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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-KSB
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[X] Annual Report under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the fiscal year ended June 30, 1999
[ ] Transition Report under Section 13 or 15(d)
of the Securities Exchange Act of 1934
Commission File No.: 0-27878
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ADRENALIN INTERACTIVE, INC.
(Name of small business issuer in its charter)
Delaware 13-3779546
(State or other jurisdiction (IRS Employer
of incorporation or organization Identification No.)
5301 Beethoven Street, Suite 255, Los Angeles, CA 90066
(Address of principal executive offices) (Zip code)
Issuer's telephone number: (310) 821-7880
Securities registered under Section 12(b) of the Exchange Act: None
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, par value $.03 per share,
(Title of each class)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports) and (2)
has been subject to such filing requirements for the past 90 days. Yes [X]
No ____
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB [ ].
The issuer's revenues for its fiscal year ended June 30, 1999 were
$2,880,936.
The aggregate market value of shares of Common Stock held by
non-affiliates of the registrant as reported by the Nasdaq SmallCap Market on
September 20, 1999 was $11,259,210 (computed on the basis of $3.50 per share,
the last reported sale price for shares of the Company's Common Stock on the
Nasdaq SmallCap Market as of such date).
As of September 20, 1999, the registrant had outstanding 3,539,343 shares
of Common Stock.
Page 1 of 48
<PAGE>
PART I
Item 1. Description of Business.
General
We were incorporated in Delaware in May 1994. In March 1995, we changed
our name to Wanderlust Interactive, Inc. In May 1998, we again changed our name
to Adrenalin Interactive, Inc. On December 29, 1998, we effected a 1-for-3 share
reverse stock split in our common stock.
As used herein, "Adrenalin", "we", "us" and "our" refer to Adrenalin
Interactive, Inc. and our subsidiaries including Western Technologies, Inc.
("Western"), unless the context requires otherwise. Similarly, the term "McGlen"
refers to McGlen Micro, Inc. and its subsidiaries, unless the context requires
otherwise. As discussed herein, we intend to merge with McGlen. We have supplied
all information contained in this report relating to us and McGlen has supplied
all information contained in this report relating to it.
Our Business
We principally develop video games for use with Sony, Nintendo and Sega
video game consoles pursuant to funded contracts with video game developers,
entertainment titles for PCs and electronic toys including interactive,
Web-powered toys which are refreshed from a PC via the Internet. We also create
interactive television games for digital set-top boxes and publish or license PC
games in 24 countries and 15 languages.
McGlen's Business
McGlen was formed in May 1996 to sell computer products over the
Internet. McGlen considers itself a global Internet retailer of computer
hardware and peripheral products servicing individuals, small offices/home
offices and the corporate market. McGlen offers approximately 40,000
stockkeeping units (SKUs) at its virtual superstore, www.mcglen.com. McGlen
recently purchased a competitor, AMT Component, Inc., and now also operates
AccessMicro.com, which sells similar products at typically lower price points.
The McGlen.com superstore has been in operation for more than three years and
has approximately 120,000 current customers. McGlen has a marketing and
promotion program in place that includes Web advertising, hyperlink allegiances,
portal alliances, and direct one-to-one marketing. For website development,
McGlen plans to enhance its virtual superstore to provide a community-like
experience while shopping online. The objectives behind the website enhancement
are to increase customer interaction and to offer a more comprehensive array of
value-added services.
Our Material Developments During Fiscal 1997 and 1998
We completed an initial public offering of our Common Stock in March
1996. We used the net proceeds of our initial public offering principally to
establish our New York headquarters and to produce two CD-ROM games based upon
the Pink Panther(TM) character. We completed such two CD-ROM games in September
1996 and September 1997. We initially marketed such games through distributors
in the United States and we now license such games for distribution by others
both in the United States and in numerous foreign countries.
Page 2 of 48
<PAGE>
In February 1997, we acquired all of the outstanding stock of Western as
well as certain assets and liabilities of Smith Engineering, a sole
proprietorship, from Jay Smith III, our current President, Chief Executive
Officer and Treasurer. Western designs and develops video and computer games and
electronic toys and electronic consumer products, mostly pursuant to funded
contracts with other name-brand manufacturers.
After expending most of the funds raised in our initial public offering
to produce the two Pink Panther(TM) CD-ROM games, we realized that the
development costs of such CD-ROM games greatly exceeded both the short-term and
long-term anticipated revenue streams from such products and shifted our focus
to pre-funded or contract design and development work, such as that historically
conducted by Western. In September 1997, we substantially downsized our New York
office and shifted our headquarters to Western's offices located in Los Angeles.
In April 1998, we closed our New York office permanently, terminated our New
York office lease, subleased almost 50% of our Los Angeles office and production
space and consolidated our entire staff in our remaining Los Angeles office and
production space.
Our Material Developments During Fiscal 1999
Our Business and Results of Operations
We continued to concentrate on funded game and toy development projects
in fiscal 1999. We completed the programming and development of Brunswick
Bowling on both the PC and Sony PlayStation for THQ. We also completed Tiger
Woods Golf on the Sony PlayStation for Electronic Arts. Electronic Arts has sold
well over 500,000 units of Tiger Woods Golf which has earned us an additional
$300,000 in gross royalties. We will earn another $200,000 in gross royalties if
more than 1,000,000 units of Tiger Woods Golf are sold.
During fiscal 1999, we continued to reduce our operating losses. Before
our one-time, non-recurring write-off of goodwill in fiscal 1999 of $1,579,132,
we realized operating losses of $1,166,602 during fiscal 1999. Our fiscal 1999
operating losses were approximately 49% less than our operating losses of
$2,307,831 in fiscal 1998 and approximately 74% less than our operating losses
of $4,486,396 in fiscal 1997. At the end of fiscal 1999, we determined to write
off all of our goodwill recognized as a result of our prior acquisition of all
of the outstanding capital stock of Western as well as certain assets and
liabilities of Smith Engineering in February 1997. This write-off brought our
total losses in fiscal 1999 up to $2,745,734.
During fiscal 1999, we have started several new projects, summarized as
follows:
o Flintstones Bowling - We began development on a new game for SouthPeak
Interactive called Flintstones Bowling. It uses a license from Warner Bros. for
the Flintstones characters in which the characters ride in a large bowling ball
through unique canyon-like environments to knock down pins and collect objects.
o Internet Toys - We have developed and licensed the technology for an
action figure for Steve Austin, a primary character of the World Wrestling
Federation. The toy was developed for JAKKS Pacific and is part of our joint
venture with MagiTech.
Page 3 of 48
<PAGE>
o WCW Game Boy - We have started developing products for Nintendo's
Color Game Boy, a very popular handheld game machine. This first game uses World
Championship Wrestling characters in various fighting arenas. This is the first
in what we believe will be a series of projects for the Color Game Boy.
o Brunswick Bowling - We are developing the next generation of Brunswick
Bowling for the Sony PlayStation. Completion is expected early in fiscal 2000
and this game represents a substantial improvement and upgrade over the previous
PlayStation game.
o Video Football - We recently completed negotiations for a multi-year
contract for video football games on the Sony PlayStation. This would include a
commitment to create a new game each year for the next three years for this
property and may include another football property as well.
During fiscal 1998, our Board of Directors concluded that, as part of
our long-term strategy for becoming profitable, we should enter into a business
combination with another entity. In October 1997, we engaged a business
consulting firm to assist us in, among other things, seeking a business
combination partner or partners. In the ensuing months, we actively reviewed
a variety of possible business combinations with a number of other companies as
well as other strategic alternatives. However, none of these opportunities came
to fruition.
Our Proposed Merger with McGlen
In February 1999, our business consulting firm identified McGlen as a
possible business combination candidate. After two months of discussions and
negotiations, we entered into a definitive agreement on April 28, 1999 with
McGlen and its principal shareholders, which provides for the merger of one of
our wholly-owned subsidiaries with and into McGlen. We publicly announced our
proposed merger with McGlen on April 30, 1999.
Upon completion of our merger with McGlen, McGlen's outstanding common
stock will be automatically converted into the right to receive the number of
shares of our Common Stock calculated such that McGlen's outstanding common
stock (calculated on a fully-diluted basis) plus 117,302 of the shares of our
Common Stock recently sold by us in our recent financing (as discussed below)
will equal, in the aggregate, 87.5% of our then outstanding shares of Common
Stock (calculated on a fully-diluted basis). For purposes of such calculations,
"fully-diluted basis" means all outstanding shares of common stock plus all
shares of common stock issuable upon the exercise or conversion of all options,
warrants, convertible securities or other rights to acquire common stock having
exercise or conversion prices which are less than the value of the common stock
into which such securities are exercisable or convertible, but specifically
excludes any shares issuable pursuant to an agreement between McGlen and Synnex
Information Technologies, Inc. to be assumed by us upon completion of our
proposed merger with McGlen.
Similarly, McGlen's outstanding options, warrants and other rights to
purchase shares of McGlen's common stock will be automatically converted into
options, warrants and similar rights to purchase whole shares of our Common
Stock, with appropriate adjustments in the number of shares purchasable and the
exercise prices based upon the above-referenced exchange ratio for conversion of
McGlen's common stock into shares of our Common Stock.
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<PAGE>
Under our agreement with our business consulting firm, we will be
required to issue to such business consulting firm, upon completion of our
proposed merger with McGlen, shares equaling 5% of our Common Stock outstanding
(calculated on a fully-diluted basis as described above) immediately prior to
the merger.
Under McGlen's agreement with the same business consulting firm (which
will become our obligation upon the completion of our merger with McGlen), we
will be required to issue to such business consulting firm, upon completion of
our proposed merger with McGlen, shares equaling 4% of our post-merger Common
Stock outstanding (calculated on a fully diluted basis as described above). If
such business consulting firm assists McGlen in raising at least $2,500,000
prior to our merger with it, we will be required to issue to such business
consulting firm upon completion of our merger with McGlen, an additional 1.5% of
our post-merger Common Stock outstanding (calculated on a fully-diluted basis as
described above). Our merger agreement with McGlen provides, in turn, that the
shares to be issued to such business consulting firm will reduce, on a
share-for-share basis, the shares of our Common Stock to be issued to McGlen's
securityholders in our merger with it.
All shares of our Common Stock issued to McGlen's former shareholders in
our proposed merger with McGlen, as well as all of our shares issuable upon
exercise of McGlen's former options, warrants and other rights to purchase
shares of its Common Stock automatically converted into options, warrants and
similar rights to purchase shares of our Common Stock and all of our shares
issued to the business consulting firm which represents both us and McGlen as
discussed above, will be "restricted securities" as that term is defined in Rule
144 under the Securities Act of 1933, as amended (the "Securities Act"), and,
accordingly, such shares must be held indefinitely unless such shares are
subsequently registered under the Securities Act or an exemption from
registration is available.
Our completion of our proposed merger with McGlen is subject to a number
of conditions and, although we are confident that such merger will take place,
such conditions may not be met and such merger may not be consummated. These
conditions include, without limitation, the satisfactory completion of due
diligence investigations by both us and McGlen, the preparation and acceptance
of final disclosure statements by both us and McGlen, the approval of the merger
by the shareholders of both us and McGlen and regulatory approval by Nasdaq. In
this latter regard, Nasdaq has advised us that our consummation of our proposed
merger with McGlen will constitute a "reverse merger" within the meaning of Rule
4330 of Nasdaq's Marketplace Rules and that we will need to reapply for listing
on the Nasdaq SmallCap Market upon completion of our proposed merger. In order
for such application to be accepted, we will need to meet the initial listing
requirements set forth in Nasdaq's Marketplace Rules including a minimum bid
price for our Common Stock of at least $4.00 per share.
