EXHIBIT 99.2
NETSILICON, INC.
CONSOLIDATED FINANCIAL STATEMENTS
TABLE OF CONTENTS
PAGE
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FINANCIAL STATEMENTS
Report of Independent Certified Public Accountants 1
Consolidated Balance Sheets as of January 31, 2002 and 2001 2
Consolidated Statements of Operations for the Years Ended January 31, 2002, 2001 and 2000 3
Consolidated Statements of Stockholders' Equity (Deficit) for the Years Ended
January 31, 2002, 2001 and 2000 4
Consolidated Statements of Cash Flows for the Years Ended January 31, 2002, 2001 and 2000 5
Notes to Consolidated Financial Statements 6-24
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The Board of Directors of
NetSilicon, Inc.
We have audited the accompanying consolidated balance sheets of NetSilicon, Inc.
as of January 31, 2002 and 2001 and the related consolidated statements of
operations, stockholders' equity (deficit) and cash flows for each of the three
years in the period ended January 31, 2002. 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 auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe our audits provide a reasonable
basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of NetSilicon, Inc.
as of January 31, 2002 and 2001, and the consolidated results of their
operations and their cash flows for each of the three years in the period ended
January 31, 2002 in conformity with accounting principles generally accepted in
the United States of America.
/S/ BDO SEIDMAN, LLP
Boston, Massachusetts
March 13, 2002
NETSILICON, INC.
CONSOLIDATED BALANCE SHEETS
January 31, 2002 2001
=======================================================================================================
ASSETS
CURRENT ASSETS
Cash and equivalents $ 4,427,300 $ 5,999,200
Short-term investments 1,821,900 6,794,400
Accounts receivable, net of allowances of $576,000 and $671,000 3,583,700 4,660,300
Inventory, net 4,315,200 6,707,000
Prepaid expenses and other current assets 1,038,500 757,400
Receivable from officer 740,000 871,200
- -------------------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 15,926,600 25,789,500
- -------------------------------------------------------------------------------------------------------
PROPERTY AND EQUIPMENT, NET 1,828,200 2,335,200
- -------------------------------------------------------------------------------------------------------
OTHER ASSETS
Capitalized software, net 547,600 990,800
Intangible assets, net 1,354,000 1,351,800
Other assets 652,700 933,800
- -------------------------------------------------------------------------------------------------------
TOTAL OTHER ASSETS 2,554,300 3,276,400
- -------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 20,309,100 $ 31,401,100
=======================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 2,624,500 $ 2,787,100
Deferred revenue 356,200 343,000
Other current liabilities 3,301,000 3,557,700
- -------------------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 6,281,700 6,687,800
- -------------------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred stock, $0.01 par value; 5,000,000 authorized;
none issued - -
Common stock, $0.01 par value; 35,000,000 authorized;
issued and outstanding:
Voting, 7,093,700 and 6,810,100 shares 70,900 68,100
Non-voting, 6,972,700 shares 69,700 69,700
Additional paid-in capital 29,575,400 28,187,400
Accumulated other comprehensive income 4,800 26,500
Accumulated deficit (15,693,400) (3,638,400)
- -------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 14,027,400 24,713,300
- -------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 20,309,100 $ 31,401,100
=======================================================================================================
See accompanying notes to consolidated financial statements.
2
NETSILICON, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Fiscal Year Ended January 31, 2002 2001 2000
===============================================================================================================
NET SALES $ 27,650,000 $ 37,382,100 $ 31,840,900
COST OF SALES 13,211,100 15,188,300 15,422,900
- ---------------------------------------------------------------------------------------------------------------
GROSS MARGIN 14,438,900 22,193,800 16,418,000
- ---------------------------------------------------------------------------------------------------------------
OPERATING EXPENSES
Selling and marketing 9,661,800 10,753,500 7,560,300
Engineering, research and development 8,212,100 7,054,200 3,083,500
General and administrative 8,344,500 4,689,900 3,550,500
Amortization of intangibles assets 631,600 337,700 -
Intangible and other asset impairment charges - 1,497,900 -
- ---------------------------------------------------------------------------------------------------------------
TOTAL OPERATING EXPENSES 26,850,000 24,333,200 14,194,300
- ---------------------------------------------------------------------------------------------------------------
OPERATING INCOME (LOSS) (12,411,100) (2,139,400) 2,223,700
Interest income (expense), net of interest income of
$364,700 in 2000 356,100 882,500 (206,100)
- ---------------------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE INCOME TAXES (12,055,000) (1,256,900) 2,017,600
Income taxes - - -
- ---------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) $(12,055,000) $ (1,256,900) $ 2,017,600
===============================================================================================================
NET INCOME (LOSS) PER COMMON SHARE
Basic $ (0.86) $ (0.09) $ 0.18
Diluted $ (0.86) $ (0.09) $ 0.17
SHARES USED IN PER SHARE CALCULATIONS
Basic 14,037,100 13,674,200 11,326,600
Diluted 14,037,100 13,674,200 11,978,200
See accompanying notes to consolidated financial statements.
3
NETSILICON, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
Accumulated
Other
Common Stock Additional Comprehensive
------------------------- Paid-in Income Accumulated
Shares Amount Capital (Loss) Deficit
===================================================================================================================
BALANCE AT JANUARY 31, 1999 10,000,000 $ 100,000 $ 2,463,000 $ - $ (4,399,100)
Sale of common stock, net of issuance
costs of $788,000 3,537,500 35,400 22,213,700 - -
Issuance of common stock options to
non-employees - - 78,700 - -
Net income - - - - 2,017,600
Unrealized loss on short-term investments - - - (26,400) -
- -------------------------------------------------------------------------------------------------------------------
Comprehensive income - - - - -
- -------------------------------------------------------------------------------------------------------------------
BALANCE AT JANUARY 31, 2000 13,537,500 135,400 24,755,400 (26,400) (2,381,500)
Common stock issued in connection
with asset acquisition 90,000 900 2,270,700 - -
Common stock issued under stock plans 155,300 1,500 1,086,300 - -
Issuance of common stock options to
non-employees - - 75,000 - -
Net loss - - - - (1,256,900)
Unrealized gain on short-term investments - - - 52,900 -
- -------------------------------------------------------------------------------------------------------------------
Comprehensive loss - - - - -
- -------------------------------------------------------------------------------------------------------------------
BALANCE AT JANUARY 31, 2001 13,782,800 137,800 28,187,400 26,500 (3,638,400)
Common stock issued in connection
with business acquisition 241,700 2,400 1,255,300 - -
Common stock issued under stock plans 41,900 400 132,700 - -
Net loss - - - - (12,055,000)
Foreign currency translation adjustment - - - (4,900) -
Unrealized loss on short-term investments - - - (16,800) -
- -------------------------------------------------------------------------------------------------------------------
Comprehensive loss - - - - -
- -------------------------------------------------------------------------------------------------------------------
BALANCE AT JANUARY 31, 2002 14,066,400 $ 140,600 $ 29,575,400 $ 4,800 $(15,693,400)
===================================================================================================================
Total
Stockholders' Comprehensive
Equity Income
(Deficit) (Loss)
=======================================================================
BALANCE AT JANUARY 31, 1999 $ (1,836,100)
Sale of common stock, net of issuance
costs of $788,000 22,249,100
Issuance of common stock options to
non-employees 78,700
Net income 2,017,600 $ 2,017,600
Unrealized loss on short-term investments (26,400) (26,400)
- -----------------------------------------------------------------------
Comprehensive income - $ 1,991,200
- -----------------------------------------------------------------------
BALANCE AT JANUARY 31, 2000 22,482,900
Common stock issued in connection
with asset acquisition 2,271,600
Common stock issued under stock plans 1,087,800
Issuance of common stock options to
non-employees 75,000
Net loss (1,256,900) $ (1,256,900)
Unrealized gain on short-term investments 52,900 52,900
- -----------------------------------------------------------------------
Comprehensive loss - $ (1,204,000)
- -----------------------------------------------------------------------
BALANCE AT JANUARY 31, 2001 24,713,300
Common stock issued in connection
with business acquisition 1,257,700
Common stock issued under stock plans 133,100
Net loss (12,055,000) $(12,055,000)
Foreign currency translation adjustment (4,900) (4,900)
Unrealized loss on short-term investments (16,800) (16,800)
- -----------------------------------------------------------------------
Comprehensive loss - $(12,076,700)
- -----------------------------------------------------------------------
BALANCE AT JANUARY 31, 2002 $ 14,027,400
=======================================================================
See accompanying notes to consolidated financial statements.
