<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K/A
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Date of Report (Date of earliest event reported): November 22, 1999
Terayon Communications Systems, Inc.
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of incorporation)
00-2467 77-0328533
(Commission File No.) (I.R.S. Employer Identification No.)
2952 Bunker Hill Lane
Santa Clara, CA 95054
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (408) 726-4400
<PAGE>
Item 2. Acquisition or Disposition of Assets
A. Radwiz Ltd.
On November 22, 1999, (the "Radwiz Closing Date"), the registrant, Terayon
Communication Systems, Inc. ("Terayon"), acquired Radwiz Ltd. ("Radwiz"),
pursuant to that certain Share Purchase Agreement (the "Radwiz Agreement")
adopted by Terayon, the shareholders of Radwiz Ltd. and Radwiz Ltd. dated
October 12, 1999 (the "Radwiz Acquisition"). Radwiz develops, markets and sells
telecommunication access products to the business market that enable its users
to access integrated telephone and data over symmetrical DSL lines.
Pursuant to the Radwiz Agreement, Terayon acquired all outstanding shares
of capital stock of Radwiz, and Radwiz became a wholly-owned subsidiary of
Terayon on November 22, 1999 (the "Effective Time"). As consideration for the
Radwiz Acquisition, the former shareholders of Radwiz received an aggregate of
Nine Hundred Ninety Six thousand One Hundred Fifty Three (996,153) shares of
Terayon common stock as described in the Radwiz Agreement attached hereto as
Exhibit 2.1. The Radwiz Agreement provides for the payment by Terayon of certain
additional consideration to the former shareholders of Radwiz in the form of
cash or additional shares of Terayon common stock (at Terayon's option in the
event that certain pricing conditions relative to the Radwiz Acquisition are
satisfied. The Radwiz Acquisition is intended to qualify for "purchase"
accounting treatment under the requirements of Opinion 16 of the Accounting
Principles Board of the American Institute of Certified Public Accountants
("AICPA") and the related published interpretations of the AICPA, the Financial
Accounting Standards Board and the rules and regulations of the Securities and
Exchange Commission.
B. Telegate Ltd.
On or about December 20, 1999, Terayon intends to acquire Telegate Ltd.
("Telegate"), pursuant to that certain Share Purchase Agreement (the "Telegate
Agreement") adopted by Terayon, the shareholders of Telegate Ltd. and Telegate
Ltd. dated October 14, 1999 (the "Telegate Acquisition"). Telegate develops,
manufactures, markets and sells local access systems for public
telecommunication services over CATV infrastructures.
Under the Telegate Agreement, Terayon will acquire all outstanding shares
of capital stock of Telegate, and Telegate will become a wholly-owned subsidiary
of Terayon. As consideration for the Telegate Acquisition, the shareholders of
Telegate will receive an aggregate of Two Million Two Hundred Thousand
(2,300,000) shares of Terayon common stock as described in the Telegate
Agreement attached hereto as Exhibit 2.2 The Telegate Acquisition is intended
to qualify for "purchase" accounting treatment under the requirements of Opinion
16 of the Accounting Principles Board of the American Institute of Certified
Public Accountants ("AICPA") and the related published interpretations of the
AICPA, the Financial Accounting Standards Board and the rules and regulations of
the Securities and Exchange Commission.
1
<PAGE>
Item 7. Financial Statements and Exhibits
The following financial statements and exhibits are filed as part of this
report.
(a) Financial Statements of Radwiz Ltd.
Included herein are the consolidated balance sheets of Radwiz Ltd.
("Radwiz") as of December 31, 1997 and 1998 and September 30, 1999 and the
related consolidated statements of operations and cash flows for each of
the years in the two year period ended December 31, 1998 and for the nine
months ended September 30, 1998 and 1999 and the consolidated statement of
changes in shareholders' equity (deficiency) for each of the years in the
two year period ended Decemer 31, 1998 and for the nine months ended
September 30, 1999.
2
<PAGE>
RADWIZ LTD.
CONTENTS
--------
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated balance sheets as of December 31, 1997 and 1998
and September 30, 1999
Consolidated statements of operations for the years ended
December 31, 1997 and 1998 and for the nine months ended
September 30, 1998 and 1999
Statements of Changes in Shareholders' Equity (Deficiency) for
the years ended December 31, 1997 and 1998 and for the nine months
ended September 30, 1999
Consolidated statements of cash flows for the years ended
December 31, 1997 and 1998 and for the nine months ended
September 30, 1998 and 1999
Notes to the consolidated financial statements
3
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
OF
RADWIZ LTD.
We have audited the accompanying consolidated balance sheets of Radwiz Ltd. (the
"Company") as of December 31, 1998 and 1997, and the related consolidated
statements of operations, changes in shareholders' equity (deficiency) and cash
flows for the year ended December 31, 1998 and for the period of commencement of
operations (October 15, 1997) to December 31, 1997. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards
in Israel and in the United States, including those prescribed under the
Auditors' Regulations (Auditor's Mode of Performance), 1973. Those standards
require that we plan and perform the audit to obtain reasonable assurance about
whether the consolidated financial statements are free of material misstatement.
An audit includes examining, on a test basis, evidence supporting the amounts
and disclosures in the consolidated 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 consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of the
Company as of December 31, 1998 and 1997, and the results of operations, changes
in shareholders' equity (deficiency) and cash for the year ended December 31,
1998 and for the period of commencement of operations (October 15, 1997) to
December 31, 1997, in conformity with generally accepted accounting principles.
/s/ Luboshitz Kasierer
Member Firm of Arthur Andersen
Tel-Aviv, Israel
June 23, 1999
4
<PAGE>
RADWIZ LTD.
CONSOLIDATED BALANCE SHEETS
(in U.S. dollars)
<TABLE>
<CAPTION>
December 31, September 30,
--------------------------- -------------
Note 1997 1998 1999
------- ----------- ------------ -------------
CURRENT ASSETS (Unaudited)
<S> <C> <C> <C> <C>
Cash and cash equivalents........................... (3) $ - $ 1,075,747 $ 3,561,343
Short-term investments.............................. - - 3,700
Trade receivables (1998 - net of allowance
for doubtful accounts of $66,300)................. 535,138 898,305 149,492
Other receivables and prepaid expenses.............. (4) 1,705 191,277 587,336
Inventories......................................... (5) 1,369,436 379,738 505,266
------------ ----------- -----------
Total current assets......................... 1,906,279 2,545,067 4,807,137
------------ ----------- -----------
PROPERTY AND EQUIPMENT (6)
Cost................................................ 290,462 621,696 799,522
Less - accumulated depreciation..................... 20,357 134,689 253,905
------------ ----------- -----------
Total property and equipment................. 270,105 487,007 545,617
------------ ----------- -----------
DEPOSIT WITH INSURANCE COMPANIES..................... (8) 106,724 119,941 130,939
------------ ----------- -----------
Total assets................................. $ 2,283,108 $ 3,152,015 $ 5,483,693
============ =========== ===========
CURRENT LIABILITIES
Current maturities of long term loan................ $ - $ - $ 12,250
Trade payables...................................... 2,584,945 1,011,345 505,541
Other payables and accrued expenses................. (7) 731,168 496,670 657,750
------------ ----------- -----------
Total current liabilities..................... 3,316,113 1,508,015 1,175,541
------------ ----------- -----------
LONG TERM LOAN, NET .................................. - - 34,326
ACCRUED SEVERANCE PAY................................. (8) 180,243 238,474 252,050
------------ ----------- -----------
Total liabilities............................. 3,496,356 1,746,489 1,461,917
------------ ----------- -----------
COMMITMENTS........................................... (9)
SHAREHOLDERS' EQUITY (DEFICIENCY) (10)
Share capital
Ordinary shares of NIS 0.1 par value
Authorized - 400,000 shares (1997 -
344,000); Issued -312,197 shares (1997- 2);
Outstanding - 312,197 shares (1997 - none)......... - 8,708 13,303
Additional paid-in capital........................... - 7,544,687 14,246,433
Deferred compensation................................ - (458,490) (636,216)
Capital reserve...................................... (750,000) (750,000) (750,000)
Accumulated deficit.................................. (463,248) (4,939,379) (8,851,744)
------------ ----------- -----------
Total shareholders' equity (deficiency)....... (1,213,248) 1,405,526 4,021,776
------------ ----------- -----------
Total liabilities and shareholders' equity
(deficiency).................................. $ 2,283,108 $ 3,152,015 $ 5,483,693
============ =========== ===========
</TABLE>
The accompanying notes form an integral part of these consolidated financial
statements.
5
<PAGE>
RADWIZ LTD.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In U.S. dollars)
<TABLE>
<CAPTION>
For the For the
period (*) ended year ended For the nine months ended
December 31, December 31, September 30,
Note 1997 1998 1998 1999
------ ------------------- -------------- ---------------- ---------------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C> <C>
Sales................................ (12) $ 784,901 $ 3,057,679 $ 2,286,321 $ 1,546,811
Cost of sales........................ (13) 455,271 2,361,680 1,222,291 1,210,679
------------------- -------------- ---------------- ---------------
Gross profit....................... 329,630 695,999 1,064,030 336,132
------------------- -------------- ---------------- ---------------
Operating expenses
Research and development
expenses........................... (14) 217,328 2,061,437 1,297,331 1,862,180
Less - participation by the
Chief Scientist of Israel......... (9A) - 297,515 - 390,186
------------------- -------------- ---------------- ---------------
Research and development
expenses, net...................... 217,328 1,763,922 1,297,331 1,471,994
Marketing and selling
expenses, net...................... (15) 442,260 2,730,793 1,772,924 1,932,008
General and administrative
expenses........................... 133,290 745,088 658,553 828,494
------------------- -------------- ---------------- ---------------
Total operating expenses........... 792,878 5,239,803 3,728,808 4,232,496
------------------- -------------- ---------------- ---------------
Operating loss..................... (463,248) (4,543,804) (2,664,778) (3,896,364)
Financing income (expense),
net................................ - 67,673 119,879 (16,001)
------------------- -------------- ---------------- ---------------
Net loss........................... $ (463,248) $ (4,476,131) $ (2,544,899) $ (3,912,365)
=================== ============== ================ ===============
</TABLE>
(*) From commencement of operations - October 15, 1997.
The accompanying notes form an integral part of these consolidated financial
statements.
6
<PAGE>
RADWIZ LTD.
CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS' EQUITY (DEFICIENCY)
(In U.S. dollars)
<TABLE>
<CAPTION>
Ordinary shares Additional Accumu-
----------------- paid-in Deferred Capital lated Total
Shares Amount capital compensation reserve deficit
--------- ------- --------------- -------------- ---------- -------------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Shares issued 2 $ - $ - $ - $ - $ - $ -
Capital reserve - - - - (750,000) - (750,000)
Net loss (*) - - - - - (463,248) (463,248)
--------- ------- --------------- -------------- ---------- -------------- -----------
Balance as of
December 31, 1997 2 - - - (750,000) (463,248) $(1,213,248)
Ordinary shares
issued 312,195 8,708 6,710,854(**) - - - 6,719,562
Deferred
compensation - - 833,833 (833,833) - - -
Amortization of
deferred stock
compensation - - - 375,343 - - 375,343
Net loss - - - - - (4,476,131) (4,476,131)
--------- ------- --------------- -------------- ---------- -------------- -----------
Balance as of
December 31, 1998 312,197 8,708 7,544,687 (458,490) (750,000) (4,939,379) 1,405,526
Ordinary shares
issued (unaudited) 190,072 4,595 6,085,579 - - - 6,090,174
Deferred
compensation
(unaudited) - - 680,843 (680,843) - - -
Amortization of
deferred stock
compensation
(unaudited) - - (64,676) 503,117 - - 438,441
Net loss(unaudited) - - - - - (3,912,365) (3,912,365)
--------- ------- --------------- -------------- ---------- -------------- -----------
Balance as of
September 30, 1999
(unaudited) 502,269 $13,303 $ 14,246,433 $ (636,216) $(750,000) $ (8,851,744) $ 4,021,776
========= ======= =============== ============== ========== ============== ===========
</TABLE>
(*) For the period from October 15, 1997.
(**) Net of issuance expenses of approximately $67,000.
The accompanying notes form an integral part of these consolidated financial
statements.
