1
Exhibit 99.2
MINNESOTA EDUCATIONAL COMPUTING CORPORATION (MECC)
INDEX TO FINANCIAL STATEMENTS
PAGE
----
FINANCIAL STATEMENTS:
Independent auditors' report................................................................. F-2
Balance Sheets at March 31, 1994 and 1995 and December 31, 1995 (Unaudited).................. F-3
Statements of Operations for the Years Ended March 31, 1993, 1994 and 1995 and for the Nine
Months Ended December 31, 1994 and 1995 (Unaudited)....................................... F-4
Statements of Cash Flows for the Years Ended March 31, 1993, 1994 and 1995 and for the Nine
Months Ended December 31, 1994 and 1995 (Unaudited)....................................... F-5
Statements of Shareholders' (Deficiency) Equity for the Years Ended March 31, 1993, 1994 and
1995 and for the Nine Months Ended December 31, 1995 (Unaudited).......................... F-6
Notes to Financial Statements................................................................ F-7
2
INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholders
Minnesota Educational Computing Corporation (MECC)
Minneapolis, Minnesota
We have audited the balance sheets of Minnesota Educational Computing
Corporation (MECC) as of March 31, 1994 and 1995 and the related statements of
operations, shareholders' (deficiency) equity and cash flows for each of the
three years in the period ended March 31, 1995. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on the financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of Minnesota Educational Computing Corporation
(MECC) as of March 31, 1994 and 1995 and the results of its operations and its
cash flows for each of the three years in the period ended March 31, 1995, in
conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Minneapolis, Minnesota
May 24, 1995
(June 30, 1995 as to the second paragraph of Note 4)
F-2
3
MINNESOTA EDUCATIONAL COMPUTING CORPORATION (MECC)
BALANCE SHEETS
MARCH 31,
------------------------- DECEMBER 31,
1994 1995 1995
---- ---- ------------
(UNAUDITED)
ASSETS
------
CURRENT ASSETS:
Cash and cash equivalents................................. $12,600,365 $15,462,786 $21,214,365
Accounts receivable (net of the allowance for doubtful
accounts and returns of $500,678, $1,320,839 and
$1,235,655, respectively).............................. 3,074,673 4,055,052 8,974,500
Inventories............................................... 871,542 1,333,005 1,952,007
Prepaid expenses.......................................... 9,409 22,439 81,108
Deferred income taxes (Note 8)............................ 300,000 580,000 770,000
----------- ----------- -----------
Total current assets............................... 16,855,989 21,453,282 32,991,980
PROPERTY AND EQUIPMENT, Net (Note 2)............................. 2,553,359 2,666,874 3,236,804
INTANGIBLES, Net:
Capitalized software development costs.................... 481,318 263,809 326,081
Acquired software......................................... 40,199 140,425 741,745
Noncompete agreement...................................... 118,000
Other 16,500
----------- ----------- -----------
Total intangibles, net............................. 656,017 404,234 1,067,826
----------- ----------- -----------
TOTAL ASSETS....................................... $20,065,365 $24,524,390 $37,296,610
=========== =========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Accounts payable.......................................... $ 1,223,392 $ 1,301,739 $ 2,805,513
Deferred revenue.......................................... 21,079 8,664 8,774
Accrued salaries, bonuses, and employee benefits.......... 844,942 981,729 954,016
Other accrued liabilities................................. 4,596 160,294 51,778
Income taxes payable...................................... 50,000 407,748 1,142,159
Obligations under capital leases (Note 3)................. 23,647
Deferred lease incentives (Note 3)........................ 120,254 133,112 143,777
----------- ----------- -----------
Total current liabilities.......................... 2,287,910 2,993,286 5,106,017
DEFERRED INCOME TAXES (Note 8)................................... 210,000 160,000 160,000
DEFERRED LEASE INCENTIVES (Note 3)............................... 581,210 448,098 337,596
CONTINGENCIES AND COMMITMENTS
(Notes 1 and 3)..............................................
SERIES A REDEEMABLE PREFERRED SHARES--par
value $5.00; authorized 1,000,000; none issued and
outstanding .................................................
SHAREHOLDERS' EQUITY:
Undesignated preferred shares--par value $5.00; authorized
9,000,000; none issued and outstanding.................
Common shares--par value $0.01; authorized 20,000,000;
issued and outstanding--7,688,937, 7,753,679 and
8,033,957, respectively (Note 4)....................... 76,889 77,537 80,340
Additional paid-in capital................................ 19,425,429 19,554,211 25,978,618
Unearned compensation on stock options.................... (46,240)
(Deficit) retained earnings............................... (2,469,833) 1,291,258 5,634,039
----------- ----------- -----------
Total shareholders' equity......................... 16,986,245 20,923,006 31,692,997
----------- ----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS'
EQUITY.......................................... $20,065,365 $24,524,390 $37,296,610
=========== =========== ===========
See notes to financial statements.
