in rent based upon increases in the lessor's annual operating costs or the consumer price index. Rent expense was $4,472 for the year ending December 31, 1999.
The Company also leases equipment under capital leases, which expire on various dates through 2004. The cost of assets under capital leases and the related accumulated depreciation is $23,145 and $2,647, respectively, at December 31, 1999. Depreciation expense related to these leases is included with depreciation in the statement of cash flows.
ONEMAIN.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 9--COMMITMENTS AND CONTINGENCIES--(CONTINUED)
Future minimum lease payments for both operating and capital leases at December 31, 1999 were as follows:
The Company is engaged in ordinary and routine litigation incidental to its business. Management does not anticipate that any amounts, which it may be required to pay by reason thereof, will have a material effect on the Company's financial position or results of operations.
The Company routinely enters into employment agreements with certain members of senior management and other key employees. These agreements specify minimum annual salaries as well as performance bonus amounts and criteria. The terms of these agreements are usually three years.
NOTE 10--TRANSACTIONS WITH RELATED PARTIES
One of the Company's subsidiaries contracts with a third party for billing and other accounting services. A shareholder of this third party is also a Company director. For the year ended December 31, 1999, the subsidiary incurred $1,549 for these services. At December 31, 1999, the Company has included in accounts payable $111 due to this third party.
One of the Company's subsidiaries leases telephone lines used to provide Internet access from a company in which the shareholder was a former shareholder of the subsidiary. For the year ended December 31, 1999, the subsidiary incurred $405 related to these services. This amount is included in accounts payable at December 31, 1999.
Certain of the Company's subsidiaries lease office space from former shareholders of those subsidiaries. For the year ended December 31, 1999, rent expense paid to these individuals amounted to $166.
ONEMAIN.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 11--QUARTERLY INFORMATION--UNAUDITED
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders of D&E SuperNet, Inc.
We have audited the accompanying balance sheet of D&E SuperNet, Inc. as of December 31, 1998, and the related statements of operations, stockholders' equity, and cash flows for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of D&E SuperNet, Inc. at December 31, 1998, and the results of its operations and its cash flows for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, in conformity with accounting principles generally accepted in the United States.
As discussed in Note 2 to the financial statements, the Company's working capital deficiency and compliance with debt covenants raise substantial doubt about its ability to continue as a going concern. Management's plans as to these matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ ERNST & YOUNG LLP
McLean, Virginia May 13, 1999
D&E SUPERNET, INC. BALANCE SHEET
See accompanying notes.
D&E SUPERNET, INC. STATEMENTS OF OPERATIONS
See accompanying notes.
D&E SUPERNET, INC. STATEMENTS OF STOCKHOLDERS' EQUITY
See accompanying notes.
D&E SUPERNET, INC. STATEMENTS OF CASH FLOWS
See accompanying notes.
D&E SUPERNET, INC.
NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION
D&E SuperNet, Inc. (the 'Company') is a regional provider of Internet access. The Company was originally organized as a general partnership (the 'Partnership') on June 22, 1995 by D&E Marketing, Inc. (50%) and SuperNet Interactive Services, Inc. (50%) and began marketing services in July of the same year. The partners shared equally in profits and losses.
On September 4, 1998, D&E SuperNet converted from a partnership to a corporation. The holders of partnership interests were issued shares of common stock, having no par value, of the Company, representing the same percentage of equity interest in the Company as they had in the Partnership. For financial accounting purposes, the conversion to corporate form has been treated as a reorganization, with the assets and liabilities recorded at their historical costs. In addition, the Company recognized a net deferred income tax liability for temporary differences in accordance with Statement of Financial Accounting Standards No. 109 ('Statement No. 109'), Accounting for Income Taxes, which resulted in a one-time charge to earnings of $13,250 in 1998 (see Note 10).
The Company's targeted market is Pennsylvania. The Company expects to continue to focus on increasing its subscriber base and geographic coverage. The online services and Internet markets are highly competitive. The Company believes that existing competitors, Internet-based services, Internet service providers, Internet directory services and telecommunication companies are likely to enhance their service offerings resulting in greater competition for the Company. The competitive conditions could have the following effects: require additional pricing programs; increase spending on marketing; limit the Company's ability to expand its subscriber base and result in increased attrition in the existing subscriber base. There can be no assurance that growth in the Company's revenues or subscriber base will continue or that the Company will be able to achieve or sustain profitability or positive cash flow.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Going Concern
The accompanying financial statements have been presented in conformity with generally accepted accounting principles, which contemplates continuation of the Company as a going concern. However, the Company has a significant working capital deficiency and is not in compliance with the Term Notes financial covenants. Further, the Company depends on the continuing financial support of an affiliate. Management believes that the actions presently being taken, as described below, and the intent of the Stockholders to fund the operations will provide the Company with sufficient funds to continue as a going concern. Such actions include, but are not limited to the short-term line of credit and revolving line of credit agreements entered into in 1998 (see Note 7), continued investment in its network infrastructure to increase its network efficiencies and capacity to serve additional subscribers and employing marketing strategies to increase its subscriber base. Further, management has obtained a waiver of the debt to net worth financial covenant for the year ended December 31, 1998, which it did not meet and has obtained an amendment revising this ratio from 3.0 to 1 to 4.0 to 1 for the three month periods ending March 31, 1999, June 30, 1999, September 30, 1999, and December 31, 1999. In addition, management believes that the demand line of credit from an affiliate will continue to be available throughout the next year.
The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.
D&E SUPERNET, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Property and Equipment
Property, equipment, and software are stated at cost. Depreciation is calculated using the straight-line method over the estimated useful lives ranging between three to seven years.
Inventory
Inventory consists of purchased goods for resale and is stated at the lower of cost or market on the first-in, first-out (FIFO) method.
Impairment of Long-Lived Assets
The Company reviews the recoverability of long-lived assets whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. If the expected future cash flows from the use of such assets (undiscounted and without interest charges) are less than the carrying value, the Company's policy is to record a write-down that is determined based on the difference between the carrying value of the asset and its estimated fair value.
Goodwill
Goodwill, which represents the cost in excess of the fair market value of identifiable net assets acquired, is being amortized using the straight-line method over 10 years.
Revenue Recognition
The Company recognizes Internet access revenue when the services are provided. The Company defers recognizing revenue on advance payments and amortizes the unearned revenue amounts to revenue on a straight-line basis over the period in which the services are provided. No revenue is recognized during a subscriber cancellation period.
Other revenues include network installation, maintenance, and consulting services. These services are provided on a time-and-material basis and revenue is recognized based upon time (at established rates) and other direct costs as incurred.
Costs of Revenues
Costs of access revenues primarily consist of telecommunication expenses inherent in the network infrastructure. Costs of access revenues also include fees paid for lease of the Company's network infrastructure, as well as license fees for Web browser software based on a per-user charge, other license fees paid to third-party software vendors, product costs, and contractor fees for operation and support services.
D&E SUPERNET, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Advertising Costs
All advertising and promotion costs are expensed as incurred. For the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, advertising costs were $123,940, $267,938 and $64,945, respectively.
Income Taxes
For tax years prior to September 4, 1998, D&E Supernet operated as a partnership, and therefore was exempt from taxation under the partnership provisions of the Internal Revenue Code (the 'Code'). Under the partnership provisions of the Code, the partners of the Partnership include their share of the Partnership's income on their personal income tax returns. Accordingly, the Partnership was not subject to Federal and state corporate income taxes during the period in which it was a partnership. The Company converted to a corporation on September 4, 1998, and became subject to Federal and state corporate income taxes.
For periods prior to the revocation of its partnership status, the unaudited pro forma income tax information included in the statements of operations and Note 10 is presented in accordance with Statement of Financial Accounting Financial Standards No. 109 (Statement No. 109), Accounting for Income Taxes, as if the Company had been subject to Federal and state income taxes for the year ended December 31, 1997 and for the period from January 1, 1998 to September 3, 1998.
For periods after the revocation of its partnership status, the Company accounts for income taxes using the liability method. The liability method provides that deferred tax assets and liabilities are recorded based on the differences between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes, referred to as 'temporary differences.' Temporary differences result from the use of different accounting methods for financial statement and income tax reporting purposes.
Financial Instruments and Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and accounts receivable. The cash is held by a high credit quality financial institution. For accounts receivable, the Company performs ongoing credit evaluations of its customers' financial condition and generally does not require collateral. The concentration of credit risk is mitigated by the large customer base. The carrying amount of the accounts receivable approximates their fair value.
Sources of Supplies
The Company relies on local telephone companies and other companies to provide data communications. Although management feels alternative telecommunication facilities could be found in a timely manner, any disruption of these services could have an adverse effect on operating results.
Although the Company attempts to maintain numerous vendors for required products, its modems, terminal servers, and high-performance routers, which are important components of its network, are each currently acquired from three sources. In addition, some of the Company's suppliers have limited resources and production capacity. If the suppliers are unable to meet the Company's needs as its network infrastructure grows, then delays and increased costs in the expansion of the Company's network infrastructure could result, having an adverse effect on operating results.
D&E SUPERNET, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
3. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
4. INTANGIBLE ASSETS
Intangible assets consist of the following:
5. ACQUISITIONS
On June 10, 1998, the Company acquired substantially all of the assets of Cumberland Valley Network ('CVN'), a general partnership. At the date of the acquisition, the CVN partnership dissolved and all operations were continued under the D&E SuperNet name. CVN's results of operations since June 10, 1998 are included within the December 31, 1998 statement of operations of the Company. CVN's results of operations for the periods presented prior to the period ended June 10, 1998 are not included in the Company's results of operations.
The Company, on December 1, 1998, acquired substantially all of the operating assets of Cyberia Communications, Inc. ('Cyberia'), a corporation. Cyberia's results of operations since December 1, 1998 are included within the December 31, 1998 statement of operations of the Company. Cyberia's results of operation for the periods presented prior to the period ended December 1, 1998 are not included in the Company's results of operations.
The unaudited pro forma results of operations set forth below assumes the acquisition of CVN and Cyberia occurred at the beginning of the periods presented. Pro forma adjustments include increased amortization for the cost over net assets acquired and increased interest expense from debt incurred for the acquisitions. The unaudited pro forma information is provided for information purposes only and does not purport to be indicative of the Company's results of operations that would have been achieved had the acquisition and related financing transaction been completed for the periods presented, or results that may be obtained in the future.
D&E SUPERNET, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
5. ACQUISITIONS--(CONTINUED)
The acquisitions were accounted for under the purchase method of accounting; accordingly, assets acquired have been recorded at their estimated fair market values at the date of acquisition. Goodwill is being amortized over its estimated economic life of 10 years using the straight-line method.
The CVN and Cyberia purchase prices of $1,050,000 and $921,356, respectively, have been preliminarily allocated as follows:
6. DEBT WITH AFFILIATED PARTIES
The Company had a short-term line of credit payable on demand with an affiliated company allowing for borrowings of up to $650,000. In conjunction with the Term Note dated June 30, 1998 discussed below, the Company retired the line of credit and created a note payable to an affiliate in the amount of $200,000. Principal payments on the note payable to an affiliate cannot be made until the earlier of full payment of the Term Note dated June 30, 1998 or June 29, 2002. The note payable to an affiliate bears a fixed interest rate of 12.5% and is subordinated to the Term Notes discussed below.
7. LONG-TERM DEBT
Long-term debt consists of the following:
The interest rate on the Term Note dated June 30, 1998 is fixed at 7.80% from June 1998 through June 2000. Beginning in July 2000, the interest rate will convert to a floating rate at the bank's commercial base rate. The term of the note is four years with a provision for interest only payments during the first twelve months. Beginning in the thirteenth month, the Company will pay 35 fixed principal monthly installments of $21,875 plus related interest. The balance of the note is due in a balloon payment on July 1, 2002.
The interest rate on the Term Note dated December 31, 1998 is fixed at 7.80% from December 1998 through June 2000. Beginning in July 2000, the interest rate will convert to a floating rate at the bank's commercial base rate plus 1%. The term of the note is three and one half years with a provision for interest
D&E SUPERNET, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
7. LONG-TERM DEBT--(CONTINUED)
only payments during the first seven months. Beginning in the eighth month, the Company will pay 35 equal, monthly installments, with each such installment in an amount sufficient to amortize the outstanding principal balance based on the interest rate in effect on the Term Note on July 1, 1999. The balance of the note is due in a balloon payment on July 1, 2002.
Principal payments on long-term debt are due as follows:
The notes contain restrictive covenants and a cross default clause which require the Company, beginning December 31, 1998, to maintain certain financial ratios, the most restrictive of which is maintaining a cash flow to debt service ratio of at least 1.2 to 1 at the end of each fiscal quarter and a maximum debt to net worth ratio, as defined, of 3.0 to 1. The Company has obtained a waiver of the debt to net worth financial covenant for the year ended December 31, 1998, which it did not meet and has obtained an amendment revising this ratio from 3.0 to 1 to 4.0 to 1 for the three month periods ended March 31, 1999, June 30, 1999, September 30, 1999 and December 31, 1999. Thereafter, the Company must maintain a maximum debt to net worth ratio of 3.0 to 1.
8. RELATED PARTY TRANSACTIONS
The Company has various transactions with its Partners and affiliates. These transactions can be generally classified into the following categories:
o Access services--the Company pays D&E Telephone Company for telephone services used to provide Internet access to its customers. During the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, telephone charges paid to D&E Telephone Company were $87,276, $124,184 and $29,975, respectively.
o Operations and customer support services--the Company pays D&E Marketing and SuperNet Interactive Services salaries, wages, and commissions for providing technical, selling, and marketing services to the Company. During the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, selling and marketing expenses paid to these affiliates were $608,852, $1,130,862 and $285,462, respectively.
o General and administrative services--D&E TDS and D&E Marketing charge the Company for administrative support, rent, and billing services provided to the Company. During the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, total rent and billing services paid to these affiliates were $29,700, $72,745 and $20,129, respectively.
Management believes that the overall amount of charges to the Company are reasonable and that the accompanying financial statements reflect all of the Company's costs of doing business.
D&E SUPERNET, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
9. COMMITMENTS
Lease Commitments
The Company leases office space and various office and computer equipment under noncancelable operating lease agreements. The leases generally provide for renewal terms and the Company is required to pay a portion of the common areas' expenses including maintenance, real estate taxes, and other expense. Rent expense for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, was $32,025, $61,279 and $26,677, respectively.
Minimum future lease payments under operating leases are summarized as follows:
10. INCOME TAXES
In connection with the conversion to corporate form, the Company recognized a net deferred income tax liability for temporary differences in accordance with Statement No. 109, which resulted in a one-time charge to earnings of $13,250 in 1998. Deferred income taxes reflect the net tax effects of temporary differences between the amount of assets and liabilities for financial reporting purposes and the amount used for income tax purposes.
The Company's deferred tax asset as of December 31, 1998 was $19,875 related to differences resulting from the use of different methods of depreciation and amortization of property and equipment for financial statement and income tax reporting purposes.
Income tax provision was comprised of the following:
A reconciliation between the amount of reported income taxes and the amount computed by multiplying the applicable statutory Federal income tax rate times the pre-tax income:
D&E SUPERNET, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
10. INCOME TAXES--(CONTINUED)
No pro forma income tax provision or benefit is reflected for the year ended December 31, 1997, as the Company would have provided a full valuation allowance against the deferred tax asset had it been a C Corporation in 1996 and then taken the benefit in 1997. The pro forma income tax provision for the period from January 1, 1998 to September 3, 1998 has been recorded in an amount to reflect the Company's effective tax rate for the year of 41%.
11. PENDING TRANSACTION
During 1998, the Company's stockholders entered into an agreement to sell their shares in the Company to OneMain.com, Inc. ('OneMain.com'). The Company's stockholders will exchange their shares in the Company for cash and shares of common stock of OneMain.com concurrently with the consummation of the initial public offering of the common stock of OneMain.com. Additionally, the Company's stockholders will be given additional consideration, contingent upon certain operational and earnings margin requirements, which shall be equal to one-fifth of the difference between total revenue for the Company for the 12 months ended June 30, 1999, and the revenues for the Company for the period from April 1, 1998, through June 30, 1998, multiplied by four. The amount of the additional consideration will be payable in either cash or stock, at the option of OneMain.com. Upon consummation of the agreement, OneMain.com will become the sole stockholder of the Company. Subsequent to the acquisition, the Company will continue to exist.
The related party transactions as described in Note 8 will be amended upon consummation of the merger discussed above so that all continuing obligations will be similar to terms and conditions of agreements/arrangements with unaffiliated third parties.
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders of SunLink, Inc.
We have audited the accompanying balance sheet of SunLink, Inc. as of December 31, 1998, and the related statements of operations, stockholders' equity, and cash flows for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of SunLink, Inc. at December 31, 1998, and the results of its operations and its cash flows for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, in conformity with accounting principles generally accepted in the United States.
As discussed in Note 2 to the financial statements, the Company's working capital deficiency and losses from operations raise substantial doubt about its ability to continue as a going concern. Management's plans as to these matters are also described in Note 2 to the financial statements. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/S/ ERNST & YOUNG LLP
McLean, Virginia May 13, 1999
SUNLINK, INC. BALANCE SHEET
See accompanying notes.
SUNLINK, INC. STATEMENTS OF OPERATIONS
See accompanying notes.
SUNLINK, INC. STATEMENTS OF STOCKHOLDERS' EQUITY
See accompanying notes.
SUNLINK, INC. STATEMENTS OF CASH FLOWS
See accompanying notes.
SUNLINK, INC. NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION
SunLink, Inc. (the 'Company') is a regional provider of Internet access. The Company was incorporated in the Commonwealth of Pennsylvania on October 1, 1991 as a Subchapter S Corporation and began providing Internet access services in Sunbury, Pennsylvania on October 1, 1995.
The Company expects to continue to focus on increasing its subscriber base and geographic coverage. The online services and Internet markets are highly competitive. The Company believes that existing competitors, Internet-based services, Internet service providers, Internet directory services and telecommunication companies are likely to enhance their service offerings resulting in greater competition for the Company. The competitive conditions could have the following effects: require additional pricing programs; increase spending on marketing; limit the Company's ability to expand its subscriber base and result in increased attrition in the existing subscriber base. There can be no assurance that growth in the Company's revenues or subscriber base will continue or that the Company will be able to achieve or sustain profitability or positive cash flow.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Financial Statement Presentation
The accompanying financial statements have been presented in conformity with generally accepted accounting principles, which contemplates continuation of the Company as a going concern. However, the Company has a significant working capital deficiency and has incurred an operating loss for the year ended December 31, 1998. Management believes that actions presently being taken, as described below, and the intent of the stockholders to fund the Company's operations will provide the Company with sufficient funds to continue as a going concern. Such actions include, but are not limited to, operating under a newly signed telephone service agreement with a competitive local exchange carrier which is expected to reduce the cost of telephone services provided to a significant portion of its subscriber base, continued investments in its network infrastructure to increase its network efficiency and capacity to serve additional subscribers, and employing marketing strategies to increase its subscriber base. Further, the Company believes that its stockholders will be able to provide it with any working capital needs during the next year.
The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Inventory
Inventory consists of purchased goods for resale and is stated at the lower of cost or market on the first-in, first-out (FIFO) method.
Property and Equipment
Property and equipment are stated at cost. Depreciation is calculated using the straight-line method over the estimated useful lives ranging between five to seven years. Leasehold improvements are amortized over their useful life not to exceed 7 years.
SUNLINK, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED) Impairment of Long-Lived Assets
The Company reviews the recoverability of long-lived assets whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. If the expected future cash flows from the use of such assets (undiscounted and without interest charges) are less than the carrying value, the Company's policy is to record a write-down that is determined based on the difference between the carrying value of the asset and its estimated fair value.
Revenue Recognition
The Company recognizes Internet access revenue when the services are provided. The Company offers contracts for Internet access that are generally paid for in advance by customers. The Company has deferred recognizing revenue on these advance payments and amortizes the amounts to revenue on a straight-line basis as the services are provided. The Company records a reserve for the estimated amount of uncollectible accounts for customers who are provided credit terms. No revenue is recognized during a subscriber cancellation period.
Other revenues include network installation, maintenance and consulting services. These services are provided on a time-and-material basis and revenue is recognized based upon time (at established rates) and other direct costs as incurred.
Bartered Services
The Company participates in bartered services transactions with certain radio stations, computer retailers and subscribers. In exchange for free Internet service from the Company, radio stations provide advertising and computer retailers demo and refer computer buyers to the Company for Internet access service. In addition, the Company's subscribers can participate in a referral program in which they can earn free service up to one year and or cash, for making valid referrals of the Company's Internet access service. These transactions are recognized by the Company as Internet access revenues and selling and administrative expense in equal amounts at the fair value of Internet access services provided by the Company. For the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, the Company recognized bartered services transactions in the amount of $22,136, $30,755, and $9,437, respectively.
Stock Compensation
During 1997, the Company issued 5 shares of common stock to a contractor in exchange for $50 in cash and recorded $450 of stock compensation for services performed.
Costs of Revenues
Costs of access revenues primarily consist of telecommunication expenses inherent in the network infrastructure. Costs of access revenues also include fees paid for lease of the Company's backbone, as well as license fees for Web browser software based on a per-user charge, other license fees paid to third-party software vendors, product costs and contractor fees for distribution of software to new subscribers.
Advertising Costs
All advertising and promotion costs are expensed as incurred. During the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, advertising and promotion costs were $11,489, $41,165, and $7,413, respectively.
SUNLINK, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED) Income Taxes
Historically, the Company has elected, by the consent of its stockholders, to be taxed under the provisions of Subchapter S of the Internal Revenue Code (the 'Code'). Under the Subchapter S provisions of the Code, the stockholders include the Company's corporate income in their personal income tax returns. Accordingly, the Company was not subject to Federal and state corporate income tax during the period for which it was an S Corporation.
