-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, FuOf4ziRyJnJOb0f3Gm3HVNU4CYF5kNJasaW2O4sJGaU67y58nhsJKrebPbk05Cg jiKRchctW23gQ9YQjolUhw== 0000950144-00-004484.txt : 20000404 0000950144-00-004484.hdr.sgml : 20000404 ACCESSION NUMBER: 0000950144-00-004484 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000403 FILER: COMPANY DATA: COMPANY CONFORMED NAME: EMERGE INTERACTIVE INC CENTRAL INDEX KEY: 0001092605 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-BUSINESS SERVICES, NEC [7389] IRS NUMBER: 650534535 FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-29037 FILM NUMBER: 592621 BUSINESS ADDRESS: STREET 1: 10315 102ND TERRACE CITY: SEBASTIAN STATE: FL ZIP: 32958 BUSINESS PHONE: 5615897331 MAIL ADDRESS: STREET 1: 10315 102ND TERRACE CITY: SEBASTIAN STATE: FL ZIP: 32958 10-K405 1 EMERGE INTERACTIVE, INC. 1 =============================================================================== SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------------- FORM 10-K (Mark One) [X] Annual Report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 [No fee required] for the fiscal year ended December 31, 1999. [ ] Transition Report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 [No fee required] for the transition period from to Commission File Number: 000-2903-7 eMerge Interactive, Inc.. (Exact name of registrant as specified in its charter) Delaware 65-0534535 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 10315 102nd Terrace Sebastian, Florida 32958 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (561) 589-7331 Securities registered pursuant to Section 12(b) of the Act: Title of Each Class: Name of Each Exchange on which None. Registered: None. Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $.008 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days: YES [_] NO [X] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The approximate aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $746.1 million as of March 17, 2000, based upon the closing sale price per share of the common stock, as quoted on the Nasdaq National Market, excluding 17,959,515 shares of common stock held by directors, officers and stockholders with representatives on the board of directors whose ownership exceeds five percent of the common stock outstanding at March 17, 2000. Exclusion of shares held by any person should not be construed to indicate that such person possesses the power, direct or indirect, to direct or cause the direction of the management or policies of the registrant, or that such person is controlled by or under common control with the registrant. The number of shares of the registrant's common stock outstanding as of March 17, 2000 was 33,031,395. Documents incorporated by reference: Portions of eMerge Interactive, Inc. proxy statement for its 2000 Annual Meeting of Stockholders to be filed within 120 days after the end of the year covered by this Form 10-K Report are incorporated by reference into Part III of this Form 10-K. =============================================================================== 2 eMerge Interactive, Inc. FORM 10-K ANNUAL REPORT (For Fiscal Year Ended December 31, 1999) TABLE OF CONTENTS
Page ---- Part I Item 1. Business............................................................................. 4 Item 2. Properties........................................................................... 17 Item 3. Legal Proceedings.................................................................... 17 Item 4. Submission Of Matters To A Vote Of Security Holders.................................. 18 Part II Item 5. Market For Registrant's Common Equity And Related Stockholder Matters................ 18 Item 6. Selected Financial Data.............................................................. 20 Item 7. Management's Discussion And Analysis Of Financial Condition And Results Of Operations........................................................................... 21 Item 7A. Quantitative And Qualitative Disclosure About Market Risk............................ 36 Item 8. Financial Statements And Supplementary Data.......................................... 36 Item 9. Changes In And Disagreements With Accountants On Accounting And Financial Disclosure........................................................................... 36 Part III Item 10. Directors And Executive Officers Of The Registrant................................... 36 Item 11. Executive Compensation............................................................... 36 Item 12. Security Ownership Of Certain Beneficial Owners And Management....................... 36 Item 13. Certain Relationships And Related Transactions....................................... 36 Part IV Item 14. Exhibits, Financial Statement Schedules And Reports On Form 8-K...................... 37
2 3 This Report contains, in addition to historical information, forward-looking statements that involve risks and uncertainties. These forward-looking statements include statements regarding, among other things, electronic commerce strategy, acquisition and expansion strategy, development of services, use of proceeds, projected capital expenditures, the sufficiency of our liquidity and capital, development of additional revenue sources, market acceptance of the Internet, expansion into new market segments, technological advancement, ability to develop "brand" awareness and global expansion. Such statements are based on management's current expectations and are subject to a number of uncertainties and risks that could cause actual results to differ significantly from those described in the forward-looking statements. Factors that may cause such a difference include, but are not limited to, those discussed in "Management's Discussion and Analysis of Financial Condition and Results of Operations," as well as those discussed elsewhere in this Report. Our subsidiaries include STS Agriventures, Ltd. ("STS"), a Canadian corporation and Cyberstockyard, Inc. ("Cyberstockyard"). 3 4 PART I ITEM 1. BUSINESS ITEM 1(A). GENERAL DEVELOPMENT OF THE BUSINESS COMPANY OVERVIEW We are a business-to-business electronic commerce company combining content, community and transaction services to create an online marketplace for the cattle industry. We offer our products and services to cattle industry participants through our family of integrated Web sites, our proprietary information management application and our direct sales force. Our products and services are designed to create an efficient market for the purchase and sale of cattle and to improve quality and productivity in the cattle industry. Our current products and services include: - Livestock procurement services consisting of cattle sales and auctions; - Daily performance analyses of a customer's feedlot operations; - Comparative cattle industry analysis and feedlot operations benchmarking studies; - Cattle inventory management tools; and - Livestock health management and quality enhancement products. THE ONLINE LIVESTOCK OPPORTUNITY We believe that the production chain of the cattle industry, which includes cattle producers, feedlots, packers and suppliers, contains inefficiencies that reduce animal health and value. These inefficiencies, which include excessive animal transportation and handling, result in additional transaction costs and reduced beef quality. Further, we believe that inadequate access to current and accurate data and a lack of integrated information management tools have limited the ability of industry participants to optimize their operating results and performance. Due to its functionality, scalability and accessibility, the Internet is emerging as a single destination for commerce and information related to the livestock industry. Many of the variables that affect beef quality and cattle performance can be addressed by using the Internet's open architecture, universal accessibility and ability to provide more timely and comprehensive information. We believe the Internet can create a more efficient marketplace for the exchange of cattle by directly connecting buyers and sellers and providing information related to the cattle for sale. A report by the National Association of Farm Broadcasters showed that as of February 1999, 45.5% of producers and 53.4% of feedlots used a personal computer for farm business, and 19.7% of producers and 29.1% of feedlots accessed Web sites for farm-related topics. According to a Gallup and Agricultural Publisher's Survey, it is estimated that by 2001 over 55% of large producers in the beef industry will use the Internet for primary information in the conduct of their daily business. According to Forrester Research, business-to-business electronic commerce in the United States is expected to grow from $43.0 billion in 1998 to $1.3 trillion in 2003. THE EMERGE INTERACTIVE SOLUTION We offer commerce, information and technology to cattle industry participants. Our complementary products and services are designed to reduce inefficiencies throughout the cattle production chain, improve cattle quality and improve overall productivity in the cattle industry. Our current products and services include the following: 4 5 - Cyberstockyard.com, our online cattle sales and auction services Web site, allows our customers to participate in our live cattle sales and auctions, thereby providing efficient and effective access to an inventory of cattle by directly connecting buyers and sellers of cattle. We believe a less fragmented market for cattle sales may reduce the excessive handling of cattle that results from transportation and commingling during transactions, thereby reducing animal stress, which can lead to improved cattle quality. In addition, by reducing the need for multiple transactions, we seek to lower overall transaction costs associated with cattle sales. - The Feedlot Information System, our cattle information management product, is designed to assist in the effective daily management of our customers' cattle operations. Using our proprietary information management application, subscribing feedlot customers transmit raw operating data to us on a daily basis over the Internet. We then use each subscribing customer's raw data to compile customer-specific information and performance data and analyses, such as feed consumption data, feed-to-gain ratios and a comprehensive summary of health results, which we disseminate daily to that customer over the Internet. - PCC-online.com, our Professional Cattle Consultants service, is designed to provide our customers with national, regional and customer-specific industry analysis services that are derived from our proprietary centralized database of cattle industry information. This information has been compiled from over 90 different feedlots over the last 26 years. These services include feed performance benchmarking services and monthly market analysis that we provide to subscribing customers on a periodic basis. PCC-online.com enables our feedlot customers to compare the performance of their feedlot to the average performance of other feedlots in our database. - NutriCharge, our therapeutic product for livestock, is a restorative feed supplement designed to reduce the effects of stress on the animals caused by transportation, handling and commingling. We sell our NutriCharge product over our Web sites and through our direct sales force. Our customers can access our family of integrated Web sites through our platform site, CattleInfoNet.com. This industry-specific Web site features general industry information, such as current industry news, links to commodities pricing and weather updates, as well as personalized information based upon customers' individual preferences and geographic location. CattleInfoNet.com also provides customers with an online community to facilitate the exchange of information among livestock producers, feedlots and packers and to provide access to our in-house cattle industry experts. We were incorporated in 1994 as a subsidiary of XL Vision, Inc. to develop and commercialize infrared technology applications. XL Vision is a private company that provides strategic, technical and business support to create technology companies. Our initial focus was on the transportation market in which we sold our navigational infrared imaging system, the AMIRIS system. The AMIRIS system uses infrared technology to create an image based on small differences in the temperatures of the objects being viewed, such as an iceberg in water. In 1997, we expanded our infrared applications to the animal sciences industry with the development of an equine imaging system to detect health problems. The equine imaging system enables veterinarians to visualize small differences in the surface temperature of horses, and therefore identify heat, a common sign of inflammation associated with injury at early stages. To expand our product base, in July 1998, we licensed a portfolio of patents from a division of the Canadian government relating to the application of infrared technology to the animal science field and a restorative feed supplement called NutriCharge. Under this agreement, we will begin paying royalties based on a percentage of sales beginning on July 29, 2000. In order to focus on the cattle industry, we discontinued production of the AMIRIS system. In January 1999, we entered into a license agreement with 5 6 Sperry Marine, Inc., a subsidiary of Litton Industries, Inc., which granted them the right to become the sole producer of the AMIRIS system. In connection with this license, we will receive a royalty of 8% of sales of the AMIRIS system up to a maximum royalty of $4.3 million over a four-year period or up to a maximum royalty of $5.0 million if $4.3 million is not received within four years. Upon receipt of the maximum amount, we will transfer all rights, title and interest to the licensed intellectual property to Sperry. To date, we have not received any royalties from this license. Results from this line of business and the related loss on disposal have been segregated from continuing operations and included in discontinued operations in our financial statements. In February 1999, we purchased substantially all of the assets of CIN, LLC, a company which collected, analyzed and distributed information for use in animal food sciences markets, for an aggregate purchase price of approximately $2.3 million. The purchase price consisted of 750,000 shares of our class A common stock valued at $720,000, the assumption of $812,000 of liabilities, a cash payment of $358,000, an agreement to pay the first $350,000 from Internet sales of third-party products over the Web site and transaction costs of $57,000. In March 1999, we purchased all of the outstanding stock of Cyberstockyard, Inc., a company selling cattle and other products through auction software over the Internet for approximately $542,000. The purchase price consisted of 250,000 shares of our class A common stock valued at $450,000, the assumption of $90,000 of liabilities and transaction costs of $2,000. In May 1999, we purchased substantially all of the assets of Professional Cattle Consultants, L.L.C. for an aggregate purchase price of approximately $1.8 million. The purchase price consisted of $1.8 million of cash, the assumption of $3,000 of liabilities and transaction costs of $25,000. The primary asset of Professional Cattle Consultants, L.L.C. was a proprietary database of cattle and market information and analysis. For the past 26 years, Professional Cattle Consultants, L.L.C. has collected a variety of performance and other data from its subscribers' feedlot operations and provided subscribers with periodic analyses of certain performance characteristics of their feedlot operations and comparative analysis related to the performance of feedlots within their regions. In August 1999, we entered into an agreement to acquire 19% of the common stock of Turnkey Computer Systems, Inc., a provider of administrative/accounting legacy systems to feedlots, for an aggregate purchase price of $1.8 million. The purchase price consisted of 62,500 shares of our class A common stock, which is subject to redemption, $1.4 million of cash and $23,000 of transaction costs. In connection with this investment, we obtained the exclusive right to provide cattle sales and auction services and feed sales services to customers of Turnkey through Turnkey's system. This right will expire in August 2019. If we reach a specified level of revenue per feedlot and that feedlot is a customer of Turnkey, we will pay a fee to Turnkey. ITEM 1(B). FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS Information for the Company's two operating segments for the three year period ended December 31, 1999, is contained in Note 11 to the Consolidated Financial Statements on page F-23. ITEM 1(C). NARRATIVE DESCRIPTION OF BUSINESS INDUSTRY BACKGROUND BEEF INDUSTRY According to the National Cattlemen's Beef Association, or NCBA, the cattle industry is the largest single segment of the American agricultural economy. The U.S. Department of Agriculture reports that sales of cattle accounted for approximately $34 billion in 1998. On an annual basis, the U.S. beef production industry spends over $6 billion for feed and, based on our estimates, approximately $600 million for medication. At the retail level, the cattle industry generates over $51 billion in sales of beef. Furthermore, the NCBA estimates that worldwide cattle production is three times greater than U.S. production. INDUSTRY PARTICIPANTS The U.S. beef production chain can be classified into three primary segments: producers, feedlots, and packers. 6 7 PRODUCERS According to the NCBA, there are approximately one million producers comprised of ranchers and small farm owners who breed and raise cattle. Most of the producers are independently owned and are dispersed throughout the United States. Each year these producers market approximately 35 million head of cattle that are eventually harvested for food, of which approximately 27 million are processed through feedlots. These cattle, raised for 12-18 months in an average herd size of approximately 35 head, are often located in different geographic regions, aggregated into larger herds and then sold to centralized feedlots to increase their weight and value. FEEDLOTS Feedlots typically purchase cattle weighing 300 to 900 pounds and manage the health and growth of the cattle for a period of 110 to 250 days. We estimate that during this time, each animal is fed on average 20-30 lbs. of grain per day. There are approximately 700 major feedlot operations concentrated in 10 Midwestern states. These feedlots can manage from 4,000 to 115,000 head of cattle at any given time. After reaching a weight of approximately 900 to 1,400 pounds, the animal is typically sold to a packer for harvesting. PACKERS Packers usually hold the cattle for 2 to 24 hours before harvesting and fabricating them for sale and eventual consumption. In addition to processing beef, packers inspect beef for cleanliness in preparation for quality grading. There are currently 64 major beef packing operations in the United States, which in total process approximately 35 million head of cattle into roughly 25 billion pounds of beef annually. Approximately 82% of the beef processed in the United States is processed by beef packing operations owned by IBP, Inc., Cargill, ConAgra, Inc., and Farmland Industries, Inc LIMITATIONS OF THE CURRENT SYSTEM The current cattle production chain contains a number of inefficiencies that reduce livestock quality and increase cost. These inefficiencies include multiple transaction costs, exposure to stress and disease, and the loss of important feeding and medication information. INEFFICIENCIES IN THE CATTLE SALES PROCESS CREATE TRANSACTION COSTS As cattle move through the beef production chain, from an individual producer's ranch to a feedlot to a meat packing facility, the cattle may be bought, sold and transported three or four times. Due to the highly fragmented nature of the cattle producer segment, the majority of cattle are sold through traditional livestock sales and auctions, which bring together regional buyers and sellers. The cattle are then sold either directly to feedlots or sold once again to larger buyers and then onto feedlots. Typically, cattle sales and auctions are hosted at sale barns, where livestock brokers act as agents in the buying and selling of animals. The livestock broker is paid a fee or commission each time an individual lot of cattle is bought or sold. As a result of the geographic dispersion of producers and sale barns, buyers often purchase cattle from livestock brokers without having the opportunity to visually survey the cattle. In addition, this current method of exchange does not facilitate easy access to real-time price information or a geographically broad marketplace for the product. REPETITIVE TRANSPORTATION CREATES ANIMAL STRESS, REDUCING BEEF QUALITY AND PROFITABILITY The combination of the method of exchange used in traditional cattle sales and auctions and the fragmentation of the producer segment of the industry results in the repetitive transportation and handling of cattle. As cattle are moved from one environment to another throughout the production chain, they are commingled multiple times and can be exposed to contagious diseases. In addition, the transportation, handling and commingling of cattle often results in a predictable stress response, which 7 8 may cause significant health deterioration. However, because there is currently no convenient or cost-effective method available to measure an animal's stress level, stress is not assessed today as a meaningful measure of health. Stress and exposure to disease often result in sub-optimal performance at the feedlot and reduced beef quality. A study conducted by researchers at Texas A&M University estimated that sick animals yield approximately $80 per head less than comparable healthy animals, which represents a significant loss based on the average value cited by the U.S. Department of Agriculture of $600 per head. THE LACK OF CURRENT AND ACCURATE INFORMATION IMPACTS ANIMAL PERFORMANCE We believe that industry participants generally collect and analyze information on cattle that go through the beef production process inconsistently and in a manual and time-consuming manner. Due to the nature of data collection and dissemination, cattle industry participants are unable to exchange critical information in an efficient and timely manner to optimize performance and beef quality. We believe that businesses in the cattle industry have not maximized the use of information to effectively address health, quality and performance issues. PRODUCERS Cattle producers typically do not receive data related to the weight of their animals upon arrival to and departure from feedlots or the quality grades of their animals, making herd management difficult. Animal-specific health and medication information is generally not passed on to subsequent buyers at or prior to the feedlot, which may result in unnecessary additional medication. FEEDLOTS Feedlots are the primary source of information currently used in livestock management. As a general practice, information is collected manually on a daily basis and subsequently entered into multiple information systems that are typically not integrated. Given the time-intensive nature of aggregating data under the current process, it is difficult to collect, analyze and interpret this data in a meaningful way. Historically, feedlots collect and share industry-wide information for benchmarking and performance purposes by submitting reports to data warehouse services that aggregate and disseminate the combined results in monthly reports. Although these data warehouse services are valuable as general strategic and analytical tools, because of the delay in disseminating the information, they are less effective for daily cattle management decisions, such as decisions relating to feed and medication. PACKERS Packers, at the end of the cattle production chain, collect critical carcass and quality information such as weight, dimension, yield and meat quality grade after the animal is harvested. However, in 1997, only 47.5% of cattle harvested were purchased based on these measures. Therefore, feedlots receive carcass and quality data on less than half of harvested cattle. The remaining harvested cattle are sold to packers based strictly on live weight, and consequently very little health and quality data is provided to feedlots or producers on these cattle. We believe improved information flow between and within the three main groups of industry participants can significantly enhance product quality. There is currently no network or method for compiling and communicating information rapidly throughout all stages of the cattle production chain. Product performance information gathered by packers and feedlots will help refine and improve handling practices earlier in the production chain. Information relating to an animal's medical history will minimize redundant medication. In addition, we believe that information about an animal's genealogy disseminated by producers and feedlots will enable more accurate differentiation among breeds of cattle at the packer level and a more easily implemented quality branding strategy at the retail level. Finally, information linking handling, feeding and medication techniques and the ensuing performance results, gathered and disseminated on a daily basis by feedlots, can help the entire segment rapidly adopt best practices. 8 9 OUR PRODUCTS AND SERVICES Our products and services can be accessed through our integrated Web sites. These sites include: - CattleInfoNet.com, the platform from which our customers can access our comprehensive product and services offerings; - Cyberstockyard.com, our online cattle sales and auction site; and - PCC-online.com, our cattle industry-specific information Web site. In addition, through our Feedlot Information System, we provide our feedlot customers with daily analyses of their feedlot operations as well as information management products and services. THE EMERGE MARKETPLACE CATTLEINFONET.COM - Industry news - Regional weather - Links to commodity pricing - Expert corner 9 10 - Reports online - Links to industry information ONLINE MARKETPLACE MANAGEMENT INFORMATION SOLUTIONS Cyberstockyard.com Feedlot Information System - - Cattle sales - Feedlot specific content - - Cattle auctions - Daily performance data - - Order fulfillment - Web-enabled with graphical user interface - Analytical services eMerge Online Store - - eMerge branded products Professional Cattle Consultants - Regional feedlot benchmarking data Specialized Database Services CATTLEINFONET.COM CattleInfoNet.com is our industry-specific Web site that serves as the platform from which participants in the cattle industry can access our comprehensive product and service offerings. This site features content to facilitate cattle management, including industry news, weather and links to commodities pricing. Also, through this site, our customers can access Cyberstockyard.com to purchase or sell cattle, and PCC-online.com, our information resource and database. In addition, our customers can use this Web site to purchase our NutriCharge product. ONLINE MARKETPLACE Cyberstockyard.com is our cattle sales and auction service Web site. Through Cyberstockyard.com, our customers utilize our online listing of cattle to obtain access to inventory and market pricing from various buyers and sellers located throughout the United States in an efficient and effective manner. In addition, our customers can access scheduled online video cattle auctions. We transmit inventory lists with detailed product descriptions to our customers by both e-mail and facsimile and periodically post schedules for live video auctions on the Web site. CATTLE SALES We have developed a detailed posting and transaction process to ensure that adequate information is provided to the purchaser prior to the transaction. We verify the identity of a purchaser through use of a secure password system and verify credit-worthiness of each participant prior to enabling access to our system. Our expert livestock brokers in the field certify all cattle offered for sale through Cyberstockyard.com. We provide a detailed description of each lot of cattle, which can be accessed by a purchaser online. We update our inventory of cattle for sale daily and customers can review our full inventory listings. In addition, customers can post descriptions, quantity and pricing criteria for cattle they would like to purchase and our system will automatically search for a match. If a match is found, the customer is notified immediately online. If no match is found, the customer can choose to have our system perform a daily search for a match as new inventory is added to our system. Notification of a match is sent to the customer by email or facsimile. Our livestock brokers and online producers also have access to these postings and may respond with potential matches. After identifying particular cattle to purchase, our customers complete the transaction through e-mail or the telephone. Once cattle have been purchased, we manage the shipment logistics through our sales and customer service organization. 10 11 CATTLE AUCTIONS In addition to our online cattle sales, we offer cattle for sale through our online video auctions. Although not necessary to facilitate cattle sales transactions, video is available to customers who have installed our satellite dish system. We offer a mock auction to help our customers get acquainted with the auction process. We have developed a system that allows participants to automatically bid in set increments up to a predetermined limit. Once a bid is accepted, the purchaser is notified online. Our customer service team then follows-up by telephone and e-mail with specific shipment logistics regarding the cattle. We believe that because online procurement results in fewer cattle shipments and less handling, transaction costs are reduced and animals arrive at their destination healthier and less stressed, thereby increasing the value of the animals. We also believe that online cattle procurement creates a medium for obtaining access to market pricing from various buyers and sellers located throughout the United States. We believe that this may eventually reduce the amount of commission fees paid by the cattle industry as a whole, and thereby reduce the cost to produce cattle. Through this comprehensive online marketplace, we also have the ability to sell products and services that are designed to improve productivity within the livestock industry. We currently offer NutriCharge through our online marketplace to help our customers reduce the effects of pre-harvest stress in their cattle. MANAGEMENT INFORMATION SOLUTIONS THE FEEDLOT INFORMATION SYSTEM The Feedlot Information System provides feedlot customers daily information services. This secure proprietary information management application resides on our customers' operating systems and interfaces with our centralized database over the Internet. Our system integrates information contained in their disparate legacy systems into our database daily to create relevant customer-specific analyses and graphical presentations. Customers' information is automatically integrated into our database, analyzed and available for use on the following day. The analyses created include information and performance data designed to assist in the effective daily management of a feedlot business. These analyses include: - Feed consumption data; - Feed-to-gain ratios; and - A comprehensive summary of health results. The Feedlot Information System also enables our customers to compare their performance against other regional and national feedlot data and provides useful proprietary content for business management decisions. Our customers can use our system to manage their feedlot operations on a real-time basis using numerous performance variables and individual parameters. Customers can also access data and product performance results posted by practicing veterinarians to further refine their business practices. All of our Internet applications are easily accessible from our Feedlot Information System. In addition, our staff provides valuable analysis and interpretation of the information contained in the database. PROFESSIONAL CATTLE CONSULTANTS Through PCC-online.com, our Professional Cattle Consultants service, we provide our customers access to services that are based on our confidential and proprietary database of cattle industry information. This database has been compiled over the last 26 years from over 90 different feedlots representing over 20% of the total cattle processed annually through U.S. feedlots. As part of their subscription, our customers submit information to our analysts twice per month to update our database. Each month these customers receive our Cattle Gram, a marketing report that analyzes and reports cattle market related information, and our newsletter, a feed performance report containing compiled data relating to over 100 different feed performance parameters. In our newsletter, we provide national, regional and customer-specific analyses. Customers may use a password to view these reports online or receive them via e-mail or mail. 11 12 SPECIALIZED DATABASE SERVICES We offer specialized database management and Internet-based networking services that target specific customer requirements, including individual animal tracking through the entire production chain. We can also provide customized data management and formatting services designed to enable suppliers to better understand product performance in the field. Our analysts are available to assist customers in understanding how to derive the most value from the information being acquired. STRESS MANAGEMENT PRODUCTS AND SERVICES As part of our comprehensive solution, we offer our proprietary NutriCharge restorative feed supplement for sale to our customers through our Web sites and direct sales force. NutriCharge is designed to reduce the effects of stress on the animals caused by transportation, handling and commingling, which can result in a loss of product quality. In addition, we offer educational materials and services to assist our customers to reduce handling of animals and therefore reduce stress. EQUINE IMAGING SYSTEMS We have developed our infrared imaging thermography system and image management software for use in the equine industry. Infrared thermography is a non-invasive diagnostic imaging technique that is used to detect surface temperature differences. The camera is lightweight, portable and has a high degree of resolution and sensitivity. Our infrared camera and software allow a user to download thermal images to the user's computer to be viewed, catalogued, annotated and measured. Our system is used by veterinarians to detect heat, one of the first indicators of inflammation or injury, in horses and exotic animals. 12 13 RESEARCH AND DEVELOPMENT We intend to continue to devote significant time and resources to enhance our current core technology to improve our existing products, expand our product line and enter into other market segments. Approximately $1.1 million during the year ended December 31, 1998 and approximately $4.3 million for the year ended December 31, 1999 were related to research and development. As of December 31, 1999 we had 36 employees dedicated to product development. We intend to continue to invest in research and development and focus on the recruitment of experienced scientists and engineers. Our current research and development activities are primarily focused on the development of information technologies to complement our products and services for the animal sciences industry. We have entered into agreements for the development of technology with a division of the Canadian government as represented by the Minister of Agriculture and Agri-Food Canada. We license patents and technology related to NutriCharge and our Animal Science Tracker infrared camera, which is currently under development. This agreement also gives us and the Canadian government, through the Lacombe Research Centre, the right to collaborate with the other on any project which relates to the license. Any improvements will be owned by the Canadian government and licensed to us on an exclusive basis. Please see the section entitled Intellectual Property for a description of the license. We have entered into a Research Support Agreement with the Canadian government, under which we provide the Lethbridge Research Centre with one of our infrared imaging systems, analytical software, and technical support in exchange for a right of first refusal to license any resulting technology. The Canadian government may terminate this agreement at any time. We have entered into a cooperative research and development agreement with the USDA Agricultural Research Service and Iowa State University of Science and Technology, in which we have been granted exclusive rights and responsibilities for product development and commercialization of technology developed and patented by them for the detection of small, diluted quantities of mammalian fecal matter on animal carcasses. We will provide design and engineering expertise. When commercialized, we believe that this technology may reduce safety inspection and processing costs at packing plants while reducing e-coli contamination risks. The parties to the agreement may only terminate in the event of a breach by another party. In connection with this agreement, we have also entered into an exclusive license agreement with Iowa State University for patent rights relating to the research and development agreement. Under the license agreement, we have the right to make or have made, use, sell, offer to sell and import products using technical data and information owned by the Iowa State University Research Foundation, or ISURF. The license agreement applies to all present and future patents, patent applications and inventions relating to meat and carcass inspection technology. In exchange for the license, we paid a license fee in the amount of $10,000. We will also pay a royalty of six percent of the net sales of any licensed products. If we sublicense the technology, we will also pay ISURF 50% of any fees paid to us by the sublicensees. Currently, there are no licensed products and we have not made any royalty payments to date. The license will expire when the last of the patents covered by the license expire, unless we terminate earlier. SALES AND MARKETING SALES Our sales organization is structured around a direct sales team and an electronic commerce sales team. We have a staff of account managers who are responsible for sales of products and services through our electronic commerce platform to feedlot and packer customers in given geographic territories. We have a staff of cattle buying representatives who, along with independent buyer representatives with whom we have entered into relationships, are responsible for obtaining inventory for livestock sales from producers. We are assembling a dedicated team to increase advertising revenue and to add third party products to our electronic commerce offering. 13 14 MARKETING We seek to establish broad customer awareness of our technologies, products and services within the industries we serve. Our marketing efforts include direct advertising through trade journals and press releases coordinated by our communications and public relations firm. We also participate in professional societies and university programs and have developed strategic marketing relationships with industry professionals and academic institutions. Much of the initial interest in our products and services has been created through the extensive network of relationships we have in the cattle industry as well as through our sales organization. We are developing an international marketing effort to promote our products and services worldwide. OUR CUSTOMERS Our initial customer focus is the 300 largest feedlots in the United States. These feedlots manage 20.1 million head of cattle annually, accounting for 74% of cattle processed through feedlots in the United States. Currently, we sell our products and services to approximately 130 of those feedlots, which account for approximately 30% of the total cattle harvested in the U.S. We also offer our products and services to participants throughout the cattle production chain. CUSTOMER SERVICE Currently our order entry, e-commerce transactions and hardware and software support functions are conducted at our Sebastian, Florida facility. Our current field support organization is based in Meade, Kansas. We have a dedicated toll free number for customer calls, which is staffed from 8:00 a.m. to 8:00 p.m. EST. INFRASTRUCTURE AND TECHNOLOGY INFORMATION SYSTEMS SYSTEM ARCHITECTURE Our Web sites use multiple front-end servers and a master database located at our Sebastian, Florida facility. We have implemented scalable Web site management, search, customer interaction, transaction processing and fulfillment services and systems. Our Web site and extranet provide customization, interactivity and performance required for business-to-business electronic commerce. We utilize applications for: - Accepting and validating customer orders; - Placing and managing orders with suppliers and manufacturers; - Notifying and updating customer order status; and - Management of shipment of products. All data communication between remotely located computers uses secure socket layer, or SSL, encryption technology. This allows the transfer of a local database from a feedlot to our main database which uses a Sun Enterprise 4500 server. DATA COLLECTION The data collection system for our Feedlot Information System gathers information from the accounting, feedbunk and hospital systems at the feedlot. This information is compared to a local database, and the changes and additions are encrypted and transmitted securely to our main database storage along with any orders that are being processed in the off-line batch mode. Once received, we add the data to our master database for statistical analysis and generate reports for individual site locations. The results are encrypted and sent back to the individual feedlots. All confirmations of placed orders are sent back to the feedlot that generated the order. Professional Cattle Consultants data is collected on a monthly basis using a variety of interfaces with feedlot software vendors. Data is transmitted electronically or by hard copy. This information is then imported into the Professional Cattle Consultants architecture where it is stored and utilized as necessary. 