Buyers United
2002 Annual Report
to Stockholders
UCN buyersonline
United Carrier Networks Helping you zero-out monthly bills
TABLE OF CONTENTS
Section Page No.
------- --------
Letter to Stockholders 3
Our Business 5
Market for Common Equity and Related Stockholder Matters 6
Summary Financial Information 7
Management's Discussion and Analysis of Financial Condition and
Results of Operations 7
Financial Statements F-1
buyersonline
Helping you zero-out monthly bills
UCN
United Carrier Networks
May 1, 2003
Dear Fellow Shareholders:
The year 2002 saw your company continue its impressive growth by more than
doubling the revenue achieved in the year 2001. Net income (before preferred
stock dividends) was positive for the first time in our history. And in December
we entered into two acquisition agreements that will continue our revenue growth
in 2003, while reducing our costs of revenue. Our net profit for the 2003 year
is expected to increase significantly.
The Touch America acquisition, involving the purchase of switched voice
telecommunication customers, was consummated in March 2003 when the conditions
for closing were satisfied. We are still negotiating a reduction in the purchase
price because of discrepancies in the list of purchased accounts. We will begin
to realize the benefit of this acquisition in our second quarter 2003 results.
Our second acquisition agreement involves the purchase from I-Link, Inc. of a
real-time Internet protocol communications network that includes both the
dedicated equipment required to operate the network and I-Link's customer base
serviced through the network. This acquisition transforms your company from the
business of only reselling telecommunication services to a combination
reseller-network operator. Our agreements with multiple wholesale carriers in
conjunction with our network will allow us to use "least cost routing" that we
believe will significantly reduce our operating costs, and thereby increase our
profit margins. With this acquisition we also acquired a license in perpetuity
for software developed for the operation of the network that provides our
customer base with a fuller suite of services.
During 2003, we plan to introduce a series of services to provide complete
communications needs in one stop. Examples of our new offerings are:
o Fax to e-mail, which allows a customer to send or receive faxes through an
e-mail address on his own personal computer;
o Voice mail, which allows a customer to receive, store, forward, and access
voice mail messages; and
o Account management, which allows a customer to review billing on his
account, make service inquiries, and add or delete services over the
Internet.
Using our Internet protocol network, we will be able to offer these services at
a lower capital infrastructure cost.
3
We closed on the I-Link acquisition effective May 1, 2003. Prior to the closing,
we operated all of the assets under a management agreement that gave us the
right to service all our customers utilizing the network. We are now in the
process of transferring some of our customer base to the I-Link network. In
addition to the revenue growth from these two acquisitions, we expect continued
growth through the traditional sales channels that we have developed.
Concurrent with the acquisitions, we have shifted day-to-day responsibility for
operation from Paul Jarman to Kenneth Krogue, thus freeing Paul to concentrate
on the integration of the acquisitions and significant longer-term strategic
objectives. The Board of Directors elected Paul to President of your company and
Ken as its Chief Operating Officer. We are also bringing additional talent into
the organization as part of our plan for well-managed growth.
Last year Congress passed legislation requiring public companies to improve
their corporate governance environment. As most of this legislation, known as
Sarbanes-Oxley, is applicable to Buyers United, we are in the process of
augmenting our Audit Committee charter whereby this committee will have greater
oversight responsibilities and direct oversight of our independent auditors. Our
intention is to implement the Sarbanes-Oxley requirements to improve our
management processes.
In March of this year, Buyers United earned the "2002 Reseller of the Year
Award" from the Agent Alliance, a national trade association of independent
telecommunications agents, in recognition of the high degree of effectiveness of
our customer service and support programs.
Last year was a good year, and we intend to make 2003 even better.
Thank you for your continued interest in our company.
Sincerely,
/s/ Theodore Stern
Chairman and CEO
Buyers United, Inc.
4
OUR BUSINESS
Buyers United, Inc. is a domestic telecommunications company that offers a
wide range of long distance, toll free, data transmission, and related
communication service options at competitive prices, and provides to its
customers a standard of service it believes is comparable to other industry
participants. The telecommunications services offered include the following:
o Switched long distance services to business and residential customers
o Dedicated access long distance service
o Toll-free 800/888/877/866 services
o Dedicated data transmission
o Private line data services
o Calling card services
o Conference calling
o Automatic call distribution
o Interactive Voice Response (IVR)
o Outbound dialing and voice message broadcasting
These services can be offered individually, or in a suite of services tailored
to a customer's needs.
For the past five years Buyers United has been engaged in the business of
reselling telecommunication services provided by others to Buyers United at
wholesale rates. Domestic and international long distance services make up a
major portion of our sales with the other services listed above making smaller
contributions to our sales mix.
Buyers United now services approximately 150,000 business and residential
consumers across America. We have refined our business model over the past
several years to address specific niche opportunities in the vast communications
industry. Our new brand, United Carrier Networks (UCN), targets business
customers, while the brand developed during 2000, BuyersOnline (BOL), is
intended to cater to the residential consumer. The use of the two distinct
brands allows us to specifically meet the needs of both customer types, without
creating channel conflicts.
Buyers United is now pursuing multiple marketing avenues, including using
independent agents, implementing promotional and rebate programs to attract
customers, and marketing through the Internet. Buyers United's sale incentive
programs offered from time to time give customers additional cost saving
opportunities that we believe enhances customer retention. The new UCN web site
gives specialized services and options for business customers and the agents
that represent them. Buyers United also pursues customers through strategic
relationships with companies that operate independent sales and marketing
programs for a variety of products and services.
Recent Developments
On December 6, 2002, Buyers United entered into an agreement to purchase
assets of I-Link, Inc., and its subsidiary, I-Link Communications, Inc., and
license in perpetuity software developed by I-Link for the operation of a
real-time Internet protocol communications network (RTIP Network). The assets
acquired include dedicated equipment required for operating the RTIP Network,
customers of I-Link serviced through the network, and certain trademarks. In
consideration for the assets and software license, Buyers United agreed to issue
to I-Link 300,000 shares of Series B Convertible Preferred Stock and assume
certain liabilities. Completion of the purchase is subject to obtaining
government and third-party approvals, and obtaining releases of third party
security interests in the assets. The parties are pursuing efforts to satisfy
these closing conditions for the purchase of assets, but cannot predict when or
if the conditions will be satisfied and the transaction closed.
5
Concurrently with the agreement for the purchase of I-Link assets, I-Link
and Buyers United entered into transition and management agreements pursuant to
which Buyers United was appointed to manage all of the assets to be acquired
from I-Link pending the closing of the purchase. Under the agreements, Buyers
United assumed responsibility for day-to-day operation of the RTIP Network
previously operated by I-Link that is to be sold to Buyers United, is
responsible for all customer billing and collection, has the right to use the
RTIP Network to provide telecommunications service to its customers, and is
entitled to receive a management fee equal to 10 percent of revenue generated
from I-Link customers after the payment of all expenses of the RTIP Network and
providing service to such customers.
In connection with the transaction, Buyers United agreed to sublease
certain space occupied by I-Link, but subsequently negotiated a new lease
arrangement for the space. Buyers United is leasing through November 2004,
14,339 square feet of space at 13751 S. Wadsworth Park Drive, Draper, Utah, at a
monthly cost of $16,728. In consideration for entering into this agreement,
I-Link agreed to subsidize a total of $36,232 in lease payments, which
represents the difference between the amount of the original sublease obligation
of Buyers United and the monthly cost of the space under the new lease
arrangement. In the event the asset purchase transaction between Buyers United
and I-Link does not close, Buyers United has the right to terminate the lease
arrangement without further liability to I-Link or the landlord.
On December 20, 2002, Buyers United entered into an agreement with Touch
America, Inc., a subsidiary of Touch America Holdings, Inc., to purchase
approximately 70,000 of the switched voice telecommunication customers of Touch
America, including the carrier identification code used to service those
customers. Buyers United did not purchase any accounts receivable, equipment, or
other assets of Touch America. Buyers United agreed to pay to Touch America
account receivable balances that predate the sale as collected by Buyers United,
subject to certain fees payable to Buyers United. Buyers United made an initial
payment of $3,000,000 to Touch America. The original purchase price was
$6,750,000, but the parties are now attempting to negotiate a reduction in the
purchase price due to errors and other discrepancies the parties subsequently
discovered in the list of accounts sold to Buyers United. The balance of the
final purchase price will be paid in monthly increments based on a percentage of
revenue generated by the acquired customer accounts. The conditions for closing
the purchase were satisfied in March 2003.
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The common stock of Buyers United trades in the over-the-counter market.
The following table sets forth for the respective periods indicated the prices
of the common stock in the over-the-counter market, as reported and summarized
on the OTC Bulletin Board. Such prices are based on inter-dealer bid and asked
prices, without markup, markdown, commissions, or adjustments and may not
represent actual transactions.
Calendar Quarter Ended: High Bid ($) Low Bid ($)
---------------------- ------------ -----------
March 31, 2001 1.94 0.94
June 30, 2001 1.75 0.72
September 30, 2001 1.16 0.61
December 31, 2001 1.01 0.52
Calendar Quarter Ended: High Bid ($) Low Bid ($)
---------------------- ------------ -----------
March 31, 2002 1.30 0.61
June 30, 2002 2.00 1.10
September 30, 2002 1.93 1.30
December 31, 2002 2.00 1.25
6
Since its inception, no dividends have been paid on the common stock.
Buyers United intends to retain any earnings for use in its business activities,
so it is not expected that any dividends on the common stock will be declared
and paid in the foreseeable future. As of March 28, 2003, there were outstanding
1,865,000 shares of Series A Convertible Preferred Stock and 537,800 shares of
Series B Convertible Preferred Stock. Under the terms of this preferred stock,
Buyers United cannot make any distributions on its common stock without the
approval of a majority of the preferred stockholders. At March 28, 2003, there
were approximately 4,500 holders of record of the common stock.
