[LETTERHEAD]
NARESH ARORA
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors
Nayna Networks, Inc.
(a company in the development stage)
We have audited the accompanying balance sheets of Nayna Networks, Inc., a
development stage enterprise as of December 31, 2004 and 2003 and the related
statements of operations, stockholders' (deficit) equity, and cash flows for the
years then ended. 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 audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (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 audit provides a
reasonable basis for our opinion.
As stated in our earlier report dated September 7, 2004 on financial statements
for the year 2003, we were unable to examine independent third party valuation
report on 100% acquisition of an entity during 2003, as explained in Note B to
the financial statements; nor were we able to satisfy ourselves as to the
aggregate cost of acquisition allocated to goodwill and the related charge to
results of operations for its impairment.
In our opinion, except for the effects of such adjustments in 2003, if any, as
might have been determined to be necessary had we been able to examine evidence
regarding cost of acquisition, the financial statements referred to above,
present fairly, in all material respects, the financial position of Nayna
Networks, Inc. as of December 31, 2004 and 2003, and the results of their
operations and their cash flows for the year then ended in conformity with U.S.
generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note A to the
financial statements, the Company is in the development stage and has incurred
losses from operations that raise substantial doubt about its ability to
continue as a going concern. Management's plans in regard to these matters are
also described in Note A. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
Santa Clara, California
July 20, 2005
1
NAYNA NETWORKS, INC.
(a development stage enterprise)
BALANCE SHEETS
(in thousands, except share and per share data)
- ----------------------------------------------------------------------------------------------
December 31,
----------------------
ASSETS 2004 2003
-------- --------
Current assets:
Cash and cash equivalents $ 709 $ 1,663
Restricted cash 49 48
Accounts receivable, net of allowance of $33 and $0 as of
December 31, 2004 and 2003, respectively 160 121
Prepaid expenses and other current assets 35 63
-------- --------
Total current assets 953 1,895
Property and equipment, net 798 1,388
Other assets 16 9
-------- --------
Total assets $ 1,767 $ 3,292
======== ========
LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY
Current liabilities
Accounts payable $ 655 $ 682
Accrued liabilities 240 162
Accrued payroll liabilities 295 361
Notes payable 718 843
Current portion of capital lease obligations 9 184
-------- --------
Total current liabilities 1,919 2,232
Capital lease obligations, less current portion -- 9
Notes payable 298 997
Bridge to common stock 922 --
-------- --------
Total liablities 3,138 3,239
-------- --------
Stockholders' (deficit) equity
Series A preferred stock, $0.001 par value:
Authorized shares - 15,000,000; issued and outstanding
shares - 15,000,000 at December 31, 2003
(Liquidation preference $12,000) -- 15
Series B preferred stock, $0.001 par value:
Authorized shares - 11,111,112; issued and outstanding
shares - 7,999,997 at December 31, 2003
(Liquidation preference $36,000) -- 199
Series C preferred stock, $0.001 par value:
Authorized shares - 13,840,000; issued and outstanding
shares - 4,680,647 at December 31, 2003
(issued for consideration other than cash;
liquidation preference $5,041) -- --
Series D preferred stock, $0.001 par value:
Authorized shares - 52,500,000; issued and outstanding
shares - 19,531,247 at December 31, 2004
(Liquidation preference $36,000) 20 --
Common stock, $0.001 par value:
Authorized shares - 125,000,000; issued and outstanding
shares - 48,794,091 at December 31, 2004
and 20,512,289 at December 31, 2003 80 52
Additional paid-in capital 51,911 48,071
Deficit accumulated during the development stage (53,382) (48,284)
-------- --------
Total stockholders' (deficit) equity (1,371) 53
-------- --------
Total liabilities and stockholders' (deficit) equity $ 1,767 $ 3,292
======== ========
Accompanied notes are an integral part of these financial statements.
2
NAYNA NETWORKS, INC.
(a development stage enterprise)
STATEMENTS OF OPERATIONS
(in thousands)
- -----------------------------------------------------------------------------------------------
Cumulative
Period from
February 10,
2000 (date of
Year Ended December 31, inception) to
----------------------- December 31,
2004 2003 2004
-------- --------- -----------
Operating expenses:
Research and development $ 2,971 $ 3,051 $ 38,950
Business development 1,011 720 2,611
General and administrative 1,069 3,675 7,533
-------- -------- --------
Total operating expenses 5,051 7,447 49,094
-------- -------- --------
Loss from operations (5,051) (7,447) (49,094)
Interest income 14 121 2,390
Interest expense (40) (137) (832)
Loss on sale of assets (12) -- (12)
Impairment of goodwill and other intangible assets (9) (5,825) (5,834)
-------- -------- --------
Net loss $ (5,098) $(13,288) $(53,382)
======== ======== ========
Accompanied notes are an integral part of these financial statements.