F-3
4
MINNESOTA EDUCATIONAL COMPUTING CORPORATION (MECC)
STATEMENTS OF OPERATIONS
NINE MONTHS ENDED
FISCAL YEARS ENDED MARCH 31, DECEMBER 31,
--------------------------------------------- -----------------------
1993 1994 1995 1994 1995
---- ---- ---- ---- ----
(UNAUDITED)
NET REVENUE........................... $18,021,440 $21,681,158 $28,046,430 $20,996,783 $26,765,964
COST OF SALES......................... 4,811,290 4,857,763 5,685,521 4,261,815 5,346,199
----------- ----------- ----------- ----------- -----------
Gross margin................... 13,210,150 16,823,395 22,360,909 16,734,968 21,419,765
OPERATING EXPENSES:
Marketing...................... 6,665,363 7,457,434 9,665,574 6,771,762 8,693,982
Product development............ 4,612,419 5,144,914 5,477,550 3,903,923 4,867,718
General and administrative..... 2,120,702 1,970,231 2,593,337 1,686,868 2,031,150
Merger-related................. 302,000
Amortization of acquisition-
related intangibles (Note 1) 137,762 206,186 134,500 134,500
----------- ----------- ----------- ----------- -----------
Total operating expenses 13,536,246 14,778,765 17,870,961 12,497,053 15,894,850
----------- ----------- ----------- ----------- -----------
OPERATING (LOSS) INCOME............... (326,096) 2,044,630 4,489,948 4,237,915 5,524,915
INTEREST (EXPENSE)
INCOME (Notes 5 and 6)............ (165,169) (174,465) 575,189 375,199 769,366
----------- ----------- ----------- ----------- -----------
(LOSS) INCOME BEFORE
TAXES............................. (491,265) 1,870,165 5,065,137 4,613,114 6,294,281
PROVISION FOR INCOME
TAXES (Note 8).................... 6,000 10,000 1,270,000 1,243,000 1,951,500
----------- ----------- ----------- ----------- -----------
NET (LOSS) INCOME..................... $ (497,265) $ 1,860,165 $ 3,795,137 $ 3,370,114 $ 4,342,781
=========== =========== =========== =========== ===========
NET (LOSS) INCOME
APPLICABLE TO COMMON
SHAREHOLDERS...................... $ (977,265) $ 1,388,165 $ 3,795,137 $ 3,370,114 $ 4,342,781
=========== =========== =========== =========== ===========
NET (LOSS) INCOME PER
COMMON AND COMMON
EQUIVALENT SHARE
(Note 1).......................... $ (0.19) $ 0.26 $ 0.46 $ 0.41 $ 0.50
=========== =========== =========== =========== ===========
WEIGHTED AVERAGE
NUMBER OF COMMON
AND COMMON
EQUIVALENT SHARES
OUTSTANDING (Note 1).............. 5,193,827 5,421,434 8,224,662 8,227,976 8,636,764
=========== =========== =========== =========== ===========
See notes to financial statements.
F-4
5
MINNESOTA EDUCATIONAL COMPUTING CORPORATION (MECC)
STATEMENTS OF CASH FLOWS
FISCAL YEARS ENDED
MARCH 31,
----------------------------------
1993 1994 1995
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income ....................................... $(497,265) $ 1,860,165 $ 3,795,137
Adjustments to reconcile net (loss) income to net cash
provided by operating activities:
Depreciation ....................................... 519,239 645,170 788,879
Amortization of:
Capitalized software development costs ........... 227,352 422,102 479,123
Acquired software ................................ 9,000 68,801 341,774
Acquisition-related intangibles .................. 137,762 206,186 134,500
Tax benefit from exercise of stock options ......... 76,000
Deferred income taxes .............................. (90,000) (330,000)
Compensation expense--common stock options ......... 11,560 12,440
Deferred lease incentives .......................... (143,672) (108,670) (120,254)
Loss on sale of equipment .......................... 1,771 903 33,414
Cash provided (used) due to changes in:
Accounts receivable .............................. (99,028) (1,037,636) (980,379)
Inventories ...................................... 80,914 15,089 (461,463)
Prepaid expenses ................................. 38,731 (5,461) (13,030)
Accounts payable ................................. 76,303 (171,995) 78,347
Other liabilities ................................ 173,216 (63,154) 280,070
Income taxes payable ............................. 50,000 357,748
--------- ----------- -----------
Net cash provided by operating
activities............................. 524,323 1,803,060 4,472,306
--------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures .................................... (608,738) (747,712) (952,972)
Proceeds from sale of equipment ......................... 583 13,541 17,164
Capitalization of software development costs ............ (218,186) (643,748) (261,614)
Acquired software ....................................... (40,000) (78,000) (442,000)
--------- ----------- -----------
Net cash used in investing activities ... (866,341) (1,455,919) (1,639,422)
--------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from note payable to related party ............. 975,000 490,000
Payments on note payable to related party ............... (700,000) (1,265,000)
Proceeds from note payable to bank ...................... 1,890,000
Payments on note payable to bank ........................ (1,890,000)
Payments on capital lease obligations ................... (94,687) (29,403) (23,647)
Payment of preferred shares dividend .................... (1,552,000)
Proceeds from issuance of common shares ................. 6,250 14,455,089 53,465
Payments for repurchase of common shares ................ (37,000) (9,041) (281)
--------- ----------- -----------
Net cash provided (used) by financing
activities ............................ 149,563 12,089,645 29,537
