<PAGE>
SECURITIES EXCHANGE AND 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): September 27, 2000
Terayon Communication Systems, Inc.
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of incorporation)
000-24647 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) 727-4400
<PAGE>
Item 2. Acquisition or Disposition of Assets.
A. Digital Transmission Equipment.
On September 27, 2000 (the "Digitrans Closing Date"), the registrant,
Terayon Communication Systems, Inc., a Delaware corporation ("Terayon"),
acquired Digital Transmission Equipment, a California corporation ("Digitrans"),
pursuant to that certain Stock Purchase Agreement (the "Digitrans Agreement") by
and among Terayon, Digitrans, The D.W. Thomas Companies, Inc., a California
corporation and Donald W. Thomas, an individual dated September 27, 2000 (the
"Digitrans Acquisition"). Digitrans develops, markets and sells digital
equipment solutions that enable broadcasters, satellite operators and cable
television system operators to optimize network services.
Pursuant to the Digitrans Agreement, Terayon acquired all outstanding
shares of capital stock of Digitrans, and Digitrans became a wholly-owned
subsidiary of Terayon on September 27, 2000 (the "Effective Time"). As
consideration for the Digitrans Acquisition, the former shareholders and the
employees of Digitrans received an aggregate of three hundred ninety four
thousand three hundred twenty nine (394,329) shares of Terayon common stock and
approximately two hundred ninety three thousand four hundred dollars ($293,400)
in cash payments as described in the Digitrans Agreement attached hereto as
Exhibit 2.1. The Digitrans 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. Mainsail Networks, Inc.
On September 29, 2000 (the "Mainsail Closing Date"), the registrant,
Terayon Communication Systems, Inc., a Delaware corporation ("Terayon"),
acquired Mainsail Networks, Inc., a Delaware corporation ("Mainsail"), pursuant
to that certain Agreement and Plan of Merger and Reorganization among Terayon,
MN Acquisition Corp., a Delaware corporation, Mainsail and Certain Stockholders
of Mainsail dated August 1, 2000 (the "Mainsail Acquisition"), as amended by
that Certain First Amendment to Agreement and Plan of Reorganization dated
September 29, 2000 (collectively, the "Merger Agreement"). Mainsail develops and
markets next-generation broadband networks that enable telecommunications
carriers to deliver multiple services over a single network infrastructure.
Pursuant to the Merger Agreement, Terayon acquired all outstanding
shares of capital stock of Mainsail, and Mainsail became a wholly-owned
subsidiary of Terayon on September 29, 2000 (the "Effective Time"). As
consideration for the Mainsail Acquisition, the former stockholders of Mainsail
received an aggregate of three million one hundred thirty seven thousand two
hundred sixty five (3,137,265) shares of Terayon common stock and approximately
three million nine hundred nineteen thousand four hundred and ten dollars in a
cash payment as described in the Merger Agreement attached hereto as Exhibit
2.2. The Mainsail 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.
Item 5. Other Events
Forms 10(K) and 10(Q)
The Company hereby amends Form 10-K filed on March 30, 2000 and Forms 10-Q filed
on May 15, 2000 and August 14, 2000 and any amendments filed thereon to revise
the section, where applicable, entitled Business.
The section entitled Legal Proceedings and Management's Discussion and Analysis
of Financial Condition and Results of Operations - Litigation should be deleted
and replaced with the following section:
Legal Proceedings
In September 1999, Imedia, now our subsidiary, was named as a defendant in a
case alleging that Imedia breached its term sheet agreement with the plaintiffs
by negotiating with us while a no-shop provision was in place and refusing to
allowing the plaintiffs to invest in Imedia. The plaintiffs are seeking damages
in excess of $12.0 million. As part of the terms of the Imedia Agreement and
Plan of Merger and Reorganization, shares of our common stock to be issued to
the former shareholders of Imedia were placed in escrow to indemnify us for any
damages that are directly or indirectly suffered as a result any claim brought
by any person who was a prospective investor in Imedia and was not a
securityholder of Imedia on the closing date of the Imedia acquisition. The
value of the escrowed shares was approximately $10.0 million based on the market
value of our common stock on the closing date. The case is in its initial
stages, and no trial date has been established. We have reviewed the allegations
made by the plaintiffs and we do not believe that the outcome will have a
negative impact on our financial position, results of operations or cash flows.
On or about September 5, 2000, we received a draft amended complaint
("Complaint") in a matter captioned Evergreen Canada Israel Management, Ltd. v.
Imedia Corporation, case no. 306185, pending in the Superior Court of the State
of California for the City and County of San Francisco. The Complaint alleges
"Intentional Interference with Prospective Economic Advantage" against us,
claiming that we "formed and operated a conspiracy to deprive plaintiffs of the
opportunity to invest in Imedia", a company that we acquired in 1999.
Plaintiffs argue that, prior to our purchase of the Imedia shares, we knew of an
alleged, pre-existing financing agreement between plaintiffs and Imedia that
contained a "no shop" clause, prohibiting Imedia from seeking or obtaining
financing from any other sources, including (apparently, in plaintiffs' view) a
prohibition against Imedia selling its own stock.
We have not yet been served with the Complaint, and we are not aware of
whether plaintiffs have obtained permission from the court to serve and file
such pleading.
On April 13, 2000, a lawsuit against us and certain of our officers and
directors, entitled Birnbaum v. Terayon Comm. Systems, Inc., was filed in the
United States District Court for the Central District of California. The
plaintiff purports to be suing on behalf of a class of stockholders who
purchased or committed to purchase our securities during the period from
February 2, 2000 to April 11, 2000. The complaint alleges that the defendants
violated the federal securities laws by issuing materially false and misleading
statements and failing to disclose material information regarding our
technology. Several other lawsuits similar to the Birnbaum suit have since been
filed. The lawsuits seek an unspecified amount of damages, in addition to other
forms of relief. On August 24, 2000, the lawsuits against us and other named
individual defendants were consolidated in the U.S. District Court of the
Northern District of California and lead plaintiffs and lead plaintiffs' counsel
was appointed pursuant to the Private Securities Litigation Reform Act. On
September 21, 2000, plaintiffs filed a Consolidated Class Action Complaint for
violation of federal securities laws. The consolidated complaint contains
allegations nearly identical to the Birnbaum suit. We consider the lawsuits to
be without merit and we intend to defend vigorously against these allegations.
However, the litigation could prove to be costly and time consuming to defend,
and there can be no assurances about the eventual outcome.
<PAGE>
Item 7. Financial Statements and Exhibits.
a. The financial statements required by this Item will be filed by
amendment no later than 60 days after the date of this report.
Included herein are the balance sheets of Mainsail Networks, Inc.
("Mainsail"), a development stage company, as of June 30, 2000 and 1999 and the
related statements of operations and cash flows for each of the years in the
three year period ended June 30, 2000 and for the period from June 3, 1997
(inception) to June 30, 2000 and the statements of shareholders' equity for each
of the years in the three year period ended June 30, 2000.
<PAGE>
FINANCIAL STATEMENTS
Mainsail Networks, Inc. (a development stage company)
Years ended June 30, 2000 and 1999 with Report of
Independent Auditors
Mainsail Networks, Inc.
(a development stage company)
Financial Statements
Years ended June 30, 2000 and 1999
Contents
<TABLE>
<S> <C>
Report of Independent Auditors.............................. 1
Audited Financial Statements
Balance Sheets.............................................. 2
Statements of Operations.................................... 3
Statements of Stockholders' Equity.......................... 4
Statements of Cash Flows.................................... 5
Notes to Financial Statements............................... 6
</TABLE>
<PAGE>
Report of Independent Auditors
The Board of Directors and Stockholders
Mainsail Networks, Inc.
We have audited the accompanying balance sheets of Mainsail Networks, Inc. (a
development stage company) as of June 30, 2000 and 1999 and the related
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended June 30, 2000 and for the period from June 3,
1997 (inception) to June 30, 2000. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted air audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statement referred to above present fairly, in all
material respects, the financial position of Mainsail Networks Inc. at June 30,
2000 and 1999, and the results of its operations and its cash flows for each of
the three years in the period ended June 30, 2000 and for the period from June
3, 1997 (inception) to June 30, 2000 in conformity with accounting principles
generally accepted in the United States.
The accompanying financial statements have been prepared assuming that Mainsail
Networks, Inc. will continue as a going concern. As more fully described in
Note 1, the Company has incurred recurring operating losses. This condition
raises substantial doubt about the Company's ability to continue as a going
concern. Management's plans in regard to these matters are also described in
Note 1. The financial statements do not include any adjustments to reflect the
possible future effects on the recoverability and classification of assets or
the amounts and classification of liabilities that may result from the outcome
of this uncertainty.
