EXHIBIT 13.1 CREATIVE COMPUTERS, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Report of Independent Accountants F-2 Consolidated Balance Sheet at December 31, 1997 and 1996 F-3 Consolidated Statement of Operations for the Years Ended December 31, 1997, 1996 and 1995 F-4 Consolidated Statement of Stockholders' Equity for the Years Ended December 31, 1997, 1996 and 1995 F-5 Consolidated Statement of Cash Flows for the Years Ended December 31, 1997, 1996 and 1995 F-6 Notes to Consolidated Financial Statements F-7 F-1 REPORT OF INDEPENDENT ACCOUNTANTS TO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF CREATIVE COMPUTERS, INC. In our opinion, the consolidated financial statements listed in the index appearing under Item 14 (a) (1) and (2) present fairly, in all material respects, the financial position of Creative Computers, Inc. and its subsidiaries at December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. 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 of these statements in accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PRICE WATERHOUSE LLP Costa Mesa, California February 4, 1998, except as to Note 12 which is as of March 20, 1998 F-2 CREATIVE COMPUTERS, INC. CONSOLIDATED BALANCE SHEET (in thousands, except share data) December 31, ------------------- 1997 1996 -------- -------- ASSETS Current assets: Cash and cash equivalents $ 8,018 $ 17,329 Securities available for sale (Note 1) - 521 Accounts receivable, net of allowance for doubtful accounts of $2,859 and $2,134, respectively 42,455 19,948 Inventories (Note 1) 44,723 55,092 Prepaid expenses and other current assets 2,894 3,410 Income tax refund receivable (Notes 1 and 5) 469 1,753 Deferred income taxes (Notes 1 and 5) 2,484 4,284 -------- -------- Total current assets 101,043 102,337 Property, plant and equipment, net (Notes 1 and 2) 14,788 10,909 Goodwill, net (Notes 1 and 10) 15,141 - Other assets 182 185 -------- -------- $131,154 $113,431 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable (Note 3) $ 45,958 $ 50,770 Accrued expenses and other current liabilities 13,275 8,684 Line of credit (Note 3) 9,956 - Capital leases--current portion (Note 2) 207 243 Notes payable--current portion (Note 4) 23 40 -------- --------- Total current liabilities 69,419 59,737 Capital leases (Note 2) 148 293 Notes payable (Note 4) 348 32 Deferred income taxes (Notes 1 and 5) 1,469 564 -------- --------- Total liabilities 71,384 60,626 Stockholders' equity: Common stock, $.001 par value; authorized 15,000,000 shares; 10,105,258 and 9,791,825 shares issued 10 10 Preferred stock, $.001 par value; authorized 5,000,000 shares; none issued and outstanding Additional paid in capital 56,772 53,932 Treasury stock, at cost: 15,000 shares (91) (91) Retained earnings (accumulated deficit) 3,079 (1,046) -------- -------- Total stockholders' equity 59,770 52,805 -------- -------- $131,154 $113,431 ======== ======== See notes to the consolidated financial statements F-3 CREATIVE COMPUTERS, INC. CONSOLIDATED STATEMENT OF OPERATIONS (in thousands, except per share data) Year ended December 31, ------------------------------ 1997 1996 1995 ---- ---- ---- Net sales $546,131 $444,971 $420,877 Cost of goods sold 476,061 395,000 361,803 -------- -------- -------- Gross profit 70,070 49,971 59,074 Selling, general and administrative expenses 61,255 60,585 48,455 Expenses associated with the relocation of the Company's distribution center - - 1,389 Expenses associated with the relocation of the Company's headquarters (Note 11) 815 - - Expenses related to acquisition of Elek-Tek (Note 10) 1,470 - - -------- -------- -------- Income (loss) from operations 6,530 (10,614) 9,230 Interest income, net 118 593 371 -------- -------- -------- Income (loss) before income taxes 6,648 (10,021) 9,601 Income tax provision (benefit) (Notes 1 and 5) 2,523 (3,972) 3,754 -------- -------- -------- Net income (loss) $ 4,125 $ (6,049) $ 5,847 ======== ======== ======== Basic earnings (loss) per share $ 0.42 $ (0.62) $ 0.71 ======== ======== ======== Diluted earnings (loss) per share $ 0.41 $ (0.62) $ 0.66 ======== ======== ======== Basic weighted average number of shares outstanding 9,895 9,767 8,291 ======== ======== ======== Diluted weighted average number of shares outstanding 10,030 9,767 8,890 ======== ======== ======== See notes to the consolidated financial statements F-4 CREATIVE COMPUTERS, INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (in thousands) Common Stock Additional Retained ------------ Paid In Earnings Treasury Shares Amount Capital (Deficit) Stock Total ------ ------ ------- --------- ----- ----- Balance at December 31, 1994 4,900 $ 5 $ 52 $ 833 $ $ 890 Initial public