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Digitalconvergence Com Inc – IPO: ‘S-1’ on 4/28/00

On:  Friday, 4/28/00, at 4:56pm ET   ·   Accession #:  912057-0-20438   ·   File #:  333-35906

Previous ‘S-1’:  None   ·   Next:  ‘S-1/A’ on 9/26/00   ·   Latest:  ‘S-1/A’ on 11/13/00

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  As Of                Filer                Filing    For·On·As Docs:Size              Issuer               Agent

 4/28/00  Digitalconvergence Com Inc        S-1                   31:1.0M                                   Merrill Corp/FA

Initial Public Offering (IPO):  Registration Statement (General Form)   —   Form S-1
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: S-1         Registration Statement (General Form)                145    640K 
 2: EX-2.1-1    Plan of Acquisition, Reorganization, Arrangement,      6     26K 
                          Liquidation or Succession                              
 3: EX-2.1-2    Plan of Acquisition, Reorganization, Arrangement,      1     11K 
                          Liquidation or Succession                              
 4: EX-3.1      Articles of Incorporation/Organization or By-Laws     12     40K 
 5: EX-3.2      Articles of Incorporation/Organization or By-Laws     18     72K 
 6: EX-4.2      Instrument Defining the Rights of Security Holders    13     49K 
 7: EX-4.3      Instrument Defining the Rights of Security Holders    15     52K 
 8: EX-4.4      Instrument Defining the Rights of Security Holders    15     53K 
 9: EX-10.1     Material Contract                                      9     35K 
18: EX-10.13    Material Contract                                      4     27K 
19: EX-10.14    Material Contract                                      5     31K 
20: EX-10.15    Material Contract                                      5     31K 
21: EX-10.16    Material Contract                                      5     31K 
22: EX-10.17    Material Contract                                     11     50K 
23: EX-10.18-1  Material Contract                                     20     85K 
10: EX-10.2     Material Contract                                      9     36K 
24: EX-10.20    Material Contract                                     10     40K 
25: EX-10.21    Material Contract                                      4     27K 
26: EX-10.22    Material Contract                                     24    106K 
27: EX-10.23    Material Contract                                      7     40K 
28: EX-10.24    Material Contract                                     11     45K 
11: EX-10.3-1   Material Contract                                      8     38K 
12: EX-10.3-2   Material Contract                                      1     11K 
13: EX-10.4     Material Contract                                      9     37K 
14: EX-10.5     Material Contract                                      8     34K 
15: EX-10.6     Material Contract                                      9     36K 
16: EX-10.8-1   Material Contract                                     20     90K 
17: EX-10.8-2   Material Contract                                      3     18K 
29: EX-21.1     Subsidiaries of the Registrant                         1      9K 
30: EX-23.1     Consent of Experts or Counsel                          1     10K 
31: EX-27.1     Financial Data Schedule (Pre-XBRL)                     2     13K 


S-1   —   Registration Statement (General Form)
Document Table of Contents

Page (sequential) | (alphabetic) Top
 
11st Page   -   Filing Submission
"Patrick V. Stark
5Common Stock
7Summary
10The Virtual Network
12The Offering
15Risk Factors
28Forward-Looking Statements
29Use of Proceeds
30Dividend Policy
31Capitalization
32Dilution
34Selected Consolidated Financial Data
35Management's Discussion and Analysis of Financial Condition and Results of Operations
38Revenues
39Production and media costs
"Depreciation and amortization
"Research and development
"Interest income
"Interest expense
40Liquidity and Capital Resources
43Business
54Strategic Relationships
"Belo Corp
"National Broadcasting Company, Inc
58Competition
59Legal Proceedings
60Management
"Directors and Executive Officers
65Employment Agreements
"Michael N. Garin
"Scott P. Carlin
67Certain Relationships and Related Transactions
69Young & Rubicam, Inc
72Security Ownership of Principal Stockholders and Management
74Description of Capital Stock
75Registration Rights
80Shares Eligible for Future Sale
82Certain U.S. Federal Tax Considerations for Non-United States Holders of Common Stock
"Dividends
84Estate Tax
85Underwriting
89Legal Matters
"Experts
"Where You Can Find More Information
90Index to Financial Statements
91Report of Independent Accountants
92Assets
93Consolidated Statement of Operations for the year ended December 31, 1999
94Total
95Consolidated Statement of Cash Flows for the year ended December 31, 1999
96Notes to Consolidated Financial Statements
"Cash and cash equivalents
112Statements of Operations for the years ended December 31, 1997 and 1998
113Statements of Changes in Stockholder's Deficit for the years ended December 31, 1997 and 1998
114Statements of Cash Flows for the years ended December 31, 1997 and 1998
115Notes to Financial Statements
"Property and equipment
132Item 13. Other Expenses of Issuance and Distribution
"Item 14. Indemnification of Directors and Officers
133Item 15. Recent Sales of Unregistered Securities
135Item 16. Exhibits and Financial Statement Schedules
137Item 17. Undertakings
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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON APRIL , 2000 REGISTRATION NO. 333- -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------------ FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ------------------------------ DIGITALCONVERGENCE.:COM INC. (Exact Name of Registrant as Specified in its Charter) [Download Table] DELAWARE 7373 75-2791929 (State or Other Jurisdiction (Primary Standard (I.R.S. Employer of Industrial Identification No.) Incorporation or Organization) Classification Code Number) [Enlarge/Download Table] PATRICK V. STARK EXECUTIVE VICE PRESIDENT 9101 N. CENTRAL EXPRESSWAY DIGITALCONVERGENCE.:COM INC. 6TH FLOOR 9101 N. CENTRAL EXPRESSWAY DALLAS, TEXAS 75231 6TH FLOOR (214) 292-6000 DALLAS, TEXAS 75231 (Address, Including Zip Code, and Telephone Number, (214) 292-6000 including (Name, Address, Including Zip Code, and Telephone Number, Area Code, of Registrant's Principal Executive Offices) Including Area Code, of Agent For Service) ------------------------------ COPIES OF ALL COMMUNICATIONS TO: [Download Table] MARK EARLY DENNIS J. FRIEDMAN P. GREGORY HIDALGO CLAUDE S. SERFILIPPI VINSON & ELKINS L.L.P. CHADBOURNE & PARKE LLP 2001 ROSS AVENUE, SUITE 3700 30 ROCKEFELLER PLAZA DALLAS, TEXAS 75201 NEW YORK, NEW YORK 10112 TELEPHONE: (214) 220-7700 TELEPHONE: (212) 408-5100 FACSIMILE: (214) 220-7716 FACSIMILE: (212) 541-5369 ------------------------------ APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: AS SOON AS PRACTICABLE AFTER THIS REGISTRATION STATEMENT BECOMES EFFECTIVE. ------------------------------ If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933 check the following box. / / If this Form is filed to register additional securities for an offering pursuant to Rule 426(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. / / If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. / / If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. / / If delivery of the prospectus is expected to be made pursuant to rule 434, please check the following box. / / ------------------------------ CALCULATION OF REGISTRATION FEE [Enlarge/Download Table] TITLE OF EACH CLASS OF SECURITIES PROPOSED MAXIMUM AMOUNT OF TO BE REGISTERED AGGREGATE OFFERING PRICE (1) REGISTRATION FEE Common Stock, $0.01 par value......... $100,000,000 $26,400 (1) Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(o) under the Securities Act of 1933. ------------------------------ THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a), MAY DETERMINE. -------------------------------------------------------------------------------- --------------------------------------------------------------------------------
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[inside front cover page of the prospectus] The prospectus has been Internet Enhanced. The inside cover of this prospectus will contain photographs of consumer products and excerpts from selected magazines and newspapers, including exposed bar codes. Potential investors will be able to access the related website either by using our :Cue:C.A.T. device to swipe the code or by typing the related URL address.
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EXPLANATORY NOTE This registration statement contains two forms of prospectus: one (the "U.S. Prospectus") to be used in connection with an offering in the U.S. and Canada (the "U.S. Offering") of Common Stock of DigitalConvergence.:Com Inc. (the "Company") (which includes Common Stock subject to the U.S. Underwriters' over-allotment option) and one (the "International Prospectus") to be used in connection with a concurrent international offering outside the U.S. and Canada (together with the U.S. Offering, the "Offerings") of Common Stock of the Company (which includes Common Stock subject to the International Managers' over-allotment option). The U.S. Prospectus and the International Prospectus will be identical in all respects except for the front cover and back cover pages of the prospectuses and the information under the caption "Underwriting." The form of the U.S. Prospectus is included herein and is followed by those pages to be used in the International Prospectus that differ from those in the U.S. Prospectus. Each of the pages to be used in the International Prospectus included herein is labeled "Alternative Page for International Prospectus." Final forms of such prospectuses will be filed with the Securities and Exchange Commission pursuant to Rule 424(b).
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SUBJECT TO COMPLETION PRELIMINARY PROSPECTUS DATED , 2000 THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
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PROSPECTUS SHARES [LOGO] COMMON STOCK ------------------ This is DigitalConvergence.:Com Inc.'s initial public offering of common stock. DigitalConvergence.:Com Inc. is selling all of the shares in this offering. The U.S. underwriters are offering shares in the U.S. and Canada and the international managers are offering shares outside the U.S. and Canada. We expect the public offering price to be between $ and $ per share. Currently, no public market exists for the shares. After pricing of the offering, we expect that the shares will be quoted on the Nasdaq National Market under the symbol "DGTL." INVESTING IN THE COMMON STOCK INVOLVES RISKS THAT ARE DESCRIBED IN THE "RISK FACTORS" SECTION BEGINNING ON PAGE 9 OF THIS PROSPECTUS. --------------------- [Download Table] PER SHARE TOTAL --------- ----- Public offering price.................................... $ $ Underwriting discount.................................... $ $ Proceeds, before expenses, to DigitalConvergence.:Com Inc........................................................ $ $ The U.S. underwriters may also purchase up to an additional shares from DigitalConvergence.:Com Inc. at the public offering price, less the underwriting discount, within 30 days from the date of this prospectus to cover over-allotments. The international managers may similarly purchase up to an additional shares from DigitalConvergence.:Com Inc. Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. The shares of common stock will be ready for delivery on or about , 2000. ------------------------ JOINT BOOK-RUNNING MANAGERS MERRILL LYNCH & CO. ING BARINGS ---------------- BANC OF AMERICA SECURITIES LLC BEAR, STEARNS & CO. INC. ---------------- The date of this prospectus is , 2000
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TABLE OF CONTENTS [Download Table] PAGE -------- Summary..................................................... 1 Risk Factors................................................ 9 Forward-Looking Statements.................................. 22 Use of Proceeds............................................. 23 Dividend Policy............................................. 24 Capitalization.............................................. 25 Dilution.................................................... 26 Selected Consolidated Financial Data........................ 28 Management's Discussion and Analysis of Financial Condition and Results of Operations................................. 29 Business.................................................... 37 Management.................................................. 54 Certain Relationships and Related Transactions.............. 61 Security Ownership of Principal Stockholders and Management................................................ 66 Description of Capital Stock................................ 68 Shares Eligible for Future Sale............................. 74 Certain U.S. Federal Tax Considerations for Non-United States Holders of Common Stock............................ 76 Underwriting................................................ 79 Legal Matters............................................... 83 Experts..................................................... 83 Where You Can Find More Information......................... 83 Index to Financial Statements............................... F-1 ------------------------ You should rely only on the information contained in this prospectus. We have not, and the underwriters have not, authorized any other person to provide you with different information. If anyone provides you with different or inconsistent information, you should not rely on it. We are not, and the underwriters are not, making an offer to sell these securities in any jurisdiction where the offer or sale is not permitted. You should assume that the information appearing in this prospectus is accurate as of the date on the front cover of this prospectus only. Our business, financial condition, results of operations and prospects may have changed since that date. ii
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SUMMARY THIS SUMMARY HIGHLIGHTS INFORMATION CONTAINED ELSEWHERE IN THIS PROSPECTUS. THIS SUMMARY IS NOT COMPLETE AND MAY NOT CONTAIN ALL OF THE INFORMATION THAT YOU SHOULD CONSIDER BEFORE INVESTING IN OUR COMMON STOCK. YOU SHOULD READ THE ENTIRE PROSPECTUS CAREFULLY, INCLUDING THE "RISK FACTORS" AND THE CONSOLIDATED FINANCIAL STATEMENTS AND THE NOTES TO THOSE CONSOLIDATED FINANCIAL STATEMENTS APPEARING ELSEWHERE IN THIS PROSPECTUS. UNLESS THE CONTEXT OTHERWISE REQUIRES, REFERENCES IN THIS PROSPECTUS TO "DIGITALCONVERGENCE.:COM," "DIGITALCONVERGENCE," "DIGITAL," "US," "WE" OR "OUR" REFER TO DIGITALCONVERGENCE.:COM INC.-TM- AND ITS SUBSIDIARIES AND THE TERM "YOU" REFERS TO A PROSPECTIVE INVESTOR. UNLESS WE INDICATE OTHERWISE, ALL INFORMATION IN THIS PROSPECTUS ASSUMES NO EXERCISE OF THE OVER-ALLOTMENT OPTIONS GRANTED TO THE U.S. UNDERWRITERS AND INTERNATIONAL MANAGERS, ASSUMES THE CONVERSION INTO COMMON STOCK OF EACH OUTSTANDING SHARE OF OUR PREFERRED STOCK AND GIVES EFFECT TO A FOR ONE STOCK SPLIT OF OUR OUTSTANDING SHARES OF COMMON STOCK TO BE COMPLETED PRIOR TO THE COMPLETION OF THIS OFFERING. DIGITALCONVERGENCE.:COM INC. We are a company whose technology allows media companies, manufacturers and virtually all organizations to instantly and easily link their products with web pages deep within their websites. Until we release our technology, we believe that it is not possible for these companies to realize the full value of their Internet efforts, because their websites have to be entered through their front pages, often making access to a desired web page time-consuming and difficult. Our :C.R.Q.-TM- software will send an Internet user's web browser to a specific web page in response to our proprietary digital signal called a ":Cue-SM-" transmitted by a television broadcast. Our :C.R.Q. software will also send an Internet user's web browser to a specific web page when an Internet user utilizes our :Cue:C.A.T.-TM- device to scan our proprietary codes called "Print :Cues" on print media or to scan existing bar codes on consumer products. We believe that our technology will empower media companies and corporate advertisers to enhance their content and to transform television broadcasts or other electronic media, print media or items bearing Print :Cues or bar codes into powerful new advertising, promotional or e-commerce opportunities. Our technology will be free to the public and will allow Internet users to quickly and easily obtain relevant information and conduct e-commerce activities by eliminating the input of lengthy website addresses and time-intensive web navigation. We intend to initiate a nationwide roll-out of our technology in September 2000 and plan to distribute, free to the public, at least 50 million CD-ROMs containing our :C.R.Q. software and 50 million :Cue:C.A.T. devices by the end of 2001. To assist in the promotion, marketing and deployment of our technology, we have established several strategic media, advertising and distribution partnerships. We expect that our strategic partners will provide promotional support and distribution capabilities to help build consumer awareness and adoption of our technology and products. Our media partners include National Broadcasting Company, Inc., Belo Corp., Forbes Inc., The Milwaukee Journal and Wired Magazine. These partners have agreed to implement our technology in television and cable networks, local television broadcasts and print publications. Forbes Inc., The Milwaukee Journal and Wired Magazine have also agreed to distribute our products to their subscribers. We expect that these relationships, taken together, will provide us with broad media exposure in six of the top ten U.S. media markets and a number of smaller markets, for total coverage of approximately 40% of U.S. households. In addition, we are in discussions with broadcast media companies covering approximately an additional 20% of U.S. households to also implement our technology in their television broadcasts. Additionally, we have partnered with Tandy Corporation to produce our :Cue:C.A.T. devices and make them available, free to consumers, in over 7,000 RadioShack retail outlets throughout the U.S. In addition, Tandy has invested in us. Other companies that have made investments in us include Young & Rubicam, Inc., Belo Corp., The Coca-Cola Company, The E.W. Scripps Company and Spielberg/Katz Associates, LLC. 1
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MARKET OPPORTUNITY Companies are investing billions of dollars in the development, execution and promotion of Internet strategies. The growth in both the number of Internet users and the volume of e-commerce creates significant challenges and opportunities for businesses across multiple industries. We believe that our technology will provide powerful solutions for a number of these companies and will provide a means to create new revenue opportunities. To quickly establish our technology on a broad scale, we have targeted the following significant opportunities: - BROADCAST AND CABLE MEDIA. In 1998, $47 billion was spent on television advertising and $91 billion on goods and services purchased through direct response television programming. - PRINT MEDIA. In 1998, the following amounts were spent in the following print media segments: - $87 billion on goods purchased from print catalogs; - $40 billion on direct mail advertising; - $44 billion on newspaper display and classified advertising; and - $14 billion on advertising in trade and consumer magazines. - CODED CONSUMER PRODUCTS. There are tens of millions of active bar codes that are widely used in labeling consumer products in the U.S. Until now, no widely-adopted technology has emerged that allows a manufacturer to leverage these codes to link to relevant sites on the Internet. While the growth of the Internet has attracted Internet users at an unprecedented pace, the volume of online information has made it increasingly difficult for users to navigate the Internet effectively and efficiently. Major corporate websites contain many layers of web pages, which often make finding relevant information a frustrating and time-consuming experience. As websites continue to proliferate and grow in size and complexity, we believe that users will increasingly need a quicker, more direct link to their intended destinations. Search engines will continue to have useful applications on the Internet, but we believe that users want a more precise tool that takes them directly to a specific web page deep within a website. THE DIGITALCONVERGENCE.:COM SOLUTION We believe that our technology will provide the solution to the desire of broadcasters, publishers, merchants and advertisers for a simple, cost-effective means of leveraging the Internet across all forms of traditional media. In addition, our technology also addresses the needs of Internet users for a more satisfying Internet experience. Elements of our solution include Internet Enhanced-TM- broadcasting, print and coded products, and our Virtual Network, an "L"-shaped area containing banner advertisements and related information that will appear on the border of the user's web browser when using our technology. INTERNET ENHANCED BROADCASTING A broadcast can be linked to a website, or Internet Enhanced, by simply embedding a :Cue in the broadcast. Unlike current television content and advertisements in which a website address is briefly displayed on the television screen, Internet Enhanced programming will load the web page on a user's web browser for immediate access or store the web page address for later use. With our technology, viewers will no longer need to recall and manually enter a website address. By embedding :Cues in programming, our technology provides broadcasters and advertisers with a powerful new tool to supplement existing content and advertisements, which we believe will drive viewers to selected websites, increase advertising revenue and generate additional e-commerce opportunities. Accordingly, our technology will offer a platform for broadcasters to enhance content and advertisers to deliver immediate buying opportunities to their target consumers. As a result, we believe broadcasters will be able to command premium rates for Internet Enhanced advertisements. 2
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For example, our technology could be used in the following ways: - A local television station differentiates its newscast with Internet Enhanced weather reporting. While reporting the weather, the station broadcasts a :Cue that directs the viewer's web browser to the broadcaster's web page that includes detailed forecast information for each city and town in the viewing area. - An automobile company inserts a :Cue in a television advertisement, which launches an Internet user's web browser to a web page designated by the company. This enables the automobile company to provide more detailed information on its web page than can be presented in the advertisement, including specific information on an automobile's features and pricing, local dealerships and immediate e-commerce opportunities. We intend to generate our broadcast revenue from: - fees from the sale of advertising :Cues to broadcast networks, cable networks and local television stations; - a fixed fee per sale completed by home shopping networks as a result of using our :Cues; and - fees from annual licenses to cable networks for the use of :Cues in content. INTERNET ENHANCED PRINT Our :Cue:C.A.T. device will enable an Internet user to scan our Print :Cues to link the user to a particular web page designated by the publisher or corporate advertiser. With the swipe of a :Cue:C.A.T. device, users will be immediately directed to more detailed information impractical to include in print copy. Through the use of Internet Enhanced print content, publishers will be able to drive readers deep in their websites for more detailed information. In addition, print advertisers will have the ability to create Internet Enhanced advertisements that place the consumer one swipe away from an e-commerce opportunity. For example, a computer company can insert a Print :Cue in a newspaper or magazine advertisement, which launches an Internet user's web browser to a web page designated by the company. Internet Enhanced print advertising provides the user with immediate access to more specific information on the computer's features, pricing and special promotions and provides the computer company with immediate e-commerce opportunities. We intend to generate our print revenue from: - fees from licenses to publishers for the use of Print :Cues for content enhancement purposes; - fees from the sale of any advertising Print :Cues in almost any print media, including newspapers and magazines; - a fixed fee per sale completed by catalog shoppers as a result of using our Print :Cues; and - commissions on increased revenues resulting from the use of Print :Cues in classified ads. INTERNET ENHANCED PRODUCTS AND OTHER :CUE:C.A.T. APPLICATIONS We are completing a massive database that links existing bar codes, including UPC, ISBN, EAN and other codes, to websites, thereby enabling manufacturers to utilize their existing product codes for advertising and other marketing purposes. Our technology will enable a user of the :Cue:C.A.T. device to scan the bar code on a product, linking the user to a specified web page. For example, a prescription drug bottle from a pharmacy can include a bar code that directs the recipient's web browser to the drug manufacturer's website containing information regarding the illness for which the drug was prescribed, side effects of the drug, and additional products that may be useful in treating the illness. Because our :Cue:C.A.T. technology scans substantially all bar codes and will not require consumer 3
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goods manufacturers to alter labels in any way, our solution is an inexpensive and unobtrusive way of turning an existing label into a powerful new marketing tool. In addition, our Print :Cues can be placed on credit cards and other physical objects that are not normally assigned bar codes. In sum, our technology allows any product to become Internet Enhanced. We intend to generate our enhanced product revenue from: - annual fees for bar codes on consumer products that are Internet Enhanced; - fees per Print :Cue sold to publishers of free-standing inserts and direct mail, and sold to manufacturers for use in product manuals; and - annual fees for Print :Cues used on credit card statements. THE VIRTUAL NETWORK Each time our :C.R.Q. software or :Cue:C.A.T. device directs a user's web browser to a specific web page, an "L"-shaped area called the "Virtual Network" will appear on the border of the user's Internet web browser. The Virtual Network will be populated with banner advertisements and a series of tabs that, when clicked, will display information related to the website being viewed. The Virtual Network is only visible when an individual is using our technology. Banner advertisements and tabs will be customized to each user's profile, displaying information and promotional offers designed to appeal to the individual's interests. We believe that our Virtual Network, through modest usage of our :C.R.Q. and :Cue:C.A.T. technology, will generate a significant number of ad impressions and click-throughs to our advertisers' websites. We intend to generate revenues from the sale of sponsorships and banner advertisements on our Virtual Network. STRATEGY Our objective is to establish our technology as the primary means for television and cable networks, local television broadcasters, newspaper, magazine and catalog publishers, other mass media companies, as well as corporate advertisers, to link their broadcasts, publications and products to the Internet. To achieve this objective, we have adopted the following strategies: - leverage media relationships in order to support adoption and sustain our first mover advantage; - execute a nationwide roll-out of our :C.R.Q. and :Cue:C.A.T. technology; - establish our technology as the "system standard" on personal computers; - develop multiple revenue streams from multi-billion dollar advertising markets; - develop sophisticated research and data-mining capabilities as a value-added service to customers; and - pursue international markets. RECENT DEVELOPMENTS PREFERRED STOCK FINANCINGS In April 2000, we issued 5,929,364 shares of Series B preferred stock and 5,372,593 shares of Series C preferred stock to various investors, including Belo Corp., The Coca-Cola Company, The E.W. Scripps Company, Spielberg/Katz Associates, LLC, Tandy Corporation and Young & Rubicam, Inc., for aggregate consideration of $98.3 million. All outstanding shares of our preferred stock will be automatically converted into our common stock upon completion of this offering. 4
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In April 2000, we issued two warrants to an affiliate of National Broadcasting Company, Inc. to purchase 3,752,445 shares and 4,505,165 shares, respectively, of our common stock at per share exercise prices of $5.00 and $10.54, respectively. We are required to issue additional warrants to National Broadcasting Company, Inc.'s affiliate with a per share exercise price of $10.54, depending on the number of shares we reserve for issuance under our 1999 Stock Option Plan. The warrants will terminate in April 2005. OTHER INFORMATION We were incorporated in Delaware in September 1998 and began operations in January 1999. Our executive offices are located at 9101 N. Central Expressway, 6th Floor, Dallas, Texas 75231, and our telephone number is (214) 292-6000. Information contained on any website to which you are directed by this prospectus does not constitute part of this prospectus. 5
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THE OFFERING [Enlarge/Download Table] Common stock offered by DigitalConvergence.:Com U.S. offering................................ shares International offering....................... shares Total...................................... shares Common stock outstanding after the offering.... shares(1) Use of proceeds................................ We estimate that our net proceeds from this offering without exercise of over-allotment options will be approximately $ million. We intend to use these net proceeds: - to pay expenses related to the manufacture and distribution of our :C.R.Q. CD-ROMs and :Cue:C.A.T. devices; - to market and promote the adoption of our technology by Internet users; - to purchase additional network server and support equipment; - to repay outstanding indebtedness; and - for general corporate purposes, including operating expenses, working capital and other capital expenditures. See "Use of Proceeds." Risk Factors................................... See "Risk Factors" and other information included in this prospectus for a discussion of factors that you should carefully consider before deciding to invest in our common stock. Proposed Nasdaq National Market symbol......... DGTL ------------------------ (1) Includes: - 61,113,150 shares of common stock outstanding immediately before completion of this offering; and - 21,360,537 shares of common stock that will be issued upon conversion of our preferred stock upon completion of this offering. Excludes: - 9,245,200 shares of common stock issuable upon the exercise of stock options granted by us, with exercise prices ranging from $3.31 to $9.37 per share and a weighted average exercise price of $4.17 per share, of which stock options to purchase up to shares of common stock are exercisable or will become exercisable within 60 days after the date of this prospectus; and - 8,382,350 shares of common stock issuable upon the exercise of warrants issued by us, with exercise prices ranging from $5.00 to $10.54 per share and a weighted average exercise price of $7.98 per share, of which all warrants are immediately exercisable. 6
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SUMMARY CONSOLIDATED FINANCIAL DATA The following table summarizes the consolidated statements of operations and consolidated balance sheet data for our business. In January 1999, we acquired from Infotainment Telepictures, Inc., our predecessor company for accounting purposes (the "Predecessor"), our television show NET TALK LIVE! THE INTERNET TALK SHOW and certain proprietary technology rights. We have included in this prospectus the financial statements and the notes related thereto of the Predecessor. The historical results presented below are not necessarily indicative of the results to be expected for any future period. For a more detailed explanation of this financial data, see "Selected Consolidated Financial Data," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the consolidated financial statements and the notes thereto appearing elsewhere in this prospectus. The unaudited pro forma consolidated balance sheet data gives effect to the issuance of 48 shares of our Series A preferred stock in January 2000 for cash consideration of $151,200 and the issuance of 5,929,364 shares of our Series B preferred stock and 5,372,593 shares of our Series C preferred stock in April 2000, for cash consideration of $98.3 million and also gives effect to the use of proceeds therefrom. The unaudited pro forma, as adjusted, consolidated balance sheet data gives further effect to the following: - the automatic conversion of all of our preferred stock into 21,360,537 shares of common stock upon completion of this offering; and - the sale of shares of common stock in this offering at an assumed initial public offering price of $ per share after deducting the estimated underwriting discounts and commissions and our estimated offering expenses and the application of the net proceeds as set forth under "Use of Proceeds." For an explanation of the number of shares used to compute net loss per share, see Note 2 of the notes to our consolidated financial statements and Note 2 of the Predecessor financial statements, each appearing elsewhere in this prospectus. [Enlarge/Download Table] PREDECESSOR FINANCIAL DATA YEAR ENDED DECEMBER 31, YEAR ENDED ----------------------------------------------------- DECEMBER 31, 1995 1996 1997 1998 1999 ----------- ----------- ----------- ----------- ----------- (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) CONSOLIDATED STATEMENTS OF OPERATIONS DATA: Net revenues............................... $ 97 $ 109 $ 690 $ 1,636 $ 1,543 Operating expenses: Production and media costs............... 78 137 591 939 1,012 Selling, general and administrative...... 48 91 284 671 3,921 Depreciation and amortization............ -- 17 41 55 106 Research and development................. -- -- -- 36 410 ----------- ----------- ----------- ----------- ----------- Total operating expenses............... 126 245 916 1,701 5,449 ----------- ----------- ----------- ----------- ----------- Operating loss............................. (29) (136) (226) (65) (3,906) Interest income............................ -- -- -- -- 660 Interest expense........................... (3) (14) (17) (24) (731) ----------- ----------- ----------- ----------- ----------- Net loss................................... $ (32) $ (150) $ (243) $ (89) $ (3,977) =========== =========== =========== =========== =========== Basic and diluted weighted average common shares outstanding....................... 25,000 25,000 25,000 25,000 59,507,271 Basic and diluted net loss per common share.................................... $ (1.30) $ (6.02) $ (9.72) $ (3.54) $ (0.07) =========== =========== =========== =========== =========== 7
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[Enlarge/Download Table] AS OF DECEMBER 31, 1999 ----------------------------------- PRO FORMA ACTUAL PRO FORMA AS ADJUSTED --------- --------- ----------- (IN THOUSANDS) CONSOLIDATED BALANCE SHEET DATA: Cash and cash equivalents................................... $ 45,540 $138,378 Total assets................................................ 46,518 139,356 Long-term liabilities....................................... 9,145 3,521 Convertible preferred stock subject to redemption........... 47,888 146,350 Total stockholders' equity (deficit)........................ (11,246) (11,246) 8
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RISK FACTORS THE VALUE OF AN INVESTMENT IN DIGITALCONVERGENCE.:COM WILL BE SUBJECT TO THE SIGNIFICANT RISKS INHERENT IN OUR BUSINESS. YOU SHOULD CONSIDER CAREFULLY THE RISKS AND UNCERTAINTIES DESCRIBED BELOW AND THE OTHER INFORMATION INCLUDED IN THIS PROSPECTUS BEFORE YOU DECIDE TO PURCHASE ANY SHARES OF OUR COMMON STOCK. IF ANY EVENT DESCRIBED BELOW OCCURS, WE COULD BE ADVERSELY AFFECTED IN A MATERIAL WAY. THIS COULD CAUSE THE TRADING PRICE OF OUR COMMON STOCK TO DECLINE, PERHAPS SIGNIFICANTLY. OUR LIMITED OPERATING HISTORY MAKES IT DIFFICULT FOR YOU TO EVALUATE OUR BUSINESS AND PROSPECTS. We have a limited operating history on which to base an evaluation of our business and prospects. We were formed in September 1998 and did not begin operations until January 1999. To date, our principal source of revenues has been our television show NET TALK LIVE! THE INTERNET TALK SHOW. We have not yet commercially released our :C.R.Q. and :Cue:C.A.T. technology, which we expect to be our principal source of revenues in the future. Consequently, there is little historical financial or other information on which to evaluate our business and prospects. Accordingly, you must consider our prospects in light of the risks, expenses and difficulties frequently encountered by early stage companies in new and rapidly evolving markets. WE CANNOT PREDICT WHETHER WE WILL BE SUCCESSFUL IN IMPLEMENTING OUR BUSINESS STRATEGY. Our business model is new. We cannot be certain that our business model will be successful or that we can achieve or sustain revenue growth or generate any profits. This business model is unproven and depends upon our ability to, among other things: - effectively distribute our :C.R.Q. CD-ROMs and :Cue:C.A.T. devices to millions of individual Internet users; - generate acceptance of our :C.R.Q. and :Cue:C.A.T. technology by the broadcast industry, print and media companies, leading consumer companies, manufacturers, the marketing and advertising industries and individual Internet users; - gain advertiser acceptance of our Virtual Network; - maintain our current relationships with our broadcast, publishing, manufacturing, retail and marketing partners and enter into agreements with many additional distribution and promotional partners; and - generate significant revenues through usage fees, licensing fees and advertising fees. INTERNET USERS MAY NOT ADOPT OUR TECHNOLOGY. To use our technology, Internet users must download or install our :C.R.Q. software, register as a user of our technology, connect an audio cable from the television to the computer and plug the :Cue:C.A.T. device into the computer. Internet users may be unwilling to make these efforts because of their comfort with existing habits, because of general reticence about technology or the Internet, because they find the process confusing, burdensome or time-consuming or for other reasons. OUR FAILURE TO GAIN BROAD MARKET ACCEPTANCE WOULD RESULT IN OUR BEING UNABLE TO MARKET AND SELL OUR SERVICES SUCCESSFULLY. The market for technology allowing the convergence of the Internet with virtually any form of media or product is new and rapidly evolving. As is typical for any new, rapidly developing market, demand and market acceptance for newly introduced technology, products and services are subject to a high level of uncertainty and risk. The market for our technology may develop more slowly than 9
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expected or become saturated with competitors, or our technology may not achieve or sustain mass media, market or public acceptance. In order to gain broad market acceptance, we must, among other things: - successfully implement and execute our business and marketing strategy, including the commercial release of our :C.R.Q. and :Cue:C.A.T. technology; - develop, maintain and enhance our brand recognition; - continue to develop and upgrade our technology, systems, products and services; - respond quickly and effectively to competitive developments; - generate sufficient revenue to achieve and maintain profitability; - maintain existing and establish new strategic partnerships; and - attract, retain and motivate qualified personnel. We cannot assure you that we will be successful in doing any of the foregoing or that our technology will gain broad market acceptance. Some or all of our targeted customers, which include broadcasters, publishers, manufacturers, merchants and direct marketers, may choose not to use our technology because Internet users do not adopt our technology, because the cost of implementing an Internet strategy utilizing our technology exceeds its perceived or actual benefits or for other reasons that we may not have anticipated. OUR FUTURE OPERATING RESULTS ARE UNCERTAIN AND WE ANTICIPATE SIGNIFICANT FUTURE LOSSES AND NEGATIVE CASH FLOW. To implement our business strategy, we plan to incur substantial costs to produce and distribute, free to the public, at least 50 million :C.R.Q. CD-ROMs and 50 million :Cue:C.A.T. devices by the end of 2001. These costs will be incurred before we derive significant revenues from this increased spending. Therefore, we expect significant operating and net losses and negative cash flow for the foreseeable future. We do not have sufficient cash to indefinitely sustain these operating losses. Further, we will need to generate significant revenues if we are to achieve and then maintain profitability. We cannot assure you that we will be able to do this. Our limited operating history and the rapidly evolving nature of our industry also make forecasting quarterly results difficult. Even if we do achieve profitability, we cannot be certain that we can sustain or increase profitability on a quarterly or annual basis in the future. WE MAY BE UNABLE TO MEET OUR FUTURE CAPITAL REQUIREMENTS. We will require substantial additional working capital to fund our business and the deployment of our :C.R.Q. and :Cue:C.A.T. technology and, therefore, will need to raise significant additional funds in the future. We cannot be certain that additional financing will be available to us on favorable terms when required or at all. If we raise additional funds through the issuance of equity-related or debt securities, these securities may have rights, preferences or privileges senior to those of the rights of our common stock and our stockholders may experience additional dilution. WE NEED TO DEPLOY OUR TECHNOLOGY RAPIDLY SO THAT IT BECOMES THE MARKET STANDARD. We believe that we must establish the DigitalConvergence.:Com brand and our :C.R.Q. and :Cue:C.A.T. products as the leading brand names in our targeted markets in order for our technology to be widely adopted by Internet users, mass media sources and advertisers. Such acceptance will be essential to generate revenues from licensing and :Cue fees. Brand recognition will become increasingly important as more companies, some with well-established brands, offer competing products and 10
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services. We expect that we will need to substantially increase our spending on programs and marketing in order to create and perpetuate strong brand loyalty and to ensure that our technology becomes the market standard. We cannot be certain that our efforts will be successful. WE ARE DEPENDENT ON THE EFFECTIVE AND RELIABLE PERFORMANCE OF OUR :C.R.Q. AND :CUE:C.A.T. TECHNOLOGY. The successful implementation and reliability of our :C.R.Q. and :Cue:C.A.T. technology on a commercial basis are crucial to our success. Our technology will not have been tested on a wide-scale basis prior to our launch date in September 2000. Technology and products as complex as ours frequently contain errors and defects, especially when first introduced to the market. Any errors or defects discovered in our :C.R.Q. or :Cue:C.A.T. technology after our launch date could: - result in our failure to achieve mass media, market or public acceptance; - divert development resources; - injure our reputation; - cause customer and Internet user dissatisfaction; - result in cancellation of strategic partnership, licensing and advertising agreements; and - result in legal actions by customers against us. Any delays caused by technological glitches in our :C.R.Q. or :Cue:C.A.T. technology could be detrimental to the implementation of our business model and our overall success. WE RELY ON OUR STRATEGIC PARTNERS TO DEPLOY AND PROMOTE OUR TECHNOLOGY. Development of our brand will depend largely on the success of our strategic partners in providing a high quality interactive Internet experience for Internet users and enhancing the Internet content and advertising value to Internet users, which cannot be assured. We expect our strategic partners to devote significant resources to the promotion and marketing of our technology, which is important to promote Internet user adoption and acceptance of our technology. However, most of our strategic partners are not contractually obligated to do so. To the extent that our strategic partners do not promote and market our technology or are ineffective in doing so, our efforts to gain broad market acceptance by Internet users will be materially adversely affected. WE MAY ENCOUNTER DIFFICULTIES IN ESTABLISHING OR MAINTAINING STRATEGIC RELATIONSHIPS. We intend to expand our operations and market presence by entering into significant additional agreements, investments, joint ventures or other strategic relationships with third parties, such as our agreements with National Broadcasting Company, Inc., Belo Corp., Tandy Corporation, Forbes Inc., Wired Magazine and The Milwaukee Journal. Each relationship will involve risks commonly encountered in such relationships, which include, among others: - the difficulty of implementing the relationship; - the potential disruption of our ongoing business; - the potential inability of our management to maximize our financial and strategic position in the relationship; - additional operating losses and expenses associated with implementing the terms of the relationship; - the maintenance of uniform standards, controls and policies; and - the possible impairment of relationships with existing partners, employees or customers. 11
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We cannot assure you that we will be successful in overcoming these risks or any other problems encountered in connection with these relationships or that we will be able to enter into any additional relationships on terms and conditions favorable to us. OUR DEPENDENCE ON TANDY CORPORATION FOR THE PRODUCTION OF OUR :CUE:C.A.T. DEVICES COULD ADVERSELY AFFECT US. Tandy Corporation has agreed to act as a product sourcing manager for the production of our :Cue:C.A.T. devices until December 31, 2001, and then for successive one year terms if the agreement is not terminated by either party. The agreement can be terminated by either party at any time upon 90 days prior notice. Tandy currently utilizes two manufacturing facilities in Asia with which it has manufacturing subcontracts for the production of our :Cue:C.A.T. devices. Any manufacturing disruption caused by the termination of our agreement with Tandy, the termination of Tandy's subcontracts with the two manufacturing facilities or other factors would impair our ability to timely distribute a large quantity of :Cue:C.A.T. devices to the public, which in turn would impair our ability to implement our business strategy. In addition, if our agreement with Tandy is terminated for any reason, we may be unable to negotiate another manufacturing agreement for our :Cue:C.A.T. devices on terms acceptable to us or at all. Our dependence on Tandy to manage the production of our :Cue:C.A.T. devices also exposes us to additional risks, including the following: - reduced control over delivery schedules; - inadequate quality assurance by Tandy or its manufacturing subcontractors; - inadequate production capacity during periods of excess demand; and - misappropriation of our technology. THE VIRTUAL NETWORK MAY NOT BE ACCEPTED AS AN ADVERTISING MEDIUM. Many of our customers will likely have only limited experience with the Internet as an advertising and promotion medium and neither those customers nor their advertising agencies will likely have devoted a significant portion of their advertising budgets to Internet-based advertising and promotion in the past. In order for us to generate substantial revenue from our Virtual Network, advertisers and advertising agencies must direct a greater portion of their budgets to the Internet and, specifically, to the use of our Virtual Network. There can be no assurance that advertisers or advertising agencies will be persuaded to allocate increased portions of their budgets to Internet-based advertising, or, if so persuaded, that they will find Internet-based advertising on our Virtual Network to be effective. Acceptance of the Internet and our Virtual Network by advertisers and advertising agencies also depends to a large extent on growth in the number of Internet users, on the development of a large base of users of our technology having demographic characteristics attractive to advertisers and on the acceptance of new methods of conducting business and exchanging information. WE ARE DEPENDENT ON INTELLECTUAL PROPERTY RIGHTS AND OTHERS MAY INFRINGE UPON THOSE RIGHTS. Our success is dependent on the protection of our internally developed technology, applications and products and on the goodwill associated with our trademarks, trade names, service marks and other proprietary rights. We rely on patent, trademark, trade secret and copyright laws, as well as confidentiality procedures and licensing arrangements, to protect the proprietary technology that we have developed, but we can give no assurance that such laws or procedures will provide sufficient protection to us or that others will not develop technologies that are similar or superior to ours. These risks are particularly heightened in foreign countries, in which effective patent, trademark, copyright and trade secret protection may not be available. 12