SUMMARY FINANCIAL INFORMATION
Operating statement data for the years ended December 31, 2002, 2001, and 2000:
2002 2001 2000
---- ---- ----
Revenue $30,163,450 $14,341,977 $ 7,355,559
Total operating expenses 28,306,799 19,811,215 13,853,238
Total other expenses, net 1,526,468 982,311 1,604,269
Extraordinary gain (loss) - 383,520 (1,024,574)
----------- ----------- ------------
Net income (loss) 330,183 (6,068,029) (9,126,522)
Preferred stock dividends 759,425 759,455 2,481,592
----------- ----------- ------------
Net loss applicable to common
shareholders $ (419,542) $(6,827,484) $(11,608,114)
=========== =========== ============
Net loss per share applicable to
common shareholders $ (0.07) $ (1.49) $ (3.12)
=========== =========== ============
Balance sheet data as of December 31, 2002, 2001, and 2000:
2002 2001 2000
---- ---- ----
Current assets $ 7,443,445 $ 3,301,525 $ 2,044,032
Total assets 13,144,948 4,331,742 4,402,907
Current liabilities 14,720,259 6,871,313 5,910,462
Total liabilities 18,608,062 10,486,313 6,225,218
Total stockholders' deficit (5,463,114) (6,154,571) (1,822,311)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Overview
Buyers United is a domestic telecommunications company that offers and
sells a wide range of long distance and related communication service options to
business and residential customers. In the past we functioned as an aggregator
and reseller of telecommunications services provided by others, and intend to
pursue and develop this type of business. However, in December 2002 Buyers
United entered into agreements to purchase and manage assets of I-Link, Inc.,
and its subsidiary, I-Link Communications, Inc., and license in perpetuity
software developed by I-Link for the operation of a real-time Internet protocol
communications network (RTIP Network). This transaction will enable us to
develop and offer enhanced services, such as fax to email, and transmit data and
other communication services for a portion of the journey over the RTIP Network
rather than entirely through third party providers.
7
We generate internal growth by pursuing multiple marketing avenues,
including using independent agents, implementing promotional and rebate programs
to attract customers, marketing through the Internet, and obtaining customers
from unrelated marketing companies. In December 2002 we agreed to purchase
approximately 70,000 of the switched voice telecommunication customers of Touch
America, which will result in a significant increase in our customer base in
2003. We believe recent financial difficulties and uncertainty in the
telecommunications industry that arose in 2002 may result in opportunities to
acquire customers from unrelated companies, and we intend to remain open to
these opportunities. However, at the present we are not evaluating any new
acquisitions.
Results of Operations - Year Ended December 31, 2002 Compared to 2001
Revenues increased 110% during 2002 to $30.2 million as compared to $14.3
million during 2001. The increase was due to a substantial increase in our
customer base that was a direct result of obtaining more customers through
independent agents and referral arrangements with unrelated Internet marketing
companies.
During 2002, Buyers United realized the benefit of its efforts in
negotiating with its vendors during 2001 to lower the cost of long distance
service provided to customers. By offering to increase business volume to
certain levels, vendors agreed in exchange to offer lower rates. Accordingly,
Buyers United continued concentrating volume and new customer sign-ups with two
of its largest long-distance wholesale carriers. At the beginning of 2001,
Buyers United's business was primarily placed with these two carriers, but
continued to offer service to customers through five different wholesale
vendors. In response to the lower costs thus realized during 2002, we continued
to offer services to new customers, particularly those in the agent-sponsored
channels, at lower, more competitive prices. As a result, costs of revenues for
the year ended December 31, 2002 were $16.3 million, or 54% of revenue, as
compared to costs of $9.3 million, or 65% of revenue, for the year ended
December 31, 2001. The resultant gross profit margin for 2002 was higher at 46%,
as compared to the margin of 35% experienced during 2001. Buyers United expects
that gross margins will increase during 2003, as it markets to all its customers
the high-margin, enhanced services it plans to provide using the RTIP Network
technology.
General and administrative expenses for 2002 increased 20% to $7.4 million
as compared to $6.1 million for the previous year. Approximately two-thirds of
the increase stemmed from higher bad debt estimated write-offs incidental to the
increased level of revenue. The remaining increase resulted primarily from
higher customer service and support expenses, along with higher billing costs,
all incidental to the increase in revenue. Offsetting these higher amounts were
decreased levels of maintenance and depreciation expenses stemming from
terminating high-cost equipment leases and writing off obsolete web-site
development costs during 2001. As a result of the combination of the above
factors, total general and administrative expenses during 2002 were 24% of
revenue, as compared to 43% of revenue for the prior year. Except for certain
RTIP Network integration costs, Buyers United anticipates lower levels of
general administrative expenses, as a percentage of revenue, throughout 2003.
Selling and promotion expenses for the year ended December 31, 2002 were
$4.6 million, an increase of 40% over the prior year's expenses of $3.3 million.
Virtually all of the increase was directly related to the increase in revenue
during the 2002 year. Included in the increase were higher expenses for sales
commissions, sales support staff, and the amortization of deferred customer
referral fees. Selling and promotion costs as a percentage of revenue were 15%
during 2002, as compared to 23% during the year ended December 31, 2001. We
believe selling and promotion expenses during 2003 will continue to decrease as
a percentage of revenue.
During 2001, Buyers United reviewed its investment in leased computer
equipment and software, the related ongoing maintenance expenses, and the costs
primarily incurred in 2000 in connection with the creation of various web sites
designed to work with Oracle-based applications. We determined that we could
achieve our growth objectives and serve existing and potential customers using a
more economical equipment and software solution. Accordingly, Buyers United
negotiated with the equipment lessor to return the equipment and cancel the
8
lease. We also replaced our web site software with newly developed programs
designed to operate on an SQL-based operating system and determined that the
costs previously capitalized and associated with the returned equipment and
software no longer had a realizable value. The total cost of removing the
unamortized book value of the lease obligation, equipment, software, and
capitalized web site development costs totaled $980,086 and was included in
operating expenses for the year ended December 31, 2001.
Interest income for 2002 was $17,980 as compared to $15,571 in 2001. The
difference is attributable to the higher amount of funds on hand during 2002.
Interest expense for 2002 was $1.5 million as compared to $997,882 for 2001, an
increase of 55%. The increase is attributable to the significant amount of
additional debt financing Buyers United had outstanding during 2002, which it
raised to fund operations and take advantage of its online marketing opportunity
with an unrelated Internet marketing company.
In December 2001, Buyers United recognized an extraordinary gain on the
early extinguishment of debt of $383,520. Earlier in the year, one of our
noteholders sold the obligation to an investment relations firm. Subsequently,
we negotiated a settlement with the investment relations firm. We paid $120,000
and issued 35,000 shares of common stock in exchange for canceling the
outstanding obligation plus $25,921 in accrued interest. The stock had a fair
market value of $22,401. The difference between the balance due, the cash paid
and the fair market value of the stock issued was recognized as a gain on early
extinguishment of debt during 2001.
As a result of the above factors, Buyers United earned net income before
preferred stock dividends of $330,183 for the year ended December 31, 2002, as
opposed to the net loss experienced during the prior year of $6.1 million.
During 2002, preferred stock dividends amounted to $749,725 of 8% cumulative
dividends on outstanding Series A and B preferred stock. This compares to total
preferred stock dividends during 2001 of $759,455, consisting of $738,957 of 8%
cumulative dividends on outstanding Series A and B preferred stock, and $20,498
of preferred stock dividends related to the beneficial conversion feature
associated with the issuance of the last 110,000 Series B Preferred shares in
early 2001.
Liquidity and Capital Resources
Buyers United's current ratio at the end of 2002 increased slightly to
0.51:1 from 0.48:1 at the end of 2001. The reasons for the increase mainly
resulted from the combination of net increases in current asset amounts and
higher current liability amounts, all related primarily to higher revenues and
increased debt financing. Restricted cash decreased over the 2001 level due to
the timing of weekly draws on restricted accounts by the finance company that
provides our line of credit. The line of credit agreement requires control over
certain bank accounts to which customer payments are remitted as part of the
repayment terms. While this cash eventually repays the debt obligation with the
balance transferring to us, due to the controlled nature of the account it is
reflected on the balance sheet as being "restricted." Accounts receivable
increased 149% due to higher revenue levels. Debt levels deemed current (other
than the line of credit) rose 508%, due to the significant increase in debt
financing (discussed more fully below) raised during the year. Accounts payable
rose 47% since a year earlier, due to higher revenue and related operating
payable increases. Accrued liabilities increased 47% due mainly to increases in
accrued interest and payroll costs at year-end, relating to the increases in
debt financing and higher employee levels. Accrued rebates and commissions rose
52% at the end of 2002 as compared to the previous year due to the increase in
revenues.
On May 25, 2002 Buyers United renewed for another year its account
receivable financing agreement with RFC Capital Corporation, and paid a $50,000
commitment fee at that time. The facility allows Buyers United to obtain
financing on its eligible accounts receivable, including unbilled receivables
and regular monthly billings. Interest during 2002 was at prime plus 6%. At
December 31, 2002, Buyers United had financed the maximum amount available based
on eligible accounts receivable at that time, which amounted to $1,276,252. The
facility requires us to maintain a restricted cash account for the collection of
the receivables. As of December 31, 2002 we had $584,002 of restricted cash. On
January 21, 2003, Buyers United and RFC Capital amended the facility to increase
9
the available borrowing limit to $5 million, and decrease the interest rate to
prime plus 3%. The amendment also extended the facility to January 21, 2006.
As of December 31, 2002, Buyers United had several unsecured promissory
notes payable to its officers and members of the Board of Directors totaling
$2,957,498. All bear interest at a rate of 12%, with interest on 3/4 of the
notes accruing monthly until July 2003, when such accrued interest is due.
Interest on the remaining notes is payable monthly. All the notes mature in
2004, except for notes aggregating $79,998 which are due in July 2003. By the
end of February 2003, another $500,000 in notes were issued ($400,000 to
Directors) with interest payable monthly at 12%, and all maturing by the end of
2004.
Starting in October 2001 through December 2002, Buyers United raised a
total of $5,065,000 via promissory notes for working capital and to fund payment
of up-front referral fees for new customers obtained via an unrelated Internet
marketing company. All the notes carry essentially the same terms. They are
unsecured and bear interest at 10% to 12%, payable monthly. Principal is also
payable monthly, based on 20% to 40% of billings collected during each monthly
billing period from a specific group of existing customers or from any new
customers referred to us via the Internet marketing company. No principal
repayments were made during 2001, but $1,829,835 in principal was repaid during
2002. Included in that amount was $600,000 of the earliest notes that were
completely repaid. Inasmuch as principal payments could vary over time, we
believe the principal will be repaid over a period of approximately one year
from the time the notes were issued. Accordingly, the entire $3,235,165 amount
(less applicable discounts relating to issuance costs) outstanding at December
31, 2002 is classified as current on the accompanying balance sheet. Up through
the end of March 2003, we had repaid additional principal in the amount of
$805,534.
