<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 8-K/A
AMENDMENT NO. 1 TO FORM 8-K
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
December 17, 1999
-----------------
(Date of Report - date of earliest event reported)
VIRTUAL TECHNOLOGY CORPORATION
------------------------------
(Exact name of registrant as specified in charter)
Minnesota 000-25397 41-1639011
--------------------------------------------------------------------------
(State or other jurisdiction (Commission File No.) (IRS Employer
of incorporation or organization) Identification No.)
3100 West Lake Street, Suite 400, Minneapolis, MN 55416
-------------------------------------------------------
(Address of principal executive offices)
612-915-1122
------------
(Registrant's telephone number, including area code)
<PAGE> 2
Explanatory note: This Amendment No. 1 to the Form 8-K dated December 17, 1999
is filed solely to supply the financial statements required by Item 7 of Form
8-K.
Items 1,2,3,4,5,6 and 8 are not applicable and are therefore omitted.
Item 7. Financial Statements and Exhibits.
Index To Financial Statements
VIRTUAL TECHNOLOGY CORPORATION
Unaudited pro forma combined condensed financial statement information.
Unaudited pro forma combined condensed balance sheet as of October 31, 1999.
Notes to unaudited pro forma combined condensed balance sheet.
Unaudited pro forma combined condensed statement of operations for the nine
months ended October 31, 1999.
Unaudited pro forma combined condensed statement of operations for the year
ended January 31, 1999.
Notes to unaudited pro forma combined condensed statements of operations.
TECH SQUARED INC. AND SUBSIDIARIES
Report of Independent Public Accountants.
Consolidated balance sheets as of December 31, 1998 and 1997.
Consolidated statements of operations for the years ended December 31, 1998,
1997, and 1996.
Consolidated statements of comprehensive income (loss) for the years ended
December 31, 1998, 1997, and 1996.
Consolidated statements of stockholders' equity for the years ended December 31,
1998, 1997, and 1996.
Consolidated statements of cash flows for the years ended December 31, 1998,
1997, and 1996.
Notes to consolidated financial statements.
Consolidated balance sheet as of September 30, 1999 (unaudited).
Consolidated statements of operations (unaudited) for the nine months ended
September 30, 1999 and 1998.
Consolidated statements of cash flows (unaudited) for the nine months ended
September 30, 1999 and 1998.
Notes to financial statements (unaudited).
2
<PAGE> 3
VIRTUAL TECHNOLOGY CORPORATION
Unaudited Pro Forma Combined Condensed Financial Statement Information
On December 17, 1999, Virtual Technology Corporation (the "Company"), through
its wholly-owned subsidiary, T2 Acquisition Corporation, completed its
acquisition of substantially all of the operating assets of Tech Squared Inc.
("Tech") for approximately $3.2 million in cash and the assumption of certain
liabilities.
Tech sells microcomputer hardware and software products. Tech's target markets
are (i) desktop publishing, graphic arts and pre-press industries, (ii) computer
dealers and value-added resellers and (iii) developers of internal corporate
intranet and external Internet sites and managers of local area networks and
wide area networks. At December 31, 1998, Tech consisted of an operating
division (which was acquired by the Company), investments in mining properties
and assets, and an investment in Digital River, Inc. common stock.
Concurrent with the Company's December 1999 acquisition of Tech, Tech
distributed the shares of Digital River, Inc. stock to the Tech shareholders.
Tech previously distributed its investment in mining properties and assets in
May 1999.
The following unaudited pro forma combined condensed balance sheet as of October
31, 1999 and statements of operations for the year ended January 31, 1999, and
for the nine months ended October 31, 1999, give effect to the acquisition of
substantially all of the operating assets of Tech by the Company using the
purchase method of accounting. The unaudited pro forma combined condensed
financial statements combine the historical consolidated balance sheet and
statement of operations of the Company and the historical balance sheet and
statement of operations of Tech (collectively "the Entities"). The unaudited
pro forma combined condensed balance sheet as of October 31, 1999, assumes the
acquisition occurred as of October 31, 1999. The unaudited pro forma combined
condensed statements of operations for the year ended January 31, 1999 and for
the nine months ended October 31, 1999, assume the acquisition occurred
effective February 1, 1998. The unaudited pro forma combined condensed financial
statements give effect to (i) the acquisition of Tech, (ii) the payment of $3.2
million in cash in connection with the acquisition of the operating assets of
Tech, and (iii) other adjustments to eliminate certain assets and liabilities
(primarily the investments in Digital River, Inc. and the mining properties and
assets) which were not acquired.
The unaudited pro forma combined condensed financial statements are not
necessarily indicative of the financial position or results of operations of the
Company as they may be in the future or as they might have been for the periods
presented had the acquisition occurred effective February 1, 1998 or as of the
date of the unaudited pro forma combined condensed balance sheet. The unaudited
pro forma combined condensed financial statements and accompanying notes should
be read in conjunction with the historical financial statements of Virtual
Technology Corporation, as filed on Form 10-K for the year ended January 31,
1999 and on Form 10-Q for the nine month period ended October 31, 1999, and the
historical financial statements of Tech Squared Inc., including the notes to
such financial statements, as of December 31, 1998 and for the year then ended,
and as of September 30, 1999 and for the nine month period then ended, as set
forth in this Form 8-K/A.
The pro forma adjustments are based upon information available at this time and
upon certain assumptions that the Company's management believes are reasonable
in the circumstances. However, the actual allocation of purchase price and the
resulting effect on operations may differ significantly from the pro forma
amounts included herein. Consequently, the amounts reflected in the unaudited
pro forma combined condensed financial statements are subject to change, and the
final amounts may differ substantially.
3
<PAGE> 4
VIRTUAL TECHNOLOGY CORPORATION
Unaudited Pro Forma Combined Condensed Balance Sheet
October 31, 1999
<TABLE>
<CAPTION>
Historical Pro Forma
---------------------------------- -----------------------------
Virtual Tech
Technology Squared,
Corporation Inc.