The pro forma income tax information included in the statements of operations and Note 7 is presented in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, as if the Company had been subject to Federal and certain state income taxes for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999.
Financial Instruments and Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and accounts receivable. The cash is held by a high credit quality financial institution. For accounts receivable, the Company performs ongoing credit evaluations of its customers' financial condition and generally does not require collateral. The concentration of credit risk is mitigated by the large customer base and small accounts receivable balances. The carrying amount of the receivables approximates their fair value.
Sources of Supplies
The Company relies on local telephone companies and other companies to provide data communications. Although management feels alternative telecommunication facilities could be found in a timely manner, any disruption of these services could have an adverse effect on operating results.
Although the Company attempts to maintain vendors for required products, its modems, terminal servers and high-performance routers, which are important components of its network, are each currently acquired from three sources. In addition, some of the Company's suppliers have limited resources and production capacity. If the suppliers are unable to meet the Company's needs as its network infrastructure grows, then delays and increased costs in the expansion of the Company's network infrastructure could potentially result in an adverse effect on the Company's operating results.
3. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
4. RELATED PARTY TRANSACTIONS
The Company engages Amerman & Company, which is owned and operated by Company stockholders, to perform accounting services and prepare the Company's Federal and state tax returns. For the years ended
SUNLINK, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
4. RELATED PARTY TRANSACTIONS--(CONTINUED) December 31, 1997 and 1998, and the three months ended March 31, 1999, the amounts paid to the stockholders for accounting services were $1,460, $24,695, and $8,075, respectively.
For the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, the Company paid a stockholder $2,600, $40,000, and $8,900, respectively, to provide technical support and consulting services to the Company.
In addition, the Company occupies office space in a building owned by a Company stockholder. For the years ended December 31, 1997 and 1998, the amounts paid for rent were $4,000 and $22,500, respectively. For the three months ended March 31, 1999, the amount paid for rent was $5,250.
In December 1998, a stockholder made an unsecured $123,000 loan to the Company. The loan is due on December 28, 1999 and bears an interest rate of 8.5%.
5. NOTE PAYABLE
The Company had a short-term line of credit payable on demand with a bank allowing for borrowings of up to $125,000. The line was secured by and was personally guaranteed by a stockholder of the Company. The line of credit was paid off and terminated by the stockholders during December 1998.
6. LONG-TERM DEBT
Long-term debt consists of the following:
The Company incurred interest related to the long-term debt of $15,422 and $4,637 for the year ended December 31, 1998 and three months ended March 31, 1999, respectively.
Principal payments on long-term debt are due as follows: 1999--$44,906; 2000--$48,465; 2001-- $52,305; 2002--$56,450; 2003--$19,460.
7. INCOME TAXES
Upon consummation of an agreement with OneMain.com, Inc. ('OneMain.com') to sell the outstanding stock of the Company and concurrent with the related initial public offering of OneMain.com (as more fully described in Note 8) the Company's status as an S Corporation under the Code will automatically terminate and Federal and state corporate income tax rates will apply. Based upon the cumulative temporary differences, the Company would have recognized a deferred Federal and state income tax liability of $11,223 as of December 31, 1998, had the termination of its election to be treated as an S Corporation occurred on that date.
The pro forma provision for income taxes is reflected on the statements of operations as if the Company had been a C Corporation.
SUNLINK, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
8. PENDING TRANSACTION
During 1998, the Company's stockholders entered into an agreement whereby they will sell their shares in the Company to OneMain.com. The Company's stockholders will exchange their shares in the Company for cash and shares of common stock of OneMain.com concurrently with the consummation of the initial public offering of the common stock of OneMain.com. Additionally, the Company's stockholders will be given additional consideration, contingent upon certain operational and earnings margin requirements, which shall be equal to one-tenth of the difference between total revenue for the Company for the 12 months ended June 30, 1999, and the revenues for the Company for the period from April 1, 1998 through June 30, 1998, multiplied by four. Upon consummation of the agreement, OneMain.com will become the sole stockholder of the Company. Subsequent to the acquisition, the Company will continue to exist.
The related party transactions as described in Note 4 will be amended upon consummation of the merger discussed above so that all continuing obligations will be similar to terms and conditions of agreements/arrangements with unaffiliated third parties.
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
To the Stockholder of LebaNet, Inc.
We have audited the accompanying balance sheet of LebaNet, Inc. as of December 31, 1998 and the related statements of operations, stockholder's equity, and cash flows for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of LebaNet, Inc. at December 31, 1998 and the results of its operations and its cash flows for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, in conformity with accounting principles generally accepted in the United States.
/S/ ERNST & YOUNG LLP
McLean, Virginia May 13, 1999
LEBANET, INC. BALANCE SHEET
See accompanying notes.
LEBANET, INC. STATEMENTS OF OPERATIONS
See accompanying notes.
LEBANET, INC. STATEMENTS OF STOCKHOLDER'S EQUITY
See accompanying notes.
LEBANET, INC. STATEMENTS OF CASH FLOWS
See accompanying notes.
LEBANET, INC. NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION
LebaNet, Inc. (the 'Company') is a regional provider of Internet access. The Company is also a provider of network system set-up and installations and related equipment and software sales. The Company was incorporated in the Commonwealth of Pennsylvania on February 21, 1996 and began marketing services on March 1, 1996. The Company's target market is central Pennsylvania.
The Company expects to continue to focus on increasing its subscriber base and geographic coverage. The online services and Internet markets are highly competitive. The Company believes that existing competitors, Internet-based services, Internet service providers, Internet directory services and telecommunication companies are likely to enhance their service offerings resulting in greater competition for the Company. The competitive conditions could have the following effects: require additional pricing programs; increase spending on marketing; limit the Company's ability to expand its subscriber base and result in increased attrition in the existing subscriber base. There can be no assurance that growth in the Company's revenues or subscriber base will continue or that the Company will be able to achieve or sustain profitability or positive cash flow.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Property and Equipment
Equipment and software are stated at cost. Depreciation is calculated using the straight-line method over the estimated useful lives of five years.
Impairment of Long-Lived Assets
The Company reviews the recoverability of long-lived assets whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. If the expected future cash flows from the use of such assets (undiscounted and without interest charges) are less than the carrying value, the Company's policy is to record a write-down that is determined based on the difference between the carrying value of the asset and its estimated fair value.
Revenue Recognition
The Company recognizes Internet access revenue when the services are provided. The Company offers contracts for Internet access that are generally paid for in advance by customers. The Company has deferred recognizing revenue on these advance payments and amortizes the amounts to revenue on a straight-line basis as the services are provided.
Other revenues include network installation, maintenance and consulting services. These services are provided on a time-and-material basis and revenue is recognized based upon time (at established rates) and other direct costs as incurred.
Cost of Revenues
Cost of access revenues primarily consists of telecommunication expenses inherent in the network infrastructure. Cost of access revenues also includes fees paid for lease of the Company's backbone, other license fees paid to third-party software vendors, product costs, and contractor fees for distribution of software to new subscribers.
LEBANET, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Advertising Costs
All advertising and promotion costs are expensed as incurred. For the years ended December 31, 1997 1998, and the three months ended March 31, 1999, the Company expensed $1,502, $448, and $0 respectively, as advertising costs.
Income Taxes
Historically, the Company has elected, by the consent of its stockholder, to be taxed under the provisions of Subchapter S of the Internal Revenue Code (the 'Code'). Under the Subchapter S provisions of the Code, the stockholder includes the Company's corporate income in his personal income tax return. Accordingly, the Company was not subject to Federal and state corporate income tax during the period for which it was an S Corporation.
The pro forma income tax information included in the statements of operations and Note 5 is presented in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, as if the Company had been subject to Federal and certain state income taxes.
Financial Instruments and Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and accounts receivable. The cash is held by a high credit quality financial institution. For accounts receivable, the Company performs ongoing credit evaluations of its customers' financial condition and generally does not require collateral. The concentration of credit risk is mitigated by the large customer base. The carrying amount of the accounts receivable approximates their fair value.
Sources of Supplies
The Company relies on local telephone companies and other companies to provide data communications. Although management feels alternative telecommunication facilities could be found in a timely manner, any disruption of these services could have an adverse effect on operating results.
Although the Company attempts to maintain vendors for required products, its modems, terminal servers and high-performance routers, which are important components of its network, are each currently acquired from three sources. In addition, some of the Company's suppliers have limited resources and production capacity. If the suppliers are unable to meet the Company's needs as it is building out its network infrastructure, then delays and increased costs in the expansion of the Company's network infrastructure could result, having an adverse effect on operating results.
3. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
4. RELATED PARTY TRANSACTIONS
On March 1, 1996, the stockholder of the Company contributed property and equipment with a fair value of $40,812 to the Company in exchange for a non-interest bearing note payable to the stockholder. During 1998, the Company repaid the advance to the stockholder.
LEBANET, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
4. RELATED PARTY TRANSACTIONS--(CONTINUED)
The Company provides consulting services to another corporation in which the stockholder of the Company is also an officer and stockholder. During the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, the Company recognized consulting fee revenue of $2,600, $40,000 and $8,900, respectively.
In addition, the Company paid office rent to the stockholder of the Company for its use of the stockholder's residence on a month to month basis. During the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, the Company recorded $3,000, $7,200, and $1,800 respectively, as rent expense.
5. INCOME TAXES
Upon consummation of an agreement with OneMain.com, Inc. ('OneMain.com') to sell the outstanding stock of the Company and concurrent with the related initial public offering of OneMain.com (as more fully described in Note 6), the Company's status as an S Corporation under the Code will automatically terminate and normal Federal and state corporate income tax rates will apply. Based upon the Company's cumulative temporary differences which arose mainly from the difference between its book and tax depreciation methods, the Company would have recognized a deferred Federal and state income tax liability of $26,279 as of December 31, 1998, had the termination of its election to be treated as an S Corporation occurred on that date.
The pro forma provision for income taxes is reflected on the statement of operations as if the Company had been a C corporation.
6. PENDING TRANSACTION
During 1998, the Company's stockholder entered into an agreement whereby he will sell his shares in the Company to OneMain.com. The Company's stockholder will exchange his shares in the Company for cash and shares of common stock of OneMain.com concurrently with the consummation of the initial public offering of the common stock of OneMain.com. Additionally, the Company's stockholder will be given additional consideration, contingent upon certain operational and earnings margin requirements, which shall be equal to one-tenth of the difference between total revenue for the Company for the 12 months ended June 30, 1999, and the revenues for the Company for the period from April 1, 1998, through June 30, 1998, multiplied by four. The amount of the additional consideration will be payable in either cash or stock, at the option of OneMain.com. Upon consummation of the agreement, OneMain.com will become the sole stockholder of the Company. Subsequent to the acquisition, the Company will continue to exist.
The related party transactions as described in Note 4 will be amended upon consummation of the acquisition discussed above so that all continuing obligations will be similar to terms and conditions of agreements/arrangements with unaffiliated third parties.
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders SouthWind Internet Access, Inc.
We have audited the accompanying balance sheet of SouthWind Internet Access, Inc. as of December 31, 1998, and the related statements of operations, stockholders' equity, and cash flows for the year then ended and the three months ended March 31, 1999. 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 SouthWind Internet Access, Inc. at December 31, 1998, and the results of its operations and its cash flows for the year then ended and the three months ended March 31, 1999, in conformity with accounting principles generally accepted in the United States.
/s/ ERNST & YOUNG LLP
McLean, Virginia May 13, 1999
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The Board of Directors and Stockholders of SouthWind Internet Access, Inc.
We have audited the statements of operations, stockholders' equity and cash flows of SouthWind Internet Access, Inc. for the year ended December 31, 1997. 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 results of operations and cash flows of SouthWind Internet Access, Inc. for the year ended December 31, 1997, in conformity with accounting principles generally accepted in the United States.
/s/ GRANT THORNTON, LLP
Wichita, Kansas October 23, 1998
SOUTHWIND INTERNET ACCESS, INC. BALANCE SHEET
See accompanying notes.
SOUTHWIND INTERNET ACCESS, INC. STATEMENTS OF OPERATIONS
See accompanying notes.
SOUTHWIND INTERNET ACCESS, INC. STATEMENTS OF STOCKHOLDERS' EQUITY
See accompanying notes.
SOUTHWIND INTERNET ACCESS, INC. STATEMENTS OF CASH FLOWS
See accompanying notes.
SOUTHWIND INTERNET ACCESS, INC. NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION
SouthWind Internet Access, Inc. (the 'Company') is a regional provider of Internet access, as well as design and hosting services for world wide web sites. The Company was incorporated in Kansas on July 6, 1994, and began marketing services in October 1994. The Company's targeted market is the state of Kansas.
The Company expects to continue focusing on increasing its subscriber base and geographic coverage. The online services and Internet markets are highly competitive. The Company believes that existing competitors, Internet-based services, Internet service providers, Internet directory services, and telecommunication companies are likely to enhance their service offerings resulting in greater competition for the Company. The competitive conditions could have the following effects: require additional pricing programs; increase spending on marketing; limit the Company's ability to expand its subscriber base; and result in increased attrition in the existing subscriber base. There can be no assurance that growth in the Company's revenues or subscriber base will continue or that the Company will be able to sustain profitability or positive cash flow.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company considers all highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents.
Property and Equipment
Property and equipment, including leasehold improvements, are stated at cost. Depreciation is calculated using the straight-line method over the estimated useful lives ranging between three and seven years. Leasehold improvements are amortized over the lesser of the related lease term or the estimated useful life, using the straight-line method.
Impairment of Long-Lived Assets
The Company reviews the recoverability of long-lived assets whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. If the expected future cash flows from the use of such assets (undiscounted and without interest charges) are less than the carrying value, the Company's policy is to record a write-down that is determined based on the difference between the carrying value of the asset and its estimated fair value.
Revenue Recognition
The Company recognizes Internet access revenue when the services are provided. The Company offers contracts for Internet access that are generally paid in advance by customers. The Company has deferred recognizing revenue on these advance payments and amortizes the amounts to revenue on a straight-line basis as the services are provided.
The Company provides internet access services to certain organizations in exchange for advertising. Revenue and corresponding advertising expense in the amount of $62,053 and $17,384 was recorded during the year ended December 31, 1998 and the three months ended March 31, 1999, respectively, relating to these non-monetary transactions. Similar non-monetary transactions were not significant in 1997. The
SOUTHWIND INTERNET ACCESS, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Company values these non-monetary transactions based upon the fair value of the internet access services provided.
Cost of Revenues
Cost of access revenues primarily consist of telecommunication expenses inherent in the network infrastructure. Cost of access revenues also include fees paid for lease of the Company's backbone, as well as license fees for Web browser software based on a per-user charge, other license fees paid to third-party software vendors, product costs, and contractor fees for distribution of software to new subscribers.
Advertising Costs
All advertising and promotion costs are expensed as incurred. During the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, the Company expensed $4,583, $67,128, and $23,501, respectively, as advertising costs. As noted above, $62,053 and $17,384 of costs recorded in 1998 and the three months ended March 31, 1999, respectively, related to non-monetary transactions.
Income Taxes
Historically, the Company has elected, by the consent of its stockholders, to be taxed under the provisions of Subchapter S of the Internal Revenue Code (the 'Code'). Under the provisions of the Code, the stockholders include the Company's corporate income in their personal income tax returns. Accordingly, the Company was not subject to federal and state corporate income tax during the period for which it was an S Corporation.
The unaudited pro forma income tax information included in the statements of operations and Note 6 is presented in accordance with Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes, as if the Company had been subject to federal and certain state income taxes.
Financial Instruments and Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and accounts receivable. The cash is held by a high-credit quality financial institution. For accounts receivable, the Company performs ongoing credit evaluations of its customers' payment history and generally does not require collateral. The Company maintains reserves for credit losses, and such losses have been within management's expectations. The carrying amount of the receivables approximates their fair value.
Sources of Supplies
The Company relies on local telephone companies and other companies to provide data communications. Although management feels alternative telecommunication facilities could be found in a timely manner, any disruption of these services could have an adverse effect on operating results.
In addition, some of the Company's suppliers have limited resources and production capacity. If the suppliers are unable to meet the Company's needs as it is building out its network infrastructure, then delays and increased costs in the expansion of the Company's network infrastructure could result, having an adverse effect on operating results.
SOUTHWIND INTERNET ACCESS, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
3. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
4. LONG-TERM DEBT
Long-term debt consisted of the following:
The Company received funding from various cities in Kansas, in the form of notes payable, to establish dial-up internet access service in the respective calling areas. The loan agreements require the Company to maintain such internet access for a period of at least 12 months.
As of December 31, 1998, principal payments on long-term debt are due as follows: 1999--$13,091; 2000--$11,303; 2001--$8,674; 2002--$3,696.
Effective February 11, 1999, the Company entered into a short-term line of credit agreement which provides for borrowings up to $67,000.
5. COMMITMENTS
During the three months ended March 31, 1999, the Company entered into a commitment to purchase computer equipment of approximately $65,000.
The Company leases office space under a non-cancelable operating lease agreement. The lease generally provides for renewal terms, and the Company is required to pay a portion of the common areas' expenses including maintenance, real estate taxes, and other expenses. Rent expense for the years ended December 1997 and 1998, and the three months ended March 31, 1999, was $26,011, $58,437, and $14,727, respectively.
SOUTHWIND INTERNET ACCESS, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
5. COMMITMENTS--(CONTINUED)
Minimum future lease payments under operating leases are summarized as follows:
In December 1998, the Company entered into another lease agreement for additional office space. This agreement provides that costs of remodeling the space up to $25,500 will be paid by the lessor and billed to the Company as additional rent, including interest at 9%, over the lease term.
6. INCOME TAXES
Upon consummation of an agreement with OneMain.com, Inc. ('OneMain.com') and concurrent with the related initial public offering of OneMain.com (as more fully described in Note 9), the Company's status as an S Corporation under the Internal Revenue Code will automatically terminate and normal federal and state corporate income tax rates will apply. Based upon the cumulative temporary differences, the Company would have recognized a deferred federal and state income tax liability of $21,430 as of December 31, 1998, had the termination of its election to be treated as an S Corporation occurred on that date.
The pro forma provision for income taxes is reflected on the statement of operations as if the Company had been a C Corporation.
7. DISTRIBUTIONS
The Company makes distributions to its stockholders for the purpose of paying federal and state income taxes, including required estimated tax payments associated with the Company's taxable income which must be reported on the individual stockholder's income tax returns. The Company made distributions of $168,000, $258,799, and $105,604 for the years ended December 31, 1997 and 1998, and for the three months ended March 31, 1999.
8. RETIREMENT PLAN
Effective July 1, 1998, the Company established a Simple Individual Retirement Account (IRA) Plan. Full-time and part-time employees are eligible to participate after 90 days of employment and one year of employment, respectively. Each year, participants may contribute up to $6,000 of their annual pre-tax compensation, subject to annual changes based on the Internal Revenue Code. The Company makes a matching contribution from 1% to 3% of each participant's salary. Total employer contributions during 1998 and the three months ended March 31, 1999 were $10,862 and $3,583, respectively.
9. PENDING TRANSACTION
During 1998, the Company's stockholders entered into an agreement whereby they will sell their shares in the Company to OneMain.com. The Company's stockholders will exchange their shares in the Company for cash and shares of common stock of OneMain.com concurrently with the consummation of the initial public offering of the common stock of OneMain.com. Additionally, the Company's stockholders will be given additional consideration, contingent upon certain operational and earnings margin requirements, which shall be equal to one-tenth of the difference between total revenue for the Company for the 12 months ended June 30, 1999, and the revenues for the Company for the period from April 1, 1998 through June 30, 1998, multiplied by four. The amount of the additional consideration will be payable in either cash or stock, at the option of OneMain.com. Upon consummation of the agreement, OneMain.com will become the sole stockholder of the Company. Subsequent to the acquisition, the Company will continue to exist.
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders Horizon Internet Technologies, Inc.
We have audited the accompanying consolidated balance sheet of Horizon Internet Technologies, Inc. as of December 31, 1998, and the related consolidated statements of operations, stockholders' deficit and cash flows for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Horizon Internet Technologies, Inc. at December 31, 1998, and the results of its operations and its cash flows for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, in conformity with accounting principles generally accepted in the United States.
/s/ ERNST & YOUNG LLP
McLean, Virginia May 13, 1999
HORIZON INTERNET TECHNOLOGIES, INC. CONSOLIDATED BALANCE SHEET
See accompanying notes.
HORIZON INTERNET TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS
See accompanying notes.
HORIZON INTERNET TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
See accompanying notes.
HORIZON INTERNET TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes.
HORIZON INTERNET TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION
Horizon Internet Technologies, Inc. (the 'Company') is a regional provider of Internet access. The Company was incorporated in Kansas on July 26, 1995. The Company's targeted markets include Missouri, Oklahoma and Kansas.
The Company expects to continue to focus on increasing its subscriber base and geographic coverage. The online services and Internet markets are highly competitive. The Company believes that existing competitors, Internet-based services, Internet service providers, Internet directory services and telecommunication companies are likely to enhance their service offerings resulting in greater competition for the Company. The competitive conditions could have the following effects: require additional pricing programs; increase spending on marketing; limit the Company's ability to expand its subscriber base and result in increased attrition in the existing subscriber base. There can be no assurance that growth in the Company's revenues or subscriber base will continue or that the Company will be able to achieve or sustain profitability or positive cash flow.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, MoCom Corporation (see Note 3). All significant intercompany balances and transactions have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company considers all highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents.
Property and Equipment
Property and equipment are stated at cost. Depreciation is calculated using the straight-line method over the estimated useful lives ranging between three to five years.
Intangibles
The Company capitalizes a portion of the purchase price paid to acquire customer bases from Internet service providers ('ISPs'). Amortization is provided using straight line method over five years commencing when the customer base is received. Accumulated amortization of intangible cost was $5,835 at December 31, 1998.