In December of 2002 Buyers United issued $3,187,500 in promissory notes for
cash used in purchasing customers from Touch America. The notes are unsecured
and bear interest at 10%, payable monthly. Principal is also payable monthly,
based on 12.24% of billings collected during each monthly billing period from
the acquired Touch America customers. We believe that these notes will most
likely be repaid over a period of approximately eighteen months. Accordingly,
one-third of the amount outstanding is classified as long-term debt.
As of December 31, 2002, Buyers United had a $1,050,000 note payable to an
individual bearing interest at 18%, payable monthly. The note was paid and
settled in February 2003 in exchange for $250,000 in cash, 50,000 shares of
Buyers United common stock valued at $92,500, and a new $800,000 promissory
note. The new note is unsecured and bears interest at 10%, payable monthly.
Principal is paid in an amount equal to 20% of a specific group of customer
billings collected during the preceding calendar month.
During the years ended December 31, 2002 and 2001, Buyers United's net loss
applicable to common stockholders was $419,542 and $6,827,484, respectively. As
of December 31, 2002, we had a working capital deficit of $7,276,814 and an
accumulated deficit of $26,050,671. During the years ended December 31, 2002 and
2001, our operations used $1,678,158 and $4,145,290 of cash, respectively.
Although management believes Buyers United's financial condition is steadily
improving, these matters raise substantial doubt about our ability to continue
as a going concern. The financial statements do not include any adjustments
relating to the recoverability and classification of asset carrying amounts or
the amount and classification of liabilities that might result should we be
unable to continue as a going concern.
During 2001 we began several cost-reduction initiatives, which continued
into 2002. The net result of these efforts resulted in operating expenses
(unrelated to costs of revenue and termination of lease and web-site costs)
decreasing as a percentage of revenue from 66% during 2001 to 40% during 2002.
In addition, our revenues increased 110% during 2002 as compared to 2001.
On December 6, 2002, Buyers United entered into agreements to purchase and
manage the RTIP Network. In connection with the transaction, Buyers United
10
agreed to sublease certain space occupied by the sellers, but subsequently
negotiated a new lease arrangement for the space. Buyers United is leasing an
additional 14,339 square feet of space through November 2004, at a monthly cost
of $16,728. In consideration for entering into this agreement, the sellers
agreed to subsidize a total of $36,232 in lease payments. In the event the asset
purchase transaction does not close, Buyers United has the right to terminate
the lease arrangement without further liability to the Sellers or the landlord.
On December 20, 2002, Buyers United entered into an agreement with Touch
America to purchase approximately 70,000 of its switched voice telecommunication
customers. Buyers United made an initial payment of $3,000,000 to Touch America.
The original purchase price was $6,750,000, but the parties are now attempting
to negotiate a reduction in the purchase price due to errors and other
discrepancies the parties subsequently discovered in the list of accounts sold
to Buyers United. The balance of the final purchase price will be paid in
monthly increments based on a percentage of revenue generated by the acquired
customer accounts. The conditions for closing the purchase were satisfied in
March 2003.
As a result of these two transactions, Buyers United anticipates revenue
during 2003 to increase significantly. At the same time, we are currently
engaged in streamlining RTIP Network operations, integrating Touch America
customers into our billing and customer service business model, and working with
our wholesale providers to achieve lower costs of revenue. Accordingly, we
believe we will achieve increased profitability during the year ending December
31, 2003.
Forward-looking statements
The Private Securities Litigation Reform Act of 1985 provides a safe harbor
for forward-looking statements made by Buyers United. All statements, other than
statements of historical fact, which address activities, actions, goals,
prospects, or new developments that Buyers United expects or anticipates will or
may occur in the future, including such things as expansion and growth of its
operations and other such matters are forward-looking statements. Any one or a
combination of factors could materially affect Buyers United's operations and
financial condition. These factors include the availability of capital,
competitive pressures, success or failure of marketing programs, changes in
pricing and availability of services and products offered to members, legal and
regulatory initiatives affecting long distance service, and conditions in the
capital markets. Forward-looking statements made by Buyers United are based on
knowledge of its business and the environment in which it operates as of the
date of this report. Because of the factors listed above, as well as other
factors beyond its control, actual results may differ from those in the
forward-looking statements.
11
BUYERS UNITED, INC. AND SUBSIDIARY
Consolidated Financial Statements
TABLE OF CONTENTS
Report of Independent Auditors ......................................... F - 2
Consolidated Balance Sheet.............................................. F - 3
Consolidated Statements of Operations .................................. F - 4
Consolidated Statements of Stockholders' Equity (Deficit) .............. F - 5
Consolidated Statements of Cash Flows .................................. F - 7
Notes to Consolidated Financial Statements ............................. F - 9
F-1
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders
Buyers United, Inc. and Subsidiary
Salt Lake City, Utah
We have audited the accompanying consolidated balance sheet of Buyers United,
Inc. and Subsidiary as of December 31, 2002 and the related consolidated
statements of operations, stockholders' deficit, and cash flows for each of the
two years in the period ended December 31, 2002. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Buyers United, Inc.
and Subsidiary as of December 31, 2002 and the results of their operations and
their cash flows for each of the two years in the period ended December 31, 2002
in conformity with accounting principles generally accepted in the United States
of America.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has suffered recurring losses from operations,
deficit cash flows from operations, negative working capital, and has a net
capital deficiency. These results as reported in the accompanying financial
statements raise substantial doubt about the Company's ability to continue as a
going concern. Management's plans in regard to these matters are also described
in Note 1. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
Crowe Chizek and Company LLC
Oak Brook, Illinois
March 14, 2003
F-2
BUYERS UNITED, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
December 31, 2002
--------------------------------------------------------------------------------
ASSETS
Current assets:
Cash $ 994,360
Restricted cash 584,002
Accounts receivable, net of allowance for doubtful accounts
of $1,425,000 5,650,214
Other current assets 214,869
-----------
Total current assets 7,443,445
Property and equipment, net 540,578
Deposit to purchase Touch America customers 3,000,000
Deferred advertising costs, net 1,776,124
Other assets 384,801
-----------
Total assets $13,144,948
===========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Line of credit $ 1,276,252
Notes payable 6,099,580
Accounts payable 5,700,753
Accrued liabilities 772,347
Accrued dividends payable on preferred stock 377,688
Accrued commissions and rebates 493,639
-----------
Total current liabilities 14,720,259
Notes payable 3,887,803
-----------
Total liabilities 18,608,062
Stockholders' deficit:
Preferred stock, $0.0001 par value; 15,000,000 shares authorized;
Series A 8% cumulative convertible preferred stock; 1,865,000
shares issued and outstanding (liquidation value of $3,730,000) 187
Series B 8% cumulative convertible preferred stock; 553,800
shares issued and outstanding (liquidation value of $5,538,000) 55
Common stock, $0.0001 par value; 100,000,000 shares authorized;
5,985,262 shares issued and outstanding 599
Additional paid-in capital 16,019,376
Warrants and options outstanding 4,592,514
Deferred consulting fees (25,174)
Accumulated deficit (26,050,671)
-----------
Total stockholders' deficit (5,463,114)
-----------
Total liabilities and stockholders' deficit $13,144,948
===========
--------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
F-3
BUYERS UNITED, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended December 31, 2002 and 2001
--------------------------------------------------------------------------------
2002 2001
---- ----
Revenues:
Telecommunications services $30,110,528 $14,256,990
Other 52,922 84,987
----------- -----------
Total revenues 30,163,450 14,341,977
Operating expenses:
Costs of revenues 16,295,201 9,348,215
General and administrative 7,365,569 6,163,505
Selling and promotion 4,646,029 3,319,409
Termination of lease and write-off of web-site
development costs - 980,086
----------- -----------
Total operating expenses 28,306,799 19,811,215
----------- -----------
Income (loss) from operations 1,856,651 (5,469,238)
Other income (expense):
Interest income 17,980 15,571
Interest expense (1,544,448) (997,882)
----------- -----------
Total other expense, net (1,526,468) (982,311)
----------- -----------
Income (loss) before extraordinary item 330,183 (6,451,549)
Extraordinary gain on early extinguishment of debt - 383,520
----------- -----------
Net income (loss) $ 330,183 $(6,068,029)
Preferred stock dividends:
8% dividends on Series A and B preferred stock (749,725) (738,957)
Beneficial conversion feature related to Series B
preferred stock - (20,498)
----------- -----------
Total preferred stock dividends (749,725) (759,455)
----------- -----------
Net loss applicable to common stockholders $ (419,542) $(6,827,484)
=========== ===========
Basic and diluted net loss per common share:
Net loss applicable to common stockholders before
extraordinary item $ (0.07) $ (1.57)
Extraordinary gain on early extinguishment of debt - 0.08
----------- -----------
Net loss applicable to common stockholders $ (0.07) $ (1.49)
=========== ===========
Weighted average common shares outstanding:
Basic and diluted 5,740,811 4,583,698
=========== ===========
--------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
F-4
BUYERS UNITED, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
Years ended December 31, 2002 and 2001
------------------------------------------------------------------------------------------------------------------------------------
Additional Warrants/ Deferred
Preferred Stock Common Stock Paid-in Options Consulting Accumulated
Shares Amount Shares Amount Capital Outstanding Fees Deficit Total
--------- ------ --------- ------ ----------- ----------- --------- ------------- ------------
Balance at December 31, 2000 2,328,800 $ 233 3,988,940 $ 399 $13,005,703 $4,073,144 $(98,145) $(18,803,645) $(1,822,311)
Issuance of common shares for
services - - 148,805 15 104,572 - - - 104,587
Issuance of common shares with
consulting agreement - - 100,000 10 124,990 - (125,000) - -
Issuance of common shares in
connection with debt extinguishment - - 35,000 4 22,397 - - - 22,401
Conversion of preferred shares to
common (5,000) - 5,000 - - - - - -
Issuance of common shares in
connection with notes payable - - 430,000 43 360,130 - - - 360,173
Issuance of warrants for services
and with consulting agreements - - - - - 54,515 - - 54,515
Amortization of deferred consulting
fees - - - - - - 45,774 - 45,774
Issuance of warrants with notes
payable - - - - - 32,239 - - 32,239
Issuance of common stock for debt
guarantee - - 100,000 10 144,990 - - - 145,000
Imputed interest on notes payable - - - - 25,500 - - - 25,500
Issuance of Series B preferred stock
and warrants, net of offering costs 110,000 11 - - 797,588 302,401 - - 1,100,000
Beneficial conversion dividend on
Series B preferred stock - - - - 20,498 - - (20,498) -