3
NAYNA NETWORKS, INC.
(a development stage enterprise)
Statements of Stockholders' (Deficit) Equity
For the Cumulative Period from February 10, 2000 (date of inception) to
December 31, 2004
(in thousands, except share and per share data)
Series A Redeemable Series B Redeemable Series C Redeemable
Convertible Convertible Convertible
Preferred Stock Preferred Stock Preferred Stock
Shares Amount Shares Amount Shares Amount
----------------------------------------------------------------------------------------------------
Issuance of common stock
to founders in March 2000
at $0.001 per share for cash -- $ -- -- $ -- -- $ --
Issuance of Series A
redeemable convertible
preferred stock in March
2000 at $0.80 per share
for cash 15,000,000 15 -- -- -- --
Issuance of Series B
redeemable convertible
preferred stock in
December 2000 at
$4.50 per share for
cash, net of $73 of
issuance cost -- -- 7,999,997 8 -- --
Issuance of warrants
to purchase Series B
redeemable convertible
preferred stock in
connection with an
equipment lease in
July 2000 -- -- -- 180 -- --
Exercise of common
stock options for cash -- -- -- -- -- --
Repurchase of common
stock issued to founders
in July 2000 at $0.001 per
share for cash -- -- -- -- --
Net loss and
comprehensive loss -- -- -- -- -- --
----------------------------------------------------------------------------------------------------
Balances, December 31, 2000 15,000,000 15 7,999,997 188 -- --
Issuance cost related to
Series B preferred stock -- -- -- (30) -- --
Issuance of warrants to
purchase Series B
redeemable convertible
preferred stock to a
lessor in July 2001 -- -- -- 79 -- --
Compensation expense
related to accelerated
stock options issued
to terminated employees
in september 2001 -- -- -- -- -- --
Compensation expense
related to stock option
grants to consultants
in July and December 2001 -- -- -- -- -- --
Adjustment to valuation
of warrant issued to a
lessor to purchase Series
B redeemable convertible
preferred stock -- -- -- (38) -- --
Exercise of common stock
options for cash -- -- -- -- -- --
Repurchase of common stock
issued to founders at
$0.10 per share for cash -- -- -- -- -- --
Net loss and
comprehensive loss -- -- -- -- -- --
----------------------------------------------------------------------------------------------------
Balances,
December 31, 2001 15,000,000 $ 15 7,999,997 $ 199 -- $ --
Repurchase of common
stock for $0.10 to
$0.90 per share -- -- -- -- -- --
Exercise of common
stock options for cash -- -- -- -- -- --
Cancellation of
previously issued common
stock subject to
restriction -- -- -- -- -- --
Net loss -- -- -- -- -- --
----------------------------------------------------------------------------------------------------
Balances,
December 31, 2002 15,000,000 15 7,999,997 199 -- --
Issuance of Series C
redeemable convertible
preferred stock for
consideration other than
cash in connection with
Xpeed acquisition -- -- -- -- 4,680,647 --
Issuance of common stock
for consideraion other
than cash in connection
with Xpeed acquisition -- -- -- -- -- --
Exercise of common stock
options for cash -- -- -- -- -- --
Repurchase of common
stock for $0.10 per share -- -- -- -- -- --
Net loss -- -- -- -- -- --
----------------------------------------------------------------------------------------------------
Balances,
December 31, 2003 15,000,000 15 7,999,997 199 4,680,647 --
Conversion of Series A,
B & C into common stock (15,000,000) (15) (7,999,997) (199) (4,680,647) --
Issuance of Series D
redeemable convertible
preferred stock for cash ~~ ~~ ~~ ~~ ~~ ~~
Issuance of Series D
redeemable convertible
preferred stock for
consideration other than
cash in connection with
note payable to Siemens ~~ ~~ ~~ ~~ ~~ ~~
Exercise of common stock
options for cash ~~ ~~ ~~ ~~ ~~ ~~
Issuance of common stock
for consideration other
than cash on purchase of
intangible assets
Net loss
Balances, ----------------------------------------------------------------------------------------------------
December 31, 2004 -- $ -- -- $ -- -- $ --
====================================================================================================
Series D Redeemable Accumulated Total
Convertible Additional During the Stockholders'