Impairment of Long-Lived Assets
The Company reviews the recoverability of long-lived assets whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. If the expected future cash flows from the use of such assets (undiscounted and without interest charges) are less than the carrying
HORIZON INTERNET TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
value, the Company's policy is to record a write-down that is determined based on the difference between the carrying value of the asset and its estimated fair value.
Revenue Recognition
The Company recognizes Internet access revenues when the services are provided. The Company offers contracts for Internet access that are generally paid for in advance by customers. The Company has deferred recognizing revenues on these advance payments and amortizes the amounts to revenues on a straight-line basis as the services are provided.
Costs of Revenues
Costs of access revenues primarily consist of telecommunication expenses inherent in the network infrastructure. Costs of access revenues also include fees paid for lease of the Company's backbone, as well as license fees for Web browser software based on a per-user charge, other license fees paid to third-party software vendors, product costs and contractor fees for distribution of software to new subscribers.
Advertising Costs
All advertising and promotion costs are expensed as incurred. During the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, the Company expensed $7,531, $21,144, and $5,138, respectively, as advertising costs.
Income Taxes
Historically, the Company had elected by the consent of its stockholders to be taxed under the provisions of Subchapter S of the Internal Revenue Code (the 'Code'). Under the Subchapter S provisions of the Code, the stockholders include the Company's corporate income or loss in their personal income tax returns. Accordingly, the Company was not subject to federal and state corporate income tax during the period for which it was an S Corporation.
The pro forma income tax information included in the statements of operations and Note 9 is presented in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, as if the Company had been subject to Federal and certain state income taxes.
Financial Instruments and Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and accounts receivable. The cash is held by a high-credit quality financial institution. For accounts receivable, the Company performs ongoing credit evaluations of its customers' payment history and generally does not require collateral. The Company maintains reserves for credit losses, and such losses have been within management's expectations. The carrying amount of the receivables approximates their fair value.
Sources of Supplies
The Company relies on local telephone companies and other companies to provide data communications. Although management believes alternative telecommunication facilities could be found in a timely manner, any disruption of these services could have an adverse effect on operations.
In addition, some of the Company's suppliers have limited resources and production capacity. If the suppliers are unable to meet the Company's needs as it is building out its network infrastructure, then delays and increased costs in the expansion of the Company's network infrastructure could result, having an adverse effect on operating results.
HORIZON INTERNET TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
3. ACQUISITION OF MOCOM
During 1997, the Company purchased 650 shares, or 32.5%, of the stock of MoCom. On November 2, 1998, the Company acquired the remaining interest from four shareholders for $124,557, net of cash. MoCom, which began operations in October 1997, is a regional provider of Internet access in the Missouri area. MoCom was accounted for using the equity method of accounting through November 2, 1998. Subsequently, the financial statements of MoCom have been accounted for on a consolidated basis with the Company. The acquisition has been accounted for using the purchase method and, accordingly, assets acquired and liabilities assumed have been recorded at their estimated fair values as of November 2, 1998.
The unaudited pro forma results of operations set forth below assumes the acquisition of MoCom had occurred at the beginning of the years presented.
4. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
5. NOTES PAYABLE
The Company has a short-term line of credit with a bank allowing for borrowings of up to $75,000 subject to a borrowing base that is calculated based upon defined levels of accounts receivable and equipment. Borrowings against the line of credit bear interest at 9.75% at December 31, 1998. The line is secured by the assets of, and is personally guaranteed by, the President and the Vice President of the Company. At December 31, 1998, borrowings under this line of credit were $75,000. Notes payable also includes $200,000 of unsecured notes payable to the bank with interest rates at 8.5% to 9.25%.
6. RELATED PARTY TRANSACTIONS
The Company purchased computer equipment from, and paid sales commissions to, a related party for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, in the amounts of $23,741, $37,505 and $10,042, respectively.
The Company has a dealer incentive agreement with a related party whereby a twenty-five percent commission is paid on access revenues generated by the related party. Commissions paid under this agreement for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, totaled $20,914, $53,559, and $17,391, respectively.
HORIZON INTERNET TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
7. LONG-TERM DEBT
Long-term debt consisted of the following:
Principal payments on long-term debt are due as follows: 1999--$45,120; 2000--$43,873; and 2001-- $15,028.
8. COMMITMENTS
Lease Commitments
The Company leases office space and various office and computer equipment under non-cancelable operating lease agreements. The leases generally provide for renewal terms and the Company is required to pay a portion of the common areas' expenses including maintenance, real estate taxes and other expense. Rent expense for the years ended December 31, 1997 and 1998, and for the three months ended March 31, 1999, was $7,732, $36,627, and $8,463, respectively.
The Company leases certain computer and office equipment under an agreement which has been accounted for as a capital lease. The related equipment had a cost of $73,143 as of December 31, 1998, and accumulated amortization of $16,579 as of December 31, 1998. The agreements require monthly payments of $2,537 and expire during 2001.
Minimum future lease payments under operating leases together with the present value of the net minimum lease payments under capital leases are summarized as follows:
9. INCOME TAXES
Upon consummation of an agreement with OneMain.com, Inc. ('OneMain.com') to sell the outstanding stock of the Company and concurrent with the related initial public offering of OneMain.com (as described more fully in Note 10), the Company's status as an S Corporation under the Code will automatically terminate and normal federal and state corporate income tax rates will apply. Based upon the cumulative temporary differences, the Company would have recognized a deferred federal and state income tax asset (before valuation allowance) of $8,525 as of December 31, 1998, had the termination of its election to be treated as an S Corporation occurred on this date.
HORIZON INTERNET TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
9. INCOME TAXES--(CONTINUED)
No pro forma income tax expense (benefit) is reflected on the statement of operations as the Company would have provided a full valuation allowance against the deferred tax asset had it been a C Corporation.
10. PENDING TRANSACTION
During 1998, the Company's stockholders entered into an agreement whereby they will sell their shares in the Company to OneMain.com. The Company's stockholders will exchange their shares in the Company for cash and shares of common stock of OneMain.com concurrently with the consummation of the initial public offering of the common stock of OneMain.com. Additionally, the Company's stockholders will be given additional consideration, contingent upon certain operational and earnings margin requirements, which shall be equal to one-tenth of the difference between total revenue for the Company for the 12 months ended June 30, 1999 and the revenues for the Company for the period from April 1, 1998 through June 30, 1998 multiplied by four. The amount of the additional consideration will be payable in either cash or stock, at the option of OneMain.com. Upon consummation of the agreement, OneMain.com will become the sole stockholder of the Company. Subsequent to the acquisition, the Company will continue to exist.
The related party transactions as described in Note 6 will be amended upon consummation of the merger discussed above so that all continuing obligations will be similar to terms and conditions of agreements/arrangements with unaffiliated third parties.
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders United States Internet, Inc.
We have audited the accompanying balance sheet of United States Internet, Inc. as of December 31, 1998, and the related statements of operations, stockholders' deficit and cash flows for the year then ended and the three months ended March 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of United States Internet, Inc. at December 31, 1998, and the results of its operations and its cash flows for the year then ended and the three months ended March 31, 1999, in conformity with accounting principles generally accepted in the United States.
As discussed in Note 2 to the financial statements, the Company's working capital deficiency and losses from operations raise substantial doubt about its ability to continue as a going concern. Management's plans as to these matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ ERNST & YOUNG LLP
McLean, Virginia May 13, 1999
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Stockholders of United States Internet, Inc.
We have audited the statements of operations, stockholders' deficit, and cash flows of United States Internet, Inc. for the year ended December 31, 1997. 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 generally accepted auditing standards. 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 results of operations and cash flows of United States Internet, Inc. for the year ended December 31, 1997, in conformity with generally accepted accounting principles.
/s/ COULTER & JUSTUS, P.C.
Knoxville, Tennessee November 4, 1998
UNITED STATES INTERNET, INC. BALANCE SHEET
See accompanying notes.
UNITED STATES INTERNET, INC. STATEMENTS OF OPERATIONS
See accompanying notes.
UNITED STATES INTERNET, INC. STATEMENTS OF STOCKHOLDERS' DEFICIT
See accompanying notes.
UNITED STATES INTERNET, INC. STATEMENTS OF CASH FLOWS
See accompanying notes.
UNITED STATES INTERNET, INC. NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION
United States Internet, Inc. (the 'Company') was incorporated in 1994 and has points of presence in Tennessee, Virginia, Kentucky and Alabama. The Company's principal business is to provide access to the Internet, design and host web pages on the Internet and resell Internet hardware and software.
The Company expects to continue to focus on increasing its subscriber base and geographic coverage. The online services and Internet markets are highly competitive. The Company believes that existing competitors, Internet-based services, Internet service providers, Internet directory services and telecommunication companies are likely to enhance their service offerings resulting in greater competition for the Company. The competitive conditions could have the following effects: require additional pricing programs; increase spending on marketing; limit the Company's ability to expand its subscriber base and result in increased attrition in the existing subscriber base. There can be no assurance that growth in the Company's revenues or subscriber base will continue or that the Company will be able to achieve or sustain profitability or positive cash flow.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Financial Statement Presentation
The accompanying financial statements have been presented in conformity with generally accepted accounting principles, which contemplates continuation of the Company as a going concern. However, the Company has a significant working capital deficiency and has incurred operating losses for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999. Management believes that actions presently being taken, as described below, and the remaining facility with Ascend Communications will provide the Company with sufficient funds to continue as a going concern. Such actions include but are not limited to operating under a newly signed telephone service agreement with a competitive local exchange carrier which is expected to reduce the cost of telephone services provided to its subscriber base, continued investments in its network infrastructure to increase its network efficiency and capacity to serve additional subscribers, and employing marketing strategies to increase its subscriber base.
The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results may differ from these estimates and such differences could be material.
Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company considers all highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents.
Property and Equipment
Property and equipment, including leasehold improvements, are stated at cost. Depreciation is calculated using the straight-line method over the estimated useful lives ranging between three to seven years. Leasehold improvements are amortized over the lesser of the related lease term or the useful life.
UNITED STATES INTERNET, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Inventories
Inventories consists of purchased goods for resale and is stated at the lower of cost or market on a first-in, first-out (FIFO) method.
Impairment of Long-Lived Assets
The Company reviews the recoverability of long-lived assets whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. If the expected future cash flows from the use of such assets (undiscounted and without interest charges) are less than the carrying value, the Company's policy is to record a write-down that is determined based on the difference between the carrying value of the asset and its estimated fair value.
Acquired Customer Base
The Company capitalizes the purchase price paid to acquire customer bases from other Internet Service Providers ('ISPs'). Amortization is provided using the straight-line method over three years commencing when the customer base is received.
Accumulated amortization was $641,589 at December 31, 1998.
Stock Compensation
In October 1995, the Financial Accounting Standards Board issued Statement of Financial accounting Standards No. 123 ('SFAS 123'), Accounting for Stock-Based Compensation. SFAS 123 allows companies to account for stock-based compensation under either the new provisions of SFAS 123 or the provisions of Accounting Principles Board Opinion No. 25.
('APB 25'), Accounting for Stock Issued to Employees, but requires pro forma disclosure in the footnotes to the financial statements as if the measurement provisions of SFAS 123 had been adopted. The Company has chosen to continue accounting for its stock-based compensation in accordance with the provisions of APB 25.
Revenue Recognition
The Company recognizes Internet access revenue when the services are provided. The Company offers contracts for Internet access that are generally paid for in advance by customers. The Company has deferred recognizing revenue on these advance payments and amortizes the amounts to revenue on a straight-line basis as the services are provided.
Cost of Revenues
Cost of access revenues primarily consists of telecommunication expenses inherent in the network infrastructure. Cost of access revenues also includes fees paid for lease of the Company's backbone, as well as license fees for Web browser software based on a per-user charge, other license fees paid to third-party software vendors, product costs and contractor fees for distribution of software to new subscribers.
Advertising Costs
All advertising and promotion costs are expensed as incurred. During the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, the Company expensed $17,582, $107,608, and $39,921 respectively, as advertising costs.
UNITED STATES INTERNET, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Financial Instruments and Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents and accounts receivable.
At December 31, 1998, approximately $225,691 of cash is deposited in one financial institution. Credit risk is subject to the financial security of these institutions.
Accounts receivable are unsecured and due under stated terms. Credit risk with respect to accounts receivable is subject to the financial security of each customer. The Company does not require collateral. The Company maintains reserves for credit losses and such losses have been within management's expectations. The concentration of credit risk is mitigated by the large customer base.
Fair Value of Financial Instruments
The fair value of the Company's financial instruments classified as current assets or liabilities, including cash and cash equivalents, accounts receivable and accounts payable approximated carrying value, principally because of the short maturity of these items.
The carrying amounts of the long-term debt payable approximate fair value due to the interest rates on these agreements approximating the Company's incremental borrowing rates, and the fair values of capitalized lease obligations approximate carrying value based on their effective rates compared to current market rates.
Sources of Supplies
The Company relies on local telephone companies and other companies to provide data communications. Although management feels alternative telecommunication facilities could be found in a timely manner, any disruption of these services could have an adverse effect on operating results.
The Company attempts to maintain alternative vendors for required products. Its modems, terminal servers and high-performance routers, which are important components of its network, are currently acquired from four sources. Some of the Company's suppliers have limited resources and production capacity. If the suppliers are unable to meet the Company's needs as it is building out its network infrastructure, then delays and increased costs in the expansion of the Company's network infrastructure could result, having an adverse effect on operating results.
Income Taxes
The Company accounts for income taxes using the liability method. The liability method provides that deferred tax assets and liabilities are recorded based on the difference between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes, referred to as 'temporary differences.' Temporary differences result from the use of different accounting methods for financial statement and income tax reporting purposes.
UNITED STATES INTERNET, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
3. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
4. LONG-TERM DEBT
Long-term debt consists of the following:
In March 1998, the Company entered into a working capital and equipment purchase facility with Ascend Communications allowing up to $5,878,000 to be provided in scheduled draws through December 1999. These notes are secured by equipment, inventories and accounts receivable. In connection with this facility, the Company issued a warrant to purchase 28,299 shares of common stock at an exercise price of $0.01 per share. The warrants are immediately exercisable and expire on March 31, 2001. Under the conditions of this agreement any unexercised warrants at the date of expiration will automatically be converted to common stock based on the difference between the fair market value of the common stock, at such date, and the warrant exercise price, divided by the fair value of the common stock, at such date. Of the approximate $3,145,000 borrowed under this facility during 1998, approximately $200,000 has been allocated to the value of the warrants, thereby providing a discount on the note. During the year ended December 31, 1998 and three months ended March 31, 1999, the Company recognized interest expense of $54,759 and $11,847, respectively, in connection with the amortization of the debt discount on the Ascend Communications note.
The First American National Bank note was entered into on May 31, 1998, resulting from the maturity of a $200,000 revolving credit facility. The note is collateralized by various operating equipment and requires
UNITED STATES INTERNET, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
4. LONG-TERM DEBT--(CONTINUED)
the Company to maintain two financial statement covenants; a debt service coverage covenant required at December 31, 1998 and a minimum tangible net worth covenant required at December 31, 1999. At December 31, 1998 the Company was in violation of the debt service covenant and therefore, the entire outstanding balance of $163,300 has been included in the current portion of long-term debt.
The National Bank of Blacksburg note is collateralized by accounts receivable from customers serviced by the related financed Internet equipment located in Blacksburg, Virginia.
Maturities of long-term debt as of December 31, 1998, are as follows:
5. STOCKHOLDER NOTES PAYABLE
Maturities of unsecured stockholder notes payable as of December 31, 1998, are as follows:
During 1998 the Company offered an inducement to the convertible noteholders to convert their notes outstanding at December 31, 1997 to common stock at $5.50 per share, and issued an additional $35,000 in convertible stockholder notes payable. Approximately $395,000 of convertible notes were converted into common stock at $5.50 per share, resulting in issuance of 68,184 shares of common stock. Approximately $30,000 of these notes were converted at $7.50 per share, the original conversion rate for the notes, resulting in an issuance of 4,058 shares of common stock and the remaining notes, approximately $130,000, were repaid in cash. In connection with these notes, accrued interest in the amount of approximately $21,900 was converted into common stock at $5.50 per share, resulting in an issuance of 3,982 shares of common stock. Warrants to purchase common stock, granted in connection with the note issuances, were exercised at an exercise price of $0.50 per share, resulting in an issuance of 3,989 shares of common stock. In connection with these notes converted to common stock, the Company granted conversions at a price per share of Company stock less than fair value at the time of such conversion, recognizing approximately $110,000 of debt conversion expense during 1998. The Company recognized interest expense of $42,197 and $45,533 during the years ended December 31, 1997 and 1998, respectively, in connection with the amortization of a debt discount on the stockholder notes.
UNITED STATES INTERNET, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
6. INCOME TAXES
Deferred income taxes reflect the net tax effects 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 net deferred tax assets are as follows:
The Company has net operating loss carryforwards aggregating approximately $7,996,460 at December 31, 1998. The carryforwards expire in various years through 2017.
Effective Rate Reconciliation
7. STOCKHOLDERS' DEFICIT
Stock Options
The Company adopted a nonqualified and qualified stock option plan, effective June 1, 1995, for granting of options to key employees and for granting of options to nonemployee directors. The aggregate number of common shares reserved for issuance under these plans is 600,000 shares. The option price, number of shares and grant date under these plans are determined at the discretion of the Stock Option Committee ('the Committee') of the Company's Board of Directors.
The Committee may also include stock appreciation rights in any option granted under the Plan. Such rights shall entitle the holder, upon exercising the right, to receive in cash or property up to 100% of the excess of the fair market value, on the date of such exercise, over the option price of the common stock. Exercise of the rights precludes the holder from exercising the options. The holder is not required to make a payment in order to exercise the right.
UNITED STATES INTERNET, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
7. STOCKHOLDERS' DEFICIT--(CONTINUED)
Stock appreciation rights are included in all 532,046 stock options. The stock appreciation rights liability reflects the excess of the fair market value of $12.08 per share of common stock at December 31, 1998, over the option price of the common stock. The rights terminate upon a change in control as defined in the agreement and are required to be settled in cash or options to purchase common stock of the acquiror.
The following table summarizes information about fixed-price stock options outstanding at December 31, 1998:
Had compensation expense related to the stock option plan been determined based on fair value at the grant date for options granted during the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999 consistent with the provisions of SFAS 123, rather than as stock appreciation rights in accordance with APB 25, the Company's net loss would have been $1,248,461, $1,966,065 and $489,814, respectively.
The effect of applying SFAS 123 pro forma net income as stated above is not necessarily representative of the effects on reported net income for future periods due to, among other things, the vesting period of the stock options and the fair value of additional stock options in future years.
The fair value of each option grant is estimated on the date of grant using the minimum value option pricing fair value model with the following weighted-average assumptions used for the years ended December 31, 1997 and 1998, respectively: divided yield of 0%, risk-free interest rates of 6.24% and 6.48%, no weighted average volatility factors and expected life of the option terms of 7 years. The weighted average fair values of options granted during the years ended December 31, 1997 and 1998 were $2.63 and $2.91, respectively.
As of December 31, 1998, the Company had reserved 54,414 shares of common stock for future issuances under the Option Plan.
Stock Options (continued)
A summary of the Company's option activity and related information follows:
Exercise prices for options outstanding as of December 31, 1998 range from $0 to $10.00 per share. Options outstanding at December 31, 1998 had a weighted average remaining contractual life of 5.93 years. There were 498,546 options exercisable at December 31, 1998.
UNITED STATES INTERNET, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
7. STOCKHOLDERS' DEFICIT--(CONTINUED)
Stock Warrants
As discussed in Note 4, Long-Term Debt, and Note 5, Stockholder Notes Payable, the Company has issued warrants to purchase common stock of the Company in connection with various debt agreements. At December 31, 1998, the Company had outstanding warrants as follows:
The related parties are certain officers of the Company.
Employee Stock Grant
In addition to the stock options discussed above, the Company granted 6,000 shares of restricted common stock, with a market value at the date of issuance of $10.00, to two employees during 1998. The ability to sell this common stock was restricted to the earlier of 12 months after issue or the date of an initial public offering.
8. COMMITMENTS AND CONTINGENCIES
Lease Commitments
The Company leases real estate from stockholders and is responsible for repairs, taxes and other expenses. The Company also leases various office and computer equipment under noncancelable operating lease agreements which generally provide for renewal terms. Rent expense for the years ended December 31, 1997 and 1998, and for the three months ended March 31, 1999, was $99,118, $145,770, and $68,009 respectively, including rent to the stockholders of $49,072, $76,896, and $20,093, respectively.
The Company leases certain computer equipment under agreements which have been accounted for as capital leases. The related computer equipment had a cost of $1,822,168 and accumulated amortization of $438,241 at December 31, 1998.
In 1997, the Company entered into a sale-leaseback transaction for $86,067 of computer equipment. Under terms of the agreement, the Company will make scheduled payments of principal and interest through December 1999, at which time the Company intends to purchase the equipment for 5% of the original purchase price.
UNITED STATES INTERNET, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
8. COMMITMENTS AND CONTINGENCIES--(CONTINUED)
Minimum future lease payments under operating leases together with the present value of the net minimum lease payments under capital leases including amounts due under the sale-leaseback transaction, as of December 31, 1998, are summarized as follows:
The Company has certain line usage commitments with numerous communications companies aggregating $1,980,893, $513,122 and $30,844 in 1999, 2000 and 2001, respectively.
9. ACQUISITIONS
During 1998, the Company purchased the listings of customers of four internet service providers totaling approximately 2,008 customers for $174,260. In addition, the purchase agreements included non-compete provisions. The purchase price was settled in Company common stock and cash with a portion of the cash payment made over a six month period. The cost of these purchases have been allocated to customer base, which is being amortized over three years.
In September and October 1998, the Company acquired all of the outstanding stock of three internet service providers. The aggregate purchase price was $4,052,493 consisting of 336,988 shares of the Company's common stock valued at either $11.36 or $11.45 a share and cash of $220,020. The acquired companies were merged into the Company. The acquisitions were accounted for under the purchase method of accounting. Accordingly, net assets acquired have been recorded based on their estimated fair market values at the date of acquisition.
