EXHIBIT 99.2
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of ITK International, Inc.
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations, of changes in stockholders' deficit
and of cash flows present fairly, in all material respects, the financial
position of ITK International, Inc. and its subsidiaries (the "Company") at
June 30, 1998 and 1997, and the results of their operations and their cash
flows for each of the three years in the period ended June 30, 1998, 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.
As described in Note 13, the Company was acquired on July 29, 1998.
PricewaterhouseCoopers LLP
Boston, Massachusetts
October 26, 1998
ITK INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEET
JUNE 30, 1998 AND 1997 (IN THOUSANDS, EXCEPT SHARE DATA)
1998 1997
---- ----
ASSETS
Current assets:
Cash $ 2,373 $ 429
Accounts receivable, net of allowance for doubtful accounts
of $607 and $195 at June 30, 1998 and 1997, respectively 3,019 3,615
Inventories, net 5,267 7,271
Prepaid expenses and other currrent assets 678 556
-------- --------
Total current assets 11,337 11,871
Property and equipment, net 10,668 9,934
Intangible assets, net 4,405 535
Other assets 247 -
-------- --------
Total assets $ 26,657 $ 22,340
-------- --------
-------- --------
LIABILITIES AND STOCKHOLDER'S DEFICIT
Current liabilities:
Demand notes payable $ 14,168 $ 8,717
Accounts payable 4,756 4,278
Accrued expenses 5,573 910
Accrued compensation 1,847 888
Current portion of long-term debt 115 109
-------- --------
Total currrent liabilities 26,459 14,902
Long-term debt, less current portion 9,511 8,697
-------- --------
Total liabilities 35,970 23,599
-------- --------
Commitments and contingencies (Note 6)
Stockholders' deficit:
Common stock, $.001 par value, 33,000,000 shares authorized,
27,392,904 and 19,179,680 shares issued and outstanding at
June 30, 1998 and 1997, respectively 27 19
Additional paid-in capital 36,948 18,503
Deferred compensation (3,307) -
Accumulated deficit (42,891) (19,576)
Cumulative translation adjustment (90) (205)
-------- --------
Total stockholders' deficit (9,313) (1,259)
-------- --------
Total liabilities and stockholders' deficit $ 26,657 $ 22,340
-------- --------
-------- --------
The accompanying notes are an integral part of these consolidated
financial statements.
2
ITK INTERNATIONAL, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE YEARS ENDED JUNE 30, 1998, 1997 AND 1996
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- -------------------------------------------------------------------------------
1998 1997 1996
---- ---- ----
Revenues $ 32,699 $ 22,188 $ 26,331
Cost of revenues 24,353 12,857 13,848
---------- ---------- ----------
Gross profit 8,346 9,331 12,483
---------- ---------- ----------
Operating expenses:
Selling, general and administrative 24,034 14,224 10,402
Research and development 6,784 4,916 2,148
---------- ---------- ----------
Total operating expenses 30,818 19,140 12,550
---------- ---------- ----------
Loss from operations (22,472) (9,809) (67)
Other income (expense):
Interest income 152 115 14
Interest expense (1,585) (973) (152)
Other income, net 607 519 231
---------- ---------- ----------
Income (loss) before income taxes $ (23,298) $ (10,148) 26
Income taxes 17 169 963
---------- ---------- ----------
Net loss $ (23,315) $ (10,317) $ (937)
---------- ---------- ----------
---------- ---------- ----------
Net loss per common share:
Basic and diluted $ (0.98) $ (0.58) $ (0.07)
---------- ---------- ----------
---------- ---------- ----------
Weighted average number of common and
common equivalent shares outstanding:
Basic and diluted 23,746 17,830 14,325
---------- ---------- ----------
---------- ---------- ----------
The accompanying notes are an integral part of these consolidated
financial statements.
3
ITK INTERNATIONAL, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' DEFICIT
FOR THE YEARS ENDED JUNE 30, 1998, 1997 AND 1996
(IN THOUSANDS, EXCEPT SHARE DATA)
- -------------------------------------------------------------------------------
TOTAL
COMMON STOCK ADDITIONAL CUMULATIVE STOCKHOLDERS'
------------------- PAID-IN ACCUMULATED DEFERRED TRANSLATION EQUITY
SHARES AMOUNT CAPITAL DEFICIT COMPENSATION ADJUSTMENT (DEFICIT)
---------- ------- ---------- ----------- ------------ ----------- ------------
Balance, June 30, 1995 14,325,080 $ 14 $ 1,328 $ 590 $ - $ 53 $ 1,985
Net loss (937) (937)
Foreign currency translation (141) (141)
---------- ------- ---------- ----------- --------- ---------- ----------
Balance, June 30, 1996 14,325,080 14 1,328 (347) - (88) 907
Issuance of common stock 4,854,600 5 17,175 17,180
Dividends paid (8,912) (8,912)
Net loss (10,317) (10,317)
Foreign currency translation (117) (117)
---------- ------- ---------- ----------- --------- ---------- ----------
Balance, June 30, 1997 19,179,680 19 18,503 (19,576) - (205) (1,259)
Contributed capital 1,569 1,569
Issuance of common stock upon
Merger with ITK AG 7,609,860 7 11,717 11,724
Exercise of common stock options 603,364 1 59 60
Compensation related to the grant
of common stock options 5,100 (5,100) -
Amortization of deferred compensation 1,793 1,793
Net loss (23,315) (23,315)
Foreign currency translation 115 115
---------- ------- ---------- ----------- --------- ---------- ----------
Balance, June 30, 1998 27,392,904 $ 27 $ 36,948 $ (42,891) $ (3,307) $ (90) $ (9,313)
---------- ------- ---------- ----------- --------- ---------- ----------
---------- ------- ---------- ----------- --------- ---------- ----------
The accompanying notes are an integral part of these consolidated
financial statements.
4
ITK INTERNATIONAL, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE YEARS ENDED JUNE 30, 1998, 1997 AND 1996 (IN THOUSANDS)
- ------------------------------------------------------------------------------
1998 1997 1996
-------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(23,315) $(10,317) $ (937)
Adjustments to reconcile net loss
to net cash provided by operating
activities:
Depreciation and amortization 2,327 811 403
Provision for doubtful accounts 412 145 -
Amortization of deferred
compensation 1,793
Loss on sale of property and
equipment 403 26 -
Changes in operating assets and
liabilities, excluding effects
of acquired business:
Accounts receivable 4,191 1,768 (1,716)
Inventories 5,630 1,077 (3,297)
Prepaid expenses and other current
assets 50 (203) (264)
Other assets 104 111 377
Accounts payable (1,444) (1,191) 28
Accrued expenses and compensation 2,421 (365) 508
--------- --------- --------
Net cash used by operating
activities (7,428) (8,138) (4,898)
--------- --------- --------
Cash flows from investing activities:
Purchases of property and equipment (641) (8,496) (2,261)
Cash of acquired business 3,111 - -
Proceeds from sale of property and
equipment 73 167 7
--------- --------- --------
Net cash used in investing
activities 2,543 (8,329) (2,254)
--------- --------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock 60 17,180 -
Dividends paid - (8,912) -
Proceeds from debt issuance 6,271 8,312 7,117
--------- --------- --------
Net cash provided by financing
activities 6,331 16,580 7,117
--------- --------- --------
Net increase in cash and cash
equivalents 1,446 113 (35)
Effect of exchange rate changes on
cash and cash equivalents 498 80 (370)
Cash at beginning of year 429 236 641
--------- --------- --------
Cash at end of period $ 2,373 $ 429 $ 236
--------- --------- --------
--------- --------- --------
Cash paid during the period for:
Interest $ 972 $ 631 $ 259
Income taxes 670 690 143
NONCASH INVESTING AND FINANCING
ACTIVITIES:
Common stock issued on Merger with
ITK AG $ 11,724 $ - $ -
Capital contribution, land received
from shareholder 1,569 - -
The accompanying notes are an integral part of these
consolidated financial statements.
5
ITK INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- ------------------------------------------------------------------------------
1. DESCRIPTION OF BUSINESS
ITK International, Inc. and its subsidiaries (the "Company") design,
manufacture, sell, market and support a broad range of high
performance remote network access products. These products enable
customers to build: (i) dial-up local area network ("LAN")
inter-networks that provide remote offices, telecommuters and mobile
computer user access to corporate networks; (ii) remote LAN access
networks that provide access to the Internet; and (iii) mission
critical wide area network access facilities that provide LAN or
host access over the public switched telephone network. The Company
markets its products worldwide through distributors, value added
resellers and service providers. The Company also sells its modem
products to certain original equipment manufacturers.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All intercompany
transactions and balances have been eliminated.
On August 7, 1997, Telebit Incorporated ("TI") consummated a merger
(the "Merger") with ITK Telekommunikation AG ("ITK AG"), a German
corporation. The Company's common stock was recapitalized and ITK
AG's stockholders received an aggregate of 19,179,680 previously
unissued shares of common stock of the Company, representing 66.5%
of the common stock outstanding upon consummation of the Merger.
Due to the majority ownership received by ITK AG's stockholders,
the Merger was accounted for as a "reverse acquisition" such that
TI was designated as the acquired entity and ITK AG the acquirer.
Accordingly, the consolidated balance sheet as of June 30, 1997 and
the related consolidated statements of operations, of cash flows
and of changes in stockholders' equity (deficit) for each of the
two years in the period ended June 30, 1997 represent the historical
results of ITK AG and its subsidiaries. The results of operations
of TI are included in the consolidated financial statements from
August 7, 1997. In addition, the Company changed its name
concurrent with the Merger from "Telebit Incorporated" to "ITK
International, Inc." See Note 3.
All shares of common stock, options and per share amounts included
in the accompanying financial statements have been adjusted to
give retroactive effect to the recapitalization for all years
presented.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosures of contingent assets and liabilities at
the dates of the financial statements and the reported amounts of
revenues and expenses during the reporting periods. Actual results
could differ from those estimates.
6
ITK INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- ------------------------------------------------------------------------------
REVENUE RECOGNITION
Revenue relating to products sold is recognized upon transfer of
legal title, which is generally upon shipment. The Company derives
a significant percentage of its revenue from sales to distributors.
Under the Company's standard distribution agreements, distributors
are granted certain "stock balancing" and "price protection"
rights. The Company provides reserves for such returns or price
adjustments at the time the related revenue is recorded, based on
historic rates of returns or price adjustments. The Company's
stock balancing and price protection obligations have historically
been within management's expectations.
CONCENTRATION OF CREDIT RISK
Financial instruments which potentially expose the Company to
concentrations of credit risk consist principally of cash and trade
accounts receivable. The Company places its cash with financial
institutions which management believes are of high credit quality.
FINANCIAL INSTRUMENTS
The carrying amount of the Company's financial instruments, which
include cash, accounts receivable, accounts payable, accrued
expenses, notes payable and long-term debt, approximates their
fair value at the balance sheet dates.
INVENTORIES
Inventories are stated at the lower of cost, determined on the
first-in, first-out (FIFO) basis, or market.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Depreciation is
based on the following estimated useful lives of the assets
using the straight-line method:
Buildings 25 years
Office equipment 4-10 years
Expenditures for additions, renewals and betterments of property and
equipment are capitalized. Expenditures for repairs and maintenance
are charged to expense as incurred. As assets are retired or sold,
the related cost and accumulated depreciation are removed from the
accounts and any resulting gain or loss is included in the results
of operations.
INTANGIBLE ASSETS
Intangible assets, comprised primarily of acquired technology
(Note 3), are recorded at their fair value determined at time of
acquisition. Amortization is based on the estimated useful lives of
the assets of 4 years, using the straight-line method.
The Company periodically analyzes intangible assets for potential
impairment, assessing the appropriateness of lives and recoverability
of unamortized balances through measurement of undiscounted operating
cash flows on a basis consistent with generally accepted accounting
principles.
7
ITK INTERNATIONAL,INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
INCOME TAXES
The Company recognizes deferred tax assets and liabilities for the expected
future tax consequences of events that have been included in the Company's
consolidated financial statements. Under this method, deferred tax
liabilities and assets are determined based on the difference between the
financial statement and tax bases of assets and liabilities using currently
enacted tax rates for the year in which the differences are expected to
reverse. The Company records a valuation allowance against net deferred
tax assets if, based upon the available evidence, it is more likely than
not that some or all of the deferred tax assets will not be realized.
NET LOSS PER COMMON SHARE
For each of the years presented, basic and diluted earnings per share are
the same due to the antidilutive effect of potential common shares
outstanding. Antidilutive potential common shares excluded from the
computation of diluted loss per share for the fiscal year 1998 include
4,617,848 common shares issuable upon the exercise of stock options.
FOREIGN CURRENCY
The accounts of foreign subsidiaries are translated using exchange rates in
effect at period-end for assets and liabilities and at average exchange
rates during the period for results of operations. The local currency for
all foreign subsidiaries is the functional currency. The related
transaction adjustments are reported as a separate component of
stockholders' equity (deficit). Gains or losses resulting from foreign
currency transactions are included in other income (expense) and were
immaterial for all periods presented.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income". The statement establishes standards for the reporting and display
of comprehensive income and its components. Comprehensive income is
defined as the change in equity of a business enterprise during a period
from transactions and other events and circumstances from non-owner
sources. It includes all changes in equity during a period except those
resulting from investments by owners and distributions to owners. This
standard will require that an enterprise display an amount representing
total comprehensive income for the period. SFAS No. 130 will be effective
for the Company's fiscal year ending June 30, 1999. Adoption of SFAS No.
130 is not expected to impact the Company's financial position or results
of operations.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information" which supersedes SFAS No. 14. This
statement changes the way that public business enterprises report segment
information, including financial and descriptive information about their
operating segments, in annual financial statements and would require that
those enterprises report selected segment information in interim financial
reports to stockholders. Operating segments are defined as
revenue-producing components of the enterprise which are generally used
internally for evaluating segment performance. SFAS No. 131 will be
effective for the Company beginning with the Company's fiscal year ending
June 30, 1999. Adoption of SFAS No. 131 will not impact the Company's
financial position or results of operations.
8
ITK INTERNATIONAL,INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." The statement requires that all
derivative instruments be recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designated as
part of a hedge transaction and, if it is, the type of hedge transaction.
The ineffective portion of all hedges will be recognized in current-period
earnings. SFAS No. 133 will be effective for the Company beginning with
the Company's fiscal year ending June 30, 2000. As the Company has no
derivative instruments and is not involved in hedging activity, the Company
does not expect the adoption of SFAS No. 133 to have an impact on the
Company's financial position or results of operations.
3. MERGER OF TELEBIT INCORPORATED AND ITK AG
As described in Note 1, on August 7, 1997, Telebit Incorporated ("TI")
consummated a merger (the "Merger") with ITK Telekommunikation AG ("ITK
AG"), a German corporation.
The Merger was accounted for using the purchase method. The purchase price
for financial accounting purposes was determined to be $11,724,000, based
upon an independent appraisal of the 7,609,860 shares of common stock and
the 2,051,000 options to purchase common stock of the Company received upon
the Merger by former stockholders and option holders of TI.
The following summarizes the allocation of the purchase price to the
estimated fair value of the assets acquired and liabilities assumed as of
August 7, 1997 (in thousands):
Assets acquired:
Cash $ 3,111
Accounts receivable 3,183
Inventories 4,126
Prepaid expenses and other current assets 172
Property, plant and equipment 1,054
Other assets 259
Identifiable intangible assets 4,650
Cost in excess of net assets acquired 262
Liabilities assumed:
Accounts payable (1,922)
Accrued expenses (3,171)
--------
Total purchase price $11,724
--------
--------
The identifiable intangible assets consist primarily of acquired technology
valued at $3,900,000, as well as established customer base, workforce and
trademark. The identifiable intangible assets were fair valued by an
independent appraisal based on discounted cash flow analyses.
9
ITK INTERNATIONAL,INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
The following unaudited pro forma information is presented to illustrate
the results of operations had the Merger occurred on July 1, 1996 (in
thousands, except share data):
Year ended
June 30,
1998 1997
(Unaudited) (Unaudited)
Total revenues $ 35,202 $ 41,449
Loss from operations (22,769) (19,635)
Net loss (23,958) (20,758)
Loss per share - basic and diluted $ (0.88) $ (0.82)
The above pro forma results of operations are not necessarily indicative of
the results of operations which actually would have been realized had the
Merger occurred as of July 1, 1996, nor of the future results of the
combined companies.
4. INVENTORIES
Inventories consist of the following (in thousands):
June 30,
1998 1997
Raw materials $ 1,270 $ -
Work in process 601 1,130
Finished goods 3,396 6,141
--------- ---------
$ 5,267 $ 7,271
--------- ---------
--------- ---------
5. PROPERTY AND EQUIPMENT
Property and equipment consists of the following (in thousands):
June 30,
1998 1997
Land $ 749 $ 749
Buildings 8,845 7,081
Office equipment 4,516 4,150
Construction in progress - 157
--------- ---------
14,110 12,137
Less accumulated depreciation (3,442) (2,203)
--------- ---------
$ 10,668 $ 9,934
--------- ---------
--------- ---------
Depreciation expense relating to property and equipment was $1,394,000,
$137,000 and
10
ITK INTERNATIONAL,INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
$276,000 for the fiscal years 1998, 1997 and 1996, respectively.
6. COMMITMENTS AND CONTINGENCIES
OPERATING LEASES
The Company leases facilities under various operating leases. Future
minimum lease payments under noncancelable operating leases with initial or
remaining terms of one or more years consisted of the following at June 30,
1998 (in thousands):
1999 $ 933
2000 404
2001 187
2002 122
2003 74
Thereafter 773
-------
Total future minimum lease payments $ 2,493
-------
-------
Rental expense during the fiscal years 1998, 1997 and 1996 was $805,000,
$295,000 and $225,000, respectively.
7. DEMAND NOTES PAYABLE
On June 12, 1998, the Company entered into a $5,000,000 loan facility with
Digi International Inc. (see Note 13). Under this loan facility, Digi
International Inc. has advanced $5,000,000 to the Company as a demand note
payable. The outstanding balance of this demand note payable bears
interest at 8 percent. The Company has pledged as collateral for this
demand note payable 98,400 common shares of ITK AG.
At June 30, 1998, short-term liabilities exist with banks in the amount of
$9,168,000. These amounts are due daily. Interest is calculated quarterly
and is also due daily.
The weighted average interest rate on demand notes payable was 4.6% and
4.9% at June 30, 1998 and 1997, respectively.
11
ITK INTERNATIONAL,INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
8. LONG-TERM DEBT
Long-term debt consists of the following (in thousands):
1998 1997
---- ----
5.2% fixed rate long-term collateralized note $2,882 $1,782
6.0% Fixed rate long-term collateralized note 1,498 1,546
6.3% fixed rate long-term collateralized note 4,433 4,597
6.0% fixed rate long-term uncollateralized note 574 591
6.0% subsidized long-term note 239 290
------ ------
Total long-term debt 9,626 8,806
Less: current maturities (115) (109)
------ ------
$9,511 $8,697
------ ------
------ ------
The 5.2% fixed rate long-term note is payable in semi annual installments
beginning June 2001. Interest is payable on a quarterly basis. The 6.0%
fixed rate long-term note is payable in full in September 2003. Interest
is payable on a quarterly basis. The 6.3% fixed rate long term note is
payable in semi annual installments beginning March 2000. Interest is
payable on a semi-annual basis. These notes are collateralized by certain
land, building and equipment.
The 6.0% fixed rate long term note is due in full on November 5, 2001.
Borrowings under this note are uncollateralized.
The 6.0% subsidized long term note is payable in quarterly installments.
Interest is payable on a quarterly basis. Borrowings under this note are
uncollateralized.
Aggregate maturities of long-term debt over the next five fiscal years are
as follows: $115,000 in 1999, $213,000 in 2000, $407,000 in 2001,
$1,870,000 in 2002, $429,000 in 2003 and $6,592,000 thereafter.
9. STOCK PLANS
The Company maintains two stock plans. The 1996 Stock Option Plan (the
"1996 Plan") provided for the issuance of up to 5,000,000 shares of common
stock pursuant to the grant of incentive and non-qualified stock options.
The Company does not intend to issue any additional options under the 1996
Plan, but options that are forfeited will become available for grant under
the 1997 Stock Option Plan (the "1997 Plan").
12
ITK INTERNATIONAL,INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
Under the terms of the 1997 Plan, employees, directors and certain
other individuals may be awarded incentive stock options, nonqualified
stock options or restricted stock. The 1997 Plan provides for the
issuance of a maximum of 3,000,000 shares of common stock, plus such
additional number of shares that become available due to the forfeiture
of options granted under the 1996 Plan. Non-qualified options may be
granted to any employee, officer, director or consultant at an exercise
price per share to be determined by the Board of Directors on the date
of grant. Options granted under the 1997 Plan are exercisable over
periods determined by the Board of Directors, not to exceed ten years
from the date of grant.
In fiscal year 1997, the Company adopted SFAS No. 123, "Accounting for
Stock-Based Compensation." SFAS No. 123 requires that companies either
recognize compensation expense for grants of stock, stock options and other
equity instruments based on fair value or provide pro forma disclosure of
net income and earnings per share in the notes to the financial statements
as if such method had been applied. The Company adopted the pro forma
disclosure provisions of SFAS No 123 in fiscal 1997 and has applied APB
Opinion No. 25 and related interpretations in accounting for all of its
stock option grants.
Stock option activity is summarized as follows:
WEIGHTED
AVERAGE
NUMBER EXERCISE
OF SHARES PRICE
--------- ---------
Outstanding at June 30, 1997 -- $ --
Options of acquired company 2,707,167 0.10
Granted 4,595,000 0.10
Forfeited (2,085,494) 0.10
Exercised (598,825) 0.10
----------- -------
Outstanding at June 30, 1998 4,617,848 0.10
----------- -------
Options available for future grant 2,755,344
Information related to the stock options outstanding at June 30,
1998 is as follows:
WEIGHTED EXERCISABLE
NUMBER AVERAGE NUMBER
RANGE OF OF REMAINING OF
EXERCISE PRICE OPTIONS CONTRACTUAL LIFE OPTIONS
-------------- ------- ---------------- --------
$ .10 4,617,848 9.36 years 2,213,468
Had compensation cost for the Company's stock option grants been determined
based on the fair value at the grant dates, as calculated in accordance
with SFAS No. 123, the Company's net loss and net loss per common share
(both basic and diluted) for the fiscal year ended June 30, 1998 would not
have been materially different from the amount reported. Because options
vest over several years and additional option grants are expected to be
made in subsequent years, the pro forma impact above is not representative
of the pro forma effects for future years.
The fair value of each option granted during the fiscal year ended June 30,
1998 was estimated
13
ITK INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
on the date of grant using the minimum value method utilizing the
following weighted-average assumptions: (1) expected risk-free
interest rate of 5.4% to 5.7%; (2) expected option life of 7 years;
(3) expected stock volatility of 0%; and (4) expected dividend yield
of 0%. The weighted average fair value per option for options
granted in fiscal year 1998 was $1.11.
In accordance with APB No. 25, deferred compensation recorded under
the 1997 Plan during the year ended June 30, 1998 was $5,100,000
which is being amortized to expense over the vesting periods of the
related options. The related compensation expense recorded for the
year ended June 30, 1998 was $1,793,000.
As discussed in Note 13, on July 29, 1998, Digi International Inc.
acquired the Company. In connection with the acquisition, each
option holder of the Company received an option to purchase common
stock of Digi International Inc.
10. INCOME TAXES
The income tax provision consisted entirely of current foreign tax
expense of $17,000, $169,000 and $963,000 in fiscal years 1998, 1997
and 1996, respectively. Since the Merger, the Company has incurred
losses for tax purposes and, accordingly, has not provided for any
current or deferred federal and state income taxes.
Domestic and foreign income (loss) before income taxes for the
fiscal years 1998, 1997 and 1996 is as follows (in thousands):
1998 1997 1996
-------- -------- --------
Domestic $(11,933) $ - $ -
Foreign (11,365) (10,148) 26
-------- -------- --------
$ 23,298 $(10,148) 26
-------- -------- --------
-------- -------- --------
The following is a reconciliation between the provision for income
taxes based upon U.S. statutory income tax rates and the Company's
effective income tax expense (in thousands):
1998 1997 1996
-------- -------- --------
Income taxes (benefit) at
federal statutory rates $ (8,154) $ (3,552) $ 9
Foreign tax rate differential (4,419) (1,404) (337)
Amortization of intangible assets 669 - -
State taxes (net) (709) - -
Research and development credits (142) - -
Valuation allowance adjustments 12,650 5,125 710
Nondeductible expenses 122 - 217
Other - - 364
-------- -------- --------
$ 17 $ 169 $ 963
-------- -------- --------
-------- -------- --------
14
ITK INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
The components of the net deferred tax asset are as follows (in
thousands):
1998 1997
---- ----
Net operating loss carryforwards $ 18,991 $ 7,169
Research and development credits 143 -
Depreciation 652 7
Accrued expenses 168 7
Accounts receivable 38 202
Other 229 186
---------- ----------
Total gross deferred tax assets 20,221 7,571
Valuation allowance (20,221) (7,571)
---------- ----------
Total net deferred tax asset $ - $ -
---------- ----------
---------- ----------
Under SFAS No. 109, the benefit associated with future deductible
temporary differences is recognized if it is more likely than not
that a benefit will be realized. Based on historical evidence of
net losses, the Company has recorded a valuation allowance that
offsets the full amount of its net deferred tax assets.
As of June 30, 1998, the Company had U.S. and state net operating
loss ("NOL") carryforwards of approximately $13,601,000 and
$11,481,000, respectively, available to offset future taxable income,
which expire at various dates through 2011.
A subsequent change in the Company's ownership as defined in Section
382 of the Internal Revenue Code may significantly limit the future
utilization of the federal NOL carryforwards incurred prior to an
ownership change. In fiscal year 1997 and in July 1998, substantial
changes in the ownership of the Company occurred.
At June 30, 1998, the Company's foreign subsidiaries had NOL
carryforwards of approximately $24,586,000.
15
ITK INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
11. GEOGRAPHIC DATA
The Company's operations are conducted in one business segment in
the United States and Europe. Geographic information about the
Company for fiscal years 1998, 1997 and 1996 is as follows:
1998 1997 1996
-------- -------- --------
Revenues
United States $ 12,100 $ 32 $ 934
Europe 20,599 22,156 25,397
-------- -------- --------
$ 32,699 $ 22,188 $ 26,331
-------- -------- --------
-------- -------- --------
Loss from operations:
United States $(10,854) $ (775) $ (455)
Europe $(11,618) (9,034) 388
-------- -------- --------
$(22,472) $ (9,809) $ (67)
-------- -------- --------
-------- -------- --------
Identifiable assets:
United States $ 6,393 $ 734 $ 757
Europe 20,264 21,606 17,103
-------- -------- --------
$ 26,657 $ 22,340 $ 17,860
-------- -------- --------
-------- -------- --------
12. EMPLOYEE BENEFIT PLANS
The Company sponsors a qualified 401(k) Plan which covers all
eligible employees of the Company. The Company made no matching
contributions to the plan during fiscal years 1998, 1997 and 1996.
13. SUBSEQUENT EVENT
On July 29, 1998, Digi International Inc. ("Digi") acquired 100% of
the outstanding common stock of the Company for $13.3 million in
cash, 576,357 shares of common stock of Digi and 125,174 options to
purchase Digi common stock issued to all existing option holders of
the Company. Accordingly, the Company became a wholly owned
subsidiary of Digi. The acquisition of the Company will be
accounted for by Digi using the purchase method. Certain
restructuring activities are expected as a result of the acquisition
by Digi.
16