7
<PAGE>
RADWIZ LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In U.S. dollars)
<TABLE>
<CAPTION>
For the period For the
(*) ended year ended For the nine months ended
December 31 December 31 September 30,
1997 1998 1998 1999
----------------- ------------ --------------- -----------------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss................................................ $ (463,248) $(4,476,131) $ (2,544,899) $ (3,912,365)
Adjustments to reconcile net loss to net cash used in
operating activities:
Income and expenses not affecting operating cash flows:
Depreciation......................................... 20,357 114,332 65,381 119,216
Accrued severance pay, net........................... 3,798 45,014 34,277 2,578
Amortization of deferred stock compensation.... - 375,343 - 438,441
Changes in operating assets and liabilities:
(Increase) decrease in trade receivables............. (535,138) (363,167) (472,570) 748,813
Increase in other receivables and prepaid
expenses............................................ (1,705) (189,572) (76,687) (396,059)
Decrease (increase) in inventories.................. (117,784) 989,698 275,852 (125,528)
Increase (decrease) in accounts payables............. 1,042,831 (1,573,600) (1,746,189) (505,804)
Increase (decrease) in other payables and
accrued expenses.................................... 50,889 (234,498) (82,616) 161,080
-------------- ------------ --------------- -----------------
Net cash used in operating activities.............. - (5,312,581) (4,547,451) (3,469,628)
-------------- ------------ --------------- -----------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of short-term investments - - - (3,700)
Purchase of property and equipment - (331,234) (109,517) (177,826)
-------------- ------------ --------------- -----------------
Net cash used in investing activities................ - (331,234) (109,517) (181,526)
-------------- ------------ --------------- -----------------
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of long term loan - - - 46,576
Issuance of share capital, net......................... - 6,719,562 6,726,358 6,090,174
-------------- ------------ --------------- -----------------
Net cash provided by financing activities............ - 6,719,562 6,726,358 6,136,750
-------------- ------------ --------------- -----------------
INCREASE IN CASH AND CASH EQUIVALENTS. - 1,075,747 2,069,390 2,485,596
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD..................................... - - - 1,075,747
-------------- ------------ --------------- -----------------
CASH AND CASH EQUIVALENTS AT END OF
PERIOD.................................................. $ - $ 1,075,747 $ 2,069,390 $ 3,561,343
============== ============ =============== =================
</TABLE>
(*) From commencement of operations - October 15, 1997.
The accompanying notes form an integral part of these consolidated financial
statements.
8
<PAGE>
RADWIZ LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In U.S. dollars)
Note 1 - GENERAL
A. Radwiz Ltd. ("The Company"), an Israeli corporation, is engaged in
development, manufacture, market and support Wide-Area Network
routing solutions.
B. The consolidated financial statements include the financial
statements of the Company and its wholly-owned subsidiary in the
United States, Radwiz Inc., which was incorporated on September 1,
1998 under the laws of the State of New Jersey. The subsidiary is
primarily engaged in the sale and marketing, within the United
States, of the Company's products.
C. The consolidated financial statements of the Company have been
prepared in U.S. dollars, as the currency of the primary economic
environment in which the operations of the Company are conducted is
the U.S. dollar. Substantially all of the Company's sales are made
outside Israel, in U.S. dollars. Most purchases of materials and
components and most marketing costs, are denominated in U.S.
dollars. Therefore, the functional currency of the Company is the
U.S. dollar.
Transactions and balances originally denominated in dollars are
presented at their original amounts. Transactions and balances in
other currencies are translated into dollars in accordance with the
principles set forth in Statement No. 52 of the Financial Accounting
Standards Board of the United States ("FASB"). Accordingly, items
have been translated as follows:
Monetary items - at the exchange rate in effect on balance sheet
date.
Nonmonetary items - at historical exchange rates.
Revenue and expense items - at the exchange rates in effect as of
date of recognition of those items (excluding depreciation and other
items deriving from non-monetary items).
All exchange gains and losses from the translation mentioned above
(which are immaterial for all periods presented) are reflected in
the Statement of Operations. The representative rate of exchange of
the New Israeli Shekel (NIS) at December 31, 1998 was U.S.$1.00 =
4.16 (1997 - NIS 3.536).
D. The accompanying financial statements at September 30, 1999 and for
the nine months ended September 30, 1998 and 1999 are unaudited but
include all adjustments (consisting of normal recurring accruals)
which, in the opinion of management, are necessary for a fair
statement of the financial position and the operating results and
cash flows for the interim date and periods presented. These
financial statements have also been prepared in conformity with
generally accepted accounted principles in the United States.
Results for the interim period ended September 30, 1999 are not
necessarily indicative of results for the entire fiscal year or
future periods.
9
<PAGE>
RADWIZ LTD.
Note 2 - SIGNIFICANT ACCOUNTING POLICIES
The Company's consolidated financial statements are prepared in
accordance with accounting principles generally accepted in the
United States. The significant accounting policies followed in the
preparation of the consolidated financial statements, applied on a
consistent basis, are as follows:
A. PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiary in the U.S. (Radwiz
Inc.). Material intercompany balances and transactions have been
eliminated.
B. CASH AND CASH EQUIVALENTS
All highly liquid investments with an original maturity of three
months or less are considered cash equivalents.
C. ALLOWANCE FOR DOUBTFUL ACCOUNTS
Allowance for doubtful accounts is computed for specific debts
the collectibility of which is doubtful based upon the Company's
experience.
D. INVENTORIES
Inventories are valued at the lower of cost or market. Cost is
determined on the basis of the "First-in, First-out" basis.
E. PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is
computed by the straight-line method over the estimated useful
life of the assets, ranging from three to ten years.
10
<PAGE>
Note 2 - SIGNIFICANT ACCOUNTING POLICIES (Cont.)
F. REVENUE RECOGNITION
Revenues from product sales are recognized upon shipment to
customers when no right of return exists and collection is
probable.
G. RESEARCH AND DEVELOPMENT COSTS
Research and development cost, net of participation by the
Government of Israel through the Ministry of Industry and Trade,
Office of the Chief Scientist, are charged to operations as
incurred.
H. INCOME TAXES
The Company accounts for income taxes under the liability method
of accounting. Under the liability method, deferred taxes are
determined based on the differences between the financial
statement and tax bases of assets and liabilities at enacted tax
rates in effect in the year in which the differences are
expected to reserve. Valuation allowances are established, when
necessary, to reduce deferred tax assets to amounts expected to
be realized.
I. FAIR VALUE OF FINANCIAL INSTRUMENTS
Unless otherwise noted, the carrying amount of financial
instruments approximates fair value.
J. SHARE-BASED COMPENSATION
The Company accounts for shares subject to options issued to
employees under Accounting Principles Board No. 25 - "Accounting
for Stock Issued to Employees", ("APB 25").
11
<PAGE>
Note 2 - SIGNIFICANT ACCOUNTING POLICIES (Cont.)
K. WARRANTY COSTS
The Company provides warranty for period of up to twelve months.
Provision for warranty costs is based on Company's experience
and engineering estimates.
L. USE OF ESTIMATES
The preparation of the consolidated financial statements in
conformity with generally accepted accounting principles
requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of
the consolidated financial statements and the reported amounts
of revenues and expenses during the reporting periods. Actual
results could differ from these estimates.
N. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities". SFAS No. 133 established accounting and reporting
standards requiring that every derivative instrument be recorded
on the balance sheet at its fair value. SFAS No. 133 requires
that changes in the derivative's fair value be recognized
currently in earnings unless specific hedge accounting criteria
are met. Special accounting for qualifying hedges allows a
derivative's gains and losses to offset related results on the
hedged item in the statement of operations. SFAS No. 133 is
effective for fiscal years beginning after June 15, 2000. The
Company believes that the adoption of SFAS No. 133 will not have
a material effect on its financial statements.
12
<PAGE>
Note 3 - CASH AND CASH EQUIVALENTS
<TABLE>
<CAPTION>
December 31
----------------------------------
1997 1998
---------------- ----------------
<S> <C> <C>
Cash in banks - 113,553
Bank deposits
In U.S. Dollars (bearing annual interest
rate of 4.5% to 5.2%) - 680,000
In NIS (bearing annual interest rate of
9.0% to 12.5%) - 282,194
---------------- ----------------
- 1,075,747
================ ================
</TABLE>
Note 4 - OTHER RECEIVABLES AND PREPAID EXPENSES
<TABLE>
<CAPTION>
December 31
----------------------------------
1997 1998
---------------- ----------------
<S> <C> <C>
Grants receivable:
Fund for Encouragement of Marketing Activities - 57,088
Chief Scientist - 17,814
Prepaid expenses - 74,609
Value added receivable - 29,237
Others 1,705 12,529
---------------- ----------------
1,705 191,277
================ ================
</TABLE>
Note 5 - INVENTORIES
<TABLE>
<CAPTION>
December 31
----------------------------------
1997 1998
---------------- ----------------
<S> <C> <C>
Components 527,710 221,741
Work in progress 408,613 51,836
Finished goods 433,113 106,161
---------------- ----------------
1,369,436 379,738
================ ================
</TABLE>
13
<PAGE>
Note 6 - PROPERTY AND EQUIPMENT
<TABLE>
<CAPTION>
December 31
----------------------------------
1997 1998
---------------- ----------------
<S> <C> <C>
COST
Research and development equipment 191,116 337,796
Computer equipment 41,153 86,744
Leasehold improvements - 24,173
Motor vehicles 53,683 153,804
Office furniture and equipment 4,510 19,179
---------------- ----------------
290,462 621,696
---------------- ----------------
ACCUMULATED DEPRECIATION
Research and development equipment 14,806 88,860
Computer equipment 3,425 26,446
Leasehold improvements - 861
Motor vehicles 2,013 16,710
Office furniture and equipment 113 1,812
---------------- ----------------
20,357 134,689
---------------- ----------------
270,105 487,007
================ ================
</TABLE>
The Company's property and equipment are primarily located in Israel.
For the period ended December 31, 1997 and for the year ended December
31, 1998, depreciation expenses were $20,357 and $114,332, respectively.
14
<PAGE>
Note 7 - OTHER PAYABLES AND ACCRUED EXPENSES
<TABLE>
<CAPTION>
December 31
----------------------------------
1997 1998
---------------- ----------------
<S> <C> <C>
Employees and employees institutions 88,579 329,850
Accrued royalties to the Chief Scientist - 50,461
A related company 574,031 -
Accrued expenses - 52,211
Other (including provision for warranty
costs) 68,558 64,148
---------------- ----------------
731,168 496,670
================ ================
</TABLE>
Note 8 - ACCRUED SEVERANCE PAY, NET
Under Israeli law and labor agreements, the Company is required to
make severance payments to its dismissed employees and employees
leaving its employment in certain other circumstances. The Company's
severance pay liability to its employees, which is calculated on the
basis of the salary of each employee for the last month of the
reported period multiplied by the years of such employee's
employment, is reflected in the Company's consolidated balance sheet
on the accrual basis, and is partially funded by a purchase of
insurance policies in the name of the Company. Severance pay expense
for the periods ended December 31, 1997 and 1998 amounted to $4,121
and $58,231, respectively.
15
<PAGE>
Note 9 - COMMITMENTS
A. The Company has purchased, under the approval of the Chief Scientist
of the Ministry of Industry and Trade ("OCS"), technology that was
developed by a Fellow Subsidiary. As a condition for this approval,
the Company has committed to pay royalties to the Government of
Israel, on proceeds from sales of products based on this technology,
except for such proceeds from sales to the Fellow Subsidiary.
Royalty rates are 3% - 5%. Royalties are payable from the
commencement of sales of each of these products until the cumulative
amount of the royalties paid and accrued by the Company and by the
Fellow Subsidiary equals 100% of the dollar linked amount received
by the Fellow Subsidiary. The Company's total commitment for
royalties payable with respect to future sales, based on Government
participations received or accrued, net of royalties paid or
accrued, totaled approximately $5,698,000 as of December 31, 1998.
B. In connection with its marketing activities, the Company accrued
participation payments from the Government of Israel - Fund for the
Encouragement of Marketing Activities, in total amount of $57,088.
In return for the participation payments, the Company is committed
to pay royalties at a rate of 4% of the Company's total increase in
export sales, from the end of the second year of implementation of
the marketing plan until the date at which the participation has
been fully repaid.
C. The Company is a party to an agreement with 13 related companies
that guarantees that damages caused to uninsured motor vehicles
owned by any of these companies will, after payment of a deductible,
be shared by these companies.
D. The Company operates from leased premises in Tel-Aviv, Israel and in
New-Jersey in the United States. Lease agreements expire in the
year 1999 to 2002. Annual minimum future rental payments due under
the above agreements, at exchange rates in effect on December 31,
1998, are approximately as follows:
<TABLE>
<S> <C>
1999 166,000
2000 146,000
2001 146,000
2002 73,000
----------
$531,000
==========
</TABLE>
16
<PAGE>
Note 10 - SHAREHOLDERS' EQUITY (DEFICIENCY)
A. During 1998, the Company issued 312,195 Ordinary Shares
NIS 0.1 par value in consideration for $6,786,665.
B. In 1997, the Company adopted a key employee share incentive plan
which provides for the grant by the Company of options awards to
purchase up to an aggregate of 54,840 Ordinary shares to officers
and employees of the Company and its subsidiaries. The options vest
ratably over vesting periods ranging from four to five year period.
The options expire 62 months from the date of issuance. The
exercise price of option award under the plan will be NIS 0.1.
Transactions related to the above discussed options during the
period ended December 31, 1997 and the year ended December 31, 1998
and the weighted average exercise prices per share and weighted
average fair value of the options at the date of grant are
summarized as follows:
<TABLE>
<CAPTION>
Weighted Weighted
average average fair
exercise value of
Outstanding price per options
options share granted
--------------- --------------- ---------------
<S> <C> <C> <C>
Inception
Options granted - $ - $ -
--------------- --------------- ---------------
Outstanding
December 31, 1997 - -
Options granted 52,390 0.03 15.92
Options forfeited (6,626) 0.03
--------------- ---------------
Outstanding
December 31, 1998 45,764 $ 0.03
=============== ===============
</TABLE>
For options granted in 1998, the exercise prices were less than the
market value of the shares at the date of grant.