The unaudited pro forma results of operations set forth below assumes the acquisitions had occurred at the beginning of the periods presented.
In connection with one of the acquisitions the Company issued a promissory note in favor of the previous owner for $500,000. The promissory note is held in escrow and will only be released contingent on the Company, or any successor entity, failing to file an effective registration statement in connection with an initial public offering of its capital stock by June 30, 1999. No liability has been recorded in respect of this note as its release is not considered probable.
10. PENDING TRANSACTION
During 1998, the Company's stockholders entered into an agreement whereby they will sell their shares in the Company to OneMain.com., Inc. ('OneMain.com'). The Company's stockholders will exchange their
UNITED STATES INTERNET, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
10. PENDING TRANSACTION--(CONTINUED)
shares in the Company for cash and shares of common stock of OneMain.com concurrent with the consummation of the initial public offering ('IPO') of the common stock of OneMain.com. Additionally, the Company's stockholders will be given additional consideration, contingent upon certain operational and earnings margin requirements, which shall be equal to one-fifth of the difference between total revenue for the Company for the 12 months ended June 30, 1999, and the revenues for the Company for the period from April 1, 1998, through June 30, 1998 multiplied by four. The amount of the additional consideration will be payable in either cash or stock, at the option of OneMain.com. Upon consummation of the agreement, OneMain.com will become the sole stockholder of the Company. Subsequent to the acquisition, the Company will continue to exist.
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Members Internet Partners of America, LC
We have audited the accompanying balance sheet of Internet Partners of America, LC, as of December 31, 1998, and the related statements of operations, members' deficit, and cash flows for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Internet Partners of America, LC at December 31, 1998, and the results of its operations and its cash flows for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, in conformity with accounting principles generally accepted in the United States.
/s/ ERNST & YOUNG LLP
McLean, Virginia May 13, 1999
INTERNET PARTNERS OF AMERICA, LC BALANCE SHEET
See accompanying notes.
INTERNET PARTNERS OF AMERICA, LC STATEMENTS OF OPERATIONS
See accompanying notes.
INTERNET PARTNERS OF AMERICA, LC STATEMENTS OF MEMBERS' DEFICIT
See accompanying notes.
INTERNET PARTNERS OF AMERICA, LC STATEMENTS OF CASH FLOWS
See accompanying notes.
INTERNET PARTNERS OF AMERICA, LC NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION
Internet Partners of America, LC (the 'Company') is a regional provider of Internet access. The Company was formed in Arkansas on May 12, 1995 and began marketing services in June 1995. The Company's targeted markets include Arkansas, Missouri, and Oklahoma.
The Company will terminate on December 31, 2025, unless dissolved earlier in accordance with the Company agreement.
The Company expects to continue focusing on increasing its subscriber base and geographic coverage. The online services and Internet markets are highly competitive. The Company believes that existing competitors, Internet-based services, Internet service providers, Internet directory services, and telecommunication companies are likely to enhance their service offerings resulting in greater competition for the Company. The competitive conditions could have the following effects: require additional pricing programs; increase spending on marketing; limit the Company's ability to expand its subscriber base; and result in increased attrition in the existing subscriber base. There can be no assurance that growth in the Company's revenues or subscriber base will continue or that the Company will be able to achieve or sustain profitability or positive cash flow.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Property and Equipment
Property and equipment are stated at cost. Depreciation is calculated using the straight-line method over the estimated useful lives ranging between three to seven years. Leasehold improvements are amortized over the lesser of the related lease term or the useful life.
Impairment of Long-Lived Assets
The Company reviews the recoverability of long-lived assets whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. If the expected future cash flows from the use of such assets (undiscounted and without interest charges) are less than the carrying value, the Company's policy is to record a write-down that is determined based on the difference between the carrying value of the asset and its estimated fair value.
Intangible Assets
The Company capitalizes specific costs incurred for the purchase of customer bases from other Internet Service Providers ('ISPs'). The customer acquisition costs include the actual fee paid to the selling ISP as well as legal expenses specifically related to the transactions. Amortization is provided using the straight-line method over five years commencing when the customer base is received.
Revenue Recognition
The Company recognizes Internet access revenues when the services are provided. The Company offers contracts for Internet access that are generally paid for in advance by customers. The Company has deferred recognizing revenue on these advance payments and amortizes the amounts to revenue on a straight-line basis as the services are provided.
INTERNET PARTNERS OF AMERICA, LC NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Costs of Revenues
Costs of access revenues primarily consist of telecommunication expenses inherent in the network infrastructure. Costs of access revenues also include fees paid for lease of the Company's backbone, as well as license fees for Web browser software based on a per-user charge, other license fees paid to third-party software vendors, product costs, and contractor fees for distribution of software to new subscribers.
Advertising Costs
All advertising and promotion costs are expensed as incurred. During the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, the Company incurred approximately $89,000, $134,000, and $51,000 respectively, in advertising costs.
Income Taxes
The Company is organized as a limited liability company under the laws of the state of Arkansas. The Company is taxed under the partnership provisions of the Internal Revenue Code (the 'Code'). Under the partnership provisions of the Code, the members of the limited liability company include the Company's income on their personal income tax returns. Accordingly, the Company is not subject to federal and state corporate income taxes.
The unaudited pro forma income tax information included in Note 5 is presented in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, as if the Company had been subject to federal and certain state income taxes.
Financial Instruments and Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and accounts receivable. The cash is held by a high credit quality financial institution. For accounts receivable, the Company performs ongoing credit evaluations of its customers' financial condition and generally does not require collateral.
The Company maintains reserves for credit losses, and such losses have been within management's expectations. The concentration of credit risk is mitigated by the large customer base. The carrying amount of the receivables approximates their fair value.
Sources of Supplies
The Company relies on local telephone companies and other companies to provide data communications. Although management believes alternative telecommunication facilities could be found in a timely manner, any disruption of these services could have an adverse effect on operating results.
Although the Company attempts to maintain vendors for required products, its modems, terminal servers, and high-performance routers, which are important components of its network, are each currently acquired from three sources. In addition, some of the Company's suppliers have limited resources and production capacity. If the suppliers are unable to meet the Company's needs as it is building out its network infrastructure, then delays and increased costs in the expansion of the Company's network infrastructure could result, having an adverse effect on operating results.
INTERNET PARTNERS OF AMERICA, LC NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
3. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
4. INTANGIBLE ASSETS
Intangible assets consisted of the following:
5. INCOME TAXES
Upon consummation of an agreement with OneMain.com, Inc. ('OneMain.com') to sell the outstanding stock of the Company and concurrent with the related initial public offering of OneMain.com (as more fully described in Note 12), the Company's status as an LLC under the Code will automatically terminate and normal federal and state corporate income tax rates will apply. Based upon the cumulative temporary differences, the Company would have recognized a deferred federal and state income tax asset before valuation allowance of $35,929 as of December 31, 1998, had the termination of its election to be treated as an LLC occurred on this date.
No pro forma income tax provision (benefit) is reflected on the statement of operations as the Company would have provided a full valuation allowance against the deferred tax asset had it been a C Corporation.
6. LINE OF CREDIT
In 1998, the Company had a line of credit with a bank allowing for borrowings of up to $350,000. Borrowings against this line bear interest at 10%. This line was secured by and personally guaranteed by the members. No borrowings were outstanding against this line at December 31, 1998.
In 1998, the Company had a line of credit with a bank allowing for borrowings of up to $150,000. Borrowings against this line bear interest at the prime rate (8.25% as of December 31, 1998), as defined in the agreement, and were personally guaranteed by the members. Borrowings of $150,000 were outstanding against this line at December 31, 1998.
7. LONG-TERM DEBT
Long-term debt consisted of the following:
INTERNET PARTNERS OF AMERICA, LC NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
7. LONG-TERM DEBT--(CONTINUED)
The Company incurred interest related to the long-term debt of $218,936, $250,054, and $64,197 for the years ended December 31, 1997 and 1998, and for the three months ended March 31, 1999, respectively.
Principal payments on long-term debt are as follows:
The notes generally contain restrictive covenants addressing certain activities of the Company and its members. The Company and its members were in violation of a covenant on a note that totaled $234,705 at December 31, 1998. The balance of this debt is classified as current at December 31, 1998.
8. LEASES COMMITMENTS
The Company leases storage space under non-cancelable operating lease agreements. The leases generally provide for renewal terms of one to three years. Rent expense for the years ended December 31, 1997 and 1998, and for the three months ended March 31, 1999, was $49,350, $71,622, and $28,793, respectively.
Minimum future lease payments under operating leases are summarized as follows:
INTERNET PARTNERS OF AMERICA, LC NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
8. LEASES COMMITMENTS--(CONTINUED)
In connection with its operations, the Company has certain line usage commitments with numerous communications companies. Minimum payments under these commitments will be approximately $1,200,000, $1,200,000, $1,000,000, $700,000 and $50,000 in 1999, 2000, 2001, 2002 and 2003, respectively.
9. CONTINGENCIES
The Company is involved in various litigation matters on an ongoing basis as a result of its day-to-day operations. However, management does not believe that any of these matters will have a material adverse effect on the Company's financial condition.
10. RELATED PARTY TRANSACTIONS
On December 14, 1998, the Company transferred certain real estate, consisting of land and a building, to its members. On that date, the land and building had a book value of $307,796 and was encumbered by a bank note with a carrying value of $232,990. According to the agreement, the Company will pay the note after the members have obtained other financing. At December 31, 1998, the Company has recorded $232,990 due from members. The $75,500 difference between the carrying value of the real estate and the amount due from the members has been recognized as a distribution to members.
The agreement referred to above also provides that the Company lease the land and building from the members beginning January, 1999, for 60 months at the rate of $5,500 per month. The Company will account for this lease as an operating lease and this lease commitment is included in the summary of minimum future lease payments in Note 8.
11. ACQUISITION
On April 6, 1998, the Company completed the acquisition of substantially all of the assets of On The Net of Boliver, Missouri for approximately $867,000. Only a portion of this amount has been paid to the seller at closing and the remaining amount expected to be paid is included in Due to Seller in the balance sheet. This purchase price is to be finalized in 1999 based upon the number of On The Net customers that switch their service to the Company. The acquisition has been accounted for under the purchase method and, accordingly, the operating results of On The Net have been included in the operating results since the date of acquisition. On The Net is a provider of dial-up Internet access services. The acquisition resulted in $803,000 being allocated to purchased customer lists. The cost of the customer list is being amortized over a 5 year period.
12. PENDING TRANSACTION
During 1998, the Company's members entered into an agreement whereby they will sell their interest in the Company to OneMain.com. The Company's members will exchange their interest in the Company for cash and shares of common stock of OneMain.com concurrently with the consummation of the initial public offering of the common stock of OneMain.com. Additionally, the Company's members will be given additional consideration, contingent upon certain operational and earnings margin requirements, which shall be equal to one-fifth of the difference between total revenue for the Company for the 12 months ended June 30, 1999, and the revenues for the Company for the period from April 1, 1998, through June 30, 1998, multiplied by four. The amount of the additional consideration will be payable in either cash or stock, at the option of OneMain.com. Upon consummation of the agreement, OneMain.com will become the sole stockholder of the Company. Subsequent to the acquisition, the Company will continue to exist.
The related party transactions as described in Note 10 will be amended upon consummation of the acquisition discussed above so that all continuing obligations will be similar to terms and conditions of agreements/arrangements with unaffiliated third parties.
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders ZoomNet, Inc.
We have audited the accompanying balance sheet of ZoomNet, Inc. (the 'Company') as of December 31, 1998 and the related statements of operations, stockholders' equity, and cash flows for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of ZoomNet, Inc. at December 31, 1998, and the results of its operations and its cash flows for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, in conformity with accounting principles generally accepted in the United States.
/s/ ERNST & YOUNG LLP
McLean, Virginia May 13, 1999
ZOOMNET, INC. BALANCE SHEET
See accompanying notes.
ZOOMNET, INC. STATEMENTS OF OPERATIONS
See accompanying notes.
ZOOMNET, INC. STATEMENTS OF STOCKHOLDERS' EQUITY
See accompanying notes.
ZOOMNET, INC. STATEMENTS OF CASH FLOWS
See accompanying notes.
ZOOMNET, INC. NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION
ZoomNet, Inc. (the 'Company') is a regional provider of Internet access. The Company was incorporated in Ohio on June 19, 1995 and began marketing services in September 1995. The Company's target markets include Ohio, Kentucky and West Virginia.
The Company expects to continue to focus on increasing its subscriber base and geographic coverage. The online services and Internet markets are highly competitive. The Company believes that existing competitors, Internet-based services, Internet service providers, Internet directory services and telecommunication companies are likely to enhance their service offerings resulting in greater competition for the Company. The competitive conditions could have the following effects: require additional pricing programs; increase spending on marketing; limit the Company's ability to expand its subscriber base; and result in increased attrition in the existing subscriber base. There can be no assurance that growth in the Company's revenues or subscriber base will continue or that the Company will be able to achieve or sustain profitability or positive cash flow.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company considers all highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents.
Property and Equipment
Property and equipment, including equipment under capital lease and leasehold improvements, are stated at cost. Depreciation is calculated using the straight-line method over the estimated useful lives ranging between five and seven years. Leasehold improvements are amortized over the lesser of the related lease term or the useful life.
Impairment of Long-Lived Assets
The Company reviews the recoverability of long-lived assets whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. If the expected future cash flows from the use of such assets (undiscounted and without interest charges) are less than the carrying value, the Company's policy is to record a write-down that is determined based on the difference between the carrying value of the asset and its estimated fair value.
Intangible Assets
The Company capitalizes specific costs incurred for the purchase of customer bases and non-compete agreements from other Internet service providers ('ISPs'). Amortization is provided using the straight-line method over five years commencing at the date of acquisition of the intangible assets.
ZOOMNET, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Recent Accounting Pronouncements
In March 1998, AcSEC issued Statement of Position 98-1 ('SOP 98-1'), Accounting for the Costs of Computer Software Developed For or Obtained For Internal Use. SOP 98-1 is effective for the Company beginning January 1, 1999. SOP 98-1 will require the capitalization of certain costs incurred after the date of adoption in connection with developing or obtaining software for internal use. The Company currently capitalizes costs related to software developed for internal use. The Company has not evaluated whether the pronouncement will have an impact on the Company's existing capitalization policy for internal-use software.
Revenue Recognition
The Company recognizes Internet access revenue when the services are provided. The Company offers contracts for Internet access that are generally paid for in advance by customers. The Company has deferred recognizing revenue on these advance payments and amortizes the amounts to revenue on a straight-line basis as the services are provided.
The Company provides Internet access services to certain organizations in exchange for advertising, hardware storage, and other services. Revenue and corresponding expenses in the amount of $9,500, $53,036, and $15,049 were recorded during the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, respectively, relating to these non-monetary transactions. The Company values these non-monetary transactions based upon the fair values of the Internet access services provided.
Costs of Revenues
Cost of access revenues primarily consist of telecommunication expenses inherent in the network infrastructure. Cost of access revenues also include fees paid for lease of the Company's backbone, product costs, and contractor fees for distribution of software to new subscribers.
Advertising Costs
All advertising and promotion costs are expensed as incurred. During the years ended December 31, 1997 and 1998, and for the three months ended March 31, 1999, the Company expensed $52,827, $186,873, and $18,733, respectively, as advertising costs.
Income Taxes
The Company accounts for income taxes using the liability method. The liability method provides that deferred tax assets and liabilities are recorded based on the differences between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes, referred to as 'temporary differences.' Temporary differences result from the use of different accounting methods for financial statement and income tax reporting purposes.
Financial Instruments and Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and accounts receivable. The cash is held by a high credit quality financial institution. The Company maintains reserves for credit losses, and such losses have been within management's expectations. The concentration of credit risk is mitigated by the large customer base. The carrying amount of the receivables approximates their fair value.
ZOOMNET, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Sources of Supplies
The Company relies on local telephone companies and other companies to provide data communications. Although management feels alternative telecommunication facilities could be found in a timely manner, any disruption of these services could have an adverse effect on operating results.
Although the Company attempts to maintain vendors for required products, its modems, terminal servers, and high-performance routers, which are important components of its network, are each currently acquired from two sources. In addition, some of the Company's suppliers have limited resources and production capacity. If the suppliers are unable to meet the Company's needs as it is building out its network infrastructure, then delays and increased costs in the expansion of the Company's network infrastructure could result, having an adverse effect on operating results.
3. RELATED PARTY TRANSACTIONS
In September 1998, a shareholder loaned $34,301 to the Company which was repayable on demand. Also, a relative of a shareholder loaned $250,000 to the Company which was also payable on demand. The related party obligations were repaid in November 1998 primarily through a $265,000 loan from a bank. (see Note 6) Interest expense associated with these loans paid to related parties totaled $3,233 during the year ended December 31, 1998.
A stockholder of the Company works part-time for the Company at no charge. As no records are maintained of the hours of service provided, estimating the value of these services is not practicable. No amount has been recorded in the accompanying financial statements to reflect the costs of these services.
4. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
DECEMBER 31, ------------ Computer equipment..................................... $1,099,174 Furniture, fixtures, and office equipment.............. 90,967 Leasehold improvements................................. 155,820 ----------- 1,345,961 Less accumulated depreciation.......................... 329,164 ----------- $1,016,797 ----------- -----------
5. SHORT-TERM DEBT
In June 1998, the Company obtained a $100,000 short-term note with a bank, due December 1998. In December 1998, the note was refinanced with the bank such that the Company is required to make monthly interest payments at the bank's prime rate (8.25% at December 31, 1998) plus 0.5% through June 1999 and a lump sum principal payment in June 1999. The loan is secured by all the Company's assets that have not been individually collateralized under separate loan agreements (see Note 6) and is personally guaranteed by the Company's stockholders.
ZOOMNET, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
6. LONG-TERM DEBT
Long-term debt consisted of the following:
The long-term debt is secured by specific equipment of the Company and is personally guaranteed by the Company's stockholders.
The Company incurred interest related to the long-term debt of approximately $22,000 for the year ended December 31, 1998 and approximately $5,700 for the three months ended March 31, 1999. The carrying value of long-term debt approximates fair value.
Principal payments on long-term debt are due as follows: 1999--$101,512; 2000--$105,559; 2001-- $75,721, 2002--$40,013, 2003 and thereafter--$130,969.
7. COMMITMENTS
Lease Commitments
The Company leases office space under noncancelable operating lease agreements. Rent expense for the years ended December 31, 1997 and 1998, and for the three months ended March 31, 1999, was $7,740, $17,381, and $4,519, respectively.
The Company leases certain computer equipment under agreements which have been accounted for as capital leases. All leases contain purchase options either at fair value or at nominal amounts. The related computer equipment has a cost of $367,945 and accumulated amortization of $117,795 at December 31, 1998.
ZOOMNET, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
7. COMMITMENTS--(CONTINUED)
Minimum future lease payments under operating leases together with the present value of the net minimum lease payments under capital leases are summarized as follows:
Termination Penalties
The Company enters into long-term telephone contracts which provide for early termination penalties. If all such contracts had been terminated at December 31, 1998, the Company would have incurred termination penalties of approximately $345,000. The Company has no present plan to terminate these contracts.
8. INCOME TAXES
Income tax provision was comprised of the following:
The Company's deferred tax assets and liabilities were as follows:
DECEMBER 31, ------------ Deferred tax assets: Cash to accrual adjustment.......................... $ 36,545 Reserve for bad debts............................... 15,550 ------------ Total deferred tax assets............................. 52,095 Deferred tax liabilities--depreciation................ 106,042 ------------ Net deferred tax liabilities.......................... $(53,947) ------------ ------------
ZOOMNET, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
8. INCOME TAXES--(CONTINUED)
A reconciliation between the amount of reported income taxes and the amount computed by multiplying the applicable statutory Federal income tax rate was as follows:
9. ACQUISITIONS
In September 1998, the Company purchased the customer base of another ISP which had approximately 1,164 customers. Also, the Company acquired all names, trade names, servicemarks, trademarks, domain names, customer lists, web pages, licenses, marketing materials and other intellectual property of the ISP. In addition, the purchase agreement included a non-compete provision. The cost of the acquisition was $232,800.
In September 1998, the Company purchased the customer base of another ISP which had approximately 63 customers. The Company acquired all names, trade names, servicemarks, trademarks, domain names, customer lists, web pages, licenses, marketing materials and other intellectual property of the ISP. In addition, the purchase agreement included a non-compete provision. The cost of the acquisition was $3,185.
The cost of these acquisitions have been allocated to the customer bases and non-compete agreements, which are being amortized over five years.
10. PENDING TRANSACTION
During 1998 the Company's stockholders entered into an agreement whereby they will sell their shares in the Company to OneMain.com, Inc. ('OneMain.com'). The Company's stockholders will exchange their shares in the Company for cash and shares of common stock of OneMain.com concurrently with the consummation of the initial public offering of the common stock of OneMain.com. Additionally, the Company's stockholders will be given additional consideration, contingent upon certain operational and earnings margin requirements, which shall be equal to one-fifth of the difference between total revenue for the Company for the 12 months ended June 30, 1999, and the revenues for the Company for the period from April 1, 1998, through June 30, 1998, multiplied by four. The amount of the additional consideration will be payable in either cash or stock, at the option of OneMain.com. Upon consummation of the agreement, OneMain.com will become the sole stockholder of the Company. Subsequent to the acquisition, the Company will continue to exist.
The related party transactions as described in Note 3 will be amended upon consummation of the acquisition discussed above so that all continuing obligations will be similar to terms and conditions of agreements/arrangements with unaffiliated third parties.
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders Palm.Net, USA, Inc.
We have audited the accompanying balance sheet of Palm.Net, USA, Inc. as of December 31, 1998, and the related statements of operations, stockholders' equity (deficit), and cash flows for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Palm.Net, USA, Inc. at December 31, 1998, and the results of its operations and its cash flows for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, in conformity with accounting principles generally accepted in the United States.