--------- ----------- -----------
NET (DECREASE) INCREASE IN CASH AND CASH
EQUIVALENTS ............................................ (192,455) 12,436,786 2,862,421
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD .................................... 356,034 163,579 12,600,365
--------- ----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ................ $ 163,579 $12,600,365 $15,462,786
========= =========== ===========
Nine Months Ended
December 31,
------------------
1994 1995
---- ----
(Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income ....................................... $ 3,370,114 $ 4,342,781
Adjustments to reconcile net (loss) income to net cash
provided by operating activities:
Depreciation ....................................... 578,945 746,505
Amortization of:
Capitalized software development costs ........... 365,886 277,208
Acquired software ................................ 239,008 162,180
Acquisition-related intangibles .................. 134,500
Tax benefit from exercise of stock options ......... 782,400
Deferred income taxes .............................. (190,000)
Compensation expense--common stock options ......... 8,670
Deferred lease incentives .......................... (90,203) (99,837)
Loss on sale of equipment .......................... 8,101 3,028
Cash provided (used) due to changes in:
Accounts receivable .............................. (2,117,730) (4,919,448)
Inventories ...................................... (403,793) (619,002)
Prepaid expenses ................................. (4,356) (58,669)
Accounts payable ................................. 115,535 1,503,774
Other liabilities ................................ (167,438) (136,119)
Income taxes payable ............................. 381,992 734,411
----------- -----------
Net cash provided by operating
activities............................. 2,419,231 2,529,212
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures .................................... (831,092) (1,319,463)
Proceeds from sale of equipment
Capitalization of software development costs ............ (215,464) (339,480)
Acquired software ....................................... (442,000) (763,500)
----------- -----------
Net cash used in investing activities ... (1,488,556) (2,422,443)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from note payable to related party
Payments on note payable to related party
Proceeds from note payable to bank
Payments on note payable to bank
Payments on capital lease obligations ................... (23,647)
Payment of preferred shares dividend
Proceeds from issuance of common shares ................. 12,195 5,645,259
Payments for repurchase of common shares ................ (281) (449)
----------- -----------
Net cash provided (used) by financing
activities ............................ (11,733) 5,644,810
----------- -----------
NET (DECREASE) INCREASE IN CASH AND CASH
EQUIVALENTS ............................................ 918,942 5,751,579
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD .................................... 12,600,365 15,462,786
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ................ $13,519,307 $21,214,365
=========== ===========
See notes to financial statements.
F-5
6
MINNESOTA EDUCATIONAL COMPUTING CORPORATION (MECC)
STATEMENTS OF SHAREHOLDERS' (DEFICIENCY) EQUITY
UNEARNED
COMPENSA-
COMMON SHARES ADDITIONAL TION
---------------------- PAID-IN ON STOCK
NUMBER AMOUNT CAPITAL OPTIONS
------ ------ ---------- ---------
Balance (Deficit) at March 31, 1992 ............. 4,942,875 $ 49,429
Issuance of shares on exercise of stock
options ................................. 5,250 52 $ 6,198
Shares acquired ........................... (84,000) (840) (6,198)
Net loss ..................................
Preferred shares dividend (Note 4) ........
----------- ----------- ----------- --------
Balance (Deficit) at March 31, 1993 ............. 4,864,125 48,641
Issuance of shares:
Initial public offering, less issuance
costs of $1,826,873 (Note 4) ...... 2,123,550 21,235 14,432,442
Exchange of redeemable preferred
stock in conjunction with initial
public offering (Note 4) .......... 701,262 7,013 4,992,987
On exercise of stock options ......... 5,471 55 1,357
Shares acquired ........................... (5,471) (55) (1,357)
Common stock options granted .............. $(57,800)
Common stock options vested ............... 11,560
Net income ................................
Preferred shares dividend (Note 4)
----------- ----------- ----------- --------
Balance at March 31, 1994 ....................... 7,688,937 76,889 19,425,429 (46,240)
Issuance of shares on exercise of stock
options, including related tax benefits . 64,848 649 128,816
Shares acquired ........................... (106) (1) (34)
Common stock options vested ............... 12,440
Common stock options canceled ............. 33,800
Net income ................................
----------- ----------- ----------- --------
Balance at March 31, 1995 ....................... 7,753,679 77,537 19,554,211
Issuance of shares-secondary public
offering, less issuance costs of $640,141
(unaudited) ............................. 200,000 2,000 5,557,859
Issuance of shares on exercise of stock
options, including related tax benefits
(unaudited) ............................. 80,291 803 866,997
Shares acquired (unaudited) ............... (13) (449)
Net income (unaudited) ....................