ASSETS (1) (2) Adjustments Adjusted
------------- -------------- ------------ ------------
<S> <C> <C> <C> <C>
CURRENT ASSETS
Cash and cash equivalents $ 625,049 $ 1,433,117 $ (1,433,117)(3) $ 625,049
Accounts receivable, net 8,703,019 3,325,666 12,028,685
Inventories, net 3,131,474 1,538,431 4,669,905
Other current assets 2,907,587 660,451 (247,434)(3) 3,320,604
------------ ----------- ------------ ------------
TOTAL CURRENT ASSETS 15,367,129 6,957,665 (1,680,551) 20,644,243
------------ ----------- ------------ ------------
EQUIPMENT, net 628,028 458,474 1,086,502
------------ ----------- ------------ ------------
INVESTMENT IN DIGITAL RIVER - 65,250,000 (65,250,000)(3) -
------------ ----------- ------------ ------------
OTHER ASSETS
Deferred consulting costs 862,986 - 862,986
Prepaid consulting services 2,499,208 - 2,499,208
Other 178,984 - 178,984
------------ ----------- ------------ ------------
TOTAL OTHER ASSETS 3,541,178 - 3,541,178
INTANGIBLE ASSETS, net 8,321,887 - 1,200,000 (5) 9,521,887
------------ ----------- ------------ ------------
11,863,065 - 1,200,000 13,063,065
============ =========== ============ ============
$ 27,858,222 $72,666,139 $(65,730,551) $ 34,793,810
============ =========== ============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 8,068,228 $ 3,518,947 $ (335,570)(3) $ 11,251,605
Accrued expenses and other accrued liabilities 4,319,678 1,047,274 (697,421)(3)
200,000 (5) 4,869,531
Notes payable 800,970 - 800,970
Line of credit 5,748,122 337,375 2,146,465 (4)
(337,375)(3) 7,894,587
Current amount of capital lease obligations 11,296 - 11,296
------------ ----------- ------------ ------------
TOTAL CURRENT LIABILITIES 18,948,294 4,903,596 976,099 24,827,989
------------ ----------- ------------ ------------
OTHER LIABILITIES
Capital lease obligations, net of current amount 40,794 - 40,794
Notes payable - long term 250,000 - 250,000
Loans from related parties 30,000 - 30,000
Deferred income taxes - 24,470,000 (24,470,000)(3) -
------------ ----------- ------------ ------------
320,794 24,470,000 (24,470,000) 320,794
------------ ----------- ------------ ------------
STOCKHOLDERS' EQUITY (DEFICIT)
Common stock, $.001 par value; 100,000,000
shares authorized; shares issued and outstanding,
30,538,680 30,539 - 1,056 (4) 31,595
Additional paid in capital 33,930,261 6,945,599 1,054,837 (4)
(6,945,599)(3) 34,985,098
Stock subscription receivable (925,000) (725,000) 725,000 (3) (925,000)
Accumulated deficit $(24,446,666) (879,228) 879,228 (3) (24,446,666)
Unrealized gain on available-for-sale securities - 37,951,172 (37,951,172)(3) -
------------ ----------- ------------ ------------
8,589,134 43,292,543 (42,236,650) 9,645,027
----------- ----------- ------------ ------------
$ 27,858,222 $72,666,139 $(65,730,551) $ 34,793,810
============ =========== ============ ============
</TABLE>
See accompanying notes to unaudited pro forma combined condensed financial
statements
4
<PAGE> 5
VIRTUAL TECHNOLOGY CORPORATION
Notes to Unaudited Pro Forma Combined Condensed Balance Sheet
(1) Reflects the historical balance sheet of Virtual Technology Corporation as
derived from the Company's unaudited balance sheet as of October 31, 1999
as filed on Form 10-Q.
(2) Reflects the historical balance sheet of Tech Squared Inc. as derived from
Tech's unaudited balance sheet as of September 30, 1999 as filed on
Form 10-Q.
(3) To eliminate assets, liabilities and equity of Tech which were not
acquired. The table below is a summary of these items:
<TABLE>
<S> <C>
Cash $ 1,433,117
Other current assets 247,734
Investment in Digital River Inc. 65,250,000
Accounts payable (335,570)
Accrued expenses (697,421)
Line of credit (337,375)
Deferred income taxes (24,470,000)
Paid in capital (6,945,599)
Stock subscription receivable 725,000
Accumulated deficit 879,228
Unrealized gain on available for sale securities (37,951,172)
------------
Net liabilities not acquired $ (2,202,358)
============
</TABLE>
(4) To recognize the $3.2 million cash paid to acquire Tech. The cash was
obtained by selling 1,055,893 shares of the Company's common stock at $1.00
per share, and the borrowing of $2,146,465 under the Company's revolving
line of credit. The revolving line of credit expires on March 31, 2003.
(5) To record the allocation of the excess of the purchase price over the
estimated fair value of the Tech assets acquired.
The table below is a summary of the purchase price and the preliminary
allocation of the purchase price to the assets acquired and the liabilities
assumed:
<TABLE>
<S> <C>
Cash $3,202,358
Tech liabilities assumed 3,533,230
Estimated direct acquisition costs 200,000
----------
Total purchase price $6,935,588
==========
Estimated fair value of tangible assets
acquired (approximates recorded book value):
Accounts receivable $3,325,666
Inventory 1,538,431
Other current assets 413,017
Equipment 458,474
----------
$5,735,588
==========
Purchase price in excess of the estimated fair
value of assets acquired $1,200,000
==========
</TABLE>
The Company has preliminarily allocated the excess of the purchase price
over the fair value of the tangible assets acquired to the following
identifiable intangible assets:
<TABLE>
<CAPTION>
Estimated Useful
Description Amount Life (Years)
----------- -------- ----------------
<S> <C> <C>
Customer list $ 690,000 5
Stable workforce 225,000 4
Domain names 130,000 7
Trade names 155,000 7
----------
$1,200,000
==========
</TABLE>
5
<PAGE> 6
VIRTUAL TECHNOLOGY CORPORATION
Unaudited Pro Forma Combined Condensed Statement of Operations
Nine Months Ended October 31, 1999
<TABLE>
<CAPTION>
Historical Pro Forma
------------------------------ -----------------------------
Virtual Tech
Technology Squared,
Corporation Inc.
(1) (2) Adjustments Adjusted
------------ ----------- ----------- ------------
<S> <C> <C> <C> <C>
NET SALES $ 53,966,489 $33,166,578 $ 87,133,067
COST OF SALES 50,189,221 29,267,366 79,456,587
------------ ----------- ----------- ------------
GROSS PROFIT 3,777,268 3,899,212 7,676,480
OPERATING EXPENSES
Sales and marketing 4,908,994 1,899,125 $ 6,808,119
General and administrative 5,328,294 5,631,139 10,959,433
Consulting services 8,092,363 - 8,092,363
Amortization of intangibles 698,477 - $ 176,223 (9) 874,700
------------ ----------- ----------- ------------
19,028,128 7,530,264 176,223 26,734,615
------------ ----------- ----------- ------------
LOSS FROM OPERATIONS (15,250,860) (3,631,052) (176,223) (19,058,135)
OTHER INCOME (EXPENSE)
Interest income (expense), net (1,264,327) 52,834 (156,530)(6) (1,368,023)
Investment income - 2,048 2,048
Loss on mining assets - (145,947) 145,947 (3) -
Other expense (205,809) - (205,809)
------------ ----------- ----------- ------------
(1,470,136) (91,065) (10,583) (1,571,784)
------------ ----------- ----------- ------------
NET LOSS (16,720,996) (3,722,117) (186,806) (20,629,919)
PREFERRED STOCK DIVIDENDS - (51,456) 51,456 (7) -
------------ ----------- ----------- ------------
NET LOSS APPLICABLE
TO COMMON SHARES $(16,720,996) $ (3,773,573) $ (135,350) $(20,629,919)
============ ============ =========== ============
NET LOSS PER COMMON SHARE
- BASIC AND DILUTED $ (0.58) $ (0.69)
============ ============
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING - BASIC AND DILUTED 28,691,364 1,055,893 (10) 29,747,257
</TABLE>
See accompanying notes to unaudited pro forma combined condensed financial
statements
6
<PAGE> 7
VIRTUAL TECHNOLOGY CORPORATION
Unaudited Pro Forma Combined Condensed Statement of Operations
Year Ended January 31, 1999
<TABLE>
<CAPTION>
Historical Pro Forma
----------------------------- ---------------------------------
Virtual Tech
Technology Squared,
Corporation Inc.