Preferred Stock Common Stock Paid-In Development (Deficit)
Shares Amount Shares Amount Capital Stage Equity
--------------------------------------------------------------------------------------------------
Issuance of common stock
to founders in March 2000
at $0.001 per share for cash -- $ -- 15,000,000 $ 15 $ -- $ -- $ 15
Issuance of Series A
redeemable convertible
preferred stock in March
2000 at $0.80 per share
for cash -- -- -- -- 11,938 -- 11,953
Issuance of Series B
redeemable convertible
preferred stock in
December 2000 at
$4.50 per share for
cash, net of $73 of
issuance cost -- -- -- -- 35,919 -- 35,927
Issuance of warrants
to purchase Series B
redeemable convertible
preferred stock in
connection with an
equipment lease in
July 2000 -- -- -- -- -- -- 180
Exercise of common
stock options for cash -- -- 4,069,000 4 403 -- 407
Repurchase of common
stock issued to founders
in July 2000 at $0.001 per
share for cash -- -- (66,667) -- -- -- --
Net loss and
comprehensive loss -- -- -- -- -- (6,267) (6,267)
--------------------------------------------------------------------------------------------------
Balances, December 31, 2000 -- -- 19,002,333 19 48,260 (6,267) 42,215
Issuance cost related to
Series B preferred stock -- -- -- -- -- -- (30)
Issuance of warrants to
purchase Series B
redeemable convertible
preferred stock to a
lessor in July 2001 -- -- -- -- -- -- 79
Compensation expense
related to accelerated
stock options issued
to terminated employees
in september 2001 -- -- -- 28 -- -- 28
Compensation expense
related to stock option
grants to consultants
in July and December 2001 -- -- -- 12 -- -- 12
Adjustment to valuation
of warrant issued to a
lessor to purchase Series
B redeemable convertible
preferred stock -- -- -- -- -- -- (38)
Exercise of common stock
options for cash -- -- 93,374 0.09 10 -- 10
Repurchase of common stock
issued to founders at
$0.10 per share for cash -- -- (1,174,399) (1) (116) -- (117)
Net loss and
comprehensive loss -- -- -- -- -- (20,117) (20,117)
--------------------------------------------------------------------------------------------------
Balances,
December 31, 2001 -- $ -- 17,921,308 $ 58 $ 48,154 $ (26,384) $ 22,042
Repurchase of common
stock for $0.10 to
$0.90 per share -- -- (997,195) (1) (100) -- (101)
Exercise of common
stock options for cash -- -- 100,750 0.10 10 -- 10
Cancellation of
previously issued common
stock subject to
restriction -- -- (1,472,500) (1) -- -- (1)
Net loss -- -- -- -- -- (8,612) (8,612)
--------------------------------------------------------------------------------------------------
Balances,
December 31, 2002 -- -- 15,552,363 56 48,064 (34,996) 13,338
Issuance of Series C
redeemable convertible
preferred stock for
consideration other than
cash in connection with
Xpeed acquisition -- -- -- -- -- -- --
Issuance of common stock
for consideraion other
than cash in connection
with Xpeed acquisition -- -- 5,348,572 -- -- -- --
Exercise of common stock
options for cash -- -- 25,000 0.03 6 -- 7
Repurchase of common
stock for $0.10 per share -- -- (413,646) (4) -- -- (4)
Net loss -- -- -- -- -- (13,288) (13,288)
--------------------------------------------------------------------------------------------------
Balances,
December 31, 2003 -- -- 20,512,289 52 48,071 $ (48,284) $ 53
Conversion of Series A,
B & C into common stock -- -- 27,680,644 28 186 -- --
Issuance of Series D
redeemable convertible
preferred stock for cash 18,220,425 18 3,381 3,399
Issuance of Series D
redeemable convertible
preferred stock for
consideration other than
cash in connection with
note payable to Siemens 1,310,822 1 249 250
Exercise of common stock
options for cash 301,158 0.30 16 16
Issuance of common stock
for consideration other
than cash on purchase of
intangible assets 300,000 0.30 9 9
Net loss (5,098) (5,098)
Balances, --------------------------------------------------------------------------------------------------
December 31, 2004 19,531,247 $ 20 48,794,091 $ 80 $ 51,911 $ (53,382) $ (1,371)
==================================================================================================
Accompanied notes are an integral part of these financial statements
4
NAYNA NETWORKS, INC.