/s/ Ernst & Young LLP
September 1, 2000
F-1
<PAGE>
Mainsail Networks, Inc.
(a development stage company)
Balance Sheets
<TABLE>
<CAPTION>
June 30,
-------------------------------
2000 1999
-------------------------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 3,543,802 $ 8,113,516
Inventory 484,158 -
Prepaid expenses and other assets 18,197 16,130
-------------------------------
Total current assets 4,046,157 8,129,646
Property and equipment, net 849,298 355,407
Deposits 33,250 38,693
-------------------------------
Total assets $ 4,928,705 $ 8,523,746
===============================
Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 511,624 $ 58,669
Accrued compensation 217,599 47,913
Other accrued liabilities 29,749 27,323
Notes payable to related parties 503,381 -
Notes payable 464,659 -
-------------------------------
Total current liabilities 1,727,012 133,905
Commitments and contingencies
Stockholders' equity:
Convertible preferred stock, $0.0001 par value:
Authorized shares - 16,653,402
Issued and outstanding shares - 15,514,101
Liquidation preference of $12,427,266 1,551 1,551
Common stock, $0.001 par value:
Authorized shares - 40,000,000
Issued and outstanding shares - 13,281,041 in 2000 and
13,675,001 in 1999 1,329 1,368
Additional paid-in capital 17,244,535 12,489,880
Deferred compensation (2,355,541) -
Deficit accumulated during the development stage (11,690,181) (4,102,958)
-------------------------------
Total stockholders' equity 3,201,693 8,389,841
-------------------------------
Total liabilities and stockholders' equity $ 4,928,705 $ 8,523,746
===============================
</TABLE>
See accompanying notes.
F-2
<PAGE>
Mainsail Networks, Inc.
(a development stage company)
Statements of Operations
<TABLE>
<CAPTION>
Period From
June 3, 1997
Years Ended June 30, (Inception) to
----------------------------------------------- June 30,
2000 1999 1998 2000
--------------------------------------------------------------------
<S> <C> <C> <C> <C>
Operating expenses:
Research and development $ 4,869,775 $ 2,253,794 $ 803,809 $ 7,927,378
Sales and marketing 1,818,246 458,241 61,235 2,337,722
General and administrative 1,054,777 453,865 338,973 1,847,615
--------------------------------------------------------------------
Total operating expenses 7,742,798 3,165,900 1,204,017 12,112,715
Interest income and other, net 265,968 234,996 32,170 533,134
Interest expense (110,393) (207) - (110,600)
--------------------------------------------------------------------
Net loss $ (7,587,223) $ (2,931,111) $ (1,171,847) $ (11,690,181)
====================================================================
Basic and diluted net loss per share $ (0.60) $ (0.24) $ (0.10)
===============================================
Shares used in computing basic and
diluted net loss per share 12,606,810 12,192,724 11,956,555
===============================================
</TABLE>
Operating expenses in 2000 and for the period from June 3, 1997 (inception) to
June 30, 2000 include the following amortization of deferred compensation
related to research and development - $155,908; sales and marketing - $181,820;
and general and administrative - $6,096.
See accompanying notes.
F-3
<PAGE>
Mainsail Networks, Inc.
(a development stage company)
Statements of Stockholders' Equity
<TABLE>
<CAPTION>
Additional
Convertible Preferred Stock Common Stock Paid-In Deferred
----------------------------------------------------
Shares Amount Shares Amount Capital Compensation
---------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Issuance of common stock to founders at
$0.00167 per share in June 1997 - $ - 12,000,000 $ 1,200 $ 18,800 $ -
Issuance of Series A preferred stock at $0.167
per share in June 1997 6,000,000 600 - - 999,400 -
Issuance of Series B preferred stock at $0.333
per share in February 1998 4,994,448 499 - - 1,664,316 -
Exercise of stock options in December 1997
and February 1998 - - 920,001 92 15,241 -
Net and comprehensive loss - - - - -
---------------------------------------------------------------------------------
Balance at June 30, 1998 10,994,448 1,099 12,920,001 1,292 2,697,757 -
Issuance of Series C preferred stock at $2.16
per share in December 1998 4,519,653 452 - - 9,761,998 -
Exercise of stock options from July 1998 to
November 1998 - - 755,000 76 30,125 -
Net and comprehensive loss - - - - -
---------------------------------------------------------------------------------
Balance at June 30, 1999 15,514,101 1,551 13,675,001 1,368 12,489,880 -
Exercise of stock options from July 1999 to
June 2000 - - 190,000 19 42,081 -
Common stock repurchased from August 1999
to May 2000 - - (583,960) (58) (16,791) -
Issuance of common stock warrants in
connection with debt financing - - - - 2,030,000 -
Deferred compensation - - - - 2,699,365 (2,699,365)
Amortization of deferred compensation - - - - - 343,824
Net and comprehensive loss - - - - - -
---------------------------------------------------------------------------------
Balance at June 30, 2000 15,514,101 $ 1,551 13,281,041 $ 1,329 $ 17,244,535 $ (2,355,541)
=================================================================================
<CAPTION>
Deficit
Accumulated
During the Total
Development Stockholders'
Stage Equity
-------------------------------
<S> <C> <C>
Issuance of common stock to founders at
$0.00167 per share in June 1997 $ - $ 20,000
Issuance of Series A preferred stock at $0.167
per share in June 1997 - 1,000,000
Issuance of Series B preferred stock at $0.333
per share in February 1998 - 1,664,815
Exercise of stock options in December 1997
and February 1998 - 15,333
Net and comprehensive loss (1,171,847) (1,171,847)
-------------------------------
Balance at June 30, 1998 (1,171,847) 1,528,301
Issuance of Series C preferred stock at $2.16
per share in December 1998 - 9,762,450
Exercise of stock options from July 1998 to
November 1998 - 30,201
Net and comprehensive loss (2,931,111) (2,931,111)
-------------------------------
Balance at June 30, 1999 (4,102,958) 8,389,841
Exercise of stock options from July 1999 to
June 2000 - 42,100
Common stock repurchased from August 1999
to May 2000 - (16,849)
Issuance of common stock warrants in
connection with debt financing - 2,030,000
Deferred compensation - -
Amortization of deferred compensation - 343,824
Net and comprehensive loss (7,587,223) (7,587,223)
-------------------------------
Balance at June 30, 2000 $ (11,690,181) $ 3,201,693
===============================
</TABLE>
See accompanying notes.
F-4
<PAGE>
Mainsail Networks, Inc.
(a development stage company)
Statements of Cash Flows
<TABLE>
<CAPTION>
Period From
June 3, 1997
(Inception) to
Years Ended June 30, June 30,
--------------------------------------------
2000 1999 1998 2000
------------------------------------------------------------
<S> <C> <C> <C> <C>
Operating activities
Net loss $ (7,587,223) $ (2,931,111) $ (1,171,847) $(11,690,181)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 251,599 44,440 12,777 308,816
Gain on disposition of property and equipment (338) -- -- (338)
Amortization of deferred compensation 343,824 -- -- 343,824
Amortization of debt discount 98,040 -- -- 98,040
Changes in operating assets and liabilities:
Inventory (484,158) -- -- (484,158)
Prepaid expenses and other assets (2,067) (16,130) -- (18,197)
Deposits 5,443 (32,000) (6,693) (33,250)
Accounts payable 452,955 58,669 -- 511,624
Accrued compensation 169,686 (18,541) 66,454 217,599
Other accrued liabilities 2,426 18,258 9,065 29,749
------------------------------------------------------------
Net cash used in operating activities (6,749,813) (2,876,415) (1,090,244) (10,716,472)
Investing activities
Purchase of property and equipment (746,502) (359,868) (52,756) (1,159,126)
Proceeds from disposition of property
and equipment 1,350 -- -- 1,350
------------------------------------------------------------
Net cash used in investing activities (745,152) (359,868) (52,756) (1,157,776)
Financing activities
Proceeds from issuance of notes payable 2,900,000 -- -- 2,900,000
Proceeds from issuance of preferred stock -- 9,762,450 2,664,815 12,427,265
Proceeds from issuance of common stock -- -- 20,000 20,000
Exercise of options to purchase common stock 42,100 30,201 15,333 87,634
Repurchase of common stock (16,849) -- -- (16,849)
------------------------------------------------------------
Net cash provided by financing activities 2,925,251 9,792,651 2,700,148 15,418,050
------------------------------------------------------------
Net increase (decrease) in cash and
cash equivalents (4,569,714) 6,556,368 1,557,148 3,543,802
Cash and cash equivalents at beginning of period 8,113,516 1,557,148 -- --
------------------------------------------------------------
Cash and cash equivalents at end of period $ 3,543,802 $ 8,113,516 $ 1,557,148 $ 3,543,802
============================================================
Supplemental disclosures of cash flow information
Income taxes paid $ 800 $ 1,600 $ 800 $ 3,200
Supplemental schedule of noncash investing and
financing information
Deferred compensation $ 2,699,365 $ -- $ -- $ 2,699,365
Common stock warrants issued in connection
with debt $ 2,030,000 $ -- $ -- $ 2,030,000
</TABLE>
See accompanying notes.