----------- ----------- ----------- --------
Balance at December 31, 1995 (unaudited) ........ 8,033,957 $ 80,340 $25,978,618 $
=========== =========== =========== ========
TOTAL
(DEFICIT) SHAREHOLDERS'
RETAINED (DEFICIENCY)
EARNINGS EQUITY
--------- -------------
Balance (Deficit) at March 31, 1992.................. $(2,900,942) $(2,851,513)
Issuance of shares on exercise of stock
options...................................... 6,250
Shares acquired................................ (29,962) (37,000)
Net loss...................................... (497,265) (497,265)
Preferred shares dividend (Note 4)............ (480,000) (480,000)
----------- -----------
Balance (Deficit) at March 31, 1993.................. (3,908,169) (3,859,528)
Issuance of shares:
Initial public offering, less issuance
costs of $1,826,873 (Note 4)........... 14,453,677
Exchange of redeemable preferred
stock in conjunction with initial
public offering (Note 4)............... 5,000,000
On exercise of stock options.............. 1,412
Shares acquired................................ (7,629) (9,041)
Common stock options granted.................. 57,800
Common stock options vested................... 11,560
Net income.................................... 1,860,165 1,860,165
Preferred shares dividend (Note 4)............ (472,000) (472,000)
----------- -----------
Balance at March 31, 1994............................ (2,469,833) 16,986,245
Issuance of shares on exercise of stock
options, including related tax benefits...... 129,465
Shares acquired................................ (246) (281)
Common stock options vested................... 12,440
Common stock options canceled................. (33,800)
Net income.................................... 3,795,137 3,795,137
----------- -----------
Balance at March 31, 1995............................ 1,291,258 20,923,006
Issuance of shares-secondary public
offering, less issuance costs of $640,141
(unaudited).................................. 5,559,859
Issuance of shares on exercise of stock
options, including related tax benefits
(unaudited).................................. 867,800
Shares acquired (unaudited).................... (449)
Net income (unaudited)........................ 4,342,781 4,342,781
----------- -----------
Balance at December 31, 1995 (unaudited)............. $ 5,634,039 $31,692,997
=========== ===========
See notes to financial statements.
F-6
7
MINNESOTA EDUCATIONAL COMPUTING CORPORATION (MECC)
NOTES TO FINANCIAL STATEMENTS
FISCAL YEARS ENDED MARCH 31, 1993, 1994 AND 1995
AND NINE MONTHS ENDED DECEMBER 31, 1994 AND 1995 (UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Minnesota Educational Computing Corporation (MECC) (the "Company"), is a
developer and publisher of educational software for the school and home markets.
The Company provides educational software and related services to a diverse
group of primarily domestic customers, with a concentration of revenue from
school districts across the United States. School market sales accounted for
63%, 57% and 53% of total revenue in fiscal years 1993, 1994 and 1995,
respectively and 55% and 40% of total revenue for the nine months ended December
31, 1994 and 1995, respectively. Sales to one customer were 10% of total sales
during fiscal year 1993.
Unaudited Financial Statements--The financial statements as of December 31,
1995 and for the nine months ended December 31, 1994 and 1995 are unaudited. In
the opinion of management, such unaudited financial statements include all
adjustments, consisting of only normal, recurring accruals, necessary for a fair
presentation thereof. The results of operations for any interim period are not
necessarily indicative of the results for the year.
Net Revenue--Revenues from product sales are recognized when the products
are shipped, because, generally, no post-shipment obligations remain
outstanding. Deferred revenue is recorded for the portion of membership
(including MathKeys) sales related to unshipped products. The Company currently
maintains a stock-balancing policy which allows distributors and retailers to
return products according to negotiated terms or pursuant to any promotional
terms which may be in effect. The Company also accepts returns of defective,
shelf-worn and damaged products at any time in accordance with negotiated terms.
The Company does not have any other significant product return or warranty
programs. The Company provides an allowance for estimated returns at the time of
product shipment. The Company has a volume incentive rebate policy which it
offers to certain customers. The rebate is based upon a percentage of a sales
goal which is specific to each customer and is recorded at the time of product
shipment.
Cost of Sales--Cost of sales includes all costs associated with the
manufacture and assembly of the Company's products, including packaging,
warehousing and shipping, as well as royalties paid to co-developers, including
amortization of prepaid royalties, and amortization of capitalized software
development costs and acquired software. In the fiscal years ended March 31,
1993, 1994 and 1995 amortization of capitalized software development costs was
$227,352, $422,102 and $479,123, and amortization of acquired software/prepaid
royalties was $9,000, $68,801 and $341,774, respectively and for the nine months
ended December 31, 1994 and 1995 capitalized software development costs were
$365,886 and $277,208, respectively, and amortization of acquired
software/prepaid royalties was $239,008 and $162,180, respectively.
Concentrations of Credit Risks--The Company's cash and cash equivalents
consist of U.S. Treasury Bills, commercial paper and cash. The majority of these
investments are not specifically insured. The Company has not experienced any
losses on these investments.
The Company also grants credit to customers in the ordinary course of
business. Concentrations of credit risk with respect to trade receivables are
limited due to the number of customers and their geographic dispersion.
F-7
8
MINNESOTA EDUCATIONAL COMPUTING CORPORATION (MECC)
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
Inventories--Inventories are stated at the lower of cost or realizable
value, calculated by using the average cost method (which approximates the
first-in, first-out cost method) of inventory valuation. Inventories consist of
software components, primarily manuals, CD-ROM and disks, ready for assembly or
assembled. The Company records a provision each period for identified
slow-moving or obsolete inventory items. The allowance for obsolete and
overstock inventory was $141,434 and $91,000 at March 31, 1994 and 1995,
respectively, and was $88,000 at December 31, 1995.