(a development stage enterprise)
STATEMENTS OF CASH FLOWS
(in thousands)
- --------------------------------------------------------------------------------------------------------------------------
Cumulative
Period from
February 10,
2000 (date of
inception) to
Year Ended December 31, December 31,
2004 2003 2004
Cash flows from operating activities :
Net loss $ (5,098) $(13,288) $(53,382)
Adjustments to reconcile net loss to net cash used in operations:
Noncash charges related to stock options granted to consultants and
accelerated vesting of employee stock options -- -- 40
Depreciation and amortization 615 930 3,751
Amortization of discount on warrants associated with equipment financing -- 67 202
Impairment of goodwill related to acquisitions 9 5,825 5,834
Loss on sale of property and equipment 12 364 1,126
Changes in operating assets and liabilities:
Restricted cash (1) 117 (49)
Accounts receivable (39) (121) (160)
Prepaid expenses and other current assets 28 13 (35)
Other assets (8) (9) (16)
Accounts payable (27) 306 655
Accrued liabilities 78 80 240
Accrued payroll liabilities (66) 215 295
-------- -------- --------
Net cash used in operating activities (4,496) (5,502) (41,499)
-------- -------- --------
Cash flows from investing activities :
Purchase of property and equipment (45) (108) (1,238)
Proceeds from sale of property and equipment 8 193 445
Costs associated with acquisition of Xpeed, Inc. -- (3,685) (3,685)
-------- -------- --------
Net cash used in investing activities (37) (3,600) (4,478)
-------- -------- --------
Cash flows from financing activities :
Proceeds from loan facility -- -- 327
Payments on capital lease obligations and loan facility (758) (1,373) (5,589)
Proceeds from issuance of common stock, net of repurchases 16 4 243
Proceeds from issuance of Series A redeemable convertible
preferred stock, net of issuance costs -- -- 11,953
Proceeds from issuance of Series B redeemable convertible
preferred stock, net of issuance costs -- -- 35,897
Proceeds from issuance of Series D redeemable convertible
preferred stock, net of issuance costs 3,399 -- 3,399
Issuance of convertible debt 922 -- 622
Restricted cash -- -- (165)
-------- -------- --------
Net cash provided (used) by financing activities 3,579 (1,369) 46,686
-------- -------- --------
Net decrease in cash and cash equivalents (954) (10,471) 709
Cash and cash equivalents at beginning of period 1,663 12,134 --
Cash and cash equivalents at end of period $ 709 $ 1,663 $ 709
======== ======== ========
Accompanied notes are an integral part of these financial statements
5
NAYNA NETWORKS, INC.
(a development stage enterprise)
NOTES TO FINANCIAL STATEMENTS
($ in thousands, except shares and per share data)
- --------------------------------------------------------------------------------
NOTE A: THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) The Company
Nayna Networks, Inc., a development stage enterprise (the Company or Nayna), is
engaged in the development of next-generation broadband access networking
solutions. During 2003, the Company expanded its business development focus as a
result of an acquisition of another company, to develop and market passive
optical networks ("PON") equipment and digital subscriber line ("DSL")
equipment. PON equipment delivers high performance broadband access over fiber
cable, linking business and residential subscribers to the local central office.
DSL technology provides high-speed data transmission using the local telephone
company's existing infrastructure. During 2004, the Company shifted its focus in
its development efforts in the Ethernet in the First Mile (EFM) segment of the
broadband access market. The Company has introduced a new platform that builds
upon the Company's PON expertise through its support for the latest generation
Gigabit Ethernet. The company is in the development stage and since inception,
has devoted substantially all of its efforts to the development of its products,
raising capital, and recruiting personnel.
Nayna Networks, Inc. was incorporated in Delaware on February 10, 2000 and is
located in San Jose, California.
The Company has incurred losses since its inception, and management believes
that it will continue to do so for the foreseeable future because of additional
costs and expenses related to continued development and expansion of the
Company's product offerings. The Company currently plans to generate revenues
and reduce operating expenses to levels that will result in at least neutral
cash flows from operations. However, until that stage is reached, the Company
will continue to use its current cash on hand and require additional financing
to support its operations. Failure to generate sufficient cash flows from
operations, raise additional financing or reduce certain discretionary spending
could have a material adverse effect on the Company's ability to continue as a
going concern and to achieve its intended business objectives. The accompanying
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
(b) Development Stage
Since its inception although the Company has commenced its principal operations,
it has not achieved a sufficient level of sales and market demand to become an
established operating enterprise. Therefore, as per the Statement of Financial
Accounting Standards ("SFAS") No.7, "Accounting and Reporting by Development
Stage Enterprises", the Company is being classified as a development stage
enterprise. The Company is in the development stage and accordingly, its
financial statements are presented in accordance with Statement of Financial
Accounting Standards (SFAS) No. 7, "Accounting and Reporting by Development
Stage Enterprises". Successful completion of the Company's developmental program
and, ultimately, the attainment of profitable operations are dependent upon
future events, including future financing, successfully completing product
development, and achieving a sufficient level of sales and market demand to
become an established operating enterprise. However, there can be no assurance
that the Company will be able to achieve profitable operations.
6
(c) Estimates and Assumptions
Preparing financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. A change in the facts and circumstances
surrounding these estimates could result in a change to the estimates and could
impact future operating results.
