SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K/A
Amendment No. 1
Current Report
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Date of Report (Date of Earliest Event Reported): December 30, 1999
Digital Privacy, Inc.
(Exact Name of Registrant as Specified in its Charter)
Delaware 52-1680936
- -------------------------- ----------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
4820 Minnetonka Blvd., Suite 410, St. Louis Park, MN 55416
- ----------------------------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (612) 285-1163
--------------
(Former Name or Former Address if Changed Since Last Report)
<PAGE>
Item 4. Changes in Registrant's Certifying Accountants.
Prior to TelePad's bankruptcy filing on March 17, 1999,
TelePad's independent auditors were Ernst & Young LLP ("E&Y"). E&Y reported on
TelePad's financial statements for the year ended December 31, 1997 and was
engaged to audit TelePad's financial statements for the year ended December 31,
1998; however the 1998 audit was not completed due to TelePad's bankruptcy
filing on March 17, 1999. E&Y has not performed any professional services for
TelePad subsequent to the date of the bankruptcy filing.
The report of E&Y on TelePad's financial statements for fiscal
year 1997 did not contain an adverse opinion or disclaimer of opinion and was
not qualified or modified as to uncertainty, audit scope or accounting
principles except that it included an explanatory paragraph regarding TelePad's
ability to continue as a going concern.
In connection with the audit of TelePad's financial statements
for the year ended December 31, 1997, and in the subsequent period prior to the
bankruptcy filing, there were no disagreements with TelePad on any matters of
accounting principles or practices, financial statement disclosure, or auditing
scope and procedures which, if not resolved to the satisfaction of E&Y would
have caused E&Y to make reference to the matter in their report. In connection
with the audit of TelePad's financial statements for the year ended December 31,
1997, there were no "reportable events" as that term is described in Item 304
(a)(1)(v) of Regulation S-K.
In connection with E&Y's engagement to audit TelePad's
financial statements for the year ended December 31, 1998, E&Y identified
certain issues such as proper inventory controls, sufficient internal control
structure and management cooperation to discuss with TelePad's Audit Committee.
Upon notice of these issues, TelePad's Audit Committee Chairman shared E&Y's
concerns with management and expressed an intent to work with E&Y to address
these issues. E&Y did not perform any auditing procedures for TelePad subsequent
to the date of the bankruptcy filing. Therefore E&Y cannot express an opinion as
to whether it would have concluded to make reference to these issues in its
report, had the relationship continued and had the audit for the year ended
December 31, 1998 been completed.
The Registrant has requested E&Y to furnish it a letter addressed to
the Commission stating whether it agrees with the above statements. A copy of
that letter, dated February 28, 2000 is filed as Exhibit 16.1 to this Form
8-K/A.
Item 7. Financial Statements, Pro Forma Financial Information and Exhibits.
(a and b) Financial Statements and Pro Forma Financial Statements
The required financial statements are included
herewith following this Item.
(c) Exhibits
The following exhibits are filed herewith:
2.1 Agreement and Plan of Merger*
4.1 Certificate of Designation*
4.2 Convertible Note*
4.3 Subscription Agreement*
16.1 Accountant's letter
99.1 Howard Miller Employment Agreement*
99.2 J. Virgil Bradley Employment Agreement*
99.3 Stock Option Plan*
- -----------------
* Previously filed
<PAGE>
DIGITAL PRIVACY, INC.
FINANCIAL STATEMENTS
Period September 9, 1999 through December 31, 1999,
Period January 1, 1999 through September 8, 1999,
Year Ended December 31, 1998
<PAGE>
C O N T E N T S
Page
INDEPENDENT AUDITOR'S REPORT 1 - 2
FINANCIAL STATEMENTS
Balance sheets 3
Statements of operations 4
Statements of stockholders' deficit 5
Statements of cash flows 6
Notes to financial statements 7 - 16
<PAGE>
INDEPENDENT AUDITOR'S REPORT
Board of Directors
Digital Privacy, Inc.
St. Louis Park, Minnesota
We have audited the accompanying balance sheets of DIGITAL PRIVACY, INC.
(formerly TelePad Corporation - see Note 1) as of December 31, 1999 and 1998,
and the related statements of operations, stockholders' deficit and cash flows
for the periods September 9, 1999 through December 31, 1999, and January 1, 1999
through September 8, 1999, and the year 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 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 DIGITAL PRIVACY, INC., as of
December 31, 1999 and 1998, and the results of its operations and its cash flows
for the periods September 9, 1999 through December 31, 1999, and January 1, 1999
through September 8, 1999, and the year ended December 31, 1998, in conformity
with generally accepted accounting principles.
As more fully discussed in Note 2 to the financial statements, the Company
emerged from protection under Chapter 11 of the U.S. Bankruptcy Code pursuant to
a reorganization plan confirmed by the United States Bankruptcy Court for the
District of Minnesota on September 8, 1999. In accordance with American
Institute of Certified Public Accountants (AICPA) Statement of Position No.