14 15 DATA DISSEMINATION The data that is sent back to the feedlots includes video data for Cyberstockyard and daily content and statistical data for our information management products and services. This information is then stored in our local databases, which function as a backup for off-line operation. Professional Cattle Consultants provides information back to feedlots on a monthly basis either through electronic mail, a password-protected Internet site, or in hard copy form. Surveys are available only in hard copy form. DATA DISPLAY AT THE FEEDLOT Our system uses a standard browser to connect to the CattleInfoNet.com Web site. A secure login is required for full access to Cyberstockyard.com, PCC-online.com and the Feedlot Information System. When logged on, the system downloads display applets, written in Java, to the user's system to display relevant information. The user can view auction videos and bid on cattle in real-time. INTELLECTUAL PROPERTY Our ability to protect and utilize our intellectual property rights is important to our continued success. We have filed applications to register Cyberstockyard and NutriCharge as trademarks of eMerge Interactive with the U.S. Patent and Trademark Office. We currently have three patent applications that are pending before the U.S. Patent and Trademark Office relating to: - Early detection of inflammation using our infrared imaging camera; - Feedlot information systems and methods; and - The cattle transaction process. The intellectual property rights to use several patents that are critical to our products and services are licensed to us by third parties. The U.S. patents and corresponding international patent applications related to our NutriCharge products and infrared animal screening methods are licensed to us by the Canadian government under a master license agreement dated July 29, 1998. The master license provides us with an exclusive worldwide license to develop and sell products and services that utilize the inventions contained in the patents. The license continues until July 2018 and may be renewed after that time unless the license is terminated by the Canadian government upon our breach of and failure to cure a fundamental term of the license agreement, our commencement of bankruptcy or insolvency proceedings, or the assignment of the license agreement without Canada's prior written consent. In exchange for the license, we must pay the Canadian government a royalty on a semi-annual basis that is calculated as a percentage of the revenues we receive from the sale of products and services related to the license. Our obligation to pay this royalty begins July 29, 2000. Under the master license, we must achieve milestones in order to maintain the master license. To date we are achieving all required milestones. The U.S. patents relating to technology for detecting fecal contamination on meat carcasses during and after slaughter are licensed to us by the Iowa State University Research Foundation and the USDA under a license agreement entered into August 1999. The license provides us with an exclusive worldwide license until the patents expire on a country by country basis to develop and sell products and services that utilize the inventions contained in the patents. In exchange for the license, we are obligated to pay Iowa State University a royalty on revenues we receive from the sale of products and services related to the license. 15 16 We believe our commercial success depends on our ability to protect our proprietary technology and enforce our rights in the technology we license to other parties. We currently rely on a combination of patents, copyrights and trade secrets to protect our proprietary technology. We are not aware of any patents held by others that would prevent us from manufacturing and commercializing our technology in the United States and abroad. We have filed an application to register eMerge Interactive and related service marks with the U.S. Patent and Trademark Office. We have received notice from a third party claiming superior rights to these marks and indicating an intent to oppose our registration of the marks in Patent and Trademark Office proceedings as well as oppose our commercial use of the marks. We believe that we will be able to ultimately overcome any such challenge. If we are unsuccessful, however, we may be required to cease using the eMerge marks at a future date. PURCHASE AND LICENSE AGREEMENT In January 1999, we granted a license to Sperry Marine, Inc., a subsidiary of Litton Industries, Inc., to design, manufacture and assemble infrared marine systems for worldwide sale. The license is exclusive and nontransferable and applies to infrared technology that is unrelated to our products and markets. Although we have not received any royalties to date, under the agreement, we will receive a royalty of 8% of system sales up to a maximum royalty of $4.3 million over a four year period or up to a maximum royalty of $5.0 million if $4.3 million is not received within four years. Upon receipt of the maximum amount, we will transfer all rights, title and interests to the licensed intellectual property. In connection with this license agreement, we also entered into an asset purchase agreement with Sperry for the sale of assets relating to the infrared systems for approximately $1.9 million. COMPETITION In the cattle sales and auction services market, we compete against traditional cattle auction services, as well as video cattle auction providers and other online cattle auction services. Currently, the majority of cattle and calf sales transactions occur through auctions held at traditional sale barns. These sale barn operations are highly fragmented and vary in size. We believe that the primary competitive factors in the cattle sales and auction services market include: - Availability and quality of inventory; - Pricing; - Reliability of service; - Efficiency; - Brand awareness; - Customer service; and - Convenience and ease of use. We believe that we compete based on these factors, particularly due to our access to inventory, our focus on ensuring quality and reliability, the brand awareness developed through our comprehensive solution and the convenience and ease of use of our Web site. We compete against other companies in the information services segment, including established cattle and livestock information services. We also face competition from cattle industry product manufacturers who use information technology to promote the effectiveness of their products. These services are often provided in connection with the sale of products to industry 16 17 participants. In addition, providers of software to feedlots also offer information services to their feedlot customers. We believe that the primary competitive factors in the information services market include: - Breadth of available data; - Quality of analyses; - Timeliness of information; - Brand recognition; - Value-added consulting services; and - Convenience and ease of use. We believe that we compete based on these factors particularly due to the size and quality of our proprietary database, the timeliness of our service offerings, the expertise of our professionals and the convenience and ease of use of our Web sites. Our current competitors may include large companies that have substantially greater market presence, brand-name recognition and financial resources than we do. Some of our smaller competitors may also enjoy greater recognition and close relationships within a particular community. EMPLOYEES As of December 31, 1999, we employed a total of 99 persons, including 36 persons in product development and engineering, 35 persons in marketing and sales, 18 persons in production and 10 persons in administration. We are not subject to any collective bargaining agreements and we believe that our relationship with our employees is good. ITEM 1(D). FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES The Company does not have foreign sales and does not believe geographic sales are significant to obtain an understanding of its business operations during the three year period ended December 31, 1999. ITEM 2. PROPERTIES Our corporate facilities located in Sebastian, Florida, occupy approximately 17,000 square feet. We sublease our facilities from XL Vision, which leases the entire facility from XL Realty, Inc., a subsidiary of Safeguard. We believe that the rent that we pay pursuant to our lease is consistent with the market rent for similar space in the area. Our lease terminates on January 1, 2001, at which time we have the option to renew the lease for an additional one year term. We believe that this space is adequate to support our needs for the foreseeable future. We also maintain offices in Meade, Kansas; Denver, Colorado; Austin, Texas; and Weatherford, Oklahoma. ITEM 3. LEGAL PROCEEDINGS We have been named as a defendant in a lawsuit filed by Central Biotech, Inc. on January 12, 2000 in the Queen's Bench Judicial Centre of Regina, Province of Saskatchewan, Canada. The complaint alleges that eMerge and E-Y Laboratories Inc. 17 18 were each subject to confidentiality agreements with the plaintiff, and subsequently engaged in discussions concerning a potential business arrangement allegedly in violation of these agreements. The complaint asserts damages, including punitive damages, from the defendants in the aggregate amount of $18 million (Canadian dollars), as well as injunctive relief. Although we have not yet completed our assessment of these claims, we believe that there are a number of substantive and procedural defenses that exist and intend to defend these claims vigorously. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the fourth quarter of 1999. PART II ITEM 5. MARKET FOR REREGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS RECENT SALES OF UNREGISTERED SECURITIES In February of 1999, eMerge Interactive issued 750,000 shares of class A common stock in connection with the acquisition of assets of CIN, LLC, at a price of $.96 per share. eMerge Interactive issued 250,000 shares of class A common stock in connection with the acquisition of 100% of the issued and outstanding stock of Cyberstockyard, Inc. on March 29, 1999, at a price of $1.80 per share. In August of 1999, eMerge Interactive issued 62,500 shares of class A common stock at $6.40 per share, for 19% of the common stock of Turnkey Computer Systems, Inc. All of such sales were made under the exemption from registration provided under Section 4(2) of the Act. The issuance to the stockholders of Cyberstockyard, Inc. was also made pursuant to Rule 504 under the Act. In May of 1999, we issued 1,000,000 shares of series C preferred stock to Safeguard 99 Capital L.P. and 100,000 shares to purchasers associated with Applewood Associates, L.P., now Wheatley Partners II, L.P., at a price of $5.00 per share. In November 1999, we issued 4,555,556 shares of series D preferred stock to Internet Capital Group, Inc. at a purchase price of $7.20 per share, payable in cash and a promissory note. In connection with the sale of preferred stock, we also issued to Internet Capital Group a warrant to purchase up to 1,138,889 shares of class B common stock. All of such sales were made under the exemption from registration provided under Section 4(2) of the Act. II-2 131 Pursuant to eMerge Interactive's 1996 and 1999 Equity Compensation Plans, eMerge Interactive granted options to purchase a total of 1,415,250 shares of common stock to its employees and certain other individuals in the year ended December 31, 1999 at a weighted average exercise price of $4.96 per share. In the year ended December 31, 1999, 200,819 shares were purchased pursuant to options at an average exercise price of $.93. In granting the options and selling the underlying securities upon exercise of the options, eMerge Interactive is relying upon exemptions from registration set forth in Rule 701 and Section 4(2) of the Act Our common stock trades on the Nasdaq National Market under the symbol "EMRG." Prior to February 4, 2000, there was no established public trading market for any of our securities. The following table sets forth, for the periods indicated, the range of high and low closing sales prices for our common stock as reported on the Nasdaq National Market. 18 19
High Low ------ ------ Fiscal 2000 First Quarter (from February 4, 2000 through March 17, 2000) $70.50 $39.00
On March 17, 2000, the last reported sale price of our common stock as reported on the Nasdaq National Market was $49.50 per share and we had 622 holders of record of our common stock. We have never declared or paid any dividends on our common stock. We do not anticipate paying any cash dividends in the foreseeable future. We currently intend to retain future earnings, if any, to finance operations and the expansion of our business. Any future determination to pay cash dividends will be at the discretion of the board of directors and will be dependent upon our financial condition, operating results, capital requirements and such other factors as the board of directors deems relevant. CHANGES IN SECURITIES AND USE OF PROCEEDS On February 4, 2000, we commenced an initial public offering of our common stock. The registration statement relating to this offering (File No. 333-89815) was declared effective on February 3, 2000. Adams, Harkness & Hill, Inc., First Union Securities, Inc., and FAC Equities were the managing underwriters of the offering. As part of the offering, we offered 2,806,000 shares of our class A common stock at the public offering price to shareholders of Safeguard Scientifics, Inc., one of our principal stockholders, that owned at least 100 shares of common stock of Safeguard as of October 20, 1999 and Safeguard offered 694,000 shares to its shareholders. The number of shares registered, the aggregate price of the offering amount registered, the amount of shares sold and the aggregate offering price of the shares sold were as follows:
Shares of Common Aggregate Price of Amount of Shares Aggregate Price Registered Shares Registered Sold of Shares Sold ---------- ------------------ ---------------- --------------- 7,175,000 $107,625,000 7,175,000 $107,625,000
We incurred the following expenses with respect to the offering during the period from July 1998 through February 2000:
Underwriting Discounts and Commissions Management Underwriters' Expenses Fee Finders' Fees Expenses Other Expenses Total Expenses ------------ ---------- ------------- ------------- -------------- -------------- $4,587,750 $1,178,520 $0 $0 $2,000,000 $7,765,970
In addition, we issued 500,000 shares of class A common stock at $15.00 per share in a private placement that was completed concurrently with the offering. The net proceeds from the offering and the private placement after deducting the foregoing discounts, commissions, management fees, finders fees and expenses were $107.4 million. We have used the proceeds for payments to related parties and Turnkey Computer Systems, Inc. and for general working capital. None of the foregoing expenses constituted direct or indirect payments to our directors, officers, general partners or their associates or to persons 19 20 owning 10% or more of any class of our equity securities or to our affiliates. ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA All business activities from inception through 1996 related to the transportation segment which was disposed of in January 1999. As a result, we have not included operations data for the years ended December 31, 1994, 1995 and 1996. Selected consolidated financial data for the Company is set forth below for the periods indicated:
Year Ended December 31, -------------------------------------------- (in thousands, except per share data) 1997 1998 1999 -------- -------- -------- CONSOLIDATED STATEMENTS OF OPERATIONS DATA: Revenue $ -- $ 1,792 $ 43,783 Cost of revenue -- 2,623 43,517 Operating expenses: Selling, general and administrative 628 3,660 11,240 Research and development 728 1,109 4,343 -------- -------- -------- Total operating expenses 1,356 4,769 15,583 Interest expense/other income, net (141) (332) (288) -------- -------- -------- Loss from continuing operations $ (1,497) $ (5,932) $(15,605) ======== ======== ======== Loss from continuing operations per common share basic and diluted $ (3.91) $ (1.36) $ (3.11) ======== ======== ======== Weighted average number of common shares outstanding - basic and diluted 382 4,357 6,795 ======== ======== ========
The following table summarizes our balance sheet data for the periods indicated:
December 31, ----------------------------------------------------------------------- 1995 1996 1997 1998 1999 1999 ------- ------- ------- ------ ------- -------- (in thousands) Pro forma (Unaudited) CONSOLIDATED BALANCE SHEET DATA: Cash $ -- $ 2 $ -- $ -- $12,316 $107,673 Total assets 6 260 2,165 6,602 25,762 120,671 Total indebtedness 1,747 3,636 8,040 5,572 13,260 460 Total stockholders' equity (deficit) (1,742) (3,457) (6,875) 3 8,891 117,006
The unaudited pro forma consolidated balance sheet data give effect to: - The sale of 7,175,000 shares of class A common stock in our initial public offering; - The issuance of 500,000 shares of class A common stock in a concurrent private placement; 20 21 - The automatic conversion of all outstanding shares of series A, series B, series C and series D preferred stock into shares of our common stock concurrent with the offering; - The termination of the redemption right relating to 62,500 shares of class A common stock, which occurs immediately prior to the consummation of the offering; - The repayment of $1.6 million of principal and interest owed to XL Vision as of December 31, 1999 - The repayment of $10.3 million of principal and interest owed to Safeguard as of December 31, 1999. - The repayment of a $900,000 note payable to Turnkey Computer Systems, Inc., as of December 31, 1999. ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD LOOKING STATEMENTS The following discussion of our financial condition and results of operations should be read together with the consolidated financial statements and the related notes included elsewhere in this document and which are deemed to be incorporated into this section. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in those forward-looking statements as a result of certain factors, including but not limited to, those set forth under and included in other portions of this document. REVENUE RECOGNITION We recognize revenue in accordance with the terms of the sale or contract, generally as products are shipped or services are provided. In cattle sales transactions we act as principal when purchasing cattle from suppliers and reselling them to customers. We take title when the supplier delivers the cattle to us, arrange for shipment to our customer, and own as inventory until delivered to and accepted by the buyer, typically a 24 to 48 hour period. We are responsible for the resale of the cattle, bear all risk associated with the cattle until resold, and bear the credit risk until full payment is received from our customers. We recognize revenue when cattle are shipped to the customer equal to the purchase price paid by the customer. Gross profit on cattle sale transactions is determined by the mark-up that we add to the price that we pay to purchase the cattle. Revenue from the sale of livestock health management and quality enhancement products, equine imaging cameras and NutriCharge, is recognized on shipment to the customer. Revenue from our information management products is recognized in the period in which the information or analysis is delivered to the customer, normally on a monthly basis. ACQUISITIONS In February 1999, we purchased substantially all of the tangible and intangible assets of CIN, LLC for an aggregate purchase price of approximately $2.3 million. These assets included the Feedlot Information System, a proprietary, patent pending, information system for cattle feedlots. In addition, we acquired tangible assets including computers and office equipment and furnishings, which we are currently utilizing. The purchase price for the assets consisted of 750,000 shares of our class A common stock valued at $720,000, the assumption of $812,000 of liabilities, a cash payment due in October 1999 of $358,000, and an agreement to pay the first $350,000 from Internet sales of third-party products over the Web site and transaction costs of $57,000. In March 1999, we acquired 100% of the common stock of Cyberstockyard, Inc. for approximately $542,000. The purchase price consisted of 200,000 shares of our class A common stock valued at $450,000, the assumption of $90,000 of liabilities and transaction costs of $2,000. Through this acquisition, we obtained Cyberstockyard.com, our online cattle sales and 21 22 auction services, and related software applications. Cyberstockyard.com has been integrated into our suite of products and services. During the three months ended June 30, 1999, we began executing cattle sales utilizing Cyberstockyard.com. In May 1999, we purchased substantially all of the tangible and intangible assets of Professional Cattle Consultants, L.L.C., a leading cattle industry information resource and database for approximately $1.8 million. The purchase price consisted of $1.8 million in cash, the assumption of approximately $3,000 in liabilities and transaction costs of $25,000. In June 1999, we began selling comparative analysis and market information for the feedlot industry with the assets acquired from Professional Cattle Consultants, L.L.C. Because of the significance of these acquisitions and the resulting additions to our products and services, the historical financial results are not indicative of future performance. We have incurred significant net losses since our inception. At December 31, 1999, we had an accumulated deficit of $32.4 million. The net losses and accumulated deficit resulted from our lack of substantial revenues, the costs of the significant personnel infrastructure and other costs incurred for the development and marketing of our initial products. We may never achieve significant revenue or profitability, or if we achieve significant revenue or profitability they may not be sustained. RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1999 Revenue increased from $1.8 million for the year ended December 31, 1998 to $43.8 million for the year ended December 31, 1999. Revenue from cattle sales increased to $42.3 million for the year ended December 31,1999. There was no revenue from cattle sales in 1998. Revenue from animal science products decreased by 17% from $1.8 million for the year ended December 31, 1998 to $1.5 million for the year ended December 31, 1999. This decrease is due primarily to lower revenue from sales of our equine imaging system due primarily to a decline in units sold. Increased sales of NutriCharge and the sale of subscriptions to our comparative feedlot analysis and market information service partially offset the decline in revenue from equine camera sales. Cost of revenue consists primarily of the direct cost to acquire cattle, NutriCharge and equine imaging systems components and indirect manufacturing overhead costs such as support personnel, facilities costs, supplies and depreciation, which were primarily associated with the production of the equine imaging system. Direct costs attributed to cattle sales were $41.7 million for the year ended December 31, 1999. There were no direct costs from cattle sales in 1998. Direct costs attributed to animal science products decreased by 38% from $901,000 for the year ended December 31, 1998 to $558,000 for the year ended December 31, 1999. This decrease is due principally to the decline in unit sales of equine imaging systems. We generated a gross loss of $831,000 for the year ended December 31, 1998 and a gross profit of $266,000 for the year ended December 31, 1999. The change from a gross loss to a gross profit is due primarily to the increase in revenue, while cost of goods, principally manufacturing overhead, did not increase in proportion to the increase in revenue. Selling, general and administrative expenses increased 202% from $3.7 million for the year ended December 31, 1998 to $11.2 million for the year ended December 31, 1999. Sales and marketing expenses consist primarily of salaries and related costs, commissions for sales and marketing personnel, consulting fees, travel and entertainment, advertising and trade shows. Sales and marketing expenses increased 214% from $2.2 million for the year ended December 31, 1998 to $6.9 million for the year ended December 31, 1999. The increase is due primarily to expenses associated with expanding the number of personnel from 11 people at December 31, 1998 to 35 people at December 31, 1999 and consulting, travel and advertising costs to effect our business strategy. We expect these costs to continue to increase significantly as we continue to pursue additional sales and marketing opportunities. 22 23 Our general and administrative expenses consist primarily of salaries, bonuses and related costs for executives, amortization of intangibles and administrative and professional service fees, including administrative support fees to XL Vision and Safeguard. We have contractual service agreements with XL Vision and Safeguard Scientifics. Under an administrative services agreement dated December 15, 1997, as amended on August 17, 1999, XL Vision and Safeguard provide us with management consultation, investor relations, financial management, human resource management, legal services, insurance programs, and administrative services. We pay a fee calculated pursuant to a formula that is based on a percentage of our revenue, not to exceed $300,000 annually. The fee is not due until we achieve positive cash flow from operations. The agreement extends through December 31, 2002 and continues unless terminated by either party. As of December 31, 1999, we have not paid any amounts due to XL Vision and Safeguard under these agreements. As of December 31, 1999 we owed XL Vision and Safeguard approximately $45,000 and $56,000, respectively, under these agreements. In addition, under a direct charge administrative services agreement dated April 14, 1997, XL Vision also provides us with management services on a time and materials basis. This agreement continues on a month-to-month basis, and may be terminated at any time by either party. As of December 31, 1999, we owed XL Vision $1,635,000 under this agreement. The amounts due under these agreements will continue to accrue as we use the services. General and administrative expenses increased 187% from $1.5 million for the year ended December 31, 1998 to $4.3 million for the year ended December 31,1999. The increase was primarily due to increased amortization of intangibles, increased expenses associated with expanding the number of personnel from 4 people at December 31, 1998 to 10 people at December 31, 1999 and increased legal and travel expenses required to support and grow our business. We expect these expenses to continue to increase as additional personnel are hired and additional expenses are incurred to support future growth. Our research and development expenses consist of salaries and related costs, payments to outside consultants, material costs for prototype imaging systems and, to a lesser extent, depreciation on equipment used for development. Our expenses increased 292% from $1.1 million for the year ended December 31, 1998 to $4.3 million for the year ended December 31, 1999. This increase in expenses was primarily due to increased consulting costs, an increase in personnel, and increased spending for materials and supplies. The increase in expenses was required to integrate and expand our product lines such as our online cattle sales and auction software, Feedlot Information System software, and continued development efforts on imaging systems. We expect these costs to increase significantly as we plan to invest heavily to develop and commercialize new products, expand our offerings and adapt our technologies to new markets. Interest expense/other income, net decreased 13% from $332,000 for the year ended December 31, 1998 to $288,000 for the year ended December 31, 1999. This decrease was primarily due to a lower average level of borrowing accompanied by an increase in interest income. Due to the losses incurred, we did not have any income tax expense for the year ended December 31, 1998 or the year ended December 31, 1999. As of December 31, 1999 we had approximately $28.0 million of federal income tax loss carry forwards that can be used to offset future taxable income. Our tax loss carry forwards begin to expire in 2012 and we are not currently aware of any limitation on our ability to offset future taxable income. YEAR ENDED DECEMBER 31, 1997 COMPARED WITH YEAR ENDED DECEMBER 31, 1998 Substantially all of our 1998 revenue of $1.8 million was from the sale of equine imaging systems that we began selling in March of 1998. There was no revenue from equine imaging systems sales in 1997. Our gross loss of $831,000 in 1998 was due primarily to a substantial increase in manufacturing overhead as we built our manufacturing infrastructure. There was no manufacturing activity related to the production of equine imaging systems in 1997. Selling, general and administrative expenses increased 483% from $628,000 in 1997 to $3.7 million in 1998. 23 24 Our sales and marketing expenses increased 527% from $344,000 in 1997 to $2.2 million in 1998. The increase in these expenses was due primarily to increased staffing and related costs, advertising, travel, trade shows and consulting fees in these areas to effect our business strategy. Our general and administrative expenses increased 430% from $284,000 in 1997 to $1.5 million in 1998. The increase in these expenses from 1997 to 1998 was primarily due to increases in the number of personnel and related support costs to expand and grow our business and increased administrative support fees to XL Vision and Safeguard. Our research and development expenses increased 52% from $728,000 in 1997 to $1.1 million in 1998. This increase was driven primarily by increased staffing of research and development personnel, related costs, and depreciation of development equipment costs necessary to further develop our products. Interest expense/other income, net increased 135% from $141,000 in 1997 to $332,000 in 1998. This increase was primarily due to a higher average level of borrowing. Due to the losses incurred, we did not have any income tax expense in 1997 or 1998. QUARTERLY RESULTS OF OPERATIONS The following table sets forth certain consolidated statements of operations data for the quarters ended March 31, June 30, September 30, and December 31, 1998, and March 31, June 30, September 30, and December 31, 1999. The information for each quarter has been prepared on substantially the same basis as the audited statements included in other parts of this annual report and, in the opinion of management, include all adjustments, consisting of only normal recurring adjustments necessary for a fair presentation of the results of operations for such periods. Historical results are not necessarily indicative of the results to be expected in the future, and the results of the interim periods are not indicative of results of any future period.
Three Months Ended ------------------------------------------------------------------------------- Mar. 31, June 30, Sep. 30, Dec. 31, Mar. 31, June 30, Sep. 30, Dec. 31, 1998 1998 1998 1998 1999 1999 1999 1999 -------- -------- -------- -------- -------- -------- -------- -------- (in thousands, except per share amounts) Consolidated Statements of Operations Data Revenue $ 323 $ 342 $ 442 $ 685 $ 605 $ 1,973 $ 15,761 $ 25,444 Cost of revenue 459 578 649 937 540 2,228 15,514 25,235 Operating expenses 930 948 1,237 1,654 1,962 3,557 4,777 5,287 Interest expense/other income, net (77) (85) (85) (85) (127) (162) (155) 155 -------- -------- -------- -------- -------- -------- -------- -------- (Loss) from continuing operations $ (1,143) $ (1,269) $ (1,529) $ (1,991) $ (2,024) $ (3,974) $ (4,685) $ (4,923) ======== ======== ======== ======== ======== ======== ======== ======== (Loss) from continuing operations per common share -- basic and diluted $ (0.35) $ (0.39) $ (0.30) $ (0.34) $ (0.33) $ (0.58) $ (0.67) $ (1.48) ======== ======== ======== ======== ======== ======== ======== ========
24 25 LIQUIDITY AND CAPITAL RESOURCES Historically, we have funded our operating and investing cash requirements principally through private equity financings and through borrowings from XL Vision and Safeguard Scientifics. As of December 31, 1999, we have raised approximately $45.6 million from the sale of our common stock and preferred stock. On November 16, 1999, we issued 4,555,556 shares of series D preferred stock and a warrant to purchase 1,138,889 shares of class B common stock to Internet Capital Group for aggregate consideration of $38.8 million. We received $18.0 million of this amount in cash on November 16, 1999 and $20.8 million in the form of a non-interest bearing note, which is due on November 16, 2000. Interest on the promissory note was imputed at 9.5%, or $2.2 million over the life of the note. At December 31, 1999, we had approximately $12.3 million in cash and indebtedness to XL Vision and its affiliates of $12.4 million. We repaid all of this outstanding debt balance in February 2000 with a portion of the cash proceeds from our Initial Public Offering. We have had significant negative cash flows from operating activities for each fiscal and quarterly period to date. Net cash used in operating activities was $1.7 million in 1996, $6.0 million in 1997, $8.9 million in 1998 and $15.6 million in 1999. Cash used in operating activities from inception through December 31, 1999 consisted mostly of net operating losses offset in part by increases in accrued liabilities. Net cash used in investing activities was $157,000 in 1996, $507,000 in 1997, $892,000 in 1998, and $1.60 million for the year ended December 31, 1999. Net cash used in investing activities in these periods consisted mostly of business acquisitions and capital expenditures. Net cash provided by financing activities was $1.9 million in 1996, $6.5 million in 1997, $9.8 million in 1998 and $29.5 million for the year ended December 31, 1999. Cash provided by financing activities consisted primarily of the sale of our stock and borrowings from Internet Capital Group, XL Vision and Safeguard. In August 1999, we entered into an agreement to acquire a 19% interest in the common stock of Turnkey Computer Systems, Inc. for a purchase price of 62,500 shares of our common stock valued at $400,000 and additional cash payments totaling $1.4 million, of which $900,000 was outstanding at December 31, 1999. We repaid all of this outstanding debt balance in February 2000 with a portion of the cash proceeds from our Initial Public Offering. Our Recent Initial Public Offering On February 17, 2000, we closed on our initial public offering, which generated net proceeds of $107.4 million, and a private placement of $7.5 million. Subsequent to the offering, approximately $12.8 million of the proceeds were used to pay amounts due to related parties and Turnkey Computer Systems. The Company's cash balances as of February 29, 2000, approximated $100.0 million. We believe that the net proceeds from the offering, together with our existing cash and cash equivalents, will be sufficient to meet our working capital and capital expenditure requirements for at least the next 24 months under our current business plan, which may change. To the extent we are required to raise additional capital, we may need to issue additional equity securities or incur additional debt. If additional funds are raised through the issuance of equity securities, our existing shareholders may experience significant dilution. Furthermore, additional financing may not be available when needed or, if available, such financing may not be on terms favorable to us. If such financing is not available when required or is not available on acceptable terms, we may be unable to develop or enhance our products and services. In addition, we may be unable to take advantage of business opportunities or to respond to competitive pressures. Any of these events could have a material adverse effect on our business, financial condition or results of operations. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board, or FASB, issued SFAS No. 133, Accounting for Derivatives and Hedging Activities, which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activities. The adoption of SFAS No. 133 is not expected to have a material impact on our results of operations, financial position or cash flows. 