Cancellation of options issued for
services - - - - - (78,965) 78,965 - -
Preferred stock dividends - - - - - - - (738,957) (738,957)
Issuance of common shares as payment
of preferred stock dividends - - 504,884 50 584,487 - - - 584,537
Net loss - - - - - - - (6,068,029) (6,068,029)
-----------------------------------------------------------------------------------------------
Balance at December 31, 2001 2,433,800 $ 244 5,312,629 $ 531 $15,190,855 $ 4,383,334 $(98,406) $(25,631,129) $(6,154,571)
--------------------------------------------------------------------------------
(Continued)
F-5
BUYERS UNITED, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) - (Continued)
Years ended December 31, 2002 and 2001
------------------------------------------------------------------------------------------------------------------------------------
Additional Warrants/ Deferred
Preferred Stock Common Stock Paid-in Options Consulting Accumulated
Shares Amount Shares Amount Capital Outstanding Fees Deficit Total
--------- ------ --------- ------ ----------- ----------- --------- ------------- ------------
Balance at December 31, 2001 2,433,800 $ 244 5,312,629 $ 531 $15,190,855 $ 4,383,334 $(98,406) $(25,631,129) $(6,154,571)
Conversion of preferred shares to
common (15,000) (2) 55,000 6 (4) - - - -
Issuance of common shares in
connection with notes payable - - 17,998 2 18,796 - - - 18,798
Issuance of warrants for services
and with consulting agreements - - - - - 102,118 - - 102,118
Amortization of deferred consulting
fees - - - - - - 73,232 - 73,232
Issuance of warrants with notes
payable - - - - - 232,259 - - 232,259
Issuance of common stock for debt
guarantee - - 25,000 3 30,747 - - - 30,750
Imputed interest on notes payable - - - - 28,686 - - - 28,686
Cancellation of warrants issued for
services - - - - - (125,197) - - (125,197)
Preferred stock dividends - - - - - - - (749,725) (749,725)
Issuance of common shares as payment
of preferred stock dividends - - 574,635 57 750,296 - - - 750,353
Net income - - - - - - - 330,183 330,183
----------------------------------------------------------------------------------------------
Balance at December 31, 2002 2,418,800 $ 242 5,985,262 $ 599 $16,019,376 $ 4,592,514 $(25,174) $(26,050,671) $(5,463,114)
==============================================================================================
--------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
F-6
BUYERS UNITED, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2002 and 2001
--------------------------------------------------------------------------------
2002 2001
------------ ------------
Cash flows from operating activities:
Net income (loss) $ 330,183 $(6,068,029)
Adjustments to reconcile net income (loss) to net cash used in
operating activities:
Extraordinary gain on early extinguishment of debt - (383,520)
Depreciation and amortization 1,191,196 766,869
Interest expense resulting from issuing stock and warrants with notes 28,686 255,623
Amortization of discount on notes payable 237,444 6,140
Amortization of note financing costs 174,977 169,154
Amortization of deferred consulting fees 73,232 45,774
Services rendered in exchange for shares of common stock - 104,587
Expense related to the grant of options to purchase common shares (23,079) 54,515
Termination of lease and write-off of web-site development costs - 980,086
Changes in operating assets and liabilities:
Accounts receivable (3,378,341) (724,591)
Other assets (2,379,009) (112,176)
Checks in excess of available cash balances (186,866) 186,866
Accounts payable 1,821,236 430,271
Accrued commissions and rebates 168,861 249,244
Accrued liabilities 263,322 (106,103)
------------ ------------
Net cash used in operating activities (1,678,158) (4,145,290)
------------ ------------
Cash flows from investing activities:
Increase in other assets (194,915) (63,535)
Purchases of property and equipment (317,399) (213,145)
Deposits to purchase Touch America customers (3,000,000) -
------------ ------------
Net cash used in investing activities (3,512,314) (276,680)
------------ ------------
Cash flows from financing activities:
Change in restricted cash 106,310 (462,542)
Net borrowings under line of credit 702,080 574,172
Borrowings under notes payable, net of debt issuance costs 7,818,850 3,833,750
Principal payments on notes payable (2,297,351) (120,000)
Principal payments on capital lease obligations (202,157) (500,358)
Issuance of preferred/common shares for cash, net of offering costs - 1,097,223
------------ ------------
Net cash provided by financing activities 6,127,732 4,422,245
------------ ------------
Net increase in cash 937,260 275
Cash at the beginning of the period 57,100 56,825
------------ ------------
Cash at the end of the period $ 994,360 $ 57,100
============ ============
(Continued)
F-7
BUYERS UNITED, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS - (Continued)
Years ended December 31, 2001 and 2000
--------------------------------------------------------------------------------
2002 2001
------------ ------------
Supplemental cash flow information:
Cash paid for interest $ 890,490 $ 459,442
Supplemental schedule of noncash investing and financing activities:
Issuance of common shares in payment of preferred stock dividend $ 750,353 $ 584,537
Issuance of common shares in payment of deferred services - 125,000
Issuance of common shares in payment of deferred financing cos 18,793 222,075
Issuance of common shares in extinguishment of debt - 22,400
Issuance of warrants with promissory notes 232,259 32,239
Beneficial conversion dividend on Series B preferred shares - 20,498
Accrual of dividend payable on preferred stock 749,725 738,957
Assets acquired under capital lease arrangements - 109,100
Issuance of common shares for supplier guaranty 30,750 27,475
See accompanying notes to consolidated financial statements
F-8
BUYERS UNITED, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
--------------------------------------------------------------------------------
NOTE 1 - DESCRIPTION OF THE COMPANY AND NATURE OF OPERATIONS
Buyers United, Inc. ("the Company") was incorporated on August 23, 1994 in the
state of Utah and was reincorporated in the state of Delaware on April 9, 1999.
The Company was formerly known as Linguistix, Inc., Buyers United International,
Inc., BUI, Inc., and BuyersOnline.com, Inc. In 2001, the Company changed its
name to Buyers United, Inc., the same name as its dormant, wholly owned Utah
subsidiary. The Company merged the subsidiary into the parent entity during
2002. At the time of the name change, the Company's trading symbol also changed
to "BYRS."
The Company is a consumer buying organization with the objective of providing
high quality consumer products and services at favorable prices to its members.
The Company forms strategic alliances with various consumer service providers in
an effort to combine the purchasing power of its members to negotiate favorable
prices from these providers. During the years ended December 31, 2002 and 2001,
the Company primarily provided discounted long distance telecommunication
services to its members.
On December 6, 2002, Buyers United entered into an agreement to purchase assets
of I-Link, Inc., and its subsidiary, I-Link Communications, Inc., and license in
perpetuity software developed by I-Link for the operation of a real-time
Internet protocol communications network (RTIP Network). The assets acquired
include dedicated equipment required for operating the RTIP Network, customers
of I-Link serviced through the network, and certain trademarks. In consideration
for the assets and software license, Buyers United agreed to issue to I-Link
300,000 shares of Series B Convertible Preferred Stock and assume certain
liabilities. Completion of the purchase is subject to obtaining government and
third-party approvals, and obtaining releases of third party security interests
in the assets. The parties are pursuing efforts to satisfy these closing
conditions for the purchase of assets, but cannot predict when or if the
conditions will be satisfied and the transaction closed. Since this transaction
has not closed, the effects of this transaction have not been reflected in the
accompanying financial statements.
Concurrently with the agreement for the purchase of I-Link assets, I-Link and
Buyers United entered into transition and management agreements pursuant to
which Buyers United was appointed to manage all of the assets to be acquired
from I-Link pending the closing of the purchase. Under the agreements, Buyers
United assumed responsibility for day-to-day operation of the RTIP Network
previously operated by I-Link that is to be sold to Buyers United, is
responsible for all customer billing and collection, has the right to use the
RTIP Network to provide telecommunications service to its customers, and is
entitled to receive a management fee equal to 10 percent of revenue generated
from I-Link customers after the payment of all expenses of the RTIP Network and
providing service to such customers. Since the revenues generated and expenses
paid are not legally the Company's the net impact of these items is reflected in
other liabilities and operating expenses in the accompanying financial
statements.
--------------------------------------------------------------------------------
(Continued)
F-9
BUYERS UNITED, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
--------------------------------------------------------------------------------
In connection with the transaction, Buyers United agreed to sublease certain
space occupied by I-Link, but subsequently negotiated a new lease arrangement
for the space. Buyers United is leasing through November 2004, 14,339 square
feet of space at 13751 S. Wadsworth Park Drive, Draper, Utah, at a monthly cost
of $16,728. In consideration for entering into this agreement, I-Link agreed to
subsidize a total of $36,232 in lease payments, which represents the difference
between the amount of the original sublease obligation of Buyers United and the
monthly cost of the space under the new lease arrangement. In the event the
asset purchase transaction between Buyers United and I-Link does not close,
Buyers United has the right to terminate the lease arrangement without further
liability to I-Link or the landlord.
On December 20, 2002, Buyers United entered into an agreement with Touch
America, Inc., a subsidiary of Touch America Holdings, Inc., to purchase
approximately 70,000 of the switched voice telecommunication customers of Touch
America, including the carrier identification code used to service those
customers. Buyers United did not purchase any accounts receivable, equipment, or
other assets of Touch America. Buyers United agreed to pay to Touch America
account receivable balances that predate the sale as collected by Buyers United,
subject to certain fees payable to Buyers United. Buyers United made an initial
payment of $3 million dollars to Touch America. The original purchase price was
$6,750,000, but the parties are now attempting to negotiate a reduction in the
purchase price due to errors and other discrepancies the parties subsequently
discovered in the list of accounts sold to Buyers United. The balance of the
final purchase price will be paid in monthly increments based on a percentage of
revenue generated by the acquired customer accounts. Since the transaction had
not yet closed as of December 31, 2002, no additional amounts have been
reflected in the accompanying balance sheet. The conditions for closing the
purchase were satisfied in March 2003.
During the years ended December 31, 2002 and 2001, the Company's net loss
applicable to common stockholders was $419,542 and $6,827,484, respectively. As
of December 31, 2002, the Company had a working capital deficit of $7,276,814
and an accumulated deficit of $26,050,671. During the years ended December 31,
2002 and 2001, the Company's operations used $1,678,158 and $4,145,290 of cash,
respectively. These matters raise substantial doubt about the Company's ability
to continue as a going concern. The financial statements do not include any
adjustments relating to the recoverability and classification of asset carrying
amounts or the amount and classification of liabilities that might result should
the Company be unable to continue as a going concern.