(d) Cash and cash equivalents
For purposes of the statement of cash flows, the Company considers all
instruments with an original maturity of three months or less to be cash
equivalents.
(e) Property and Equipment
Property and equipment are stated at cost less accumulated depreciation.
Depreciation expense is determined using the straight-line method over the
estimated useful lives of the respective assets, which are generally three to
five years for computers, equipment and furniture. Depreciation on leasehold
improvements is provided using the straight-line method over the shorter of the
estimated useful lives of the improvements or the lease term. Expenditures for
maintenance and repairs are charged to operating expense as incurred. Upon
retirement or sale, the original cost and related accumulated depreciation are
removed from the respective accounts, and the gains and losses are included in
other income or expense.
(f) Impairment of long-lived assets
The Company evaluates its long-lived assets, including property and equipment,
for impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. When the sum of the present
value of future net cash flows expected to result from the use of the asset and
its eventual disposition is less than its carrying amount, an impairment loss
would be measured based on the discounted cash flows compared to the carrying
amount. No impairment charge has been recorded in any of the periods presented.
(g) Business and credit risk
Financial instruments that potentially subject the Company to concentrations of
credit risk consist primarily of cash, cash equivalents invested in deposits and
trade receivables. The Company has not experienced any losses on its deposits of
cash and cash equivalents. Management believes that the institutions are
financially sound and, accordingly, minimal credit risk exists. The carrying
values reported in the balance sheets for cash, cash equivalents and trade
receivables approximate their fair values.
(h) Research and development
The Company accounts for research and development costs in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 2, "Accounting for
Research and development Costs," and, accordingly, the Company expenses research
and development costs when incurred.
7
(i) Income Taxes
The Company recognizes deferred tax assets and liabilities for operating loss
carryforwards, tax credit carryforwards and the estimated future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
in effect for the year in which the temporary differences are expected to be
recovered or settled. A valuation allowance is recorded to reduce the carrying
amounts of net deferred tax assets if there is uncertainty regarding their
realization.
(j) Stock-Based Compensation
The Company accounts for its stock-based employee compensation using the
intrinsic-value method, which follows the recognition and measurement principles
of Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock
Issued to Employees", and Financial Accounting Standards Board ("FASB")
Interpretation ("FIN") No. 44, "Accounting for Certain Transactions Involving
Stock Compensation." Stock and other equity instruments issued to non-employees
are accounted for in accordance with SFAS No. 123, "Accounting for Stock-Based
Compensation," and EITF Issue No. 96-18, "Accounting for Equity Instruments That
Are Issued to Other Than Employees for Acquiring, or in Conjunction with
Selling, Goods or Services," and are valued using the Black-Scholes model.
No stock-based employee compensation cost related to stock options is reflected
in net income (loss), as all options granted under stock-based compensation
plans had an exercise price equal to fair value of the underlying common stock
on grant date.
(k) Goodwill and Purchased Intangible Assets
In July 2001, the FASB issued Statement of Financial Accounting Standards No.
142, "Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS 142 requires
goodwill to be tested for impairment on an annual basis and between annual tests
in certain circumstances, and written down when impaired, rather than being
amortized as previous accounting standards required. Furthermore, SFAS 142
requires purchased intangible assets other than goodwill to be amortized over
their useful lives unless these lives are determined to be indefinite.
(l) Recently Issued Accounting Pronouncements
In March 2004, the FASB approved the consensus reached on EITF Issue No. 03-1,
"The Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments." The objective of EITF Issue No. 03-1 is to provide guidance for
identifying other-than-temporarily impaired investments. EITF Issue No. 03-1
also provides new disclosure requirements for investments that are deemed to be
temporarily impaired. In September 2004, the FASB issued a FASB Staff Position
(FSP) EITF 03-1 that delays the effective date of the measurement and
recognition guidance in EITF Issue No. 03-1 until further notice. The disclosure
requirements of EITF Issue No. 03-1 are effective for the year ended December
31, 2004. Once the FASB reaches a final decision on the measurement and
recognition provisions, the Company will evaluate the impact of the adoption of
the accounting provisions of EITF Issue No. 03-1.
In December 2004, the FASB issued SFAS No. 123 (R), "Share-Based Payment," which
replaces SFAS No. 123 and supersedes APB Opinion No. 25. SFAS No. 123 (R)
requires that compensation cost relating to all share-based payment
transactions, including grants of employee stock options, be recognized in the
statement of operations based on their fair values. Pro forma disclosure is no
longer an alternative. SFAS No. 123 (R) is effective the first interim or annual
reporting period that begins after June 15, 2005. The company expects to adopt
SFAS No. 123 (R) on July 1, 2005 and expects to apply the modified prospective
method upon adoption. The modified prospective method requires companies to
record compensation cost beginning with the effective date (a) based on the
requirements of SFAS No. 123 (R) for all share-based payments granted after the
effective date and (b) based on the requirements of SFAS No. 123 for all awards
granted to employees prior to the effective date of SFAS No. 123 (R) that remain
unvested on the effective date.