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We currently hold three United States patents for our technology and have filed over 50 patent applications, both in the United States and internationally, with respect to other aspects of our business. However, there can be no assurance that our applications will be granted, that any current or future patents will not be challenged, invalidated or circumvented, or that the rights granted will provide a competitive advantage for us. Specifically, for a variety of reasons, our patent applications may be rejected by a country's patent office and never issue into a patent. Even if some of our patent applications issue into patents, the legal protection provided by these patents may not be sufficient to protect the technology described in the patent. Further, most foreign countries do not give the same patent protection to patentable inventions as does the United States. The laws of these foreign countries may place a higher burden on us to prove that our invention is patentable and may restrict the types of inventions that can be patented. For example, software based inventions may not be patentable in foreign countries. The laws may also restrict the scope of protection given to a particular invention and the legal rights and remedies available to patent holders. These laws also make it expensive for us to obtain a patent in the first place because the cost of translating a patent application into a country's native language and paying maintenance fees to keep the patent enforceable are generally greater than similar costs in the United States. As a result, obtaining patent protection for our inventions internationally is generally more difficult and costly than it is in the United States and often results in less protection than is available in the United States. We typically enter into confidentiality and non-disclosure agreements with our employees and strategic partners in an attempt to control access to our proprietary technology and information. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use our products and technology without authorization or to develop similar technology independently through reverse engineering or other means. While we have filed applications for registration for several of our trademarks in the United States and internationally, there can be no assurance that the trademarks described in these applications will ever become registered trademarks. A country's trademark office can reject a trademark application for any number of reasons. A rejection can prevent our mark from being registered, or require us to seek registration of the mark in association with only some of the products and services originally desired. In addition, while a trademark application is pending, most countries provide for some period of time during which a third party can challenge the registration of the mark. A third party challenge would delay the registration of the mark, and defending the mark against a challenge would be costly. In addition, registering a trademark in a foreign country is often more difficult and expensive than registering the same mark in the United States. Further, if the mark is registered, the legal rights and remedies available to us in these foreign countries vary greatly from country to country, and, generally, are less than corresponding rights and remedies available in the United States. While we attempt to ensure that the quality of our trademarks and brands are maintained by the licensees of our trademark and brands, we cannot assure you that the licensees will not take actions that would adversely affect the value of our proprietary rights or reputation. Policing unauthorized use of our proprietary technology and other intellectual property rights could entail significant expense and could be difficult or impossible, particularly given the global nature of the Internet and that the laws of other countries may afford us little or no effective protection of our intellectual property. In addition, third parties may bring claims of copyright or trademark infringement against us or claim that our use of certain technology violates a patent. Furthermore, litigation may be necessary to enforce our intellectual property rights, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Any claims of infringement, with or without merit, could: - be time consuming to defend; - result in costly litigation; 13
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- divert management's attention; - require us to enter into costly royalty or licensing arrangements; and - prevent us from using or distributing our technology or products. We license some technology from third parties, including operating systems and the financial and reporting systems for our business. There can be no assurance that these third-party technology licenses will continue to be available to us on commercially reasonable terms. The loss of this technology could require us to obtain substitute technology of lower quality or performance standards or at greater cost. OUR RIGHT TO KEEP INFORMATION COLLECTED IN OUR DATABASES MAY BE CHALLENGED IN THE FUTURE. We intend to use our :C.R.Q. and :Cue:C.A.T. technology to develop and maintain a substantial database of consumer demographic information that our customers can use with our permission to conduct advertising campaigns. In particular, we intend to require each user of our technology to provide basic individual information in order to register and activate our :C.R.Q. software application. Under our privacy policy, individual user information will not be made available to outside parties and will be used internally by us only if a user gives express permission for such use. Some summary demographic data, however, may be made available to outside parties. Privacy concerns may cause users to resist providing the personal data necessary to support this profiling capability. More importantly, even the perception of security and privacy concerns, whether or not valid, may inhibit Internet user acceptance of our technology and products. Furthermore, users may bring lawsuits against us seeking to prohibit us from collecting this data. Even if without merit, lawsuits could impair Internet user acceptance of our technology and products. In addition, legal requirements may heighten these concerns if businesses must notify Internet users that the data captured after visiting certain websites may be used by marketing entities to direct product promotion and advertising to that user. We are not aware of any such laws currently in effect in the United States. Other countries and political entities, such as the European Economic Community, have adopted these types of laws. We cannot predict how the international roll-out of our technology will be affected by these types of laws. SECURITY BREACHES COULD CAUSE INTERRUPTIONS, DELAYS OR CESSATION OF THE SERVICES WE PROVIDE. We must protect our computer systems and network from physical break-ins, security breaches and other disruptions. Computer break-ins could jeopardize the security of information stored in and transmitted through our computer systems and network, which could adversely affect our ability to retain or attract customers and users, damage our reputation and subject us to litigation. Although we continue to implement security technology and establish operational procedures to prevent break-ins, damage and failures, these security measures may fail. Our insurance coverage may be insufficient to cover losses that may result from these events. WE ARE DEPENDENT ON KEY PERSONNEL. Our future success depends, in significant part, upon the continued service of our key technical, sales and senior management personnel, particularly J. Jovan Philyaw, our Chairman and Chief Executive Officer, and Michael N. Garin, our President and Chief Operating Officer. Mr. Garin has entered into an employment agreement with us. Mr. Philyaw does not have an employment agreement with us. See "Management--Employment Agreements." The loss of the services of one or more of our key personnel could have a material adverse effect on us. 14
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WE MUST ATTRACT AND RETAIN ADDITIONAL PERSONNEL. Our future success depends on our ability to attract and retain highly qualified technical, sales and marketing, customer support, financial and accounting, and managerial personnel. If our technology is widely adopted, we will need to hire many additional personnel for all facets of our business. Competition for personnel in the Internet industry is intense, and there can be no assurance that we will be able to retain our key personnel or that we can attract, assimilate or retain other highly qualified personnel in the future. We expect to experience difficulty in hiring and retaining candidates with appropriate qualifications. Our failure to successfully hire and retain candidates with appropriate qualifications could have a material adverse effect on us. WE MAY BE UNABLE TO MANAGE OUR GROWTH. If our technology gains broad market acceptance, we expect to experience rapid and significant growth of our operations, including the number of our employees, especially sales and marketing personnel, the geographic scope of our activities and our service offerings. Any failure to manage growth effectively could harm our business. We may also experience difficulties meeting the public's demand for our technology and products. We cannot assure you that our systems, procedures or controls will be adequate to support the anticipated growth in our operations. THE INTEGRATION OF ANY FUTURE ACQUISITIONS MAY BE DIFFICULT AND DISRUPTIVE. Although we may seek to grow our business through strategic acquisitions from time to time in the future, we have no immediate plans or current agreements to acquire any companies or businesses. If we acquire companies in the future, however, these acquisitions will be subject to numerous risks commonly encountered in completing and integrating acquisitions, including: - diversion of management's attention from other business concerns, including the implementation of our business strategy; - potential disruption of our ongoing business; - difficulties associated with assimilating technologies, products, personnel and operations; - the assumption of known or unknown liabilities in the acquisition; and - loss of key personnel of the acquired company or business. We may not successfully overcome these risks or any other problems encountered in connection with any future acquisitions. CAPACITY CONSTRAINTS OF OR SYSTEM FAILURES BY OUR NETWORK INFRASTRUCTURE OR OF OTHER INTERNET BROWSERS' INFRASTRUCTURE MAY LEAD TO SYSTEM DISRUPTIONS. The satisfactory performance, reliability and availability of our servers and network infrastructure and users' web browsers are critical to attracting and retaining users and maintaining relationships with our customers. System interruptions that result in the unavailability of our software or slower response times for users would reduce the number of Internet sites delivered through the use of our technology and reduce the attractiveness of our products. Although we intend to expand our network infrastructure, any unexpected increase in traffic on our infrastructure may require us to further expand and adapt new network infrastructure. If we are unable to add additional hardware to accommodate increased traffic on our infrastructure, an unanticipated system disruption could result, slowing response times. In addition, any disruption to our infrastructure resulting from a natural disaster or other event could result in an interruption in our service and impair our reputation. There can be no assurance that we will be able to expand our network infrastructure on a timely basis to meet increased demand or protect our network infrastructure from disruptions. 15
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OUR CUSTOMERS MAY ENCOUNTER DIFFICULTIES DUE TO INCREASED INTERNET TRAFFIC ON THEIR WEBSITES. If our technology is widely adopted by Internet users, our customers may experience difficulties managing the Internet traffic on their own websites. They may find it necessary to invest substantial resources in improving their own network capacity in order to meet the increased demand. If our customers are unable or unwilling to adequately address the increase in user traffic on their websites, users may perceive our technology and products as ineffective and may decrease or stop using our technology. WE MAY FACE RISKS FROM THE EXPANSION OF OUR OPERATIONS INTERNATIONALLY. We intend to expand our operations into international markets. As a result, we will face risks from doing business on an international basis, including, among other things: - reduced protection for intellectual property rights in some countries; - licenses, tariffs and other barriers; - difficulties in staffing and managing foreign operations; - political and economic instability; - potentially adverse tax consequences; - compliance with a wide variety of complex foreign laws and treaties; and - variance and unexpected changes in local laws and regulations. We currently anticipate opening an office in London within the next several months and plan to establish additional facilities in other parts of the world. The expansion of our operations into international markets will require significant management attention and financial resources. We cannot be certain that our investments in establishing operations in other countries will produce desired levels of revenue or profitability. WE ARE DEPENDENT ON CONTINUED GROWTH IN THE USE OF THE INTERNET. Rapid growth in the use of and interest in the Internet is a recent phenomenon, and there can be no assurance that acceptance and use of the Internet will continue to develop or that a sufficient base of users will emerge to support our customers and thus our business. Our revenues will depend largely on the widespread acceptance and use of the Internet as a source of information and entertainment and as a vehicle for commerce in goods and services. Demand for recently introduced services and products integrating other communication mediums with the Internet is very uncertain and few proven services and products exist. To the extent that the Internet continues to experience an increase in users and frequency of use by consumers resulting in increased bandwidth demands, there can be no assurance that the infrastructure for the Internet will be able to support the demands placed upon it. The Internet may not be accepted as a viable commercial medium due to delays in the development or adoption of new standards and protocols required to handle increased levels of Internet activity or due to increased government regulation. Changes in the pricing or quality of, or insufficient availability of, telecommunications services to support the Internet could also result in higher prices to end users or slower response times and could adversely affect use of the Internet generally and of our Internet services particularly. If use of the Internet does not continue to grow or grows more slowly than expected, or if the Internet infrastructure does not effectively support the growth that may occur, our business would be materially adversely affected. 16
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WE MAY NOT BE ABLE TO IMPROVE THE PERFORMANCE, FEATURES AND RELIABILITY OF OUR TECHNOLOGY, PRODUCTS AND SERVICES FAST ENOUGH OR AT ALL TO COMPETE EFFECTIVELY WITH NEW TECHNOLOGY. The market for our technology, products and services is characterized by rapid technological developments, frequent new product introductions and evolving industry standards. The emerging character of this technology and its rapid evolution will require that we continually improve the performance, features and reliability of our technology, products and services, particularly in response to competitive offerings. There can be no assurance that we will be successful in responding quickly, cost effectively and sufficiently to these developments. In addition, the widespread adoption of new Internet technologies or standards could require substantial expenditures by us to modify or adopt our technology, products and services and could fundamentally affect the character, viability and frequency of Internet-based advertising and commerce, either of which could have a material adverse effect on us. New technology or enhancements offered by us may contain design flaws or other defects that could require costly modifications or result in a loss of confidence in our technology by customers and users, either of which could have a material adverse effect on us. WE MAY NOT BE ABLE TO COMPETE SUCCESSFULLY AGAINST RELATED TECHNOLOGY, AND COMPETITIVE PRESSURES COULD HAVE A NEGATIVE IMPACT ON US. We may be unable to compete successfully against related technology, and competitive pressures could have a negative impact on us. The market for Internet convergence technology is new and rapidly evolving, and we expect competition to intensify significantly in the future as companies further utilize the advantages of the Internet. We face competition in the Internet convergence market from existing companies with related technology, including, among others: - BarPoint.com, Inc.; - Code Corporation; - Digimarc Corp.; - FastFrog.com; - MicroCast, Inc.; - NeoMedia Technologies, Inc.; - WebTV Networks, Inc.; - Wink Communications, Inc.; and - WorldGate Communications, Inc. We expect competition to increase as current competitors increase the sophistication of their products and as new competitors enter the market. Some of our competitors have, and new potential competitors may have: - more experience deploying Internet convergence software and solutions; - larger technology staffs; - larger customer bases; - more established distribution channels; - greater brand recognition; and - greater financial, marketing and other resources than we have. 17
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In addition, our competitors may be able to develop or offer superior technology, products or services that achieve greater market and public acceptance or that have significantly improved functionality as compared to our existing and future technology, products and services. In addition, as we develop new products and services, we may begin competing with companies with whom we have not previously competed. It is also possible that our competitors will form alliances that may enable them to rapidly increase their market share. FUTURE GOVERNMENT REGULATIONS OF THE INTERNET COULD DECREASE DEMAND FOR OUR PRODUCTS AND SERVICES OR INCREASE OUR COST OF CONDUCTING BUSINESS. Although there are currently few laws and regulations directly applicable to the Internet, a range of new laws and regulations have been proposed, and could be adopted, covering issues such as privacy, copyrights, obscene or indecent communications and the pricing, characteristics and quality of Internet products and services. In 1996, Congress enacted the Communications Decency Act, which, among other things, purported to impose criminal penalties on anyone who distributes "obscene" or "indecent" materials over the Internet. A number of states have adopted or proposed similar legislation. Although certain provisions of the Communications Decency Act have been held to be unconstitutional, the manner in which the act and similar existing or future federal and state laws will ultimately be interpreted and enforced and their effect on our operations cannot yet be fully determined. Such laws could subject us to substantial liability. For example, we do not and cannot practically screen the contents of the various Internet sites that are accessible with our :C.R.Q. and :Cue:C.A.T. technology. Restrictive laws or regulations could also dampen the growth of the Internet generally and decrease the acceptance of the Internet as an advertising medium, and could, thereby, have a material adverse effect on us. Application to the Internet of existing laws and regulations governing issues such as property ownership, libel and personal privacy is also subject to substantial uncertainty. The television industry is subject to extensive regulation at the federal, state and local levels. In addition, legislative and regulatory proposals under consideration by Congress and federal agencies may materially affect the industry and our ability to distribute our :C.R.Q. technology to television broadcasters. There can be no assurance that current or new government laws and regulations, or the application of existing laws and regulations, will not: - subject us to significant liabilities; - significantly dampen growth in Internet usage; - prevent us from distributing our technology; or - otherwise cause a material adverse effect on us. WE COULD FACE LIABILITY FOR THE CONTENT WE PUBLISH ON OUR WEBSITE OR BROADCAST ON NET TALK LIVE! THE INTERNET TALK SHOW. As a publisher, producer and distributor of content on our website and on NET TALK LIVE! THE INTERNET TALK SHOW, we face potential liability for defamation, negligence, copyright, patent or trademark infringement and other claims based on the nature and content of the materials we publish, produce or distribute. In addition, because our technology facilitates the downloading of materials from third-parties' websites, there is a potential that claims will be made against us for defamation, negligence, copyright or trademark infringement, personal injury or other theories based on the nature and content of such materials. Such claims have been brought, and sometimes successfully pressed, against Internet service providers in the past. Our insurance may not be adequate to indemnify us for all liability that may be imposed on us. 18
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NO PUBLIC MARKET FOR OUR COMMON STOCK CURRENTLY EXISTS AND OUR STOCK PRICE MAY FLUCTUATE AFTER THIS OFFERING. AS A RESULT, INVESTORS IN OUR COMMON STOCK MAY NOT BE ABLE TO RESELL THEIR SHARES AT OR ABOVE THE INITIAL PUBLIC OFFERING PRICE. Prior to this offering, there has been no public market for our common stock. We will negotiate the initial public offering price with the underwriters. The initial public offering price may not be indicative of the price at which the common stock will trade following completion of this offering. The completion of this offering provides no assurance that an active trading market for our common stock will develop or, if developed, that it will be sustained. The market price of our common stock also could be subject to significant fluctuation and may be influenced by many factors, some of which are beyond our control, including: - variations in quarterly operating results; - changes in financial estimates by securities analysts; - announcements by us or our competitors of significant contracts, acquisitions, strategic partnerships, joint ventures or capital commitments; - additions or departures of key personnel; - sales of common stock in the future; - fluctuations in stock market price and trading volume, which are particularly common among highly volatile securities of Internet companies; and - investor perceptions of us and the Internet industry. As a result, investors in our common stock may not be able to resell their shares at or above the initial offering price. In the past, securities class action litigation has often been brought against a company following periods of volatility in the market price of its securities. We may be the target of similar litigation. Securities litigation could result in substantial costs and divert our management's attention and resources, which could negatively impact us. THE MARKET FOR TECHNOLOGY STOCKS IS VOLATILE. The stock market in general, and the Nasdaq National Market and the market for Internet and technology companies in particular, has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of technology companies. These broad market and industry factors may have a material adverse effect on the market price of our common stock, regardless of our operating performance. The trading prices of the stocks of many technology companies are at or near historical highs and reflect price-earnings ratios substantially above historical levels. There can be no assurance that these trading prices and price-earnings ratios will be sustained. CERTAIN EXISTING STOCKHOLDERS OWN A LARGE PERCENTAGE OF OUR VOTING STOCK. Following the closing of this offering, our officers, directors and affiliated entities together will beneficially own approximately % of the outstanding shares of our common stock ( % if the underwriters' over-allotment options are exercised in full). As a result, these stockholders will be able to control all matters requiring stockholder approval and, thereby, our management and affairs. Matters that typically require stockholder approval include: - the election of directors; - mergers or consolidations; - the sale of all or substantially all our assets; 19
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- the amendment of our charter; and - our dissolution. This concentration of ownership may delay, deter or prevent acts that would result in a change of control, which in turn could reduce the market price of our common stock. See "Security Ownership of Principal Stockholders and Management." FUTURE SALES OF OUR COMMON STOCK MAY DEPRESS OUR STOCK PRICE. After this offering, we will have outstanding shares of common stock. Sales of a substantial number of shares of common stock in the public market following this offering could substantially decrease the market price of our common stock. All the shares sold in this offering will be freely tradeable, other than those shares sold in this offering to any of our affiliates. The remaining %, or shares, of our total outstanding shares will become available for resale in the public market in the near future. In addition, an affiliate of the National Broadcasting Company, Inc., the holders of shares of common stock that will be issued upon conversion of the outstanding shares of preferred stock upon completion of this offering and other holders of our common stock have the right to require us to register their shares for resale after 180 days following the date of this prospectus. As restrictions on resale end or upon registration of any such shares for resale, the market price could drop significantly if the holders of these shares sell them or are perceived by the market as intending to sell them. See "Shares Eligible for Future Sale." INVESTORS IN THIS OFFERING WILL EXPERIENCE IMMEDIATE AND SUBSTANTIAL DILUTION. The initial public offering price is substantially higher than the pro forma book value per share of our common stock. Purchasers of common stock in this offering will experience immediate and substantial dilution in the pro forma net tangible book value of their stock of $ per share assuming an initial offering price for our common stock of $ per share. See "Dilution." OUR MANAGEMENT'S BROAD DISCRETION IN THE USE OF PROCEEDS OF THIS OFFERING INCREASES THE RISK THAT WE MAY NOT USE THEM EFFECTIVELY OR THAT WE MAY USE THEM IN WAYS IN WHICH OUR STOCKHOLDERS OR THE MARKET IN GENERAL MAY NOT AGREE. We currently plan to use the net proceeds of this offering: - to pay expenses related to the manufacture and distribution of our :C.R.Q. CD-ROMs and :Cue:C.A.T. devices; - to market and promote the adoption of our technology by Internet users; - to purchase additional network server and support equipment; - to repay outstanding indebtedness; and - for general corporate purposes, including operating expenses, working capital and other capital expenditures. Depending on future events, we may determine at a later time to use our net proceeds for different purposes. We cannot assure you that, pending their use, the proceeds will be invested to yield a favorable return. See "Use of Proceeds." WE HAVE NOT PAID DIVIDENDS AND DO NOT ANTICIPATE PAYING ANY DIVIDENDS ON OUR COMMON STOCK IN THE FORESEEABLE FUTURE. We currently intend to retain any earnings for the future operation and development of our business and do not anticipate paying any dividends on our common stock in the foreseeable future. 20
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Any future dividends may be restricted by any loan agreements that we may enter into from time to time. See "Dividends." PROVISIONS IN OUR CHARTER DOCUMENTS AND UNDER DELAWARE LAW COULD DISCOURAGE A TAKEOVER THAT STOCKHOLDERS MAY CONSIDER FAVORABLE. Our certificate of incorporation and bylaws may discourage, delay or prevent a merger or acquisition that a stockholder may consider favorable because they: - authorize the issuance of "blank check" preferred stock; - provide for a classified board of directors with staggered, three-year terms; - prohibit cumulative voting in the election of directors; - limit the persons who may call special meetings of stockholders; - prohibit stockholder action by written consent; and - establish advance notice requirements for nominations for election to the board of directors or for proposing matters to be approved by stockholders at stockholder meetings. Certain provisions of Delaware law may also discourage, delay or prevent someone from acquiring or merging with us. In addition, purchase rights distributed pursuant our stockholder rights plan will cause substantial dilution to any person or group that attempts to acquire us without conditioning the offer on our redemption of the rights. For a detailed description of the anti-takeover provisions in our charter documents, stockholder rights plan and those provisions of Delaware law, see "Description of Capital Stock." 21
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FORWARD-LOOKING STATEMENTS This prospectus includes forward-looking statements. All statements other than statements of historical facts contained in this prospectus, including statements regarding our future financial position, business strategy, budgets, projected costs and plans and objectives of management for future operations, are forward-looking statements. The words "believe," "may," "will," "estimate," "continue," "anticipate," "intend," "expect," and similar expressions, as they relate to us, are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including, among other things: - our ability to implement our technology on a commercial basis; - our ability to obtain additional capital to finance the implementation of our technology on a commercial basis; - acceptance and adoption of our technology by the mass media, the Internet convergence market and the public; - the effectiveness and reliability of our :C.R.Q. and :Cue:C.A.T. applications; - the promotion and marketing of our technology by our strategic partners; - our dependence on intellectual property rights; - rapid technology changes within our market; - our ability to compete with related and new technologies in the Internet convergence market; - our ability to effectively integrate the operations of any companies that we may acquire in the future; and - regulation of the Internet by the government. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this prospectus may not occur and actual results could differ materially from those anticipated or implied in the forward-looking statements. "See Risk Factors." 22
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USE OF PROCEEDS We expect to receive approximately $ million in net proceeds from the sale of shares of common stock in this offering at an assumed initial public offering price of $ per share (approximately $ if the underwriters' over-allotment options are exercised in full), after deducting underwriting discounts and commissions and estimated offering expenses, which we expect to be approximately $ . We currently expect to use the net proceeds of this offering: - to pay expenses related to the manufacture and distribution of our :C.R.Q. CD-ROMs and :Cue:C.A.T. devices; - to market and promote the adoption of our technology by Internet users; - to purchase additional network server and support equipment; - to repay outstanding indebtedness to Infotainment Telepictures, Inc.; and - for general corporate purposes, including operating expenses, working capital and other capital expenditures. Depending on future events, we may determine at a later time to use our net proceeds for different purposes, including future acquisitions of or investments in strategic businesses or technology. Pending these uses, we intend to invest the net proceeds in short-term, interest-bearing, investment-grade instruments. Our promissory note payable to Infotainment Telepictures, Inc. bears interest at 6.0% per annum. This promissory note and related accrued and unpaid interest will become due and payable upon completion of this offering. As of the date of this prospectus, a principal balance of $3.5 million and accrued and unpaid interest of approximately $ was outstanding. We believe that, based on our current business plan and related assumptions, the net proceeds of this offering, cash on hand and cash expected to be generated by operations will be sufficient to fund our operations and capital requirements for approximately the next 12 months after completion of this offering. However, we may be required to seek additional sources of capital prior to such time if: - our operating assumptions change or prove to be inaccurate; - we accelerate or expand the implementation of our business strategy; or - we pursue future acquisitions of or investments in strategic businesses or technology. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources" for a further discussion of our current and future capital requirements and our belief regarding our ability to meet those requirements. 23
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DIVIDEND POLICY We have not declared or paid any dividends on our common stock, and we do not anticipate declaring or paying any dividends on our common stock in the foreseeable future. We currently intend to retain all future earnings to fund the development and growth of our business. The payment of any future dividends will be at the discretion of our board of directors and will depend on our results of operations, financial condition, capital requirements, and other factors deemed relevant by our board of directors. 24
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CAPITALIZATION The following table sets forth our cash and cash equivalents and capitalization as of December 31, 1999: - on an actual basis; - on a pro forma basis giving effect to the issuance of 48 shares of our Series A preferred stock in January 2000, for total cash consideration of $151,200, the issuance of 5,929,364 shares of our Series B preferred stock and 5,372,593 shares of our Series C preferred stock in April 2000, for total cash consideration of $41.7 million and $56.6 million, respectively, and also gives effect to the use of proceeds therefrom; and - on a pro forma basis as adjusted to reflect: - the automatic conversion of 11,317,923 shares of outstanding preferred stock into 21,360,537 shares of common stock upon completion of this offering; and - the sale of shares of common stock in this offering at an assumed initial public offering price of $ per share after deducting the estimated underwriting discounts and commissions and our estimated offering expenses and the application of the net proceeds as set forth under "Use of Proceeds." None of the columns set forth below reflects the exercise of: - 9,245,200 shares of common stock issuable upon the exercise of stock options granted by us, with exercise prices ranging from $3.31 to $9.37 per share and a weighted average exercise price of $4.17 per share, of which stock options to purchase up to shares of common stock are exercisable or will become exercisable within 60 days after the date of this prospectus; and - 8,382,350 shares of common stock issuable upon the exercise of warrants issued by us, with exercise prices ranging from $5.00 to $10.54 per share and a weighted average exercise price of $7.98 per share, of which all warrants are immediately exercisable. You should read this table together with "Use of Proceeds," "Management's Discussion and Analysis of Financial Condition and Results of Operations," and the consolidated financial statements and the notes thereto appearing elsewhere in this prospectus. [Enlarge/Download Table] AS OF DECEMBER 31, 1999 ------------------------------------- PRO FORMA ACTUAL PRO FORMA AS ADJUSTED ---------- ---------- ----------- (IN THOUSANDS) Cash and cash equivalents................................... $ 45,540 $138,378 $ ======== ======== ======== Short-term and long-term debt............................... 9,152 3,529 Series A convertible preferred stock subject to redemption................................................ 47,888 48,039 Series B convertible preferred stock subject to redemption................................................ -- 41,683 Series C convertible preferred stock subject to redemption................................................ -- 56,627 Stockholders' equity (deficit): Common stock, $0.01 par value; 110,250,000 shares authorized, 61,113,150 shares issued and outstanding actual; 125,000,000 shares authorized, 61,113,150 shares issued and outstanding pro forma; shares authorized, shares issued and outstanding pro forma as adjusted....................... 611 611 Additional paid-in capital................................ 517 517 Excess of purchase price over Predecessor cost of net liabilities acquired.................................... (8,397) (8,397) Accumulated deficit....................................... (3,977) (3,977) -------- -------- -------- Total stockholders' equity (deficit).................... (11,246) (11,246) -------- -------- -------- Total capitalization................................ $ 45,794 $138,632 $ ======== ======== ======== 25
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DILUTION If you invest in our common stock, your interest will be diluted to the extent of the difference between the public offering price per share of our common stock and the pro forma as adjusted net tangible book value per share of our common stock after this offering. Net tangible book value per share represents the amount of total tangible assets less total liabilities, divided by the number of shares of common stock then outstanding. Our net tangible book value at December 31, 1999, would have been $ million, or $ per share of common stock, after giving effect to the automatic conversion of 11,317,923 shares of outstanding preferred stock into 21,360,537 shares of common stock upon completion of this offering. After giving effect to the sale of the shares of common stock in this offering at an assumed initial public offering price of $ per share and after deducting estimated underwriting discounts and commissions and estimated offering expenses, our pro forma net tangible book value at December 31, 1999, would have been $ million, or $ per share. This represents an immediate increase in the pro forma net tangible book value of $ per share to existing stockholders and an immediate and substantial dilution of $ per share to new investors purchasing common stock in this offering. The following table illustrates this per share dilution: [Download Table] Assumed initial public offering price per share............. $ Net tangible book value per share at December 31, 1999.... $ [Increase] [Decrease] per share attributable to preferred stock conversion........................................ -------- Pro forma net tangible book value per share before this offering................................................ Increase per share attributable to new investors.......... -------- Pro forma net tangible book value per share after this offering.................................................. -------- Dilution in pro forma net tangible book value per share to new investors(1).......................................... $ ======== ------------------------ (1) If the underwriters' over-allotment option is exercised in full, dilution per share to new investors will be $ . The following table summarizes on a pro forma basis as of December 31, 1999, the total number of shares of common stock purchased from us, the total consideration paid to us, and the average price per share paid by existing stockholders and by new investors purchasing shares of common stock in this offering at an assumed initial public offering price of $ per share and before deducting underwriting discounts and commissions and estimated offering expenses: [Enlarge/Download Table] SHARES PURCHASED TOTAL CONSIDERATION ---------------------- ---------------------- AVERAGE PRICE NUMBER PERCENT AMOUNT PERCENT PER SHARE ----------- -------- ----------- -------- ------------- (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) Existing stockholders............... % $ % $ Existing stockholders--conversion of preferred stock................... New investors....................... ----------- ------- ----------- ------ Total............................... 100.0% $ 100.0% =========== ======= =========== ====== The foregoing discussion and tables assume no exercise of outstanding stock options or warrants. As of the date of this prospectus, there were outstanding: - stock options granted by us to purchase 9,245,200 shares of common stock at a weighted average exercise price of $4.17 per share, of which stock options to purchase up to shares of 26
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common stock are exercisable or will become exercisable within 60 days after the date of this prospectus; and - warrants issued by us to purchase 8,382,350 shares of common stock at a weighted average exercise price of $7.98 per share, of which all warrants are immediately exercisable. To the extent that any of these stock options or warrants are exercised, there will be further dilution to new investors. See "Capitalization" and Note 8 to our consolidated financial statements included elsewhere in this prospectus. 27
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SELECTED CONSOLIDATED FINANCIAL DATA The following selected consolidated statement of operations data for the year ended December 31, 1999, and the consolidated balance sheet data as of December 31, 1999, are derived from our audited consolidated financial statements included elsewhere in this prospectus. The selected statements of operations data for the years ended December 31, 1998 and 1997 and the balance sheet data as of December 31, 1998 are derived from the audited financial statements of the Predecessor, included elsewhere in this prospectus. The balance sheet data as of December 31, 1997 are derived from the audited financial statements of the Predecessor but are not included in this prospectus. The selected statement of operations data for the year ended December 31, 1995 and the balance sheet data as of December 31, 1995 and 1996 are derived from our unaudited financial statements that include, in our opinion, all adjustments, consisting of only normal recurring adjustments, necessary for fair presentation of the financial condition at that date and results of operations for such period. The historical results presented below are not necessarily indicative of the results to be expected for any future period. The selected consolidated financial data should be read in conjunction with our consolidated financial statements and the notes to those consolidated financial statements, the Predecessor financial statements and "Management's Discussion and Analysis of Financial Condition and Results of Operations" appearing elsewhere in this prospectus. [Enlarge/Download Table] PREDECESSOR FINANCIAL DATA YEAR ENDED DECEMBER 31, YEAR ENDED --------------------------------------------------------- DECEMBER 31, 1995 1996 1997 1998 1999 ------------ ------------ ------------ ------------ ------------- (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) CONSOLIDATED STATEMENTS OF OPERATIONS DATA: Net revenues........................................ $ 97 $ 109 $ 690 $ 1,636 $ 1,543 Operating expenses: Production and media costs........................ 78 137 591 939 1,012 Selling, general and administrative............... 48 91 284 671 3,921 Depreciation and amortization..................... -- 17 41 55 106 Research and development.......................... -- -- -- 36 410 ----------- ----------- ----------- ----------- ----------- Total operating expenses........................ 126 245 916 1,701 5,449 ----------- ----------- ----------- ----------- ----------- Operating loss...................................... (29) (136) (226) (65) (3,906) Interest income..................................... -- -- -- -- 660 Interest expense.................................... (3) (14) (17) (24) (731) ----------- ----------- ----------- ----------- ----------- Net loss............................................ $ (32) $ (150) $ (243) $ (89) $ (3,977) =========== =========== =========== =========== =========== Basic and diluted weighted average common shares outstanding....................................... 25,000 25,000 25,000 25,000 59,507,271 Basic and diluted net loss per common share......... $ (1.30) $ (6.02) $ (9.72) $ (3.54) $ (0.07) =========== =========== =========== =========== =========== PREDECESSOR FINANCIAL DATA AS OF DECEMBER 31, AS OF --------------------------------------------------------- DECEMBER 31, 1995 1996 1997 1998 1999 ------------ ------------ ------------ ------------ ------------- (IN THOUSANDS) CONSOLIDATED BALANCE SHEET DATA: Cash and cash equivalents........................... $ 143 $ 87 $ -- $ 175 $ 45,540 Total assets........................................ 143 281 273 381 46,518 Accounts payable and accrued liabilities............ 2 11 41 85 722 Short-term borrowings, including current portion of long-term debt(1)................................. 173 312 227 651 10 Long-term liabilities............................... -- 1 3 3 9,145 Series A convertible preferred stock subject to redemption........................................ -- -- -- -- 47,888 Accumulated deficit................................. (32) (183) (426) (514) (3,977) Total stockholders' deficit......................... (32) (183) (426) (514) (11,246) ------------------------------ (1) As of December 31, 1995, 1996 and 1997, short-term borrowings consisted entirely of indebtedness to an officer of the Predecessor. As of December 31, 1998, short-term borrowings consisted of $197,919 of indebtedness to an officer of the Predecessor and $452,900 of advances from a stockholder of ours. 28
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THE FOLLOWING DISCUSSION AND ANALYSIS OF OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS SHOULD BE READ IN CONJUNCTION WITH OUR CONSOLIDATED FINANCIAL STATEMENTS AND THE NOTES THERETO AND THE PREDECESSOR FINANCIAL STATEMENTS AND THE NOTES THERETO, APPEARING ELSEWHERE IN THIS PROSPECTUS. GENERAL We are a company whose technology allows media companies, manufacturers and virtually all organizations to instantly and easily link their products with web pages deep within their websites. Until we release our technology, we believe that it is not possible for these companies to realize the full value of their Internet efforts, because their websites have to be entered through their front pages, often making access to a desired web page time-consuming and difficult. Our :C.R.Q. software will send an Internet user's web browser to a specific web page in response to our proprietary digital signal called a ":Cue" transmitted by a television broadcast. Our :C.R.Q. software also will send an Internet user's web browser to a specific web page when an Internet user utilizes our :Cue:C.A.T. device to scan our proprietary codes called "Print :Cues" on print media or to scan existing bar codes on consumer products. We believe that our technology will empower media companies and corporate advertisers to enhance their content and to transform television broadcasts or other electronic media, print media or items bearing Print :Cues or bar codes into powerful new advertising, promotional or e-commerce opportunities. Our technology will be free to the public and will allow Internet users to quickly and easily obtain relevant information and conduct e-commerce activities by eliminating the input of lengthy website addresses and time-intensive web navigation. From our inception in September 1998 through the end of that year, we had no operating activity. In January 1999, we acquired from Infotainment Telepictures, Inc. the television show NET TALK LIVE! THE INTERNET TALK SHOW and certain proprietary technology rights in exchange for an unsecured promissory note with a principal amount of $8,000,000. Because of this transaction, we have included in this prospectus the financial statements of Infotainment Telepictures, Inc. as our predecessor for accounting purposes. For the year ended December 31, 1999, we generated limited revenues from our television show NET TALK LIVE! THE INTERNET TALK SHOW. Since our inception, we have conducted research, developed our Internet convergence technology and established sales and distribution outlets for our technology by educating potential partners in the media and consumer products industries about how to adopt and utilize our technology. We plan to achieve widespread distribution and adoption of our technology through the strategic partnerships that we have established with a major television network, local station groups, cable networks, publishers, merchants and direct marketers and additional strategic partnerships that we intend to establish. We intend to initiate a nationwide roll-out of our technology beginning in September 2000 and plan to distribute, free to the public, at least 50 million :C.R.Q. CD-ROMs and 50 million :Cue:C.A.T. devices by the end of 2001. Although the initial roll-out of our technology will be limited to the United States, we believe that there is a substantial market for our technology outside the United States. Our :C.R.Q. and :Cue:C.A.T. technology does not require foreign language translations or technical modifications to be compatible with specific broadcasting or recording technology used in foreign markets. Instead, international broadcasters, publishers, advertisers and merchants can place our :Cues in any type of electronic or printed medium and direct Internet users to websites using any language. We intend to expand our international presence aggressively by adding direct sales and marketing personnel and establishing strategic relationships with international partners to capitalize fully on international market opportunities. We have hired a president of our International Group and anticipate opening an office in London within the next several months. We intend to commence international deployment of our technology during 2001. 29
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REVENUE SOURCES We have divided initial applications for our technology into four groups from which we expect to derive revenue: - broadcasting and electronic media; - print media, bar-coded products and other :Cue:C.A.T. applications; - Internet advertising; and - database research and marketing. Our initial pricing model for each application is described below. We will, however, periodically review our pricing model for each application, and we expect to make adjustments in our pricing model from time to time. BROADCASTING AND ELECTRONIC MEDIA. Our :C.R.Q. technology works with any television broadcast, cable programming, or other electronic media such as DVDs, videotapes and CD-ROMs, and will offer a range of benefits to broadcasters. With our :C.R.Q. technology, television and cable broadcasts become an instant and direct link to the Internet. Broadcasters will be able to offer more engaging interactive programming to their viewers and more valuable interactive ads to their corporate advertisers. We expect to derive our revenue from the following sources: - fees from the sale of advertising :Cues to broadcast networks, cable networks and local television stations; - a fixed fee per sale completed by home shopping networks as a result of using our :Cues; and - fees from annual licenses to cable networks for the use of :Cues in content. We intend to sell :Cues to networks and television stations, who will resell them to advertisers. We expect to limit the number of advertising :Cues that each broadcast network, cable network or local television station can sell for use in advertising spots each day and to charge a flat fee per :Cue. Revenues from the sale of advertising :Cues will be recognized upon notification that the :Cue has been transmitted. Revenues generated from the sale of :C.R.Q. licenses to cable operators will be recognized ratably over the respective contract period, which will generally be 18 months. PRINT MEDIA, BAR CODED PRODUCTS AND OTHER :CUE:C.A.T. APPLICATIONS. By inserting a Print :Cue in any print media or by linking existing bar codes for consumer products to websites, our technology enables virtually any consumer product or any printed media, including magazine articles, catalogs, print advertisements, newspapers, free-standing inserts, billing invoices, bank statements and newsletters, to become instantly interactive with the Internet. With the swipe of a :Cue:C.A.T. device over a Print :Cue or a bar code, a user can gain immediate access to in-depth information that was not previously included in the printed version or on the consumer product due to space limitations. We expect that publishers will be able to attain higher ad revenues due to increased traffic on the website and generate additional e-commerce opportunities for their advertisers. We also expect that manufacturers will be able to transform the billions of consumer products on retailers' shelves into powerful advertising, promotional and e-commerce opportunities. For most print applications, we intend to allow publishers to use Print :Cues at no cost for the first several months after launch, until we have achieved widespread distribution of our :Cue:C.A.T. devices to Internet users. We are completing a massive database that links existing UPC, ISBN, EAN and other bar codes found on consumer products to web pages. We plan to activate substantially all of these bar 30
