-----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, SxInbLkbTLCq4rnl8V8fRk4V71FQYa9oTTFR5BnQ6cEyhxYJXwSyVF7kgsvJhtRh yMrIZHoSqgbaSXKTEsgVxA== 0000950153-99-001428.txt : 19991117 0000950153-99-001428.hdr.sgml : 19991117 ACCESSION NUMBER: 0000950153-99-001428 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19990930 FILED AS OF DATE: 19991115 FILER: COMPANY DATA: COMPANY CONFORMED NAME: TESSERACT GROUP INC CENTRAL INDEX KEY: 0000873601 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-EDUCATIONAL SERVICES [8200] IRS NUMBER: 411581297 STATE OF INCORPORATION: MN FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-11111 FILM NUMBER: 99756049 BUSINESS ADDRESS: STREET 1: 9977 NORTH 90TH STREET STREET 2: SUITE 180 CITY: SCOTTSDALE STATE: AZ ZIP: 85260 BUSINESS PHONE: 6128320092 MAIL ADDRESS: STREET 1: 1300 NORWEST FINANCIAL CENTER STREET 2: 7900 XERXES AVENUE SOUTH CITY: MINNEAPOLIS STATE: MN ZIP: 55431 FORMER COMPANY: FORMER CONFORMED NAME: EDUCATION ALTERNATIVES INC/MN DATE OF NAME CHANGE: 19930328 10-Q 1 10-Q 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (MARK ONE) [ X ] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended September 30, 1999 Or [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from _______________ to ________________. Commission File Number 1-11111 THE TESSERACT GROUP, INC. Minnesota 41-1581297 (State or other jurisdiction (I.R.S. Employer Identification No.) of incorporation or organization) 9977 North 90th Street Suite 180 Scottsdale, Arizona 85258 (Address of principal executive offices) (Zip Code) (480) 767-2300 (Registrant's telephone number, including area code) (Former name, former address and former fiscal year, if changed since last report) Indicate by checkmark 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 X No ___ As of September 30, 1999, there were issued and outstanding 9,780,331 shares of Common Stock, Par value $.01 per share. 2 THE TESSERACT GROUP, INC. INDEX TO QUARTERLY REPORT ON FORM 10-Q SEPTEMBER 30, 1999 PART I. FINANCIAL INFORMATION ITEM 1. CONDENSED CONSOLIDATED FINANCIAL INFORMATION
PAGE NUMBER Condensed consolidated balance sheets as of September 30, 1999 (Unaudited) and June 30, 1999 3 Condensed consolidated statements of operations for 4 the three months ended September 30, 1999 and 1998 (Unaudited) Condensed consolidated statements of cash flows for the three months ended September 30, 1999 and 1998 (Unaudited) 5 Notes to condensed consolidated financial statements 6 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 10 PART II. OTHER INFORMATION 16 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 16 Signatures 17
2 3 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS THE TESSERACT GROUP, INC. CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS) September 30, June 30, 1999 1999 ASSETS (Unaudited) -------- -------- CURRENT ASSETS Cash and cash equivalents $ 2,196 $ 2,545 Settlement receivable -- 650 Accounts receivable, net 3,300 1,958 Other current assets 2,034 2,228 -------- -------- TOTAL CURRENT ASSETS 7,530 7,381 INTANGIBLE ASSETS, NET 17,107 17,291 FURNITURE, FIXTURES AND EQUIPMENT, NET 35,780 37,002 OTHER ASSETS 1,378 1,550 -------- -------- $ 61,795 $ 63,224 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Lines of credit $ 5,999 $ 5,999 Accounts payable 3,106 1,999 Other current liabilities 31,667 9,861 -------- -------- TOTAL CURRENT LIABILITIES 40,772 17,859 LONG-TERM OBLIGATIONS 913 21,615 OTHER 401 990 -------- -------- 42,086 40,464 COMMITMENTS AND CONTINGENCIES SHAREHOLDERS' EQUITY Preferred stock, $.01 par value, 5,000,000 Shares authorized; no shares issued and Outstanding Common stock, $.01 par value, 25,000,000 Shares authorized, issued and outstanding at September 30, 1999 9,780,331 and 9,780,331 at June 30, 1999 98 98 Additional paid-in capital 58,711 58,371 Accumulated deficit (39,100) (35,709) -------- -------- TOTAL SHAREHOLDERS' EQUITY 19,709 22,760 $ 61,795 $ 63,224 ======== ========
See notes to condensed consolidated financial statements. 3 4 THE TESSERACT GROUP, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) SEPTEMBER 30, 1999 1998 ------- ------- REVENUE: School tuition and other $ 9,954 $ 6,905 PROGRAM RELATED COSTS 6,088 3,977 ------- ------- PROGRAM OPERATING PROFIT 3,866 2,928 OPERATING EXPENSES 5,839 5,349 ------- ------- LOSS FROM OPERATIONS BEFORE DEPRECIATION AND AMORTIZATION AND INCOME TAX EXPENSE (1,973) (2,421) DEPRECIATION AND AMORTIZATION (855) (619) OTHER INCOME (EXPENSE) (563) 99 ------- ------- LOSS BEFORE INCOME TAX EXPENSE (3,391) (2,941) INCOME TAX EXPENSE -- -- ------- ------- NET LOSS $(3,391) $(2,941) NET LOSS PER COMMON SHARE (Basic and diluted) $ (0.35) $ (0.31) WEIGHTED AVERAGE COMMON SHARES OUTSTANDING (Basic and diluted) 9,780 9,577
See notes to condensed consolidated financial statements. 4 5 THE TESSERACT GROUP, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
THREE MONTHS ENDED (IN THOUSANDS) SEPTEMBER 30, 1999 1998 ------- ------- OPERATING ACTIVITIES Net Loss $(3,391) $(2,941) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation and amortization 855 619 Changes in operating assets and liabilities 3,659 2,744 ------- ------- Net cash provided by operating activities 1,123 422 ------- ------- INVESTING ACTIVITIES Additions to property and equipment (1,749) (6,896) Cash of Preschool Services, Inc. -- 1,137 ------- ------- Net cash used in investing activities (1,749) (5,759) ------- ------- FINANCING ACTIVITIES Proceeds from exercise of stock options -- 30 Proceeds from financing transactions 695 5,247 Repayment of long-term debt (418) (543) ------- ------- Net cash provided by financing activities 277 4,734 ------- ------- DECREASE IN CASH AND CASH EQUIVALENTS (349) (603) Cash and cash equivalents at beginning of period 2,545 5,543 ------- ------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 2,196 $ 4,940 ======= =======
SUPPLEMENTAL CASH FLOW DISCLOSURE:
Non-Cash transaction 1999 1998 ------- -------- Furniture, fixtures and equipment written off the closed school reserve $1,391 $ -- Loss on sale of closed school charged to the closed school reserve $ 250 $ -- Issuance of Warrants $ 340 $ --
See notes to condensed consolidated financial statements. 5 6 THE TESSERACT GROUP, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1999 1. BASIS OF PRESENTATION The accompanying unaudited and condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting solely of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three-month period ended September 30, 1999, are not necessarily indicative of the results that may be expected for the year ending June 30, 2000. For further information, refer to the financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the year ended June 30, 1999. 2. ACCOUNTING POLICIES BASIS OF CONSOLIDATION The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant inter-company balances and transactions have been eliminated in consolidation. Due to implied control of Preschool Services, Inc. ("PSI"), a Hawaii non-profit corporation, the accounts of PSI have been combined in the Company's financial statements as of and for the year ended June 30, 1999. The accounts of PSI for the period from July 1 through September 30, 1999 were not included in the condensed consolidated financial statements due to the establishment of an independent board of directors by PSI resulting in the lack of implied control by the Company. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts and contingency disclosures included in the financial statements. Ultimate results could differ from these estimates. 6 7 REVENUE RECOGNITION Revenue is recognized as services are performed. During the three months ended September 30, 1999, the Company operated schools located in Texas and Washington D.C., under management contracts with two 501(c)(3) organizations. Revenue is recognized for schools under management contracts as management fees are earned and for reimbursable costs as incurred by the Company for the operations of the schools as defined under the terms of the contracts. Total revenue recognized under the management contracts totaled $852,000 for the three months ended September 30, 1999. FINANCIAL STATEMENT RECLASSIFICATIONS Certain prior period amounts have been reclassified to conform to the current year presentation. These reclassifications had no effect on the previously reported results of operations or shareholders' equity. 3. CONCENTRATION OF CREDIT RISK The Company receives a significant amount of charter school revenue from state and federal agencies. As of and for the three months ended September 30, 1999, approximately 26% and 25% of the Company's accounts receivable and revenue, respectively, were related to charter funds from state and federal agencies. A significant amount of the funds received from the State of Arizona relate to funding for transportation of charter school students. Effective for the Company's fiscal year beginning July 1, 2000, the State of Arizona funding for transportation of charter school students will be significantly reduced. If the Company is unable to secure alternative, additional funding from the State of Arizona for charter school services, the impact of the reduction in funding in transportation services could have a material, adverse impact on the Company's financial position and results of operations. Although management is currently in negotiations with the State of Arizona to resolve this issue, there can be no assurance that these negotiations will be successful or that funds will be obtained sufficient to offset the reduction in transportation funding. Charter school transportation revenue totaled approximately $760,000 for the three months ended September 30, 1999. 4. LONG TERM OBLIGATIONS During 1999 and 1998, the Company entered into certain sale-leaseback arrangements related to four properties. Under the terms of these agreements, the Company is required to prepay on September 1 of each year, the next 12 months lease payments, estimated property taxes and insurance into a jointly held escrow account. The account is jointly 7 8 controlled by the lender and the Company. Each month, funds are to be transferred from the escrow account to pay rent, property taxes, or insurance as applicable. The amount of required annual prepayment due at September 1, 1999 totaled $2,754,000. The Company has not complied with the prepayment requirement. Accordingly, approximately $21 Million of long-term obligations have been reclassified as a current liability in the accompanying condensed consolidated financial statements. The Company is paying rent of $200,000 on a monthly basis relative to these obligations. Since the Company is making monthly payments instead of the annual prepayment, all related and cross-collateralized obligations have been reflected as a current liability in the accompanying condensed consolidated financial statements. If the lender proceeds with default remedies, and the Company is unable to meet the prepayment obligation and fund any additional costs necessary to cure the default, the four related schools may be closed. Revenue from the schools totaled $1,755,000 for the three months ended September 30, 1999. 