Acquired Software--The Company enters into contracts to have products
developed by external software developers which involve expenditures to external
developers. To the extent the Company acquires completed software from external
developers or makes expenditures to external developers for development on
products after they have reached technological feasibility, the expenditures are
capitalized and recorded as an asset under acquired software. To the extent the
expenditures for development to external developers are made prior to the
product reaching technological feasibility, they are expensed. Amortization of
acquired software is expensed as part of cost of sales based on the revenue
generated by the product.
Property and Equipment--Property and equipment, which consists principally
of computer and office equipment, purchased application software, furniture and
office partitions, is carried at cost and is depreciated using the straight-line
method over the estimated useful lives of the property.
Intangible Assets--Intangible assets include capitalized software
development costs, acquired software and various other intangible assets
purchased at acquisition, including software, a noncompete agreement, a prepaid
royalty and goodwill. Capitalized software development costs, acquired software
and software purchased at acquisition are amortized on a product-by-product
basis based on the greater of the amount computed using (a) the ratio that
current gross revenues for a product bear to the total of current and
anticipated future gross revenues for that product or (b) the straight-line
method over the remaining estimated economic life of the product including the
period being reported. Amortization starts when the product is available for
general release to customers. The noncompete agreement and goodwill are
amortized using the straight-line method. Accumulated amortization of
capitalized software development costs was $853,558, $1,332,681 and $1,609,889
at March 31, 1994 and 1995 and December 31, 1995, respectively. Accumulated
amortization of acquired software was $77,801, $419,575 and $581,755 at March
31, 1994 and 1995 and December 31, 1995, respectively. Accumulated amortization
of acquisition-related intangibles was $568,082 at March 31, 1994 and $702,582
at March 31, 1995, at which time acquisition-related intangibles were fully
amortized. Estimated useful lives of the intangibles are as follows:
Capitalized software development costs... 1--2 years
Acquired software........................ 1--2 years
Acquisition-related intangibles.......... 4 years
F-8
9
MINNESOTA EDUCATIONAL COMPUTING CORPORATION (MECC)
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
The amortization of the acquisition-related intangibles consisted of the
following:
NINE MONTHS
FISCAL YEARS ENDED MARCH 31, ENDED
---------------------------- DECEMBER
1993 1994 1995 31, 1994
---- ---- ---- -----------
Amortization of acquisition-related intangibles:
Noncompete agreement .................... $100,000 $157,000 $118,000 $118,000
Other ................................... 37,762 49,186 16,500 16,500
-------- -------- -------- --------
Total ............................. $137,762 $206,186 $134,500 $134,500
======== ======== ======== ========
Management of the Company periodically reviews the carrying value of its
intangible assets for potential impairment by comparing the carrying value of
these assets with their related, expected future net cash flows. Should the sum
of the related, expected future net cash flows be less than the carrying value,
management would determine whether an impairment loss should be recognized. An
impairment loss would be measured by the amount by which the carrying value of
the asset exceeds the fair value of the asset. To date, management has
determined that no impairment of these assets exists.
Capitalized Software Development Costs and Product Development
Expenses--Product development costs are capitalized as incurred in accordance
with Statement of Financial Accounting Standards (SFAS) No. 86. Total product
development costs capitalized by the Company were $218,186, $643,748, and
$261,614 for the years ended March 31, 1993, 1994 and 1995, respectively, and
$215,464 and $339,480 for the nine months ended December 31, 1994 and 1995,
respectively.
Capitalization of software development costs begins upon the establishment
of technological feasibility. The establishment of technological feasibility and
the ongoing assessment of recoverability of capitalized software development
costs requires considerable judgment by management with respect to certain
external factors, including, but not limited to, anticipated future gross
revenue, estimated economic life, and changes in software and hardware
technologies.
Income Taxes--The Company records income taxes in accordance with SFAS No.
109, "Accounting for Income Taxes", which requires the use of the liability
method of accounting for deferred income taxes (see Note 8).
Income taxes are deferred for all temporary differences between the
financial statement and tax basis of assets and liabilities. Deferred taxes are
recorded using the enacted tax rates scheduled by tax law to be in effect when
the temporary differences are expected to be settled or realized. Deferred tax
assets are reduced by a valuation allowance to the extent that the assets may
not be realizable.
Cash Equivalents--The Company considers investments with original
maturities of three months or less to be cash equivalents.
Supplemental Cash Flow Information--The Company paid interest of $75,593,
$64,972 and $727 for the years ended March 31, 1993, 1994 and 1995,
respectively, and $1,000 and $0 for the nine months ended December 31, 1994 and
1995, respectively. Interest received for the years ended March 31, 1993, 1994
and 1995 was $8,046,
F-9
10
MINNESOTA EDUCATIONAL COMPUTING CORPORATION (MECC)
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
$10,591 and $523,369, respectively, and for the nine months ended December 31,
1994 and 1995 was $310,000 and $801,000, respectively. Income taxes paid by the
Company were $2,800, $51,729 and $1,166,340 for the years ended March 31, 1993,
1994 and 1995, respectively, and $861,000 and $623,000 for the nine months ended
December 31, 1994 and 1995, respectively.