/S/ ERNST & YOUNG LLP
McLean, Virginia May 13, 1999
PALM.NET, USA, INC. BALANCE SHEET
See accompanying notes.
PALM.NET, USA, INC. STATEMENTS OF OPERATIONS
See accompanying notes.
PALM.NET, USA, INC. STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
See accompanying notes.
PALM.NET, USA, INC. STATEMENTS OF CASH FLOWS
See accompanying notes.
PALM.NET, USA, INC. NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION
Palm.Net, USA, Inc. (the 'Company') is a regional provider of Internet access. The Company was incorporated in Florida on January 3, 1996 and began marketing services on April 1, 1996. The Company's targeted markets include Florida.
The Company expects to continue to focus on increasing its subscriber base and geographic coverage. The on-line services and Internet markets are highly competitive. The Company believes that existing competitors, Internet-based services, Internet service providers, Internet directory services, and telecommunication companies are likely to enhance their service offerings resulting in greater competition for the Company. The competitive conditions could have the following effects: require additional pricing programs; increase spending on marketing; limit the Company's ability to expand its subscriber base; and result in increased attrition in the existing subscriber base. There can be no assurance that growth in the Company's revenues or subscriber base will continue or that the Company will be able to achieve or sustain profitability or positive cash flow.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company considers all highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents.
Property and Equipment
Property and equipment, including leasehold improvements, are stated at cost. Depreciation is calculated using the straight-line method over the estimated useful lives ranging between five to seven years. Leasehold improvements are amortized over the lesser of the related lease term or the useful life.
Revenue Recognition
The Company recognizes Internet access revenue when the services are provided. The Company offers contracts for Internet access that are generally paid for in advance by customers. The Company has deferred recognizing revenue on these advance payments and amortizes the amounts to revenue on a straight-line basis as the services are provided.
Costs of Revenues
Costs of access revenues primarily consist of telecommunication expenses inherent in the network infrastructure. Costs of access revenues also include fees paid for lease of the Company's backbone, as well as license fees for Web browser software based on a per-user charge, other license fees paid to third-party software vendors, product costs, and contractor fees for distribution of software to new subscribers.
PALM.NET, USA, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Advertising Costs
All advertising and promotion costs are expensed as incurred. During the years ended December 31, 1997 and 1998, and for the three months ended March 31, 1999, the Company expensed $20,469, $28,349, and $9,578, respectively, as advertising costs.
Income Taxes
Historically, the Company has elected by the consent of its stockholders, to be taxed under the provisions of Subchapter S of the Internal Revenue Code (the 'Code'). Under the Subchapter S provisions of the Code, the stockholders include the Company's corporate income in their personal income tax returns. Accordingly, the Company was not subject to federal and state corporate income tax during the period for which it was an S Corporation.
The unaudited pro forma income tax information included in the statements of operations and Note 6 is presented in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, as if the Company had been subject to federal and certain state income taxes.
Financial Instruments and Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and accounts receivable. The cash is held by a high credit quality financial institution. For accounts receivable, the Company performs ongoing credit evaluations of its customers' financial condition and generally does not require collateral. The Company maintains reserves for credit losses, and such losses have been within management's expectations. The concentration of credit risk is mitigated by the large customer base. The carrying amount of the receivables approximates their fair value.
Sources of Supplies
The Company relies on local telephone companies and other companies to provide data communications. Although management feels alternative telecommunication facilities could be PALM.NET, USA, INC. found in a timely manner, any disruption of these services could have an adverse effect on operating results.
Although the Company attempts to maintain vendors for required products, its modems, terminal servers, and high-performance routers, which are important components of its network, each are currently acquired from Computer Max. In addition, some of the Company's suppliers have limited resources and production capacity. If the suppliers are unable to meet the Company's needs as it is building out its network infrastructure, then delays and increased costs in the expansion of the Company's network infrastructure could result, having an adverse effect on operating results.
3. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
PALM.NET, USA, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
4. LEASE COMMITMENTS
The Company leases office space under noncancelable operating lease agreements. The leases generally provide for renewal terms and the Company is required to pay a portion of the common areas' expenses including maintenance, real estate taxes, and other expenses. Rent expense for the years ended December 31, 1997 and 1998, and for the three months ended March 31, 1999, was $10,338, $10,438, and $3,754, respectively. The Company has no material lease commitments for future periods.
5. RELATED PARTY TRANSACTIONS
Loan agreements exist between the Company and the stockholders for an amount equal to the amount of business operating expenses advanced on the stockholder's personal lines of credit. Payments are due in coordination with the timing of payments due to the lenders. In addition, certain Company funds were used by the stockholders to fund personal PALM.NET, USA, INC. expenses. The net amount due from stockholders at December 31, 1998 in the amount of $40,385 was written off by the Company. Interest expense incurred with the loan agreements during the years ended December 31, 1997 and 1998, and for the three months ended March 31, 1999 was $11,541, $7,880, and $0, respectively.
6. INCOME TAXES
Upon consummation of an agreement with One Main.com, Inc. ('One Main.com') to sell the outstanding stock of the Company and concurrent with the related initial public offering of One Main.com, the Company's status as an S Corporation under the Code will automatically terminate and normal federal and state corporate income tax rates will apply. Based upon the cumulative temporary differences, the Company would have recognized a deferred federal and state income tax benefit and asset of $18,412 as of December 31, 1998, had the termination of its election to be treated as an S Corporation occurred on that date.
7. PENDING TRANSACTION
During 1998, the Company's stockholders entered into an agreement whereby they will sell their shares in the Company to OneMain.com. The Company's stockholders will exchange their shares in the Company for cash and shares of common stock of OneMain.com concurrently with the consummation of the initial public offering of the common stock of OneMain.com. Additionally, the Company's stockholders will be given additional consideration, contingent upon certain operational and earnings margin requirements, which shall be equal to one-fifth of the difference between total revenue for the Company for the 12 months ended June 30, 1999, and the revenues for the Company for the period from April 1, 1998, through June 30, 1998, multiplied by four. The amount of the additional consideration will be payable in either cash or stock, at the option of OneMain.com. Upon consummation of the agreement, OneMain.com will become the sole stockholder of the Company. Subsequent to the acquisition, the Company will continue to exist.
The related party transactions as described in Note 5 will be amended upon consummation of the acquisition discussed above so that all continuing obligations will be similar to terms and conditions of agreements/arrangements with unaffiliated third parties.
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders Internet Access Group, Inc.
We have audited the accompanying combined balance sheet of Internet Access Group, Inc. as of December 31, 1998, and the related combined statements of operations, stockholders' deficit, and cash flows for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the combined financial statements referred to above present fairly, in all material respects, the financial position of Internet Access Group, Inc. at December 31, 1998, and the combined results of its operations and its cash flows for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, in conformity with accounting principles generally accepted in the United States.
As discussed in Note 2 to the financial statements, the Company's working capital deficiency and net losses accumulated since inception raise substantial doubt about its ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/S/ ERNST & YOUNG LLP
McLean, Virginia May 13, 1999
INTERNET ACCESS GROUP, INC. COMBINED BALANCE SHEET
See accompanying notes.
INTERNET ACCESS GROUP, INC. COMBINED STATEMENTS OF OPERATIONS
See accompanying notes.
INTERNET ACCESS GROUP, INC. COMBINED STATEMENTS OF STOCKHOLDERS' DEFICIT
See accompanying notes.
INTERNET ACCESS GROUP, INC. COMBINED STATEMENTS OF CASH FLOWS
See accompanying notes.
INTERNET ACCESS GROUP, INC. NOTES TO COMBINED FINANCIAL STATEMENTS
1. ORGANIZATION
Internet Access Group, Inc. ('IAG' or the 'Company') is a regional provider of Internet access which was incorporated on December 2, 1994 and began marketing services in January 1995 with a targeted customer base primarily in Florida.
The Company expects to continue to focus on increasing its subscriber base and geographic coverage. The on-line services and Internet markets are highly competitive. The Company believes that existing competitors, Internet-based services, Internet service providers, Internet directory services, and telecommunication companies are likely to enhance their service offerings resulting in greater competition for the Company. The competitive conditions could have the following effects: require additional pricing programs; increase spending on marketing; limit the Company's ability to expand its subscriber base; and result in increased attrition in the existing subscriber base. There can be no assurance that growth in the Company's revenues or subscriber base will continue or that the Company will be able to achieve or sustain profitability or positive cash flow.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The combined financial statements include the following operating companies owned by the same individual. The companies included in Internet Access Group, Inc. are:
Peiman and Associates, Inc. specializes in software development and computer consulting services; became inactive as of January 1, 1997.
Internet Access Group, Inc. provides internet services; formed as an S Corporation on December 2, 1994. The Company revoked its S Corporation status and became a C Corporation effective January 1, 1998.
Significant intercompany transactions and balances have been eliminated.
Going Concern
The accompanying financial statements have been prepared in conformity with generally accepted accounting principles, which contemplates the continuation of the Company as a going concern. However, the Company has accumulated net losses since its inception and, as a result, has a stockholders' deficit of $203,790 and negative working capital of $306,403 at December 31, 1998. Management believes that actions presently being taken, as described below, will provide the Company with sufficient funds to continue as a going concern. The results to date reflect significant investments made by management in its infrastructure and its efforts in order to enhance its ability to provide internet access services to subscribers in its service area. The Company has allocated substantial resources to enhance its customer service department and implemented a new billing system in 1998 to meet the needs of its subscribers. During 1998, the Company also decided to eliminate its web development department which had been generating operating losses during 1997 and the first half of 1998. The Company believes operating results achieved in the third and fourth quarters of 1998 reflect an operating profitability that demonstrates the Company will be able to meet its working capital obligations and enable the Company to continue as a going concern.
The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.
INTERNET ACCESS GROUP, INC. NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company considers all highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents.
Property and Equipment
Property and equipment is stated at cost. Depreciation is calculated using the straight-line method over the estimated useful life of five years.
Impairment of Long-Lived Assets
The Company reviews the recoverability of long-lived assets whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. If the expected future cash flows from the use of such assets (undiscounted and without interest charges) are less than the carrying value, the Company's policy is to record a write-down that is determined based on the difference between the carrying value of the asset and its estimated fair value.
Revenue Recognition
The Company recognizes Internet access revenue when the services are provided. The Company offers contracts for Internet access that are generally paid for in advance by customers. The Company has deferred recognizing revenue on these advance payments and amortizes the amounts to revenue as the services are provided.
Cost of Revenues
Cost of access revenues primarily consists of telecommunication expenses inherent in the network infrastructure.
Advertising Costs
All advertising and promotion costs are expensed as incurred. During the years ended December 31, 1997 and 1998, and for the three months ended March 31, 1999, the Company expensed $38,055, $38,637, and $10,272, respectively, as advertising costs.
Income Taxes
For tax years prior to 1998, the Company elected tax treatment as an S Corporation; accordingly, the Company was taxed under the provisions of Subchapter S of the Internal Revenue Code (the 'Code'). Under the Subchapter S provisions of the Code, the stockholders included the Company's corporate income in their personal income tax returns. Accordingly, the Company was not subject to federal and state corporate income tax during the period for which it was an S Corporation.
INTERNET ACCESS GROUP, INC. NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
The Company revoked its S Corporation election on March 1, 1998. Therefore, the Company was subject to normal federal and state corporate income taxes effective January 1, 1998.
For periods prior to the revocation of its S Corporation status, the unaudited pro forma income tax information included in Note 7 is presented in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, as if the Company had been subject to federal and certain state income taxes for the year ended December 31, 1997.
For periods after the revocation of its S Corporation status, the Company accounts for income taxes using the liability method. The liability method provides that deferred tax assets and liabilities are recorded based on the differences between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes, referred to as 'temporary differences.' Temporary differences result from the use of different accounting methods for financial statement and income tax reporting purposes.
Financial Instruments and Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and accounts receivable. The cash is held by high credit quality financial institutions. For accounts receivable, the Company performs ongoing credit evaluations of its customers' financial condition and generally does not require collateral. The Company maintains reserves for credit losses, and such losses have been within management's expectations. The concentration of credit risk is mitigated by the large customer base. The carrying amount of the receivables approximates their fair value.
Sources of Supplies
The Company relies on local telephone companies and other companies to provide data communications. Although management feels alternative telecommunication facilities could be found in a timely manner, any disruption of these services could have an adverse effect on operating results.
Although the Company attempts to maintain vendors for required products, its modems, terminal servers, and high-performance routers, which are important components of its network, each are currently acquired from nine sources. In addition, some of the Company's suppliers have limited resources and production capacity. If the suppliers are unable to meet the Company's needs as it is building out its network infrastructure, then delays and increased costs in the expansion of the Company's network infrastructure could result, having an adverse effect on operating results.
3. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
DECEMBER 31, ------------ Computer equipment.............................................. $314,257 Other fixed assets.............................................. 22,037 ------------ 336,294 Less accumulated depreciation and amortization.................. (97,574) ------------ $238,720 ------------ ------------
INTERNET ACCESS GROUP, INC. NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
4. NOTES PAYABLE
Notes payable consists of the following:
DECEMBER 31, ------------ Promissory notes payable, interest at 12%....................... $180,899 Secured automobile loan......................................... 11,474 ------------ Total notes payable........................................... 192,373 Less: current portion......................................... (41,195) ------------ Notes payable, noncurrent....................................... $151,178 ------------ ------------
The promissory notes are payable to a minority stockholder. The terms of the promissory notes allow for either party, giving six months written notice, the option of converting principal and accumulated interest into a maximum 48-month, 12% amortized payoff schedule. Subsequent to December 31, 1997, the creditor formally made demand on two of the notes which had amounts outstanding of $148,301 as of December 31, 1998.
Principal payments on notes payable for each of the years from 1999 to 2003 are as follows:
5. COMMITMENTS
Lease Commitments
The Company leases office space under noncancelable operating lease agreements. The leases generally provide for renewal terms and the Company is required to pay a portion of the common areas' expenses including maintenance, real estate taxes, and other expenses. Rent expense for the years ended December 31, 1997 and 1998, and for the three months ended March 31, 1999, was $38,990, $34,288, and $9,539, respectively. The Company also leases certain computer equipment under agreements which have been accounted for as capital leases.
INTERNET ACCESS GROUP, INC. NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
5. COMMITMENTS--(CONTINUED)
At December 31, 1998, future minimum lease payments under operating leases together with the present value of the net minimum lease payments under capital leases are as follows:
DECEMBER 31, 1998 --------------------- CAPITAL OPERATING -------- --------- 1999.................................................... $ 85,238 $15,895 2000.................................................... 77,251 -- 2001.................................................... 6,919 -- 2002.................................................... -- -- 2003.................................................... -- -- Thereafter.............................................. -- -- -------- --------- Total minimum lease payments............................ $169,408 $15,895 --------- --------- Less amounts representing interest...................... (19,106) -------- Present value of minimum lease payments................. $150,302 -------- --------
6. COMMON STOCK
At December 31, 1998, the common stock of Internet Access Group, Inc. consists of 100 shares ($1 par value) authorized, issued and outstanding.
7. INCOME TAXES
As discussed in Note 2, the Company revoked its S Corporation status and became a C Corporation effective January 1, 1998. Based upon the cumulative temporary differences, the Company's deferred federal and state income tax asset as of December 31, 1998 was $25,815. A full valuation allowance of $25,815 was provided resulting in a deferred asset of $0. No pro forma income tax provision (benefit) is reflected for the year ended December 31, 1997, as the Company would have provided a full valuation allowance against the deferred tax asset had it been a C Corporation.
The components of the Company's income tax benefit are as follows:
THREE MONTHS ENDED MARCH 31, 1999 -------------------- Deferred: Federal................................................ 34,928 State.................................................. 6,164 ---------- Total Deferred...................................... $ 41,092 ---------- ----------
A reconciliation between the amount of reported income taxes and the amount computed by multiplying the applicable statutory Federal income tax rate was as follows:
THREE MONTHS ENDED MARCH 31, 1999 -------------- Federal income tax benefit at statutory rates................. $ 16,921 State income tax benefit net of federal taxes................. 1,742 Other......................................................... 22,429 -------------- Income tax benefit............................................ $ 41,092 -------------- --------------
INTERNET ACCESS GROUP, INC. NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
8. RELATED PARTY TRANSACTIONS
At December 31, 1998 the Company reported amounts receivable from stockholder of $100,151, respectively, which relate to Company funds used by the stockholder to fund personal expenses. No formal note exists related to these advances.
9. PENDING TRANSACTION
During 1998, the Company's stockholders entered into an agreement whereby they will sell their shares in the Company to OneMain.com, Inc. ('OneMain.com'). The Company's stockholders will exchange their shares in the Company for cash and shares of common stock of OneMain.com concurrently with the consummation of the initial public offering of the common stock of OneMain.com. Additionally, the Company's stockholders will be given additional consideration, contingent upon certain operational and earnings margin requirements, which shall be equal to one-fifth of the difference between total revenue for the Company for the 12 months ended June 30, 1999, and the revenues for the Company for the period from April 1, 1998, through June 30, 1998, multiplied by four. The amount of the additional consideration will be payable in either cash or stock, at the option of OneMain.com. Upon consummation of the agreement, OneMain.com will become the sole stockholder of the Company. Subsequent to the acquisition, the Company will continue to exist.
The related party transactions as described in Note 8 will be amended upon consummation of the acquisition discussed above so that all continuing obligations will be similar to terms and conditions of agreements/arrangements with unaffiliated third parties.
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
Members Midwest Internet, L.L.C.
We have audited the accompanying balance sheet of Midwest Internet, L.L.C. as of December 31, 1998, and the related statements of operations, changes in members' deficit, and cash flows for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Midwest Internet, L.L.C. at December 31, 1998, and the results of its operations and its cash flows for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, in conformity with accounting principles generally accepted in the United States.
/s/ ERNST & YOUNG LLP
McLean, Virginia May 13, 1999
MIDWEST INTERNET, L.L.C. BALANCE SHEET
See accompanying notes.
MIDWEST INTERNET, L.L.C. STATEMENTS OF OPERATIONS
See accompanying notes.
MIDWEST INTERNET, L.L.C. STATEMENTS OF CHANGES IN MEMBERS' DEFICIT
See accompanying notes.
MIDWEST INTERNET, L.L.C. STATEMENTS OF CASH FLOWS
See accompanying notes.
MIDWEST INTERNET, L.L.C. NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION
Midwest Internet, L.L.C. (the Company) is a regional provider of Internet access. The Company was organized in the State of Illinois on February 2, 1995 (inception) and began marketing services in March 1995. The Company's targeted markets include residential and business customers in Illinois, Tennessee, Kentucky, and Missouri.
The Company expects to continue to focus on increasing its subscriber base and geographic coverage. The online services and Internet markets are highly competitive. The Company believes that existing competitors, Internet-based services, Internet service providers, Internet directory services, and telecommunication companies are likely to enhance their service offerings, resulting in greater competition for the Company. The competitive conditions could have the following effects: require additional pricing programs, increase spending on marketing, limit the Company's ability to expand its subscriber base, and result in increased attrition in the existing subscriber base. There can be no assurance that growth in the Company's revenues or subscriber base will continue or that the Company will be able to achieve or sustain profitability or positive cash flow.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company considers all highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents.
Property and Equipment
Property and equipment are stated at cost. Depreciation is calculated using the straight-line method over the estimated useful lives ranging from three to seven years. All computer equipment is being depreciated using a three-year useful life.
Intangible Assets
Intangible assets consist of goodwill and costs incurred for the purchase of a non-compete agreement from another Internet service provider. Goodwill, which represents the cost in excess of the fair market value of identifiable net assets acquired, is being amortized using the straight line method over five years. The non-compete agreement is being amortized using the straight line method over its term of two years.
Impairment of Long-lived Assets
The Company reviews the recoverability of long-lived assets whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. If the expected future cash flows from the use of such assets (undiscounted and without interest charges) are less than the carrying value, the Company's policy is to record a write-down that is determined based on the difference between the carrying value of the asset and its estimated fair value.
MIDWEST INTERNET, L.L.C. NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Revenue Recognition
The Company recognizes Internet access revenue when the services are provided. The Company offers contracts for Internet access that are generally paid for in advance by customers. The Company has deferred recognizing revenue on these advance payments and amortizes the amounts to revenue on a straight-line basis as the services are provided.
Costs of Access Revenues
Costs of access revenues primarily consist of telecommunications expenses inherent in the network infrastructure. Costs of access revenues also include fees paid for lease of the Company's backbone, as well as license fees for Web browser software based on a per-user charge, other license fees paid to third-party software vendors, product costs, and contractor fees for distribution of software to new subscribers.
Advertising Costs
All advertising and promotion costs are expensed as incurred. During the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, the Company expensed $27,554, $82,156, $10,857, respectively, as advertising costs.
Income Taxes
The Company was organized as a limited liability company; accordingly, the Company is taxed under the partnership provisions of the Internal Revenue Code (the Code). Under the partnership provisions of the Code, the limited liability company members include the Company's income on their personal income tax returns. Accordingly, the Company is not subject to federal corporate income tax.
The unaudited pro forma income tax information included in the statements of operations and Note 7 is presented in accordance with Statement of Financial Accounting Standards No. 109, Accounting and Income Taxes, as if the Company had been subject to federal and state income taxes for all periods presented.
Financial Instruments and Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and accounts receivable. The cash is held by a high credit quality financial institution. For accounts receivable, the Company performs ongoing credit evaluations of its customers' financial condition and generally does not require collateral. The Company maintains reserves for credit losses, and such losses have been within management's expectations. The concentration of credit risk is mitigated by the large customer base. Other financial instruments consist of accounts payable and notes payable. The carrying values of such amounts reported at the applicable balance sheet dates approximate their fair value.