In July 1999, we retained Billich Associates to render an opinion as to
the fairness of our proposed merger with McGlen from a financial point of view
to our stockholders. Billich Associates has delivered its opinion to us that, in
its view, such proposed merger is fair to our shareholders from a financial
point of view.
Page 5 of 48
<PAGE>
Our Recent Financing
As contemplated by our merger agreement with McGlen, we consummated a
financing pursuant to a purchase agreement entered into on July 12, 1999 with
Escalade Investors, LLC ("Escalade"). Under this purchase agreement, we sold
293,255 shares of our Common Stock to Escalade for gross proceeds of $1,250,000
($4.2625 per share, which was 110% of the closing price of our Common Stock on
July 9, 1999) and received an irrevocable commitment from Escalade to purchase
an additional $750,000 of our Common Stock upon the completion of our proposed
merger with McGlen. The $750,000 will be placed into escrow within three
business days after we deliver written notice to Escalade that the SEC has
approved the proxy statement soliciting the consent of our shareholders for our
proposed merger with McGlen. The $750,000 will be held in the escrow pending the
closing of our merger with McGlen. The price per share of our Common Stock to be
paid by Escalade for the $750,000 in escrow will be equal to 110% of the closing
price for our Common Stock on the trading day prior to such funding.
Escalade also received, at no additional cost, a three-year warrant to
purchase 29,325 additional shares of our Common Stock at an exercise price of
$4.843 per share (which was 125% of the closing price of our Common Stock on
July 9, 1999). Upon the funding of the $750,000, Escalade will also receive, at
no additional cost, an additional three-year warrant covering a number of shares
of our Common Stock equal to 10% of the number of shares of our Common Stock it
receives in consideration for such $750,000. Such additional warrant will have
an exercise price equal to 125% of the closing price for our Common Stock on the
trading day prior to such funding.
The warrants issued or issuable by us to Escalade may be exercised by
Escalade on a "cashless exercise" basis to the extent that the average market
value of the shares of our Common Stock issuable upon exercise of such warrants
for the five trading days prior to exercise exceeds the aggregate exercise price
for the shares as to which the warrants are being exercised.
If the average closing price for our Common Stock for the two 90-day
periods immediately subsequent to October 10, 1999 (subject to certain
adjustments) does not equal 115% and 118%, respectively, of the aggregate price
paid by Escalade for such Common Stock, Escalade has repricing rights under our
purchase agreement with it such that we will be required to issue additional
shares to Escalade for no additional consideration so that the value of the
purchased shares plus the additional shares equals 115% or 118%, as applicable,
of the aggregate purchase price paid by Escalade for such Common Stock.
The proceeds raised by us from such financing have been, and will be,
used to fund our immediate operational obligations, our payables, our expenses
arising from our proposed merger with McGlen (including legal and accounting
fees and other merger-related expenses) and our loan to McGlen described below.
Under our purchase agreement with Escalade, we agreed to register all
shares of our Common Stock issued or issuable to it, including shares of our
common stock issued upon exercise of the warrants described above, pursuant to a
registration statement which becomes effective by October 10, 1999. We also
agreed to use our best efforts to keep the registration statement effective
until July 12, 2001, until Escalade no longer holds or has the right to acquire
shares or until all of its shares may be sold pursuant to Rule 144 under the
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<PAGE>
Securities Act, whichever comes first. We also agreed to bear all reasonable
expenses, other than underwriting discounts, selling commissions, selling
concessions and other expenses incurred by Escalade and other than legal fees in
excess of $4,500 incurred by Escalade, in connection with the registration and
sale of the shares of our Common Stock being offered by it. After such
registration statement becomes effective, Escalade may not sell more than
33-1/3% of the shares of our Common Stock it holds in any 30-day period.
Our purchase agreement with Escalade also provides that we may not offer
or sell shares of our Common Stock or securities convertible into shares of our
Common Stock without Escalade's prior written consent until the date which is
180 days after the latter of the effective date of the above-referenced
registration statement or the funding of the remaining $750,000 by Escalade.
Escalade's consent is not required in connection with securities sold pursuant
to the our proposed merger with McGlen, securities sold in an underwritten
public offering with gross proceeds of at least $10,000,000, securities sold for
an effective price per share of our Common Stock equal to or greater than the
weighted average of the price per share paid and to be paid by Escalade for
shares that are "restricted securities" throughout such 180-day period and under
certain other circumstances;
We are not obligated to issue additional shares of our Common Stock to
Escalade to the extent such issuance would violate Nasdaq's rules relating to
limitations on the amount of shares that can be issued without stockholder
approval. However, we are required to seek such approval and, if we do not
obtain it, we will be obligated to redeem, at a redemption price equal to 120%
of the price paid by Escalade, such number of shares of our Common Stock held by
Escalade such that we can issue the additional shares without violating the
limitations imposed by Nasdaq.
Our Loan to McGlen
On July 23, 1999, we loaned $500,000 to McGlen. The loan was made from a
portion of the proceeds of the financing with Escalade described above, as
required by the terms of our merger agreement with McGlen.
Under the terms of the note issued to us by McGlen evidencing such loan,
the loan has a term of 366 days (although McGlen may prepay the principal
without penalty or premium). The outstanding principal amount of the loan
accrues interest at an 8% annual rate. In the event of a default, the total
amount outstanding becomes immediately due and payable in full at our option.
McGlen may use the proceeds of the loan only for working capital or other
corporate purposes until the loan has been repaid in full. We and McGlen also
entered into a security agreement which provides us with a junior security
interest in McGlen's assets. McGlen's indebtedness to us evidenced by the note
is also subordinate in right of payment to the prior payment in full of the
principal amount of any currently existing secured obligation of McGlen or its
subsidiaries and any future vendor/supplier accounts which from time to time
require a security interest in McGlen's assets, and all related interest, fees,
expenses, refinancings thereof and other amounts payable with respect thereto.
Our Marketing and Sales
We rely primarily on Jay Smith III, our current President, Chief
Executive Officer and Treasurer, and Michael Cartabiano, our current Vice
President and Secretary, for sales and licensing of our products and proposed
products to brand-name manufacturers, distributors and licensees.
Page 7 of 48
<PAGE>
We also rely on our contacts and relationships within the industry to
license our concepts and obtain development contracts. In addition, we are
constantly seeking new relationships and customers.
Our Product Development
The development of our products and product concepts is generally
performed in-house with our full-time employees plus occasional freelance
artists, animators, writers or programmers. We maintain a schedule and budgeting
system designed to control our development costs and to meet our deadlines.
Our product development capabilities include programming for a variety
of game systems including PCs, Sony PlayStations and Sega Saturn systems.
Artwork and graphics include two-dimensional animation for the Pink Panther(TM)
CD-ROM games developed by us and three-dimensional animation and graphics for
other games developed by us. Audio includes sound effects, music and voiceover
in a variety of formats. Producers direct the design and development of each of
the games and are involved in each step of such development.
We also license the manufacturing and distribution of certain of our
products to marketing firms, both domestic and international.
Our Competition
The markets for our products are characterized by intense competition.
We expect that companies which have developed similar products, as well as other
companies with the financial resources and expertise that would enable them to
attempt to develop competitive products, make it more difficult for us to get
contracts to develop such products. Many of our competitors such as Sega,
Nintendo and Sony are well-established, have much greater financial resources,
much greater public and industry recognition and much broader marketing
capabilities than us. They also have the ability to control the use of our
products on their proprietary systems. We believe the principal competitive
factors in our markets are product quality, reliability, features, functions,
creativeness, performance, price, financial stability, product reputation, ease
of use and quality of support. A number of companies offer competitive products
addressing our markets. We may not be able to compete successfully, or our
competitors or others may develop technologies or products that render our
products or product concepts obsolete or less marketable.
Our Intellectual Property Rights
We presently own approximately 40 patents in various areas ranging from
circuit boards to toys. Some of the patents are mechanical design patents, some
are software or article patents and some are for basic technology ranging from
hardware to optical. We also have an aggregate of five trademarks which are
registered or in the process of being registered.
We have historically treated, and intend to continue to treat, our
products and product concepts and software as proprietary and have relied, and
will continue to rely, primarily on a combination of trademark, copyright and
trade secret laws and employee and third-party nondisclosure agreements to
protect our intellectual property rights.
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Our Research and Development
With our shift in focus to pre-funded or contract design and development
work during fiscal 1998, we do not presently spend any material amounts on
research or development activities relating to new products which we intend to
own and market.
Our Employees
As of June 30, 1999, we employed 33 people on a full-time basis,
including persons engaged in game design, writing, research, sound, art,
animation, computer programming, management and administration. At June 30,
1999, we also employed 4 persons as part-time employees. We believe that our
relations with our employees are satisfactory.
Item 2. Description of Property.
We presently lease approximately 13,140 rentable square feet of office
and production space in Los Angeles, California pursuant to a noncancellable
lease expiring on January 31, 2002 at a current minimum monthly rent equal to
$15,768. We currently sublease approximately 10% of such office and production
space to an unrelated third-party sublessee for an aggregate of $1,300 in
monthly rent. We believe that our present lease provides us with adequate space
for the foreseeable future.
As noted above, we terminated our New York office lease as a part of the
down-sizing of our staff and facilities in or about April 1998 and presently
have no further liabilities in respect of such New York office lease.
Item 3. Legal Proceedings
We are not presently a party to any pending litigation.
Item 4. Submission of Matters to a Vote of Security Holders.
We did not submit any matter to a vote of our security holders during
the fourth quarter of fiscal 1999.
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PART II
Item 5. Market for Common Equity and Related Stockholder Matters.
(a) Our Common Stock is traded on the Nasdaq SmallCap Market under the
symbol "ADRN". The following table sets forth, for our last two fiscal
years, the high and low quarterly sales prices for our Common Stock as
reported by the Nasdaq SmallCap Market:
Common Stock*
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Quarter Ended High Low
------------- ---- ---
Fiscal 1998
September 30, 1997 $1.19 $0.25
December 31, 1997 2.25 0.44
March 31, 1998 0.88 0.38
June 30, 1998 3.81 0.63
Fiscal 1999
September 30, 1998 $4.60 $1.85
December 31, 1998 1.85 1.50
March 31, 1999 3.70 0.75
June 30, 1999 8.50 3.38
- ----------------------------
* Figures through December 31, 1998 have been adjusted to reflect our 3-for-1
reverse stock split effected on December 29, 1998.
(b) On September 8, 1999, there were 439 holders of record of our Common
Stock. We believe that there are significantly more beneficial holders
of our Common Stock as approximately 71% of our Common Stock is held in
"street" name.
(c) No cash dividends have been paid on our Common Stock, and we do not
anticipate paying cash dividends on our Common Stock in the
foreseeable future.
(d) We did not issue or sell any equity securities during the fourth quarter
of fiscal 1999 which were not registered under the Securities Act.