Net (Loss) Income Per Common and Common Equivalent Share--The net (loss)
income per common and common equivalent share is based on the weighted average
number of common and common equivalent shares outstanding during the period.
Assuming the preferred shares, as discussed in Note 4, were exchanged for common
shares on April 1, 1992, supplementary net (loss) income per common and common
equivalent share would have been $(0.08) and $0.30 for the fiscal years ended
March 31, 1993 and 1994, respectively.
Reclassifications--Certain reclassifications have been made to the 1993 and
1994 financial statements in 1995. Such reclassifications had no effect on net
(loss) income or shareholders' equity.
2. PROPERTY AND EQUIPMENT
Property and equipment is summarized as follows:
MARCH 31,
ESTIMATED ---------------------- DECEMBER 31,
LIFE 1994 1995 1995
-------------- ---- ---- ------------
Computer equipment........... 5 years $2,329,917 $3,000,683 $3,783,507
Purchased software........... 3 years 30,932 30,932 65,585
Office equipment and fixtures 5-7 years 1,363,632 1,400,969 1,754,375
Automobiles.................. 3 years 13,700
Machinery and equipment...... 5 years 355,053 375,494 415,645
Leasehold improvements....... 5 years 31,707 104,391 199,800
---------- ---------- ----------
4,124,941 4,912,469 6,218,912
Less accumulated depreciation 1,571,582 2,245,595 2,982,108
---------- ---------- ----------
Property and equipment, net.. $2,553,359 $2,666,874 $3,236,804
========== ========== ==========
The net book value of equipment under capital leases was $48,679 at March
31, 1994.
3. LEASES
The Company has both operating and capital leases, the latter being for
office equipment that expired in fiscal year 1995. The noncancelable operating
leases are for office and materials management facilities. Rent expense was
$440,480, $507,032 and $533,540 for the years ended March 31, 1993, 1994 and
1995, respectively, and $393,954 and $433,364 for the nine months ended December
31, 1994 and 1995, respectively.
F-10
11
MINNESOTA EDUCATIONAL COMPUTING CORPORATION (MECC)
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
The Company entered into an operating lease agreement for office space on
June 1, 1991 which has a term of seven years and six months. The Company
received cash incentives in conjunction with this lease agreement. In addition,
the Company was not required to make lease payments for the first six months
under the lease agreement. These lease incentives were deferred and are being
amortized on a straight-line basis over the lease term and are excluded from the
minimum lease payments shown below. The Company has options for space expansion
and an option to extend the term of the lease for two additional periods of
three years each.
In 1991, the Company entered into a lease agreement for a materials
management center with a term of seven years. The agreement contains an option
for space expansion and a one-time option to extend the term of the lease for
three years. The agreement also provides for a right of cancellation for a fee,
two years prior to lease expiration.
On September 19, 1995, the Company entered into an operating lease
agreement for 2,583 square feet of satellite office space in Bellevue,
Washington, at a basic annual rate of $19 per square foot. The term of the lease
is three years with a one-time option to extend the term for another three years
and options for space expansion.
At March 31, 1995, minimum lease payments under all noncancelable operating
lease agreements are as follows:
Fiscal 1996................. $ 729,071
Fiscal 1997................. 733,716
Fiscal 1998................. 629,702
Fiscal 1999................. 469,596
----------
Total minimum lease payments $2,562,085
==========
4. SHAREHOLDERS' EQUITY
Secondary Public Offering--On August 21, 1995, 3,340,000 Common Shares were
sold in a secondary public offering. Of the total shares, 200,000 shares were
sold by the Company and 3,140,000 shares were sold by Selling Shareholders at
$31.00 per share. Net proceeds to the Company were approximately $5,560,000,
after deducting offering costs, including underwriting commissions, of
approximately $640,000.
Common Stock Split--On June 5, 1995, the Company's Board of Directors
approved a 3-for-2 stock split in the form of a 50% stock dividend effective
June 30, 1995. All share and per share amounts in the financial statements have
been restated to reflect the split.
Merger--On May 16, 1996, the Company's stockholders approved the Agreement
and Plan of Merger dated as of October 30, 1995 by and among the Company,
SoftKey International Inc. (SoftKey) and SchoolCo Inc., a wholly-owned
subsidiary of SoftKey (SchoolCo), pursuant to which, on May 17, 1996, SchoolCo
was merged with and into the Company with the Company surviving the merger as a
wholly-owned subsidiary of SoftKey, and each of the Company's Common Shares was
converted into the right to receive 1.14286 shares of SoftKey common stock.
Initial Public Offering--On March 25, 1994, the Company sold 2,123,550
common shares at $7.67 per share in an initial public offering. Net proceeds
were $14,453,677, after deducting offering costs of $1,826,873.