F-5
<PAGE>
Mainsail Networks, Inc.
(a development stage company)
Notes to Financial Statements
June 30, 2000
1. Organization and Summary of Significant Accounting Policies
Description of Business
Mainsail Networks, Inc. (the Company) was incorporated on June 3, 1997 in the
state of Delaware to develop, manufacture, and market proprietary computer-based
software and hardware for use in broadband services. The Company's products
incorporate the functions of multiple networking devices into a single
integrated system for all types of voice, data, and Internet traffic over both
fiber optical and copper wire networks. The Company's principal activities to
date have involved conducting research and development, recruiting management
and technical personnel, obtaining financing, and securing operating facilities.
Therefore, the Company is classified as a development stage company.
The Company commenced operations in June 1997. Operations through June 30, 1997
consisted of initial development activities. Operating expenses for the period
from June 3, 1997 (inception) to June 30, 1997 were not significant and have
been included in operations for the period ended June 30, 1998.
The Company has incurred operating losses to date of $11,690,181 at June 30,
2000. The Company may need to raise additional capital through the issuance of
debt or equity securities. Such financing may not be available on terms
satisfactory to the Company, if at all. If adequate funds are not available, the
Company may be required to reduce its level of spending. These facts raise
substantial doubt about the Company's ability to continue as a going concern.
The financial statements do not include any adjustments relating to the
recoverability of recorded asset amounts or the amount and classification of
liabilities that might be necessary should the Company be unable to raise
sufficient capital to continue operations.
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.
F-6
<PAGE>
Mainsail Networks, Inc.
(a development stage company)
Notes to Financial Statements (continued)
1. Organization and Summary of Significant Accounting Policies (continued)
Advertising Expenses
The Company accounts for advertising costs as expense in the period in which
they are incurred. Advertising expense for the years ended June 30, 2000, 1999,
and 1998 was not significant.
Cash and Cash Equivalents
The Company considers short-term investments having original maturities of three
months or less to be cash equivalents.
Concentration of Suppliers' Risk
Currently, the Company relies on three main suppliers of materials. As a result,
should the current suppliers not produce and deliver materials on a timely
basis, research and development efforts and future sales may be adversely
impacted.
Inventory
Inventory is stated at the lower of cost (first-in, first-out) or market and
consisted primarily of raw materials at June 30, 2000.
F-7
<PAGE>
Mainsail Networks, Inc.
(a development stage company)
Notes to Financial Statements (continued)
1. Organization and Summary of Significant Accounting Policies (continued)
Property and Equipment
Property and equipment are carried at cost less accumulated depreciation and
amortization. Property and equipment are depreciated for financial reporting
purposes using the straight-line method over the estimated useful lives of the
assets, generally three years. Leasehold improvements are amortized using the
straight-line method over the shorter of the useful lives of the assets or the
term of the lease. Property and equipment consisted of the following at June 30:
2000 1999
---------------------------
Machinery and equipment $ 957,777 $ 308,137
Furniture and fixtures 76,760 11,544
Leasehold improvements 123,239 92,943
---------------------------
1,157,776 412,624
Accumulated depreciation and amortization (308,478) (57,217)
---------------------------
$ 849,298 $ 355,407
===========================
Software Development Costs
Costs incurred internally in creating a computer software product are expensed
when incurred as research and development until technological feasibility has
been established for the product. After the achievement of technological
feasibility, any additional costs to complete the product or enhancements would
be capitalized. There were no software development costs capitalized for the
years ended June 30, 2000 and 1999 as the Company's first product reached
technological feasibility in late fiscal 2000.
Fair Value of Financial Instruments
All current assets and liabilities are carried at cost, which approximates fair
value because of the short-term maturity and nature of these instruments.
F-8
<PAGE>
Mainsail Networks, Inc.
(a development stage company)
Notes to Financial Statements (continued)
1. Organization and Summary of Significant Accounting Policies (continued)
Stock-Based Compensation
The Company accounts for stock-based awards to employees under the intrinsic
value method in accordance with Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" (APB 25), and has adopted the
disclosure-only alternative of Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation" (FAS 123).
Comprehensive Income
The Company's comprehensive net loss was the same as its net loss for the years
ended June 30, 2000, 1999, and 1998.
Net Loss Per Share
Basic and diluted net loss per share was computed using the weighted average
number of common shares outstanding. Options, warrants, and preferred stock were
not included in the computation of diluted net loss per share because the effect
would be antidilutive.
A reconciliation of shares used in the calculation of basic and diluted net loss
per share follows:
<TABLE>
<CAPTION>
Years Ended June 30,
----------------------------------------------
2000 1999 1998
----------------------------------------------
<S> <C> <C> <C>
Net loss $ (7,587,223) $ (2,931,111) $ (1,171,847)
==============================================
Shares used in computing basic and diluted net loss per share:
Weighted average common shares outstanding 13,519,963 13,520,057 12,419,889
Less shares subject to repurchase (913,153) (1,327,333) (463,334)
----------------------------------------------
12,606,810 12,192,724 11,956,555
==============================================
Basic and diluted net loss per share $ (0.60) $ (0.24) $ (0.10)
==============================================
</TABLE>
F-9
<PAGE>
Mainsail Networks, Inc.
(a development stage company)
Notes to Financial Statements (continued)
1. Organization and Summary of Significant Accounting Policies (continued)
Net Loss Per Share (continued)
The following were outstanding but not included in the computation of diluted
net loss per share since the effect would be antidilutive:
<TABLE>
<CAPTION>
June 30,
-------------------------------------------------
2000 1999 1998
-------------------------------------------------
<S> <C> <C> <C>
Options to purchase common stock 1,611,937 723,500 190,000
Stock subject to repurchase 987,762 1,176,668 920,001
Warrants to purchase common stock 1,661,455 - -
Convertible preferred stock 15,514,101 15,514,101 10,994,448
</TABLE>
Impact of Recently Issued Accounting Standards
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (FAS 133). FAS 133 provides a comprehensive
and consistent standard for the recognition and measurement of derivatives and
hedging activities. The statement applies to all periods after June 15, 2000.
The Company believes that the adoption of FAS 133 will not have a significant
impact on its operating results or cash flows.
In March 2000, Interpretation No. 44, "Accounting for Certain Transactions
Involving Stock Compensation" (FIN 44), was issued. This interpretation contains
rules designed to clarify the application of APB 25. FIN 44 became effective on
July 1, 2000, and the Company adopted it at that time. The Company believes the
impact of adoption of FIN 44 will not be material to its operating results and
financial position.
F-10
<PAGE>
Mainsail Networks, Inc.
(a development stage company)
Notes to Financial Statements (continued)
2. Cash and Cash Equivalents
Cash and cash equivalents consisted of the following at June 30:
2000 1999
-------------------------------
Cash $ 223,223 $ 66,469
Money market instruments 835,068 318,983
U.S. treasury bills - 7,728,064
Commercial paper 2,485,511 -
-------------------------------
Total $ 3,543,802 $ 8,113,516
===============================
The fair value, based on quoted market prices of the cash equivalents, is
substantially equal to their carrying value at June 30, 2000 and 1999.
3. Notes Payable
In June 2000, the Company received a total of $2,900,000 in loans from third-
party ($1,400,000) and related-party ($1,500,000) investors. The related parties
consisted of a Company founder, an executive of the Company, and a venture
capital firm owned by an executive of the Company. The notes bear interest at
10% per annum and are payable with the principal on May 31, 2001.