17
<PAGE>
Note 10 - SHAREHOLDERS' EQUITY (DEFICIENCY) (Cont.)
B. (Cont.)
The following table summarizes information about options outstanding
and exercisable at December 31, 1998:
<TABLE>
<CAPTION>
Options outstanding Option exercisable
----------------------------------------------- -------------------------------
Weighted -
Number average Weighted - Number Weighted -
outstanding at remaining average outstanding at average
Exercise December 31, contractual exercise December 31, exercise
price 1998 life prices 1998 prices
- ------------- --------------- -------------- -------------- --------------- --------------
<S> <C> <C> <C> <C> <C>
$ 0.03 45,764 4.48 $0.03 11,832 $0.03
=============== ============== ============== =============== ==============
</TABLE>
The amounts of deferred compensation recognized arising from the
difference between the exercise price and the fair market value on
the date of grant of $0 and $833,833, for options granted in the
period ended December 31, 1997 and for the year ended December 31,
1998, respectively, are included in shareholders' equity and are
being amortized over the vesting periods of the respective options
in accordance with APB 25. The balance of unamortized deferred
compensation at December 31, 1998 is $458,490. Under APB 25, the
deferred compensation that has been charged to operations for the
year ended December 31, 1998 amounted to $375,343 (period ended
December 31, 1997 - none).
If deferred compensation had been determined under the alternative
fair value accounting method provided for under SFAS Statement No.
123, "Accounting for Stock-Based Compensation", using the "minimum
value" method with the following weighted average assumptions used
for grants in all reported periods: (1) expected life of the options
of 3 years; (2) dividend yield of 0%; (3) expected volatility of 0%
and (4) risk - free interest rate of 5%, the effect of the Company's
net loss would not have been changed for all reported periods.
18
<PAGE>
Note 11 - TAXES ON INCOME
A. The Company is subject to the Income Tax Law (Inflationary
Adjustments), 1985, measuring income on the basis of changes in the
Israeli Consumer Price Index.
B. Through December 31, 1997 the Company was a "Family Company" as
defined by Section 64A of the Israeli Income Tax Ordinance.
Therefore, Company's losses for tax purposes through that date were
assigned to the shareholders, and are not available to the Company.
As of December 31, 1998, the net operating loss carryforwards for
tax purposes amounted to approximately $3.25 million. Such net
operating losses may be carried forward indefinitely and offset
against future taxable income. Due to uncertainty of the
realization of the carryforwards losses prior to their expiration,
the Company has recorded a valuation allowance for the entire amount
of the tax related asset. Deferred taxes in respect of other
temporary difference are immaterial.
C. The Company has not received final tax assessments since
commencement of operations (1997).
Note 12 - REVENUES
The Company manages its business on the basis of one reportable
segment.
19
<PAGE>
Note 13 - COST OF SALES
<TABLE>
<CAPTION>
For the For the
period ended year ended
December 31 December 31
1997 1998
---------------- ----------------
<S> <C> <C>
Materials consumed 493,276 1,101,183
Payroll and related benefits - 78,640
Subcontractors work 124,051 87,157
Other - 410,971
---------------- ----------------
617,327 1,677,951
Increase (decrease) in finished goods and
work in progress (162,056) 683,729
---------------- ----------------
455,271 (*)2,361,680
================ ================
</TABLE>
(*) Including amortization of slow moving inventory in the amount of $483,520.
Note 14 - RESEARCH AND DEVELOPMENT EXPENSES
<TABLE>
<CAPTION>
For the For the
period ended year ended
December 31 December 31
1997 1998
---------------- ----------------
<S> <C> <C>
Payroll and related benefits 181,322 1,611,155
Materials consumed 11,862 80,684
Subcontractors work 8,483 119,758
Other 15,661 249,840
---------------- ----------------
217,328 2,061,437
================ ================
</TABLE>
20
<PAGE>
Note 15 - MARKETING AND SELLING EXPENSES, NET
<TABLE>
<CAPTION>
For the For the
period ended year ended
December 31 December 31
1997 1998
---------------- ----------------
<S> <C> <C>
Marketing and selling expenses include:
royalties to the Government of Israel 15,904 85,430
================ ================
Marketing and selling expenses 442,260 2,787,881
Participation by the Government of Israel - 57,088
---------------- ----------------
Marketing and selling expenses, net 442,260 2,730,793
================ ================
</TABLE>
Note 16 - CONCENTRATION OF CREDIT RISK
For the period ended December 31, 1997, no single customer accounted
for more than 10% of the Company's sales and no customer represented
more than 10% of trade receivables. For the year ended December 31,
1998, one customer accounted for 11.5% of net revenues and one
customer represented 20.8% of trade receivables. The Company does
not require to support credit sales. Allowances are maintained for
potential credit losses.
21
<PAGE>
Note 17 - RELATED PARTY BALANCES AND TRANSACTIONS
A. BALANCES WITH RELATED PARTIES
<TABLE>
<CAPTION>
December 31
------------------------------
1997 1998
-------------- --------------
<S> <C> <C>
Trade receivables 576,742 520,160
Trade payables 2,572,403 549,222
Other payables and accrued expenses 574,031 -
</TABLE>
B. TRANSACTIONS WITH RELATED PARTIES
<TABLE>
<CAPTION>
For the For the
period ended year ended
December 31 December 31
1997 1998
---------------- ----------------
<S> <C> <C>
Sales - 411,246
Cost of sales - 975,203
Operating expenses - 930,282
</TABLE>
The Company's products are marketed and sold in North America
through an affiliated company.
22
<PAGE>
Financial statements of Telegate Ltd.
Included herein are the balance sheets of Telegate Ltd. ("Telegate") as of
December 31, 1997 and 1998 and September 30, 1999 and the related statements of
operations and cash flows for each of the years in the three year period ended
December 31, 1998 and for the nine months ended September 30, 1998 and 1999 and
the statement of changes in shareholders' equity (deficiency) for each of the
years in the three year period ended December 31, 1998 and for the nine months
ended September 30, 1999.
INDEX
Report of Independent Auditors
Balance Sheets
Statements of Operations
Statements of Changes in Shareholders' Deficiency
Statements of Cash Flows
Notes to Financial Statements
23
<PAGE>
ERNST & YOUNG [LOGO]
KOST FORER & GABBAY
REPORT OF INDEPENDENT AUDITORS
To the Shareholders of
TELEGATE LTD.
We have audited the accompanying balance sheets of Telegate Ltd. as of
December 31, 1997 and 1998, and the related statements of operations, changes in
shareholders' deficiency and cash flows for each of the three years in the
period ended December 31, 1998. 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 generally accepted auditing
standards 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 the 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 financial position of Telegate Ltd. as of December
31, 1997 and 1998, and the results of its operations and cash flows for each of
the three years in the period ended December 31, 1998, in conformity with
generally accepted accounting principles in the United States.
The accompanying financial statements have been prepared assuming the Company
will continue as a going concern. As discussed in note 1c, the Company has
suffered recurring losses from operations, a working capital deficiency and a
shareholders' deficiency. These conditions raise substantial doubt about its
ability to continue as a going concern. Management's plans in regard to these
matters are described in Note 1c. The accompanying financial statements do not
include any adjustments to reflect the possible future effects on the
recoverability and classification of asset carrying amounts or the amounts and
classification of liabilities that might result from the outcome of this
uncertainty.
Tel-Aviv, Israel /s/ KOST FORER & GABBAY
March 16, 1999 A Member of Ernst & Young International
(except for Note 1c, as to which
the date is June 30, 1999)
24
<PAGE>
TELEGATE LTD.
BALANCE SHEETS
- --------------------------------------------------------------------------------
U.S. dollars in thousands, except share data
<TABLE>
<CAPTION>
December 31, September 30,
-------------------------------------- 1999
1997 1998 Unaudited
---------------- ----------------- -------------------
<S> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 2,409 $ 385 $ 10
Trade receivables - related parties (Note 14) - 320 1,661
Government grants receivable 232 331 1,656
Other accounts receivable 111 12 331
Inventories (Note 3) - 1,210 4,699
---------------- ----------------- -------------------
2,752 2,258 8,357
---------------- ----------------- -------------------
SEVERANCE (Note 7) 267 429 565
---------------- ----------------- -------------------
PROPERTY AND EQUIPMENT, NET (Note 4) 898 1,548 1,559
---------------- ----------------- -------------------
Total assets 3,917 4,235 10,481
- -----
================ ================= ===================
LIABILITIES AND SHAREHOLDERS' DEFICIENCY
CURRENT LIABILITIES:
Short-term bank credit(Note 5) - 21 663
Short-term bank loans (Note 5) - 1,135 2,115
Trade payables 743 1,332 2,090
Employees and payroll accruals 541 791 978
Advances from a customer - related party (Note 14) - 385 -
Other accounts payable (Note 6) (* 81 372 437
---------------- ----------------- -------------------
Total current liabilities 1,365 4,036 6,283
- -----
---------------- ----------------- -------------------
ACCRUED SEVERANCE PAY (Note 7) 406 677 907
---------------- ----------------- -------------------
CONVERTIBLE LOANS (Note 8) (* 2,500 5,633 12,335
---------------- ----------------- -------------------
SHAREHOLDERS' DEFICIENCY (Note 9):
Share capital
Authorized: 1,100,000 Ordinary shares of NIS 0.1 par value
as of December 31, 1997 and 1998, and 3,000,000 as of
September 30, 1999
Issued and outstanding: 706,900 Ordinary shares of NIS 0.1 par
value as of December 31, 1997 and 1998 and 836,598 as of
September 30, 1999 23 23 26
Additional paid-in capital 9,569 9,569 12,892
Deferred compensation (362) (109) (300)
Accumulated deficit (9,584) (15,594) (21,662)
---------------- ----------------- -------------------
(354) (6,111) (9,044)
---------------- ----------------- -------------------
Total liabilities and shareholders' deficiency $ 3,917 $ 4,235 $ 10,481
- -----
================ ================= ===================
</TABLE>
*) Reclassified.
The accompanying notes are an integral part of the financial statements.
25
<PAGE>
TELEGATE LTD.
STATEMENTS OF OPERATIONS
- --------------------------------------------------------------------------------
U.S. dollars in thousands, except share and per share data
<TABLE>
<CAPTION>
Year ended Nine months ended
December 31, September 30,
--------------------------------------------------- ------------------------------
1996 1997 1998 1998 1999
-------------- --------------- -------------- ------------- -------------
Unaudited
------------------------------
<S> <C> <C> <C> <C> <C>
Sales to related parties (Note 14) $ - $ - $ 3,569 $ 1,612 $ 4,338
Cost of sales to related parties - - 3,737 2,130 4,094
-------------- --------------- -------------- ------------- -------------
Gross profit (loss) - - (168) (518) 244
-------------- --------------- -------------- ------------- -------------
Operating expenses:
Research and development, net (Note 12) 2,236 3,362 4,660 3,280 4,187
Selling and marketing 324 392 489 396 560
General and administrative 598 608 716 566 970
-------------- --------------- -------------- ------------- -------------
Total operating expenses 3,158 4,362 5,865 4,242 5,717
- -----
-------------- --------------- -------------- ------------- -------------
Operating loss (3,158) (4,362) (6,033) (4,760) (5,473)
Financial income (expenses), net (Note 13) 221 102 23 70 (595)
-------------- --------------- -------------- ------------- -------------
Net loss ($ 2,937) ($ 4,260) ($ 6,010) ($ 4,690) ($ 6,068)
============== =============== ============== ============= =============
Basic and diluted net loss per share ($5.08) ($6.22) ($8.50) ($6.63) ($8.16)
============== =============== ============== ============= =============
Weighted average number of shares
used in computing basic and diluted
loss per share 578,308 684,902 706,900 706,900 743,215
============== =============== ============== ============= =============
</TABLE>
The accompanying notes are an integral part of the financial statements.
26
<PAGE>
TELEGATE LTD.
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIENCY)
- --------------------------------------------------------------------------------
U.S. dollars in thousands, except share data
<TABLE>
<CAPTION>
Total
Additional shareholders'
paid-in Deferred Accumulated equity
Share capital capital compensation deficit (deficiency)
-------------------- ---------- ------------ ------------ -----------
Number of
shares Amount
---------- --------
<S> <C> <C> <C> <C> <C> <C>
Balance as of January 1, 1996 447,779 $15 $ 3,322 $ - $ (2,387) $ 950
Deferred compensation related to stock-based
options granted to employees - - 1,674 (1,674)
Amortization of deferred compensation - - - 940 - 940
Issuance of shares, net 179,829 6 3,107 - - 3,113
Conversion of a convertible loan into shares, net 37,681 1 923 - - 924
Net loss - - - - (2,937) (2,937)
---------- -------- ---------- ------------ ------------ -----------
Balance as of December 31, 1996 665,289 22 9,026 (734) (5,324) 2,990
Deferred compensation related to stock-based
options granted to employees - - (10) 10
Amortization of deferred compensation - - - 362 - 362
Conversion of a convertible loan into shares, net 41,611 1 553 - - 554
Net loss - - - - (4,260) (4,260)
---------- -------- ---------- ------------ ------------ -----------
Balance as of December 31, 1997 706,900 23 9,569 (362) (9,584) (354)
Amortization of deferred compensation - - - 253 - 253
Net loss - - - - (6,010) (6,010)
---------- -------- ---------- ------------ ------------ -----------
Balance as of December 31, 1998 706,900 23 9,569 (109) (15,594) (6,111)
Conversion of convertible loans into shares, net 129,698 3 2,767 - - 2,770
Deferred compensation related to stock-based
options granted to employees and bank - - 556 (556)
Amortization of deferred compensation - - - 365 - 365
Net loss - - - - (6,068) (6,068)
---------- -------- ---------- ------------ ------------ -----------
Balance as of September 30, 1999 (Unaudited) 836,598 $26 $12,892 $ (300) $(21,662) $(9,044)
========== ======== ========== ============ ============ ===========
</TABLE>
The accompanying notes are an integral part of the financial statements.