During 2001 the Company began several cost-reduction initiatives, which
continued into 2002. The net result of these efforts resulted in operating
expenses (unrelated to costs of revenue and termination of lease and web-site
costs) decreasing as a percentage of revenue from 66% during 2001 to 40% during
2002. In addition, the Company's revenues increased 110% during 2002 as compared
to 2001.
--------------------------------------------------------------------------------
(Continued)
F-10
BUYERS UNITED, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
--------------------------------------------------------------------------------
The Company is subject to certain risk factors frequently encountered by
companies lacking adequate capital and are continuing the development of
multiple business lines that may impact its ability to become a profitable
enterprise. These risk factors include:
a) The consumer buying organization industry is characterized by intense
competition, and many of the Company's competitors are substantially
larger than the Company with greater financial and other resources. In
addition, the Company is currently marketing telecommunications
services, including long distance services, to its members. The U.S.
long distance telecommunications industry is highly competitive and
significantly influenced by the marketing and pricing strategies of
the major industry participants, which are significantly larger than
the Company and have substantially greater resources.
b) The Company's relationship marketing system is or may be subject to or
affected by extensive government regulation, including without
limitations, state regulation of marketing practices and federal and
state regulation of the offer and sale of business franchises,
business opportunities, and securities. Long distance
telecommunications carriers currently are subject to extensive federal
and state government regulation.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation: The accompanying consolidated financial statements
include the accounts of Buyers United, Inc. and its wholly owned subsidiary. All
significant intercompany accounts and transactions have been eliminated upon
consolidation.
Use of Estimates in the Preparation of Financial Statements: The preparation of
financial statements in conformity with accounting principles generally accepted
in the United States of America 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 these estimates. Significant
estimates include the allowance for doubtful accounts.
Revenue Recognition: The Company's revenue recognition policy with respect to
reseller agreements is to record gross revenues and receivables from customers
when the Company acts as principal in the transaction; takes title to the
products or services; and has risks and rewards of ownership, such as risk of
loss for collection, delivery, or returns. Revenues from sales of services are
recognized upon providing the services to the customers
Restricted Cash: In accordance with the Company's agreements with RFC Capital
Corp. (Note 4) and with certain vendors, the Company maintains a restricted cash
--------------------------------------------------------------------------------
(Continued)
F-11
BUYERS UNITED, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
--------------------------------------------------------------------------------
account for the collection of the Company's receivables. As of December 31,
2002, the Company had $584,002 of cash that was restricted.
Accounts Receivable and Allowance for Doubtful Accounts: Accounts receivable is
comprised of amounts billed and billable to customers, net of an allowance for
uncollectible amounts. The gross receivable balance outstanding as of December
31, 2002 is comprised of the following:
Billed amounts $ 4,524,390
Unbilled amounts 2,550,824
-----------
$ 7,075,214
===========
Finance charges are assessed to accounts once the amount owed is past due based
on their specific terms. The amount of trade receivables billed and outstanding
that are not being assessed finance charges are $2.2 million. The amount of
trade receivables that are past due more than 90 days and still accruing fees
are approximately $700,000.
The allowance for doubtful accounts is estimated by management and is based on
specific information about customer accounts, past loss experience, and general
economic conditions. During the three months ended December 31, 2002 the Company
recorded a $400,000 adjustment to increase the allowance for doubtful accounts.
An account is written off by management when deemed uncollectible, although
collections efforts may continue.
Property and Equipment: Property and equipment are stated at cost. Major
additions and improvements are capitalized, while minor repairs and maintenance
costs are expensed when incurred. In accordance with Statement of Position 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use," the Company capitalizes certain costs incurred for the
development of internal use software. These costs include the costs associated
with coding, software configuration, upgrades, and enhancements. In March 2000,
the Emerging Issues Task Force issued its consensus on Issue No. 00-2,
"Accounting for Web Site Development Costs." Of such costs the Company disposed
of significant amounts during 2001, and capitalized approximately $127,000
during 2002.
Depreciation and amortization are computed using the straight-line method over
the estimated useful lives of the related assets as follows:
Computer and office equipment 2 to 3 years
Internal-use software and web site development costs 2 years
Furniture and fixtures 3 to 7 years
Advertising Costs: The Company advertises its services through traditional
venues such as print media to the general public. Costs associated with these
advertising efforts are expensed as incurred, and were $29,781 and $66,455 for
the years ended December 31, 2002 and 2001, respectively.
--------------------------------------------------------------------------------
(Continued)
F-12
BUYERS UNITED, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
--------------------------------------------------------------------------------
In addition to the traditional advertising means noted above, the Company
participates in a direct response advertising campaign with LowerMyBills.com,
Inc. (LMB), a web-based comparison shopping service. Through this campaign, the
Company's name and the services it provides are displayed on LMB's web site. The
Company is obligated to pay LMB a referral fee when a customer signs up for
services through LMB's web site. The fees associated with this advertising
campaign were deferred and aggregated $2,579,307 during the year ended December
31, 2002. These fees have been amortized over the period during which the future
benefits are expected to be received, which was 24 months at December 31, 2002.
The fees and related accumulated amortization of $803,183 was included with
other assets as of December 31, 2002.
Fair Value of Financial Instruments: The carrying amounts reported in the
accompanying consolidated balance sheet for cash, receivables, and accounts
payable approximate fair values because of the immediate or short-term
maturities of these financial instruments. The fair value of the Company's notes
payable and preferred stock also approximate fair value based on current rates
for similar debt and fixed-rate instruments.
Debt Issuance Costs: As an inducement to various investors, shareholders, and
board members to lend monies to the Company, shares of common stock and warrants
to purchase shares of common stock were issued to them. The fair market value of
those shares at the date of issuance has been capitalized as debt issuance costs
and is being amortized over the life of the loans. Amortization of these costs
for the years ended December 31, 2002 and 2001 was $237,446 and $149,104,
respectively, and are included in interest expense. The remaining amortization
period for these costs is less than two years as of December 31, 2002.
Stock-Based Compensation: Employee compensation expense via stock option grants
is reported using the intrinsic method. No stock option-based compensation
expense is included in net income (loss) as all options granted had an exercise
price equal to or greater than the market price of the underlying common stock
at the date of grant. The following table illustrates the effect on net income
(loss) and earnings (loss) per share if expense was measured using the fair
value recognitions provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation":
2002 2001
------------ ------------
Net loss applicable to common stockholders:
As reported $ (419,542) $(6,827,484)
Pro forma stock-option based compensation (748,857) (710,762)
------------ ------------
Pro forma net loss applicable to common stockholders $(1,168,399) $(7,538,246)
============ ============
Basic and diluted net loss per common share:
As reported $ (0.07) $ (1.49)
Pro forma basic and diluted net loss per common share $ (0.20) $ (1.64)
--------------------------------------------------------------------------------
(Continued)
F-13
BUYERS UNITED, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
--------------------------------------------------------------------------------
The fair value of the options was estimated at the date of grant using the
following weighted average assumptions:
2002 2001
---- ----
Risk-free interest rate 3.71% 2.18%
Dividend yield - -
Expected volatility 104% 111%
Weighted average expected life 4.7 years 5.6 years
The weighted average fair values of options granted during the years ended
December 31, 2002 and 2001 was $1.01 and $2.51, respectively. The pro forma
effects of applying SFAS No. 123 are not indicative of future amounts.
Additional awards in future years are anticipated.
Income Taxes: The Company recognizes a liability or asset for the deferred
income tax consequences of all temporary differences between the tax bases of
assets and liabilities and their reported amounts in the financial statements
that will result in taxable or deductible amounts in future years when the
reported amounts of the assets and liabilities are recovered or settled. These
deferred income tax assets or liabilities are measured using the enacted tax
rates that will be in effect when the differences are expected to reverse.
Recognition of deferred tax assets is limited to amounts considered by
management to be more likely than not of realization in future periods.
Net Loss Per Common Share : Basic net loss per common share ("Basic EPS")
excludes dilution and is computed by dividing net loss by the weighted average
number of common shares outstanding during the year. Diluted net loss per common
share ("Diluted EPS") reflects the potential dilution that could occur if stock
options or other common stock equivalents were exercised or converted into
common stock. The computation of Diluted EPS does not assume exercise or
conversion of securities that would have an antidilutive effect on net loss per
common share.
Outstanding options of employees and directors to purchase 3,592,721 and
2,818,585 shares of common stock as of December 31, 2002 and 2001, respectively;
4,634,000 and 4,689,000 shares of common stock issuable upon the conversion of
preferred stock as of December 31, 2002 and 2001, respectively; and 5,529,282
and 5,345,732 shares of common stock issuable upon exercise of warrants to
purchase common stock as of December 31, 2002 and 2001, respectively, were not
included in the computation of Diluted EPS because they would be antidilutive.
Reclassifications: Certain reclassifications have been made to the prior year
financial statements to conform to the current year presentation.
Recent Accounting Pronouncements: On June 29, 2001, the Financial Accounting
Standards Board (FASB) approved its proposed SFAS No. 141 ("SFAS No. 141"),
"Business Combinations," and SFAS No. 142 ("SFAS No. 142"), "Goodwill and Other
Intangible Assets."
--------------------------------------------------------------------------------
(Continued)
F-14
BUYERS UNITED, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
--------------------------------------------------------------------------------
Under SFAS No. 141, all business combinations should be accounted for using the
purchase method of accounting; use of the pooling-of-interests method is
prohibited. The provisions of the statement apply to all business combinations
initiated after June 30, 2001. SFAS No. 142 applies to all acquired intangible
assets whether acquired singly, as part of a group, or in a business
combination. The statement supersedes Accounting Principles Board ("APB")
Opinion No. 17, "Intangible Assets," and will carry forward provisions in APB
Opinion No. 17 related to internally developed intangible assets. The adoption
of these statements as of January 1, 2002 did not have a material impact on the
Company's results of operations, financial position, or liquidity.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations." The Company is required to adopt SFAS No. 143 for fiscal years
beginning after June 15, 2002. Thus, the Company will need to adopt SFAS No. 143
as of January 1, 2003. SFAS No. 143 requires businesses to recognize a liability
for an asset retirement obligation when it is incurred. This liability should be
recorded at its fair value, and a corresponding increase in the carrying amount
of the related long-term asset should be recorded as well. The adoption of SFAS
No. 143 on January 1, 2003 did not have a material impact on the Company's
results of operations, financial position, or liquidity.