25 26 In June 1999, the FASB issued SFAS No. 137, which amended the implementation date for SFAS No. 133 to be effective for all fiscal quarters of all fiscal years beginning after June 15, 2000. FACTORS AFFECTING OUR BUSINESS, FINANCIAL CONDITION, AND RESULTS OF OPERATIONS In addition to the other information included in this report, the following factors should be considered while evaluating the Company and its future prospects: our business, financial condition and results of operations. We commenced operations in 1994 and commercially released our initial product in November 1997. Accordingly, we have only a limited operating history upon which to evaluate our business. In addition, our business strategy and revenue model have changed significantly during the past year. Prior to this change, we generated revenue primarily from the sale and licensing of our AMIRIS product, a maritime navigational thermal imaging system, which we no longer sell, and our equine imaging system, an infrared product used to detect injuries in horses, which we continue to sell. We have sold the AMIRIS product line and have changed our business strategy to focus on business-to-business Internet commerce for the livestock industry. We only recently launched our commercial Web site for our initial target market, the cattle industry, in August 1999. Our limited operating history, combined with our recent shift in business strategy, makes predicting our future results of operations difficult. Our new business model has not been tested and, accordingly, we cannot be certain that our business strategy will be successful. Specific uncertainties relating to our new business model include our ability to: - Achieve acceptance of our Web site as a marketplace for electronic commerce; - Expand the number of cattle producers, feedlots and packers that utilize our services; - Develop and upgrade our products and technologies more effectively and rapidly than our competitors; and - Successfully implement our sales and marketing strategy. We have a history of net losses and expect to continue to incur losses for the foreseeable future. If we continue to incur losses, our business may not ultimately be financially viable. We have incurred significant net losses since inception. We reported a net loss of approximately $7.8 million for the year ended December 31, 1998, or 437% of total revenue, and approximately $15.6 million for the year ended December 31, 1999, or 36% of total revenue. As of December 31, 1999, we had accumulated net losses totaling approximately $32.4 million. Our operating expenses have increased significantly in each year of our operation, and we anticipate that such expenses will continue to increase over the next several years as we expand our operations. Our revenue may not grow or may not even continue at its current level and, as a result, our financial condition and results of our operations may be harmed and our business may not be financially viable in the future. To achieve profitability, we must successfully address the following risks: - Lack of commercial acceptance of our online cattle sales and auction services; - Failure to expand the number of livestock industry participants using our network; - Failure to obtain access to data from feedlots to adequately address the information needs of our customers; - Inability to respond to competitive developments; - Failure to achieve brand recognition; 26 27 - Failure to introduce new products and services; and - Failure to upgrade and enhance our technologies to accommodate expanded product and service offerings and increased customer traffic. If we are unable to successfully address any of these risks, our business may be harmed. The Internet livestock products and services market, including, in particular, the online cattle sales and auction market, is new and uncertain and our business may not develop as we anticipate. The Internet market for livestock products and services, including, in particular, the online cattle sales and auction market, has only recently developed, and its continued development is subject to substantial uncertainty. To date, we have not realized adequate revenues from this market to achieve profitability. We cannot be assured that this market will continue to develop as we expect, if at all. Our revenue model depends on the commercial acceptance of our Internet-based products and services. We do not know if our target customers will use the Internet as a means of purchasing products and services. Even if potential customers choose to purchase livestock products and services over the Internet, they may not choose our online services to do so. If the market for livestock products and services over the Internet does not develop as we anticipate, our business and the results of our operations will be harmed. To date, we have not achieved revenues from cattle sales and auction services over the Internet that are sufficient for us to determine whether these services will achieve commercial acceptance. Any failure to successfully gain commercial acceptance of these services would harm our business and the results of our operations. We recently completed significant acquisitions of businesses and technologies and we may make other business acquisitions in the future, which may be difficult to integrate into our business and may disrupt or negatively impact our business. We recently made, and will continue to make, investments in and acquisitions of complementary companies, technologies and assets that constitute critical aspects of our current and future business operations. If we fail to successfully integrate the operations of these companies, technologies or assets into our business, we may not be able to successfully execute our business strategy. We acquired substantially all of the assets of CIN, LLC in February 1999, and Professional Cattle Consultants, L.L.C. in May 1999. In connection with our acquisition of CIN, we hired Scott Crain, one of our key employees. We also acquired all of the issued and outstanding stock of Cyberstockyard, Inc. in March 1999. Each of these acquired businesses is critical to our current business operations and growth strategy. These and any future acquisitions may result in: - Difficulties in assimilating technologies, products, personnel and operations; - Diversion of our management's attention; - Entering markets in which we have no or limited prior experience; - Loss of key employees of acquired organizations; and - Capital requirements in excess of what we anticipate. 27 28 In the future, acquiring companies, assets or technologies may also require us to make cash payments, assume debt, incur large write-offs related to intangible assets and issue equity, which will dilute ownership interest. If we fail to generate sufficient cash flows in the future, we may be unable to recover the carrying amount of our intangible assets, which would harm our results of operations and financial condition. As a result of our recent acquisitions of companies, technologies and assets, we have recorded $6.0 million of intangible assets on our balance sheet as of December 31, 1999. If we are unable to generate sufficient cash flows that are attributable to these intangible assets, we may be unable to recover all or a portion of the carrying amount of such assets. Therefore, we may be required to reduce the value of these assets as recorded on our balance sheet. This would require us to record an expense in our statement of operations. This would also reduce our net assets and increase our losses, or reduce our profits, as the case may be. Any negative impact on our results of operations or balance sheet could reduce the price of our common stock. For the year ended December 31, 1999, we derived over 96% of our revenue from products and services relating to the sale of cattle. If the demand for beef declines, the demand for our products and services would likely decline, and our results of operations would be harmed. If we are unable to manage our growth effectively, our business may be harmed. We cannot assure that we will be able to effectively or successfully manage our growth. If we are unable to manage our growth effectively, our business operations would suffer. We seek to grow by increasing transaction and subscription volume, adding new products and services and by hiring additional employees. In particular, we are currently seeking to hire a Vice President of Human Relations and additional order buyers for our cattle auction and sales services. Our growth is likely to place a significant strain on our resources and systems. As we continue to increase the scope of our operations, we will need an effective planning and management process to implement our business strategy successfully and we will need to implement new and improve existing systems, procedures and controls. We will also need to expand, train and manage our workforce. We currently do not have an adequate corporate infrastructure to support our operations and we depend upon XL Vision and Safeguard to provide such services. We depend upon XL Vision and Safeguard for accounting, management and administrative resources. We are currently in the process of establishing our own corporate infrastructure. If our management team fails to manage this growth effectively, successfully establish our corporate infrastructure or if there are unanticipated costs or delays in the improvement and implementation of new and existing systems, procedures and controls, our business and financial condition may be harmed. If we are unable to protect our intellectual property rights, our business and competitive position will be harmed. Proprietary rights are important to our success and our competitive position. We protect our intellectual property through a combination of patent, copyright, trade secret and trademark law and confidentiality agreements with third parties. We currently have three pending U.S. patent applications, which relate to (i) the early detection of inflammation using our infrared imaging camera, (ii) feedlot information systems and methods and (iii) the cattle transaction process. We also have 31 pending U.S. trademark applications relating to our corporate identity, products and services. We cannot guarantee that any of our pending patent or trademark applications will be approved. Even if they are approved, the patents or trademarks may be challenged by other parties or invalidated. Because brand recognition is an important component of our business strategy, the protection of our trademarks is critical to our success. We also depend upon patents licensed to us by the Canadian government and trade secret law to protect the proprietary nature of our NutriCharge products. In addition, we depend upon our proprietary database of industry and client information to provide our clients with our information services. Despite our efforts to protect our proprietary rights, unauthorized parties may copy aspects of our products and technology or obtain access to our confidential 28 29 proprietary database. Other parties may also breach confidentiality agreements and other protective contracts. We may not become aware of these breaches or have adequate remedies available. In addition, effective copyright, patent and trademark protection may be unavailable in certain countries to which we might expand our operations. In technology markets, there is generally frequent and substantial intellectual property litigation. We may be subject to legal proceedings and claims, including claims that we infringe third-party proprietary rights. While we are not aware of any patents, copyrights or other rights that would prevent us from manufacturing and commercializing our products or services in the United States and abroad, there can be no assurance that other parties will not assert infringement claims against us. There also can be no assurance that former employers of our present and future employees will not claim that our employees have improperly disclosed confidential or proprietary information to us. Any of these claims, with or without merit, could subject us to costly litigation and divert the attention of our personnel. We have filed an application to register eMerge Interactive and related service marks with the U.S. Patent and Trademark Office. We have received notice from a third party claiming superior rights to these marks and indicating an intent to oppose our registration of the marks in Patent and Trademark Office proceedings as well as oppose our commercial use of the marks. If we are unsuccessful in defending any such opposition, we may be required to cease using the eMerge marks at a future date, which may cause us to change our name. A change in our name may be costly and may result in customer confusion, which could harm our business. We typically assume the ownership of cattle sold through our Internet cattle marketplace and are subject to the risk of loss while we hold title and market risk. In the sales transactions conducted through our Internet cattle sales and auction services network, we typically contract to purchase cattle from a seller, identify a buyer for the cattle, take title to the cattle from the seller and then resell the cattle to the buyer. In this process, we enter into a contract to purchase cattle in advance of entering into a contract to sell the cattle. Therefore, until we actually complete a sale transaction, we are subject to the risk that we may be unable to sell cattle that we are contractually obligated to purchase. In addition, once we purchase the cattle, we assume title to the cattle for generally up to 48 hours. As a result, we assume the risk of liability, loss and deterioration in value of the cattle during that period. Although we review the background and credit history of our customers, we cannot assure that we will receive full and timely payment in each instance. If the buyer does not accept the cattle, we may not be able to sell the cattle to other buyers on the same terms, and our profitability may be harmed. If the cattle suffer from health deterioration or weight loss while in our ownership, the purchasers may assert claims against us. Our business and financial condition may be harmed if we have to defend any claims or pay any refunds. If the cattle are destroyed while we have ownership, we may be held responsible for the loss or may be obligated to purchase additional cattle to fulfill our delivery commitments. As a result, our business may be harmed. We depend on our key employees for our success. The loss of any of these persons could harm our ability to compete. Our success depends on the continued services of the following executive officers and key employees: - Charles L. Abraham; - T. Michael Janney; - Scott L. Mathews; - Marvin L. Slosman; - Arvind Subramanian; - J. Tom Brink; - Scott Crain, D.V.M.; and - Jim Gibb, Ph.D. The loss of the services of any of these persons could harm our business, including our ability to compete effectively. Our performance also depends on our ability to attract, retain and motivate additional key officers and employees. We may be unable 29 30 to retain our employees or to attract, assimilate and retain other qualified employees with relevant livestock and electronic commerce industry skills in the future. If we fail to attract, retain and motivate qualified employees, our business will be harmed. We may face costly product liability claims that could result in significant awards against us or impair our ability to market and sell our products and services. A successful product liability claim brought against us could harm our financial condition and reputation in the industry. We may face product liability claims in connection with our cattle sales and auction services, feedlot operations analysis, comparative cattle industry analysis and benchmarking studies, cattle inventory management tools and NutriCharge, as well as future products and services. Even if unsuccessful, a product liability claim could result in costly litigation and divert management's attention and resources. We do not maintain product liability insurance. We expect our quarterly operating results to fluctuate. If we fail to meet the expectations of public market analysts and investors, the market price of our common stock could decline. We expect that our revenue and operating results will vary in the future as a result of a number of factors. Our quarterly results of operations may not meet the expectations of securities analysts and investors, which could cause the price of our common stock to decline. Our operating results in the future may not follow any prior trends and should not be relied as an indication of future results. The factors that affect our quarterly operating results include: - Our ability to retain existing customers and attract new customers; - Our ability to develop and market new and enhanced products and services on a timely basis; - The introduction of new or enhanced Web sites, products and services by us; - Continued purchases by our existing customers; and - Future revenues from our equine imaging system, a decline in which may result in disproportionate fluctuations in our results of operations, since related manufacturing costs to a large extent remain fixed regardless of the number of units sold. In addition, a number of factors that are beyond our control will also affect our quarterly operating results, such as: - Demand for our products and services; - Product and price competition; - The introduction of new or enhanced Web sites, products and services by our competitors; and - Significant downturns in our targeted markets. Our quarterly results could fluctuate as a result of seasonal fluctuations in the cattle industry. The cattle industry has historically experienced, and may continue to experience, seasonal fluctuations. These seasonal patterns may cause quarterly fluctuations in our operating results. In particular, a disproportionate number of cattle are sold to feedlots during the third and fourth quarters of each calendar year. Therefore, a greater number of sales transactions occur during these two calendar quarters. Due to our limited operating history and the recent changes in our business as a result of acquisitions, it is difficult to predict the effect that this seasonal pattern will have on our revenue and quarterly operating results. 30 31 Our back-up mechanisms are unproven, and therefore are vulnerable to damage or interruption which would harm our ability to reliably service our customers. Our network server, satellites, computers and facilities are vulnerable to damage or interruption from a number of sources, including fire, flood, power loss, earthquakes, telecommunications failures, system failures, Internet brownouts, computer viruses, electronic break-ins and similar disruptions. We depend on these systems to provide our customers with online cattle sales and auction services, feedlot and cattle industry analyses, cattle inventory management tools and the sale of NutriCharge. During the past year, we experienced a system interruption caused by adverse weather conditions, which resulted in our system shutting down for approximately 24 hours. We may experience such an interruption in the future. Any substantial interruptions could result in the loss of data and could impair our ability to provide our products and services to customers and to generate revenues. Presently, we do not have a formal disaster recovery plan in effect. Moreover, our business interruption insurance may not be sufficient to compensate us for losses that may occur if any of our Internet-based services are interrupted. We intend to expand our business to international markets. The additional expenses and risks relating to our international expansion may harm our business, financial condition and results of operations. As part of our business strategy, we intend to expand internationally by offering our products and services in markets within North and South America, Asia/Pacific and Europe, although we have not yet completed the development of our plan for international expansion. International expansion may require significant management attention, which could negatively impact our business. We may also incur significant costs in order to enter new international markets, which could harm our results of operations. Our business would be harmed if: - We experience difficulty expanding as a result of foreign laws and regulations, including export and import regulations applicable to commerce conducted across borders within regions; - We experience difficulty in tailoring our products and services to international markets; and - We experience difficulty in enforcing contractual obligations and intellectual property rights in foreign countries. If we successfully expand into foreign markets, our international business and our results of operations could be harmed as the result of: - Fluctuations in foreign exchange rates or rates of inflation; - Recessions in foreign countries; - Adverse U.S. and foreign tax laws; and - Political and economic instability. If electronic commerce does not continue to grow as expected, our business, financial condition and results of operations will be harmed. Our long-term success depends on widespread market acceptance of the Internet and online commercial services as a medium for commerce. If the Internet commerce market does not grow or grows more slowly than anticipated, our business, financial condition and results of operations will be harmed. A number of factors could prevent such acceptance, including: - The early stage of the Internet; - The lack of continued development of the Internet's technological infrastructure; and 31 32 - Consumer concern about the security of electronic commerce transactions. If the Internet or our Web sites and systems cannot support the growth in electronic commerce, our business, financial condition and results of operations will be harmed. If the Internet fails to evolve to support growth in electronic commerce, our business, financial condition and results of operations will be harmed. Specifically, we would be harmed if: - The infrastructure of the Internet does not evolve to sufficiently support the substantial growth in usage of the Internet and therefore cannot process a growing number of transactions; and - The availability of telecommunication services is insufficient or telecommunication services do not evolve promptly to support real-time interactions with customers. If we do not continue to develop our Web sites and systems to sufficiently support growth in the demand for our services, our business will also be harmed. Specifically, we would be harmed if: - We fail to expand our infrastructure, including our Web sites, internet software and servers to accommodate an increased number of users; and - We fail to adapt our products and services to be compatible with new technology, and are therefore unable to provide our services to users of the new technology. We may also need to devote substantial resources to updating our Web sites and online services to support the growth of online commerce. Risks associated with the security of transactions and transmitting confidential information over the Internet may negatively impact our electronic commerce business. We believe that concern regarding the security of confidential information transmitted over the Internet, such as credit card numbers and proprietary data, may prevent many potential customers from engaging in online transactions and may harm our business. We intend to use authentication technology, which requires passwords and other information to prevent unauthorized persons from accessing a customer's information, or encryption, which transforms information into a code designed to be unreadable by third parties, to protect confidential information. In addition, despite the measures we intend to take, our infrastructure is potentially vulnerable to physical or electronic break-ins, viruses or similar problems. If our security measures are circumvented, proprietary information could be misappropriated or our operations could be interrupted. Security breaches that result in access to confidential information could expose us to a risk of loss or liability. If we do not adequately address these concerns or face any claims in connection with a breach of security, our business, financial condition and operating results could be harmed. We could face liability for information retrieved from or transmitted through our Web sites, which could result in high litigation or insurance costs. As a publisher and distributor of online content, we face potential liability for defamation, negligence, copyright, patent or trademark infringement and other claims based on the nature and content of the materials that we publish or distribute on our Web sites. Any imposition of liability could negatively impact our reputation and result in increased insurance costs. Claims have been successfully brought against online services. Although we carry general liability insurance, our insurance may not cover claims of these types or may not be adequate to cover us for all liability that may be imposed. 32 33 Government regulation and legal uncertainties could result in additional burdens to doing business on the Internet. The laws governing the Internet remain largely unsettled, even in areas where there has been some legislative action. It may take years to determine whether and how existing laws including those governing intellectual property, privacy, libel and taxation apply to the Internet. Our business, results of operations and financial condition could be harmed by the adoption or modification of laws or regulations relating to the Internet that result in the imposition of additional cost on conducting business over the Internet or impose additional restrictions on our ability to conduct our business operations. In 1998, the Internet Tax Freedom Act placed a three-year moratorium on state and local taxes on Internet access, except for taxes imposed prior to October 1, 1998, and on taxes that discriminate against online commerce. However, Congress may not renew this legislation in 2001 and state and local governments would be able to impose Internet-specific taxes on goods purchased electronically, in addition to taxes that are otherwise imposed on sales transactions. Laws and regulations that apply to Internet communications, commerce and advertising could increase the costs of communicating on the Web and adversely affect the demand for our products and services and thereby harm our business, results of operations and financial conditions. In addition, as a general matter, laws and regulations may also be adopted in the future covering e-commerce issues such as user privacy, pricing, content, copyrights, distribution, antitrust matters, taxation and quality of products and services that may increase the cost of e-commerce. Several telecommunications carriers have asked the Federal Communications Commission to regulate telecommunications connections to the Internet, which could result in higher costs of doing business over the Internet. Legislation of these kinds could hinder growth in the use of the Internet and decrease the acceptance of the Internet as a communications and commercial medium. Due to the global nature of the Internet, it is possible that governments of foreign countries might attempt to regulate our transmissions or levy sales or other taxes relating to our activities and we may incur significant costs to comply with foreign laws. Furthermore, the European Union recently adopted a directive addressing data privacy that may result in limits on the collection and use of user information. In addition, the growth and development of the market for Internet commerce may prompt calls for more stringent consumer protection laws, both in the United States and abroad, that may impose additional burdens on companies conducting business over the Internet. There is intense competition for Internet products and services, which could reduce our market share and harm our financial performance. Competition for Internet products and services and electronic commerce is intense. We expect that competition will continue to intensify. Barriers to entry are minimal, and competitors can launch new Web sites at a relatively low cost. Our competitors, such as traditional cattle auction services, video cattle auction providers, online cattle auction services, cattle and livestock information services and cattle industry product manufacturers, may develop Internet products or services that are superior to, or have greater market acceptance, than our products and services. If we are unable to compete successfully against our competitors, our business, financial condition and operating results will be harmed. Internet Capital Group, Safeguard and XL Vision will be able to control matters requiring stockholder approval. The concentration of ownership of our common stock may delay, deter or prevent acts that would result in a change of control, which could reduce the market price of our common stock. Internet Capital Group and Safeguard are affiliated entities and Safeguard and XL Vision are affiliated entities. Internet Capital Group, Safeguard and XL Vision together have the power to vote approximately 66.4% (as of March 17, 2000) of the aggregate number of votes to which the holders of our common stock are entitled. In addition, Safeguard and Internet Capital Group are parties to a joint venture agreement under which they have agreed to use their best efforts to vote together on matters submitted to stockholders for approval. As a result, these stockholders will be able to control all matters requiring stockholder approval. Matters that typically require stockholder approval include: 33 34 - Election of directors; - Approval of a merger or consolidation; and - Approval of a sale of all or substantially all of our assets. Of the seven members of our board of directors, the following four directors also serve as directors and/or officers of Internet Capital Group, Safeguard or XL Vision: - John S. Scott, Chairman of our board of directors, is the Chief Executive Officer and the Chairman of the board of directors of XL Vision; - Douglas A. Alexander, a member of our board of directors, is the Managing Director of Internet Capital Group; - Anthony A. Ibarguen, a member of our board of directors, is a Managing Director of Internet Capital Group; and - John W. Poduska, Sr., Ph.D., a member of our board of directors, is a member of the board of directors of Safeguard and a member of the board of directors of XL Vision. In addition, Internet Capital Group has the right to elect two directors to our board, one of which has not yet been designated. Under the joint venture agreement, Safeguard and Internet Capital Group have agreed to vote for two designees of Safeguard and two designees of Internet Capital Group in all future elections of directors. Safeguard, XL Vision and Internet Capital Group will therefore have the ability to significantly influence our management. The sale of outstanding shares in the market by our existing stockholders in the future may adversely affect our stock price. If our stockholders sell substantial amounts of our common stock, including shares issued upon the exercise of outstanding options and warrants, then the market price of our common stock could fall. Based upon the 33,031,395 shares outstanding as of March 17, 2000: - 8,675,000 shares are freely tradeable in the public market; - 24,007,080 shares may be sold subject to compliance with Rule 144, of which 11,312,633 shares may be sold without restriction under Rule 144(k) if they are not held by our affiliates; and - 349,315 shares may be sold 90 days after February 4, 2000, subject to compliance with Rule 701. Although 23,131,956 of the shares described above are subject to lock-up agreements, such shares may become tradeable, subject to compliance with Rule 144 or Rule 701, beginning 180 days after February 4, 2000. In addition, as of December 31, 1999 there are options to purchase 2,769,116 shares of class A common stock outstanding that were granted under our equity compensation plans. We intend to file a registration statement on Form S-8 to register the shares issued pursuant to the exercise of options granted under our equity compensation plans. There is also a warrant to purchase 1,138,889 shares of class B common stock outstanding. Our common stock price is likely to be highly volatile. 34 35 The market price of our common stock, like the market for Internet-related and technology companies in general, has been and will likely continue to be highly volatile. Any significant fluctuations in the future might result in a material decline in the market price of our common stock. The price at which our common stock trades is likely to be highly volatile and may fluctuate substantially due to factors such as: - Actual or anticipated variations in quarterly operating results; - Announcements of technological innovations; - Conditions or trends in the cattle industry; - New sales formats of new products or services; - Changes in or failure by us to meet financial estimates of securities analysts; - Conditions or trends in the Internet industry; - Announcements by us or our competitors of significant acquisitions, strategic partnerships or joint ventures; - Capital commitments; - Additions or departures of key personnel; and - Sales of common stock. In addition, the U.S. stock markets have from time to time experienced significant price and volume fluctuations that have affected the market prices for the common stock of technology companies, particularly Internet companies. In the past, these broad market fluctuations have been unrelated or disproportionate to the operating performance of these companies. In the past, following periods of volatility in the market price of a particular company's securities, securities class action litigation has often been brought against that company. We may become involved in this type of litigation in the future. Litigation is often expensive and diverts the attention and resources of management, which could harm our business and operating results. Our undesignated preferred stock may deter potential acquisition bids for our business. Our board of directors may issue up to 15,000,000 shares of preferred stock in one or more series. The board of directors can fix the number of shares of each class and the voting rights, preferences, limitations and special rights, if any, without any further vote or action by our stockholders. The issuance of shares of preferred stock without further action by our stockholders may delay or prevent a change in control transaction. The issuance of shares of preferred stock may adversely affect your relative voting and other rights relating to your shares of common stock. Delaware law may deter potential bids for our business. We are subject to the anti-takeover provisions of the Delaware General Corporation Law, which regulates corporate acquisitions. Delaware law prevents us from engaging in a business combination with any interested stockholder for three years following the date that the stockholder became an interested stockholder. For purposes of Delaware law, a business combination includes a merger or consolidation involving us and the interested stockholder and the sale of more than 10% of our assets. In general, Delaware law defines an interested stockholder as any entity or person beneficially owning 15% or more of the outstanding voting stock of a corporation and any entity or person 35 36 affiliated with or controlling or controlled by such entity or person. Under Delaware law, a Delaware corporation may opt out of the anti-takeover provisions. We do not intend to opt out of these anti-takeover provisions. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK We held no derivative securities as of December 31, 1999. We are exposed to changes in interest rates as a result of our borrowings from XL Vision and Safeguard, which are based on the prime lending rate. A 10% increase in interest rates related to our borrowings would not have a material effect on our result of operations over the next fiscal year or the fair value of our borrowings. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The consolidated financial statements of the Company are submitted as a separate section of this report beginning on page F-1. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT We incorporate by reference the information contained under the captions "Election of Directors (Item 1 on Proxy Card)" and "Section 16(a) Beneficial Ownership Reporting Compliance" in our Definitive Proxy Statement relative to our annual meeting of shareholders, to be filed within 120 days after the end of the year covered by this Form 10-K Report pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended. We also incorporate by reference "Executive Officers of the Registrant" as set forth under Item 4A of this Report on Form 10-K. ITEM 11. EXECUTIVE COMPENSATION We incorporate by reference the information contained under the captions "Executive Compensation" and "Other Forms of Compensation" in our Definitive Proxy Statement relative to its annual meeting of shareholders, to be filed within 120 days after the end of the year covered by this Form 10-K Report pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT We incorporate by reference the information contained under the caption "Security Ownership of Certain Beneficial Owners and Directors and Officers" in our Definitive Proxy Statements relative to our annual meeting of shareholders, to be filed within 120 days after the end of the year covered by this Form 10-K Report pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS We incorporate by reference the information contained under the caption "Certain Relationships and Related Transactions" in its Definitive Proxy Statement relative to its annual meeting of shareholders, to be filed within 120 days after the end of the year covered by this Form 10-K Report pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended. 36 37 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AN REPORTS ON FORM 8-K (a) Documents Filed with Report 1. The Consolidated Financial Statements and Schedules listed below are located after the signature page beginning on page F-1:
DESCRIPTION PAGE NO. ----------- -------- Independent Auditors' Reports............................... F-1 Consolidated Balance Sheets -- December 31, 1998 and 1999.. F-2 Consolidated Statements of Operations -- December 31, 1997 1998 and 1999.......................................... F-3 Consolidated Statements of Stockholders' Equity -- December 31, 1998 and 1999............................. F-4 Consolidated Statements of Cash Flows....................... F-5 Notes to Consolidated Financial Statements.................. F-7
2. Financial Statement Schedules: Not required or the information required to be included therein is reflected in the Financial Statements. 3. Exhibits
EXHIBIT NUMBER DESCRIPTION REFERENCE ------- ----------- --------- 1.1 Form of Underwriting Agreement. * 1.2 Form of Standby Stock Purchase Agreement. * 3.1 Second Amended and Restated Certificate of Incorporation of eMerge Interactive. * 3.2 Amended and Restated Bylaws of eMerge Interactive. * 10.1 Amended and Restated 1996 Equity Compensation Plan. * 10.2 1999 Equity Compensation. * 10.3 Master License Agreement dated July 29, 1998 between eMerge Interactive and Her Majesty the Queen of Canada, as represented by the Minister of Agriculture and Agri-Food Canada. ** 10.4 Administrative Services Agreement dated December 15, 1997 between eMerge Interactive, Safeguard Scientifics, Inc. and XL Vision, Inc., as amended on August 17, 1999. * 10.5 Direct Charge Administrative Services Agreement dated April 15, 1997 between eMerge Interactive and XL Vision, Inc. * 10.6 Asset Purchase Agreement dated February 24, 1999 between eMerge Interactive, CIN, LLC and Dr. Scott Crain. * 10.7 Stock Purchase Agreement dated March 22, 1999 between eMerge Interactive, Cyberstockyard, Inc. and J. Scott Sanders, David Sanders, Scott Calhoun and Dr. Duane Pankratz * 10.8 Stockholders Agreement dated July 29, 1998 among eMerge Interactive, and individuals designated as the former shareholders of STS Agriventures, Ltd. * 10.9 Purchase Agreement dated July 29, 1998 among eMerge Interactive, NutriCharge, J Technologies, LLC, and the Biegert Family Irrevocable Trust. * 10.10 Asset Purchase Agreement dated January 15, 1999 between eMerge Interactive and Sperry Marine, Inc. * 10.11 Purchase and License Agreement dated January 15, 1999 between eMerge Interactive and Sperry Marine, Inc. * 10.12 Asset Purchase Agreement dated May 19, 1999 between eMerge Interactive and Professional Cattle Consultants, L.L.C. * 10.13 Letter of Agreement dated January 12, 2000 between eMerge Interactive and Southern States, Cooperative, Inc. * 10.14 Subscription Agreement letter for purchase of Series B Junior Preferred Stock. * 10.15 Preferred Stock Purchase Agreement dated April 1, 1999 (Series C Preferred Stock). * 10.16 Common Stock Purchase Agreement dated August 16, 1999 between eMerge Interactive and Turnkey Computer Systems, Inc. * 10.17 Registration Rights Agreement dated July 18, 1997. * 10.18 Real Property Sublease between XL Vision and eMerge Interactive, dated December 1999. * 10.19 Stockholders' and Registration Rights Agreement dated February 24, 1999. * 10.20 Joinder and Correction to Stockholders and Registration Rights Agreement dated March 29, 1000. * 10.21 (a) Revolving Note dated July 21, 1999 from eMerge Interactive to Safeguard Delaware, Inc., Amended Revolving Note dated August 3, 1999, * (b) Second Amended Revolving Note dated October 25, 1999, * (c) Third Amended Revolving Note dated December 6, 1999 and * (d) Fourth Amended Revolving Note dated January 31, 2000. * 10.22 Revolving Note dated January 1, 1999 from XL Vision to eMerge Interactive. * 10.23 Promissory Note dated August 31, 1999 from eMerge Interactive to Safeguard Delaware, Inc. (cancelled). * 10.24 Term note dated October 25, 1999 from eMerge Interactive to Safeguard. * 10.25 Promissory Note dated October 6, 1999 from eMerge Interactive to Safeguard Delaware, Inc. (cancelled). * 10.26 Stockholders Agreement dated July 17, 1997 and Joinder to Stockholder's Agreement. * 10.27 Subordinated Purchase Money Note from eMerge Interactive to XL Vision dated July 15, 1997. * 10.28 Toll Processing Agreement dated August 16, 1999 between eMerge Interactive and ADM Animal Health & Nutrition, a division of Archer-Daniels-Midland Company. * 10.29 Term Note dated October 25, 1999 from eMerge Interactive to Safeguard Delaware, Inc. * 10.30 Securities Purchase Agreement dated October 27, 1999 between eMerge Interactive Technologies, LLC and Internet Capital Group, Inc. * 10.31 Registration Rights Agreement dated October 27, 1999 between eMerge Interactive and Internet Capital Group, Inc. * 10.32 Cooperative Research and development Agreement between USDA's Agricultural Research Service, eMerge and Iowa State University of Science and Technology concerning Methods for Detecting Fecal and Ingesta Contamination on Meat dated on Meat dated August 4, 1999. * 10.33 Exclusive License Agreement between Iowa State University Research Foundation, Inc., and eMerge dated August 3, 1999. * 10.34 Term Note and Pledge Agreement dated January 28, 2000 between eMerge and Charles Abraham. * 21.1 Subsidiaries of the Registrant. * 27.1 Financial Data Schedule. ** 99.1 Form letter from eMerge Interactive, Inc. to holders of more than 100 shares of Safeguard Scientifics, Inc. describing the Safeguard Subscription Program. * 99.2 Form of letter from Adams, Harkness & Hill, Inc. to Safeguard Scientific Inc. shareholders. * 99.3 Form of letter from eMerge Interactive, Inc. to Brokers describing the Safeguard Subscription Program. * 99.4 Form of Subscription Form for Safeguard Subscription Program. *
* Exhibit and exhibit number incorporated by reference to Registration Statement No. 333-89815, dated February 4, 2000. ** Filed herewith. 38 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Dated: March 31, 2000 eMerge Interactive, Inc. By: /s/ Charles L. Abraham President Chief Executive -------------------------------------- Officer and Director (Principal Charles L. Abraham Executive Officer) /s/ T. Michael Janney Vice President and Chief -------------------------------------- Financial Officer (principal T. Michael Janney financial and accounting officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities and on the date indicated.