offering, net 2,250 2 34,399 34,401 Exercise of warrant 2,100 2 4,948 4,950 Purchase of building from related parties (1,677) (1,677) Follow-on offering, net 500 1 12,148 12,149 Net income 5,847 5,847 ------ ----- ------- --------- ----- ------- Balance at December 31, 1995 9,750 10 51,547 5,003 56,560 Purchase of treasury stock (91) (91) Stock option exercises 42 239 239 Proceeds from director, net (Note 7) 2,146 2,146 Net loss (6,049) (6,049) ------ ----- ------- --------- ----- ------- Balance at December 31, 1996 9,792 10 53,932 (1,046) (91) 52,805 Issuance of stock in connection with acquisition (Note 10) 272 2,500 2,500 Stock option exercises, including related income tax benefit 41 340 340 Net income 4,125 4,125 ------ ----- ------- --------- ----- ------- Balance at December 31, 1997 10,105 $ 10 $56,772 $ 3,079 $ (91) $59,770 ====== ===== ======= ========= ===== ======= See notes to the consolidated financial statements F-5 CREATIVE COMPUTERS, INC. CONSOLIDATED STATEMENT OF CASH FLOWS (in thousands) Year ended December 31, ------------------------------- 1997 1996 1995 -------- ------- -------- Cash flows from operating activities: Net income (loss) $ 4,125 $(6,049) $ 5,847 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 2,337 1,955 1,254 Provision (benefit) for deferred income taxes 2,350 (3,010) 651 Loss on disposal of property, plant and equipment 783 - 19 Changes in operating assets and liabilities, net of acquisitions: Accounts receivable (5,112) (1,643) (12,578) Inventories 17,414 (3,066) (26,387) Prepaid expenses and other current assets 906 27 (2,201) Other assets 3 242 (344) Accounts payable (6,827) 4,164 17,160 Accrued expenses and other current liabilities 1,064 550 5,677 Income taxes 1,723 (959) (1,888) -------- ------- -------- Total adjustments 14,641 (1,740) (18,637) -------- ------- -------- Net cash provided by (used in) operating activities 18,766 (7,789) (12,790) Cash flows from investing activities: Redemptions of securities available for sale 1,536 31,805 135,597 Purchase of securities available for sale (1,015) (19,751) (148,172) Acquisition of Elek-Tek (Note 10) (9,083) - - Acquisition of ComputAbility (Note 10) (5,482) - - Acquisition of property, plant and equipment (3,276) (2,050) (7,900) Proceeds from sale of equipment 13 - - Increase in related party notes receivable - - (125) -------- ------- -------- Net cash provided by (used in) investing activities (17,307) 10,004 (20,600) Cash flows from financing activities: Net line of credit payments (10,775) - (3,279) Payments under notes payable, net (81) (13) (1,044) Payments on notes payable-related parties - - (164) Subordinated debt borrowings - - 2,000 Proceeds from profits realized by Director in sale of stock - 2,146 - Principal payments of obligations under capital leases (254) (249) (939) Purchase of treasury stock - (91) - Proceeds from stock issued under stock option plans 340 239 - Net proceeds from initial and follow-on public offerings - - 46,550 -------- ------- -------- Net cash provided by (used in) financing activities (10,770) 2,032 43,124 Net increase (decrease) in cash and cash equivalents (9,311) 4,247 9,734 Cash and cash equivalents: Beginning of period 17,329 13,082 3,348 -------- ------- -------- End of period $ 8,018 $17,329 $ 13,082 ======== ======= ======== See notes to the consolidated financial statements F-6 CREATIVE COMPUTERS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share data) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES DESCRIPTION OF COMPANY Creative Computers, Inc. (the "Company") is a direct marketer of personal computer hardware, software and peripheral products founded in 1987. During 1997, the Company acquired and assimilated two marketers of personal computer hardware and software products, Elek-Tek, Inc. and ComputAbility, Inc. In November 1997, the Company formed a wholly-owned subsidiary, uBid, to sell computer related products and consumer electronics through an auction format on the Internet. The Company offers products to individual consumers, home offices, small businesses and large corporations through direct response catalogs, dedicated inbound and outbound telemarketing sales executives, a direct sales force, retail showrooms and advertising on the Internet. The Company offers a broad selection of products through its distinctive, full-color catalogs, MacMall, PC Mall, DataCom Mall and ComputAbility, the Company's worldwide websites on the Internet, and other promotional materials. USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS 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 respective reporting periods. Actual results could differ from those estimates. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. CASH EQUIVALENTS All highly liquid investments with initial maturities of three months or less are considered cash equivalents. F-7 CREATIVE COMPUTERS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share data) SECURITIES AVAILABLE FOR SALE The Company adopted Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" effective January 1, 1995. In accordance with the principles thereunder, the Company has classified its investments as securities available for sale and has reported them at fair value, with unrealized gains and losses included in equity. Unrealized gains or losses were not material at December 31, 1997 or 1996. Realized gains or losses are determined on the specific identification method and are reported in income. INVENTORIES Inventories consist of computer hardware, software and peripheral products, and are stated at cost (determined under the first-in, first-out cost method) or market, whichever is lower. The Company had reserves of approximately $5,364 and $6,304 for demonstration inventory, lower of cost or market pricing and potential excess and obsolete inventory at December 31, 1997 and 1996, respectively. DEFERRED ADVERTISING COSTS AND REVENUE The Company produces and circulates catalogs at various dates throughout the year. The Company receives market development funds and cooperative (co-op) advertising funds from vendors included in each catalog. These funds are recognized based on sales taken over the life of the catalog, which approximates eight weeks. The costs of developing and circulating each catalog are deferred and charged to advertising expense in the same time period as the co-op funds based on sales over the life of the catalog. Advertising expense, net of advertising revenue earned, included in selling, general and administrative expenses, was approximately $1,397, $8,155 and $11,500 for the years ended December 31, 1997, 1996, and 1995, respectively. Deferred advertising costs were approximately $2,105 and $2,800 at December 31, 1997 and 1996, respectively. REVENUE RECOGNITION Revenue on product sales is recognized at the time of shipment. The Company's return policy provides for a 30-day money back guarantee on certain items. An allowance for potential product returns is established based upon historical trends. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment (including equipment acquired under capital leases) are stated at cost and are depreciated using straight-line methods over the estimated useful lives of the assets, as follows: Furniture and fixtures 5 - 7 years Leasehold improvements Life of lease--not to exceed 15 years Computer, machinery and equipment 3 - 7 years Building 31.5 years F-8 CREATIVE COMPUTERS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share data) DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amount of cash, cash equivalents and accounts receivable approximate fair value because of the short maturity of these instruments. The carrying amount of the Company's notes payable approximate fair value based upon the current rates offered to the Company for obligations of the same remaining maturities. GOODWILL Goodwill resulting from acquisitions is amortized on a straight-line method over periods not exceeding twenty-five years and is subject to periodic review for impairment. Accumulated amortization at December 31, 1997 and 1996 was $90 and $0, respectively. Amortization expense totaled $90 in fiscal 1997. Goodwill arose from the acquisitions consummated in 1997 (Note 10). ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS The Company reviews long-lived assets and certain intangible assets for impairment when events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. In the event the sum of the expected undiscounted future cash flows resulting from the use of the asset is less than the carrying amount of the asset, an impairment loss equal to the excess of the asset's carrying value over its fair value is recorded. The Company has recognized no such losses. INCOME TAXES (BENEFIT) The Company accounts for income taxes under Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." Under this method, deferred income taxes are recognized by applying enacted statutory tax rates applicable to future years to differences between the tax bases and financial reporting amounts of existing assets and liabilities. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. The provision (benefit) for income taxes represents the income tax payable for the period and the change during the period in deferred income tax assets and liabilities. INCOME (LOSS) PER SHARE Effective in the fourth quarter of fiscal 1997, the Company adopted Statement of Financial Accounting Standards No. 128, "Earnings per Share" (SFAS 128) and related interpretations. SFAS 128 requires dual presentation of Basic Earnings (Loss) per Share (Basic EPS) and Diluted Earnings (Loss) per Share (Diluted EPS). Basic EPS excludes dilution and is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the reported periods. Diluted EPS reflects the potential dilution that could occur if stock options and other commitments to issue common stock were exercised using the treasury stock method. Earnings (loss) per share have been restated for all periods to reflect the adoption of SFAS 128. F-9 CREATIVE COMPUTERS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share data) The composition of Basic and Diluted EPS is as follows: Year ended December 31, ----------------------- 1997 1996 1995 ---- ---- ---- Net income (loss) $ 4,125 $ (6,049) $ 5,847 =========== ========== ========== Weighted average shares - Basic 9,895,179 9,766,863 8,291,328 Effect of dilutive stock options and warrants 135,238 - 598,216 ----------- ---------- ---------- Weighted average shares - Diluted 10,030,417 9,766,863 8,889,544 =========== ========== ========== Net income (loss) per share - Basic $ 0.42 $ (0.62) $ 0.71 =========== ========== ========== Net income (loss) per share - Diluted $ 0.41 $ (0.62) $ 0.66 =========== ========== ========== ACCOUNTING FOR STOCK-BASED COMPENSATION The Company accounts for employee stock based compensation in accordance with Accounting Principles Board Opinion No. 25 and related interpretations. The disclosures required by Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS 123), have been included in Note 8. NEW ACCOUNTING STANDARDS In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS 130), which will become effective in 1998. The Company does not expect the adoption of SFAS 130 to have a material impact on its reported consolidated financial condition or results of operations. In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131, "Disclosure about Segments of an Enterprise and Related Information" (SFAS 131), which will become effective in 1998. SFAS 131 establishes standards for the way publicly-held companies report information about operating segments as well as disclosures about products and services, geographic areas and major customers. The Company does not expect the adoption of SFAS 131 to have a material effect on its reported consolidated financial condition or results of operations. F-10 CREATIVE COMPUTERS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share data) RECLASSIFICATIONS Certain reclassifications have been made to the 1995 and 1996 financial statement balances to conform to the 1997 presentation. 2. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consist of the following as of December 31: 1997 1996 ---- ---- Furniture and fixtures $ 2,907 $ 1,943 Leasehold improvements 3,483 2,739 Computer, machinery and equipment 10,257 8,685 Building 2,827 912 Land 1,446 911 ------- ------- 20,920 15,190 Less accumulated depreciation (6,132) (4,281) ------- ------- $14,788 $10,909 ======= ======= The Company leases certain equipment under capital leases. The following is a summary of this equipment as of December 31: 1997 1996 ---- ---- Computer, machinery and equipment $ 1,705 $ 1,724 Furniture and fixtures 372 372 ------- ------- 2,077 2,096 Less accumulated depreciation (1,660) (1,327) ------- ------- $ 417 $ 769 ======= ======= The following is a schedule of future minimum payments required under capital leases, together with their estimated present value as of December 31, 1997: 1998 $ 216 1999 153 2000 6 2001 and thereafter - ----- Total minimum lease payments 375 Less amount representing interest (20) ----- Present value of minimum lease payments 355 Current portion (207) ----- $ 148 ===== F-11 CREATIVE COMPUTERS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share data) 3. LINE OF CREDIT As of December 31, 1997, the Company had advances of $16,340 pursuant to a $80,000 line of credit with a finance company. The advances outstanding at December 31,1997 are comprised of $9,956 of working capital loans borrowed in connection with the acquisition of Elek-Tek (Note 10) and $6,384 of floorplan inventory financing to purchase inventory, which is included in accounts payable. The line of credit allows working capital advances up to $47,500 and floorplan inventory financing up to $50,000, however, total advances and floorplan financing cannot exceed $80,000. Working capital advances are also limited to eligible accounts receivable and inventory collateral. The line of credit is secured by substantially all of the Company's assets and is cancelable upon 90 days' advance notice. Interest for amounts owed for working capital advances are calculated at the finance company's prime rate (8.25% at December 31, 1997). Floorplan financing does not bear interest if paid within an average of 45 days of the inventory purchase date. Interest on floorplan financing not paid within an average of 45 days is charged at the finance company's prime rate plus 2% (10.25% at December 31, 1997 and 1996). The line of credit requires that the Company maintain a minimum tangible net worth, a minimum pretax earnings to interest expense ratio and limits debt as a ratio to tangible net worth. At December 31, 1997, the Company was in compliance with these covenants. 