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Item 6. Management's Discussion and Analysis or Plan or Operation.
(a) Results of Operations.
During fiscal 1999, we realized revenues of $2,880,936, an
increase of $124,238, or approximately 4.5%, over our revenues of $2,756,698 for
fiscal 1998. We believe that our growth in revenues during fiscal 1999 was
limited during the last two quarters of such year due to our management's focus
on matters relating to our proposed merger with McGlen. We realized $2,156,754
in revenues from our toy and game development contracts during fiscal 1999 as
compared to $1,886,497 during fiscal 1998. Our increased toy and game
development contract revenue during fiscal 1999 was principally due to a greater
number of significant contracts and our more efficient utilization of our unique
skills. Royalty income was $724,182 during fiscal 1999 as compared to $870,201
in fiscal 1998 and $601,713 in fiscal 1997.
Our operating expenses of $4,047,538 during fiscal 1999
(exclusive of the goodwill write-off discussed below) were $998,155 less than
our operating expenses of $5,045,693 during fiscal 1998, an improvement of
approximately 20%. Although our expenses related to our toy and game development
contracts increased to $1,922,460 in fiscal 1999 as compared to $1,533,917 in
fiscal 1998, such increase was more than offset by our reduction in our selling,
general and administrative expenses from $2,367,973 in fiscal 1998 to $1,305,169
in fiscal 1999 and the elimination of our research and development expenses in
fiscal 1999 as compared to $152,126 in fiscal 1998. Our approximately 52%
reduction in our selling, general and administrative expenses in fiscal 1999
from fiscal 1998 resulted from our improved management of our non-production
related expenses and the elimination of our expenses related to our New York
office closed during fiscal 1998. Our interest expense was $55,057 in fiscal
1999 as compared to $60,663 in fiscal 1998 and $37,086 in fiscal 1997.
Prior to our write-off of goodwill as discussed below, we
realized operating losses of $1,166,602 during fiscal 1999, which was
approximately 49% less than our operating losses of $2,307,831 in fiscal 1998.
Our improvement in operating losses during fiscal 1999 was primarily due to a
combination of higher revenues and a significant reduction in our selling,
general and administrative expenses from fiscal 1998. An aggregate of $764,852
of our operating losses in fiscal 1999 were the result on non-cash charges for
depreciation and amortization of intangible assets, including amortization in
respect of our patents and licenses and the write-off of advance royalties.
Another $99,244 of such losses during fiscal 1999 resulted from non-cash charges
relating to our issuance of securities in exchange for consulting services.
At the end of fiscal 1999, we elected to write off the entire
amount of our remaining unamortized goodwill of $1,579,132 appearing on our
balance sheet which arose from our prior acquisition of all of the
outstanding common stock of Western and certain of the assets and liabilities of
Smith Engineering in February 1997. Such write-off has streamlined our
operations in preparation for our pending merger with McGlen but has resulted in
our reporting total net losses of $2,745,734 for fiscal 1999.
Due to our continued net losses in fiscal 1999, we had an
accumulated deficit of $11,896,785 at June 30, 1999 as compared to an
accumulated deficit of $9,151,051 at June 30, 1998.
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(b) Liquidity and Capital Resources.
As a result of our continued losses during fiscal 1999, we began
a search for additional equity capital in the latter part of fiscal 1999 to fund
our continued operations through at least the completion of our proposed merger
with McGlen. In July 1999, we successfully raised gross proceeds of $1,250,000
from the sale of shares of our Common Stock to Escalade and received an
irrevocable commitment from Escalade to purchase another $750,000 worth of our
Common Stock upon completion of our proposed merger with McGlen. See "Our
Material Developments During Fiscal 1999-Our Recent Financing" commencing on
page 5 of this report.
If our proposed merger with McGlen takes place, of which we can
give no assurance, we anticipate that we will require additional equity and/or
debt capital in order for us and McGlen to accomplish our combined short-term
and long-term business objectives. If our proposed merger with McGlen does not
take place, which we do not presently anticipate, we will definitely need to
raise additional equity and/or debt capital if we are to continue in business.
Under either scenario, we presently have no preliminary or definitive agreement
to complete any such additional financing with any other person or persons.
Accordingly, we cannot make any assurances that we will be able to raise any
such required additional capital. In addition, our ability to complete any such
future equity and/or debt financing will depend upon our then financial
condition, results of operations and future business prospects as well as market
conditions at the time such additional equity and/or debt financing is
consummated. Many of the factors which will influence our ability to conduct any
such future financing will be outside of our control. For these reasons, we
cannot make any assurances that we will successfully complete any such required
equity and/or debt financing.
Safe Harbor Statement
---------------------
Statements contained in this report which are not historical facts,
including statements about our business strategies and our expectations about
existing products and product development opportunities, market and industry
segment growth, demand for and acceptance of our existing products and product
concepts, are forward looking statements that involve risks and uncertainties.
These include, but are not limited to, product demand and market acceptance
risks; the impact of competitive products and pricing; the results of financing
efforts; the loss of any significant customers; the effect of our accounting
policies; the effects of economic conditions and trade, legal, social and
economic risks such as import, licensing and trade restrictions; the results of
our execution our business plan and the impact on us of our relationships with
our lenders, investors, customers and vendors.
Item 7. Financial Statements.
Our financial statements listed below are included on pages F-1 through
F-21 following the signature page to this report:
Title of Document Page
Independent Auditors' Report F-1
Consolidated Balance Sheet F-2
June 30, 1999
Page 12 of 48
<PAGE>
Consolidated Statements of Operations F-3
Years Ended June 30, 1999 and 1998
Consolidated Statements of Changes in Shareholders' Equity F-4
Years Ended June 30, 1999 and 1998
Consolidated Statements of Cash Flows F-6
Years Ended June 30, 1999 and 1998
Notes to Consolidated Financial Statements F-8
Years Ended June 30, 1999 and 1998
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance
With Section 16(a) of the Exchange Act.
(a) Information Relating to Executive Officers and Directors.
The following table sets forth certain information relating to
our current executive officers and directors:
Position(s) with
Name Age the Company
---- --- ----------------
Jay Smith, III 59 President, Chief Executive
Officer, Treasurer and
Director
Michael Cartabiano 48 Vice President and
Secretary
Robert A.D. Wilson 48 Director
Edward H. MacKay 65 Director
Jay Smith III. Mr. Smith has been one of our directors since
February 1997. In May 1997, Mr. Smith was appointed as our President, Chief
Executive Officer and Treasurer. Mr. Smith also served as our Secretary from
September 1997 to May 1998. Prior to our acquisition of Western, Mr. Smith
served as the founder, President and sole shareholder of Western. Mr. Smith was
also the sole owner of Smith Engineering. Mr. Smith owned and operated Western
and Smith Engineering for approximately 17 years and 23 years, respectively,
prior to our acquisition of the stock of Western and certain of the assets of
Smith Engineering in February 1997. Mr. Smith has over 30 years' experience in
engineering, invention and research and development in the electronic toy
Page 13 of 48
<PAGE>
and game industry and mechanical and electronic consumer products. Prior to
establishing Western and Smith Engineering, Mr. Smith served as a founding
partner of California R&D Center, the Vice President of Engineering of Innova,
Inc., a toy and doll designer for Mattel Toys and a member of the Space Program
Technical staff at TRW, Inc. Mr. Smith holds a B.S. Degree in Engineering
Mechanics from Virginia Institute of Technology and an M.S. Degree in Applied
Mechanics with California Institute of Technology.
Michael Cartabiano. Mr. Cartabiano's association with Western
began in 1994. In February 1997, Mr. Cartabiano was appointed to manage our toy
and game group. Mr. Cartabiano was appointed as our Vice President in February
1998 and as our Secretary in May 1998. Mr. Cartabiano has approximately 25 years
of experience in the consumer products industry having previously held the
position of Vice President of Design for Mattel Toys in El Segundo, California
from 1987 to 1993. Mr. Cartabiano has also held research and development
management positions at Tonka Toys in Minnetonka, Minnesota, Milton Bradley
Games in East Longmeadow, Massachusetts, and Hasbro Products in Pawtucket, Rhode
Island. Mr. Cartabiano earned his B.S. degree from the University of Bridgeport
in Connecticut in 1973.
Robert A.D. Wilson. Mr. Wilson first became one of our directors
in November 1997. Mr. Wilson has been Chairman and majority owner of Sound
Technology PLC, an electronics distribution company located in the United
Kingdom, since 1978. In addition, Mr. Wilson serves as Vice Chairman of Alesis
Studio Electronics, Inc., an international manufacturing and marketing company
for studio electronics located in California. Currently, Mr. Wilson is a
director of Business Link, a United Kingdom government sponsored initiative to
new and emerging industries, and is Chairman of the British Music Fairs Ltd., as
well as past President of the Music Industries Association.
Edward H. MacKay. Mr. MacKay first became one of our directors
in February 1999. Since October 1998, Mr. MacKay has been CEO of Cyberdat. From
1995 to 1997, he was Executive Vice President, Chief Operating Officer and Chief
Financial Officer of Visicom Laboratories, a developer of software and hardware
for C41 applications for the U.S. Navy. From 1981 to 1995, he was Chief
Executive Officer and Chairman of the Board of ATM Service Corporation, an
automated teller machine service business.
There are no family relationships among any of our directors or
executive officers.
(b) Section 16(a) Reporting Delinquencies.
The following executive officers and directors failed to file on
a timely basis one or more reports required to be filed by them under Section
16(a) of the Exchange Act during or with respect to fiscal 1999:
Number of
Name of Executive Number of Late Transactions
Officer or Director Capacity or Capacities Reports Filed Reported Late
- ------------------- ---------------------- ------------- -------------
Michael Cartabiano Vice President and Secretary 1 1
Robert A.D. Wilson Director 2 1
Edward H. MacKay Director 2 1
Thomas A. Schultz Former Director 2 2
Page 14 of 48
<PAGE>
As of the date hereof, we are not aware of the continued failure
of any of our current officers and directors to file such required reports.
Item 10. Executive Compensation.
(a) The following Summary Compensation Table sets forth the names,
positions and annual compensation paid by us for each of our fiscal years ended
June 30, 1999, 1998 and 1997 to Jay Smith, III, our current President, Chief
Executive Officer and Treasurer, and Michael Cartabiano, our only other current
executive officer or key employee whose aggregate annual compensation exceeded
$100,000 during fiscal 1999:
<TABLE>
SUMMARY COMPENSATION TABLE
<CAPTION>
Long Term
Annual Compensation Compensation Awards
------------------- -------------------
Securities All Other
Fiscal Salary Bonus Underlying Options Compensation
Name and Position(s) Year ($) ($) (#) ($)
- -------------------- ------ ------ ----- ------------------ -------------
<S> <C> <C> <C> <C> <C>
Jay Smith, III, President, 1999 $149,300 -0- -0- $21,294(1)
Chief Executive Officer, 1998 150,000 -0- 233,333 $23,461(2)
Treasurer and Director 1997 57,775(3) -0- -0- -0-(4)
Michael Cartabiano, 1999 130,000 -0- 333 -0-
Vice President and 1998 118,240 -0- 58,333 -0-(5)
Secretary 1997 n/a n/a 6,333 n/a
</TABLE>
- --------------------------
(1) Reflects legal fees and costs we paid in defense of a lawsuit against
Mr. Smith d/b/a Smith Engineering and the reimbursement of automobile
costs for Mr. Smith, but excludes $25,407 received by Mr. Smith pursuant
to his license agreement with Western (See Item 12(a)).