5. COMMITMENTS AND CONTINGENCIES TITLE IV PROGRAMS FUNDING: Participation in the U.S. Department of Education's Title IV programs through the Company's wholly-owned subsidiary, Academy of Business College ("ABC"), is subject to certain financial capability requirements. Due to operating losses incurred by ABC, the financial capability requirements were not met at June 30, 1999. As a result, the Company may be required to post a letter of credit or meet certain cash deposit requirements for at least one-half of the Title IV funds received by ABC during fiscal 1999, which amount to approximately $1,709,000. If the Company is unable to obtain the letter of credit or place the required funds on deposit, ABC's participation in Title IV programs could be suspended. Since a majority of students attending ABC participate in the Title IV program, suspension of these funds without alternative sources available could have a material adverse impact on ABC's financial position and the Company's consolidated financial position and results of operations. Tuition revenue at ABC totaled $639,000 for the three months ended September 30, 1999. DEVELOPMENT AGREEMENT During 1999, the Company entered into build-to-suit lease and development agreements with a developer for the construction of two charter schools in Arizona and one charter school in Washington D.C. As of September 30, 1999, the Company has advanced approximately $4,500,000 related to those projects, which is reflected in the accompanying condensed, consolidated financial statements as construction in progress or leasehold improvements. Two of the schools are in operation as of September 30, 1999. Due to the inability of the developer to obtain financing, one of the Arizona schools has not been completed, further construction has been suspended and certain commitments have not been paid by the developer. As of September 30, 1999, existing commitments related to all three schools and estimated costs to complete the unopened Arizona charter school totaled approximately $7,800,000. Management is in negotiations with the developer to finalize the remaining school and resolve certain issues related to all three of the schools. Although management believes that negotiations with the developer will result in the completion of the unfinished school and resolution of issues at all of these schools, there can be no assurance that these 8 9 negotiations will be successful. Accordingly, the Company may have to obtain necessary funding for completion. In that event, if the Company is unable to obtain sufficient capital to meet existing commitments and funds necessary for completion, the remaining school would remain unopened and the $4,500,000 advanced by the Company could be at risk. Several contractors have filed mechanics liens against the Arizona school properties. In addition, a subcontractor has filed suit for foreclosure on its mechanics lien. Management expects the remaining lien-holders will join in the suit. As of October 31, 1999 preliminary notices for mechanics liens totaled $3,972,000. MANAGEMENT CONTRACTS In fiscal 1999, the Company entered into management contracts with two 501(c)(3) organizations for the management and operation of charter schools in Texas and Washington D.C. Under the terms of the agreements, the Company will receive a management fee of 12.5% of each school's charter revenue. Funds required for operations are either advanced or reimbursed to the Company and distributed by the Company to cover related operational costs. Under the terms of the agreements, if the schools incur operating losses, the Company incurs such losses only to the extent costs exceed approved budgeted amounts. At September 30, 1999, management does not expect to incur material losses related to these management agreements. 5. RECENTLY ISSUED ACCOUNTING STANDARDS Management does not expect the impact of recently issued accounting standards that are not yet effective to have a material impact on the Company's financial position or results from operations. 6. SEGMENT INFORMATION Information by reportable segment for the three months ended September 30, 1999 is as follows: (in thousands)
Preschool Charter Private College Corporate Revenue $ 4,188 $ 3,372 $ 1,755 $ 639 $ -- ------- ------- ------- ------- -------- Income before taxes $ 45 $ 310 $(1,032) $ (271) $(2,443) ------- ------- ------- ------- -------
7. RELATED PARTY TRANSACTIONS A member of the Board of Directors and shareholder provides legal services to the Company. Total amounts incurred for these related party services totaled $35,000 for the three months ended September 30, 1999. The Company currently has a $5,000,000 line of credit from a related party. Total borrowings outstanding at September 30, 1999 totaled $4,999,000. When the line of credit became due and payable on September 30, 1999, management exercised its option to extend the due date until March 30, 2000 with the issuance of 9 10 a warrant for the purchase of 250,000 shares of the Company's common stock at $3.00 per share. Interest expense of $340,000, calculated using the Black Sholes model, will be amortized over the extended due date period. At March 31, 2000, if unpaid, the related party holder of the note may elect to convert the debt into the Company's common stock at $1.00 per share for each dollar then owed. 8. GOING CONCERN MATTERS The accompanying condensed consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course or business. As shown in the financial statements, the Company incurred a net loss of $3,391,000 for the three months ended September 30, 1999 and had negative working capital of $33,242,000 and an accumulated deficit of $39,100,000. These factors, among other things, may indicate that the Company will be unable to continue as a going concern for a reasonable period of time. The condensed consolidated financial statements do not include any adjustments relating to the recoverability and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. Management has plans in process to resolve near-term cash flow issues and believes that if it can finalize financing alternatives along with achieving projected improvement in operating results for the remainder of the fiscal year, the Company will generate sufficient resources to permit uninterrupted performance of its operating obligations as currently structured and anticipated. There can be no assurance, however, that the financing alternatives will be available to the Company on acceptable terms or when necessary. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATION Revenue for the three months ended September 30, 1999 increased 44% to $9,954,000 as compared to $6,905,000 for the same period in the prior year. The increase in revenue over the prior year is due primarily to an increase in student enrollment at TesseracT schools. Total students served in TesseracT schools increased from 5,200 to 6,500 as of September 30, 1998 and 1999, respectively. Program related costs totaled $6,088,000 and $3,977,000, or 61% and 58% of revenue for the three months ended September 30, 1999 and 1998, respectively. The 3% increase in program related costs as a percentage of revenue is due primarily to start-up costs related to the opening of four new charter schools and the expansion of the Company's Scottsdale, Arizona private school. 10 11 Operating expenses totaled $5,839,000 and $5,349,000, or 59% and 77% of revenue for the three months ended September 30, 1999 and 1998, respectively. The increase in operating expenses in total dollars and a decrease as a percentage of related sales is primarily due to disproportionately high costs in the prior year related to expenses associated with the acquisitions of Sunrise and ABC. The provision for depreciation and amortization increased to $855,000 as compared to $619,000 for the three months ended September 30, 1999 and 1998, respectively. The increase is due primarily to capital lease treatment and related interest charge for four of the Company's private school sites, and an overall increase in the Company's furniture, fixtures and equipment from $26,254,000 at September 30, 1998 to $35,780,000 at September 30, 1999. Other expenses totaled $563,000 for the three months ended September 30, 1999 as compared to other income of $99,000 for the same period in the prior year. The change is due primarily to an increase in interest expense for property held under capital leases and an increase in debt as compared to the previous year's comparable quarter. The Company reported a net loss of $3,391,000 or $0.35 per share as compared to $2,941,000 or $0.31 per share for the three months ended September 30, 1999 and 1998, respectively. The increased net loss is due to growth related start-up costs as previously described, additional interest charges and additional administrative costs necessary to support this growth. CAPITAL RESOURCES AND LIQUIDITY During the three months ended September 30, 1999, net cash provided by operating activities totaled $1,123,000 primarily due to changes in operating assets and liabilities, offset by the net loss incurred during the three-month period. Net cash used by investing activities totaled $1,749,000 for the three months ended September 30, 1999. The use of cash was primarily related to the acquisition of furniture, fixtures and equipment related to opening new schools in the current quarter. Net cash provided from financing transactions for the three months ended September 30, 1999 totaled $277,000. TITLE IV FUNDING As discussed in Note 5 to the condensed consolidated financial statements, the financial capability tests as required under Title IV of the U.S. Department of Education have not been met by ABC, a wholly-owned subsidiary of the Company. As a result, it appears likely that the Company will be required to post a letter of credit or equivalent of approximately $850,000 which represents one-half of Title IV funds received by ABC during fiscal 1999. Management is pursuing various options to obtain the letter of credit or equivalent deposit as required. However, there can be no assurance that such 11 12 arrangements will be finalized or obtained prior to the date required. In the event the Company is unable to comply with the requirement, Title IV funds would be unavailable for ABC students. Since the majority of students attending ABC as of September 30, 1999 participate in the Title IV program, non compliance would have a material, adverse impact on ABC's financial position and results from operations. CHARTER SCHOOL REVENUE The Company receives a significant amount of charter school revenues from state and federal agencies. As of and for the three months ended September 30, 1999, approximately 26% and 25% of the Company's accounts receivable and revenue, respectively, were related to charter funds from state and federal agencies. A significant amount of the funds received from the State of Arizona relate to funding for transportation of charter school students. Effective for the Company's