4. NOTES PAYABLE The Company is obligated under the following notes payable at December 31: 1997 1996 ---- ---- Various notes dated June 1992 to March 1996. Interest payable at 9% per annum. Certain notes require monthly payments of approximately $2; others are payable on demand. Certain notes are guaranteed by the Company's founding stockholders. $371 $ 72 Less current portion (23) (40) ---- ---- $348 $ 32 ==== ==== Maturities of notes payable, subsequent to December 31, 1997 are as follows: $23 in 1998, $192 in 1999, $7 in 2000, $149 thereafter. F-12 CREATIVE COMPUTERS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share data) 5. INCOME TAXES The provision (benefit) for income taxes consists of the following for the years ended December 31: 1997 1996 1995 ------ -------- ------ Current Federal $ 103 $(1,011) $2,459 State 70 49 644 ------ ------- ------ 173 (962) 3,103 Deferred Federal 2,101 (2,514) 598 State 249 (496) 53 ------ ------- ------ 2,350 (3,010) 651 ------ ------- ------ $2,523 $(3,972) $3,754 ====== ======= ====== The provision (benefit) for income taxes differed from the amount computed by applying the U.S. federal statutory rate to income (loss) before income taxes due to the effects of the following: 1997 1996 1995 ---- ----- ---- Expected taxes at federal statutory tax rate 34.0 % (34.0)% 34.0% State income taxes, net of federal income tax benefit 5.0 % (4.6) 5.0 Other (1.0)% (1.0) 0.1 ----- ------ ---- 38.0 % (39.6)% 39.1% ===== ====== ===== The significant components of deferred tax assets (liabilities) are as follows at December 31: 1997 1996 ------- ------- Accounts receivable $ 530 $ 776 Inventory 1,326 2,347 Prepaid expenses - (10) Accrued expenses and reserves 359 830 Allowance for sales returns 170 166 Section 481 adjustments 21 (43) Tax credits and loss carryforwards 143 226 Property, plant and equipment (1,222) (798) Amortization (340) - Other 28 226 ------- ------ Net deferred tax asset $ 1,015 $3,720 ======= ====== At December 31, 1997 and 1996, the Company had various state net operating loss carryforwards ranging in amounts from $48 to $1,025 and $505 to $871, respectively. At December 31, 1997 and 1996, the Company had federal and state capital loss carryforwards of $71, which begin to expire in 2001. The Company also had state tax credit carryforwards of $208 and $199, respectively, which begin to expire in 2011. F-13 CREATIVE COMPUTERS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share data) 6. COMMITMENTS AND CONTINGENCIES LEASES The Company occupies office and warehouse space under various operating leases with independent parties which provide for minimum annual rentals and escalations based on increases in real estate taxes and other operating expenses. Minimum annual rentals at December 31, 1997 were as follows: 1998 $ 2,559 1999 2,474 2000 2,686 2001 2,663 2002 2,016 Thereafter 1,564 ------- Total $13,962 ======= In 1997, 1996 and 1995 rent expense was $1,978, $1,408 and $863, respectively. Some of the leases contain renewal options, escalation clauses and require the Company to pay taxes, insurance and maintenance costs. LEGAL PROCEEDINGS Various claims and actions, considered normal to the Company's business, have been asserted and are pending against the Company. The Company believes that such claims and actions will not have any material adverse effect upon the Company's financial position or results of operations. 