(2) Reflects legal fees and costs we paid in respect of the defense of a
lawsuit against Mr. Smith d/b/a Smith Engineering and the reimbursement
of automobile costs for Mr. Smith, but excludes $143,403 received by Mr.
Smith pursuant to his license agreement with Western (See Item 12(a)).
(3) Reflects Mr. Smith's salary from February 1997 through June 30, 1997
after our acquisition of Western.
(4) Excludes $69,928 received by Mr. Smith pursuant to his license agreement
with Western referred to in
footnote 1 above.
(5) Excludes $55,200 received by Mr. Cartabiano pursuant to a
royalty-sharing arrangement with Western entered into prior to the
Company's acquisition of Western in February 1997 and subsequently
modified and supplemented (See Item 12(b)).
Page 15 of 48
<PAGE>
(b) The following table sets forth certain information with respect to
all stock options granted by us during fiscal 1999 to Messrs. Smith and
Cartabiano:
OPTION GRANTS IN LAST FISCAL YEAR
Individual Grants
--------------------------------------------------------------------------
Number of % of Total
Securities Options
Underlying Granted to
Options Employees Exercise
Granted in Fiscal Price Expiration
Name (#) Year ($/Sh) Date
---- ---------- ---------- -------- ----------
Jay Smith, III -0- -0- n/a n/a
Michael Cartabiano 333 1.56% $1.00 01/31/04
(c) The following table sets forth certain information with respect to
the exercise of stock options during fiscal 1999 and the value of unexercised
stock options held by Messrs. Smith and Cartabiano at the end of fiscal 1999:
<TABLE>
AGGREGATED OPTION EXERCISES IN LAST FISCAL
YEAR AND FISCAL YEAR-END (FYE) OPTION VALUES
--------------------------------------------
<CAPTION>
Number of Securities Value of Unexercised
Underlying In-the-Money
Unexercised Options Options At FYE ($)
Shares Acquired At FYE Exercisable/ Exercisable/
Name On Exercise(#) Value Realized Unexercisable Unexercisable
- ---- --------------- -------------- -------------------- --------------------
<S> <C> <C> <C> <C>
Jay Smith, III None n/a 145,068/99,098 $290,136/$198,196
Michael Cartabiano None n/a 43,721/21,278 $105,739/$51,850
</TABLE>
(d) Executive Officer Employment Contracts.
1. On December 16, 1997, we entered into a three-year employment
agreement with Mr. Smith (the "Smith Employment Agreement"). The Smith
Employment Agreement provides that he will serve as our President and Chief
Executive Officer and receive a base salary of $150,000 per year for his
services. Mr. Smith is also entitled to receive bonuses based upon our
achievement of our goals as determined by our Board of Directors. The Smith
Employment Agreement also provides that Mr. Smith will devote all of his
business time, attention and energy to our business and will be subject to a
one-year covenant not to directly compete with us after his relationship with us
ends. Mr. Smith is also entitled to participate in all group health and
insurance programs and other fringe benefits or retirement plans available to
other of our employees.
Page 16 of 48
<PAGE>
The Smith Employment Agreement automatically terminates upon Mr. Smith's
death, permanent disability or involuntary termination for cause. If Mr. Smith
is terminated without cause (which is deemed to include Mr. Smith's resignation
after we: (a) reduce his monthly base compensation by more than 25% other than
as a result of a decrease in the compensation of all of our executive officers
based upon our financial performance; (b) significantly change Mr. Smith's
duties, responsibilities, authority, powers or functions; (c) require Mr. Smith
to relocate to an office more than 25 miles from our current executive offices
in Los Angeles; or (d) fail to perform any of our material obligations to Mr.
Smith), we will be obligated to: (i) pay Mr. Smith a lump-sum payment equal to
$150,000; (ii) continue to provide Mr. Smith's other employment benefits at our
expense 12 months; (iii) enter into a post-termination consulting agreement with
Mr. Smith pursuant to which Mr. Smith will be required to provide no more than
10 hours of consulting services per week to us and will be entitled to receive
the sum of $150 for each hour actually worked; and (iv) grant Mr. Smith a
120-day exclusive option to repurchase all of the stock of Western for Western's
then net book value as reflected on our books and records.
The Smith Employment Agreement also provided that Mr. Smith was to be
awarded stock options to purchase up to 233,333 share of our Common Stock at an
exercise price equal to $1.875 per share. Such options have a 10-year term and
become exercisable at the rate of 19,244 shares at the end of each calendar
quarter of Mr. Smith's employment under the Smith Employment Agreement from and
after December 16, 1997.
Page 17 of 48
<PAGE>
Item 11. Security Ownership of Certain Beneficial Owners and Management.
The following table sets forth, as of September 20, 1999, the number of
shares of our Common Stock held of record or beneficially: (i) by each person
who held of record, or was known by us to own beneficially, more than 5% of the
outstanding shares of the our Common Stock; (ii) by each of our current
executive officers and directors; and (iii) by all of our current executive
officers and directors as a group:
Percent of
Names and Address Number of Outstanding Shares
of Beneficial Owner Shares Owned (1) of Common Stock(2)
------------------- ---------------- ------------------
Jay Smith, III
5301 Beethoven St.
Los Angeles, CA 90066 406,095(3) 11.0%
Michael Cartabiano
5301 Beethoven St.
Los Angeles, CA 90066 43,721(4) 1.2%
Robert A.D. Wilson
Letchworth Point
Dunhams Lane
Letchworth, Hertfordshire
SG6 1 AND England 80,843 2.3%
Edward H. Mackay
1643 Fuerte Hills Drive
El Cajon, CA 92020 25,000(5) 0.7%
Escalade Investors, LLC
One World Trade Center, Ste. 4563
New York, New York 10046 322,580(6) 9.0%
All current executive officers
and directors as a group
(four persons) 555,659(7) 14.8%
------------------------
(1) Except as otherwise indicated and subject to applicable community
property and similar statutes, the persons listed as beneficial
owners of the shares of our Common Stock have sole voting and
dispositive power with respect of such shares.
Page 18 of 48
<PAGE>
(2) For purposes of computing the percentages, the number of shares
of Common Stock outstanding includes shares purchasable within 60
days upon exercise of outstanding stock options and warrants, as
follows: Mr. Smith (164,512 shares), Mr. Cartabiano (43,721
shares), Mr. Mackay (25,000 shares), Escalade Investors, LLC
(29,325 shares) and all executive officers and directors as a
group (233,233 shares).
(3) Includes 241,583 shares of Common Stock owned of record by a
family trust established for the benefit of Mr. Smith and his
spouse and 164,512 shares purchasable within 60 days upon
exercise of outstanding stock options.
(4) All of the shares of Common Stock beneficially owned by Mr.
Cartabiano are shares purchasable within 60 days upon exercise of
outstanding stock options.
(5) All of the shares of Common Stock beneficially owned by Mr.
Mackay are shares purchasable within 60 days upon exercise of
outstanding options.
(6) Includes 29,325 shares purchasable within 60 days upon exercise
of an outstanding warrant.
(7) Includes 233,233 shares of Common Stock purchasable within 60
days upon exercise of outstanding stock options.
Item 12. Certain Relationships and Related Transactions.
(a) In February 1997, we acquired all of the issued and outstanding
capital stock of Western and certain of the assets and liabilities of Smith
Engineering from Jay Smith, III, our current President, Chief Executive Officer,
Treasurer and Director, in exchange of 267,666 shares of our Common Stock. As a
part of such acquisition, Western entered into a license agreement with Mr.
Smith (the "Smith License Agreement") pursuant to which Mr. Smith granted to
Western the exclusive right to use and market patents and license agreements
owned by Mr. Smith and Smith Engineering. The Smith License Agreement provides
that 75% of the revenues of such patents and licenses are to be retained by
Western and 25% are to be retained by Mr. Smith until Mr. Smith receives the
aggregate sum of $2,000,000 from such patents and licenses, after which time no
further revenue is to inure to Mr. Smith and the patents and licenses will be
assigned to Western. During fiscal 1999, Mr. Smith received an aggregate of
$25,407 in revenues pursuant to the Smith License Agreement. During fiscal 1998,
Mr. Smith received an aggregate of $143,303 in revenues pursuant to the Smith
License Agreement.
(b) Michael Cartabiano, our Vice President and Secretary is entitled to
share in certain royalties generated by us in respect of certain products
created by him pursuant to an arrangement entered into between Mr. Cartabiano
and Western prior to our acquisition of Western, which arrangement has been
modified and supplemented subsequent to our acquisition of Western. During
fiscal 1999, Mr. Cartabiano did not receive any revenues pursuant to such
arrangement. During fiscal 1998, Mr. Cartabiano received an aggregate of $55,200
in revenues pursuant to such arrangement.
Page 19 of 48
<PAGE>
(c) On November 18, 1997, we entered into a consulting agreement with
Kayne International, Inc., a business consulting firm with which Thomas A.
Schultz, a former director, is affiliated (the "Kayne Consulting Agreement").
The Kayne Consulting Agreement, which expired on December 31, 1998, provided
that we were to pay Kayne the sum of $1,500 per day plus expenses for all
business consulting services rendered to us by Mr. Schultz on behalf of Kayne.
During fiscal 1998, we paid Kayne the sum of $163,000 in fees for the consulting
services performed by Mr. Schultz under the Kayne Consulting Agreement (which
sum includes the issuance date value of an aggregate of 73,333 shares of our
Common Stock issued to Kayne on May 12, 1998 at a price equal to $1.875 per
share in lieu of previously accrued but unpaid consulting fees due Kayne
thereunder).
(d) On April 10, 1998, we entered into a consulting agreement with
Robert A.D. Wilson, a director, pursuant to which Mr. Wilson agreed to provide
certain consulting services to us in exchange for 8,333 shares of our Common
Stock issued to Mr. Wilson at a deemed price of $1.875 per share.
Item 13. Exhibits and Reports on Form 8-K.
<TABLE>
(a) Exhibits.
<CAPTION>
Exhibit
No. Description Page No.
------- --------------------------------------------------------------------------- --------
<S> <C> <C>
2.1 Agreement and Plan of Merger, dated as of April 28, 1999, among Adrenalin,
Adrenalin's subsidiary, McGlen and McGlen's principal shareholders,
incorporated by reference from Exhibit 2.1 to our Current Report on Form 8-K,
dated April 30, 1999 ("April 30 Form 8-K"). N/A
2.2 First Amendment to Agreement and Plan of Merger, dated July 23, 1999,
among Adrenalin, Adrenalin's subsidiary, McGlen and McGlen's principal
shareholders, incorporated by reference from Exhibit 2.1 to our Current Report
on Form 8-K, dated July 23, 1999 ("July 23, 1999 Form 8-K"). N/A
3.1 Certificate of Incorporation of Adrenalin, as amended, incorporated by
reference from Exhibit 3.1 to our Registration Statement on Form SB-2, No.