fiscal year beginning July 1, 2000, the State of Arizona funding for transportation of charter school students will be significantly reduced. If the Company is unable to secure alternative, additional funding from the State of Arizona for charter school services, the impact of the reduction in funding in transportation services could have a material, adverse impact on the Company's financial position and results of operations. Although management is currently in negotiations with the State of Arizona to resolve this issue, there can be no assurance that these negotiations will be successful or that the Company will be able to obtain funds sufficient to offset the reduction in transportation funding. Charter school transportation revenue totaled approximately $760,000 for the three months ended September 30, 1999. DEBT COMPLIANCE During 1999 and 1998, the Company entered into certain sale-leaseback arrangements related to four properties. Under the terms of these agreements, the Company is required to prepay on September 1 of each year, the next 12 months lease payments, estimated property taxes and insurance into an escrow account jointly controlled by the lender and the Company. Each month, with both parties approval, funds are transferred from the escrow account to pay rent, property taxes, or insurance as applicable. At September 1, 1999, the Company failed to make a required $2,754,000 prepayment resulting in default under the terms of the agreement. Accordingly, all related and cross-collateralized obligations totaling approximately $21 million has been reflected as a current liability in the accompanying condensed consolidated financial statements. The Company is paying rent of $200,000 related to these obligations on a monthly basis. If the lender proceeds with default remedies, and the Company is unable to obtain financing necessary to meet the prepayment obligation and fund any additional costs necessary to cure 12 13 the default, the four related schools may be closed. Revenue from these schools totaled $1,755,000 for the three months ended September 30, 1999. Management is negotiating to cure the default related to these schools with a restructuring of the agreements. There can be no assurance that the Company will be able to finalize this restructuring plan. The Company currently has a $5,000,000 line of credit from a director. Total borrowings outstanding at September 30, 1999 totaled $4,999,000. The line of credit was due and payable on September 30, 1999. The Company exercised its option to extend the due date until March 31, 2000. In connection with this extension the Company issued a warrant for the purchase of 250,000 shares of the Company's common stock at $3.00 per share. If the line of credit remains unpaid at the holder of the note may elect to convert the debt into the Company's common stock at $1.00 per share for each dollar then owed. DEVELOPMENT AGREEMENT During 1999, the Company entered into three build-to-suit lease and development agreements with a developer for the construction of two charter schools in Arizona and one charter school in Washington D.C. As of September 30, 1999, the Company has advanced approximately $4,500,000 related to those projects, which is reflected in the accompanying condensed consolidated financial statements in section 1 herein as construction in progress or leasehold improvements. Two of the schools are in operation as of September 30, 1999. Due to inability of the developer to obtain financing, one of the Arizona schools has not been completed, further construction has been suspended and certain commitments have not been paid by the developer. As of September 30, 1999, existing commitments related to all three schools and estimated costs to complete the unopened Arizona charter school totaled approximately $7,800,000. Management is in negotiations with the developer to finalize the remaining school and resolve certain issues related to all three of the schools. Although management believes that negotiations with the developer will result in the completion and resolution of issues at both of these schools, there can be no assurance that these negotiations will be successful. Accordingly, the Company may have to obtain necessary funding for completion. In that event, if the Company is unable to obtain sufficient capital to meet existing commitments for completion, the remaining school would remain unopened and the $4,500,000 advanced by the Company could be at risk. Several contractors have filed mechanics liens against the Arizona school properties. In addition a subcontractor has filed suit for foreclosure on its mechanics lien. Management expects the remaining lienholders will join in the suit. As of October 31, 1999 preliminary notices for mechanics liens totaled $3,972,000. GOING CONCERN ISSUE: The accompanying condensed consolidated financial statements included in Section 1 herein have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course or business. The Company 13 14 incurred a net loss of $3,391,000 for the three months ended September 30, 1999, had negative working capital of $33,242,000, and an accumulated deficit of $39,100,000. These factors, among other things, may indicate that the Company will be unable to continue as a going concern for a reasonable period of time. Management believes that if it can finalize some of the financing alternatives that it is pursuing, the Company will generate sufficient resources to ensure uninterrupted performance of its operating obligations as currently structured and anticipated. The Company's continuance as a going concern is dependent upon its ability to generate sufficient cash flow to meet its obligations in a timely manner, to obtain additional financing as required, and ultimately to attain profitability. There can be no assurance, however, that these sources would be available to the Company on acceptable terms or when necessary. FORWARD-LOOKING STATEMENTS Certain statements made in this Report on Form 10-Q are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements involve risks and uncertainties, and actual results may be materially different. These forward-looking statements include, but are not limited to, statements herein regarding the opening of additional private schools, the application for and receipt of additional public charter school contracts and the opening of new charter schools, the completion of future strategic acquisitions, the integration of services into single education facilities, the profitability of existing and new private and public charter schools, the development of partnerships with real estate developers in high growth communities, the ability to secure financing on acceptable terms, and the ability of the Company to compete in the education industry. Factors that could cause actual results to differ from those expected include, but are not limited to, general economic conditions such as inflation and interest rates, both nationally and in Arizona where the Company's operations are concentrated; competitive conditions within the Company's markets, including the acceptance of the education services offered by the Company; unanticipated expenses; the ability of the Company to successfully integrate all of its services into single education facilities; the ability of the Company to obtain public charter school contracts; changes in government regulation of the education industry or in state charter school statutes; the availability of equipment financing at acceptable terms; and future claims for accidents at the Company's education facilities and the extent of insurance coverage for such claims. 14 15 YEAR 2000 ISSUE The Year 2000 issue ("Y2K") refers to a condition in computer software where a two-digit field rather than a four-digit field is used to distinguish a calendar year. Unless corrected, some computer programs, hardware and non-information system technology systems could be unable to process information containing dates subsequent to December 31, 1999. As a result, such programs and systems could experience miscalculations, malfunctions or disruptions. The Company has completed its initial assessment of potential exposure of its own core business information systems for Y2K readiness and is in the process of assessing the readiness of significant suppliers, business partners, banking agencies and governmental agencies. During the fourth quarter of 1999, the Company entered into an agreement with Arthur Andersen, LLP ("AA") to provide certain agreed upon accounting, tax and information technology services. In connection with the information technology services, the Company has begun a system conversion integrating its current multiple financial systems into a consolidated system and implementing PeopleSoft for all financially significant systems. Management expects the conversion process to be completed for all critical internal information systems prior to the end of 1999. All hardware and software upgrades required for the system's conversion are Y2K compliant. To date, excluding the cost of upgrading our current information system, the amount the Company has spent on Year 2000 efforts was immaterial. Additionally, excluding the cost of upgrading our current information systems, we currently believe that the additional costs of implementing our Y2K plan will not exceed $100,000 and will not have a material effect on the Company's financial position. These expenditures include our evaluation of our systems and the replacement and upgrading of non-compliant hardware and software. There can be no assurance that the cost estimates associated with the Company's Y2K issues will prove to be accurate or that those actual costs will not have a material adverse effect on the Company's results from operations and financial condition. The Company is in the process of contacting key business partners asking for assurances that they have taken steps to evaluate their Year 2000 compliance. The Company is not dependent upon a single source for any products or services. In the event a significant supplier, bank or other business partner or vendor is unable to provide products or services to the Company due to a Y2K failure, the Company believes it has adequate alternate sources for such products or services. For the three months ending September 30, 1999, 25% of the Company's revenue was for tuition and programs funded from state and federal sources. Processing of payments due to the Company by state and federal agencies will be handled by their respective computer systems. The Company is in the process of assessing the Y2K state of readiness at these federal agencies and will complete that assessment prior to December 1999. However, any prolonged interruption 15 16 would have a material adverse impact on the education industry and upon the Company's business, results of operations, liquidity and financial condition. A significant number of the Company's customers consist of individuals who make tuition payments to the Company on behalf of themselves or their children in exchange for educational services. The ability of these customers to make tuition payments is not expected to be affected by the Year 2000 issue. The Company has developed a preliminary contingency plan for the IT systems and material non-IT systems that it controls. In the event the Company has not completed the system enhancement to its IT systems prior to January 1, 2000, it will use contingent manual systems as required. Due to the AA agreement, management believes it would be able to respond effectively. The contingency plan for material non-IT systems that the Company controls includes, among other things, investigating the availability and replacement costs of such systems that are not Y2K compliant and adjusting clocks on such non-IT systems that are not date sensitive. PART II. OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 3.1 Restated Articles of Incorporation of the Company, as amended.