Name Title Date ---- ----- ---- /s/ Charles L. Abraham President, Chief Executive Officer March 31, 2000 - -------------------------------------- and Director (principal Charles L. Abraham executive officer) /s/ Michael Janney Vice Chairman and Chief Financial March 31, 2000 - -------------------------------------- Officer (principal financial Michael Janney and accounting officer) /s/ John S. Scott Chairman of the Board March 31, 2000 - -------------------------------------- John S. Scott /s/ Douglas A. Alexander Director March 31, 2000 - -------------------------------------- Douglas A. Alexander /s/ Thomas C. Lynch Director March 31, 2000 - -------------------------------------- Thomas C. Lynch /s/ John W. Poduska Director March 31, 2000 - -------------------------------------- John W. Poduska /s/ Anthony A. Ibarguen Director March 31, 2000 - -------------------------------------- Anthony A. Ibarguen
39 INDEPENDENT AUDITORS' REPORT To the Board of Directors of eMerge Interactive, Inc.: We have audited the accompanying consolidated balance sheets of eMerge Interactive, Inc. as of December 31, 1998 and 1999 and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1999. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of eMerge Interactive, Inc. at December 31, 1998 and 1999 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1999 in conformity with generally accepted accounting principles. /s/ KPMG LLP Orlando, Florida February 7, 2000, except for Note 14 which is as of February 17, 2000 F-1 40 eMERGE INTERACTIVE, INC. CONSOLIDATED BALANCE SHEETS December 31, 1998 and 1999
PROFORMA ASSETS 1998 1999 1999 ------------ ------------ ------------ (UNAUDITED) Current assets: Cash $ 268 $ 12,316,497 $ 12,316,497 Trade accounts receivable, less allowance for doubtful accounts of $0 in 1998 and $75,000 in 1999. 68,421 1,144,133 1,144,133 Inventories (note 3) 706,557 1,201,203 1,201,203 Cattle deposits -- 473,859 473,859 Prepaid expenses 27,837 71,078 71,078 Net assets of discontinued operations (note 12) 2,285,341 297,003 297,003 Other current assets -- 136,349 136,349 ------------ ------------ ------------ Total current assets 3,388,424 15,640,122 15,640,122 Property and equipment, net (note 4) 513,837 1,895,754 1,895,754 Capitalized offering costs -- 447,644 447,644 Investment in Turnkey Computer Systems, Inc. (note 5) -- 1,822,833 1,822,833 Intangibles, net (note 6) 2,699,828 5,955,360 5,955,360 ------------ ------------ ------------ Total assets $ 6,602,089 $ 25,761,713 25,761,713 ============ ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current installments of capital lease obligation with related party (note 10) $ 79,852 $ 82,320 $ 82,320 Note payable (note 5) -- 500,000 500,000 Accounts payable 423,946 1,187,900 1,187,900 Accrued liabilities: Salaries and benefits 283,103 967,749 967,749 Other 319,989 818,041 818,041 Advance payments from customers -- 222,750 222,750 Due to related parties (note 10) 5,187,334 12,053,715 12,053,715 ------------ ------------ ------------ Total current liabilities 6,294,224 15,832,475 15,832,475 Capital lease obligation with related party, excluding current installments (note 10) 305,018 224,068 224,068 Note payable (note 5) -- 400,000 400,000 ------------ ------------ ------------ Total liabilities 6,599,242 16,456,543 16,456,543 ------------ ------------ ------------ Commitments and contingencies (notes 10 and 13) Subsequent event (note 14) Redeemable Class A common stock, no shares issued and outstanding in 1998, 62,500 shares issued and outstanding in 1999, no shares issued and outstanding pro forma (note 5) -- 414,339 -- ------------ ------------ ------------ Stockholders' equity (notes 7, 9, 10 and 14): Preferred stock, $.01 par value, authorized 15,000,000 shares: Series A preferred stock, (aggregate involuntary liquidation preference of $7,386,314 in 1998 and $8,030,675 in 1999), designated 6,500,000 shares, issued and outstanding 6,443,606 shares in 1998 and 1999; no shares issued and outstanding proforma 64,436 64,436 -- Series B junior preferred stock, (aggregate involuntary liquidation preference of $4,801,315 in 1998 and $5,281,316 in 1999), designated 2,400,000 shares, issued and outstanding 2,400,000 shares in 1998 and 1999; no shares issued and outstanding proforma 24,000 24,000 -- Series C preferred stock, (aggregate liquidation preference of $0 in 1998 and $5,891,781 in 1999), designated 1,300,000 shares; issued outstanding -0- shares in 1998 and 1,100,000 shares in 1999; no shares issued and outstanding proforma -- 11,000 -- Series D preferred stock, (aggregate liquidation preference of $0 in 1998 and $41,823,749 in 1999), designated 4,555,556 shares, issued and outstanding no shares in 1998 and 4,555,556 in 1999; no shares issued and outstanding proforma -- 45,556 -- Common stock, $.008 par value, authorized 100,000,000 shares: Class A common stock, designated 92,711,110 shares, issued and outstanding 5,845,625 shares in 1998 and 7,046,444 shares in 1999 and 19,538,452 shares proforma 46,765 56,372 156,308 Class B common stock, designated 7,288,890 shares; no shares issued and outstanding in 1998 and 1999; 5,694,445 shares outstanding proforma -- -- 45,556 Additional paid-in capital 16,648,286 62,312,315 62,726,154 Accumulated deficit (16,780,640) (32,375,926) (32,375,926) Subscription receivable from Internet Capital Group, Inc. -- (21,188,320) (21,188,320) Unearned compensation -- (58,602) (58,602) ------------ ------------ ------------ Total stockholders' equity 2,847 8,890,831 9,305,170 ------------ ------------ ------------ Total liabilities and stockholders' equity $ 6,602,089 $ 25,761,713 $ 25,761,713 ============ ============ ============
See accompanying notes to consolidated financial statements. F-2 41 eMERGE INTERACTIVE, INC. CONSOLIDATED STATEMENTS OF OPERATIONS Years ended December 31, 1997, 1998 and 1999
1997 1998 1999 ----------- ----------- ------------ Revenue (note 11) $ -- $ 1,792,471 $ 43,783,124 Cost of revenue (including $-0-, $511,000 and $343,000 to related parties - notes 10 and 11) -- 2,623,447 43,517,459 ----------- ----------- ------------ Gross profit (loss) -- (830,976) 265,665 ----------- ----------- ------------ Operating expenses: Selling, general and administrative (note 10) 627,606 3,659,810 11,239,188 Research and development (including $51,000, $119,000 and $233,000 to related parties - note 10) 727,753 1,109,382 4,343,783 ----------- ----------- ------------ Total operating expenses 1,355,359 4,769,192 15,582,971 ----------- ----------- ------------ Profit (loss) from continuing operations (1,355,359) (5,600,168) (15,317,306) Related party interest expense (note 10) (141,167) (331,594) (764,042) Interest and other income -- -- 475,642 ----------- ----------- ------------ Profit (loss) from continuing operations before income taxes (1,496,526) (5,931,762) (15,605,706) Income tax expense (benefit) (note 8) -- -- -- ----------- ----------- ------------ Profit (loss) from continuing operations (1,496,526) (5,931,762) (15,605,706) Discontinued operations (note 12): Income (loss) from operations of discontinued transportation segment (including $814,000, $370,000 and $171,000 to related parties - note 10) (3,987,097) (1,808,951) 10,420 Loss on disposal of transportation segment -- (91,415) -- ----------- ----------- ------------ Net profit (loss) $(5,483,623) $(7,832,128) $(15,595,286) =========== =========== ============ Net profit (loss) attributable to common shareholders $(5,483,623) $(7,832,128) $(21,133,237) =========== =========== ============ Net profit (loss) from continuing operations per common share -- basic and diluted $ (3.91) $ (1.36) $ (3.11) =========== =========== ============ Net profit (loss) per common share -- basic and diluted $ (14.34) $ (1.80) $ (3.11) =========== =========== ============ Weighted average number of common shares outstanding -- basic and diluted 382,273 4,356,926 6,794,755 =========== =========== ============
See accompanying notes to consolidated financial statements. F-3 42 eMERGE INTERACTIVE, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY DECEMBER 31, 1998 AND 1999
PREFERRED STOCK PREFERRED STOCK PREFERRED STOCK PREFERRED STOCK COMMON STOCK SERIES A SERIES B SERIES C SERIES D CLASS A ------------------- ------------------- ------------------ ------------------- ------------------ SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT --------- ------- --------- ------- --------- ------- --------- ------- --------- ------- Balances at December 31, 1996 -- $ -- -- $ -- -- $ -- -- $ -- 450,000 $ 3,600 Issuance of common stock to XL Vision, Inc., for cash at $.008 per share (note 10) -- -- -- -- -- -- -- -- 2,808,125 22,465 Sale of Series A preferred stock for cash at $1.00 per share (note 6) 6,443,606 64,436 -- -- -- -- -- -- -- -- Transfer of technology by XL Vision, Inc. (note 10) -- -- -- -- -- -- -- -- -- -- Net profit (loss) -- -- -- -- -- -- -- -- -- -- --------- ------- --------- ------- --------- ------- --------- ------- --------- ------- Balances at December 31, 1997 6,443,606 64,436 -- -- -- -- -- -- 3,258,125 26,065 Contribution of debt to equity by XL Vision, Inc. (note 10) -- -- -- -- -- -- -- -- -- -- Issuance of Series B preferred stock in exchange for contribution of debt to equity by XL Vision, Inc. at $2.00 per share (note 10) -- -- 2,400,000 24,000 -- -- -- -- -- -- Issuance of common stock in connection with Nutri-Charge transaction at $0.80 per share (note 6) -- -- -- -- -- -- -- -- 2,587,500 20,700 Contribution of put rights by XL Vision, Inc. (note 6) -- -- -- -- -- -- -- -- -- -- Net profit (loss) -- -- -- -- -- -- -- -- -- -- --------- ------- --------- ------- --------- ------- --------- ------- --------- ------- Balances at December 31, 1998 6,443,606 64,436 2,400,000 24,000 -- -- -- -- 5,845,625 46,765 Exercise of stock options for cash at $.80 per share -- -- -- -- -- -- -- -- 200,819 1,607 Issuance of common stock in connection with CIN transaction at $0.96 per share (note 6) -- -- -- -- -- -- -- -- 750,000 6,000 Issuance of common stock in connection with Cyberstockyard transaction at $1.80 per share (note 6) -- -- -- -- -- -- -- -- 250,000 2,000 Issuance of Series C preferred stock at $5.00 per share (note 7) -- -- -- -- 1,100,000 11,000 -- -- -- -- Issuance of Series D preferred stock at $9.00 per share, including beneficial conversion feature of $5,523,612 (note 10) -- -- -- -- -- -- 4,555,556 45,556 -- -- Beneficial conversion feature (note 10) -- -- -- -- -- -- -- -- -- -- Issuance of warrant (note 10) -- -- -- -- -- -- -- -- -- -- Accretion to redemption value of Class A common stock issued in connection with the Turnkey Computer Systems, Inc. transaction (note 5) -- -- -- -- -- -- -- -- -- -- Accretion of imputed interest on note receivable from Internet Capital Group, Inc. (note 10) -- -- -- -- -- -- -- -- -- -- Net profit (loss) -- -- -- -- -- -- -- -- -- -- Unearned compensation (note 9) -- -- -- -- -- -- -- -- -- -- Amortization of unearned compensation (note 9) -- -- -- -- -- -- -- -- -- -- --------- ------- --------- ------- --------- ------- --------- ------- --------- ------- Balances at December 31, 1999 6,443,606 $64,436 2,400,000 $24,000 1,100,000 $11,000 4,555,556 $45,556 7,046,444 $56,372 ========= ======= ========= ======= ========= ======= ========= ======= ========= =======
NOTE RECEIVABLE COMMON STOCK FROM CLASS B ADDITIONAL INTERNET ------------------- PAID-IN ACCUMULATED CAPITAL UNEARNED SHARES AMOUNT CAPITAL DEFICIT GROUP, INC. COMPENSATION TOTAL --------- ------- ---------- ------------- ------------ ------------ ------------ Balances at December 31, 1996 -- $ -- $ 3,816 $ (3,464,889) $ -- -- $ (3,457,473) Issuance of common stock to XL Vision, Inc., for cash at $.008 per share (note 10) -- -- -- -- -- -- 22,465 Sale of Series A preferred stock for cash at $1.00 per share (note 6) -- -- 6,379,170 -- -- -- 6,443,606 Transfer of technology by XL Vision, Inc. (note 10) -- -- (4,400,000) -- -- -- (4,400,000) Net profit (loss) -- -- -- (5,483,623) -- -- (5,483,623) --------- ------- ---------- ------------ ------------ ------- ------------ Balances at December 31, 1997 -- -- 1,982,986 (8,948,512) -- -- (6,875,025) Contribution of debt to equity by XL Vision, Inc. (note 10) -- -- 7,500,000 -- -- -- 7,500,000 Issuance of Series B preferred stock in exchange for contribution of debt to equity by XL Vision, Inc. at $2.00 per share (note 10) -- -- 4,776,000 -- -- -- 4,800,000 Issuance of common stock in connection with Nutri-Charge transaction at $0.80 per share (note 6) -- -- 2,049,300 -- -- -- 2,070,000 Contribution of put rights by XL Vision, Inc. (note 6) -- -- 340,000 -- -- -- 340,000 Net profit (loss) -- -- -- (7,832,128) -- -- (7,832,128) --------- ------- ---------- ------------ ------------ ------- ------------ Balances at December 31, 1998 -- -- 16,648,286 (16,780,640) -- -- 2,847 Exercise of stock options for cash at $.80 per share -- -- 185,798 -- -- -- 187,405 Issuance of common stock in connection with CIN transaction at $0.96 per share (note 6) -- -- 714,000 -- -- -- 720,000 Issuance of common stock in connection with Cyberstockyard transaction at $1.80 per share (note 6) -- -- 448,000 -- -- -- 450,000 Issuance of Series C preferred stock at $5.00 per share (note 7) -- -- 5,489,000 -- -- -- 5,500,000 Issuance of Series D preferred stock at $9.00 per share, including beneficial conversion feature of $5,523,612 (note 10) -- -- 40,967,503 -- (20,815,000) -- 20,198,059 Beneficial conversion feature (note 10) -- -- (5,523,612) -- -- -- (5,523,612) Issuance of warrant (note 10) -- -- 3,325,553 -- -- -- 3,325,553 Accretion to redemption value of Class A common stock issued in connection with the Turnkey Computer Systems, Inc. transaction (note 5) -- -- (14,339) -- -- -- (14,339) Accretion to redemption value of note receivable from Internet Capital Group, Inc. (note 10) -- -- -- (373,320) -- (373,320) Net profit (loss) -- -- -- (15,595,286) -- -- (15,595,286) Unearned compensation (note 9) -- -- 72,126 -- -- (72,126) -- Amortization of unearned compensation (note 9) -- -- -- -- -- 13,524 13,524 --------- ------- ---------- ------------ ------------ ------- ------------ Balances at December 31, 1999 -- $ -- 62,312,315 $(32,375,926) $(21,188,320) (58,602) $ 8,890,831 ========= ======= ========== ============ ============ ======= ============
See accompanying notes to consolidated financial statements. F-4 43 eMERGE INTERACTIVE, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Years ended December 31, 1997, 1998 and 1999
1997 1998 1999 ----------- ----------- ------------ Cash flows from operating activities: Net profit (loss) $(5,483,623) $(7,832,128) $(15,595,286) Adjustments to reconcile net profit (loss) to net cash used in operating activities: Depreciation and amortization 122,486 438,576 1,770,571 Accretion of imputed interest on note receivable -- -- (373,320) Amortization of unearned compensation -- -- 13,524 Changes in operating assets and liabilities: Trade accounts receivable, net -- (368,421) (759,162) Inventories (635,963) (70,594) (494,646) Cattle deposits -- -- (473,859) Prepaid expenses and other assets (32,338) 5,805 (179,590) Net assets of discontinued operations (853,501) (1,140,425) -- Accounts payable 719,694 (301,423) 593,645 Accrued liabilities 198,759 328,791 (343,729) Advance payments from customers -- -- 222,750 ----------- ----------- ------------ Net cash used by operating activities (5,964,486) (8,939,819) (15,619,102) ----------- ----------- ------------ Cash flows from investing activities: Proceeds from sale of discontinued operations -- -- 1,927,230 Purchases of property and equipment (506,540) (460,290) (1,672,461) Purchases of intangibles -- (431,923) (25,002) Business combinations, net of cash acquired of $737 -- -- (1,799,263) Investment in Turnkey Computer Systems, Inc. -- -- (22,833) ----------- ----------- ------------ Net cash used by investing activities (506,540) (892,213) (1,592,329) ----------- ----------- ------------ Cash flows from financing activities: Net borrowings from related parties 3,810 9,447,030 6,866,381 Proceeds from capital lease financing with related party -- 440,832 -- Payment on note payable -- -- (500,000) Payments on capital lease obligations -- (55,962) (78,482) Capitalized Offering costs -- -- (447,644) Sale of preferred stock 6,443,606 -- 23,500,000 Sale of common stock 22,465 -- 187,405 ----------- ----------- ------------ Net cash provided by financing activities 6,469,881 9,831,900 29,527,660 ----------- ----------- ------------ Net increase (decrease) in cash (1,145) (132) 12,316,229 Cash - beginning of period 1,545 400 268 ----------- ----------- ------------ Cash - end of period $ 400 $ 268 $ 12,316,497 =========== =========== ============
F-5 44 eMERGE INTERACTIVE, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Years ended December 31, 1997, 1998 and 1999
1997 1998 1999 ---------- ---------- --------- Supplemental disclosures: Cash paid for interest $ -- $ 23,594 $ Non-cash investing and financing activities: Transfer of technology by XL Vision, Inc. (note 10) 4,400,000 -- -- Contribution of debt to equity by XL Vision, Inc. (note 10) -- 7,500,000 -- Issuance of preferred stock in exchange for contribution of debt to equity by XL Vision, Inc. (note 10) -- 4,800,000 -- Non-cash issuance of Class A common stock in connection with Nutri-Charge transaction (note 6) -- 2,070,000 -- Contribution of put rights by XL Vision, Inc. (note 6) -- 340,000 -- Issuance of Class A common stock in connection with CIN transaction (note 6) -- -- 720,000 Issuance of Class A common stock with Cyberstockyard transaction (note 6) -- -- 450,000 Issuance of redeemable Class A common stock with Turnkey Computer Systems, Inc. transaction (note 5) -- -- 400,000 Issuance of note payable to Turnkey Computer Systems, Inc. (note 5) -- -- 1,400,000
See accompanying notes to consolidated financial statements. F-6 45 EMERGE INTERACTIVE, INC. Notes to Consolidated Financial Statements December 31, 1998 and 1999 (1) ORGANIZATION (a) OVERVIEW eMerge Interactive, Inc. (the "Company") is a Delaware corporation that was incorporated on September 12, 1994 as Enhanced Vision Systems, a wholly owned subsidiary of XL Vision, Inc. ("XL Vision"). The Company's name was changed to eMerge Vision Systems, Inc. on July 16, 1997 and to eMerge Interactive, Inc. on June 11, 1999. The Company was incorporated to develop and commercialize infrared technology focused on the transportation segment. In 1997, the Company entered a new business segment, animal sciences, by developing an infrared camera system for use primarily by veterinarians. The Company further expanded its operations in 1998 by licensing NutriCharge and infrared technology (see note 6) for commercialization. In December 1998, the Company's Board of Directors decided to dispose of the transportation segment. The Company's AMIRIS thermal imaging system, which was the sole product sold by the transportation segment, was sold on January 15, 1999. (b) BASIS OF PRESENTATION The consolidated financial statements include the accounts of eMerge Interactive, Inc. and its wholly-owned subsidiaries, STS Agriventures, Ltd. ("STS"), a Canadian corporation and Cyberstockyard, Inc. ("Cyberstockyard"). All significant intercompany balances and transactions have been eliminated upon consolidation. The proforma balance sheet as of December 31, 1999 assumes the conversion of all redeemable common stock and preferred stock into common stock upon an initial public offering ("IPO"). F-7 46 EMERGE INTERACTIVE, INC. Notes to Consolidated Financial Statements December 31, 1998 and 1999 (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (a) REVENUE RECOGNITION The Company recognizes revenue in accordance with the terms of the sale or contract, generally as products are shipped or services are provided. The Company bears both the inventory and credit risk with respect to sales all of its products. In cattle sales transactions, the Company purchases cattle from the seller, takes title at shipment and records the cattle as inventory until delivered to and accepted buyer, typically a 24 to 48 hour period. In both cattle auction and resale transactions, the Company acts as a principal in purchasing cattle from suppliers and sales to customers so that the Company recognizes revenue equal to the amount paid by customers for the cattle. (b) INVENTORIES Inventories are stated at standard cost which approximates the lower of first-in, first-out cost or market. (c) PROPERTY AND EQUIPMENT Property and equipment are stated at cost. Depreciation of property and equipment is computed using the straight-line method over the estimated useful lives of the assets. Amortization of equipment under capital lease is computed over the shorter of the lease term or the estimated useful life of the related assets. (d) INTANGIBLES Intangibles are stated at amortized cost. Amortization is computed using the straight-line method over the estimated useful lives of the assets. (e) IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF The Company accounts for long-lived assets in accordance with the provisions of SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of ". This Statement requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceed the fair value of the assets. Assets to be disposed of are reported at the lower of their carrying amount or fair value less costs to sell. F-8 47 EMERGE INTERACTIVE, INC. Notes to Consolidated Financial Statements December 31, 1998 and 1999 (f) INCOME TAXES The Company accounts for income taxes using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. (g) STOCK-BASED COMPENSATION Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation," permits entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively, SFAS No. 123 also allows entities to continue to apply the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB Opinion No. 25") and provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants as if the fair-value-based method defined in SFAS No. 123 had been applied. The Company has elected to apply the provisions of APB Opinion No. 25 and provide the pro forma disclosure provisions of SFAS No. 123. (h) USE OF ESTIMATES The preparation of the Company's consolidated financial statements, in conformity with generally accepted accounting principles, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses. Actual results could differ from those estimates. F-9 48 EMERGE INTERACTIVE, INC. Notes to Consolidated Financial Statements December 31, 1998 and 1999 (i) NET PROFIT (LOSS) PER SHARE Net profit (loss) per share is computed in accordance with SFAS No. 128, "Earnings Per Share," by dividing the net profit (loss) allocable to common stockholders (net profit (loss) less accretion related to redeemable Class A common stock and beneficial conversion feature related to Series D preferred stock) by the weighted average number of shares of common stock outstanding less the shares of redeemable Class A common stock. The Company's stock options (338,125 at December 31, 1997, 1,632,500 at December 31, 1998 and 2,769,116 at December 31, 1999) and convertible preferred stock (6,443,606 at December 31, 1997, 8,843,606 at December 31, 1998 and 14,499,162 at December 31, 1999), have not been used in the calculation of diluted net profit (loss) per share because to do so would be anti-dilutive. As such, the numerator and the denominator used in computing both basic and diluted net profit (loss) per share allocable to common stockholders are equal. Pursuant to Securities and Exchange Commission ("SEC") Staff Accounting Bulletin No. 98 and SEC staff policy, all common stock and common stock equivalents issued for nominal consideration during the periods presented herein and through the filing of the registration statement for the IPO are to be reflected in a manner similar to a stock split or stock dividend for which retroactive treatment is required in the calculation of net profit (loss) per share; the Company did not have any such issuances. (j) ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying value of cash, trade accounts receivable, note payable, accounts payable, accrued liabilities and amounts due to related parties reflected in the consolidated financial statements approximates fair value due to the short-term maturity of these instruments. (3) INVENTORIES Inventories consist of:
1998 1999 ---------- ---------- RAW MATERIALS $ 424,130 $ 658,454 WORK-IN-PROCESS 282,427 139,187 CATTLE -- 403,562 ---------- ---------- $ 706,557 $1,201,203 ========== ==========
F-10 49 EMERGE INTERACTIVE, INC. Notes to Consolidated Financial Statements December 31, 1998 and 1999 (4) PROPERTY AND EQUIPMENT Property and equipment consists of:
DECEMBER 31, ------------------------------ ESTIMATED USEFUL 1998 1999 LIVES ---------- ---------- --------- Engineering and manufacturing equipment $ 366,150 $ 673,782 5 years Office and computer equipment 259,462 1,896,741 3 years Furniture and fixtures 104,706 112,122 7 years Leasehold improvements 46,865 80,430 7 years Automobiles -- 54,717 5 years ---------- ---------- 777,183 2,817,792 Less accumulated depreciation and amortization 263,346 922,038 ---------- ---------- Property and equipment, net $ 513,837 $1,895,754 ========== ==========
Assets under capital lease amounted to $440,832 as of December 31, 1998 and 1999. Accumulated amortization for assets under capital lease totaled approximately $152,300 and $239,200 as of December 31, 1998 and 1999, respectively. (5) INVESTMENT IN TURNKEY COMPUTER SYSTEMS, INC. On August 16, 1999, the Company acquired 19% of the common stock of Turnkey Computer Systems, Inc. ("Turnkey") for $1,822,833. The purchase price consisted of 62,500 shares of the Company's redeemable Class A common stock valued at $400,000, $1,400,000 in cash and $22,833 of transaction costs. The $1,400,000 is payable upon the earlier of the completion of the Company's IPO or $500,000 at December 31, 1999 (which was paid in December 1999,) $500,000 at December 31, 2000 and $400,000 at December 31, 2001. This investment is carried on the cost method since the Company does not have significant influence over Turnkey. The common stock purchase agreement with Turnkey contains a put right which allows Turnkey to have a one time right to put to the Company its 62,500 redeemable Class A common shares with a fixed purchase price of $500,000. The put right can only be exercised upon a change in control or after December 31, 2001, if the company has not completed an IPO. This redeemable Class A common stock is classified outside of stockholders' equity as of December 31, 1999. The difference between the carrying amount and the redemption amount of $500,000 is being accreted to redeemable Class A common stock as a charge to additional paid-in capital from issuance to December 31, 2001 using the effective interest method. F-11 50 EMERGE INTERACTIVE, INC. Notes to Consolidated Financial Statements December 31, 1998 and 1999 (6) INTANGIBLES Intangible assets consist of:
DECEMBER 31, ESTIMATED ---------------------------- USEFUL 1998 1999 LIVES ----------- ---------- -------- NutriCharge license $2,273,538 $2,273,538 10 years Infrared technology license 568,385 568,385 5 years Goodwill - CIN -- 2,076,368 5 years Non-compete agreement - CIN -- 100,000 5 years Goodwill - Cyberstockyard -- 427,274 3 years Non-compete agreement - Cyberstockyard -- 100,000 3 years Goodwill - PCC -- 1,487,791 5 years Non-compete agreement - PCC -- 100,000 4 years ---------- ---------- 2,841,923 7,133,356 Less accumulated amortization 142,095 1,177,996 ---------- ---------- Intangibles, net $2,699,828 $5,955,360 ========== ==========
On July 29, 1998, the Company acquired licenses for NutriCharge and infrared technology. The purchase price of $2,841,923 (consisting of $300,000 in cash, 2,587,500 of the Company's Class A common shares valued at $0.80 per share, $131,923 in acquisition costs and the estimated fair value of put rights granted by XL Vision) was allocated to the acquired NutriCharge and infrared technology licenses based on estimated fair values determined by estimated cash flows from the underlying licensed product. In connection with the transaction, XL Vision granted a put right that allows the sellers to require XL Vision to purchase up to 1,250,000 shares of the Company's Class A common stock at $3.00 per share. The fair value of the put was estimated to be $340,000 and was credited to additional paid-in capital. The put right may only be exercised thirty days prior to or after the fourth anniversary of the agreement. The ultimate amount payable under the put agreement is reduced by the amount, if any, of indemnification obligations related to the transaction. The estimated fair value of the put was determined with the assistance of an independent third party valuation expert by calculating the net present value (at 10% interest) of the product of the $2,000,000 intrinsic value of the put adjusted for the 25% probability that the put would be exercised. F-12 51 EMERGE INTERACTIVE, INC. Notes to Consolidated Financial Statements December 31, 1998 and 1999 On February 24, 1999, the Company acquired substantially all of the tangible and intangible assets of CIN, LLC d/b/a Cattle's Information Network ("CIN") for $2,296,610. The purchase price for the assets consisted of 750,000 shares of the Company's Class A common stock valued at $720,000, the assumption of $812,021 of liabilities, a cash payment of $357,816, and an agreement to pay the first $350,000 from Internet sales of third party products over the Company's Web site and transaction costs of $56,773. CIN is in the business of selling access to its cattle feedlot performance measurements database. On March 29, 1999, the Company acquired 100% of the stock of Cyberstockyard, Inc. for $542,265. The purchase price consisted of 250,000 shares of the Company's Class A common stock valued at $450,000, the assumption of $89,972 of liabilities and transaction costs of $2,293. Cyberstockyard, Inc. is in the business of selling cattle through its proprietary auction software over the Internet. On May 19, 1999, the Company acquired substantially all of the tangible and intangible assets of PCC, LLC d/b/a/ Professional Cattle Consultants, L.L.C. ("PCC") for $1,827,861. The purchase price consists of a cash payment of $1,800,000 and an assumption of $2,861 of liabilities and transaction costs of $25,000. PCC is in the business of providing comparative analysis and market information for the feedlot industry. Each acquisition was accounted for as a purchase and the results of operations of the acquired companies is included in the statement of operations since the respective date of acquisition. The aggregate purchase price of the above acquisitions was approximately $4,666,736, which included related acquisition costs of approximately $84,000 and was allocated as follows: Goodwill $3,991,433 Non-compete agreements 300,000 Equipment 358,016 Current assets, including cash acquired of $737 17,287 --------- $4,666,736 =========
Unaudited pro forma information for the Company as if the acquisition above had been consummated as of January 1, 1998 and 1999 follows:
1998 1999 ---------- ------------ Revenue $ 2,282,893 $ 44,005,044 =========== ============ Net profit (loss) $(7,161,345) $(16,074,834) =========== ============ Net profit (loss) attributable to common shareholders $(7,161,345) $(21,612,785) =========== ============ Net profit (loss) per common share $ (1.34) $ (3.10) =========== ============
F-13 52 EMERGE INTERACTIVE, INC. Notes to Consolidated Financial Statements December 31, 1998 and 1999 (7) EQUITY COMMON STOCK As of December 31, 1999, the Company had authorized the issuance of 100,000,000 shares of common stock. CLASS A -- In 1999, the Company designated 92,711,110 as Class A common stock. CLASS B -- In 1999, the Company designated 7,288,890 shares as Class B common stock. Holders of Class B common stock are entitled to two and one-half votes for each share. The shares of Class A and Class B are identical in all other respects. PREFERRED STOCK As of December 31, 1999, the Company had authorized the issuance of 15,000,000 shares of preferred stock and had designated 6,500,000 as Series A shares, and 2,400,000 as Series B shares, 1,300,000 as Series C shares and 4,555,556 as Series D shares. Each share of preferred stock is convertible into 1.25 shares of Class A common stock at the option of the holder or upon the vote of holders of two-thirds of the respective preferred stock class outstanding except for Series D shares which are convertible at the offering price into 1.25 shares of class B common stock. Preferred stock is automatically converted into common stock upon a qualified IPO of at least $10 million with a Company valuation of at least $30 million or upon a public rights offering of the Company to shareholders of Safeguard Scientifics, Inc. F-14 53 EMERGE INTERACTIVE, INC. Notes to Consolidated Financial Statements December 31, 1998 and 1999 SERIES A - The Series A shares are entitled to a liquidation preference before any distribution to common stockholders equal to the greater of (a) $1.00 per share plus an additional $.10 per year (pro rated for partial years) from July 16, 1997 or (b) the amount which would be distributed if all of the preferred stock of the Company were converted to Class A common stock prior to liquidation. The holders of Series A preferred stock are entitled to vote as a separate class to elect two directors to the Board of Directors of the Company. SERIES B - Series B shares are entitled to a liquidation preference before any distribution to common stockholders equal to the greater of (a) $2.00 per share plus an additional $.20 for each year (pro rated for partial years) from December 31, 1998 or until the date of distribution of available assets or (b) the amount which would be distributed if all of the preferred stock of the Company were converted to Class A common stock prior to liquidation. Series B shares are junior to Series A, C and D shares. SERIES C - On April 15, 1999, the Company designated 1,100,000 as Series C shares. Series C shares are entitled to a liquidation preference before any distribution to common stockholders equal to the greater of (a) $5.00 per share plus an additional $.50 for each year (pro rated for partial years) from April 15, 1999 or until the date of distribution of available assets or (b) the amount which would be distributed if all of the preferred stock of the Company were converted to Class A common stock prior to liquidation. Series C shares are on parity with Series A and D shares except as to voting rights. SERIES D - Series D shares are entitled to a liquidation preference before any distribution to common stockholders equal to the greater of (a) $9.00 per share plus an additional $1.00 for each year (pro rated for partial years) from October 27, 1999 or until the date of distribution of available assets or (b) the amount which would be distributed if all the preferred stock of the Company were converted to Class B common stock prior to liquidation. Series D shares are on parity with Series A and C shares except as to voting rights. Series D stockholders are entitled to two and one-half votes per share. F-15 54 EMERGE INTERACTIVE, INC. Notes to Consolidated Financial Statements December 31, 1998 and 1999 (8) INCOME TAXES Deferred income taxes reflect the net tax effects of temporary difference between the carrying amounts of assets and liabilities for financial reporting purposes and amounts used for income tax purposes. Significant components of the Company's deferred income tax assets and liability are as follows:
1998 1999 ----------- ----------- Deferred tax assets: Net operating loss carryforwards $ 5,967,000 $10,903,000 Amortization of acquired technology from XL Vision (note 10) 1,704,000 1,500,000 Research and experimentation tax credits 448,000 740,000 Other 596,000 853,000 ----------- ----------- 8,715,000 13,996,000 Less valuation allowance 8,715,000 13,996,000 ----------- ----------- Net deferred tax assets -- -- =========== ===========
The Company has available at December 31, 1999 for federal income tax purposes, unused net operating loss carryforwards of approximately $28,000,000 which may be applied against future taxable income and expires in years beginning in 2012. The Company also has approximately $740,000 in research and experimentation credits carryforwards. The research and experimentation credits, which begin to expire in 2012, can also be used to offset future regular tax liabilities. A valuation allowance for deferred tax assets is provided when it is more likely than not that some portion or all of the deferred tax assets will not be realized. The difference between the "expected" tax benefit (computed by applying the federal corporate income tax rate of 34% to the loss before income taxes) and the actual tax benefit is primarily due to the effect of the valuation allowance. F-16 55 EMERGE INTERACTIVE, INC. Notes to Consolidated Financial Statements December 31, 1998 and 1999 (9) STOCK PLAN In January 1996, the Company adopted an equity compensation plan (the "1996 Plan") pursuant to which the Company's Board of Directors may grant shares of common stock or options to acquire common stock to certain directors, advisors and employees. The Plan authorizes grants of shares or options to purchase up to 2,168,750 shares of authorized but unissued common stock. Stock options granted have a maximum term of ten years and have vesting schedules which are at the discretion of the Compensation Committee of the Board of Directors and determined on the effective date of the grant. In May 1999, the Company's stockholders approved the 1999 Equity Compensation Plan (the "1999 Plan"). Under the 1999 Plan, an additional 1,250,000 shares of authorized, unissued shares of common stock of the Company are reversed for issuance to employees, advisors and for non-exempt members of the Board of Directors. Option terms under the 1999 Plan may not exceed 10 years. A summary of option transactions follows:
WEIGHTED AVERAGE RANGE OF WEIGHTED REMAINING EXERCISE PRICE AVERAGE CONTRACTUAL SHARES PER SHARE EXERCISE PRICE LIFE (IN YEARS) ----------------- ------------------ ---------------- ----------------- Balance outstanding, December 31, 1996 3,125 $ 0.80 $ 0.80 4.85 ==== Granted 335,000 0.80 0.80 --------- --------------- -------- Balance outstanding, December 31, 1997 338,125 0.80 0.80 9.64 ==== Granted 1,692,500 0.80 - 1.60 0.84 Canceled (398,125) 0.80 0.80 --------- --------------- -------- Balance outstanding, December 31, 1998 1,632,500 0.80 - 1.60 0.84 9.48 ==== Granted 1,415,250 1.60 - 11.20 4.96 Exercised (200,819) 0.80 0.93 Cancelled (77,815) 0.80 - 1.60 1.35 --------- --------------- -------- Balance outstanding, December 31, 1999 2,769,116 $ 0.80 - 11.20 $ 2.93 9.01 ========= =============== ======== ====
F-17 56 EMERGE INTERACTIVE, INC. Notes to Consolidated Financial Statements December 31, 1998 and 1999 At December 31, 1997, 1998 and 1999, there were 76,719, 414,375 and 761,045 shares exercisable, respectively, at weighted average exercise prices of $0.80. $0.82 and $1.68, respectively. At December 31, 1997, 1998 and 1999, 99,375, 511,250 and 1,597,875 shares were available for grant, respectively. The per share weighted-average fair value of stock options granted was $-0- in 1997, $0.08 in 1998 and $1.47 in 1999 on the date of grant using the Black Scholes option-pricing model with the following weighted-average assumptions:
1997 1998 1999 ----- ----- ----- Volatility 0% 0% 0% Dividend paid 0% 0% 0% Risk-free interest rate 6.11% 4.73% 4.99% Expected life in years 6.75 5.57 6.75
No volatility was assumed due to the use of the Minimum Value Method of computation for options issued by the Company as a private entity through December 31, 1999 as prescribed by SFAS No. 123. All stock options granted, except as noted in the paragraph below, have been granted to directors or employees with an exercise price equal to the fair value of the common stock at the date of grant. The Company applies APB Opinion No. 25 for issuances to directors and employees in accounting for its Plan and, accordingly, no compensation cost has been recognized in the consolidated financial statements through December 31, 1998. On March 19, 1999, the Company granted 360,625 stock options with an exercise price of $1.60 and a fair value of $1.80. The Company recorded $72,126 of unearned compensation at the date of grant and is amortizing the unearned compensation over the vesting period. Compensation expense amounted to $13,524 for the year ended December 31, 1999. F-18 57 EMERGE INTERACTIVE, INC. Notes to Consolidated Financial Statements December 31, 1998 and 1999 Had the Company determined compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123, the Company's net loss would have increased to the pro forma amounts indicated below:
1997 1998 1999 ----------- ------------ ------------- Net loss as reported $(5,483,623) $ (7,832,128) $ (15,595,286) =========== ============ ============= Pro forma net loss $ 5,483,623) $ 7,865,031) $ (16,049,980) =========== ============ ============= Net loss per share, as reported: Basic and diluted $ (14.34) $ (1.80) $ (2.30) =========== ============ ============= Pro forma net loss per share: Basic and diluted $ (14.34) $ (1.81) $ (3.17) =========== ============ =============
(10) RELATED PARTY TRANSACTIONS DUE TO RELATED PARTIES Due to related parties consist of:
1998 1999 ----------- ----------- XL Vision $ 5,158,436 $ 1,668,317 Safeguard Scientifics, Inc. and Safeguard Delaware, Inc. 28,898 10,385,398 ----------- ----------- $ 5,187,334 $12,053,715 =========== ===========
F-19 58 EMERGE INTERACTIVE, INC. Notes to Consolidated Financial Statements December 31, 1998 and 1999
AMOUNTS DUE TO XL VISION Amounts due to XL Vision consist of: Balance as of December 31, 1996 $ 3,636,494 Allocation of costs and funding of working capital to the Company 6,318,405 Technology transfer fee 4,400,000 Interest charges on technology transferred 141,167 Proceeds from Series A Preferred Stock (6,443,606) Issuance of Class A common stock (22,465) ----------- Balance as of December 31, 1997 8,029,995 Allocation of costs and funding of working capital to the Company 9,120,441 Interest charges on technology transferred 308,000 Contribution of debt to equity (7,500,000) Contribution of debt to equity in exchange for Series B Preferred stock (4,800,000) ----------- Balance as of December 31, 1998 5,158,436 Allocation of costs and funding of working capital to the Company (3,771,964) Interest charges on technology transferred 281,845 ----------- Balance as of December 31, 1999 $ 1,668,317 ===========
The average outstanding balance due to XL Vision was approximately $6,239,600 in 1997, $12,782,400 in 1998 and $6,266,800 in 1999. On January 1, 1999, the Company signed a revolving promissory note with XL Vision for up to $3,000,000. The revolving promissory note bears interest at the prime rate plus 1% (9.5% at December 31, 1999) and is due in full when the Company completes an IPO or sells all of its assets of stock. F-20 59 EMERGE INTERACTIVE, INC. Notes to Consolidated Financial Statements December 31, 1998 and 1999 NOTES PAYABLE TO SAFEGUARD DELAWARE, INC. On July 21, 1999, the Company obtained a $3,000,000 revolving note payable from Safeguard Delaware, Inc. ("Safeguard"). The revolving note payable, as amended, bears interest payable monthly at the prime rate plus 1% (9.5% at December 31, 1999) and is due February 29, 2000. In August, September and October 1999, the Company signed demand notes with interest payable monthly at the prime rate plus 1% (9.5% at December 31, 1999) with Safeguard for $2,500,000, $2,000,000 and $2,500,000, respectively. These notes were cancelled in October 1999, in exchange for a $7,050,000 note due in full on October 25, 2000, the repayment of a promissory note issued concurrently with the sale of Series D preferred stock or an IPO, whichever is earlier. Interest expense was approximately $0 in 1997, $0 in 1998 and $454,800 in 1999. TECHNOLOGY FEE On July 15, 1997, the Company entered into an agreement with XL Vision for the transfer of certain technology that is sued by the Company in the sale of its products for a $4,400,000 note payable. The transfer was accounted for as a distribution to XL Vision as it represented amounts paid for an asset to en entity under common control in excess of the cost of such asset. The note payable (included in amounts due to XL Vision above) bears interest at 7% per annum. Interest expense was approximately $141,200 in 1997, $308,000 in 1998 and $281,800 in 1999. DIRECT CHARGE FEE Prior to April 1, 1997 personnel, and other services were provided by XL Vision and the costs were allocated to the Company. The Company believes that the allocation method used by XL Vision was reasonable. Effective April 1, 1997, the Company entered into a direct charge fee agreement with XL Vision which allows for cost-based charges based upon actual hours incurred. Costs allocated to or service fees charged by XL Vision were approximately $720,000 in 1997, $460,000 in 1998 and $455,000 in 1999. A portion of the fees in 1998 and all of the fees in 1997 were allocated to the discontinued transportation segment. F-21 60 EMERGE INTERACTIVE, INC. Notes to Consolidated Financial Statements December 31, 1998 and 1999 ADMINISTRATIVE SERVICES FEE Effective December 15, 1997, the Company entered into an agreement which requires accrual of an administrative services fee based upon a percentage of gross revenues. The fee for administrative support services, including management consultation, investor relations, legal services and tax planning, is payable monthly to XL Vision and Safeguard Scientifics, Inc., the largest shareholder of XL Vision, based upon an aggregate of 1.5% of gross revenues with such service fees to be not more than $300,000 annually. Effective August 17, 1999, the agreement was amended such that the administrative services fee is applied to net contribution margin on cattle sales and gross revenue for all other sales. The fee is accrued monthly but is only payable in months during which the Company has achieved positive cash flow from operations. The agreement extends through December 31, 2002 and continues thereafter unless terminated by any party. Administrative service fees were approximately $10,300 in 1997, $37,200 in 1998 and $53,200 in 1999. LEASES The Company leases equipment under a capital lease, effective April 20, 1998, with an affiliated entity, XL Realty, Inc. Future minimum lease payments, including imputed interest at 7.53%, are $85,765 in 2000, $92,684 in 2001, $100,154 in 2002 and $26,415 in 2003. Interest expense was approximately $23,600 in 1998 and $27,400 in 1999. The Company rents its facilities from XL Vision. Rent expense varies based on space occupied by the Company and includes charges for base rent, repairs and maintenance, telephone and networking expenses, real estate taxes and insurance. Rent expense was approximately $354,000 in 1997, $1,129,000 in 1998 and $985,000 in 1999. SALE OF SERIES D PREFERRED STOCK On October 27, 1999, the Company agreed to issue 4,555,556 shares of Series D preferred stock and a warrant to acquire 1,138,889 shares of Class B common stock to Internet Capital Group, Inc., an affiliate of Safeguard. Each share of Series D preferred stock is convertible into 1.25 shares of Class B common stock at any time at the option of the holder or immediately upon an IPO. The warrant is exercisable at the Company's IPO price. In the event the Company does not complete an IPO, the warrant is exercisable at $9.00 after November 16, 2000 or earlier if the Company has an equity financing of not less than $20,000,000 from private investors. The warrant expires on November 16, 2002. In return for these instruments, the Company received $18,000,000 of cash in November 1999 and a $23,000,000 non-interest, bearing note receivable due on October 27, 2000. Imputed interest at 9.5% amounts to $2,185,000 over the life of the note. F-22 (Continued) 61 EMERGE INTERACTIVE, INC. Notes to Consolidated Financial Statements December 31, 1998 and 1999 The net consideration of $38,815,000 was allocated to the warrant and preferred stock as follows. The warrant was valued at $3,325,553 using the Black-Scholes method and assuming a strike price of $11.20, expiration of three years, 90% volatility, and 5.8% interest. The remaining proceeds were allocated to preferred stock and amounted to $7.79 per preferred share ($6.23 per common share). The beneficial conversion feature was calculated as the difference between the conversion price ($6.23) and the fair value of the common stock ($7.20) multiplied by the number of Class B common shares into which the preferred stock is convertible (5,694,445) and amounts to $5,523,612. The note receivable is shown as a reduction of stockholders' equity, net of imputed interest. Interest income is accreted over the life of the note using the effective interest method. The value of the warrant was credited to additional paid-in capital. The beneficial conversion feature was credited to preferred stock with a corresponding charge to additional paid-in capital at issuance. The beneficial conversion feature reduces net income available to common shareholders. (11) SEGMENT INFORMATION In 1998, the Company adopted SFAS No. 131, which requires the reporting of segment information using the "management approach" versus the "industry approach" previously required. The management approach requires the Company to report certain financial information related to continuing operations that is provided to the Company's chief operating decision-maker. The Company's chief operating decision-maker receives revenue and contribution margin (revenue less direct costs and excluding overhead) by source, and all other statement of operations data and balance sheet data on a consolidated basis. The Company's reportable segments consist of cattle sales and animal sciences products and services. While the Company operates entirely in the animal science marketplace, the contribution margin associated with cattle sales and the related prospects for this portion of the Company's business differ from the rest of the Company's product offerings. F-23 62 EMERGE INTERACTIVE, INC. Notes to Consolidated Financial Statements December 31, 1998 and 1999 The following summarizes revenue and contribution margin information related to the Company's two operating segments:
DECEMBER 31, ----------------------------- 1998 1999 ----------- ------------ Revenue: Cattle $ -- $ 42,191,884 Animal sciences 1,792,471 1,591,240 ----------- ------------ Total $ 1,792,471 $ 43,783,124 =========== ============ Cost of revenue: Direct costs: Cattle $ -- $ 41,746,723 Animal sciences 900,824 558,243 ----------- ------------ Total direct costs 900,824 42,304,966 Unallocated overhead 1,722,623 1,212,493 ----------- ------------ Total $ 2,623,447 $ 43,517,459 =========== ============ Gross profit (loss): Contribution margin: Cattle $ -- $ 445,161 Animal sciences 891,647 1,032,997 ----------- ------------ Total 891,647 1,478,158 Unallocated overhead (1,722,623) (1,212,493) ----------- ------------ Gross profit (loss) $ (830,976) $ 265,665 =========== ============
The Company's assets and other statement of operations data are not allocated to a segment. F-24 63 EMERGE INTERACTIVE, INC. Notes to Consolidated Financial Statements December 31, 1998 and 1999 (12) DISCONTINUED OPERATIONS In December 1998, the Company's Board of Directors decided to dispose of its transportation segment. The Company's AMIRIS thermal imaging system, which was the sole product sold in the transportation segment, was sold on January 15, 1999 to Sperry Marine, Inc. for approximately $1,900,000. The Company received $200,000 of cash at closing and collected an additional $1,388,000 through December 31, 1999. The remaining balance of approximately $294,142 is expected to be collected by April 30, 2000. The Company is entitled to a royalty of 8% of net AMIRIS system sales, up to a maximum royalty of $4.3 million over a four year period or up to a maximum royalty of $5.0 million, if $4.3 million is not received within four years. Net assets of the discontinued transportation segment consist of:
1998 1999 ----------- --------- Accounts receivable $ 381,435 $ 10,353 Inventory, net 2,020,625 123,093 Note receivable -- 294,142 Property and equipment, net 134,098 -- Intangibles, net 61,108 -- Accounts payable (80,510) (28,185) Accrued liabilities including provision for operating loss during phase out period of $72,667 in 1998 and $0 in 1999 (231,415) (102,400) ----------- --------- Net assets $ 2,285,341 $ 297,003 =========== =========
(13) COMMITMENTS AND CONTINGENCIES VOLUNTARY EMPLOYEE SAVINGS 401(k) PLAN The Company established a voluntary employee savings 401(k) plan in 1997 which is available to all full time employees 21 years or older. The plan provides for a matching by the Company of the employee's contribution to the plan for 50% of the first 6% of the employee's annual compensation. The Company's matching contributions were approximately $38,200 in 1997, $62,100 in 1998 and $81,700 in 1999. F-25 64 EMERGE INTERACTIVE, INC. Notes to Consolidated Financial Statements December 31, 1998 and 1999 ROYALTIES In connection with the NutriCharge license, the Company is obligated to a royalty of 5% of gross revenues from the sale of NutriCharge products and infrared technology related to the Company's Canadian license agreement. Royalty expense in connection with this agreement was nominal through the period ended December 31, 1999. The Company is also obligated to a royalty of 6% of net revenues from product or services related to technology patented by Iowa State University. No such royalties have been paid as of December 31, 1999. LEGAL PROCEEDING The Company has been named as a defendant in a lawsuit filed by Central Biotech, Inc. on January 12, 2000 in the Queen's Bench Judicial Centre of Regina, Providence of Saskatchewan, Canada. The complaint alleges that eMerge and E-Y laboratories, Inc. were each subject to confidentiality agreements with the plaintiff, and subsequently engaged in discussions concerning a potential business arrangement in violation of such agreements. The complaint asserts damages, including punitive damages, from the defendants in the aggregate amount of $18,000,000 (Canadian dollars), as well as injunctive relief. Although the Company has not yet completed its assessment of these claims, the Company believes that there are a number of substantive and procedural defenses that exist and intends to defend these claims vigorously. (14) SUBSEQUENT EVENTS On February 17, 2000, the Company closed on its IPO and a concurrent private placement of common stock and raised net proceeds of approximately $107,400,000. Approximately $12,800,000 of the proceeds were used to pay amounts due to related parties (see note 10) and $900,000 was paid to Turnkey (see note 5). F-26 EX-10.3 2 MASTER LICENSE AGREEMENT 1 Exhibit 10.3 * Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. MASTER LICENCE AGREEMENT ELECTROLYTE THERAPY & INFRA-RED THERMOGRAPHY BETWEEN: HER MAJESTY THE QUEEN IN RIGHT OF CANADA as represented by the Minister of Agriculture and Agri-Food Canada (LICENCOR) AND: eMERGE VISION SYSTEMS INC. a corporation incorporated under the laws of Delaware; and having its head office at 10315 102nd Terrance Sebastian, Florida, United States, 32958 (LICENCEE) 2 PROTECTED - BUSINESS INFORMATION TABLE OF CONTENTS ------------ MASTER LICENCE AGREEMENT ELECTROLYTE THERAPY & INFRA-RED THERMOGRAPHY INTRODUCTION.................................................................. 1 DEFINITIONS........................................................... 2 SURRENDER & GRANT OF LICENCE.......................................... Surrender............................................................. Grant................................................................. Sub-licencing......................................................... Canada's Consent...................................................... Sub-licence Conditions................................................ Termination........................................................... Third Party Obligations - eVS......................................... Third Party Obligations - Canada...................................... Use of Canadian Corporations.......................................... Disclosure Obligation - Canada........................................ Material Terms........................................................ 3 TERM.................................................................. Initial Term.......................................................... Renewal Conditions.................................................... No Dispute................................................... Dispute /Contingent Renewal Pending ADR...................... 4 EXPLOITATION OF LICENCED TECHNOLOGIES................................. Best Efforts to Commercialize......................................... Royalty Holiday....................................................... Start-Up Costs........................................................ Continuing Obligations During Holiday................................. Patents...................................................... Collaborations............................................... Research Support Payment..................................... Fundamental Terms..................................................... 5 ROYALTIES............................................................. Percentage Royalty of Gross Revenues.................................. Payments Semi-Annually................................................ 2 3 PROTECTED - BUSINESS INFORMATION Payment Dates......................................................... Payment Method........................................................ Cheque Requirements................................................... Payments to Canada after Termination.................................. Attribution of Royalties.............................................. 6 IP OWNERSHIP & REPRESENTATIONS........................................ Canada Owns Licenced Technologies..................................... No Impeachment........................................................ Inimical Use of Confidential Information.............................. Regulatory Rights..................................................... Inventors Rights...................................................... No Litigation......................................................... Third Party Rights.................................................... Infringement.......................................................... Patent Coverage & Formula............................................. US Federal Department of Agriculture (FDA) Regulatory................. Manufacture.................................................. No Export.................................................... Disclosure by Canada......................................... Product Claims............................................... Animal Food.................................................. FDA Problems................................................. No Misrepresentations........................................ Laboratory Practices......................................... Material Terms........................................................ 7 IMPROVEMENTS, R & D, COLLABORATIONS................................... Carve Out............................................................. Licencing of Improvements from Canada's R & D under Carve Out......... No Competition........................................................ Collaborations Between eVS and Canada................................. Licencing of Improvements from eVS / Canada Collaborations............ Licencing of Serendipitous Technologies from eVS / Canada Collaborations............................................... Third Party Licences Resulting Technology............................. Improvements Part of Licenced Technologies............................ Discretion to Collaborate............................................. Either Party Unable / Unwilling to Collaborate........................ Third Party Collaborations............................................ Ownership of Background Intellectual Property......................... Material Terms........................................................ 8 WARRANTIES OF QUALITY................................................. No Warranties......................................................... 3 4 PROTECTED - BUSINESS INFORMATION Disclaimer of Implied Warranties...................................... Third Party Representations........................................... Disclosure by Canada.................................................. Disclosure & Due Diligence............................................ Confidential Information Without Warranty / No Reliance............... 9 PATENTS............................................................... Queen Owns All Patents................................................ eVS Discretion to Patent.............................................. eVS Responsibility for Patent Costs................................... Canada Responsibility for Patent Costs................................ Material Terms........................................................ 10 REGULATORY............................................................ Notice to Assist...................................................... Assistance............................................................ Canada's Advisory Board Positions..................................... Costs of Canada's Advisory Board Members.............................. Regulatory Costs...................................................... Decision to Register.................................................. Registration Ownership................................................ Trademark Use......................................................... Trademark and Quality Control......................................... 11 AUDITS & QUALITY CONTROL.............................................. Audit Rights and Purposes............................................. Audit Timing / Process / Cost......................................... Regulatory Quality Standards.......................................... Contractual Quality Standards......................................... Spot Audits........................................................... Material Terms........................................................ 12 REPORTS............................................................... Administrative Meetings............................................... 13 CORPORATE REPRESENTATIONS & WARRANTIES................................ eVS................................................................... Ability...................................................... Authorization................................................ Enforceable.................................................. Litigation................................................... Veracity of Statements....................................... Third Party Representations.................................. Canada................................................................ Authorization................................................ Veracity of Statements....................................... 4 5 PROTECTED - BUSINESS INFORMATION Compliance of Laws........................................... 14 PATENT INFRINGEMENT................................................... Notice ............................................................... Core Countries........................................................ Canada Defends / Prosecutes........................................... eVS Co-Counsel........................................................ eVS Assumes Control of Litigation............................ Costs when eVS Assumes Control of Litigation.......................... Canada Controls Payment of Damage / Settlement Terms.................. Canada's Damage Awards Distribution.......................... eVS Defends / Prosecutes.............................................. Non-Core Country Infringement Actions........................ Parties Jointly Police Infringement.......................... 15 INDEMNIFICATION....................................................... Reciprocal for Negligence / Contract Breach........................... Procedures............................................................ Notice....................................................... Indemnifying Party Defends................................... Indemnified Party Defends.................................... Co-operation................................................. Mutual Consent of Settlement................................. 16 TERMINATION........................................................... By Canada for Cause................................................... Trademark Rights Terminated........................................... Procedure............................................................. The Company's Duties on Termination................................... Surviving Obligations................................................. Surrender of Licence.................................................. 17 CONFIDENTIALITY / FIDUCIARY & EQUITABLE REMEDIES...................... Confidentiality Obligations........................................... Confidentiality Measures.............................................. Distribution by the Receiving Party................................... Common Law Duty of Confidentiality.................................... Confidentiality Exceptions............................................ Public Domain................................................ Published.................................................... Already Known................................................ Third Party Discloses........................................ Independently Developed...................................... Judicial / Administrative Order.............................. Access to Information................................................. 5 6 PROTECTED - BUSINESS INFORMATION Access to Information Disclosure............................. Fiduciary.................................................... Elements of Fiduciary Relationship........................... Equitable Relief...................................................... Fundamental Terms..................................................... 18 ALTERNATE DISPUTE RESOLUTION (ADR).................................... Negotiation........................................................... Informal Negotiations........................................ Formal Negotiations.......................................... Mediation............................................................. Direct to Arbitration........................................ Process ..................................................... Location..................................................... Unsuccessful................................................. Arbitration........................................................... Procedure............................................................. Law, Code & Rules............................................ Tribunal & Jurisdiction...................................... Final & Binding.............................................. Proceedings.................................................. Language..................................................... Written Communications....................................... Costs........................................................ Arbitrator's Written Decision................................ Power to Settle.............................................. Adjournment to Empower Representative........................ Deemed Abandonment........................................... General ADR Conditions................................................ No Litigation................................................ Obligations During Alternate Dispute Resolution (ADR)........ Privilege.................................................... Confidentiality.............................................. ADR Disclosures Not Admissible in Subsequent Proceedings..... Normally Admissible Evidence................................. Material Breach.............................................. 19 INTENT AND INTERPRETATION............................................. Entire Agreement...................................................... Pre-Contractual Representations....................................... Due Diligence Search.................................................. Independent Legal Advice.............................................. No Adverse Presumption in Case of Ambiguity........................... 6 7 PROTECTED - BUSINESS INFORMATION Severability.......................................................... Plurality and Gender.................................................. Not a Joint Venture................................................... Minister Not Fettered................................................. Federal Legislation................................................... Right to Legislate.................................................... No Implied Obligations................................................ Access to Information................................................. Governing Law......................................................... Waiver................................................................ Contract Always Speaks................................................ Time is of the Essence................................................ Force Majeure......................................................... Headings.............................................................. Appendices............................................................ 20 LEGAL RIGHTS.......................................................... Amendments............................................................ Assignment by Canada.................................................. Sub-Contract Rights................................................... Assignment............................................................ No Third Party Rights................................................. Remedies Cumulative................................................... Mutual Assistance..................................................... Facsimile Counterparts................................................ 21 CROWN GENERAL......................................................... No Bribes............................................................. No Share to Members of Parliament..................................... Public Office Holders................................................. Compliance with Law................................................... Disclosure of Master Licence during Due Diligence Audit - eVS......... Disclosure of Master Licence during Due Diligence Audit - Canada...... Material Terms........................................................ 22 NOTICE................................................................ Addresses / Contacts.................................................. Deemed Delivery....................................................... Change of Address..................................................... APPENDIX...................................................................... LICENCED TECHNOLOGIES PATENTS......................................... APPENDIX...................................................................... ARBITRATION RULES..................................................... APPENDIX...................................................................... 7 8 PROTECTED - BUSINESS INFORMATION PRE-MIX FORMULATION................................................... APPENDIX...................................................................... RMS / AGRESEARCH AGREEMENTS........................................... APPENDIX...................................................................... eVS INFRA RED TECHNOLOGIES............................................ 8 9 PROTECTED - BUSINESS INFORMATION MASTER LICENCE AGREEMENT ELECTROLYTE THERAPY & INFRA-RED THERMOGRAPHY BETWEEN: HER MAJESTY THE QUEEN IN RIGHT OF CANADA as represented by the Minister of Agriculture and Agri-Food ("Canada") AND: eMERGE VISION SYSTEMS INC., a corporation incorporated under the laws of Delaware; and having its head office at 10315 102nd Terrance Sebastian, Florida ("eVS") INTRODUCTION A. A. Transport and handling stress can cause significant, metabolic and physiological changes in livestock. Dehydration, low blood and tissue sugar levels, electrolyte imbalance and thermoregulatory problems associated with stress can result in live and carcass weight losses, as well as degraded meat quality; B. Live weight losses in 500 kg market-weight steers can vary from approximately 5 kg (1% of body weight) for short-hauled (1-2 hours) animals to upwards of 50kg (10% of body weight) in long-distance (24 to 48 hours) transported beef animals; C. Stress during handling and transport can result in dark, firm, dry (DFD) beef that results in significant discounts for these carcasses by packers as the DFD meat is discriminated against by most consumers; D. Stress also results in the loss of intramuscular fat as cattle quickly mobilize this source of energy while under stress, thereby resulting in a potential grade loss; E. Canada has developed, patented and registered an electrolyte therapy which significantly reduces live weight shrink associated with transport and handling stress in cattle. This therapy together with all directly related know-how and any 9 10 PROTECTED - BUSINESS INFORMATION directly related trade secrets is referred to herein as "ET". This supplement has also been shown to significantly reduce the incidence of DFD carcasses as well as reducing the incidence of grade loss; F. Canada has also developed and patented a method, and the software required, to identify cattle that are under physiological stress using infra-red thermography. This software and method, together with all directly related know-how and any directly related trades secrets is referred to herein as "IR". This technology is effective in identifying stressed animals which are pre-disposed to producing poor quality meat; G. R and ET are complementary technologies in that IR detects stressed cattle at various stages in the production cycle while ET is a restorative which reduces weight and grade loss and the incidence of poor quality, DFD, meat; H. ET has been licenced and marketed based on a PRE-MIX and LICENCED PRODUCT concept. i) The PRE-MIX consists of the protected formulation of the essential elements for the electrolyte therapy. ii) The LICENCED PRODUCT is a mix of a specific quantity of PRE-MIX and other feed base materials such as corn, barley, alfalfa, or other carriers (dependent on the livestock and the medium of delivery, for instance pellets). In order to ensure maintenance of quality standards as well as protect the confidentiality of the Pre-Mix formulation, the PRE-MIX is licenced to a single supplier. Distributers who manufacture and sell the LICENCED PRODUCT must purchase the PRE-MIX from this sole supplier; I. Several formulations of the ET for beef cattle are registered in Canada, and one is in the process of being registered in the U.S. Formulations for other livestock, such as swine and poultry are being developed; J. Although the IR technology has been proven in a pilot setting, it is recognized that it requires considerable engineering development to scale-up to a commercial system; K. Canada has previously licenced selected rights, selected versions and different territories of the ET and IR and consented to sub-licences of those licenced rights; L. An abbreviated version of those licenced selected rights is shown in the following 10 11 PROTECTED - BUSINESS INFORMATION table, fixed approximately at the point when the PARTIES were negotiating the MASTER LICENCE; 1 STS ET United States Exclusive LICENCED Sale & Beef PRODUCT Distribution cattle 2 STS ET Canada Exclusive LICENCED Manufacture Beef PRODUCT & Cattle PRE-MIX 3 Nutri-Charge ET USA Sub-licence LICENCED Non-Excl. Beef Exclusive PRODUCT & Manufacture, Cattle Non-exclusive PRE-MIX Excl. Sale & Distribute 4 RMS ET Canada Sub-licence LICENCED Manufacture Beef PRODUCT Cattle 5 RMS ET Canada Exclusive LICENCED Manufacture, Beef PRODUCT Sale & Distribute Cattle 6 AgResearch ET Australia & New Exclusive LICENCED Manufacture, Beef Zealand PRODUCT Sale & Distribute Cattle 7 STS IR North America Exclusive n/a Manufacture, Beef & Sale & Distribute Swine 8 Nutri-Charge IR USA Sub-licence n/a Manufacture, Beef & Sale & Distribute Swine