8
As permitted by SFAS No. 123, the Company currently accounts for share-based
payments to employees using APB Opinion No. 25's intrinsic value method and, as
such, generally recognizes no compensation cost for employee stock options.
Accordingly, the adoption of SFAS no. 123 (R)'s fair value method may have a
significant impact on the Company's results of operations, although it will have
no impact on the Company's overall financial position. The impact of the
adoption of SFAS No. 123 (R) cannot be predicted at this time because it will
depend on levels of share-based payments granted in the future. However, had the
Company adopted SFAS No. 123 (R) in prior periods, the impact of that standard
would have approximated the impact of SFAS No. 123 as described in the
disclosure of pro forma net income (loss) in Note H. The company expects its
earnings will be adversely affected upon adoption of SFAS No. 123 (R).
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary Assets
- - an amendment of APB Opinion No. 29," which amends APB Opinion No. 29,
"Accounting of Nonmonetary Transactions," to eliminate the exception for
nonmonetary exchanges of similar productive assets and replaces it with a
general exception for exchanges of nonmonetary assets that do not have
commercial substance. A nonmonetary exchange has commercial substance if the
future cash flows of the entity are expected to change significantly as a result
of the exchange. SFAS No. 153 is effective for nonmonetary exchanges occurring
in fiscal periods beginning after June 15, 2005. The Company does not expect the
adoption of SFAS No. 153 to have a material impact on its results of operations
or financial condition.
NOTE B: ACQUISITION
On April 1, 2003, the Company acquired 100 percent of the outstanding common and
preferred shares of Xpeed, Inc. The results of Xpeed's operations have been
included in the consolidated financial statements since that date. Xpeed, Inc
was engaged in development and marketing of affordable passive optical network
("PON") and digital subscriber line (DSL) products. As a result of the
acquisition, the Company has introduced a new platform that builds upon the
Company's PON expertise through its support for the latest generation Gigabit
Ethernet.
The acquisition involved issuance of 10,029,219 shares of the Company's common
and preferred stock, cancellation of $300 convertible note and assumption of
liabilities $5,604.
SFAS No. 141 requires that all business combinations be accounted for by the
purchase method and accordingly, it requires acquisition cost to be determined
and allocated to assets acquired and liabilities assumed. However, independent
third party valuation of Xpeed was not performed and therefore no value could be
assigned to the shares issued as part of purchase consideration. Based on the
information available, the cost of acquisition in this report is determined and
allocated as follows:
Cost of acquisition:
Cancellation of note $ 300
Liabilities assumed 5,604
------
$5,904
======
Allocation:
Current assets $ 79
Goodwill 5,825
------
$5,904
======
9
As discussed in Note A, the cost allocated to goodwill is written down entirely
in the current year, following testing for impairment as required by SFAS No.
142 on "Goodwill and Other Intangible Assets". However, for tax purpose Goodwill
is being amortized over 15 years.
NOTE C: PROPERTY AND EQUIPMENT
Property and equipment consisted of the following (in thousands):
December 31,
2004 2003
Computer equipment $ 417 $ 416
Computer software 1,354 1,354
Test equipment 1,608 1,629
Furniture and fixtures 2 2
------- -------
3,381 3,401
Less: Accumulated depreciation (2,583) (2,013)
------- -------
Balances as at December 31, 2004 and 2003 $ 798 $ 1,388
======= =======
NOTE D: IMPAIRMENT OF PURCHASED INTANGIBLE ASSETS
In April 2004, the Company purchased intangible assets from Accordion Networks,
Inc. and as purchase consideration issued 300,000 shares (valued at $0.03 per
share) of the Company's common stock.
Based on the impairment tests performed using present value of future cash
flows, the value of intangible asset acquired in April 2004 was considered
impaired as of December 31, 2004. Accordingly, the Statement of Operations for
the year ended December 31, 2004, included a charge of $9 for impairment of
intangible asset.
NOTE E: DEBT
In July 2001, the Company entered into a $1,500 equipment line of credit.
Borrowings outstanding at December 31, 2004 were $9, bearing interest at a rate
of 13% to 15%, for each of the draw downs that comprise the total outstanding
balance. The borrowings are payable in 36 equal installments, the last of which
is due in January 2005.