333-00178 ("1996 Registration Statement"). N/A
3.2 Certificate of Amendment of Certificate of Incorporation of Adrenalin, filed
with the Delaware Secretary of State on May 14, 1998, incorporated by
reference from Exhibit 3.1 to our Current Report on Form 8-K, dated June 3,
1998. N/A
3.3 Bylaws of Adrenalin, as amended, incorporated by reference from Exhibit 3.2
to our 1996 Registration Statement. N/A
4.1 Common Stock Purchase Agreement, dated July 12, 1999, between Adrenalin
and Escalade, incorporated by reference from Exhibit 4.1 to our Current Report
on Form 8-K, dated July 12, 1999 ("July 12, 1999 Form 8-K"). N/A
Page 20 of 48
<PAGE>
4.2 Registration Rights Agreement, dated July 12, 1999, between Adrenalin and
Escalade, incorporated by reference from Exhibit 4.2 to our July 12, 1999 Form
8-K. N/A
4.3 Form of Warrant issued and to be issued by Adrenalin to Escalade,
incorporated by reference from Exhibit 4.3 to our July 12, 1999 Form 8-K. N/A
4.4 Form of Escrow Instructions to be entered into between Adrenalin and
Escalade, incorporated by reference from Exhibit 4.4 to our July 12, 1999 Form
8-K. N/A
4.5 Form of Warrant issued to affiliates and transferees of Mackenzie Shea, Inc.
("MSI"), incorporated by reference from Exhibit 4.1 to our Quarterly Report on
Form 10-QSB for our quarterly period ended March 31, 1998 ("March 1998
Form 10-QSB"). N/A
4.6 Form of Incentive Stock Option Agreement issued to our executive officers and
key employees pursuant to our 1995 Stock Option Plan, incorporated by
reference from Exhibit 4.2 to our March 1998 Form 10-QSB. N/A
4.7 Form of Nonqualified Stock Option Agreement issued to our outside directors,
business consultants and other service providers, incorporated by reference
from Exhibit 4.3 to our March 1998 Form 10-QSB. N/A
4.8 Form of Warrant issued to Lloyd Wade Securities, Inc. ("LWSI") and three of
its principals, incorporated by reference from Exhibit 4.4 to our March 1998
Form 10-QSB. N/A
4.9 Form of Warrant to Purchase Common Stock issued to affiliates and transferees
of MSI, incorporated by reference from Exhibit 4.3 to our 1998 Registration
Statement. N/A
10.1 Agreement, dated October 1, 1997, as amended, between Adrenalin and MSI
relating to business consulting services provided to Adrenalin by MSI,
incorporated by reference from Exhibit 10.1 to our Form 10-KSB for our fiscal
year ended June 30, 1998 ("1998 Form 10-KSB"). N/A
10.2 Letter Agreement, dated November 18, 1997, as amended on April 21, 1998
and August 31, 1998, between Adrenalin and Kayne relating to management
consulting services provided to Adrenalin by Kayne, incorporated by reference
from Exhibit 10.2 to our 1998 Form 10-KSB. N/A
10.3 Employment Agreement, dated December 16, 1997, between Adrenalin and Jay
Smith, III, incorporated by reference from Exhibit 10.1 to our March 1998
Form 10-QSB. N/A
10.4 Consulting Agreement, dated April 10, 1998, between Adrenalin and Robert
A.D. Wilson relating to general consulting services provided to Adrenalin by
Mr. Wilson, incorporated by reference from Exhibit 10.5 to our 1998 Form 10-
KSB. N/A
10.5 Optional Advance Note ("Variable Note") for $400,000 Plus Interest, dated
June 30, 1998, issued by Adrenalin to Bay Area Financial Corporation,
incorporated by reference from Exhibit 10.8 to our 1998 Form 10-KSB. N/A
Page 21 of 48
<PAGE>
10.6 Secured Promissory Note, dated July 23, 1999, by McGlen to Adrenalin in the
principal amount of $500,000 and payable on July 23, 2000, incorporated by
reference from Exhibit 10.1 to our Current Report on Form 8-K, dated July 23,
1999. N/A
10.7 Adrenalin's 1995 Stock Option Plan, as amended, incorporated by reference
from Exhibit 10.4 to our 1996 Registration Statement. N/A
10.8 Amendment No. 2 to Adrenalin's 1995 Stock Option Plan, dated December 1,
1997, incorporated by reference from Exhibit 10.13 to our 1998 Form 10-KSB. N/A
10.9 Adrenalin's 1996 Stock Option Plan, as amended, incorporated by reference
from Exhibit A to Adrenalin's definitive proxy materials in respect of
Adrenalin's 1996 Annual Meeting of Shareholders. N/A
10.10 Amendment No. 2 to Adrenalin's 1996 Stock Option Plan, dated December 1,
1997, incorporated by reference from Exhibit 10.15 to our 1998 Form 10-KSB. N/A
10.11 Acquisition Agreement among Adrenalin, Western and Jay Smith III d/b/a
Smith Engineering, dated as of December 30, 1996, incorporated by reference
from Exhibit 7(c)(1) to our Current Report on Form 8-K, dated February 4,
1997 ("1997 Form 8-K"). N/A
10.12 License Agreement, dated February 4, 1997, between Western and Jay Smith,
III, incorporated by reference from Exhibit 7(c)(2) to our 1997 Form 8-K. N/A
21 Subsidiaries of Adrenalin. 47
27 Financial Data Schedules. 48
</TABLE>
(b) Reports on Form 8-K.
1. On April 30, 1999, we filed a Current Report on Form 8-K announcing
our plan to raise between $500,000 and $2,000,000 of additional capital pursuant
to a private placement to accredited investors.
2. On April 30, 1999, we filed a second Current Report on Form 8-K
correcting certain information relating to our proposed private placement
erroneously reported by Dow Jones.
3. On April 30, 1999, we filed a third Current Report on Form 8-K
announcing our proposed merger with McGlen.
4. On June 10, 1999, we filed a Current Report on Form 8-K announcing
the termination of our proposed private placement announced on April 30, 1999
and the commencement of a new plan to raise $2,000,000 of additional capital
pursuant to a private placement to accredited investors.
5. On July 13, 1999, we filed a Current Report on Form 8-K announcing
that we had successfully consummated a $2,000,000 private placement with
Escalade.
Page 22 of 48
<PAGE>
6. On July 26, 1999, we filed a Current Report on Form 8-K announcing
that we had loaned $500,000 to McGlen and had amended our merger agreement with
McGlen to extend the termination date to October 31, 1999.
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
Date: September 22, 1999
ADRENALIN INTERACTIVE, INC.
By: /s/ Jay Smith
-----------------------------
Jay Smith III, President, Chief
Executive Officer and Treasurer
(principal executive, financial and
accounting officer)
Page 23 of 48
<PAGE>
In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the registrant and in the capacities and
on the dates indicated.
Signatures Title Date
---------- ----- ----
/s/ Jay Smith President, Chief Executive Officer, September 22, 1999
- ---------------------- Treasurer and Director
Jay Smith, III
/s/ Michael Cartabiano Vice President and Secretary September 22, 1999
- ----------------------
Michael Cartabiano
/s/ Robert A.D. Wilson Director September 22, 1999
- ----------------------
Robert A.D. Wilson
/s/ Edward H. Mackay Director September 22, 1999
- ----------------------
Edward H. Mackay
Page 24 of 48
<PAGE>
ADRENALIN INTERACTIVE, INC.
AND SUBSIDIARY
FOR THE YEARS ENDED JUNE 30, 1999
AND JUNE 30, 1998
Page 25 of 48
<PAGE>
Independent Auditors' Report
Board of Directors
Adrenalin Interactive, Inc.
Los Angeles, California
We have audited the accompanying consolidated balance sheet of Adrenalin
Interactive, Inc. and subsidiary ("Company") as of June 30, 1999, and the
related consolidated statements of operations, changes in shareholders' equity
and cash flows for the years ended June 30, 1999 and 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 audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Adrenalin Interactive, Inc. and subsidiary as of June 30, 1999, and the
consolidated results of its operations and its consolidated cash flows for the
years ended June 30, 1999 and 1998, in conformity with generally accepted
accounting principles.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 2 to the
consolidated financial statements, the Company has suffered recurring losses
from operations, which raises substantial doubt as to the Company's ability to
continue as a going concern. Management's plans in regard to this are discussed
in Note 2. The consolidated financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
/s/ Drucker, Math & Whitman, P.C.