In connection with these loans, warrants were issued to purchase an aggregate of
1,661,455 (859,374 to related parties and 802,081 to third parties) shares of
common stock with an exercise price of $0.24 per share. The warrants are
exercisable at any time and expire on the earlier of May 31, 2002, the closing
of a firm commitment underwritten public offering pursuant to a registration
statement under the Securities Act of 1933, or a change in control of the
Company. The detachable warrant and related debt were recorded at $2,030,000 and
$870,000, respectively, based on an allocation of the total proceeds. The
allocation was based on the relative fair value of the warrant and the debt. The
difference between the face amount of the debt of $2,900,000 and the recorded
amount will be amortized as additional debt discount over the life of the loan.
Interest expense of approximately $98,000 related to debt discount amortization
was recorded in the period ended June 30, 2000.
F-11
<PAGE>
Mainsail Networks, Inc.
(a development stage company)
Notes to Financial Statements (continued)
4. Commitments and Contingencies
The Company leases its facilities under an operating lease which expires in
2002. Rental expense was approximately $334,000, $127,000, $78,000, and $539,000
for the years ended June 30, 2000, 1999, 1998, and the period from June 3, 1997
(inception) to June 30, 2000, respectively. In June 1999, the Company subleased
a portion of its facilities to a third party through September 2000. Sublease
rental income was approximately $45,000 for the year ended June 30, 2000.
Future minimum lease payments under noncancelable operating leases are as
follows at June 30, 2000:
2001 $ 304,950
2002 293,150
----------
Total minimum payments $ 598,100
==========
5. Stockholders' Equity
Stock Split
On March 27, 1998 the Company's Board of Directors and stockholders approved a
three-for-one stock split of the Company's common and preferred stock. All
preferred stock, common stock, and per share amounts have been adjusted
retroactively to give effect to the stock splits.
F-12
<PAGE>
Mainsail Networks, Inc.
(a development stage company)
Notes to Financial Statements (continued)
5. Stockholders' Equity (continued)
Convertible Preferred Stock
The Company is authorized to issue 16,653,402 shares of convertible preferred
stock, designated in series. A summary of convertible preferred stock is as
follows:
June 30,
-------------------------
2000 1999
-------------------------
Series A:
Authorized, issued, and outstanding shares 6,000,000 6,000,000
Series B:
Authorized, issued, and outstanding shares 4,994,448 4,994,448
Series C:
Authorized shares 5,658,954 5,658,954
Issued and outstanding shares 4,519,653 4,519,653
All preferred stock series are convertible into common stock at the option of
the stockholder on a one-for-one basis subject to antidilution adjustments.
Conversion is automatic concurrent with a qualified initial public offering of
not less than $20,000,000 and a per share price of not less than $4.00. Such
conversion can occur for Series A and B convertible preferred stock upon the
consent of the holders of a majority of the then outstanding shares of
convertible preferred stock voting as a single class or for Series C convertible
preferred stock upon a two-thirds majority vote. The preferred stockholders have
voting rights equal to the voting rights of the common stockholders on an as-if-
converted basis.
The Series A, B, and C preferred stockholders are entitled to dividends, prior
and in preference to any other dividends payable, at the rate of $0.0133,
$0.0267, and $0.1728 per share, respectively. The dividends are noncumulative
and payable quarterly, when and if declared by the Board of Directors. Such
dividends have a preference over the payment of dividends on common stock. No
dividends have been declared to date.
F-13
<PAGE>
Mainsail Networks, Inc.
(a development stage company)
Notes to Financial Statements (continued)
5. Stockholders' Equity (continued)
Convertible Preferred Stock (continued)
In the event of liquidation, payment will be made to Series A, B, and C
preferred stockholders, prior and in preference to any other stockholders, for
the amount equal to $0.17, $0.33, and $2.16 per share, respectively, plus all
declared and unpaid dividends. Any amounts in excess of these amounts will be
distributed ratably to Series C preferred stockholders and common stockholders
until the Series C preferred stockholders have received an aggregate
distribution of $4.32 per share. If any assets remain, common stockholders will
receive a distribution equal to the remaining assets.
Common Stock
Common stock reserved for issuance at June 30, 2000 is as follows:
Stock option plan:
Outstanding options 1,611,937
Reserved for future grants 3,107,022
-----------
4,718,959
Common stock warrants 1,661,455
Convertible preferred stock 15,514,101
------------
Total common stock reserved for future issuance 21,894,515
============
F-14
<PAGE>
Mainsail Networks, Inc.
(a development stage company)
Notes to Financial Statements (continued)
5. Stockholders' Equity (continued)
Stock-Based Compensation
In June 1997, the Board of Directors approved a stock option plan (the Plan)
that authorized the grant of options to purchase shares of the Company's common
stock. At June 30, 2000, the maximum aggregate number of shares that may be
optioned and sold under the Plan is 6,000,000 shares of common stock. The Plan
is administered by the Board of Directors and provides for incentive stock
options or nonqualified stock options to be issued to employees and consultants
of the Company. Prices for incentive stock options may not be less than the fair
value of the common stock at the date of grant. Prices for nonqualified stock
options may not be less than 85% of the fair value of the common stock at the
date of grant. However, for any incentive stock options or nonqualified stock
options granted to an optionee who owns more than 10% of the combined total
voting stock at the time the option is granted, the price may not be less than
110% of the fair market value of the common stock at the date of grant. The fair
market value is determined in good faith by the Board of Directors or a
committee designated by the Board of Directors. Options are immediately
exercisable and vest over a period of four years from the date of grant. Any
unvested stock issued is subject to repurchase by the Company at the original
issuance price upon termination of the option holder's employment. Unexercised
options expire ten years after the date of grant. However, in the case of
incentive stock options, shares granted to an optionee who owns more than 10% of
the combined total voting stock at the time the option is granted, the term is
five years from the date of grant.
In the event of a proposed sale of all or part of the Company's assets into
another corporation, the acquiring company may assume or substitute an
equivalent option or right. However, the option shall be terminated if the
successor corporation does not agree to assume the option or to substitute an
equivalent option.
During the year ended June 30, 2000, the Company recorded aggregate deferred
compensation of approximately $2,699,365, representing the difference between
the grant price and the deemed fair value of the Company's common stock options
granted during that year. The amortization of deferred compensation is being
charged to operations and is being amortized over the vesting period of the
options, which is typically four years. For the year ended June 30, 2000, the
amortized expense was approximately $343,824.
F-15
<PAGE>
Mainsail Networks, Inc.
(a development stage company)
Notes to Financial Statements (continued)
5. Stockholders' Equity (continued)
Stock-Based Compensation (continued)
The following is a summary of additional information with respect to the Plan:
<TABLE>
<CAPTION>
Options
-------------------------------------------
Options Weighted
Available Number of Average
For Grant Shares Exercise Price
----------------------------------------------------------------
<S> <C> <C> <C>
Authorized 6,000,000 - $ -
Granted (1,110,001) 1,110,001 $0.021
Exercised - (920,001) $0.017
----------------------------------------
Balance at June 30, 1998 4,889,999 190,000 $0.040
Granted (1,328,500) 1,328,500 $0.135
Exercised - (755,000) $0.040
Canceled 40,000 (40,000) $0.240
----------------------------------------
Balance at June 30, 1999 3,601,499 723,500 $0.203
Granted (1,355,000) 1,355,000 $0.240
Exercised - (190,000) $0.222
Canceled 276,563 (276,563) $0.224
Repurchased 583,960 - $0.029
----------------------------------------
Balance at June 30, 2000 3,107,022 1,611,937 $0.228
========================================
</TABLE>
The following table summarizes information about stock options that were
outstanding and exercisable at June 30, 2000:
<TABLE>
<CAPTION>
Options Outstanding and Exercisable
--------------------------------------------------
Weighted
Average
Weighted Remaining
Number of Average Contractual Life
Exercise Prices Shares Exercise Price (In Years)
--------------------------------------------------------------------------------
<S> <C> <C> <C>
$0.040 30,000 $0.040 8.17
$0.080 75,000 $0.080 8.40
$0.240 1,506,937 $0.240 9.33
---------
Total 1,611,937 $0.228 9.27
=========
</TABLE>
F-16
<PAGE>
Mainsail Networks, Inc.
(a development stage company)
Notes to Financial Statements (continued)
5. Stockholders' Equity (continued)
Stock-Based Compensation (continued)
At June 30, 2000, 1999, and 1998, approximately 988,000, 1,177,000, and 920,000,
respectively, shares of common stock were subject to repurchase by the Company.
Common stock subject to repurchase represents any unvested shares of common
stock held by an optionholder which, upon termination of the optionholder's
employment, may be repurchased by the Company. Such shares are subject to
repurchase at their original issuance price.