(1) (2) Adjustments Adjusted
----------- ----------- ----------- -----------
<S> <C> <C> <C>
NET SALES $ 4,945,907 $38,800,270 $43,746,177
COST OF SALES 4,769,313 33,829,265 38,598,578
----------- ----------- ----------- -----------
GROSS PROFIT 176,594 4,971,005 5,147,599
OPERATING EXPENSES
Sales and marketing 1,792,238 3,101,205 4,893,443
General and Administrative 2,727,937 2,734,190 5,462,127
Amortization of intangibles - - 234,964 (9) 234,964
----------- ----------- ----------- -----------
4,520,175 5,835,395 234,964 10,590,534
----------- ----------- ----------- -----------
LOSS FROM OPERATIONS (4,343,581) (864,390) (234,964) (5,442,935)
OTHER INCOME (EXPENSE)
Interest expense (79,618) (96,677) (209,280)(6) (385,575)
Gain (loss) on sale of securities - 3,780,872 (4,048,000)(5) (267,128)
Equity in loss from
Digital River - (1,829,207) 1,829,207 (4) -
Loss on mining assets - (538,276) 538,276 (3) -
Other 66,111 - - 66,111
----------- ----------- ----------- -----------
(13,507) 1,316,712 (1,889,797) (586,592)
----------- ----------- ----------- -----------
Income (loss) before
income taxes (4,357,088) 452,322 (2,124,761) (6,029,527)
PROVISION FOR INCOME TAXES - 988,000 (988,000)(8) -
----------- ----------- ----------- -----------
NET LOSS (4,357,088) (535,678) (1,136,761) (6,029,527)
PREFERRED STOCK DIVIDENDS - (31,045) 31,045 (7) -
----------- ----------- ----------- -----------
NET LOSS APPLICABLE
TO COMMON SHARES $(4,357,088) $ (566,723) $(1,105,716) $(6,029,527)
=========== =========== =========== ===========
NET LOSS PER COMMON SHARE - BASIC $ (0.26) $ (0.34)
=========== ===========
WEIGHTED AVERAGE COMMON SHARES 16,958,284 1,055,893 (10) 18,014,177
OUTSTANDING
</TABLE>
See accompanying notes to unaudited pro forma combined condensed financial
statements
7
<PAGE> 8
VIRTUAL TECHNOLOGY CORPORATION
Notes to Unaudited Pro Forma Combined Condensed Statements of Operations
(1) Reflects the historical statement of operations of Virtual Technology
Corporation as derived from the Company's unaudited statement of operations
for the nine months ended October 31, 1999 as filed on Form 10-Q, or the
statement of operations for the year ended January 31, 1999 as filed on
Form 10-K.
(2) Reflects the historical statement of operations of Tech Squared Inc. as
derived from Tech's unaudited statement of operations for the nine months
ended September 30, 1999 as filed on Form 10-Q, or the statement of
operations for the year ended December 31, 1998 as filed on Form 10-K.
(3) To eliminate the losses on Tech's mining properties and assets of $145,947
for the nine-month period ended September 30, 1999 and $538,276 for the
year ended December 31, 1998. The Company did not acquire Tech's investment
in these mining assets.
(4) To eliminate the $1,829,207 loss recognized by Tech resulting from the
equity method of accounting applied to Tech's common stock investment in
Digital River Inc. Virtual Technology Corporation did not acquire Tech's
investment in Digital River Inc.
(5) To eliminate Tech's gain on sale of Digital River Inc. common stock of
$4,048,000.
(6) To record interest, at an assumed rate of 9.75%, on borrowings of
$2,146,465 under the Company's revolving line of credit used to complete
the acquisition of Tech Squared Inc. Additional interest expense was
$156,310 for the nine months ended October 31, 1999 and $209,280 for the
year ended January 31, 1999.
(7) To eliminate Tech's redeemable preferred stock dividends of $51,456 for the
nine months ended September 30, 1999 and $31,045 for the year ended
December 31, 1998.
(8) To eliminate Tech's provision for income taxes of $988,000 for the year
ended December 31, 1998. The tax provision resulted from Tech's gain on the
sale of Digital River Inc. common stock. (See Note (5), above.)
(9) To record amortization expense based upon the preliminary allocation of the
purchase price and the amount of identifiable intangible assets.
(10) To reflect the sale of 1,055,893 shares of common stock to fund a portion
of the purchase price.
8
<PAGE> 9
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Tech Squared Inc.:
We have audited the accompanying consolidated balance sheets of Tech Squared
Inc. (a Minnesota corporation) and Subsidiaries as of December 31, 1998 and
1997, and the related consolidated statements of operations, comprehensive
income (loss), stockholders' equity and cash flows for each of the three years
in the period ended December 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Tech Squared Inc. and
Subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Minneapolis, Minnesota,
February 19, 1999
9
<PAGE> 10
TECH SQUARED INC. AND SUBSIDIARIES
Consolidated Balance Sheets
As of December 31
<TABLE>
<CAPTION>
1998 1997
------------- -------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 4,436,276 $ 300
Restricted cash 229,466 143,623
Available-for-sale securities -- 467,438
Trade accounts receivable, less allowance
for doubtful accounts of $365,000 and $180,000, respectively 3,387,907 2,727,883
Inventories 1,783,905 1,890,480
Prepaids and other current assets 416,666 234,936
------------- -------------
Total current assets 10,254,220 5,464,660
Property and Equipment, net 499,874 346,419
Receivable From Officer/Stockholder -- 201,512
Mining Assets 190,000 748,276
Investment in Digital River 106,500,000 839,202
------------- -------------
$ 117,444,094 $ 7,600,069
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Revolving line of credit $ 7,395 $ 765,728
Current maturities of long-term debt 15,000 80,000
Accounts payable 5,008,449 2,816,959
Accrued compensation and benefits 205,156 239,748
Other accrued expenses 1,404,776 791,743
Dividend payable to officer/shareholder 200,000 200,721
------------- -------------
Total current liabilities 6,840,776 4,894,899
Dividend Payable to Officer/Shareholder 83,857 283,136
Long-Term Debt, less current maturities -- 15,000
Deferred Income Taxes 39,815,000 --
Redeemable Preferred Stock, 12% cumulative convertible, $1 par value,
1,000,000 shares authorized; 160,000 shares issued and outstanding 247,744 216,700
------------- -------------
Commitments and Contingencies (Note 7)
Stockholders' Equity:
Common stock, no par value, 25,000,000 shares authorized; 11,603,075 and
10,375,037 shares issued and outstanding, respectively 3,990,200 3,189,436
Stock subscription receivable (284,000) --
Retained earnings (accumulated deficit) 2,894,345 (912,539)
Unrealized gain (loss) on available-for-sale securities 63,856,172 (86,563)
------------- -------------
Total stockholders' equity 70,456,717 2,190,334
------------- -------------
$ 117,444,094 $ 7,600,069
============= =============
</TABLE>
The accompanying notes are an integral part of these consolidated balance sheets
10
<PAGE> 11
TECH SQUARED INC. AND SUBSIDIARIES
Consolidated Statements of Operations
For the Years Ended December 31
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Net sales $38,800,270 $36,995,277 $37,386,715
Cost of sales 33,829,265 32,527,878 33,475,525
----------- ----------- -----------
Gross profit 4,971,005 4,467,399 3,911,190
----------- ----------- -----------
Selling and marketing expenses 3,101,205 1,882,729 2,083,961
General and administrative expenses 2,734,190 2,182,458 2,676,190
----------- ----------- -----------
Total operating expenses 5,835,395 4,065,187 4,760,151
----------- ----------- -----------
Income (loss) from operations (864,390) 402,212 (848,961)
Gain on sale of securities 3,780,872 26,646 -
Loss on mining assets (538,276) - -
Interest expense, net (96,677) (85,078) (43,068)
Equity in loss from Digital River (1,829,207) (1,356,370) -
----------- ----------- -----------
Income (loss) before income taxes and
minority interest in losses of Digital
River 452,322 (1,012,590) (892,029)
Provision for income taxes 988,000 - -
----------- ----------- -----------
Loss before minority interest (535,678) (1,012,590) (892,029)