Sources of Supplies
The Company relies on local telephone companies and other companies to provide data communications. Although management believes alternative telecommunications facilities could be found in a timely manner, any disruption of these services could have an adverse effect on operating results.
The Company maintains various vendors for required products, such as modems, terminal servers, and high-performance routers, which are important components of its network. Some of the Company's suppliers have limited resources and production capacity. If the suppliers are unable to meet the Company's needs as it is building out its network infrastructure, then delays and increased costs in the expansion of the Company's network infrastructure could result, having an adverse effect on operating results.
MIDWEST INTERNET, L.L.C. NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
3. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
4. NOTES PAYABLE
Notes payable consisted of the following:
The prime rate used by all of the banks above was 7.75% at December 31, 1998. The Company incurred interest related to the notes of $84,847, $66,257 and $13,494 for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, respectively.
The notes payable are secured by substantially all of the Company's assets and personal guarantees of its members. In addition, most of the above notes are due on demand; accordingly, such notes have been classified as a current liability.
In August 1998, the Company obtained an additional $50,000 unsecured line of credit from a bank. The line of credit expires in August 1999 and is personally guaranteed by the Company's members. There were no borrowings on this line in 1998.
MIDWEST INTERNET, L.L.C. NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
5. COMMITMENTS
Lease Commitments
The Company leases certain sites for its servers, office space, and various office and computer equipment under noncancelable operating lease agreements. The site leases generally provide for renewal terms, and for certain sites the Company is required to pay a portion of the common areas' expenses including maintenance, real estate taxes, and other expense. Rent expense for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, was $53,370, $97,024, and $30,402, respectively.
The Company leases certain computer equipment under agreements which have been accounted for as capital leases. The related computer equipment had a cost and accumulated amortization of $740,604 and $163,467, respectively, at December 31, 1998. Amortization of leased equipment is included in depreciation. The computer equipment lease agreements require aggregate monthly payments ranging from $191 to $1,300 and expire at various dates through November 2000.
Future minimum lease payments for both capital and operating leases at December 31, 1998 were as follows:
On February 3, 1999, the Company entered into an additional lease commitment related to computer equipment. The lease expires in July 2001 and the aggregate future minimum lease payments under this lease totals approximately $283,000.
Purchase Commitment
In February 1998, the Company entered into a three-year noncancelable agreement for the supply of bandwidth for use as the Company backbone. Under the terms of the agreement, the monthly service fee is $12,000.
6. RELATED PARTY TRANSACTIONS
Members have affiliated enterprises that provide a variety of services to the Company including Internet consulting and Web page development. During the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, the Company expensed payments for services provided from these related parties of $31,600, $66,696, and $13,462, respectively.
The Company has borrowed certain amounts from its members. No formal written terms exist for these advances; however, because such amounts are considered payable within the next year, the Company has classified these advances as current liabilities in the accompanying balance sheets.
MIDWEST INTERNET, L.L.C. NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
7. INCOME TAXES
Upon consummation of an agreement with OneMain.com, Inc. ('OneMain.com') to sell the outstanding members' interest of the Company and concurrent with the related initial public offering of OneMain.com (as more fully described in Note 9), the Company's tax status as a partnership will terminate and, accordingly, the Company will be subject to federal and state corporate income tax. Because of the Company's lack of profitability since formation, deferred tax assets that would have existed had the Company been a C Corporation of approximately $125,000 as of December 31, 1998, would have been offset in the entirety by a valuation allowance. Accordingly, no deferred tax assets would have been recorded at that date.
No pro forma income tax provision (benefit) is reflected for the year ended December 31, 1997 because the Company would have provided a full valuation allowance against the deferred tax asset had it been a C Corporation. For the year ended December 31, 1998 and three months ended March 31, 1999, no pro forma income tax provision is reflected because the Company would have used net operating loss carryforwards to offset current year taxable income.
8. ACQUISITIONS
On December 8, 1998, the Company consummated a transaction to purchase the subscriber base of MyChoice Internet, a local ISP, and certain other assets (including equipment, software used in the provisioning of customers, and accounts receivable) and assume certain capital leases and customer support obligations. In addition, the seller agreed to a noncompete period of two years after closing. The purchase agreement required an initial payment of $14,960, with future payments totaling $535,040 to be paid in 20 equal monthly installments of $26,752 beginning December 15, 1998. To ensure payments of the purchase price, a $250,000 irrevocable letter of credit has been issued by a bank. The acquisition has been accounted for as a purchase transaction and the results of operations of the acquired company have been included in the accompanying statements of operations since the date of acquisition.
The unaudited pro forma results of operations set forth below assumes the acquisition of the local ISP had occurred at the beginning of the periods presented.
9. PENDING TRANSACTION
On December 14, 1998, the Company's members entered into an agreement whereby they will sell their membership shares in the Company to OneMain.com. The Company's members will exchange their membership shares in the Company for cash and shares of common stock of OneMain.com concurrently with the consummation of the initial public offering of the common stock of OneMain.com. Additionally, the Company's members will be given additional consideration, contingent upon certain operational and earnings margin requirements, which shall be equal to one-fifth of the difference between total revenue for the Company for the 12 months ended June 30, 1999 and the revenues for the Company for the period from April 1, 1998 through June 30, 1998 multiplied by four. The amount of the additional consideration will be payable in either cash or stock, at the option of OneMain.com. Upon consummation of the agreement, OneMain.com will become the sole shareholder of the Company. Subsequent to the acquisition, the Company will continue to exist and maintain its status as an LLC.
The related party transactions as described in Note 6 will be amended upon consummation of the acquisition discussed above so that all continuing obligations will be similar to terms and conditions of agreements/arrangements with unaffiliated third parties.
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
To the Members, Internet Solutions, LLC
We have audited the accompanying balance sheet of Internet Solutions, LLC as of December 31, 1998, and the related statements of operations, members' equity, and cash flows for the year ended December 31, 1998 and the three months ended March 31, 1999. 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 Internet Solutions, LLC at December 31, 1998, and the results of its operations and its cash flows for the year ended December 31, 1998 and the three months ended March 31, 1999, in conformity with accounting principles generally accepted in the United States.
/S/ ERNST & YOUNG LLP
McLean, Virginia May 13, 1999
REPORT OF KEVIN J. TOCHTROP, INDEPENDENT AUDITOR
To the Members, Internet Solutions, LLC
I have audited the statements of operations, members' equity, and cash flows of Internet Solutions, LLC for the year ended December 31, 1997. These financial statements are the responsibility of the Company's management. My responsibility is to express an opinion on these financial statements based on my audits.
I conducted my audits in accordance with generally accepted auditing standards. Those standards require that I plan and perform the audits 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. I believe that my audit provides a reasonable basis for my opinion.
In my opinion, the financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Internet Solutions, LLC for the year ended December 31, 1997, in conformity with generally accepted accounting principles.
/S/ KEVIN J. TOCHTROP
Kevin J. Tochtrop Certified Public Accountant Washington, Missouri December 3, 1998
INTERNET SOLUTIONS, LLC (A LIMITED LIABILITY COMPANY) BALANCE SHEET
See accompanying notes.
' INTERNET SOLUTIONS, LLC (A LIMITED LIABILITY COMPANY) STATEMENTS OF OPERATIONS
See accompanying notes.
INTERNET SOLUTIONS, LLC (A LIMITED LIABILITY COMPANY) STATEMENTS OF MEMBERS' EQUITY
See accompanying notes.
INTERNET SOLUTIONS, LLC (A LIMITED LIABILITY COMPANY) STATEMENTS OF CASH FLOWS
See accompanying notes.
INTERNET SOLUTIONS, LLC (A LIMITED LIABILITY COMPANY)
NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION
Internet Solutions, LLC (the 'Company') is a regional provider of Internet access. The Company was organized in Missouri on August 30, 1995 as a limited liability company and began providing services on October 1, 1995. The Company's targeted markets include rural areas in Missouri.
The Company expects to continue to focus on increasing its subscriber base and geographic coverage. The online services and Internet markets are highly competitive. The Company believes that existing competitors, Internet-based services, Internet service providers, Internet directory services and telecommunication companies are likely to enhance their service offerings resulting in greater competition for the Company. The competitive conditions could have the following effects: require additional pricing programs; increase spending on marketing; limit the Company's ability to expand its subscriber base; and result in increased attrition in the existing subscriber base. There can be no assurance that growth in the Company's revenues or subscriber base will continue or that the Company will be able to achieve or sustain profitability or positive cash flow.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company considers all highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents.
Property and Equipment
Property and equipment are stated at cost. Depreciation is calculated using the straight-line method over the estimated useful lives, ranging between three to five years. Leasehold improvements are amortized over the lesser of the related lease term or the useful life.
Impairment of Long-Lived Assets
The Company reviews the recoverability of long-lived assets whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. If the expected future cash flows from the use of such assets (undiscounted and without interest charges) are less than the carrying value, the Company's policy is to record a write-down that is determined based on the difference between the carrying value of the asset and its estimated fair value.
Intangible Assets
The Company capitalizes specific costs incurred for the purchase of customer bases from other Internet service providers ('ISPs'). The customer acquisition costs are based on the value of retained customers. Amortization is provided using the straight-line method over five years commencing when the customer base is received.
INTERNET SOLUTIONS, LLC (A LIMITED LIABILITY COMPANY)
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Revenue Recognition
The Company recognizes Internet access revenue when the services are provided. The Company offers contracts for Internet access that are generally paid for in advance by customers. The Company has deferred recognizing revenue on these advance payments and amortizes the amounts to revenue on a straight-line basis as the services are provided.
Cost of Revenues
Cost of access revenues primarily consists of telecommunication expenses inherent in the network infrastructure. Cost of access revenues also includes fees paid for lease of the Company's backbone, as well as license fees for Web browser software based on a per-user charge, other license fees paid to third-party software vendors, product costs, and contractor fees for distribution of software to new subscribers.
Advertising Costs
All advertising and promotion costs are expensed as incurred. During the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, the Company expensed $19,961, $29,993, and $10,657, respectively, as advertising costs.
Income Taxes
The Company is organized as a limited liability company under the laws of the state of Missouri. Accordingly, the Company is taxed under the partnership provisions of the Internal Revenue Code ('the Code'). Under the partnership provisions of the Code, the limited liability company members include the Company's income on their individual tax returns. As a result, the Company is not subject to federal and state corporate income tax.
The unaudited pro-forma income tax information included in the statements of operations and Note 8 is presented in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, as if the Company had been subject to federal and state income taxes for all periods presented.
If the Company had been subject to federal and certain state income taxes for the year ended December 31, 1997, the Company would have been in a net deferred tax asset position, which would have been fully offset by a valuation allowance. Any tax benefit or provision for that year would have been fully offset by changes in the deferred tax asset valuation allowance. Therefore, no pro-forma income tax information is reflected for the year ended December 31, 1997.
Financial Instruments
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and accounts receivable. The cash is held by a high credit quality financial institution. For accounts receivable, the Company performs ongoing credit evaluations of its customers' financial condition and generally does not require collateral. The Company maintains reserves for credit losses, and such losses have been within management's expectations. The concentration of credit risk is mitigated by the large customer base. The carrying amount of the receivables approximates their fair value.
Compensation Expense for Members' Capital
During the period from August 30, 1995 (inception) to July 1, 1997, certain officers of the Company performed work for the Company without drawing a salary from the Company. The members of the Company agreed to recognize the fair value of the work performed by the officers as a contribution to
INTERNET SOLUTIONS, LLC (A LIMITED LIABILITY COMPANY)
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Members' capital and adjusted the ownership percentages of the Company, as stipulated in the Company's Operating Agreement, accordingly. The amount contributed by the officers was $104,800.
Sources of Supplies
The Company relies on local telephone companies and other companies to provide data communications. Although management feels alternative telecommunication facilities could be found in a timely manner, any disruption of these services could have an adverse effect on operating results.
Although the Company attempts to maintain vendors for required products, its modems, terminal servers, and high-performance routers, which are important components of its network, are each currently acquired from varied sources. In addition, some of the Company's suppliers have limited resources and production capacity. If the suppliers are unable to meet the Company's needs as it is building out its network infrastructure, then delays and increased costs in the expansion of the Company's network infrastructure could result, having an adverse effect on operating results.
3. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
4. INTANGIBLE ASSETS
Intangible assets consisted of the following:
5. ACQUISITION
On September 1, 1998, the Company entered into an agreement with K4 Cyber Tech Ltd. ('K4'), to acquire its list of dial-up Internet access customers for approximately $167,000, of which approximately $43,000 represented a note payable to K4. In addition to acquiring the list, the Company assumed a liability of approximately $52,000 to provide services to certain of the newly acquired customers who had already paid in advance for their services. The non-cash portion of this transaction related to the issuance of the note payable and the assumption of the liability have been excluded from the statement of cash flows. To finance this transaction, the Company entered into an agreement with a financial institution to borrow up to a maximum of $150,000, in the form of a line of credit, bearing variable interest rate of prime plus 1% (8.75%
INTERNET SOLUTIONS, LLC (A LIMITED LIABILITY COMPANY)
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
5. ACQUISITION--(CONTINUED)
at December 31, 1998) and payable at December 30, 1998. At December 30, 1998, the line of credit was amended by a reduction in the borrowing line to $91,000 and an extension of the maturity date to April 30, 1999.
6. LINE OF CREDIT, RELATED PARTY
The Company has a short-term line of credit with a related party allowing for borrowings of up to $200,000 based upon defined levels of accounts receivable and inventory, which is payable on demand. Borrowings against the line bear interest at the bank's prime rate plus 2% (9.75% at December 31, 1998). The line is secured by certain assets.
7. COMMITMENTS
Lease Commitments
The Company leases office space from a related party and various office and computer equipment under noncancelable operating lease agreements. The leases generally provide for renewal terms. Rent expense for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, was $7,571, $12,485, and $3,671, respectively.
The Company leases certain equipment under capital leases. The cost of assets under capital leases and the related accumulated amortization is $125,953 and $4,667, respectively, at December 31, 1998. Amortization expense related to these leases is included with depreciation and amortization expense in the statement of cash flows.
The aggregate liability for future rentals as of December 31, 1998 is as follows:
8. INCOME TAXES
Upon consummation of an agreement with OneMain.com, Inc., ('OneMain.com') to sell the outstanding stock of the Company and concurrent with the related initial public offering of OneMain.com (as more fully described in Note 9), the Company's status as a partnership will automatically terminate and normal federal and state corporate income tax rates will apply. Based upon the cumulative temporary differences, the Company would have recognized a deferred federal and state income tax liability of $954 as of December 31, 1998.
INTERNET SOLUTIONS, LLC (A LIMITED LIABILITY COMPANY)
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
9. PENDING TRANSACTION
During 1998, the Company's members entered into an agreement whereby they will sell their membership shares in the Company to OneMain.com. The Company's members will exchange their shares in the Company for cash and shares of common stock of OneMain.com concurrently with the consummation of the initial public offering of the common stock of OneMain.com. Additionally, the Company's members will be given additional consideration, contingent upon certain operational and earnings margin requirements, which shall be equal to one-fifth of the difference between total revenue for the Company for the 12 months ended June 30, 1999 and the revenues for the Company for the period from April 1, 1998 through June 30, 1998 multiplied by four. The amount of the additional consideration will be payable in either cash or stock, at the option of OneMain.com. Upon consummation of the agreement, OneMain.com will become the sole member of the Company. Subsequent to the acquisition, the Company will continue to exist.
The related party transactions as described in Note 6 will be amended upon consummation of the acquisition discussed above so that all continuing obligations will be similar to terms and conditions of agreements/arrangements with unaffiliated third parties.
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
Board of Directors and Stockholders of FGInet, Inc.
We have audited the accompanying balance sheet of FGInet, Inc. as of December 31, 1998, and the related statements of operations, stockholders' equity, and cash flows for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of FGInet, Inc. at December 31, 1998, and the results of its operations and its cash flows for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, in conformity with accounting principles generally accepted in the United States.
/s/ ERNST & YOUNG LLP
McLean, Virginia May 13, 1999
FGINET, INC. BALANCE SHEET
See accompanying notes.
FGINET, INC. STATEMENTS OF OPERATIONS
See accompanying notes.
FGINET, INC. STATEMENTS OF STOCKHOLDERS' EQUITY
See accompanying notes.
FGINET, INC. STATEMENTS OF CASH FLOWS
NON CASH TRANSACTIONS
In 1998, the Company acquired $113,840 of property and equipment and $382,710 of intangible assets in exchange for 64,285 shares of FGInet common stock and notes payable of $461,050.
See accompanying notes.
FGINET, INC.
NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION
FGInet, Inc. (the 'Company') is a regional provider of Internet access. The Company was incorporated in Illinois on September 16, 1994 and began marketing services in November 1994. The Company's targeted market is the State of Illinois.
The Company expects to continue to focus on increasing its subscriber base and geographic coverage. The online services and Internet markets are highly competitive. The Company believes that existing competitors, Internet-based services, Internet service providers, Internet directory services and telecommunication companies are likely to enhance their service offerings resulting in greater competition for the Company. The competitive conditions could have the following effects: require additional pricing programs; increase spending on marketing; limit the Company's ability to expand its subscriber base; and result in increased attrition in the existing subscriber base. There can be no assurance that growth in the Company's revenues or subscriber base will continue or that the Company will be able to achieve or sustain profitability or positive cash flow.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company considers all highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents.
Property and Equipment
Property and equipment, including leasehold improvements, are stated at cost. Depreciation is calculated using the straight-line method over the estimated useful lives ranging between three to seven years. Leasehold improvements are amortized over the lesser of the related lease term or the useful life.
Inventory
Inventory consists of purchased goods held for resale and is stated at the lower of cost or market on a first-in, first-out (FIFO) method.
Impairment of Long-Lived Assets
The Company reviews the recoverability of long-lived assets whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. If the expected future cash flows from the use of such assets (undiscounted and without interest charges) are less than the carrying value, the company's policy is to record a write-down that is determined based on the differnece between the carrying value of the asset and its estimated fair value.
FGINET, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Intangible Assets
The Company has recorded the value of acquired customer bases purchased from existing companies at the estimated fair market value. These customer bases are being amortized using the straight-line method over three years.
The Company has recorded the value of non-competition agreements entered into with other companies purchased by the Company. These non-compete agreements are amortized using the straight-line method over the term of the specific agreement, generally two to three years.
Stock Compensation
In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 ('SFAS 123'), Accounting for Stock-Based Compensation. SFAS 123 allows companies to account for stock-based compensation under either the new provisions of SFAS 123 or the provisions of Accounting Principles Board Opinion No. 25 ('APB 25'), Accounting for Stock Issued to Employees, but requires pro forma disclosure in the footnotes to the financial statements as if the measurement provisions of SFAS 123 had been adopted. The Company has chosen to continue accounting for its stock-based compensation in accordance with the provisions of APB 25.
Revenue Recognition
The Company recognizes Internet access revenues when the services are provided. The Company offers contracts for Internet access that are generally paid for in advance by customers. The Company has deferred recognizing revenues on these advance payments and amortizes the amounts to revenues on a straight-line basis as the services are provided.
The Company does not refund advance payments in instances of contract cancellation. The Company continues service to the customer until the contract term expires.
Cost of Revenues
Costs of access revenues primarily consist of telecommunication expenses inherent in the network infrastructure. Costs of access revenues also include fees paid for lease of the Company's backbone, as well as license fees for Web browser software based on a per user charge, other license fees paid to third-party software vendors, product costs, and contractor fees for distribution of software to new subscribers.
Advertising Costs
All advertising and promotion costs are expensed as incurred. During the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, the Company expensed $118,769, $204,159, and $55,693, respectively, as advertising costs.
Income Taxes
For tax years prior to 1997, the Company elected tax treatment as an S corporation; accordingly, the Company was taxed under the Subchapter S provisions of the Internal Revenue Code (the 'Code'). Under the Subchapter S provisions of the Code, the stockholders included the Company's income on their personal income tax returns. As a result, the Company was not subject to federal and state corporate income tax during the period for which it was an S corporation.
Beginning in 1997, the Company revoked its S corporation election. Therefore, beginning in 1997, the Company was subject to normal federal and state corporate income taxes.
FGINET, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
For periods after the revocation of its S Corporation status, the Company accounts for income taxes using the liability method. The liability method provides that deferred tax assets and liabilities are recorded based on the differences between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes, referred to as 'temporary differences.' Temporary differences result from the use of different accounting methods for financial statement and income tax reporting purposes.
Financial Instruments and Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and accounts receivable. The cash is held by a high credit quality financial institution. For accounts receivable, the Company performs ongoing credit evaluations of its customers' financial condition and generally does not require collateral. The Company maintains reserves for credit losses, and such losses have been within management's expectations. The concentration of credit risk is mitigated by the large customer base. The carrying amount of the receivables approximates their fair value.
Sources of Supplies
The Company relies on local telephone companies and other companies to provide data communications. Although management believes alternative telecommunication facilities could be found in a timely manner, any disruption of these services could have an adverse effect on operating results.
Although the Company attempts to maintain vendors for required products, its modems, terminal servers, and high-performance routers, which are important components of its network, are each currently acquired from two sources. In addition, some of the Company's suppliers have limited resources and production capacity. If the suppliers are unable to meet the Company's needs as it is building out its network infrastructure, then delays and increased costs in the expansion of the Company's network infrastructure could result, having an adverse effect on operating results.
3. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
FGINET, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
4. INTANGIBLE ASSETS
Intangible assets consisted of the following:
5. FINANCING ARRANGEMENTS
The Company has a noninterest bearing note payable due to a stockholder in 1999. The outstanding balance was $3,852 at December 31, 1998. The Company has a non-interest bearing note payable due to ICEnet no later than March 30, 1999. The amount due at maturity is $361,050.
The Company has a revolving line of credit with a financial institution. The line of credit has a maximum borrowing amount of $80,000, provides for interest at the institution's prime rate plus 1%, and matures on October 2, 1999. Interest is payable monthly with principal due at maturity. The line of credit is collateralized by substantially all of the assets of the Company. The outstanding balance was $80,000 at December 31, 1998.