On October 3, 2001 the FASB issued SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets." SFAS No. 144 develops one accounting model
for long-lived assets that are to be disposed of by sale. The long-lived assets
that are to be disposed of by sale should be measured at the lower of book value
or fair value less any selling expenses. Additionally, SFAS No. 144 expands the
scope of discontinued operations to include all components of an entity with
operations that can be distinguished from the rest of the entity and will be
eliminated from the ongoing operations of the entity in a disposal transaction.
The statement is effective for the Company for all financial statements issued
for fiscal years beginning after December 15, 2001. The adoption of this
pronouncement did not have a material effect on the Company's results of
operations, financial position, or liquidity.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statement 4,
44, and 64, Amendment of FASB Statements 13, and Technical Corrections." SFAS
No. 145 rescinds the provisions of SFAS No. 4 that requires companies to
classify certain gains and losses from debt extinguishments as extraordinary
items and amends the provisions of SFAS No. 13 to require that certain lease
modifications be treated as sale/leaseback transactions. The provisions of SFAS
No. 145 related to classification of debt extinguishments are effective for
fiscal years beginning after May 15, 2002. Commencing January 1, 2003 the
Company will classify debt extinguishments costs within income from operations.
The provisions of SFAS No. 145 related to lease modifications are effective for
transactions occurring after May 15, 2002. The adoption of this statement on
January 2, 2003 did not have a material impact on the Company's financial
position or results of operations.
--------------------------------------------------------------------------------
(Continued)
F-15
BUYERS UNITED, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
--------------------------------------------------------------------------------
In December 2002 the FASB issued SFAS No. 148 "Accounting for Stock Based
Compensation - Transition and Disclosure." This statement amends SFAS No. 123,
"Accounting for Stock-Based Compensation" to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. This amendment also changes the
disclosure requirements of SFAS No. 123 to require more prominent disclosures in
both annual and interim financial statements about the methods of accounting for
stock-based employee compensation and the effects of the method used on reported
amounts. SFAS No. 148 is effective for fiscal years ending after December 15,
2002. The Company has opted to continue accounting for stock options under the
intrinsic value method prescribed in APB Opinion No. 25 for the year ended
December 31, 2002.
NOTE 3 - PROPERTY AND EQUIPMENT
At December 31, 2002, property and equipment consists of the following:
Computer and office equipment $1,325,175
Internal-use software 209,096
Furniture and fixtures 270,371
----------
1,804,642
Accumulated depreciation and amortization 1,264,064
----------
$ 540,578
==========
During 2001 the Company reviewed its investment in leased computer equipment and
software, and determined that it could achieve its growth objectives and serve
its customers with a different equipment and software solution. During 2001, the
Company also replaced its web site software with a newly-developed program. The
total cost of removing the unamortized book value of the above assets was
$980,086 and is included in the consolidated statement of operations.
NOTE 4 - LINE OF CREDIT
During 2002 the Company renewed its line of credit agreement with RFC Capital
Corporation ("RFC"). The facility allowed the Company to borrow up to $2.5
million based on the Company's eligible accounts receivable and unbilled
receivables. On January 21, 2003, the Company amended its agreement with RFC.
The new arrangement allows the Company to borrow up to $5 million based on
eligible accounts receivable and unbilled receivables. The facility bears
interest at prime plus 3% and expires in January 2006.
As security for the line of credit, the Company is required to maintain a lock
box at a financial institution. As of December 31, 2002, there was $506,639 of
--------------------------------------------------------------------------------
(Continued)
F-16
BUYERS UNITED, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
--------------------------------------------------------------------------------
restricted cash specifically associated with this agreement. At December 31,
2002, the Company had borrowed the maximum amount available based on eligible
accounts receivable at that time, which amounted to $1,276,252.
NOTE 5 - LONG-TERM DEBT AND NOTES PAYABLE
Long-term debt consists of the following:
Unsecured notes payable to the Chairman of the Board,
bearing interest at 12%, accrued monthly. All accrued
interest is payable on July 5, 2003, thereafter monthly.
In January 2003, the notes were amended such that all
principal and any unpaid interest is due and payable in
July 2004. $2,377,500
Unsecured notes payable to a Director bearing interest at
12%, payable monthly. Principal and any unpaid interest
due in 2004. 500,000
Secured note payable bearing interest at 18%, payable
monthly. Principal and any unpaid interest due
February 28, 2003, at which time 50,000 shares of common
stock will also be payable. The note is secured by certain
assets of a member of the Board of Directors (see Note 12). 1,050,000
Unsecured promissory notes bearing interest at 10% and 12%,
payable monthly. Principal payments due monthly, based on
20% to 40% of billings collected from
specifically-designated customers referred from
LowerMyBills.com, Inc. ("LMB"). The majority of these
notes do not have a maturity date. The Company believes
that virtually all of the principal will be repaid in
approximately one year or less, based on forecasted
billings to these customers. 2,940,354
Unsecured promissory notes bearing interest at 10%, payable
monthly. Principal payments due monthly, based on 10% of
billings collected from customer recently acquired from
Touch America, Inc. These notes do not have a maturity
date. The Company believes that principal will be repaid
--------------------------------------------------------------------------------
(Continued)
F-17
BUYERS UNITED, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
--------------------------------------------------------------------------------
over a period of approximately 18 months from the date of
issue, based on forecasted billings to these customers. 3,035,000
Other 84,529
------------
9,987,383
Less current portion (6,099,580)
------------
$ 3,887,803
============
Long-term debt maturities are as follows:
2003 $6,099,580
2004 3,887,803
----------
9,987,383
Less current maturities 6,099,580
----------
$3,887,803
==========
In connection with some of the LMB-related unsecured promissory notes, two-year
warrants to purchase 562,950 shares of common stock at $2.50 per share (later
amended to $2.00 per share) have also been issued to the noteholders during 2002
and 2001. Warrants for an additional 94,950 shares have also been issued to the
sales agents. The estimated fair value of the warrants of $264,717, based on
using the Black-Scholes pricing model, was allocated to the warrants and
recorded as a discount to the carrying value of the notes. The Company paid
approximately $232,000 in commissions to sales agents. The Company paid
approximately $152,000 in commissions to sales agents in connection with the
Touch America-related unsecured promissory notes. All these commission costs are
also included in the discounts to the carrying value of the notes. The discount
is being amortized to interest expense over the respective notes' estimated
payment terms.
In June 2001, the Company entered into a joint sales agreement with Infotopia,
Inc. ("Infotopia"), a direct response marketer. In connection with the
agreement, Infotopia agreed to loan the Company $500,000. Subsequent to entering
into the sales agreement, the two companies decided not to pursue further any
joint activity. During 2001, Infotopia sold the loan obligation to Pali
Investments, Inc. ("Pali"), an unrelated investment relations firm. In December
2001, the Company negotiated a settlement with Pali. Under the terms of the
settlement, the Company paid $120,000 and issued 35,000 shares of common stock
in exchange for canceling the outstanding obligation plus $25,921 in accrued
interest. The stock had a fair market value of $22,401. Accordingly, based on
these amounts, the Company recorded an extraordinary gain on the early
extinguishments of the debt in the amount of $383,520 (see Note 11).
--------------------------------------------------------------------------------
(Continued)
F-18
BUYERS UNITED, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
--------------------------------------------------------------------------------
NOTE 6 - LEASES
In connection with the I-Link transaction, the Company agreed to sublease
certain space occupied by I-Link, but subsequently negotiated a new lease
arrangement for the space. The Company is leasing 14,339 square feet of space at
13751 S. Wadsworth Park Drive, Draper, Utah, at a monthly cost of $16,728. The
new lease expires at the end of November 2004. In consideration for entering
into this agreement, I-Link agreed to subsidize a total of $36,232 in lease
payments, which represents the difference between the amount of the original
sublease obligation of Buyers United and the monthly cost of the space under the
new lease arrangement. In the event the asset purchase transaction between
Buyers United and I-Link does not close, Buyers United has the right to
terminate the lease arrangement without further liability to I-Link or the
landlord.
The following is a schedule of future minimum payments under both leases as of
December 31, 2002:
2003 544,410
2004 571,689
2005 397,373
2006 407,307
Thereafter 417,490
----------
Total future minimum lease payments $2,338,269
==========
Rent expense was approximately $348,300 and $517,600 for the years ended
December 31, 2002 and 2001, respectively.
NOTE 7 - INCOME TAXES
The components of the Company's net deferred income tax assets and liabilities
are as follows:
Deferred income tax assets:
Net operating loss carryforwards $5,690,000
Reserves and accrued liabilities 800,000
Other 1,000
-----------
Total deferred income tax assets 6,491,000
Valuation allowance (6,313,000)
-----------
Net deferred income tax asset 178,000
--------------------------------------------------------------------------------
(Continued)
F-19
BUYERS UNITED, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
--------------------------------------------------------------------------------
Deferred income tax liabilities:
Capitalized software costs -
Tax depreciation in excess of book depreciation (178,000)
Net deferred income tax liability (178,000)
Net deferred income taxes $ -
As of December 31, 2002, the Company had net operating loss carryforwards for
federal income tax reporting purposes of approximately $15,000,000. The tax net
operating loss carryforwards will expire beginning in 2012.
Inasmuch as the Company's history includes accumulated net operating losses, it
is uncertain as to whether the Company's deferred tax asset can be fully
realized. Accordingly, a valuation allowance has been recorded to reduce the
deferred income tax assets. The net change in the valuation allowance for
deferred tax assets during the year ended December 31, 2002 was a decrease of
$438,000. No benefit for income taxes has been recorded during the year ended
December 31, 2001. During 2002 no income tax expense was recorded due the
reduction of the valuation allowance.
NOTE 8 - CAPITAL TRANSACTIONS
Preferred Stock: The Board of Directors is authorized to classify any shares of
the Company's authorized but unissued preferred stock in one or more series.