Minority interest in losses of Digital River - - 275,634
----------- ----------- -----------
Net loss (535,678) (1,012,590) (616,395)
Preferred stock dividends 31,045 19,200 35,000
----------- ----------- -----------
Net loss applicable to common shares
$ (566,723) $(1,031,790) $ (651,395)
=========== =========== ===========
Net loss per common share, basic and diluted $ (.05) $ (.10) $ (.06)
=========== =========== ===========
Weighted average common shares outstanding, basic and
diluted 11,050,724 10,374,870 10,374,870
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
11
<PAGE> 12
TECH SQUARED INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income (Loss)
For the Years Ended December 31
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ----------
<S> <C> <C> <C>
Net loss $ (535,678) $(1,012,590) $(616,395)
------------ ------------ ----------
Other comprehensive income, net of tax:
Unrealized gains (losses) on securities-
Unrealized holding gains (losses) arising during the year 67,723,607 (199,917) (260,000)
Less- Reclassification adjustment for gains included in
net loss (3,780,872) (26,646) -
------------ ------------ ----------
Other comprehensive income (loss) 63,942,735 (226,563) (260,000)
------------ ------------ ----------
Comprehensive income (loss) $63,407,057 $(1,239,153) $(876,395)
============ ============ ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
12
<PAGE> 13
TECH SQUARED INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
For the Years Ended December 31
<TABLE>
<CAPTION>
Common Stock
------------------------- Stock
Subscription
Shares Amount Receivable
---------- ------------ -------------
<S> <C> <C> <C>
Balance, December 31, 1995 10,374,870 $ 3,302,066 $ --
Net loss -- -- --
Payment for shares to effect Jaguar Group, Ltd. merger
-- (193,485) --
Preferred stock dividends -- -- --
Final allocation of purchase price to effect Jaguar Group,
Ltd. merger -- 80,522 --
Net change in unrealized loss on available-for-sale securities
-- -- --
---------- ------------ -------------
Balance, December 31, 1996 10,374,870 3,189,103 --
Net loss -- -- --
Gain on sale of stock by Digital River -- -- --
Preferred stock dividends -- -- --
Warrants exercised 167 333 --
Net change in unrealized loss on available-for-sale securities -- -- --
---------- ------------ -------------
Balance, December 31, 1997 10,375,037 3,189,436 --
Net loss -- -- --
Preferred stock dividends -- -- --
Payment for options exercised 1,228,038 800,764 (284,000)
Gain on sale of stock by Digital River -- -- --
Net change in unrealized gain on available-for-sale securities -- -- --
---------- ------------ -------------
Balance, December 31, 1998 11,603,075 $ 3,990,200 $ (284,000)
========== ============ =============
<CAPTION>
Retained
Earnings Unrealized
(Accumulated Gain (Loss) on
Deficit) Securities Total
------------ ------------ -------------
Balance, December 31, 1995 $ (1,463,569) $ 400,000 $ 2,238,497
Net loss (616,395) -- (616,395)
Payment for shares to effect Jaguar Group, Ltd. merger
-- -- (193,485)
Preferred stock dividends (35,000) -- (35,000)
Final allocation of purchase price to effect Jaguar Group,
Ltd. merger -- -- 80,522
Net change in unrealized loss on available-for-sale securities -- (260,000) (260,000)
------------ ------------ -------------
Balance, December 31, 1996 (2,114,964) 140,000 1,214,139
Net loss (1,012,590) -- (1,012,590)
Gain on sale of stock by Digital River 2,234,215 -- 2,234,215
Preferred stock dividends (19,200) -- (19,200)
Warrants exercised -- -- 333
Net change in unrealized loss on available-for-sale securities -- (226,563) (226,563)
------------ ------------ -------------
Balance, December 31, 1997 (912,539) (86,563) 2,190,334
Net loss (535,678) -- (535,678)
Preferred stock dividends (31,045) -- (31,045)
Payment for options exercised -- -- 516,764
Gain on sale of stock by Digital River 4,373,607 -- 4,373,607
Net change in unrealized gain on available-for-sale securities -- 63,942,735 63,942,735
------------ ------------ -------------
Balance, December 31, 1998 $ 2,894,345 $ 63,856,172 $ 70,456,717
============ ============ =============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
13
<PAGE> 14
TECH SQUARED INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Years Ended December 31
<TABLE>
<CAPTION>
1998 1997 1996
----------- ------------ -----------
<S> <C> <C> <C>
Operating Activities:
Net loss $ (535,678) $(1,012,590) $ (616,395)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities-
Depreciation and amortization 174,931 191,737 244,599
Equity in losses of Digital River 1,829,207 1,356,370 -
Gain on sale of securities (3,780,872) (26,646) -
Minority interest in Digital River - - (275,634)
Loss on mining assets 538,276 - -
Change in operating assets and liabilities:
Trade accounts receivable (660,024) 151,317 (573,104)
Inventories 106,575 16,066 1,612,822
Prepaids and other current assets (181,730) 110,787 173,297
Accounts payable 2,191,490 (1,457,016) (511,199)
Accrued compensation and benefits (34,592) 52,098 44,804
Other accrued expenses 730,033 280,090 (32,865)
----------- ------------ -----------
Net cash provided by (used in) operating activities 377,616 (337,787) 66,325
----------- ------------ -----------
Investing Activities:
Change in restricted cash (85,843) (143,623) -
Purchase of property and equipment (345,012) (168,016) (244,047)
Patents and organization costs - - (27,964)
Proceeds from sale of securities 4,709,272 272,646 -
Proceeds from sale of mining assets 20,000 - -
Decrease in cash due to deconsolidation of Digital River - (799,721) -
Change in officer/stockholder receivable 201,512 - 4,288
----------- ------------ -----------
Net cash provided by (used in) investing activities 4,499,929 (838,714) (267,723)
----------- ------------ -----------
Financing Activities:
Net borrowings (payments) on revolving line of credit (758,333) 486,363 (377,277)
Issuance of common stock, net 516,764 - -
Stock repurchase - - (37,500)
Dividends paid (200,000) (208,120) (200,730)
Proceeds from issuance of Digital River long-term debt, net - - 848,093
----------- ------------ -----------
Net cash provided by (used in) financing activities (441,569) 278,243 232,586
----------- ------------ -----------
Increase (decrease) in cash and cash equivalents 4,435,976 (898,258) 31,188
Cash and cash equivalents, beginning of year 300 898,558 867,370
----------- ------------ -----------
Cash and cash equivalents, end of year $4,436,276 $ 300 $ 898,558
----------- ------------ -----------
Supplemental cash flow information:
Cash paid for interest $ 112,770 $ 93,970 $ 50,375
Cash paid for income taxes - - -
Noncash Financing Activities:
Dividends accrued 31,045 19,200 35,000
Noncash repurchase of shares - - 178,485
Stock subscription receivable 284,000 - -
Decrease in various accounts upon deconsolidation of Digital River:
Prepaids and other current assets - (8,934) -
Property and equipment - (106,617) -
Debt issuance costs - (147,413) -
Patents and organization costs - (133,488) -
Convertible debentures - (998,750) -
Accounts payable - (142,445) -
Other accrued liabilities - (93,621) -
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
14
<PAGE> 15
TECH SQUARED INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES:
BUSINESS AND OPERATIONS
Tech Squared Inc. and its wholly owned subsidiaries (the Company) is a national
direct marketer and distributor of microcomputer hardware and software products
primarily for users of Apple Macintosh(R) personal computers and IBM-compatible
personal computers. The Company's sales and marketing efforts are currently
targeted at desktop publishing, graphic arts and prepress industries through its
catalog, "DTP Direct," to computer dealers and value-added resellers through its
distribution business, and to developers of internal corporate intranet and
external Internet sites and managers of local area networks and wide area
networks through its "Net Direct" catalog.