27
<PAGE>
TELEGATE LTD.
STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
U.S. dollars in thousands
<TABLE>
<CAPTION>
Year ended Nine months ended
December 31, September 30,
------------------------------------------------ -------------------------------
1996 1997 1998 1998 1999
------------ ------------- ------------- ------------- -------------
Unaudited
-------------------------------
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
- -----------------------------------------
Net loss $(2,937) $(4,260) $(6,010) $(4,690) $ (6,068)
Adjustments to reconcile net loss to net
cash used in operating activities:
Amortization of deferred compensation 940 362 253 204 365
Depreciation 110 211 411 294 418
Loss (gain) on sale of property and
equipment - (1) (2) 2 -
Increase in accrued severance pay, net 38 70 109 126 94
Decrease in value of marketable
securities 7 221 - - -
Increase of accrued interest on
convertible loans - - 193 124 349
Increase in trade receivables - related
parties - - (320) (39) (1,341)
Decrease (increase) in government
grants receivable (90) 112 (99) (468) (1,325)
Decrease (increase) in other accounts
receivable (110) 18 99 (214) (319)
Increase in inventories - - (1,210) (2,149) (3,489)
Increase in trade payables 142 455 589 1,467 758
Increase in employees and payroll
accruals 95 230 250 373 187
Increase (decrease) in advances from
a customer - related party - - 385 1,122 (385)
Increase in other accounts payable 29 6 291 34 65
------------ ------------- ------------- ------------- -------------
Net cash used in operating activities (1,776) (2,576) (5,061) (3,814) (10,691)
------------ ------------- ------------- ------------- -------------
Cash flows from investing activities:
- -------------------------------------
Purchase of property and equipment (269) (597) (1,110) (1,013) (447)
Proceeds from sale of property and
equipment - 19 51 51 18
------------ ------------- ------------- ------------- -------------
Net cash used in investing activities (269) (578) (1,059) (962) (429)
------------ ------------- ------------- ------------- -------------
</TABLE>
The accompanying notes are an integral part of the financial statements.
28
<PAGE>
TELEGATE LTD.
STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
U.S. dollars in thousands
<TABLE>
<CAPTION>
Year ended Nine months ended
December 31, September 30,
------------------------------------------------- -------------------------------
1996 1997 1998 1998 1999
------------ ------------- -------------- ------------- -------------
Unaudited
-------------------------------
<S> <C> <C> <C> <C> <C>
Cash flows from financing activities:
- -------------------------------------
Proceeds from issuance of shares, net 3,113 - - - -
Short-term bank credit, net - - 21 999 642
Short-term bank loans - - 1,135 1,196 980
Proceeds from convertible loans 1,720 1,960 2,940 540 9,150
Issuance expenses related to conversion
of shareholders' loan into shares (9) (6) - - (27)
------------ ------------- -------------- ------------- -------------
Net cash provided by financing activities 4,824 1,954 4,096 2,735 10,745
------------ ------------- -------------- ------------- -------------
Increase (decrease) in cash and cash
equivalents 2,779 (1,200) (2,024) (2,041) (375)
Cash and cash equivalents at the
beginning of the period 830 3,609 2,409 2,409 385
------------ ------------- -------------- ------------- -------------
Cash and cash equivalents at the
end of the period $3,609 $ 2,409 $ 385 $ 368 $ 10
============ ============= ============== ============= =============
Non-cash transactions:
- ----------------------
Conversion of convertible loans into
shares $ 933 $ 560 $ - $ - $ 2,797
============ ============= ============== ============= =============
Supplemental disclosure of cash flows
- -------------------------------------
activities:
-----------
Cash paid during the year for interest $ 1 $ - $ 66 $ 21 $ 231
============ ============= ============== ============= =============
</TABLE>
The accompanying notes are an integral part of the financial statements.
29
<PAGE>
TELEGATE LTD.
NOTES TO FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
U.S. dollars in thousands
NOTE 1:- GENERAL
a. Telegate Ltd. ("the Company") was incorporated on May 6, 1993, under
the name Capitec (1993) Ltd. In 1994, the Company changed its name
to Telegate Ltd.
The Company is engaged in the research, development, manufacturing
and marketing of local access systems that interface and transport
public telecommunications services over existing Cable TV
infrastructures.
The Company is dependent upon sole source of suppliers for the
production of a modem, which is a key component used in its product.
b. The Company's ability to continue to operate is dependent upon
additional financial support until profitability is achieved.
c. As of December 31, 1998, the Company shareholders' deficiency was
$ 6,111 and its working capital deficiency was $ 1,778. In 1998, the
Company had a loss of $ 6,010 and a negative cash flow from
operating activities of $ 5,061. The Company's management
anticipates a negative cash flow from operating activities in 1999,
in the amount of approximately $ 2,500, and considers that the
Company will require additional financing in order to finance its
activities in the future. Accordingly, there is substantial doubt
whether the Company is able to continue as a going concern.
Management's plans to address these issues include the following:
In the near future, the Company expects to sign a convertible loans
agreement in the aggregate amount of $ 7,000 with several new
investors.
In addition, the Company is in the process of raising additional
$ 6,000 - $ 10,000 from an investment bank.
Management believes that existing cash balances, expected operating
results and the anticipated sources of financing will be sufficient
to support operations over the next twelve months.
The accompanying financial statements have been prepared assuming
that the Company will continue as a going concern and accordingly do
not include any adjustments relating to the recoverability and
classification of asset carrying amounts or the amount and
classification of liabilities or reclassifications which might be
necessary should management be unable to satisfactorily execute its
plans which then may result in the Company's inability to continue
as a going concern.
30
<PAGE>
TELEGATE LTD.
NOTES TO FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
U.S. dollars in thousands
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES
a. Use of estimates:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from
those estimates.
b. Financial statements in U.S. dollars:
Company's management believes that the U.S. dollar is the currency
of the primary economic environment in which it operates. Therefore,
the functional and reporting currency for the Company is the U.S.
dollar.
The Company's transactions and balances denominated in U.S. dollars
are presented at their original amounts. Non-dollar transactions and
balances have been remeasured to U.S. dollars in accordance with
Statement No. 52 of the Financial Accounting Standards Board
("FASB"). All transaction gains and losses from remeasurement of
monetary balance sheet items denominated in non-dollar currencies
are reflected in the statements of operations as financial income or
expenses, as appropriate. Certain amounts in the dollar financial
statements may represent the dollar equivalent of other currencies,
including new Israeli shekels (NIS), and may not be exchangeable for
dollars.
c. Cash and cash equivalents:
The Company considers all highly liquid investments originally
purchased with maturities of three months or less to be cash
equivalents.
d. Marketable securities:
In accordance with Statement of Financial Accounting Standards No.
115, "Accounting for Certain Investments in Debt and Equity
Securities" ("SFAS 115"), the Company has classified its marketable
debt into trading category. Under SFAS 115 marketable securities
classified as trading are stated according to the quoted market
prices as of balance sheet date.
Gains and losses (realized and unrealized) related to trading
securities as well as interest on such securities are included in
"financial income (expenses), net".
31
<PAGE>
TELEGATE LTD.
NOTES TO FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
U.S. dollars in thousands
e. Inventories:
Inventories are valued at the lower of cost or market value. Cost is
determined as follows:
Raw materials and components - on the moving average basis.
Work in progress and finished products:
Raw materials and components - on the moving average basis.
Labor, overhead and subcontracted work - on the basis of actual
costs.
Periodically, the Company evaluates the quantities on hand relative
to current selling prices and historical and forecasted sales
volume. Based on these evaluations, provisions are made in each
period to write inventory down to its net realizable value, which
establishes a new cost basis.
f. Property and equipment:
Property and equipment are stated at cost. Depreciation is
calculated using the straight-line method over the estimated useful
lives, at the following annual rates:
<TABLE>
<CAPTION>
%
--------------------------
<S> <C>
Computers and peripheral equipment 7 - 33
Machinery and engineering equipment 15 - 20
Motor vehicles 15
Office furniture and equipment 7 - 15
Leasehold improvements Over the term of the lease
</TABLE>
g. Income taxes:
The Company accounts for income taxes in accordance with Statement
of Financial Accounting Standards (SFAS) 109, "Accounting for Income
Taxes". This statement prescribes the use of the liability method
whereby deferred tax asset and liability account balances are
determined based on differences between financial reporting and tax
bases of assets and liabilities and are measured using the enacted
tax rates and laws that will be in effect when the differences are
expected to reverse. The Company provides a valuation allowance, if
necessary, to reduce deferred tax assets to their estimated
realizable value.
h. Revenue recognition:
Revenues from sales are recognized upon shipment when no significant
obligations remain on the part of the Company and the collection of
the related receivable is probable. Generally, the Company does not
have any significant obligations after delivery.
32
<PAGE>
TELEGATE LTD.
NOTES TO FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
U.S. dollars in thousands
i. Warranty costs:
A provision for warranty costs is calculated and provided based on a
percentage of sales.
j. Advertising expenses:
Advertising expenses are charged to expenses, as incurred.
Advertising expenses for the years ended 1996, 1997 and 1998 were
not material.
k. Research and development costs:
Research and development costs are charged to expenses as incurred.
l. Royalty-bearing grants:
Royalty-bearing grants from the Government of Israel and others for
funding of approved research projects are recognized at the time the
Company is entitled to such grants on the basis of the related costs
incurred. (see Note 12).
m. Concentrations of credit risk:
SFAS No. 105, "Disclosure of Information About Financial Instruments
with Off-Balance-Sheet Risk and Financial Instruments with
Concentrations of Credit Risk", requires disclosure of any
significant Off-Balance-Sheet and credit risk concentrations. The
Company has no significant Off-Balance-Sheet concentration of credit
risk such as foreign exchange contracts, option contracts or other
foreign hedging arrangements.
Financial instruments that potentially subject the Company to
concentrations of credit risk consist principally of cash and cash
equivalents and trade receivables.
The Company's cash and cash equivalents are invested in deposits
with major Israeli banks. Management believes that the financial
institutions that hold the Company's investments are financially
sound, and accordingly, minimal credit risk exists with respect to
these investments.
The Company's trade receivables are derived from sales to a
shareholder. The Company performs ongoing credit evaluations of its
shareholders debt and, to date, has not experienced any material
losses.
33
<PAGE>
TELEGATE LTD.
NOTES TO FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
U.S. dollars in thousands
n. Severance pay:
The Company's liability for severance pay is calculated pursuant to
Israeli severance pay law based on the most recent salary of the
employees multiplied by the number of years of employment, as of the
balance sheet date. Employees are entitled to one month's salary for
each year of employment or a portion thereof. The Company's
liability for all of its employees, is fully provided by monthly
deposits with severance pay funds, insurance policies and by an
accrual.
The deposited funds include profits accumulated up to the balance
sheet date. The deposited funds may be withdrawn only upon the
fulfillment of the obligation pursuant to Israeli severance pay law
or labor agreements. The value of the deposited funds is based on
the cash surrendered value of these policies, and includes
immaterial profits.
o. Accounting for stock-based compensation:
The Company has chosen to account for stock-based compensation in
accordance with the provisions of Accounting Principles Board
Opinion No. 25 ("APB-25"), "Accounting for Stock issued to
Employees". Under APB-25, when the exercise price of the Company's
stock options equals the market price of the underlying stock on the
date of grant, no compensation expense is recognized.
Financial Accounting standards Board Statement No. 123 "Accounting
for Stock Based Compensation" (SFAS 123") requires the use of option
valuation model to measure the fair value of the options at the
grant date. The proforma disclosures required by Statement 123, are
provided in Note 9b.
p. Fair value of financial instruments:
The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments:
Cash and cash equivalents, trade receivables, short-term bank credit
and trade payables- The carrying amounts of these items approximate
their fair value due to the short-term maturity of such instruments.
Short-term loans - The carrying amounts of the Company's borrowing
arrangements approximate their fair value. Fair values were
estimated using discounted cash flow analyses, based on the
Company's incremental borrowing rates for similar types of borrowing
arrangements.
34
<PAGE>
TELEGATE LTD.