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codes when our :Cue:C.A.T. technology is launched and provide manufacturers with one free year in which to evaluate the results. We expect to derive our revenue from the following sources: - after the first few months, fees from licenses to magazine and newspaper publishers for the use of Print :Cues for content enhancement purposes; - after the first few months, fees from the sale of any advertising Print :Cues in any print media, including newspapers and magazines; - a fixed fee per sale completed by catalog shoppers as a result of using our Print :Cues; - annual fees for Print :Cues assigned by credit card issuers to their cardholders for tracking accounts online; - fees per Print :Cue sold to publishers of free-standing inserts and direct mail and sold to manufacturers for use in product manuals; - after the first anniversary of our launch date, annual fees for bar codes on consumer products that are Internet Enhanced; and - commissions on increased revenues resulting from the use of Print :Cues in classified ads. Revenues from the sale of advertising Print :Cues will be recognized upon notification from the respective publisher that the Print :Cues were incorporated into publications during the applicable publication period. Revenues generated from the sale of content Print :Cues will be on an annual license basis, regardless of the number of content Print :Cues used, and will be recognized ratably over the respective contract period, which is generally 12 months. Revenues generated from the licensing of bar codes will be based upon a fixed annual fee per bar code and will be recognized annually on a straight-line basis. INTERNET ADVERTISING. Each time our :C.R.Q. software launches a user's personal computer to a web page, our Virtual Network will border the user's Internet browser window. The Virtual Network will be populated with banner advertisements and a series of tabs that, when clicked, will display information related to that subject. We expect to sell up to eight banner ads along the Virtual Network's vertical frame. We expect to charge advertisers a fee and will remit 30% of the total advertising revenues to the agency that will sell the banner ads on our behalf as well as 10-15% to advertising agencies representing the corporate advertisers. Revenue from the sale of banner advertisements on the Virtual Network, net of commissions, will be recognized ratably over the period in which the advertisements are displayed. DATABASE RESEARCH AND MARKETING. We intend to require each user of our technology to provide basic individual information in order to register and activate our :C.R.Q. and :Cue:C.A.T. technology. Additionally, we plan to offer promotional and other incentives to encourage users to provide more detailed individual information. We plan to use this information to develop a substantial database of demographic information reflecting users' interests and preferences, and tracking Internet behavior related to :Cues and viewing patterns of Internet Enhanced content. This information will be used to better tailor our Virtual Network banner ads and special vendor offers to each user, as well as to generate summary demographic data reports for advertisers and merchants. These firms would use our reports and data collection expertise to tailor advertising campaigns, banner ads and website content to appeal to targeted consumer segments. Under our privacy policy, individual user information will not be made available to outside parties and will only be used internally by us with a user's express permission. Some summary demographic data will be provided to purchasers of :Cues free of charge. For more complex or detailed demographic data, we intend to charge advertisers a flat fee per month, plus a small charge per record. 31
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EXPENSE COMPONENTS Costs associated with our business primarily include product costs, selling, general and administrative expenses, depreciation and amortization and research and development. Although we expect these costs to continue to increase over time, we expect each of them to decrease as a percentage of revenues as revenues increase after we roll out our :C.R.Q. and :Cue:C.A.T. technology. Product costs consist of the costs of manufacturing and distributing our :C.R.Q. CD-ROMs and :Cue:C.A.T. devices. Our :C.R.Q. CD-ROMs and :Cue:C.A.T. devices will be distributed free of charge to the public. In some cases, we expect that certain of the costs of manufacturing and/or distributing :C.R.Q. CD-ROMs and :Cue:C.A.T. devices will be borne or defrayed by our strategic partners and by advertisers who advertise directly on :Cue:C.A.T. devices. Costs incurred in manufacturing and distributing the :C.R.Q. CD-ROMs and :Cue:C.A.T. devices will be charged to expense as incurred. Selling, general and administrative expenses consist of: - payroll and related expenses for executive, sales and marketing and administrative personnel; - corporate facilities expenses; - professional services expenses; - maintenance costs for our database and network infrastructure; - marketing expenses; - travel expenses; and - other general corporate expenses. We expect that in support of the expected growth of our business and our operations as a public company, selling, general and administrative expenses will continue to increase for the foreseeable future. Depreciation and amortization expenses consist primarily of the amortization of goodwill associated with business acquisitions, as well as fixed asset depreciation. We anticipate larger depreciation and amortization expenses in the foreseeable future as we continue to expand our network infrastructure. For example, we anticipate using a portion of the net proceeds from this offering to purchase additional network server and support equipment to prepare for the anticipated launch of our technology in September 2000. Research and development expenses include costs incurred by us to develop, enhance, and develop new applications for our technology. These expenses consist primarily of salaries and benefits for our Technology Group, systems personnel and consultants. We intend to continue to enhance our technology and to develop new uses and other products that utilize our technology. Accordingly, we expect that our product research and development expenses will continue to increase for the foreseeable future. RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 1999 REVENUES: During the year ended December 31, 1999, we derived $1.5 million in revenue from the sale of advertisements and sponsorships on our show, NET TALK LIVE! THE INTERNET TALK SHOW. Two customers accounted for approximately 81% and 17% of our annual revenues, respectively. 32
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OPERATING EXPENSES: PRODUCTION AND MEDIA COSTS. Production and media costs were $1.0 million, or 66%, of revenue for the year ended December 31, 1999. Production and media costs consist of the personnel and other costs associated with producing, editing and airing NET TALK LIVE! THE INTERNET TALK SHOW. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses were comprised primarily of payroll and related expenses for executive and administrative personnel, facilities expenses, professional service expenses and other general corporate expenses. These expenses were $3.9 million, or 254%, of total revenues for the year ended December 31, 1999. Employee related costs were $2.0 million, or 51%, of the total selling, general and administrative expenses for the year. We significantly increased our employee expenses during the fourth quarter of the year when our employee base increased from approximately 22 at September 30, 1999 to 61 at December 31, 1999. Selling, general and administrative expenses also include $380,300 in legal fees primarily associated with the filing of patents and trademarks to enhance our intellectual property and $529,400 in travel costs primarily incurred in the second half of the year in connection with travel to meetings with potential customers and investors. DEPRECIATION AND AMORTIZATION. Depreciation and amortization was $105,721, or 7%, of total revenues during the year ended December 31, 1999. We purchased $616,000 of property and equipment and capitalized software during the year ended December 31, 1999. The majority of these assets were purchased during the later portion of the year and did not have a full year of depreciation expense in the year ended December 31, 1999. RESEARCH AND DEVELOPMENT. Research and development costs during the year ended December 31, 1999 were $410,017. These costs primarily consist of payroll and related expenses associated with technology personnel for the development of our :C.R.Q. software and :Cue:C.A.T. device. OTHER INCOME (EXPENSE): INTEREST INCOME. Interest income of $660,498 was recorded during the year ended December 31, 1999. The income was earned from the investment of the proceeds net of fees and cash issuance costs of $48.3 million raised from the issuance of the Series A preferred stock. These proceeds were primarily received by us in October, November and December of 1999; therefore, only a few months of interest was earned on the proceeds. INTEREST EXPENSE. Interest expense of $731,355 was recorded during the year ended December 31, 1999. The interest primarily related to the $8.0 million promissory note issued to the Predecessor in January 1999 for the purchase of NET TALK LIVE! THE INTERNET TALK SHOW and certain proprietary technology rights. Additional interest expense related to $2.5 million of debentures issued by us in January 1999 to certain stockholders. RESULTS OF OPERATIONS-PREDECESSOR YEARS ENDED DECEMBER 31, 1997 AND 1998 REVENUES: The Predecessor's revenues increased 137% from $689,967 in 1997 to $1,636,422 in 1998. The increase was primarily related to $813,400 in additional sponsorships sold on the Predecessor's television show, NET TALK LIVE! THE INTERNET TALK SHOW, in 1998. Additionally, the Predecessor had $259,300 more revenue related to infomercial productions in 1998 than in 1997. 33
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OPERATING EXPENSES: PRODUCTION AND MEDIA COSTS. Production and media costs increased $348,764, or 59%, from $590,704 in 1997 to $939,468 in 1998. This increase was primarily related to higher revenues recorded during the year ended December 31, 1998. As a percentage of revenues, production and media costs decreased from 86% in 1997 to 57% in 1998. The decrease in costs as a percentage of revenues was primarily related to the higher margin revenue recorded in 1998 related to the sale of sponsorships on the Predecessor's show, NET TALK LIVE! THE INTERNET TALK SHOW. There are very few incremental costs associated with the sale of advertising and sponsorships on NET TALK LIVE! THE INTERNET TALK SHOW in comparison to the costs associated with the production of an infomercial. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses increased 136% from $284,370 in 1997 to $670,953 in 1998. As a percentage of revenues these expenses were constant at 41%. The largest increase in selling, general and administrative expenses was related to employee-related costs which increased by $171,000 from 1997 to 1998. The increase in employee-related costs comprised 44% of the total increase in selling, general and administrative expenses for the years ended December 31, 1997 and 1998, and were largely related to supporting the growth of NET TALK LIVE! THE INTERNET TALK SHOW. Facilities expense, professional service expense and other general corporate expenses increased from 1997 to 1998 to support the growth of the Predecessor. DEPRECIATION AND AMORTIZATION. Depreciation expense increased $14,393 from $40,515 in 1997 to $54,908 in 1998 primarily due to the addition of certain studio and phone equipment related to the Predecessor's NET TALK LIVE! THE INTERNET TALK SHOW. RESEARCH AND DEVELOPMENT. Research and development costs incurred during the year ended December 31, 1998 were related to the Predecessor allocating certain personnel resources toward the development of certain technology designed to converge the radio, television and Internet mediums. OTHER INCOME (EXPENSE): INTEREST EXPENSE. Interest expense is primarily related to accrued interest on certain advances from an officer of the Predecessor. Additionally, during the fourth quarter of 1998, the Predecessor issued a note payable to one of our stockholders. The note was repaid in January 1999 in conjunction with our purchase of the Predecessor's assets. LIQUIDITY AND CAPITAL RESOURCES Our principal source of liquidity at December 31, 1999 included cash and cash equivalents of $45.5 million. Since inception, we have financed our cash requirements for investments in property and equipment and operations primarily through the sale of $2.5 million of debentures in January 1999 and the sale of $50.1 million of preferred stock in the fourth quarter of 1999. Working capital at December 31, 1999 was $45.0 million. At December 31, 1999, we had an accumulated deficit of $4.0 million. Our operating activities during the year ended December 31, 1999 utilized cash of $3.0 million. The net cash utilized during this period was to fund our growth in employee costs, infrastructure and operations, research and development and legal costs incurred in registering our intellectual property rights in the United States and abroad. Capital expenditures during 1999 consisted of purchases of equipment, furniture and software of $616,000. A source of cash for investing activities in 1999 included the cash acquired in the acquisition of entities under common control of $165,278. In January 1999, we issued a promissory note for $8.0 million to purchase substantially all of the assets of Infotainment Telepictures, Inc., consisting of rights, title and interest in certain intellectual 34
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property and NET TALK LIVE! THE INTERNET TALK SHOW. We made voluntary principal payments of $1.5 million on this note in October 1999 and $3.0 million in principal and $584,137 in accrued interest in April 2000. We currently anticipate using a portion of the proceeds of this offering to repay the remaining balance of this promissory note. Net cash provided by financing activities during the year ended December 31, 1999 was $48.8 million. Net cash provided by financing activities primarily consisted of $2.5 million of cash proceeds from the issuance of debentures in January 1999, $48.3 million in cash proceeds, net of fees and cash issuance costs, from the issuance of Series A preferred stock in September 1999 including $252,000 cash received as a subscription for Series A preferred stock that was issued subsequent to year end. Although we currently have no material commitments for capital expenditures, we anticipate a significant increase in our capital expenditures and lease commitments during the year ending December 31, 2000, consistent with anticipated growth in operations, infrastructure and personnel during 2000. This will include approximately $20 million in anticipated expenditures on hardware and software to build the network infrastructure necessary to service anticipated Internet traffic during the first twelve months following our product launch in September 2000. Additionally, in fiscal 2000, we expect to spend approximately $1.4 million for costs associated with the build-out and furnishing of our new corporate offices. Also, during the second half of fiscal 2000 we expect to spend approximately $125.0 million to manufacture and distribute at least 20 million :C.R.Q. CD-ROMs and 12 million :Cue:C.A.T. devices by the end of 2000. In February 2000, we issued a letter of credit to Tandy Corporation for approximately $15.5 million as security for our payment obligations to Tandy Corporation for the manufacture of our :Cue:C.A.T. devices. In April 2000, we issued 5,929,364 shares of Series B preferred stock to various investors for aggregate consideration of approximately $41.7 million and 5,372,593 shares of Series C preferred stock to various investors for aggregate consideration of approximately $56.6 million. We have used $6.3 million of the proceeds to repay a portion of our outstanding indebtedness and intend to use the remaining proceeds to pay expenses related to the manufacture and distribution of our :C.R.Q. CD-ROMs and :Cue:C.A.T. devices and for general corporate purposes. We currently anticipate that the net proceeds of this offering, together with cash on hand and cash expected to be generated from operations, will be sufficient to meet our anticipated needs for working capital and capital expenditures for approximately the next 12 months after the date of this prospectus. However, we may need to raise additional funds prior to the expiration of such period if, for example, we accelerate the rollout of our technology or pursue other acquisitions, or we pursue business or technology acquisitions or experience operating losses that exceed our current expectations. In any event, after such time we will need to raise significant additional capital. If we raise such funds through the issuance of equity, equity-related or debt securities, such securities may have rights, preferences or privileges senior to those of the rights of our common stock and our stockholders may experience additional dilution. We cannot be certain that additional financing will be available to us on acceptable terms when required, or at all. NON-CASH CHARGES During the second quarter of the year ending December 31, 2000, we anticipate recording a one-time charge to earnings in the amount of $37.2 million to reflect the difference between the respective issuance price of $7.03 and $10.54 and the estimated fair market value of the Series B and C preferred stock, respectively, of $11.99, as determined by a contemporaneous independent appraisal. 35
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During February and April 2000, we issued 1,128,000 and 595,000 stock options, respectively, to various employees at exercise prices ranging from $5.00 to $9.37 per option. The February options were issued at the fair market value of the common stock on the date of grant. The April options were issued below the fair market value on the dates of grant. We will recognize compensation expense for the difference between the fair market value at the dates of grant of $10.90 per share, as determined by a contemporaneous, independent appraisal, and the exercise price on the dates of grant. The compensation will be deferred and will be amortized ratably over the applicable vesting period for the April stock options. In April 2000, we issued two warrants to an affiliate of National Broadcasting Company, Inc. to purchase 3,752,445 and 4,505,165 shares, respectively, of common stock at per share exercise prices of $5.00 and $10.54, respectively. We valued the warrants using the Black-Scholes option-pricing model at $31.7 million and $31.4 million, respectively, based on the following assumptions: - volatility of 70.0%; - risk free interest rate of 6.5%; - expected life of five years; and - zero dividend yield. We recognized a one-time charge to earnings for the fair market value of these warrants on the date of grant. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133 (SFAS No. 133), "Accounting for Derivative Instruments and Hedging Activities," which establishes accounting and reporting standards for derivative instruments and hedging activities. SFAS No. 133, which will be effective for us for the fiscal year and quarters beginning after June 15, 2000, requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. During June 1999, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("FAS") No. 137, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES-DEFERRAL OF THE EFFECTIVE DATE OF FASB STATEMENT 133. The Statement defers the effective date of FAS 133 to fiscal 2001. We are evaluating FAS 133 but do not expect the potential effect of adopting the provisions of SFAS No. 133 to have a significant impact on our financial position, results of operations, and cash flows. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101, REVENUE RECOGNITION IN FINANCIAL STATEMENTS ("SAB 101"), which provides guidance on the recognition, presentation and disclosure of revenue in financial statements filed with the Commission. SAB 101 outlines the basic criteria that must be met to recognize revenue and provides guidance for disclosure related to revenue recognition policies. We believe that SAB 101 will not have a material effect on our financial statements. 36
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BUSINESS OVERVIEW We are a company whose technology allows media companies, manufacturers and virtually all organizations to instantly and easily link their products with web pages deep within websites. Until we release our technology, we believe that it is not possible for these companies to realize the full value of their Internet efforts, because their websites have to be entered through their front pages, often making access to a desired web page time-consuming and difficult. Our technology includes our :C.R.Q. software and our :Cue:C.A.T. device, which will enable a broadcast viewer or reader of print media to immediately access relevant information or conduct e-commerce activities on a web page deep within a website without inputting lengthy website addresses or conducting time-intensive website navigation. Our :C.R.Q. software will respond to a digital signal, referred to as a ":Cue," currently transmitted through an audio cable from any television or other electronic media source, and direct a user's personal computer to open any specified web page regardless of how deep the web page is within a website. Our :Cue:C.A.T., a hardware device similar in size to a computer mouse, will enable an Internet user to scan our proprietary codes in print media, referred to as "Print :Cues," or existing bar codes on consumer products to link the user to a designated web page. In addition, each time a user uses our technology to open a web page, our Virtual Network will border the user's browser. The Virtual Network will display banner advertisements with special vendor offers targeted to the preferences of each user and will also have a series of tabs that, when clicked, will display information related to the specified subject. Our :C.R.Q. and :Cue:C.A.T. technology and our Virtual Network will be available free to consumers. We believe that our technology will empower media companies and corporate advertisers to enhance their content and to transform television broadcasts or other electronic media, print media or items bearing Print :Cues or bar codes into powerful new advertising, promotional or e-commerce opportunities. We plan to achieve widespread distribution and adoption of our technology through our strategic partnerships with major television and cable networks, local station groups, magazine and newspaper publishers, merchants and direct marketers. We intend to initiate a nationwide roll-out of our technology in September 2000 and plan to distribute, free to the public, at least 50 million :C.R.Q. CD-ROMs and 50 million :Cue:C.A.T. devices by the end of 2001. MARKET OPPORTUNITY The Internet has emerged as a global medium for communications, information and commerce and is dramatically changing the competitive environment in which companies operate. Companies are investing billions of dollars in the development, execution and promotion of Internet strategies. The growth in both the number of Internet users and the volume of e-commerce creates significant challenges and opportunities for businesses across multiple industries. Currently, we believe that advertising for websites through traditional mass media is limited by an Internet user's ability to recall a website home page address and, once at the home page, to navigate the website through perhaps multiple web pages to reach the desired destination. The proliferation of websites, as well as of web pages within each corporate website, creates a fundamental challenge of facilitating interaction with Internet users. We believe that our technology provides powerful solutions for a number of these challenges as well as a means to take advantage of new opportunities. BROADCAST MEDIA Television is one of the most pervasive communications media in society today. According to Nielsen Media Research, there were approximately 99 million television households in the United States in August 1999. Television advertising is generally considered to be one of the most effective methods of building brand and general consumer awareness of products and services. McCann 37
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Erickson, Inc., a market research firm, estimates that $47 billion was spent on television advertising in 1998. Approximately $91 billion of goods and services were purchased through direct response television programming and advertising in 1998 according to the Direct Marketing Association. Nevertheless, traditional television broadcasting, cable and direct broadcast satellite television systems do not provide an integrated means for viewers to respond to programs and advertisements without the addition of set-top boxes or other add-on technologies. Although television is pervasive and effective in reaching mass audiences, television programmers face several challenges. Advertisers are increasingly seeking highly targeted marketing programs that will generate measurable returns on investment. This trend toward targeted marketing is intensifying the pressure on television programmers to efficiently convert viewers into customers of its advertising clients. In addition, as the reach and popularity of television has grown, so too has the amount of programming available to viewers. As television becomes more fragmented and the competition for viewers increases, networks and other television programmers must find new ways to attract viewers and increase viewer loyalty. Viewer loyalty determines network ratings that ultimately determine advertising spot rates. We believe that broadcasters view the Internet as an ideal interactive medium through which they can provide consumers with greater content, appeal to individualized interests and create opportunities for commerce. Broadcasters are devoting increasing resources to website development, content and promotion. The reach of television and growth of the Internet create an opportunity for broadcasters to drive viewers either to their websites or to the websites of their advertising clients. According to 24/7 Media, in January 1999, there were 33 million U.S. households connected to the Internet, of which 23 million households had a computer in the same room as their television set. Furthermore, 18 million households, or 55% of all households connected to the Internet, use the Internet while watching television. PRINT MEDIA Print media permeate the consumer world in the form of newspapers, magazines, catalogs, coupons and direct mail and represent a larger share of total advertising and marketing expenditures than broadcast media. According to industry sources, advertising expenditures made in the following print media categories in the U.S. in 1998 were: - $87 billion on goods purchased from print catalogs; - $40 billion on direct mail advertising; - $44 billion on newspaper display and classified advertising; and - $14 billion on advertising in trade and consumer magazines. Traditional publishers are experiencing competitive pressures from the electronic distribution of information and content. Information in print is static and often out of date by the time it reaches the reader; as a result, consumers increasingly access the Internet for more timely or relevant information. We believe that publishers are concerned about the growing competitive threat posed by web-based classified advertising. Classified advertising accounted for approximately 40% of all advertising revenues for newspaper publishers in 1998. Publishers are investing heavily in Internet strategies to leverage content, create cross-selling synergies, maintain readership and develop new revenue streams. CONSUMER PRODUCTS The use of bar codes on consumer products is widespread. These codes appear on everything from food and other consumer products to drivers' licenses and prescription drug containers. Currently, there are over 40 different bar code topologies in commercial use, including UPC, ISBN and EAN. There 38
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are tens of millions of active bar codes in use. Currently, these bar codes are used primarily to track inventory, assist in quality control, track product pricing and perform other internal corporate tasks. To date, no technology has been widely adopted that connects the millions of bar codes to the Internet. USER WEB EXPERIENCE While the growth of the Internet has attracted Internet users at an unprecedented pace, the volume of online information has made it increasingly difficult for users to navigate the Internet effectively and efficiently. The total number of websites on the Internet grew 79% in 1999 to 3.6 million sites. Internet users currently rely on Internet search engines or directories of websites and web pages to locate information and make online purchases. Search engines typically require users to construct keyword or complex search strings that often result in hundreds or thousands of matches. In addition, we believe that these methods often result in incomplete searches. The difficulty of online navigation does not end when the desired website is found. Once there, users often face the difficult task of searching an overwhelming amount of information. Major corporate websites contain many layers of web pages, which often make finding relevant information a frustrating and time-consuming experience. As websites continue to proliferate and grow in size and complexity, we believe that users will increasingly need a quicker, more direct link to their intended destinations. Search engines will continue to have useful applications on the Internet, but we believe that users want a more precise tool that takes them directly to a specific web page deep within a website. THE DIGITALCONVERGENCE.:COM SOLUTION Our technology enables companies to implement new Internet strategies that enhance content, improve the targeting and overall effectiveness of advertising and generate new revenue sources. Our technology enables users of virtually any form of media or product to interact instantly and easily with the Internet to obtain relevant information or conduct e-commerce activities. We believe that our technology will provide the solution to the desire of broadcasters, publishers, merchants and advertisers for a simple, cost-effective means of leveraging the Internet across all forms of traditional media. INTERNET ENHANCED BROADCASTING Our :C.R.Q. software responds to a :Cue from any television or other mass media source and directs a user's personal computer to open any specified web page within a website. A broadcast can be Internet Enhanced by simply embedding a :Cue in the broadcast. Unlike current television content and advertisements in which a website address is briefly displayed on the television screen, Internet Enhanced programming will load the web page on a user's web browser for immediate access or store the web page address for later use. With our technology, viewers will no longer need to recall and manually enter a website address. Broadcasters can now offer Internet Enhanced interactive programming to their viewers and more valuable interactive ads to their advertisers and advertising agencies. For example, news programming can become instantly interactive, allowing local stations to enhance their content, capture Internet advertising revenues and use their scale and promotional muscle to become significant local portals. Our :C.R.Q. technology is designed to make television programming more appealing to all viewers and particularly to younger demographic groups which are highly attractive to advertisers and difficult to reach. In an era of declining audience ratings and shares, we believe that we offer broadcasters the means to increase revenue dramatically. By placing :Cues in their television spots, advertisers can aggregate large viewing audiences, direct them to specific web pages containing content designed to reinforce their branding, and offer specific 39
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promotions and e-commerce opportunities. Accordingly, our technology will offer a platform for broadcasters to enhance content and advertisers to deliver immediate buying opportunities to their target consumers. As a result, we believe broadcasters will be able to demand premium rates for Internet Enhanced advertisements. Our technology allows users to take advantage of enhanced content and e-commerce opportunities without interrupting or overlaying the original broadcast. These opportunities are experienced on the personal computer, allowing viewers or groups of viewers to continue watching the broadcast without disruption. INTERNET ENHANCED PRINT Our :Cue:C.A.T. device will enable an Internet user to scan our Print :Cues to link the user to a particular web page designated by the publisher or corporate advertiser. A print advertisement can be Internet Enhanced simply by printing a Print :Cue on the advertisement, which, with a swipe of a :Cue:C.A.T. device, can immediately direct the reader to in-depth information impractical to include in the printed version. In this way, publishers gain a powerful new tool to supplement existing printed content and drive traffic deep in their websites, thereby increasing advertising revenue on the website and generating additional e-commerce opportunities. Print advertisers, like their broadcast counterparts, now have the ability to create ads that place the consumer one swipe away from an e-commerce transaction. We believe that newspapers, in particular, are concerned about the growing competitive threat posed by web-based classified advertising and will now be able to offer Internet Enhanced classifieds. For example, a Print :Cue placed in a classified ad can take a reader directly to a web page showing photographs of a house, car or boat advertised for sale or a job application form for an advertised employment opportunity. INTERNET ENHANCED PRODUCTS AND OTHER :CUE:C.A.T. APPLICATIONS We are completing a massive database that links existing bar codes, including UPC, ISBN, EAN and other codes, to websites, thereby enabling manufacturers to utilize their existing product codes for advertising and other marketing purposes. Our technology can transform any off-the-shelf product into an interactive advertisement. For example, 15 billion soda cans on store shelves around the world can be transformed into 15 billion interactive advertising, promotional and e-commerce opportunities. Because our :Cue:C.A.T. technology scans substantially all bar codes and will not require consumer goods manufacturers to alter labels in any way, our solution is an inexpensive and unobtrusive way of turning an existing label into a powerful new marketing tool. Manufacturers will be able to offer alternative ideas for consumption of their products and brand their other products on websites we link to their Internet Enhanced bar codes. Most importantly, manufacturers will be able to update the content on the website to ensure that their customers are never exposed to stale information or expired promotional offers. Our technology can be easily applied to a wide range of other products, such as prescription drug labels, bank statements, insurance and brokerage statements, credit cards or instruction manuals. KEY ADVANTAGES We believe that our technology solution represents a revolutionary approach to marketing. Our solution provides the following key advantages: - POWERFUL MEANS TO ENABLE MASS MEDIA TO LEVERAGE THE INTERNET. Our technology allows television broadcasters, television and cable networks, newspaper, magazine and catalog publishers and other mass media companies to provide Internet Enhanced programming and advertising. Broadcasters and publishers do not need to make extensive technology build-outs or investments 40
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in order to use our :C.R.Q. or :Cue:C.A.T. technology. We believe that our :C.R.Q. technology can greatly increase the effectiveness of advertising in an era of declining market shares and ratings for television broadcasters and many cable networks. Newspaper and magazine publishers and direct marketers can deploy :Cue:C.A.T. devices to enhance the power of advertisements, catalogs and articles to drive online direct sales. Broadcasters, publishers, merchants and advertisers can use our technology and our associated database and related services to monitor, measure and analyze, on a real time basis, the number of confirmed advertising deliveries for each broadcast of an advertisement and to refine advertising campaigns quickly to target consumers more effectively. - ATTRACTIVE TECHNOLOGY FOR INTERNET USERS. Our technology offers Internet users numerous benefits and complements rather than modifies Internet user behavior. We plan to make our technology widely available and to distribute it free to the public. Users can download our :C.R.Q. software or install a :C.R.Q. CD-ROM or :Cue:C.A.T. device onto a computer easily and quickly. Once installed, our :C.R.Q. technology links a television viewer to the Internet instantly upon transmission of an audio :Cue, and a :Cue:C.A.T. device links a user to the Internet instantly upon the simple swipe of the :Cue:C.A.T. device over an Internet Enhanced bar code or Print :Cue on a newspaper, magazine, catalog, prescription drug container, credit card statement, consumer product or other print advertising medium. Users have full control over their use of our technology and therefore view only the Internet-based information and advertising that interests them. Internet users will benefit from our technology because it enables them to execute easier, highly targeted Internet searches and navigation, and allows them to experience Internet Enhanced television and print media experiences and improved e-commerce opportunities. Furthermore, we believe that our relationships with broadcasters, publishers, manufacturers and other licensees of our technology will create applications that appeal to Internet users and will increase the adoption and usage of our products. - COMPELLING OPPORTUNITY FOR MERCHANTS. We provide merchants with an innovative and efficient means to achieve their Internet objectives. Our technology empowers merchants to instantly link virtually any type of media or product to the merchants' websites at no cost to the public. We have designed our :C.R.Q. software to empower merchants to utilize a single :Cue to direct users to a web page deep within a website depending on the particular Internet user's individual profile. Our technology takes users directly to a transaction page without the trouble of clicking through numerous links or needlessly searching through a website. STRATEGY Our objective is to establish our technology as the primary means for television and cable networks, local television broadcasters, newspaper, magazine and catalog publishers, other mass media companies, as well as corporate advertisers, to link their their broadcasts, publications and products to the Internet. To achieve this objective, we have adopted the following strategies: LEVERAGE MEDIA RELATIONSHIPS IN ORDER TO SUPPORT ADOPTION AND SUSTAIN OUR FIRST MOVER ADVANTAGE In order to build awareness of our brand and support adoption of our products, we have established strategic relationships with several well-established broadcasting and print media companies, including National Broadcasting Company, Inc., Belo Corp., Forbes Inc., The Milwaukee Journal and Wired Magazine. We expect that these relationships, taken together, will provide us with broad media exposure in six of the top ten U.S. media markets and a number of smaller markets, for total coverage of approximately 40% of U.S. households. In addition, we are in discussions with broadcast media companies covering approximately an additional 20% of U.S. households. By coordinating our distribution strategy with the promotional, advertising and content support of our media partners, we believe we will be able to attain widespread consumer awareness of our brand and quickly build 41
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interest in our technology. Once consumers are introduced to our technology, we believe they will quickly adopt the technology due to the ease with which it allows users to access relevant, but difficult to find, websites. As consumer and media partner usage increases, we believe that the familiarity and ubiquity of our technology will deter consumers and media partners from adopting competing products. We intend to continue to pursue strategic relationships with companies that can help us establish awareness of our brand and provide further penetration of our selected media markets. As we continue discussions with additional partners, we intend to convey to them the unique opportunities that our technology brings to traditional media companies. Specifically, we intend to highlight that our technology: - allows advertisers to direct large numbers of viewers from television broadcasts and print media directly to specific web pages; and - provides incremental revenue opportunities through the sale of Internet Enhanced advertising. EXECUTE A NATIONWIDE ROLL-OUT OF OUR :C.R.Q. AND :CUE:C.A.T. TECHNOLOGY We intend to widely distribute our products at no cost to consumers. To meet this goal, we have entered into strategic relationships to assist in distributing :C.R.Q. CD-ROMs and :Cue:C.A.T. devices. We have entered into an agreement with Tandy Corporation in which Tandy has agreed to manufacture and distribute our products through its over 7,000 owned or franchised RadioShack retail outlets. Additionally, we have established a distribution arrangement with Forbes Inc. in which Forbes has agreed to mail our :C.R.Q. and :Cue:C.A.T. products to its approximately 750,000 subscribers. We have entered into similar agreements with The Milwaukee Journal and Wired Magazine to distribute our products to their subscribers. We intend to aggressively pursue additional strategic partnerships that will assist us in executing the nationwide roll-out of our :C.R.Q. and :Cue:C.A.T. technology. ESTABLISH OUR TECHNOLOGY AS THE "SYSTEM STANDARD" ON PERSONAL COMPUTERS We intend to establish "system standard" strategic relationships with major computer manufacturers pursuant to which the manufacturers will agree to pre-install our :C.R.Q. software on, and to include a :Cue:C.A.T. device with, each personal computer sold. We believe that bundling our products with new personal computers will expose a greater number of consumers to our technology and will solidify our position as the market standard. DEVELOP MULTIPLE REVENUE STREAMS FROM MULTI-BILLION DOLLAR ADVERTISING MARKETS Initially we intend to generate revenue through usage fees paid by our print and television partners. Our technology is also well-suited for other applications, including radio broadcasting, wireless communications and other applications. In addition, we intend to derive revenue from banner advertisements on our Virtual Network. As adoption of our :C.R.Q. and :Cue:C.A.T. technology grows, we believe other practical applications of our technology will emerge. DEVELOP SOPHISTICATED RESEARCH AND DATA-MINING CAPABILITIES AS A VALUE-ADDED SERVICE TO CUSTOMERS We intend to require each user of our technology to provide basic individual information to register and activate our :C.R.Q. and :Cue:C.A.T. technology. In addition, we will be able to track how many people viewed or interacted with an advertiser's website as a result of a :Cue. We plan to use this type of information to develop a substantial database reflecting users' demographic information, interests and preferences and Internet activity to generate summary data reports for advertisers and merchants. These firms would use our reports and data mining capabilities to tailor advertising campaigns, banner ads and website content to appeal to targeted consumer segments. Under our 42
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privacy policy, we will not make individual user information available to outside parties and will use the information internally only with a user's express permission. PURSUE INTERNATIONAL MARKETS We believe that there is a substantial market for our technology outside the United States. Our :C.R.Q. and :Cue:C.A.T. technology does not require foreign language translations or technical modifications to be compatible with specific broadcasting or recording technology used in foreign markets. Instead, international broadcasters, publishers, advertisers and merchants can place :Cues in any type of electronic or print medium and direct users to websites using any language. We intend to expand our international presence aggressively by adding sales and marketing personnel and establishing strategic relationships with international partners to capitalize fully on international market opportunities. We have hired a president for our International Group and anticipate opening an office in London within the next several months. We intend to commence international deployment of our technology during 2001. RECENT DEVELOPMENTS PREFERRED STOCK FINANCINGS. In April 2000, we issued 5,929,364 shares of Series B preferred stock and 5,372,593 shares of Series C preferred stock to various investors, including Belo Corp., The Coca-Cola Company, The E.W. Scripps Company, Spielberg/Katz Associates, LLC, Tandy Corporation and Young & Rubicam, Inc., for aggregate consideration of approximately $98.3 million. All outstanding shares of our preferred stock will be automatically converted into our common stock upon completion of this offering. We will recognize a one-time expense in the amount of $37.2 million to reflect the difference between the issuance price of $7.03 per share for the Series B preferred stock and $10.54 per share for the Series C preferred stock and the estimated fair market value of the Series B and C preferred stock of $11.99 per share, as determined by a contemporaneous, independent appraisal. In April 2000, we issued two warrants to an affiliate of National Broadcasting Company, Inc. to purchase 3,752,445 shares and 4,505,165 shares, of our common stock at per share exercise prices of $5.00 and $10.54, respectively. We are required to issue additional warrants to National Broadcasting Company, Inc.'s affiliate with a per share exercise price of $10.54, depending on the number of shares we reserve for issuance under our 1999 Stock Option Plan. The warrants will terminate in April 2005. We valued the warrants using the Black-Scholes option pricing model at $31.7 million and $31.4 million, respectively. We recognized a one-time charge to earnings for the fair market value of these warrants on the date of grant. PRODUCTS AND SERVICES Our products and services consist of four integrated components: - :C.R.Q., our software application; - :Cue:C.A.T. device, a hardware device similar in size to a computer mouse; - our Virtual Network, an advertising application that borders the Internet user's browser window; and - the aggregation, analysis and marketing of targeted consumer demographic data collected through use of our :C.R.Q. and :Cue:C.A.T. technology and our Virtual Network. :C.R.Q. Our patented :C.R.Q. software will respond to an audio signal, or :Cue, from any television or other mass media source and direct a user's personal computer to open any specified web page within a website, regardless of how deep the web page is within that website. Our :C.R.Q. software will be available for downloading onto a personal computer from our websites, our strategic partners' websites 43
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and promotional CD-ROMs. When initially downloading :C.R.Q. software, a consumer will be required to register as a user and will be offered incentives to provide additional personal preference and demographic data. Depending on the amount of information a user provides, a :Cue will direct a user's personal computer to a designated web page of particular interest to that user. Our :C.R.Q. software will listen for the :Cue, which television viewers will hear as a low level tone one-third of a second in duration. An audio cable connecting the television and the computer will transmit the signal to the computer. We have also designed a wireless version of our :C.R.Q. technology in which a wireless transmitter and receiver replace the audio cable, allowing wireless transmission. We expect to make our wireless version of our :C.R.Q. software available for sale to consumers in September 2000. A user may use our :C.R.Q. technology in several ways. For example, if the user selects the active mode, the :C.R.Q. technology will immediately launch the computer's web browser to retrieve the targeted web page. A user may also choose to collect :Cues in a passive mode similar to receiving e-mail messages and then automatically launch the web browser at a later time chosen by the user. Our :C.R.Q. software is compatible with all available web browsers. :Cues can be embedded in any type of video or audio media, including television broadcasts, CD-ROMs, DVDs and video tapes, to create Internet Enhanced broadcasts and commercial advertisements. Through our :C.R.Q. technology, television and cable broadcasts become an instant and direct link and gateway to the Internet. The following are examples of Internet Enhanced commercial advertising, content and event promotion: - COMMERCIAL ADVERTISING. A television commercial for a particular automobile model will contain a :Cue that directs the viewer's web browser to that model's specific web page within the manufacturer's website. The web page will include detailed information concerning that model's features and pricing, dealerships and related Internet sites. - CONTENT. A local television station may differentiate its newscast with Internet Enhanced weather reporting. While reporting the weather, the station will broadcast a :Cue that directs the viewer's web browser to the broadcaster's web page that includes detailed forecast information for each city and town in the viewing area. - EVENT PROMOTION. A television broadcast of a major league baseball game will contain a :Cue that directs the viewer's web browser to the team's website. The web page may contain information such as players' statistics and functionality to purchase tickets and memorabilia. :CUE:C.A.T. Our :Cue:C.A.T. device, a hardware device similar in size to a computer mouse, enables an Internet user to scan bar codes and Print :Cues included on products and in printed material to link users to a particular website designated by the manufacturer or publisher. The swipe of a :Cue:C.A.T. device over a Print :Cue or bar code will direct a user to in-depth information impractical to include in print copy. To install a :Cue:C.A.T. device, a user simply installs our :C.R.Q. software and plugs the :Cue:C.A.T. device into his personal computer. Our :Cue:C.A.T. device reads substantially all known existing bar code topologies as well as our proprietary codes that we generate to create Internet Enhanced print media and products. Through our :Cue:C.A.T. technology, publishers gain a powerful new tool to supplement existing printed content. In turn, publishers will be able to attain higher advertising revenue on their websites and potentially generate additional e-commerce opportunities. Marketers will be able to transform the billions of consumer products on retailers' shelves into powerful advertising, promotional and e-commerce opportunities. Examples of the use of :Cue:C.A.T. devices include the following: - A newspaper advertisement for a department store's clothing sale will include a Print :Cue that directs readers' web browsers to the department store's web page featuring photographs of a complete line of clothing products and ordering information. 44