North Brunswick, New Jersey
September 17, 1999
F-1
Page 26 of 48
<PAGE>
Adrenalin Interactive, Inc. and Subsidiary
Consolidated Balance Sheet
June 30, 1999
ASSETS
Current assets:
Cash and cash equivalents $ 134,608
Accounts receivable, net of allowance for
doubtful accounts of $13,355 89,595
Costs and estimated earnings in excess
of billings on uncompleted contracts 103,146
Prepaid expenses 35,804
-----------
Total current assets 363,153
-----------
Fixed assets, net 258,827
-----------
Other assets:
Patents and licenses, net of accumulated
amortization of $1,098,355 2,196,711
Security deposits and other 25,465
Deferred merger costs 100,383
Deferred private placement costs 86,805
-----------
2,409,364
-----------
$ 3,031,344
===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Notes and loans payable, current portion $ 12,360
Accounts payable and accrued liabilities 540,075
Billings in excess of costs and estimated
earnings on uncompleted contracts 158,874
-----------
Total current liabilities 711,309
-----------
Notes and loans payable, non-current portion 424,253
-----------
Total liabilities 1,135,562
-----------
Commitments and contingencies
Shareholders' equity:
Preferred stock, $.01 par value;
authorized, 100,000 shares;
issued and outstanding, none -
Common stock, $.03 par value;
authorized, 20,000,000 shares;
issued and outstanding, 3,229,422 96,883
Additional paid-in capital 13,695,684
Accumulated deficit ( 11,896,785)
-----------
Total shareholders' equity 1,895,782
-----------
$ 3,031,344
===========
See notes to consolidated financial statements. F-2
Page 27 of 48
<PAGE>
Adrenalin Interactive, Inc. and Subsidiary
Consolidated Statements of Operations
For the year ended June 30,
-----------------------------
1999 1998
------------ ------------
Revenues:
Development contracts $2,156,754 $1,886,497
Royalties 724,182 870,201
----------- -----------
2,880,936 2,756,698
----------- -----------
Expenses:
Cost of development contracts 1,922,460 1,533,917
Research and development - 152,126
Selling, general and administrative 1,305,169 2,367,973
Depreciation and amortization 764,852 931,014
Write-off of goodwill 1,579,132 -
Interest expense, net 55,057 60,663
----------- -----------
5,626,670 5,045,693
----------- -----------
Loss before income taxes ( 2,745,734) ( 2,288,995)
Income taxes - 18,836
----------- -----------
Net loss ($2,745,734) ($2,307,831)
=========== ===========
Per share information:
Basic:
Net loss per share ($ .90) ($ 1.10)
=========== ===========
Weighted average shares outstanding 3,043,823 2,105,804
=========== ===========
Diluted:
Net loss per share ($ .90) ($ 1.10)
=========== ===========
Weighted average shares outstanding 3,174,485 2,236,219
=========== ===========
See notes to consolidated financial statements. F-3
Page 28 of 48
<PAGE>
Adrenalin Interactive, Inc. and Subsidiary
Consolidated Statements of Changes in Shareholders' Equity
For the years ended June 30, 1999 and 1998
Additional Total
Common stock paid-in Accumulated shareholders'
Shares Amount capital deficit equity
--------- ------- ---------- ----------- ------------
Balances,
June 30, 1997
as previously
reported 5,041,228 $50,412 $11,504,573 ($6,843,220) $4,711,765
Effect of 1 for
3 split (3,360,819)
--------- ------- ----------- ---------- ----------
Balances,
June 30, 1997
as adjusted 1,680,409 50,412 11,504,573 ( 6,843,220) 4,711,765
Sept. 1997, issued
in exchange for
convertible
debentures 45,138 1,354 79,896 81,250
October 1997,
issued for capital 95,000 2,850 168,150 171,000
raising services ( 171,000) ( 171,000)
November 1997, issued
in exchange for
convertible
debentures 45,138 1,354 79,896 81,250
November 1997,
issued in settlement
of accounts payable 16,667 500 29,500 30,000
March 1998,
issued in settlement
of note payable 39,177 1,175 59,372 60,547
March 1998, issued
for services 50,000 1,500 75,751 77,251
May 1998, issued
for services 106,333 3,190 196,185 199,375
May 1998, issued
in exchange for
convertible
debentures 66,540 1,997 100,503 102,500
May 1998, issued
in settlement of
accounts payable 110,951 3,329 206,794 210,123
June 1998, issued
for services 33,333 1,000 99,000 100,000
Issued for cash,
common stock and
100,000 warrants 400,000 12,000 588,000 600,000
Costs related to
issuance of common
stock and warrants ( 202,075) ( 202,075)
(continued) F-4
Page 29 of 48
<PAGE>
Adrenalin Interactive, Inc. and Subsidiary
Consolidated Statements of Changes in Shareholders' Equity
Additional Total
Common stock paid-in Accumulated shareholders'
Shares Amount capital deficit equity
--------- ------- ---------- ----------- ------------
Common stock
subscription
receivable 208,334 6,250 493,750 500,000
Costs related to
common stock
subscription
receivable ( 65,000) ( 65,000)
Issued 60,000 options
for services 226,146 226,146
Issued 300,000 warrants 396,808 396,808
for capital
raising services ( 396,808) ( 396,808)
Net loss for the year
ended June 30, 1998 ( 2,307,831)( 2,307,831)
--------- ------- ----------- ---------- ----------
Balances,
June 30, 1998 2,897,020 $86,911 $13,469,441 ($9,151,051) $4,405,301
========= ======= =========== ========== ==========
Balances,
June 30, 1998 2,897,020 $86,911 $13,469,441 ($9,151,051) $4,405,301
September 1998,
issued for services 35,000 1,050 51,450 52,500
September 1998,
issued in exchange
for warrants 19,736 592 ( 592) -
December 1998,
adjustment for
fractional shares
from reverse split ( 185) ( 5) ( 5)
January and February
1999, issued
in exchange for
warrants 217,765 6,533 ( 6,533) -
February 1999, issued
in settlement of
accounts payable 18,423 553 27,081 27,634
February 1999, 70,000
options issued for
services 46,724 46,724
April 1999, warrants
exercised for cash 41,663 1,249 108,113 109,362
Net loss for the year
ended June 30, 1999 ( 2,745,734)( 2,745,734)
--------- ------- ----------- ----------- ----------
Balances,
June 30, 1999 3,229,422 $96,883 $13,695,684 ($11,896,785) $1,895,782
========= ======= =========== =========== ==========
See notes to consolidated financial statements. F-5
Page 30 of 48
<PAGE>
Adrenalin Interactive, Inc. and Subsidiary
Consolidated Statements of Cash Flows
For the year ended June 30,
----------------------------
1999 1998
------------- -------------
Cash flows from operating activities:
Net loss ($2,745,734) ($2,307,831)
Adjustments to reconcile net loss
to net cash used in operating
activities:
Write-off of goodwill 1,579,132 -
Write-off of license rights 100,000 100,000
Amortization 491,440 542,871
Depreciation 171,927 288,143
(Gain) loss on disposal of fixed
assets ( 26,500) 250,669
Allowance for doubtful accounts ( 32,395) 22,250
Common stock issued for services 52,500 376,625
Options issued for services 46,724 226,146
Change in:
Accounts receivable 123,504 34,027
Costs and estimated earnings in
excess of billings on uncompleted
contracts ( 88,060) 5,514
Prepaid expenses 38,970 ( 50,274)
Other assets ( 6,236) 36,722
Accounts payable and accrued
liabilities ( 37,759) 101,363
Billings in excess of costs and
estimated earnings on uncompleted
contracts 122,819 ( 94,230)
Deferred private placement costs ( 86,805) -
Deferred merger costs ( 100,383) -
---------- ----------
Net cash used in operating activities ( 396,856) ( 468,005)
---------- ----------
Cash flows from investing activities:
Purchase of fixed assets ( 100,635) ( 22,463)
Proceeds from sale of fixed assets 50,800 -
---------- ----------
Net cash used in investing activities ( 49,835) ( 22,463)
---------- ----------
(Continued) F-6
Page 31 of 48
<PAGE>
Adrenalin Interactive, Inc. and Subsidiary
Consolidated Statements of Cash Flows (continued)
For the year ended June 30,
----------------------------
1999 1998
------------- -------------
Cash flows from financing activities:
Issuance of common stock and
warrants, net of costs of
issuance $ - $ 397,927
Payments on notes and loans
payable ( 412,817) ( 1,234,004)
Proceeds from notes and loans 339,331 1,291,512
Payments on due to officer ( 55,935) ( 27,365)
Proceeds from common stock
subscription 435,000 -
Proceeds from exercise of warrants 109,357 -
---------- ----------
Net cash provided by financing
activities 414,936 428,070
---------- ----------
Decrease in cash and cash equivalents ( 31,755) ( 62,398)
Cash and cash equivalents,
beginning 166,363 228,761
---------- ----------
Cash and cash equivalents, ending $ 134,608 $ 166,363
========== ==========
Cash paid during the year for:
Interest $ 46,327 $ 61,073
========== ==========
Income taxes $ - $ 32,633
========== ==========
Noncash investing and financing activities: See Note 18.
See notes to consolidated financial statements. F-7
Page 32 of 48
<PAGE>
Adrenalin Interactive, Inc. and Subsidiary
Notes to Consolidated Financial Statements
For the years ended June 30, 1999 and 1998
1. Summary of significant accounting policies and business activity:
Business activity and basis of presentation:
The consolidated financial statements of Adrenalin Interactive, Inc. and
subsidiary ("Company") include the accounts of Adrenalin Interactive,
Inc. (formerly Wanderlust Interactive, Inc.) ("Adrenalin"), its
wholly-owned subsidiary, Western Technologies, Inc. ("Western"), and
certain assets and certain liabilities of Smith Engineering ("SE"),
which was a sole proprietorship prior to the acquisition discussed in
Note 3. Intercompany transactions and balances have been eliminated. The
Company is located in Los Angeles, California.
Adrenalin is engaged in the creation, development, publishing, marketing
and selling of interactive multimedia software entertainment titles on
CD-ROM for personal computers.
Western is engaged in the invention and development (including
engineering and software development) of electronic designs, technology,
and software, principally for toys and electronic games. Western
licenses or sells inventions, designs, and software to independent
manufacturers and publishers. Such manufacturers and publishers
generally pay advance royalties or development fees and may pay
additional royalties based on products sold. Western also provides
product development services to manufacturers.
SE is inactive at June 30, 1999.
The Company's customers are concentrated in the toy and electronic
entertainment industries. These industries are characterized by rapid
changes in technology and customer preferences.
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. Actual results could differ from those
estimates.
Reverse stock split:
On December 29, 1998, the Company effected a 1 for 3 "reverse" stock
split. All share, option, warrant, per share and weighted average share
amounts have been restated to reflect this reverse stock split.
Cash and cash equivalents:
The Company considers all highly liquid debt instruments purchased with
a maturity of three months or less to be cash equivalents.
F-8
Page 33 of 48
<PAGE>
Adrenalin Interactive, Inc. and Subsidiary
Notes to Consolidated Financial Statements
For the years ended June 30, 1999 and 1998
1. Summary of significant accounting policies and business activity
(continued):
Concentration of credit risk:
Financial instruments which subject the Company to concentrations of
credit risk consist of temporary cash investments and accounts
receivable. The Company places its temporary cash investments with high
quality financial institutions. At times, the Company's cash balances
with these institutions exceed the current insured amount under the
Federal Deposit Insurance Corporation. Accounts receivable are primarily
from development contracts. The Company reviews its accounts receivable
monthly and provides allowances for potential uncollectible accounts.
Fixed assets:
Fixed assets consist primarily of computers, leasehold improvements and
furniture, and are stated at cost. Amortization of leasehold
improvements is provided on a straight-line basis over the shorter of
the estimated useful lives of the improvements or the life of the lease.
Depreciation is provided on a straight-line basis over the estimated
useful lives of the related assets.
Patents and licenses:
The Company amortizes patents and licenses over their estimated useful
lives. The Company revised its estimate of the useful lives during the
fiscal year ended June 30, 1998 from four years to eight years. For the
year ended June 30, 1998 the effect of applying the new estimated life
was to reduce amortization expense by $425,170, and to decrease net loss
by $425,170, and net loss per share by $0.21. The Company assesses the
recoverability of patents and licenses, and whenever continued adverse
circumstances indicate impairment, a write-off will be recorded. Based
on continued cash flow from these assets, no write-off is required at
June 30, 1999.
Goodwill:
Goodwill represents the excess of cost over the fair value of assets
acquired and was amortized using the straight-line method over 40 years.
At the end of the fiscal year ended June 30, 1999 the Company
re-assessed the recoverability of its goodwill and wrote-off the
remaining balance of $1,579,132.
Capitalized software:
Capitalized software (fully amortized at June 30, 1999) consists of
salaries and other costs incurred to develop software from the time
technical feasibility is established thru the date the product is ready
for sale. Amortization begins when the software is available for general
release and is calculated on a product-by-product basis using the faster
of the straight-line method over the estimated useful life or based on
expected units of sale. Amortization expense was $24,254 for the year
ended June 30, 1999 and $75,684 for the year ended June 30, 1998.
F-9
Page 34 of 48
<PAGE>
Adrenalin Interactive, Inc. and Subsidiary
Notes to Consolidated Financial Statements
For the years ended June 30, 1999 and 1998
1. Summary of significant accounting policies and business activity
(continued):
Development contract revenue and cost recognition:
Revenues from fixed-price and modified fixed-price development contracts
are recognized on the percentage-of-completion method measured by the
percentage that costs incurred to date bear to total estimated costs.
A contract is considered complete when all costs, except insignificant
items, have been incurred.
Contract costs include all direct labor, subcontractor and other costs
and those indirect costs related to contract performance, such as
indirect salaries, employee benefits, insurance, and payroll taxes.
Provisions for estimated losses on uncompleted contracts are made in the
period in which such losses are determined. Changes in job performance,
customer acceptance of work done, technological developments and
estimated profitability may result in revisions to costs and income and
are recognized in the period in which the revisions are determined.