Prior to January 1, 1997, the consolidated financial statements included the
accounts of the Company and Digital River, Inc. (Digital River), an on-line
distributor of software products via the Internet. In December 1995, the Company
obtained a bargain purchase option to acquire 3,200,000 shares of Digital River
common stock from the Company's majority stockholder and Chairman, representing
at the time a 60% ownership in Digital River. The option is not transferable and
is exercisable at any time through December 31, 2000 for a total exercise price
of $1. During 1997, Digital River converted all of its outstanding debentures
and issued additional common stock pursuant to private placements which reduced
the Company's effective control from 60% at December 31, 1996 to approximately
35% at December 31, 1997. As a result of the reduction in the Company's
ownership percentage, the financial results of Digital River are no longer
consolidated with those of the Company. Beginning January 1, 1997, the Company
accounted for its investment in Digital River using the equity method of
accounting. Digital River sold additional shares of common stock in 1998 through
private placements and its initial public offering of common stock. The
following amounts were recorded as credits to retained earnings in the
accompanying statement of stockholders' equity as a result of the 1997 and 1998
sales of stock by Digital River:
<TABLE>
<CAPTION>
Year Ended December 31
-------------------------
1998 1997
---------- ----------
<S> <C> <C>
Increase to investment in Digital River $6,964,607 $2,234,215
Deferred income taxes 2,591,000 -
---------- ----------
Gain on sale $4,373,607 $2,234,215
========== ==========
</TABLE>
On August 11, 1998, Digital River completed an initial public offering of
3,000,000 shares of common stock. This caused the Company's ownership to
decrease to approximately 19%. As of August 12, 1998, the Company began
accounting for its investment in Digital River as an available-for-sale security
in accordance with Statement of Financial Accounting Standards (SFAS) No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," which is
valued at $35.50 per share, the closing market price at December 31, 1998. In
December 1998, the Company participated in Digital River's follow-up offering by
selling 200,000 shares, further reducing the Company's ownership to
approximately 15% as of December 31, 1998.
15
<PAGE> 16
Digital River had total assets of $80,328,000 and $3,405,000 as of December 31,
1998 and 1997, respectively. For the years ended December 31, 1998, 1997 and
1996, Digital River recorded a net loss of $13,798,000, $3,485,000 and $689,000
on net sales of $20,911,000, $2,472,000 and $111,000, respectively.
Digital River currently occupies approximately 7,000 square feet of warehouse
space at the Company's corporate headquarters. Prior to August 1998, the offices
of Digital River were also located in the Company's facilities. The Company
bills Digital River for the leased space, and prior to 1999, certain related
costs such as direct labor costs, phone services, general liability insurance
and janitorial services through an administrative charge. Total charges by the
Company to Digital River for administrative expenses were approximately
$207,000, $160,000 and $82,000 in 1998, 1997 and 1996, respectively.
During 1997, the Company began performing fulfillment services for Digital River
on physical shipments of products, for which Digital River pays the Company a
fulfillment fee. The Company billed Digital River $246,000 and $8,000 for these
services in 1998 and 1997, respectively.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with original
maturities of three months or less to be cash equivalents. Cash equivalents are
carried at cost, which approximates market value.
RESTRICTED CASH
Restricted cash represents amounts held in escrow by certain financial service
providers.
INVENTORIES
Inventories, consisting primarily of products held for resale, are stated at the
lower of cost or market, as determined by the first-in, first-out inventory
method.
PROPERTY AND EQUIPMENT
Property and equipment, consisting of furniture, equipment and leasehold
improvements, are stated at cost. For financial reporting purposes, depreciation
is computed using the straight-line method over the estimated useful lives of
the assets, generally five years, or for leasehold improvements, over the length
of the lease.
Property and equipment consisted of the following at December 31:
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Furniture and equipment $1,551,112 $1,224,304
Leasehold improvements 159,134 140,929
---------- ----------
1,710,246 1,365,233
Less- Accumulated depreciation
and amortization (1,210,372) (1,018,814)
---------- ----------
$ 499,874 $ 346,419
========== ==========
</TABLE>
16
<PAGE> 17
REVENUE RECOGNITION
Revenue from product sales is recognized upon shipment to the customer. Certain
product sales to end users are made pursuant to a 30-day cash back refund
policy. A reserve for returns is established based on historical trends.
ADVERTISING COSTS
Advertising costs related to mailed direct-response advertising are deferred and
charged to expense over the period during which the related sales are expected
to occur. The cost of nondirect-response advertising is charged to expense the
first time the advertising takes place. The Company uses an accelerated
amortization schedule for its "DTP Direct" catalog whereby approximately 90% of
the costs are amortized in the first four months and fully amortized by the
sixth month. Direct-response-related advertising expense was $1,000,000,
$371,000 and $491,000 in 1998, 1997 and 1996, respectively.
INCOME TAXES
Deferred income tax assets and liabilities are determined based on the
differences between the financial statement and tax bases of assets and
liabilities using currently enacted tax rates in effect for the years in which
the differences are expected to reverse. Valuation allowances are established
when necessary to reduce deferred tax assets to amounts expected to be realized.
NET LOSS PER COMMON SHARE
Basic loss per common share is computed by dividing net loss applicable to
common shares by the weighted average number of shares of common stock
outstanding during the year. The computation of diluted earnings per common
share is similar to the computation of basic loss per common share, except that
the denominator is increased for the assumed conversion of convertible
securities and the exercise of dilutive options using the treasury stock method.
The shares used in computing basic and diluted earnings per share were the same
for the years ended December 31, 1998, 1997 and 1996. Options and warrants
totaling 4,452,974, 5,661,484 and 6,201,958 were excluded from dilutive earnings
per share in 1998, 1997 and 1996, respectively, as their effect is antidilutive.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Ultimate results could differ from those estimates.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
The Company adopted SFAS No. 130, "Reporting Comprehensive Income," on January
1, 1998. SFAS No. 130 establishes standards for reporting and display in the
financial statements of net income and the components of all other nonowner
changes in equity, referred to as comprehensive income. The Company has elected
to present comprehensive income (loss) as a separate statement in the
accompanying consolidated financial statements.