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- A book by a noted author will include a Print :Cue that directs readers to the author's web page within the publisher's website that features summaries of the author's other books and ordering information. - An advertisement for a shampoo or the shampoo bottle itself will include a bar code that directs the recipient's web browser to the advertiser's web page containing an interactive form to request a free sample or provide a coupon for the next purchase. - A prescription drug bottle from a pharmacy will include a bar code that directs the recipient's web browser to the drug manufacturer's web page containing information regarding the illness for which the drug was prescribed, side effects of the drug, and additional products that may be useful in treating the illness. - A credit card statement will include a bar code that directs the card holder's web browser to the credit card company's web page where the card holder can file a complaint with the credit card company regarding erroneous charges or other types of disputes. Additionally, the bar code could direct the card holder's web browser to the credit card company's web page containing e-commerce possibilities or transaction history. THE VIRTUAL NETWORK Each time our :C.R.Q. software or :Cue:C.A.T. device launches a user's web browser to a specific web page, an "L"-shaped area called the "Virtual Network" will appear on the border of the user's Internet web browser window. The Virtual Network will be populated with banner advertisements and a series of tabs that, when clicked, will display information related to that subject. The Virtual Network is only visible when an individual is using our technology. Banner advertisements and tabs will be customized to each user's profile, displaying information and promotional offers designed to strongly appeal to the individual's interests. The Virtual Network will reach mass audiences, allowing advertisers to offer complementary products via banner advertisements and providing us with an additional channel to sell sponsorships and banner advertisements. We believe that with modest usage of our :C.R.Q. and :Cue:C.A.T. technology, the number of original ad impressions we would generate would exceed those of the largest websites currently in operation. DATABASE RESEARCH AND MARKETING We intend to require each user of our technology to provide basic individual information in order to register and activate our :C.R.Q. technology. Additionally, we plan to offer promotional and other incentives to encourage users to provide more detailed individual information. We plan to use this information to develop a substantial database of demographic information reflecting users' interests and preferences, tracking of Internet behavior related to :Cues, and viewing patterns of Internet Enhanced content. This information will be used to better tailor our Virtual Network banner ads and special vendor offers to each user, as well as to generate summary demographic data reports for advertisers and merchants. These firms would use our reports and data mining expertise to tailor advertising campaigns, banner ads and website content to appeal to targeted consumers. Under our privacy policy, we will not make personal user information available to outside parties and will only use the information internally with a user's express permission. We will provide some summary demographic data to purchasers of :Cues free of charge. For more complex or detailed demographic data, we intend to charge advertisers a flat fee per month, plus a small charge per record. 45
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TECHNOLOGY INFRASTRUCTURE SERVER NETWORK We will use a network of approximately 25 servers to be housed in several colocation facilities located throughout the United States. Currently, we have an agreement with Exodus Communications to house our servers in its facilities. We selected each of these facilities for its strategic location, network availability and ability to meet the demands of a 24 hours a day, 7 days a week environment. We are currently in discussions with a number of other web hosting services companies, and we expect to finalize an agreement with them prior to the effective date of this prospectus, at which time we intend to complete the build-out of our entire server network. In addition, we designed our system and network architecture specifically to handle large numbers of simultaneous hits to our customers' website servers that will result from the widespread use of our :C.R.Q. technology. Our large number of strategically located servers, combined with ISP caching, provides several levels of redundancy to prevent traffic bottlenecks and extreme loads on our customers' website servers. As an additional precaution, we plan to enter into agreements with content streaming companies that will help our clients and us deliver content to Internet users more efficiently. HARDWARE AND SOFTWARE INFRASTRUCTURE We use Compaq Nonstop-TM- Himalaya-Registered Trademark- servers that offer availability 24 hours a day, 365 days a year. These servers have the flexibility to scale systems and solutions as desired and provide open access to our :C.R.Q. application software. Our software has been constructed in a highly scalable, easily upgradable and low-maintenance manner. Developing our software with Microsoft's Visual Studio-Registered Trademark- C++ offers greater design and maintenance flexibility and the abundance of trained personnel available in the marketplace. PROCESS After our :C.R.Q. software on a user's computer identifies a :Cue from a media source, the :Cue is then sent to our server network where it is translated into a URL. This translation process includes both a direct tie in and a lookup for a more specific website address based on demographic information. Once the URL is determined, it is transferred back to the Internet user's computer operating system where the appropriate registered program will launch and connect to the specified URL. Our technology not only allows the URLs to launch web browsers to web pages, but it also allows the URLs to launch other applications. MARKETING AND PROMOTION We have designed our marketing and promotion strategy to attain widespread adoption of our technology by Internet users and to establish strong partnerships with major networks, local station groups, cable networks, publishers, merchants and direct marketers. We expect to employ multiple channels to achieve our goals, including: USER ADOPTION - MASS DISTRIBUTION. We intend to initiate a nationwide roll-out of our technology in the United States beginning in September 2000 and plan to distribute free to the public at least 50 million :C.R.Q. CD-ROMs and 50 million :Cue:C.A.T. devices by the end of 2001. We intend to distribute our :C.R.Q. CD-ROMs and :Cue:C.A.T. devices without charge to the public through the over 7,000 RadioShack retail outlets nationwide, through our strategic partners and through our websites. For example, Forbes Inc. has agreed to mail :C.R.Q. CD-ROMs and :Cue:C.A.T. devices to its approximately 750,000 subscribers prior to mailing its September 2000 issue of BEST 46
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OF THE WEB magazine. Also, Wired Magazine has agreed to mail :C.R.Q. CD-ROMs and :Cue:C.A.T. devices to its approximately 375,000 subscribers, and The Milwaukee Journal has agreed to mail :Cue:C.A.T. devices to subscribers of the Milwaukee Journal Sentinel. - LEVERAGE STRATEGIC RELATIONSHIPS. We have established strategic relationships with a major television network, local station groups, cable networks, publishers and direct marketers. We expect our strategic partners to promote our technology to consumers by marketing their programming and printed materials as being Internet Enhanced in order to increase viewership and readership. We also anticipate that our strategic partners will aggressively market our technology to their advertisers in an effort to increase advertising revenues. To assist our strategic partners in their efforts, we have limited the number of audio :Cues that will be broadcast in any particular market in order to create demand and enhance the value of these :Cues. - TRADITIONAL ADVERTISING. We intend to begin a program of print, radio and television advertising to create public awareness of our technology. We will produce television commercials which will be placed in media by our strategic partners, affiliate kits given to our licensees, and an infomercial which we will produce and place in appropriate media. We intend to utilize NET TALK LIVE! THE INTERNET TALK SHOW, which reaches approximately 550 million homes per week, to develop public interest and knowledge of our :C.R.Q. and :Cue:C.A.T. technology. - PROMOTIONS. We intend to engage in commercial giveaways sponsored both by us and local sponsors and to institute :C.R.Q. Club, an organization of Internet users who utilize our technology. We anticipate that :C.R.Q. Club members will receive free gifts from some of our strategic partners and that membership will encourage consumer loyalty to us. COMMERCIAL ADOPTION AND MAINTENANCE - LEVERAGE SENIOR MANAGEMENT RELATIONSHIPS. We have an experienced management team that has many established relationships with broadcasters, publishers, manufacturers and direct marketers. We intend to leverage these relationships to encourage the adoption of our technology, as well as to establish additional strategic partnerships. See "Management--Directors and Executive Officers." - SALES TEAM. In order to assist our strategic partners in executing a successful launch strategy and to ensure Internet user acceptance, we are building a diverse and highly skilled executive team to manage the sales and implementation of our technology by various media-related companies. The media team consists of executives from the broadcasting, cable, print and advertising disciplines. In addition to guiding the implementation of production procedures and the integration of our technology into existing business practices, our team will provide insight and guidance regarding local events and roll-outs to maximize Internet user acceptance. We expect to form five media teams to oversee the sales process for broadcast and cable networks, local television stations, newspapers and magazines, studios and production companies and advertising agencies. Each team will consist initially of a primary manager, as well as up to four account executives, depending on the needs of our customers. - STRATEGIC ACCOUNT MANAGEMENT TEAM. We are forming a team to manage the accounts of our customers. We are employing people with substantial experience in each market targeted by us, including television broadcasting, print media, direct marketing and cable networks, to assist our customers in developing compelling content for their websites. Each of our customers will be assigned to a strategic account manager. Currently, we have two strategic account managers and we expect to hire an additional twelve to fifteen strategic account managers over the next 18 months. 47
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- INTERACTIVE DATABASE. We are completing a massive database that links existing UPC, ISBN, EAN and other codes to web pages, thereby enabling manufacturers to utilize their existing product codes for advertising purposes. We intend to activate substantially all of these bar codes when our :Cue:C.A.T. technology is launched and will provide manufacturers with one free year in which to evaluate the results. At the end of the first year, we intend to provide manufacturers with the results to demonstrate the effectiveness of our technology. - TRADE SHOWS. In order to maintain a high level of visibility among media partners and corporate clients, we expect to participate in three to four trade events per year, such as the National Association of Television Programming Executives conference. STRATEGIC RELATIONSHIPS We believe that our strategic relationships provide us with significant opportunities to gain market acceptance for our technology. We maintain strategic relationships with, among others, the following companies: BELO CORP. We entered into an agreement with Belo Corp. on September 29, 1999, under which we granted Belo Corp.'s newspapers and television stations an exclusive license to deploy our technology for local programming in their markets. Belo Corp. currently operates 18 television stations in 16 markets reaching 14% of the total U.S. television audience and owns 7 newspapers in 7 markets. FORBES INC. We entered into an agreement with Forbes Inc. on January 13, 2000, to launch Internet Enhanced content and advertising in its September 2000 issue of BEST OF THE WEB magazine. Forbes Inc. has agreed to promote this issue as the first Internet Enhanced business magazine and thereafter to Internet Enhance FORBES magazines for a one-year period. Forbes Inc. has also agreed to mail :C.R.Q. CD-ROMs and :Cue:C.A.T. devices to its approximately 750,000 subscribers prior to mailing its September 2000 issue of BEST OF THE WEB magazine. The term of the agreement ends on August 31, 2001. NATIONAL BROADCASTING COMPANY, INC. We entered into an agreement with National Broadcasting Company, Inc. on April 18, 2000, to license our :C.R.Q. software to National Broadcasting Company, Inc. and certain of its affiliates for a term ending on March 1, 2002. As part of the agreement, we granted National Broadcasting Company, Inc.'s owned and operated television stations the exclusive right to use :Cues in local programs, except in the Dallas market where Belo Corp. has exclusive rights to use our :C.R.Q. software. The term of the agreement ends 18 months after our launch date. TANDY CORPORATION. We entered into an agreement effective on December 6, 1999, with our stockholder Tandy Corporation to act as a product sourcing manager for the production of our :Cue:C.A.T. devices. Our principal retail distribution channel for :Cue:C.A.T. devices will be Tandy's owned or franchised RadioShack retail outlets. As our manufacturing and distribution partner, Tandy offers substantial advertising strength, a 25,000 person sales force, which will be trained to conduct :Cue:C.A.T. device demonstrations, and over 7,000 owned or franchised RadioShack retail outlets located within five minutes of approximately 94% of the U.S. population. The term of the agreement ends on December 31, 2001, and will automatically renew for successive one-year terms unless it is terminated by either party. The agreement can be terminated by either party at any time upon 90 days prior notice. WIRED MAGAZINE. We entered into an agreement on February 16, 2000, with Wired Magazine to launch Internet Enhanced content and advertising in three consecutive issues commencing with its October 2000 issue. Wired Magazine has agreed to promote the October 2000 issue as Internet Enhanced and has also agreed to mail :C.R.Q. CD-ROMs and :Cue:C.A.T. devices to its approximately 48
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375,000 subscribers prior to mailing the October 2000 issue. The term of the agreement ends on December 31, 2000. THE MILWAUKEE JOURNAL. We entered into an agreement on February 8, 2000, with Journal Sentinel Incorporated, an affiliate of The Milwaukee Journal, granting Journal Sentinel Incorporated the non-exclusive right to acquire Print :Cues for use within its various publications. Journal Sentinel Incorporated, Inc. has also agreed to mail :Cue:C.A.T. devices to the subscribers of The Milwaukee Journal Sentinel. We also entered into an agreement on February 8, 2000, with Journal Broadcast Group, Inc., an affiliate of The Milwaukee Journal, granting Journal Broadcast Group, Inc. the non-exclusive right to acquire :Cues for use within television programs and station promotions in the Milwaukee, Wisconsin area. The terms of these agreements end 18 months after our launch date. YOUNG & RUBICAM. By letter agreement, dated September 29, 1999, with Young & Rubicam, Inc., a principal stockholder of ours, we granted Young & Rubicam an exclusive right to resell our :C.R.Q. software and :Cue:C.A.T. devices in the United States for the period of six months after the public launch of this technology in the United States. The economic terms of this right are to be negotiated in good faith by Young & Rubicam and us. In addition, we granted to Young & Rubicam an exclusive right for a period of six months from a date to be mutually determined by Young & Rubicam and us to resell this technology outside the United States. The terms of this right are to be negotiated in good faith by Young & Rubicam and us. We also agreed that, on economic terms to be negotiated by Young & Rubicam and us, Young & Rubicam will act as our marketing and sales agent with respect to the deployment of our technology to our advertising customers or clients. By a separate letter agreement, also dated September 29, 1999, we granted Young & Rubicam a right of first refusal on our marketing and communication assignments to third parties, provided that Young & Rubicam possesses core competency to handle these assignments. The terms of each assignment are to be negotiated by Young & Rubicam and us. In addition, we granted Young & Rubicam a right to receive a percentage of revenues paid to us by clients or licensees of Young & Rubicam. This percentage will equate to a "finders" or referral fee customary for blanket licensing agreements or a commission or mark-up on the Internet Enhancement of individual advertisements that is customary in the broadcast or entertainment industries. We also agreed to recommend Young & Rubicam as our preferred provider of marketing and communications services in response to inquiries from our potential licensees or customers or from those of Young & Rubicam. The rights described in this paragraph will no longer exist when Young & Rubicam ceases to own Series A preferred stock, or at least 50% of the common stock into which Young & Rubicam's Series A preferred stock is converted upon completion of this offering. MANUFACTURING AND DISTRIBUTION Tandy Corporation has agreed to act as a product sourcing manager for the production of our :Cue:C.A.T. devices until December 31, 2001, and then for successive one-year terms if the agreement is not terminated by either Tandy or us. Tandy currently utilizes two manufacturing facilities in Asia, with which it has manufacturing subcontracts, for our manufacturing needs. Tandy has advised us that they have the capacity to devote additional manufacturing facilities to manufacture our :Cue:C.A.T. devices. Our :C.R.Q. CD-ROMs will be manufactured in at least four locations in the United States. Our :C.R.Q. CD-ROMs and :Cue:C.A.T. devices will be distributed without charge to consumers. In some cases, we expect that the costs of manufacturing and/or distributing :C.R.Q. CD-ROMs and :Cue:C.A.T. devices will be borne or defrayed by our strategic partners and by advertisers who advertise directly on :Cue:C.A.T. devices. Our principal retail distribution channel for :Cue:C.A.T. devices and :C.R.Q. CD-ROMs will be Tandy's over 7,000 owned or franchised RadioShack retail outlets nationwide. We will also distribute :Cue:C.A.T. devices and :C.R.Q. software directly to consumers, principally through promotions by our 49
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strategic partners and other advertisers and merchants. For example, Forbes Inc. has agreed to mail :C.R.Q. CD-ROMs and :Cue:C.A.T. devices to its approximately 750,000 subscribers prior to mailing its September 2000 issue of BEST OF THE WEB magazine. We are in discussions with an OEM manufacturer to bundle our :C.R.Q. software application and :Cue:C.A.T. devices with new personal computers. We intend to initiate a nationwide roll-out of our technology beginning in September 2000 and plan to distribute free to consumers at least 20 million :C.R.Q. CD-ROMs and 12 million :Cue:C.A.T. devices by the end of 2000. By the end of 2001, we plan to distribute free to consumers at least an additional 30 million :C.R.Q. CD-ROMs and 38 million :Cue:C.A.T. devices. PATENTS AND PROPRIETARY RIGHTS We rely on a combination of patent, trademark, trade secret, and copyright laws and contractual agreements to protect our proprietary technology and intellectual property rights, and our success and ability to compete are substantially dependent upon our internally developed technology and know-how. We currently own U.S. Patent No. 5,907,793, entitled "Telephone-based Interactive Broadcast or Cable Radio or Television Methods and Apparatus," U.S. Patent No. 5,925,865, entitled "Automated Check Verification and Tracking System" and U.S. Patent No. 5,594,226, entitled "Automated Check Verification and Tracking System Using Bar Code Information." In addition, we have filed approximately 50 other patent applications in the United States, and these patent applications are currently pending in the United States Patent and Trademark Office (the "USPTO"). We have also filed foreign counterpart applications for some of our pending U.S. applications. Some of these foreign applications have been filed as PCT patent applications, while others have been filed with the European Patent Office. Additional patent applications have been filed in South Korea, Japan and Taiwan. To date, we have filed approximately ten foreign patent applications. Generally, under the laws of most, if not all, of the countries where we have filed patent applications, a pending patent application affords very little, if any, legal protection to the invention described in the application, as legal protection to the invention described in the patent application only arises after a particular country's patent office approves the patent application and allows the application to issue into a patent. There can be no assurance that our pending patent applications will ever issue into enforceable patents. Also, once a patent application issues into a patent, there can be no assurance that our patent rights will afford any significant degree of protection or provide us with a competitive advantage. In particular, there can be no assurance that any such patents will not be challenged, invalidated or circumvented in the future. Failure to maintain the protection afforded by our patents may have a material adverse effect on our future revenues and ability to become profitable. Further, there can be no assurance that our patents will ultimately be found to be valid or enforceable, or that our patent rights will deter others from developing substantially equivalent or competitive products. In addition, it may be necessary for us to undertake infringement actions against others. The defense and prosecution of patent litigation is costly and involves substantial commitments of management time. Adverse determinations in patent proceedings to which we are a party could subject us to significant liabilities to third parties and require us to seek licenses from third parties. Although patent and intellectual property disputes are often settled through licensing or similar arrangements, costs associated with such arrangements may be substantial and could include ongoing royalties. Furthermore, there can be no assurance that necessary licenses would be available to us on satisfactory terms or at all. Accordingly, an adverse determination in a judicial or administrative proceeding or failure to obtain necessary licenses could prevent us from manufacturing and selling our products in one or more markets and would have a material adverse effect on us. We also seek to protect our proprietary technology, in part, through confidentiality and non-disclosure agreements with employees, consultants and other parties. Our confidentiality agreements with our employees and consultants also contain industry standard provisions requiring such individuals 50
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to assign to us without additional consideration any inventions conceived or reduced to practice by them while employed or retained by us, subject to customary exceptions. There can be no assurance that our confidentiality and non-disclosure agreements with employees, consultants and others will not be breached, that we would have adequate remedies for any breach or that our trade secrets will not otherwise become known to or independently developed by competitors. We have filed applications for registration with the USPTO for several of the trademarks we use or plan to use in our business. Some of the marks we are attempting to register with the USPTO include DigitalConvergence-TM-, DigitalConvergence.Com-TM- and the :C-TM- symbol. We are attempting to register these marks in association with various products and services provided by us. In addition, we have filed applications to register these marks mentioned above, as well as other marks, in the European Community and Japan. We plan on pursuing the trademark registration applications we have already filed and filing additional applications as we develop new trademarks. Although we have filed trademark applications for these marks, we have not received official word that any of the trademarks described in the various applications will ultimately become our registered trademarks. While our trademark applications are being reviewed by the various countries' trademark offices, many events and circumstances could arise that would prevent a given mark from ultimately being registered or from being registered in association with all of the products and services described in the original trademark application. We have licensed in the past, and expect that we may license in the future, certain of our proprietary rights, such as trademarks or copyrighted material, to third parties. While we attempt to ensure that the quality of our brand is maintained by such licensees, there can be no assurance that such licensees will not take actions that would materially adversely affect the value of our proprietary rights or reputation. We also rely on certain technology that we license from third parties, including the suppliers of the operating systems and financial and reporting system for our business. There can be no assurance that these third-party technology licenses will continue to be available to us on commercially reasonable terms. The loss of such technology could require us to obtain substitute technology of lower quality or performance standards or at greater cost, which could materially adversely affect our business, results of operations and financial condition. We hold the Internet domain name "digitalconvergence.com." Under current domain name registration practices, no one else can obtain an identical domain name, but they can obtain a similar name, or the identical name with a country designation. The relationship between regulations governing domain names and the laws protecting trademarks and similar proprietary rights is evolving. Domain names are regulated by Internet regulatory bodies, while trademarks are enforceable under local national law. In addition, the regulation of domain names in the United States and in foreign countries is subject to change. There are plans to establish additional top-level domains, appoint additional domain name registrars and modify the requirements for holding domain names in countries in which we conduct business, and we could be unable to prevent third-parties from acquiring domain names that infringe or otherwise decrease the value of our domain names or trademarks. Like other technology-based businesses, we face the risk that we will be unable to protect our patents and other intellectual property and proprietary rights, and the risk that we will be found to have infringed the proprietary rights of others. For an expanded discussion of these risks, see "Risk Factors." GOVERNMENT REGULATION We are subject to varying degrees of federal, state, and local regulation, as well as U.S. and state statutes and common law. The Federal Communications Commission has established regulations, that, among other things, set installation and equipment standards for communications systems. Additionally, 51
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the television industry is subject to extensive regulation at the federal, state and local levels. Legislative and regulatory proposals under consideration by Congress and federal agencies may materially affect that industry and our ability to obtain distribution of our :C.R.Q. and :Cue:C.A.T. technology to television broadcasters. As a result of the increasing popularity and use of the Internet, the Internet is receiving increasing legislative scrutiny. Applicability to the Internet of existing laws and regulations governing issues such as intellectual property ownership, copyrights and other intellectual property issues, taxation, libel, obscenity and consumer privacy is uncertain. For example, in 1996 Congress enacted the Communications Decency Act, which, among other things, purported to impose criminal penalties on anyone who distributes "obscene" or "indecent" materials over the Internet. A number of states have adopted or proposed similar legislation. Although certain provisions of the act have been held to be unconstitutional, the manner in which the act and similar existing or future federal and state laws will ultimately be interpreted and enforced and their effect on our operations cannot yet be fully determined. Such laws could subject us to substantial liability. Restrictive laws or regulations could also dampen the growth of the Internet generally and decrease the acceptance of the Internet as an advertising medium, and could, thereby, have a material adverse effect on us. In addition, it is possible that laws and regulations may be modified or adopted at the federal, state and local levels related to issues such as consumer privacy, defamation, network access, pricing, taxation, content regulation, characteristics and quality of products and services, advertising and intellectual property ownership and infringement. The application of modified or new legislation or regulations to our products and services could expose us to liability, increase our cost of doing business, and adversely affect consumer or advertiser acceptance of our product. In sum, new or modified legislation or regulation could have a material adverse effect on us. To the extent that we do business in foreign countries or otherwise fall within the jurisdiction of foreign countries, we could become subject to foreign regulation and laws. Certain countries, such as some of the members of the European Community, have passed Internet privacy and consumer protection laws which are stricter than those in the United States. The application of foreign legislation or regulations to our products and services could expose us to liability, increase our cost of doing business, and adversely affect consumer or advertiser acceptance of our product. To our knowledge, there are currently no investigations, inquiries, citations, fines or allegations of violations or noncompliance against us pending before any government agencies or third parties. Whether noncompliance may be discovered at some future time is unknown. Although the likelihood of this risk is currently unknown, if noncompliance were to be found, it could result in civil or criminal penalties, including monetary fines and injunctions, as well as negative publicity. Such penalties could have a material adverse effect on us. COMPETITION We believe that our technology is unique and innovative. As a result, we believe that we currently have no direct competition because of the low cost and ease of use of our technology and our use of two devices rather than multi-tasking on a television. However, we have identified several related technologies in the area of media convergence. In broadcasting and electronic media, interactive set-top box companies, including WebTV Networks, Inc., Wink Communications, Inc., WorldGate Communications, Inc. and MicroCast, Inc., attempt to link television programming and the Internet. We believe that our technology should be perceived as complementary and not competitive to these products and services because it can be used in conjunction with set-top boxes. However, we also believe that our "two-device" solution is more likely to be widely accepted by the public than a "one-box" solution because our solution does not require the public to change habits or make additional monetary investments. Viewers can continue to receive one-way information via the passive, public 52
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medium of their televisions, while using their personal computer to establish interactive one-on-one relationships with advertisers and content providers. In print media, companies such as BarPoint.com, Inc., Digimarc Corp., FastFrog.com, NeoMedia Technologies, Inc. and Code Corporation have created technology enabling users to use scanners to access relevant web pages. We believe that these technologies will not compete effectively with our technology for a number of reasons, including our superior product features, our low manufacturing costs and deployment to the public without charge. We expect that competition will increase as other established and emerging companies enter the Internet convergence market and as new products and technologies are introduced. Increased competition may result in price reductions and loss of market share, either of which could materially adversely affect us. See "Risk Factors--Competition." FACILITIES We lease 38,000 square feet in Dallas, 3,120 square feet in Addison, Texas, and occupy approximately 5,500 square feet in New York. We believe that our current facilities are adequate to meet our needs for the foreseeable future. EMPLOYEES As of March 31, 2000, we had 94 full-time employees and 28 part-time/temporary employees. Of our full-time employees, 30 are in sales and marketing, 23 are in research and development and 41 are in general and administrative positions. Most of our part-time/temporary employees assist us in matching bar codes to websites. We consider our employee relations to be good. LEGAL PROCEEDINGS We are a co-defendant, with Infotainment Telepictures, Inc. in a lawsuit pending in state court in Dallas, Texas. The plaintiff, Nissi Cosmetics, Inc., alleges that Infotainment Telepictures breached a 1997 contract for the creation of two websites, two infomercials, and two direct response spots for the advertising and marketing of certain of Nissi Cosmetics' body color, or self-tanning, products. Nissi Cosmetics also alleges we were the "alter ego" of Infotainment Telepictures in committing the alleged breaches. Nissi Cosmetics seeks recovery of $585,000 paid to defendants, and unspecified damages for "lost profits." We filed a general denial and intend to vigorously defend the matter. Under the terms of our asset purchase agreement with Infotainment Telepictures, Infotainment has agreed to indemnify us for any costs, expenses, liabilities or other losses we may incur in connection with this matter. From time to time, we may be involved in litigation relating to claims arising out of our operations in the normal course of business. As of the date of this prospectus, we are not aware of any legal proceedings pending or threatened that we expect would have a material adverse effect on us. 53
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MANAGEMENT DIRECTORS AND EXECUTIVE OFFICERS The following table sets forth certain information with respect to our executive officers and directors as of March 31, 2000: [Enlarge/Download Table] NAME AGE POSITION ---- -------- ----------------------------------------------------- J. Jovan Philyaw............... 35 Chairman of the Board and Chief Executive Officer Michael N. Garin............... 53 President, Chief Operating Officer and Director Patrick V. Stark............... 45 Executive Vice President and Director Scott P. Carlin................ 44 President of the Media Group Gregory D. Lerman.............. 54 President of the Interactive Group Douglas L. Davis............... 33 President of the Technology Group Stuart B. Graber............... 46 President of the International Group Donald E. Welsh................ 56 President of the Publishing Group William S. Leftwich............ 50 Vice President, Chief Financial Officer and Secretary Blaine L. Thacker.............. 56 Chief Strategy Officer Jeffrey A. Glickman............ 48 President of DigitalDemographics.:Com Inc. John G. Huncke................. 47 Executive Vice President of the Media Group William O. Hunt................ 66 Director Michael H. Jordan.............. 63 Director Jack A. Turpin................. 69 Director J. Jovan Philyaw founded us in September 1998. Prior to founding us, Mr. Philyaw created NET TALK LIVE! THE INTERNET TALK SHOW in September 1996 and served as its Executive Producer and host from September 1996 to February 2000. Since December of 1997, Mr. Philyaw has served as the President and Chief Executive Officer of Infotainment Telepictures, Inc., the predecessor company that produced NET TALK LIVE! THE INTERNET TALK SHOW, before we acquired these predecessor rights. Mr. Philyaw served as Executive Vice President and Chief Marketing Officer of Internet America, an Internet service provider, from September 1995 to September 1996. Michael N. Garin joined us as our President and Chief Operating Officer in August 1999. From 1989 to 1999, Mr. Garin served as the global head of Media and Communications for Furman Selz and ING Barings LLC after ING Barings acquired Furman Selz in October 1997. Mr. Garin also served on the management committee and board of directors of Furman Selz from 1993 to 1997. Mr. Garin holds a masters degree in Philosophy and Arts from the New School of Social Research, New York, and an A.B. in Economics from Harvard College. Patrick V. Stark joined us as our Executive Vice President on December 31, 1999. Mr. Stark became one of our directors in September 1998. Mr. Stark was a shareholder/director at the law firm of Kane, Russell, Coleman & Logan, P.C. in Dallas, Texas, from January 1992 until he joined us. Mr. Stark holds a law degree from Georgetown University Law Center and a B.A. in Spanish from Arizona State University. Scott P. Carlin joined us as the President of our Media Group in August 1999. From June 1995 until he joined us, he served as Executive Vice President of Warner Bros. Domestic Television Distribution and Executive Vice President, Telepictures Distribution. From March 1991 to June 1995, Mr. Carlin served as Senior Vice President, Sales, Warner Bros. Domestic Television Distribution. Mr. Carlin holds a B.A. in communications from the University of Colorado. Gregory D. Lerman joined us as the President of our Interactive Group in August 1999. Prior to joining us, Mr. Lerman served as President of E-Commerce for Paxson Communications, which owns and operates television broadcast stations, from February 1999 to October 1999 and Executive Vice President and General Manager of Valuevision International, an integrated direct marketing company, 54
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from January 1998 to February 1999. From January 1997 to September 1997, Mr. Lerman served as President and Chief Operating Officer of Kent and Spiegel Direct, a television direct marketing firm. Within one year after Mr. Lerman left Kent and Spiegel Direct, the company filed for bankruptcy. From January 1995 to December 1996, Mr. Lerman was retired. From October 1989 to December 1994, he served as Executive Vice President of Fingerhut Companies, Inc., a catalog direct marketer. Mr. Lerman holds a B.A. in history from the University of Minnesota. Douglas L. Davis joined us as the President of our Technology Group in December 1999. Prior to joining us, he was employed by Internet America, an Internet service provider, where he served as Executive Vice President and Chief Operating Officer from July 1996 to December 1999 and as Chief Technology Officer from January 1996 to July 1996. Mr. Davis was head of research and development at Internet America from November 1995 to January 1996. From July 1990 to November 1995, Mr. Davis was a Director of Computer Operations for the School of Engineering and Applied Science of Southern Methodist University. Stuart B. Graber joined us as the President of our International Group in December 1999. Mr. Graber served as Chief Executive of Music Choice Europe, a digital audio company part-owned by Time Warner, British Sky Broadcasting, Sony and EMI, from October 1993 to December 1999. Mr. Graber holds a masters degree in international communications from Brooklyn College and a B.A. in journalism, broadcasting and administration from the University of Maryland. Donald E. Welsh joined us as the President of our Publishing Group in January 2000. Prior to joining us, Mr. Welsh, who has been in publishing for thirty years, was Chairman of Group XXVII Communications from August 1997 to December 1999. From March 1995 to March 1997, he was Executive Vice President of Marvel Publications. From March 1990 to March 1996, he served as chairman of the Welsh Publishing Group. Mr. Welsh holds an A.B. from Columbia University and a J.D. from Cleveland Marshall School of Law. William S. Leftwich joined us as our Vice President, Chief Financial Officer and Secretary in May 1999. From March 1995 to May 1999, he served as Chief Financial Officer for ViewCast.com (formerly MultiMedia Access Corporation), a company that develops and sells streaming video products and desktop video conferencing products. From January 1993 to March 1995, he served as Chief Financial Officer of Integrated Security Systems, Inc., a provider of fully integrated building security systems. Mr. Leftwich holds a B.B.A. in Accounting from Texas A&M University and is a certified public accountant. Blaine L. Thacker joined us as our Chief Strategy Officer in October 1999. Prior to joining us, Mr. Thacker served as Executive Vice President of Sterling Communications, Inc., an international systems integration firm, from August 1998 to September 1999. Prior to that, Mr. Thacker was the Vice President of Sales and Marketing for Digital Network Access, an Internet service provider, from September 1997 to August 1998. He served as President of Choice Com, Inc., a competitive local exchange carrier, from March 1997 until August 1997 after acting as British Telecom's Vice President of Global Sales for its Information Technology outsourcing business from May 1993 until January 1997. Mr. Thacker has over 30 years of executive level experience with companies such at AT&T, General Electric, and Oracle. He holds an M.B.A. from Western New England College and a B.B.A. in marketing and finance from the University of Oklahoma. Jeffrey A. Glickman joined us as the President of DigitalDemographics.:Com Inc., our subsidiary that collects and sells demographic data, in December 1999. Prior to joining us, Mr. Glickman served as President of World Class Marketing, a database marketer, from March 1995 to December 1999. Mr. Glickman holds a Ph.D. in reproductive endocrinology from the University of Western Ontario, an M.Sc. in embryology from McGill University and a B.S. in marine biology from McGill University. John G. Huncke joined us as the Executive Vice President of our Media Group in January 2000. Prior to joining us, Mr. Huncke served as General Counsel of Universal Pictures from June 1998 to 55
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December 1999. From January 1995 to June 1998, Mr. Huncke served as General Counsel and Chief Operating Officer of Polygram Television, a television production and distribution company. From January 1987 to January 1995, Mr. Huncke served as Executive Vice President and General Counsel for ITC Entertainment Group, a motion picture production and distribution company. Mr. Huncke holds a J.D. from the University of Southern California and a B.S. from the University of Notre Dame. William O. Hunt has served as one of our directors since January 1999. Mr. Hunt has served as Chairman of the Board of Internet America since May 1995. Mr. Hunt has also served as Chairman of the Board of Intellicall Inc., a company that provides telephone network switching and other services, since 1992. Mr. Hunt served as President and Chief Executive Officer of Intellicall from December 1992 to May 1998. Mr. Hunt also currently holds directorships in Andrew Corporation, American Homestar Corporation and Mobility Electronics, Inc. Mr. Hunt holds an M.B.A. and a B.B.A. from the University of North Texas. Michael H. Jordan has served as one of our directors since August 1999. Mr. Jordan has served as Chairman of Luminant Worldwide Corporation, a leading provider of Internet and electronic commerce professional services, since September 1999. He also serves as Chairman and Chief Executive Officer of EOriginal Inc., an electronic commerce company that provides secure documents. Mr. Jordan retired in December 1998 as Chairman and Chief Executive Officer of CBS Corporation (formerly Westinghouse Electric Corporation), positions he had held since June 1993. Mr. Jordan is also a member of the Boards of Directors of Aetna Inc., Dell Computer Corp. and Marketwatch.com. Mr. Jordan is a member of the President's Export Council; is the Chairman of the U.S.-Japan Business Council; is the Chairman of The College Fund/UNCF; and is the Chairman of the Policy Board of the Americans for the Arts. Jack A. Turpin has served as one of our directors since January 1999. Mr. Turpin founded Hall-Mark Electronics Corporation, an electronics distribution firm, in 1962 and served as its Chairman of the Board until its sale in 1993. Mr. Turpin holds a B.S. in electrical engineering from Rice University. Pursuant to an amendment to our certificate of incorporation that will become effective upon consummation of the offering, our Board of Directors will be classified into three classes of directors, denoted as Class I, Class II and Class III. Messrs. Hunt and Garin will be Class I directors, Messrs. Turpin and Stark will be Class II directors, and Messrs. Philyaw and Jordan will be Class III directors. The term of the Class I directors will expire at the 2001 annual meeting of our stockholders, the term of the Class II directors will expire at the 2002 annual meeting of our stockholders and the term of the Class III directors will expire at the 2003 annual meeting of our stockholders. BOARD COMPENSATION Directors who are also our officers, employees or affiliates do not receive compensation for their services as directors. Each non-employee director is entitled to an award of stock options to purchase 15,000 shares of our common stock, when he becomes a non-employee director, at an exercise price equal to the fair market value of our common stock on the date of grant. Additionally, each non-employee director in office following each annual stockholders' meeting is entitled to an award of stock options to purchase 8,000 shares of common stock at an exercise price equal to the fair market value of our common stock on the date of grant. In each case, the stock options granted to the non-employee directors are fully vested on the date of grant. Directors are entitled to reimbursement of their reasonable out-of-pocket expenses in connection with their travel to and attendance at meetings of the board of directors or committees thereof. 56
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INDEMNIFICATION OF DIRECTORS We have entered into agreements to indemnify our directors and officers. Under these agreements, we are obligated to indemnify our directors and officers to the fullest extent permitted under Delaware General Corporate Law for certain expenses (including attorneys' fees), judgments, fines and settlement amounts incurred by them in any action or proceeding arising out of their services as a director or officer. We believe that these agreements are necessary to attract and retain qualified directors and officers. COMPENSATION OF EXECUTIVE OFFICERS The following table sets forth certain information concerning the compensation of our chief executive officer and our other most highly paid executives serving in such capacity at the end of 1999 whose total annual salary and bonus exceeded $100,000 in 1999. These three individuals are referred to in this prospectus as our "Named Executive Officers." SUMMARY COMPENSATION TABLE [Enlarge/Download Table] LONG-TERM ANNUAL COMPENSATION COMPENSATION ---------------------------------- ------------ OTHER SECURITIES ANNUAL UNDERLYING ALL OTHER SALARY BONUS COMPENSATION OPTIONS COMPENSATION NAME AND PRINCIPAL POSITION ($) ($) ($) (#) ($) --------------------------- -------- -------- ------------ ------------ ------------ J. Jovan Philyaw ........................ $230,500 $150,000 $ -- $ -- $ -- Chief Executive Officer and Chairman of the Board Michael N. Garin ........................ 100,000 -- -- 2,677,500 -- President and Chief Operating Officer Scott P. Carlin ......................... 62,500 150,000 -- 1,102,500 18,900(1) President--Media Group ------------------------ (1) This number represents reimbursement of Mr. Carlin for moving expenses. The following table provides information regarding stock options granted to our Named Executive Officers during 1999. OPTION GRANTS IN LAST FISCAL YEAR [Enlarge/Download Table] INDIVIDUAL GRANTS ------------------------------------------------------------------- GRANT DATE PERCENT OF VALUE TOTAL OPTIONS ------------ NUMBER OF GRANTED TO EXERCISE PRICE GRANT DATE SECURITIES UNDERLYING EMPLOYEES IN OR BASE PRICE EXPIRATION PRESENT NAME OPTIONS GRANTED (#) FISCAL YEAR ($/SHARE) DATE VALUE ($)(1) ---- --------------------- ------------- -------------- ---------- ------------ J. Jovan Philyaw............. -- -- $ -- -- $ -- Michael N. Garin............. 157,500(2) 2.0% 3.31 8/2/09 123,323 2,520,000(3) 33.2% 3.31 8/16/09 1,973,160 Scott P. Carlin.............. 1,102,500(3) 14.5% 3.31 8/16/09 863,258 ------------------------ (1) The present value of each grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions: dividend yield of 0% for all years; expected volatility of 0.10%; risk-free interest rate of 5.40% to 6.10%; and expected life of five years. 57
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(2) 25% of the stock options became exercisable on August 2, 1999, the date of grant, and 25% of the stock options will become exercisable on each anniversary of the date of grant until they become fully exercisable. (3) 25% of the stock options became exercisable on August 16, 1999, the date of grant, and 25% of the stock options will become exercisable on each anniversary of the date of grant until they become fully exercisable. The following table provides summary information with respect to stock options held by our Named Executive Officers as of December 31, 1999. The value of unexercised in-the-money options is based on an assumed initial public offering price of $ , less the exercise price payable for the shares. AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION VALUES [Enlarge/Download Table] NUMBER OF SECURITIES VALUE OF THE UNEXERCISED UNDERLYING OPTIONS IN-THE-MONEY OPTIONS AT FISCAL YEAR-END (#) AT FISCAL YEAR-END ($) SHARES ACQUIRED VALUE --------------------------- --------------------------- NAME ON EXERCISE (#) REALIZED ($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE ---- --------------- ------------ ----------- ------------- ----------- ------------- J. Jovan Philyaw...... -- $ -- -- -- $ $ Michael N. Garin...... -- -- 669,375 2,008,125 Scott P. Carlin....... -- -- 275,625 826,875 COMMITTEES OF THE BOARD Our board of directors has established an audit committee and a compensation committee. Our board has no nominating committee or other committee performing similar functions at this time. AUDIT COMMITTEE. The audit committee is comprised of Messrs. Hunt, Jordan and Turpin. The audit committee reports on its activities to the board of directors and is responsible for reviewing: - the scope and timing of the audit and non-audit services performed by our independent accountants; - the appropriateness of our accounting policies; - the adequacy of our financial controls; and - the reliability of the financial information we report to the public. COMPENSATION COMMITTEE. The compensation committee is comprised of Messrs. Hunt, Jordan and Turpin. The primary functions of the compensation committee are to: - provide a general review of our compensation and benefit plans to determine if they meet corporate objectives; - evaluate and make recommendations regarding our chief executive officer's compensation; and - review our chief executive officer's recommendations regarding the: - compensation of all of our other officers; - granting of awards under our benefit plans; and - adoption of, and changes to, our major compensation policies and practices. 58