90-7, "Financial Reporting by Entities in Reorganization Under the Bankruptcy
Code," the Company was required to account for the reorganization using "Fresh
Start Reporting" whereby its assets, liabilities and new capital structure were
adjusted to reflect estimated fair values as of September 9, 1999. Accordingly,
all financial statements prior to September 9, 1999, are not comparable to the
financial statements for the period after reorganization.
<PAGE>
- 2 -
The accompanying financial statements have been prepared assuming the Company
will continue as a going concern. As discussed in Notes 2 and 3 to the financial
statements, the Company has incurred losses since commencement of operations,
filed for bankruptcy under Chapter 11 with the United States Bankruptcy Court,
and had their bankruptcy reorganization plan recently confirmed. These
conditions raise substantial doubt about the Company's ability to continue as a
going concern. Management's plans concerning these matters are also disclosed.
The financial statements do not include any adjustments that might result from
the outcome of these uncertainties.
/s/Lurie, Besikof, Lapidus & Co., LLP
LURIE, BESIKOF, LAPIDUS & CO., LLP
Minneapolis, Minnesota
February 22, 2000
<PAGE>
- 3 -
DIGITAL PRIVACY, INC.
BALANCE SHEETS
<TABLE>
<S> <C> <C>
December 31,
----------------------------
ASSETS 1999 1998
--------- -------
CURRENT ASSETS
Cash $ 84,493 $ 4,233
Inventory 14,765 11,835
Other 4,753 38,983
----------- ------------
TOTAL CURRENT ASSETS 104,011 55,051
---------- ------------
PROPERTY AND EQUIPMENT 48,584 85,455
---------- ------------
OTHER ASSETS
Patents and trademarks 387,821 374,116
License fee escrow 49,996 49,996
Deferred finance costs (net of accumulated
amortization of $-0- and $622,975) - 326,371
---------- ------------
437,817 750,483
---------- ------------
$ 590,412 $ 890,989
========== ============
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Notes payable to stockholders $ - $ 1,831,539
Notes payable to vendor 10,000 -
Accounts payable 56,326 489,053
Accrued interest 13,601 159,072
Accrued expenses - other 16,087 40,802
---------- ------------
TOTAL CURRENT LIABILITIES 96,014 2,520,466
---------- ------------
NOTE PAYABLE TO DIRECTOR 600,000 -
---------- ---------
STOCKHOLDERS' DEFICIT Preferred stock:
Series A, 8% cumulative convertible - $.01 par value, $10 stated and
liquidation value (authorized - 40,000 and 0 shares; issued
and outstanding - 15,000 and 0 shares) 150,000 -
Undesignated - $.01 par value (authorized - 4,960,000 and
10,000,000 shares; no shares issued and outstanding) - -
Common stock - $.01, par value (authorized - 95,000,000 and
20,000,000 shares; issued and outstanding - 3,620,113 and
6,307,106 shares) 36,201 63,071
Additional paid-in capital 80,449 5,454,002
Warrants 4,877 1,640,240
Accumulated deficit ( 377,129) (8,786,790)
---------- -------------
( 105,602) (1,629,477)
---------- ------------
$ 590,412 $ 890,989
========== ============
</TABLE>
See notes to financial statements.
<PAGE>
- 4 -
DIGITAL PRIVACY, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<S> <C> <C> <C>
Period Period
September 9, January 1,
1999 Through 1999 Through Year Ended
December 31, September 8, December 31,
1999 1999 1998
---------------- ---------------- ----------
REVENUE $ 761 $ 322 $ 19,736
COST OF GOODS SOLD 442 89 1,432
---------- ----------- -----------
GROSS PROFIT 319 233 18,304
---------- ----------- -----------
OPERATING EXPENSES
Selling, general and administrative 228,805 603,225 2,790,916
Research and development 65,591 172,969 381,277
---------- ----------- -----------
294,396 776,194 3,172,193
---------- ----------- -----------
OPERATING LOSS ( 294,077) ( 775,961) ( 3,153,889)
INTEREST EXPENSE 13,010 14,507 148,333
---------- ----------- -----------
LOSS BEFORE REORGANIZATION ITEMS
AND EXTRAORDINARY GAIN ( 307,087) ( 790,468) ( 3,302,222)
---------- ----------- -----------
REORGANIZATION ITEMS
Recapitalization under fresh start
reporting - 889,655 -
Professional fees 35,769 ( 133,882) -
Chapter 11 settlement expense 34,273 ( 94,535) -
---------- ----------- --------
70,042 661,238 -
---------- ----------- --------
LOSS BEFORE EXTRAORDINARY GAIN ( 377,129) ( 129,230) ( 3,302,222)
EXTRAORDINARY GAIN ON DISCHARGE
OF PREPETITION LIABILITIES - 1,838,259 -
---------- ----------- --------
NET INCOME (LOSS) ($ 377,129) $ 1,709,029 ($ 3,302,222)
========== =========== ===========
NET LOSS PER SHARE OF COMMON STOCK -
BASIC AND DILUTED ($ .11)
==========
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING 3,375,122
</TABLE>
See notes to financial statements.