The Company has elected to follow APB 25 and related interpretations in
accounting for its employee stock plans because, as discussed below, the
alternative fair value accounting provided for under FAS 123 requires the use of
valuation models that were not developed for use in valuing employee stock
instruments. Under APB 25, when the exercise price of the Company's employee
stock options equals the market price of the underlying stock on the date of
grant, no compensation expense is recognized.
Pro forma information regarding net loss is required under FAS 123 and is
calculated as if the Company had accounted for its employee stock options
granted during the years ended June 30, 2000, 1999, and 1998 under the fair
value method of FAS 123. The fair value for employee stock options granted was
estimated at the date of grant based on the minimum value method using the
following assumptions:
June 30,
----------------------------------------------
2000 1999 1998
----------------------------------------------
Expected life 5 years 5 years 5 years
Expected dividend yield 0.0% 0.0% 0.0%
Risk-free interest rate 6.0% 5.4% 5.5%
As discussed above, the valuation models used under FAS 123 were developed for
use in estimating the fair value of traded options that have no vesting
restrictions and are fully transferable. In addition, valuation models require
the input of highly subjective assumptions, including the expected life of the
option. Because the Company's employee stock options 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 employee stock instruments.
F-17
<PAGE>
Mainsail Networks, Inc.
(a development stage company)
Notes to Financial Statements (continued)
5. Stockholders' Equity (continued)
Stock-Based Compensation (continued)
For purposes of pro forma disclosures, the estimated fair value of the options
granted is amortized to expense over their respective vesting periods. Had
compensation cost for the Company's stock-based compensation plans been
determined based on the fair value at the grant dates consistent with the method
of FAS 123, the Company's net loss and net loss per share would not have been
materially different from the historical amounts reported. Therefore, such pro
forma information is not presented herein. In future years, the application of
FAS 123 may result in pro forma net income or loss that is materially different
from historical reported results.
The options' weighted average grant date fair value, which is the value assigned
to the options under FAS 123, was $0.06, $0.03, and $0.01 for options granted
during 2000, 1999, and 1998, respectively.
6. Income Taxes
Due to operating losses and the inability to recognize the benefits therefrom,
there is no provision for income taxes for the fiscal years ended June 30, 2000,
1999, and 1998.
The reconciliation of income tax expense (benefit) attributable to net loss
applicable to common stockholders computed at the U.S. federal statutory rates
to income tax expense (benefit) for the fiscal years ended June 30, 2000, 1999,
and 1998 is as follows:
June 30,
-------------------------------------------
2000 1999 1998
-------------------------------------------
Tax provision (benefit) at U.S.
statutory rate $(2,579,656) $(996,578) $(398,428)
Loss for which no tax benefit is
currently recognizable 2,579,656 996,578 398,428
-------------------------------------------
$ - $ - $ -
===========================================
F-18
<PAGE>
Mainsail Networks, Inc.
(a development stage company)
Notes to Financial Statements (continued)
6. Income Taxes (continued)
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 assets as of June 30 are as follows:
2000 1999
-------------------------------------
Deferred tax assets and liabilities:
Net operating loss carryforwards $ 4,500,000 $ 1,500,000
Other, net 170,000 80,000
-------------------------------------
Total deferred tax assets 4,670,000 1,580,000
Valuation allowance (4,670,000) (1,580,000)
-------------------------------------
Net deferred tax assets $ - $ -
=====================================
Realization of deferred tax assets is dependent on future earnings, if any, the
timing and the amount of which are uncertain. Accordingly, a valuation allowance
in an amount equal to the net deferred tax asset as of June 30, 2000 and 1999
has been established to reflect these uncertainties. The change in the valuation
allowance was a net increase of approximately $3,090,000 and $1,140,000 for the
years ended June 30, 2000 and 1999, respectively.
As of June 30, 2000, the Company has federal and state net operating loss
carryforwards of approximately $11,000,000, expiring at various dates from June
30, 2006 for state to June 30, 2020 for federal.
Utilization of net operating loss and tax credit carryforwards may be subject to
a substantial annual limitation due to the ownership change limitations provided
by the Internal Revenue Code of 1986, as amended, and similar state provisions.
The annual limitation may result in the expiration of net operating loss and tax
credit carryforwards before full utilization.
F-19
<PAGE>
Mainsail Networks, Inc.
(a development stage company)
Notes to Financial Statements (continued)
7. Employee Benefit Plan
In January 2000, the Company adopted a 401(k) Profit Sharing Plan that allows
voluntary contributions by eligible employees. Employees may elect to contribute
up to the maximum allowed under the Internal Revenue Service regulations. The
Company may make discretionary contributions as determined by the Board of
Directors. No amount was contributed by the Company to the plan during the year
ended June 30, 2000. Plan administrative costs were immaterial for the year
ended June 30, 2000.
8. Subsequent Events (Unaudited)
Financing
On July 3, 2000 the Company entered into a second round of debt financing with
two founders and six employees of the Company with similar terms to those
described in Note 3. The principal amount of the notes and the number of
warrants granted under this round of financing are as follows:
Amount of Number of
the Note Warrants
--------------------------------------
Founders $ 150,000 85,936
Employees 470,000 269,268
--------------------------------------
$ 620,000 355,204
======================================
Warrants to purchase 57,291 shares of common stock related to the second round
of debt financing were exercised in July 2000 by one of the founders of the
Company.
Merger
On August 1, 2000, the Company entered into a "Plan of Merger and
Reorganization" agreement with Terayon Communication Systems Inc. (the Parent),
a publicly traded company. Under this agreement, the Parent is to acquire all
outstanding stock of the Company. The acquisition is expected to close in early
October 2000 pending certain closing conditions.
F-20
<PAGE>
UNAUDITED PRO FORMA COMBINED
CONDENSED FINANCIAL STATEMENTS
(b) Terayon Communication Systems, Inc. unaudited pro forma combined
condensed financial statements.
The following unaudited pro forma combined condensed financial statements
give effect to the Terayon Communication Systems, Inc. ("Terayon") acquisition
of Mainsail Networks, Inc. ("Mainsail") through a merger and exchange of shares
that was completed on September 29, 2000. In addition, the unaudited pro forma
combined condensed financial statements give effect to Terayon's acquisition of
certain assets and liabilities of Access Network Electronicss ("ANE"), a
division of Tyco Electronics Corporation, Ltd. ("Tyco") that was completed on
April 22, 2000, Terayon's acquisition of Combox Ltd. ("Combox") that was
completed on April 18, 2000, Terayon acquisition of Telegate Ltd. ("Telegate")
that was completed on January 2, 2000, Terayon's acquisition of Radwiz Ltd.
("Radwiz") that was completed on November 22, 1999 and Terayon's acquisition of
Imedia Corporation ("Imedia") that was completed on September 16, 2000.
F-21
<PAGE>
UNAUDITED PRO FORMA COMBINED CONDENSED BALANCE SHEET
AS OF JUNE 30, 2000
(in thousands)
<TABLE>
<CAPTION>
Terayon Mainsail Pro-forma
Actual Actual Adjustments Total
--------- -------- ----------- -----
<S> <C> <C> <C> <C>
Assets
Current assets:
Cash and cash equivalents......................... $ 59,018 $ 3,544 $ - $ 62,562
Short-term investments............................ 62,329 - - 62,329
Accounts receivable, net.......................... 40,557 - - 40,557
Accounts receivable from related party............ 15,720 - - 15,720
Other current receivables......................... 18,740 - - 18,740
Inventory......................................... 19,272 484 - 19,756
Other current assets.............................. 4,794 18 - 4,812
--------- --------- ---------- ----------
Total current assets............................ 220,430 4,046 - 224,476
Property and equipment, net.............................. 18,594 849 $ - 19,443
Developed technology..................................... 100,461 - 49,000 [1] 149,461
Assembled workforce...................................... 20,091 - 2,800 [1] 22,891
Trademark................................................ 5,083 - - 5,083
Customer relationship.................................... 28,817 - - 28,817
Customer base............................................ 2,368 - - 2,368
Other assets............................................. 5,518 33 - 5,551
Goodwill................................................. 344,945 - 88,504 [1] 433,449
--------- --------- ---------- ----------
Total assets........................................ $ 746,307 $ 4,928 $ 140,304 $ 891,539
========= ========= ========== ==========
Liabilities and Stockholders' Equity
Current liabilities:
Short-term bank debt.............................. 776 - - 776
Current portion of long-term debt................. 283 - - 283
Accounts payable.................................. 61,078 512 - 61,590
Accrued payroll and related expenses.............. 9,479 217 - 9,696
Other accrued liabilities......................... 18,736 30 5,575 [2] 24,341
Notes payable to related parties.................. - 503 - 503
Notes payable..................................... - 465 - 465
Current portion of capital lease obligations...... 4 - - 4
--------- --------- ---------- ----------
Total current liabilities....................... 90,356 1,727 5,575 97,658
Long-term debt........................................... 876 - - 876
Long-term portion of capital lease obligations........... 4 - - 4
Other long-term obligations.............................. 2,653 - - 2,653
Deferred tax liability................................... 22,407 - - 22,407
Stockholders' equity (deficiency):
Convertible preferred stock....................... 1 (1) [3] -
Common stock...................................... 842,341 17,246 125,684 [3] 1,007,729
22,458 [5]
Accumulated deficit............................... (211,170) (11,690) 6,690 [4] (216,170)
Deferred compensation............................. (1,237) (2,356) (20,102) [5] (23,695)
Stockholders' notes receivable.................... (6) - - (6)
Accumulated other comprehensive income............ 83 - - 83
--------- --------- ---------- ----------
Total stockholders' equity (deficiency)......... 655,951 3,201 134,729 793,881
--------- --------- ---------- ----------
Total liabilities and stockholders' equity...... $ 746,307 $ 4,928 $ 140,304 $ 891,539
========= ========= ========== ==========
</TABLE>
See notes to unaudited pro forma combined condensed financial statements.