The Company also adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," in 1998. SFAS No. 131 requires disclosure
of business and geographic segments in the consolidated financial statements of
the Company. The adoption of the disclosure requirements of SFAS
17
<PAGE> 18
No. 131 had no impact on the Company's consolidated financial statements as
there is only one reportable segment.
2. INVESTMENTS:
The Company acquired the following assets in a merger in 1995 that are not
related to its current operations or to its future operating plans.
CAM DESIGNS, INC.
Cam Designs, Inc. (Cam Designs), a Delaware corporation, is the parent company
of MGA Holdings Ltd., a United Kingdom corporation which designs, engineers and
prototypes tools for the automobile and aerospace industries. During 1998, the
Company sold a portion of its holdings of Cam Designs stock, resulting in
realized gains of approximately $5,000. In October 1998, Cam Designs announced
that its United Kingdom companies were placed in receivership because Cam
Designs could not secure adequate bank financing. Due to Cam Designs distressed
financial situation, the Company wrote off the balance of the Cam Designs stock
during 1998.
During 1997, the Company sold shares resulting in realized gains on sale of Cam
Designs common stock of $27,500, less commissions and fees. As part of a
settlement agreement, the Company is required to hold shares of Cam Design stock
with an escrow agent. The number of escrow shares will be adjusted downward and
released from escrow as payments, set forth in the agreement, are made. These
shares remain in escrow at December 31, 1998.
MINING ASSETS
The Company holds certain mining properties and rights in the Alder Gulch area
of the Virginia City Mining District in southwest Montana, and also near Rimini,
Montana. These properties and rights were obtained in a 1995 merger. In December
1998, the Company sold a portion of these assets and reduced the remaining
assets to the estimated fair value based upon an independent appraisal performed
on the properties.
3. REVOLVING LINE OF CREDIT AND LONG-TERM DEBT:
The Company has a revolving credit agreement with a bank which expires in June
1999. Borrowings under the $2,500,000 line are payable on demand, limited by
eligible percentages of accounts receivable and inventory, as defined, and bear
interest at the prime rate plus 1.75%. Borrowings under the agreement are
secured by substantially all the Company's assets. Borrowings on the line
averaged $751,000, $642,000 and $638,000 at average interest rates of 10.10%,
10.25% and 10.25% in 1998, 1997 and 1996, respectively.
Long-term debt consisted of the following at December 31:
<TABLE>
<CAPTION>
1998 1997
--------- ---------
<S> <C> <C>
Note payable, with interest at 7.5% $15,000 $95,000
Less- Current portion (15,000) (80,000)
--------- ---------
$ - $15,000
========= =========
</TABLE>
The Company has a flooring program with a financing company covering up to
$633,000 in inventory purchases. As of December 31, 1998, the flooring program
is secured by a standby letter of credit in the amount of $560,000 issued
pursuant to the Company's line of credit with the bank.
18
<PAGE> 19
4. INCOME TAXES:
As of December 31, 1998, the Company had net operating loss carryforwards
(NOL's) of approximately $2.0 million. Certain restrictions caused by the change
in ownership could limit annual utilization of the net operating loss
carryforwards. The NOL's expire in various years from 1999 to 2007. The Company
recorded a full valuation allowance in 1998 and 1997 due to the uncertainty
associated with the Company's ability to realize the benefits related to net
operating losses generated.
A reconciliation of the statutory federal income tax rate to the Company's
effective income tax rate is as follows for the years ended December 31:
<TABLE>
<CAPTION>
1998 1997 1996
------ -------- -------
<S> <C> <C> <C>
U.S. statutory rate 34.0% (34.0)% (34.0)%
State taxes, net of federal benefit 3.2 (3.2) (3.2)
Digital River net losses 181.2 49.7 20.0
Increase (decrease) in valuation allowance - (12.5) 17.2
----- ------- ------
Effective income tax rate 218.4% - % - %
===== ======= ======
</TABLE>
Significant components of the Company's deferred tax assets and liabilities are
as follows as of December 31:
<TABLE>
<CAPTION>
1998 1997
------------ ----------
<S> <C> <C>
Deferred tax assets:
Inventories $ 114,000 $ 159,000
Accrued expenses and reserves 292,000 184,000
Net operating loss carryforwards
and credits 853,000 999,000
Investments 664,000 684,000
------------ ----------
1,923,000 2,026,000
Deferred tax valuation allowance (1,183,000) (1,183,000)
------------ ----------
Total deferred tax assets 740,000 843,000
------------ ----------
Deferred tax liabilities:
Depreciation and other (106,000) (12,000)
Investment in Digital River (40,449,000) (831,000)
------------ ----------
Total deferred tax liabilities (40,555,000) (843,000)
------------ ----------
Net deferred tax liability $(39,815,000) $ -
============ ==========
</TABLE>
5. STOCK OPTIONS AND WARRANTS:
MACUSA PLAN
In 1995, the Company's stockholders approved the MacUSA 1995 Stock Option Plan
(the MacUSA Plan), reserving and granting options for 2,870,016 shares of the
Company's common stock. Options granted under the MacUSA Plan have been granted
at the current market price on the date of grant. Such options generally vest
six years from the date of grant and may vest earlier in the event certain
targeted net income is achieved. At December 31, 1998, 199,996 of these options
remain outstanding.
19
<PAGE> 20
TECH SQUARED INC. 1995 STOCK OPTION PLAN
In December 1995, the Company's board of directors approved the Tech Squared
Inc. 1995 Stock Option Plan (the 1995 Plan) and reserved 2,500,000 shares for
future grant. In July 1997, the Company's board of directors approved an
increase to the maximum number of shares available for grant under the 1995 Plan
to 4,000,000 shares, subject to shareholder approval. Options granted under the
1995 Plan are granted at not less than the current market price on the date of
grant, cannot remain outstanding for over ten years and generally become
exercisable over a period of four years. Options outstanding under the 1995 Plan
totaled 2,642,000, 3,600,500 and 2,425,000 in 1998, 1997 and 1996, respectively.
As of December 31, 1998, 373,857 options in the Plan remain to be granted.
1995 NON-EMPLOYEE DIRECTOR OPTION PLAN
Also in December 1995, the Company's board of directors approved the Tech
Squared Inc. 1995 Non-Employee Director Option Plan (the Plan), reserving
350,000 shares of stock for future grant. The Plan allows each director to be
granted options for up to 60,000 shares, exercisable at the share price on the
date of issuance. These options vest over a two-year period and remain
exercisable for a period of seven years. Of previously granted shares, 140,000
remain outstanding pursuant to the Plan as of December 31, 1998.