The asset, "Costs and estimated earnings in excess of billings on
uncompleted contracts", represents revenues recognized in excess of
amounts billed. The liability, "Billings in excess of costs and
estimated earnings on uncompleted contracts", represents billings in
excess of revenues recognized.
Royalty revenue:
Royalties earned by the Company as a result of development contracts are
generally reported by the licensees on a calendar quarter basis. The
Company recognizes such royalty revenue when received. Royalties earned
by the Company as a result of its publishing segment are recognized as
earned.
Income (loss) per share:
Basic income (loss) per share is computed by dividing net income (loss)
available to common stockholders by the weighted average number of
common shares outstanding during the period. Diluted income (loss) per
share is computed as above while giving effect to all potential common
shares (but not giving effect to securities that would have an
antidilutive effect, as would occur in loss years) that were outstanding
during the period.
F-10
Page 35 of 48
<PAGE>
Adrenalin Interactive, Inc. and Subsidiary
Notes to Consolidated Financial Statements
For the years ended June 30, 1999 and 1998
2. Going concern:
The accompanying consolidated financial statements have been prepared on
a going concern basis which contemplates the realization of assets and
satisfaction of liabilities in the normal course of business. The
Company has suffered recurring losses from operations and, at June 30,
1999, has a working capital deficiency. These circumstances raise
substantial doubt about the Company's ability to continue as a going
concern. The consolidated financial statements do not include any
adjustments relating to the recoverability and classification of
recorded asset amounts and/or the amount of liabilities that might be
necessary should the Company be unable to continue in existence.
Continuation of the Company as a going concern is dependent on achieving
profitable operations and additional equity above that obtained in July,
1999; see "Subsequent events" note. Management's plans to achieve
profitability and equity include developing new products, obtaining new
customers, and merging with another entity; see "Subsequent events"
note.
3. Acquisition:
On February 4, 1997, Adrenalin closed on an acquisition agreement
between Adrenalin, Western, SE and Mr. Jay Smith, III ("Mr. Smith"). The
agreement provided for the sale of 100% of the outstanding shares of
stock of Western and certain assets and certain liabilities of SE in
exchange for 266,667 shares (adjusted for the 1 for 3 split) of the
Company's common stock. As part of the acquisition, a license agreement
was entered into between Western and Mr. Smith in which Mr. Smith
granted to Western the exclusive right to use and market patents and
license agreements owned by Mr. Smith. The license agreement provides
that 75% of the revenues from such patents and licenses will be retained
by Western and 25% will be retained by Mr. Smith until Mr. Smith
receives an aggregate revenue from such patents and licenses of
$2,000,000, at which time no further revenue will inure to Mr. Smith.
The business combination has been accounted for using the purchase
method.
The cost of the acquired enterprise was $5,082,000. The Company issued
266,667 shares (adjusted for the 1 for 3 split) of common stock with an
assigned value of $15 each (adjusted for the 1 for 3 split) and assumed
liabilities in excess of assets which amounted to $1,082,000.
Acquired goodwill was amortized over forty years using the straight-line
method, thru June 30, 1999, at which date the balance was written-off.
F-11
Page 36 of 48
<PAGE>
Adrenalin Interactive, Inc. and Subsidiary
Notes to Consolidated Financial Statements
For the years ended June 30, 1999 and 1998
4. Accounts receivable:
June 30, 1999
-------------
Completed contracts $ -
Contracts in progress 60,000
Other 42,950
-----------
102,950
Less allowance for doubtful accounts 13,355
-----------
$ 89,595
===========
5. Billings in excess of costs and estimated earnings on uncompleted
contracts:
June 30, 1999
-------------
Costs incurred $1,515,199
Estimated earnings 94,681
-----------
1,609,880
Less billings to date ( 1,665,608)
----------
($ 55,728)
===========
Included in the accompanying consolidated balance sheet under the
following:
Costs and estimated earnings
in excess of billings on
uncompleted contracts $ 103,146
Billings in excess of costs
and estimated earnings on
uncompleted contracts ( 158,874)
----------
($ 55,728)
===========
6. Fixed assets, net:
June 30, 1999
-------------
Computers $1,247,936
Furniture 127,015
Leasehold improvements 19,544
----------
1,394,495
Less accumulated depreciation
and amortization 1,135,668
-----------
$ 258,827
==========
F-12
Page 37 of 48
<PAGE>
Adrenalin Interactive, Inc. and Subsidiary
Notes to Consolidated Financial Statements
For the years ended June 30, 1999 and 1998
7. Notes and loans payable:
June 30, 1999
-------------
Unsecured note payable, due December 30, 1999.
Interest only (at prime plus 3.5%)
is payable monthly. Prime was 7.75%
at June 30, 1999. Personally guaranteed
by an officer/shareholder and his wife and
secured by a Second Trust Deed on the
officer/shareholder's residence. $396,000
Other unsecured notes and capital lease obligation 40,613
--------
436,613
Current portion 12,360
--------
$424,253
========
8. Convertible debentures:
In May, 1995, the Company issued units consisting of convertible
debentures and common stock. An aggregate of $507,500 of debentures
payable and 155,125 shares (adjusted for the 1 for 3 split) of common
stock were issued to various investors in exchange for $1,015,000. The
debentures were due in May, 1997. The Company offered the debenture
holders two options in lieu of payment: 1) Conversion into shares of
common stock at the rate of $0.60 (not adjusted for the 1 for 3 split)
per share or, 2) extend the due date for one year in exchange for 200
shares (not adjusted for the 1 for 3 split) of common stock for each
$1,000 so extended. As of June 30, 1997, 134,720 shares (adjusted for
the 1 for 3 split) of common stock were issued in exchange for $242,500
of convertible debentures, and 4,333 shares (adjusted for the 1 for 3
split) were issued to extend the due date of $65,000 of convertible
debentures. During the year ended June 30, 1998, 156,817 shares
(adjusted for the 1 for 3 split) of common stock were issued in exchange
for $265,000 of convertible debentures, and accrued interest thereon. At
June 30, 1998, no convertible debentures were outstanding.
F-13
Page 38 of 48
<PAGE>
Adrenalin Interactive, Inc. and Subsidiary
Notes to Consolidated Financial Statements
For the years ended June 30, 1999 and 1998
9. Stock options:
In the fiscal year ended June 30, 1995, the Company adopted the 1995
Stock Option Plan ("95 Plan"). In September, 1995, the Company amended
the 95 Plan. The 95 Plan (as amended) provides for the granting of
options to purchase up to 360,000 shares of common stock at an exercise
price equal to the fair market value of the common stock (110% of fair
market value for a holder of in excess of 10%) on the date of the grant.
No options have been exercised to date.
95 Plan activity during the year ended June 30, 1999 (adjusted for the 1
for 3 split) follows:
Average
Shares Price
------ -------
Outstanding at beginning of year 81,658 $1.59
Granted 21,660 0.90
Exercised - -
Forfeited 9,830 2.12
-------
Outstanding at end of year 93,488 $1.39
======= =====
Options exercisable at June 30, 1999 55,712 $1.45
======= =====
Weighted average remaining
contractual life, years 3.8
=======
Options outstanding at June 30, 1999:
Shares Price
------ -------
5,000 $ 0.66
2,500 0.84
13,827 1.00
58,333 1.41
12,162 1.88
1,666 3.28
------
93,488
======
95 Plan activity during the year ended June 30, 1998 (adjusted for the 1
for 3 split) follows:
Average
Shares Price
------ -------
Outstanding at beginning of year 106,498 $6.18
Granted 80,167 1.59
Exercised - -
Forfeited 105,007 6.24
-------
Outstanding at end of year 81,658 $1.59
======= =====
Options exercisable at June 30, 1998 27,008 $1.59
======= =====
Weighted average remaining
contractual life, years 4.6
======= F-14
Page 39 of 48
<PAGE>
Adrenalin Interactive, Inc. and Subsidiary
Notes to Consolidated Financial Statements
For the years ended June 30, 1999 and 1998
9. Stock options (continued):
In July, 1996, the Company adopted the 1996 Stock Option Plan ("96
Plan"). The 96 Plan provides for the granting of options to purchase up
to 360,000 shares of common stock at an exercise price equal to the fair
market value of the common stock (110% of fair market value for a holder
of in excess of 10%) on the date of the grant. No options have been
exercised to date.
96 Plan activity during the year ended June 30, 1999 (adjusted for the 1
for 3 split) follows:
Average
Shares Price
------ -------
Outstanding at beginning of year 13,500 $ 1.88
Granted - -
Exercised - -
Forfeited - -
--------
Outstanding at end of year 13,500 $ 1.88
======== ======
Options exercisable at June 30, 1999 10,125 $ 1.88
======== ======
Weighted average remaining
contractual life, years 2.6
========
Options outstanding at June 30, 1999:
Shares Price
------ -------
13,500 $ 1.88
======= ======
96 Plan activity during the year ended June 30, 1998 (adjusted for the 1
for 3 split) follows:
Average
Shares Price
------ -------
Outstanding at beginning of year 39,417 $ 4.08
Granted - -
Exercised - -
Forfeited 25,917 $ 5.25
--------
Outstanding at end of year 13,500 $ 1.88
======== ======
Options exercisable at June 30, 1998 6,750 $ 1.88
======== ======
Weighted average remaining
contractual life, years 3.6
========
F-15
Page 40 of 48
<PAGE>
Adrenalin Interactive, Inc. and Subsidiary
Notes to Consolidated Financial Statements
For the years ended June 30, 1999 and 1998
9. Stock options (continued):
Non-plan options:
Non-plan option activity during the year ended June 30, 1999 (adjusted
for the 1 for 3 split) follows:
Average
Shares Price
------ -------
Outstanding at beginning of year 318,329 $ 2.42
Granted 70,000 1.02
Exercised 24,999 0.63
Forfeited 14,999 0.63
--------
Outstanding at end of year 348,331 $ 2.20
======== ======
Options exercisable at June 30, 1999 232,218 $ 2.28
======== ======
Weighted average remaining
contractual life, years 7.0
========
Options outstanding at June 30, 1999:
Shares Price
------ -------
45,000 $ 0.75
8,333 1.20
25,000 1.50
256,665 1.88
13,333 15.00
--------
348,331
========
Non-plan option activity during the year ended June 30, 1998 (adjusted
for the 1 for 3 split) follows:
Average
Shares Price
------ -------
Outstanding at beginning of year 31,665 $ 7.41
Granted 286,664 1.87
Exercised - -
Forfeited - -
--------
Outstanding at end of year 318,329 $ 2.42
======== ======
Options exercisable at June 30, 1998 97,777 $ 2.72
======== ======
Weighted average remaining
contractual life, years 8.0
========
F-16
Page 41 of 48
<PAGE>
Adrenalin Interactive, Inc. and Subsidiary
Notes to Consolidated Financial Statements
For the years ended June 30, 1999 and 1998
10. Accounting for stock based compensation:
The Company follows the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"). Accordingly, no compensation cost has been
recognized in the consolidated financial statements for the employee
stock options issued.