6. COMMITMENTS
The Company leases office space under non-cancelable operating lease agreements. Minimum future lease payments under non-cancelable operating leases is summarized as follows:
The Company also has purchase commitments with various telecommunications providers for internet access. These non-cancelable agreements have varying terms and rates. No minimum purchase provisions apply to these agreements.
Rent expense for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999 was $26,560, $13,855, and $12,986, respectively.
7. STOCK OPTIONS
The Board of Directors may grant voting and nonvoting common stock options to employees, board members, and others who contribute materially to the success of the Company. Stock options have been granted at prices which the Company's Board of Directors believe approximate the fair market value of its common stock at the date of grant, taking into consideration the stock's voting rights, transferability and liquidity. Individual grants generally become exercisable immediately. The contractual term of the options granted are five years from the date of grant.
FGINET, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
7. STOCK OPTIONS--(CONTINUED)
Common stock option activity was as follows:
Had compensation expense related to stock options been determined based on fair value at the grant date for options granted during the year ended December 31, 1998 and the three months ended March 31, 1999, consistent with the provisions of SFAS 123, the Company's net loss would have been $131,800 and $30,400, respectively. All of the options granted in 1998 are exercisable at December 31, 1998.
The fair value of each option grant is estimated on the date of grant using the minimum value option pricing fair value model with the following assumptions used for grants in 1998 and for grants in the first three months of 1999: no dividend yield, a risk-free interest rate of 5.25%, and expected life of the option term of 4 years.
8. INCOME TAXES
Based upon cumulative temporary differences, the Company recognized a deferred tax asset (before valuation allowance) of $20,680 as of December 31, 1998. The deferred tax asset is mainly related to the carryforward of net operating losses.
The components of the Company's income tax provision (benefit) are as follows:
Effective Rate Reconciliation
FGINET, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
9. ACQUISITIONS
On May 30, 1998, the Company completed the acquisition of substantially all of the assets of FGInet of Highland, a company in the same line of business, for $15,000 in cash and 20,000 shares of FGInet common voting stock valued at $1 per share. The acquisition of FGInet of Highland has been accounted for using the purchase method and, accordingly, the acquired assets have been recorded at their estimated fair values as of May 30, 1998.
The estimated fair value of the assets acquired on May 30, 1998 are as follows:
On September 15, 1998, the Company completed the acquisition of substantially all of the assets of Great Plains Group, Inc., a company in the same line of business, for $74,709 in cash. The acquisition of Great Plains Group, Inc. has been accounted for using the purchase method and, accordingly, the acquired assets have been recorded at their estimated fair values as of September 15, 1998.
The estimated fair value of the assets acquired September 15, 1998, are as follows:
On September 21, 1998, the Company completed the acquisition of substantially all of the assets of Interactive Communications and Explorations, a partnership in the same line of business, for $461,050; $100,000 in cash and $361,050 short term note payable due in March 1999. Because the short term note payable is non interest bearing, the imputed interest of $15,500 will be recognized over the note term. The aggregate purchase price will be reduced by a like amount.
The acquisition of Interactive Communications and Explorations has been accounted for using the purchase method and, accordingly, the acquired assets have been recorded at their estimated fair value as of September 21, 1998.
The estimated fair value of the assets acquired September 21, 1998, are as follows:
On September 28, 1998, the Company completed the acquisition of a customer base estimated at 220 from FGInet of Mt. Zion, a company in the same line of business, in exchange for 44,285 shares of FGInet common voting stock valued at $31,000. The acquisition of FGInet of Mt. Zion has been accounted for using the purchase method and, accordingly, the acquired assets have been recorded at their estimated fair value as of September 28, 1998.
FGINET, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
9. ACQUISITIONS--(CONTINUED)
The estimated fair value of the assets acquired September 28, 1998, are as follows:
On September 30, 1998, the Company completed the acquisition of substantially all of the assets of Wyman Computer Services, a company in the same line of business, for $10,000 short-term note payable, $4,700 of which is outstanding as of December 31, 1998. The acquisition of Wyman Computer Services has been accounted for using the purchase method and, accordingly, the acquired assets have been recorded at their estimated fair value as of September 30, 1998.
The estimated fair value of the assets acquired on September 30, 1998, are as follows:
10. PENDING TRANSACTION
The Company's stockholders have entered into an agreement whereby they will sell their shares in the Company to OneMain.com, Inc. ('OneMain.com'). The Company's stockholders will exchange their shares in the Company for cash and shares of common stock of OneMain.com concurrently with the consummation of the initial public offering of the common stock of OneMain.com. Additionally, the Company's stockholders will be given additional consideration, contingent upon certain operational and earnings margin requirements, which shall be equal to one-fifth of the difference between total revenue for the Company for the 12 months ended June 30, 1999 and the revenues for the Company for the period from April 1, 1998 through June 30, 1998 multiplied by four. The amount of the additional consideration will be payable in either cash or stock, at the option of OneMain.com. Upon consummation of the agreement, OneMain.com will become the sole member of the Company. Subsequent to the acquisition, the Company will continue to exist and maintain its status as an LLC.
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
Board of Directors and Stockholder Superhighway, Inc. d/b/a Indynet
We have audited the accompanying balance sheet of Superhighway, Inc. d/b/a Indynet as of December 31, 1998, and the related statements of income, stockholder's equity, and cash flows for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Superhighway, Inc. d/b/a Indynet at December 31, 1998, and the results of its operations and its cash flows for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, in conformity with accounting principles generally accepted in the United States.
/S/ ERNST & YOUNG LLP
McLean, Virginia May 13, 1999
SUPERHIGHWAY, INC. D/B/A INDYNET BALANCE SHEET
See accompanying notes.
SUPERHIGHWAY, INC. D/B/A INDYNET STATEMENTS OF INCOME
See accompanying notes.
SUPERHIGHWAY, INC. D/B/A INDYNET STATEMENTS OF STOCKHOLDER'S EQUITY
See accompanying notes.
SUPERHIGHWAY, INC. D/B/A INDYNET STATEMENTS OF CASH FLOWS
See accompanying notes.
SUPERHIGHWAY, INC. D/B/A INDYNET
NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION
Superhighway, Inc. d/b/a Indynet (the 'Company'), incorporated as a Subchapter S Corporation under the laws of Indiana on June 1, 1995, is a regional provider of internet access. The Company's target market is central Indiana.
The Company expects to continue to focus on increasing its subscriber base and geographic coverage. The online services and Internet markets are highly competitive. The Company believes that existing competitors, Internet-based services, Internet service providers, Internet directory services and telecommunication companies are likely to enhance their service offerings resulting in greater competition for the Company. The competitive conditions could have the following effects: require additional pricing programs; increase spending on marketing; limit the Company's ability to expand its subscriber base and result in increased attrition in the existing subscriber base. There can be no assurance that growth in the Company's revenues or subscriber base will continue or that the Company will be able to achieve or sustain profitability or positive cash flow.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
All highly liquid investments with maturities of three months or less at the time of purchase are classified as cash equivalents.
Property and Equipment
Property and equipment, including leasehold improvements, are stated at cost. Depreciation is calculated using the straight-line method over the estimated useful lives ranging between three to seven years. Leasehold improvements are amortized over the lesser of the related lease term or the useful life.
Other Assets
Other assets include intangibles which have been recorded as a result of the purchase of a competitor and will be amortized over 3 years on a straight line basis. Other assets are net of $795 of accumulated amortization at December 31, 1998.
Impairment of Long-Lived Assets
The Company reviews the recoverability of long-lived assets whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. If the expected future cash flows from the use of such assets (undiscounted and without interest charges) are less than the carrying value, the Company's policy is to record a write-down that is determined based on the difference between the carrying value of the asset and its estimated fair value.
SUPERHIGHWAY, INC. D/B/A INDYNET
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Revenue Recognition
The Company offers monthly contracts for Internet access that are generally billed for on the first day of the month. The Company recognizes access revenue as services are provided.
The Company has entered into agreements to provide internet access and other internet services to various non-profit organizations in exchange for non-monetary goods and services. These agreements have been accounted for as non-monetary transactions and are recorded at the value of the service provided by the Company. During the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, access revenues and sales and marketing expense include approximately $198,000, $297,000, and $79,000, respectively, of such non-monetary transactions.
Cost of Revenues
Cost of access revenues primarily consists of telecommunication expenses inherent in the network infrastructure. Cost of access revenues also includes fees paid for lease of the Company's backbone, as well as license fees for Web browser software based on a per-user charge, other license fees paid to third-party software vendors, product costs, and contractor fees for distribution of software to new subscribers.
Advertising Costs
All advertising and promotion costs are expensed as incurred. For the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, the Company expensed approximately $233,000, $367,000, and $5,290, respectively, as advertising costs.
Income Taxes
Historically, the Company has elected, by the consent of its stockholder, to be taxed using provisions of Subchapter S of the Internal Revenue Code (the 'Code'). Under the Subchapter S provisions of the Code, the stockholder includes the Company's corporate income in his personal income tax return. Accordingly, the Company was not subject to federal and state corporate income tax during the period for which it was an S Corporation.
The unaudited pro forma income tax information included in the statements of operations and Note 7 is presented in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, as if the Company had been subject to federal and certain state income taxes.
Financial Instruments and Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and accounts receivable. The cash is held by a high credit quality financial institution. For accounts receivable, the Company performs ongoing credit evaluations of its customers' financial condition and generally does not require collateral. The Company maintains reserves for credit losses, and such losses have generally been within management's expectations. The concentration of credit risk is mitigated by the large customer base. The carrying amount of the receivables approximates fair value.
Sources of Supplies
The Company relies on local telephone companies and other companies to provide data communications. Although management feels alternative telecommunication facilities could be found in a timely manner, any disruption of these services could have an adverse effect on operating results. Although the Company attempts to maintain vendors for required products, its modems, terminal servers, and high-performance routers, which are important components of its network, are each currently acquired from numerous sources.
SUPERHIGHWAY, INC. D/B/A INDYNET
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
In addition, some of the Company's suppliers have limited resources and production capacity. If the suppliers are unable to meet the Company's needs as it is building out its network infrastructure, then delays and increased costs in the expansion of the Company's network infrastructure could result, having an adverse effect on operating results.
3. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
4. LINE OF CREDIT
The Company has a $300,000 short-term line of credit with a bank. Borrowings against the line bear interest at the bank's prime rate plus 1% (8.75% at December 31, 1998). The line is secured by all business assets and is personally guaranteed by the sole stockholder. Borrowings of $50,000 and $80,000 were outstanding against the line at December 31, 1997 and 1998, respectively.
5. LONG-TERM DEBT
Long-term debt consists of the following:
6. LEASE COMMITMENT RELATED PARTY
The Company leases office space on a month to month basis from the sole stockholder and is required to pay the common areas' expenses including maintenance, real estate taxes and other expense. Rent expense for the years ended 1997 and 1998, and the three months ended March 31, 1999 was approximately $37,000, $60,000, and $24,975, respectively.
7. INCOME TAXES
Upon consummation of an agreement with OneMain.com, Inc. ('OneMain.com') to sell the outstanding stock of the Company and concurrent with the related initial public offering of OneMain.com (as more fully described in Note 9), the Company's status as an S Corporation under the Code will automatically terminate and normal federal and state corporate income tax rates will apply. Based upon the cumulative temporary
SUPERHIGHWAY, INC. D/B/A INDYNET
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
7. INCOME TAXES--(CONTINUED)
differences, the Company would have recognized a deferred tax liability of $40,000 as of December 31, 1998, had the termination of its election to be treated as an S Corporation occurred on that date.
8. ACQUISITION
During 1998, the Company purchased the computer equipment and customer lists of another Internet service provider for $23,844. The purchase price was allocated to the net assets acquired based upon their estimated fair values at the date of acquisition. The estimated fair value of the computer equipment was $7,640 at the acquisition date and the remaining $16,204 was recorded as an intangible.
9. PENDING TRANSACTION
During 1998, the Company's stockholder entered into an agreement whereby he will sell his shares in the Company to OneMain.com. The Company's stockholder will exchange his shares in the Company for cash and shares of common stock of OneMain.com concurrently with the consummation of the initial public offering of the common stock of OneMain.com. Additionally, the Company's stockholder will be given additional consideration, contingent upon certain operational and earnings margin requirements, which shall be equal to one-fifth of the difference between total revenue for the Company for the 12 months ended June 30, 1999 and the revenues for the Company for the period from April 1, 1998, through June 30, 1998, multiplied by four. The amount of the additional consideration will be payable in either cash or stock, at the option of OneMain.com. Upon consummation of the agreement, OneMain.com will become the sole stockholder of the Company. Subsequent to the acquisition, the Company will continue to exist.
The related party transactions as described in Note 6 will be amended upon consummation of the acquisition discussed above so that all continuing obligations will be similar to terms and conditions of agreements/arrangements with unaffiliated third parties.
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholder Lightspeed Net, Inc.
We have audited the accompanying balance sheet of Lightspeed Net, Inc. as of December 31, 1998, and the related statements of operations, stockholder's equity, and cash flows for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Lightspeed Net, Inc. at December 31, 1998, and the results of its operations and its cash flows for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, in conformity with accounting principles generally accepted in the United States.
As discussed in Note 2 to the financial statements, the Company's recurring losses from operations raise substantial doubt about its ability to continue as a going concern. Management's plans as to these matters are also described in Note 2. The 1998 financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/S/ ERNST & YOUNG LLP
McLean, Virginia May 13, 1999
LIGHTSPEED NET, INC. BALANCE SHEET
See accompanying notes.
LIGHTSPEED NET, INC. STATEMENTS OF OPERATIONS
See accompanying notes.
LIGHTSPEED NET, INC. STATEMENTS OF STOCKHOLDER'S EQUITY
See accompanying notes.
LIGHTSPEED NET, INC. STATEMENTS OF CASH FLOWS
See accompanying notes.
LIGHTSPEED NET, INC. NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION
Lightspeed Net, Inc. (the 'Company') is a regional provider of Internet access with targeted markets in central California. The Internet business operated as a line of business of Lightspeed Software, an affiliated company which is wholly owned by the sole shareholder of the Company, from March 27, 1995 through December 31, 1996. On June 28, 1996 the Company was incorporated and became a separate company beginning January 1, 1997.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The financial statements have been prepared assuming that the Company will continue as a going concern. The Company has incurred losses since inception and has had negative cash flows from operations in all periods except the period ended December 31, 1998 and March 31, 1999. In addition, management anticipates that its cash and working capital requirements in the short term cannot be met entirely from funds generated internally from operations.
Management's operational and financing plans to address the above issues include continued focus on increasing its subscriber base and geographic coverage and obtaining equity and debt financing. The online services and internet markets are highly competitive. The Company believes that existing competitors, internet-based services, internet service providers, internet directory services and telecommunication companies are likely to enhance their service offerings resulting in greater competition for the Company. The competitive conditions could have the following effects: require additional pricing programs; increase marketing spending; limit the Company's ability to expand its subscriber base and result in increased attrition in the existing subscriber base. There can be no assurance that growth in the Company's revenues or subscriber base will continue or that the Company will be able to achieve or sustain profitability or positive cash flow. The financial statements do not include any adjustments that might result from the outcome of these uncertainties.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Property and Equipment
Property and equipment are stated at cost. Depreciation is calculated using the straight-line method over the estimated useful lives ranging between three to seven years.
Impairment of Long-Lived Assets
The Company reviews the recoverability of long-lived assets whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. If the expected future cash flows from the use of such assets (undiscounted and without interest charges) are less than the carrying value, the Company's policy is to record a write-down that is determined based on the difference between the carrying value of the asset and its estimated fair value.
LIGHTSPEED NET, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Stock Compensation
In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation ('SFAS 123'). SFAS 123 allows companies to account for stock-based compensation under either the new provisions of SFAS 123 or the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ('APB 25'), but requires pro forma disclosure in the footnotes to the financial statements as if the measurement provisions of SFAS 123 had been adopted. The Company has chosen to continue accounting for its stock-based compensation in accordance with the provisions of APB 25.
Revenue Recognition
The Company recognizes internet access revenue when the services are provided. The Company offers contracts for internet access which are billed in the month prior to the month of service. The Company has deferred recognizing revenue on these advance billings until earned.
In June 1995, the Company entered into a strategic alliance with ACN Communications ('ACN'), which provides for ACN to sell internet services provided by the Company as part of a telecommunications bundle of services. ACN markets, invoices and collects for these internet services provided by the Company. In return, ACN retains approximately 30% of the revenues received for these services, or a minimum of $22,000 per month. The remainder of the revenues are paid to the Company. Revenues from this alliance are included in access revenues in the statement of operations.
Cost of Revenues
Cost of access revenues primarily consists of telecommunication expenses inherent in the network infrastructure. Cost of access revenues also includes fees paid to lease the Company's backbone, other license fees paid to third-party software vendors, and product costs.
Advertising Costs
All advertising and promotion costs are expensed as incurred. For the three months ended March 31, 1999 and for the years ended December 31, 1998 and 1997, the Company expensed $29,281, $201,276, and $254,510, respectively, as advertising costs.
Income Taxes
Historically, the Company has elected, by consent of its sole stockholder, to be taxed as a subchapter S corporation, as provided by the Internal Revenue Code and the California Revenue and Taxation Code. Accordingly, the Company's results of operations are reported in the individual income tax return of the sole shareholder. The Company recorded California franchise tax provisions of $800 for each of the years ended December 31, 1998 and 1997.
The pro forma income tax information included in the statements of operations and Note 7 is presented in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, as if the Company had been subject to Federal and certain state income taxes.
Financial Instruments and Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and accounts receivable. The cash is held by a high credit quality financial institution. For accounts receivable, the Company performs ongoing credit evaluations of its customers' financial condition and generally does not require collateral. The Company maintains reserves for credit losses, and such losses
LIGHTSPEED NET, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
have been within management's expectations. The concentration of credit risk is mitigated by the large customer base. The carrying amount of the receivables approximates their fair value.
Sources of Supplies
The Company relies on local telephone companies and other companies to provide data communications. Disruption of these services could have an adverse effect on operating results.
Although the Company attempts to maintain vendors for required products, its modems, terminal servers, and high-performance routers, which are important components of its network, are each currently acquired from primarily one source for each product. In addition, some of the Company's suppliers have limited resources and production capacity. If the suppliers are unable to meet the Company's needs as it is building out its network infrastructure, then delays and increased costs in the expansion of the Company's network infrastructure could result, having an adverse effect on operating results.
3. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
4. COMMITMENTS
The Company leases office space under non-cancelable operating lease agreements. The leases generally provide for renewal terms and the Company is required to pay a portion of the common areas' expenses including maintenance, real estate taxes and other expense. Rent expense for the three months ended March 31, 1999 and the years ended December 31, 1998 and 1997, was $41,797, $133,618, and $74,719, respectively.
Minimum future lease payments under operating leases with initial terms of one year or more consist of the following:
LIGHTSPEED NET, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
5. STOCK OPTION PLAN
On July 24, 1998, the Company adopted the Lightspeed Net, Inc. Grant of Incentive Stock Option (Option Plan) which permits the Company to grant stock options to the Company's President. Under the Option Plan, the Company's President may purchase up to eleven shares of the Company's common stock at a price of $33,333.63 per share, the fair market value of the common stock on the grant date as determined by the Company's Board of Directors. The options granted under the Option Plan are fully vested and shall expire five years from the date of grant. Subsequent to year end this award was modified. Refer to Note 9 for a possible settlement of these options.
Stock option activity was as follows:
Had compensation expense related to the Option Plan been determined based on fair value at the grant date for options granted during the year ended December 31, 1998 and the three months ended March 31, 1999 under the provisions of SFAS 123, the Company's net loss would have been increased by $10,017 and $3,759, respectively. The effect of applying SFAS 123 for purposes of recognizing compensation expense is not necessarily representative of the effects on reported net income for future periods.
The fair value of the option grant was estimated on the date of grant using the minimum value option pricing fair value model as provided for under SFAS 123, with the following weighted-average assumptions used for grants in 1998: dividend yield of 0%, a risk-free interest rate of 5.54%, and expected life of the option term of six months. The weighted average fair values of the options granted in 1998 with a stock price equal to the exercise price is $10,017.
As of December 31, 1998, the Company had no reserved shares of common stock for future issuance under the Option Plan.
6. PROFIT SHARING PLAN
On December 28, 1989, Lightspeed Software, formerly known as MacSoft, entered into the MacSoft Profit Sharing Plan and Trust (the Profit Plan). As the shareholder has started additional companies, the Profit Plan has covered the employees of those companies. Under the terms of the Profit Plan, the sole shareholder of the Company historically contributed 15% of the base salaries for all eligible employees to the plan. An employee becomes eligible for the Profit Plan after reaching the age of 21 and completing one year of service with the Company. Benefits under the Profit Plan vest at a rate of 20% per year after three to seven years of service. The Profit Plan for the Company and the affiliated companies is administered by a third party. Voluntary contributions to the Profit Plan in the amounts of $90,689 was made by the Company for the year ended December 31, 1997. In January 1999, the Company decided to make a voluntary contribution for the year ended December 31, 1998 in the amount of $168,175, which has been accrued as of December 31, 1998. There were no contributions for the three months ended March 31, 1999.
LIGHTSPEED NET, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
7. INCOME TAXES
Upon consummation of an agreement with OneMain.com, Inc. ('OneMain.com') to sell the outstanding stock of the Company and concurrent with the related initial public offering of OneMain.com as more fully described in Note 9, the Company's status as an S Corporation under the Code will automatically terminate and normal federal and state corporate income tax rates will apply. Based upon the cumulative temporary differences, the Company would have recognized a deferred federal and state income tax asset of $59,748 as of December 31, 1998, with a full valuation allowance had the termination of its election to be treated as an S Corporation occurred on that date.