A summary of the Company's various stock option plans at year-end, with changes
during the year then ended, is as follows (see Note 8):
<TABLE>
<CAPTION>
1998 1997 1996
--------------------- ------------------------ ---------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
---------- --------- ---------- -------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Outstanding, beginning
of year 5,661,484 $ 0.89 6,201,958 $ 1.18 6,974,468 $ 1.27
Granted 1,561,500 1.54 1,354,000 0.75 1,602,500 0.75
Exercised (1,228,038) 0.78 -- -- -- --
Forfeited/
canceled (1,541,972) 1.08 (1,894,474) 1.72 (2,375,010) 0.75
---------- ------- ---------- -------- --------- --------
Outstanding,
end of year 4,452,974 $ 1.06 5,661,484 $ .89 6,201,958 $ 1.18
========== ======= ========== ======== ========= ========
Exercisable,
end of year 2,784,838 $ 0.83 2,002,366 $ .99 3,066,958 $ 1.51
========== ======= ========== ======== ========= ========
Weighted average fair
value of employee
options granted
$ 1.54 $ .50 $ .22
======== ======== ========
</TABLE>
20
<PAGE> 21
The Company accounts for these plans under Accounting Principles Board Opinion
No. 25, under which no compensation cost has been recognized. Had compensation
cost for these plans been determined consistent with SFAS No. 123, "Accounting
for Stock-Based Compensation," the Company's net loss and net loss per share
would have been increased to the following pro forma amounts:
<TABLE>
<CAPTION>
1998 1997 1996
----------- ------------ ----------
<S> <C> <C> <C>
Net loss:
As reported $ (535,678) $(1,012,590) $(616,395)
Pro forma (2,425,937) (1,453,394) (884,399)
Basic and diluted loss per share:
As reported $ (.05) $ (.10) $ (.06)
Pro forma (.22) (.14) (.09)
</TABLE>
Because the SFAS No. 123 method of accounting has not been applied to options
granted prior to January 1, 1995, the resulting pro forma compensation cost may
not be representative of that to be expected in future years.
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions used for employee option grants: risk-free interest rate from 4.22%
to 5.50% in 1998, 6.11% in 1997 and 6% in 1996; no expected dividend yield;
expected lives of five years; and expected volatility of 162% to 195% in 1998,
and 206% in 1997. No volatility was used for 1996 as trading was limited.
6. STOCKHOLDERS' EQUITY:
The Company's redeemable preferred stock carries a 12% cumulative dividend
payable quarterly, is convertible into common stock at any time for $12.50 per
share, carries a preference on liquidation or dissolution of the Company, and
has equal voting rights with the Company's outstanding common stock. The
preferred shares are callable by the Company at any time with 60 days' written
notice, and all outstanding shares must be redeemed by 2002. The Company has no
obligation to redeem the preferred stock prior to 2002. In 1996, the Company
redeemed 25,000 shares of preferred stock for total consideration of $22,500.
The dividend payable to officer/shareholder is evidenced primarily by a note
payable to the Company's majority stockholder and Chairman. The Company paid
approximately $200,000 of this dividend during 1998 and approximately $200,000
in 1997. The note is noninterest-bearing, due on demand and subordinated to the
revolving line of credit. Pursuant to the debt subordination agreement, the
Company can only make payments up to $200,000 in a calendar year.
STOCK SUBSCRIPTION RECEIVABLE
The Company advanced $469,500 to an employee which was used to purchase shares
of common stock. The balance is due in full by September 2000. During 1998, the
employee repaid $185,500 of the loan, and 142,000 shares of common stock are
held by the Company as collateral on the note at December 31, 1998.
WARRANTS
In 1995, the Company granted a warrant to purchase 150,000 shares of stock for
$1.00 per share as compensation for investment banking services and a warrant to
purchase 50,000 shares for $1.00 per share as partial settlement of a note
payable. Both warrants were exercised in 1998.
21
<PAGE> 22
In connection with a 1995 merger, the Company acquired the Jaguar Group, Ltd.
options and warrants outstanding. These options and warrants allow the holders
to purchase 1,114,354 shares of stock at prices between $2.00 and $15.00 per
share. At December 31, 1997, 1,098,076 of these shares expired and were
forfeited. The remaining 16,278 options and warrants will expire at various
dates from May 1999 through July 2000.
7. COMMITMENTS AND CONTINGENCIES:
LITIGATION
The Company has been named as a defendant in lawsuits in the normal course of
business. Management believes that the ultimate resolution of these matters will
not have a material adverse effect on the Company's financial position or
results of operations.
EMPLOYEE RETIREMENT SAVINGS PLAN
The Company maintains an employee retirement savings plan (the Plan) which
qualifies under Section 401(k) of the Internal Revenue Code. The Plan is
designed to provide eligible employees with an incentive to make regular
contributions into a long-term investment and savings program. The Company
contributed $3,000 in 1998 and $0 in 1997 and 1996.
OPERATING LEASES
The Company leases all of its warehouse and office space and certain equipment
under operating lease agreements. The Company recorded operating lease rental
expense totaling $209,000, $193,000 and $184,000 for the years ended December
31, 1998, 1997 and 1996, respectively. Future minimum lease payments of
$110,000, including estimated common area maintenance, are due by December 31,
1999.
GOVERNMENT REGULATION
The Company presently collects Minnesota sales tax on sales made within the
state of Minnesota. Various states have attempted to impose on direct marketers
the burden of collecting use taxes on the sale of products shipped to state
residents. The United States Supreme Court affirmed its position that it is
unlawful for a state to impose use tax collection obligations on an out-of-state
mail order company whose only contact with the state was the distribution of
catalogs and other advertising materials through the mail and subsequent
delivery of purchased goods by parcel post and interstate common carriers. If
legislation is passed to overturn the United States Supreme Court's decision,
the imposition of a use tax collection obligation on the Company in states to
which it ships products would result in additional administrative expenses to
the Company, could result in price increases to the customer and could have a
material adverse effect on the Company.
8. RELATED-PARTY TRANSACTIONS:
In December 1995, the Company entered into a consulting agreement with Jaguar
Ventures, Limited, an entity owned by one of the Company's board members and by
two significant stockholders who were principals of Jaguar Group, Ltd. Pursuant
to the agreement, the Company agreed to issue warrants to acquire 300,000 shares
of the Company's common stock at $1.75 per share with certain registration
rights, and paid $50,000 in cash. In September 1996, the Company repriced these
warrants to $1.01 per share. In September 1997, the Company agreed to extend the
term by one year to December 1999, subject to certain restrictions.
22
<PAGE> 23
The Company has agreed to indemnify its majority stockholder and Chairman for
any tax liability resulting from any challenges to the Company's S corporation
tax returns from 1994 through the date of the Company's conversion to a C
corporation in 1995.
23
<PAGE> 24
Tech Squared Inc. and Subsidiaries
Consolidated Balance Sheet
<TABLE>
<CAPTION>
September 30,
1999
(Unaudited)
<S> <C>
ASSETS
Current Assets
Cash and cash equivalents $ 1,433,117
Restricted cash 126,923
Accounts receivable, net of allowance for doubtful receivables of $510,000 and
$365,000 respectively 3,325,666
Inventories 1,538,431
Prepaids and other current assets 533,528
------------
Total Current Assets 6,957,665
Property and equipment, net 458,474
Investment in Digital River 65,250,000
------------
$ 72,666,139
------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Revolving line of credit $ 337,375
Accounts payable 3,518,947
Accrued compensation and benefits 166,396
Accrued expenses 880,878
------------
Total Current Liabilities 4,903,596
Deferred income taxes 24,470,000
Stockholders' Equity:
Common stock: no par value; 25,000,000 shares authorized, 13,730,453
issued and outstanding --
Additional paid-in capital 6,945,599
Stock subscription receivable (725,000)
Retained earnings (879,228)
Unrealized gain on available-for-sale securities 37,951,172
------------
Total Stockholders' Equity 43,292,543
------------
$ 72,666,139
------------
</TABLE>
See accompanying notes to financial statements.