F-22
<PAGE>
UNAUDITED PRO FORMA COMBINED CONDENSED STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 2000
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
Terayon Mainsail ANE Combox Pro-forma
Actual Actual Actual Actual Adjustments Total
------- -------- ------ ------ ----------- -----
<S> <C> <C> <C> <C> <C> <C>
Revenues:
Product revenues............................. $ 89,344 $ - $ 17,819 $ 147 $ - $ 107,310
Related party product revenues............... 62,012 - - - - 62,012
--------- -------- --------- --------- --------- ---------
Total revenues.............................. 151,356 - 17,819 147 - 169,322
Cost of Goods Sold:
Cost of product revenues..................... 77,188 - 14,401 434 5,761 [6] 101,042
88 [9]
2,399 [10]
771 [13]
Cost of related party product revenues....... 33,260 - - - - 33,260
--------- -------- --------- --------- --------- ---------
Total cost of goods sold.................... 110,448 - 14,401 434 9,019 134,302
Gross profit (loss)........................... 40,908 - 3,418 (287) (9,019) 35,020
Operating Expenses:
Research and development, net................. 27,134 3,013 3,397 1,658 2,487 [6] 38,709
178 [9]
732 [10]
110 [13]
Cost of product development assistance
agreement.................................... 9,563 - - - 9,563
In-process research and development........... 19,835 - - - (735) [8] 4,300
(8,000) [12]
(6,800) [16]
Sales and marketing........................... 18,472 1,490 2,177 280 957 [6] 24,135
288 [9]
457 [10]
14 [13]
General and administrative.................... 9,946 823 683 913 478 [6] 13,251
278 [9]
109 [10]
21 [13]
Goodwill amortization......................... 21,650 - - - 8,850 [6] 37,917
2,664 [10]
4,753 [13]
--------- -------- --------- --------- --------- ---------
Total operating expenses...................... 106,600 5,326 6,257 2,851 6,841 127,875
--------- -------- --------- --------- --------- ---------
Operating loss................................ (65,692) (5,326) (2,839) (3,138) (15,860) (92,855)
Interest income (expense), net................ 2,934 23 - (177) - 2,780
--------- -------- --------- --------- --------- ---------
Net loss applicable to common stockholders.... $ (62,758) $ (5,303) $ (2,839) $ (3,315) $ (15,860) $ (90,075)
========= ======== ========= ========= ========= =========
Historical basic and diluted net loss per
share attributable to common stockholders.... $ (1.09) $ (1.51)
========= =========
Shares used in computing historical basic and
diluted net loss per share attributable to
common stockholders......................... 57,696 1,793 59,489
========= ========= =========
</TABLE>
See notes to unaudited pro forma combined condensed financial statements.
F-23
<PAGE>
UNAUDITED PRO FORMA COMBINED CONDENSED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1999
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
Terayon Mainsail ANE Combox Radwiz Telegate Imedia Pro-forma
Actual Actual Actual Actual Actual Actual Actual Adjustments Total
-------- -------- -------- -------- -------- -------- -------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Product revenues............... $ 57,345 $ - $ 73,069 $ 1,012 $ 1,704 $ - $ 3,567 $ (2,762) [17] $ 133,935
Related party product revenues. 39,664 - - - - 9,144 - 48,808
-------- -------- -------- -------- -------- -------- -------- --------- ---------
Total revenues................ 97,009 - 73,069 1,012 1,704 9,144 3,567 (2,762) 182,743
Cost of Goods Sold:
Cost of product revenues..... 46,215 - 49,308 757 1,573 1,697 11,522 [6] 142,296
175 [9]
5,050 [10]
2,569 [13]
15,672 [15]
4,450 [19]
3,308 [22]
Cost of related party product
revenues.................... 25,829 - - - - 9,399 - (2,762) [17] 32,466
-------- -------- -------- -------- -------- -------- -------- --------- ---------
Total cost of goods sold... 72,044 - 49,308 757 1,573 9,399 1,697 39,984 174,762
Gross profit (loss)............. 24,965 - 23,761 255 131 (255) 1,870 (42,746) 7,981
Operating Expenses:
Research and development, net... 17,579 3,086 13,913 930 1,649 5,467 2,432 4,975 [6] 55,116
355 [9]
2,350 [10]
367 [13]
987 [15]
668 [19]
358 [22]
Cost of product development
assistance agreement........... 35,147 - - - - - - - 35,147
In-process research and
development.................... 14,600 - - - - - - (3,600) [20] -
(11,000) [23]
Sales and marketing............. 15,727 576 7,061 512 2,351 914 2,705 1,913 [6] 35,391
575 [9]
1,470 [10]
46 [13]
215 [15]
588 [19]
738 [22]
General and administrative...... 7,476 453 2,774 870 1,001 1,927 2,534 957 [6] 19,544
555 [9]
350 [10]
69 [13]
269 [15]
167 [19]
142 [22]
Goodwill amortization........... 3,524 - - - - - - 17,701 [6] 68,758
8,564 [10]
15,842 [13]
12,075 [15]
3,516 [19]
7,536 [22]
-------- -------- -------- -------- -------- -------- -------- --------- ---------
Total operating expenses........ 94,053 4,115 23,748 2,312 5,001 8,308 7,671 68,748 213,956
-------- -------- -------- -------- -------- -------- -------- --------- ---------
Operating loss.................. (69,088) (4,115) 13 (2,057) (4,870) (8,563) (5,801) (111,494) (205,975)
Interest income (expense), net.. 5,008 250 - 70 (42) (711) (629) - 3,946
-------- -------- -------- -------- -------- -------- -------- --------- ---------
Net loss applicable to common
stockholders................... $(64,080) $ (3,865) $ 13 $ (1,987) $ (4,912) $ (9,274) $ (6,430) $(111,494) $(202,029)
-------- -------- -------- -------- -------- -------- -------- --------- ---------
Historical basic and diluted net
loss per share attributable to
common stockholders............ $ (1.55) $ (3.70)
======== =========
Shares used in computing
historical basic and diluted
net loss per share attributable
to common stockholders......... 41,260 13,390 54,650
======== ========= =========
</TABLE>
See notes to unaudited pro forma combined condensed financial statements.
F-24
<PAGE>
NOTES TO UNAUDITED PRO FORMA COMBINED
CONDENSED FINANCIAL STATEMENTS
As of, and For the Six Months Ended June 30, 2000 and For the Year Ended
December 31, 1999
The Unaudited Pro Forma Combined Condensed Financial Statements as of and for
the six months ended June 30, 2000 give effect to:
. Terayon Communication Systems, Inc.'s ("Terayon") acquisition of Mainsail
Networks, Inc. ("Mainsail") through a merger and exchange of shares ("the
Mainsail merger") that was completed on September 29, 2000.
. Terayon's acquisition of certain assets and liabilities of Access Network
Electronics ("ANE"), a division of Tyco Electronics Corporation, Ltd.
("Tyco"), in exchange for common shares of Terayon ("the ANE acquisition")
that was completed on April 22, 2000.
. Terayon's acquisition of Combox Ltd. ("Combox") through a merger and
exchange of shares ("the Combox merger") that was completed on April 18,
2000.