(1) 3.2 By-Laws of the Company.(2) 10 Warrant issued to Pioneer Venture Fund, LLC. dated October 19, 1999 27 Financial Data Schedule (EDGAR) version only). - -------- (1) Incorporated by reference to the same numbered exhibit to the Company's Annual Report on Form 10-K for the year ended June 30, 1998. (2) Incorporated by reference to Exhibit 3.3 to the Company's Form S-18 Registration Statement (Registration Number 33-39481-C). (b) Reports on Form 8-K No reports on Form 8-K were filed during the three-months ended September 30, 1999. 16 17 SIGNATURES Pursuant to the requirements 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. Date: November 12, 1999 THE TESSERACT GROUP, INC. BY: /s/ Martha Taylor Thomas ------------------------------ Martha T. Thomas, Interim Chief Executive Officer Date: November 12, 1999 BY: /s/ Richard C. Yonker ------------------------------ Richard C. Yonker, Vice President Chief Financial Officer 17 EX-10 2 EX-10 1 THIS WARRANT HAS NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR ANY STATE SECURITIES LAWS. NO SALE OR DISPOSITION MAY BE EFFECTED WITHOUT (I) AN EFFECTIVE REGISTRATION STATEMENT RELATED THERETO, (II) AN OPINION OF COUNSEL FOR THE HOLDER, REASONABLY SATISFACTORY TO THE COMPANY, THAT SUCH REGISTRATION IS NOT REQUIRED, (III) RECEIPT OF A NO-ACTION LETTER(S) FROM THE APPROPRIATE GOVERNMENTAL AUTHORITY(IES), OR (IV) OTHERWISE COMPLYING WITH THE PROVISIONS OF SECTION 7 OF THIS WARRANT. THE TESSERACT GROUP, INC. WARRANT TO PURCHASE 250,000 SHARES OF COMMON STOCK (this "WARRANT") Warrant No. 2 THE TESSERACT GROUP, INC., a Minnesota corporation (the "COMPANY"), hereby certifies that, for value received, PIONEER VENTURE FUND, L.L.C., a Delaware limited liability company ("PIONEER"), or registered assigns, is the registered holder of a warrant (the "WARRANT") to subscribe for and purchase 250,000 shares of the fully paid and nonassessable Common Stock (as adjusted pursuant to Section 4 hereof, the "WARRANT SHARES") of the Company, at the price of $3.00 per share (such price and such other price as shall result, from time to time, from the adjustments specified in Section 4 hereof is herein referred to as the "WARRANT PRICE"), subject to the provisions and upon the terms and conditions hereinafter set forth. As used herein, (a) the term "COMMON STOCK" shall mean the Company's presently authorized Common Stock, par value $.01 per share, and any stock into or for which such Common Stock may hereafter be converted or exchanged in a transaction described in paragraph (c) of Section 4.2, (b) the term "DATE OF GRANT" shall mean October 14, 1999, and (c) the term "OTHER WARRANTS" shall mean any warrant issued upon transfer or partial exercise of this Warrant. The term "WARRANT" as used herein shall be deemed to include Other Warrants unless the context hereof or thereof clearly requires otherwise. 1. Term. The purchase right represented by this Warrant is exercisable, in whole or in part, at any time and from time to time from the Date of Grant through and including the close of business on September 30, 2004 (the "EXPIRATION DATE"). 2 2. Method of Exercise; Payment; Issuance of New Warrant. Subject to Section 1 hereof, the purchase right represented by this Warrant may be exercised by the holder hereof, in whole or in part and from time to time, by the surrender of this Warrant (with the notice of exercise form attached hereto as Exhibit A duly executed) at the principal office of the Company, along with (i) the delivery of cash, or a certified or official bank check in the amount of such Warrant Price, (ii) by an instruction to the Company to withhold a number of Warrant Shares then issuable upon exercise of the particular Warrant pursuant to Section 10.2 below (the "Net Exercise Option"), (iii) the surrender to the Company of Notes (as defined in Section 22) in principal amount plus accrued interest equal to the applicable Warrant Price, or (iv) the surrender to the Company of shares of Common Stock previously acquired by the Holder with an aggregate Fair Market Value (as defined in Section 4(h)) equal to such Warrant Price, or any combination of foregoing. In the event of any withholding of Warrant Shares or surrender of Common Stock pursuant to clause (ii) or (iv) above where the number of shares whose Fair Market Value is equal to the Warrant Price is not a whole number, the number of shares withheld by or surrendered to the Company shall be rounded down to the nearest whole share. The person or persons in whose name(s) any certificate(s) representing shares of Common Stock shall be issuable upon exercise of this Warrant shall be deemed to have become the holder(s) of record of, and shall be treated for all purposes as the record holder(s) of, the shares represented thereby (and such shares shall be deemed to have been issued) immediately prior to the close of business on the date or dates upon which this Warrant is exercised. In the event of any exercise of the rights represented by this Warrant, certificates for the shares of stock so purchased shall be delivered to the holder hereof as soon as possible and in any event within thirty (30) days after such exercise and, unless this Warrant has been fully exercised (including without limitation, exercise pursuant to Section 2(b) below), a new Warrant representing the portion of the Warrant Shares, if any, with respect to which this Warrant shall not then have been exercised shall also be issued to the holder hereof as soon as possible and in any event within such thirty (30)-day period. 3. Stock Fully Paid; Reservation of Shares. All Warrant Shares that may be issued upon the exercise of the rights represented by this Warrant will, upon issuance pursuant to the terms and conditions herein, be fully paid and nonassessable, and free from all taxes (other than any taxes determined with respect to, or based upon, the income of the person to whom such shares are issued), liens and charges (other than liens or charges created by actions of the holder of this Warrant or the person to whom such shares are issued), and preemptive rights with respect to the issue thereof. The Company shall pay all transfer taxes, if any, attributable to the issuance of the Warrant Shares upon the exercise of this Warrant. During the period within which the rights represented by this Warrant may be exercised, the Company will at all times have authorized, and reserved for the purpose of the issue upon exercise of the purchase rights evidenced by this Warrant, a sufficient number of shares of its Common Stock to provide for the exercise of the rights represented by this Warrant. 4. Adjustment of Warrant Price and Number of Shares. The number and kind of securities purchasable upon the exercise of this Warrant and the Warrant Price shall be subject to adjustment from time to time upon the occurrence of certain events, as follows: a. Reclassification or Merger. In case of any reclassification, change or conversion of securities of the class issuable upon exercise of this Warrant (other than a change in 2 3 par value, or from par value to no par value, or from no par value to par value, or as a result of a subdivision or combination), or in case of any merger of the Company with or into another corporation (other than a merger with another corporation in which the Company is the acquiring and the surviving corporation and which does not result in any reclassification or change of outstanding securities issuable upon exercise of this Warrant), or in case of any sale of all or substantially all of the assets of the Company, the Company, or such successor or purchasing corporation, as the case may be, shall duly execute and deliver to the holder of this Warrant a new Warrant (in form and substance satisfactory to the holder of this Warrant), so that the holder of this Warrant shall have the right to receive, at a total purchase price not to exceed that payable upon the exercise of the unexercised portion of this Warrant, and in lieu of the shares of Common Stock theretofore issuable upon exercise of this Warrant, the kind and amount of shares of stock, other securities, money and property receivable upon such reclassification, change or merger by a holder of the number of shares of Common Stock then purchasable under this Warrant. Such new Warrant shall provide for adjustments that shall be as nearly equivalent as may be practicable to the adjustments provided for in this Section 4. The provisions of this subparagraph (a) shall similarly apply to successive reclassifications, changes, mergers and transfers. b. Subdivision or Combination of Shares. If the Company at any time while this Warrant remains outstanding and unexpired shall subdivide or combine its outstanding shares of Common Stock, the Warrant Price shall be proportionately decreased in the case of a subdivision or increased in the case of a combination, effective at the close of business on the date the subdivision or combination becomes effective. c. Stock Dividends. If the Company at any time while this Warrant is outstanding and unexpired shall pay a dividend with respect to Common Stock payable in Common Stock, then the Warrant Price shall be adjusted, from and after the date of determination of stockholders entitled to receive such dividend or distribution, to that price determined by multiplying the Warrant Price in effect immediately prior to such date of determination by a fraction (i) the numerator of which shall be the total number of shares of Common Stock outstanding immediately prior to such dividend, and (ii) the denominator of which shall be the total number of shares of Common Stock outstanding immediately after such dividend. In the event such dividend is not so paid, the Warrant Price shall again be adjusted to the Warrant Price that would then be in effect if the holders of Common Stock to receive such dividend had not been so determined, but such subsequent adjustment shall not affect the number of Warrant Shares issued upon any exercise of the Warrant prior to the date such subsequent adjustment was made. d. Rights Offering. In case the Company shall, at any time after the Date of Grant, issue rights, options or warrants to the holders of equity securities of the Company, entitling