NOTES TO FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
U.S. dollars in thousands
q. Comprehensive income:
As of January 1, 1998, the Company adopted Statement 130, "Reporting
Comprehensive Income". Statement 130 establishes new rules for the
reporting and display of comprehensive income and its components.
The adoption of this Statement had no impact on the Company's net
income or shareholders' equity for the years ended December 31,
1996, 1997 and 1998.
r. Future adoption of new accounting standard:
In June 1998, the Financial Accounting Standards Board issued SFAS
No.133, "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS No. 133"). This Statement establishes accounting
and reporting standards requiring that every derivative instrument
(including certain derivative instruments embedded in other
contracts) be recorded in the balance sheet as either an asset or
liability measured at its fair value. The Statement also requires
that changes in the derivative's fair value be recognized currently
in earnings unless specific hedge accounting criteria are met.
Special accounting for qualifying hedges allows a derivative's gains
and losses to offset related results on the hedged item in the
income statement, and requires that a company must formally
document, designate and assess the effectiveness of transactions
that receive hedge accounting. SFAS No. 133 is effective for fiscal
years beginning after June 15, 2000 and cannot be applied
retroactively. The Company does not expect that this new Statement
will have any material impact on the Company's consolidated balance
sheets or results of operations.
s. Unaudited interim financial information
The accompanying financial statements at September 30, 1999 and for
the nine months ended September 30, 1998 and 1999 are unaudited but
include all adjustments (consisting of normal recurring accruals)
which, in the opinion of management, are necessary for a fair
statement of the financial position and the operating results and
cash flows for the interim date and periods presented. These
financial statements have also been prepared in conformity with
generally accepted accounting principles in the United States.
Results for the interim period ended September 30, 1999 are not
necessarily indicative of results for the entire fiscal year or
future periods.
NOTE 3:- INVENTORIES
<TABLE>
<CAPTION>
December 31,
------------------ September 30,
1997 1998 1999
------- ------- --------------
Unaudited
--------------
<S> <C> <C> <C>
Raw materials and components $ - $ 937 $3,362
Work-in-progress - 203 817
Finished products - 70 520
------- ------- --------------
$ - $1,210 $4,699
======= ======= ==============
</TABLE>
35
<PAGE>
TELEGATE LTD.
NOTES TO FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
U.S. dollars in thousands
NOTE 4:- PROPERTY AND EQUIPMENT
<TABLE>
<CAPTION>
December 31,
------------------------------------------
1997 1998
------------------ -----------------
<S> <C> <C>
Cost:
Computers and peripheral equipment $ 547 $1,135
Machinery and engineering equipment 382 799
Motor vehicles 231 131
Office furniture and equipment 67 114
Leasehold improvements 71 131
------------------ -----------------
1,298 2,310
------------------ -----------------
Accumulated depreciation:
Computers and peripheral equipment 212 462
Machinery and engineering equipment 97 205
Motor vehicles 75 54
Office furniture and equipment 11 19
Leasehold improvements 5 22
------------------ -----------------
400 762
------------------ -----------------
Depreciated cost $ 898 $1,548
================== =================
</TABLE>
NOTE 5:- SHORT-TERM BANK CREDIT AND SHORT-TERM BANK LOANS
a. The Company received two NIS denominated banks loans. The loans bear
annual interest rate of prime and prime minus 0.75%, and are to be
repaid on an on-call basis during 1999.
b. As of December 31, 1998, the Company has an authorized line of
credit in the amount of $ 2,500, of which dollar denominated credit
bears interest at the rate of Libor + 1% and NIS denominated credit
bears interest at the prime rate minus 0.75% to prime rate +3%.
The weighted average interest rate of the line of credit as of
December 31, 1998 was approximately 7-9%.
The Company had an unused line of credit in the amount of $ 1,326
for December 31, 1998 (there is no fee for the unused portion of the
line of credit).
36
<PAGE>
TELEGATE LTD.
NOTES TO FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
U.S. dollars in thousands
NOTE 6:- OTHER ACCOUNTS PAYABLE
<TABLE>
<CAPTION>
December 31,
------------------------------------------
1997 1998
------------------ -----------------
<S> <C> <C>
Due to Office of the Chief Scientist
and the BIRD-F *) $ 44 $ 149
Tax authorities - 116
Related parties **) 32 32
Accrued expenses 5 75
------------------ -----------------
$ 81 $ 372
================== =================
</TABLE>
*) See Note 10a
**) See Note 14b.
NOTE 7:- ACCRUED SEVERANCE PAY
The Company's liability for severance pay, pursuant to Israeli law, is
fully provided by an accrual. Part of the liability is funded through
insurance policies. The cash value of these policies is recorded as an
asset in the Company's balance sheets.
Severance expenses for the three years ended December 31, 1996, 1997 and
1998 amounted to approximately $ 113, $ 195 and $ 322, respectively.
NOTE 8:- CONVERTIBLE LOANS
a. In April 1998, the Company received a loan from one of its
shareholders in the amount of $ 540. The loan is in addition to
those received during 1997, in the aggregate amount of $ 1,960.
The loan shall be convertible into preferred shares upon the earlier
of:
1. Sale of over 50% of the Company's issued share capital to other
than existing shareholders of the Company.
2. An IPO (or future private placement) of the Company's shares of
not less than $ 5,000.
3. Three years after they were received.
The loan is linked to the U.S. dollar, bears interest at the rate of
LIBOR + 1.5%, and matures three years after the date of grant,
provided that conversion has not taken place prior to such date.
The preferred shares will have all the rights of the ordinary shares
of the Company and will also have antidilution rights liquidation
preference and preemptive, registration and come along rights.
37
<PAGE>
TELEGATE LTD.
NOTES TO FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
U.S. dollars in thousands
b. In October and November 1998, the Company received loans from
another shareholder in an aggregate amount of $ 2,400. The loan is
linked to the U.S. dollar, and bears annual interest at the rate of
Libor+2.5%.
In the event of issuing of equity securities, excluding exercise of
options or the conversion of loans ("Financing"), the loan shall be
convertible into shares of the same class and under the same terms
as determined in the Financing, except for the price per share,
which will be 75% of the price per share of the Financing.
Any part of the loan not converted, will be payable upon the earlier
of December 1, 1998, or 15 days after the closing of a financing
arrangement. In the event a Financing does not occur, such amounts
will be payable no later than September 15, 1999. As of December 31,
1998, the loans were neither converted nor repaid.
NOTE 9:- SHARE CAPITAL
Stock options to employees:
a. According to the Company's stock option plan to employees ("the
plan"), 120,000 options may, from time to time, be granted to
employees of the Company. As of December 31, 1998, an aggregate of
31,557 options of the Company are still available for future grant.
Most of the options vest over a period of 4 years ending on various
dates.
Any options which are canceled or not exercised before expiration
become available for future grant.
An option must be granted within ten years from the date the plan is
adopted and expires no later than ten years from the date of grant.
A summary of the Company's share option activity under the Plan is
as follows:
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------------------------------------------------------
1996 1997 1998
--------------------- ------------------------ ----------------------
Weighted Weighted Weighted
Number average Number average Number average
of exercise of exercise of exercise
options price options price options price
-------- ---------- ------------ --------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
Options outstanding at the
beginning of the year - $ - 89,168 $ 5.99 88,468 $ 5.96
Granted 89,168 5.99 - - - -
Exercised - - - - - -
Forfeited - - (700) 10.00 (25) 10.00
-------- ---------- ----------- -------- --------- ----------
Options outstanding at the
end of the year 89,168 $ 5.99 88,468 $ 5.96 88,443 $ 5.96
======== ========== =========== ======== ========= ==========
Options exercisable 54,892 4.75 76,243 5.31 83,243 5.71
======== ========== =========== ======== ========= ==========
</TABLE>
38
<PAGE>
TELEGATE LTD.
NOTES TO FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
U.S. dollars in thousands, except per share data
The options outstanding as of December 31, 1998 have been separated
into ranges of exercise price, as follows:
<TABLE>
<CAPTION>
Options Weighted
outstanding average Options
as of remaining exercisable as Weighted
Exercise December 31, contractual of December 31, average
price 1998 life 1998 exercise price
- --------------------------------- ----------------- ----------------- ------------------ -----------------
<S> <C> <C> <C> <C>
$ 0.03 32,501 7 32,501 $ 0.03
$ 5.00 6,667 7 6,667 $ 5.00
$ 10.00 49,275 7 44,075 $10.00
- --------------------------------- ----------------- ----------------- ------------------ -----------------
$ 0.03-$ 10 88,443 7 83,243 $ 5.96
================================= ================= ================= ================== =================
</TABLE>
b. Pro forma information regarding net loss is required by SFAS 123,
which also requires that the information be determined as if the
Company has accounted for its employee stock options under the fair
value method of that Statement. The fair value for these awards was
estimated at the date of grant using the minimum value options
pricing model. The minimum value options pricing valuation model was
developed for use in estimating the fair value of options that have
no vesting restrictions and are fully transferable. Option valuation
models require the input of highly subjective assumptions. Because
the Company's stock-based awards have characteristics significantly
different from those of traded options and because changes in the
subjective input assumptions can materially affect the fair value
estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of
its stock-based awards. The fair value of these options was
estimated at the date of grant using the minimum value method option
pricing model with the following weighted-average assumptions for
1996: risk-free interest rates of approximately 6%, no dividend
yield; and a weighted-average expected life of the option of
approximately 5 years for all options.
The weighted average grant date fair value of options granted for
the year ended December 31, 1996, was $ 20.23.
Pro-forma information under SFAS No. 123 is as follows:
<TABLE>
<CAPTION>
Year ended December 31,
---------------------------------------------------
1996 1997 1998
-------------- -------------- ---------------
<S> <C> <C> <C>
Net loss $2,937 $4,260 $6,010
============== ============== ===============
Pro-forma net loss $2,993 $4,296 $6,037
============== ============== ===============
Pro-forma basic and diluted loss per share $ 5.18 $ 6.27 $ 8.54
============== ============== ===============
</TABLE>
39
<PAGE>
TELEGATE LTD.
NOTES TO FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
U.S. dollars in thousands
NOTE 10:- CONTINGENT LIABILITIES AND COMMITMENTS
a. Royalties:
(i) Under the Company's research and development agreements with
the Office of the Chief Scientist ("OCS") and pursuant to
applicable law, the Company is required to pay royalties at
the rate of 3% to 5% of sales of products developed with
funds provided by the OCS, up to an amount equal to 100% of
the OCS's research and development grants (dollar-linked)
related to such projects.
Repayment of such grants is not required, in the event that
there are no sales of products with respect to such grants.
For the years ended December 31, 1997 and 1998, the Company
recognized grants in the amounts of $ 1,662 and $ 2,173,
respectively, which are presented in the financial statements
as an offset to research and development costs.
(ii) The Company is committed to pay royalties of 2.5% to the
Israeli-U.S. Binational Industrial Research and Development
Foundation ("BIRD-F") on proceeds from sales of any product
arising from the research and development project, up to the
amount of 100%-150% of the grant. The Company received a
grant in the amount of $ 111.
(iii) The Company has expensed royalties relating to the repayment
of such grants in the amount of $ 0, $ 0 and $ 107 for the
years ended December 31, 1996, 1997 and 1998, respectively.
(iv) As of December 31, 1998, the Company has a contingent
obligation to pay royalties in the amount of $ 6,331, in
respect of the aforementioned grants and participations
received from the OCS and the BIRD-F.
b. Charges and guarantees:
The Company has floating charges in favor of two banks on its
property, assets and insurance rights, and also a fixed charge on
its share capital and goodwill.
c. Lease commitments:
The Company's premises are rented from a related party, under an
operating lease, for a period until August 31, 2003, including a
renewal option.
The future minimum lease commitment, under a non-cancelable
operating lease is $ 264, annually.
Total rent expenses for the years ended December 31, 1996, 1997 and
1998, were approximately $ 33, $ 172 and $ 216, respectively.
40
<PAGE>
TELEGATE LTD.
NOTES TO FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
U.S. dollars in thousands
NOTE 11:- TAXES ON INCOME
a. Tax benefits under the Law for the Encouragement of Capital
Investments, 1959 (hereinafter - "the law"):
According to the provisions of this law, the Company has chosen to
enjoy "alternative benefits" - waiver of grants in return for a tax
exemption - and, accordingly, the Company's income is tax-exempt for
a period of two years commencing with the year it first earns
taxable income. In the remaining five years of benefits, the Company
will be subject to a corporate tax of 25%. The period of tax
benefits has not commenced yet.
The period of tax benefits, detailed above, is subject to limits of
12 years from the commencement of production, or 14 years from the
approval date (which is December 29, 1996), whichever is earlier.
If a dividend is distributed out of such tax-exempt profits, the
Company will be liable for corporate tax at the rate of 25%.
The law also grants entitlement to claim accelerated depreciation on
buildings, machinery and equipment used by the "approved
enterprise", during five tax years.
Should the Company derive income from sources other than the
approved enterprises during the relevant period of benefits, such
income will be taxable at regular corporate tax rate of 36%.
b. Measurement of results for tax purposes under the Income Tax Law
(Inflationary Adjustments), 1985.