The Unaudited Pro Forma Combined Condensed Statement of Operations for the six
months ended June 30, 2000 reflect the Mainsail, ANE and Combox transactions as
if they had taken place on January 1, 2000. The results of ANE and Combox
following April 22, 2000 and April 18, 2000, respectively, are included in
Terayon results for the six months ended June 30, 2000. The Unaudited Pro Forma
Combined Condensed Balance Sheet gives effect to the Mainsail transaction as if
it had occurred on June 30, 2000.
In addition to the Mainsail, ANE and Combox acquisitions, the Unaudited Pro
Forma Combined Condensed Statement of Operations for the year ended December 31,
1999 gives effect to:
F-25
<PAGE>
NOTES TO UNAUDITED PRO FORMA COMBINED
CONDENSED FINANCIAL STATEMENTS -- continued
. Terayon's acquisition of Imedia Corporation ("Imedia") through a merger and
exchange of shares that was completed on September 16, 1999.
. Terayon's acquisition of Radwiz Ltd. ("Radwiz") through a merger and
exchange of shares that was completed on November 22, 1999.
. Terayon's acquisition of Telegate Ltd. ("Telegate") through a merger and
exchange of shares that was completed on January 2, 2000.
The Unaudited Pro Forma Combined Condensed Statements of Operations for the year
ended December 31, 1999 reflect the Imedia, Radwiz, Telegate, ANE, Combox and
Mainsail transactions as if they had taken place on January 1, 1999.
The results of Imedia, Radwiz and Telegate are included in Terayon's actual
results for the period following September 16, 1999, November 22, 1999 and
January 2, 2000, respectively.
The Unaudited Pro Forma Combined Condensed Financial Statements do not include
the impact of the Internet Telecom Ltd. and Ultracom Ltd. Communications
Holdings (1995) acquisitions that closed on April 18, 2000 and April 19, 2000,
respectively. The combined purchase price for the Internet Telecom and Ultracom
acquisitions was approximately $101.2 million. A significant portion of the
purchase price was allocated to intangible assets which will be amortized over
lives ranging from two to five years. The results of Internet Telecom and
Ultracom are included in Terayon's actual results for the period following April
18, 2000 and April 19, 2000, respectively.
The Mainsail, ANE, Combox, Telegate, Radwiz and Imedia transactions 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. 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 above transactions.
In connection with the acquisition of Mainsail, Terayon expects to incur write-
offs related to in-process research and development of approximately $5.0
million. In connection with the acquisition of ANE, Terayon incurred write-offs
related to in-process research and development of approximately $735,000 in the
six months ended June 30, 2000. In connection with the acquisition of Combox,
Terayon incurred write-offs related to in-process research and development of
approximately $8.0 million in the six months ended June 30, 2000. In connection
with the acquisition of Telegate, Terayon incurred write-offs related to in-
process research and development of approximately $6.8 million in the six months
ended June 30, 2000. In connection with the acquisition of Radwiz, Terayon
F-26
<PAGE>
NOTES TO UNAUDITED PRO FORMA COMBINED
CONDENSED FINANCIAL STATEMENTS -- continued
incurred write-offs related to in-process research and development of
approximately $3.6 million in the year ended December 31, 1999. In connection
with the acquisition of Imedia, Terayon incurred write-offs related to in-
process research and development of $11.0 million in the year ended December 31,
1999. The Unaudited Pro Forma Combined Condensed Balance Sheet includes the ANE,
Combox, Telegate, Radwiz and Imedia write-offs and the anticipated Mainsail
write-off related to in-process research and development; however, the Unaudited
Pro Forma Combined Condensed Statements of Operations do not reflect these
charges. The charge related to in-process research and development for Mainsail
will be reflected in Terayon's consolidated financial statements when the merger
is consummated. Terayon expects integration costs to be insignificant as a
result of the mergers.
Terayon's Board of Directors approved a two-for-one stock split in April 2000.
The stock split was paid in the form of a stock dividend to all stockholders of
record on April 25, 2000, and was distributed on May 5, 2000. All share numbers
reflect the two-for-one split.
The unaudited pro forma combined condensed financial statements are not
necessarily indicative of what the actual financial results would have been had
all of the above mergers taken place on January 1, 1999, January 1, 2000 or June
30, 2000 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 Agreement and Plan of Merger and Reorganization
among Terayon and Mainsail ("the Agreement"), Mainsail will become a
wholly-owned subsidiary of Terayon, and all outstanding shares of its
preferred stock and common stock will be converted into shares of common
stock of Terayon. The Mainsail merger closed on early September 29, 2000.
The Mainsail acquisition will be accounted for using the purchase method of
accounting. In general, the former shareholders of Mainsail will receive
approximately 2.6 million shares of Terayon common stock. In addition, the
holders of vested and unvested Mainsail options will receive approximately
482,000 options to purchase Terayon common stock the value of which will be
included in the purchase price and the intrinsic value of the unvested
options will be recorded as unearned compensation.
For purposes of the pro forma combined condensed financial statements the
purchase price was estimated to be approximately $142.9 million based on
the closing price of Terayon's common stock on the days immediately
preceding and following the announcement of the Mainsail acquisition. The
unearned compensation for the intrinsic value of the options issued to the
holders of unvested Mainsail options is estimated to be approximate $22.5
million.
F-27
<PAGE>
NOTES TO UNAUDITED PRO FORMA COMBINED
CONDENSED FINANCIAL STATEMENTS -- continued
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 to the former
shareholders and optionholders of Mainsail 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
Mainsail 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):
<TABLE>
<CAPTION>
Annual
Amortization Amortization
Life of Intangibles
-------------------------------------
<S> <C> <C> <C>
Estimated Acquisition Cost:
Estimated purchase price.................. $ 142,930
Estimated transaction and other direct
costs................................... 5,575
---------
Total Estimated Acquisition Cost... $ 148,505
=========
Purchase Price Allocation:
Historical value of net assets to be
acquired of Mainsail at June 30, 2000... $ 3,201
Intangible assets acquired:
Developed technology................. 49,000 5 years $ 9,800
Assembled workforce.................. 2,800 2 1,400
In-Process technology................ 5,000
Goodwill............................. 88,504 5 17,700
---------
$ 148,505
=========
</TABLE>
Tangible assets of Mainsail to be acquired principally include cash, inventory
and property and equipment. Liabilities of Mainsail to be assumed principally
include accounts payable, accrued liabilities and notes payable.
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 $49.0 million
for developed technology that has reached technological feasibility and
therefore is capitalizable. The developed technology will be amortized on a
straight line basis over a five year period.
F-28
<PAGE>
NOTES TO UNAUDITED PRO FORMA COMBINED
CONDENSED FINANCIAL STATEMENTS -- continued
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 will be amortized on a straight line basis over a two year period.
The preliminary goodwill allocation as of June 30, 2000 is approximately
$88.5 million. Amortization of goodwill will occur over five years.
The projects identified as in-process at Mainsail are those that will be
underway at the time of the acquisition of Mainsail and will, after
consummation of the acquisition, require additional effort to establish
technological feasibility. These projects have identifiable technological
risk factors that indicate that even though successful completion is
expected, it is not assured. The value of the in-process research and
development is estimated at $5.0 million.
In-process technology to be acquired in the transaction consists primarily
of additions to Mainsail's core technology, which is related to Mainsail's
planned development of new features. A portion of the intended
functionality of these new features is not supported by Mainsail's current
technology. The resultant technology is intended to provide a high capacity
CPE and a low cost gateway.
Terayon expects that the in-process technology will be successfully
developed, and that initial benefits from these projects will begin in
calendar mid-to-late 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.
2. The pro forma adjustment to "Other accrued liabilities" reflects the
accrual of acquisition costs arising from the Mainsail acquisition, for a
total of approximately $5.5 million.
3. The pro forma adjustment to "Common stock" reflects the elimination of
Mainsail's preferred ($1,000) and common ($17.2 million) stock and the
issuance of Terayon common stock ($142.9 million).
4. The pro forma adjustment reflects the elimination of Mainsail's accumulated
deficit ($11.7 million) and the in-process technology charge ($5.0
million).
5. The pro forma adjustment reflects the elimination of Mainsail's deferred
compensation ($2.4 million) and records the unearned compensation ($22.5
million) arising from the issuance of options to purchase Terayon common
stock to the holders of unvested Mainsail options.
6. The pro forma adjustment reflects the amortization of goodwill, developed
technology, trademark, assembled workforce and unearned compensation.