M. Discussions with STS Agriventures Ltd. ("STS") and RMS Research Management Systems, Inc. ("RMS") concerning new licence rights resulted in new arrangements implemented during the time the PARTIES were negotiating the . This also resulted in the termination of a sub-licence. 11 12 PROTECTED - BUSINESS INFORMATION N. The following table details the state of agreements prior to signing of this MASTER LICENCE: New STS ET Worldwide Exclusive PRE-MIX Manufacture and All sale animals manufacturers of LICENCED PRODUCT 1 STS ET U.S. 1) Exclusive LICENCED 1) Sales and Beef 2) Non- PRODUCT & Distribution Cattle exclusive PRE-MIX 2) Manufacture LICENCED PRODUCT 3 Nutri-Charge ET U.S. Sub-licence LICENCED 1) Sales and Beef 1) Exclusive PRODUCT & Distribution Cattle 2) Non- PRE-MIX 2) Manufacture Exclusive LICENCED PRODUCT 5 RMS ET Canada Exclusive LICENCED Manufacture, Sale & Beef PRODUCT Distribute 6 AgResearch ET Australia & Exclusive LICENCED Manufacture, Sale & Beef New PRODUCT Distribute Zealand New RMS ET Canada Exclusive LICENCED Manufacture Sales & Swine Pend PRODUCT Distribution - -ing 7 STS IR North Exclusive n/a Manufacture, Sale & Beef & America Distribute Swine 8 Nutri-Charge IR USA Sub-licence n/a Manufacture, Sale & Beef & Distribute Swine
O. eVS is a company whose strength is in commercializing image technologies, with emphasis on animal science applications. eVS's affiliated company, Safeguard Scientifics Inc., has considerable expertise in the development of spin-off companies which commercialize new technologies; P. Simultaneously with the execution of this Licence ("MASTER LICENCE"), eVS is purchasing all of the shares of the capital stock of STS and all of the partnership interests of Nutricharge, and will thereby take ownership of the licences previously held by STS and Nutricharge but not those held by New Zealand Pastoral Agriculture Research Institute Limited ("AgResearch") and RMS; Q. As a result of the share purchases identified in recital P, eVS has: i) the North American rights to manufacture, sell and distribute IR for beef & 12 13 PROTECTED - BUSINESS INFORMATION swine; ii) the worldwide rights to manufacture, sell and distribute ET in PRE-MIX format for kingdom animalia; and iii) the U.S. rights to manufacture, sell, and distribute ET in LICENCED PRODUCT format for beef cattle. R. eVS and Canada agreed to a process under which concurrently with the execution of the MASTER LICENCE: i) eVS will cause the identified licencees and sub-licencees assign, transfer and release all their rights, whether under executed Licence / sub-licence or inchoate, to eVS; ii) eVS surrenders those rights to Canada; and iii) Canada and eVS execute the MASTER LICENCE that globally: a incorporates the then extant rights and obligations; and b augments those rights and obligations; S. Under the MASTER LICENCE, eVS has: i) an exclusive Licence; ii) to IR and ET; iii) worldwide for IR for food animals, including but not limited to beef & dairy cattle, sheep, swine, elk, bison, deer, reindeer, ratites (i.e. emus) poultry, rabbit; iv) worldwide for ET PRE-MIX for Kingdom Animalia; and v) worldwide for ET sales, manufacture and distribution of the LICENCED PRODUCT; a except for Australia, New Zealand and Canada for beef; and b except for Canada for swine. with no right to export the LICENCED PRODUCT into the territories cited in T(v)(a)(b) above, in which eVS does not have the right to sell or distribute such LICENCED PRODUCT. T. The underlying principles of the MASTER LICENCE are that: i) eVS has commercial freedom with the concomitant obligation to make all commercially reasonable best efforts to COMMERCIALIZE the ET and IR; ii) Canada will receive a royalty from the COMMERCIALIZATION of ET and IR or either of them or any technology sold or licenced incorporating either or both of them; iii) Canada and eVS collaborate on the enhancement of ET and IR; iv) Canada provides scientific backing to eVS; and 13 14 PROTECTED - BUSINESS INFORMATION v) Canada has scientific freedom to continue to conduct research and development concerning IR and ET with the concomitant obligation to notify eVS to any IMPROVEMENTS. NOW THEREFORE in consideration of the premises, the terms and conditions hereinafter contained and other good and valuable consideration, the receipt of which is hereby acknowledged by each PARTY, the PARTIES hereto covenant and agree as follows: 1 DEFINITIONS 1.1 "AFFILIATE" means a subsidiary or corporation controlled (as defined in the Income Tax of Act of Canada) by eVS, but does not include a parent or upstream corporation or sister corporation of eVS or Safeguard Scientifics Inc. 1.2 "COMMERCIALIZATION" or "COMMERCIALIZE" means: 1.2.1 the making, using and sale (and when sold, sold at the SALES PRICE); 1.2.2 by eVS; 1.2.3 of the LICENCED TECHNOLOGIES; 1.2.4 within the LICENCED TERRITORIES; 1.2.5 within the FIELDS OF USE; 1.2.6 for the commercially reasonable best efforts return to eVS and Canada in accordance with Article 4 (Exploitation of Licenced Technologies); and includes 1.2.7 eVS obtaining any authorizations or permits that may be required in order for eVS to legally carry out all of its activities under this MASTER LICENCE. 1.3 "CONFIDENTIAL INFORMATION" means: 1.3.1 without limitation: 1.3.1.1 all scientific (including INTELLECTUAL PROPERTY), technical, business, financial, legal or marketing information; and 1.3.1.2 information that is non-public, confidential, privileged or proprietary in nature; 1.3.2 disclosed orally, in writing or by any medium, electronic or otherwise (and includes, without limitation, samples, prototypes, specimens and derivatives); 14 15 PROTECTED - BUSINESS INFORMATION 1.3.3 during discussions, audits, spot audits, meetings, tests, demonstrations, correspondence or otherwise; or any part or portion thereof, related to activities pursuant to the LICENCE AGREEMENT, irrespective of whether or not such information is specifically marked confidential or identified as confidential at the time of disclosure. Notwithstanding the foregoing any oral disclosures that contain CONFIDENTIAL INFORMATION may be identified either: 1.3.4 at the time of disclosure as confidential; or 1.3.5 reduced into writing and designated as confidential within fifteen (15) days of disclosure. 1.4 "CORE COUNTRIES" means: 1.4.1 Canada; 1.4.2 USA; 1.4.3 France; 1.4.4 Denmark; 1.4.5 Germany; 1.4.6 Ireland; 1.4.7 United Kingdom; 1.4.8 Australia; and 1.4.9 New Zealand. 1.5 "DISCLOSING PARTY" or "RECEIVING PARTY" as applicable means either of the PARTIES who is releasing CONFIDENTIAL INFORMATION to the other PARTY or is acquiring CONFIDENTIAL INFORMATION from the other PARTY. 1.6 "ET" means: 1.6.1 the use and formulation of electrolyte therapy (as invented and practised by the Lacombe Research Centre) to improve the general health, meat quality and grading of meat and livestock and other agricultural, zoological and nutraceutical applications premised on such electrolyte therapy; and 15 16 PROTECTED - BUSINESS INFORMATION 1.6.2 the use and formulation of electrolyte therapy as claimed in Canadian Patent #2,009,532; US Patent #5,728,675" and the other patents listed in Appendix A (LICENCED TECHNOLOGIES PATENTS); 1.6.3 including all directly related know-how and directly related trade secrets in respect of the matter identified in subparagraphs 1.6.2 and 1.6.2. 1.7 "ET PENDING PRODUCT" means the ET formula which is the subject of the US Federal Department of Agriculture's (FDA) Notice of Claimed Investigations Exemption for a New Animal Drug (INAD). 1.8 "FIELDS OF USE" means the family of agricultural, zoological or nutraceutical products directly related to ET and IR, more particularly: 1.8.1 ET as PRE-MIX and LICENCED PRODUCT, for the Kingdom Animalia in any medium (including without limitation, liquid, pelletized or cubed); and 1.8.2 IR for food animals, which includes without limitation: beef and dairy cattle, swine, sheep, elk, deer, bison, ratites (i.e. emus); reindeer (or caribou), poultry and rabbit. 1.9 "GROSS REVENUES" means revenues received by eVS (or its sub-licencees under paragraph 2.3 (Sub-licencing)) after the two (2) year royalty holiday prescribed by paragraph 4.2 (Royalty Holiday) from the: 1.9.1 the COMMERCIALIZATION (including without limitation, all transfers, sub-licences, leases, transfers, distributorships or other transactions) of the ET and IR or either of them if only one is being COMMERCIALIZED; and 1.9.2 the COMMERCIALIZATION of any agricultural, zoological or nutraceutal derivative of, or product that incorporates in any percentage, ET or IR; For greater clarity, whenever eVS sells a product incorporating in any way ET or IR, in a bona fide commercial transaction the GROSS REVENUES shall be the monies received as the SALES PRICE in that transaction. Alternatively phrased, in transactions which do not constitute sub-licences under paragraph 2.3 (Sub-licencing), in which eVS sells product derivatives of or incorporating ET or IR, to third parties for a specified SALES PRICE, including a distributor or other entity which intends to resell such product, GROSS REVENUES shall means such SALES PRICE. 1.10 "IMPROVEMENT" means any modification to the LICENCED TECHNOLOGIES which would infringe the PATENTS for either ET or IR or otherwise directly modify or directly improve the LICENCED TECHNOLOGIES: 16 17 PROTECTED - BUSINESS INFORMATION 1.11 "INTELLECTUAL PROPERTY" means ET and IR; and all directly related: copyrights, designs, methods and processes, show-how, know-how, trade secrets; and other intellectual property rights directly related to the LICENCED TECHNOLOGIES, and for greater clarity, includes any IMPROVEMENTS. 1.12 "IR" means: 1.12.1 use of infra-red technology (as invented and practised by the Lacombe Research Centre) for the determination of general health, meat quality and grading of meat and livestock and other agricultural, zoological and nutraceutical applications premised on such infra-red technology; as claimed in Canadian patent #2,099,529; US patent #5,458,418 & 5,595,44 and the other relevant patents listed in Appendix A (LICENCED TECHNOLOGIES PATENTS); and 1.12.2 including all directly related know-how and directly related trade secrets needed to exercise the technology claimed in the PATENTS but excluding without limitation: 1.12.3 the infra red technology previously created or owned by eVS and identified in Appendix E (eVS Infra Red Technologies) and all improvements thereto not directly derived from the IR or IMPROVEMENTS; 1.12.4 any other infra red technology or improvements thereto acquired by eVS or independently developed by eVS after the date hereof which is not directly derived from the IR or IMPROVEMENTS; and 1.12.5 the visual grading system (known as "CVS") previously created or owned by Canada including subsequent improvements thereto which is not directly derived from the IR or IMPROVEMENTS;. 1.13 "LICENCED PRODUCT" means any livestock or animal ready form of ET, more particularly 1.13.1 the appropriate mix of a specific quantity of PRE-MIX and certain feed base materials, 1.3.1.1 which mix is dependent on both the livestock or animal being treated and the medium of delivery. 1.14 "LICENCED TERRITORIES" means: 17 18 PROTECTED - BUSINESS INFORMATION 1.14.1 worldwide for IR; 1.14.2 worldwide for (ET) PRE-MIX; 1.14.3 worldwide for (ET) LICENCED PRODUCT except for: 1.14.3.1 Australia, New Zealand and Canada for beef; and 1.14.3.2 Canada for swine. 1.5 "LICENCED TECHNOLOGIES " means ET and IR and any IMPROVEMENTS that eVS elects to licence pursuant to Article 7 (Improvements, R & D, Collaborations). 1.6 "MASTER LICENCE" means this agreement that includes attached appendices and refers to the whole of this agreement, not to any particular section or portion thereof. 1.7 "NUTRI-CHARGE AGREEMENTS" means the following licences, as those agreements stood, as of the date of execution of the MASTER LICENCE 1.17.1 Sub-Licence Nutri-Charge Agreement dated December 1, 1993, between the parties S.T.S. Agriventures Ltd. and Nutri-Charge; and 1.17.2 Sub-Licence Detection Technology Agreement dated December 1, 1993, between the parties S.T.S. Agriventures Ltd. and Nutri-Charge. 1.18 "PARTY" means any one of the signatories to the MASTER LICENCE and PARTIES means both of them and their respective employees, servants and agents. 1.19 "PATENT" means: 1.19.1 the patents listed Appendix A (LICENCED TECHNOLOGIES PATENTS); 1.19.2 any continuations, divisions, reissues and any subsequent patents whose priorities are derived from any of the patents in Appendix A (LICENCED TECHNOLOGIES PATENTS); and 1.19.3 subsequently patented improvements to the patents in Appendix A (LICENCED TECHNOLOGIES PATENTS). 1.20 "PATENT OFFICE" means a PATENT OFFICE in any part of the LICENCED TERRITORIES and PATENT Offices means all of them. 18 19 PROTECTED - BUSINESS INFORMATION 1.21 "PERIOD ONE" means for each year during any subsisting term of the MASTER LICENCE the period from 1 January through 30 June inclusive. 1.22 "PERIOD TWO" means for each year during any subsisting term of the MASTER LICENCE the period from 1 July through 31 December inclusive. 1.23 "PRE- MIX" means the protected / confidential formulation of the essential active ingredients of ET, which when combined with carriers such as corn constitute the LICENCED PRODUCT as specified and identified in Appendix "C" (PRE-MIX FORMULATION) and as claimed in the US patents. 1.24 "SALES PRICE" means the gross price paid by an arms length purchaser for any LICENCED TECHNOLOGIES sold by eVS or its authorized sub-licencees. In an non-arms length transaction, involving an AFFILIATE, Safeguard Scientifics Inc. or a sister corporation, if the gross price is less than the fair market value, then, for royalty calculation purposes, the gross price shall then be deemed to be the fair market value as set by Canada. 1.25 "SERENDIPITOUS TECHNOLOGIES" are technologies or improvements that: 1.25.1 do not infringe the PATENTS; and 1.25.2 are created at the Agriculture Canada's Lacombe Research Centre, Alberta, Canada. 1.26 "STS AGREEMENTS" means the following licences, as those agreements stood, as of the date of execution of the MASTER LICENCE: 1.26.1 Exclusive Licence Agreement - NUTRI-CHARGE(R) - dated October 22, 1993, between Her Majesty the Queen in Right of Canada, as represented by the Minister of Agriculture and S.T.S. Agriventures Ltd.; 1.26.2 Amendment to the Exclusive Licence Agreement - NUTRI-CHARGE(R) - STS dated March 21 1997, between Her Majesty the Queen in Right of Canada, as represented by the Minister of Agriculture and S.T.S. Agriventures Ltd.; 1.26.3 Sub-licence - NUTRI-CHARGE(R) - Agreement dated December 1, 1993, between S.T.S. Agriventures Ltd. and Nutri-Charge; 1.26.4 Agreement - NUTRI-CHARGE(R) - dated March 21, 1997, between Her Majesty the Queen in Right of Canada, as represented by the Minister of Agriculture and S.T.S. Agriventures Ltd.; 19 20 PROTECTED - BUSINESS INFORMATION 1.26.5 Sole Licence Agreement - Detection Technology dated December 1, 1993, between Her Majesty the Queen in Right of Canada, as represented by the Minister of Agriculture and S.T.S. Agriventures Ltd.; 1.26.6 Sub-licence Agreement - Detection Technology - dated December 1, 1993, between S.T.S. Agriventures Ltd. and Nutri-Charge; and 1.26.7 Exclusive Licence Agreement - NUTRICHARGE(R) - between Her Majesty the Queen in Right of Canada, as represented by the Minister of Agriculture and STS Agriventures Ltd. 1.27 "TRADEMARK" means the trade name NUTRI-CHARGE(R) which is owned by Canada for Canada, but does not include that trade name as owned by: 1.27.1 AgResearch for New Zealand, Australia; 1.27.2 STS Agriventures for the UK & EEC; and 1.27.3 Nutri-charge Partnership for the United States 20 21 PROTECTED - BUSINESS INFORMATION 2 SURRENDER & GRANT OF LICENCE Surrender 2.1 eVS hereby surrenders its STS AGREEMENTS and NUTRI-CHARGE AGREEMENTS to Canada, and Canada accepts the surrender of those agreements. Thereafter the aforementioned agreements: 2.1.1 shall be of no further force and effect; and 2.1.2 neither PARTY shall have any further liabilities or obligations under any such agreements Grant 2.2 Subject to the provisions of this MASTER LICENCE, Canada grants to eVS an exclusive, fixed term, terminable pursuant to Article 16 (Termination), royalty bearing licence for: 2.2.1 the COMMERCIALIZATION of the LICENCED TECHNOLOGIES; and 2.2.2 the TRADEMARK in any jurisdictions for which Canada owns the TRADEMARK and Canada is free to licence it, whether such ownership vests in Canada prior to or subsequent to the execution of the MASTER LICENCE. Sub-licencing 2.3 eVS is permitted to sub-licence on the same terms and conditions as the MASTER LICENCE: 2.3.1 AFFILIATES without the consent of Canada; or 2.3.2 non-affiliated or non-controlled parties with the prior written consent of Canada, which consent shall not be unreasonably withheld; granted that in either situation: 2.3.3 the sub-licencee is a reputable party capable of meeting its obligations under the sub-licence; and 2.3.4 the sub-licence or sub-licencee is in no way prejudicial to Canada's good faith commercial interests concerning the COMMERCIALIZATION of the LICENCED TECHNOLOGIES. Canada's Consent 21 22 PROTECTED - BUSINESS INFORMATION 2.4 Canada's consent is required in order to: 2.4.1 avoid any pronounced conflicts of interest with respect to ongoing planned research or licenced activities by Canada; 2.4.2 avoid any contractual conflicts by Canada; or 2.4.3 allow Canada to know who has access to and are exploiting the LICENCED TECHNOLOGIES for reasons of feedback to Canada to allow improvements and development. Sub-licence Conditions 2.5 Any sub-licence granted by eVS shall: 2.5.1 be royalty-bearing, revocable, without the right to sub-licence, only within the LICENCED TERRITORIES or any portion thereof, and only within the FIELDS OF USE or a subset thereof; 2.5.2 prescribe a royalty against GROSS REVENUES of the sub-licencee of not less than [ ** ]; 2.5.3 the first [ ** ] of any undivided royalty shall be payable directly to Canada so that Canada is receiving the same monies as if eVS has conducted the COMMERCIALIZATION of the LICENCED TECHNOLOGIES rather than the sub-licencee; 2.5.4 give eVS all rights necessary to strictly monitor and enforce quality control standards; 2.5.5 be subject to the same obligations and restrictions as those required of eVS under the MASTER LICENCE; 2.5.6 be copied to Canada within thirty (30) days of execution; and 2.5.7 not be a de facto assignment. Termination 2.6 Termination of the MASTER LICENCE shall also terminate any subsisting sub-licences. Third Party Obligations - eVS 22 23 PROTECTED - BUSINESS INFORMATION 2.7 eVS shall honour any obligations Canada has in its licences or collaboration agreements with RMS and AgResearch including without limitation 2.7.1 the supply and pricing of ET PRE-MIX; 2.7.2 use of the TRADEMARK; and 2.7.3 rights to improvements to the technologies licenced under those agreements. These eVS obligations only apply to the contracts listed in Appendix D (RMS / AgResearch Agreements). For greater certainty, the RMS contract for swine ET in Canada shall be deemed to be an executed contract antecedent in time to the MASTER LICENCE, notwithstanding its actual date of execution or effective date. Third Party Obligations - Canada 2.8 Canada shall not modify or extend the Appendix D Agreements other than pursuant to the terms of those Appendix D Agreements. Canada will not agree to renew any such agreement without offering to eVS the prior right to enter into an agreement on substantially the same terms and conditions unless the other contracting party has the right to renew such agreement. Use of Canadian Corporations 2.9 eVS agrees that, when it deems such action to be commercially prudent, it will use Canadian corporations to provide outsourcing or subcontracting services in connection with the COMMERCIALIZATION of ET and IR. Disclosure Obligation - Canada 2.10 Canada shall have a continuing obligation to disclose in a reasonable manner and time to eVS any new INTELLECTUAL PROPERTY. Material Terms 2.11 Paragraphs 2.3 (Sub-licencing) to 2.10 (Disclosure Obligation - Canada) are material terms of the MASTER LICENCE. 23 24 PROTECTED - BUSINESS INFORMATION 3 TERM Initial Term 3.1 Subject to paragraph 3.2 (Renewal Conditions) and Article 16 (Termination) the term of the MASTER LICENCE shall be twenty (20) years from the date of execution. Renewal Conditions 3.2 eVS shall have the right to elect to renew after the initial term for five (5) year terms, so long as: No Dispute 3.2.1 eVS is not in breach of the extant MASTER LICENCE; or Dispute /Contingent Renewal Pending ADR 3.2.2 if at the time of an automatic renewal, there is an outstanding dispute or disputes between the PARTIES that has been articulated and referred to negotiation, paragraph 18.2 (Formal Negotiations) or in mediation, paragraph 18.3 (Mediation) or in arbitration, paragraph 18.8 (Arbitration) as the case may be, then the MASTER LICENCE shall contingently renew until the dispute is resolved under the dispute resolution mechanisms prescribed under Article 18 (Alternate Dispute Resolution (ADR)). 3.2.2.1 If the resolution of the dispute determines that eVS has committed an act of termination as defined in Article 16 (Termination), then Canada shall elect either to: 3.2.2.1.1 allow the renewal to vest; or 3.2.2.1.2 terminate the MASTER LICENCE, subject to any cure periods. 3.2.2.2 If the resolution of the dispute determines that eVS was not or is not in breach of the MASTER LICENCE, then the renewal of the MASTER LICENCE shall vest. 24 25 PROTECTED - BUSINESS INFORMATION 4 EXPLOITATION OF LICENCED TECHNOLOGIES Best Efforts to Commercialize 4.1 During the term (or the renewal) of the MASTER LICENCE, eVS shall: 4.1.1 use its commercially reasonable best efforts to COMMERCIALIZE the LICENCED TECHNOLOGIES; and 4.1.2 not do, or assist anyone to do, anything inimical to the COMMERCIALIZATION of the LICENCED TECHNOLOGIES or TRADEMARK. Royalty Holiday 4.2 Notwithstanding paragraph 4.1 (Best Efforts to Commercialize), because: 4.2.1 ET requires regulatory approvals for each of the different products; 4.2.2 as of the date of the execution of the MASTER LICENCE, IR is not sufficiently developed for COMMERCIALIZATION due to software and hardware issues; and 4.2.3 acquisition, start-up, marketing, manufacturing costs are substantial and well in excess of one million dollars US ($1,000,000). eVS shall have a two (2) year royalty holiday from the date of execution of the MASTER LICENCE in order to obtain the necessary regulatory approvals, mature the IR for market and preserve capital for COMMERCIALIZATION purposes. Start-Up Costs 4.3 If Canada requires broad details of the costs cited in sub-paragraph 4.2.3 (Royalty Holiday), then eVS shall provide those details sufficient to satisfy Canada's need and motivation for such details. Such information is deemed to be CONFIDENTIAL INFORMATION because of the highly sensitive financial and marketing intelligence contained therein. Continuing Obligations During Holiday 4.4 The royalty holiday under paragraph 4.2 (Royalty Holiday), does not relieve eVS of its obligations to: Patents 25 26 PROTECTED - BUSINESS INFORMATION 4.4.1 apply for, register, prosecute, secure and maintain PATENTS as further prescribed in Article 9 (Patents); Collaborations 4.4.2 fund collaborations concerning ET and IR as prescribed in Article 7 (Improvements, R & D, Collaborations); and Research Support Payment 4.4.3 pay twenty thousand dollars US ($20,000) to Canada at the first anniversary of the execution of MASTER LICENCE towards a research support agreement for research purposes designated solely by Canada which may or may not involve the LICENCED TECHNOLOGIES. Fundamental Terms 4.5 Paragraph 4.1 (Best Efforts to Commercialize) is a fundamental term of the MASTER LICENCE. 26 27 PROTECTED - BUSINESS INFORMATION 5 ROYALTIES Percentage Royalty of Gross Revenues 5.1 eVS shall pay a royalty to Canada of [ ** ] of GROSS REVENUES. Payments Semi-Annually 5.2 The royalties under paragraph 5.1 (Percentage Royalty of Gross Revenues) shall be payable semi-annually to Canada. Payment Dates 5.3 eVS shall calculate the royalties for PERIOD ONE and PERIOD TWO each year. 5.3.1 The payment related to PERIOD ONE, which shall be estimated and based upon unaudited financial statements, shall be made on or about 31 July each year. 5.3.2 The payment related to PERIOD TWO, which shall be based upon audited year-end financial statements and adjusted, if necessary, to reflect actual royalties earned in PERIOD ONE, shall be made on or before 15 March each year. Payment Method 5.4 Cheques for the payment of royalties shall be in US funds and made payable to the "Receiver General for Canada". They shall be sent to: Director Agriculture and Agri-Food Canada Lacombe Research Centre 6000 C&E Trail Lacombe, Alberta T4L 1W1 Cheque Requirements 5.5 Each cheque shall be accompanied by a statement bearing the Financial Coding of this MASTER LICENCE and the LICENCED TECHNOLOGIES name/identification, and showing the period covered, the total sales, the royalty applicable and the total royalty paid. Payments to Canada after Termination 27 28 PROTECTED - BUSINESS INFORMATION 5.6 eVS shall pay to Canada any sums due and payable under the MASTER LICENCE, whether incurred prior to termination or after, in accordance with Article 16 (Termination). Attribution of Royalties 5.7 eVS shall use its commercially reasonable best efforts to identify how much of the aggregate annual royalties are attributable to each of ET or IR. This information will be disclosed to Canada at the same time the PERIOD TWO payment is made. 28 29 PROTECTED - BUSINESS INFORMATION 6 IP OWNERSHIP & REPRESENTATIONS Canada Owns Licenced Technologies 6.1 eVS agrees and is estopped from alleging otherwise, that: 6.1.1 subject to the provisions of paragraph 7.12 (Ownership of Background Intellectual Property) the LICENCED TECHNOLOGIES, its creation, discovery, development and every matter relating thereto, forming part thereof and arising therefrom, are vested in and are the sole property of Canada; 6.1.2 subject to the provisions of paragraph 7.12 (Ownership of Background Intellectual Property) ownership and all rights to, related to, connected with or arising out of the foregoing, including without limitation, PATENTS, INTELLECTUAL PROPERTY and copyright in and the right to produce and publish or cause to be produced and published all information material and documents, and the right to issue a licence, are vested in and are the sole property of Canada; 6.1.3 eVS shall have no rights in and to the foregoing except as may be expressly granted in the MASTER LICENCE and eVS shall not apply for any pertinent or other right and shall not divulge or disclose, without the prior written consent of Canada, any information, material or documents concerning same or make available in any way or use the LICENCED TECHNOLOGIES except as expressly provided in this MASTER LICENCE; 6.1.4 Canada is the exclusive owner of the TRADEMARK and all goodwill associated therewith, and any unauthorized use of the TRADEMARK is an infringement of Canada's rights; and 6.1.5 eVS acquires no right, title or interest in the TRADEMARK, and eVS shall not in any manner represent that it has any ownership interest in the TRADEMARK or applications or registrations therefor. No Impeachment 6.2 eVS shall neither impeach or otherwise attack, directly or indirectly, the PATENTS the TRADEMARK or any INTELLECTUAL PROPERTY rights held by Canada in the LICENCED TECHNOLOGIES nor assist any third party to do the same, except where prohibited by law. Inimical Use of Confidential Information 6.3 Notwithstanding prohibition in paragraph 6.2 (No Impeachment), eVS shall not use any CONFIDENTIAL INFORMATION obtained from Canada in the negotiation of the 29 30 PROTECTED - BUSINESS INFORMATION MASTER LICENCE, under due diligence searches or otherwise related to this MASTER LICENCE in any manner that violates eVS rights and obligations under the MASTER LICENCE and is inimical to the interests of Canada. Regulatory Rights 6.4 Canada represents to the best of its knowledge that any regulatory rights to the LICENCED TECHNOLOGIES are as follows: 6.4.1 STS Agriventures Ltd. owns the registration for Canada for five ET products for beef cattle; 6.4.2 Nutricharge Partnership is in the final stages of the process of getting ownership for one ET product for beef cattle in the USA; 6.4.3 Canada is in the process getting ownership for one ET product in Canada for swine; and 6.4.4 Agriventures STS Ltd. has obtained a registration for one ET product beef cattle in UK and EEC, which registration does not provide proprietary rights. Inventors Rights 6.5 Canada has obtained an enforceable written assignment from each named inventor, and the proper inventors have been identified in the PATENTS. Canada has provided to eVS true and correct copies of each such assignment. 6.6 To the best of Canada's knowledge the PATENTS both constitute a valid and enforceable right of Canada and do not infringe or conflict with the rights of any other person. To the best of Canada's knowledge, Canada has no obligation to compensate any non-governmental third parties in order to use the LICENCED TECHNOLOGIES other than: 6.6.1 as prescribed under the Public Servants Inventions Act, pursuant to which payments are carved from any royalties received by Canada for the use of the LICENCED TECHNOLOGIES; 6.6.2 a carve out of any royalty stream of Canada's attributable to the use of technology arising out of a collaboration with the Alberta Pork Producers Development Corporation, which collaboration was terminated on 1 July 1994, and which carve shall, as between the PARTIES, be Canada's sole responsible. 30 31 PROTECTED - BUSINESS INFORMATION No Litigation 6.7 As of the date of execution of the MASTER LICENCE, to the best of Canada's knowledge, there is no threatened suit, action, claim, arbitration, grievance, litigation, administrative or legal or other proceeding, or investigation, against Canada or its licencees contesting the validity of, or Canada's rights to use, any of the LICENCED TECHNOLOGIES. Third Party Rights 6.8 Except for: 6.8.1 the licences listed in Appendix D ("RMS / AgResearch Agreements); 6.8.2 the right to conduct research concerning the LICENCED TECHNOLOGIES; and 6.8.3 the regulatory rights listed in paragraph 6.4 (Regulatory Rights); as of the date of execution of the MASTER LICENCE, Canada has not granted any commercial licence or other commercial right to use, in any manner, any item of the LICENCED TECHNOLOGIES whether or not requiring the payment of royalties. Infringement 6.9 To the best of Canada's knowledge, as of the date of execution of the MASTER LICENCE, no person or entity is infringing upon any of Canada's rights to the PATENTS. To the best of Canada's knowledge, Canada's use of the PATENTS prior to the date of this MASTER LICENCE does not infringe, and has not infringed, the rights of any third party. Canada has not received any formal notice of infringement upon, misappropriation of any asserted right of any third party, and to the best of Canada's knowledge, there is no basis for any such notice. Patent Coverage & Formula 6.10 Canada represents and warrants that: 6.10.1 the confidential formulation of the PRE-MIX as identified in Appendix "C" in particular NUTRI-CHARGE(R) MR (market-ready) and NUTRI-CHARGE(R) ON (over- night), but excluding NUTRI-CHARGE(R) TM (tank mixable) are within at least one claim on the US patents; 6.10.2 this formulation, as adapted for a particular species or medium of delivery, was disclosed under licence to STS Agriventures Ltd. and Nutricharge (a limited partnership) for regulatory registration. 31 32 PROTECTED - BUSINESS INFORMATION US Federal Department of Agriculture (FDA) Regulatory Manufacture 6.11 As of the date of execution of the MASTER LICENCE, to the best of Canada's knowledge, its licencee for the US territory, Nutricharge, manufactured ET PENDING PRODUCT in full compliance with FDA good manufacturing practice requirements. No Export 6.12 As of the date of execution of the MASTER LICENCE, Canada has not exported PRE-MIX or LICENCED PRODUCT to the USA, and to the best of Canada's knowledge, none of Canada's licencees have exported PRE-MIX or LICENCED PRODUCT to the USA. Disclosure by Canada 6.13 As of the date of execution of the MASTER LICENCE, Canada has made its best efforts to discuss, satisfy inquiries, locate and disclose to eVS or its agents, all documents or other information in Canada's possession concerning communications to or from the FDA or prepared by the FDA, concerning the ET PENDING PRODUCT, and the related FDA regulatory requirements for new animal drugs. Product Claims 6.14 As of the date of execution of the MASTER LICENCE, Canada has agreed with the FDA as to a protocol to prove the following claims concerning the ET PENDING PRODUCT: 6.14.1 increased dressing percentage; 6.14.2 reduced proportions of dark cutter which are animals with low muscle glycogen and high pH; 6.14.3 reduced mobility of intra-muscular fat resulting in a higher marbling score; As evidenced by FDA memo dated 28 June 1996, an FDA letter 29 September 1997. Animal Food 6.15 As of the date of the execution of the MASTER LICENCE, to the best of Canada's knowledge, the ET PENDING PRODUCT meets all FDA requirements for use as a 32 33 PROTECTED - BUSINESS INFORMATION non-human animal food. For greater clarity, Canada has not assessed the ET PENDING PRODUCT with respect to the American Association of Feed Control Officials (AAFCO). FDA Problems 6.16 As of the date of execution of the MASTER LICENCE, Canada is not currently aware of any issues or problems that would significantly delay or prevent FDA approval of a new animal drug application for the ET PENDING PRODUCT, with the exception of clinical trial results which are the subject of the report entitled "Investigator Final Study Report, INAD, 9267-0-0004". No Misrepresentations 6.17 As of the date of execution of the MASTER LICENCE, Canada has not, and to the best of Canada's knowledge, Her authorized agents and licencees have not, 6.17.1 made any untrue statements of a material fact or fraudulent statement to the FDA; 6.17.2 deliberately failed to disclose a fact requirement to be disclosed to the FDA; and 6.17.3 paid any bribe or illegal gratuities or committed any deceptive act to or upon the FDA. Laboratory Practices 6.18 Canada has conducted itself with respect to ET and IR under good laboratory practices, but Canada has not knowingly conducted itself in accordance with any good laboratory practices prescribed by a statute or regulation of another nation. Material Terms 6.19 Article 6 (IP Ownership & Representations) is a material term of the MASTER LICENCE. 33 34 PROTECTED - BUSINESS INFORMATION 7 IMPROVEMENTS, R & D, COLLABORATIONS Carve Out 7.1 Notwithstanding any other provision of this MASTER LICENCE, Canada shall retain from the MASTER LICENCE any and all rights necessary for research and development both: 7.1.1 to improve ET and IR; and 7.1.2 to pursue research and development directly or indirectly related to ET and IR. Licencing of Improvements from Canada's R & D under Carve Out 7.2 If IMPROVEMENTS arise from research conducted by Canada at the Lacombe Research Centre under paragraph 7.1 (Carve Out), and 7.2.1 those IMPROVEMENTS are exclusively owned by Canada; or 7.2.2 there are no pre-emptory or third party rights to those IMPROVEMENTS under pre-existing agreements concerning IR or ET; then those IMPROVEMENTS shall be licenced exclusively to eVS under the MASTER LICENCE upon notification by Canada of such IMPROVEMENTS and acceptance of same by eVS in writing within one hundred and eighty (180) days of the notification. Any SERENDIPITOUS IMPROVEMENTS arising from research conducted by Canada under paragraph 7.1 (Carve Out) shall not be covered by the MASTER LICENCE. No Competition 7.3 Canada shall not COMMERCIALIZE ET or IR or any IMPROVEMENTS, but nothing in this obligation shall derogate or diminish Canada's right to conduct research and development as contemplated in paragraph 7.1 (Carve Out). Collaborations Between eVS and Canada 7.4 eVS and Canada shall each have the option to be a collaborator with the other in any projects concerning IR or ET. If the PARTIES agree to such a collaboration, then eVS and Canada (through the Lacombe Research Centre) shall support on a case-by-case, mutually agreed upon basis, such collaborations in cash or in kind, or both. Each PARTY shall thereafter provide the other PARTY with periodic progress reports regarding the status of the collaboration as provided for in the applicable collaboration agreement. 