Results for tax purposes are measured in terms of earnings in NIS
after certain adjustments for increases in the Israeli CPI. As
explained in Note 2b, the financial statements are presented in US
dollars. The difference between the annual change in the CPI and in
the NIS\dollar exchange rate causes a difference between taxable
income and the income before taxes shown in the financial
statements. In accordance with paragraph 9(f) of SFAS No. 109, the
Company has not reserved for deferred income taxes on the difference
between the reporting currency and the tax bases of assets and
liabilities.
41
<PAGE>
TELEGATE LTD.
NOTES TO FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
U.S. dollars in thousands
c. Deferred income taxes:
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities
for financial reporting purposes and the amounts used for income tax
purposes. Significant components of the Company's deferred tax are
as follows:
<TABLE>
<CAPTION>
December 31,
------------------------------------------
1997 1998
------------------ ------------------
U.S. dollars
------------------------------------------
<S> <C> <C>
Operating loss carryforwards $ 2,996 $ 4,715
Reserves and allowances 153 235
------------------ ------------------
Net deferred tax asset before valuation allowance 3,149 4,950
Valuation allowance (3,149) (4,950)
------------------ ------------------
Net deferred tax asset $ - $ -
================== ==================
</TABLE>
The Company has provided valuation allowances against the deferred
tax assets in respect of its tax loss carryforwards and other
temporary differences due to a history of losses and uncertainty
concerning its ability to realize these deferred tax assets in the
future.
d. Carryforward losses:
As of December 31, 1998 the Company has approximately $ 13,400 in
losses to offset against future taxable income.
e. Final tax assessments:
The Company has not received final tax assessments since its
incorporation.
NOTE 12:- RESEARCH AND DEVELOPMENT EXPENSES
<TABLE>
<CAPTION>
Year ended December 31,
-------------------------------------------------------
1996 1997 1998
--------------- --------------- ---------------
<S> <C> <C> <C>
Total cost $ 3,474 $ 5,024 $ 6,833
Less - royalty-bearing grant (Note 10a) (1,238) (1,662) (2,173)
--------------- --------------- ---------------
$ 2,236 $ 3,362 $ 4,660
=============== =============== ===============
</TABLE>
42
<PAGE>
TELEGATE LTD.
NOTES TO FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
U.S. dollars in thousands
NOTE 13: FINANCIAL INCOME
<TABLE>
<CAPTION>
Year ended December 31,
-------------------------------------------------------
1996 1997 1998
--------------- --------------- ---------------
<S> <C> <C> <C>
Financial expenses:
Interest $ (1) $ (15) $(258)
Other expenses (2) (4) (8)
Foreign currency translation differences (40) (66) (223)
--------------- --------------- ---------------
(43) (85) (489)
--------------- --------------- ---------------
Financial income:
Interest 248 116 60
Gain from marketable securities 16 33 -
Foreign currency translation differences - 38 452
--------------- --------------- ---------------
264 187 512
--------------- --------------- ---------------
Financial income, net $ 221 $ 102 $ 23
=============== =============== ===============
</TABLE>
NOTE 14:- TRANSACTIONS AND BALANCES WITH RELATED PARTIES
All of the Company's sales are made to its sole customer through a
company who is also a 28% shareholder in the Company.
a. Transactions with related parties:
<TABLE>
<CAPTION>
Year ended December 31,
------------------------------------------------------
1996 1997 1998
---------------- --------------- ---------------
<S> <C> <C> <C>
Revenues $ - $ - $3,569
Rent and maintenance $ 119 $ 252 $ 270
Subcontractors $ - $ - $ 139
Interest $ - $ 14 $ 193
</TABLE>
b. Balances with related parties:
<TABLE>
<CAPTION>
December 31,
------------------------------------------------------
1996 1997 1998
---------------- --------------- ---------------
<S> <C> <C> <C>
Trade receivables $ - $ - $320
Advances from a customer $ - $ - $385
Other accounts payable $ - $ $ 32
</TABLE>
43
<PAGE>
TELEGATE LTD.
NOTES TO FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
U.S. dollars in thousands, except per share data
NOTE 15:- SUBSEQUENT EVENTS
a. Line of credit:
During the first quarter of 1999, the Company increased its line of
credit from banks to $ 3,000.
In connection with one of the credit lines, the Company issued to a
subsidiary of Bank Hapoalim B.M., a warrant to purchase Ordinary
shares of the Company. The warrant is exercisable into the number of
ordinary shares totaling $ 500 according to the price per share paid
by purchasers of the Company's securities in one of the following
events ("Liquidity Events") less a discount of twenty percent of the
event price:
1. Issuance of equity securities, excluding exercise of options to
employees.
2. An Initial Public Offering ("IPO").
3. Sale of all or substantially all of the Company's property and
assets.
4. Merger or consolidation with or into another corporation.
If a Liquidity Event will not take place until February 2000 the
exercise price will be determined according to several conditions as
described in the agreement. If a liquidity event does not occur
until February 2002, the warrant can be exercise at an exercise
price of $ 58 per warrant during the following thirty days.
b. On July 8, 1999, the Company entered into a convertible loans
agreement ("the agreement") with one existing shareholder and with
several new investors, in the aggregate amount of $ 11,694 (such
amount includes loans which were received prior to executing the
agreement, as described below, and an accrued interest in the amount
of $ 144).
The loans are denominated in dollars and bear annual interest at the
rate of 5%, payable annually on December 31, of each calendar year
commencing on December 31, 1999.
The loans shall be due on December 31, 2002 ("the repayment date")
and shall be convertible, including accrued but unpaid interest, at
any time until the repayment date. The loans shall be converted into
the number of issued and outstanding Ordinary shares equal to the
principal amount of the loan divided by the conversion price, which
is $ 40.6 per share, subject to adjustments set forth in the
agreement.
The conversion price regarding $ 2,400 received during the fourth
quarter of 1998, shall at all times and in any event be equal to 75%
of the applicable conversion price (see Note 8b).
44
<PAGE>
TELEGATE LTD.
NOTES TO FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
U.S. dollars in thousands, except per share data
The aggregate principal amount of loans is composed as follows:
(1) $ 7,000 were received during the third quarter of 1999 from new
investors:
(2) $ 2,150 were received during the second quarter of 1999 from an
existing shareholder.
(3) $ 2,400 were received during the fourth quarter of 1998 from an
existing shareholder.
In addition, the Company granted options Series A,B,C and D to the
shareholder and to the new investors. The exercise price of the
options and the number of options are dependent upon the volume of
sales of the Company during the years 1999 and 2000, as determined
in the agreement.
The options are exercisable upon the earlier of:
(1) Series A and C: December 31, 2001; Series B and D: December 31,
2002.
(2) The initial offering of Company's shares to the public.
(3) A merger or acquisition pursuant to which the Company is not the
surviving entity.
c. On July 15, 1999, shareholders' loans in the aggregate amount of $
2,797, including accrued interest in the amount of $ 297 thousand
were converted into 129,698 Ordinary shares of the Company.
d. On October 2, 1999, the Company reached an investment agreement
whereby an investor will invest $ 6,500 in the Company in
consideration for 240,741 Ordinary shares.
In addition, the Company granted warrants to the investor for the
purchase of Ordinary shares, entitling the investor to purchase
214,500 Ordinary shares at an exercise price of $ 35 per share
during the period from date of agreement until the earlier of:
1. The initial offering of Company's shares to the public.
2. The sale of substantially all of the assets or the shares of the
Company.
3. December 31, 2001.
e. On October 14, 1999 the Company's shareholders signed a share
purchase agreement with Terayon Communication Systems, Inc.
("Terayon") pursuant to which Terayon will acquire all of their
shares and related warrants in the Company in consideration of
2,200,000 shares of Terayon plus cash equal to the Company's net
cash as of the closing date less $ 2,000.
45
<PAGE>
(b) Terayon Communication Systems, Inc. unaudited pro forma combined financial
statements.
The following unaudited pro forma combined condensed financial statements give
effect to the Terayon Communication Systems, Inc. ("Terayon") acquisition of
Radwiz Ltd. ("Radwiz") through a merger and exchange of shares that was
completed on November 22, 1999 ("the Radwiz merger") and the acquisition of
Telegate Ltd. ("Telegate") through a merger and exchange of shares expected to
close on or about December 27, 1999 ("the Telegate merger"). In addition, the
unaudited pro forma combined condensed financial statements give effect to the
Terayon Communication Systems, Inc. acquisition of Imedia Corporation ("Imedia")
through a merger and exchange of shares that was completed on September 16,
1999.
TERAYON COMMUNICATION SYSTEMS, INC.
UNAUDITED PRO FORMA COMBINED CONDENSED BALANCE SHEET
AS OF SEPTEMBER 30, 1999
(in thousands)
<TABLE>
<CAPTION>
Terayon Radwiz Telegate Pro-forma
Actual Actual Actual Adjustments Total
----------- ---------- ------------ ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 23,971 $ 3,561 $ 10 $ (250) (3) $ 24,292
(3,000) (12)
Short-term investments 82,287 4 - 82,291
Accounts receivable, net 9,323 150 - - 9,473
Accounts receivable from related party 2,705 - 1,661 - 4,366
Government Grants Receivable - 428 1,656 - 2,084
Inventory 5,530 505 4,699 - 10,734
Other current assets 2,662 159 331 - 3,152
----------- ---------- ------------ ------------ -----------
Total current assets 126,478 4,807 8,357 (3,250) 136,392
Property and equipment, net 5,798 546 1,559 7,903
Developed technology 26,812 - - 29,850 (1) 77,762
21,100 (8)
Assembled workforce 2,448 - - 2,800 (1) 9,448
4,200 (8)
Trademark 3,972 - - 1,150 (1) 5,122
Customer Relationship - - - 39,530 (8) 39,530
Restricted Cash - - - - -
Other assets 1,842 131 565 - 2,538
Goodwill 63,390 - - 23,145 (1) 156,302
69,767 (8)
----------- ---------- ------------ ------------ -----------
Total assets $ 230,740 $ 5,484 $ 10,481 $188,292 $ 434,997
=========== ========== ============ ============ ===========
Liabilities and Stockholders' Equity
Current liabilities:
Current portion long-term debt $ - $ 12 $ - $ - $ 12
Short-term bank credit - - 663 - 663
Short-term bank loan - - 2,115 - 2,115
Accounts payable 14,708 506 2,090 - 17,304
Accrued payroll and related expenses 3,751 444 978 - 5,173
Other accrued liabilities 9,626 214 437 600 (2) 12,202
1,325 (9)
Current portion of capital lease obligations 5 - - - 5
----------- ---------- ------------ ------------ -----------
Total current liabilities 28,090 1,176 6,283 1,925 37,474
Deferred tax liabilities - - - 10,998 (7) 10,998
167 (17) 167
Long-term obligations 134 34 - 168
Accrued severance pay - 252 907 - 1,159
Convertible loans - 12,335 (12,335)(10) -
Stockholders' equity (deficiency):
Common stock 333,657 13,510 12,918 302 (2) 526,522
52,417 (3)
(13,510) (3)
604 (9)
12,335 (10)
139,542 (11)
(25,253)(11)
Accumulated deficit (129,424) (8,852) (21,662) 8,852 (4) (139,774)
(3,600) (4)
21,662 (13)
(6,750)(13)
Deferred compensation (1,711) (636) (300) 636 (6) (1,711)
300 (15)
Stockholders' notes receivable (6) - - - (6)
----------- ---------- ------------ ------------ -----------
Total stockholders' equity (deficiency) 202,516 4,022 (9,044) 187,537 385,031
----------- ---------- ------------ ------------ -----------
Total liabilities and stockholders' equity $ 230,740 # $ 5,484 $ 10,481 $188,292 $ 434,997
=========== ========== ============ ============ ===========
</TABLE>
See notes to unaudited pro forma combined condensed financial statements.
46
<PAGE>
TERAYON COMMUNICATION SYSTEMS, INC.
UNAUDITED PRO FORMA COMBINED CONDENSED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1998
(in thousands, except per share amounts)
<TABLE>
Terayon Radwiz Telegate Imedia Pro-forma
Actual Actual Actual Actual Adjustments Total
------------ ---------- --------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Product revenues $ 19,150 $ 3,058 $ - $ - $ (1,728) (16) $ 20,480
Related party product revenues 12,546 - 3,569 - 16,115
------------ ---------- --------- --------- ---------- ---------
Total revenues 31,696 3,058 3,569 - (1,728) 36,595
Cost of Goods Sold:
Cost of product revenues 22,296 2,362 - - 4,975 (5) 47,479
13,177 (14)
Cost of related party product 4,669 (19)
revenues 12,222 - 3,737 - 3,956 (14) 18,187
(1,728) (16)
------------ ---------- --------- --------- ---------- ---------
Total cost of goods sold 34,518 2,362 3,737 - 25,049 65,666
Gross profit (loss) (2,822) 696 (168) - (26,777) (29,071)
Operating Expenses:
Research and development, net 10,685 1,764 4,660 3,449 747 (5) 23,147
1,336 (14)
506 (19)
Sales and marketing 6,947 2,731 489 2,301 659 (5) 14,264
95 (14)
1,042 (19)
General and administrative 3,223 745 716 3,147 186 (5) 8,446
229 (14)
200 (19)
Goodwill - - - - 3,858 (5) 26,125
11,628 (14)
10,639 (19)
------------ ---------- --------- --------- ---------- ---------
Total operating expenses 20,855 5,240 5,865 8,897 31,125 71,982
------------ ---------- --------- --------- ---------- ---------
Operating loss (23,677) (4,544) (6,033) (8,897) (57,902) (101,053)
Interest income (expense), net 449 68 23 715 - 1,255
------------ ---------- --------- --------- ---------- ---------
Net loss (23,228) (4,476) (6,010) (8,182) (57,902) (99,798)
Convertible preferred stock
dividend and redeemable
convertible preferred stock dividend (23,910) - - - - (23,910)
------------ ---------- --------- --------- ---------- ---------
Net loss applicable to common
stockholders $(47,138) $(4,476) $(6,010) $(8,182) $(57,902) $(123,708)
============ ========== ========= ========= ========== =========
Historical basic and diluted net loss
per share attributable to common
stockholders $(5.25) $(9.66)
========== =========
Shares used in computing historical
basic and diluted net loss per share
attributable to common stockholders 8,986 3,820 12,806
========== ======== =========
</TABLE>
See notes to unaudited pro forma combined condensed financial statements.