Had compensation cost for the Company's employee stock option plans been
recognized based on the fair value at the grant date for awards
consistent with the provisions of SFAS 123, the Company's net loss and
loss per share (adjusted for the 1 for 3 split) would have been as
indicated below:
Year ended Year ended
June 30, 1999 June 30, 1998
------------- -------------
Net loss - as reported $2,745,734 $2,307,831
Net loss - pro forma $2,842,548 $2,445,099
Loss per share - as reported $0.90 $1.10
Loss per share - pro forma $0.93 $1.17
For the years ended June 30, 1999 and 1998, respectively, 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 grants: expected volatility of 228% and 209%;
risk-free interest rate of 6.0% and 6.0%; and expected lives of 4.5 and
6.4 years.
11. Commitments and contingencies:
Commitments:
In February, 1997, the Company entered into a three year employment
agreement with an officer providing for base salary of $150,000 per
year.
In May, 1995, the Company entered into a four year nonexclusive license
agreement with Metro-Goldwyn-Mayer Inc., ("MGM") which provides for use
of the "Pink Panther" character. The agreement was amended in May of
1996, and the Company paid $300,000 as a nonrefundable advance royalty,
to be applied to future royalties. The agreement provides for payment of
the greater of a percentage royalty on wholesale prices or an absolute
minimum per unit sold. The agreement also provides for the shipment of
minimum copies by certain due dates. Failure to ship such minimum copies
may cause termination of the agreement. The agreement grants MGM a right
of first negotiation and last refusal in regards to distribution of the
licensed products. MGM also has the right to approve, at its sole
discretion, the Company's software titles that contain the "Pink
Panther" character.
The Company wrote off $100,000 of the advance royalty in each year of
the three years ended June 30, 1999, as a result of weaker than expected
sales of the licensed product.
F-17
Page 42 of 48
<PAGE>
Adrenalin Interactive, Inc. and Subsidiary
Notes to Consolidated Financial Statements
For the years ended June 30, 1999 and 1998
11. Commitments and contingencies (continued):
Commitments (continued):
The Company is obligated under a lease agreement for office space in Los
Angeles, California. Minimum monthly payments of $15,768 (subject to a
minimum 3% increase) are due through January 31, 2002. Future minimum
rental commitments under the lease are 2000, $189,216; 2001, $194,892;
2002, $83,641. Rent expense for the fiscal years ended June 30, 1999 and
1998 was $184,826 and $208,566, respectively.
The Company leases computer equipment under several operating leases
that are substantially similar. These leases have expiration dates from
fiscal years ending 2000 to 2002. Future minimum lease payments are:
2000, $11,012; 2001, $6,691; 2002,$3,387.
12. Initial public offering:
In March and April, 1996, the Company closed an initial public offering
of common stock and redeemable warrants. In connection with such
offering, the investment banker received, for nominal consideration,
five year warrants to purchase 43,333 shares (adjusted for the 1 for 3
split) of common stock and 70,000 redeemable warrants (adjusted for the
1 for 3 split). These warrants are exercisable at any time during a four
year period ending March 20, 2001 for $18.00 per share (adjusted for the
1 for 3 split) of common stock and $.90 per redeemable warrant (adjusted
for the 1 for 3 split).
13. Related party transactions:
During the year ended June 30, 1998, the Company incurred $45,830 of
legal fees and disbursements to a law firm. For the year ended June 30,
1999 legal fees and disbursements of $6,555 were incurred to the same
law firm. A partner in that firm was an officer/shareholder/director,
and is currently a shareholder.
In May, 1998, the Company issued 73,333 shares of common stock at a
deemed price of $1.875 (adjusted for the 1 for 3 split) to a business
consulting firm with which a director of the Company is affiliated and
8,333 shares (adjusted for the 1 for 3 split) of common stock to another
director as consideration for consulting services.
14. Income taxes:
For income tax purposes, as of June 30, 1999 the Company has deferred
start-up costs and a net operating loss carryforward approximating the
financial accounting net loss since inception. The start-up costs are
being amortized over five years commencing during the third quarter of
fiscal 1997. The net operating loss carryforward will begin to expire in
2013. These items result in a deferred tax asset of approximately
$4,000,000. However, a valuation reserve has been recorded for the full
amount due to the uncertainty of realization of the deferred tax asset.
F-18
Page 43 of 48
<PAGE>
Adrenalin Interactive, Inc. and Subsidiary
Notes to Consolidated Financial Statements
For the years ended June 30, 1999 and 1998
15. Business segment information and foreign revenue:
The Company's operations have been classified into two business
segments: publishing and development contracts. Prior to the Company's
acquisition of Western, it operated as a publisher.
For the fiscal year ended June 30, 1999:
Development
Publishing contracts Total
---------- ----------- -----------
Revenues $ 186,000 $2,695,000 $2,881,000
Operating income
(loss) 18,000 ( 2,764,000) ( 2,746,000)
Total assets 199,000 2,832,000 3,031,000
Depreciation and
amortization 126,000 639,000 765,000
Capital expenditures - 125,000 125,000
For the fiscal year ended June 30, 1998:
Development
Publishing contracts Total
---------- ----------- -----------
Revenues $ 460,000 $2,300,000 $2,760,000
Operating loss 1,620,000 670,000 2,290,000
Total assets 820,000 4,765,000 5,585,000
Depreciation and
amortization 305,000 625,000 930,000
Capital expenditures - 20,000 20,000
Foreign royalties for the fiscal year ended June 30, 1999 and 1998 were
$170,000 and $518,000, respectively.
16. Concentration of credit risk and major customers:
The Company deals with a relatively small number of customers which
account for revenues and receivables as presented below:
% of Revenues % of Receivables
Year ended June 30, As of June 30,
------------------- --------------
1999 1998 1999
---- ---- ----
Customer "A" 26% 27% 67%
Customer "B" 22% 25% -
Customer "C" 32% - -
F-19
Page 44 of 48
<PAGE>
Adrenalin Interactive, Inc. and Subsidiary
Notes to Consolidated Financial Statements
For the years ended June 30, 1999 and 1998
17. Private offering and warrants issued:
During the fiscal year ended June 30, 1998, the Company effected a
private offering of 400,000 shares (adjusted for the 1 for 3 split) of
common stock and 100,000 warrants (adjusted for the 1 for 3 split) for
aggregate consideration (net of expenses) of $397,927. The warrants are
exercisable at $3.75 per share, and expire one year from the date of
issuance.
During the fiscal year ended June 30, 1998, the following warrants,
exercisable upon issuance, were issued for capital raising services:
16,667 exercisable at $3.75 per share, expiring January 14, 2001 166,667
exercisable at $0.75 per share, expiring December 31, 2004 116,666
exercisable at $1.875 per share, expiring December 31, 2004
These warrants were valued using the Black Scholes pricing model (see
Note 10 for assumptions) which resulted in a valuation of $396,808.
18. Supplemental disclosure of noncash investing and financing activities:
During the fiscal year ended June 30, 1998:
See Note 8 regarding convertible debentures converted.
156,817 shares issued in exchange for $265,000 of convertible
debentures.
127,618 shares issued in settlement of $240,123 of accounts payable.
39,177 shares issued in settlement of $60,547 of notes payable.
189,666 shares issued for consulting services.
On June 30, 1998, subscription agreements for an aggregate of 208,334
shares (adjusted for the 1 for 3 split) of common stock were executed.
Net proceeds were received in July, 1998 in the amount of $435,000.
During the fiscal year ended June 30, 1999:
35,000 shares issued for consulting services.
18,423 shares issued in settlement $27,634 of accounts payable.
237,502 shares issued upon cashless exercise of warrants for 274,998
shares of common stock.
Options for 70,000 shares of common stock issued for services.
$24,969 of furniture was acquired by capital lease.
F-20
Page 45 of 48
<PAGE>
Adrenalin Interactive, Inc. and Subsidiary
Notes to Consolidated Financial Statements
For the years ended June 30, 1999 and 1998
19. Subsequent events:
Private placement:
On July 12, 1999, the Company and a private investor entered into a
Stock Purchase Agreement ("Agreement") under which the Company issued
293,255 shares of common stock for $1,250,000. Additional shares (and
three year warrants) for an aggregate additional consideration of
$750,000 are required to be issued and purchased upon the closing of the
merger discussed below. The Agreement provides for two repricing periods
which may result in issuance of additional shares if the average bid
price during specified 90 day periods does not equal or exceed 115% (or
118% for the second repricing period) of the purchase price(s). In
addition to the 293,255 shares issued, the Company issued a warrant for
29,325 shares exercisable at $4.843 per share through and including July
31, 2002. The Company also agreed to prepare and file with the SEC a
registration statement, at its own expense, related to the shares (and
warrants) issued.
At June 30, 1999, costs related to the private placement aggregated
$86,805 which amount is reflected in "Other assets" on the consolidated
balance sheet. These costs will be deducted from the proceeds of the
private placement during the fiscal year ended June 30, 2000.
Loan transaction:
On July 23, 1999, the Company entered into a loan transaction with
McGlen Micro, Inc. ("McGlen") (see below re: contemplated merger) under
which the Company loaned $500,000 to McGlen. The loan is evidenced by a
secured subordinated promissory note, is due one year from issuance, and
bears interest at 8%.
Contemplated merger:
The Company is in the process of consummating a "reverse" merger. At its
annual meeting, which is scheduled in October, 1999, the Company will
seek stockholder approval for an Agreement and Plan of Merger dated
April 28, 1999 ("Merger Agreement"). If the Merger Agreement is
approved, McGlen will become a wholly-owned subsidiary of the Company
and the Company will issue to McGlen security holders shares of the
Company's common stock and options to purchase shares of the Company's
common stock equaling approximately 87% of the shares that will be
outstanding immediately following the "reverse" merger. If the merger is
completed, the Company will be required to issue 5% of its common stock
outstanding immediately prior to such merger to a consulting firm.
At June 30, 1999, costs related to the merger aggregated $100,383 which
amount is reflected in "Other assets" on the consolidated balance sheet.
These costs will be deducted from shareholders' equity if the merger is
consummated. If the merger is not consummated, such costs will be
charged to operations during the fiscal year ended June 30, 2000.
F-21
Page 46 of 48
<PAGE>
Exhibit 21
----------
Subsidiaries of Adrenalin Interactive, Inc.
------------------------------------------
Jurisdiction of
Name of Subsidiary Organization Percentage Ownership
- ------------------ -------------- --------------------
Western Technologies, Inc. California 100%
Adrenalin Acquisition Corp. California 100%
Adrenalin Entertainment, Inc. California 100%
(name holding subsidiary only)
Page 47 of 48
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-END> JUN-30-1999
<CASH> 134,608
<SECURITIES> 0
<RECEIVABLES> 102,950
<ALLOWANCES> 13,355
<INVENTORY> 0
<CURRENT-ASSETS> 363,153
<PP&E> 1,394,498
<DEPRECIATION> 1,135,670
<TOTAL-ASSETS> 3,031,344
<CURRENT-LIABILITIES> 711,309
<BONDS> 0
0
0
<COMMON> 96,883
<OTHER-SE> 1,798,899
<TOTAL-LIABILITY-AND-EQUITY> 3,031,344
<SALES> 0
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<CGS> 0
<TOTAL-COSTS> 1,922,460
<OTHER-EXPENSES> 3,649,153
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 55,057
<INCOME-PRETAX> (2,745,734)
<INCOME-TAX> 0
<INCOME-CONTINUING> (2,745,734)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,745,734)
<EPS-BASIC> (0.90)
<EPS-DILUTED> (0.90)
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