34 35 PROTECTED - BUSINESS INFORMATION Licencing of Improvements from eVS / Canada Collaborations 7.5 Any IMPROVEMENTS produced in any collaboration between eVS and Canada (Lacombe Research Centre) pursuant to paragraph 7.4 (Collaborations Between eVS and Canada) shall be licenced exclusively to eVS under the MASTER LICENCE after notification by Canada of such IMPROVEMENT and acceptance of same by eVS in writing within one hundred and eighty (180) days from such notification. The IMPROVEMENTS shall be owned by Canada unless eVS brought technology into the collaboration which was crucial to the collaboration in which case the resulting technology shall be jointly owned in proportion to the values of the technologies brought by the PARTIES. Licencing of Serendipitous Technologies from eVS / Canada Collaborations 7.6 After notification by Canada of any SERENDIPITOUS TECHNOLOGIES produced in any collaboration between eVS and Canada pursuant to paragraph 7.4 (Collaborations Between eVS and Canada), eVS shall have an option (exercisable in writing within one hundred and eighty (180) days from the aforementioned notification) to exclusively licence those SERENDIPITOUS TECHNOLOGIES, on reasonable commercial terms which terms shall include a commercially reasonable best efforts to COMMERCIALIZE obligations. The SERENDIPITOUS TECHNOLOGIES resulting from the collaboration shall be owned by Canada unless eVS brought technology into the collaboration which was crucial to the collaboration in which case the resulting technology shall be jointly owned in proportion to the values of the technology brought by the PARTIES. Third Party Licences Resulting Technology 7.7 If under paragraph 7.6, (Licencing Serendipitous Technologies from eVS / Canada Collaborations) 7.7.1 eVS funds a collaboration but does not exercise any rights to licence any technology resulting from that collaboration; and 7.7.2 Canada commercializes that resulting technology with a third party; then eVS shall be entitled to a portion of any consideration payable under the licence with the third party in an amount to be agreed upon by the PARTIES, which may be determined in part by considering each PARTY's contribution to the collaboration. Improvements Part of Licenced Technologies 7.8 For greater clarity, if eVS elects to licence IMPROVEMENTS, pursuant to any or all of: 35 36 PROTECTED - BUSINESS INFORMATION 7.8.1 paragraph 7.2 (Canada's R & D under Carve Out); 7.8.2 paragraph 7.5 (eVS / Canada Collaborations); and 7.8.3 paragraph 7.6 (Serendipitous Technologies from eVS / Canada Collaborations); then such IMPROVEMENTS shall be deemed to be included in the definition of LICENCED TECHNOLOGIES of ET or IR, as applicable. Discretion to Collaborate 7.9 Collaborations pursuant to paragraph 7.4 (Collaborations Between eVS and Canada) shall be conducted subject to the discretion of Canada and eVS (as applicable), factoring in, amongst other factors: 7.9.1 research planning priorities; 7.9.2 mandate; 7.9.3 pre-existing contractual obligations; 7.9.4 scarcity of resources & personnel; 7.9.5 Ministerial prerogative; and 7.9.6 commercial needs / priorities / time constraints. Either Party Unable / Unwilling to Collaborate 7.10 If either PARTY is unable or unwilling to collaborate or conduct a collaboration pursuant to paragraph 7.4 (Collaborations Between eVS and Canada) due to reasons contemplated in paragraph 7.9 (Discretion to Collaborate) then the other PARTY may enter into a collaboration with a third party, subject to the applicable criteria in paragraph 7.11 (Third Party Collaborations). Third Party Collaborations 7.11 When the PARTIES enter into third party collaboration, as prescribed in paragraph 7.10 (Either Party Unable / Unwilling to Collaborate), Canada and eVS shall: 7.11.1 disclose to the other the nature of the collaboration prior to the start of the project; 36 37 PROTECTED - BUSINESS INFORMATION 7.11.2 determine if the third party would collaborate with Canada or eVS as the case may be; 7.11.3 ensure that if Canada or eVS (as applicable) do not actively participate in collaborative project, then the project shall be subject to any necessary confidentiality restrictions and third party approvals necessary to protect the CONFIDENTIAL INFORMATION of either Canada or eVS; 7.11.4 supply candid, timely and complete disclosure of the findings, results and their impact, potential or otherwise, on ET or IR notwithstanding any confidentiality strictures, to Canada or eVS (as applicable); 7.11.5 ensure that eVS or Canada, as the case may be, are signatories to any third party collaborations, even though eVS or Canada are not actively participating in the third party collaboration; and 7.11.6 if Canada is an active PARTY to a third party collaboration and eVS is not, Canada will use its best efforts to ensure that any IMPROVEMENTS resulting from such third party collaborations are licenced to eVS under the MASTER LICENCE. For greater clarity, pursuant to subparagraph 7.11.5 (Third Party Collaborations), the PARTIES agree that each must deliver an executed signature page to any third party agreement within thirty (30) days of the receipt of the execution copy of such agreement. Ownership of Background Intellectual Property 7.12 Any IMPROVEMENTS solely discovered, created, assigned to, licenced or otherwise bought by Canada or eVS remain the property of the PARTY that discovered, created or bought that IMPROVEMENT. Any jointly discovered, created or bought IMPROVEMENTS shall be jointly owned in the ratio which may be determined by the collaboration, contribution or purchase. Material Terms 7.13 eVS's obligations under this Article are material terms of the MASTER LICENCE. 37 38 PROTECTED - BUSINESS INFORMATION 8 WARRANTIES OF QUALITY No Warranties 8.1 Other than as explicitly stated in the MASTER LICENCE, Canada makes no warranties, express or implied, of any nature, for the LICENCED TECHNOLOGIES including without limitation: 8.1.1 merchantability; 8.1.2 fitness for any or a particular purpose; 8.1.3 commercial utility; 8.1.4 latent or other defects; 8.1.5 infringement or non-infringement of PATENTS or other third party rights; 8.1.6 conformity with the laws of any jurisdictions; or 8.1.7 fitness for eVS's corporate objectives. Disclaimer of Implied Warranties 8.2 No legal or equitable warranties implied by law or convention under any domestic, foreign or international legal regime shall apply to the MASTER LICENCE. eVS acknowledges this disclaimer and is estopped from relying on any such warranties against Canada. Third Party Representations 8.3 eVS shall not represent to any sub-licencee the existence of any warranty concerning the LICENCED TECHNOLOGIES unless such warranty is explicitly stated in the MASTER LICENCE. Disclosure by Canada 8.4 As of the date of execution of the MASTER LICENCE, Canada has made its best efforts to locate and disclose to eVS all relevant information, studies, publications in Canada's possession or control concerning: 8.4.1 any regulatory processes; 8.4.2 the use, safety and effectiveness of the PATENTS; and 38 39 PROTECTED - BUSINESS INFORMATION 8.4.3 the safety for consumption by animals that have been treated by the PATENTS; for the purposes originally contemplated under the MASTER LICENCE. To the best of Canada's knowledge all of the aforementioned information, studies, and publications are true and correct in all material respects and omit no material facts the absence of which renders the studies misleading. Disclosure & Due Diligence 8.5 eVS acknowledges that: 8.5.1 eVS has conducted a due diligence search of all matters relevant to the LICENCED TECHNOLOGIES, the PATENTS and the MASTER LICENCE; 8.5.2 eVS has had an opportunity to confer with Canada and receive satisfactory answers from Canada; and 8.5.3 Canada makes no representation that all the characteristics both favourable and unfavourable have been identified. Confidential Information Without Warranty / No Reliance 8.6 Except for the representations of Canada in the MASTER LICENCE, 8.6.1 eVS shall not rely in any way on the accuracy or completeness of any CONFIDENTIAL INFORMATION or other information provided by Canada under the MASTER LICENCE; 8.6.2 any use of such CONFIDENTIAL INFORMATION shall be at eVS sole risk and expense; and 8.6.3 any CONFIDENTIAL INFORMATION provided to eVS by Canada is without any warranty or guarantee of any kind whatsoever. 39 40 PROTECTED - BUSINESS INFORMATION 9 PATENTS Queen Owns All Patents 9.1 The PARTIES agree that all PATENTS shall be in the name of "Her Majesty the Queen in Right of Canada as represented by the Minister of Agriculture and Agri-Food Canada" except in those instances of joint inventions as contemplated in Article 7 (Improvements, R & D, & Collaborations) in which case such patents shall be in joint names. eVS Discretion to Patent 9.2 eVS shall have discretion as to the jurisdictions in which it seeks patent protection. eVS Responsibility for Patent Costs 9.3 eVS shall be responsible for all future fees related to present and future PATENT applications, registration, prosecution and maintenance for: 9.3.1 all PATENTS in existence at the time of the execution of the MASTER LICENCE, irrespective of whether or not eVS deems those extant PATENTS necessary; and 9.3.2 patents deemed necessary by eVS and Canada, or by eVS only. Canada Responsibility for Patent Costs 9.4 Canada shall be responsible for all fees for patent applications that: 9.4.1 are initiated after the execution of the MASTER LICENCE; and 9.4.2 deemed necessary by Canada alone. Material Terms 9.5 eVS's obligations under this Article are material terms of the MASTER LICENCE. 40 41 PROTECTED - BUSINESS INFORMATION 10 REGULATORY Notice to Assist 10.1 Canada shall assist eVS to obtain any required regulatory approvals in the CORE COUNTRIES and as necessary elsewhere, for the COMMERCIALIZATION of ET and IR. Such assistance shall be provided after receipt of advance notice by Canada from eVS. eVS shall use its best efforts to provide advance notice to Canada to enable resource planning and allocation, which notice in any event shall be given not less than two (2) weeks prior to the date on which Canada's assistance is needed. Assistance 10.2 This assistance shall include without limitation: 10.2.1 educating eVS personnel or clients in the technology in support of hearings or registration trials; 10.2.2 making scientists familiar with the technology available for hearings or registration trials; 10.2.3 disclosing scientific reports (under appropriate confidentiality strictures when applicable); 10.2.4 establishing / disclosing protocols; and 10.2.5 scientific support. eVS acknowledges that when possible, third parties will be used to provide the said assistance in order to preserve and best utilize Canada's scientific resources. Such assistance will be provided by Canada subject to: 10.2.6 scarcity of scientific resources and personnel; 10.2.7 pre-existing contractual obligations; 10.2.8 research and development priorities; and 10.2.9 time constraints. In the event third parties cannot be utilized, Canada shall render the necessary support to eVS within a reasonable period of time as mutually agreed to by the parties taking into account the foregoing after receipt of sufficient advance notice pursuant to paragraph 10.1 (Notice to Assist). 41 42 PROTECTED - BUSINESS INFORMATION Canada's Advisory Board Positions 10.3 Canada shall have up to two positions on any scientific advisory boards used by eVS regarding ET and IR COMMERCIALIZATION. Canada shall ensure that, as applicable, the Director of the Lacombe Research Centre (or the Director's designate) and one of its scientists who is most conversant with IR or ET shall be Canada's nominees. Canada's scientist position on any advisory boards will be filled on a revolving basis as required. Costs of Canada's Advisory Board Members 10.4 eVS shall pay all travel, accommodation and victualing and incidental costs for Canada's members to travel for regulatory or advisory board purposes at rates: 10.4.1 not to exceed those prescribed by the Treasury Board of Canada for civil servants where those costs are incurred before notice or approval of the aforementioned costs by eVS; or 10.4.2 at the rates in accordance with the policies and procedures of eVS then in effect when the aforementioned costs are approved in advance by eVS; but salary and related expenses shall be borne by Canada. Regulatory Costs 10.5 eVS shall be solely responsible for any and all regulatory costs, applicable in any jurisdiction, including without limitation: professional fees, consultant costs, trial costs, government fees, levies and charges. For greater clarity and without restricting the generality of the foregoing, eVS shall not be responsible for infringement or litigation costs, other than as prescribed under Article 14 (Patent Infringement). Decision to Register 10.6 eVS shall be responsible, upon consultation with Canada, for determining if a product is to be registered under any regulatory regime, as well as the nature of the registration. Should eVS decide not to register, with or without claims, Canada may independently pursue registration at Canada's own cost. Registration Ownership 10.7 Registrations shall vest in the name of the PARTY that paid for the registration. Any registrations in the name of eVS shall be as soon as practicable assigned, 42 43 PROTECTED - BUSINESS INFORMATION transferred or licenced to Canada, for one dollar, upon the expiration or termination of the MASTER LICENCE. Trademark Use 10.8 eVS shall: 10.8.1 use the TRADEMARK only in the manner and form prescribed by Canada in accordance with the reasonable standards and specifications of Canada; 10.8.2 observe such reasonable requirements with respect to trademark notices and other forms of marking as Canada from time to time may, in its sole discretion, direct and communicate to eVS; and 10.8.3 indicate clearly when using the TRADEMARK that the TRADEMARK is owned by Canada and that the TRADEMARK is being used by eVS under a licence from Canada. Trademark and Quality Control 10.9 eVS shall only use the TRADEMARK in the territories for which Canada is the owner and only in association with ET which conforms in nature and quality and are produced or performed by eVS in compliance with the contractual and regulatory standards as prescribed in Article 11 (Audits & Quality Control). 43 44 PROTECTED - BUSINESS INFORMATION 11 AUDITS & QUALITY CONTROL Audit Rights and Purposes 11.1 Canada shall have the right to audit eVS and examine eVS's records, documentation and data related to the COMMERCIALIZATION of ET and IR in ensure compliance with all terms of the MASTER LICENCE and protection of the TRADEMARK. Audit Timing / Process / Cost 11.2 Such audits will be conducted during the 2nd quarter of any fiscal year after the completion of the preceding years annual audit. The audit will be conducted during normal business hours following reasonable written notice. Canada shall have the option to use the independent auditors of eVS to conduct the forensic royalty audit. If there is a five percent (5%) or more deficiency in royalty payment uncovered by the forensic arm of the independent auditors of eVS, then in addition to immediately paying the deficiency, eVS shall pay Canada's costs, if any, in conducting the audit. Regulatory Quality Standards 11.3 eVS shall use its best efforts to ensure that all ET and IR processes or products meet or exceed any contractual (pursuant to paragraph 11.4 - Contractual Quality Standards), regulatory or statutory standards. eVS shall contractually require the same compliance from its contractors, sub-contractors or sub-licences. Contractual Quality Standards 11.4 Canada and eVS shall clearly define in writing quality standards with respect to both product and manufacturing procedures, prior to the manufacture of each product. Spot Audits 11.5 If: 11.5.1 eVS becomes insolvent; 11.5.2 eVS fails to pay royalties within thirty (30) days of written notice of the arrears; 11.5.3 eVS is notified by a regulatory authority that eVS or one of its contractors, sub-licencees has breached statutory or regulatory standards in the production or use of ET or IR; 44 45 PROTECTED - BUSINESS INFORMATION 11.5.4 eVS fails to meet the contractual standards as prescribed in the procedure in paragraph 11.4 (Contractual Quality Standards); or 11.5.5 Canada becomes aware of bona fide complaints about the quality of PRE-MIX or LICENCED PRODUCT; then irrespective of the quarter, Canada may ask eVS to conduct spot audits of eVS production and sales sites anywhere in the LICENCED TERRITORIES within fourteen (14) days from written notification from Canada. eVS shall disclose those audit results to Canada within thirty (30) days of each audit. Material Terms 11.6 eVS's obligations under this Article are material terms of the MASTER LICENCE. 45 46 PROTECTED - BUSINESS INFORMATION 12 REPORTS Administrative Meetings 12.1 The PARTIES agree to meet annually to review for the preceding and upcoming year, both the progress of the COMMERCIALIZATION of ET and IR, and related scientific research, in addition to any other issues the PARTIES deem relevant. At the meeting the PARTIES may address: 12.1.1 a description of the steps taken by eVS to COMMERCIALIZE and sub-licence the LICENCED TERRITORIES; 12.1.2 a description of the marketing conditions for the LICENCED PRODUCT; 12.1.3 a report on the production, distribution and sales of the LICENCED PRODUCT; 12.1.4 a statement of: 12.1.4.1 the names and addresses of all sub-licences to whom the LICENCED PRODUCT has been sub-licenced; 12.1.4.2 the latest period (PERIOD ONE or TWO) reports, and if possible the revenues from each sub-licencee; 12.1.5 a discussion of the business plan for the COMMERCIALIZATION of the LICENCED TECHNOLOGIES both on a strategic and short term basis; 12.1.6 a discussion of the research conducted by the PARTIES relevant to the LICENCED TECHNOLOGIES; and 12.1.7 a discussion of the proposed research for the next two (2) years both on a strategic and short term basis. 46 47 PROTECTED - BUSINESS INFORMATION 13 CORPORATE REPRESENTATIONS & WARRANTIES eVS 13.1 eVS represents and warrants to Canada that as of the date of execution of the MASTER LICENCE: Ability 13.1.1 eVS can COMMERCIALIZE the LICENCED PRODUCTS, and eVS has the necessary access to funds, resources and personnel to perform its obligations under the MASTER LICENCE subject to: 13.1.1.1 eVS demonstrating that it can produce products or services or both based on the LICENCED TECHNOLOGIES in a financially profitable manner and that a commercial market exists for such sales at profitable prices; and 13.1.1.2 the receipt of the anticipated applicable USDA regulatory approvals for the LICENCED TECHNOLOGIES; This representation and warranty is a fundamental condition of the MASTER LICENCE but is not a guarantee by eVS that there is commercial market for the LICENCED TECHNOLOGIES or that the LICENCED TECHNOLOGIES can be successfully COMMERCIALIZED. Authorization 13.1.2 it has the corporate power and authority to negotiate, execute and comply with the MASTER LICENCE; Enforceable 13.1.3 it is bound by the MASTER AGREEMENT as a legal, valid and enforceable contract upon execution, limited only by applicable bankruptcy or creditor laws, and general principles of equity; Litigation 13.1.4 it has no knowledge of any no legal proceeding or order pending against or, to the knowledge of eVS, threatened against or affecting, eVS or any of its properties or otherwise that could adversely affect or restrict the ability of eVS to consummate fully the transactions contemplated by this MASTER LICENCE, (including without limitation the COMMERCIALIZATION of the 47 48 PROTECTED - BUSINESS INFORMATION LICENCED TECHNOLOGIES) or that in any manner draws into question the validity of this MASTER LICENCE. Veracity of Statements 13.1.5 no representation or warranty by eVS contained in this MASTER LICENCE and no statement contained in any certificate, schedule or other instrument furnished to Canada pursuant hereto or in connection with the transactions contemplated hereby, contains any untrue statement of a material fact or omits to state a material fact. Third Party Representations 13.1.6 it has not given any undertaking, express or implied, to any third party which would: 13.1.6.1 preclude eVS from fulfilling eVS's obligations under the MASTER LICENCE; or 13.1.6.2 cause eVS to breach an agreement with a third party. Canada 13.2 Canada represents and warrants to eVS as of the date of execution of the MASTER LICENCE. Authorization 13.2.1 She has the power and authority to negotiate, execute and comply with the MASTER LICENCE, subject to all applicable laws and the royal prerogative and 13.2.1.1 no further action is required by or in respect of any governmental or regulatory authority; 13.2.1.2 to the best of Canada's knowledge the MASTER LICENCE does not contravene, violate or constitute a breach or default under, any requirement of law applicable to Canada or any contract to which Canada is bound or subject; and 13.2.1.3 the MASTER LICENCE is legal, binding and enforceable in accordance with its terms. Veracity of Statements 48 49 PROTECTED - BUSINESS INFORMATION 13.2.2 no representation or warranty by Canada contained in this MASTER LICENCE and no statement contained in any certificate, schedule or other instrument furnished to eVS pursuant hereto or in connection with the transactions contemplated hereby, contains any untrue statement of a material fact or omits to state a material fact. Compliance of Laws 13.2.3 to the best of Canada's knowledge as of the date of execution of the MASTER LICENCE there is: 13.2.3.1 no suit, action, claim, arbitration, administrative or legal or other proceeding, or governmental or other investigation pending or threatened against or affecting the PATENTS other than 13.2.3.1.1 a grievance by a fee for service contractor, Dick Graham,(operating under the corporate name of sensIRscan) who assigned his rights of inventorship to Canada under IR patent #5,458,418, and is now claiming a share of any royalties received by Canada for that patent. 13.2.3.2 no failure to comply with, nor any default under, any law, requirement, regulation, or order affecting the PATENTS; 13.2.3.3 no violation of or default with respect to any order, or judgment of any court, board, agency, or other instrumentality with jurisdiction issued or pending against Canada which might have a material adverse effect on the PATENTS or the ownership or use thereof; and 13.2.3.4 no incident, events and claims of product liability relating to the PATENTS. 49 50 PROTECTED - BUSINESS INFORMATION 14 PATENT INFRINGEMENT Notice 14.1 In case of a PATENT infringement, or suspected PATENT infringement eVS or Canada shall promptly notify the other in writing of the alleged infringement of which a PARTY has knowledge. Core Countries 14.2 If the infringement occurs in the CORE COUNTRIES then Canada shall have 14.2.1 in the case of a defence, fourteen (14) days from service of a claim; or 14.2.2 in the case of a prosecution / enforcement, ninety (90) days from notification the possible infringement, to determine if Canada will prosecute or defend the infringement action, as the case may be. Canada Defends / Prosecutes 14.3 If Canada elects to prosecute / enforce or defend an action in a CORE COUNTRY, then eVS shall have the right to participate in the litigation as co-counsel at eVS's sole cost. Any prosecution / enforcement action will claim in addition to any other applicable damages or costs, both the lost revenues to the Canada and the lost revenues to eVS. eVS Co-Counsel 14.4 All decisions related to the conduct and settlement of the litigation shall be made jointly by the PARTIES except that Canada may settle suits seeking damages for infringement against third party patents without the consent of eVS so long as: 14.4.1 such settlement is solely for monetary damages for which Canada is solely responsible as owner of ET or IR; 14.4.2 such settlement in no way derogates, diminishes or restricts the rights granted to eVS in the MASTER LICENCE. For greater clarity, the prior written consent of eVS shall be required in all cases where a settlement would derogate, diminish or restrict the rights granted to eVS in the MASTER LICENCE. eVS Assumes Control of Litigation 50 51 PROTECTED - BUSINESS INFORMATION 14.5 If there is a disagreement between the PARTIES as to a significant strategic or tactical decision during the course of litigation contemplated in paragraph 14.3 (Canada Defends / Prosecutes), then eVS shall have the right to take over the litigation pursuant to paragraph 14.9 (eVS Defends / Prosecutes) and conduct the litigation in a commercially responsible manner. Costs when eVS Assumes Control of Litigation 14.6 eVS shall remain responsible for its costs up to the point the transfer of the case under paragraph 14.5 (eVS Assumes Control of Litigation). Canada Controls Payment of Damage / Settlement Terms 14.7 Notwithstanding the foregoing, eVS shall not have the right to: 14.7.1 compromise or otherwise settle damages that might be payable by Canada; or 14.7.2 enter a settlement that might derogate, diminish or restrict the rights granted to Canada in the Patents, without Canada's written prior consent. Canada's Damage Awards Distribution 14.8 If Canada is awarded damages or costs or both, then Canada shall: 14.8.1 firstly, deduct its total litigation costs from the amount of the award, if costs are not awarded; 14.8.2 secondly, if the court issues a judgment identifying damages for the lost revenues of Canada and of eVS, then the lost revenues damages of eVS shall be forthwith paid to eVs upon receipt; 14.8.3 thirdly, if a global damage award is made which does not identify the damage owing to Canada and eVS respectively, then the remaining amount of the award (excluding any punitive damages), shall be deemed to be GROSS REVENUES, and subject to the royalty rate under the MASTER LICENCE; and 14.8.4 any punitive damages shall be divided equally between the PARTIES. eVS Defends / Prosecutes 51 52 PROTECTED - BUSINESS INFORMATION 14.9 If Canada declines to prosecute or defend in a CORE COUNTRY, then eVS shall be free to take all action that is commercially responsible to prosecute or defend the infringement action, subject always to paragraph 14.7 (Canada Controls Payment of Damage / Settlement Terms). 14.9.1 From the date the litigation is commenced, in the case of a prosecution, or from the date of service, in the case of a defence, eVS shall then be entitled to defray from the subsequently generated royalties Article 5 (Royalties) costs of the litigation including without limitation legal fees, court costs, disbursements, and expert fees. 14.9.2 If at the time of the PERIOD ONE and PERIOD TWO royalty payments pursuant to paragraph 5.3 (Payment Dates), litigation costs exceed accrued royalties, then no royalties shall be paid, and the excess costs shall be carried forward and set-off against future royalties. 14.9.3 If the PARTIES determine that no future royalties are possible, then from that time forward eVS shall bear any additional litigation costs. In any case, Canada shall not be liable for funds greater than the royalty stream owing to Canada. 14.9.4 If eVS is awarded damages or costs or both, then after deducting total litigation costs from the amount of the award, if costs are not awarded, eVS shall reimburse Canada: 14.9.4.1 firstly, for any amounts set-off against royalties pertaining to any litigation costs; 14.9.4.2 secondly, the remaining amount of the award (excluding any punitive damages) shall be deemed to be GROSS REVENUES, and subject to the royalty rate under the MASTER Licence; and 14.9.4.3 thirdly, any punitive damages shall be divided equally between the PARTIES. Notwithstanding the foregoing, eVS shall not be entitled to "double dip" or have its total litigation costs reimbursed both by Canada and under any general damages or costs award. It is the intention of the PARTIES that for every dollar in costs recovered by eVS, eVS shall reimburse Canada a dollar in set-off royalties. Non-Core Country Infringement Actions 52 53 PROTECTED - BUSINESS INFORMATION 14.10 In non-CORE COUNTRIES, eVS alone shall be responsible for all decisions, costs and obligations associated with any infringement prosecutions / enforcements or defences and shall indemnify Canada for the same. Notwithstanding the foregoing, eVS shall brief Canada on not less than an annual basis as to the status of such actions, unless requested by Canada on a case specific basis. Parties Jointly Police Infringement 14.11 The PARTIES agree that they will jointly police infringement of the ET/IR PATENTS and will consult with the other with respect thereto. 53 54 PROTECTED - BUSINESS INFORMATION 15 INDEMNIFICATION Reciprocal for Negligence / Contract Breach 15.1 Subject to any applicable federal laws, Canada and eVS shall each defend, indemnify and hold the other harmless against: 15.1.1 any third party claims, costs, or suits arising out of the negligence of the other; and 15.1.2 negligence damages related to breaches of material or fundamental representations or covenants contained in the MASTER LICENCE. Procedures Notice 15.2 Promptly after acquiring knowledge of any claims that fall within the compass of paragraph 15.1 (Reciprocal for Negligence / Contract Breach) Canada or eVS, as the case may be, shall give to the other written notice of such claim. Failure to give this notice shall not relieve the indemnifying party of any liability it may have to the indemnified party if such failure does not materially prejudice the indemnifying party. Indemnifying Party Defends 15.3 Subject to indemnifying party waiving its right to contest its obligation to indemnify the indemnified party for any such claims, the indemnifying party shall have the right to assume the defense. The indemnifying party shall not be liable to the indemnified party for any legal expenses of other counsel or any other expenses subsequently incurred by such indemnified party in connection with the defense. Indemnified Party Defends 15.4 If the indemnifying party fails to assume such defense or advises that there are issues which raise conflicts of interest between the PARTIES, the indemnified party may retain one counsel satisfactory to it, and the indemnifying party shall pay all reasonable fees and expenses of such counsel promptly as statements therefor are receive. If the conflict of interest is the reason for such claims or the indemnified party's action resulted in such claims, then the indemnifying party shall be reimbursed by the indemnified party all monies paid under paragraph 15.4. Co-operation 54 55 PROTECTED - BUSINESS INFORMATION 15.5 The indemnifying party shall receive from the indemnified party all necessary and reasonable cooperation in said defense including, but not limited to, the services of employees who are familiar with the transactions out of which any such claims may have arisen. Mutual Consent of Settlement 15.6 The indemnifying party shall not be liable for any settlement effectuated without its prior written consent. 55 56 PROTECTED - BUSINESS INFORMATION 16 TERMINATION By Canada for Cause 16.1 The MASTER LICENCE, at the option of Canada, may be terminated forthwith by Canada without compensation to eVS if: 16.1.1 eVS fails to COMMERCIALIZE either one of ET or IR in at least one of the CORE COUNTRIES within the earlier of two (2) years from the USFDA regulatory approval for ET as a New Animal Drug Application or four (4) years from the execution of the MASTER LICENCE; 16.1.2 eVS fails to fund at least one collaboration or research support agreement within two (2) years from the date of the execution of the MASTER LICENCE; 16.1.3 eVS fails to make any required payment within forty five (45) days of receipt of the written notice of the arrears; 16.1.4 eVS continues to neglect, or fails to meet, a contractual, regulatory, or statutory standard after receipt of written notice of such deficiency and the expiration of a reasonable period of time to cure the deficiency, as defined in the paragraph 11.3 (Regulatory Quality Standards) or paragraph 11.4 (Contractual Quality Standards); 16.1.5 eVS commits or permits a breach of the identified material or fundamental terms and conditions in the MASTER LICENCE identified in paragraphs and Articles: 2.1, Surrender 2.2, Grant 2.3, Sub-licencing 2.4, Canada's Consent 2.5, Sub-licencing Conditions 2.6, Termination 2.7, Third Party Obligations - eVS 4.1, Best Efforts to Commercialize 6.2, No Impeachment 6.3, Inimical Use of Confidential Information 8.3, Third Party Representations 8.6, Confidential Information without Warranty / No Reliance 9.3, eVS Responsibility for Patent Costs 10.4, Costs of Canada's Advisory Board Members 10.5, Regulatory Costs 10.6, Decision to Register 56 57 PROTECTED - BUSINESS INFORMATION 10.7, Registration Ownership 10.8, Trademark Use 10.9, Trademark and Quality Control 11.1, Audit Rights and Purposes 11.2, Audit Timing / Process / Costs 11.5, Spot Audits 14.6, Costs when eVS Assumes Control of Litigation 14.7, Canada Controls Payment of Damage / Settlement Terms 15.1, Reciprocal Indemnification for Negligence / Contract Breach 17.1, Confidentiality Obligations 17.2, Confidentiality Measures 17.3, Distribution by the Receiving Party 17.4, Common Law Duty of Confidentiality 17.5, Confidentiality Exceptions 17.8, Fiduciary 17.9, Elements of Fiduciary Relationship 17.10, Equitable Relief 21.1, No Bribes 21.4, Compliance with Law; and Article 7, Improvements, R & D Collaborations. and fails to remedy such breach within ninety (90) days after being required in writing to do so by Canada; 16.1.6 eVS breaches a representation or warranty in paragraph 13.1 ( eVS) made to Canada hereunder and such breach has a material adverse effect on the benefits to Canada or eVS's ability to perform its obligations hereunder; 16.1.7 eVS commences bankruptcy or insolvency proceedings, or has a receiving order made against it or has a receiver appointed to continue its operations, or has its assets seized or otherwise attached for the benefit of creditors, or passes a resolution for winding up, or takes the benefit of any statute for the time being in force, relating to bankrupt or insolvent debtors or the orderly payment of debts; 16.1.8 eVS assigns the MASTER LICENCE without the prior written consent of Canada; or Trademark Rights Terminated 16.2 Canada may terminate the trademark rights and permissions granted under the MASTER LICENCE if eVS breaches any of its obligations with respect to the 57 58 PROTECTED - BUSINESS INFORMATION TRADEMARK including without limitation eVS's obligations to maintain the quality and character of the LICENCED TECHNOLOGIES or the quality control standards as prescribed in the MASTER LICENCE and such breach is not remedied within 30 days of written notice thereof or sooner as circumstances dictate. For greater certainty the termination of the TRADEMARK rights / licence shall not mean or result in the termination of the MASTER LICENCE and the rights granted thereunder to ET and IR. Procedure 16.3 Termination shall be effected by a notice, that shall be effective as of the date stated therein, but subject to paragraph 16.4 (The Company's Duties on Termination), to terminate the MASTER LICENCE, together with all rights of eVS hereunder, without prejudice: 16.3.1 to the right of Canada to sue for and recover any royalties or other sums due Canada; and 16.3.2 to the remedy of either PARTY in respect of any previous breach of the MASTER LICENCE. The Company's Duties on Termination 16.4 Upon termination or expiration of the MASTER LICENCE, eVS shall, at its own cost: 16.4.1 return immediately to Canada all CONFIDENTIAL INFORMATION and LICENCED TECHNOLOGIES, including copies thereof; 16.4.2 certify in writing to Canada, within thirty (30) days, that to the best of eVS's knowledge all of the CONFIDENTIAL INFORMATION (including copies) has been returned; 16.4.3 deliver a detailed statement to Canada of the inventory of the LICENCED TECHNOLOGIES, then existing, but not sold by eVS, as of the date of expiration or termination; 16.4.4 provide Canada the right of first refusal to purchase from eVS any LICENCED TECHNOLOGIES stocks at fair market value; 16.4.5 dispose of any remaining LICENCED TECHNOLOGIES stocks as specified by Canada; 16.4.6 pay all costs due under the MASTER LICENCE, up to and including the termination date, within thirty (30) days of the termination; 58 59 PROTECTED - BUSINESS INFORMATION 16.4.7 pay all costs due under the MASTER LICENCE, subsequent to the termination, for any LICENCED TECHNOLOGIES sold after termination, within seven (7) days of the liability being incurred; and 16.4.8 transfer to Canada at no cost, all rights, permits, authorizations, registrations concerning the LICENCED TECHNOLOGIES not already in Canada's name. Surviving Obligations 16.5 All obligations of the PARTIES which expressly or by their nature survive termination or expiration, shall continue in full force and effect subsequent to and notwithstanding such termination or expiration, until they are satisfied or by their nature expire. For greater clarity, and without restricting the generality of the foregoing, the following provisions survive termination or expiration: Articles 5 (Royalties), 17 (Confidentiality / Fiduciary & Equitable Remedies), 15 (Indemnification) and 14 (Patent Infringement) shall survive early termination or expiration of the MASTER LICENCE. Surrender of Licence 16.6 If eVS does not pay any royalty to Canada within seven (7) years from the execution of the MASTER LICENCE, then eVS shall surrender the MASTER LICENCE to Canada at Canada's election. 