With respect to each series, the Board of Directors is authorized to determine
the number of shares that constitutes such series; the rate of dividend, if any,
payable on shares of such series; whether the shares of such series shall be
cumulative, non-cumulative, or partially cumulative as to dividends and the
dates from which any cumulative dividends are to accumulate; whether the shares
of such series may be redeemed, and, if so, the price or prices at which and the
terms and conditions on which shares of such series may be redeemed; the amount
payable upon shares of such series in the event of the voluntary or involuntary
dissolution, liquidation, or winding up of the affairs of the Company; the
sinking fund provisions, if any, for the redemption of shares of such series;
the voting rights, if any, of the shares of such series; the terms and
conditions, if any, on which shares of such series may be converted into shares
of capital stock of the Company of any other class or series; whether the shares
of such series are to be preferred over shares of capital stock of the Company
of any other class or series as to dividends or upon the voluntary or
involuntary dissolution, liquidation, or termination of the affairs of the
Company or otherwise; and any other characteristics, preferences, limitations,
rights, privileges, immunities, or terms.
Series A 8% Cumulative Convertible Preferred Stock: During 1999, the Board of
Directors authorized the issuance of 2,000,000 shares of Series A 8% Cumulative
Convertible Preferred Stock ("Series A Preferred Stock") at an offering price of
$2.00 per share. Gross proceeds of $4,000,000 were raised upon sale of the
shares.
--------------------------------------------------------------------------------
(Continued)
F-20
BUYERS UNITED, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
--------------------------------------------------------------------------------
The Series A Preferred Stock is convertible to common stock at any time at the
election of the holder and, under limited circumstances, at the election of the
Company. The conversion rate is one for one, subject to adjustment in the event
of a recapitalization, reorganization, or other corporate restructuring or in
the event that the Company shall sell or otherwise issue securities at a price
below $2.00 per share or the then adjusted conversion price. The Series A
Preferred Stock can be redeemed at the Company's election at any time commencing
January 1, 2005 at a redemption price of $2.00 per share plus all accrued
dividends as of the redemption date. During each of 2002 and 2001, certain
stockholders converted 5,000 Series A preferred shares, respectively, into
common shares.
Series B 8% Cumulative Convertible Preferred Stock: In September 2000, the Board
of Directors authorized the issuance of 1,234,500 shares of Series B 8%
Cumulative Convertible Preferred Stock ("Series B Preferred Stock") and related
warrants to purchase common shares at an offering price of $10.00 per unit. Each
unit consists of one share of Series B Preferred Stock and five warrants to
purchase one share of common stock at an exercise price of $2.50 per share.
During 2000, various investors made loans to the Company and subsequently
elected to exchange their promissory notes for units. In addition to the
converted loans of $2,545,000, the Company raised $1,993,000 through the
issuance of units through December 31, 2000 and $1,100,000 through the issuance
of units in 2001.
In connection with the unit offering, the Company agreed to pay the Placement
Agent a sales commission and expense allowance aggregating 13% of the gross
proceeds from the sale of the Series B Preferred Stock, in addition to 10% of
the gross proceeds of certain related bridge financing. The Company also
incurred approximately $23,000 of direct expenses in connection with the
offering. As additional consideration, the Company agreed to issue to the
Placement Agent warrants to purchase 319,300 shares of the Company's common
stock at an exercise price of $2.50 per share.
As part of the Series B Preferred Stock offering, the Company issued 2,269,000
warrants to purchase common stock at $2.50 per share. The Company allocated the
net proceeds from the offering of $4,208,762 between the Series B Preferred
Stock and the warrants based on estimated relative fair values. The Series B
Preferred Stock was recorded at $2,432,476, and the warrants were recorded at
$1,776,286. The estimated fair value of the warrants was determined using the
Black-Scholes pricing model. The Series B Preferred Stock is convertible to
common stock at any time at the election of the holder and, under limited
circumstances, at the election of the Company. The conversion rate is five for
one, subject to adjustment in the event of a recapitalization, reorganization,
or other corporate restructuring or in the event that the Company shall sell or
otherwise issue securities at a price below $2.00 per share or the then adjusted
conversion price. During 2002, one of the stockholders converted 10,000 Series B
preferred shares into common shares.
During the three months ended March 31, 2001, the Company issued an additional
110,000 shares of preferred stock and 550,000 warrants to purchase common stock.
--------------------------------------------------------------------------------
(Continued)
F-21
BUYERS UNITED, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
--------------------------------------------------------------------------------
The Company allocated the net proceeds from the offering of $1,097,223 between
the Series B Preferred Stock and the warrants based on estimated relative fair
values. Accordingly, the stock was recorded at $794,822, and the warrants were
recorded at $302,401. In connection with these additional Series B shares, the
intrinsic value of the beneficial conversion feature of $20,498 was reflected in
the accompanying 2001 consolidated financial statements as a preferred stock
dividend and as an increase to additional paid in capital. The Series B
Preferred Stock Offering closed on April 13, 2001.
In May 2002 the Board of Directors approved a plan to modify the exercise price
on certain Preferred Stock and promissory note-related warrants from $2.50 to
$2.00 per share, extend the expiration date of certain warrants from December
31, 2002 to December 31, 2004, and amend the redemption provisions of certain
warrants so that the warrants could be called for redemption when the market
price for our common stock is $4.00 per share, rather than $6.00 per share.
Both Series A and B Preferred Stock can be redeemed at the Company's election at
any time commencing January 1, 2005, at the applicable redemption price plus all
accrued dividends as of the redemption date.
Cumulative dividends accrue on both Series A and B Preferred Stock at the rate
of 8% per annum from the date of original issue and are payable semi-annually on
June 30 and December 31 of each year out of funds legally available for the
payment of dividends. Dividends are payable in cash or common stock at the
election of the Company. If paid in common stock, the number of shares issued
will be based on the average of the closing bid prices for the common stock over
the five trading days immediately prior to the dividend payment date. If the
Company fails to pay any dividend within 60 days of its due date, the conversion
price (see below) is adjusted downward by $0.25 per share for each occurrence.
During the years ended December 31, 2002 and 2001, the Company declared
dividends aggregating $749,725 and $738,957, respectively, and to satisfy
payment obligations, issued a total of 574,635 and 504,884 shares of common
stock, respectively. As of December 31, 2002, the Company had accrued dividends
payable in the amount of $377,688. In February 2003, the Company settled the
dividend payable by issuing 199,951 shares of common stock.
The Series A and B Preferred Stock have no voting rights, except as required by
the General Corporation Laws of Delaware that require class votes on certain
corporate matters and matters affecting the rights of the holders of the
Preferred Stock. The Preferred Stock is senior in right of payment in the event
of liquidation and with respect to dividends to the common stock and all other
subsequent preferred stock issuances that may be authorized. The Series A
Preferred Stock has a liquidation preference of $2.00 per share and the Series B
Preferred Stock has a liquidation preference of $10.00 per share.
Issuances of Common Stock: During January 2002 the Company issued 17,998 shares
of common stock in connection with the issuance of $179,998 of promissory notes,
--------------------------------------------------------------------------------
(Continued)
F-22
BUYERS UNITED, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
--------------------------------------------------------------------------------
at an aggregated fair market value of $18,798. During 2001, the Company issued
113,300 shares of common stock to four employees in payment of services
rendered, at an aggregated fair market value of $77,100.
During February 2002 the Company issued 25,000 shares of stock to one of its
directors for providing a credit guaranty with respect to business expansion
activities. The Company also issued 35,500 shares of stock in 2001 for providing
similar guarantees. The fair market values of the 2002 and 2001 share issuances
were, respectively, $30,750 and $27,475.
In March 2001, the Company entered into three-year marketing contracts with one
of its Series B Preferred stockholders. Under the terms of the contracts,
100,000 shares of common stock were issued with a fair market value of $125,000.
This amount was recorded on the balance sheet as a deferred consulting fee and
included in operating expenses on a straight-line basis over the life of the
contracts. During 2001, $39,931 was recorded in promotion expenses as a result
of this amortization. Consideration granted under the contracts' terms also
included options to purchase up to 150,000 additional shares of common stock at
$2.50 per share. These options vest gradually over the term of the contract.
These options are accounted for as variable plan options since the issuance of
these options was under the premise that the grantee will be providing current
and future services for the Company. Accordingly, using the Black-Scholes option
pricing model, $29,581 in consulting expense was recorded to reflect the vesting
of these options through December 31, 2001. During 2002 an additional $48,060 of
deferred consulting fees were amortized and included in promotion expenses, and
another $95,615 in consulting expense was recorded to reflect the vesting of
additional options. However, at the end of 2002 the Company and the stockholder
agreed to cancel one of the marketing contracts and to rescind the as-yet
unearned options. Accordingly, the Company included in promotion expenses an
additional $25,174 of remaining unamortized deferred consulting fees, and
recorded income of $125,197 to reflect the cancellation of the unearned options.
Warrants to Purchase Common Shares: As mentioned above, the Company issued
warrants in connection with its Series B preferred stock offering and in
connection with certain marketing contracts.
In connection with some of the LMB-related unsecured promissory notes, two-year
warrants to purchase a total 562,950 shares of common stock at $2.50 per share
have been issued to the noteholders during the two years ended December 31,
2002. Warrants for an additional 97,950 shares have also been issued to the
sales agents. The estimated fair value of the warrants of $264,717, based on
using the Black-Scholes pricing model, was allocated to the warrants and
recorded as a discount to the carrying value of the notes. The discount is being
amortized to interest expense over the estimated term of the notes.
During 2001, the Company issued 10,000 warrants to purchase common shares at
$2.50 per share to independent sales agents, which were valued at $9,236. In
addition, the Company renegotiated and settled certain terms of an outside
consulting contract entered into during 2000. Under the terms of the settlement,
--------------------------------------------------------------------------------
(Continued)
F-23
BUYERS UNITED, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
--------------------------------------------------------------------------------
the Company modified the exercise price from $5.00 per share to $2.50 per share
on 50,000 warrants outstanding and issued an additional 15,000 warrants with an
exercise price of $2.50 per share. In connection with the settlement the Company
recognized $15,696 in expense.
All of the warrants were exercisable at December 31, 2002. The following tables
summarize the warrant activity for 2002 and 2001:
Weighted
Average
Price Exercise
Warrants Range Price
---------- ------------- --------
Balance at December 31, 2000 4,601,382 $1.25 - $5.13 $2.44
Cancelled or expired (268,000) $2.00 - $5.00 $2.60
Issued 1,012,350 $2.50 $2.50
----------
Balance at December 31, 2001 5,345,732 $1.25 - $5.13 $2.44
Cancelled or expired (250,000) $2.50 - $2.85 $2.64
Issued 433,550 $2.00 - $2.50 $2.01
----------
Balance at December 31, 2002 5,529,282 $1.25 - $2.95 $2.00
==========
Long-Term Stock Incentive Plan: Effective March 11, 1999, the Company
established the Buyers United International, Inc. Long-Term Stock Incentive Plan
("the Stock Plan"). The Stock Plan provides for a maximum of 1,200,000 shares of
common stock of the Company to be awarded to participants and their
beneficiaries. A Committee, as determined by the Board of Directors, determines
and designates the eligible participants and awards to be granted under the
Stock Plan. The Committee may grant incentive stock options; non-qualified
options; stock appreciation rights ("SAR"); and on a limited basis, stock
awards. The terms and exercise prices of options and SARs will be established by
the Committee; except that the exercise prices cannot be less than 100 percent
of the fair market value of a share of common stock on the date of grant. As of
December 31, 2002, incentive stock options to purchase a total of 1,194,153
shares of common stock had been granted under this particular plan, and of that
amount, options for 615,347 shares were still outstanding.