F-11
12
MINNESOTA EDUCATIONAL COMPUTING CORPORATION (MECC)
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
During 1991, the Company issued 1,000,000 Series A preferred shares $5 par
value per share (10,000,000 shares authorized) to the North American Fund II,
L.P. (the "Fund") for $5,000,000. The general partner and manager of the Fund is
North American Business Development Company, L.C. The principals of this general
partner are members of the Company's Board of Directors. In connection with the
Company's initial public offering, all the redeemable preferred shares were
exchanged for 701,262 common shares and all dividends in arrears were paid.
Stock Option Plans--In 1991, under the MECC 1991 Restricted Stock and
Nonqualified Option Plan (the "1991 Plan"), the Company granted stock purchase
awards and issued 480,375 common shares for $22,875 ($0.0476 per share) to
certain officers of the Company. Under the terms of the 1991 Plan, the officers
become vested in the shares ratably over a service period or upon a change in
control of the Company otherwise than pursuant to a public offering of the
Company's common shares.
The Company has also granted stock options to certain officers and
employees under the 1991 Plan (as amended to be consolidated with another
nonqualified stock option plan adopted by the Company in 1991) to purchase
898,508 common shares for exercise prices ranging between $.0476 to $9.50 per
share. Under the terms of the 1991 Plan, the options become exercisable
according to a vesting schedule, in general, over a six-year period or upon a
change in control otherwise than pursuant to a public offering of the Company's
common shares. The 1991 Plan expired in November, 1994.
The 1995 Stock Incentive Plan (the "1995 Plan") has been approved by the
Board of Directors and the Company's shareholders. The aggregate number of
shares that could be issued under the 1995 Plan, as amended, is 900,000 shares
of Common Stock. The 1995 Plan gives discretion to the Compensation Committee of
the Board of Directors to grant unqualified stock options and incentive stock
options, in accordance with such vesting schedules and other terms that the
Compensation Committee deems appropriate.
F-12
13
MINNESOTA EDUCATIONAL COMPUTING CORPORATION (MECC)
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
The following summarizes the activity for the plans:
NUMBER OF SHARES
UNDER OPTION PLANS OPTION PRICE PER SHARE
--------------------- ----------------------
1991 1995
---- ----
Outstanding at March 31, 1992..... 522,113 $ .0476 -- $ 1.1905
Granted.................... 54,075 $1.4286
Exercised and repurchased.. (5,250) $1.1905
Canceled................... (97,020) $ .0476 -- $ 1.4286
--------
Outstanding at March 31, 1993..... 473,918 $ .0476 -- $ 1.4286
Granted.................... 185,220 $1.4286 -- $ 2.1429
Exercised and repurchased.. (5,471) $ .0476 -- $ 1.1905
Canceled................... (27,768) $ .0476 -- $ 1.4286
--------
Outstanding at March 31, 1994..... 625,899 $ .0476 -- $ 2.1429
Granted.................... 91,530 449,250 $ 7.00 -- $11.6667
Exercised.................. (64,848) $ .0476 -- $ 1.7238
Canceled................... (108,622) (37,500) $ .0476 -- $11.6667
-------- ------- ------- --------
Outstanding at March 31, 1995..... 543,959 411,750 $ .0476 -- $11.6667
Granted................... 275,657 $ 15.50 -- $ 28.75
Exercised.................. (80,291) $ .0476 -- $ 8.50
Canceled................... (14,462) (3,685) $ .0476 -- $ 28.00
-------- ------- ------- --------
Outstanding at December 31, 1995.. 449,206 683,722 $ .0476 -- $ 28.75
======== ======= ======= ========
Options to purchase 38,037, 104,700 and 151,929 shares at March 31, 1993,
1994 and 1995, respectively, were exercisable and the weighted average option
price per share for outstanding options at March 31, 1995 was $6.2246. Options
to purchase 276,288 shares at December 31, 1995 were exercisable and the
weighted average option price per share was $6.1205.
The exercise of nonqualified stock options result in a tax deduction for
the Company equivalent to taxable income recognized by the optionee. For
financial reporting purposes, the tax effect of this deduction is accounted for
as a credit to additional paid-in capital rather than as a reduction in income
tax expense. The options exercised in fiscal 1995 and the nine months ended
December 31, 1995 resulted in a tax benefit to the Company of approximately
$76,000 and $782,400, respectively.
5. RELATED PARTY TRANSACTIONS
Through April 1993, the Company borrowed monies from the Fund under demand
notes bearing interest at prime rate plus one quarter percent per annum.
Interest expense on this debt was $64,000 for fiscal year 1993. The maximum
amount outstanding, the average amount outstanding, and the weighted average
interest rate was $1,475,000, $1,082,877, and 6.63%, respectively, for the year
ended March 31, 1993 and $775,000, $16,986, and
F-13
14
MINNESOTA EDUCATIONAL COMPUTING CORPORATION (MECC)
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
6.5%, respectively, for the year ended March 31, 1994. In April 1993, the
Company established a line of credit (see Note 6) and drew on the line to repay
these demand notes.
6. LINE OF CREDIT
In April 1993, the Company established a $1,500,000 bank line of credit.
The bank line of credit was amended in September 1993 to increase the line of
credit to $2,000,000, and again in December 1994 to decrease the line of credit
to $1,000,000. The line of credit expires on October 31, 1996. Interest on the
outstanding borrowings under the line is the reference rate (9.0% at March 31,
1995). The line of credit is secured by the assets of the Company, including
receivables, inventory, and property. At March 31, 1994 and 1995 and December
31, 1995, the Company had no outstanding borrowings under this line of credit.