them to subscribe for or purchase shares of Common Stock (or securities convertible or exchangeable into Common Stock) at a price per share of Common Stock (or having a conversion or exchange price per share of Common Stock if a security convertible or exchangeable into Common Stock) less than the Fair Market Value per share of Common Stock on the record date for such issuance (or the date of issuance, if there is no record date), the Warrant Price to be in effect on and after such record date (or issuance date, as the case may be) shall be determined by multiplying the Warrant Price in effect immediately prior to such record date (or issuance date, as the case may be) by a fraction (i) the numerator of which shall be the number of shares of Common Stock outstanding on such record 3 4 date (or issuance date, as the case may be) plus the number of shares of Common Stock which the aggregate offering price of the total number of shares of such Common Stock so to be offered (or the aggregate initial exchange or conversion price of the exchangeable or convertible securities so to be offered) would purchase at such Fair Market Value on such record date (or issuance date, as the case may be) and (ii) the denominator of which shall be the number of shares of Common Stock outstanding on such record date (or issuance date, as the case may be) plus the number of additional shares of Common Stock to be offered for subscription or purchase (or into which the convertible securities to be offered are initially exchangeable or convertible). In case such purchase or subscription price may be paid in part or in whole in a form other than cash, the fair value of such consideration shall be determined by the Board of Directors of the Company in good faith as set forth in a duly adopted board resolution certified by the Company's Secretary or Assistant Secretary. Such adjustment shall be made successively whenever such an issuance occurs; and in the event that such rights, options, warrants, or convertible or exchangeable securities are not so issued or expire or cease to be convertible or exchangeable before they are exercised, converted, or exchanged (as the case may be), then the Warrant Price shall again be adjusted to be the Warrant Price that would then be in effect if such issuance had not occurred, but such subsequent adjustment shall not affect the number of Warrant Shares issued upon any exercise of this Warrant prior to the date such subsequent adjustment is made. e. Special Distributions. In case the Company shall fix a record date for the making of a distribution to all holders of shares of Common Stock (including any such distribution made in connection with a consolidation or merger in which the Company is the surviving corporation) or evidences of indebtedness or assets (other than dividends and distributions referred to in subparagraphs (d) and (e) above and other than cash dividends) or of subscription rights, options, warrants, or exchangeable or convertible securities containing the right to subscribe for or purchase shares of any class of equity securities of the Company (excluding those referred to in subparagraph (f) above), the Warrant Price to be in effect on and after such record date shall be adjusted by multiplying the Warrant Price in effect immediately prior to such record date by a fraction (i) the numerator of which shall be the Fair Market Value per share of Common Stock on such record date, less the fair value (as determined by the Board of Directors of the Company in good faith as set forth in a duly adopted board resolution certified by the Company's Secretary or Assistant Secretary) of the portion of the assets or evidences of indebtedness so to be distributed or of such subscription rights, options, warrants, or exchangeable or convertible securities applicable to one (i) share of the Common Stock outstanding as of such record date, and (ii) the denominator of which shall be such Fair Market Value per share of Common Stock. Such adjustment shall be made successively whenever such a record date is fixed; and in the event that such distribution is not so made, the Warrant Price shall again be adjusted to be the Warrant Price which would then be in effect if such record date had not been fixed, but such subsequent adjustment shall not affect the number of Warrant Shares issued upon any exercise of this Warrant prior to the date such subsequent adjustment was made. f. Other Issuances of Securities. In case the Company or any subsidiary shall, at any time after the Date of Grant, issue shares of Common Stock, or rights, options, warrants or convertible or exchangeable securities containing the right to subscribe for or purchase shares of Common Stock (excluding (i) shares, rights, options, warrants, or convertible or exchangeable securities or issued in any of the transactions described in subparagraphs (a), (b), (c), (d) or (e) above, 4 5 (ii) shares issued upon the exercise of such rights, options or warrants or upon conversion or exchange of such convertible or exchangeable securities, (iii) shares, rights or options issued to employees, officers or directors of the Company pursuant to a plan approved by the board of directors of the Company (and shares issued upon exercise of such rights or options), and (iv) this Warrant and any shares issued upon exercise thereof), at a price per share of Common Stock (determined in the case of such rights, options, warrants, or convertible or exchangeable securities by dividing (x) the total amount receivable by the Company in consideration of the sale and issuance of such rights, options, warrants, or convertible or exchangeable securities, plus the total minimum consideration payable to the Company upon exercise, conversion, or exchange thereof by (y) the total maximum number of shares of Common Stock covered by such rights, options, warrants, or convertible or exchangeable securities) lower than the Fair Market Value per share of Common Stock on the date the Company fixes the offering price of such shares, rights, options, warrants, or convertible or exchangeable securities, then the Warrant Price shall be adjusted so that it shall equal the price determined by multiplying the Warrant Price in effect immediately prior thereto by a fraction (i) the numerator of which shall be the sum of (A) the number of shares of Common Stock outstanding immediately prior to such sale and issuance plus (B) the number of shares of Common Stock which the aggregate consideration received (determined as provided below) for such sale or issuance would purchase at such Fair Market Value per share, and (ii) the denominator of which shall be the total number of shares of Common Stock outstanding immediately after such sale and issuance. Such adjustment shall be made successively whenever such an issuance is made. For the purposes of such adjustment, the maximum number of shares of Common Stock which the holder of any such rights, options, warrants or convertible or exchangeable securities shall be entitled to subscribe for or purchase shall be deemed to be issued and outstanding as of the date of such sale and issuance and the consideration received by the Company therefor shall be deemed to be the consideration received by the Company for such rights, options, warrants, or convertible or exchangeable securities, plus the minimum consideration or premium stated in such rights, options, warrants, or convertible or exchangeable securities to be paid for the shares of Common Stock covered thereby. In case the Company shall sell and issue shares of Common Stock, or rights, options, warrants, or convertible or exchangeable securities containing the right to subscribe for or purchase shares of Common Stock for a consideration consisting, in whole or in part, of property other than cash or its equivalent, then in determining the price per share of Common Stock and the consideration received by the Company for purposes of the first sentence of this subparagraph (h), the Board of Directors of the Company shall determine, in good faith, the fair value of said property, and such determination shall be described in a duly adopted board resolution certified by the Company's Secretary or Assistant Secretary. In case the Company shall sell and issue rights, options, warrants, or convertible or exchangeable securities containing the right to subscribe for or purchase shares of Common Stock together with one (1) or more other securities as a part of a unit at a price per unit, then in determining the price per share of Common Stock and the consideration received by the Company for purposes of the first sentence of this subparagraph (h), the Board of Directors of the Company shall determine, in good faith, which determination shall be described in a duly adopted board resolution certified by the Company's Secretary or Assistant Secretary, the fair value of the rights, options, warrants, or convertible or exchangeable securities then being sold as part of such unit. Such adjustment shall be made successively whenever such an issuance occurs, and in the event that such rights, options, warrants, or convertible or exchangeable securities expire or cease to be convertible or exchangeable before they are exercised, converted, or exchanged (as the case may be), then the Warrant Price shall again be adjusted to the Warrant Price that would then be in effect if such sale 5 6 and issuance had not occurred, but such subsequent adjustment shall not affect the number of Warrant Shares issued upon any exercise of the Warrant prior to the date such subsequent adjustment is made. g. Adjustment of Number of Shares. Upon each adjustment in the Warrant Price, the number of Warrant Shares purchasable hereunder shall be adjusted, to the nearest whole share, to the product obtained by multiplying the number of Warrant Shares purchasable immediately prior to such adjustment in the Warrant Price by a fraction, the numerator of which shall be the Warrant Price immediately prior to such adjustment and the denominator of which shall be the Warrant Price immediately thereafter. h. Determination of Fair Market Value. For purposes of this Section 4, "FAIR MARKET VALUE" of a share of Common Stock as of a particular date (the "DETERMINATION DATE") shall mean (i) if shares of Common Stock are traded on a national securities exchange (an "EXCHANGE"), the weighted average of the closing prices of a share of the Common Stock of the Company on the last five (5) trading days prior to the Determination Date reported on such Exchange as reported in The Wall Street Journal (weighted with respect to the trading volume with respect to each such day), (ii) if shares of Common Stock are not traded on an Exchange but trade in the over-the-counter market and such shares are quoted on the Nasdaq National Market ("NASDAQ"), (A) the average of the last sale prices reported on NASDAQ or (B) if such shares are an issue for which last sale prices are not reported on NASDAQ, the average of the closing bid and ask prices, in each case on the last five (5) trading days (or if the relevant price or quotation