--------------------------------------------------------------------------------
(Continued)
F-24
BUYERS UNITED, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
--------------------------------------------------------------------------------
Stock Options: The Company's Board of Directors has from time to time authorized
the grant of stock options to directors, officers, key employees, and
consultants as compensation and in connection with obtaining financing. The
following tables summarize the option activity for 2002 and 2001:
Weighted
Average
Price Exercise
Warrants Range Price
---------- ------------- --------
Balance at December 31, 2000 3,053,019 $2.00 - $9.00 $2.66
Granted 562,501 $2.50 - $3.50 $2.50
Cancelled or expired (796,935) $2.00 - $5.00 $2.41
----------
Balance at December 31, 2001 2,818,585 $2.00 - $9.00 $2.69
Granted 902,913 $2.00 - $2.50 $2.31
Cancelled or expired (128,777) $2.00 - $9.00 $3.11
----------
Balance at December 31, 2002 3,592,721 $2.00 - $5.39 $2.58
==========
A summary of the options outstanding and options exercisable at December 31,
2002 is as follows:
Options
Options Outstanding Exercisable
--------------------------------------------------- -----------------------
Average Weighted Options Weighted
Range of Remaining Average Exercisable at Average
Exercise Options Contractual Exercise December 31, Exercise
Prices Outstanding Life Price 2002 Price
------------- ----------- ----------- -------- -------------- --------
$2.00 - $3.99 3,352,620 3.2 years $ 2.41 2,896,620 $ 2.41
$4.00 - $5.39 240,101 2.8 years 5.05 240,101 5.05
----------- --------------
3,592,721 3.2 years $ 2.58 3,136,721 $ 2.61
=========== ==============
NOTE 9 - RELATED PARTY TRANSACTIONS
During 2002 and 2001, certain board members and stockholders performed various
services to the Company. These services included, but were not limited to,
consulting, marketing and capital and debt raising activities. The Company
incurred $109,259 and $167,000 in fees associated with these services for the
years ended December 31, 2002 and 2001, respectively. Amounts outstanding
related to these services were $14,300 and $31,300 at December 31, 2002, and
2001, respectively.
--------------------------------------------------------------------------------
(Continued)
F-25
BUYERS UNITED, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
--------------------------------------------------------------------------------
NOTE 10 - MAJOR SUPPLIERS
Approximately 97% and 84% of the Company's cost of revenue for the years ended
December 31, 2002 and 2001, respectively, was generated from three
telecommunication providers. As of December 31, 2002, the Company owed
$2,748,426 to these providers. The Company has entered into contractual
agreements with these vendors. During 2002 two of these providers had filed for
bankruptcy protection under Chapter 11, and the other provider is currently
being scrutinized by the Securities and Exchange Commission over certain
accounting matters. Although the Company had not experienced a disruption of
service and feels it could replace any one of these sources with other wholesale
telecommunication service providers, the effect on the Company's operations of
potentially losing any one or all three of these service providers is unknown.
NOTE 11 - COMMITMENTS AND CONTINGENCIES
On June 14, 2001, a lawsuit was filed against Buyers United by Profitec, Inc.,
in New Haven, Connecticut. Profitec asserted that it agreed to perform certain
billing services in 1999 for the Company's telecommunication customers and that
the Company agreed to pay Profitec for such services. Profitec further claimed
that Buyers United breached the contract by terminating the contract and failing
to pay fees allocable under a "liquidated damage" provision for early
termination. Profitec claimed damages in excess of $140,000, based upon the
contract's liquidated damage provisions. The Company filed a general denial
answer and asserted affirmative defenses, including breach of contract, failure
of consideration, and other issues. It also filed a counter claim seeking
damages for Profitec's breach of the contract. In November 2001, Profitec
answered and denied the counter-claim. An out-of-court settlement was reached on
October 17, 2002 in which the Company agreed to pay $17,500.
In June 2001, Buyers United entered into a joint sales agreement with Infotopia,
Inc., a direct response marketer. In connection with the agreement, Infotopia
loaned $500,000 to Buyers United. Subsequent to entering into the sales
agreement, the two companies decided not to pursue further any joint activity.
In December 2001, Buyers United negotiated a settlement of the $500,000 loan in
which Buyers United paid $120,000 and issued 35,000 shares of common stock in
exchange for canceling the outstanding obligation plus $25,921 in accrued
interest. The stock had a fair market value of $22,401. Accordingly, based on
these amounts, the Company recorded an extraordinary gain on the early
extinguishments of the debt in the amount of $383,520. However, unbeknownst to
Buyers United, during 2001 Infotopia allegedly entered into a General Security
Agreement with Sea Spray Holdings, Ltd., which purportedly included the loan
obligation. By letter dated November 22, 2002, Sea Spray asserted that it had a
perfected security interest in the obligation and demanded payment as
successor-in-interest to Infotopia. The Company responded that Sea Spray did not
have a perfected security interest since it did not take possession of the note
evidencing the obligation, and that the obligation was fully discharged under
--------------------------------------------------------------------------------
(Continued)
F-26
BUYERS UNITED, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
--------------------------------------------------------------------------------
applicable provisions of the Uniform Commercial Code. On February 21, 2003
Buyers United filed with the American Arbitration Association a Demand for
Arbitration and Statement of Claim in order to resolve the dispute. On March 11,
2003 Sea Spray filed an action against Buyers United in the Supreme Court for
the State of New York, County of New York, case number 104468/03, seeking to
enforce its security interest in the Infotopia note obligation through
collection of the Note, and obtained an order to show cause why the arbitration
proceeding we instigated should not be stayed in favor of resolving the dispute
in the state court proceeding. Before the stay issue was heard by the state
court, Buyers United removed the entire action to the Federal District Court,
Southern District of New York, and it intends to file a motion to dismiss the
action in favor of proceeding with arbitration in Utah. The Company intends to
defend this claim vigorously, but cannot predict at this time how the dispute
will eventually resolve.
On March 20, 2002, a shareholder filed a civil lawsuit in Salt Lake County
alleging that in mid-2000 Buyers United had offered to sell him 150,000 shares
in the corporation for $300,000, and that it represented it had received certain
funds for promotion. The shareholder alleged that no such funds were available,
that consequently the value of his shares were reduced, and that he was seeking
rescission of the stock purchase. The Company filed an answer to the complaint
denying the allegations and raising various affirmative defenses. The
shareholder was then to initiate dates for discovery and other procedures, but
so far has failed to do so and has not otherwise made certain mandatory
disclosures under Utah law. Buyers United categorically denies the shareholder's
allegations, denies making misrepresentations of any kind, and asserts the
shareholder's claims are baseless. Furthermore, it believes that regardless of
any such alleged claims, the shareholder has suffered no actual damages, and
intends to vigorously defend the case in the event the shareholder resumes the
discovery process.
Buyers United is the subject of certain other legal matters, which it considers
incidental to its business activities. It is the opinion of management, after
discussion with legal counsel, that the ultimate disposition of these other
matters will not have a material impact on the financial position, liquidity or
results of operations of Buyers United.
NOTE 12 - SUBSEQUENT EVENTS
In January and February 2003, the Company received $500,000 from the issuance of
promissory notes payable, $400,000 of which came from three Directors of the
Company. The unsecured notes bear interest at 12% and are due in 2004 through
early 2005.
On February 28, 2003, the Company retired its $1,050,000 note payable by paying
$250,000 in cash, issuing a new promissory note for $800,000, and issuing 50,000
shares of common stock in connection with the original agreement. The new note
is unsecured and bears interest at 10%, payable monthly. Principal payments are
to be made in a manner similar to the Company's other promissory notes related
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(Continued)
F-27
BUYERS UNITED, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
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to customers referred to the Company by LowerMyBills, Inc. In this case, monthly
principal payments will equal 20% of specifically-designated customers' billings
collected during the preceding calendar month.
On January 15, 2003, the Company issued 15,000 shares of stock to one of its
directors for providing a credit guaranty to one of its wholesale
telecommunication service providers. The fair market value of the stock was
$36,300.
F-28
Board of Directors and Executive Officers Independent Public Accountants
Theodore Stern Crowe Chizek and Company LLC
Chairman of the Board Oak Brook, Illinois
Chief Executive Officer
Gary Smith Corporate Counsel
Director
Business Consultant Cohne, Rappaport & Segal
Salt Lake City, Utah
Edward Dallin Bagley
Director
Business Consultant Transfer Agent
Steve Barnett Atlas Stock Transfer Company
Director Salt Lake City, Utah
Business Consultant
Paul Jarman Business Office
President
14870 Pony Express Road
Kenneth Krogue Bluffdale, Utah 84065
Chief Operating Officer (801) 320-3300
G. Douglas Smith
Executive Vice President
--------------------------------------------
Upon written consent we will furnish to our
stockholders without charge a copy of our report on
Form 10-KSB for the year ended December 31, 2002 as
filed with the Securities and Exchange Commission.
Requests should be directed to:
Kimm Partridge
Corporate Secretary
Buyers United, Inc.
14870 Pony Express Road
Bluffdale, Utah 84065
Our corporate website is http://www.buyersonline.com.
We make available on this website, free of charge,
access to our Annual Report on Form 10-KSB, Quarterly
Reports on Form 10-QSB, Current Reports on Form 8-K,
Proxy Statement on Schedule 14A and amendments to those
materials filed or furnished pursuant to Section 13(a)
or 15(d) of the Securities and Exchange Act of 1934 as
soon as reasonably practicable after we electronically
submit such material to the Securities Exchange Commis-
sion. In addition, the Commission's website is
http://www.sec.gov. The Commission makes available
on its website, free of charge, reports, proxy and
information statements, and other information
regarding issuers, such as us, that file
electronically with the Commission.