The covenants of the line credit require the Company to maintain a specific
capital base and maintain certain debt to net worth and current ratios. The
covenants also restrict the Company from expending more than $1,100,000 per
fiscal year for the purchase of fixed assets, or more than $1,700,000 for
purchase or redemption of any shares of its stock (except for redemptions under
the Plan (see Note 4) which may not exceed $300,000), or paying any dividends or
making distribution to shareholders of any assets. The maximum amount
outstanding, the average amount outstanding, and the weighted average interest
rate for the year ended March 31, 1994 was $1,980,000, $1,542,247 and 7.0%,
respectively.
7. EMPLOYEE BENEFIT PLANS
The Company established a defined contribution savings plan in fiscal year
1992 covering substantially all employees who meet eligibility requirements.
Expense under this plan is based on a percentage of each participant's
compensation, and was $182,377, $221,440 and $240,248 for the years ended March
31, 1993, 1994 and 1995, respectively, and $189,760 and $221,379 for the nine
months ended December 31, 1994 and 1995, respectively. Beginning April 1, 1995,
the Company commenced making matching contributions in its Common Shares. The
Company may also make discretionary contributions to the plan; however, no
discretionary contributions have been made.
The Company has employment agreements with certain officers that require
the Company to pay those officers' salary and benefits for up to 12 and 18
months (24 to 36 months under certain change in control circumstances) if the
Company terminates that officer's employment other than because of disability or
for cause (as defined).
F-14
15
MINNESOTA EDUCATIONAL COMPUTING CORPORATION (MECC)
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
8. INCOME TAXES
Temporary differences and tax carryforwards comprising the net deferred
taxes shown on the balance sheets are as follows:
MARCH 31, DECEMBER 31,
-----------------------
1994 1995 1995
---- ---- ------------
Current Deferred Tax Asset:
Allowance for doubtful accounts and returns............... $ 185,000 $ 480,000 $ 670,000
Inventory................................................. 62,000 48,000 60,000
Prepaid expenses.......................................... 12,000 52,000 40,000
Accruals for employee compensation........................ 41,000
--------- --------- ---------
Total current deferred tax asset.................... $ 300,000 $ 580,000 $ 770,000
========= ========= =========
Noncurrent Deferred Tax Liability:
Accelerated depreciation for tax purposes................. $(239,000) $(240,000) $(285,000)
Capitalized intangible costs.............................. 14,000 125,000 125,000
Other..................................................... 15,000
Tax loss and tax credit carryforwards..................... 720,000 275,000
Valuation allowance....................................... (720,000) (320,000)
--------- --------- ---------
Total noncurrent deferred tax liability............. $(210,000) $(160,000) $(160,000)
========= ========= =========
At March 31, 1995, the Company has available research and experimental
credits of approximately $220,000 which expire from 2009 to 2011. The Company
also has available alternative minimum tax credit carryforwards of approximately
$55,000 for federal tax purposes; this federal credit can be carried forward
indefinitely.
F-15
16
MINNESOTA EDUCATIONAL COMPUTING CORPORATION (MECC)
NOTES TO FINANCIAL STATEMENTS - (CONCLUDED)
The provisions for income taxes consisted of the following:
NINE MONTHS ENDED
FISCAL YEARS ENDED MARCH 31, DECEMBER 31,
------------------------------------ -----------------------
1993 1994 1995 1994 1995
---- ---- ---- ---- ----
Current:
Federal....... $ 90,000 $1,590,000 $1,234,000 $2,121,500
State......... $6,000 10,000 10,000 9,000 20,000
------ -------- ---------- ---------- ----------
6,000 100,000 1,600,000 1,243,000 2,141,500
Deferred:
Federal....... (90,000) (330,000) (190,000)
-------- ---------- ----------
$6,000 $ 10,000 $1,270,000 $1,243,000 $1,951,500
====== ======== ========== ========== ==========
The Company's income tax expense differs from the amount computed by
applying the federal income tax rate (34% for the year ended March 31, 1993 and
35% for all periods subsequent to March 31, 1993), to net (loss) income before
taxes as follows:
NINE MONTHS ENDED
FISCAL YEARS ENDED MARCH 31, DECEMBER 31,
--------------------------------------- ------------------------
1993 1994 1995 1994 1995
---- ---- ---- ---- ----
Statutory rate applied to (loss)
income before taxes.......... $(169,000) $ 655,000 $1,773,000 $1,615,000 $2,203,000
State income taxes, net......... (25,000) 41,000 (20,000)
Tax credits..................... (389,000) (165,000) (120,000) (100,000)
Valuation allowance adjustment.. 111,000 (341,000) (400,000) (330,000) (320,000)
Nondeductible expenses and
other........................ 89,000 44,000 82,000 78,000 168,500
--------- --------- ---------- ---------- ----------
$ 6,000 $ 10,000 $1,270,000 $1,243,000 $1,951,500
========= ========= ========== ========== ==========
F-16