did not exist on any of such days, the relevant price or quotation on the next preceding business day on which there was such a price or quotation) prior to the Determination Date as reported in The Wall Street Journal, or (iii) if no price can be determined on the basis of the above methods of valuation, then the judgment of valuation shall be determined in good faith by the Board of Directors of the Company, which determination shall be described in a duly adopted board resolution certified by the Company's Secretary or Assistant Secretary. If the Board of Directors of the Company is unable to determine any Valuation (as defined below), or if the holders of at least fifty-one percent (51%) of all of the Warrant Shares then issuable hereunder (collectively, the "REQUESTING HOLDERS") disagree with the Board's determination of any Valuation by written notice delivered to the Company within five (5) business days after the determination thereof by the Board of Directors of the Company is communicated to holders of the Warrants affected thereby, which notice specifies a majority-in-interest of the Requesting Holders' determination of such Valuation, then the Company and a majority-in-interest of the Requesting Holders shall select a mutually acceptable investment banking firm of national reputation which has not had a material relationship with the Company or any officer of the Company within the preceding two (2) years, which shall determine such Valuation. Such investment banking firm's determination of such Valuation shall be final, binding and conclusive on the Company and the holders of all of the Warrants issued hereunder and then outstanding. If the Board of Directors of the Company was unable to determine such Valuation, all costs and fees of such investment banking firm shall be borne by the Company. If the Requesting Holders disagreed with the Board's determination of such Valuation, the party whose determination of such Valuation differed from the Valuation determined by such investment banking firm by the greatest amount shall bear all costs and fees of such investment banking firm. For purposes of this Section 4(h), the term "VALUATION" shall mean the determination, to be made initially by the Board of Directors of the Company, of the Fair Market Value per share of Common Stock pursuant to clause (iii) above. 6 7 i. If, at any time after any adjustment of the Warrant Price shall have been made hereunder as the result of any issuance, sale or grant of any rights, options, warrants or convertible or exchangeable securities, any of such rights, options or warrants or the rights of conversion or exchange associated with such convertible or exchangeable securities shall expire by their terms or any of such rights, options, warrants or convertible or exchangeable securities shall be repurchased by the Company or a subsidiary thereof for a consideration per underlying share of Common Stock not exceeding the amount of such consideration received by the Company in connection with the issuance, sale or grant of such rights, options, warrants or convertible or exchangeable securities, the Warrant Price then in effect shall forthwith be increased to the Warrant Price that would have been in effect if such expiring right, option or warrant or rights of conversion or exchange or such repurchased rights, options, warrants or convertible or exchangeable securities had never been issued. Similarly, if at any time after any such adjustment of the Warrant Price shall have been made pursuant to subparagraph (e) above (i) any additional aggregate consideration is received or becomes receivable by the Company in connection with the issuance of exercise of such rights, options, warrants or convertible or exchangeable securities or (ii) there is a reduction in the conversion or exchange ratio applicable to such convertible or exchangeable securities so that fewer shares of Common Stock will be issuable upon the conversion or exchange thereof or there is a decrease in the number of shares of Common Stock issuable upon exercise of such rights, options or warrants, the Warrant Price then in effect shall be forthwith readjusted to the Warrant Price that would have been in effect had such changes taken place at the time that such rights, options, warrants or convertible or exchangeable securities were initially issued, granted or sold. In no event shall any readjustment under this subparagraph (i) affect the validity of any Warrant Shares issued upon any exercise of this Warrant prior to such readjustment. 5. Notice of Adjustments. Whenever the Warrant Price or the number of Warrant Shares purchasable hereunder shall be adjusted pursuant to Section 4 hereof, the Company shall deliver to the holder of this Warrant a certificate signed by its chief financial officer setting forth, in reasonable detail, the event requiring the adjustment, the amount of the adjustment, the method by which such adjustment was calculated, and the Warrant Price and the number of Warrant Shares purchasable hereunder after giving effect to such adjustment. 6. Fractional Shares. No fractional shares of Common Stock will be issued in connection with any exercise hereunder, but in lieu of such fractional shares the Company shall make a cash payment therefor based on the Fair Market Value of a share of Common Stock on the date of exercise. 7. Compliance with Securities Act; Disposition of Warrant or Warrant Shares. a. Compliance with Securities Act. The holder of this Warrant, by acceptance hereof, agrees that this Warrant and the shares of Common Stock to be issued upon exercise hereof are being acquired for investment and that such holder will not offer, sell or otherwise dispose of this Warrant, or any shares of Common Stock to be issued upon exercise hereof except under circumstances which will not result in a violation of the Securities Act of 1933, as amended (the "ACT"). Upon exercise of this Warrant, the holder hereof shall confirm in writing, by executing the form attached as Schedule 1 to Exhibit A hereto, that the shares of Common Stock so purchased are being acquired for investment and not with a view toward distribution or resale. This Warrant and 7 8 all shares of Common Stock issued upon exercise of this Warrant (unless registered under the Act) shall be stamped or imprinted with a legend in substantially the following form: "THE SECURITIES EVIDENCED HEREBY HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR ANY STATE SECURITIES LAWS. NO SALE OR DISPOSITION MAY BE EFFECTED WITHOUT (I) AN EFFECTIVE REGISTRATION STATEMENT RELATED THERETO, (II) AN OPINION OF COUNSEL FOR THE HOLDER, REASONABLY SATISFACTORY TO THE COMPANY, THAT SUCH REGISTRATION IS NOT REQUIRED, (III) RECEIPT OF A NO-ACTION LETTER(S) FROM THE APPROPRIATE GOVERNMENTAL AUTHORITY(IES), OR (IV) OTHERWISE COMPLYING WITH THE PROVISIONS OF SECTION 7 OF THE WARRANT UNDER WHICH THESE SECURITIES WERE ISSUED DIRECTLY OR INDIRECTLY." In addition, in connection with the issuance of this Warrant, the holder specifically represents to the Company by acceptance of this Warrant as follows: i. The holder is aware of the Company's business affairs and financial condition, and has acquired information about the Company sufficient to reach an informed and knowledgeable decision to acquire this Warrant. The holder is acquiring this Warrant for its own account for investment purposes only and not with a view to, or for the resale in connection with, any "distribution" thereof for purposes of the Act. ii. The holder understands that this Warrant and the Warrant Shares have not been registered under the Act in reliance upon a specific exemption therefrom, which exemption depends upon, among other things, the bona fide nature of the holder's investment intent as expressed herein. In this connection, the holder understands that, in the view of the Securities and Exchange Commission (the "SEC"), the statutory basis for such exemption may be unavailable if the holder's representation was predicated solely upon a present intention to hold the Warrant and the Warrant Shares for the minimum capital gains period specified under applicable tax laws, for a deferred sale, for or until an increase or decrease in the market price of the Warrant and the Warrant Shares, or for a period of one (1) year or any other fixed period in the future. iii. The holder further understands that this Warrant and the Warrant Shares must be held indefinitely unless subsequently registered under the Act and any applicable state securities laws, or unless exemptions from registration are otherwise available. iv. The holder is aware of the provisions of Rule 144 and 144A, promulgated under the Act, which, in substance, permit limited public resale of "restricted securities" acquired, directly or indirectly, from the issuer thereof (or from an affiliate of such issuer), in a non-public offering subject to the satisfaction of certain conditions, if applicable, including, among other things: the availability of certain public information about the Company, the resale occurring not less than one (1) year after the party has purchased and paid for the securities to be sold; the sale being 8 9 made through a broker in an unsolicited "broker's transaction" or in transactions directly with a market maker (as said term is defined under the Securities Exchange Act of 1934, as amended) and the amount of securities being sold during any three-month period not exceeding the specified limitations stated therein. v. The holder further understands that at the time it wishes to sell this Warrant and the Warrant Shares there may be no public market upon which to make such a sale, and that, even if such a public market then exists, the Company may not be satisfying the current public information requirements of Rule 144 and 144A, and that, in such event, the holder may be precluded from selling this Warrant and the Warrant Shares under Rule 144 and 144A even if the one (1)-year minimum holding period had been satisfied. vi. The holder further understands that in the event all of the requirements of Rule 144 and 144A are not satisfied, registration under the Act, compliance with Regulation A, or some other registration exemption will be required; and that, notwithstanding the fact that Rule 144 and 144A is not exclusive, the Staff of the SEC has expressed its opinion that persons proposing to sell private placement securities other than in a registered offering and otherwise than pursuant to Rule 144 and 144A will have a substantial burden of proof in establishing that an exemption from registration is available for such offers or sales, and that such persons and their respective brokers who participate in such transactions do so at their own risk. b. Disposition of Warrant or Warrant Shares. With respect to any offer, sale or other disposition of this Warrant, or any Warrant Shares acquired pursuant to the exercise of this Warrant prior to registration of such Warrant or Warrant Shares, the holder hereof and each subsequent holder of this Warrant agrees to give written notice to the Company prior thereto, describing