<PAGE>
- 5 -
DIGITAL PRIVACY, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Preferred Stock Common Stock
----------------------- -------------- Additional
Number Number Paid-in Accumulated
of Shares Amount of Shares Amount Capital Warrants Deficit Total
--------- ------- --------- --------- ---------- --------- ----------- ------
BALANCE,
DECEMBER 31, 1997 - $- 5,563,605 $55,636 $4,176,876 $ 748,800 ($5,484,568) ($503,256)
Net loss for year - - - - - - (3,302,222) (3,302,222)
Issuance of stock - - 743,501 7,435 1,277,126 - - 1,284,561
Issuance of warrants - - - - - 891,440 - 891,440
-------- ---- --------- ------ -------- --------- ------ ---------
BALANCE,
DECEMBER 31, 1998 - - 6,307,106 63,071 5,454,002 1,640,240 (8,786,790) (1,629,477)
Net income for period - - - - - - 1,709,029 1,709,029
Bankruptcy
reorganization
adjustments - - (3,961,993) (39,620) (5,397,901)(1,640,240) 7,077,761 -
BALANCE,
SEPTEMBER 9, 1999 - - 2,345,113 23,451 56,101 - - 79,552
Issuance of common
stock and warrants - - 275,000 2,750 34,348 4,877 - 41,975
Issuance of preferred
stock 15,000 150 - - 149,850 - - 150,000
TelePad merger - - 1,000,000 10,000 (10,000) - - -
Net loss for period - - - - - - (377,129) (377,129)
------- ---- --------- ------ -------- --------- --------- -----------
BALANCE,
DECEMBER 31, 1999 15,000 $150 3,620,113 $36,201 $ 230,299 $ 4,877 ($377,129) ($105,602)
====== === ========= ====== ======== ========= ========= ==========
</TABLE>
See notes to financial statements.
<PAGE>
- 6 -
DIGITAL PRIVACY, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<S> <C> <C> <C>
Period Period
September 9, January 1,
1999 Through 1999 Through Year Ended
December 31, September 8, December 31,
1999 1999 1998
--------------- ---------------- ----------
OPERATING ACTIVITIES
Net income (loss) ($ 377,129) $ 1,709,029 ($ 3,302,222)
Adjustments to reconcile net income (loss) to
net cash used by operating activities:
Extraordinary gain on discharge of
prepetition liabilities - ( 1,838,259) -
Common stock issued for services 2,420 - -
Depreciation 9,379 19,259 33,796
Loss on sale or disposal of property and
equipment - 9,292 15,075
Amortization and impairment of deferred
finance costs - 326,371 747,188
Changes in operating assets and liabilities:
Inventory ( 3,012) 82 ( 5,798)
Other current assets 885 33,346 ( 4,924)
Accounts payable 75,710 ( 468,882) 85,540
Accrued expenses and other liabilities ( 220,657) 67,190 66,199
---------- ----------- -----------
Net cash used by operating activities ( 512,404) ( 142,572) ( 2,365,146)
---------- ----------- -----------
INVESTING ACTIVITIES
Purchases of property and equipment ( 1,059) - -
Patent and trademark costs ( 3,230) ( 10,475) ( 46,933)
Proceeds from sale of property and equipment - - 32,700
---------- ----------- -----------
Net cash used by investing activities ( 4,289) ( 10,475) ( 14,233)
---------- ----------- -----------
FINANCING ACTIVITIES
Issuance of stock 150,000 - 1,284,561
Proceeds from notes payable 450,000 150,000 1,206,488
Payments on notes payable - - ( 34,401)
Decrease in checks issued in excess of deposits - - ( 38,639)
Deferred finance costs - - ( 57,906)
---------- ----------- -----------
Net cash provided by financing activities 600,000 150,000 2,360,103
---------- -----------
NET INCREASE (DECREASE) IN CASH 83,307 ( 3,047) ( 19,276)
CASH
Beginning of period 1,186 4,233 23,509
---------- ----------- -----------
End of period $ 84,493 $ 1,186 $ 4,233
========== =========== ===========
See notes to financial statements.
</TABLE>
<PAGE>
- 7 -
DIGITAL PRIVACY, INC.
NOTES TO FINANCIAL STATEMENTS
1. Description of the Company and Summary of Significant
Accounting Policies -
The Company
The Company designs, develops and markets smart card technology for
personal computers, laptops and network computers.