7. STOCKHOLDERS' EQUITY INITIAL PUBLIC OFFERING On April 4, 1995, the Company completed an initial public offering (the Offering) of 2,250,000 shares of common stock at an offering price of $17.00 per share. Net proceeds to the Company were $34,401, after deducting the underwriting discount and other costs associated with the Offering. In connection with the Offering, the Company purchased a retail showroom location previously owned by the Company's majority stockholders by repaying the indebtedness on the property of approximately $1,297, canceling related party notes receivable in the principal amounts of $1,646 and $125 (additional borrowings in April 1995), making a payment of approximately $181 to the stockholders, and recording a payable to a related company for $251 (which was paid in May 1995). The aggregate purchase price for the property was $3,500, an amount determined by the Board of Directors to be the current fair value of the property based on an appraisal. However, the property has been recorded in the Company's financial statements at the majority stockholders' historical cost of $1,823 which resulted in a reduction in the Company's retained earnings of $1,677. F-14 CREATIVE COMPUTERS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share data) FOLLOW-ON OFFERING On August 23, 1995, the Company completed a follow-on offering for 2,300,000 shares of common stock, of which 500,000 shares were sold by the Company, at an offering price of $26.25 per share. Net proceeds to the Company were $12,149 after deducting the underwriting discount and other costs associated with this offering. PROCEEDS FROM PROFITS REALIZED BY DIRECTOR IN THE SALE OF STOCK In June 1996, the Company recorded additional paid in capital in the amount of $2,146, net of expenses, which represents cash contributed to the Company associated with profits realized in the sale of stock by a Director pursuant to Section 16(b) of the Securities Exchange Act of 1934. 8. EMPLOYEE BENEFITS 401(k) SAVINGS PLAN Effective January 1, 1994, the Company adopted a 401(k) Savings Plan which covers substantially all full-time employees who meet the plan's eligibility requirements. Participants may make tax-deferred contributions of up to 15% of annual compensation (subject to other limitations specified by the Internal Revenue Code). In December 1995, the Company amended the 401(k) Savings Plan to make a 25% matching contribution for amounts which do not exceed 4% of the participants annual compensation. During 1997, 1996 and 1995, the Company incurred approximately $84, $66 and $5, respectively, of expenses related to the 401(k) matching component of this plan. 1994 EMPLOYEE STOCK OPTION PLAN In November 1994, the Board of Directors and stockholders of the Company approved the 1994 Stock Option Plan (the 1994 Plan), which provides for the grant of stock options to employees and consultants of the Company. Under the 1994 Plan, the Company may grant options ("Incentive Stock Options") within the meaning of Section 422A of the Internal Revenue Code of 1986, or options not intended to qualify as Incentive Stock Options ("Nonstatutory Stock Options"). A total of 1,950,000 shares of common stock have been reserved for issuance upon the exercise of options granted under the 1994 Plan. As of December 31, 1997, 1,035,304 shares of authorized but unissued common stock are available for future grants under the 1994 Plan. All options granted through December 31, 1997 have been Nonstatutory Stock Options. The 1994 Plan is administered by the Compensation and Stock Option Committee of the Board of Directors. Subject to the provisions of the 1994 Plan, the Committee has the authority to select the employees and consultants to whom options are granted and determine the terms of each option, including (i) the number of shares of common stock covered by the option, (ii) when the option becomes exercisable, (iii) the option exercise price, which must be at least 100%, with respect to Incentive Stock Options, and at least 85%, with respect to Nonstatutory Stock Options, of the fair market value of the common stock as of the date of grant, and (iv) the duration of the option (which may not exceed ten years). All options are nontransferable other than by will or by the laws of descent and distribution. F-15 CREATIVE COMPUTERS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share data) 1995 DIRECTOR STOCK OPTION PLAN (all share data stated in numbers of shares - - not rounded in thousands) The Company adopted the Directors' Non-Qualified Stock Option Plan (the "Director Plan") in 1995. A total of 50,000 shares of Common Stock are reserved for issuance under the Director Plan of which options to purchase 23,000 shares have been granted as of December 31, 1997. Under the Director Plan each non-employee director of the Company ("Non- Employee Director") receives a non-qualified option to purchase 2,000 shares of Common Stock (an "Initial Grant") upon his or her first election or appointment to the Board of Directors. In addition, the Director Plan provides that each Non-Employee Director who is a director immediately prior to an annual meeting of the Company's stockholders and who continues to be a director after such meeting will be granted an option to