In April 2003, subsequent to the acquisition of Xpeed, Inc., the Company agreed
to pay off $5,904 towards liabilities of Xpeed, Inc. As at December 31, 2004,
the following amounts are outstanding:
Notes payable - Current $ 718
Notes payable - Non-current 298
Accrued liabilities 122
------
Total $1,138
------
NOTE F: COMMITMENTS
The Company leases office space under non-cancelable operating lease agreement
which expires in July 2005. Rent expense was $206, $1,043, $842 and $2,924 for
the years ended December 31, 2004, 2003, 2002, and, cumulatively, for the period
from February 10, 2000 (date of inception) to December 31, 2004, respectively.
10
NOTE G: CONVERTIBLE PREFERRED STOCK
The holders of Series D redeemable convertible preferred stock have various
rights and preferences as follows:
Voting
The holders of Series D preferred stock are entitled to voting rights equal to
the number of shares of common stock into which each such share preferred stock
could be converted at the record date and have voting rights and powers equal to
the voting rights and powers of the shares of common stock.
Dividends
The holders of shares of Series D are entitled to receive dividends prior and in
preference to any declaration or payment of any dividend (payable other than in
common stock) to the holders of common stock of the Company at the rates of
$0.015 per year on each outstanding share (as adjusted for any stock dividends,
combination, or splits with respect to such shares). When, as, and to the extent
that any dividends are paid on common stock, the holders of shares of redeemable
convertible preferred stock will be entitled to receive, in addition to the
dividend specified above, dividends in an amount equal to the amount paid in
such year on the number of shares of common stock. Such dividends are payable
only when, as, and if declared by the Board of Directors, but only out of funds
that are legally available, and are non-cumulative. No dividends have been
declared as of December 31, 2004.
Liquidation
In the event of liquidation, dissolution, or winding up of the Company, as
further defined in the Company's certificate of incorporation, holders of Series
D are entitled to receive in preference over common stockholders an amount of
$0.38144 per share, plus any declared but unpaid dividends ("Preferred
Liquidation Preference"). After payment has been made to the holders of the
Series D of the full amounts to which they are entitled pursuant to above, all
remaining assets available for distribution, if any, will be distributed ratably
among the holders of common stock.
Conversion
Each share of Series D preferred stock, at the option of the holder, is
convertible into fully paid, non-assessable shares of common stock at an initial
one-to-one conversion rate, which is subject to subsequent adjustment for
antidilution as provided in the Company's articles of incorporation.
Additionally, conversion is automatic upon the closing of a qualified public
offering of common stock with net proceeds of at least $15,000 and a public
offering price of at least $5 per share.
Antidilution provisions
The conversion price of the Company's preferred stock is subject to adjustment,
as further defined by the Company's restated articles of incorporation, to
prevent dilution in the event that the Company issues additional shares of
preferred stock, common stock, or common stock equivalents at a purchase price
less than the then-effective conversion price, provided, however, that without
triggering antidilution adjustments, the Company may issue to directors,
officers, employees, or consultants, shares of common stock that are reserved
for issuance under the Company's stock option plan or in connection with
financings or other transactions which involve consideration and which are
approved by the Board of Directors.
NOTE H: COMMON STOCK
During 2004, the Company issued 27,680,644 shares of common stock upon
conversion of Series A, B and C redeemable convertible preferred stock. The
Company also issued 301,158 shares to employees upon exercise of stock options
and 300,000 shares to another company as consideration for purchase of
intellectual property (See Note D).
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NOTE I: STOCK OPTION PLANS
In May 2000, the Company's Board of Directors and stockholders adopted the 2000
Stock Plan (the "Plan"). The Plan provides for incentive stock options, as
defined by the Internal Revenue Code, to be granted to employees at an exercise
price not less than 100% of the fair value at the grant date as determined by
the Board of Directors, unless the optionee is a 10% stockholder, in which case
the per share exercise price will not be less than 110% of such fair value. The
plan also provides for nonqualified, stock options and stock purchase rights to
be issued to service providers at an exercise price of not less than 85% of the
fair value at the grant date unless the service provider is a 10% stockholder,
in which case the per share exercise price will not be less than 110% of such
fair value. Options granted generally have a maximum term of ten years from the
grant date, are immediately exercisable, and generally vest over a four-year
period. The Plan provides that the unvested shares are subject to repurchase by
the Company upon termination of employment at the original price paid for the
shares.