Merger
On December 30, 1999, TelePad Corporation, a Delaware corporation
("TelePad"), completed a merger with Digital Privacy, Inc., a privately
owned Minnesota corporation ("DPI"). The combined entity, in which
TelePad was the surviving corporation, changed its name to Digital
Privacy, Inc.
As discussed in Note 2, DPI's bankruptcy reorganization plan was
confirmed by the U.S. Bankruptcy Court for the District of Minnesota on
September 8, 1999. On March 17, 1999, TelePad sought protection of the
Bankruptcy Court and started a Chapter 11 proceeding. TelePad emerged
from bankruptcy on November 8, 1999, as an empty shell with no
significant assets or liabilities.
The merger was accounted for as a recapitalization of DPI, and because
the operations of TelePad prior to the merger are not meaningful, the
financial statements reflect that of DPI and have not been restated to
reflect TelePad.
Under the terms of the merger, each share of DPI common stock converted
into one share of TelePad common stock. The shareholders of DPI received
2,345,113 shares of common stock of TelePad.
Use of Estimates
The preparation of these financial statements in conformity with
generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts and
disclosures in the financial statements. Actual results could differ from
these estimates. A significant management estimate relates to the
amortization of patents and trademarks.
Fair Value of Financial Instruments
Financial instruments consist primarily of notes payable, accounts
payable and prepetition liabilities. The carrying amounts approximate
their fair values without regard to the bankruptcy reorganization.
Inventory
Inventory, consisting primarily of smart cards and related readers, is
valued at the lower of cost (first-in, first-out) or market.
(continued)
<PAGE>
- 8 -
DIGITAL PRIVACY, INC.
NOTES TO FINANCIAL STATEMENTS
1. Description of the Company and Summary of Significant Accounting
Policies - (continued)
Property and Equipment
Property and equipment were restated to fair value at September 9, 1999
(as required under fresh start reporting) and were reported at cost at
December 31, 1998. Depreciation is provided using the straight-line
method over the estimated useful lives of the assets, primarily five to
seven years.
Patents and Trademarks
The Company capitalizes costs of patents and trademarks. The Company
retained the cost of the patents and trademarks under fresh start
reporting. The Company believes this is the most appropriate value as, to
date, significant revenues have not been generated by these assets.
Patent and trademark costs will be amortized, from the date significant
revenues are first generated on the related products, on a straight-line
basis, over the expected useful life of the products, currently estimated
at five years. No patent or trademark amortization has been recorded as
significant revenues have not been generated. The Company periodically
reviews its patent and trademark portfolios to assess the recoverability
of the recorded amounts.
Deferred Finance Costs
Deferred finance costs were amortized on a straight-line basis over the
term of the related notes. The balance of the deferred finance costs was
expensed in connection with the bankruptcy reorganization plan.
Stock-Based Compensation
The Company accounts for employee stock options under Accounting
Principles Board Opinion No. 25 "Accounting for Stock Issued to
Employees" and provides the other disclosures required by Statement of
Financial Accounting Standards No. 123 "Accounting for Stock-Based
Compensation" (SFAS 123).
Research and Development Costs
Research and development expenditures are charged to expense as incurred.
Earnings per Share
Basic earnings (loss) per common share is computed by dividing the net
loss plus preferred stock dividends by the weighted average number of
shares of common stock outstanding during the period. Diluted earnings
(loss) per common share is computed similar to the computation of basic
earnings (loss) per share, except that the denominator is increased for
the assumed exercise of dilutive options and warrants using the treasury
stock method. No stock options or warrants were included in dilutive
earnings loss per share as their inclusion was antidilutive. Earnings
(loss) per share was not calculated prior to the period beginning
September 9, 1999, as it is not meaningful due to the bankruptcy
reorganization and fresh start reporting. Weighted average number of
shares outstanding reflect the TelePad merger as if it occurred on
September 9, 1999.
<PAGE>
- 9 -
DIGITAL PRIVACY, INC.
NOTES TO FINANCIAL STATEMENTS
2. Bankruptcy Reorganization and Fresh Start Reporting -
DPI filed for bankruptcy under Chapter 11 of the U.S. Bankruptcy Code on
January 6, 1999. The Reorganization Plan was confirmed by the U.S.
Bankruptcy Court for the District of Minnesota on September 8, 1999. DPI
adopted fresh start reporting upon emergence from Chapter 11 as required
under the provisions of AICPA Statement of Position 90-7, (SOP 90-7),
"Financial Reporting by Entities in Reorganization under the Bankruptcy
Code".