briefly the manner thereof, together with a written opinion of such holder's counsel, if reasonably requested by the Company, to the effect that such offer, sale or other disposition may be effected without registration or qualification (under the Act as then in effect or any federal or state law then in effect) of this Warrant or such Warrant Shares and indicating whether or not under the Act certificates for this Warrant or such Warrant Shares to be sold or otherwise disposed of require any restrictive legend as to applicable restrictions on transferability in order to ensure compliance with applicable law. Promptly upon receiving such written notice and reasonably satisfactory opinion, if so requested, the Company, as promptly as practicable, shall notify such holder that such holder may sell or otherwise dispose of this Warrant or such Warrant Shares, all in accordance with the terms of the notice delivered to the Company. If a determination has been made pursuant to this subsection (b) that the opinion of counsel for the holder is not reasonably satisfactory to the Company, the Company shall so notify the holder promptly after such determination has been made and neither this Warrant nor any Warrant shall be sold or otherwise disposed of until such disagreement has been resolved. The foregoing notwithstanding, this Warrant or such Warrant Shares may, as to such federal laws, be offered, sold or otherwise disposed of in accordance with Rule 144 and 144A under the Act, provided that the Company shall have been furnished with such information as the Company may reasonably request to provide a reasonable assurance that the provisions of Rule 144 and 144A have been satisfied. Each certificate representing this Warrant or the Warrant Shares thus transferred (except a transfer pursuant to Rule 144) shall bear a legend as to the applicable restrictions on transferability in order to ensure compliance with such laws, unless in the aforesaid opinion of counsel for the holder, such legend is not required in order to ensure compliance with such laws. The 9 10 Company may issue stop transfer instructions to its transfer agent or, if acting as its own transfer agent, the Company may stop transfer on its corporate books, in connection with such restrictions. 8. Rights as Stockholders; Information. No holder of this Warrant, as such, shall be entitled to vote or receive dividends or be deemed the holder of Common Stock or any other securities of the Company which may at any time be issuable on the exercise hereof for any purpose, nor shall anything contained herein be construed to confer upon the holder of this Warrant, as such, any of the rights of a stockholder of the Company or any right to vote for the election of the directors or upon any matter submitted to stockholders at any meeting thereof, or to receive notice of meetings, or to receive dividends or subscription rights or otherwise until this Warrant shall have been exercised and the Warrant Shares purchasable upon the exercise hereof shall have become deliverable, as provided herein. The foregoing notwithstanding, the Company will transmit to the holder of this Warrant such information, documents and reports as are generally distributed to the holders of any class or series of the securities of the Company concurrently with the distribution thereof to the stockholders. 9. Registration Rights. The shares of Common Stock issued or issuable upon exercise of the Warrant are subject to registration and other rights granted to the Holders pursuant to that certain Registration Rights Agreement dated as of March 31, 1999. 10. Additional Rights. 10.1 Mergers. In the event that the Company undertakes to (i) sell, lease, exchange, convey or otherwise dispose of all or substantially all of its property or business, or (ii) merge into or consolidate with any other corporation (other than a wholly-owned subsidiary of the Company), or effect any transaction (including a merger or other reorganization) or series of related transactions, in which more than 50% of the voting power of the Company is disposed of, the Company will use its best efforts to provide at least thirty (30) days notice of the terms and conditions of the proposed transaction. 10.2 Right to Convert Warrant into Common Stock; Net Issuance. a. Right to Convert. In addition to and without limiting the rights of the holder under the terms of this Warrant, the holder shall have the right to convert this Warrant or any portion thereof (the "CONVERSION RIGHT") into shares of Common Stock as provided in this Section 10.2 at any time or from time to time during the term of this Warrant. Upon exercise of the Conversion Right with respect to a particular number of shares subject to this Warrant (the "CONVERTED WARRANT SHARES"), the Company shall deliver to the holder (without payment by the holder of any exercise price or any cash or other consideration) that number of shares of fully paid and nonassessable Common Stock equal to the quotient obtained by dividing (i) the value of this Warrant (or the specified portion hereof) on the Conversion Date (as defined in subsection (b) hereof), which value shall be equal to (A) the aggregate Fair Market Value of the Converted Warrant Shares issuable upon exercise of this Warrant (or the specified portion hereof) on the Conversion Date less (B) the aggregate Warrant Price of the Converted Warrant Shares immediately prior to the 10 11 exercise of the Conversion Right by (ii) the Fair Market Value of one (1) share of Common Stock on the Conversion Date. Expressed as a formula, such conversion shall be computed as follows: X=A-B --- Y Where: X= the number of shares of Common Stock that may be issued to holder Y = the Fair Market Value (FMV) of one (1) share of Common Stock A = the aggregate FMV (i.e., FMV x Converted Warrant Shares) B = the aggregate Warrant Price (i.e., Converted Warrant Shares x Warrant Price) No fractional shares shall be issuable upon exercise of the Conversion Right, and, if the number of shares to be issued determined in accordance with the foregoing formula is other than a whole number, the Company shall pay to the holder an amount in cash equal to the Fair Market Value of the resulting fractional share on the Conversion Date. b. Method of Exercise. The Conversion Right may be exercised by the holder by the surrender of this Warrant at the principal office of the Company together with a written statement specifying that the holder thereby intends to exercise the Conversion Right and indicating the number of shares subject to this Warrant which are being surrendered (referred to in subsection (a) hereof as the Converted Warrant Shares) in exercise of the Conversion Right. Such conversion shall be effective upon receipt by the Company of this Warrant together with the aforesaid written statement, or on such later date as is specified therein (the "CONVERSION DATE"). Certificates for the shares issuable upon exercise of the Conversion Right and, if applicable, a new warrant evidencing the balance of the shares remaining subject to this Warrant, shall be issued as of the Conversion Date and shall be delivered to the holder within thirty (30) days following the Conversion Date. 11. Representations and Warranties. The Company represents and warrants to the holder of this Warrant as follows: a. This Warrant has been duly authorized and executed by the Company and is a valid and binding obligation of the Company enforceable in accordance with its terms, subject to laws of general application relating to bankruptcy, insolvency and the relief of debtors; b. The Warrant Shares have been duly authorized and reserved for issuance by the Company and, when issued in accordance with the terms hereof, will be validly issued, fully paid and nonassessable, 11 12 c. The rights, preferences, privileges and restrictions granted to or imposed upon the Common Stock and the holders thereof are as set forth in the Restated Articles of Incorporation of the Company, as amended to the Date of Grant (as so amended, the "CHARTER"), a true and complete copy of which has been delivered to the original holder of this Warrant; d. The execution and delivery of this Warrant are not, and the issuance of the Warrant Shares upon exercise of this Warrant in accordance with the terms hereof will not be, inconsistent with the Charter or by-laws of the Company, do not and will not contravene, in any material respect, any governmental rule or regulation, judgment or order applicable to the Company, and do not and will not conflict with or contravene any provision of, or constitute a default under, any indenture, mortgage, contract or other instrument of which the Company is a party or by which it is bound or require the consent or approval of, the giving of notice to, the registration or filing with or the taking of any action in respect of or by, any Federal, state or local government authority or agency or other person, except for the filing of notices pursuant to federal and state securities laws, which filings will be effected by the time required thereby and except for such conflicts and contraventions as will not, individually or in the aggregate, have or reasonably be expected to have, a material adverse effect on the Warrant Shares so issued or the Company's ability to perform its obligations hereunder; e. There are no actions, suits, audits, investigations or proceedings pending or, to the knowledge of the Company, threatened against the Company in any court or before any governmental commission, board or authority which, if adversely determined, will have a material adverse effect on the ability of the Company to perform its obligations under this Warrant; f. The authorized capital stock of the Company consists of the following: (i) 25,000,000 shares of Common Stock, par value $.01 per share, of which approximately 9,580,331 shares of Common Stock were issued and outstanding as of the close of business on the date immediately prior to the Date of Grant. All such outstanding shares have been validly issued and are fully paid, nonassessable shares free of preemptive rights; (ii) 5,000,000 shares of Preferred Stock, of which 200,000 have been designated as Series A Junior Participating Preferred Shares, and none of which were issued and outstanding as of the close of business on the date immediately prior to the Date of Grant; and g. Other than options to purchase 1,804,171 shares of Common Stock and warrants to purchase 450,742 shares of Common Stock, there are no subscriptions, rights, options, warrants, or calls relating to any shares of the Company's capital stock, including any right of conversion or exchange under any outstanding security or other instrument; and h. The Company is not subject to any obligation (contingent or otherwise) to repurchase or otherwise acquire or retire any shares of its capital stock or any 12 13 security convertible into or exchangeable for any of its capital stock. 