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EMPLOYMENT AGREEMENTS MICHAEL N. GARIN. On August 16, 1999, we entered into a three-year employment agreement with Michael N. Garin which provides that he will serve as our President and Chief Operating Officer. The employment agreement provides for annual compensation of $400,000, which amount will be increased upon completion of this offering to an amount commensurate to that paid by comparable companies at comparable stages of development. Mr. Garin's employment agreement provides for an annual bonus at the discretion of the board. In addition, the employment agreement provides that Mr. Garin is eligible to participate in all benefit programs for which employees and/or senior executives are generally eligible. Under his employment agreement, we may terminate Mr. Garin's services for cause or without cause. If Mr. Garin is terminated without cause or if we breach the employment agreement, Mr. Garin will be entitled to receive his base salary for the remainder of his term of employment in a lump sum payment. The employment agreement also contains confidentiality provisions. SCOTT P. CARLIN. On August 16, 1999, we entered into an employment agreement with Scott P. Carlin which, as amended, provides that he will serve as President of our Media Group for three years. We paid Mr. Carlin a $150,000 signing bonus. Mr. Carlin's employment agreement provides for annual compensation of $250,000, which amount will be increased to a level negotiated in good faith upon completion of this offering. Mr. Carlin's employment agreement provides for an annual bonus at the discretion of the board. In addition, his employment agreement provides that he is eligible to participate in all benefit programs for which employees and/or senior executives are generally eligible. Under his employment agreement, we may terminate Mr. Carlin's services for cause or without cause. If Mr. Carlin is terminated without cause or if we breach the employment agreement, Mr. Carlin will be entitled to receive his base salary for the remainder of his term of employment in a lump sum payment. Mr. Carlin's employment agreement also contains confidentiality provisions. STOCK OPTION PLAN We adopted our 1999 Stock Option Plan on September 1, 1999. A total of 12,375,000 shares of common stock are authorized for issuance under the plan, as amended. The plan provides for grants of incentive stock options to our employees, including officers and employee-directors, and for grants of nonstatutory stock options to our employees, consultants and nonemployee directors. The purposes of the plan are: - to attract and retain the best available personnel for positions of substantial responsibility; - to provide additional incentive to our employees and consultants; and - to promote the success of our business. Our compensation committee administers the plan. Our compensation committee will designate the individuals to receive the options, the number of shares subject to options, and the terms and conditions of each option. While our compensation committee determines the terms of options granted under the plan, the term of any incentive stock option cannot exceed ten years from the date of grant and any incentive stock option granted to an employee who possesses more than ten percent of the total combined voting power of all classes of our shares within the meaning of Section 422(b)(6) of the Internal Revenue Code cannot be exercisable after the expiration of five years from the date of grant. While the compensation committee determines the exercise price of options granted under the plan, an option's exercise price cannot be less than the fair market value of a share of common stock on the date the option is granted, subject to adjustments. Further, the exercise price of any incentive stock option granted to an employee who possesses more than ten percent of the total combined voting power of all classes of our shares within the meaning of Section 422(b)(6) of the Internal Revenue 59
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Code must be at least 110% of the fair market value of the underlying share at the time the option is granted. The exercise price of options granted under the plan will be paid in full in a manner prescribed by our compensation committee. EMPLOYEE STOCK PURCHASE PLAN We adopted our Employee Stock Purchase Plan in April 2000. A total of 1,000,000 shares of common stock are authorized for issuance under the plan. The plan provides for the grant of stock options to certain eligible employees. The purpose of the plan is to provide eligible employees with an incentive to advance the interests of the company by providing an opportunity to purchase stock of the company at a favorable price. The plan is administered by our compensation committee. Any eligible employee may elect to participate in the plan by authorizing our compensation committee to make payroll deductions to pay the exercise price of an option at such time and in such manner as prescribed by our compensation committee. Such payroll deduction may be a specific amount or a designated percentage to be determined by the employee, but such specific amount may not be less than an amount established by us and such designated percentage may not exceed an amount of eligible compensation established by us from which the deduction is made. In no event will an employee be granted an option under the plan that would permit him to purchase stock with a fair market value in excess of $25,000, or to purchase more than 10,000 shares, in a period established by us. There will be two six-month offering periods in each calendar year. The date of grant and the date of exercise for the first option period is January 1 and June 30, respectively, and the date of grant and date of exercise for the second option period is July 1 and December 31, respectively. The first offering period of the plan will commence on the date we close this offering, and will conclude on December 31, 2000. The exercise price of options granted under the plan is an amount equal to the lesser of 85% of the fair market value of the stock on the date of exercise or on the date of grant. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION Currently, Messrs. Hunt, Jordan and Turpin are members of our compensation committee. Mr. Hunt is the general partner of B&G Partnership, Ltd. and BCG Partnership, Ltd., which are both our stockholders. Mr. Turpin is the sole managing director of JAT FIVE, LTD., one of our stockholders. See "Certain Relationships and Related Transactions." 60
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CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS PREFERRED STOCK FINANCINGS The following information summarizes private placement transactions in which we sold shares of preferred stock to our directors and 5% stockholders and persons and entities associated with our directors and those stockholders. Each share of Series A preferred stock will convert into 630 shares of common stock and each share of Series B and Series C preferred stock will convert into one share of common stock upon completion of this offering. SERIES A FINANCING. From September 29, 1999 to January 14, 2000, we issued 15,966 shares of Series A preferred stock to various investors, including Young & Rubicam, Inc., Belo Enterprises, Inc., DING.com LLC and ING Capital LLC, for aggregate consideration of approximately $50.3 million, or $3,150 per share. A trust of our President of the Publishing Group, Donald E. Welsh, invested $200,000 in our Series A preferred stock through DING.com LLC. In addition, the spouse of our president, Michael N. Garin, invested $500,000 in our Series A preferred stock through DING.com LLC. SERIES B FINANCING. In April 2000, we issued 5,929,364 shares of Series B preferred stock to various investors, including Belo Corp., Young & Rubicam, Inc., The Coca-Cola Company, The E.W. Scripps Company, Spielberg/Katz Associates, LLC and Tandy Corporation, for aggregate consideration of approximately $41.7 million, or $7.03 per share. SERIES C FINANCING. In April 2000, we issued 5,372,593 shares of Series C preferred stock to various investors, including Belo Corp., Young & Rubicam, Inc., The Coca-Cola Company, The E.W. Scripps Company and Tandy Corporation, for aggregate consideration of approximately $56.6 million, or $10.54 per share. The following table summarizes the private placement transactions in which we sold preferred stock to our directors and 5% beneficial stockholders and persons and entities affiliated with our directors and those stockholders. [Enlarge/Download Table] NUMBER OF SHARES OF --------------------------------- DIRECTORS, 5% BENEFICIAL SERIES A SERIES B SERIES C STOCKHOLDERS AND AFFILIATED ENTITIES PREFERRED PREFERRED PREFERRED ------------------------------------ --------- --------- --------- Belo Corp................................................... 3,970 1,422,474 1,897,532 Young & Rubicam, Inc........................................ 6,350 380,986 508,222 WARRANTS We issued a warrant, dated September 29, 1999, to Belo Enterprises, Inc., an affiliate of Belo Corp., to purchase 124,740 shares of our common stock at an exercise price of $5.00 per share. The warrants will terminate on September 29, 2004. See "Business--Strategic Relationships." We issued two warrants in April 2000, to an affiliate of National Broadcasting Company, Inc., our strategic partner, to purchase 3,752,445 shares and 4,505,165 shares, respectively, of our common stock at per share exercise prices of $5.00 and $10.54, respectively. We are required to issue additional warrants to National Broadcasting Company, Inc.'s affiliate with a per share exercise price of $10.54, depending on the number of shares we reserve for issuance under our 1999 Stock Option Plan. The warrants will terminate in April 2005. See "Business--Strategic Relationships." STOCK PURCHASE AGREEMENT We entered into a stock purchase agreement, dated September 29, 1999, under which we sold the Series A preferred stock. Under the stock purchase agreement, we agreed: - to provide periodically financial and other information to the holders; 61
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- not to engage in certain transactions without the prior consent of the holders of at least two-thirds of the outstanding shares of Series A preferred stock; - as long as at least 1,900 shares of Series A preferred stock remain outstanding, at any time that Michael Jordan is not our director, to nominate to our board of directors one nominee designated by the majority of the holders of such shares of our Series A preferred stock; and - to give each investor in our Series A preferred stock preemptive rights for new issuances of any shares of our capital stock, excluding issuances of common stock in this offering (these investors waived this right in connection with the issuance of the Series B preferred stock and Series C preferred stock). These provisions in the stock purchase agreement were terminated in April 2000. STOCKHOLDERS AGREEMENTS We entered into an agreement among stockholders, dated January 28, 1999, with J. Jovan Philyaw, our Chairman of the Board and Chief Executive Officer; JAT III, L.L.C.; B&G Partnership, Ltd.; and BCG Partnership, Ltd. William Hunt, our director, is the general partner of B&G Partnership, Ltd. and BCG Partnership, Ltd. Jack A. Turpin, also our director, is the sole managing director of JAT III, L.L.C. This agreement was terminated on September 29, 1999. We entered into an amended and restated stockholders agreement, dated April 25, 2000, with J. Jovan Philyaw, Michael N. Garin, our President and Chief Operating Officer, Patrick V. Stark, our Executive Vice President, an affiliate of the National Broadcasting Company, Inc., B&G Partnership, Ltd., BCG Partnership, Ltd., JAT FIVE, LTD., for whom Jack A. Turpin is the sole managing director, Young & Rubicam, Inc., Belo Enterprises, Inc. and A.H. Belo Foundation, affiliates of Belo Corp., and each of the other holders of preferred stock. The stockholders agreement contains: - a right of first refusal, exercisable by the stockholders who are parties to the stockholders agreement and then us, to purchase any of our securities proposed to be transferred by Messrs. Philyaw, Garin or Stark and the right of those other stockholders to participate on a pro rata basis in any transfer of securities by Messrs. Philyaw, Garin or Stark; - our agreement to nominate a representative of the preferred stock holders to our board of directors if, at any time, Michael Jordan is not our director and at least 3,791,900 shares of our preferred stock remain outstanding; - our agreement to provide financial and other information to the holders; - our agreement not to engage in certain transactions without the prior consent of the holders of at least two-thirds of each class of preferred stock; and - preemptive rights for each preferred stockholder for new issuances of shares of our capital stock, excluding issuances of common stock in this offering. This agreement will automatically terminate upon the completion of this offering. REGISTRATION RIGHTS AGREEMENTS We entered into a registration rights agreement, dated January 28, 1999, with JAT III, L.L.C., B&G Partnership, Ltd. and BCG Partnership, Ltd. This agreement was terminated on September 29, 1999. An affiliate of the National Broadcasting Company, Inc. and holders of our preferred stock and other stockholders, including B&G Partnership, Ltd., BCG Partnership, Ltd., JAT FIVE, LTD., Belo Enterprises, Inc., Young & Rubicam, Inc. and A.H. Belo Foundation are entitled under an amended 62
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and restated agreement with us, dated April 25, 2000, to the following registration rights for the shares of common stock held by them or issuable upon conversion of our preferred stock or upon exercise of outstanding warrants to purchase our common stock: - at any time after 180 days from the date of completion of this offering, the holders of these registrable securities, other than the affiliate of the National Broadcasting Company, Inc., may require, on three occasions only, that we use our best efforts to register for public resale at least ten percent of the aggregate amount of registrable securities that were outstanding on April 25, 2000; - at any time after 180 days from the date of completion of this offering, the affiliate of the National Broadcasting Company, Inc. may require, on up to three occasions only, that we use our best efforts to register for public resale at least 15% of the aggregate amount of common stock issuable upon full exercise of the affiliate of the National Broadcasting Company, Inc.'s warrants; - until the tenth anniversary of this offering, if we register any common stock, either for our own account or for the account of other security holders, the holders of registrable securities are entitled to include their shares of common stock in the registration, subject to the ability of the underwriters to limit the number of shares included in the offering in view of market conditions; and - the holders of registrable securities with a fair market value of not less than $10,000,000 may require us to use our best efforts to register the securities on a Form S-3 registration statement or any successor form after we become eligible to use the form. In most cases, we will bear all registration expenses other than underwriting discounts and commissions. All demand registration rights terminate when a holder is entitled to sell all of its registrable securities under Rule 144(k) under the Securities Act. BELO CORP. AGREEMENT By letter agreement dated September 29, 1999, with Belo Corp., a strategic partner and principal beneficial stockholder, we have granted Belo Corp.'s newspapers and television stations an exclusive license to deploy our technology in their markets. We intend to enter into licensing agreements with each of Belo Corp.'s newspapers and television stations under which we will be paid a licensing fee, the amount of which will be negotiated in good faith, provided that each newspaper and television station will be entitled to the lowest licensing fee paid to us by other newspapers or televisions stations having comparable circulation levels or broadcasting in comparable markets. Belo Corp. has agreed to advertise our technology in its newspapers and on its television stations. YOUNG & RUBICAM, INC. AGREEMENT By letter agreement dated September 29, 1999, with Young & Rubicam, Inc., a principal stockholder of ours, we granted Young & Rubicam an exclusive right to resell our :C.R.Q. software and :Cue:C.A.T. devices in the United States for the period of six months after the public launch of this technology in the United States. The economic terms of this right are to be negotiated in good faith by Young & Rubicam and us. In addition, we granted to Young & Rubicam an exclusive right for a period of six months from a date to be mutually determined by Young & Rubicam and us to resell this technology outside the United States. The terms of this right are to be negotiated in good faith by Young & Rubicam and us. We also agreed that, on economic terms to be negotiated by Young & Rubicam and us, Young & Rubicam will act as our marketing and sales agent with respect to the deployment of our technology to our advertising customers or clients. 63
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By a separate letter agreement, also dated September 29, 1999, we granted Young & Rubicam a right of first refusal on our marketing and communication assignments to third parties, provided that Young & Rubicam possesses core competency to handle these assignments. The terms of each assignment are to be negotiated by Young & Rubicam and us. In addition, we granted Young & Rubicam a right to receive a percentage of revenues paid to us by clients or licensees of Young & Rubicam. This percentage will equate to a "finders" or referral fee customary for blanket licensing agreements or a commission or mark-up on the Internet Enhancement of individual advertisements that is customary in the broadcast or entertainment industries. We also agreed to recommend Young & Rubicam as our preferred provider of marketing and communications services in response to inquiries from our potential licensees or customers or from those of Young & Rubicam. The rights described in this paragraph will no longer exist when Young & Rubicam ceases to own Series A preferred stock, or at least 50% of the common stock into which Young & Rubicam's Series A preferred stock is converted upon completion of this offering. ISSUANCE OF COMMON STOCK AND DEBENTURES On January 28, 1999, we sold 15,750,000 shares of common stock for a cash purchase price of $2,500 and issued 8.0% Debentures, Series 1999A with an aggregate principal amount of $2,500,000. In particular, we sold: - 3,150,000 shares of common stock and $500,000 in aggregate principal amount of the debentures to B&G Partnership, Ltd.; - 3,150,000 shares of common stock and $500,000 in aggregate principal amount of the debentures to BCG Partnership, Ltd.; and - 9,450,000 shares of common stock and $1,500,000 in aggregate principal amount of the debentures to JAT III, L.L.C. These shares have been transferred to JAT FIVE, LTD., an affiliate of JAT III, L.L.C. No interest payments are required to be paid on the debentures through the second anniversary of their issuance unless otherwise determined by our board of directors. Any unpaid interest will then be added to the principal amount of the debentures. Any remaining principal balance and any accrued and unpaid interest will be due and payable in full upon completion of this offering. In April 2000, we fully paid the principal amount and all accrued interest on each of the debentures. EMPLOYEE STOCKHOLDERS AGREEMENT We entered into a stockholders agreement, dated January 29, 1999, with various stockholders, including William S. Leftwich, our Chief Financial Officer. This agreement provides that the parties to the agreement, should they desire to sell their stock, shall first offer the stock to us. This agreement will automatically terminate upon the completion of this offering. OTHER TRANSACTIONS On January 4, 1999, we completed the acquisition of the rights to produce our television show NET TALK LIVE! THE INTERNET TALK SHOW and certain proprietary technology rights from Infotainment Telepictures, Inc. for a promissory note with a principal amount of $8,000,000. We also assumed certain liabilities in connection with this acquisition, including post-closing liabilities associated with the Nissi Cosmetics litigation. Infotainment Telepictures, Inc. has agreed to indemnify us for any costs, expenses, liabilities or other losses we may incur in connection with the Nissi Cosmetics litigation. See "Business--Legal Proceedings." J. Jovan Philyaw was the President and Chief Executive Officer of Infotainment Telepictures, Inc., a company owned by his father. The promissory note bears interest at 6.0% per annum. No interest payments are required to be made through the second anniversary of the 64
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note. Any unpaid interest will then be added to the principal amount of the note. Any remaining principal balance and any accrued and unpaid interest will be due and payable in full upon completion of this offering. See "Use of Proceeds." We paid $1,500,000 and $3,000,000 of the principal amount of the note in 1999 and 2000, respectively. We paid $584,137 in accrued interest on the note in 2000. In connection with our acquisition of Infotainment Telepictures, Inc. in January 1999, we assumed a loan payable to Jack A. Turpin in the principal amount of $452,900, plus accrued and unpaid interest of $6,819. In January 2000, Mr. Turpin loaned us an additional $147,090 for operating capital expenditures. We repaid the principal amount of the loans, plus $10,770 in interest, in January 2000. We entered into a stock purchase agreement, dated May 17, 1999, with William S. Leftwich under which Mr. Leftwich purchased 472,500 shares of our common stock. We have the right, subject to limitations, to repurchase Mr. Leftwich's shares purchased under the agreement if he ceases for any reason to be employed by us. Each of our executive officers and employees has entered into a proprietary rights and information agreement regarding the ownership of inventions developed in his or her capacity as our employee and the confidentiality of our proprietary information. Each of our directors has entered into a nondisclosure agreement. Patrick V. Stark was a shareholder/director of the law firm of Kane, Russell, Coleman & Logan, P.C. until December 31, 1999 and became of counsel as of January 1, 2000. During 1999 and during the first quarter of 2000, we paid Kane, Russell, Coleman & Logan, P.C. $135,000 and $21,000, respectively, for legal services. We have entered into indemnification agreements with each of our executive officers and directors. 65
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SECURITY OWNERSHIP OF PRINCIPAL STOCKHOLDERS AND MANAGEMENT The following table sets forth information with respect to the beneficial ownership of our common stock as of , 2000, after giving effect to the automatic conversion of 11,317,923 shares of outstanding preferred stock into 21,360,537 shares of common stock upon completion of this offering and as adjusted to reflect the sale of the common stock in this offering by: - each security holder known by us to own beneficially more than 5% of our common stock; - each of our directors; - each of our executive officers; and - all directors and executive officers as a group. We have determined beneficial ownership in accordance with the rules of the Securities and Exchange Commission. Unless otherwise indicated, the persons or entities included in this table have sole voting and investment power with respect to all the shares of common stock beneficially owned by them, subject to applicable community property laws. The number of shares beneficially owned by a person includes shares of common stock that are subject to stock options or warrants that are either currently exercisable or exercisable within 60 days after , 2000. These shares are also deemed outstanding for the purpose of computing the percentage of outstanding shares owned by the person. These shares are not deemed outstanding, however, for the purpose of computing the percentage ownership of any other person. [Enlarge/Download Table] PERCENT OF COMMON STOCK BENEFICIALLY OWNED SHARES OF COMMON STOCK ---------------------------------------- NAME OF BENEFICIAL OWNER BENEFICIALLY OWNED BEFORE THE OFFERING AFTER THE OFFERING ------------------------ ---------------------- ------------------- ------------------ Belo Corp.(1)........................... 5,945,847 % % JAT FIVE, LTD.(2)....................... 9,765,000 % % National Broadcasting Company, Inc.(3)............................... 8,257,610 % % Young & Rubicam, Inc.(4)................ 4,889,708 % % J. Jovan Philyaw........................ 40,950,000 % % Michael N. Garin(5)..................... 1,438,750 % % Patrick V. Stark(6)..................... 730,000 * * Gregory D. Lerman(7).................... 551,250 * * Scott P. Carlin(7)...................... 551,250 * * Douglas L. Davis(7)..................... 117,810 * * Stuart B. Graber(7)..................... 157,500 * * Donald E. Welsh(8)...................... 7,112 * * William S. Leftwich..................... 472,500 * * Blaine L. Thacker....................... -- * * Jeffrey A. Glickman..................... -- * * John G. Huncke.......................... -- * * William O. Hunt(9)...................... 6,615,000 % % Michael H. Jordan(7).................... 78,750 * * Jack A. Turpin(10)...................... 9,765,000 % % All directors and executive officers as a group (15 persons).................. 61,434,922 % % ------------------------ * Less than one percent (1%). (1) Consists of (i) 5,267,773 shares issuable upon conversion of the shares of our preferred stock held of record by Belo Enterprises, Inc., (ii) 553,334 shares issuable upon conversion of the shares of 66
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our preferred stock held of record by A.H. Belo Foundation and (iii) 124,740 shares issuable upon exercise of outstanding warrants held by Belo Enterprises, Inc. Belo Enterprises, Inc. and A.H. Belo Foundation are both indirect wholly-owned subsidiaries of Belo Corp. The address of Belo Corp. is Silverside Carr Executive Center, 501 Silverside Road, Suite 401, Wilmington, Delaware 19809. (2) Address: 8201 Preston Road, Suite 310, Dallas, Texas 75225. (3) Consists solely of shares issuable upon exercise of outstanding warrants held by an affiliate of the National Broadcasting Company, Inc. National Broadcasting Company, Inc.'s address is 30 Rockefeller Plaza, 46th Floor, New York, New York 10112. (4) Address: 285 Madison Avenue, New York, New York 10017. (5) Consists solely of shares issuable upon exercise of stock options that have already vested or will vest within 60 days. This number does not include shares of common stock which may be attributable to Torunn Garin, the wife of Mr. Garin, due to her passive investment in DING.com LLC, a stockholder of ours. Mr. Garin disclaims beneficial ownership of these shares. See "Certain Relationships and Related Transactions". (6) Includes 257,500 shares issuable upon exercise of stock options that have already vested or will vest within 60 days. (7) Consists solely of shares issuable upon exercise of stock options that have already vested or will vest within 60 days. (8) Consists solely of shares issuable upon conversion of 7,112 shares of Series B preferred stock owned by Bourne Welsh, the wife of Mr. Welsh. This number does not include shares of common stock which may be attributable to Mr. Welsh, due to his trust's passive investment in DING.com LLC, a stockholder of ours. Mr. Welsh disclaims beneficial ownership of these shares. (9) Consists of 3,150,000 shares held of record by B&G Partnership, Ltd. and 3,465,000 shares held of record by BCG Partnership, Ltd. Mr. Hunt is the general partner of each of these partnerships. Mr. Hunt disclaims beneficial ownership of these shares. (10) Consists of 9,765,000 shares held of record by JAT FIVE, LTD. Mr. Turpin serves as the sole managing director of this entity. Mr. Turpin disclaims beneficial ownership of these shares. 67
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DESCRIPTION OF CAPITAL STOCK Our authorized capital stock consists of shares of common stock, par value $0.01 per share, and 27,000,000 shares of preferred stock, par value $0.01 per share. 16,000 shares of preferred stock are designated as Series A preferred stock, 12,100,000 shares of preferred stock are designated as Series B preferred stock, and 3,300,000 shares of preferred stock are designated as Series C preferred stock. As of the date of this prospectus, (i) shares of common stock were issued and outstanding, (ii) 15,966 shares of Series A preferred stock were issued and outstanding, (iii) 5,929,364 shares of Series B preferred stock were issued and outstanding, and (iv) 5,372,593 shares of Series C preferred stock were issued and outstanding. In addition, (i) shares of common stock were reserved for issuance under our stock option plan, (ii) shares of common stock were reserved for issuance under our stock purchase plan, (iii) shares of common stock were reserved for issuance upon exercise of outstanding warrants, and (iv) 21,360,537 shares of common stock were reserved for issuance upon conversion of all outstanding shares of preferred stock. All of our outstanding shares of preferred stock will be converted automatically into common stock upon completion of this offering. The following description of our capital stock and certain provisions of our certificate of incorporation and bylaws are summaries and are qualified by reference to our certificate of incorporation and bylaws, copies of which have been filed with the SEC as exhibits to the registration statement of which this prospectus is a part. The descriptions of the common stock and preferred stock reflect changes to our capital structure that will occur upon the closing of the offering in accordance with the terms of the certificate of incorporation. COMMON STOCK Holders of common stock are entitled to one vote for each share held on all matters submitted to a vote of stockholders and do not have cumulative voting rights. Accordingly, holders of a majority of the shares of common stock entitled to vote in any election of directors may elect all of the directors standing for election. Holders of common stock are entitled to receive proportionately any dividends that may be declared by our board of directors, subject to any preferential dividend rights of outstanding preferred stock. In the event of our liquidation, dissolution or winding up, holders of common stock will be entitled to receive proportionately any of our assets remaining after the payment of liabilities and subject to the prior rights of any outstanding preferred stock. Holders of common stock have no preemptive, subscription, redemption or conversion rights. Our outstanding shares of common stock are, and the shares offered by us in this offering will be, when issued and paid for, fully paid and nonassessable. PREFERRED STOCK Upon the closing of this offering, all outstanding shares of preferred stock will be converted into 21,360,537 shares of common stock and automatically returned to our authorized, unissued and undesignated shares of preferred stock. Thereafter, our board of directors will have the authority, without further action by the stockholders, to issue up to 27,000,000 shares of preferred stock in one or more series and to designate the rights, preferences, privileges and restrictions of each series. The issuance of preferred stock could have the effect of restricting dividends on the common stock, diluting the voting power of the common stock, impairing the liquidation rights of the common stock or delaying or preventing our change in control without further action by the stockholders. We have no present plans to issue any shares of preferred stock after the completion of this offering. 68
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WARRANTS As of the date of this prospectus, there were outstanding warrants to purchase shares of our common stock at a weighted average exercise price of $ per share. See "Certain Relationships and Related Transactions." REGISTRATION RIGHTS An affiliate of the National Broadcasting Company, Inc., holders of our preferred stock and other stockholders are entitled under an agreement with us to the following registration rights for the shares of common stock held by them or issuable upon conversion of our preferred stock or upon exercise of outstanding warrants to purchase our common stock: - at any time after 180 days from the date of this offering, the holders of these registrable securities, other than the affiliate of the National Broadcasting Company, Inc., may require, on three occasions only, that we use our best efforts to register for public resale at least ten percent of the aggregate amount of registrable securities that were outstanding on April 25, 2000; - at any time after 180 days from the date of this offering, National Broadcasting Company, Inc.'s affiliate may require, on up to three occasions only, that we use our best efforts to register for public resale at least 15% of the aggregate amount of common stock issuable upon full exercise of its warrants; - until the tenth anniversary of this offering, if we register any common stock, either for our own account or for the account of other security holders, the holders of registrable securities are entitled to include their shares of common stock in such registration, subject to the ability of the underwriters to limit the number of shares included in the offering in view of market conditions; and - the holders of registrable securities with a fair market value of not less than $10,000,000 may require us to use our best efforts to register the securities on a Form S-3 registration statement or any successor form after we become eligible to use such form. In most cases, we will bear all registration expenses other than underwriting discounts and selling commissions. All demand registration rights terminate at such time as a holder is entitled to sell all of its registrable securities under Rule 144(k) under the Securities Act. DESCRIPTION OF PROVISIONS OF OUR CERTIFICATE OF INCORPORATION AND BYLAWS CLASSIFIED BOARD OF DIRECTORS Our bylaws provide that the board of directors shall be divided into three classes of two or three directors each, with each class elected for three-year terms expiring in successive years. Section 141 of the Delaware General Corporation Law provides that, in the case of a corporation having a staggered board, holders of a majority of the shares then entitled to vote in an election of directors may remove a director only for cause. Our certificate of incorporation defines "cause" as (i) a final conviction of a felony involving moral turpitude or (ii) willful misconduct that is materially and demonstrably injurious economically to us. No act, or failure to act, by a director will be considered "willful" unless committed in bad faith and without a reasonable belief that the act or failure to act was in the best interest of us or any of our affiliates. "Cause" will not exist unless and until we have delivered to the director a written notice of the act or failure to act that constitutes "cause" and the director has not cured the act or omission within 90 days after the delivery of the notice. The effect of this may be to restrict the ability of stockholders to remove directors from our board of directors. Our certificate of incorporation also allows the board of directors to fix the number of directors in the bylaws. 69
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STOCKHOLDER MEETINGS AND PROPOSALS Our bylaws provide that special meetings of stockholders generally can be called only by the chairman of the board, the chief executive officer, the president or our board of directors. There are advance notice procedures for the nomination, other than by or at the direction of the board of directors, of candidates for election as directors as well as for other stockholder proposals to be considered at annual stockholder meetings. In general, notice of intent to nominate a director or raise business at annual meetings must be received by us not less than 90 nor more than 120 days before the meeting. The notice must contain certain information concerning the person to be nominated or the matters to be brought before the meeting and concerning the stockholder submitting the proposal. These provisions may preclude a nomination for the election of directors or preclude the conduct of business at a particular annual meeting if the proper procedures are not followed. Furthermore, these provisions may discourage or deter a third party from conducting a solicitation of proxies to elect its own slate of directors or otherwise attempting to obtain control of the company, even if the conduct of the solicitation or attempt might be beneficial to us and our stockholders. STOCKHOLDER ACTION Our certificate of incorporation does not allow stockholders to act by written consent without a meeting. Our certificate of incorporation requires the affirmative vote of the holders of not less than eighty percent of our shares entitled to vote in an election of directors to amend or repeal this prohibition of stockholder action by written consent. The effect of this provision is to restrict stockholders' ability to circumvent the notice requirements relating to an annual meeting. Our certificate of incorporation and bylaws do allow stockholders to amend our bylaws. BUSINESS COMBINATION UNDER DELAWARE LAW We are subject to Section 203 of the Delaware General Corporation Law, which regulates corporate acquisitions. Section 203 prohibits a publicly held Delaware corporation from engaging in a "business combination" with an "interested stockholder" for a period of three years following the date the person became an interested stockholder, unless: - the board of directors approved the transaction in which the stockholder became an interested stockholder prior to the date the interested stockholder attained that status; - upon consummation of the transaction that resulted in the stockholder's becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced, excluding shares owned by persons who are directors and also officers; or - on or subsequent to the date, the business combination is approved by the board of directors and authorized at an annual or special meeting of stockholders by the holders of at least 66 2/3% of our outstanding voting stock which is not owned by the interested stockholder. A "business combination" includes a merger, asset or stock sale, or other transaction resulting in a financial benefit to the interested stockholder. An "interested stockholder" is a person who, together with affiliates and associates, owns, or within three years prior to the determination of interested stockholder status, did own, 15% or more of a corporation's voting stock. LIMITATION OF LIABILITY OF OFFICERS AND DIRECTORS Our certificate of incorporation provides that no director will be personally liable to us or our stockholders for monetary damages for breach of fiduciary duty as a director, except for liability: - for any breach of the director's duty of loyalty to us or our stockholders; 70
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- for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of laws; - for unlawful payment of a dividend or unlawful stock purchase or stock redemption; and - for any transaction from which the director derived an improper personal benefit. The effect of these provisions is to eliminate our rights and the rights of our stockholders, through stockholder derivative suits on our behalf, to recover monetary damages against a director for breach of fiduciary duty as a director, including breaches resulting from grossly negligent behavior, except in the situations described above. STOCKHOLDER RIGHTS PLAN We anticipate that, immediately upon completion of this offering, our board of directors will declare, pursuant to a rights agreement, a dividend distribution of one common share purchase right for each outstanding share of our common stock. Each right will entitle the registered holder to purchase from us one thousandth of a share of our Series A Junior Participating Preferred Stock, par value $.01 per share, at a price per share to be determined by our board with the advice of our financial advisor about the long-term prospects for our value, subject to adjustment. Each thousandth of a junior preferred share will be economically equivalent to one share of our common stock. The purchase price is expected to be significantly higher than the trading price of our common stock. Therefore, the dividend will have no initial value and no impact on our financial statements. The following summary of the rights does not purport to be complete and is qualified in its entirety by reference to the rights agreement, which is an exhibit to the registration statement of which this prospectus is a part. Initially, the rights will be attached to all certificates representing shares of our common stock then outstanding, and no separate certificates representing the rights will be distributed. Subject to extension by a majority of our continuing directors (as defined in the rights agreement) acting on our behalf, the rights will separate from our common stock upon the distribution date, which is defined as the earlier of (a) ten days following a public announcement that a person or group of affiliated or associated persons has acquired, or obtained the right to acquire, beneficial ownership of 15% or more of the outstanding shares of our common stock (any of the foregoing persons being an acquiring person), or (b) ten business days following the commencement of a tender offer or exchange offer that would result in a person or group beneficially owning 15% or more of such outstanding shares of our common stock. Until the distribution date, (i) the rights will be evidenced by our common stock certificates and will be transferred with and only with our common stock certificates, (ii) all certificates representing shares of our common stock will contain a notation incorporating the rights agreement by reference and (iii) the surrender for transfer of any certificate for our common stock outstanding will also constitute the transfer of the rights associated with our common stock represented by that certificate. As soon as practicable after the distribution date, separate certificates evidencing the rights will be mailed to holders of record of our common stock. The rights are not exercisable until the distribution date and will expire ten years after consummation of this offering, unless earlier redeemed by us. In the event that, at any time following the distribution date, (a) we are the surviving corporation in a merger or combination with an acquiring person and our shares of common stock shall remain outstanding and not be changed or exchanged, (b) a person becomes the beneficial owner of 15% or more of the then outstanding shares of our common stock, or (c) an acquiring person engages in one or more "self-dealing" transactions as set forth in the rights agreement, each holder of a right will thereafter have the right to receive, upon exercise, junior preferred shares (or, in certain circumstances, our common stock, cash, property or other securities of ours) having a value equal to two times the 71
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exercise price of the right. For example, at an exercise price of $100.00 per right, each right not owned by an acquiring person following an event described above would entitle its holder to purchase from us $200.00 worth of junior preferred shares (or in certain circumstances, our common stock, cash, property or other securities of ours) for $100.00. Assuming that our common stock had a current market price per share of $20.00 at that time, the holder of each valid right would be entitled to purchase ten one-thousandths of junior preferred shares for $100.00. Notwithstanding the foregoing, following the occurrence of any of the events set forth in this paragaph, all rights that are, or (under certain circumstances specified in the rights agreement) were, beneficially owned by an acquiring person will be null and void. However, rights are not exercisable following the occurrence of any of the events set forth above until such time as the rights are no longer redeemable by us as set forth below. In the event that, at any time following the date that a person has become an acquiring person (a shares acquisition date), (a) we are acquired in a merger or other combination transaction in which we are not the surviving entity, (b) we consolidate with or merge with or into any other person pursuant to which we are the surviving entity but all or a part of the shares of our common stock are changed into or exchanged for stock of another person or cash or other property or (c) 50% or more of our assets or earning power is sold or transferred, each holder of a right (except rights that previously have been voided as described above) shall thereafter have the right to receive, upon exercise, common stock or other securities of the acquiring company having a value equal to two times the exercise price of the right. The purchase price payable and the number of junior preferred shares or other securities or property issuable upon exercise of the rights are subject to adjustment from time to time to prevent dilution (a) in the event of a stock dividend on, or a subdivision, combination or reclassification of, our common stock, (b) upon the grant to holders of our common stock of certain rights or warrants to subscribe for our common stock or convertible securities at less than the current per-share market price of our common stock or (c) upon the distribution to holders of our common stock of evidences of indebtedness or assets of ours (excluding regular periodic cash dividends at a rate approved by the majority of continuing directors of ours or dividends payable in our common stock) or of subscription rights or warrants (other than those referred to above). With certain exceptions, no adjustment to the purchase price will be required until cumulative adjustments require an adjustment of at least one percent to the purchase price. Upon the exercise of a right, we will not be required to issue fractional junior preferred shares or fractional shares of our common stock (other than fractions in multiples of one-thousandth of a junior preferred share) and, in lieu thereof, an adjustment in cash may be made based on the market price of the junior preferred shares or our common stock on the last trading date prior to the date of exercise. At any time until 15 business days following the shares acquisition date, we may redeem the rights in whole, but not in part, at a price of $.01 per right, payable in cash. Immediately upon the action of our board of directors ordering redemption of the rights, the rights will terminate and the only right of the holders of rights will be to receive the $.01 redemption price. Until a right is exercised, the holder thereof, as such, will have no rights as a stockholder of ours, including, without limitation, the right to vote or to receive dividends. While the distribution of the rights will not be taxable to stockholders or to us, stockholders may, depending upon the circumstances, recognize taxable income in the event that any of the rights are exercised for our common stock (or other consideration) or for common stock or other securities of the acquiring company as set forth above. Any of the provisions of the rights agreement, other than those provisions relating to the principal economic terms of the rights, may be amended by our board of directors before the distribution date, and no stockholder approval will be sought for noneconomic amendments to the rights agreement except as required by law or by the rules of any national securities exchange or trading system on which 72
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our common stock is then listed. After the distribution date, the provisions of the rights agreement may be amended by our board of directors to cure any ambiguity, to make changes that do not adversely affect the interests of holders of rights (excluding the interests of any acquiring person) or to shorten or lengthen any time period under the rights agreement; provided, however, that no amendment to adjust the time period governing redemption may be made when the rights are not redeemable. The rights have certain anti-takeover effects. The rights will cause substantial dilution to any person or group that attempts to acquire us without conditioning the offer on our redemption of the rights. The rights should not interfere with any merger or other business combination approved by our board of directors because the board of directors may, at its option, at any time before the close of business on the earlier of the 15th day following the shares acquisition date or ten years after the adoption of the rights agreement, redeem all, but not less than all, of the then outstanding rights at $.01 per right. LISTING We have applied for quotation of our common stock on the Nasdaq National Market under the symbol "DGTL." TRANSFER AGENT AND REGISTRAR The transfer agent for our common stock is ChaseMellon Shareholder Services, LLC. 73