47
<PAGE>
TERAYON COMMUNICATION SYSTEMS, INC.
UNAUDITED PRO FORMA COMBINED CONDENSED STATEMENT OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPT 30, 1999
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Terayon Radwiz Telegate Imedia Pro-forma
Actual Actual Actual Actual Adjustments Total
-------- ---------- ---------- ---------- ----------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Product revenues $ 42,073 $ 1,547 $ - $ 3,567 $ (2,762) (16) $ 44,425
Related party product revenues 16,271 - 4,338 - - 20,609
-------- ---------- ---------- ---------- ----------- --------
Total revenues 58,344 1,547 4,338 3,567 (2,762) 65,034
Cost of Goods Sold:
Cost of product revenues 35,692 1,211 - 1,697 3,731 (5) 55,522
9,883 (14)
Cost of related party product 3,308 (19)
revenues 10,483 - 4,094 - 2,967 (14) 14,782
(2,762) (16)
-------- ---------- ---------- ---------- ----------- --------
Total cost of goods sold 46,175 1,211 4,094 1,697 17,127 70,304
Gross profit 12,169 336 244 1,870 (19,889) (5,270)
Operating Expenses:
Research and development, net 11,669 1,472 4,187 2,432 560 (5) 21,680
1,002 (14)
358 (19)
Cost of product development
assistance agreement 23,971 - - - 23,971
Sales and marketing 9,094 1,932 560 2,705 494 (5) 15,595
72 (14)
738 (19)
General and administrative 4,689 828 970 2,534 140 (5) 9,475
172 (14)
142 (19)
In-process research and development 11,000 - - - (11,000) (20) -
Goodwill 443 - - - 2,893 (5) 19,593
8,721 (14)
7,536 (19)
-------- ---------- ---------- ---------- ----------- --------
Total operating expenses 60,866 4,232 5,717 7,671 11,828 90,314
-------- ---------- ---------- ---------- ----------- --------
Operating loss (48,697) (3,896) (5,473) (5,801) (31,717) (95,584)
Interest income (expense), net 3,575 (16) (595) (629) - 2,335
-------- ---------- ---------- ---------- ----------- --------
Net loss (45,122) (3,912) (6,068) (6,430) (31,717) (93,249)
Convertible preferred stock
dividend and redeemable convertible
preferred stock dividend - - - - -
-------- ---------- ---------- ---------- ----------- --------
Net loss applicable to common
stockholders $(45,122) $(3,912) $(6,068) $(6,430) $(31,717) $(93,249)
======== ========== ========== ========== =========== ========
Historical basic and diluted net
loss per share attributable to
common stockholders $(2.27) $(3.94)
======== ========
Shares used in computing historical
basic and diluted net loss per share
attributable to common stockholders 19,915 3,777 23,692
========= =========== ========
</TABLE>
See notes to unaudited pro forma combined condensed financial statements.
48
<PAGE>
NOTES TO UNAUDITED PRO FORMA COMBINED
CONDENSED FINANCIAL STATEMENTS
As of, and For the Nine Months Ended September 30, 1999 and For the Year Ended
December 31, 1998
The unaudited pro forma combined condensed financial statements give effect to
the Terayon Communication Systems, Inc. ("Terayon") acquisition of Radwiz Ltd.
("Radwiz") through a merger and exchange of shares ("the Radwiz merger") and the
acquisition of Telegate Ltd. ("Telegate") through a merger and exchange of
shares ("the Telegate merger"). The Radwiz merger was completed on November 22,
1999. The Telegate merger is anticipated to close on or around December 27,
1999. In addition, the unaudited pro forma combined condensed financial
statements give effect to the Terayon Communication Systems, Inc. acquisition of
Imedia Corporation ("Imedia") through a merger and exchange of shares that was
completed on September 16, 1999. The results of Imedia for the period following
September 16, 1999 are included in Terayon's results for the nine months ended
September 30, 1999. The Unaudited Pro Forma Combined Condensed Statements of
Operations for the year ended December 31, 1998 and for the nine months ended
September 30, 1999 reflect these transactions as if they had taken place on
January 1, 1998 and January 1, 1999, respectively. The Unaudited Pro Forma
Combined Condensed Balance Sheet gives effect to the Radwiz and Telegate
transactions as if they had taken place on September 30, 1999.
The Radwiz merger, the Telegate merger and the Imedia merger were accounted for
using the purchase method of accounting. The unaudited pro forma combined
condensed financial statements have been prepared on the basis of assumptions
described in the following notes and include assumptions relating to the
allocation of the consideration paid for the assets and liabilities of each of
the acquired companies based on actual fair value. The final allocation of the
purchase price may differ materially from the preliminary allocations. In the
opinion of Terayon's management, all adjustments necessary to present fairly
such unaudited pro forma combined condensed financial statements have been made
on the proposed terms and structure of the Radwiz merger, the Telegate merger
and the Imedia merger.
In connection with the acquisition of Radwiz, Terayon expects to incur write-
offs related to in-process research and development of approximately $3.6
million. In connection with the acquisition of Telegate, Terayon expects to
incur write-offs related to in-process research and development of approximately
$6.8 million. In connection with the acquisition of Imedia, Terayon incurred
write-offs related to in-process research and development of $11.0 million in
the nine months ended September 30, 1999. The Unaudited Pro Forma Combined
Condensed Balance Sheet includes the Imedia write-off and the anticipated Radwiz
and Telegate write-offs related to in-process research and development; however,
the Unaudited Pro Forma Combined Condensed Statements of Operations do not
reflect these charges. The charges related to in-process research and
development for Radwiz and Telegate will be reflected in Terayon's consolidated
financial statements when the mergers are consummated. Terayon expects
integration costs to be insignificant as a result of the mergers.
49
<PAGE>
The unaudited pro forma combined condensed financial statements are not
necessarily indicative of what the actual financial results would have been had
the Radwiz, Telegate and Imedia mergers taken place on January 1, 1998, January
1, 1999 or September 30, 1999 and do not purport to indicate the results of
future operations.
The unaudited pro forma combined condensed financial statements give effect to
the following pro forma adjustments.
1. In accordance with the Share Purchase Agreement among Terayon and Radwiz
("the Radwiz Agreement"), Radwiz became a wholly-owned subsidiary of
Terayon, and all outstanding shares of its common stock converted into
shares of common stock of Terayon.
The Radwiz merger was accounted for using the purchase method of accounting.
In general, the shareholders and vested optionholders received cash and
shares of Terayon common stock and options to purchase shares of Terayon
common stock. The aggregate number of shares of Terayon common stock to be
issued under the Radwiz Agreement will depend, among other things, on the
performance of the Company's common stock over the period between the
closing of the merger and the twelve month anniversary. On the closing,
Terayon paid $250,000 in cash and issued 873,582 shares of Terayon common
stock to the former shareholders of Radwiz and issued options to purchase
72,571 shares of Terayon common stock to the vested optionholders of Radwiz.
In addition, the unvested optionholders of Radwiz options also received
options to purchase Terayon common stock, the fair value of which will be
included in the purchase price.
For purposes of the pro forma combined condensed financial statements the
purchase price was determined to be approximately $52.7 million. This
represents the minimum purchase price, as specified in the Agreement, to be
issued to the shareholders and vested optionholders of Radwiz ($50.0
million) plus the value of the options issued to unvested optionholders of
Radwiz ($2.7 million). Proceeds to be received from the Radwiz optionholders
upon exercise of their options are not significant.
The unaudited pro forma combined condensed financial statements have been
prepared on the basis of assumptions described in the notes thereto and
include assumptions relating to the allocation of the consideration paid for
the assets and liabilities of Radwiz based upon preliminary estimates of
fair value. The actual allocation of such consideration may differ from that
reflected in the unaudited pro forma combined condensed financial statements
after valuations and other procedures to be performed after the closing of
the Radwiz merger have been completed. Below is a table of the estimated
acquisition cost, purchase price allocation and annual amortization of the
intangible assets acquired (in thousands):
50
<PAGE>
<TABLE>
<CAPTION>
Annual
Amortization Amortization
Life of Intangibles
------------------------------------
<S> <C> <C> <C>
Estimated Acquisition Cost:
Estimated Purchase Price............................. $ 52,667
Acquisition Expenses................................. 902
--------------
Total Estimated Acquisition Cost................... $ 53,569
==============
Purchase Price Allocation:
Historical net tangible assets of Radwiz
at September 30, 1999............................. $ 4,022
Intangible assets acquired:
Developed technology............................... 29,850 6 years $4,975
Assembled workforce................................ 2,800 2 1,400
Trademark.......................................... 1,150 6 192
In-Process technology.............................. 3,600
Goodwill........................................... 23,145 6 3,858
Deferred tax liability............................. (10,998)
--------------
Total............................................ $ 53,569
==============
</TABLE>
Tangible assets of Radwiz to be acquired principally include cash, accounts
receivable, inventory and property and equipment. Liabilities of Radwiz
assumed in the Radwiz merger principally include accounts payable and
accrued liabilities.
To determine the value of the developed technology, the expected future
cash flow attributed to all existing technology was discounted, taking into
account risks related to the characteristics and applications of the
technology, existing and future markets, and assessments of the life cycle
stage of technology. The analysis resulted in a valuation of approximately
$29.9 million for developed technology which had reached technological
feasibility and therefore was capitalizable. The developed technology is
being amortized on a straight line basis over a six year period.
The value of the assembled workforce was derived by estimating the costs to
replace the existing employees, including recruiting and hiring costs and
training costs for each category of employee. The analysis yielded a
valuation of approximately $2.8 million for the assembled workforce. The
asset is being amortized on a straight line basis over a two year period.
The preliminary goodwill allocation as of September 30, 1999 is
approximately $23.1 million. Amortization of goodwill will occur over six
years due to the pace of technological development within the industries
emerging to support the telecommunications industry's expansion into
multimedia functions.
51
<PAGE>
The projects identified as in-process at Radwiz are those that will be
underway at the time of the acquisition of Radwiz and would, after
consummation of the acquisition, require additional effort to establish
technological feasibility. These projects have indentifiable technological
risk factors which indicate that even though successful completion is
expected, it is not assured. The preliminary estimate of in-process
research and development is $3.6 million. The estimated amount of the in-
process research and development charge is still a preliminary estimate
which could materially differ from the actual results that will be
experienced by Terayon, as final values will not be established until after
the closing of the acquisition of Radwiz.
In-process technology acquired in the transaction consists primarily of
additions to Radwiz's core technology, which is related to Radwiz's planned
development of new features. The majority of the intended functionality of
these new features is not supported by Radwiz's current technology.
Intended new features include offering: end-to-end carrier quality of
service; allowing access via an ATM network; and, providing ISDN line
functionality.
Terayon expects that the in-process technology will be successfully
developed, and that initial benefits from these projects will begin in
calendar 2000. Notwithstanding Terayon's expectation that the in-process
technology will be successfully developed, there remain significant
technical challenges that must be resolved in order to complete the in-
process technology.
2. The pro forma adjustment to "Other accrued liabilities"($600,000) and
"Common stock" ($302,000) reflects the accrual of acquisition costs arising
from the Radwiz acquisition, for a total of approximately $902,000.
3. The pro forma adjustment to "Common stock" and "Cash" reflects the
elimination of Radwiz common stock ($13.5 million), and the impact of the
issuance of Terayon common stock ($52.4 million) and the payment of
$250,000 in cash for Rawiz.
4. The pro forma adjustment to "Accumulated deficit" reflects the elimination
of Radwiz's accumulated deficit ($8.9 million), and the in-process
technology charge ($3.6 million).
5. The pro forma adjustment is for the amortization of goodwill, developed
technology trademark and assembled workforce.
6. The pro forma adjustment is to eliminate deferred compensation related to
Radwiz options.