59 60 PROTECTED - BUSINESS INFORMATION 17 CONFIDENTIALITY / FIDUCIARY & EQUITABLE REMEDIES Confidentiality Obligations 17.1 The CONFIDENTIAL INFORMATION disclosed to the RECEIVING PARTY shall be: 17.1.1 used by the RECEIVING PARTY solely for purposes authorized under the MASTER LICENCE; 17.1.2 held in confidence, safeguarded and not disclosed by the RECEIVING PARTY; and 17.1.3 held in trust and dealt with only as authorized under the MASTER LICENCE. Confidentiality Measures 17.2 The RECEIVING PARTY shall require that all persons who receive any CONFIDENTIAL INFORMATION: 17.2.1 have a need to know; 17.2.2 are properly instructed to maintain the CONFIDENTIAL INFORMATION in confidence; and 17.2.3 sign a confidentiality agreement that binds the person to the same terms and conditions as outlined herein. Distribution by the Receiving Party 17.3 Distribution of documents beyond the RECEIVING PARTY'S staff shall be conducted on a need to know basis and only with the written permission of the DISCLOSING PARTY. Common Law Duty of Confidentiality 17.4 Nothing contained in the MASTER LICENCE derogates, displaces or otherwise diminishes the common law duty of confidentiality vested in the RECEIVING PARTY concerning the CONFIDENTIAL INFORMATION. For greater certainty, the RECEIVING PARTY acknowledges and is estopped from alleging otherwise that: 17.4.1 the CONFIDENTIAL INFORMATION is inaccessible (non-public) and identifiable; 17.4.2 the CONFIDENTIAL INFORMATION was imparted in circumstances importing an obligation of confidence; and 60 61 PROTECTED - BUSINESS INFORMATION 17.4.3 any use or disclosure of the CONFIDENTIAL INFORMATION, except as authorized in the MASTER LICENCE, prejudices and is detrimental to the DISCLOSING PARTY'S commercial and scientific interests. Confidentiality Exceptions 17.5 The contractual and common law duties of confidentially shall not apply to the RECEIVING PARTY, if the RECEIVING PARTY can demonstrate that: Public Domain 17.5.1 the information was legally and legitimately in the public domain through no act or omission of the RECEIVING PARTY at the time of disclosure; Published 17.5.2 the information was legally and legitimately published or otherwise becomes part of the public domain after the time of disclosure of the CONFIDENTIAL INFORMATION to the RECEIVING PARTY, through no act or omission of the RECEIVING PARTY; Already Known 17.5.3 the information was already in the possession of the RECEIVING PARTY at the time of disclosure and was not acquired by the RECEIVING PARTY directly or indirectly from the DISCLOSING PARTY, (as shown by documentation sufficient to establish the time of such possession), and the RECEIVING PARTY is free to disclose the information to others without breaching any contractual obligations or common law duties; Third Party Discloses 17.5.4 the information become available from an outside source who has a lawful and legitimate right to disclose the information to others, and the RECEIVING PARTY is free to disclose the information to others without breach of any contractual obligations or common law duties; Independently Developed 17.5.5 The information was independently developed by the RECEIVING PARTY without the RECEIVING PARTY reviewing or accessing any of the 61 62 PROTECTED - BUSINESS INFORMATION CONFIDENTIAL INFORMATION (as shown by documentation sufficient to establish the timing of such development); or Judicial / Administrative Order 17.5.6 the information was released due to a compulsory disclosure order under a judicial process or under a compulsory regulatory requirement, none of which was invited by or consented to by the RECEIVING PARTY, and if the RECEIVING PARTY is Canada, the invitation or consent did not emanate from the Western Region of Agriculture and Agr-Food Canada's Research Branch. Access to Information 17.6 The PARTIES agree that any document containing the following information shall be treated by the PARTIES as "confidential third party" information pursuant to section 20 of the Access to Information Act: 17.6.1 trade secrets of eVS; 17.6.2 financial, commercial, scientific or technical information that is consistently treated in a confidential manner by eVS; 17.6.3 information, the disclosure of which could reasonably be expected to result in material financial loss or gain to, or could reasonably be expected to prejudice the competitive position of eVS; and 17.6.4 information, the disclosure of which could reasonably be expected to interfere with contractual or other negotiations of eVS. Access to Information Disclosure 17.7 Notwithstanding paragraph 17.6 (Access to Information), eVS acknowledges that: 17.7.1 a court of competent jurisdiction could order the release of information, considered hereunder as confidential third party information; and 17.7.2 the Access to Information Act, s. 27, requires that both Canada and eVS be notified of any such release and eVS be allowed to make representations against such release. Fiduciary 62 63 PROTECTED - BUSINESS INFORMATION 17.8 eVS acknowledges that in the event eVS breaches its obligations under the confidentiality provisions of paragraph 17.1 (Confidentiality Obligations) to 17.7 (Access to Information Disclosure) inclusive, then: 17.8.1 eVS shall be deemed a fiduciary of Canada concerning the CONFIDENTIAL INFORMATION disclosed by Canada; 17.8.2 eVS shall be deemed to hold in trust for Canada, the CONFIDENTIAL INFORMATION and any benefits arising from eVS improper or unauthorized use of the CONFIDENTIAL INFORMATION Elements of Fiduciary Relationship 17.9 eVS agrees that under the MASTER LICENCE in the event eVS breaches its obligations under the confidentiality provisions of paragraph 17.1 (Confidentiality Obligations) to 17.7 (Access to Information Disclosure) inclusive, then: 17.9.1 eVS has power and discretion affecting Canada's interests arising from the disclosure of the CONFIDENTIAL INFORMATION and the licencing of the LICENCED TECHNOLOGIES; 17.9.2 eVS can unilaterally exercise that power and discretion so as to affect Canada's commercial and other interests; 17.9.3 Canada is vulnerable to the power and discretion vested in eVS; and 17.9.4 eVS's primary obligations are to COMMERCIALIZE the LICENCED TECHNOLOGIES and safeguard the CONFIDENTIAL INFORMATION. Equitable Relief 17.10 eVS acknowledges, and is estopped from alleging otherwise, that: 17.10.1 any unauthorized use of the LICENCED TECHNOLOGIES or unauthorized disclosure of the CONFIDENTIAL INFORMATION would cause irreparable harm to Canada; 17.10.2 Canada has spent significant money and dedicated significant human, capital and financial resources (some of which are no longer available) in order to create, assemble, or integrate the CONFIDENTIAL INFORMATION or the LICENCED TECHNOLOGIES, as the case may be; and 17.10.3 Canada shall be entitled to any and all legal and equitable relief, including, without limitation, injunctive relief, without the need for posting a bond or 63 64 PROTECTED - BUSINESS INFORMATION security, as well as the equitable remedy of disgorgement (being the ejection of all benefits gained by eVS traceable to the material breach). Fundamental Terms 17.11 eVS's obligations of confidentiality as prescribed in this Article are fundamental terms of the MASTER LICENCE. 64 65 PROTECTED - BUSINESS INFORMATION 18 ALTERNATE DISPUTE RESOLUTION (ADR) Negotiation Informal Negotiations 18.1 If a dispute arises between the PARTIES concerning the construction, interpretation, compliance with or breach of this MASTER LICENCE, then the PARTIES shall: 18.1.1 reduce the dispute to writing, and if the PARTIES cannot agree on the wording of the dispute, both PARTIES may submit to each other their written version of the dispute; 18.1.2 make bona fide efforts to resolve the dispute by amicable negotiations; and 18.1.3 provide full, frank and timely disclosure of all relevant facts, information and documents to facilitate those negotiations. Formal Negotiations 18.2 If the PARTIES are unable to resolve the dispute within fourteen (14) calendar days from the date of the dispute being reduced to writing by the first PARTY to do so, then within the following thirty (30) days the dispute shall be referred to the Director General Western Region (or the Director of the Lacombe Centre), on behalf of Canada, and to the CEO (or a directly reporting designate) on behalf of eVS to negotiate a resolution. 18.2.1 These individuals may not delegate, substitute or direct surrogates for them at these negotiations. 18.2.2 These individuals shall meet in person to negotiate and the PARTIES shall bear their own costs. 18.2.3 Unless otherwise agreed, the meeting shall alternate between the Edmonton, Alberta, Canada and Orlando, Florida, USA, commencing in Orlando for the first dispute. There shall only be one meeting per dispute, which meeting shall not exceed one business day in length. 18.2.4 The meeting shall be held within sixty (60) days from the expiration of the thirty (30) day period in paragraph 18.2 (Formal Negotiations); and 65 66 PROTECTED - BUSINESS INFORMATION 18.2.5 The PARTIES may bring no more than two consultants to a meeting. The two consultants shall not have a right of audience or otherwise to negotiate the dispute. Mediation 18.3 If, within thirty (30) days following the close of the meeting under paragraph 18.2 (Formal Negotiations), the PARTIES have not succeeded in negotiating a resolution, then the PARTIES may jointly submit the dispute to mediation. Direct to Arbitration 18.4 If the PARTIES cannot agree to jointly submit the dispute to mediation, then either PARTY may submit the dispute to binding arbitration. Process 18.5 The PARTIES shall: 18.5.1 appoint a mutually acceptable mediator with sixty (60) days from the close of the formal negotiation meeting under subparagraph; 18.5.2 participate in good faith in the mediation and negotiations related thereto; 18.5.3 send representatives to the mediation shall be empowered or have sufficient delegated authority to resolve, compromise, negotiate or settle the dispute submitted to arbitration, without seeking further instructions or approvals from any superiors or committees / corporate structures, unless the nature of the dispute by law or corporate policies or practices requires approval from the respective corporate structure. In such event, such approval shall be obtained within five (5) business days of the proffer of any settlement offer; 18.5.4 bear the costs of the mediation equally, except that each PARTY shall bear its own personal costs of the mediation; and 18.5.5 disclose in a full, frank and timely manner all relevant facts, information and documents to facilitate the mediation. Location 18.6 The mediation shall take place in the city that was not the site of the formal negotiations for the dispute. Unsuccessful 66 67 PROTECTED - BUSINESS INFORMATION 18.7 The dispute shall be referred to binding arbitration if the PARTIES are not successful in resolving the dispute through mediation. Arbitration 18.8 After negotiation (and if applicable, mediation), any subsisting dispute between the PARTIES, shall be referred to arbitration by a written submission signed by either Canada or eVS. Procedure Law, Code & Rules 18.9 The arbitration tribunal shall be governed by the UN Commercial Arbitration Code, incorporated into the Commercial Arbitration Act, R.S.C. 1985, c. C-34.6 and the Rules in Appendix (Rules). Unless the PARTIES otherwise agree in writing, where there is an inconsistency between the Code and the Rules, the Rules shall prevail to the extent of any such inconsistency. Tribunal & Jurisdiction 18.10 The arbitration tribunal shall consist of one arbitrator chosen by the PARTIES. 18.11 The scope of the arbitration shall be limited to the resolution of the dispute submitted to arbitration. 18.12 The arbitration tribunal shall decide the dispute or difference in accordance with the laws in force in the Province of Ontario and any applicable federal laws. The arbitration tribunal shall not be authorized to decide ex aequo et bono or as amiable compositeur. Final & Binding 18.13 Subject to the Code, the PARTIES agree that the award and determination of the arbitration tribunal shall be final and binding on both PARTIES. Proceedings 67 68 PROTECTED - BUSINESS INFORMATION 18.14 The proceedings shall take place in the city that was not the site of the mediation (or if there was no mediation, in the city that was not the site of the negotiation meeting), unless the PARTIES agree otherwise. Language 18.15 The language to be used in the proceedings is English, unless the PARTIES hereto agree otherwise. Written Communications 18.16 All written communication shall be delivered to the PARTIES hereto in the manner provided for in Article 22 (Notice). Costs 18.17 The costs of the tribunal's fees and expenses shall be shared equally by the PARTIES. The PARTIES shall bear their own costs. Arbitrator's Written Decision 18.18 The arbitrator shall render a written decision with reasons within thirty (30) days from the close of the hearing or submission of written argument. The decision of the arbitrator shall be final and binding, and not subject to judicial review. Power to Settle 18.19 The PARTIES' representatives at any arbitration shall be empowered or have sufficient delegated authority to resolve, compromise, negotiate or settle the dispute submitted to arbitration, without seeking further instructions or approvals from any superiors or committees / corporate structures, unless the nature of the dispute by law or corporate policies or practices requires approval from the respective corporate structure. In such event, such approval shall be obtained within five (5) business days of the proffer of any settlement offer. Adjournment to Empower Representative 18.20 Breach of this provision shall entitle the other PARTY to seek an adjournment of the arbitration proceedings, to give the breaching PARTY time to appoint a duly empowered representative within the thirty (30) days. All costs of the such delay, including tribunal costs and the non-breaching PARTY's costs, shall be paid forthwith by the breaching PARTY. Deemed Abandonment 68 69 PROTECTED - BUSINESS INFORMATION 18.21 Failure of the breaching PARTY to appoint such a representative within the thirty (30) day period shall be deemed a withdrawal or abandonment of the dispute by the breaching PARTY and the arbitrator shall render a formal decision, finding in favour of the non-breaching PARTY. General ADR Conditions No Litigation 18.22 If either PARTY has submitted the dispute to court, then the court filing PARTY shall discontinue the court proceedings forthwith, upon notice from the other PARTY, and both PARTIES shall remit the dispute to alternate dispute resolution as prescribed hereunder. Obligations During Alternate Dispute Resolution (ADR) 18.23 During the progress of ADR, the PARTIES shall continue to perform their obligations under the MASTER LICENCE. Privilege 18.24 Neither PARTY shall be required to disclose documents that are privileged or created in contemplation of litigation. If a PARTY does disclose such a document during ADR, that disclosure shall not be construed as a waiver of any privilege unless the DISCLOSING PARTY so elects in writing. Confidentiality 18.25 The ADR procedure under this Article is confidential and all conduct, statements, promises, offers, views and opinions, whether oral or written, made in the course of the ADR by either PARTY, or the mediator, or the arbitrator, are confidential. ADR Disclosures Not Admissible in Subsequent Proceedings 18.26 Subject to the paragraph 18.23 (Obligations During Alternative Dispute Resolution (ADR)), all conduct, statements, promises, offers, views and opinions, whether oral or written, made in the course of the ADR by either PARTY, or the mediator, or the arbitrator, are not discoverable or admissible for any purposes, including impeachment, in any litigation or other proceedings involving the PARTIES. Normally Admissible Evidence 18.27 Evidence that would otherwise be discoverable or admissible is not excluded from use in subsequent civil or administrative proceedings merely as a result of its use in the ADR. 69 70 PROTECTED - BUSINESS INFORMATION Material Breach 18.28 The failure, neglect or unwillingness of a PARTY to use or diligently participate in and prosecute a dispute through ADR is a material breach of the MASTER LICENCE. 70 71 PROTECTED - BUSINESS INFORMATION 19 INTENT AND INTERPRETATION Entire Agreement 19.1 The MASTER LICENCE constitutes the entire agreement between the PARTIES. The MASTER LICENCE sets forth all representations forming part of, or in any way affecting or relating to the MASTER LICENCE. The PARTIES acknowledge that there are no representations, either oral or written, between eVS and Canada other than those expressly set out in the MASTER LICENCE. Pre-Contractual Representations 19.2 The MASTER LICENCE supersedes and revokes all negotiations, arrangements, letters of intent, offers, proposals, brochures, representations and information conveyed, whether oral or in writing, between the PARTIES hereto or their respective representatives, or any other person purporting to represent eVS or Canada. The PARTIES agree that: 19.2.1 none has been induced to enter into the MASTER LICENCE by any representations not set forth in the MASTER LICENCE; 19.2.2 none has relied on any such representations; 19.2.3 no such representations shall be used in the interpretation or construction of the MASTER LICENCE; and 19.2.4 no claims (including, without limitation, loss of profits, consequential damages and economic loss) arising directly or indirectly from any such representation shall accrue in law or equity to, or be pursued by eVS, and Canada shall have no liability for any such claims. Due Diligence Search 19.3 eVS agrees that it has conducted its own due diligence examinations. Independent Legal Advice 19.4 It is acknowledged by the PARTIES that each has had legal advice to the full extent deemed necessary by each PARTY. Furthermore, the PARTIES acknowledge that neither acted under any duress in negotiating, drafting and executing the MASTER LICENCE. No Adverse Presumption in Case of Ambiguity 71 72 PROTECTED - BUSINESS INFORMATION 19.5 There shall be no presumption that any ambiguity in the MASTER LICENCE be resolved in favour of either of the PARTIES. For greater certainty, the contra proferentum rule shall not be applied in any interpretation of the MASTER LICENCE. Severability 19.6 If any part of the MASTER LICENCE is declared or held invalid for any reason, the invalidity of that part will not affect the validity of the remainder, which will continue in full force and effect and be construed as if the MASTER LICENCE had been executed without the invalid portion. The intention of the PARTIES is that the MASTER LICENCE would have been executed without reference to any portion which may, for any reason, be declared or held invalid. Plurality and Gender 19.7 The MASTER LICENCE will be for the benefit of and be binding upon the heirs, executors, administrators, successors, permitted assigns of eVS and other legal representatives, as the case may be, of each of the PARTIES. Every reference in the MASTER LICENCE to any PARTY includes the heirs, executors, administrators, successors, permitted assigns and other legal representatives of the PARTY. Not a Joint Venture 19.8 The PARTIES expressly disclaim any intention to create a partnership, joint venture or joint enterprise. 19.9 The PARTIES acknowledge and agree that: 19.9.1 nothing contained in the MASTER LICENCE nor any acts of any PARTY shall constitute or be deemed to constitute the PARTIES as partners, joint venturers or principal and agent in any way or for any purpose; 19.9.2 no PARTY has the authority to act for, or to assume any obligation or responsibility on behalf of any other PARTY; and 19.9.3 the relationship between the PARTIES is that of licencor and licencee. Minister Not Fettered 72 73 PROTECTED - BUSINESS INFORMATION 19.10 Nothing in the MASTER LICENCE shall derogate or otherwise fetter the ability of Canada to regulate, administer, manage or otherwise deal with agriculture and all attendant matters thereto. Federal Legislation 19.11 The reference in the MASTER LICENCE to any Federal act or regulation includes any subsequent amendment, revision, substitution, consolidation to that act or regulation, notwithstanding that such amendment, revision or substitution occurred after the execution of the MASTER LICENCE or may have a retroactive effect. Right to Legislate 19.12 Nothing in the MASTER LICENCE shall prohibit, restrict or affect the right or power of the Parliament of Canada to enact any laws of general application whatsoever with respect to any area of law for which the Parliament of Canada has legislative jurisdiction, even if the enactment of any such law affects the MASTER LICENCE, its interpretation, or the rights of either PARTY. No Implied Obligations 19.13 No implied terms or obligations of any kind, by or on behalf of either of the PARTIES, shall arise from anything in the MASTER LICENCE. The express covenants and agreements herein contained and made by the PARTIES are the only covenants and agreements upon which any rights against either of the PARTIES may be founded. Access to Information 19.14 Notwithstanding any provision to the contrary in the MASTER LICENCE, eVS acknowledges that Canada is subject to the Access to Information Act, R.S.C. 1985, c.A-1 and related acts, and may be required to release, in whole or in part, the MASTER LICENCE and any other information or documents in Canada's possession or control relating to the MASTER LICENCE and the PARTIES. Governing Law 19.15 The MASTER LICENCE shall be governed firstly by applicable Canadian Federal laws, and secondly by the laws of the Province of Ontario. The PARTIES expressly exclude: 19.15.1 application of the United Nations Convention on Contracts for the International Sale of Goods; and 73 74 PROTECTED - BUSINESS INFORMATION 19.15.2 any conflict of laws rules or principles which might refer disputes under the MASTER LICENCE to the laws of another jurisdiction. The MASTER LICENCE shall be treated in all respects as an Alberta, Canada contract. Subject to Article 18 (Alternate Dispute Resolution (ADR)) the PARTIES irrevocably attorn to and submit to the exclusive jurisdiction of the courts of Ontario, Canada with respect to any matter arising under the MASTER LICENCE Waiver 19.16 No condoning, excusing, or overlooking by either of the PARTIES of any default by the other PARTY, at any time or times, in performing or observing any of the PARTIES' respective covenants, will operate as a waiver of or otherwise affect the rights of the PARTIES in respect of any continuing or subsequent default. No waiver of these rights will be inferred from anything done or omitted by the PARTIES, except by an express waiver in writing. 19.17 For greater clarity, the failure by either of the PARTIES or their authorized representatives, as the case may be, to require the fulfilment of these obligations or to exercise any rights herein contained, shall not constitute a waiver, a renunciation, or a surrender of those obligations or rights. Contract Always Speaks 19.18 Where a matter or thing is expressed in the present tense, it shall be applied to the circumstances as they arise, so that effect may be given to the MASTER LICENCE according to its true spirit, intent and meaning. Time is of the Essence 19.19 Time shall be of the essence in this MASTER LICENCE. Force Majeure 19.20 Except with regard to any payments required pursuant to the MASTER LICENCE neither of the PARTIES shall be liable for any default, or delay in performance in any obligations under the MASTER LICENCE occasioned by any cause beyond the power of that PARTY, including without limitation: 19.20.1 acts of God, war, riot, fire, explosion, flood, sabotage, accidents floods, droughts, weather, natural calamities; 19.20.2 compliance with any demand or requirement of any governmental agency or authority other than Agriculture and Agri-Food Canada's Western Research Branch; or 74 75 PROTECTED - BUSINESS INFORMATION 19.20.3 restraining orders or decrees of any court or judge having jurisdiction. The PARTY affected by such event hereunder shall give written notice to the other PARTY upon becoming aware of the event. The affected PARTY shall complete performance as required by this MASTER LICENCE immediately after removal or cessation of the cause for the delay. Headings 19.21 All headings in the MASTER LICENCE have been inserted as a matter of convenience and for reference only, and in no way define, limit, enlarge, modify, the scope or meaning of the MASTER LICENCE or any of its provisions. 19.22 Any reference in the MASTER LICENCE to an Article, paragraph, subparagraph, will mean an Article, paragraph or subparagraph of the MASTER LICENCE, unless otherwise expressly provided. Appendices 19.23....The documents attached hereto as Appendix "A" to " E" form an integral part of this MASTER LICENCE as fully as if it were set forth herein in extenso, and consist of: Appendix "A" - LICENCED TECHNOLOGIES Appendix "B" - (Arbitration) Rules Appendix "C" - PRE-MIX Formulation Appendix "D" - RMS / AgResearch Agreements Appendix "E" - eVS Infra Red Technologies 75 76 PROTECTED - BUSINESS INFORMATION 20 LEGAL RIGHTS Amendments 20.1 No modification or waiver of any provision of the MASTER LICENCE will be inferred from anything done or omitted by either of the PARTIES, except by an express amendment in writing, duly executed by the PARTIES. Assignment by Canada 20.2 Canada shall not sell, assign or transfer the MASTER LICENCE or any of the LICENCED Technologies without the prior written consent of eVS, which consent shall not be unreasonably withheld. Sub-Contract Rights 20.3 eVS shall have the right to subcontract any portion of its obligations under the MASTER LICENCE granted: 20.3.1 all of eVS's material obligations under the MASTER LICENCE are not subcontracted to any one subcontractor or group of related subcontractors; 20.3.2 eVS notifies Canada in writing in a timely manner of any significant subcontracts or subcontractors; 20.3.3 eVS takes all necessary precautions to ensure quality control and protection of any disclosed CONFIDENTIAL INFORMATION; and 20.3.4 the subcontract is not a de facto assignment. Assignment 20.4 eVS shall not assign (or transfer, sell, encumber, sub-licence or otherwise deal) or permit any such assignment, in whole or in part, of the MASTER LICENCE, whether such assignment takes place by way of: 20.4.1 sale of assets; 20.4.2 amalgamation, merger or other reorganization of eVS; 20.4.3 acquisition by a person or persons acting in concert of a majority interest of the securities of eVS, by a person or persons acting in concert who did not hold such a majority interest at the time of the initial public offering (IPO), at any time after the IPO 76 77 PROTECTED - BUSINESS INFORMATION 20.4.4 operation of law; 20.4.5 operation of contract; or 20.4.6 otherwise; without the prior written consent of Canada, which consent will not be unreasonably withheld. The failure to obtain written consent shall render such assignment void, and shall be a material breach of the MASTER LICENCE. 20.5 It will not be unreasonable for Canada to refuse to consent to any assignment, if it is foreseeable that the assignment might negatively affect Canada in any way or derogate from the COMMERCIALIZATION of the LICENCED TECHNOLOGIES. Notwithstanding the foregoing, Canada may still consent in exchange for payment of [ ** ] of the consideration . being exchanged between eVS and any assignee, transferee, sub-licencee or otherwise. 20.6 Consent to any assignment will not be construed as consent to any other assignment. 20.7 Failure of eVS to obtain the prior written consent of Canada to any assignment shall be deemed to be a material breach of the MASTER LICENCE. No Third Party Rights 20.8 Nothing expressed or implied in the MASTER LICENCE is intended to, or shall be construed to confer on or give to, any person other than the PARTIES and their respective successors and permitted assigns, any rights or remedies under or by reason of the MASTER LICENCE. Remedies Cumulative 20.9 All rights and remedies of the PARTIES are cumulative and are in addition to, and do not exclude any other right or remedy provided in the MASTER LICENCE, or otherwise allowed by law. Mutual Assistance 20.10 The PARTIES will at all times hereafter, upon every reasonable request of the other, make, do, and execute or cause to be procured, made, done, and executed, all such further acts, deeds and assurances for the carrying out of the terms, covenants and agreements of the MASTER LICENCE, according to the true intent and meaning of the MASTER LICENCE. 77 78 PROTECTED - BUSINESS INFORMATION Facsimile Counterparts 20.11 The MASTER LICENCE may be validly executed by facsimile transmission and in any number of counterparts, all of which taken together shall constitute one and the same agreement and each of which shall constitute an original. MASTER LICENCE. 78 79 PROTECTED - BUSINESS INFORMATION 21 CROWN GENERAL No Bribes 21.1 eVS warrants that no bribe, gift, or other inducement has been paid, given, promised or offered to any Government official or employee for the obtaining of this MASTER LICENCE. No Share to Members of Parliament 21.2 Pursuant to the Parliament of Canada Act, R.S.C. 1985, c.P-1, no member of the House of Commons or Senate will be admitted to any share or part of the MASTER LICENCE or to any benefit to arise from the MASTER LICENCE. Public Office Holders 21.3 It is a term of this MASTER LICENCE that no former public Office holder, who is not in compliance with the post employment provisions of the Conflict of Interest and Post-Employment Code for Public OFFICE Holders, shall derive a direct benefit from this MASTER LICENCE. Compliance with Law 21.4 eVS shall comply with all municipal, provincial, state and federal laws applicable to eVS's obligations under the MASTER LICENCE in that jurisdiction. The failure by eVS to comply with such laws shall have a material adverse effect on eVS or Canada in order to be a grounds of termination as contemplated in Article 16 (Termination). Disclosure of Master Licence during Due Diligence Audit - eVS 21.5 If under a commercially prudent practice involving a commercial transaction a third party conducting due diligence searches, requires the disclosure of the fact and contents of the MASTER LICENCE, then eVS authorizes Canada to disclose the MASTER LICENCE to such a third party, less any material financial, scientific or business information that could prejudice eVS or is not relevant to the due diligence search. Disclosure of Master Licence during Due Diligence Audit - Canada 21.6 If under a commercially prudent practice involving a commercial transaction a third party conducting due diligence searches, requires the disclosure of the fact and contents of the MASTER LICENCE, then subject to: 79 80 PROTECTED - BUSINESS INFORMATION 21.6.1 the Access to Information Act, Privacy Act, and any other then relevant statutes or regulations; and 21.6.2 the protection and confidentiality of any material financial, business scientific information that could prejudice Canada or is not relevant to the due diligence search; Canada authorizes eVS to disclose the MASTER LICENCE to such a third party. Material Terms 21.7 The obligations invested in eVS pursuant to this Article (Crown General) are material terms of the MASTER LICENCE. 80 81 PROTECTED - BUSINESS INFORMATION 22 NOTICE Addresses / Contacts 22.1 Wherever in this MASTER LICENCE it is required or permitted that notice or demand be given, or served by either PARTY to or on the other PARTY, such notice or demand will be in writing and will be validly given or sufficiently communicated if hand delivered or forwarded by certified mail, priority post mail, telegram, telex, or facsimile or sent by overnight delivery by a nationally recognized courier as follows: The addresses for delivery are: To eMERGE Vision Systems Inc.: Chuck Abraham, President & CEO 10315 102nd Terrance Sabastian, Florida United States, 32958 Telephone: (561) 581-7135 Facsimile: (561) 581-7110 To Canada: Director Agriculture and Agri-Food Canada Lacombe Research Centre, 6000 C&E Trail Lacombe, Alberta, T4L 1W1 Telephone: (403) 327-4561 Facsimile: (403) 382-3156 Deemed Delivery 22.2 Notice will be deemed to have been delivered: 22.2.1 if delivered by hand, upon receipt; 22.2.2 if sent by electronic transmission, forty eight (48) hours after the time of transmission, excluding from the calculation weekends and public holidays; 22.2.3 if sent by certified mail, four (4) days after the mailing thereof, provided that if there is a postal strike or other disruption, such notice will be delivered by hand or electronic transmission. 81 82 PROTECTED - BUSINESS INFORMATION Change of Address 22.3 The PARTIES may change their respective addresses for delivery by delivering notice of change as provided in this paragraph. IN WITNESS WHEREOF this MASTER LICENCE has been executed by duly authorized representatives of the PARTIES. Executed in duplicate and effective this 29th day of July 1998. FOR HER MAJESTY THE QUEEN IN RIGHT OF CANADA: - --------------------------- -------------------------- (Witness) Dr. David Bailey Director Lacombe Research Centre Agriculture & Agri-Food Canada EMERGE VISION SYSTEMS INC.: - --------------------------- -------------------------- (Witness) Chuck Abraham President & CEO FINANCIAL CODE: -------------------- 82 83 PROTECTED - BUSINESS INFORMATION APPENDIX "A" LICENCED TECHNOLOGIES PATENTS 83 84 PROTECTED - BUSINESS INFORMATION PATENT LISTING INFRA-RED THERMOGRAPHY PATENTS 1) Method for detecting meat quality in live animals. Inventors: S.D. Morgan Jones, A.L. Schaefer, A.K. Tong, S.L. Scott, C.D.J. Gariepy, R.C. Graham
Country Status Application # Filing Date Patent # Issue Date ------- ------ ------------- ----------- -------- ---------- US Issued 08/084,993 02/07/1993 5458418 17/10/1995 Canada Pending 2099532 02/07/1993 New Zealand Granted 268868 30/06/1994 268868 13/12/1996 Australia Granted 72248/94 34514 673942 22/04/1997 United Kingdom Granted 94921561 30/06/1994 706654 14/05/1997 Ireland Granted 94921561 30/06/1994 E74008 14/05/1997 Denmark Granted 94921561 30/06/1994 706654 14/05/1997 France Granted 94921561 30/06/1994 706654 14/05/1997 Japan Pending 7-503190 30/06/1994 China Pending 94193218.4 30/06/1994 South Korea Pending 706009/95 30/06/1994
84 85 PROTECTED - BUSINESS INFORMATION 2) Method for detecting poor meat quality in groups of live animals. Continuation in Part of Patent 5,458,418 Inventors: A.K. Tong, S.D. Morgan Jones, A.L. Schaefer
Country Status Application # Filing Date Patent # Issue Date ------- ------ ------------- ----------- -------- ---------- US Issued 08/543,752 16/10/1995 5595444 21/01/1997 Canada Pending 2234953 16/10/1996 New Zealand Pending 319540 16/10/1996 268868 Australia Pending 72085/96 16/10/1996 673942 Europe(1) Pending 96933288.1 16/10/1996
(1) Countries designated: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Netherlands, Portugal, Spain, Sweden, Switzerland/Liechtenstein, United Kingdom. 3) Process for determining a tissue composition characteristic of an animal Inventors: A.L. Schaefer, A.K. Tong
Country Status Application # Filing Date Patent # Issue Date ------- ------ ------------- ----------- -------- ---------- US Pending 09/039,630 16/03/1998 PCT Search report due PCT/CA98/00209 17/03/1998 17/07/1998
85 86 PROTECTED - BUSINESS INFORMATION 4) Antemortem nutrient supplement for livestock. Inventors: A.L. Schaefer, S.D. Morgan-Jones, R.W. Stanley, I.K.S. Turnbull, J.R. Johanns
- -------------------------------------------------------------------------------- Country Status Application # Filing Date Patent # Issue Date - -------------------------------------------------------------------------------- US Issued 08/084,989 02/07/1993 5505968 09/04/1996 - -------------------------------------------------------------------------------- US Issued 08/465,324 05/06/1995 5728675 17/03/1998 (Continuation) - -------------------------------------------------------------------------------- Canada Pending 2099529 02/07/1993 - -------------------------------------------------------------------------------- New Zealand Granted 268322 27/06/1994 268322 02/12/1997 - -------------------------------------------------------------------------------- Australia Granted 71,188/94 34511 692784 * - -------------------------------------------------------------------------------- Europe (2) Pending 94920356.6 27/06/1994 - -------------------------------------------------------------------------------- Japan Pending 7-503189 27/06/1994 - -------------------------------------------------------------------------------- China Pending 94193219.2 27/06/1994 - -------------------------------------------------------------------------------- South Korea Pending 706008/95 27/06/1994 - --------------------------------------------------------------------------------
(2) Countries designated: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Monaco, Netherlands, Portugal, Spain, Slovinia, Sweden, Switzerland, United Kingdom. * Allowed, 5 / 28/ 98, no issuance date yet. 86 87 PROTECTED - BUSINESS INFORMATION APPENDIX "B" ARBITRATION RULES 87 88 APPENDIX "D" 88 89 PROTECTED - BUSINESS INFORMATION RMS / AGRESEARCH AGREEMENTS 1) AgResearch Collaboration Agreement, Electrolyte Therapy, 1 November 1994. 2) AgResearch Licence, NUTRI-CHARGE(R), for Beef Cattle, dated 29 May 1997, effective 1 July 1997. 3) RMS Research Management Systems Inc., Letter of Intent, dated 26 April 1996, & Licence, Swine Electrolyte (pending). 4) RMS Research Management Systems Inc., Licence, NUTRI-CHARGE(R) for Beef Cattle, dated 5 March 1997, effective 1 January 1997. 5) STS Agriventures Inc., Nutri-Charge Partnership, IBP Inc., collaboration overnight NUTRI-CHARGE(R) and Infra-Red Thermography for Cattle, dated 1 May 1996. 89 90 PROTECTED - BUSINESS INFORMATION APPENDIX "E" eVS INFRA RED TECHNOLOGIES APPLICATIONS FOR THERMAL IMAGING EQUIPMENT CYROGENIC COOLED THERMAL CAMERA WITH 3-5 MICRON SPECTRALBAND Features: - - With single field of view or three field of view step zoom - - With visible camera image overlay - - With precision pan and tilt platform - - With line of sights stabilization - - With remote control Applications: - - Maritime, navigation, search and rescue, collision avoidance, iceberg detection - - Airborne navigation, pilotage, night operation, target tracking - - Surveillance for harbors, borders, railways, airports - - Thermal inspection for mechanical or electrical faults, i.e. machinery, industrial processes and transportation equipment - - Spectral inspections of chemical, vapor, gases, for leaks, contamination and illegal production - - Spectral surveys for crops, forest, and mineral characteristics - - Medical applications for cryo and vascular surgery, inflammatory conditions, arthritis, and cancer detection - - Military applications for surveillance, guidance, and fire control UNCOOLED THERMAL CAMERA WITH 8-12 MICRON SPECTRABAND Applications: - - Animal health for Equine for injuries and illness - - Exotic animal health and observation - - Human medical applications for cryo and vascular surgery, inflammatory conditions, arthritis, and cancer detection - - Industrial inspection - - Military applications for night vision, driving, and fire control - - Spectral inspections of chemical, vapor, gases, for leaks, contamination and illegal production - - Inspection of industrial processes and fault detection 90 EX-27.1 3 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM EMERGE INTERACTIVE, INC.'S CONSOLIDATED FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 0001092605 EMERGE INTERACTIVE, INC. 1 U.S. DOLLARS YEAR DEC-31-1999 JAN-01-1999 DEC-31-1999 1 12,316,497 0 1,144,133 75,000 1,201,203 15,640,122 2,817,792 922,038 25,761,713 15,832,475 0 0 144,992 56,372 8,689,467 25,761,713 43,783,124 43,783,124 43,517,459 15,582,971 288,400 75,000 764,042 (15,605,706) 0 (15,605,706) 10,420 0 0 (15,595,286) (3.11) (3.11)
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