4
NETSILICON, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Fiscal Year Ended January 31, 2002 2001 2000
=====================================================================================================================
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $(12,055,000) $ (1,256,900) $ 2,017,600
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating activities:
Depreciation and amortization 2,315,200 1,815,400 1,127,300
Intangible and other asset impairment charges - 1,497,900 -
Forgiveness of notes receivable to officer 908,500 - -
Stock option compensation - non-employee - - 78,700
Changes in operating assets and liabilities, net of effects
of acquisition:
(Increase) decrease in accounts receivable 2,094,500 (2,302,800) 1,938,500
(Increase) decrease in inventories 2,446,400 (2,384,600) (553,100)
(Increase) decrease in other assets (504,500) 41,500 (560,300)
Increase (decrease) in accounts payable (731,600) (226,100) 223,400
Increase (decrease) in other current liabilities (522,700) 224,800 2,112,100
Increase (decrease) in deferred revenue 13,200 290,500 52,500
- ---------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN) OPERATING
ACTIVITIES (6,036,000) (2,300,300) 6,436,700
- ---------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale (purchases) of short-term investments 4,955,700 1,462,200 (8,230,100)
Purchases of property and equipment (745,400) (1,848,600) (1,322,400)
Software development costs (63,000) (532,900) (938,100)
Net cash acquired (paid) in acquisition 413,600 (439,800) -
Other assets (225,000) (625,200) (84,500)
- ---------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN) INVESTING
ACTIVITIES 4,335,900 (1,984,300) (10,575,100)
- ---------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of notes receivable to officer - (871,200) -
Repayments of affiliates advances - (56,900) (5,147,900)
Repayments of short-term debt, net - (779,700) (2,411,800)
Payments of capital lease obligation - (192,700) (37,100)
Proceeds from issuance of stock (net of issuance costs) 133,100 - 22,249,100
Proceeds from exercise of stock options - 1,087,800 -
- ---------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN) FINANCING
ACTIVITIES 133,100 (812,700) 14,652,300
- ---------------------------------------------------------------------------------------------------------------------
EFFECT OF EXCHANGE RATE CHANGES ON
CASH AND EQUIVALENTS (4,900) - -
- ---------------------------------------------------------------------------------------------------------------------
INCREASE (DECREASE) IN CASH AND EQUIVALENTS (1,571,900) (5,097,300) 10,513,900
CASH AND EQUIVALENTS BEGINNING OF YEAR 5,999,200 11,096,500 582,600
- ---------------------------------------------------------------------------------------------------------------------
CASH AND EQUIVALENTS END OF YEAR $ 4,427,300 $ 5,999,200 $ 11,096,500
=====================================================================================================================
See accompanying notes to consolidated financial statements.
5
NETSILICON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NetSilicon, Inc. (the "Company") designs and manufactures integrated device
networking platforms for manufacturers who want to build intelligence and
Internet/Ethernet connectivity into their electronic products. These platforms
integrate system-on-silicon and software to provide a complete solution for
connecting devices to a network or the Internet. NetSilicon's NET+Works platform
allows manufacturers to shorten their time to market, reduce development risk,
lower costs, and free their engineers from the difficult task of integrating
multi-vendor networking components. NetSilicon is enabling device intelligence
and connectivity in a broad range of industries, including telecommunications,
building controls, security, retail point-of-sale and office appliances.
The accompanying financial statements are the responsibility of the management
of the Company.
A. THE COMPANY AND BASIS OF PRESENTATION
The Company was incorporated in Massachusetts on April 17, 1984 under the name
of Digital Products, Inc. In September 1996, Sorrento Networks Corporation,
formerly Osicom Technologies, Inc., ("Sorrento") acquired sole ownership of the
Company through a merger with a newly-formed corporation in exchange for
Sorrento common stock in a transaction accounted for as a pooling of interests.
On September 15, 1999, the Company completed an initial public offering of its
common stock. At January 31, 2002, Sorrento held a 49.6% non-voting interest in
the Company. The accompanying financial statements represent only the assets,
liabilities, operations and financial position of the Company and its
subsidiaries.
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries, NetSilicon GmbH and NetSilicon Japan. All
significant intercompany transactions and balances have been eliminated.
B. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Cash and Equivalents and Short-term Investments -- All highly liquid debt
instruments purchased with a remaining maturity of three months or less are
classified as cash equivalents. Management determines the classification of debt
and equity securities at the time of purchase and reevaluates the classification
at each balance sheet date. The Company classifies its short-term investments as
available-for-sale and therefore records them at fair value with unrealized
gains and losses, net of taxes, if applicable, reported as a component of
accumulated other comprehensive income (loss). All available-for-sale securities
are classified as current assets. The cost of investments sold, for purposes of
calculating realized gains and losses, is determined using the first-in,
first-out method. Realized gains and losses are recognized in the statement of
operations.
Use of Estimates -- The financial statements are prepared in conformity with
accounting principles generally accepted in the United States of America which
require management to make estimates that affect the reported amounts of assets,
liabilities, revenues and expenses, the disclosure of contingent assets and
liabilities and the values of purchased assets and assumed liabilities in
acquisitions. Actual results could differ from these estimates.
Accounts and Notes Receivable -- In the normal course of business, the Company
extends unsecured credit to its customers related to the sales of various
products. Typically credit terms require payment within thirty days from the
date of shipment. The Company evaluates and monitors the creditworthiness of
each customer on a case-by-case basis.
Allowance for Doubtful Accounts -- The Company provides an allowance for
doubtful accounts based on its continuing evaluation of its customers' credit
risk. The Company generally does not require collateral from its customers.
6
NETSILICON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
B. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Inventory -- Inventory, comprised of raw materials, work in process, finished
goods and spare parts, is stated at the lower of cost (first-in, first-out
method) or market. Inventories consisted of:
JANUARY 31,
-------------------------
2002 2001
---------- ----------
Raw material $4,905,300 $7,041,500
Work in process 38,700 126,800
Finished goods 84,000 49,500
---------- ----------
5,028,000 7,217,800
Less: Valuation reserve 712,800 510,800
---------- ----------
$4,315,200 $6,707,000
========== ==========
Fair Value of Financial Instruments -- The fair value of financial instruments
is determined by reference to various market data and other valuation techniques
as appropriate. Management believes that there are no material differences
between the recorded book values of its financial instruments, which include
cash and cash equivalents, short-term investments, accounts receivable and
accounts payable, and their estimated fair value.
Property and Equipment -- Property and equipment are recorded at historical
cost. Depreciation and amortization is provided using the straight-line method
over the estimated useful lives of two to seven years for computer and other
equipment, purchased software, and furniture and fixtures. Leasehold
improvements are amortized over the shorter of the remaining lease term or the
estimated useful life of the improvement using the straight-line method.
Capitalized leases are initially recorded at the present value of the minimum
payments at the inception of the contracts, with an equivalent liability
categorized as appropriate under current or non-current liabilities. Such assets
are depreciated on the same basis as described above. Interest expense, which
represents the difference between the minimum payments and the present value of
the minimum payments at the inception of the lease, is allocated to accounting
periods using a constant rate of interest over the term of the lease.
Property and equipment are reviewed for impairment whenever events or
circumstances indicate that the asset's undiscounted expected cash flows are not
sufficient to recover its carrying amount. The Company measures impairment loss
by comparing the fair market value, calculated as the present value of expected
future cash flows, to its net book value. Impairment losses, if any, are
recorded currently.
Software Development -- Software development costs where technological
feasibility has not been established are expensed in the period in which they
occurred, otherwise, development costs that will become an integral part of the
Company's products are deferred in accordance with Statement of Financial
Accounting Standards ("SFAS") Nos. 2 and 86. The deferred costs are amortized to
cost of sales using the straight-line method over the remaining estimated two to
three year economic life of the product or the ratio that current revenues for
the product bear to the total of current and anticipated future revenues for
that product. Amortization expense for the fiscal years ended January 31, 2002,
2001 and 2000 was $419,000, $435,100 and $382,700, respectively.
The recoverability of capitalized software costs are reviewed on an ongoing
basis primarily based upon projections of discounted future operating cash flows
from each software product line. The excess amount, if any, of the remaining net
book value over the calculated amount is fully reserved.
NETSILICON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
B. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Intangible Assets -- Intangible assets consist of completed technology,
assembled workforce, goodwill and other assets arising from the acquisition of a
business or business assets. Goodwill is the excess of the purchase price over
the fair value of net identifiable assets acquired in a business combination
accounted for as a purchase. Goodwill is amortized on a straight-line basis over
seven years. Other intangible assets are amortized using the straight-line
method over their estimated useful lives of three to seven years.
Intangible assets are reviewed for impairment whenever events or circumstances
indicate that the asset's undiscounted expected future cash flows are not
sufficient to recover its carrying amount. The Company measures impairment loss
by comparing the fair market value, calculated as the present value of expected
future cash flows, to its net book value or carrying amount. Impairment losses,
if any, are recorded currently.
Revenue Recognition -- The Company's revenues are derived primarily from the
sale of product to its OEM customers and to a lesser extent from the sale of
software licenses, fees associated with technical support, training and
engineering services and royalties. The Company recognizes revenue when
persuasive evidence of an arrangement exists, delivery has occurred, the sales
price is fixed or determinable, collectibility is probable and there are no
post-delivery obligations. Revenue from the sale of hardware products, including
embedded networking semiconductors and controller products, is generally
recognized upon shipment. Revenue from service obligations is deferred and
recognized at the time the service is provided or over the life of the
underlying service or support contract, if applicable.
The Company's software development tools and developments boards often include
multiple elements -- hardware, software, post contract customer support (PCS),
limited training and a basic hardware design review. Our customers purchase
these products and services during their product development process in which
they use the tools to build network connectivity into the devices they are
manufacturing. The Company recognizes revenue related to these multiple element
arrangements in accordance with Statement of Position ("SOP") No. 97-2 "Software
Revenue Recognition," as amended by SOP 98-4, "Deferral of the Effective Date of
Certain Provisions of SOP 97-2." Revenue related to the sale of these
development products is allocated to the various elements based on
vendor-specific objective evidence of fair value. The portion of revenue
allocated to hardware and software licenses is recognized upon shipment. The
portion of the revenue allocated to PCS is recognized ratably over the term of
the PCS arrangement and the portion of revenue allocated to training and the
hardware design review are recognized when the service is performed.
The Company's customers have a limited right of return. The Company records an
estimated reserve for warranty costs and an allowance for sales returns during
the month of shipment.
The Company's embedded networking semiconductor and controller products
accounted for 85.8%, 87.3%, and 94.0% of total net sales in fiscal years 2002,
2001 and 2000, respectively. Software development tools and development boards
accounted for 4.2%, 5.6%, and 2.0% of total net sales in fiscal years 2002, 2001
and 2000, respectively, and 6.8%, 6.1%, and 4.0% of net sales in fiscal years
2002, 2001, and 2000, respectively, related to royalty, maintenance and service
revenue. Software licensing revenue accounted for 3.2%, 1.0% and 0% of revenue
in fiscal years 2002, 2001 and 2000, respectively.
Income Taxes -- Income taxes are accounted for in accordance with SFAS No. 109
"Accounting for Income Taxes." The statement employs an asset and liability
approach for financial accounting and reporting of deferred income taxes
generally allowing for recognition of deferred tax assets in the current period
for future benefit of net operating loss and research credit carryforwards as
well as items for which expenses have been recognized for financial statement
purposes but will be deductible in future periods. A valuation allowance is
recognized if, on the weight of available evidence, it is more likely than not
that some portion or all of the deferred tax assets will not be realized.
8
NETSILICON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
B. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Income and Loss Per Common Share -- The Company follows the provisions of SFAS
No. 128, "Earnings Per Share." SFAS 128 requires dual presentation of basic and
diluted earnings per share on the face of the income statement. It also requires
a reconciliation of the numerator and denominator of the basic EPS computation
to the numerator and denominator of the diluted EPS computation. Basic income
and loss per common share is computed by dividing net income or loss available
to common shareholders by the weighted average number of common shares
outstanding during each period presented. Diluted EPS is based on the weighted
average number of common shares outstanding as well as dilutive potential common
shares, which in the Company's case consist of warrants to acquire common stock
and shares issuable related to options granted under stock option plans.
Potential common shares are not included in the diluted loss per share
computation if their effect would be anti-dilutive.
Stock-Based Compensation -- The Company follows SFAS No. 123, "Accounting for
Stock Based Compensation." SFAS No. 123 encourages, but does not require,
companies to record compensation cost for stock-based employee compensation. The
Company has chosen to continue to account for employee stock-based compensation
utilizing the intrinsic value method prescribed in Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees." Accordingly,
compensation cost for stock options issued to employees is measured as the
excess, if any, of the fair market price of the Company's stock at the date of
grant over the amount an employee must pay to acquire the stock. As required by
SFAS No. 123, the Company records compensation for stock options issued to
non-employees, in exchange for product or services, utilizing the fair value
method outlined in SFAS No. 123.
Foreign Currency Translation -- The functional currency of the foreign
subsidiaries is the local currency. Accordingly, assets and liabilities of the
subsidiaries are translated using the exchange rates in effect at the end of the
period, while income and expenses are translated at average rates of exchange
during the period. Gains and losses from translation of foreign operations are
included as other comprehensive income or loss and were not significant for any
of the periods presented.
Derivative Instruments -- In June 1998, the FASB issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS 133
provides a comprehensive and consistent standard for the recognition and
measurement of derivatives and hedging activities and requires all derivatives
to be recorded on the balance sheet at fair value. SFAS 133, as amended, was
effective for years beginning after June 15, 2000. To date, we have not engaged
in derivative and hedging activities, and accordingly, the adoption of SFAS No.
133 has not had a material impact on our results of operations, financial
position or cash flows.
Reclassifications -- Certain prior period amounts have been reclassified to
conform to the current period presentation. These reclassifications had no
effect on net income (loss) or stockholders' equity.
Recent Accounting Pronouncements -- In June 2001, the Financial Accounting
Standards Board finalized FASB Statement No. 141, "Business Combinations ("SFAS
141"), and No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS
141 requires the use of the purchased method of accounting and prohibits the use
of the pooling-of-interests method of accounting for business combinations
initiated after June 30, 2001. SFAS 141 also requires that the Company recognize
acquired intangible assets apart from goodwill if the acquired intangible assets
meet certain criteria. SFAS 141 applies to all business combinations initiated
after June 30, 2001 and for purchase business combinations completed on or after
July 1, 2001. Upon adoption of SFAS 142, it requires that the Company reclassify
the carrying amounts of intangible assets and goodwill based on the criteria in
SFAS 141.
9
NETSILICON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
B. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Recent Accounting Pronouncements (Continued)
SFAS 142 requires, among other things, that companies no longer amortize
goodwill, but instead test goodwill for impairment at least annually. In
addition, SFAS 142 requires that the Company identify reporting units for the
purposes of assessing potential future impairments of goodwill, reassess the
useful lives of other existing recognized intangible assets, and cease
amortization of intangible assets with an indefinite useful life. An intangible
asset with an indefinite useful life should be tested for impairment in
accordance with the guidance in SFAS 142. SFAS 142 is required to be applied in
fiscal years beginning after December 15, 2001 to all goodwill and other
intangible assets recognized at that date, regardless of when those assets were
initially recognized. SFAS 142 requires the Company to complete a transitional
goodwill impairment test six months from the date of adoption. The Company is
also required to reassess the useful lives of other intangible assets within the
first interim quarter after adoption of SFAS 142.
The Company's previous business combinations were accounted for using the
purchase method. All future business combinations will be accounted for under
the purchase method, which may result in the recognition of goodwill and other
intangible assets, some of which may subsequently be charged to operations,
either by amortization or impairment charges. For purchase business combinations
completed prior to June 30, 2001, the net carrying amount of goodwill was
$109,000 and other intangible assets was $1,245,000 as of January 31, 2002.
Amortization expense during the years ended January 31, 2002 and 2001 was
$631,600 and $337,700 respectively. The Company is assessing but has not yet
determined how the adoption of SFAS 141 and SFAS 142 will affect its future
financial position and results of operations.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," which addresses financial accounting and
reporting for the impairment or disposal of long-lived assets. This statement
supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets To Be Disposed Of," and APB Opinion No.30, "Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions for the Disposal of a Segment of a Business." SFAS No. 144 becomes
effective for the fiscal years beginning after December 15, 2001. The Company is
currently reviewing the effects of adopting SFAS No. 144 on its financial
position and results of operations.
C. SHORT-TERM INVESTMENTS
Short-term investments consist of the following available-for-sale securities:
Unrealized
-------------------
Holding Holding
Amortized Cost Market Value Gains Losses
-------------- ------------ ----- ------
JANUARY 31, 2002:
Corporate bonds .............. $1,311,700 $1,321,000 $ 9,300 $ --
Medium and short-term notes .. 500,500 500,900 400 --
---------- ---------- ------- ------
Total ........................ $1,812,200 $1,821,900 $ 9,700 $ --
========== ========== ======= ======
JANUARY 31, 2001:
Corporate bonds .............. $1,199,100 $1,203,800 $ 4,700 $ --
Medium and short-term notes .. 1,650,600 1,655,700 5,100 --
Euro dollar bonds ............ 3,918,200 3,934,900 16,700 --
---------- ---------- ------- ------
Total ........................ $6,767,900 $6,794,400 $26,500 $ --
========== ========== ======= ======
The corporate bonds, medium and short-term notes, and euro dollar bonds all
mature within one year. The Company realized no gains or losses on the sale of
short-term investments in 2002, 2001 and 2000.
10
NETSILICON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
D. PROPERTY AND EQUIPMENT
Property and equipment of the Company consisted of the following components:
JANUARY 31,
----------------------------
2002 2001
----------- -----------
Manufacturing, engineering and plant
equipment and software .................... $ 5,501,100 $ 5,116,800
Equipment held under capital lease ........ 240,200 240,200
Office furniture and fixtures ............. 1,011,500 740,000
Leasehold and building improvements ....... 451,700 327,100
----------- -----------
Total property and equipment .. 7,204,500 6,424,100
Less: Accumulated depreciation ............ (5,376,300) (4,088,900)
----------- -----------
Net book value ............................ $ 1,828,200 $ 2,335,200
=========== ===========
Depreciation expense was $1,264,600, $1,042,600 and $437,600 for the fiscal
years ended January 31, 2002, 2001 and 2000, respectively.
E. OTHER CURRENT LIABILITIES
Other current liabilities consisted of the following:
JANUARY 31,
-------------------------
2002 2001
---------- ----------
Commissions and royalties ........... $ 250,900 $ 410,300
External product development costs .. 150,000 440,000
Compensation and benefits ........... 1,101,100 1,225,000
Professional services ............... 743,300 556,600
Other ............................... 1,055,700 925,800
---------- ----------
Total ............................... $3,301,000 $3,557,700
========== ==========
F. RECEIVABLE FROM OFFICER
Pursuant to an amended employment agreement with the Company's Chairman and
Chief Executive Officer, which considered the Company's merger with Digi
International, Inc. in February 2002, the Company advanced compensation to the
executive in the amount of $740,000 in December 2001. The advanced compensation
is recorded as a current asset at January 31, 2002.
During the fiscal year 2001, the Company's Chairman and Chief Executive Officer
signed two secured personal promissory notes, borrowing a total of $871,200 from
the Company. The notes accrue interest at the rate of 8.0% per year, and were
due in April and October 2001. The notes were secured by personal assets owned
by the executive. In December 2001, pursuant to the executive's amended
employment agreement, the Company forgave the payment obligations of the two
promissory notes, including accrued interest, and made an additional payment
necessary to cover the taxes owed by the Chairman and Chief Executive Officer as
a result of the forgiveness. Compensation expense of $1,702,800 related to the
forgiveness was recorded in December 2001.
11
NETSILICON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
G. LEASES AND OTHER COMMITMENTS
(i) LEASES
Rental expense under operating leases for office space and office equipment was
$1,110,800, $622,500 and $455,800 for the years ended January 31, 2002, 2001 and
2000, respectively. Rent expense in 2002 includes a charge of $302,600 related
to the Company's decision to vacate a portion of leased space at its
headquarters in Massachusetts. The table below sets forth minimum payments under
operating leases with remaining terms in excess of one year, at January 31,
2002:
OPERATING
LEASES
----------------
2003..................................................................... $ 636,900
2004..................................................................... 152,900
2005..................................................................... 700
----------------
$ 790,500
================
(ii) EMPLOYMENT CONTRACTS
The Company has an amended employment agreement with its Chairman and Chief
Executive Officer. The agreement provides that, in the event of a change of
control, the executive's unvested stock options will vest immediately and all of
his stock options will remain in full force and effect and may be exercised at
any time up to their latest possible date of expiration. Pursuant to the
agreement, in December 2001, the Company forgave the payment obligations of two
promissory notes, plus interest, and made additional payments necessary to cover
taxes owed by the executive as a result of the forgiveness. As a result of the
forgiveness of the promissory notes, the Company recorded a compensation charge
in December 2001 of $1,702,800. In addition, pursuant to the executive's
employment agreement, upon consummation of the Company's merger with Digi
International, Inc., the executive will receive a transaction bonus of $740,000.
In December 2001, the Company advanced compensation to the executive in the
amount of $740,000. The advanced compensation is recorded as a current asset at
January 31, 2002.
The Company has an employment agreement with its Executive Vice President of
Finance and Operations and Chief Financial Officer pursuant to which the
executive's unvested stock options with a per-share exercise price of $7.00 or
less vest immediately upon the consummation of a change of control and are
exercisable for a period of 24 months following the consummation of such a
change in control. Furthermore, upon consummation of the Company's merger with
Digi International, Inc., the executive will receive a payment equal to 0.25% of
the total merger consideration, or approximately $140,100.
The Company also has employment agreements with its Vice President, Intelligent
Device Markets EMEA and Vice President, Intelligent Device Markets Japan which
provide for base annual salaries and other employment terms. The agreement with
the Vice President, Intelligent Device Markets Japan requires the acceleration
of certain bonus payments totaling $250,000 in the event of a change in control.
12
NETSILICON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
H. LITIGATION
On or about August 9, 2001, a purported securities class action lawsuit
captioned "Ellis Investments, Ltd. v. NetSilicon, Inc., et al." (01-CV-7281) was
filed in the United States District Court for the Southern District of New York.
Later in August 2001, two additional nearly identical complaints were filed in
the same Court in lawsuits captioned "Michael Rasner v. NetSilicon, Inc., et
al." (01-CV-7651) and "Walter Weitz v. NetSilicon, Inc., et al." (01-CV-8217).
The suits name as defendants the Company, certain of its officers and directors,
and certain underwriters involved in the Company's initial public offering
("IPO"). The Ellis Investments suit also names Osicom Technologies, Inc. as a
defendant. The Court consolidated the complaints in September 2001. The
complaints in these actions are allegedly brought on behalf of purchasers of the
Company's common stock during the period from September 15, 1999 to December 6,
2000, and assert, among other things, that the Company's IPO prospectus and
registration statement violated federal securities laws because they contained
material misrepresentations and/or omissions regarding the conduct of the
Company's IPO underwriters in allocating shares in the Company's IPO to the
underwriters' customers. The actions seek rescission or rescissory and other
damages, fees and costs associated with the litigation, and interest. The
Company understands that various plaintiffs have filed substantially similar
lawsuits against approximately three hundred other publicly traded companies in
connection with the underwriting of their initial public offerings. The Company
and its officers and directors believe that the allegations in the complaints
are without merit and intend to contest them vigorously. An unfavorable
resolution of the actions could have a material adverse effect on the business,
results of operations or financial condition of the Company.
Websprocket, LLC Legal Claims - On November 2, 2001, the Company and
Websprocket, LLC entered into a Settlement Agreement and Mutual Release settling
all claims between the companies, including all claims and counterclaims
asserted in the litigation captioned Websprocket, LLC v. NetSilicon, Inc., Civil
Action No. C-00-20915 RMV pending in the United States District Court for the
Northern District of California. On November 13, 2001, the court approved and
entered a Stipulation of Dismissal With Prejudice, in which the Company and
Websprocket, LLC dismissed all claims in the litigation and waived all rights to
appeal. During fiscal year 2002, the Company paid Websprocket, LLC the full
settlement amount of $162,000 in accordance with the Settlement Agreement.
I. STOCKHOLDERS' EQUITY
The Company's authorized capital stock consists of:
35,000,000 shares of Common Stock ($0.01 par value) and 5,000,000 shares of
Preferred Stock ($0.01 par value).
The Company's Board of Directors has discretion to issue preferred stock in such
series and with such preferences as it may designate without the approval of the
holders of common shares. As of January 31, 2002 no such designations have been
made.
The Company has 7,093,700 shares of voting common stock outstanding and
6,972,700 shares of non-voting common stock held by Sorrento as of January 31,
2002.
On September 12, 2000, the Board of Directors of NetSilicon declared a dividend
of one preferred share purchase right (a "Right") for each share of common stock
outstanding on September 23, 2000 to the stockholders of record on that date, as
part of a rights plan designed to protect the Company's investors against any
potential takeover attempts that are coercive or unfair. The Rights will be
exercisable only if a person or group acquires or announces a tender or exchange
offer that would result in such person or group owning 15% or more of the voting
securities of the Company. Each Right entitles the registered holder to
purchase, at an exercise price of $200.00 per Right, Series A Junior
Participating Preferred Stock of the Company having a market value of $400.00.
The nature of the preferred shares' dividend, liquidation and voting rights are
such that the value of the Preferred Stock purchasable upon exercise of the
Right should approximate the value of a common share. The Rights will expire on
September 12, 2010 unless the expiration date is extended or the Rights redeemed
by the Company. The Company will generally be entitled to redeem the Rights at
$0.01 per Right at any time prior to the 10th day after a person or group has
acquired a 15% voting stock position.
13
NETSILICON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
I. STOCKHOLDERS' EQUITY (Continued)
In connection with the proposed merger with Digi International, Inc. ("Digi"),
the Company's Rights Agreement was amended on October 30, 2001 to provide, among
other things, that Digi would not become an "Acquiring Person"(as such term is
defined in the Rights Agreement) as a result of the consummation of the merger
of Digi and the Company. Additionally, the Rights Agreement was amended to
provide that all outstanding Rights issued and outstanding under the Rights
Agreement will expire immediately prior to the closing date of the merger with
Digi and, notwithstanding anything in the Rights Agreement to the contrary, the
Rights Agreement shall terminate and have no further force and effect upon the
consummation of the merger with Digi.
J. BUSINESS ACQUISITIONS AND OTHER CAPITAL STOCK TRANSACTIONS
On February 16, 2001, the Company purchased all of the equity securities of
Dimatech Corporation ("Dimatech") pursuant to a Stock Purchase Agreement, dated
as of February 16, 2001, by and among Dimatech, Hiroyuki Kataoka and the
Company. Prior to the acquisition, Dimatech was a major distributor of the
Company's products in Japan and Asia and Hiroyuki Kataoka was the President and
owner of Dimatech. Dimatech, under a new name, continues to operate in Japan and
Asia as a distributor of the Company's products and provides technical support
and other services to customers in the region. Hiroyuki Kataoka has joined
NetSilicon as Vice President of Intelligent Device Markets for Japan.
The purchase price was allocated to the tangible and intangible assets acquired
and liabilities assumed on the basis of their respective estimated fair values
on the acquisition date. The following represents the allocation of the purchase
price:
Cash ................................... $ 761,400
Accounts receivable .................... 1,017,900
Other tangible assets................... 161,900
Customer list .......................... 351,400
Workforce .............................. 148,000
Goodwill ............................... 134,400
----------
Total purchase price ................... $2,575,000
==========
The purchase price consisted of 241,667 shares of the common stock of the
Company, valued at $1,257,700, assumed liabilities of $969,400, $250,000 in cash
and $97,800 of acquisition related costs, including legal and accounting fees.
On August 31, 2000, the Company completed the acquisition of the strategic
network technology assets (the "Purchased Assets") of Pacific Softworks
Technology, Inc. ("Pacific"), a subsidiary of PASW, Inc. (formerly Pacific
Softworks, Inc.). The Purchased Assets, which represented substantially all of
the assets of Pacific, will be used by the Company to develop and license
embedded network protocols, software that enables electronic devices to
communicate over local and wide area networks.
The purchase price was allocated to the tangible and intangible assets acquired
and liabilities assumed on the basis of their respective estimated fair values
on the acquisition date, as follows:
Completed technology ................... $2,417,700
Workforce .............................. 228,700
Fixed assets............................ 103,700
Accounts receivable .................... 91,500
----------
Total purchase price ................... $2,841,600
==========
14
NETSILICON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
J. BUSINESS ACQUISITIONS AND OTHER CAPITAL STOCK TRANSACTIONS (Continued)
The purchase price consisted of 90,000 shares of common stock of the Company,
valued at $2,271,600 and $570,000 of acquisition-related costs, including
$400,000 for investment banking fees and fees for legal, accounting and
consulting. The purchased completed technology and workforce assets were being
amortized over three years.
During the fourth quarter of fiscal year 2001, the Company recorded an
impairment charge of $957,000 related to a component of the completed technology
intangible assets resulting from the Company's decision to no longer sell or
market the underlying products.
The summary table below, prepared on an unaudited pro forma basis, combines the
results of operations of the Company with the results of operations of Dimatech
as if the acquisition had occurred at February 1, 2000 and the operations of
Pacific as if the acquisition had occurred on February 1, 1999. The unaudited
pro forma results are not necessarily indicative of what would have occurred if
the acquisitions had been in effect for the periods presented and are not
necessarily indicative of future operating results. Pro forma results for the
year ended 2002 are not included in the table as substantially all of the
results of operations of Dimatech and Pacific for fiscal year 2002 are included
in the consolidated financials of the Company for fiscal year 2002.
Year Ended Year Ended
January 31, 2001 January 31, 2000
---------------- ----------------
Revenue ................................. $ 41,269,300 $ 34,083,400
Net loss ................................ $ (2,492,700) $ (1,328,600)
Basic and diluted net loss per share .... $ (0.18) $ (0.12)
K. EMPLOYEE RETIREMENT SAVINGS PLAN
In fiscal year 2001, the Company established an employee retirement savings plan
(the "Savings Plan") that is designed to qualify as a deferred salary
arrangement under Section 401(k) of the Internal Revenue Code. Under the Savings
Plan, participating employees may defer a portion of their pre-tax earnings, up
to the Internal Revenue Service annual contribution limit. Each Plan year, the
Company may make discretionary matching contributions of a percent, if any, of
employee pretax contributions. As of January 31, 2002 and 2001, there were no
discretionary matching contributions made by the Company.
L. STOCK OPTION PLANS AND STOCK AWARD PLAN
The Company adopted two stock option plans in August 1998: The 1998 Incentive
and Non-Qualified Stock Option Plan and the 1998 Director Option Plan. In
addition, the Company adopted The 2001 Stock Option and Incentive Plan in July,
2001. The purpose of these plans is to attract, retain, motivate and reward
officers, directors, employees and consultants of the Company to maximize their
contribution towards the Company's success. All options are granted at prices
not less than fair value at the date of grant and have terms varying up to 10
years. The Company's stock option plans authorize the issuance of 8,800,000
shares of common stock for the grant of stock options.
Additionally, certain employees of the Company held options to purchase Sorrento
common stock under Sorrento's stock option plans. All of these options were
granted prior to the Company's initial public offering in September 1999.
Pursuant to the Company's Agreement and Plan of Merger, dated October 30, 2001,
with Digi International Inc., Company stock options with per share exercise
prices in excess of $7.00 and exercisable for 1,005,200 shares of common stock
were effectively canceled and, based on the terms of the underlying option
agreements, were rendered fully vested and exercisable for thirty days following
the notification to option holders on January 11, 2002. None of these options
were exercised during the thirty-day period that concluded on February 11, 2002.
15
NETSILICON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
L. STOCK OPTION PLANS AND STOCK AWARD PLAN (Continued)
The following table summarizes the activity in the Company's stock option plans:
WEIGHTED AVERAGE
NUMBER OF SHARES EXERCISE PRICE
---------------- --------------
Shares under option at January 31, 1999 - -
Granted ............................. 3,320,778 $ 7.53
Exercised ........................... - -
Canceled ............................ (5,325) 7.00
--------------
Shares under option at January 31, 2000 3,315,453 7.53
Granted ............................. 2,549,030 15.53
Exercised ........................... (155,280) 7.00
Canceled ............................ (658,054) 13.75
--------------
Shares under option at January 31, 2001 5,051,149 10.85
Granted ............................. 1,291,400 3.99
Exercised ........................... -
Canceled ............................ (1,125,219) 9.63
--------------
Shares under option at January 31, 2002 5,217,330 $ 9.41
==============
Additional information about outstanding options to purchase the Company's
common stock held at January 31, 2002 is as follows:
OUTSTANDING EXERCISABLE
-------------------------------------------------- ------------------------------
WEIGHTED AVERAGE
EXERCISE PRICE -------------------------------- WEIGHTED AVERAGE
PER SHARE SHARES LIFE (YEARS) EXERCISE PRICE SHARES EXERCISE PRICE
--------- ------ ------------ -------------- ------ --------------
$2.10 to $6.94 1,644,905 9.21 $ 4.16 337,091 $ 4.10
$7.00 2,397,274 7.62 7.00 1,280,450 7.00
$13.13 to $34.13 1,175,151 1.10 21.69 1,062,651 22.08
--------- ---------
$2.10 to $34.13 5,217,330 6.66 9.41 2,680,192 12.62
========= =========
16
NETSILICON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
L. STOCK OPTION PLANS AND STOCK AWARD PLAN (Continued)
All stock options issued to employees have an exercise price not less than the
fair market value of the common stock on the date of grant, and in accordance
with the accounting for such options utilizing the intrinsic value method there
is no related compensation expense recorded in the Company's financial
statements. Had compensation cost for stock-based compensation related to the
grant of Company and Sorrento options been determined based on the fair value at
the grant dates in accordance with the method delineated in SFAS No. 123, the
Company's income (loss) and per share amounts for the years ended January 31,
2002, 2001 and 2000 would have been revised to the pro forma amounts presented
below:
JANUARY 31,
---------------------------------------------------------------
2002 2001 2000
-------------- -------------- --------------
Net income (loss):
As reported ................ $ (12,055,000) $ (1,256,900) $ 2,017,600
Pro forma .................. (21,286,100) (8,590,500) 734,200
Basic income (loss) per share:
As reported ................ $ (0.86) $ (0.09) $ 0.18
Pro forma .................. (1.52) (0.63) 0.06
Diluted income per share:
As reported ................ $ (0.86) $ (0.09) $ 0.17
Pro forma .................. (1.52) (0.63) 0.06
The fair value of option grants is estimated on the date of grant utilizing the
Black-Scholes option-pricing model with the following weighted average
assumptions for grants during the year ended January 31, 2002, 2001 and 2000,
respectively: expected life of option 4.5 years, expected volatility of 80.0%,
80.0% and 45.8%, risk-free interest rate of 4.25%, 4.5% and 5.88% and a 0%
dividend yield in each year. The fair value, at date of grant, using these
assumptions was $1.95 to $22.16 per option and the weighted average was $2.55,
$10.06, and $3.42, respectively, in fiscal years 2002, 2001 and 2000.
The assumptions for grants of Sorrento options for the year ended January 31,
2000 were: expected life of 3 years, expected volatility of 45%, risk-free
interest rate of 5.28% and a 0% dividend yield. The fair value, at date of
grant, using these assumptions was $1.23 to $9.52 per option and the weighted
average was $5.57 in 2000. There were no grants of Sorrento options to
NetSilicon employees in the years ended January 31, 2001 and 2002.
During fiscal year 2001, the Company issued warrants to purchase 20,000 shares
of common stock at a weighted average exercise price of $ 17.56 per share. The
warrants were issued in connection with a third party product development
agreement. The Company capitalized the fair value of the warrants, $75,000, as
capitalized software costs on the balance sheet. During the year ended January
31, 2000, the Company issued non-statutory options to non-employees for the
purchase of 25,000 shares of common stock at a weighted average exercise price
of $7.00 per share. Such options were granted for services provided during the
year. Accordingly, the Company recorded the $78,700 fair value of such awards as
an expense in the accompanying financial statements.
In April 2000, the Company's board of directors adopted the 2000 Employee Stock
Purchase Plan ("ESPP"). The aggregate number of shares that may be issued under
the plan is 500,000 and is subject to adjustment. The ESPP allows eligible
participating employees to purchase shares of common stock as determined at
specific dates at six-month intervals. As of January 31, 2002, approximately
$85,500 of payroll deductions was withheld from employees for future purchases
under the plan.
17
NETSILICON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
M. INCOME TAXES
The Company's provision for taxes on income for the fiscal years ended January
31 consists of:
YEARS ENDED JANUARY 31,
---------------------------------------
2002 2001 2000
------- ------ ------
Income taxes:
Current ....... $ -- $ -- $ --
Deferred ...... -- -- --
------
------- ------ ------
Total ......... $ -- $ -- $ --
======= ====== ======
The Company's operations generate permanent and temporary differences for
depreciation, amortization and valuation allowances. The Company has recorded a
100% valuation allowance against its deferred tax assets, including net
operating loss and research credit carryforwards, in accordance with the
provisions of Statement of Financial Accounting Standards No. 109. Such
allowance is recognized if, based on the weight of available evidence, it is
more likely than not that some portion or all of the deferred tax assets will
not be realized.
Deferred income taxes reflect the impact of temporary differences between the
amount of assets and liabilities recognized for financial reporting purposes and
such amounts recognized for tax purposes. Deferred tax assets and liabilities
are comprised of the following at January 31:
JANUARY 31,
---------------------------------
2002 2001
----------- -----------
Deferred tax assets:
Reserves and allowances ...................... $ 1,007,000 $ 741,700
Research and development credits ............. 785,000 457,100
Tax loss carryforward ........................ 7,133,000 1,927,500
Intangible assets ............................ 622,000 512,800
Fixed assets ................................. (37,200) 207,400
----------- -----------
Gross deferred tax assets ........ 9,509,800 3,846,500
Less: valuation allowance .................... (9,278,800) (3,428,900)
----------- -----------
Deferred tax asset ............................. 231,000 417,600
----------- -----------
Deferred tax liabilities:
Software developments costs .................. (231,000) (417,600)
----------- -----------
Deferred tax liabilities ......... (231,000) (417,600)
----------- -----------
Net deferred tax asset (liability) $ -- $ --
=========== ===========
At January 31, 2002, the Company has federal net operating losses of
approximately $17,200,000 and research and development credits of $785,000
that may be available to reduce future taxable income; these carryforwards
expire at various dates through 2023. The Internal Revenue Code of 1986, as
amended, reduces the extent to which NOLs and tax credit carryforwards may be
utilized in a single taxable year in the event there has been an ownership
change of a company as defined by applicable Code provisions. The acquisition of
the Company by Sorrento in September 1996 resulted in such an ownership change.
Further ownership changes, as defined by the Code, may reduce the extent to
which any net operating losses and credits may be utilized.
18
NETSILICON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
M. INCOME TAXES (Continued)
These carryforwards expire as follows:
NOL CREDITS
----------- ----------
2008 .............................. $ -- $ 54,800
2009 .............................. -- 102,300
2010 .............................. 384,800 63,900
2013 .............................. 998,100 --
2014 .............................. 2,130,500 --
2022 .............................. 1,097,600 236,100
2023 .............................. 12,589,000 327,900
----------- ----------
$17,200,000 $ 785,000
=========== ==========
The reconciliation between income tax expense and a theoretical United States
tax computed by applying a rate of 35% for the fiscal years ended January 31,
2002, 2001 and 2000 is as follows:
YEARS ENDED JANUARY 31,
--------------------------------------------------------
2002 2001 2000
------------ ----------- -----------
Income (loss) before income taxes ...... $(12,055,000) $(1,256,900) $ 2,017,600
============ =========== ===========
Theoretical tax expense (benefit) at 35% $ (4,219,300) $ (439,900) $ 706,200
Taxable income absorbed by former parent -- -- (988,600)
Impact of non-qualified stock options .. -- (353,900) --
Impact of state taxes and other taxes .. (656,100) (159,900) 186,300
R&E tax credit ......................... (200,000) (457,100) --
Change in valuation allowance .......... 5,120,900 1,341,500 96,100
Foreign rate differential .............. (500) -- --
Other .................................. (45,000) 69,300 --
------------ ----------- -----------
Tax benefit ............................ $ -- $ -- $ --
============ =========== ===========
N. EARNINGS PER SHARE CALCULATION
The following data shows the amounts used in computing basic earnings per share:
YEARS ENDED JANUARY 31,
---------------------------------------------------------
2002 2001 2000
------------ ------------ -----------
Net income (loss) ............ $(12,055,000) $ (1,256,900) $ 2,017,600
Less: preferred dividends .... -- -- --
------------ ------------ -----------
Net income (loss) available to
common shareholders used
in basic EPS ............... $(12,055,000) $ (1,256,900) $ 2,017,600
============ ============ ===========
Average number of common
shares used in basic EPS .... 14,037,100 13,674,200 11,326,600
============ ============ ===========
19
NETSILICON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
N. EARNINGS PER SHARE CALCULATION (Continued)
The Company had a net loss for the fiscal years ending January 31, 2002 and
2001. Accordingly, the effect of dilutive securities including warrants to
acquire common stock and stock options, vested and non-vested, are not included
in the calculations of EPS because their effect would be anti-dilutive. The
following data shows the effect on income and the weighted average number of
shares of dilutive potential common stock.
YEARS ENDED JANUARY 31,
---------------------------------------------------------
2002 2001 2000
------------ ------------ -----------
Net income (loss) available to common
shareholders used in basic EPS ............... $(12,055,000) $ (1,256,900) $ 2,017,600
Adjustments ..................................... -- -- --
------------ ------------ -----------
Net income (loss) available to common
shareholders after assumed conversions of
dilutive securities .......................... $(12,055,000) $ (1,256,900) $ 2,017,600
============ ============ ===========
Average number of common
shares used in basic EPS ...................... 14,037,100 13,674,200 11,326,600
Effect of dilutive securities:
Stock options ..................... -- -- 651,600
------------ ------------ -----------
Average number of common shares and dilutive
potential common stock used in dilutive EPS .. 14,037,100 13,674,200 $11,978,200
============ ============ ===========
The shares issuable upon exercise of options and warrants represent the shares
issuable at exercise net of the shares assumed to have been purchased, at the
average market price for the period, with the assumed exercise proceeds.
Accordingly, options with exercise prices in excess of the average market price
for the period are excluded because their effect would be anti-dilutive.
For the years ended January 31, 2002, 2001 and 2000, options for approximately
5,217,300 shares, 5,051,100 shares and 42,000 shares, respectively, were
excluded from the calculation of diluted income per share, as their effect would
be anti-dilutive.
O. SUBSEQUENT EVENTS
On November 5, 2001, the Company and Digi International, Inc. ("Digi"),
announced the signing of an Agreement and Plan of Merger dated October 30, 2001
(the "Agreement") pursuant to which the Company became a wholly-owned subsidiary
of Digi on February 13, 2002. Under the terms of the Agreement, each outstanding
share of the Company's common stock was converted into the right to receive
either cash, Digi common stock or a combination of cash and Digi common stock at
the election of the holder. The Agreement provided that each holder of the
Company's common stock may elect to receive 0.6500 of a share of Digi common
stock for each share of the Company's common stock, or cash in the amount of
0.6500 multiplied by the average per-share closing price of Digi common stock
during the period of ten trading days ending on the third trading day before the
date of closing, or a combination of both stock and cash, provided that the
maximum amount of cash to be paid by Digi would be $15 million. Additionally,
outstanding stock options were either assumed or cancelled (see Note L) and
certain executives received transaction related bonuses totalling approximately
$1,130,000.
20
NETSILICON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
P. SUPPLEMENTAL CASH FLOW DISCLOSURES
Cash paid for interest and income taxes are as follows:
YEARS ENDED JANUARY 31,
-------------------------------------------
2002 2001 2000
-------- -------- --------
Interest ...... $5,300 $21,900 $898,400
Income taxes .. $ -- $ -- $ --
Non-cash investing and financing activities are as follows:
YEARS ENDED JANUARY 31,
----------------------------------------------
2002 2001 2000
--------- --------- ---------
Forgiveness of notes receivable to officer
(including accrued interest) ................ $ 908,500 $ -- $ --
Unrealized gains (losses) on investments ...... $ (16,800) $52,900 $ (26,400)
Common stock options issued to non-employees .. $ -- $75,000 $ 78,700
Capital leases entered in during the year ..... $ -- $ -- $ 240,200
========= ========= =========
Q. CONCENTRATIONS OF CREDIT RISK
Financial instruments that potentially subject the Company to concentrations of
credit risk consist primarily of temporary cash investments and trade
receivables. The Company places its temporary cash investments with high credit
financial institutions.
Substantially all of the Company's OEM office imaging customers are
headquartered in Japan. The current economic conditions existing in many Asian
countries, including Japan, are uncertain and may have a significant effect on
the business operations of such OEM customers. Consequently, the Company's
dependence on its OEM office imaging customers in Japan and the uncertain
factors affecting Japan's economic condition could have a material adverse
effect on the Company's business, operating results, cash flows and financial
condition.
Although the Company is directly affected by the economic well being of its
significant customers listed in the following tables, management does not
believe that significant credit risk exists at January 31, 2002. The Company
performs ongoing credit evaluations of its customers' financial condition and
does not require collateral.
21
NETSILICON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Q. CONCENTRATIONS OF CREDIT RISK (Continued)
The following data shows the customers accounting for more than 10% of net
receivables:
JANUARY 31,
------------------------------------------------
2002 2001
--------------------- -----------------------
Customer A.................................. 38.6 % 17.1 %
Customer B.................................. 14.4 --
Customer C.................................. -- 11.0
The following data shows the net sales to major customers (customers who
represented 10% or more of net sales during any of the periods shown) as a
percentage of net sales:
YEARS ENDED JANUARY 31,
------------------------------------------------------------------
2002 2001 2000
------------------- ------------------- --------------------
Customer A................................... 25.6 % 20.0 % 25.8 %
Customer B................................... 17.3 3.9 5.1
Customer C................................... 12.9 4.9 12.5
Customer D.................................. -- 23.2 23.8
R. SEGMENT INFORMATION
Information in the tables below is presented on the same basis utilized by the
Company to manage its business. The Company manages its business primarily on a
geographic basis. The Company operates in one principle industry segment: the
development and marketing of embedded networking solutions. The Company's
primary products include integrated semiconductor and controller products and
are sold to customers in a broad range of industries, including
telecommunications, building controls, security, retail point-of-sale and office
appliances. The Company also licenses software products that are embedded into
electronic devices to enable Internet and Web-based communications. Revenue from
these software product licenses was 3.2% of total net sales in fiscal year 2002
and 1% in fiscal year 2001. The Company also receives revenue from royalty and
services, including technical support.
Summary information by geography is as follows:
Geographic: YEARS ENDED JANUARY 31,
-----------------------------------------------------
2002 2001 2000
----------- ----------- -----------
Net sales:
United States .................. $12,909,500 $16,669,100 $15,917,000
Japan .......................... 11,660,600 15,090,900 14,153,100
Europe, Middle East, Africa .... 2,889,500 3,222,800 1,575,700
Other .......................... 190,400 2,399,300 195,100
----------- ----------- -----------
Total net sales ..... $27,650,000 $37,382,100 $31,840,900
=========== =========== ===========
Export sales and certain income and expense items are reported in the geographic
area where the final sale to customers is made, rather than where the
transaction originates. Other net sales include sales to Australia, New Zealand,
Canada and South America for each period presented. The Company does not have
significant long-lived assets at foreign locations.
22
NETSILICON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
R. SEGMENT INFORMATION (Continued)
Summary information by product and service is as follows:
YEARS ENDED JANUARY 31,
-----------------------------------------------------
2002 2001 2000
----------- ----------- -----------
Net sales:
Semiconductor and controller
products, including development tools ... $25,772,500 $35,101,900 $30,567,300
Royalty, maintenance, service and other ... 1,877,500 2,280,200 1,273,600
----------- ----------- -----------
Total net sales ................ $27,650,000 $37,382,100 $31,840,900
=========== =========== ===========
S. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table sets forth certain unaudited quarterly results of operations
of the Company for the fiscal years ended January 31, 2002 and 2001. In the
opinion of management, this information has been prepared on the same basis as
the audited financial statements and includes all adjustments necessary for a
fair presentation of Company's operations. This quarterly information should be
read in conjunction with the audited financial statements and accompanying notes
included in this annual report on Form 10-K. Operating results for the quarterly
periods are not necessarily indicative of future results of operations.
FISCAL YEAR 2002 FISCAL YEAR 2001
------------------------------------------ -------------------------------------
Q1-02 Q2-02 Q3-02 Q4-02 Q1-01 Q2-01 Q3-01 Q4-01
-------- -------- -------- -------- ------- ------- ------- --------
Net Sales $ 6,977 $ 7,053 $ 7,171 $ 6,449 $ 9,010 $ 9,857 $10,688 $ 7,827
Cost of sales 2,970 3,410 3,306 3,525 3,512 4,129 4,429 3,118
-------- -------- -------- -------- ------- ------- ------- --------
Gross margin 4,007 3,643 3,865 2,924 5,498 5,728 6,259 4,709
Operating expenses 6,182 6,028 6,935 7,705 4,941 5,223 5,805 8,364
-------- -------- -------- -------- ------- ------- ------- --------
Operating income (loss) (2,175) (2,385) (3,070) (4,781) 557 505 454 (3,655)
Interest income 117 90 106 43 224 241 218 199
Taxes on income -- -- -- -- -- -- -- --
-------- -------- -------- -------- ------- ------- ------- --------
Net income (loss) $ (2,058) $ (2,295) $ (2,964) $ (4,738) $ 781 $ 746 $ 672 $ (3,456)
======== ======== ======== ======== ======= ======= ======= ========
Earnings (loss) per share:
Basic $ (0.15) $ (0.16) $ (0.21) $ (0.34) $ 0.06 $ 0.05 $ 0.05 $ (0.25)
Diluted $ (0.15) $ (0.16) $ (0.21) $ (0.34) $ 0.06 $ 0.05 $ 0.04 $ (0.25)
Weighted shares outstanding:
Basic 13,979 14,036 14,055 14,066 13,569 13,621 13,718 13,782
Diluted 13,979 14,036 14,055 14,066 15,865 15,928 15,813 13,782
23
NETSILICON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
T. VALUATION AND QUALIFYING ACCOUNTS
Changes in the inventory valuation reserve were as follows:
Balance at January 31, 1999 .......................................... $ 124,600
Additions charged to costs and expenses ............................. 554,500
Amounts used during year ............................................ (54,100)
---------
Balance at January 31, 2000 .......................................... 625,000
Additions charged to costs and expenses ............................. --
Amounts used during year ............................................ (114,200)
---------
Balance at January 31, 2001 .......................................... 510,800
Additions charged to costs and expenses ............................. 295,300
Amounts used during year ............................................ (93,300)
---------
Balance at January 31, 2002 .......................................... $ 712,800
=========
Changes in the accounts receivable and sales valuation reserves were as follows:
Balance at January 31, 1999 .......................................... $ 300,000
Additions charged to costs and expenses ............................. 443,900
Amounts used during year ............................................ (40,900)
---------
Balance at January 31, 2000 .......................................... 703,000
Additions charged to costs and expenses ............................. --
Amounts used during year ............................................ (32,000)
---------
Balance at January 31, 2001 .......................................... 671,000
Additions charged to costs and expenses (recoveries) ................ (46,700)
Amounts used during year ............................................ (48,300)
---------
Balance at January 31, 2002 .......................................... $ 576,000
=========
24