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SHARES ELIGIBLE FOR FUTURE SALE Prior to this offering, there has been no public market for our common stock. Future sales of substantial amounts of common stock in the public market could adversely affect the market price of our common stock. After this offering is completed, the number of shares available for future sale into the public markets will be subject to legal and contractual restrictions, some of which are described below. The lapsing of these restrictions will permit sales of substantial amounts of our common stock in the public market or could create the perception that these sales could occur, which could adversely affect the market price for our common stock. These factors could also make it more difficult to raise funds through future offerings of common stock. After this offering, shares of common stock will be outstanding ( shares if the U.S. underwriters and international managers exercise their over-allotment options in full). Of these shares, - the shares sold in this offering, plus any shares issued upon exercise of the U.S. underwriters' and international managers' over-allotment options, will be freely tradable without restriction under the Securities Act, unless purchased by our "affiliates" as that term is defined in Rule 144 under the Securities Act; and - the remaining shares of common stock that will be outstanding after this offering will be "restricted securities" within the meaning of Rule 144 of the Securities Act. Upon the closing of this offering, we intend to file one or more registration statements under the Securities Act to register the shares of common stock to be issued under our 1999 Stock Option Plan and our Employee Stock Purchase Plan and, as a result, all shares of common stock acquired upon exercise of stock options granted under our stock option plan or stock purchase plan will also be freely tradable under the Securities Act unless purchased by our affiliates. Restricted securities generally may be sold only if they are registered under the Securities Act or are sold pursuant to an exemption from registration, such as the exemptions provided by Rules 144 and 701 under the Securities Act, which are summarized below. Subject to the lock-up agreements described below, shares held by our affiliates that are not restricted securities may be sold subject to compliance with Rule 144 of the Securities Act without regard to the prescribed holding period under Rule 144. Our executive officers and directors and certain existing stockholders have agreed, with exceptions, not to sell or transfer any common stock for 180 days after the date of this prospectus without first obtaining the written consent of Merrill Lynch. Specifically, these persons have agreed not to directly or indirectly: - offer, pledge, sell or contract to sell any common stock; - sell any option or contract to purchase any common stock; - purchase any option or contract to sell any common stock; - grant any option, right or warrant for the sale of any common stock; - lend or otherwise dispose of or transfer any common stock; - request or demand that we file a registration statement related to the common stock; or - enter into any swap or other agreement that transfers, in whole or in part, the economic consequence of ownership of any common stock whether any such swap or transaction is to be settled by delivery of shares or other securities, in cash or otherwise. This lockup provision applies to common stock and to securities convertible into or exchangeable or exercisable for or repayable with common stock. It also applies to common stock owned now or acquired later by the person executing the agreement or for which the person executing the agreement later acquires the power of disposition. 74
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Following the lock-up period, the number of shares of common stock that will become eligible for sale in the public market under Rule 144 under the Securities Act will be as follows: - Beginning 180 days after the date of this prospectus, approximately shares will be eligible for sale; and - At various times thereafter upon the expiration of the applicable holding periods, approximately shares will become eligible for sale. Some of our stockholders have the right to require us to register shares of common stock for resale in some circumstances. See "Description of Capital Stock--Registration Rights." In general, under Rule 144 as currently in effect, any person or persons whose shares are aggregated, including an affiliate, who has beneficially owned restricted securities for a period of at least one year is entitled to sell, within any three-month period, a number of shares that does not exceed the greater of: - one percent of the then outstanding shares of common stock, which will equal approximately shares immediately after this offering; or - the average weekly trading volume in the common stock on the Nasdaq National Market during the four calendar weeks preceding the date on which the notice of the sale is filed with the Securities and Exchange Commission. Sales under Rule 144 are also subject to provisions relating to notice and manner of sale and the availability of current public information about us. Under Rule 144(k), a person who is not deemed to have been one of our affiliates at any time during the 90 days preceding a sale, and who has beneficially owned the shares for at least two years, including the holding period of any prior owner other than an "affiliate," is entitled to sell the shares without complying with the manner of sale, public information, volume limitation or notice provisions of Rule 144. Subject to certain limitations on the aggregate offering price of a transaction and other conditions, Rule 701 under the Securities Act may be relied upon for the resale of our common stock originally issued by us before the date of this prospectus to our employees, directors, officers, consultants or advisers under written compensatory benefit plans, including our 1999 Stock Option Plan, or contracts relating to the compensation of such persons. Shares of our common stock issued in reliance on Rule 701 are "restricted securities" and, beginning 90 days after the date of this prospectus, may be sold by non-affiliates subject only to the manner of sale provisions of Rule 144 and by affiliates under Rule 144 without compliance with the one-year holding period, in each case subject to the lock-up agreements. 75
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CERTAIN U.S. FEDERAL TAX CONSIDERATIONS FOR NON-UNITED STATES HOLDERS OF COMMON STOCK The following is a summary of the material United States federal income and estate tax consequences of the ownership and disposition of common stock generally applicable to non-United States holders. Subject to the discussion below under "Estate Tax," a non-United States holder is any beneficial owner of common stock that, for United States federal income tax purposes, is a non-resident alien individual, a foreign corporation, a foreign partnership or a foreign estate or trust as such terms are defined in the Internal Revenue Code of 1986, as amended. This discussion is based on the Internal Revenue Code, existing, proposed and temporary regulations promulgated thereunder, and administrative and judicial interpretations, all as of the date of this prospectus, and all of which are subject to change either retroactively or prospectively. This discussion does not address all aspects of United States federal income and estate taxation that may be relevant to non-United States holders in light of their particular circumstances and does not address any tax consequences arising under the laws of any state, local or foreign taxing jurisdiction or the application of any particular tax treaty. Further, it does not consider non-United States holders subject to special tax treatment under the United States federal income tax laws including banks, insurance companies, dealers in securities and holders of securities held as a part of a "straddle," "hedge" or "conversion transaction." PROSPECTIVE INVESTORS ARE URGED TO CONSULT THEIR TAX ADVISORS REGARDING THE UNITED STATES FEDERAL, STATE AND LOCAL INCOME AND OTHER TAX CONSEQUENCES, AND THE NON-UNITED STATES TAX CONSEQUENCES, OF OWNING AND DISPOSING OF COMMON STOCK. DIVIDENDS Subject to the discussion below (including the discussion of backup withholding), any dividend paid to a non-United States holder generally will be subject to United States withholding tax at a rate of 30% of the gross amount of the dividend or such lower rate as may be specified by any applicable tax treaty. For purposes of determining whether tax is required to be withheld under United States Treasury Regulations currently in effect we ordinarily will presume that dividends paid to a holder with an address in a foreign country are paid to a resident of such country absent knowledge that such presumption is not warranted. Under such regulations, dividends paid to a holder with an address within the United States generally will be presumed to be paid to a holder who is not a non-United States holder and will not be subject to the 30% (or lower treaty rate) withholding tax, unless we have actual knowledge that the holder is a non-United States holder. Under final United States Treasury Regulations, scheduled to become effective January 1, 2001, however, a non-United States holder who wishes to claim the benefit of an applicable treaty rate would be required to satisfy applicable certification and other requirements, which would include the requirement that the non-United States holder file with us a United States Internal Revenue Service Form W-8 which provides the holder's name and address. In the case of a non-United States holder that is a foreign partnership, the certification requirements would generally be applied to the partners of the partnership. Dividends received by a non-United States holder that are effectively connected with a United States trade or business conducted by such non-United States holder (or, if a tax treaty applies, that are attributable to a permanent establishment in the United States maintained by such non-United States holder) are exempt from withholding tax if the non-United States holder files an IRS Form W-8ECI (or, prior to January 1, 2001, an IRS Form 4224) with the payor. However, such effectively connected dividends are subject to regular United States federal income tax. Effectively connected dividends received by a corporate non-United States holder may be subject to an additional "branch profits tax" at a rate of 30% (or such lower rate as may be specified by an applicable tax treaty) of such corporate non-United States holder's effectively connected earnings and profits for the taxable year, subject to certain adjustments. 76
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A non-United States holder eligible for a reduced rate of United States withholding tax pursuant to a tax treaty may obtain a refund of any excess amounts withheld by filing an appropriate claim for refund with the IRS. GAIN ON DISPOSITION OF COMMON STOCK A non-United States holder generally will not be subject to United States federal income tax with respect to gain realized upon the sale or other disposition of common stock unless: (1) such gain is effectively connected with a United States trade or business of the non-United States holder (or, if a tax treaty applies, attributable to a permanent establishment in the United States maintained by such non-United States holder); (2) the non-United States holder is an individual who holds the common stock as a capital asset, is present in the United States for a period or periods aggregating 183 days or more during the taxable year in which such sale or disposition occurs, and certain other conditions are met; (3) the non-United States holder is an individual subject to tax pursuant to the provisions of United States tax law applicable to certain United States expatriates; or (4) we are or have been a "United States real property holding corporation" for United States federal income tax purposes at any time within the shorter of the five-year period preceding such disposition of such holder's common stock and such holder's holding period and certain other conditions are met. We believe that we are not and have never been, and we do not believe that we will become, a "United States real property holding corporation" for United States federal income tax purposes. BACKUP WITHHOLDING AND INFORMATION REPORTING Generally, we must report to the IRS the amount of dividends paid, the name and address of the recipient, and the amount, if any, of tax withheld. A similar report is sent to the recipient. Pursuant to tax treaties or other agreements, the IRS may make its reports available to tax authorities in the recipient's country of residence. For payments made before January 1, 2001, backup withholding generally will not apply to dividends paid to holders at an address outside the United States (unless we have knowledge that the holder is a United States person). Unless we have actual knowledge that a holder is a non-United States holder, dividends paid during such period to a holder at an address within the United States may be subject to backup withholding at a rate of 31% if the holder (1) is not a corporation or other "exempt recipient" as defined in Treasury Regulations and (2) fails to provide a correct taxpayer identification number and other information to us. For payments made after December 31, 2000, non-United States holder that is not an "exempt recipient" generally will be subject to backup withholding at a rate of 31%, rather than withholding at a 30% rate or lower treaty rate discussed above, unless such non-United States holder certifies as to its foreign status (which certification may be made on IRS Form W-8). Proceeds from the disposition of common stock by a non-United States holder effected by or through a United States office of a broker will be subject to information reporting and to backup withholding at a rate of 31% of the gross proceeds unless such non-United States holder certifies under penalties of perjury as to, among other things, its address and status as a non-United States holder or otherwise establishes an exemption. Generally, United States information reporting and backup withholding will not apply to a payment of disposition proceeds if the transaction is effected outside the United States by or through a non-United States office of a broker. However, if such broker is, for United States federal income tax purposes, a United States person, a "controlled foreign corporation," a foreign person who derives 50% or more of its gross income for certain periods from the conduct of a United States trade or business, or, for payments after December 31, 2000, a partnership with certain connections to the United States, information reporting (but not backup withholding) will apply unless (1) such broker has documentary evidence in its files that the holder is a non-United States holder and certain other conditions are met or (2) the holder otherwise establishes an exemption. Under final 77
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United States Treasury Regulations, effective January 1, 2001, a non-United States holder generally would not be subject to backup withholding if the beneficial owner certifies to such owner's foreign status on a valid Form W-8 filed with us. Backup withholding is not an additional tax. Rather, the tax liability of persons subject to backup withholding will be reduced by the amount of tax withheld. If backup withholding results in an overpayment of United States income taxes, a refund may be obtained, provided the required documents are filed with the IRS. ESTATE TAX An individual non-United States holder who is treated as the owner of common stock at the time of such individual's death or has made certain lifetime transfers of an interest in common stock will be required to include the value of such common stock in such individual's gross estate for United States federal estate tax purposes and may be subject to United States federal estate tax, unless an applicable tax treaty provides otherwise. For United States federal estate tax purposes, a "non-United States holder" is an individual who is neither a citizen nor a domiciliary of the United States. Whether an individual is considered a "domiciliary" of the United States for estate tax purposes is generally determined on the basis of all of the facts and circumstances. 78
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UNDERWRITING GENERAL We are offering our shares in the U.S. and Canada through the U.S. underwriters and elsewhere through the international managers. Merrill Lynch, Pierce, Fenner & Smith Incorporated, ING Barings LLC, Banc of America Securities LLC and Bear, Stearns & Co. Inc. are acting as U.S. representatives of the U.S. underwriters named below. Subject to the terms and conditions described in a U.S. purchase agreement among us and the U.S. underwriters, and concurrently with the sale of shares to the international managers, we have agreed to sell to the U.S. underwriters, and the U.S. underwriters severally have agreed to purchase from us, the number of shares listed opposite their names below. [Download Table] NUMBER OF U.S. UNDERWRITER SHARES ---------------- ----------- Merrill Lynch, Pierce, Fenner & Smith Incorporated...................................... ING Barings LLC............................................. Banc of America Securities LLC.............................. Bear, Stearns & Co. Inc..................................... ----------- Total..................................................... =========== We have also entered into an international purchase agreement with the international managers, for whom Merrill Lynch International, ING Barings Limited, as agent for ING Bank, N.V., London Branch, Bank of America International Limited and Bear, Stearns International Limited are acting as lead managers, for sale of the shares outside the U.S. and Canada. Subject to the terms and conditions in the international purchase agreement, and concurrently with the sale of shares to the U.S. underwriters pursuant to the U.S. purchase agreement, we have agreed to sell to the international managers, and the international managers severally have agreed to purchase from us, shares. The initial public offering price per share and the total underwriting discount per share are identical under the U.S. purchase agreement and the international purchase agreement. The U.S. underwriters and the international managers have agreed to purchase all of the shares sold under the U.S. and international purchase agreements if any of these shares are purchased. If an underwriter defaults, the U.S. and international purchase agreements provide that the purchase commitments of the nondefaulting underwriters may be increased or the purchase agreements may be terminated. The closings for the sale of shares to be purchased by the U.S. underwriters and the international managers are conditioned on one another. We have agreed to indemnify the U.S. underwriters and the international managers against certain liabilities, including liabilities under the Securities Act, or to contribute to payments the U.S. underwriters and international managers may be required to make in respect of those liabilities. The underwriters are offering the shares, subject to prior sale, when, as and if issued to and accepted by them, subject to approval of legal matters by their counsel, including the validity of the shares, and other conditions contained in the purchase agreements, such as the receipt by the underwriters of officer's certificates and legal opinions. The underwriters reserve the right to withdraw, cancel or modify offers to the public and to reject orders in whole or in part. Merrill Lynch will be facilitating Internet distribution for this offering to certain of its Internet subscription customers. Merrill Lynch intends to allocate a limited number of shares for sale to its 79
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online brokerage customers. An electronic prospectus is available on the website maintained by Merrill Lynch. Other than the prospectus in electronic format, the information on the Merrill Lynch website relating to this offering is not a part of this prospectus. COMMISSIONS AND DISCOUNTS The U.S. representatives have advised us that the U.S. underwriters propose initially to offer the shares to the public at the initial public offering price set forth on the cover page of this prospectus and to dealers at that price less a concession not in excess of $ per share. The U.S. underwriters may allow, and the dealers may reallow, a discount not in excess of $ per share to other dealers. After the initial public offering, the public offering price, concession and discount may be changed. The following table shows the public offering price, underwriting discount and proceeds before expenses to us. The information assumes either no exercise or full exercise by the U.S. underwriters and the international managers of their over-allotment options. [Enlarge/Download Table] PER SHARE WITHOUT OPTIONS WITH OPTIONS --------- --------------- ------------ Public offering price................................... $ $ $ Underwriting discount................................... $ $ $ Proceeds, before expenses, to DigitalConvergence.:Com... $ $ $ The total expenses of the offering, not including the underwriting discount, are estimated at $ and are payable by us. OVER-ALLOTMENT OPTIONS We have granted an option to the U.S. underwriters to purchase up to additional shares at the public offering price less the underwriting discount. The U.S. underwriters may exercise this option for 30 days from the date of this prospectus solely to cover any over-allotments. If the U.S. underwriters exercise this option, each will be obligated, subject to conditions contained in the purchase agreements, to purchase a number of additional shares proportionate to that U.S. underwriter's initial amount reflected in the above table. We have also granted an option to the international managers, exercisable for 30 days from the date of this prospectus, to purchase up to additional shares to cover any over-allotments on terms similar to those granted to the U.S. underwriters. INTERSYNDICATE AGREEMENT The U.S. underwriters and the international managers have entered into an intersyndicate agreement that provides for the coordination of their activities. Under the intersyndicate agreement, the U.S. underwriters and the international managers may sell shares to each other for purposes of resale at the initial public offering price, less an amount not greater than the selling concession. Under the intersyndicate agreement, the U.S. underwriters and any dealer to whom they sell shares will not offer to sell or sell shares to persons who are non-U.S. or non-Canadian persons or to persons they believe intend to resell to persons who are non-U.S. or non-Canadian persons, except in the case of transactions under the intersyndicate agreement. Similarly, the international managers and any dealer to whom they sell shares will not offer to sell or sell shares to U.S. persons or Canadian persons or to persons they believe intend to resell to U.S. or Canadian persons, except in the case of transactions under the intersyndicate agreement. 80
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RESERVED SHARES At our request, the underwriters have reserved for sale, at the initial public offering price, approximately % of the shares offered by this prospectus for sale to some of our employees and persons having business relationships with us. If these persons purchase reserved shares, the number of shares available for sale to the general public will be reduced accordingly. Any reserved shares that are not orally confirmed for purchase within one business day of the pricing of this offering will be offered by the underwriters to the general public on the same terms as the other shares offered by this prospectus. NO SALES OF SIMILAR SECURITIES We and our executive officers and directors and certain existing stockholders have agreed, with exceptions, not to sell or transfer any common stock for 180 days after the date of this prospectus without first obtaining the written consent of Merrill Lynch. Specifically, we and these other persons have agreed not to directly or indirectly - offer, pledge, sell or contract to sell any common stock, - sell any option or contract to purchase any common stock, - purchase any option or contract to sell any common stock, - grant any option, right or warrant for the sale of any common stock, - lend or otherwise dispose of or transfer any common stock, - request or demand that we file a registration statement related to the common stock, or - enter into any swap or other agreement that transfers, in whole or in part, the economic consequence of ownership of any common stock whether any such swap or transaction is to be settled by delivery of shares or other securities, in cash or otherwise. This lockup provision applies to common stock and to securities convertible into or exchangeable or exercisable for or repayable with common stock. It also applies to common stock owned now or acquired later by the person executing the agreement or for which the person executing the agreement later acquires the power of disposition. QUOTATION ON THE NASDAQ NATIONAL MARKET We expect the shares to be approved for quotation on the Nasdaq National Market, subject to notice of issuance, under the symbol "DGTL." Before this offering, there has been no public market for our common stock. The initial public offering price will be determined through negotiations among us and the U.S. representatives and lead managers. In addition to prevailing market conditions, the factors to be considered in determining the initial public offering price are - the valuation multiples of publicly traded companies that the U.S. representatives and the lead managers believe to be comparable to us, - our financial information, - the history of, and the prospects for, our company and the industry in which we compete, - an assessment of our management, its past and present operations, and the prospects for, and timing of, our future revenues, - the present state of our development, and 81
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- the above factors in relation to market values and various valuation measures of other companies engaged in activities similar to ours. An active trading market for the shares may not develop. It is also possible that after the offering the shares will not trade in the public market at or above the initial public offering price. The underwriters do not expect to sell more than 5% of the shares being offered in this offering to accounts over which they exercise discretionary authority. PRICE STABILIZATION, SHORT POSITIONS AND PENALTY BIDS Until the distribution of the shares is completed, SEC rules may limit underwriters from bidding for and purchasing our common stock. However, the U.S. representatives may engage in transactions that stabilize the price of the common stock, such as bids or purchases to peg, fix or maintain that price. If the underwriters create a short position in the common stock in connection with the offering, i.e., if they sell more shares than are listed on the cover of this prospectus, the U.S. representatives may reduce that short position by purchasing shares in the open market. The U.S. representatives may also elect to reduce any short position by exercising all or part of the over-allotment option described above. Purchases of the common stock to stabilize its price or to reduce a short position may cause the price of the common stock to be higher than it might be in the absence of such purchases. The U.S. representatives may also impose a penalty bid on underwriters and selling group members. This means that if the U.S. representatives purchase shares in the open market to reduce the underwriter's short position or to stabilize the price of such shares, they may reclaim the amount of the selling concession from the underwriters and selling group members who sold those shares. The imposition of a penalty bid may also affect the price of the shares in that it discourages resales of those shares. Neither we nor any of the underwriters make any representation or prediction as to the direction or magnitude of any effect that the transactions described above may have on the price of the common stock. In addition, neither we nor any of the underwriters makes any representation that U.S. representatives or the lead managers will engage in these transactions or that these transactions, once commenced, will not be discontinued without notice. OTHER RELATIONSHIPS ING Barings LLC has performed investment banking and financial advisory services for us in the past for which it has received customary fees and may, in the future, perform similar services for us and receive additional compensation from us for those services. In connection with our private placement of Series A preferred stock in September 1999, ING Barings LLC received a placement fee of approximately $1.7 million in December 1999 for acting as placement agent. In addition, ING Barings LLC and DING.com LLC, an entity affiliated with ING Barings, purchased 1,587 and 2,875 shares of Series A preferred stock, respectively, in our Series A financing for a purchase price of $4,999,050 and $9,056,250, respectively. The shares held by ING Barings LLC and DING.com LLC will convert automatically into 999,810 and 1,811,250 shares of our common stock, respectively, upon completion of this offering. 82
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LEGAL MATTERS The validity of the shares of common stock offered by this prospectus will be passed upon for us by Vinson & Elkins L.L.P., Dallas, Texas. Vinson & Elkins L.L.P. owns 39,118 shares of our Series B preferred stock. In addition, Jeffrey A. Chapman, a partner of Vinson & Elkins L.L.P., owns 5,040 shares of our common stock and 3,556 shares of our Series B preferred stock. Various legal matters in connection with the common stock offered by this prospectus will be passed upon for the underwriters by Chadbourne & Parke LLP. EXPERTS The consolidated financial statements of DigitalConvergence.:Com Inc. as of December 31, 1999 and for the year then ended included in this prospectus have been so included in reliance on the report of PricewaterhouseCoopers LLP, independent accountants, given on the authority of said firm as experts in auditing and accounting. The financial statements of Infotainment Telepictures, Inc. as of December 31, 1998 and for the years ended December 31, 1998 and 1997 included in this prospectus have been so included in reliance on the report of PricewaterhouseCoopers LLP, independent accountants, given on the authority of said firm as experts in auditing and accounting. WHERE YOU CAN FIND MORE INFORMATION We have filed a registration statement on Form S-1 with the Securities and Exchange Commission for the common stock we are offering by this prospectus. This prospectus is a part of that registration statement. As allowed by SEC rules, this prospectus does not include all of the information contained in the registration statement or the exhibits to the registration statement. You should refer to the registration statement and its exhibits for additional information. When we complete this offering, we will be required to file annual, quarterly and special reports, proxy statements and other information with the SEC. You can obtain our SEC filings, including the registration statement, over the Internet at the SEC's website at HTTP://WWW.SEC.GOV. You may also read and copy any document we file with the SEC at its public reference facilities at 450 Fifth Street, N.W., Washington, D.C. 20549; Seven World Trade Center, Suite 1300, New York, New York 10048; and Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661-2511. You may also obtain copies of these documents at prescribed rates by writing to the Public Reference Section of the SEC at 450 Fifth Street, N.W., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0300 for further information on the operation of the public reference facilities. Our filings are also expected to be available at the office of the Nasdaq National Market. For further information on obtaining copies of our public filings at the Nasdaq National Market, you should call (212) 656-5060. 83
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INDEX TO FINANCIAL STATEMENTS [Download Table] PAGE NO. -------- DIGITALCONVERGENCE.:COM INC. Report of Independent Accountants........................... F-2 Consolidated Balance Sheet as of December 31, 1999.......... F-3 Consolidated Statement of Operations for the year ended December 31, 1999......................................... F-4 Consolidated Statement of Stockholders' Deficit for the year ended December 31, 1999................................... F-5 Consolidated Statement of Cash Flows for the year ended December 31, 1999......................................... F-6 Notes to Consolidated Financial Statements.................. F-7 INFOTAINMENT TELEPICTURES, INC. (PREDECESSOR) Report of Independent Accountants........................... F-21 Balance Sheet as of December 31, 1998....................... F-22 Statements of Operations for the years ended December 31, 1997 and 1998............................................. F-23 Statements of Changes in Stockholder's Deficit for the years ended December 31, 1997 and 1998.......................... F-24 Statements of Cash Flows for the years ended December 31, 1997 and 1998............................................. F-25 Notes to Financial Statements............................... F-26 F-1
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REPORT OF INDEPENDENT ACCOUNTANTS To the Stockholders of DigitalConvergence.:Com Inc. In our opinion, the accompanying consolidated balance sheet and the related consolidated statement of operations, stockholders' deficit and cash flows present fairly, in all material respects, the financial position of DigitalConvergence.:Com Inc. (the "Company") at December 31, 1999, and the results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States. 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 of these statements in accordance with auditing standards generally accepted in the United States, which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PricewaterhouseCoopers LLP Dallas, Texas April 27, 2000 F-2
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DIGITALCONVERGENCE.:COM INC. CONSOLIDATED BALANCE SHEET DECEMBER 31, 1999 [Enlarge/Download Table] PRO FORMA DECEMBER 31, DECEMBER 31, 1999 1999 ------------ ------------- ASSETS Current assets: Cash and cash equivalents................................. $ 45,539,823 Accounts receivable....................................... 31,847 Prepaid expenses and other................................ 90,482 ------------ Total current assets.................................. 45,662,152 Property and equipment, net................................. 469,991 Intangibles, net............................................ 79,365 Other assets................................................ 306,859 ------------ Total assets.......................................... $ 46,518,367 ============ LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Current liabilities: Accounts payable.......................................... $ 357,818 Accrued liabilities....................................... 363,998 Current portion of capital lease obligations.............. 9,780 ------------ Total current liabilities............................. 731,596 ------------ Long-term debt to related parties (net of unamortized discount of $515,871)..................................... 8,484,129 Accrued interest on long-term debt.......................... 639,541 Capital lease obligation.................................... 18,911 Other liabilities........................................... 2,475 Series A convertible preferred stock subject to redemption................................................ 47,887,725 -- Stockholders' equity (deficit): Common stock, $.01 par value, 110,250,000 shares authorized; 61,113,150 shares issued and outstanding; 71,141,490 shares issued and outstanding pro forma...... 611,132 711,415 Additional paid-in capital................................ 517,325 48,304,767 Excess of purchase price over Predecessor cost of net liabilities acquired................................................ (8,397,389) (8,397,389) Accumulated deficit....................................... (3,977,078) (3,977,078) ------------ ----------- Total stockholders' equity (deficit).................. (11,246,010) 36,641,715 ------------ ----------- Total liabilities and stockholders' equity (deficit)......................................... $ 46,518,367 $46,518,367 ============ =========== The accompanying notes are an integral part of these consolidated financial statements. F-3
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DIGITALCONVERGENCE.:COM INC. CONSOLIDATED STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1999 [Download Table] YEAR ENDED DECEMBER 31, 1999 ------------ Revenues.................................................... $ 1,542,800 ----------- Costs and expenses: Production and media costs................................ 1,012,407 General and administrative expenses....................... 3,920,876 Depreciation and amortization............................. 105,721 Research and development costs............................ 410,017 ----------- Total operating expenses................................ 5,449,021 ----------- Operating loss.......................................... (3,906,221) Other income (expense): Interest income........................................... 660,498 Interest expense.......................................... (731,355) ----------- Total other expense..................................... (70,857) ----------- Net loss.............................................. $(3,977,078) =========== Basic and diluted weighted average common shares outstanding............................................... 59,507,271 =========== Basic and diluted net loss per common share................. $ (0.07) =========== Pro forma basic and diluted weighted average common shares outstanding (unaudited)................................... 69,535,611 =========== Pro forma basic and diluted net loss per common share (unaudited)............................................... $ (0.06) =========== Supplemental pro forma basic and diluted weighted average common shares outstanding (unaudited)..................... =========== Supplemental pro forma basic and diluted net loss per common share (unaudited)......................................... =========== The accompanying notes are an integral part of these consolidated financial statements. F-4
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DIGITALCONVERGENCE.:COM INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIT FOR THE YEAR ENDED DECEMBER 31, 1999 [Enlarge/Download Table] COMMON STOCK ------------------------------------ EXCESS OF PURCHASE NUMBER COMMON STOCK ADDITIONAL PRICE OVER PREDECESSOR ACCUMULATED OF SUBSCRIPTION PAID-IN COST OF NET DEFICIT/RETAINED SHARES AMOUNT RECEIVABLE CAPITAL LIABILITIES ACQUIRED EARNINGS ---------- -------- ------------ ----------- ---------------------- ---------------- Balances as of December 31, 1998......................... 41,422,500 $414,225 (1,000) $ (413,225) -- $ -- Issuance of common stock..... 19,690,650 196,907 -- 407,053 -- -- Purchase of assets on January 4 (see Note 1)............... -- -- -- -- (8,397,389) -- Cash received on common stock subscription............... -- -- 1,000 -- -- -- Employee compensation (see Note 8)............... -- -- -- 132,188 -- -- Warrants issued in connection with preferred stock issuance (see Note 6)............... -- -- -- 391,309 -- -- Net loss..................... -- -- -- -- (3,977,078) ---------- -------- ------- ----------- ----------- ----------- Balances as of December 31, 1999............ 61,113,150 $611,132 $ -- $ 517,325 (8,397,389) $(3,977,078) ========== ======== ======= =========== =========== =========== TOTAL ------------ Balances as of December 31, 1998......................... $ -- Issuance of common stock..... 603,960 Purchase of assets on January 4 (see Note 1)............... (8,397,389) Cash received on common stock subscription............... 1,000 Employee compensation (see Note 8)............... 132,188 Warrants issued in connection with preferred stock issuance (see Note 6)............... 391,309 Net loss..................... (3,977,078) ------------ Balances as of December 31, 1999............ $(11,246,010) ============ The accompanying notes are an integral part of these consolidated financial statements. F-5
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DIGITALCONVERGENCE.:COM INC. CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 1999 [Download Table] YEAR ENDED DECEMBER 31, 1999 ------------ Cash flows from operating activities: Net loss.................................................. $(3,977,078) Adjustments to reconcile net loss to net cash used in operating activities: Deferred revenue from acquisition (see Note 1)........ (156,000) Depreciation and amortization......................... 105,721 Accretion of discount on long-term debt to related parties (see Note 5)................................ 84,963 Noncash compensation expense (see Note 8)............. 132,188 Changes in operating assets and liabilities: Accounts receivable................................. (31,847) Prepaid expenses.................................... (65,283) Other assets........................................ (304,259) Accounts payable.................................... 357,818 Accrued expense..................................... 886,264 ----------- Net cash used in operating activities............. (2,967,513) ----------- Cash flows from investing activities: Purchases of property and equipment....................... (397,277) Cash acquired in acquisition of entities under common control................................................. 165,278 Purchase of intangibles................................... (80,246) ----------- Net cash used in investing activities............. (312,245) ----------- Cash flows from financing activities: Proceeds from long-term debt from related party (see Note 5)...................................................... 2,500,000 Payment of long-term debt to related party (see Note 5)... (1,500,000) Proceeds from sale of common and preferred stock, net of costs and placement fees................................ 48,283,161 Proceeds from stockholder................................. 147,090 Repayments to stockholder................................. (610,670) ----------- Net cash provided by financing activities......... 48,819,581 ----------- Net increase in cash and cash equivalents................... 45,539,823 Cash and cash equivalents at beginning of year.............. -- ----------- Cash and cash equivalents at end of year.................... $45,539,823 =========== Supplemental disclosure of cash flows: Cash paid during the year for interest.................... $ -- =========== Cash paid during the year for income taxes................ $ -- =========== Non-cash investing activities: Predecessor net liabilities acquired, net of cash acquired............................................ $ 523,296 Non-cash financing activities: Issuance of promissory note to Predecessor............ $ 8,000,000 Issuance cost on Series A preferred stock (see Note 6).................................................. $ 391,309 The accompanying notes are an integral part of these consolidated financial statements. F-6
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DIGITALCONVERGENCE.:COM INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND DESCRIPTION OF BUSINESS The Company was incorporated in the state of Delaware in September 1998 under the name of DigitalConvergence.:Com Inc. ("Digital" or "the Company") at which time the founder was issued 41,422,500 shares of common stock for $1,000. The accompanying financial statements include the consolidated accounts of Digital and its wholly owned subsidiary, DigitalDemographics.:Com Inc. (collectively, "the Company" or "Digital"). The Company had no operating activity until January 4, 1999 when the Company entered into an Asset Purchase Agreement (the "Purchase Agreement" or the "Acquisition") with Infotainment Telepictures, Inc. ("Infotainment" or the "Predecessor"). Pursuant to the Purchase Agreement, the Company purchased all of the rights, title and interest in and to the trade names, trademarks, designs, copyrights, patents pending, patents filed and other intellectual property, all of the rights in and to the radio and television show known as NET TALK LIVE! THE INTERNET TALK SHOW including, but not limited to, all prior and future programming, all trademarks, copyrights, creative materials, designs and other intellectual property, all rights, title and interest in and to the furniture, fixtures and equipment, and certain liabilities ("the Assets") from the Predecessor. The aggregate purchase price for the Assets was $8,000,000 in the form of a promissory note, bearing interest at the rate of 6% per annum ("Promissory Note"). As the owner of a majority of the Company's common stock on the date of the Acquisition was part of a control group that controlled Infotainment, the Acquisition was accounted for as an acquisition of entities under common control. Accordingly, the assets and liabilities acquired were recorded at the Predecessor's historical cost, and the excess of the purchase price was charged to additional paid in capital in the amount of $8,397,389. At inception, the Company's Certificate of Incorporation authorized 63,000,000 shares of common stock, par value $0.01, and 10,000 shares of preferred stock, par value $0.01. In September 1999, the Board of Directors approved an amendment to the Certificate of Incorporation to increase the number of authorized shares of common and preferred stock to 110,250,000 and 30,000, respectively. The Company has developed technology that can link almost any form of media or product instantly with the Internet. The Company's Internet convergence technology enables users to access relevant content and conduct e-commerce instantly without inputting lengthy website addresses or conducting time-intensive website navigation. To date, the Company has not launched the convergence technology; therefore, no revenues have been recorded from the technology. The Company intends to initiate a full-scale roll out of the technology beginning in September 2000. In May 1999, DigitalDemographics.:Com Inc. ("DigitalDemographics") was formed as a Delaware corporation. The Company purchased all of the 1,000 issued and outstanding shares of DigitalDemographics for $1,000 in May 1999. DigitalDemographics was established as a data mining company, but has had no operations to date. 2. SIGNIFICANT ACCOUNTING POLICIES CONSOLIDATION The accounts of the Company and its consolidated subsidiary are included in the consolidated financial statements after elimination of significant intercompany accounts and transactions. CASH AND CASH EQUIVALENTS The Company considers all highly liquid investments with maturities of three months or less at the date of acquisition to be cash equivalents. F-7
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DIGITALCONVERGENCE.:COM INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) PROPERTY AND EQUIPMENT Property and equipment is stated at cost, less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, ranging from three to five years. Leasehold improvements are amortized over the life of the underlying lease using the straight-line method. Expenditures for maintenance and repairs, as well as minor renewals, are charged to operations as incurred, while betterments and major renewals are capitalized. Any gain or loss resulting from the retirement or sale of an asset is credited or charged to operations. The Company evaluates long-lived assets to be held and used in the business, or to be disposed of, for impairment whenever events or changes in circumstances indicate that the net book value of the asset may not be recoverable. An impairment is determined by comparing expected future cash flows (undiscounted and before interest) to the net book value of the assets. If impairment exists, the amount of impairment is measured as the difference between the net book value of the assets and the estimated fair value of the related assets. The Company believes that no impairment of property or equipment existed at December 31, 1999. CAPITALIZED SOFTWARE All costs incurred in the internal development of computer software, which will be provided free to Internet users, are expensed until a product design and a working model of the software have been tested and completed in accordance with Statement of Financial Accounting Standards No. 86, ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE TO BE SOLD, LEASED OR OTHERWISE MARKETED ("FAS 86"). Thereafter, any further development or production costs are capitalized until the software is placed into service. In the event unamortized software costs exceed the net realizable value of the software, the excess is expensed in the period the excess is determined. During the year ended December 31, 1999, no software costs were capitalized, as the Company did not incur significant development costs after the point at which a product design and working model of the software had been completed. At December 31, 1999, capitalized software is comprised of software purchased from third parties used in the operations of the Company and is reflected in "Intangibles" on the Balance Sheet. REVENUE RECOGNITION Revenue derived from the sale of advertising spots and sponsorships during NET TALK LIVE! THE INTERNET TALK SHOW is recognized upon broadcast of the show in which the advertisement or sponsorship is aired. In cases where payment is received prior to the airing of the advertisement or sponsorship, the Company defers recognition of the corresponding revenue until the advertisement or sponsorship has been aired. For the year ended December 31, 1999, two customers accounted for approximately 17% and 81% of the Company's revenues, respectively. CONCENTRATIONS OF CREDIT RISK The Company maintains cash balances exceeding federally insured limits in a money market fund. However, management believes the fund is of high credit quality and considers any exposure from concentrations of credit risk to be limited. The Company's revenue primarily relates to the sale of advertising spots and sponsorships on NET TALK LIVE! THE INTERNET TALK SHOW. The Company performs ongoing credit evaluations of its customers' F-8
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DIGITALCONVERGENCE.:COM INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) financial condition and, generally, requires no collateral from its customers. Credit losses have been within management's expectations and adequate allowance for any uncollectible trade receivables are maintained. INCOME TAXES The Company presents income taxes pursuant to Statement of Financial Accounting Standards No. 109, ACCOUNTING FOR INCOME TAXES ("FAS 109"). FAS 109 uses an asset and liability approach to account for income taxes, wherein deferred taxes are provided for book and tax basis differences for assets and liabilities. In the event differences between the financial reporting basis and the tax basis of the Company's assets and liabilities result in deferred tax assets, an evaluation of the probability of being able to realize the future benefits indicated by such assets is required. A valuation allowance is provided for a portion or all of the deferred tax assets when there is sufficient uncertainty regarding the Company's ability to recognize the benefits of the assets in future years. ADVERTISING COSTS Advertising and promotion-related expenses are charged to operations in the period incurred. Advertising expense for the year ended December 31, 1999 was approximately $13,500. RESEARCH AND DEVELOPMENT Research and development costs are primarily costs incurred to develop, enhance and develop new applications for our technology. Research and development expenses are charged to operations in the period incurred. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amount of the Company's financial instruments reflected in the consolidated balance sheet at December 31, 1999 approximate their respective fair values. PRO FORMA SERIES A CONVERTIBLE PREFERRED STOCK SUBJECT TO REDEMPTION (UNAUDITED) Effective upon the closing of this offering, the outstanding shares of Series A convertible preferred stock subject to redemption will automatically convert into approximately 10,028,340 shares of Common Stock. This conversion assumes the shares related to the preferred stock subscription will also convert into Common Stock as of December 31, 1999 (see Note 6). The pro forma effects of this transaction are unaudited and have been reflected in the accompanying pro forma balance sheet as of December 31, 1999. NET LOSS PER SHARE Basic net loss per share is computed based on the weighted average number of shares of common stock outstanding. Diluted net loss per share is computed based on the weighted average outstanding shares and the effect of dilutive potential common shares. For the year ended December 31, 1999, basic and diluted net loss per share are equal because the Company's potential common shares of 17,687,880 were anti-dilutive. F-9