No pro forma income tax benefit is reflected on the statement of operations as the Company would have provided a full valuation allowance against the deferred tax asset had it been a C Corporation.
8. RELATED PARTY TRANSACTIONS
The Company provides loans to its employees which are payable monthly and bear an interest rate of 10%. Amounts receivable from employee loans at December 31, 1998, was $15,204, and is included in other assets on the balance sheet.
The Company purchases most of its computer equipment from Lightspeed Technologies, Inc, an affiliated company which is wholly owned by the sole shareholder of the Company. Purchases from Lightspeed Technologies, Inc. for the year ended December 31, 1998 and the three months ended March 31, 1999 were $871,192 and $141,921, respectively. The Company believes that such purchases were made at the fair market value of the assets acquired.
The Company leases a customer service center from the sole shareholder of the Company. Total rental expense for the year ended December 31, 1997 and 1998 and the three months ended March 31, 1999, were $60,000, $60,280, and $15,840, respectively. On November 10, 1998, the Company entered a new agreement effective December 1, 1998 for three years increasing the monthly rent to $5,280 per month.
On November 11, 1998, the Company entered into a lease agreement for a 36 strand fiber optic connection between two of its facilities from Lightspeed Software. The lease agreement is effective December 1, 1998 for three years at $900 per month.
9. PENDING TRANSACTION
The Company's stockholder has entered into an agreement whereby he will sell his shares in the Company to OneMain.com, Inc. ('OneMain.com'). The Company's sole stockholder will exchange the shares in the Company for cash and shares of common stock of OneMain.com concurrently with the consummation of the initial public offering of the common stock of OneMain.com. Additionally, the Company's stockholder will be given additional consideration, contingent upon certain operational and earnings margin requirements, which shall be equal to one-fifth of the difference between total revenue for the Company for the 12 months ended June 30, 1999 and the revenues for the Company for the period from April 1, 1998 through June 30, 1998 multiplied by four. The amount of the additional consideration will be payable in either cash or stock, at the option of OneMain.com. Upon consummation of the agreement, OneMain.com will become the sole stockholder of the Company, and subsequent to the acquisition, the Company will continue to exist. In connection with this agreement, the outstanding stock options will be canceled by a payment to the holder. As a result, in the period of cancellation the Company will recognize compensation expense equal to the amount payable for the cancellation.
The related party transactions as described in Note 8 will be amended upon consummation of the acquisition discussed above so that all continuing obligations will be similar to terms and conditions of agreements/arrangements with unaffiliated third parties.
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
To the Stockholders of JPS.Net Corporation
We have audited the accompanying balance sheet of JPS.Net Corporation as of December 31, 1998, and the related statements of operations, stockholders' deficit, and cash flows for the period January 31, 1997 (inception) to December 31, 1997, the year ended December 31, 1998, and the three months ended March 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of JPS.Net Corporation at December 31, 1998 and the results of its operations and its cash flows for the period January 31, 1997 (inception) to December 31, 1997, the year ended December 31, 1998, and the three months ended March 31, 1999, in conformity with accounting principles generally accepted in the United States.
As discussed in Note 2 to the financial statements, the Company's recurring losses from operations and working capital deficiency raise substantial doubt about its ability to continue as a going concern. Management's plans as to these matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/S/ ERNST & YOUNG LLP
McLean, Virginia May 13, 1999
JPS.NET CORPORATION BALANCE SHEET
See accompanying notes.
JPS.NET CORPORATION STATEMENTS OF OPERATIONS
See accompanying notes.
JPS.NET CORPORATION STATEMENTS OF STOCKHOLDERS' DEFICIT
See accompanying notes.
JPS.NET CORPORATION STATEMENTS OF CASH FLOWS
See accompanying notes.
JPS.NET CORPORATION
NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION
JPS.Net Corporation (the 'Company') is a regional provider of Internet access. The Company was incorporated on January 31, 1997 under the laws of the State of California. All of the Company's stock was issued to two individuals for cash. These individuals had computer sales and consulting experience and in the months preceding the Company's incorporation, had begun to provide Internet access services to subscribers.
The Company was formed with the intention of building an Internet access subscriber base and geographic coverage. The on-line services and Internet markets are highly competitive. The Company believes that existing competitors, Internet-based services, Internet service providers, Internet directory services and telecommunication companies are likely to enhance their service offerings resulting in greater competition for the Company. The competitive conditions could have the following effects: require additional pricing programs; increase spending on marketing; limit the Company's ability to expand its subscriber base; and result in increased attrition in the existing subscriber base. There can be no assurance that growth in the Company's revenues or subscriber base will continue or that the Company will be able to achieve or sustain profitability or positive cash flow.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying financial statements have been presented in conformity with generally accepted accounting principles, which contemplates continuation of the Company as a going concern. However, the Company has incurred losses of $992,667, $911,860, and $13,373 for the period from January 31, 1997 (date of inception) to December 31, 1997, the year ended December 31, 1998, and the three month period ended March 31, 1999, respectively. These losses have significantly weakened the Company's financial position and its ability to purchase equipment and meet current operating expenses, and at December 31, 1998, the Company's current liabilities exceeded its current assets by $3,388,994. Management believes that actions presently being taken, as described below, will provide the Company with sufficient funds to continue as a going concern.
Effective November 1, 1998, the Company increased the prices it charges for its services by approximately 40%. The increase in prices charged is essential as the Company has no other immediate plans that will provide sufficient cash flows to meet current operating requirements. In the event the increase in prices reduces the number of customers substantially, the Company has plans to substantially reduce its staffing.
The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts or classifications of liabilities that may result from the outcome of this uncertainty.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
JPS.NET CORPORATION
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company considers all highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents.
At December 31, 1998, approximately $1,376,000 and $504,000 of the Company's cash and cash equivalents were held by Westamerica and National Bank of the Redwoods, respectively.
Property and Equipment
Property and equipment are stated at cost. Depreciation is calculated using the straight-line method over the estimated useful lives, ranging between three to seven years. Leasehold improvements are amortized over the lesser of the related lease term or the useful life.
Revenue Recognition
The Company recognizes Internet access revenue when the services are provided. The Company offers contracts for Internet access that are generally paid for in advance by customers. The Company has deferred recognizing revenue on these advance payments and amortizes the amounts to revenue on a straight-line basis as the services are provided.
Costs of Access Revenues
Costs of access revenues primarily consist of telecommunication expenses inherent in the network infrastructure. Costs of access revenues also include reproduction fees for Web JPS.NET CORPORATION browser software, other license fees paid to third-party software vendors and product costs.
Advertising Costs
All advertising and promotion costs are expensed as incurred. During the period from January 31, 1997 (inception) to December 31, 1997, for the year ended December 31, 1998, and the three months ended March 31, 1999, the Company expensed $292,631, $546,729, and $264,528, respectively, as advertising costs.
Income Taxes
The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109 ('SFAS 109'), Accounting for Income Taxes. Under the asset and liability method of SFAS 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS 109, the effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.
Financial Instruments
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash, cash equivalents, and accounts receivable. Management believes that the credit risk related to its deposits with financial institutions is minimal.
The Company grants credit without collateral to its customers, however, ongoing credit evaluations of customers' financial condition are performed. The Company maintains reserves for credit losses, and such
JPS.NET CORPORATION
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
losses have been within management's expectations. The concentration of credit risk is mitigated by the Company's large customer base.
Sources of Supplies
The Company relies on local telephone companies and other companies to provide data communications. Although management feels alternative telecommunication facilities could be found in a timely manner, any disruption of these services could have an adverse effect on operating results.
Although the Company attempts to maintain vendors for required products, its modems, terminal servers, and high-performance routers, which are important components of its network, are each currently acquired from varied sources. In addition, some of the Company's suppliers have limited resources and production capacity. If the suppliers are unable to meet the Company's needs as it is building out its network infrastructure, then delays and increased costs in the expansion of the Company's network infrastructure could result, having an adverse effect on operating results.
3. RESTRICTED CASH
In 1998, the Company entered into an agreement with a financial institution (the 'Institution') whereby the Institution provided credit card processing and payment services to the Company. As a requirement of performing the services, the Institution required that the Company pay for such services and maintain an amount on deposit with the Institution equal to 10% of the total dollar amount of credit card receipts processed by the Institution on behalf of the Company over the course of the immediately preceding six months. Any amounts exceeding the 10% threshold described above were deposited in the Company's operating bank account. The Institution reserves the right to use the deposit as its first recourse to offset any losses it may incur due to the inability of the Company to perform services where payment was received in advance from customers, and where the Institution might be held liable by the customer or another financial institution under the terms of the credit card agreements with such customers or financial institutions. As of December 31, 1998 the total amounts held on reserve by the Institution were approximately $327,000.
4. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
5. NOTE PAYABLE TO FORMER STOCKHOLDER
In September 1998, the Company entered into an agreement with a stockholder whereby the Company agreed to repurchase all of the outstanding shares held by the stockholder for $1,075,000. A note payable to the stockholder, in the amount of $1,075,000, bearing an annual interest rate of 7%, was issued by the Company at September 30, 1998, in exchange for the 340,190 shares held by the stockholder. The fair value of the shares repurchased was established based on an bona fide offer to purchase all the outstanding shares of the Company by another entity for approximately $15,800,000. This offer was rejected by the Company.
JPS.NET CORPORATION
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
5. NOTE PAYABLE TO FORMER STOCKHOLDER--(CONTINUED)
In accordance with Accounting Research Bulletin 43, the Company chose to allocate the purchase price of the stock between common stock and retained deficit. As a result, as of September 30, 1998, common stock was reduced by $909 or $0.0027 per share, based on the price paid by the stockholder at time of purchase. The remainder, or $1,074,091, was allocated to retained deficit.
Scheduled payments of principal on the note payable for the next five years are as follows:
6. LEASE COMMITMENTS
The Company leases office space and various office and computer equipment under noncancelable operating lease agreements. The leases generally provide for renewal terms. Rent expense for the period January 31, 1997 (inception) to December 31, 1997, the year ended December 31, 1998, and the three months ended March 31, 1999, was approximately $78,000, $233,000, and $136,000, respectively.
Minimum future lease payments under operating leases are summarized as follows:
7. INCOME TAXES
The tax effects of temporary differences that give rise to significant portions of potential deferred tax assets and deferred tax liabilities are presented below:
The Company is in a net deferred tax asset position at 1998 (before the consideration of a valuation allowance). However, in light of the Company's history of operating losses, the Company has established a valuation reserve for the entire amount of the net deferred tax assets.
JPS.NET CORPORATION
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
7. INCOME TAXES--(CONTINUED)
The income tax provisions for Federal and state income taxes for the period from January 31, 1997 (inception) to December 31, 1997, the year ended December 31, 1998, and for the three months ended March 31, 1999 are zero.
Due to aforementioned uncertainties concerning the Company's ability to realize its deferred tax assets, the Company has not recognized any income tax benefit on the statements of operations.
The pro forma income tax information included in the statements of operations and Note 7 is presented in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, as if the Company had been subject to Federal and certain state income taxes.
Effective Rate Reconciliation
8. RELATED PARTY TRANSACTIONS
The Company had notes receivable from related parties which totaled $292,101 as of December 31, 1998. The first note receivable amounted to $163,438 as of December 31, 1998, and relates to a line of credit to a stockholder approved by the Company. The line of credit may not exceed $300,000. The note is payable on demand and accrues interest at a rate of 5% annually on unpaid balances. The second note receivable amounted to $116,112 as of December 31, 1998, and relates to a loan made by the Company to a former stockholder. The note is payable on demand and accrues interest at a rate of 7% annually on unpaid balances. A third note receivable amounted to $12,551 as of December 31, 1998 and reflects to a loan made by the Company to a related company. The note is payable on demand and accrues interest at a rate of 5% annually on unpaid balances.
The Company had two notes payable which it assumed on behalf of a related party and which amounted to $19,139 at December 31, 1997. The first note payable amounted to $8,396 as of December 31, 1997, and related to a loan by an acquaintance of a stockholder of the Company, which was assumed by the Company upon its incorporation. The note was paid off in full in 1998. The second note payable, which amounted to $10,743 at December 31, 1997, related to a loan by a relative of a stockholder of the Company, which was assumed by the Company upon its incorporation. The note was paid off in full in 1998.
9. LITIGATION
The Company is involved in litigation arising in the ordinary course of business. After consultation with legal counsel, management anticipates that these matters will be resolved without material adverse effect on the Company's financial position.
10. PENDING TRANSACTION
The Company and its stockholders have entered into an agreement whereby the stockholders will sell their stock in the Company to OneMain.com, Inc. ('OneMain.com'). The Company's stockholders will exchange their stock in the Company for cash and shares of common stock of OneMain.com concurrently
JPS.NET CORPORATION
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
10. PENDING TRANSACTION--(CONTINUED)
with the consummation of the initial public offering of the common stock of OneMain.com. Additionally, the Company's stockholders will be given additional consideration, contingent upon certain operational and earnings margin requirements, which shall be equal to one-half of the difference between total revenue for the Company for the 12 months ended September 30, 1999 and the revenues for the Company for the period from June 1, 1998 through September 30, 1998 multiplied by four. The amount of the additional consideration will be payable in either cash or stock, at the option of OneMain.com. Upon consummation of the acquisition, OneMain.com will become the sole stockholder of the Company.
The related party transactions as described in Note 8 will be amended upon consummation of the acquisition discussed above so that all continuing obligations will be similar to terms and conditions of agreements/arrangements with unaffiliated third parties.
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders of TGF Technologies, Inc.
We have audited the statements of operations, changes in stockholders' equity (deficit), and cash flows of TGF Technologies, Inc. for the three months ended March 31, 1999. 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 results of operations and cash flows of TGF Technologies, Inc. for the three months ended March 31, 1999, in conformity with accounting principles generally accepted in the United States.
/s/ ERNST & YOUNG LLP
McLean, Virginia May 13, 1999
INDEPENDENT AUDITORS' REPORT
The Stockholders and Board of Directors TGF Technologies, Inc.
We have audited the accompanying balance sheet of TGF Technologies, Inc. as of December 31, 1998, and the related statements of operations, changes in stockholders' equity (deficit) and cash flows for each of the years in the two-year period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of TGF Technologies, Inc. as of December 31, 1998, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 1998 in conformity with generally accepted accounting principles.
/s/ KPMG LLP
Burlington, Vermont February 6, 1999
TGF TECHNOLOGIES, INC. BALANCE SHEET
See accompanying notes.
TGF TECHNOLOGIES, INC. STATEMENTS OF OPERATIONS
See accompanying notes.
TGF TECHNOLOGIES, INC. STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
See accompanying notes.
TGF TECHNOLOGIES, INC. STATEMENTS OF CASH FLOWS
See accompanying notes.
TGF TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS
TGF Technologies, Inc. (the 'Company') or ('TGF') was incorporated in Vermont on May 9, 1994 and commenced operations in November 1994. The stock of the Company is owned by NWST Corporation and Together Foundation for Global Unity (the 'Foundation'). The Company is a regional provider of Internet access and offers a broad spectrum of Internet access services to both individual and business customers ranging from dial-up services to continuous access services using dedicated telephone connections and Web hosting services. The principal market areas are Vermont, Central New Hampshire, Eastern New York and to a lesser extent, Southeastern Quebec.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
(B) REVENUE RECOGNITION AND CUSTOMER DEPOSITS
The Company recognizes revenue when services are provided. Services are generally billed one month in advance. Advance billings are recorded as deferred revenue and recognized as revenue when earned. Collections relating to future access services are recorded as customer deposits.
(C) BARTERED SERVICES
The Company participates in bartered services transactions with certain media organizations. In exchange for free Internet service from the Company, these organizations provide advertising services to the Company. The Company also provides Internet access to various local organizations at no charge. These transactions are recognized by the Company as Internet access revenues and marketing expense in equal amounts at the fair value of Internet access services provided by the Company. The Company has recognized bartered services transactions in the amount of $63,720, $93,480, and $24,616 in 1997, 1998, and the three months ended March 31, 1999, respectively.
(D) CASH AND CASH EQUIVALENTS
For purposes of the statement of cash flows, the Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents.
(E) PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Depreciation is provided for using the straight-line method over the estimated useful lives of the assets for property and equipment acquired after January 1, 1996. Property and equipment acquired prior to January 1, 1996 are depreciated using the double declining balance method. The estimated useful lives of the assets range from three (3) to seven (7) years. The Company leases certain of its data communications and other equipment under capital lease agreements. The assets and liabilities under capital leases are recorded at the lesser of the present value of aggregate future minimum lease payments or the fair value of the assets under the lease. Assets under capital lease are depreciated over their estimated useful lives or the lease term as applicable.
TGF TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
(F) INCOME TAXES
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statements carrying amounts of existing assets and liabilities and their respective tax bases and operating loss carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
(G) FOREIGN CURRENCY
The Company transacts some of its business in Canadian dollars. This activity has been remeasured into the Company's functional currency (U.S. dollars) as of year end. Foreign exchange gain or loss is recorded as a component of general and administrative expense, and was not material in 1998 and the three months ended March 31, 1999.
(H) ADVERTISING COSTS
The Company incurs advertising costs associated with the marketing of its services. These costs of advertising are expensed either as incurred or the first time the advertising takes place, depending on the nature of expense. Advertising expense, including advertising expense related to bartered transactions, totaled $199,065, $157,196, and $38,714 for the years ended December 31, 1997 and 1998, and the three months ended March 31, 1999, respectively.
(I) IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF
The Company reviews the recoverability of long-lived assets whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. If the expected future cash flows from the use of such assets (undiscounted and without interest charges) are less than the carrying value, the Company's policy is to record a write-down that is determined based on the difference between the carrying value of the asset and its estimated fair value.
(J) FAIR VALUE OF FINANCIAL INSTRUMENTS AND CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and accounts receivable. The cash is held by a high credit quality financial institution. For accounts receivable, the Company performs ongoing credit evaluations of its customers' financial condition and generally does not require collateral. The concentration of credit risk is mitigated by the large customer base.
The Company relies on local telephone companies and other companies to provide data communications. Although management feels alternative telecommunication facilities could be found in a timely manner, any disruption of these services could have an adverse effect on operating results.
The carrying value of short-term financial instruments, including cash and cash equivalents, trade accounts receivable and payable and certain accrued liabilities, approximates their carrying amounts in the financial statements due to the short maturity of such instruments. The carrying amount of note payable- related party approximates its fair value based on the Company's ability to obtain borrowings with similar terms from a related party.
TGF TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
(K) RECENT PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130 ('SFAS 130'), Comprehensive Income which is required to be adopted in the year ended December 31, 1998. SFAS 130 requires that an enterprise (a) classify items of other comprehensive income by their nature in the financial statements, and (b) display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the Statement of Stockholders' Equity. The adoption of SFAS 130 did not have any effect on the Company's financial statements as the Company does not have any elements of comprehensive income.
In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131 ('SFAS 131'), Disclosures about Segments of an Enterprise and Related Information, which is required to be adopted for the year ended December 31, 1998. SFAS 131 changes the way public companies report segment information in annual financial statements and also requires those companies to report selected segment information in interim financial reports to stockholders. Because the Company has only one reportable segment, the additional disclosures for segment information on the financial statements are not required.
In March 1998, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position 98-1 ('SOP 98-1') Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. The SOP requires that certain costs related to the development or purchase of internal-use software be capitalized and amortized over the estimated useful life of the software. SOP 98-1 is effective for financial statements issued for fiscal years beginning after December 15, 1998. TGF adopted the SOP early as of January 1, 1998. There was no significant impact on the Company's financial statements upon adoption of this pronouncement.
Commitments
In order to provide local access numbers to its current subscriber base, the Company must enter into agreements with various providers to provide telecommunications lines. The terms of the agreements vary in length but generally do not exceed five years. In the event TGF no longer required the service of these telecommunications lines the Company would be liable for termination fees levied by such providers.
3. LEASES
The Company leases certain equipment under capital lease agreements that expire at various dates through December 2002. At December 31, 1998, the gross amount of equipment and related accumulated amortization recorded under capital leases were as follows:
Amortization of assets held under capital lease is included with depreciation expense.
The Company also has several operating leases, primarily for office space and office equipment, with expiration dates through October 2001. Rental expense for operating leases for the years ended 1997 and 1998, and for the three months ended March 31, 1999 was $88,514, $143,835, and $42,703, respectively.
TGF TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
3. LEASES--(CONTINUED)
Future minimum lease payments under capital and operating leases as of December 31, 1998 are as follows:
4. RELATED PARTY TRANSACTIONS
The Company leases office space from a company related by common ownership. The lease is an informal agreement for $1,000 a month through June 30, 1997 and $2,500 a month thereafter. Rent expense for the years ended December 31, 1997 and 1998 and the three months ended March 31, 1999 was $21,000, $30,000, and $7,500 respectively. Rent payable of $1,000 at December 31, 1998 is included in accounts payable.
The Company pays some operating expenses, such as postage, telephone and employee benefits, for the Foundation. In addition, the Company collects some cash receipts for credit card sales by the Foundation. The expenses generally exceed the cash receipts and the Foundation reimburses the Company monthly. At December 31, 1998, the Company has recorded a receivable of $5,938 from the Foundation.
The Chairperson of the Board of Directors (a related party by common stock ownership) provides financial support to the Company for operating needs. Capital contributions in the amounts of $530,000 was contributed by this related party to TGF during 1998. During 1998 the Company borrowed $250,000 from the Chairperson. The note is non-interest bearing, unsecured and due on demand.
TGF TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
5. INCOME TAXES
The tax effect of temporary differences that give rise to significant portions of the deferred tax assets at December 31, 1998 are presented below:
The Company has provided a valuation allowance for net deferred tax assets since realization of these benefits cannot be reasonably assured.
At December 31, 1998, the Company has net operating loss carryforwards of approximately $2,200,000 which may be used to offset future taxable income. The loss carryforwards expire in the years 2009 through 2013.
Income tax provision was comprised of the following: