SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
________________________
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
__________________________
Date of Report (Date of earliest event reported): December 19, 2002
Home Director, Inc.
-------------------
(Exact Name of Registrant as Specified in Charter)
Delaware 52-2143430
- --------------------------- -------------------------
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation) Identification Number)
333-86873
---------
(Commission File Number)
2525 Collier Canyon Road, Livermore, California 94551
-----------------------------------------------------
(Address of Principal Executive Office) (Zip Code)
Registrant's telephone number, including area code: (925) 373-0438
Netword, Inc., 285 Tanglewood Crossing, Lawrence, New York 11559
----------------------------------------------------------------
(Former Name or Former Address, if Changed Since Last Report)
ITEM 1. CHANGES IN CONTROL OF REGISTRANT.
On December 19, 2002, the Registrant acquired all of the stock of Home
Director Technologies, Inc., a Delaware corporation (formerly known as Home
Director, Inc. and referred to in this Report as "HDT"), through a merger of a
special purpose subsidiary of the Registrant into HDT (the "Merger"). The
Merger was effected pursuant to an Agreement and Plan of Merger, dated as of
April 9, 2002, as amended (the "Merger Agreement"). Immediately prior to the
Merger, the Registrant effected a one-for-40 reverse split of its outstanding
common stock. Upon the Merger, the former HDT stockholders (approximately 500
persons) became entitled to receive approximately 3,225,127 shares of the
Registrant's common stock, or approximately 86% of the Registrant's shares
issued and outstanding upon completion of the Merger. In accordance with the
Merger Agreement and after giving effect to the reverse split of the
Registrant's common stock, the shares of common stock of HDT (including shares
issuable on conversion of outstanding preferred stock) were exchanged for shares
of the Registrant's common stock at the rate of approximately 36.3 shares of HDT
common stock for each share of the Registrant's common stock.
Effective at the time of the Merger, the Registrant's board of directors
was increased from two to seven members and the directors of HDT were elected to
fill the resulting vacancies. The expanded board of directors then designated
the officers of HDT as officers of the Registrant.
In connection with the Merger, certain former stockholders of HDT, who
after the Merger own approximately 10.5% of the Registrant's outstanding common
stock, agreed to vote all of their shares of such common stock in favor of the
Registrant's two pre-merger directors for up to three years after the Merger.
ITEM 2. ACQUISITION OR DISPOSITION OF ASSETS.
On December 19, 2002, the Registrant completed the acquisition of all of
the stock of HDT. For information on the nature and amount of consideration,
please see "Item 1. Changes in Control of Registrant." As a result of the
Merger, the business of HDT is now the Registrant's only business. HDT
designs, manufactures, sells and installs integrated home networking solutions
that electronically interconnect personal computers, home security systems,
audio systems, video services, televisions, utilities and the Internet.
ITEM 5. OTHER EVENTS AND REQUIRED FD DISCLOSURE.
HOME DIRECTOR MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion of the financial condition and results of operations of
Home Director, Inc. (as constituted before the Merger) should be read together
with the audited financial statements and related notes thereto included
elsewhere in this Form 8-K. References to the "company" in this MD&A are to
the company acquired in the Merger and references to "management" are references
to the management of the company. Some of the statements in this MD&A that are
not historical facts are forward-looking statements. The forward-looking
statements contained in this MD&A are estimates and predictions, and the actual
results could differ materially from those anticipated in the forward-looking
statements due to risks, uncertainties or actual events differing from the
assumptions underlying these statements. The risks, uncertainties and
assumptions include, but are not limited to, those discussed in Netword's
registration statement on Form S-4 which became effective on October 29, 2002.
1
RESULTS OF OPERATIONS
THREE AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2002 COMPARED TO
THREE AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2001
Home Director's revenue for the quarter ended September 30, 2002 was
approximately $2.7 million, a decrease of approximately $1.3 million, or 32%,
from the same period in 2001. This decrease is due primarily to the company's
inability to recapture or replace new homebuilding projects and hardware
business lost in the first half of 2002 due to inventory shortages stemming from
cash constraints that affected its relations with certain key vendors. Home
Director's revenue for the first nine months of 2002 was approximately $8.0
million, a decrease of approximately $2.6 million, or 24%, from the same period
in 2001. This decrease is due primarily to inventory shortages stemming from
cash constraints that affected Home Director's relations with certain key
vendors during the first half of 2002 and the company's inability to recapture
or replace new home building projects and hardware business in the most recent
quarter. Management believes Home Director's receipt of proceeds from the sale
of its convertible notes and completion of its debt restructuring have largely
relieved the cash constraints.
Total expenses in all categories decreased substantially in the first nine
months of 2002 compared to the first nine months of 2001, and Management
believes that its adherence to the cost reduction measures it began in 2001 will
continue to have a favorable impact on comparative expenses in future periods.
For the quarter ended September 30, 2002 compared to the quarter ended September
30, 2001, cost of revenues decreased by approximately $0.4 million (or 22%)
which was primarily attributable to decreased revenues. For the quarter ended
September 30, 2002, general and administrative expenses decreased by
approximately $0.5 million (or 43%), sales and marketing expenses decreased by
approximately $0.3 million (or 32%) and research and development expenses
decreased by approximately $1.7 million (or 90%), as compared to the quarter
ended September 30, 2001. The company's cost reduction measures included a
reduction in headcount, a reduction in its spending on new product development
and a change in the company's sales strategy for its products. For the first
nine months of 2002 compared to the first nine months of 2001, cost of revenues
decreased by approximately $0.8 million (or 13%) which was primarily
attributable to decreased revenues. For the first nine months of 2002, general
and administrative expenses decreased by approximately $1.4 million (or 37%),
sales and marketing expenses decreased by approximately $2.6 million (or 59%)
and research and development expenses decreased by approximately $4.5 million
(or 89%), as compared to the first nine months of 2001. The company's cost
reduction measures included a reduction in headcount, a reduction in spending on
new product development, a reduction in marketing and promotional expenses and a
change in sales strategy for its products.
Interest expense for the nine-months ended September 30, 2002 was also
adversely affected by certain expenses related to the company's debt financing.
The charges include interest accrued on the convertible notes, which were paid
to investors by the issuance of common stock of the company immediately prior to
the Merger, and amortization of costs of the offering both of which totaled $2.1
million in the quarter and $3.0 million for the nine-months ended September 30,
2002. All of the convertible notes were automatically converted into Home
2
Director common stock immediately prior to the Merger. Although management
views the underlying economic basis of issuance of convertible debt as a sale of
Home Director common stock, generally accepted accounting principles require the
third-party costs associated with the convertible notes to be treated as fees
paid for obtaining debt financing which are then amortized over the expected
term of the financing, which is from the date of the convertible note issuance
through the anticipated closing date of the Merger. If these transactions were
to be treated as a sale of Home Director common stock, the related costs would
be netted against the proceeds of the common stock and not presented as an
expense in the company's results of operations. The company anticipates these
costs will result in approximately $0.5 million in expenses in the quarter
ending December 31, 2002.
Home Director's net loss in the quarter ended September 30, 2002 was
approximately $2.9 million, as compared to a net loss of approximately $3.0
million in the same quarter of 2001. The improvement was primarily attributable
to the items discussed above. The company's net loss in the first nine months
of 2002 was approximately $1.2 million, as compared to a net loss of
approximately $13.9 million in the same period of 2001. The substantial
improvement was primarily attributable to the items discussed above, the
elimination of goodwill amortization as a result of a required change in
accounting principle, the non-recurrence of various restructuring charges
incurred in 2001 and the extraordinary gain on extinguishment of certain
liabilities recorded in 2002.
LIQUIDITY AND CAPITAL RESOURCES
The net increase in cash totaled approximately $1.7 million in the first
nine months of 2002. Cash used in operating activities in the first nine months
of 2002 was approximately $4.9 million. This use of cash was primarily
attributable to the loss from operations of $2.7 million together with an
accounts receivable increase of $0.6 million and a decrease in accounts payable
and accrued liabilities of $2.6 million, which excludes the impact of
settlements with vendors, and offset in part by depreciation and amortization of
$0.6 million and a decrease in net inventories of $0.3 million. Net cash used in
investing activities was approximately $1.0 million for the first nine months of
2002, consisting primarily of merger costs incurred in connection with the
Merger. Home Director does not anticipate making large expenditures for property
and equipment during the balance of 2002. Primarily as a result of the proceeds
from the issuance of convertible notes in the first nine months of 2002, offset
partially by financing costs, net cash provided by financing activities was $7.6
million, which supplied a portion of the cash used in operating activities
during the first nine months of 2002.
In February 2002, Home Director privately sold $705,000 aggregate principal
amount of secured notes and warrants to purchase up to 1,007,143 shares of its
common stock. Through October 7, 2002, it sold $8.5 million principal amount of
its 8% secured convertible notes due 2003 ($8.3 million sold through September
30, 2002). The notes sold in February 2002 automatically converted into
convertible notes in May 2002. All of the convertible notes converted into
shares of Home Director common stock at $0.10 per share (a total of 92,817,166
shares) immediately before the Merger.
As of September 30, 2002, Home Director had $2.9 million in net current
assets, excluding convertible notes and fees thereon, which management considers
adequate to meet its operating and capital requirements for at least 12 months
based on anticipated levels of revenues and operating expenses; however,
management cannot be certain that it will achieve the anticipated levels of
revenue or that it will not encounter unforeseen costs which would require it to
obtain additional capital. Furthermore, expansion of the business into new
areas, including by way of one or more strategic acquisitions, might require
additional capital. The company would expect to seek such capital through sales
of additional equity or debt securities and/or loans from banks. There is no
assurance that the company will be able to obtain additional financing, if and
when required, or that the terms of any such financing will be favorable.
CRITICAL ACCOUNTING POLICIES
The methods, estimates and judgments the company uses in applying its most
critical accounting policies have a significant impact on the results we report
in our consolidated financial statements. The company evaluates its estimates
and judgments on an on-going basis. The company bases its estimates on
historical experience and on assumptions that it believes to be reasonable under
the circumstances. The company's experience and assumptions form the basis for
its judgments about the carrying value of assets and liabilities that are not
3
readily apparent from other sources. Actual results may vary from what the
company anticipates and different assumptions or estimates about the future
could change the company's reported results. The company believes the following
accounting policies are the most critical to it, in that they are important to
the portrayal of its financial statements and they require the company's most
difficult, subjective or complex judgments in the preparation of its
consolidated financial statements:
Revenue Recognition. The company generally recognizes product revenue upon
its shipment. The company also recognizes revenues using the percentage of
completion method on installation projects, primarily by comparing contractual
billing milestones with total contract value. Changes to total estimated
contract costs or losses, if any, are recognized in the period in which they are
identified.
Allowance for Doubtful Accounts. Accounts receivable are unsecured and the
company maintains allowances for doubtful accounts for estimated losses from our
customers' inability to make payments they owe us. The company assesses each
account that is more than 90 days delinquent and in order to estimate the
appropriate level of this allowance considers such factors as historical bad
debts, current customer credit-worthiness, changes in customer payment patterns
and any correspondence between the company and the customer. If the financial
condition of the company's customers were to deteriorate and impair their
ability to make payments to us, additional allowances might be required in
future periods.
Inventory. The company presents inventory value at the lower of cost or
market and net of valuation allowances for excess and obsolete units.
Establishing this reserve requires estimates of sales volumes and pricing. To
the extent that the company is not able to correctly anticipate these trends,
additional reserves may be required in future periods.
Intangible Assets and Goodwill. Intangible assets include costs in excess
of net assets acquired ("Goodwill") and other purchased intangibles. The
carrying amounts of goodwill and intangibles are reviewed if facts and
circumstances suggest that it may be impaired. If this review indicates that
goodwill and intangibles will not be recoverable, as determined based on the
estimated undiscounted cash flows of the entity acquired, the carrying amount of
the goodwill and other intangibles are reduced to their estimated fair value.
This requires the company to estimate such factors as future sales volumes and
costs of business produced by these intangibles. To the extent that the company
is not able to correctly anticipate these trends, additional adjustments to
estimated fair value may be required in future periods.
Valuation of Common and Preferred Stock Warrants and other equity
instruments. The company has, and may continue in the future, entered into
transactions whereby it grants common or preferred stock warrants to
non-employees or issued convertible debt instruments whose terms include
beneficial conversion features. These transactions require the company to
determine the fair value of these non-exchange traded instruments. The
development of these fair values requires significant judgment and estimates by
company management. The company discloses the assumptions used in determining
these fair values in its financial statements and believes their assumptions to
be reasonable. However, the use of different valuation models, or differing
assumptions from management's, could cause materially different values to be
assigned to these instruments and could therefore have a significant impact on
the company's reported results of operations.
4
ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL STATEMENTS AND EXHIBITS.
(a) Financial Statements of Businesses Acquired.
The audited consolidated financial statements of Home Director
Technologies, Inc. (formerly Home Director, Inc.) for the years ended December
31, 2000 and 2001, and the unaudited condensed consolidated financial statements
for the nine months ended September 30, 2002, are included in this report as
Annex A.
(b) Pro Forma Financial Information.
The unaudited pro forma combined condensed financial statements of the
Registrant giving effect to the Merger are included in this report as Annex B.
(c) Exhibits
2.1 Agreement and Plan of Merger by and among Netword, Inc., Webspeak
Acquisition Corp. and Home Director, Inc., dated as of April 9, 2002, as
amended on July 31, 2002 and October 25, 2002, set forth in Annex A to the
Information Statement/Proxy Statement/Prospectus included in the
Registrant's Registration Statement on Form S-4 (File No. 333-97615),
effective October 29, 2002, incorporated herein by reference.
3.1 Certificate of Amendment of Netword, Inc., filed with the Secretary of
State of the State of Delaware on December 17, 2002, effective as of
December 19, 2002, filed herewith.
3.2 Restated Certificate of Incorporation of Netword, Inc., filed with the
Secretary of State of the State of Delaware on December 17, 2002,
effective as of December 19, 2002, filed herewith.
3.3 Amended and Restated Bylaws of Home Director, Inc., adopted as of
December 19, 2002 and filed herewith.
3.4 Certificate of Merger of Webspeak Acqusition Corp. into Home Director,
Inc., filed with the Secretary of State of the State of Delaware on
December 17, 2002, filed herewith.
5
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: December 19, 2002
HOME DIRECTOR, INC.
(Registrant)
By: /s/ Donald B. Witmer
--------------------------------
Donald B. Witmer
Chairman and Chief Executive Officer
6
ANNEX A
-------
AUDITED CONSOLIDATED FINANCIAL STATEMENTS OF HOME DIRECTOR TECHNOLOGIES, INC.
(FORMERLY HOME DIRECTOR, INC.) FOR THE YEARS ENDED DECEMBER 31, 2000 AND 2001.
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Home Director, Inc.
We have audited the accompanying consolidated balance sheet of Home Director,
Inc. as of December 31, 2001 and the related statements of operations,
shareholders' equity (deficit), and cash flows for the years ended December 31,
2001 and 2000. 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. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Home Director,
Inc. at December 31, 2001 and the consolidated results of its operations and its
cash flows for the years ended December 31, 2001 and 2000, in conformity with
accounting principles generally accepted in the United States.
The accompanying financial statements have been prepared assuming that Home
Director, Inc. will continue as a going concern. As more fully described in Note
2, the Company has incurred operating losses since inception and requires
additional capital to continue operations. These conditions raise substantial
doubt about the Company's ability to continue as a going concern. Management's
plans as to these matters are also described in Notes 2 and 15. The financial
statements do not include any adjustments to reflect the possible future effects
on the recoverability and classification of assets or the amounts and
classification of liabilities that may result from the outcome of this
uncertainty.
/s/ Ernst & Young LLP
March 8, 2002, except for Note 15,
as to which the date is July 26, 2002
A-1
HOME DIRECTOR, INC.
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 2001
ASSETS
Current assets:
Cash and cash equivalents $ 563,046
Accounts receivable, net of allowance of $274,200 1,105,393
Costs and estimated earnings in excess of billings on uncompleted contracts 134,765
Inventories, net of allowance of $2,583,200 1,234,318
Other current assets 271,756
-------------
Total current assets 3,309,278
Property and equipment 612,194
Business process, net of accumulated amortization of $8,530 4,094
Customer lists, net of accumulated amortization of $387,191 370,205
Assembled workforce, net of accumulated amortization of $222,293 224,133
Goodwill, net of accumulated amortization of $1,654,837 5,601,520
-------------
Total assets $ 10,121,424
=============
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable and accrued expenses $ 7,450,500
Billings in excess of costs and estimated earnings on uncompleted contracts 164,348
Payables to affiliate and employees 1,580,192
Notes payable 125,000
Current portion of capital lease obligations 142,656
-------------
Total current liabilities 9,462,696
Capital lease obligations, less current portion 132,799
Shareholders' equity:
Common Stock, $0.001 par value; 200,000,000 shares authorized; 1,123,372 share
issued and outstanding as of December 31, 2001 1,123
Series A Convertible Preferred Stock, $0.001 par value; 35,000,000 shares authorized;
33,333,334 shares issued and outstanding as of December 31, 2001 (aggregate
liquidation preference of $2,000,000) 33,333
Series B Convertible Preferred Stock, $0.001 par value; 100,000,000 shares authorized;
44,959,249 shares issued and outstanding as of December 31, 2001 (aggregate
liquidation preference of $44,959,249) 44,959
Series C Convertible Preferred Stock, $0.001 par value; 12,000,000 shares authorized;
10,000,000 shares issued and outstanding as of December 31, 2001 (aggregate
liquidation preference of $10,000,000) 10,000
Additional paid-in capital 60,107,185
Warrants - Preferred Stock and Common Stock 4,970,135
Accumulated deficit (64,640,806)
-------------
Total shareholders' equity 525,929
-------------
Total liabilities and shareholders' equity $ 10,121,424
=============
See accompanying notes.
A-2
HOME DIRECTOR, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31,
2001 2000
-------------------------------
Revenues $ 13,226,480 $ 5,379,517
Operating expenses:
Cost of revenues 8,774,512 3,876,751
General and administrative 5,421,653 7,825,635
Sales and marketing 5,752,232 13,904,552
Research and development 6,087,067 9,377,681
Impairment of long lived assets 8,590,051 1,483,442
Restructuring charges 4,701,233 -
Depreciation and amortization 4,440,742 1,230,340
-------------------------------
Loss from operations (30,541,010) (32,318,884)
Other income/(expense):
Interest income 257,059 913,510
Interest expense (96,830) (266,957)
-------------------------------
Net loss $(30,380,781) $(31,672,331)
===============================
Net loss per common share - basic and diluted $ (29.09) $ (4,287.58)
===============================
Shares used in computing basic and diluted net loss per common share 1,044,254 7,387
===============================
See accompanying notes.
A-3
HOME DIRECTOR, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
SERIES A SERIES B SERIES C
COMMON STOCK PREFERRED STOCK PREFERRED STOCK PREFERRED STOCK
------------------------------------------------------------------------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
------------------------------------------------------------------------------------
Balance at December 31, 1999 - $ - 33,333,334 $33,333 - $ - - $ -
Issuance of Series B preferred
stock, net - - - - 44,959,249 44,959 - -
Issuance of Series C preferred
stock, net - - - - - - 10,000,000 10,000
Issuance of warrants to purchase
Series B preferred stock - - - - - - - -
Issuance of common stock
warrants to purchase Series C
preferred stock - - - - - - - -
Issuance of common stock
warrants in exchange for
consulting services - - - - - - - -
Acceleration of vesting of options
to purchase common stock
pursuant to severance agreement - - - - - - - -
Issuance of common warrants
pursuant to research and
development agreement - - - - - - - -
Exercise of common stock
options 90,282 90 - - - - - -
Net loss - - - - - - - -
------------------------------------------------------------------------------------
Balance at December 31, 2000 90,282 90 33,333,334 33,333 44,959,249 44,959 10,000,000 10,000
Exercise of common stock options 49,632 50 - - - - - -
Issuance of common stock in
connection with acquisitions 983,458 983 - - - - - -
Issuance of stock options in
connection with acquisitions - - - - - - - -
Issuance of common stock warrants
in connection with acquisition - - - - - - - -
Issuance of common stock warrants
for consulting services, less
deferred compensation of
$ 218,943 - - - - - - -
Acceleration of vesting of certain
stock options - - - - - - - -
Net loss - - - - - - - -
------------------------------------------------------------------------------------
Balance at December 31, 2001 1,123,372 $ 1,123 33,333,334 $33,333 44,959,249 $44,959 10,000,000 $10,000
====================================================================================
TOTAL
ADDITIONAL SHAREHOLDERS'
PAID-IN ACCUMULATED EQUITY
CAPITAL WARRANTS DEFICIT (DEFICIT)
-----------------------------------------------------------
Balance at December 31, 1999 $ 1,946,004 $ - $ (2,587,694) $ (608,357)
Issuance of Series B preferred
stock, net 39,201,295 - - 39,246,254
Issuance of Series C preferred
stock, net 9,965,000 - - 9,975,000
Issuance of warrants to purchase
Series B preferred stock (2,877,392) 2,877,392 - -
Issuance of common stock
warrants to purchase Series C
preferred stock (640,000) 640,000 - -
Issuance of common stock
warrants in exchange for
consulting services - 5,386 - 5,386
Acceleration of vesting of options
to purchase common stock
pursuant to severance agreement 89,527 - - 89,527
Issuance of common warrants
pursuant to research and
development agreement - 235,410 - 235,410
Exercise of common stock
options 21,466 - - 21,556
Net loss - - (31,672,331) (31,672,331)
-----------------------------------------------------------
Balance at December 31, 2000 47,705,900 3,758,188 (34,260,025) 17,292,445
Exercise of common stock options 24,875 - - 24,925
Issuance of common stock in
connection with acquisitions 9,833,602 - - 9,834,585
Issuance of stock options in
connection with acquisitions 731,000 - - 731,000
Issuance of common stock warrants
in connection with acquisition - 930,567 - 930,567
Issuance of common stock warrants
for consulting services, less
deferred compensation of
- 281,380 - 281,380
Acceleration of vesting of certain
stock options 1,811,808 - - 1,811,808
Net loss - - (30,380,781) (30,380,781)
-----------------------------------------------------------
Balance at December 31, 2001 $60,107,185 $4,970,135 $(64,640,806) $ 525,929
===========================================================
See accompanying notes.
A-4
HOME DIRECTOR, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
2001 2000
------------------------------
OPERATING ACTIVITIES
Net loss $(30,380,781) $(31,672,331)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 4,440,742 1,230,340
Impairment of long lived assets 8,590,051 1,483,442
Noncash consulting fees 281,380 5,386
Noncash severance expense 1,811,808 89,527
Noncash research and development - 235,410
(Decrease)/increase in accounts receivable allowance (162,098) 303,794
Increase in inventory reserve 1,250,608 1,252,553
Changes in operating assets and liabilities, net of assets and liabilities acquired:
Accounts receivable 1,907,587 (2,193,646)
Inventories 802,565 (1,404,899)
Other assets 392,723 (222,288)
Accounts payable and accrued expenses (1,572,190) 6,489,384
------------------------------
Net cash used in operating activities (12,637,605) (24,403,328)
INVESTING ACTIVITIES
Purchases of property and equipment (767,324) (1,761,321)
Change in restricted certificates of deposit 426,697 (426,697)
Increase in long-term assets - (329,650)
Acquisitions of companies (3,166,513) -
------------------------------
Net cash used in investing activities (3,507,140) (2,517,668)
FINANCING ACTIVITIES
Bank overdraft - (27,038)
Borrowings under line of credit - 5,672,146
Repayments on line of credit - (5,672,146)
Advances from and payable to shareholders - 4,542,878
Repayments of shareholder advances and payables - (8,824,383)
Issuance of notes receivable - (1,200,000)
Repayment of capital lease obligations (104,295) (26,110)
Proceeds from issuance of common stock 24,925 21,556
Proceeds from issuance of preferred stock, net - 49,221,254
------------------------------
Net cash (used in) provided by financing activities (79,370) 43,708,157
------------------------------
Net (decrease) increase in cash (16,224,115) 16,787,161
Cash and cash equivalents at beginning of year 16,787,161 -
------------------------------
Cash and cash equivalents at end of year $ 563,046 $ 16,787,161
===============================
SUPPLEMENTAL DISCLOSURES
Cash paid for interest $ 75,462 $ 268,639
===============================
NONCASH INVESTING AND FINANCING ACTIVITIES
Capital lease obligations incurred $ 108,889 $ 224,403
===============================
Purchase of Digital Interiors and Los Gatos for stock and note $ 11,646,152 $ -
===============================
Issuance of preferred stock warrants to placement agent $ - $ 3,517,392
===============================
See accompanying notes.
A-5
HOME DIRECTOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001
NOTE 1 - ORGANIZATION AND DESCRIPTION OF THE BUSINESS
Home Director, Inc. (the "Company") was incorporated on October 13, 1999 under
the laws of the State of Delaware. The Company, which is headquartered in San
Jose, California, commenced operations on December 8, 1999, subsequent to
acquiring the assets of and assuming certain liabilities of IBM Corporation's
Home Director business unit.
The Company operates in a single industry, the provision of infrastructure
components for home networking, and is engaged in the design, sale and
installation of home networking products and services for the new home
construction market.
The Company acquired Digital Interiors, Inc. ("DI"), an installer of home
networking products, on January 25, 2001. The aggregate purchase price for DI
was $18,056,506 (including the assumption of certain liabilities totaling
$3,569,041, of which certain amounts are held in escrow for periods outlined in
the purchase agreement). The Company acquired DI for 983,439 shares of common
stock valued at $10.00 per share, the pro rata exchange of 121,835 stock options
valued at $731,000, the issuance of 93,057 common stock warrants valued at
$930,567, and payment of liabilities and acquisition fees of $2,991,513. The
excess of aggregate purchase price over the fair market value of the net assets
acquired of approximately $16,295,000 was recorded as goodwill (and related
intangibles) and is being amortized over period ranging from one to seven years
(see Note 12 - Impairment of Long Lived Assets). In addition, certain sellers
can "earn out" additional stock consideration based on obtaining specific
operating goals over a period of one to three years from the date of the
acquisition as outlined in the purchase agreement. Also, additional shares are
issuable upon the occurrence of defined events (including a sale or merger of
the Company). The Company's financial advisor is entitled to receive additional
warrants based on the earn-outs obtained by DI as outlined in the agreement.
The Company also acquired certain assets from Los Gatos Home Theatre, an
installer of home networking products, on May 14, 2001 for an aggregate purchase
price for $325,000. The Company paid $175,000 in cash and issued a promissory
note for $150,000. The excess of aggregate purchase price over the fair market
value of the net assets acquired of approximately $293,000 was recorded as
goodwill and is being amortized over eight years (see Note 12 - Impairment of
Long Lived Assets).
The Company accounted for these acquisitions using the purchase method of
accounting with results of operations of the acquired companies included in the
Company's operations from the respective dates of the acquisitions. In
connection with the acquisitions, the Company entered into employment agreements
with certain employees of the acquired companies ranging from one to two years.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of Home
Director, Inc. and its wholly owned subsidiary, DI. All significant intercompany
accounts and transactions have been eliminated in consolidation.
A-6
HOME DIRECTOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
BASIS OF PRESENTATION
The accompanying financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. The Company incurred a net loss of
$30,380,781 during the year ended December 31, 2001 and had limited cash
resources at that date. These factors indicate that the Company's continuation
as a going concern at that date was dependent upon its ability to obtain
adequate financing necessary to continue development and growth of its products
and services and to satisfy its obligations. In this regard, management raised
additional financing. (see Note 15 - Subsequent Events).
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States 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 date of the financials
statements and the reported amounts of revenues and expenses during the
reporting period. Significant estimates include the allowance for doubtful
accounts, the allowance for obsolete and slow moving inventory, certain
severance accruals and estimates regarding the recoverability of long lived
assets. Actual results can differ from those estimates.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with an original
or remaining maturity of less than three months at the date of purchase to be
cash equivalents.
INVENTORIES
Inventories consist of finished goods and are stated at the lower of cost or
market. Costs are determined by the weighted average costing method. Inventories
are presented net of valuation allowances of $2,583,200 at December 31, 2001.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Carrying amounts of certain of the Company's financial instruments, including
cash and cash equivalents, accounts receivable and accrued liabilities
approximate fair value because of their short maturities.
A-7
HOME DIRECTOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CREDIT RISK, SIGNIFICANT CUSTOMERS AND CONCENTRATIONS
Financial instruments that potentially subject the Company to credit risk
consist principally of accounts receivable and cash investments. Receivables are
unsecured. The Company provides an allowance for doubtful accounts equal to the
estimated losses expected to be incurred in the collection of accounts
receivable.
Cash and cash equivalents are deposited with high credit quality financial
institutions which invest primarily in U.S. government securities, highly rated
commercial paper and certificates of deposit guaranteed by banks which are
members of the FDIC. Deposits held at banks may at times exceed the amount of
insurance provided. Generally, these deposits may be redeemed upon demand and
therefore bear minimal risk.
The Company relies on a limited number of hardware manufacturers. The inability
of any supplier or manufacturer to fulfill supply requirements of the Company
could materially impact future operating results.
As of December 31, 2001, two customers accounted for 64% and 51% of the accounts
receivable balance and annual revenues, respectively.
LOSS PER SHARE
In accordance with SFAS 128, basic and diluted net loss per common share has
been computed using the weighted-average number of shares of common stock
outstanding during the period.
The effect of convertible preferred stock which is convertible into 8,829,258
shares of the Company's common stock during 2001 and 2000 using the if-converted
method was not included in the computation of diluted net income per share
because the effect would be antidilutive.
The effect of options to purchase 1,379,161 and 1,165,035 shares of the
Company's common stock outstanding during 2001 and 2000, respectively, was not
included in the computation of diluted net income per share because their effect
would be antidilutive.
The effect of warrants to purchase 2,192,241 and 2,099,184 shares of the
Company's common stock outstanding during 2001 and 2000, respectively, was not
included in the computation of diluted net income per share because their effect
would be antidilutive.
A-8
HOME DIRECTOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REVENUE RECOGNITION
The Company generally recognizes product revenue when persuasive evidence of an
arrangement exists, delivery has occurred, fee is fixed or determinable, and
collectibility is probable. The Company accrues for sales returns, rebate
programs and warranty costs based on its experience.
The Company recognizes revenues on installation projects using the percentage of
completion method, based primarily on revenue milestones compared with total
estimated milestones. Changes to total estimated contract costs or losses, if
any, are recognized in the period in which they are determined. Revenues
recognized in excess of amounts billed are classified as current assets under
"Costs and Estimated Earnings in Excess of Billings on Uncompleted Contracts."
Amounts billed in excess of revenues recognized to date are classified as
current liabilities under "Billings in Excess of Costs and Estimated Earnings on
Uncompleted Contracts."
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost and depreciated using the
straight-line method over their estimated useful lives which generally range
from two to five years. Property and equipment includes certain equipment under
capital leases. These items are depreciated over the shorter of the lease period
or the estimated useful life of the equipment.
INTANGIBLE ASSETS
Intangible assets include costs in excess of net assets acquired ("goodwill")
and other purchased intangibles. Goodwill is amortized over period ranging from
seven to ten years. Other intangible assets are amortized ratably over estimated
useful lives ranging from one to eight years.
The carrying amounts of goodwill and intangibles are reviewed if facts and
circumstances suggest that it may be impaired. If this review indicates that
goodwill and intangibles will not be recoverable, as determined based on the
estimated undiscounted cash flows of the entity acquired, the carrying amount of
the goodwill and other intangibles are reduced to their estimated fair value. In
addition, the Company assesses long-lived assets for impairment under FASB
Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of." Under those rules, goodwill associated
with assets acquired in a purchase business combination is included in
impairment evaluations when events or circumstances exist that indicate the
carrying amount of those assets may not be recoverable (see Note 13 -
Restructuring Costs).
RESEARCH AND DEVELOPMENT COSTS
Research and development costs are charged to operations as incurred.
ADVERTISING COSTS
The Company expenses advertising costs as incurred. The amount of advertising
expensed during the years ended December 31, 2001 and 2000 was $56,500 and
$2,810,674, respectively.
A-9
HOME DIRECTOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME TAXES
The Company accounts for income taxes using the liability method which requires
the recognition of deferred tax assets or liabilities for the temporary
differences between the financial reporting and tax basis of the Company's
assets and liabilities and for tax carryforwards at enacted statutory rates in
effect for the years in which the differences are expected to reverse. The
effect on deferred taxes of a change in tax rates is recognized in income in the
period that includes the enactment date. In addition, valuation allowances are
established when necessary to reduce deferred tax assets to the amounts expected
to be realized.
ACCOUNTING FOR STOCK-BASED COMPENSATION
As permitted by Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation" ("SFAS 123"), the Company has elected to account
for its stock-based compensation to employees and outside directors, where
appropriate, under the provisions of Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25") and related
interpretations and amendments. Under APB 25, because the exercise price of the
Company's employee stock options equals the market price of the underlying stock
on the date of grant, no compensation expense is recognized.
RECENT ACCOUNTING PRONOUNCEMENTS
Effective as of the beginning of 2001, the Company adopted SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," as amended,
which requires that derivative instruments be reported on the balance sheet at
fair value. The standard also establishes criteria for designation and
effectiveness of hedging relationships. Due to the absence of derivative
instruments subject to SFAS No. 133, the adoption of the new standard did not
have a material impact on the Company's financial position or results of
operations.
In June 2001, the Financial Accounting Standards Board issued SFAS No. 141,
"Business Combinations" ("SFAS 141") and SFAS No. 142, "Goodwill and Other
Intangible Assets" ("SFAS 142"). SFAS 141 eliminates the pooling of interests
method of accounting for business combinations that were initiated prior to July
1, 2001. SFAS 141 also includes new criteria to recognize intangible assets
separately from goodwill. The requirements of SFAS 141 are effective for any
business combination accounted for by the purchase method that is completed
after June 30, 2001. Under SFAS 142, goodwill and intangible assets with
indefinite lives are no longer amortized but are reviewed annually, or more
frequently if impairment indicators arise, for impairment. Separable intangible
assets that are not deemed to have an indefinite life will continue to be
amortized over their useful lives. The provisions of SFAS 142 requiring
non-amortization of goodwill and indefinite-lived intangible assets apply to
goodwill and indefinite-lived intangible assets acquired after June 30, 2001.
With respect to goodwill and intangible assets acquired prior the July 1, 2001,
the Company is required to adopt SFAS 142 on January 1, 2002. Application of the
non-amortization provisions of the standard is expected to result in an increase
of net loss of approximately $1,175,000 in 2002, in the absence of impairment
write-downs. The Company has not yet performed the required annual impairment
tests on the Company's goodwill and other intangible assets in 2002, thus, the
effect of these tests on the Company's financial position and results of
operations has not yet been determined.
A-10
HOME DIRECTOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In August 2001, the Financial Accounting Standards Board issued SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets," which is
effective for fiscal years beginning after December 15, 2001. This statement
supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to be Disposed Of," and portions of Accounting Principles
Board Opinion No. 30, "Reporting Results of Operations - Reporting the Effects
of Disposal of a Segment of a Business." SFAS 144 provides a single accounting
model for long-lived assets to be disposed of and changes the criteria that
would have to be met in order to classify an asset as held-for-sale. The
provisions of SFAS No. 144 generally are to be applied prospectively.
NOTE 3 - PROPERTY AND EQUIPMENT
Property and equipment consisted of the following at December 31, 2001:
Computer equipment and software $ 565,972 $ 514,612
Furniture and fixtures 206,143 502,840
Office equipment 111,667 84,438
Vehicles - 58,158
Leasehold improvements 82,749 25,437
------------ -----------
966,531 1,185,485
Less accumulated depreciation and amortization (121,762) (573,291)
------------ -----------
$ 844,769 $ 612,194
============ ===========
The net book value of assets acquired under capital leases at December 31, 2001
was $61,742. Amortization of assets recorded under capital leases is included
with depreciation expense.
NOTE 4 - INCOME TAXES
The Company had no income tax expense for the years ended December 31, 2001 and
2000 due to net losses. At December 31, 2001, the Company had federal and state
net operating loss carryforwards of approximately $37,400,000. The federal net
operating loss carryforwards expire beginning in the year 2019 and the state net
operating loss carryforwards begin to expire in 2014. The deferred tax asset of
$21,263,535, relating primarily to differences between book and tax treatment of
net operating losses, was fully reserved as of December 31, 2001. The Company
has established a valuation allowance of $21,263,535 for the year 2001 to reduce
the deferred tax assets due to the uncertainty surrounding the realization of
such assets. The Tax Reform Act of 1986 contains provisions that limit the
ability to utilize net operating loss carryforwards in the case of certain
events including significant changes in ownership interests.
A-11
HOME DIRECTOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4 - INCOME TAXES (CONTINUED)
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's net deferred income taxes are as follows at December 31, 2001:
Deferred tax assets:
Accounts receivable $ 108,282
Inventory 1,019,977
Depreciation 1,546,789
Net operating loss carryforwards 14,789,924
Amortization 2,087,756
Reserves 742,788
Other 968,019
---------------
Deferred tax assets 21,263,535
Less valuation allowance (21,263,535)
---------------
Net deferred taxes $ -
===============
NOTE 5 - NOTES PAYABLE
Notes payable consist of $125,000 remaining on a note payable to an individual
that matured on August 24, 2001 and is in default. The note bears interest at
10% and accrued interest of $21,000 was recorded at December 31, 2001.
NOTE 6 - CAPITAL STOCK
On January 5, 2000, the Company converted all outstanding shares of common stock
into an equal number of shares of Series A convertible preferred stock. On April
10, 2000, the Company declared a 3,333.33-for-one stock split for all common and
preferred shareholders. On May 2, 2002 (see Note 15 - Subsequent Events), the
Company declared a one-for-10 reverse common stock split. All share and per
share information has been retroactively restated to reflect these transactions.
As of December 31, 2001, the Company has authorized 200,000,000, 35,000,000,
100,000,000 and 12,000,000 shares of common stock, Series A convertible
preferred stock, Series B convertible preferred stock and Series C convertible
preferred stock, respectively, each with a par value of $0.001. The Company also
has authorized 3,000,000 shares of preferred stock, which are undesignated, with
a par value of $0.001.
Between May and October 2000, the Company sold 44,959,249 shares of Series B
convertible preferred stock at a price of $1.00 per share, which resulted in net
proceeds of $39,246,254. In connection with this offering, the Company issued
8,991,850 warrants valued at $2,877,392 to purchase the Company's Series B
convertible preferred stock at a price of $1.00 per share to a holder of the
Company's Series A convertible preferred stock who served as a placement agent.
A-12
HOME DIRECTOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6 - CAPITAL STOCK (CONTINUED)
In July 2000, the Company sold 10,000,000 shares of Series C convertible
preferred stock at a price of $1.00 per share, which resulted in net proceeds of
$9,975,000. In connection with this offering, the Company issued 2,000,000
warrants valued at $640,000 to purchase the Company's Series C convertible
preferred stock at a price of $1.00 per share to a holder of the Company's
Series A convertible preferred stock who served as a placement agent. The
Company also entered into an agreement with the sole holder of its Series C
convertible preferred stock which allows the Series C convertible preferred
shareholder ten days in which it may present an offer to acquire the Company,
after any date in which the Company receives an offer to be acquired by means of
a merger, consolidation or other business combination, as defined in the
agreement. The agreement shall terminate upon the consummation of a firm
underwritten public offering of the Company's common stock with gross proceeds
of at least $15,000,000 at a minimum per share price of at least $5.00.
RIGHTS, PREFERENCES AND TERMS OF CAPITAL STOCK
The following is a summary of the rights, preferences and terms of the Company's
outstanding common and preferred stock:
Dividends
The holders of all series of the Company's convertible preferred stock are
entitled to receive non-cumulative dividends, when and if declared by the Board
of Directors. The holders of all series of the Company's convertible preferred
stock shall be entitled to receive dividends on a pro rata, as converted, basis
with common stock dividends when and if declared by the Board of Directors.
Liquidation
In the event of any liquidation, dissolution or winding up of the Company,
holders of Series A, Series B and Series C convertible preferred stock shall be
entitled to receive, on a pro rata basis based on their respective liquidation
values, an amount equal to $0.06, $1.00 and $1.00 per share, respectively, plus
any accrued and unpaid dividends. After all payments have been made to holders
of the Company's convertible preferred stock, any remaining assets will be
distributed on a pro rata basis to the holders of common stock. If the assets
and funds of the Company are insufficient to pay the holders of Series A, Series
B and Series C convertible preferred stock the full amount, then all assets and
funds shall be distributed ratably among the holders of all preferred holders on
a pro rata basis.
Conversion
Each share of Series A, Series B and Series C convertible preferred stock, at
the option of the holder, is convertible into shares of common stock of the
Company at a ten to one ratio, subject to certain adjustments as defined.
Conversion is automatic for holders of Series A convertible preferred stock upon
the consummation of a firm underwritten public offering of the Company's common
stock. Conversion is automatic for holders of Series B and Series C convertible
preferred stock upon the consummation of a firm underwritten public offering of
the Company's common stock with gross proceeds of at least $15,000,000 at a
minimum per share price of at least $5.00.
A-13
HOME DIRECTOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6 - CAPITAL STOCK (CONTINUED)
Voting
Each holder of Series A, Series B and Series C convertible preferred stock is
entitled to the number of votes equal to the number of whole shares of common
stock into which the preferred shares are convertible.
NOTE 7 - STOCK-BASED COMPENSATION
In December 1999, the Board of Directors approved the Home Director, Inc. 1999
Stock Incentive Plan (the "Plan"). The Company has reserved a total of 2,500,000
shares of common stock for issuance under the Plan. The Plan permits the
granting of incentive stock options, nonqualified stock options and stock
appreciation rights. The terms of stock option grants are determined by the
Board of Directors. The Company's stock options generally vest over three years
and have a maximum life of ten years. Separate from the Plan, the Company has
granted stock options and warrants to consultants as compensation for their
consulting services; for this purpose, the Company has reserved an additional
55,000 shares of common stock. Shares available for future issuance under the
Plan and shares available as compensation for consultants total 1,087,977 at
December 31, 2001.
The following summarizes the stock option activity for the years ended December
31, 2001 and 2000:
WEIGHTED
AVERAGE
OPTIONS EXERCISE
OUTSTANDING PRICE
---------------------
Balance at December 31, 1999 - $ -
Granted (exercise price = fair value) 1,333,638 1.20
Granted (exercise price > fair value) 7,500 10.00
Exercised (90,282) 0.20
Canceled (85,821) 0.50
--------------------
Balance at December 31, 2000 1,165,035 1.40
Granted (exercise price = fair value) 658,723 6.60
Granted (exercise price > fair value) 98,500 8.30
Exercised (49,632) 0.50
Canceled (493,465) 4.20
--------------------
Balance at December 31, 2001 1,379,161 $ 3.40
====================
In connection with the Company's acquisition of DI on January 25, 2001, the
Company issued 121,835 stock options, each having an exercise price of $10.00
per share, in exchange for the outstanding stock options of DI. The fair value
of these exchanged stock options was $731,000 as of January 25, 2001.
During the years ended December 31, 2001 and 2000, the Company recorded non-cash
compensation expense of $500,323 and $5,385, respectively, for the fair value of
stock options granted to consultants. This expense, which equates to per share
amounts of $5.10 and $0.70 for the years ended December 31, 2001 and 2000,
respectively, was computed using the Black-Scholes option-pricing model or, if
appropriate, using the actual value of the services rendered. The following
weighted-average assumptions were used in this model: expected dividend yield
0%, risk-free interest rate 4.9%, expected life of 5.9 years and stock price
volatility of 90%. As of December 31, 2001 and 2000, the related amount of
deferred compensation was $218,943 and $0, respectively.
A-14
HOME DIRECTOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7 - STOCK-BASED COMPENSATION (CONTINUED)
During the year ended December 31, 2001, the Company recorded an additional
non-cash compensation expense of $1,811,808 for the fair value of stock option
amendments for certain terminating employees to extend the life of the stock
options; inasmuch as this expense was incurred in connection with the
restructuring discussed in Note 13, it is reported on the Statement of
Operations under Restructuring Charges. This expense, which equates to $5.90
per share, was computed using the Black-Scholes option-pricing model. The
following weighted-average assumptions were used in this model: expected
dividend yield 0%, risk-free interest rate 4.3%, expected life of 5.3 years and
stock price volatility of 90%.
Pro forma information regarding net loss is also required by SFAS 123 and has
been determined as if the Company had accounted for all of its employee stock
options under the fair value method of that Statement. The Company computes fair
value for this purpose using the minimum value option-pricing model. The
weighted-average assumptions used in this model to estimate fair value and the
resulting values are as follows:
2001 2000
-------------------------------
Expected dividend yield 0.0% 0.0%
Risk-free interest rate 4.2% 6.6%
Expected life (in years) 3.0 4.0
Weighted-average fair value per share $ 0.80 $ 0.30
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. The Company's pro
forma information is as follows:
YEAR ENDED DECEMBER 31,
2001 2000
-----------------------------
Net loss as reported (in thousands) $ (30,381) $ (31,672)
Pro forma net loss (in thousands) $ (30,567) $ (31,729)
Selected information regarding stock options as of December 31, 2001 follows:
WEIGHTED-
NUMBER OF AVERAGE NUMBER OF
EXERCISE OPTIONS REMAINING OPTIONS
PRICES OUTSTANDING LIFE EXERCISABLE
- ------------------------------------------------
0.20 666,690 7.5 525,973
2.20 268,100 9.7 86,071
2.50 40,000 4.4 40,000
4.50 43,500 9.0 30,666
10.00 308,871 8.4 169,635
12.50 52,000 6.0 2,000
----------- ------------
1,379,161 8.0 854,345
=========== ============
A-15
HOME DIRECTOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8 - COMMON STOCK RESERVED FOR FUTURE ISSUANCE
At December 31, 2001, the Company had reserved a total of 13,488,637 of its
authorized 200,000,000 shares of common stock for future issuance as follows:
For conversion of Series A Convertible Preferred Stock 3,333,333
For conversion of Series B Convertible Preferred Stock 4,495,925
For conversion of Series C Convertible Preferred Stock 1,000,000
Outstanding preferred stock warrants 1,099,185
Outstanding common stock warrants 1,093,056
Outstanding stock options 1,379,161
Possible future issuance under stock option plans 1,087,977
------------
13,488,637
============
NOTE 9 - LEASES
The Company leases certain furniture and equipment under various non-cancelable
capital leases and its office space and certain equipment under non-cancelable
operating leases. Future minimum payments under the non-cancelable capital and
operating leases at December 31, 2001 are as follows:
CAPITAL OPERATING
LEASES LEASES
============================
2001 $ 163,696 $ 93,480
2002 123,977 67,877
2003 14,156 -
----------------------------
Total minimum payments 301,829 $ 161,357
============
Less amounts representing interest (26,374)
--------------
Present value of minimum lease payments 275,455
Less current portion of capital lease obligations (142,656)
--------------
Long-term portion of capital lease obligations $ 132,799
==============
Rent expense during the year ended December 31, 2001 was $720,374.
A-16
HOME DIRECTOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10 - RELATED PARTY TRANSACTIONS
Affiliate advances and payables
Included in payables to affiliates and employees at December 31, 2001 is
$1,430,192, which represents amounts owed to a certain shareholder for the net
book value of certain inventory transferred to the Company in connection with
the acquisition of a certain shareholder's Home Director business unit. The
amounts due to the shareholder are collateralized by certain inventory of the
Company. The Company is required to remit monthly payments to a certain
shareholder for the amount of inventory sold by the Company in the preceding
month. Any remaining amounts outstanding were due in full in June 2001 and the
amount due is now in default. The Company did not remit any payments to the
shareholder based on inventory sold during the year ended December 31, 2001.
During the year ended December 31, 2001, a certain shareholder provided the
Company with certain information technology, financial consulting and support
services (including office space). Additionally, a certain shareholder paid
certain operating expenses on behalf of the Company. The Company repaid this
shareholder $180,443 during the year ended December 31, 2001 for operating
expenses.
Included in payables to affiliates and employees at December 31, 2001 is
$150,000, which represents amounts owed to a certain employee for the
acquisition of Los Gatos. The Company is required to remit the entire amount due
plus accrued interest in May 2002.
Research and development contract
During the year ended December 31, 2000, the Company entered into a two-year
technical services agreement with a holder of the Company's Series B convertible
preferred stock, whereby the shareholder would perform certain research and
development activities. Under the terms of the agreement, the research and
development activities would be provided over a two-year period in exchange for
cash of $5,000,000 and warrants to purchase 999,999 shares of the Company's
common stock at a price of $12.50 per share (valued at $235,410 using the
Black-Scholes pricing model). During the year ended December 31, 2000, the
Company recorded research and development expenses of $5,235,410 related to this
contract.
Placement and other fees
An affiliate of a holder of the Company's Series A convertible preferred stock
served as a placement agent for the Company's sale of Series B and Series C
convertible preferred stock. In exchange for these services, the affiliate of
the shareholder received a total of 10,991,850 warrants to purchase the
Company's Series B and Series C convertible preferred stock (see Note 6) and
cash fees of $4,495,925. In connection with the DI acquisition, the placement
agent received warrants to purchase an additional 93,057 shares of common stock.
Various shareholders and directors have provided services to the Company for
compensation of $549,748 for the year ending December 31, 2001. These amounts
were recorded as general and administrative expenses in the statement of
operations.
A-17
HOME DIRECTOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 11 - EMPLOYEE BENEFIT PLAN
The Company has a 401(k) Plan (the "401(k) Plan") which covers substantially all
employees. Employees may elect to contribute up to 15% of eligible compensation
during any 401(k) Plan year subject to IRS limits. Matching contributions to the
401(k) Plan are made at the discretion of the Board of Directors. Through
December 31, 2001, the Company has not made any matching contributions to the
401(k) Plan.
NOTE 12 - IMPAIRMENT OF LONG LIVED ASSETS
During the year ended December 31, 2001, the Company substantially reduced its
number of employees, exited certain facilities, reduced overall expenses, had
limited access to cash to fund operations and/or experienced other significant
changes in its business, which indicated potential impairment of its recorded
property and equipment, goodwill and related intangible values from current year
(see Note 1) and prior year acquisitions. The Company determined that certain
property and equipment and intangible assets were no longer in use and that
recorded goodwill and certain other intangible assets had become fully and
permanently impaired. This decision was based on an analysis of the estimated
undiscounted future cash flows of the associated operations. Accordingly, an
impairment loss of $8,590,051 was recorded and is included in the consolidated
statements of operations as impairment of long-lived assets. Property and
equipment, goodwill and intangible amounts and the associated accumulated
amortization were written off in conjunction with the impairment.
2000 2001
------------------------------------
Goodwill $ - $ 5,799,084
Assembled workforce 190,000 1,368,965
Customer lists - 383,309
Other Intangibles - 295,906
Property and Equipment 1,293,442 742,787
------------------------------------
$ 1,483,442 $ 8,590,051
====================================
NOTE 13 - RESTRUCTURING COSTS
During 2001, the Company recorded $4,701,233 of restructuring charges associated
with the its decision to reduce its headcount and reduce its overall facilities.
The charges were recognized in accordance with EITF 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)." The amounts recorded
consist primarily of the costs associated with future obligations on
non-cancelable leases for exited facilities and employee severance cost for 164
employees.
As of December 31, 2001, the following amounts were recorded:
WRITE-OFFS/
PAYMENTS IN BALANCE AT
ACCRUALS 2001 DECEMBER 31, 2001
--------------------------------------------------
Severance cost $ 3,887,900 $ 2,878,170 $ 1,009,730
Future lease obligations 813,333 - 813,333
--------------------------------------------------
Totals $ 4,701,233 $ 2,878,170 $ 1,823,063
==================================================
Unpaid amounts at December 31, 2001 related to the restructurings are included
in accrued expenses in the Company's balance sheet.
A-18
HOME DIRECTOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 14 - CONTINGENCIES
The Company is subject to various legal proceedings and claims, which have
arisen in the ordinary course of its business and have not been fully
adjudicated. It is impossible at this time for the Company to predict with any
certainty the outcome of such litigation. However, management is of the
opinion, based upon information presently available, that it is unlikely that
any such liability, to the extent not provided for through insurance or
otherwise, would be material in relation to the Company's consolidated financial
position or results of operations.
On June 18, 2001, Point West Ventures, LP ("Point West") filed a complaint
against the Company and Spencer Trask Ventures, Inc., the placement agent for
the Company's Series B convertible preferred stock financing. Point West, one of
the investors in that financing, has alleged misrepresentation in connection
with that financing and is seeking rescission of its $500,000 investment. As of
February 11, 2002, Point West is in receivership and, although the receiver may
wish to pursue this action at a later date, the proceedings have been stayed.
On January 30, 2002, a lawsuit for $1.9 million was brought against the Company
for lack of payment on leased property for its abandoned lease located in North
Carolina. The Company obtained a conditional acceptance from the plaintiff to
dismiss the case for a payment of $139,481 and the issuance of 800,000 in
warrants to be received no later than April 30, 2002. The conditional acceptance
states that if Company does not issue the warrants or make the payment by April
30, 2002, the legal proceedings will be reinstated for the full amount of the
initial claim. The Company has accrued the amount due under the conditional
acceptance at December 31, 2001.
NOTE 15 - SUBSEQUENT EVENTS
Agreement and Plan of Merger
On April 9, 2002, the Company executed an Agreement and Plan of Merger with
Netword, Inc. and a wholly owned subsidiary of Netword, Inc. The merger is
contingent upon a number of conditions, including a private placement offering
of at least $4.0 million of the Company's securities and a reduction in
outstanding liabilities. As of July 26, 2002, the Company had sold
approximately $7.1 million of its convertible notes and extinguished
approximately $7.0 million in outstanding liabilities. The Company expects the
remaining contingencies to be residual and anticipates closing the merger by
November 30, 2002. In related transactions, the Company received investments,
totaling $705,000, for exchangeable notes with warrants to purchase up to
1,007,142 shares of the Company's common stock. The exchangeable notes were
exchanged for convertible notes upon the first closing of the private placement.
Restructuring of Outstanding Obligations
In 2002, the Company entered into negotiated agreements with certain of its
vendors and others to settle outstanding liabilities at amounts less than the
original amounts owed. Management is in the process of further negotiations to
attempt to settle certain other outstanding obligations. As of July 26, 2002,
the Company had settled $7.0 million in outstanding liabilities for total
payments of $2.3 million, including the issuance of 800,000 common stock
warrants. The settlement included amounts due under the conditional acceptance
reference in note 14.
Stock Split
On April 1, 2002, the Board of Directors approved a one-for-10 reverse common
stock split which was subsequently approved by stockholders as of May 2, 2002.
An amendment to the Company's Certificate of Incorporation effecting the stock
split was filed with the State of Delaware on May 2, 2002. All common share and
per common share amounts for all periods presented in the accompanying financial
statements have been restated to reflect the effect of this common stock split.
A-19
HOME DIRECTOR, INC.
CONSOLIDATED BALANCE SHEETS
UNAUDITED CONDENSED FINANCIAL STATEMENTS OF HOME DIRECTOR TECHNOLOGIES, INC.
(FORMERLY HOME DIRECTOR, INC.)
FOR THE NINE MOTHS ENDED SEPTEMBER 30, 2002.
SEPTEMBER 30,
2002 DECEMBER 31,
(UNAUDITED) 2001
-------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 2,247,369 $ 563,046
Accounts receivable, net of allowance of $362,300 and $274,200, respectively 1,560,379 1,105,393
Costs and estimated earnings in excess of billings on uncompleted contracts 193,335 134,765
Inventories, net of allowance of $2,048,400 and $2,583,200, respectively 976,626 1,234,318
Deferred merger costs 996,300 -
Other current assets 143,908 271,756
-------------------------
Total current assets 6,117,917 3,309,278
Property and equipment 434,174 612,194
Business process, net of accumulated amortization of $12,624 and $8,530,
respectively - 4,094
Customer lists, net of accumulated amortization of $643,110 and $387,191,
respectively 114,286 370,205
Assembled workforce, net of accumulated amortization of $369,551 and
$222,293, respectively 76,875 224,133
Goodwill 5,601,520 5,601,520
-------------------------
Total assets $ 12,344,772 $10,121,424
=========================
A-20
SEPTEMBER 30,
2002 DECEMBER 31,
(UNAUDITED) 2001
-----------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable and accrued expenses $ 2,103,061 $ 7,450,500
Billings in excess of costs and estimated earnings on uncompleted contracts 45,022 164,348
Payables to affiliate and employees - 1,580,192
Notes payable - 125,000
Convertible notes, net of $107,209 in discounts 8,893,132 -
Current portion of capital lease obligations 42,407 142,656
-----------------------------
Total current liabilities 11,083,622 9,462,696
Capital lease obligations, less current portion 20,848 132,799
Shareholders' equity:
Common Stock, $0.001 par value; 200,000,000 shares authorized;
1,446,378 and 1,123,372 shares issued and outstanding as of
September 30, 2002 and December 31, 2001, respectively 1,446 1,123
Series A Convertible Preferred Stock, $0.001 par value; 35,000,000
shares authorized; 33,333,334 shares issued and outstanding as of
September 30, 2002 and December 31, 2001 (aggregate liquidation
preference of $2,000,000) 33,333 33,333
Series B Convertible Preferred Stock, $0.001 par value; 100,000,000
shares authorized; 44,959,249 shares issued and outstanding as of
September 30, 2002 and December 31, 2001 (aggregate liquidation
preference of $44,959,249) 44,959 44,959
Series C Convertible Preferred Stock, $0.001 par value; 12,000,000
shares authorized; 10,000,000 shares issued and outstanding as of
September 30, 2002 and December 31, 2001 (aggregate liquidation
preference of $10,000,000) 10,000 10,000
Additional paid-in capital 60,755,879 60,107,185
Warrants - Preferred Stock and Common Stock 6,230,578 4,970,135
Accumulated deficit (65,835,893) (64,640,806)
-----------------------------
Total shareholders' equity 1,240,302 525,929
-----------------------------
Total liabilities and shareholders' equity $ 12,344,772 $ 10,121,424
==============================
See accompanying notes.
A-21
HOME DIRECTOR, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS
ENDED SEPTEMBER 30,
---------------------------
2002 2001
---------------------------
Revenues $ 2,656,452 $ 3,916,497
Operating expenses:
Cost of revenues 1,596,271 2,046,209
General and administrative 673,708 1,179,581
Sales and marketing 689,217 1,011,740
Research and development 183,757 1,880,448
Restructuring charges - 115,955
Depreciation and amortization 142,759 721,548
---------------------------
Loss from operations (629,260) (3,038,984)
Interest and other (expense) income (2,127,433) 33,376
---------------------------
Net loss before extraordinary gain (2,756,693) (3,005,608)
Extraordinary (loss) gain from extinguishment of certain liabilities (137,170) -
---------------------------
Net loss (2,893,863) (3,005,608)
---------------------------
NET LOSS PER COMMON SHARE - BASIC AND DILUTED:
Net loss before extraordinary gain $ (1.91) $ (2.68)
Extraordinary (loss) gain from extinguishment of certain liabilities (0.09) -
---------------------------
Net loss $ (2.00) $ (2.68)
===========================
Shares used in computing basic and diluted net loss per common share 1,446,378 1,120,123
===========================
See accompanying notes.
A-22
HOME DIRECTOR, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
NINE MONTHS
ENDED SEPTEMBER 30,
---------------------------
2002 2001
---------------------------
Revenues $ 8,004,434 $ 10,593,328
Operating expenses
Cost of revenues 5,209,430 6,015,243
General and administrative 2,495,677 3,939,665
Sales and marketing 1,856,597 4,490,429
Research and development 545,594 5,011,302
Restructuring charges - 3,141,701
Depreciation and amortization 608,732 2,045,198
---------------------------
Loss from operations (2,711,596) (14,050,210)
Interest and other (expense) income (3,006,734) 118,003
---------------------------
Net loss before extraordinary gain (5,718,330) (13,932,207)
Extraordinary gain from extinguishment of certain liabilities 4,523,243 -
---------------------------
Net loss (1,195,087) (13,932,207)
---------------------------
NET LOSS PER COMMON SHARE - BASIC AND DILUTED:
Net loss before extraordinary gain $ (4.39) $ (13.69)
Extraordinary gain from extinguishment of certain liabilities 3.47 -
---------------------------
Net loss $ (0.92) $ (13.69)
===========================
Shares used in computing basic and diluted net loss per common share 1,302,703 1,017,881
===========================
See accompanying notes.
A-23
HOME DIRECTOR, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
SERIES A SERIES B SERIES C
COMMON STOCK PREFERRED STOCK PREFERRED STOCK PREFERRED STOCK
--------------------------------------------------------------------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
--------------------------------------------------------------------------------
Balance at December 31, 2000 90,282 $ 90 33,333,334 $33,333 44,959,249 $44,959 10,000,000 $10,000
Exercise of common stock options 49,632 50 - - - - - -
Issuance of common stock in
connection with acquisitions 983,458 983 - - - - - -
Issuance of stock options in
connection with acquisitions - - - - - - - -
Issuance of common stock warrants in
connection with acquisition - - - - - - - -
Issuance of common stock warrants
for consulting services, less deferred
compensation of $218,943 - - - - - - - -
Acceleration of vesting of certain
stock options - - - - - - - -
Net loss - - - - - - - -
----------------------------------------------------------------------------------
Balance at December 31, 2001 1,123,372 1,123 33,333,334 33,333 44,959,249 44,959 10,000,000 10,000
Exercise of common stock options
and warrants 323,006 323 - - - - - -
Issuance of common stock warrants in
connection with issuance of
convertible debt - - - - - - - -
Issuance of common stock warrants to
non-employees - - - - - - - -
Beneficial conversion for convertible
debt - - - - - - - -
Compensation related to consulting
services - - - - - - - -
Net loss - - - - - - - -
Balance at September 30, 2002
----------------------------------------------------------------------------------
(Unaudited) 1,446,378 $ 1,446 33,333,334 $33,333 44,959,249 $44,959 10,000,000 $10,000
==================================================================================
TOTAL
ADDITIONAL SHAREHOLDERS'
PAID-IN ACCUMULATED EQUITY
CAPITAL WARRANTS DEFICIT (DEFICIT)
------------------------------------------------------------
Balance at December 31, 2000 $47,705,900 $3,758,188 $(34,260,025) $ 17,292,445
Exercise of common stock options 24,875 - - 24,925
Issuance of common stock in
connection with acquisitions 9,833,602 - - 9,834,585
Issuance of stock options in
connection with acquisitions 731,000 - - 731,000
Issuance of common stock warrants in
connection with acquisition - 930,567 - 930,567
Issuance of common stock warrants
for consulting services, less deferred
compensation of $218,943 - 281,380 - 281,380
Acceleration of vesting of certain
stock options 1,811,808 - - 1,811,808
Net loss - - (30,380,781) (30,380,781)
------------------------------------------------------------
Balance at December 31, 2001 60,107,185 4,970,135 (64,640,806) 525,929
Exercise of common stock options
and warrants 418,213 (385,100) - 33,436
Issuance of common stock warrants in
connection with issuance of
convertible debt - 244,568 - 244,568
Issuance of common stock warrants to
non-employees - 1,182,032 - 1,182,032
Beneficial conversion for convertible
debt 230,481 - - 230,481
Compensation related to consulting
services - 218,943 - 218,943
Net loss - - (1,195,087) (1,195,087)
------------------------------------------------------------
Balance at September 30, 2002
(Unaudited) $60,755,879 $6,230,578 $(65,835,893) $ 1,240,302
============================================================
See accompanying notes.
A-24
HOME DIRECTOR, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS
ENDED SEPTEMBER 30,
-----------------------------
2002 2001
-----------------------------
OPERATING ACTIVITIES
Net loss $(1,195,087) $(13,932,207)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization 608,732 2,045,198
Gain from extinguishment of certain liabilities (4,523,243) -
Change in accounts receivable allowance 88,100 (170,179)
Change in inventory allowance (534,800) 1,336,608
Noncash expenses from warrant issuances and accelerated stock
option vesting 235,677 2,093,188
Interest expense on debt discount and amortization of deferred
financing fees 2,779,014 -
Change in operating assets and liabilities:
Accounts receivable and costs and estimated earnings in excess
of billings (601,656) 991,850
Inventories 792,492 137,500
Other assets 127,848 190,804
Accounts payable, accrued expenses and other liabilities (2,648,714) (4,481,407)
-----------------------------
Net cash used in operating activities (4,871,637) (11,788,645)
INVESTING ACTIVITIES
Purchases of property and equipment (23,441) (328,491)
Change in restricted certificates of deposit - 142,232
Increase in deferred merger costs (996,300) -
Acquisitions of companies - (3,178,015)
-----------------------------
Net cash used in investing activities (1,019,741) (3,364,274)
FINANCING ACTIVITIES
Repayment of capital lease obligations, net (212,200) (78,222)
Repayment of payables to affiliates - -
Proceeds from issuance of common stock 33,436 24,925
Proceeds from issuance of convertible notes, net 9,000,341 -
Debt financing costs (1,245,876) -
-----------------------------
Net cash provided by financing activities 7,575,701 (53,297)
------------ -------------
Net increase (decrease) in cash and cash equivalents 1,684,323 (15,206,216)
Cash and cash equivalents at beginning of period 563,046 16,787,161
-----------------------------
Cash and cash equivalents at end of period $ 2,247,369 $ 1,580,945
=============================
SUPPLEMENTAL DISCLOSURES
Cash paid for interest $ 11,250 $ 15,747
NONCASH INVESTING AND FINANCING ACTIVITIES
Capital lease obligation incurred $ - $ 108,889
Purchase of Digital Interiors and Los Gatos Home Theater for stock
and note $ - $ 11,646,152
See accompanying notes.
A-25
HOME DIRECTOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION AND DESCRIPTION OF THE BUSINESS
Home Director, Inc. (the "Company") was incorporated on October 13, 1999 under
the laws of the State of Delaware. The Company, which is headquartered in
Livermore, California, commenced operations on December 8, 1999, subsequent to
acquiring the assets of and assuming certain liabilities of IBM Corporation's
Home Director business unit.
The Company operates in a single industry, the provision of infrastructure
components for home networking, and is engaged in the design, sale and
installation of home networking products and services for the new home
construction market.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of Home
Director, Inc. and its wholly owned subsidiary, Digital Interiors, Inc. All
significant intercompany accounts and transactions have been eliminated in
consolidation.
Unaudited Interim Financial Statements
The accompanying unaudited interim financial statements have been prepared in
accordance with generally accepted accounting principles and applicable
Securities and Exchange Commission (SEC) regulations for interim financial
information. These financial statements are unaudited and, in the opinion of
management, include all adjustments necessary to present fairly the balance
sheets, statements of operations and statements of cash flows for the periods
presented in accordance with accounting principles generally accepted in the
United States. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to SEC rules and regulations.
Operating results for the nine months ended September 30, 2002 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2002. These financial statements and notes should be read in
conjunction with the financial statements and notes thereto for the year ended
December 31, 2001 included elsewhere in this 8-K.
The balance sheet at December 31, 2001 has been derived from the audited
consolidated financial statements of the Company.
The accompanying financial statements have been adjusted retroactively to
reflect a one-for-10 reverse stock split, which was effective on May 2, 2002.
Basis of Presentation
The accompanying financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. The Company has incurred
significant operating losses since inception and has limited cash resources.
These factors indicate that the Company's continuation as a going concern is
dependent upon its ability to obtain adequate financing necessary to continue
development and growth of its products and services, to satisfy its obligations
and ultimately attain profitability. In this regard, management has raised
additional financing during the nine months ended September 30, 2002 (see Note 6
- - Debt Issuances) and has entered into a merger agreement with Netword, Inc.
(see Note 5 - Merger). However, there can be no assurances that management will
continue to be successful in executing its plan to improve its operating results
or that the Company can continue to raise additional capital should the need
arise.
A-26
HOME DIRECTOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION AND DESCRIPTION OF THE BUSINESS (CONTINUED)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States 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 date of the financials
statements and the reported amounts of revenues and expenses during the
reporting period. Significant estimates include the allowance for doubtful
accounts, the allowance for obsolete and slow moving inventory, certain
severance accruals, certain contingency accruals and estimates regarding the
recoverability of long lived assets. Actual results can differ from those
estimates.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with an original
or remaining maturity of less than three months at the date of purchase to be
cash equivalents.
INVENTORIES
Inventories consist of finished goods and are stated at the lower of cost or
market. Costs are determined by the weighted average costing method. Inventories
are presented net of valuation allowances of $2,048,390 and $2,583,200 at
September 30, 2002 and December 31, 2001, respectively.
SIGNIFICANT CUSTOMERS AND CONCENTRATIONS
The Company relies on a limited number of hardware manufacturers. The inability
of any supplier or manufacturer to fulfill supply requirements of the Company
could materially impact future operating results.
As of September 30, 2002, two customers accounted for 48% and 51% of the
accounts receivable balance and nine months revenues, respectively. As of
December 31, 2001, two customers accounted for 64% and 51% of the accounts
receivable balance and annual revenues, respectively.
A-27
HOME DIRECTOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION AND DESCRIPTION OF THE BUSINESS (CONTINUED)
REVENUE RECOGNITION
The Company generally recognizes product revenue when persuasive evidence of an
arrangement exists, delivery has occurred, fee is fixed or determinable, and
collectibility is probable. The Company accrues for sales returns, rebate
programs and warranty costs based on its experience.
The Company recognizes revenues on installation projects using the percentage of
completion method, based primarily on revenue milestones compared with total
estimated milestones. Changes to total estimated contract costs or losses, if
any, are recognized in the period in which they are determined. Revenues
recognized in excess of amounts billed are classified as current assets under
"Costs and Estimated Earnings in Excess of Billings on Uncompleted Contracts".
Amounts billed in excess of revenues recognized to date are classified as
current liabilities under "Billings in Excess of Costs and Estimated Earnings on
Uncompleted Contracts."
NOTE 2 - RECENT ACCOUNTING PRONOUNCEMENTS
On January 1, 2002, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." As such, all
goodwill and indefinite-lived intangible assets are no longer amortized but
reviewed at least annually for impairment. Other intangible assets continue to
be amortized over their useful lives.
As of September 30, 2002, the Company had approximately $5,601,520 of goodwill.
The Company has concluded its "Step I" testing as required by SFAS 142. The
results of these tests did not indicate additional impairment of the Company's
recorded goodwill. Through December 31, 2001, goodwill was amortized on a
straight-line basis over periods from seven to 10 years. The following is a
summary of reported net loss and net loss per share, as adjusted to exclude
goodwill and indefinite intangible assets amortization expense:
NINE MONTHS
ENDED
SEPTEMBER 30, 2001
(UNAUDITED)
-------------------
Net loss $ (13,932,207)
Add: goodwill amortization 1,241,130
Less: income tax benefit -
-------------------
Adjusted net loss $ (12,691,077)
===================
Adjusted net loss per share:
Basic and Diluted $ (12.47)
===================
Shares used in computing
adjusted net loss per share -
Basic and Diluted 1,017,881
===================
A-28
HOME DIRECTOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 2 - RECENT ACCOUNTING PRONOUNCEMENTS
Amortization expense associated with identifiable intangible assets was $407,272
and $463,510 for the nine months ended September 30, 2002 and 2001,
respectively.
Estimated amortization expense for existing identifiable intangible assets is
approximately $461,800 and $43,596 per year for the years ending December 31,
2002 and 2003, respectively. Estimated amortization expense will be affected by
various factors including possible future acquisitions.
In July 2002, the Financial Accounting Standards Board issued SFAS No. 146,
Accounting for Costs Associated with Exit or Disposal Activities, which is
effective for fiscal years beginning after December 15, 2002, with earlier
application encouraged. This Statement addresses financial accounting and
reporting for costs associated with exit or disposal activities and nullifies
Emerging Issues Task Force ("EITF") Issue No. 94-3, Liability Recognition for
Certain Employee Termination Benefits and Other costs to exit an Activity
(including Certain Costs Incurred in a Restructuring). The provisions of SFAS
No. 146 are to be applied prospectively from the date of adoption. The Company
has not yet assessed any potential impact the issuance of this standard may have
on its financial position or future results of operations.
In April 2002, the Financial Accounting Standards Board issued SFAS No. 145,
Rescission of FASB Statements No. 4, 44, and 65, Amendment of FASB Statement No.
13, and Technical Corrections, effective for fiscal years beginning after May
15, 2002. SFAS No. 145 rescinds SFAS No. 4, Reporting Gains and Losses from
Extinguishment of Debt, and an amendment of that Statement, SFAS No. 64,
Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements. The statement
will require gains or losses from extinguishment of debt to be classified as
operating items, as opposed to extraordinary items, unless they meet the more
stringent criteria of APB No. 30. The statement requires retroactive
reclassification for comparative financial statements issued after adoption.
The Company will begin applying SFAS No. 145 as of the beginning of its December
31, 2003 year and will reclass the $4.5 million in extraordinary gain from
extinguishment of certain liabilities to operating income in its comparative
financial statements issued after adoption. This reclassification will not have
an impact on previously reported net income.
NOTE 3 - INCOME TAXES
At December 31, 2001, the Company had federal and state net operating loss
carryforwards of approximately $37,400,000 and had recorded a valuation
allowance of $21,263,535 to fully offset the net deferred tax asset position of
the company as of December 31, 2001, due to the uncertainty surrounding the
realization of such assets. Accordingly, the Company has not recorded any
income tax expense or benefit as a result of the substantial net operating loss
carryforwards, which are fully reserved by a valuation allowance. The Tax
Reform Act of 1986 contains provisions that limit the ability to utilize net
operating loss carryforwards in the case of certain events including significant
changes in ownership interests.
A-29
HOME DIRECTOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 4 - CAPITAL STOCK
As of September 30, 2002, the Company has authorized 200,000,000, 35,000,000,
100,000,000 and 12,000,000 shares of common stock, Series A convertible
preferred stock, Series B convertible preferred stock and Series C convertible
preferred stock, respectively, each with a par value of $0.001. The Company also
has authorized 3,000,000 shares of preferred stock, which are undesignated, with
a par value of $0.001.
During the nine months ended September 30, 2002, 273,007 options and 50,000
warrants were exercised for total proceeds of $33,436. During the nine months
ended September 30, 2002, the Company granted to employees 730,000 options to
acquire company stock at an exercise price of $0.10 per share.
In connection with the issuance of the exchangeable and convertible notes (see
Note 9), the Company issued 1,007,143 warrants to purchase common stock at $0.70
per share and 200,000 warrants to purchase common stock at $0.10 per share. The
Company also issued 14,707,482 warrants to an affiliate of a shareholder as
placements fees related to the convertible notes (see Note 5).
Common Stock Reserved for Future Issuance
At September 30, 2002, the Company had reserved a total of 140,265,854 of its
authorized 200,000,000 shares of common stock for future issuance as follows:
For conversion of Series A Convertible Preferred Stock 3,333,333
For conversion of Series B Convertible Preferred Stock 14,184,782
For conversion of Series C Convertible Preferred Stock 3,155,031
Outstanding preferred stock warrants 3,467,963
Outstanding common stock warrants 19,721,167
For conversion of convertible notes 92,817,166
Outstanding stock options 1,519,119
Possible future issuance under stock option plans 567,293
For earn-out shares related to DI acquisition 1,500,000
-------------
140,265,854
=============
The above table includes management's estimate of the impact of anti-dilution
features of preferred stock resulting from the merger with Netword, Inc.
NOTE 5 - RELATED PARTY TRANSACTIONS
Affiliate advances and payables
Included in payables to affiliates and employees at December 31, 2001 is
$1,430,192, which represents amounts owed to a certain shareholder for the net
book value of certain inventory transferred to the Company in connection with
the acquisition of a certain shareholder's Home Director business unit. In
connection with the company's liability restructuring (Note 7), the Company paid
$615,142 to this affiliate during 2002 in satisfaction of this liability, with
the difference of $815,050 recorded as an extraordinary gain.
A-30
HOME DIRECTOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 5 - RELATED PARTY TRANSACTIONS (CONTINUED)
During the year ended December 31, 2001, a certain shareholder provided the
Company with certain information technology, financial consulting and support
services (including office space). Additionally, a certain shareholder paid
certain operating expenses on behalf of the Company. The Company repaid this
shareholder $180,443 during the year ended December 31, 2001 for operating
expenses.
Included in payables to affiliates and employees at December 31, 2001 is
$150,000, which represents amounts owed to a certain employee for the
acquisition of Los Gatos Home Theater. The Company repaid the entire amount due
plus accrued interest in May 2002.
Placement and other fees
An affiliate of a holder of the Company's Series A convertible preferred stock
served as a placement agent for the Company's sale of exchangeable notes and
convertible notes. In exchange for these services, the affiliate of the
shareholder received a total of 14,707,482 warrants to purchase the Company's
common stock (see Note 4) and cash fees of $948,906.
A-31
HOME DIRECTOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 6 - NET LOSS PER SHARE
In accordance with Statement of Financial Accounting Standards No. 128 "Earnings
Per Share", basic and diluted net loss per common share has been computed using
the weighted-average number of shares of common stock outstanding during the
period.
The potentially dilutive effect of the Company's common stock equivalents has
not been included in the computation of diluted net loss per share because the
effects would be antidilutive on net loss before extraordinary gain per share
for all periods presented. Potentially dilutive securities outstanding convert
to common share equivalents as follows:
SEPTEMBER 30,
----------------------------
2002 2001
----------------------------
Options on common stock 1,519,119 1,397,156
Common stock warrants 19,721,167 1,195,556
Preferred stock warrants 1,099,185 1,099,185
Convertible preferred stock 8,829,258 8,829,258
Convertible notes 92,817,166 -
----------------------------
Total 123,985,895 12,521,155
============================
As indicated in Note 9, the Company issued $180,000 of principal amount of
convertible notes after September 30, 2002. These notes are convertible into
1,800,000 shares of common stock.
NOTE 7 - EXTRAORDINARY GAIN FROM EXTINGUISHMENT OF CERTAIN LIABILITIES
Throughout early 2002, the Company completed a restructuring of several
liabilities through negotiations with vendors for settlements and/or abatement,
which resulted in the satisfaction of approximately $7.0 million of debt,
accounts payable and other liabilities for total payments of approximately $2.5
million. In connection with this restructuring of liabilities, the Company
recorded a gain from extinguishment of certain liabilities of approximately $4.5
million, including an adjustment of $137,170 recorded in the third quarter
related to revisions of estimates utilized for the Company's June 30, 2002
financial statements.
NOTE 8 - MERGER
As of April 9, 2002, Home Director, Inc. entered into an Agreement and Plan of
Merger with Netword, Inc. ("Netword") and its newly formed, wholly-owned
subsidiary, Webspeak Acquisition Corp. Under the terms of the merger agreement,
Webspeak will merge into Home Director and Home Director will be the surviving
corporation. In the merger, Home Director stockholders will receive shares of
Netword common stock in accordance with the exchange ratio described in the
merger agreement. Upon completion of the merger, the Home Director stockholders
will own approximately 85% of the outstanding Netword common stock, subject to
certain adjustments described in the agreement and plan of merger.
A-32
HOME DIRECTOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 8 - MERGER (CONTINUED)
The Company anticipates that this transaction will be accounted for as a reverse
merger, with Home Director being the acquirer for accounting purposes. The
pre-acquisition financial statements of the accounting acquirer (Home Director)
will become the historical financial statements of the combined company. The
transaction is expected to be accounted for as the issuance of common stock by
Home Director for the net monetary assets of Netword, accompanied by a
recapitalization to reflect the legally issued and outstanding shares of the
merged companies. Pre-acquisition stockholders' equity of Home Director will be
retroactively restated for the equivalent number of shares of Netword received
by Home Director in the merger, with differences between the par value of
Netword's and Home Director's stock recorded as paid-in capital. Any
transaction costs ($996,300 as of September 30, 2002) related to the merger are
anticipated to be charged directly to equity. The Company anticipates the
transaction will not result in any additional goodwill or other intangible
assets.
NOTE 9 - DEBT ISSUANCES
In February 2002, Donald B. Witmer, chairman of the Board of Directors and chief
executive officer, Robert Wise, president, chief operating officer and a
director of the Company, and Spencer Trask Venture Partners, LLC, an affiliate
of the Company's financial adviser and one of its principal stockholders,
purchased $110,000, $55,000 and $270,000 of Home Director exchangeable notes,
which included 621,429 detachable warrants to purchase Home Director common
stock at $0.70 per share. The exchangeable notes were exchangeable into
convertible notes upon satisfying the minimum sale requirements of the private
placement of convertible debt. These notes were exchanged for an equal principal
amount of Home Director's convertible notes in May 2002. Of the $705,000
proceeds received by the Company, $230,481 was assigned as the fair value of the
detachable warrants. The exchangeable notes contained a beneficial conversion
feature determined to be $230,481 at the date of issuance. This amount was
recorded as an increase to interest expense during the quarter ended June 30,
2002 when the notes were exchanged into secured convertible notes. From May
through October 2002, Home Director sold $8.5 million principal amount of its 8%
secured convertible notes due in May 2003 at par ($8.3 million outstanding as of
September 30, 2002). All of the convertible notes will automatically convert
into Home Director common stock at a price of $0.10 per share (a total of
92,817,166 shares) immediately prior to the contemplated merger with Netword,
which excludes 2,700,000 shares that will not be issued if owned by Netword.
A-33
HOME DIRECTOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 10 - RESTRUCTURING CHARGE
During 2001, the Company recognized a restructuring charge of $4,701,233
associated with its decision to reduce its headcount and reduce its overall
facilities. The restructuring charge consisted of $3,887,900 related to
severance payments for 164 employees and $813,333 of exit costs (future
obligations on non-cancelable leases).
Activity during the first nine months of 2002 was as follows for the 2001
restructuring plan:
BALANCE ACCRUED BALANCE AT
AT DECEMBER 31, SETTLEMENT/ SEPTEMBER 30,
2001 PAYMENTS 2002
---------- ---------- ----------
Severance and related costs (1) $1,009,730 $1,009,730 $ -
Exit costs (2) 813,333 813,333 -
---------- ---------- ----------
$1,823,063 $1,823,063 $ -
========== ========== ==========
The above provisions and related restructuring reserves are estimates based on
the Company's judgment at September 30, 2002. Adjustments to the restructuring
provisions may be necessary in the future based on further developments related
to the Company's ongoing restructuring efforts.
(1) As part of the Company's efforts to restructure its liabilities, the Company
reached settlements with three former executives to reduce their amount of
previously agreed severance benefits. This reduction, $523,255, has been
reflected as a component of the extraordinary gain on extinguishment of
liabilities.
(2) At December 31, 2001, the Company estimated its remaining non-cancelable
lease obligation relating to exited facilities at $813,333. During 2002, the
Company negotiated with a lessor to issue 800,000 warrants to purchase common
stock at $0.30 per share in full satisfaction of the Company's remaining
liability to that lessor. The Company recorded the warrants at their fair value
of $16,734 and also paid $147,381 related to the exited facilities. The Company
recorded a gain of $649,218 reflected as a component of the extraordinary gain
on extinguishment of liabilities.
NOTE 11 - CONTINGENCIES
The Company is subject to various legal proceedings and claims, which have
arisen in the ordinary course of its business and have not been fully
adjudicated. It is impossible at this time for the Company to predict with any
certainty the outcome of such litigation. However, management is of the
opinion, based upon information presently available, that it is unlikely that
any such liability, to the extent not provided for through insurance or
otherwise, would be material in relation to the Company's consolidated financial
position or results of operations.
On June 18, 2001, Point West Ventures, LP ("Point West") filed a complaint
against the Company and Spencer Trask Ventures, Inc., the placement agent for
the Company's Series B convertible preferred stock financing. Point West, one of
the investors in that financing, has alleged misrepresentation in connection
with that financing and is seeking rescission of its $500,000 investment. As of
February 11, 2002, Point West is in receivership and, although the receiver may
wish to pursue this action at a later date, the proceedings have been stayed.
A-34
HOME DIRECTOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 11 - CONTINGENCIES (CONTINUED)
On October 10, 2002, IBM Corporation ("IBM") filed a complaint against the
Company alleging breach of a lease agreement and is seeking return of leased
property with a total value of $230,588. The Company has contacted IBM and has
reached a tentative agreement to settle the matter out of court.
A-35
ANNEX B
-------
UNAUDITED PRO FORMA COMBINED CONDENSED FINANCIAL STATEMENTS OF HOME DIRECTOR,
INC. (FORMERLY NETWORD, INC.) GIVING EFFECT TO THE MERGER.
The following unaudited pro forma combined condensed balance sheet gives
effect to the following events as if each had occurred on September 30, 2002:
- the merger;
- the one-for-40 reverse stock split of Netword's common stock
anticipated to occur immediately before the merger;
- anti-dilution adjustments under Home Director's Series B and Series C
Preferred Stock as a result of the conversion of Home Director's
convertible notes immediately before the merger, resulting in an
increase of 12,429,206 in the number of shares issuable upon
conversion of the preferred stock;
- the conversion of Home Director's convertible notes (including notes
issued after September 30, 2002) and the assumed conversion of Home
Director's preferred stock into Home Director's common stock
immediately prior to the merger;
- the issuance of 1,500,000 shares of Home Director's common stock to
former stockholders of Digital Interiors immediately before the
merger; and
- the exchange upon the merger of all outstanding Home Director common
stock and preferred stock for a total of 3,225,127 shares of Netword
common stock, based on an exchange ratio of 0.0276 of one share of
Netword common stock for each share of Home Director common stock.
As a result of the merger, former Home Director stockholders will hold a
majority of the voting interests in Netword. Netword anticipates that this
transaction will be accounted for as a reverse merger, with Home Director being
the acquirer for accounting purposes. The pre-acquisition financial statements
of the accounting acquirer (Home Director) will become the historical financial
statements of the combined companies. The transaction is expected to be
accounted for as the issuance of common stock by Home Director for the net
monetary assets of Netword, accompanied by a recapitalization to reflect the
legally issued and outstanding shares of the combined companies.
Pre-acquisition stockholders' equity of Home Director will be retroactively
restated for the equivalent number of shares of Netword received by Home
Director stockholders in the merger, with differences between the par value of
Netword's and Home Director's stock recorded as paid-in capital. Any
transaction costs related to the merger are anticipated to be charged directly
to equity. Netword and Home Director anticipate the transaction will not result
in any additional goodwill or other intangible assets. Netword and Home
Director have estimated the impact of the merger in developing the accompanying
pro forma balance sheet. These estimates are subject to change pending a final
analysis after completion of the merger.
As a result of Netword's decision to effectively discontinue its
businesses, Netword will be a non-operating holding company with no continuing
operations at the time of the merger. Therefore, the historical results of
operations for Netword are not meaningful when combined with the historical
results of operations of Home Director for purposes of the pro forma
presentation. Accordingly, pro forma results of operations reflecting the
merger have not been provided as they would be substantially the same as the
historical results of Home Director.
B-1
PRO FORMA COMBINED CONDENSED BALANCE SHEET
(UNAUDITED)
SEPTEMBER 30, 2002
HISTORICAL PRO FORMA
-------------------------------------------------------------------
HOME
DIRECTOR NETWORD ADJUSTMENTS COMBINED
------------- ------------ ------------- ------------
Current assets:
Cash. . . . . . . . . . . . . $ 2,247,369 $ 1,016,354 $ (53,700) a $
156,600 c 3,366,623
Accounts receivable. . . . . 1,560,379 - - 1,560,379
Inventories. . . . . . . . . 976,626 - - 976,626
Note receivable. . . . . . . - 284,400 (284,400) a -
Other. . . . . . . . . . . . 1,333,543 3,087 (996,300) a 340,330
------------------------------------------ ----------------------
Total current assets. . . . . . 6,117,917 1,303,841 (1,177,800) 6,243,958
Property and equipment, net 434,174 - - 434,174
Intangible assets, net. . . . . 5,792,681 23,700 (23,700) b 5,792,681
------------------------------------------ ----------------------
Total assets. . . . . . . . . . $ 12,344,772 $ 1,327,541 $ (1,201,500) $12,470,813
========================================== =======================
Current liabilities:
Accounts payable and accrued
expenses . . . . . . . . . . $ 2,103,061 $ 287,436 $ - $ 2,390,497
Convertible notes payable. . 8,893,132 - (8,893,132) c -
Other current liabilities. . 87,429 79,758 - 167,187
------------------------------------------ ----------------------
Total current liabilities . . . 11,083,622 367,194 (8,893,132) 2,557,684
Noncurrent liabilities. . . . . 20,848 22,334 - 43,182
------------------------------------------ ----------------------
Total liabilities . . . . . . . 11,104,470 389,528 (8,893,132) 2,600,866
------------------------------------------ ----------------------
Stockholders' equity:
Common stock . . . . . . . . 1,446 210,103 (210,103) f
36,069 e 37,515
Preferred stock. . . . . . . 88,292 - (88,292) d -
Additional paid-in capital . 60,755,879 10,397,877 (10,397,877) f
9,180,341 c
88,292 d
(36,069) e 69,988,443
Warrants . . . . . . . . . . 6,230,578 - - 6,230,578
Accumulated deficit. . . . . (65,835,893) (9,669,967) 9,669,967 f
(420,087) a
(130,609) c (66,386,589)
------------------------------------------ ----------------------
Total stockholders' equity. . . $ 1,240,302 $ 938,013 $ 7,691,632 $ 9,869,947
------------------------------------------ ----------------------
Total liabilities and equity. . $ 12,344,772 $ 1,327,541 $ (1,201,500) $12,470,813
========================================== ======================
See accompanying notes to pro forma combined condensed financial statements.
B-2
(a) Reverse merger purchase price allocation - Following is the net
monetary assets of Netword as of September 30, 2002:
Cash . . . . . . . . 1,016,354
Note receivable. . . . 284,400
Other assets . . . . . 3,087
Liabilities . . . . . (389,528)
------------
Net monetary assets. . $ 914,313
============
For purposes of this pro forma analysis, the above net monetary
assets have been utilized to estimate the adjustment to Home Director's and
Netword's combined pro forma stockholders' equity to reflect the reverse merger,
as follows:
Net monetary assets . . . . . . . . $ 914,313
Adjustments:
Estimated transaction costs . . . . (1,050,000)
Cancellation of convertible debt. . (284,400)
--------------
Adjustment to Home Director's and
Netword's combined pro forma
stockholders' equity . . . . $ (420,087)
=============
Estimated transaction costs - Home Director and Netword estimate
their transaction costs, to be reflected as a reduction of stockholders' equity
upon completion of the merger, as follows:
Financial advisory fees . . . . . . $ 250,000
Attorney and accountants fees . . . . 800,000
-------------
Estimated transaction costs . . . . $ 1,050,000
=============
The above estimate of transaction costs includes $996,300 of costs that
have been incurred and are reflected in other assets on Home Director's
September 30, 2002 balance sheet. The remaining $53,700 has been reflected as a
reduction of cash in the pro forma presentation.
Cancellation of convertible debt - Netword's $284,400 convertible note
issued by Home Director will be cancelled upon completion of the merger.
(b) Intangible assets, net - Netword's historical intangible assets
will not be recorded by the merged company.
(c) Convertible notes payable - Home Director's outstanding
convertible notes payable ($8,910,341 principal amount as of December 18, 2002,
excluding Netword's $270,000 convertible note that will be cancelled at the time
of the merger) will automatically convert into approximately 89,103,410 shares
of Home Director common stock immediately prior to the merger. Home Director
issued $180,000 face value of convertible notes after September 30, 2002. This
has been reflected in the above pro forma information as an increase to cash of
$156,600, increase to paid-in capital of $180,000 and an increase to accumulated
deficit of $23,400, to recognize the issuance costs incurred. Home Director's
exchangeable notes, issued in February 2002, were recorded at a discount. Any
unamortized discount, which was $107,209 at September 30, 2002, will be
reflected as an expense in Home Director's results of operations upon conversion
of the notes to common stock. The unamortized amount at September 30, 2002 has
been reflected as an increase to accumulated deficit and an increase to
additional paid-in capital for purposes of the above pro forma presentation.
(d) Preferred stock - Home Director's outstanding preferred stock
will be treated as though converted into 21,258,465 shares of Home Director
common stock immediately prior to the merger.
B-3
(e) Common stock - After all equity transactions contemplated in the
merger have been completed, it is estimated that there will be 3,751,467 shares
of Netword common stock outstanding. Common stock will reflect those shares
multiplied by the par value of $.01. This adjustment will be offset to
additional paid-in capital.
(f) Accumulated Deficit - Because Home Director will be the
accounting acquirer, Netword's historical stockholders' equity will not be
carried forward to the merged company.
B-4
EXHIBIT INDEX
Exhibit Number Description
- -------------- -----------
2.1 Agreement and Plan of Merger by and among Netword, Inc., Webspeak
Acqusition Corp. and Home Director, Inc., dated as of April 9, 2002
and amended as of July 31, 2002 and October 25, 2002, set forth in
Annex A to the Information Statement/Proxy Statement/Prospectus
included in Registrant's Registration Statement on Form S-4 (File No.
333-97615), effective October 29, 2002, incorporated herein by
reference.
3.1 Certificate of Amendment of Netword, Inc., filed with
the Secretary of State of the State of Delaware on December 17,
2002, effective as of December 19, 2002, filed herewith.
3.2 Restated Certificate of Incorporation of Netword, Inc., filed
with the Secretary of State of the State of Delaware on
December 17, 2002, effective as of December 19, 2002, filed
herewith.
3.3 Amended and Restated Bylaws of Home Director, Inc., adopted as of
December 19, 2002, filed herewith.
3.4 Certificate of Merger of Webspeak Acqusition Corp. into Home Director,
Inc., filed with the Secretary of State of the State of Delaware on
December 17, 2002, effective as of December 19, 2002, filed
herewith.