Accordingly, the September 9, 1999, balance sheet was prepared as if DPI
were a new reporting entity and reflected certain reorganization
adjustments that included the restatement of assets and liabilities to
approximate fair value, the discharge of outstanding liabilities related
to creditor claims against DPI, which were satisfied by the bankruptcy
confirmation, and the new capital structure. The financial statements for
the period September 9, 1999 through December 31, 1999, incorporate the
effects of fresh start reporting. However, the financial statements for
the period January 1, 1999 through September 8, 1999, and the year ended
December 31, 1998, are based on historical cost. A bold vertical line was
drawn on the accompanying financial statements to distinguish between the
Reorganized Company and the Predecessor Company.
All common shares issued and outstanding at the time of bankruptcy
reorganization were cancelled. Under the bankruptcy reorganization,
2,345,113 new shares of DPI's common stock were distributed to holders of
claims against the Predecessor Company.
The bankruptcy discharge and fresh start reporting adjustments to the
September 9, 1999, balance sheet were as follows:
<TABLE>
<S> <C> <C> <C> <C>
Preconfirm- Adjustments to Record
ation Confirmation of Plan Reorganized
Balance Bankruptcy Fresh Start Balance
Sheet Discharge Reporting Sheet
ASSETS
CURRENT ASSETS
Cash $ 1,186 $ - $ - $ 1,186
Inventory 11,753 - - 11,753
Other 21,792 (16,155) - 5,637
--------- --------- ---------- ---------
34,731 (16,155) - 18,576
PROPERTY AND EQUIPMENT 56,904 - - 56,904
OTHER ASSETS
Patents and trademarks 384,591 - - 384,591
License fee escrow 49,996 - - 49,996
Deferred finance costs 34,964 - (34,964) -
----------- ----------- ---------- -------
$561,186 ($16,155) ($34,964) $510,067
=========== =========== ========== ==========
</TABLE>
(continued)
<PAGE>
- 10 -
DIGITAL PRIVACY, INC.
NOTES TO FINANCIAL STATEMENTS
2. Bankruptcy Reorganization and Fresh Start Reporting - (continued)
<TABLE>
<S> <C> <C> <C> <C>
Preconfirm- Adjustments to Record
ation Confirmation of Plan Reorganized
Balance Bankruptcy Fresh Start Balance
Sheet Discharge Reporting Sheet
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 20,171 $ - $ - $ 20,171
Accrued expenses 107,288 ( 90,000) - 17,288
Prepetition liabilities - - 233,056 233,056
------------- ----------- ----------- ------------
127,459 ( 90,000) 233,056 270,515
------------- ----------- ----------- ------------
NOTES PAYABLE 150,000 10,000 - 160,000
------------- ----------- ----------- ------------
PREPETITION LIABILITIES 2,837,554 ( 2,604,498) ( 233,056) -
------------- ----------- ----------- ------------
STOCKHOLDERS' EQUITY
Common stock 63,071 ( 39,620) - 23,451
Additional paid-in capital 5,454,002 ( 4,508,246) ( 889,655) 56,101
Warrants 1,640,240 ( 1,640,240) - -
Retained earnings (deficit) ( 9,711,140) 8,856,449 854,691 -
------------- ----------- ----------- ---------
( 2,553,827) 2,668,343 ( 34,964) 79,552
------------- ----------- ----------- ------------
$ 561,186 ($ 16,155) ($ 34,964) $ 510,067
============= =========== =========== ============
</TABLE>
3. Going Concern -
DPI has failed to generate significant revenues and incurred operating
losses since its inception. DPI also filed for bankruptcy and had their
reorganization plan confirmed by the bankruptcy court (Note 2). DPI's
ability to continue as a going concern is dependent on its ability to
raise additional capital and, ultimately, to generate sufficient cash
flows from operations. These factors, among others, raise substantial
doubt about the Company's ability to continue as a going concern. The
financial statements do not include any adjustments relating to the
recoverability and classifications of assets and liabilities should the
Company be unable to continue as a going concern. Management believes
that it can raise sufficient capital to fund operations until the Company
becomes self-sustaining.
<PAGE>
- 11 -
DIGITAL PRIVACY, INC.
NOTES TO FINANCIAL STATEMENTS
4. Property and Equipment -
Property and equipment consists of the following:
<TABLE>
<S> <C> <C>
December 31,
---------------------------
1999 1998
--------- --------
Furniture and equipment $ 57,963 $ 167,283
Leasehold improvements - 15,067
-------- ----------
57,963 182,350
Less accumulated depreciation 9,379 96,895
-------- ----------
$ 48,584 $ 85,455
======== ==========
5. Notes Payable -
Notes payable consist of the following:
December 31,
----------------------------
1999 1998
---------- ---------
Notes payable to stockholders - discharged in
bankruptcy reorganization. $ - $ 1,831,539
========= ============
Note payable to vendor, interest at 10%, due
October 2000, unsecured. $ 10,000 $ -
======== =========
Note payable to director, interest at 10%, due October 2001,
convertible into common stock through July 7, 2000, at 36.6% of all
common stock and dilutive securities upon conversion,
collateralized by substantially all Company
assets. $ 600,000 $ -
========== =========
</TABLE>
Interest expense of approximately $120,000 was not recorded on discharged
debt for the period January 6, 1999 (petition date) through September 8,
1999, in accordance with SOP 90-7.