purchase 1,000 shares of Common Stock (a "Subsequent Grant"); provided that no Subsequent Grant will be made to any Non- Employee Director who has not served as a director of the Company, as of the time of such annual meeting, for at least one year. On July 8, 1997, the Subsequent Grant was amended to 5,000 options. The exercise price per share of each option granted under the Director Plan will be the fair market value of the Company's Common Stock on the date the option is granted. Options granted under the Director Plan vest on the first anniversary of the date of grant, subject to earlier vesting upon a change of control or corporate transaction. The following table summarizes stock option activity: Weighted Average Number Exercise Price -------- -------------- Outstanding at December 31, 1994 178,360 $ 5.50 Granted 347,400 24.59 Canceled (45,200) 23.64 Exercised - - -------- ------ Outstanding at December 31, 1995 480,560 17.60 Granted 576,200 8.51 Canceled (294,221) 9.00 Exercised (41,825) 5.66 -------- ------ Outstanding at December 31, 1996 720,714 6.36 Granted 351,750 7.61 Canceled (176,593) 7.00 Exercised (41,694) 5.42 -------- ------ Outstanding at December 31, 1997 854,177 $ 6.80 ======== ====== On February 12, 1996, the Compensation Committee of the Board of Directors repriced all stock options granted from April 15, 1995 through February 12, 1996 to the closing price for the day of $9.50. On Saturday July 27, 1996, the Compensation Committee of the Board of Directors repriced all stock options (with exercise prices in excess of $6.00 per share) to $6.00 per share. The closing price per share on July 26, 1996 was $5.25. F-16 CREATIVE COMPUTERS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share data) Of the options outstanding at December 31, 1997 and 1996, options to purchase 274,914 and 144,531 shares were exercisable at weighted average prices of $6.21 and $5.85 per share, respectively. There were no exercisable options at December 31, 1995. The following table summarizes information concerning currently outstanding and exercisable stock options: Options exercisable at Options Outstanding at December 31, 1997 December 31, 1997 -------------------------------------------------- -------------------------------- Weighted- Weighted- Weighted Average Average Average Range of Number Remaining Exercise Number Exercise Exercise Prices Outstanding Contractual Life Price Exercisable Price - -------------------------- -------------------------------------------------- -------------------------------- $5.25 to $7.63 760,377 8.5 $6.20 261,266 $5.98 $9.00 to $13.56 93,800 9.4 11.62 13,648 10.57 --------------- -------------- 854,177 274,914 =============== ============== The Company accounts for these Plans under APB Opinion No. 25. Had compensation expense for these Plans been determined consistent with SFAS 123, the Company's net income (loss) and net income (loss) per share would have been reduced (increased) to the pro forma amounts in the following table. The SFAS 123 method of accounting has not been applied to options prior to December 31, 1994. Year ended December 31, ------------------------------------------- 1997 1996 1995 ------------- ------------- -------- Net income (loss) As Reported $4,125 $(6,049) $ 5,847 Pro Forma $3,549 $(7,478) $ 5,491 Diluted net income (loss) per share As Reported $ 0.41 $ (0.62) $ 0.66 Pro Forma $ 0.37 $ (0.77) $ 0.61 The fair value of each stock option grant has been estimated pursuant to SFAS 123 on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions: 1997 1996 ----------- ------------ Risk free interest rates 6.34% 6.23% Expected dividend yield none none Expected lives 6 yrs. 5 yrs. Expected volatility 80.0% 60.0% The weighted average grant date fair values of options granted under the Plans during 1997, 1996 and 1995 were $5.55, $2.75 and $14.14, respectively. F-17 CREATIVE COMPUTERS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share data) 9. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION 1997 1996 1995 ------------ ------------ ----------- Cash paid during the year ending December 31: Interest $ 488 $119 $ 485 Income taxes $ 538 $ 74 $5,260 Non-cash investing and financing activities: Borrowing incurred in connection with the acquisition of Elek-Tek. Inc. $20,731 -- -- Equipment acquired under capital lease obligations $ 73 -- $ 228 Notes payable assumed in connection with acquisition of ComputAbility $ 380 Conversion of subordinated debt to equity -- -- $4,950 Cancellation of related party notes receivable in connection with acquisition of retail showroom -- -- $1,771 Acquisition of retail showroom purchased from a related party - noncash portion -- -- $ 94 