24
<PAGE> 25
Tech Squared Inc. and Subsidiaries
Consolidated Statements of Operations (Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30, September 30,
1999 1998
<S> <C> <C>
Net Sales $ 33,166,578 $ 27,816,363
Cost of sales 29,267,366 24,293,303
------------ ------------
Gross profit 3,899,212 3,523,060
Selling and marketing expenses 1,899,125 2,101,104
General and administrative expenses 5,631,139 1,781,535
------------ ------------
Total Operating Expenses 7,530,264 3,882,639
------------ ------------
Loss from operations (3,631,052) (359,579)
Interest income/(expense), net 52,834 (74,021)
Investment income 2,048 (266,589)
Loss on mining assets (145,947) --
Equity in losses of Digital River -- (1,829,207)
------------ ------------
Net loss $ (3,722,117) $(2,529,396)
Preferred stock dividends $ 51,456 --
------------ ------------
Net loss applicable to common shares $ (3,773,573) $(2,529,396)
------------ ------------
Net loss per common share, basic and diluted $ (0.30) $(0.23)
------------ ------------
Weighted average shares outstanding, basic and diluted 12,270,052 10,923,462
------------ ------------
</TABLE>
See accompanying notes to financial statements.
25
<PAGE> 26
Tech Squared Inc. and Subsidiaries
Consolidated Statements of Cash Flows (Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30, September 30,
1999 1998
<S> <C> <C>
Cash Flows From Operating Activities:
Net Loss $ (3,722,117) $ (2,529,396)
Non-cash items included in loss:
Depreciation and amortization 160,097 134,320
Equity in losses of Digital River -- 1,829,207
Non-cash compensation charges 1,894,923 --
Loss on sale of available-for-sale securities -- 266,589
Loss on sale of mining assets 140,000 --
Changes In Operating Assets And Liabilities:
Accounts receivable, net 62,241 97,616
Inventories 245,474 (452,296)
Prepaid and other current assets (116,862) (149,461)
Accounts payable (1,489,502) 1,026,834
Accrued compensation and benefits (38,760) (38,323)
Other accrued expenses (651,098) (228,519)
----------- -----------
Net Cash Used In Operating Activities (3,515,604) (43,429)
----------- -----------
Cash Flows From Investing Activities:
Change in restricted cash 102,543 (53,554)
Purchases of property and equipment (118,698) (216,036)
Proceeds from sale of available-for-sale securities -- 287,411
Sale of mining assets 50,000 --
----------- -----------
Net Cash Provided By Investing Activities 33,845 17,821
----------- -----------
Cash Flows From Financing Activities:
Net change in revolving line of credit 329,980 15,625
Stock options exercised, net 619,477 227,920
Redemption of preferred stock (187,000) --
Dividends paid (283,857) (200,000)
----------- -----------
Net Cash Provided By Financing Activities 478,600 43,545
----------- -----------
Net Increase (Decrease) In Cash (3,003,159) 17,937
Cash At Beginning Of Period 4,436,276 300
----------- -----------
Cash At End Of Period $ 1,433,117 $ 18,237
----------- -----------
Supplemental cash flow information:
Cash paid for interest $ 43,074 $ 75,895
</TABLE>
See accompanying notes to consolidated financial statements.
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<PAGE> 27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 1999
NOTE 1---BASIS OF PRESENTATION
The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information. 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
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the three and nine month periods ended
September 30, 1999 are not necessarily indicative of the results that may be
expected for the year ending December 31, 1999. The accompanying consolidated
financial statements and notes should be read in conjunction with the audited
financial statements and notes thereto included in the Company's 1998 annual
report on Form 10-K, as amended.
NOTE 2---INVENTORIES
The Company's inventories consist primarily of goods held for resale and
are stated at the lower of cost or market. Cost is determined using the
first-in, first-out method.
NOTE 3---DIGITAL RIVER
In December 1995, the Company's wholly-owned subsidiary, MacUSA, was
granted, by Joel Ronning, the majority shareholder and Chairman of the Board of
Directors of the Company, an option, exercisable through December 31, 2000 (the
"Digital River Option") to acquire 3,200,000 (post-split) shares (the "Digital
River Shares") of Digital River, Inc., a Minnesota corporation ("Digital River")
which was then privately held. At that time, such shares represented
approximately 60% of the outstanding common stock of Digital River.
Digital River conducted its initial public offering in August 1998. Prior
to such offering, the Company's ownership percentage of Digital River had been
reduced to approximately 23% and was being accounted for using the equity method
of accounting. Upon completion of such offering, the Company's ownership
percentage was reduced to approximately 19% at which time the Company began
accounting for its investment in Digital River as an available-for-sale security
in accordance with Statement of Financial Accounting Standards (SFAS) No. 115.
Digital River's shares are traded on the NASDAQ stock market under the symbol
"DRIV."
In December 1998, the Company participated in Digital River's secondary
offering by exercising and selling 200,000 shares subject to the Digital River
Option realizing net proceeds of $4,430,000.
In July 1999, the Company completed a cashless exercise of the Digital
River option by surrendering its right to one share of Digital River common
stock in exchange for 2,999,999 shares of Digital River common stock.
Subsequently, the Company purchased one share of Digital River stock to bring
its investment in Digital River to 3,000,000 shares, which represents ownership
of approximately 15% of Digital River as of September 30, 1999.
In July 1999, the Company executed a definitive agreement with Digital
River for the sale of the assets of the Company consisting primarily of
3,000,000 shares of Digital River common stock and cash in a tax-free
reorganization. Pursuant to the Agreement, the Company will receive 2,650,000
shares of Digital River common stock for which the Company will exchange
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<PAGE> 28
3,000,000 shares of Digital River common stock, which it currently holds, and
$1.2 million in cash. The Company has adopted a plan of liquidation, subject to
shareholder approval, which will provide that the Company will distribute the
shares of Digital River common stock received in the exchange to the Company's
shareholders after payment of the Company's liabilities and the establishment of
a liquidating trust to pay any potential future liabilities of the Company. The
Company expects to contribute $6.2 million in cash and Digital River common
stock to such trust. The Agreement requires that all of the operations of the
Company, including its catalog and distribution businesses, be sold or
liquidated prior to closing of the transaction contemplated by such Agreement.
NOTE 4---PREFERRED STOCK
In June 1999, the Company sent notice to all preferred stockholders that
the Company intended to call all preferred stock. The terms of the preferred
shares provided that after five years from the date of issuance, the Company on
sixty days notice may call such shares. In August 1999, the Company paid the
principal plus accrued dividends to the date of payment to the holders of such
preferred shares.
NOTE 5---COMPREHENSIVE INCOME
SFAS No. 130 established standards for reporting and display in the
financial statements of total net income and the components of all other
nonowner changes in equity, referred to as comprehensive income. Other
comprehensive income/(loss) for the three and nine month periods ended September
30, 1999 was approximately ($21,666,000) and ($25,905,000), respectively,
compared to $13,936,000 and $13,887,000 for the same periods of 1998. Other
comprehensive income was comprised of changes in the market value of the
available-for-sale securities and the investment in Digital River.
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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 hereunto duly authorized.
Virtual Technology Corporation
Date March 1, 2000 By /s/ John L. Harvatine
------------------------------- ----------------------------
John L. Harvatine
Chief Financial Officer
29