6. Income Taxes -
For the periods September 9, 1999 through December 31, 1999, and January
1, 1999 through September 8, 1999, and the year ended December 31, 1998,
the Company had no current or deferred income tax provision. Similarly,
no income taxes were applied against the extraordinary gain in the period
January 1, 1999 through September 8, 1999.
(continued)
<PAGE>
- 12 -
DIGITAL PRIVACY, INC.
NOTES TO FINANCIAL STATEMENTS
6. Income Taxes - (continued)
Deferred income taxes consist of the following:
<TABLE>
<S> <C> <C>
December 31,
--------------------------------
1999 1998
---------------- ----------
Deferred tax assets:
Net operating loss carryforwards $ 1,995,000 $ 2,050,000
Deferred finance costs - 318,000
Accrued salaries 2,000 16,000
----------- -----------
1,997,000 2,384,000
Deferred tax liability - depreciation ( 13,000) ( 11,000)
----------- -----------
1,984,000 2,373,000
Valuation allowance ( 1,984,000) ( 2,373,000)
----------- -----------
Net deferred taxes $ - $ -
=========== ========
</TABLE>
The Company determined the valuation allowance to be appropriate as it is
more likely than not that the net deferred tax assets will not be
realized. The valuation allowance increased by approximately $795,000 for
the year ended December 31, 1998, respectively, primarily due to the
Company's inability to utilize its net operating losses. The valuation
allowance decreased by approximately $320,000 and $69,000 for the periods
January 1, 1999 through September 8, 1999, and September 9, 1999 through
December 31, 1999, respectively, primarily due to limitations on the net
operating loss carryforwards caused by the bankruptcy reorganization.
The effective income tax rate differs from the federal statutory rate
primarily due to the Company's inability to use deferred tax assets.
At December 31, 1999, net operating loss carryforwards were approximately
$5,000,000, starting to expire in 2008. Utilization of tax net operating
losses of approximately $4,700,000 from periods prior to September 9,
1999, are limited to approximately $6,000 annually due to the bankruptcy
reorganization and Internal Revenue Code Section 382.
State tax effects are insignificant and not separately disclosed.
7. Stockholders' Deficit -
Convertible Preferred Stock
The Series A preferred stock is convertible into shares of common stock
at any time determined by the sum of the stated value per share and any
accrued and unpaid dividends divided by the lesser of $1.05 or 77.5% of
the average closing bid prices for the five trading days preceding the
conversion. The Company may redeem the Series A preferred stock, after
the effective date of a registration statement filed with the Securities
and Exchange Commission, upon 30 days notice, for 125% of the stated
value plus accrued dividends. The Company reserved 1,200,000 shares of
common stock for conversion of its Series A preferred stock.
(continued)
<PAGE>
- 13 -
DIGITAL PRIVACY, INC.
NOTES TO FINANCIAL STATEMENTS
7. Stockholders' Deficit -
Convertible Preferred Stock (continued)
---------------------------
Dividends are payable quarterly, at the election of the Company, in
either cash or additional Series A preferred shares at the rate of one
share of Series A preferred stock for each $10 of dividends not paid in
cash. Dividends may be paid at the Company's option with Series A
preferred stock only if the common stock deliverable upon conversion of
such stock was included for public resale in an effective registration
statement.
Preferred Stock
The Company also has available 4,960,000 shares of preferred stock
available for future designation.
Stock Options
The Company has an Omnibus Stock Plan (Plan) which permits the issuance
of incentive and nonstatutory stock options, stock application rights,
performance shares, and restricted stock to employees, officers,
directors, consultants and advisors. The Plan reserved 2,000,000 shares
of common stock for issuance awards with the term of each award to be
determined by the Board of Directors (Board).
The exercise price of incentive stock options may not be less than the
fair market value of the stock on the award date. Options are exercisable
for periods not to exceed ten years from grant date and vest at varying
periods. Stock appreciation rights entitle the recipient to receive a
specified excess of the fair market value of the Company's stock on the
exercise date, as determined by the Board, over the fair market value on
the date of grant. Performance shares entitle recipients to acquire
Company stock upon the attainment of specific performance goals set by
the Board. Restricted stock entitles recipients to acquire Company stock
subject to the right of the Company to repurchase the shares in the event
conditions specified by the Board are not satisfied prior to the end of
the restriction period.