12. Modification and Waiver. This Warrant and any provision hereof may be changed, waived, discharged or terminated only by an instrument in writing signed by the party against which enforcement of the same is sought, except that the provisions of Section 9 hereof may be amended with the consent of the Company and the holders of Registrable Securities constituting a majority of the Registrable Securities then outstanding. For purposes of Section 9 and this Section 12, "REGISTRABLE SECURITIES THEN OUTSTANDING" shall mean, with respect to a specified determination date, the Registrable Securities owned (beneficially or of record) by all Securityholders on such date. 13. Notices. Unless otherwise specifically provided herein, all communications under this Warrant shall be in writing and shall be deemed to have been duly given (i) on the date of service if served personally on the party to whom notice is to be given, (ii) on the day of transmission if sent by facsimile transmission to the number given below, and telephonic confirmation of receipt is obtained promptly after completion of transmission, (iii) on the day after delivery to Federal Express or similar overnight courier, or (iv) on the fifth day after mailing, if mailed to the party to whom notice is to be given, by first class mail, registered or certified, postage prepaid, and properly addressed, return receipt requested, to each such holder at its address as shown on the books of the Company or to the Company at the address indicated therefor on the signature page of this Warrant. Any party hereto may change its address for purposes of this Section 13 by giving the other party written notice of the new address in the manner set forth herein. 14. Binding Effect on Successors. This Warrant shall be binding upon any corporation succeeding the Company by merger, consolidation or acquisition of all or substantially all of the Company's assets, and all of the obligations of the Company relating to the Common Stock issuable upon the exercise or conversion of this Warrant shall survive the exercise, conversion and termination of this Warrant and all of the covenants and agreements of the Company shall inure to the benefit of the successors and assigns of the holder hereof. The Company will, at the time of the exercise or conversion of this Warrant; in whole or in part, upon request of the holder hereof but at the Company's expense, acknowledge in writing its continuing obligation to the holder hereof in respect of any rights to which the holder hereof shall continue to be entitled after such exercise or conversion in accordance with this Warrant; provided, that the failure of the holder hereof to make any such request shall not affect the continuing obligation of the Company to the holder hereof in respect of such rights. 15. Lost Warrants or Stock Certificates. The Company covenants to the holder hereof that, upon receipt of evidence reasonably satisfactory to the Company of the loss, theft, destruction or mutilation of this Warrant or any stock certificate and, in the case of any loss, theft or destruction, upon receipt of an executed lost securities bond or indemnity reasonably satisfactory to the Company, or in the case of any such mutilation upon surrender and cancellation of such Warrant or stock certificate, the Company will make and deliver a new Warrant or stock certificate, of like tenor, in lieu of the lost, stolen, destroyed or mutilated Warrant or stock certificate. 13 14 16. Descriptive Headings. The descriptive headings of the several paragraphs of this Warrant are inserted for convenience only and do not constitute a part of this Warrant. 17. Governing Law. This Warrant shall be construed and enforced in accordance with, and the rights of the parties shall be governed by, the laws of the State of California, without giving effect to conflict of law principles. 18. Survival of Representations, Warranties and Agreements. All representations and warranties of the Company and the holder hereof contained herein shall survive the Date of Grant, the exercise or conversion of this Warrant (or any part hereof) and the termination or expiration of rights hereunder. All agreements of the Company and the holder hereof contained herein shall survive indefinitely until, by their respective terms, they are no longer operative. 19. Remedies. In case any one (1) or more of the covenants and agreements contained in this Warrant shall have been breached, the holders hereof (in the case of a breach by the Company), or the Company (in the case of a breach by a holder), may proceed to protect and enforce their or its rights either by suit in equity and/or by action at law, including, but not limited to, an action for damages as a result of any such breach and/or an action for specific performance of any such covenant or agreement contained in this Warrant. 20. Acceptance. Receipt of this Warrant by the holder hereof shall constitute acceptance of and agreement to the foregoing terms and conditions. 21. No Impairment of Rights. The Company will not, by amendment of its Charter or through any other means, avoid or seek to avoid the observance or performance of any of the terms of this Warrant, but will at all times in good faith assist in the carrying out of all such terms and in the taking of all such action as may be necessary or appropriate in order to protect the rights of the holder of this Warrant against impairment. [Signature page follows.] 14 15 IN WITNESS WHEREOF, the Company has caused this Warrant to be executed on its behalf by one of its officers thereunto duly authorized. THE TESSERACT GROUP, a Minnesota corporation By /s/ John T. Golle -------------------------------------- John T. Golle Chief Executive Officer Address: 9977 N. 90th Street Suite 180 Scottsdale, AZ 85258 Dated: as of October 14, 1999 S-1 16 EXHIBIT A NOTICE OF EXERCISE To: THE TESSERACT GROUP, INC. 1 . The undersigned hereby elects to purchase shares of Common Stock of THE TESSERACT GROUP, INC. pursuant to the terms of the attached Warrant, and tenders herewith payment of the purchase price of such shares in full. 2. Please issue a certificate or certificates representing said shares in the name of the undersigned or in such other name or names as are specified below: ---------------------------------- (Name) ---------------------------------- ---------------------------------- (Address) 3. The undersigned represents that the aforesaid shares are being acquired for the account of the undersigned for investment and not with a view to, or for resale in connection with, the distribution thereof and that the undersigned has no present intention of distributing or reselling such shares. In support thereof, the undersigned has executed an Investment Representation Statement attached hereto as Schedule 1. ------------------------------------------- (Signature) - --------------------- (Date) A-1 17 Schedule 1 INVESTMENT REPRESENTATION STATEMENT Purchaser: Company: THE TESSERACT GROUP, INC. Security: Common Stock Amount: Date: In connection with the purchase of the above-listed securities (the "SECURITIES"), the undersigned (the "PURCHASER") represents to the Company as follows: (a) The Purchaser is aware of the Company's business affairs and financial condition, and has acquired sufficient information about the Company to reach an informed and knowledgeable decision to acquire the Securities. The Purchaser is purchasing the Securities for its own account for investment purposes only and not with a view to, or for the resale in connection with, any "distribution" thereof for purposes of the Securities Act of 1933, as amended (the "ACT"). (b) The Purchaser understands that the Securities have not been registered under the Act in reliance upon a specific exemption therefrom, which exemption depends upon, among other things, the bona fide nature of the Purchaser's investment intent as expressed herein. In this connection, the Purchaser understands that, in the view of the Securities and Exchange Commission ("SEC"), the statutory basis for such exemption may be unavailable if the Purchaser's representation was predicated solely upon a present intention to hold these Securities for the minimum capital gains period specified under applicable tax laws, for a deferred sale, for or until an increase or decrease in the market price of the Securities, or for a period of one year or any other fixed period in the future. (c) The Purchaser further understands that the Securities must be held indefinitely unless subsequently registered under the Act or unless an exemption from registration is otherwise available. In addition, the Purchaser understands that the certificate evidencing the Securities will be imprinted with the legend referred to in the Warrant under which the Securities are being purchased. (d) The Purchaser is aware of the provisions of Rule 144 and 144A, promulgated under the Act, which, in substance, permit limited public resale of "restricted securities" acquired, directly or indirectly, from the issuer thereof (or from an affiliate of such A-2 18 issuer), in a non-public offering subject to the satisfaction of certain conditions, if applicable, including, among other things: The availability of certain public information about the Company, the resale occurring not less than one (1) year after the party has purchased and paid for the securities to be sold; the sale being made through a broker in an unsolicited "broker's transaction" or in transactions directly with a market maker (as said term is defined under the Securities Exchange Act of 1934, as amended) and the amount of securities being sold during any three-month period not exceeding the specified limitations stated therein. (e) The Purchaser further understands that at the time it wishes to sell the Securities there may be no public market upon which to make such a sale, and that, even if such a public market then exists, the Company may not be satisfying the current public information requirements of Rule 144 and 144A, and that, in such event, the Purchaser may be precluded from selling the Securities under Rule 144 and 144A even if the one-year minimum holding period had been satisfied. (f) The Purchaser further understands that in the event all of the requirements of Rule 144 and 144A are not satisfied, registration under the Act, compliance with Regulation A, or some other registration exemption will be required; and that, notwithstanding the fact that Rule 144 is not exclusive, the Staff of the SEC has expressed its opinion that persons proposing to sell private placement securities other than in a registered offering and otherwise than pursuant to Rule 144 will have a substantial burden or proof in establishing that an exemption from registration is available for such offers or sales, and that such persons and their respective brokers who participate in such transactions do so at their own risk. Purchaser: -------------------------------- Date: ------------------------------------- A-3 EX-27 3 EX-27
5 3-MOS JUN-30-2000 JUL-01-1999 SEP-30-1999 2,196 0 3,300 0 0 7,530 35,780 0 61,455 40,772 0 0 0 98 19,272 61,455 9,954 0 6,088 11,927 1,418 0 0 0 0 0 0 0 0 (3,391) (0.35) (0.35)
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