7. Goodwill has been increased and deferred tax liabilities have been recorded
in the amount of approximately $11.0 million to reflect the net tax effect
of the book/tax basis differences in the acquired intangibles, excluding
goodwill and in-process research and development. Deferred tax assets have
been realized based on the
52
<PAGE>
projected reversal of taxable temporary differences and have been netted
against deferred tax liabilities for purposes of allocating the purchase
price.
8. In accordance with the Share Purchase Agreement among Terayon and Telegate
("the Agreement"), Telegate is to become a wholly-owned subsidiary of
Terayon, and all outstanding shares of its common stock are to be converted
into shares of common stock of Terayon.
The Telegate merger was accounted for using the purchase method of
accounting. In general, the shareholders and vested optionholders of
Telegate will receive shares of Terayon common stock and options to
purchase shares of Terayon common stock plus a cash payment equal to
Telegate's net current assets at closing in excess of $2.0 million. The
aggregate number of shares and options to purchase shares of Terayon common
stock to be issued under the Telegate Agreement will depend, among other
things, on the performance of the Terayon's common stock over the period
between the closing of the Telegate merger and the nine month anniversary.
For purposes of the pro forma combined condensed financial statements, the
purchase price was determined to be approximately $142.5 million. This
represents the minimum purchase price as specified in the Telegate
Agreement of $100.0 million, an estimated cash payment of $3.0 million and
the value of a warrant ("the Warrant") to purchase 1.0 million shares of
Terayon common stock estimated at $39.5 million issued under terms of an
agreement between Telegate and a customer of Terayon. The value of the
warrant was associated with the value of the customer relationship. For
purposes of the pro forma combined condensed financial statements, the
number of shares (2,099,301) and options to purchase shares (100,699) of
Terayon common stock was determined by taking the number of Terayon shares
divided by the exchange ratio of approximately 0.97 Telegate shares for
each Terayon share. The fair value of "shares" was calculated by taking the
minimum value of the stock specified in the Telegate Agreement ($45.46 per
share) times the number of Terayon shares to be acquired. Terayon does not
anticipate receiving any proceeds from the optionholders upon exercise of
the options and warrants.
The unaudited pro forma combined condensed financial statements have been
prepared on the basis of assumptions described in the notes thereto and
include assumptions relating to the allocation of the consideration paid
for the assets and liabilities of Telegate based upon preliminary estimates
of fair value. The actual allocation of such consideration may differ from
that reflected in the unaudited pro forma combined condensed financial
statements after valuations and other procedures to be performed after the
closing of the Telegate merger have been completed. Below is a table of the
estimated acquisition cost, purchase price allocation and annual
amortization of the intangible assets acquired:
53
<PAGE>
<TABLE>
<CAPTION>
Annual
Amortization Amortization
Life of Intangibles
------------------------------------
<S> <C> <C> <C>
Estimated Acquisition Cost:
Estimated Purchase Price.................... $142,542
Acquisition Expenses........................ 1,929
-------------
Total Estimated Acquisition Cost.......... $144,471
=============
Purchase Price Allocation:
Historical net tangible assets of
Telegate at September 30, 1999............ $ (9,044)
Conversion of Telegate convertible
notes and accrued interest................ 12,335
-------------
Pro forma net tangible assets of Telegate
at September 30, 1999..................... 3,291
Intangible assets acquired:
Developed technology...................... 21,100 6 years $ 3,516
Assembled workforce....................... 4,200 2 2,100
In-Process technology..................... 6,750
Customer relationship..................... 39,530 3 13,177
Goodwill.................................. 69,767 6 11,628
Deferred tax liability.................... (167)
-------------
Total................................... $144,471
=============
</TABLE>
Tangible assets of Telegate to be acquired principally include cash,
accounts receivable, inventory and property and equipment. Liabilities of
Telegate assumed in the Telegate merger principally include accounts
payable and accrued liabilities.
To determine the value of the developed technology, the expected future
cash flow attributed to all existing technology was discounted, taking into
account risks related to the characteristics and applications of the
technology, existing and future markets, and assessments of the life cycle
stage of technology. The analysis resulted in a valuation of approximately
$21.1 million for developed technology which had reached technological
feasibility and therefore was capitalizable. The developed technology is
being amortized on a straight line basis over a six year period.
The value of the assembled workforce was derived by estimating the costs to
replace the existing employees, including recruiting and hiring costs and
training costs for each category of employee. The analysis yielded a
valuation of approximately $4.2 million for the assembled workforce. The
asset is being amortized on a straight line basis over a two year period.
The value of the customer relationship was determined as the value of the
warrant using the Black Scholes model. The warrant will be issued upon
closing of the Telegate merger. The warrant is fully vested, non-
forfeitable, and immediately exercisable and has a term of three years.
The preliminary goodwill allocation as of September 30, 1999 is
approximately $69.8 million. Amortization of goodwill will occur over six
years due to the pace of technological development within the industries
emerging to support the cable industry's expansion into multimedia
functions.
The projects identified as in-process at Telegate are those that will be
underway at the time of the acquisition of Telegate and would, after
consummation of the acquisition,
54
<PAGE>
require additional effort to establish technological feasibility. These
projects have indentifiable technological risk factors which indicate that
even though successful completion is expected, it is not assured. The
preliminary estimate of in-process research and development is $6.8
million. The estimated amount of the in-process research and development
charge is still a preliminary estimate which could materially differ from
the actual results that will be experienced by Terayon, as final values
will not be established until after the closing of the acquisition of
Telegate.
In-process technology acquired in the transaction consists primarily of
additions to Telegate's core technology, which is related to Telegate's
planned development of new features. The majority of the intended
functionality of these new features is not supported by Telegate's current
technology. Intended new features include: connection on demand
functionality to extend the product's ISDN compatibility; the ability to
use cordless technology for either voice or data applications; and, a
subscriber end unit that can be used in multi-dwelling units.
Terayon expects that the in-process technology will be successfully
developed, and that initial benefits from these projects will begin in
calendar 2000. Notwithstanding Terayon's expectation that the in-process
technology will be successfully developed, there remain significant
technical challenges that must be resolved in order to complete the in-
process technology.
9. The pro forma adjustment to "Other accrued liabilities" ($1.3 million) and
to "Common stock" ($604,000) reflects the accrual of acquisition costs
arising from the Telegate acquisition, estimated to be approximately $1.9
million.
10. The pro forma adjustment to "Convertible loans" reflects the elimination of
Telegate's convertible loans and accrued interest on the convertible loans
as the loans and accrued interest convert into shares of Terayon common
stock upon the close of the Telegate merger.
11. The pro forma adjustment to "Common stock" reflects the elimination of
Telegate common stock ($25.3 million), the impact of the issuance of
Terayon common stock ($100.0 million) and the issuance of the Warrant
($39.5 million).
12. The pro forma adjustment reflects the estimated cash payment ($3.0
million).
13. The pro forma adjustment to "Accumulated deficit" reflects the elimination
of Telegate's accumulated deficit ($21.7 million), and the in-process
technology charge ($6.8 million).
14. The pro forma adjustment is for the amortization of goodwill, developed
technology, assembled workforce and customer relationship.
55
<PAGE>
15. The pro forma adjustment is for the elimination of deferred compensation
related to Telegate options.
16. The pro forma adjustment is for the elimination of intercompany
transactions between Terayon and Telegate prior to the merger.
17. Goodwill has been increased and deferred tax liabilities have been recorded
in the amount of approximately $167,000 to reflect the net tax effect of
the book/tax basis differences in the acquired intangibles, excluding
goodwill and in-process research and development. Deferred tax assets have
been realized based on the projected reversal of taxable temporary
differences and have been netted against deferred tax liabilities for
purposes of allocating the purchase price.
18. In accordance with the Agreement and Plan of Merger and Reorganization
among Terayon and Imedia ("the Agreement"), Imedia became a wholly-owned
subsidiary of Terayon, and all outstanding shares of its common stock were
converted into shares of common stock of Terayon. The Imedia merger closed
on September 16, 1999. The results of Imedia for the period following
September 16, 1999 are included in Terayon's actual results.
The Imedia merger was accounted for using the purchase method of accounting
and has been reflected in the September 30, 1999 balance sheet of Terayon.
In general, the shareholders, vested optionholders and warrantholders will
receive shares of Terayon common stock, options and warrants to purchase
shares of Terayon common stock and cash, in certain circumstances, in
varying amounts in a series of three stock payments, the last of which will
occur on or before the 18-month anniversary of the closing of the Imedia
merger. The aggregate number of shares of Terayon common stock issued under
the Imedia Agreement will depend, among other things, on the performance of
Terayon's common stock over the period during which the payments are to be
made. Terayon issued 827,407 shares of common stock on the closing of the
Imedia merger.
The estimated purchase price of $106.3 million was determined using the
maximum value of the consideration (approximately $99.0 million) as
specified in the Imedia Agreement, the value of the options to purchase
Terayon shares issued to the unvested optionholders of Imedia
(approximately $6.3 million) and the forgiveness of the Imedia note payable
($1.0 million). The estimated purchase price is net of the estimated
proceeds which will be received from the optionholders and warrantholders
upon exercise (approximately $3.1 million). Terayon may be required to
issue additional consideration should the market value of Terayon's common
stock decline between the closing of the Imedia merger and the 18-month
anniversary. The issuance of additional consideration will not impact the
determination of the purchase price.
56
<PAGE>
Below is a table of the acquisition cost, purchase price allocation and
annual amortization of the intangible assets acquired:
<TABLE>
<CAPTION>
Annual
Amortization Amortization
Life of Intangibles
------------------------------------
<S> <C> <C> <C>
Acquisition Cost:
Purchase Price............................. $106,347
Acquisition Expenses....................... 2,631
------------
Total Acquisition Cost................... $108,978
===========
Purchase Price Allocation:
Historical net tangible assets of Imedia
at September 16, 1999.................... $ (355)
Forgiveness of Imedia note payable......... 1,000
------------
Pro forma net tangible assets of Imedia
at September 16, 1999.................... 645
Intangible assets acquired:
Developed technology..................... 27,000 6 Years $ 4,500
Assembled workforce...................... 2,500 2 1,250
Trademark................................ 4,000 6 667
In-Process technology.................... 11,000
Goodwill................................. 63,833 6 10,639
------------
Total.................................. $108,978
============
</TABLE>
Tangible assets of Imedia acquired in the Imedia merger principally include
cash, accounts receivable and property and equipment. Liabilities of Imedia
assumed in the Imedia merger principally include accounts payable and
accrued liabilities. Upon the closing of the Imedia merger, Imedia's note
payable obligation to Terayon of $1.0 million was forgiven by Terayon.
To determine the value of the developed technology, the expected future
cash flow attributed to all existing technology was discounted, taking into
account risks related to the characteristics and applications of the
technology, existing and future markets, and assessments of the life cycle
stage of technology. The analysis resulted in a valuation of approximately
$27.0 million for developed technology which had reached technological
feasibility and therefore was capitalizable. The developed technology is
being amortized on a straight line basis over a six year period.
The value of the assembled workforce was derived by estimating the costs to
replace the existing employees, including recruiting and hiring costs and
training costs for
57
<PAGE>
each category of employee. The analysis yielded a valuation of
approximately $2.5 million for the assembled workforce. The asset is being
amortized on a straight line basis over a two year period.
The goodwill allocation as of September 16, 1999 is approximately $63.8
million. Amortization of goodwill will occur over six years due to the pace
of technological development within the industries emerging to support the
cable industry's expansion into multimedia functions.
The projects identified as in-process at Imedia are those that were
underway at the time of the acquisition of Imedia and would, after
consummation of the acquisition, require additional effort to establish
technological feasibility. These projects have indentifiable technological
risk factors which indicate that even though successful completion is
expected, it is not assured. Terayon incurred $11.0 million in in-process
research and development write-offs in the nine months ended September 30,
1999 as result of the Imedia merger.
In-process technology acquired in the transaction consists primarily of
major additions to Imedia's core technology, which is related to Imedia's
planned development of new features. The majority of the intended
functionality of these new features is not supported by Imedia's current
technology. Intended new features include offering high quality video
service over the Internet and multiplexing data with video.
Terayon expects that the in-process technology will be successfully
developed, and that initial benefits from these projects will begin in
calendar 2001. Notwithstanding Terayon's expectation that the in-process
technology will be successfully developed, there remain significant
technical challenges that must be resolved in order to complete the in-
process technology.
Terayon's valuation allowance on deferred tax assets has been decreased by
approximately $10.2 million to reflect the net tax effect of the book/tax
basis differences in the acquired intangibles, excluding goodwill and
in-process research and development. Deferred tax assets have been realized
based on the projected reversal of taxable temporary differences and have
been netted against deferred tax liabilities for purposes of allocating the
purchase price.
19. The pro forma adjustment is for the amortization of goodwill, developed
technology trademark and assembled workforce for the year ended
December 31, 1998 and the period from January 1, 1999 to September 16,
1999.
20. The pro forma adjustment is for the elimination of $11.0 million of
in-process research and development write-offs incurred by Terayon in the
nine months ended September 30, 1999 relating to the Imedia merger.
58
<PAGE>
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.
Terayon Communication Systems, Inc.
Dated December 27, 1999 By: /s/ Ray M. Fritz
Ray M. Fritz
Chief Financial Officer
59