Stock option activity was as follows:
<TABLE>
<S> <C> <C> <C> <C>
Weighted Weighted
Average Average Contractual
Exercise Fair Life -
Options Price Value Years
Balance, December 31, 1997 195,000 $ 5.00 $ 1.28 4
Granted 60,000 5.00 1.09 8
----------
Balance, December 31, 1998 255,000 5.00 1.23 5
Cancelled in bankruptcy
reorganization ( 255,000) 5.00 1.23 5
Granted 751,059 .07 .01 7.83
----------
Balance, December 31, 1999 751,059 .07 .01 7.83
==========
</TABLE>
(continued)
<PAGE>
- 14 -
DIGITAL PRIVACY, INC.
NOTES TO FINANCIAL STATEMENTS
7. Stock Options and Warrants - (continued)
Stock Options (continued)
-------------
Options outstanding at December 31, 1999, are as follows:
<TABLE>
Outstanding Exercisable
<S> <C> <C> <C> <C> <C>
Weighted
Remaining Average
Range of Contractual Exercise
Exercise Prices Options Life-Years Options Price
--------------- ----------- ------------- ----------- ---------
$0.050 - $0.055 741,059 7.81 441,059 $0.05
$1.05 10,000 10.00 10,000 1.05
---------- ----------
751,059 451,059
========== ==========
</TABLE>
Pro forma stock option disclosures for the Predecessor Company are not
presented as they are not significant nor considered meaningful due to
the bankruptcy reorganization and fresh start reporting. The pro forma
impact on subsequent operations for stock options issued in connection
with the bankruptcy reorganization is insignificant.
Warrants
Warrant activity was as follows:
<TABLE>
<S> <C> <C> <C> <C>
Weighted Weighted
Average Average Contractual
Exercise Fair Life -
Warrants Price Value Years
Balance, December 31, 1998 585,000 $ 5.00 $ 1.28 5
Granted 1,350,667 3.00 .66 5
-----------
Balance, December 31, 1998 1,935,667 3.60 .85 5
Cancelled in bankruptcy
reorganization ( 1,935,667) 3.60 .85 5
Granted 10,000 1.05 .23 10
-----------
Balance, December 31, 1999 10,000 1.05 .23 10
===========
</TABLE>
In December 1999, the Company issued 25,000 shares of common stock and
issued 10,000 warrants exercisable for 10 years, in satisfaction of
accounts payable of $31,127.
(continued)
<PAGE>
- 15 -
DIGITAL PRIVACY, INC.
NOTES TO FINANCIAL STATEMENTS
7. Stock Options and Warrants - (continued)
Stock Option and Warrant Assumptions
The fair value of stock options and warrants is the estimated present
value at the grant date using the Black-Scholes Option-Pricing Model with
the following weighted average assumptions for 1999 and 1998:
Risk free interest rate 5.0%
Expected life 5 years
Expected volatility (stock not publicly traded) 0%
Expected dividend rate 0%
8. Operating Lease -
The Company leases offices for monthly rents of $1,087 plus operating
expenses, property taxes and repairs through August 2000. Rent expense
under all operating leases was $6,900 for the period September 9, 1999
through December 31, 1999, $16,222 for the period January 1, 1999 through
September 8, 1999, and $51,676 for the year ended December 31, 1998.
Future minimum lease payments for the year ending December 31, 2000 are
approximately $9,500.
9. Commitments -
Employment
Two officers of the Company have salary commitments of $180,000 and
$100,000 for five and three years, respectively. The President and Chief
Executive Officer may also earn additional performance stock options each
year based on net revenues, increase in revenues and the Company
valuation (all as defined in the agreements).
Marketing
In December 1999, the Company entered into a sales and marketing
agreement with two sales representatives under which the Company is
obligated to issue common stock at the rate of 0.5% of total shares
outstanding for every $3,000,000 in gross sales, up to 1.5% of the total
outstanding shares. The agreement expires March 31, 2000, and may be
terminated earlier by either party upon 30 days notice.
<PAGE>
- 16 -
DIGITAL PRIVACY, INC.
NOTES TO FINANCIAL STATEMENTS
10. Supplemental Cash Flow Information -
<TABLE>
<S> <C> <C> <C>
Period Period
September 9, January 1,
1999 Through 1999 Through Year Ended
December 31, September 8, December 31,
1999 1999 1998
---------------- -------------- ----------
Interest paid $ 3,826 $ - $ 234
Noncash financing activities:
Deferred financing costs $ - $ - $ 891,440
Transfer prepetition accounts
payable to a note - 10,000 -
Recapitalization under fresh
start reporting - 889,655 -
Conversion of accounts payable
to common stock and warrants 39,555 - -
</TABLE>
11. Subsequent Events -
In February 2000, the Company exercised a call option and received
$150,000 for the issuance of 15,000 shares of Series A, 8% cumulative
convertible preferred stock.
<PAGE>
DIGITAL PRIVACY, INC.