Activity under the Plan since adoption through December 31, 2004 is as follows:
Weighted-
Average
Shares Exercise
Available Outstanding Price
For Grant Options Per Share
Authorized at inception of the plan 10,000,000
Options granted (6,450,250) 6,450,250 $ 0.100
Options exercised -- (4,069,000) 0.100
Options canceled 346,000 (346,000) 0.100
----------- ----------
Balances at December 31, 2000 3,895,750 2,035,250 0.100
Options granted (2,747,000) 2,747,000 0.570
Options exercised -- (93,374) 0.110
Options canceled 1,054,626 (1,054,626) 0.450
Shares related to previously exercised
options subject to repurchase, which
were repurchased 1,174,399 -- 0.100
----------- ----------
Balances at December 31, 2001 3,377,775 3,634,250 0.470
Options granted (1,308,000) 1,308,000 0.250
Options exercised -- (100,750) 0.100
Options canceled 3,848,335 (3,848,335) 0.001
Shares related to previously exercised
options subject to repurchase, which
were repurchased 997,195 -- 0.001
----------- ----------
Balances at December 31, 2002 6,915,305 993,165 0.250
Options granted (3,739,586) 3,739,586 0.250
Options exercised -- (25,000) 0.260
Options canceled 1,042,900 (1,042,900) 0.253
Shares related to previously exercised
options subject to repurchase, which
were repurchased 413,646 -- 0.009
----------- ----------
Balances at December 31, 2003 4,632,265 3,664,851 0.250
Increase in authorized options 20,000,000
Options granted (22,379,561) 22,379,561 0.031
Options exercised -- (788,833) 0.135
----------- ----------
Options canceled 4,868,213 (4,868,213) 0.210
----------- ----------
Balances at December 31, 2004 7,120,917 20,387,366 0.024
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The following table summarizes information about stock options outstanding as of
December 31, 2004:
Options
Options Outstanding Exercisable
------------------------------ ------------
Weighted- Number
Number of average of
Range of exercise Options remaining life Options
prices Outstanding (years) Vested
$ 0.10 117,896 4.66 84,250
0.50 80,000 6.87 53,750
0.25 1,672,900 8.42 941,025
0.05 18,516,570 9.58 6,035,801
------------ ------------
20,387,366 7,114,826
============ ============
Stock-based compensation
The Company has adopted the disclosure on provisions of SFAS 123, "Accounting
for Stock-based Compensation." Pro forma information regarding net loss is
required in SFAS 123. Under this method, the estimated fair value of the options
is amortized to expense over the vesting period of the options. The Company's
pro forma net loss for the years ended December 31, 2004, 2003, 2002, 2001 and
cumulatively from February 10, 2000 (date of inception) to December 31, 2004
would have been $5,153, $13,320, $8,621, $20,313 and $53,720, respectively.
However, this is not likely to be representative of the effects of net loss on a
pro forma basis for future years, due to the inclusion of additional grants and
years of vesting in subsequent years.
The Company calculated the fair value of each option grant on the date of grant
using the minimum value method for employees and the Black-Scholes option
pricing model for non-employees with the following assumptions: dividend yield
at 0%; weighted average expected option term of ten years; volatility of 0% for
employees and 80% for non-employees, and risk-free interest rates of 1.13% to
5.28%. The weighted average fair value of options granted during 2004 was
$0.031.
NOTE J: INCOME TAXES
The components of net deferred tax assets are as follows:
December 31,
2004 2003
Net operating loss carryforwards $ 16,235 $ 14,626
Tax credit carryforwards 2,294 2,294
-------- --------
Total deferred tax assets 18,529 16,920
Less: Valuation allowance (18,529) (16,920)
-------- --------
$ -- $ --
======== ========
The Company has established a valuation allowance against its deferred tax
assets due to the uncertainty surrounding the realization of such assets.
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As of December 31, 2004, the Company has a net operating loss carryforward of
approximately $47 million for federal purposes. The carryforwards are available
to offset future taxable income. If not utilized, these carryforwards will
expire in varying amounts beginning in 2020.
Under the Tax Reform Act of 1986, the amounts of and benefits from net operating
loss carry-forwards may be impaired or limited in certain circumstances. Events
which cause limitations in the amount of net operating losses that the Company
may utilize in any one year include, but are not limited to, cumulative
ownership change of more than 50%, as defined, over a three year period.
NOTE K: RESEARCH AND DEVELOPMENT EXPENSE
Research and development expenses for the years ended December 31, 2004 and
2003, include the following:
Employee payroll expense $ 1,705 $ 2,248
Cost of material 890 1,099
Outside services 293 342
Allocation of administrative overheads 508 --
Recovery of expenses from customers (425) (638)
------- -------
$ 2,971 $ 3,051
======= =======
NOTE L: SUBSEQUENT EVENTS
Nayna Networks, Inc. (the "company") merged into Rescon Technology Corporation
("Rescon"), a publicly traded company, on April 4, 2005 and became a
wholly-owned subsidiary of Rescon. Following the merger, Rescon Technology
Corporation changed its name to Nayna Networks, Inc.
Accompanied notes are an integral part of these financial statements.
14