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DIGITALCONVERGENCE.:COM INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) PRO FORMA NET LOSS PER SHARE (UNAUDITED) Pro forma net loss per share for the year ended December 31, 1999 is computed using the weighted average number of common shares outstanding, including the conversion of the Company's Series A preferred stock into shares of the Company's Common Stock effective upon the closing of the Company's initial public offering, as if such conversion occurred on January 1, 1999. The resulting pro forma adjustment includes an increase in the weighted average shares used to compute the basic net loss per share by 10,028,340 shares. SUPPLEMENTAL PRO FORMA NET LOSS PER SHARE (UNAUDITED) Supplemental pro forma net loss per share for the year ended December 31, 1999 adjusts pro forma net loss per share to relect the assumed issuance of shares of Common Stock (based upon the expected initial offering price of $ per share) to fund the $3.5 million cash payment of debt plus accrued interest to the Predecessor. The resulting supplemental pro forma adjustment includes an increase in the weighted average shares used to compute the pro forma basic net loss per share by shares. STOCK SPLITS A 630-for-one stock split of the Company's common stock was effective on January 3, 2000. All references in the consolidated financial statements to common stock shares, share prices, per share amounts, options and warrants have been adjusted retroactively for this stock split. ACCOUNTING FOR STOCK-BASED COMPENSATION Statement of Financial Accounting Standards No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION ("FAS 123"), encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans at fair value. Pro forma disclosure of net loss based on the provisions of FAS 123 is presented in Note 8. For financial reporting purposes, the Company has elected to continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES ("APB 25"), and related Interpretations. COMPREHENSIVE INCOME In 1998, Statement of Financial Accounting Standards No. 130, REPORTING COMPREHENSIVE INCOME ("FAS 130") was issued. FAS 130 requires separate financial statement disclosure of comprehensive income, which encompasses changes in net asset values derived from activity from both owner and non-owner sources. There were no items that qualify for treatment as components of comprehensive income for the year ended December 31, 1999. SEGMENT INFORMATION In 1998, Statement of Financial Accounting Standards No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION ("FAS 131") was issued. FAS 131 supercedes Statement of Financial Accounting Standards No. 14, FINANCIAL REPORTING FOR SEGMENTS OF A BUSINESS ENTERPRISE,replacing the "industry" approach with the "management" approach. The management approach designates the internal organization that is used by management for making operating decisions and assessing F-10
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DIGITALCONVERGENCE.:COM INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) performance as the source of the Company's reportable segments. FAS 131 also requires disclosures about products and services, geographic areas, and major customers. The adoption of FAS 131 did not affect the results of operations or financial position of the Company. For the year ended December 31, 1999, management assessed the Company's performance and made operating decisions as one reportable segment. UNCERTAINTIES AND THE USE OF ESTIMATES AND ASSUMPTIONS The preparation of consolidated 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. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133 (SFAS No. 133), ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, which establishes accounting and reporting standards for derivative instruments and hedging activities. SFAS No. 133, which will be effective for us for the fiscal year and quarters beginning after June 15, 2000, requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. During June 1999, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 137, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES-DEFERRAL OF THE EFFECTIVE DATE OF FASB STATEMENT 133. The Statement defers the effective date of SFAS 133 to fiscal 2001. Management is evaluating SFAS 133 but does not expect the potential effect of adopting the provisions of SFAS No. 133 to have a significant impact on our financial position, results of operations, and cash flows. In December 1999, the Commission issued Staff Accounting Bulletin ("SAB") No. 101, REVENUE RECOGNITION IN FINANCIAL STATEMENTS, which provides guidance on the recognition, presentation and disclosure of revenue in financial statements filed with the Commission. SAB 101 outlines the basic criteria that must be met to recognize revenue and provides guidance for disclosure related to revenue recognition policies. Management believes that SAB 101 will not have a material effect on our financial statements. F-11
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DIGITALCONVERGENCE.:COM INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 3. PROPERTY AND EQUIPMENT A summary of property and equipment at December 31, 1999 follows: [Download Table] ESTIMATED LIFE --------- Computer and office equipment........................... $ 393,991 3 Years Studio and phone equipment.............................. 213,250 5 Years Furniture and fixtures.................................. 55,844 5 Years Leasehold improvements.................................. 24,577 Various --------- Gross property and equipment............................ 687,662 Less: accumulated depreciation.......................... (217,671) --------- Property and equipment, net............................. $ 469,991 ========= Assets recorded under capital leases, primarily consisting of computer equipment, are recorded at the lower of the present value of future minimum lease payments or the fair value of the assets. Total gross assets recorded under capital lease in 1999 amounted to $42,244, and accumulated amortization was $5,867. Amortization of assets under capital lease is included in depreciation and amortization expense. Future minimum lease payments and related interest are as follows: [Download Table] YEAR ENDING DECEMBER 31, ------------ 2000........................................................ $13,159 2001........................................................ 13,159 2002........................................................ 7,172 ------- Aggregate minimum lease payments............................ 33,490 Less: amount representing interest.......................... 4,799 Less: current portion....................................... 9,780 ------- Long-term capital lease obligation.......................... $18,911 ======= The interest rate of the capital lease is 12.59%. Interest expense on the capital lease for the year ended December 31, 1999 was $1,597. 4. ACCRUED LIABILITIES A summary of accrued liabilities follows: [Download Table] DECEMBER 31, 1999 ------------ Accrued travel costs........................................ $ 87,820 Accrued legal costs......................................... 31,000 Accrued accounting costs.................................... 20,000 Accrued payroll and taxes................................... 110,456 Accrued franchise tax....................................... 75,752 Other accruals.............................................. 38,970 -------- $363,998 ======== F-12
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DIGITALCONVERGENCE.:COM INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 5. DEBT In January 1999, the Company issued a promissory note for $8,000,000, bearing interest at the rate of 6% per annum, as consideration for the Acquisition. Accrued interest thereon is payable on a quarterly basis beginning March 31, 2001. All or a portion of the promissory note will be repaid if certain events occur. In any event, all principal and interest amounts for the promissory note will be fully paid during 2002 and 2003, and the note will be paid in full by January 31, 2004. In October 1999, the Company voluntarily repaid $1,500,000 of the promissory note. Also in January 1999, the Company entered into a Common Stock and Debenture Purchase Agreement in which the Company issued 15,750,000 shares of common stock and $2,500,000 of the Company's 8.0% Debentures, Series 1999A (the "Debentures") for total proceeds of $2,502,500. The proceeds were allocated to the stock and the debenture based on their relative fair value. The portion of the proceeds allocated to the debenture amounted to $1,899,166 and resulted in a discount of $600,834, which reflects an effective interest rate of 15% and will be accreted over the life of the debenture using the effective interest method. The accrued interest on the Debentures will be paid on a quarterly basis beginning March 31, 2001. The unpaid accrued interest balance will be added to the principal balance beginning January 28, 2001, and the principal and interest will be paid on a quarterly basis beginning March 31, 2002 and ending December 31, 2003. If certain events occur, all or a portion of the Debentures will be repaid at an earlier date. Principal payments on the Company's debt in 2000, 2001, 2002, 2003 and 2004 are estimated to be $0, $0, $4,699,064, $4,699,064 and $0, respectively. 6. SERIES A CONVERTIBLE PREFERRED STOCK SUBJECT TO REDEMPTION In September 1999, the Company's Board of Directors unanimously approved the issuance of Series A convertible preferred stock to certain outside investors pursuant to the Stock Purchase Agreement. In November 1999, 15,838 shares of the Series A preferred stock were issued to various investors for $3,150 per share for total gross proceeds in the amount of $49,889,700 subject to issuance costs of $2,253,975. In December 1999, the Company received $252,000 for 80 additional shares of Series A preferred stock at $3,150 per share. The cash received in December 1999 was classified as Series A preferred stock subscribed, as the share certificates were not issued by December 31, 1999. Following is a summary of the Series A convertible preferred stock subject to redemption issued by the Company as of December 31, 1999: [Enlarge/Download Table] NUMBER OF SHARES DATE CASH RECEIPT SHARES ISSUED AND TOTAL CARRYING SERIES ISSUED DATE DESIGNATED OUTSTANDING PROCEEDS VALUE --------------------- -------------- -------------- ---------- ----------- ----------- ----------- A November 1999 Various 27,000 15,838 $49,889,700 $47,635,725 A -- December 1999 -- -- 252,000 252,000 ----------- ----------- $50,141,700 $47,887,725 =========== =========== The carrying value of the Series A preferred stock represents proceeds from the sale of the stock and proceeds from the preferred stock subscription of $252,000, net of issuance costs of $2,253,975. The Series A preferred stock subject to redemption has a par value of $0.01 per share and has a liquidation preference over the Company's common stock. In certain situations, including a change in control, the holders of this Series A preferred stock can deem the event a liquidation of the Company. F-13
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DIGITALCONVERGENCE.:COM INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. SERIES A CONVERTIBLE PREFERRED STOCK SUBJECT TO REDEMPTION (CONTINUED) As a result, these shares have been classified as temporary equity on the balance sheet. The holders of the Series A preferred stock are entitled to receive dividends when and if declared by the Company's Board of Directors and at any time that dividends are declared on the Company's common stock. Each share of Series A preferred stock is convertible, at the option of the holder, at any time on or after the date of issuance, into 630 shares of common stock at the Conversion Price, as defined in the Certificate of Designation of Series A preferred stock. The initial Conversion Price of these shares is equal to the issuance price of $3,150 per share. The shares convert automatically into common stock upon the election of the holders of at least two-thirds of the then outstanding Series A preferred stock or the closing of a firm commitment underwritten public offering which raises gross proceeds of at least $75,000,000, and whereby the aggregate value of the shares of common stock issuable on conversion of each share of Series A preferred stock is at least two times the conversion value. In connection with the issuance of the Series A preferred stock, the Company issued a warrant to purchase 124,740 shares of the Company's common stock to one of the investors as a finder's fee for attracting additional investors. The exercise price of the warrant is $5.00 per share and the warrant expires on September 29, 2004. The warrant is exercisable immediately. The Company valued the warrant using the Black-Scholes option-pricing model. The value of the warrant on the date of grant was $391,309 using the following assumptions: (1) volatility of 70%; (2) risk-free rate of interest of 5.79%; (3) fair market value of the common stock on date of grant of $5.00 per share; (4) expected life of five years; and (5) zero dividend yield. 7. STOCKHOLDERS' EQUITY (DEFICIT) In conjunction with the incorporation of the Company on September 25, 1998, the founder purchased 41,422,500 shares of common stock for $1,000. As discussed in Note 5 in January 1999, 15,750,000 shares of common stock, along with debentures, were issued to outside investors for $2,502,500 and $603,834 of the proceeds, were allocated to additional paid-in capital as a discount to debt. Additionally, in January 1999 certain employees and outside investors of the Company purchased 3,468,150 shares of common stock for $550.50. An officer of the Company purchased an additional 472,500 shares of common stock in May 1999 for $75. 8. STOCK-BASED COMPENSATON In August 1999, the Board of Directors of the Company approved the adoption of the Company's 1999 Stock Option Plan ("1999 Plan"). In September 1999, the stockholders of the Company approved the 1999 Plan. Under the 1999 Plan, the Company is authorized to grant options to purchase 9,450,000 shares of the Company's common stock to key employees of the Company or eligible non-employees, as defined by the 1999 Plan. Options granted under the 1999 Plan may be in the form of incentive stock options or nonqualified stock options. Options granted under the 1999 Plan generally expire ten years from date of grant. The Compensation Committee of the Board of Directors ("Committee") administers the 1999 Plan and determines the number and the terms of exercisability of options granted. The exercise price of the options granted under the 1999 Plan is fixed by the Committee on the date of grant of the options and equals at least one hundred percent of the fair market value of the Company's common stock on the date of grant. The options granted under the 1999 Plan may be fulfilled with authorized and unissued shares of common stock, issued shares of the Company's common stock held in treasury, or issued shares of common stock reacquired by the Company in each situation as the Committee may determine from time to time. F-14
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DIGITALCONVERGENCE.:COM INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 8. STOCK-BASED COMPENSATON (CONTINUED) As discussed in Note 2, the Company has adopted the disclosure only provisions of FAS 123 for options issued to employees. Had compensation cost for the option issuances to employees under the Company's 1999 Plan been determined based on the fair value provisions of FAS 123, the Company's net loss and net loss per share would have increased to the pro forma amounts indicated below: [Download Table] PRO FORMA 1999 ----------- Net loss--as reported....................................... $(3,977,078) Net loss--pro forma......................................... $(5,377,568) Basic and diluted net loss per common share--as reported.... $ (0.07) Basic and diluted net loss per common share--pro forma...... $ (0.09) The pro forma disclosures provided are not likely to be representative of the effects on reported net loss for future years due to future grants and the vesting requirements of the Company's stock options issued under the 1999 plan. The weighted average fair value for options granted to employees under the 1999 Plan was $0.96 in 1999. The fair value of each option granted is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used: [Download Table] Dividend yield.............................................. -- Expected volatility......................................... 0.0% Risk-free rate of return.................................... 5.6% Expected life............................................... 5 Yrs. The following table summarizes activity under the Company's 1999 Plan during the year ended December 31, 1999: [Download Table] NUMBER OF WTD. AVG. OPTIONS EXER. PRICE --------- ----------- Options outstanding at beginning of year............... -- -- Options granted........................................ 7,585,200 $3.88 Options exercised...................................... -- -- Options canceled....................................... -- -- --------- ----- Options outstanding at end of year..................... 7,585,200 $3.88 --------- ----- Options exercisable at end of year..................... 1,575,000 $3.65 ========= ===== The following table summarizes information for stock options outstanding at December 31, 1999: [Download Table] EXERCISE PRICE NUMBER OF OPTIONS WTD. AVG. REMAINING LIFE WTD. AVG. EXER. PRICE -------------- ----------------- ------------------------ --------------------- $3.31 5,040,000 9.61 $3.31 $5.00 2,545,200 9.88 $5.00 9. INCOME TAXES Deferred taxes are provided for those items reported in different periods for income tax and financial reporting purposes. The net deferred tax asset has been fully reserved because realization is F-15
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DIGITALCONVERGENCE.:COM INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 9. INCOME TAXES (CONTINUED) not considered more likely than not. The tax effects of temporary differences that give rise to significant portions of the deferred tax assets are presented below: [Download Table] DECEMBER 31, 1999 ------------ Deferred tax assets: Net operating loss carryforwards.......................... $ 1,575,000 Intangible assets......................................... 2,888,000 Other..................................................... 11,000 ----------- Gross deferred tax assets............................... 4,474,000 Deferred tax liabilities: Depreciation.............................................. 5,000 ----------- Net deferred tax assets..................................... 4,469,000 Valuation allowance......................................... (4,469,000) ----------- Deferred tax balance........................................ $ -- =========== When realization of the deferred tax asset is more likely than not to occur, the benefit related to the asset purchase from Infotainment of approximately $2,888,000 will be credited to additional paid-in capital. The provision for income taxes is different than the amount computed using the applicable statutory federal income tax rate with the difference for each year summarized below: [Download Table] DECEMBER 31, 1999 ------------ Federal tax benefit at statutory rate....................... (34)% State taxes, net of federal benefit......................... (3)% Permanent differences....................................... (2)% Adjustment due to increase in valuation allowance........... 35% --- Provision for income taxes.................................. 0% === As of December 31, 1999, the Company has available net operating loss carryforwards totaling approximately $4,261,000 which expire beginning in 2019. Utilization of net operating loss carryforwards may be limited by ownership changes which may have occured or could occur in the future. 10. COMMITMENTS AND CONTINGENCIES COMMITMENTS On November 18, 1999, the Company entered into a ten-year lease for its new corporate facilities located in Dallas, Texas commencing in 2000 and expiring in 2010. The Company may cancel the lease effective in the 84(th) month of the lease term in accordance with the lease provisions, subject to a cancellation fee, and renew the lease for two additional 5-year terms. Additionally, the Company is obligated by the end of the third year of the lease, if not elected earlier, to acquire additional space in the building for an additional rental expense of approximately F-16
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DIGITALCONVERGENCE.:COM INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 10. COMMITMENTS AND CONTINGENCIES (CONTINUED) $320,000 per year. The Company expects to spend approximately $1.5 million during 2000 in completing the build-out and improvements in the new corporate offices. In December 1999, the Company entered into a sub-lease agreement to provide for temporary office space in Dallas, Texas. Under the terms of the lease, the Company will pay $11,500 per month. The lease expires on November 30, 2000; provided, however, that the lease can be terminated upon 30 days written notice. In January 2000, the Company entered into a lease for additional temporary office space in Dallas, Texas. The lease expires in May 2000, unless terminated earlier under certain provisions to the lease agreement. The Company will pay approximately $57,700 under the lease during 2000. The Company has an additional noncancelable lease for other Dallas, Texas facilities that expires in 2001. Rent expense totaled $56,600 during the year ended December 31, 1999 related to this facility lease and various other equipment operating leases. Total future minimum payments under all operating leases are as follows: [Download Table] YEAR ENDING DECEMBER 31, OPERATING LEASE ------------ --------------- 2000........................................................ $ 839,593 2001........................................................ 842,500 2002........................................................ 877,800 2003........................................................ 1,213,000 2004........................................................ 1,213,000 Thereafter.................................................. 6,921,750 ----------- Total minimum lease payments................................ $11,907,643 =========== In December 1999, the Company entered into a manufacturing and marketing agreement with Tandy Corporation ("Tandy") under which the Company granted Tandy a limited, royalty-free, nonexclusive, revocable worldwide license to (1) manufacture the Company's patented Cue:C.A.T. devices (2) market and sell Cue:C.A.T. devices and :C.R.Q. software, and (3) use Cue:C.A.T. and :C.R.Q. technology in Tandy's RadioShack.com web site in order to incorporate the Company's Intellectual Property into Tandy's Internet web site. Under the agreement, the Company is obligated to purchase at least 1,000,000 component parts from Tandy. During February 2000, the Company placed an order for 2,000,000 component parts and has issued a letter of credit to Tandy for approximately $15.5 million. Upon shipment of the product to the Company, the Company will pay Tandy $15.5 million in cash and cancel the underlying letter of credit. The manufacturing and marketing agreement is effective through December 31, 2001 with an automatic one year renewal absent proper nonrenewable notice. The Predecessor has agreed to indemnify the Company from any costs, expenses, liabilities or other losses in connection with lawsuits related to the Predecessor. CONTINGENCIES From time to time, the Company may have certain contingent liabilities that arise in the ordinary course of its business activities. The Company accrues contingent liabilities when it is probable that future expenditures will be made and such expenditures can be reasonably estimated. In the opinion of F-17
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DIGITALCONVERGENCE.:COM INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 10. COMMITMENTS AND CONTINGENCIES (CONTINUED) management, there are no pending claims of which the outcome is expected to result in a material adverse effect on the financial position, results of the operations or cash flows of the Company. On January 29, 1999, the Predecessor entered into individual agreements with certain independent contractors who had provided services to the Predecessor for the period from 1996 through early 1999. Certain of these contractors are now employees of the Company. According to the contract agreements, the Predecessor agreed to pay future cash bonuses to the individuals contingent upon the occurrence of (1) the finalization of an initial public offering whereby the Company raises a net amount of proceeds of at least $30 million and (2) the receipt of at least $8 million in cash collections by the Company prior to the date of an initial public offering which raises a net amount of proceeds of at least $30 million. As a result of the $1,500,000 voluntary repayment of the Promissory Note by the Company in October 1999, management of the Predecessor elected to prepay a certain percentage of these bonuses in the amount of approximately $132,000 even though the conditions of the bonus agreements had not been satisfied. The payments remain the property of the contractors regardless of whether the conditions of the bonus agreements are met. The Company accounted for these transactions as if they were a compensating plan adopted by the Company with an offsetting contribution to capital. As of the date of this report, the Predecessor remains liable for an additional $1,000,000, contingent upon the satisfaction of the stipulated conditions of the bonus agreements. 11. EMPLOYEE BENEFIT PLAN The Company sponsors a 401(k) defined contribution retirement plan ("401(k) Plan") covering all employees who have completed at least one month of service. The 401(k) Plan allows eligible employees to defer receipt of up to twenty percent of their annual compensation (not to exceed $10,000 per calendar year) and contribute such amounts to various investment funds. Eligible employees may elect to participate at the beginning of any quarter after their hire date. Employee contributions vest immediately. The Company makes matching contributions of twenty-five percent of the employees' annual contributions, not to exceed eight percent of the employee's annual pay. The Company's matching contributions vest on a pro rata basis over five years. During the year ended December 31, 1999, the Company contributed approximately $6,500 to the 401(k) Plan. 12. SUBSEQUENT EVENTS In January 2000, the Company issued 128 shares of Series A Convertible Preferred Stock to various investors for aggregate consideration of $403,000, of which $252,000 in cash was received prior to year-end. During February and April 2000, the Company issued 1,128,000 and 595,000 stock options, respectively, to various employees at strike prices ranging from $5.00 to $9.37 per option. The February options were issued at fair market value of the common stock on the date of grant, and the April options were issued below fair market value of the common stock on the dates of grant. The Company will recognize compensation expense related to the April options for the difference between the fair market value of the common stock at the date of grant and the respective strike prices, which will be amortized over the applicable vesting period. F-18
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DIGITALCONVERGENCE.:COM INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 12. SUBSEQUENT EVENTS (CONTINUED) In April 2000, the Company issued 5,929,364 shares of Series B Convertible Preferred Stock to various investors for aggregate consideration of approximately $41.7 million. The Series B Convertible Preferred Stock has a par value of $0.01 per share and has liquidation preference over the Company's common stock. The holders of the Series B Convertible Preferred Stock are entitled to receive dividends when and if declared by the Company's board of directors and at any time that dividends are declared on the Company's common stock. Each share of Series B Convertible Preferred Stock is convertible, at the option of the holder, at any time on or after the date of issuance, into one share of common stock upon the election of the holders of at least two-thirds of the then outstanding Series B Convertible Preferred Stock or the closing of a firm commitment underwritten public offering which raises gross proceeds of at least $75,000,000, and whereby the aggregate value of the Company on a pre-initial public offering basis is at least $750,000,000. In April 2000, the Company issued 5,372,593 shares of Series C Convertible Preferred Stock to various investors for aggregate consideration of approximately $56.6 million. The Series C Convertible Preferred Stock has a par value of $0.01 per share and has liquidation preference over the Company's common stock. The holders of the Series C Convertible Preferred Stock are entitled to receive dividends when and if declared by the Company's board of directors and at any time that dividends are declared on the Company's common stock. Each share of Series C Convertible Preferred Stock is convertible, at the option of the holder, at any time on or after the date of issuance, into one sharecommon stock upon the election of the holders of at least two-thirds of the then outstanding Series C Convertible Preferred Stock or the closing of a firm commitment underwritten public offering which raises gross proceeds of at least $75,000,000 and whereby the aggregate value of the Company on a pre-initial public offering basis is at least $750,000,000. During the second quarter of the year ended December 31, 2000, the Company recorded a one-time charge to earnings in the amount of $37.2 million to reflect the difference between the issuance price and the fair market value of the Series B and C preferred stock, as determined by a contemporaneous, independent appraisal. In April 2000, the Company issued two warrants to an affiliate of National Broadcasting Company, Inc. The first warrant is exercisable to purchase up to 3,752,445 shares of Common Stock at a per share exercise price of $5.00. The second warrant is exercisable to purchase up to 4,505,165 shares of Common Stock, plus an additional number of shares of Common Stock equal to 5% of any shares of Series B Preferred or Series C Preferred issued by the Company after the date of the Agreement., at a per share exercise price of $10.54. The exercise price for the first warrant is subject to adjustment if the aggregate market value of shares of Common Stock outstanding immediately after the closing of the Company's initial public offering is less than $350,000,000, determined utilizing the per share offering price in the Company's initial public offering. The exercise price for the second warrant is subject to reduction if the aggregate market value of shares of Common Stock outstanding immediately after the closing of the Company's initial public offering is less than $750,000,000, determined utilizing the per share offering price in the Company's initial public offering. The number of shares issuable upon the exercise of each warrant and the exercise of price of each warrant is subject to adjustment in the event of, among other things, a stock split, reclassification or merger, issuance of additional shares of Common Stock, issuance of options or convertible securities and payment of dividends or other distribution. Both of the warrants will expire in April 2005. F-19
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DIGITALCONVERGENCE.:COM INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 12. SUBSEQUENT EVENTS (CONTINUED) The Company valued the warrants using the Black-Scholes option-pricing model. The fair value of the first warrant on the date of grant was $31.7 million, and the fair value of the second warrant was $31.4 million using the following assumptions: 1) volatility of 70.0%, 2) risk-free rate of interest of 6.5%, 3) fair market value of the common stock on date of grant of per share, 4) expected life of five years and 5) zero dividend yield. The Company will recognize a one-time expense for the fair market value of the warrants. The Company adopted the Employee Stock Purchase Plan in April 2000. A total of 1,000,000 shares of common stock are authorized for issuance under the plan. The plan provides for the grant of stock options to certain eligible employees. The purpose of the plan is to provide eligible employees with an incentive to advance the interests of the Company by providing an opportunity to purchase stock of the Company at a favorable price. The plan is administered by the Company's Compensation Committee. In April 2000, the Company repaid $3,000,000 in principal and $584,137 in interest related to the promissory note. In addition, the Company repaid the $2,500,000 of debentures and all related accrued interest. F-20
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REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors of Infotainment Telepictures, Inc. In our opinion, the accompanying balance sheets and the related statements of operations, changes in stockholder's deficit, and cash flows present fairly, in all material respects, the financial position of Infotainment Telepictures, Inc. (the "Company") at December 31, 1998 and the results of its operations and its cash flows for each of the two years in the period ended December 31, 1998, in conformity with accounting principles generally accepted in the United States. 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 of these statements in accordance with auditing standards generally accepted in the United States, which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PricewaterhouseCoopers LLP Dallas, Texas February 29, 2000, except as to Note 11 which is as of April 27, 2000 F-21
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INFOTAINMENT TELEPICTURES, INC. BALANCE SHEET DECEMBER 31, 1998 [Download Table] 1998 --------- ASSETS Current assets: Cash and cash equivalents................................. $ 174,953 Accounts receivable....................................... -- Deferred production costs................................. -- Prepaid expenses.......................................... 22,725 Deferred tax assets....................................... 2,846 --------- Total current assets.................................. 200,524 Property and equipment, net............................... 177,554 Other assets.............................................. 2,600 --------- Total assets.......................................... $ 380,678 ========= LIABILITIES AND STOCKHOLDER'S DEFICIT Current liabilities: Accounts payable and accrued expenses..................... $ 85,299 Deferred revenue.......................................... 156,000 Advances from officer..................................... 197,919 Notes payable............................................. 452,900 --------- Total current liabilities............................... 892,118 Deferred tax liability.................................... 2,846 --------- Total liabilities....................................... 894,964 Stockholder's deficit: Common stock, no par value, 25,000 shares authorized, issued and outstanding.................................. -- Accumulated deficit....................................... (514,286) --------- Total stockholder's deficit........................... (514,286) --------- Total liabilities and stockholder's deficit......... $ 380,678 ========= The accompanying notes are an integral part of these financial statements. F-22
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INFOTAINMENT TELEPICTURES, INC. STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1998 [Enlarge/Download Table] 1997 1998 --------- ----------- Sales....................................................... $ 689,967 1,636,422 Cost and expenses: Production costs.......................................... 590,704 939,468 Selling, general and administrative....................... 284,370 670,953 Depreciation.............................................. 40,515 54,908 Research and development.................................. -- 35,771 --------- ----------- Operating loss.......................................... (225,622) (64,678) --------- ----------- Interest expense.......................................... 17,272 23,754 --------- ----------- Net loss................................................ $(242,894) $ (88,432) ========= =========== Weighted average shares outstanding......................... 25,000 25,000 ========= =========== Basic and diluted net loss per share........................ $ (9.72) $ (3.54) ========= =========== The accompanying notes are an integral part of these financial statements. F-23
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INFOTAINMENT TELEPICTURES, INC. STATEMENTS OF CHANGES IN STOCKHOLDER'S DEFICIT FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1998 [Enlarge/Download Table] TOTAL COMMON ACCUMULATED STOCKHOLDER'S SHARES STOCK DEFICIT DEFICIT -------- -------- ----------- ------------- Balance at December 31, 1996........................ 25,000 -- (182,960) (182,960) Net loss............................................ -- (242,894) (242,894) ------ ------- --------- --------- Balance at December 31, 1997........................ 25,000 (425,854) (425,854) Net loss............................................ -- (88,432) (88,432) ------ ------- --------- --------- Balance at December 31, 1998........................ 25,000 $ -- $(514,286) $(514,286) ====== ======= ========= ========= The accompanying notes are an integral part of these financial statements. F-24
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INFOTAINMENT TELEPICTURES, INC. STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1998 [Download Table] 1997 1998 --------- --------- Cash flows from operating activities: Net loss.................................................. $(242,894) $ (88,432) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation.......................................... 40,515 54,908 Deferred revenue...................................... 288,200 (272,000) Barter transactions (see Note 2 and 7) (17,000) (2,400) Changes in operating assets and liabilities: Accounts receivable................................. (38,462) 63,300 Deferred production costs........................... (4,743) 51,505 Prepaid expenses.................................... -- (22,725) Other assets........................................ -- (2,600) Accounts payable and accrued expenses............... 29,648 44,536 --------- --------- Net cash used in operating activities............. 55,264 (173,908) --------- --------- Cash flows from investing activities: Purchase of property and equipment........................ (57,538) (74,681) --------- --------- Net cash used in investing activities............. (57,538) (74,681) --------- --------- Cash flows from financing activities: Borrowings on line of credit.............................. -- 587,900 Repayment of line of credit............................... -- (135,000) Advances from officer..................................... (84,928) (29,530) --------- --------- Net cash provided by financing activities......... (84,928) 423,370 --------- --------- Net increase in cash and cash equivalents................... (87,202) 174,781 Cash and cash equivalents at beginning of year.............. 87,374 172 --------- --------- Cash and cash equivalents at end of year.................... $ 172 $ 174,953 ========= ========= Supplemental disclosure of cash flows: Cash paid during the year for interest.................... $ -- $ 6,818 ========= ========= Cash paid during the year for income taxes................ $ -- $ -- ========= ========= For disclosure of non-cash transactions see Note 7. The accompanying notes are an integral part of these financial statements. F-25
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INFOTAINMENT TELEPICTURES, INC. NOTES TO FINANCIAL STATEMENTS 1. DESCRIPTION OF BUSINESS The Company was incorporated in the state of Nevada in 1993 under the name "Gunn Industries." Since inception, the Company has been owned by a sole shareholder. By decision of the Board of Directors held on January 2, 1998, the name of the Company was changed to Infotainment Telepictures, Inc. ("Infotainment" or the "Company"). Infotainment is a media company focused on providing original radio, television and Internet programming relating to information technologies and the Internet and the production of infomercials for third parties for the sale of goods and services. The Company's properties include the radio and television program, NET TALK LIVE! THE INTERNET TALK SHOW, and the related Internet site. Revenues are derived from the sale of radio, television and Internet advertising and sponsorships on THE NET TALK LIVE! THE INTERNET TALK SHOW and revenue and royalties from the production of infomercials for third parties. In January 1999, substantially all of the Company's assets and liabilities were sold to DigitalConvergence.:Com Inc. ("Digital") (see Note 11). 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES CASH AND CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS The Company considers all highly liquid investments with maturities of three months or less at date of acquisition to be cash equivalents. PROPERTY AND EQUIPMENT Property and equipment is stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, ranging from three to five years. The Company evaluates long-lived assets to be held and used in the business for impairment whenever events or changes in circumstances indicate that the net book value of the asset may not be recoverable. An impairment is determined by comparing expected future cash flows (undiscounted and before interest) to the net book value of the assets. If impairment exists, the amount of impairment is measured as the difference between the net book value of the assets and the estimated fair value of the related assets. Based on its most recent analysis, the Company believes that no impairment of property or equipment existed at December 31, 1998. CONCENTRATION OF CREDIT RISK The Company's revenue and accounts receivable primarily relate to the sale of advertising spots and sponsorships on NET TALK LIVE! THE INTERNET TALK SHOW and the production of infomercials. The Company performs ongoing credit evaluations of its customers' financial condition and, generally, requires no collateral from its customers. Credit losses have been within management's expectations and adequate allowances for any uncollectible trade receivables are maintained. Substantially all of the Company's accounts receivable are derived from sales to one customer in each of the years ended December 31, 1997 and 1998. Historically, the Company has not incurred material credit related losses. F-26
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INFOTAINMENT TELEPICTURES, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) RESEARCH AND DEVELOPMENT Research and development costs are primarily costs incurred to develop, enhance and develop new applications for our technology. Research and development costs are charged to expense in the period incurred. ADVERTISING COSTS Advertising and promotion-related expenses are charged to operations when incurred. Advertising expense for 1997 and 1998 was approximately $0 and $10,031, respectively. INCOME TAXES Deferred income taxes are recorded to reflect the future tax consequences of temporary differences between the tax and financial bases of assets and liabilities based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect the taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. REVENUE RECOGNITION Revenue derived from the sale of advertising spots and sponsorships during NET TALK LIVE! THE INTERNET TALK SHOW is recognized upon broadcast of the show in which the advertisement or sponsorship is aired. In cases where payment is received prior to the airing of the advertisement or sponsorship, the Company defers recognition of the corresponding revenue until the advertisement or sponsorship has been aired. Revenue derived from the production of infomercials is recognized when production is complete and the master is delivered to the customer, which is less than one year. Payments received in advance and costs incurred for production are deferred until completion of the related infomercial. Infomercial royalty revenue is recognized upon the sale of goods and/or services by the customer. BARTER TRANSACTIONS The Company trades advertisements and sponsorships on NET TALK LIVE! THE INTERNET TALK SHOW and Internet site in exchange for goods and services. Barter transactions are recorded at the fair market value of the goods and services provided or received, whichever is lower. Barter revenues are recognized in the period the advertisement or sponsorship is aired. If a barter agreement extends over the end of any accounting period, an asset or a liability is recorded based on the fair value of the related goods or services earned or to be provided at such period end. Historically, the goods and services provided and received have been exchanged in the same 30-day period. Therefore, advertising and sponsorship revenues are generally offset by an equal amount of production costs and/or property and equipment. In January 2000, the Emerging Issues Task Force ("EITF") released Issue No. 99-17, "Accounting for Advertising Barter Transactions," which is effective for transactions occurring after January 20, 2000. Management does not expect adoption of the EITF to have a material impact on its operations and financial position. F-27
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INFOTAINMENT TELEPICTURES, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) NET LOSS PER SHARE Net loss per share is computed based on the weighted average number of shares of common stock outstanding and common equivalent shares. For the years ended December 31, 1997 and 1998, there were 25,000 shares of common stock issued and outstanding. Basic and diluted net loss per share are equal because the Company had no potentially dilutive shares outstanding during the years ended December 31, 1997 and 1998. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying value of the Company's cash and cash equivalents, accounts receivable, and accounts payable approximate their respective fair values. UNCERTAINTIES AND THE USE OF ESTIMATES AND ASSUMPTIONS 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. 3. PROPERTY AND EQUIPMENT A summary of property and equipment follows: [Download Table] DECEMBER 31, --------- 1998 --------- Computer equipment.......................................... $ 53,280 Production equipment........................................ 205,036 Phone equipment............................................. 8,214 Furniture and fixtures...................................... 23,856 --------- Property and equipment, gross............................... 290,386 Less accumulated depreciation............................... (112,832) --------- Property and equipment, net................................. $ 177,554 ========= F-28
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INFOTAINMENT TELEPICTURES, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 4. ACCOUNTS PAYABLE AND ACCRUED EXPENSES A summary of accounts payable and accrued expenses follows: [Download Table] DECEMBER 31, ------------ 1998 ------------ Accounts payable............................................ $21,515 Federal taxes............................................... 63,327 Other accruals.............................................. 457 ------- $85,299 ======= 5. NOTES PAYABLE During 1998, the Company borrowed $587,900 through a line of credit with an investor of Digital at an interest rate of 8.0%, of which $135,000 was repaid in the same year. The note was unsecured. The remaining amount of the borrowings were repaid in 1999 in connection with the sale of the Company's assets and liabilities to Digital (see Note 11). 6. INCOME TAXES Income tax expense on income before income taxes consists of: [Download Table] DECEMBER 31, ------------------- 1997 1998 -------- -------- Current provision: Federal............................................... $ -- $ -- State................................................. -- -- Deferred provision...................................... (74,838) (22,848) Valuation allowance..................................... 74,838 22,848 -------- -------- Total income tax benefit................................ $ -- $ -- ======== ======== Reconciliations of the U.S. corporate income tax rate and the effective tax rate on loss before income taxes are summarized below: [Download Table] DECEMBER 31, -------------------- 1997 1998 --------- -------- U.S. corporate tax rate 34% 34% Loss before taxes...................................... $(242,894) $(88,432) --------- -------- Tax benefit at statutory rates......................... $ (82,584) $(30,067) Tax effect of non income tax penalties................. 6,222 6,920 Tax effect of meals and entertainment.................. 1,524 299 Increase in valuation allowance........................ 74,838 22,848 --------- -------- Total income tax benefit............................... $ -- $ -- ========= ======== F-29
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INFOTAINMENT TELEPICTURES, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 6. INCOME TAXES (CONTINUED) The components of the deferred tax asset and liability as of December 31, 1998 are as follows. [Download Table] 1998 --------- ASSETS: Net operating losses........................................ $ 158,692 Other temporary differences................................. 2,489 Valuation allowance......................................... (158,335) --------- Deferred tax assets......................................... 2,846 ========= LIABILITIES: Differences between book and tax basis of property and equipment................................................. 2,846 ========= Deferred tax liability...................................... 2,846 --------- Net deferred tax asset (liability).......................... $ -- ========= The expiration date of the net operating losses is as follows: [Download Table] EXPIRATION AMOUNT DATE -------- ---------- $ 32,480 2010 148,854 2011 225,563 2012 59,843 2019 -------- $466,740 ======== 7. BARTER TRANSACTIONS During the periods presented, in exchange for advertisements and sponsorships on NET TALK LIVE! THE INTERNET TALK SHOW, the Company has primarily received radio and television airtime to broadcast the show. For the years ended December 31, 1997 and 1998, barter transactions are summarized as follows: [Download Table] DECEMBER 31, -------------------- 1997 1998 --------- -------- Revenues............................................... $ 293,275 $ 48,930 Expenses............................................... (276,275) (46,530) Property and equipment................................. (17,000) (2,400) --------- -------- Total.................................................. $ -- $ -- ========= ======== The decrease of barter transactions from 1997 and 1998 results from new broadcast contracts with other radio and television stations by which the Company generally pays cash to the stations for the value of the air time. F-30