10. ACQUISITIONS On August 29, 1997, the Company acquired the assets and assumed the liabilities of Milwaukee-based ComputAbility, Ltd., a privately held direct market reseller of PC/WINTEL hardware, peripheral and software products, for $8,000 consisting of $5,500 paid in cash and the remainder through the issuance of 271,739 shares of Creative common stock valued at $2,500. The acquisition of ComputAbility has been accounted for using the purchase method and the results of ComputAbility have been combined with those of the Company since the date of acquisition. The total cost of the acquisition exceeded the fair value of the net assets acquired and liabilities assumed by $6,763 and, accordingly, the excess has been recorded as goodwill and is being amortized on a straight- line basis over 25 years. On October 15, 1997, the Company acquired substantially all of the assets of Elek-Tek, Inc. (Elek-Tek), a Delaware corporation for a purchase price of $29.4 million plus direct costs of the acquisition pursuant to an Asset Purchase Agreement dated September 17, 1997, as amended. The acquisition was completed as a result of bankruptcy court approval of the agreement signed by Creative and Elek-Tek in connection with the September 17, 1997 filing by Elek-Tek for protection under Chapter 11 of the U.S. Bankruptcy Code. Elek-Tek will operate as a wholly-owned subsidiary of the Company. Such assets consisted primarily of accounts receivable, inventory, property, plant and equipment, certain intangibles and customer lists and the businesses associated with mail order, direct sales and retail activities. F-18 CREATIVE COMPUTERS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share data) The acquisition was accounted for as a purchase. Accordingly, the results of Elek-Tek, Inc. have been combined with those of the Company since the date of acquisition. The Company borrowed $20.7 million of the purchase price from Deutsche Financial Services Corporation, and the remaining $8.7 million was paid in cash. The purchase price was allocated to the net assets acquired based upon their estimated fair values at the date of acquisition. The excess of the purchase price over the net assets acquired of $8,468 is being amortized on a straight line basis over 25 years. In connection with the acquisition of Elek- Tek, the Company incurred expenses of $1,470 in the fourth quarter of 1997. These expenses related primarily to transitioning Elek-Tek's sales force and customer base into Creative Computers. The following table reflects unaudited pro forma combined results of operations of the Company, ComputAbility and Elek-Tek as if these acquisitions had occurred at the beginning of fiscal 1996. However, these pro forma results are not necessarily indicative of the actual results of operations that would have occurred. Year ended December 31, ----------------------- 1997 1996 - ------------ Net sales $791,345 $835,024 Net income (loss) $ 1,046 $(13,391) Diluted earnings (loss) per share $ 0.10 $ (1.33) 11. HEADQUARTERS MOVE Due to the Company's growth, its current headquarters and telemarketing facilities in Torrance, California were not adequate to house future operations. In November, the Company completed its consolidation of its two facilities into a 160,000 square foot building in a nearby location in Torrance, CA. The Company plans to phase in the occupancy of the entire facility over a two-year period, initially leasing approximately one third of the building. The charge associated with the move was $815, and was expensed in the fourth quarter. 12. SUBSEQUENT EVENT During February 1998, the Company closed its Indiana retail showroom. On March 20, 1998, the Company closed six retail showrooms to focus its efforts on its catalog, corporate and Internet channels of distribution. The Company expects to incur a one-time restructuring charge during the first quarter of 1998 relating to exit costs, asset write-offs, other charges and goodwill related to the retail showroom closures. The Company has not yet determined the amount of this charge. F-19 SCHEDULE II CREATIVE COMPUTERS, INC. Valuation and Qualifying Accounts For the years ended December 31, 1995, 1996 and 1997 (in thousands) Balance at Additions Deduction Balance Beginning Charged to from at End of Year Operations Reserves of Year ---------- ---------- --------- ------- Allowance for doubtful accounts for the year ended: December 31, 1995 523 996 154 1,365 December 31, 1996 1,365 2,041 1,272 2,134 December 31, 1997 2,134 5,680 4,955 2,859 Reserve for inventory for the year ended: December 31, 1995 769 1,088 438 1,419 December 31, 1996 1,419 6,432 1,547 6,304 December 31, 1997 6,304 6,548 7,488 5,364 F-20