Pro Forma Consolidated Financial Statements
The September 30, 1999, unaudited pro forma consolidated financial statements
give effect to the merger of Telepad Corporation (Telepad) and Digital Privacy,
Inc. (DPI). The merger occurred on December 30, 1999. DPI emerged from
bankruptcy on September 9, 1999 and Telepad emerged from bankruptcy on November
8, 1999. Telepad disposed of its pre-bankruptcy business and emerged as an empty
shell with no significant assets or liabilities. Thus the business of Telepad
following the merger will be the business of DPI. These unaudited pro forma
consolidated financial statements should be read in conjunction with DPI's
consolidated financial statements and notes thereto appearing elsewhere. The pro
forma consolidated information is not necessarily indicative of the results that
would have been reported had such events actually occurred on the dates
specified, nor is it indicative of the DPI's future results.
Unaudited Pro Forma Consolidated Balance Sheet
September 30, 1999
<TABLE>
<S> <C> <C> <C> <C>
Digital
Telepad Privacy,
Corporation Inc. Pro Forma Pro Forma
ASSETS Historical Historical Adjustments Consolidated
------------- ---------- -------------- --------------
CURRENT ASSETS
Cash $ - $ 370 $ - $ 370
Inventory - 15,699 - 15,699
Other - 4,952 - 4,952
-------- --------- -------- ----------
TOTAL CURRENT ASSETS - 21,021 - 21,021
-------- --------- -------- ----------
PROPERTY AND EQUIPMENT - 54,559 - 54,559
-------- --------- -------- ----------
OTHER ASSETS
Patents and trademarks - 386,674 - 386,674
License fee escrow - 49,996 - 49,996
-------- --------- -------- ----------
- 436,670 - 436,670
-------- --------- -------- ----------
$ - $ 512,250 $ - $ 512,250
======== ========= ======== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ - $ 39,345 $ - $ 39,345
Accrued expenses - 39,012 - 39,012
Prepetition liabilities - 233,056 - 233,056
-------- --------- -------- ----------
TOTAL CURRENT LIABILITIES - 311,413 - 311,413
-------- --------- -------- ----------
NOTES PAYABLE - 185,000 - 185,000
-------- --------- -------- ----------
STOCKHOLDERS' EQUITY
Common stock 10,000 23,451 - 33,451
Additional paid-in capital - 56,101 ( 10,000) (a) 46,101
Accumulated deficit ( 10,000) ( 63,715) 10,000 (a) ( 63,715)
-------- --------- -------- ----------
- 15,837 - 15,837
-------- --------- -------- ----------
$ - $ 512,250 $ - $ 512,250
======== ========= ======== ==========
</TABLE>
<PAGE>
DIGITAL PRIVACY, INC.
Unaudited Pro Forma Consolidated Statement of Operations
Period September 9, 1999 Through September 30, 1999 (b)
<TABLE>
<S> <C> <C> <C> <C>
Digital
Telepad Privacy,
Corporation Inc. Pro Forma Pro Forma
Historical Historical Adjustments Consolidated
REVENUE $ - $ 606 $ - $ 606
COST OF GOODS SOLD - 195 - 195
---------- -------- ---------- --------
GROSS PROFIT - 411 - 411
OPERATING EXPENSES - 62,806 - 62,806
---------- -------- ---------- --------
OPERATING LOSS - ( 62,395) - ( 62,395)
INTEREST EXPENSE - 1,320 - 1,320
---------- -------- ---------- --------
NET LOSS $ - ($ 63,715) $ - ($ 63,715)
============ ========= ============= ===========
NET LOSS PER COMMON SHARE -
BASIC AND DILUTED (c) $ - ($ 0.03) $ - ($ 0.02)
========== ======== ========== ========
WEIGHTED AVERAGE COMMON
SHARES OUTSTANDING (c) 1,000,000 2,345,113 - 3,345,113
</TABLE>
(a) To adjust Telepad accumulated deficit into additional paid-in capital on
recapitalization and emergence from bankruptcy.
(b) Reflects the period subsequent to bankruptcy for Digital Privacy, Inc.
(c) Basic earnings (loss) per common share was computed by dividing net loss
by the weighted average number of shares of common stock outstanding
during the period. Diluted earnings (loss) per common share was computed
similar to the computation of basic earnings (loss) per share, except
that the denominator is increased for the assumed exercise of dilutive
options and warrants using the treasury stock method. No stock options or
warrants were included in dilutive earnings per share as their inclusion
was antidilutive.
<PAGE>
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.
DIGITAL PRIVACY, INC.
By:/s/ Howard Miller
Howard Miller, President
<PAGE>
Exhibit 16.1
February 28, 2000
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Gentlemen:
We have read Item 4 of Form 8-K/A dated February 28, 2000, of Digital
Privacy, Inc. (formerly TelePad Corporation) and are in agreement with the
statements contained in Item 4 therein. We have no basis to agree or disagree
with other statements of the registrant contained therein.
/s/Ernst & Young LLP