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INFOTAINMENT TELEPICTURES, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 8. LEASES The Company has a noncancelable lease for facilities that expires in 2001. Future minimum lease payments under the lease are as follows: [Download Table] YEAR ENDING OPERATING DECEMBER 31, LEASES -------------------------------------------------- --------- 1999.............................................. $31,200 2000.............................................. 31,200 2001.............................................. 10,300 ------- Total minimum lease payments...................... $72,700 ======= Rental expense from operating leases amounted to $17,000, and $20,275 for the years ended December 31, 1997, and 1998, respectively. These expenses include $17,000, and $0, respectively resulting from a barter transaction (see Note 7). 9. MAJOR CUSTOMERS AND CONTRACTS CUSTOMERS For the year ended December 31, 1997, two customers accounted for approximately 28.0% and 63.1% of the Company's total revenues, respectively. For the year ended December 31, 1998, three customers, accounted for approximately 26.5%, 25.3% and 24.9% of the Company's total revenues, respectively. CONTRACTS In June 1997, the Company entered into a contract with Nissi Cosmetics, Inc. ("Nissi") to produce two infomercials, two direct response spots and two web sites for the advertising and marketing of a Nissi product. The Company received a flat fee for its services. In December 1997, the Company entered into a contract with Computer City, Inc. ("Computer City") for Computer City to become a broadcast sponsor of NET TALK LIVE! THE INTERNET TALK SHOW. This contract, which terminated after six months, provided for sponsorship of the show, including commercial spots within the show, as well as the linking and co-branding of the respective company's web sites and personal appearances by the cast members of the show. The Company received a per show fee for these services. In December 1997, the Company entered into a contract with GTE Internetworking for GTE Internetworking to become a broadcast sponsor of NET TALK LIVE! THE INTERNET TALK SHOW This one-year contract provided for sponsorship of the show, including commercial spots within the show, as well as the linking and co-branding of the respective company's web sites. The Company received a per show fee for these services. In December 1997, the Company entered into a contract with The Associates for The Associates to become a broadcast sponsor of NET TALK LIVE! THE INTERNET TALK SHOW. This sixteen-week contract provided for sponsorship of the show, including commercial spots within the show, and the development of a web site for The Associates' product. The Company received a per show fee for these services. F-31
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INFOTAINMENT TELEPICTURES, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 9. MAJOR CUSTOMERS AND CONTRACTS (CONTINUED) In December 1998, the Company entered into a contract with Microsoft Corporation ("Microsoft") to produce and air two commercial spots on its NET TALK LIVE! THE INTERNET TALK SHOW each week for a minimum of sixteen weeks, as a part of Microsoft's "watch and win" marketing campaign. For these services, the Company received a flat fee plus various production and modification fees. 10. RELATED PARTY TRANSACTIONS Included in current liabilities on the accompanying balance sheet is an advance from a director of the Company for $197,919 for the year ended December 31, 1998. 11. SUBSEQUENT EVENTS On January 4, 1999, the Company entered into an Asset Purchase Agreement (the "Agreement") pursuant to which the Company sold substantially all of its assets and certain liabilities to Digital. The transaction will be accounted for as a business acquisition of entities under common control. In accordance with the Agreement, the Company sold all of its rights, title and interest in and to the trade names, trademarks, designs, copyrights, patents pending, patents filed and other intellectual property, all of the Company's rights in and to the radio and television show known as NET TALK LIVE! THE INTERNET TALK SHOW including, but not limited to, all prior and future programming, all trademarks, copyrights, creative materials, designs and other intellectual property, and all of the Company's right, title and interest in and to the furniture, fixtures and equipment ("the Assets"). The aggregate purchase price for the Assets was $8,000,000, payable in the form of a promissory note, bearing interest at the rate of 6% per annum ("Promissory Note"). The promissory note and accrued interest thereon is payable on a quarterly basis to the Company beginning March 31, 2001. All or a portion of the Promissory Note will be repaid if certain events occur. In any event, all principal and interest amounts for the Promissory Note will be fully paid to the Company by January 31, 2004. During the month of October 1999, Digital repaid $1,500,000 of the promissory note. During the month of April 2000, Digital repaid $3,000,000 of principal and $584,137 of interest on the promissory note. On January 29, 1999, the Company entered into individual agreements with certain independent contractors who had provided services to the Company for the period from 1996 through early 1999. According to the contract agreements, the Company agrees to pay future cash bonuses to the individuals contingent upon the occurrence of two events including (1) the finalization of an initial public offering whereby Digital raises a net amount of proceeds of at least $30 million and (2) the receipt of at least $8 million in cash collections by Digital prior to the date of an initial public offering which raises a net amount of proceeds of at least $30 million. As a result of the $1,500,000 voluntary repayment of the promissory note by Digital in October 1999, management elected to prepay a certain percentage of these bonuses in the amount of approximately $132,000 even though the conditions of the bonus agreements had not been satisfied. The payments remain the property of the contractors regardless of whether the conditions of the bonus agreements are met. As of the date of this report, the Company remains liable for an additional $1,000,000, contingent upon the satisfaction of the stipulated conditions of the bonus agreements. F-32
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INFOTAINMENT TELEPICTURES, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 11. SUBSEQUENT EVENTS (CONTINUED) LEGAL PROCEEDINGS In September 1999, the Company became a co-defendant in a lawsuit pending in state court in Dallas, Texas. The plaintiff, Nissi Cosmetics, Inc., alleges that the Company breached a 1997 contract for the creation of two websites, two informercials, and two direct response spots for the advertising and marketing of certain of Nissi Cosmetics' body color, or self-tanning, products. Nissi Cosmetics seeks recovery of $585,000 paid to defendants, and unspecified damages for "lost profits." The Company filed a general denial and intends to vigorously defend the matter. In the opinion of management, the ultimate resolution of any such claims would not have a material adverse impact on the financial position of the Company. F-33
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-------------------------------------------------------------------------------- -------------------------------------------------------------------------------- Through and including , 2000 (the 25th day after the date of this prospectus), all dealers effecting transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealers' obligation to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions. SHARES [LOGO] COMMON STOCK --------------------- PROSPECTUS --------------------- MERRILL LYNCH & CO. ING BARINGS BANC OF AMERICA SECURITIES LLC BEAR, STEARNS & CO. INC. , 2000 -------------------------------------------------------------------------------- --------------------------------------------------------------------------------
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[ALTERNATE PAGE FOR INTERNATIONAL PROSPECTUS] SUBJECT TO COMPLETION PRELIMINARY PROSPECTUS DATED , 2000 THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
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PROSPECTUS SHARES [LOGO] COMMON STOCK ------------------ This is DigitalConvergence.:Com Inc.'s initial public offering of common stock. DigitalConvergence.:Com Inc. is selling all of the shares in this offering. The international managers are offering shares outside the U.S. and Canada and the U.S. underwriters are offering shares in the U.S. and Canada. We expect the public offering price to be between $ and $ per share. Currently, no public market exists for the shares. After pricing of the offering, we expect that the shares will be quoted on the Nasdaq National Market under the symbol "DGTL." INVESTING IN THE COMMON STOCK INVOLVES RISKS THAT ARE DESCRIBED IN THE "RISK FACTORS" SECTION BEGINNING ON PAGE OF THIS PROSPECTUS. --------------------- [Download Table] PER SHARE TOTAL --------- ----- Public offering price.................................. $ $ Underwriting discount.................................. $ $ Proceeds, before expenses, to DigitalConvergence.:Com Inc.................................................. $ $ The international managers may also purchase up to an additional shares from DigitalConvergence.:Com Inc. at the public offering price, less the underwriting discount, within 30 days from the date of this prospectus to cover over-allotments. The U.S. underwriters may similarly purchase up to an aggregate of an additional shares from Digital Convergence.:Com Inc. Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. The shares of common stock will be ready for delivery on or about , 2000. -------------------- JOINT BOOK-RUNNING MANAGERS MERRILL LYNCH INTERNATIONAL ING BARINGS LIMITED -------------------- BANK OF AMERICA INTERNATIONAL LIMITED BEAR, STEARNS INTERNATIONAL LIMITED -------------------- The date of this prospectus is , 2000
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[ALTERNATE PAGE FOR INTERNATIONAL PROSPECTUS] UNDERWRITING GENERAL We are offering our shares outside the U.S. and Canada through the international managers and in the U.S. and Canada through the U.S. underwriters. Merrill Lynch International, ING Barings Limited, as agent for ING Bank, N.V., London Branch, Bank of America International Limited and Bear, Stearns International Limited are acting as lead managers of the international managers named below. Subject to the terms and conditions described in an international purchase agreement among us and the international managers, and concurrently with the sale of shares to the U.S. underwriters, we have agreed to sell to the international managers, and the international managers severally and not jointly have agreed to purchase from us, the number of shares listed opposite their names below. [Download Table] NUMBER INTERNATIONAL MANAGER OF SHARES --------------------- ----------- Merrill Lynch International................................. ING Barings Limited, as agent for ING Bank, N.V., London Branch.................................................... Bank of America International Limited....................... Bear, Stearns International Limited......................... ----------- Total................................................... =========== We have also entered into a U.S. purchase agreement with the U.S. underwriters, for whom Merrill Lynch, Pierce, Fenner & Smith Incorporated, ING Barings LLC, Banc of America Securities LLC and Bear, Stearns & Co. Inc. are acting as U.S. representatives, for sale of the shares in the U.S. and Canada. Subject to the terms and conditions set forth in the U.S. purchase agreement, and concurrently with the sale of shares to the international managers pursuant to the international purchase agreement, we have agreed to sell to the U.S. underwriters, and the U.S. underwriters severally have agreed to purchase from us, shares. The initial public offering price per share and the total underwriting discount per share are identical under the international purchase agreement and the U.S. purchase agreement. The international managers and the U.S. underwriters have agreed to purchase all of the shares sold under the international and U.S. purchase agreements if any of these shares are purchased. If an underwriter defaults, the U.S. and international purchase agreements provide that the purchase commitments of the nondefaulting underwriters may be increased or the purchase agreements may be terminated. The closings for the sale of shares to be purchased by the international managers and the U.S. underwriters are conditioned on one another. We have agreed to indemnify the international managers and the U.S. underwriters against certain liabilities, including liabilities under the Securities Act, or to contribute to payments the international managers and the U.S. underwriters may be required to make in respect of those liabilities. The underwriters are offering the shares, subject to prior sale, when, as and if issued to and accepted by them, subject to approval of legal matters by their counsel, including the validity of the shares, and other conditions contained in the purchase agreements, such as the receipt by the underwriters of officer's certificates and legal opinions. The underwriters reserve the right to withdraw, cancel or modify offers to the public and to reject orders in whole or in part. Merrill Lynch will be facilitating Internet distribution for this offering to certain of its Internet subscription customers. Merrill Lynch intends to allocate a limited number of shares for sale to its 1
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online brokerage customers. An electronic prospectus is available on the website maintained by Merrill Lynch. Other than the prospectus in electronic format, the information on the Merrill Lynch website relating to this offering is not a part of this prospectus. COMMISSIONS AND DISCOUNTS The lead managers have advised us that the international managers propose initially to offer the shares to the public at the initial public offering price set forth on the cover page of this prospectus and to dealers at that price less a concession not in excess of $ per share. The international managers may allow, and the dealers may re-allow, a discount not in excess of $ per share to other dealers. After the initial public offering, the public offering price, concessions and discount may be changed. The following table shows the public offering price, underwriting discount and proceeds before expenses to us. The information assumes either no exercise or full exercise by the international managers and the U.S. underwriters of their over-allotment options. [Enlarge/Download Table] PER WITHOUT WITH SHARE OPTIONS OPTIONS ----------- ----------- ----------- Public offering price...................................... $ $ $ Underwriting discount...................................... $ $ $ Proceeds, before expenses, to us........................... $ $ $ The expenses of the offering, not including the underwriting discount, are estimated at $ and are payable by us. OVER-ALLOTMENT OPTIONS We have granted an option to the international managers to purchase up to additional shares at the public offering price less the underwriting discount. The international managers may exercise this option for 30 days from the date of this prospectus solely to cover any over-allotments. If the international managers exercise this option, each will be obligated, subject to conditions contained in the purchase agreements, to purchase a number of additional shares proportionate to that international manager's initial amount reflected in the above table. We have also granted an option to the U.S. underwriters, exercisable for 30 days from the date of this prospectus, to purchase up to additional shares to cover any over-allotments on terms similar to those granted to the international managers. INTERSYNDICATE AGREEMENT The international managers and the U.S. underwriters have entered into an intersyndicate agreement that provides for the coordination of their activities. Under the intersyndicate agreement, the international managers and the U.S. underwriters may sell shares to each other for purposes of resale at the initial public offering price, less an amount not greater than the selling concession. Under the intersyndicate agreement, the international managers and any dealer to whom they sell shares will not offer to sell or sell shares to U.S. or Canadian persons or to persons they believe intend to resell to U.S. or Canadian persons, except in the case of transactions under the intersyndicate agreement. Similarly, the U.S. underwriters and any dealer to whom they sell shares will not offer to sell or sell shares to persons who are non-U.S. or non-Canadian persons or to persons they believe intend to resell to persons who are non-U.S. or non-Canadian persons, except in the case of transactions under the intersyndicate agreement. 2
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NO SALES OF SIMILAR SECURITIES We and our executive officers and directors and certain existing stockholders have agreed, with exceptions, not to sell or transfer any common stock for 180 days after the date of this prospectus without first obtaining the written consent of Merrill Lynch, Pierce & Co. Specifically, we and these other individuals have agreed not to directly or indirectly - offer, pledge, sell or contract to sell any common stock, - sell any option or contract to purchase any common stock, - purchase any option or contract to sell any common stock, - grant any option, right or warrant for the sale of any common stock, - lend or otherwise dispose of or transfer any common stock, - request or demand that we file a registration statement related to the common stock, or - enter into any swap or other agreement that transfers, in whole or in part, the economic consequence of ownership of any common stock whether any such swap or transaction is to be settled by delivery of shares or other securities, in cash or otherwise. This lockup provision applies to common stock and to securities convertible into or exchangeable or exercisable for or repayable with common stock. It also applies to common stock owned now or acquired later by the person executing the agreement or for which the person executing the agreement later acquires the power of disposition. QUOTATION ON THE NASDAQ NATIONAL MARKET We expect the shares to be approved for quotation on the Nasdaq National Market, subject to notice of issuance, under the symbol "DGTL." Before this offering, there has been no public market for our common stock. The initial public offering price will be determined through negotiations among us and the U.S. representatives and lead managers. In addition to prevailing market conditions, the factors to be considered in determining the initial public offering price are - the valuation multiples of publicly traded companies that the U.S. representatives and the lead managers believe to be comparable to us, - our financial information, - the history of, and the prospects for, our company and the industry in which we compete, - an assessment of our management, its past and present operations, and the prospects for, and timing of, our future revenues, - the present state of our development, and - the above factors in relation to market values and various valuation measures of other companies engaged in activities similar to ours. An active trading market for the shares may not develop. It is also possible that after the offering the shares will not trade in the public market at or above the initial public offering price. The underwriters do not expect to sell more than 5% of the shares being offered in this offering to accounts over which they exercise discretionary authority. 3
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PRICE STABILIZATION, SHORT POSITIONS AND PENALTY BIDS Until the distribution of the shares is completed, SEC rules may limit underwriters from bidding for and purchasing our common stock. However, the U.S. representatives may engage in transactions that stabilize the price of the common stock, such as bids or purchases to peg, fix or maintain that price. If the underwriters create a short position in the common stock in connection with the offering, i.e., if they sell more shares than are listed on the cover of this prospectus, the U.S. representatives may reduce that short position by purchasing shares in the open market. The U.S. representatives may also elect to reduce any short position by exercising all or part of the over-allotment option described above. Purchases of the common stock to stabilize its price or to reduce a short position may cause the price of the common stock to be higher than it might be in the absence of such purchases. The U.S. representatives may also impose a penalty bid on underwriters and selling group members. This means that if the U.S. representatives purchase shares in the open market to reduce the underwriter's short position or to stabilize the price of such shares, they may reclaim the amount of the selling concession from the underwriters and selling group members who sold those shares. The imposition of a penalty bid may also affect the price of the shares in that it discourages resales of those shares. Neither we nor any of the underwriters make any representation or prediction as to the direction or magnitude of any effect that the transactions described above may have on the price of the common stock. In addition, neither we nor any of the underwriters makes any representation that the U.S. representatives or lead managers will engage in these transactions or that these transactions, once commenced, will not be discontinued without notice. UK SELLING RESTRICTIONS Each international manager has agreed that - it has not offered or sold and will not offer or sell any shares of common stock to persons in the United Kingdom, except to persons whose ordinary activities involve them in acquiring, holding, managing or disposing of investments (as principal or agent) for the purposes of their businesses or otherwise in circumstances which do not constitute an offer to the public in the United Kingdom within the meaning of the Public Offers of Securities Regulations 1995; - it has complied and will comply with all applicable provisions of the Financial Services Act 1986 with respect to anything done by it in relation to the common stock in, from or otherwise involving the United Kingdom; and - it has only issued or passed on and will only issue or pass on in the United Kingdom any document received by it in connection with the issuance of common stock to a person who is of a kind described in Article 11(3) of the Financial Services Act 1986 (Investment Advertisements)(Exemptions) Order 1996 as amended by the Financial Services Act 1986 (Investment Advertisements)(Exemptions) Order 1997 or is a person to whom such document may otherwise lawfully be issued or passed on. NO PUBLIC OFFERING OUTSIDE THE UNITED STATES No action has been or will be taken in any jurisdiction (except in the United States) that would permit a public offering of the shares of common stock, or the possession, circulation or distribution of this prospectus or any other material relating to us or shares of our common stock in any jurisdiction where action for that purpose is required. Accordingly, the shares of our common stock may not be offered or sold, directly or indirectly, and neither this prospectus nor any other offering material or 4
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advertisements in connection with the shares of common stock may be distributed or published, in or from any country or jurisdiction, except in compliance with any applicable rules and regulations of any such country or jurisdiction. Purchasers of the shares offered by this prospectus may be required to pay stamp taxes and other charges in accordance with the laws and practices of the country of purchase in addition to the offering price on the cover page of this prospectus. OTHER RELATIONSHIPS ING Barings LLC has performed investment banking and financial advisory services for us in the past for which it has received customary fees and may, in the future, perform similar services for us and receive additional compensation from us for those services. In connection with our private placement of Series A preferred stock in September 1999, ING Barings LLC received a placement fee of approximately $1.7 million in December 1999 for acting as placement agent. In addition, ING Barings LLC and DING.com LLC, an entity affiliated with ING Barings, purchased 1,587 and 2,875 shares of Series A preferred stock, respectively, in our Series A financing for a purchase price of $4,999,050 and $9,056,250, respectively. The shares held by ING Barings LLC and DING.com LLC will convert automatically into 999,810 and 1,811,250 shares of our common stock, respectively, upon completion of this offering. 5
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[ALTERNATE PAGE FOR INTERNATIONAL PROSPECTUS] -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- Through and including , 2000 (the 25th day after the date of this prospectus), all dealers effecting transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealers' obligation to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions. SHARES [LOGO] COMMON STOCK --------------------- PROSPECTUS --------------------- MERRILL LYNCH INTERNATIONAL ING BARINGS LIMITED BANK OF AMERICA INTERNATIONAL LIMITED BEAR, STEARNS INTERNATIONAL LIMITED , 2000 -------------------------------------------------------------------------------- --------------------------------------------------------------------------------
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PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION The following table sets forth the costs and expenses, other than underwriting discounts and commissions, payable by DigitalConvergence.:Com in connection with the sale of common stock being registered. All amounts are estimates except the SEC registration fee and the NASD filing fee. [Download Table] SEC registration fee........................................ $ 26,400 NASD filing fee............................................. 10,500 Nasdaq National Market Listing Fee.......................... * Printing and engraving costs................................ * Legal fees and expenses..................................... * Accounting fees and expenses................................ * Transfer Agent and Registrar fees........................... * Miscellaneous expenses...................................... * ---------------- Total..................................................... $ * ================ ------------------------ * To be supplied by amendment. ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS Section 145 of the Delaware General Corporation Law ("DGCL") provides that a corporation may indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding whether civil, criminal, administrative or investigative (other than an action by or in the right of the corporation by reason of the fact that he is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys' fees)), judgments, fines and amounts paid in settlement actually and reasonably incurred by him in connection with such action, suit or proceeding if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe his conduct was unlawful. Section 145 further provides that a corporation similarly may indemnify any such person serving in any such capacity who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the corporation to procure a judgment in its favor by reason of the fact that he is or was a director, officer, employee or agent of the corporation or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorney's fees) actually and reasonably incurred in connection with the defense or settlement of such action or suit if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the corporation and except that no indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable to the corporation unless and only to the extent that the Delaware Court of Chancery or such other court in which such action or suit was brought shall determine upon application that, despite the adjudication of liability but in view of all of the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses which the Delaware Court of Chancery or such other court shall deem proper. The Company's Amended and Restated Certificate of Incorporation provides for the indemnification of directors to the fullest extent permitted by the DGCL. In addition, as permitted by II-1
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the DGCL, the Amended and Restated Certificate of Incorporation provides that directors of the company shall have no personal liability to the company or its stockholders for monetary damages for breach of fiduciary duty as a director, except (1) for any breach of the director's duty of loyalty to the company or its stockholders, (2) for acts or omissions not in good faith or which involve intentional misconduct or knowing violation of law, (3) under Section 174 of the DGCL or (4) for any transaction from which a director derived an improper personal benefit. The Company's By-laws provides for the indemnification of all current and former directors and all current or former officers to the fullest extent permitted by the DGCL. DigitalConvergence.:Com has entered into indemnification agreements with its directors and executive officers, and intends to enter into indemnification agreements with any new directors and executive officers in the future. ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES The following information relates to all securities issued or sold by DigitalConvergence.:Com in the last three years and not registered under the Securities Act. Each of the transactions described below was conducted in reliance upon the exemption from registration provided in Section 4(2) of the Securities Act and the rules and regulations promulgated thereunder. Each of the certificates representing DigitalConvergence.:Com's securities issued in connection with such transaction contains a restrictive legend. The information provided in this Item takes into account a 630 for 1 stock split of the common stock effected on January 3, 2000 and a for one stock split of the common stock that will occur prior to the completion of this offering. On September 25, 1998, DigitalConvergence.:Com sold 41,422,500 shares of common stock of DigitalConvergence.:Com (the "Common Stock") to J. Jovan Philyaw for a purchase price of $1,000. On January 28, 1999, DigitalConvergence.:Com sold 3,150,000 shares of Common Stock to B&G Partnership, Ltd. for a purchase price of $500. On January 28, 1999, DigitalConvergence.:Com sold 3,150,000 shares of Common Stock to BCG Partnership, Ltd. for a purchase price of $500. On January 28, 1999, DigitalConvergence.:Com sold 9,450,000 shares of Common Stock to JAT III, L.L.C. for a purchase price of $1,500. On January 29, 1999, DigitalConvergence.:Com sold 315,000 shares of Common Stock to BCG Partnership, Ltd. for a purchase price of $50. On January 29, 1999, DigitalConvergence.:Com sold 315,000 shares of Common Stock to JAT III, L.L.C. for a purchase price of $50. On January 29, 1999, DigitalConvergence.:Com sold 850,500 shares of Common Stock to Dave Mathews for a purchase price of $135. On January 29, 1999, DigitalConvergence.:Com sold 567,000 shares of Common Stock to Brad Smith for a purchase price of $90. On January 29, 1999, DigitalConvergence.:Com sold 472,500 shares of Common Stock to Laura Lewis for a purchase price of $75. On January 29, 1999, DigitalConvergence.:Com sold 346,500 shares of Common Stock to Luis Vallecillo for a purchase price of $55. On January 29, 1999, DigitalConvergence.:Com sold 157,500 shares of Common Stock to Kurt Boxdorfer for a purchase price of $25. II-2
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On January 29, 1999, DigitalConvergence.:Com sold 78,750 shares of Common Stock to Jeff Harris for a purchase price of $12.50. On January 29, 1999, DigitalConvergence.:Com sold 78,750 shares of Common Stock to Brandon Brown for a purchase price of $12.50. On January 29, 1999, DigitalConvergence.:Com sold 220,500 shares of Common Stock to Kozette Hedger for a purchase price of $35. On January 29, 1999, DigitalConvergence.:Com sold 47,250 shares of Common Stock to Georgia Foy for a purchase price of $7.50. On January 29, 1999, DigitalConvergence.:Com sold 18,900 shares of Common Stock to Mike Simeone for a purchase price of $3. On May 17, 1999, DigitalConvergence.:Com sold 472,500 shares of Common Stock to William Leftwich for a purchase price of $75. Between September 28, 1999 and January 14, 2000, DigitalConvergence.:Com sold 2,875 shares of Series A Convertible Preferred Stock (the "Series A Convertible Preferred Stock") to DING.com LLC for a purchase price of $9,056,250. On September 30, 1999, DigitalConvergence.:Com sold 3,970 shares of Series A Convertible Preferred Stock to Belo Enterprises, Inc. for a purchase price of $12,505,500. On October 1, 1999, DigitalConvergence.:Com sold 6,350 shares of Series A Convertible Preferred Stock of DigitalConvergence.:Com to Young & Rubicam Inc. for a purchase price of $20,002,500. On October 1, 1999, DigitalConvergence.:Com sold 1,587 shares of Series A Convertible Preferred Stock to ING Capital LLC for a purchase price of $4,999,050. On October 15, 1999, DigitalConvergence.:Com sold 318 shares of Series A Convertible Preferred Stock to Michael H. Anderson for a purchase price of $1,001,700. On October 18, 1999, DigitalConvergence.:Com sold 318 shares of Series A Convertible Preferred Stock to Ingram Capital, Inc. for a purchase price of $1,001,700. On October 29, 1999, DigitalConvergence.:Com sold 318 shares of Series A Convertible Preferred Stock to LJBB Investment Group LP for a purchase price of $1,001,700. On November 3, 1999, DigitalConvergence.:Com sold 16 shares of Series A Convertible Preferred Stock to Robert D. Hamman for a purchase price of $50,400. On November 3, 1999, DigitalConvergence.:Com sold 16 shares of Series A Convertible Preferred Stock to Robert D. Hamman as Trustee for the Robert D. Hamman CLU, Inc. Profit Sharing Plan for a purchase price of $50,400. On November 5, 1999, DigitalConvergence.:Com sold 198 shares of Series A Convertible Preferred Stock to Digital Investment Partners for a purchase price of $623,700. On April 25, 2000, DigitalConvergence.:Com sold 5,929,364 shares of Series B Convertible Preferred Stock to accredited investors, as that term is defined in Rule 501(a) of Regulation D promulgated under the Securities Act, for an aggregate purchase price of $41.7 million. On April 25, 2000, DigitalConvergence.:Com sold 5,372,593 shares of Series C Convertible Preferred Stock to accredited investors, as that term is defined in Rule 501(a) of Regulation D promulgated under the Securities Act, for an aggregate purchase price of $56.6 million. II-3
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ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a) EXHIBITS [Enlarge/Download Table] EXHIBIT NUMBER DESCRIPTION --------------------- ----------- *1.1 -- Form of Underwriting Agreement +2.1.1 -- Asset Purchase Agreement, dated January 4, 1999, by and between DigitalConvergence.:Com and Infotainment Telepictures, Inc. +2.1.2 -- First Amendment to Asset Purchase Agreement, dated January 4, 1999, by and between DigitalConvergence.:Com and Infotainment Telepictures, Inc. *2.1.3 -- Second Amendment to Asset Purchase Agreement, dated April , 2000, by and between DigitalConvergence.:Com and Infotainment Telepictures, Inc. +3.1 -- Form of Second Amended and Restated Certificate of Incorporation +3.2 -- Form of Amended and Restated Bylaws *4.1 -- Form of Common Stock Certificate +4.2 -- Amended Certificate of Designation of Series A Convertible Preferred Stock +4.3 -- Certificate of Designation of Series B Convertible Preferred Stock +4.4 -- Certificate of Designation of Series C Convertible Preferred Stock *4.5 -- First Amended and Restated Registration Rights Agreement, dated April 25, 2000, by and among DigitalConvergence.:Com and the security holders named therein *4.6 -- First Amended and Restated Stockholders Agreement, dated April 25, 2000, by and among DigitalConvergence.:Com and the security holders named therein *5.1 -- Opinion of Vinson & Elkins L.L.P. +10.1 -- Employment Agreement, dated as of August 16, 1999, by and between DigitalConvergence.:Com and Michael N. Garin +10.2 -- Employment Agreement, dated as of August 16, 1999, by and between DigitalConvergence.:Com and Gregory D. Lerman +10.3.1 -- Employment Agreement, dated as of August 16, 1999, by and between DigitalConvergence.:Com and Scott P. Carlin +10.3.2 -- First Amendment to Employment Agreement, dated as of August 16, 1999, by and between DigitalConvergence.:Com and Scott P. Carlin +10.4 -- Employment Agreement, dated as of January 3, 2000, by and between DigitalConvergence.:Com and Donald E. Welsh +10.5 -- Employment Agreement, dated as of December 15, 1999, by and between DigitalConvergence.:Com and Douglas L. Davis +10.6 -- Employment Agreement, dated as of January 1, 2000, by and between DigitalConvergence.:Com and Patrick V. Stark *10.7 -- License Agreement, dated , 2000, by and between DigitalConvergence.:Com and Belo Corp. +10.8.1 -- Warrant Agreement, dated September 29, 1999, by and between DigitalConvergence.:Com and Belo Enterprises, Inc. +10.8.2 -- Warrant Certificate No. 1, dated September 29, 1999, for the purchase of DigitialConvergence.:Com common stock by Belo Enterprises, Inc. *10.9 -- Licensing Agreement, dated as of April 18, 2000, by and between DigitalConvergence.:Com Inc. and National Broadcasting Company, Inc. *10.10.1 -- Warrant Agreement, dated as of April 18, 2000, by and between DigitalConvergence.:Com and National Broadcasting Company, Inc. *10.10.2 -- Warrant Certificate No. 1, dated April 18, 2000, for the purchase of DigitalConvergence.:Com common stock by National Broadcasting Company, Inc. *10.11 -- Warrant Agreement, dated as of April 18, 2000, by and between DigitalConvergence.:Com Inc. and National Broadcasting Company, Inc. *10.12 -- Warrant Certificate No. 1, dated April 18, 2000, for the purchase of DigitalConvergence.:Com common stock by National Broadcasting Company, Inc. II-4
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[Enlarge/Download Table] EXHIBIT NUMBER DESCRIPTION --------------------- ----------- +10.13 -- Promissory Note, dated January 4, 1999, by and between DigitalConvergence.:Com and Infotainment Telepictures, Inc. +10.14 -- Debenture, dated January 28, 1999, by and between DigitalConvergence.:Com and JAT III L.L.C. +10.15 -- Debenture, dated January 28, 1999, by and between DigitalConvergence.:Com and B&G Partnership, Ltd. +10.16 -- Debenture, dated January 28, 1999, by and between DigitalConvergence.:Com and BCG Partnership, Ltd. +10.17 -- Form of Indemnification Agreement for directors and officers of DigitalConvergence.:Com +10.18.1 -- DigitalConvergence.:Com Inc. 1999 Stock Option Plan *10.18.2 -- First Amendment to the DigitalConvergence.:Com Inc. 1999 Stock Option Plan *10.19 -- DigitalConvergence.:Com Inc. Employee Stock Purchase Plan +10.20 -- Stock Purchase Agreement, dated May 17, 1999, by and between DigitalConvergence.:Com and William S. Leftwich +10.21 -- Form of Proprietary Rights and Information Agreement +10.22 -- Manufacturing and Marketing Agreement, effective as of December 6, 1999, by and between DigitalConvergence.:Com and Tandy Corporation +10.23 -- Print Publishing Agreement, dated January 13, 2000, by and between DigitalConvergence.:Com and Forbes, Inc. +10.24 -- Print License Agreement, dated February 16, 2000, by and between DigitalConvergence.:Com and Wired Magazine *10.25 -- Print License Agreement, dated as of February 8, 2000, by and between DigitalConvergence.:Com and Journal Sentinel Incorporated *10.26 -- Broadcast Station Agreement, dated as of February 8, 2000, by and between DigitalConvergence.:Com and Journal Broadcast Group, Inc. +21.1 -- Subsidiaries of DigitalConvergence.:Com +23.1 -- Consent of PricewaterhouseCoopers LLP *23.2 -- Consent of Vinson & Elkins L.L.P. (included in Exhibit 5.1) +24.1 -- Power of Attorney (included in signature page) +27.1 -- Financial Data Schedule ------------------------ + Filed herewith * To be filed by amendment II-5
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(b) FINANCIAL STATEMENT SCHEDULES The following reports of independent accountants and financial statement schedules are included in this Registration Statement: - Report of Independent Accountants on Financial Statement Schedule of DigitalConvergence.:Com Inc. - Report of Independent Accountants on Financial Statement Schedule of Infotainment Telepictures, Inc. - Valuation and Qualifying Accounts of DigitalConvergence.:Com Inc. for the year ended December 31, 1999 - Valuation and Qualifying Accounts of Infotainment Telepictures, Inc. for the years ended December 31, 1997 and 1998 ITEM 17. UNDERTAKINGS The Registrant hereby undertakes: (a) Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the Registrant pursuant to the provisions described in Item 14, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer, or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer, or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. (b) To provide to the underwriter(s) at the closing specified in the underwriting agreements, certificates in such denominations and registered in such names as required by the underwriter(s) to permit prompt delivery to each purchaser. (c) For purposes of determining any liability under the Securities Act of 1933, the information omitted from the form of prospectus filed as part of this Registration Statement in reliance upon Rule 430A and contained in the form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this Registration Statement as of the time it was declared effective. (d) For the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. II-6
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SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the Registrant has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of New York, State of New York, on the day of April, 2000. [Download Table] DIGITALCONVERGENCE.:COM INC. By: /s/ MICHAEL N. GARIN ----------------------------------------- Michael N. Garin PRESIDENT AND CHIEF OPERATING OFFICER KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Michael N. Garin, Patrick V. Stark and William S. Leftwich and each of them, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments (including pre- and post-effective amendments) to this Registration Statement and any additional registration statement pursuant to Rule 462(b) under the Securities Act of 1933, and to file the same with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that each of said attorneys-in-fact and agents or their substitute or substitutes may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed by the following persons in the capacities and on the dates indicated: [Enlarge/Download Table] SIGNATURE TITLE DATE --------- ----- ---- /s/ J. JOVAN PHILYAW ------------------------------------------- Chief Executive Officer and April 28, 2000 J. Jovan Philyaw Chairman of the Board /s/ MICHAEL N. GARIN ------------------------------------------- President, Chief Operating April 28, 2000 Michael N. Garin Officer and Director /s/ WILLIAM S. LEFTWICH ------------------------------------------- Chief Financial Officer April 28, 2000 William S. Leftwich /s/ PATRICK V. STARK ------------------------------------------- Director April 28, 2000 Patrick V. Stark /s/ MICHAEL H. JORDAN ------------------------------------------- Director April 28, 2000 Michael H. Jordan II-7
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[Download Table] SIGNATURE TITLE DATE --------- ----- ---- /s/ WILLIAM O. HUNT ------------------------------------------- Director April 28, 2000 William O. Hunt /s/ JACK A. TURPIN ------------------------------------------- Director April 28, 2000 Jack A. Turpin II-8
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REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE To the Board of Directors of DigitalConvergence.:Com Inc. Our audits of the consolidated financial statements referred to in our report dated April 27, 2000 appearing in this Registration Statement on Form S-1 of DigitalConvergence.:Com Inc. also included an audit of the financial statement schedule listed in such Registration Statement. In our opinion, this financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. PricewaterhouseCoopers LLP Dallas, Texas April 27, 2000 S-1
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REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES To the Board of Directors of Infotainment Telepictures, Inc. Our audits of the consolidated financial statements referred to in our report dated February 29, 2000, except as to Note 11 which is as of April 27, 2000 appearing in this Registration Statement on Form S-1 of DigitalConvergence.:Com Inc. also included an audit of the financial statement schedules listed in such Registration Statement. In our opinion, these financial statement schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. PricewaterhouseCoopers LLP Dallas, Texas February 29, 2000 S-2
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SCHEDULE II DIGITALCONVERGENCE.:COM INC. VALUATION AND QUALIFYING ACCOUNTS FOR THE YEAR ENDED DECEMBER 31, 1999 (IN THOUSANDS) [Enlarge/Download Table] ADDITIONS BALANCE AT CHARGED TO BALANCE AT BEGINNING COSTS AND END OF CLASSIFICATION OF PERIOD EXPENSES DEDUCTIONS PERIOD -------------- ---------- ---------- ---------- ---------- December 31, 1999 Income tax valuation allowance.................... $ 158 $4,311 $ -- $4,469 ====== ====== ======= ====== (a) This schedule should be read in conjunction with the Digitalconvergence.:Com Inc. audited consolidated financial statements and related notes thereto. S-3
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SCHEDULE II INFOTAINMENT TELEPICTURES, INC. SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1998 (IN THOUSANDS) [Enlarge/Download Table] ADDITIONS BALANCE AT CHARGED TO BALANCE AT BEGINNING COSTS AND END OF DESCRIPTION OF PERIOD EXPENSES DEDUCTIONS PERIOD ----------- ---------- ---------- ---------- ---------- 1997 Income tax valuation allowance.................... $ 61 $74 $-- $135 ==== === === ==== 1998 Income tax valuation allowance.................... $135 $23 $-- $158 ==== === === ==== (a) This schedule should be read in conjunction with the Infotainment Telepictures, Inc. audited financial statements and related notes thereto. S-4
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EXHIBIT INDEX [Enlarge/Download Table] EXHIBIT NUMBER DESCRIPTION --------------------- ----------- *1.1 -- Form of Underwriting Agreement +2.1.1 -- Asset Purchase Agreement, dated January 4, 1999, by and between DigitalConvergence.:Com and Infotainment Telepictures, Inc. +2.1.2 -- First Amendment to Asset Purchase Agreement, dated January 4, 1999, by and between DigitalConvergence.:Com and Infotainment Telepictures, Inc. *2.1.3 -- Second Amendment to Asset Purchase Agreement, dated April , 2000, by and between DigitalConvergence.:Com and Infotainment Telepictures, Inc. +3.1 -- Form of Second Amended and Restated Certificate of Incorporation +3.2 -- Form of Amended and Restated Bylaws *4.1 -- Form of Common Stock Certificate +4.2 -- Amended and Restated Certificate of Designation of Series A Convertible Preferred Stock +4.3 -- Certificate of Designation of Series B Convertible Preferred Stock +4.4 -- Certificate of Designation of Series C Convertible Preferred Stock *4.5 -- First Amended and Restated Registration Rights Agreement, dated April 25, 2000, by and among DigitalConvergence.:Com and the security holders named therein *4.6 -- First Amended and Restated Stockholders Agreement, dated April 25, 2000, by and among DigitalConvergence.:Com and the security holders named therein *5.1 -- Opinion of Vinson & Elkins L.L.P. +10.1 -- Employment Agreement, dated as of August 16, 1999, by and between DigitalConvergence.:Com and Michael N. Garin +10.2 -- Employment Agreement, dated as of August 16, 1999, by and between DigitalConvergence.:Com and Gregory D. Lerman +10.3.1 -- Employment Agreement, dated as of August 16, 1999, by and between DigitalConvergence.:Com and Scott P. Carlin +10.3.2 -- First Amendment to Employment Agreement, dated as of August 16, 1999, by and between DigitalConvergence.:Com and Scott P. Carlin +10.4 -- Employment Agreement, dated as of January 3, 2000, by and between DigitalConvergence.:Com and Donald E. Welsh +10.5 -- Employment Agreement, dated as of December 15, 1999, by and between DigitalConvergence.:Com and Douglas L. Davis +10.6 -- Employment Agreement, dated as of January 1, 2000, by and between DigitalConvergence.:Com and Patrick V. Stark *10.7 -- License Agreement, dated , 2000, by and between DigitalConvergence.:Com and Belo Corp. +10.8.1 -- Warrant Agreement, dated September 29, 1999, by and between DigitalConvergence.:Com and Belo Enterprises, Inc. +10.8.2 -- Warrant Certificate No. 1, dated September 29, 1999, for the purchase of DigitialConvergence.:Com common stock by Belo Enterprises, Inc. *10.9 -- Licensing Agreement, dated as of April 18, 2000, by and between DigitalConvergence.:Com Inc. and National Broadcasting Company, Inc. *10.10.1 -- Warrant Agreement, dated as of April 18, 2000, by and between DigitalConvergence.:Com and National Broadcasting Company, Inc. *10.10.2 -- Warrant Certificate No. 1, dated April 18, 2000, for the purchase of DigitalConvergence.:Com common stock by National Broadcasting Company, Inc. *10.11 -- Warrant Agreement, dated as of April 18, 2000, by and between DigitalConvergence.:Com Inc. and National Broadcasting Company, Inc. *10.12 -- Warrant Certificate No. 1, dated April 18, 2000, for the purchase of DigitalConvergence.:Com common stock by National Broadcasting Company, Inc. +10.13 -- Promissory Note, dated January 4, 1999, by and between DigitalConvergence.:Com and Infotainment Telepictures, Inc.
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[Enlarge/Download Table] EXHIBIT NUMBER DESCRIPTION --------------------- ----------- +10.14 -- Debenture, dated January 28, 1999, by and between DigitalConvergence.:Com and JAT III L.L.C. +10.15 -- Debenture, dated January 28, 1999, by and between DigitalConvergence.:Com and B&G Partnership, Ltd. +10.16 -- Debenture, dated January 28, 1999, by and between DigitalConvergence.:Com and BCG Partnership, Ltd. +10.17 -- Form of Indemnification Agreement for directors and officers of DigitalConvergence.:Com +10.18.1 -- DigitalConvergence.:Com Inc. 1999 Stock Option Plan *10.18.2 -- First Amendment to the DigitalConvergence.:Com Inc. 1999 Stock Option Plan *10.19 -- DigitalConvergence.:Com Inc. Employee Stock Purchase Plan +10.20 -- Stock Purchase Agreement, dated May 17, 1999, by and between DigitalConvergence.:Com and William S. Leftwich +10.21 -- Form of Proprietary Rights and Information Agreement +10.22 -- Manufacturing and Marketing Agreement, effective as of December 6, 1999, by and between DigitalConvergence.:Com and Tandy Corporation +10.23 -- Print Publishing Agreement, dated January 13, 2000, by and between DigitalConvergence.:Com and Forbes, Inc. +10.24 -- Print License Agreement, dated February 16, 2000, by and between DigitalConvergence.:Com and Wired Magazine *10.25 -- Print License Agreement, dated as of February 8, 2000, by and between DigitalConvergence.:Com and Journal Sentinel Incorporated *10.26 -- Broadcast Station Agreement, dated as of February 8, 2000, by and between DigitalConvergence.:Com and Journal Broadcast Group, Inc. +21.1 -- Subsidiaries of DigitalConvergence.:Com +23.1 -- Consent of PricewaterhouseCoopers LLP *23.2 -- Consent of Vinson & Elkins L.L.P. (included in Exhibit 5.1) +24.1 -- Power of Attorney (included in signature page) +27.1 -- Financial Data Schedule ------------------------ + Filed herewith * To be filed by amendment

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