F-29
<PAGE>
NOTES TO UNAUDITED PRO FORMA COMBINED
CONDENSED FINANCIAL STATEMENTS -- continued
7. In accordance with the Asset Purchase Agreement between Terayon and Tyco
Electronics Corporation ("the ANE Agreement), Terayon purchased
substantially all of the assets and assumed specified liabilities of ANE.
The ANE acquisition was completed on April 22, 2000. The results of ANE
following April 22, 2000 are included in Terayon's actual results.
The ANE acquisition was accounted for using the purchase method of
accounting. In general, Tyco received 1,404,552 shares of Terayon common
stock. In addition, Terayon established an employee retention program for
the purposes of retaining certain identified employees of ANE. The
retention program provides for up to three annual payments to the
identified employees in a total amount of approximately $4.2 million
provided the employees remain employed by Terayon. The retention payments
will be charged to expense over the employees' respective periods of
service.
For purposes of the pro forma combined condensed financial statements the
purchase price was determined to be approximately $85.0 million. This
represents the minimum purchase price, as specified in the Agreement, to be
issued to the shareholders.
Below is a table of the approximate purchase price, purchase price
allocation and annual amortization of the intangible assets acquired (in
thousands):
<TABLE>
<CAPTION>
Annual
Amortization Amortization
Life of Intangibles
----------------------------------------
<S> <C> <C> <C>
Approximate Purchase Price:
Purchase price............................... $ 85,000
Estimated transaction and other direct
costs...................................... 500
----------
Total Estimated Acquisition Cost... $ 85,500
==========
Purchase Price Allocation:
Historical value of net assets acquired
of ANE at April 22, 2000.............. $ 14,251
Adjustment to state net assets as fair
market value (106)
----------
14,145
Intangible assets acquired:
Developed technology.................... 12,600 5 years $ 2,520
Assembled workforce..................... 12,200 2 6,100
Trademark............................... 600 5 120
Customer base........................... 2,400 5 480
In-Process technology................... 735
</TABLE>
F-30
<PAGE>
NOTES TO UNAUDITED PRO FORMA COMBINED
CONDENSED FINANCIAL STATEMENTS -- continued
Goodwill.......................... 42,820 5 8,564
-------
$85,500
=======
Tangible assets of ANE acquired principally include accounts receivable,
inventory and property and equipment. Liabilities of ANE assumed 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 $12.6 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 five 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 $12.2 million for the assembled workforce. The asset is being
amortized on a straight line basis over a two year period.
The goodwill allocation is approximately $42.8 million. Amortization of goodwill
will occur over five years.
The projects identified as in-process at ANE are those that were underway at the
time of the acquisition of ANE and will, after consummation of the acquisition,
require additional effort to establish technological feasibility. These projects
have identifiable technological risk factors that indicate that even though
successful completion is expected, it is not assured. Terayon incurred $735,000
in in-process research and development write-offs in the six months ended June
30, 2000 as result of the ANE merger.
In-process technology acquired in the transaction consists primarily of
additions to ANE's core technology, which is related to ANE's planned
development of new features. A project was in place to enhance the
functionality of the current technology to allow the transmission from a 56 Kbps
modem without the loss of transmission rate. The project was subsequently
amended but is still intended to create the same resultant technology.
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.
F-31
<PAGE>
NOTES TO UNAUDITED PRO FORMA COMBINED
CONDENSED FINANCIAL STATEMENTS -- continued
8. The pro forma adjustment reflects the elimination of $735,000 of in-process
research and development write-offs incurred by Terayon in the six months
ended June 30, 2000 for the ANE acquisition.
9. The pro forma adjustment reflects the cost associated with the retention
program.
10. The pro forma adjustment reflects the amortization of goodwill, developed
technology, trademark and assembled workforce for the year ended December
31, 1999 and for the period from January 1, 2000 through April 22, 2000.
11. In accordance with the Share Purchase Agreement among Terayon and Combox
("the Agreement"), Combox 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 Combox acquisition was completed on April 18,
2000. The results of Combox following April 18, 2000 are included in
Terayon's actual results.
The Combox acquisition was accounted for using the purchase method of
accounting. In general, the shareholders and vested optionholders of Combox
received 1,547,770 shares and options to purchase shares of Terayon common
stock and a cash payment of approximately $250,000. In addition, Terayon
issued options to purchase shares of Terayon common stock to the unvested
optionholders of Combox, the value of which was included in the purchase
price.
For purposes of the pro forma combined condensed financial statements the
purchase price was determined to be approximately $97.7 million. The
estimated purchase price was determined as the value of Terayon's common
stock issued at closing ($92.0 million) and the value of the options to
purchase Terayon's shares issued to the unvested optionholders ($5.5
million) based on the fair market value of Terayon's common stock on the
days immediately preceding and following the date the acquisition was
announced. In addition, a cash payment of approximately $250,000 is
included in the purchase price. Proceeds to be received from the
optionholders and warrantholders upon exercise are not significant.
Below is a table of the approximate purchase price, purchase price
allocation and annual amortization of the intangible assets acquired (in
thousands):
<TABLE>
<CAPTION>
Annual
Amortization Amortization
Life of Intangibles
-------------------------------------------
<S> <C> <C> <C>
Approximate Purchase Price:
Purchase price............................... $97,684
Estimated transaction and other direct
costs................................... 540
-------
Total Estimated Acquisition Cost.... $98,224
=======
</TABLE>
F-32
<PAGE>
NOTES TO UNAUDITED PRO FORMA COMBINED
CONDENSED FINANCIAL STATEMENTS -- continued
<TABLE>
<S> <C> <C> <C>
Purchase Price Allocation:
Historical value of net assets acquired
of Combox at April 18, 2000............ $ 2,308
Intangible assets acquired:
Developed technology................... 12,500 5 years $ 2,500
Assembled workforce.................... 1,100 2 550
In-Process technology.................. 8,000
Goodwill............................... 79,212 5 15,842
Deferred tax liability................. (4,896)
-------
$98,224
=======
</TABLE>
Tangible assets of Combox acquired principally include cash and cash equivalents
and accounts receivable. Liabilities of Combox assumed principally include short
and long term debt, 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 $12.5 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 five 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 $1.1 million for the assembled workforce. The asset is being
amortized on a straight line basis over a two year period.
The goodwill allocation is approximately $79.2 million. Amortization of goodwill
will occur over five years.
The projects identified as in-process at Combox are those that were underway at
the time of the acquisition of Combox and will, after consummation of the
acquisition, require additional effort to establish technological feasibility.
These projects have identifiable technological risk factors that indicate that
even though successful completion is expected, it is not assured. Terayon
incurred $8.0 million in in-process research and development write-offs in the
six months ended June 30, 2000 as result of the Combox merger.
In-process technology acquired in the transaction consists primarily of
additions to Combox's core technology, which is related to Combox's planned
development of new features. A portion of the intended functionality of these
new features is not
F-33
<PAGE>
NOTES TO UNAUDITED PRO FORMA COMBINED
CONDENSED FINANCIAL STATEMENTS -- continued
supported by Combox's current technology. Intended new features include
modems that offer end-to-end solutions for both the cable and the satellite
infrastructure.
Terayon expects that the in-process technology will be successfully
developed, and that initial benefits from these projects will begin in late
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.
12. The pro forma adjustment reflects the elimination of $8.0 million in in-
process research and development write-offs incurred by Terayon in the six
months ended June 30, 2000.
13. The pro forma adjustment is for the amortization of goodwill, developed
technology, trademark and assembled workforce for the year ended December
31, 1999 and for the period from January 1, 2000 through April 18, 2000.
14. In accordance with the Share Purchase Agreement among Terayon and Telegate
("the Agreement"), Telegate 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 acquisition of Telegate was completed on
January 2, 2000. The results of Telegate for the period following January
2, 2000 are included in Terayon's actual results.
The Telegate merger was accounted for using the purchase method of
accounting. In general, the shareholders and vested optionholders of
Telegate received 4,400,000 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. In
addition, the Company issued a warrant to purchase 2,000,000 shares of the
Company's common stock under the terms of an agreement between Telegate and
a customer of Terayon. The value of the warrant was included in the
purchase price and was associated with the value of the customer
relationship.
The purchase price was determined to be approximately $138.0 million. This
represents the minimum purchase price as specified in the Telegate
Agreement of $100.0 million, an estimated cash payment of $3.5 million and
the value of the warrant ($34.6 million). Terayon does not anticipate
receiving any proceeds from the optionholders upon exercise of the options
and warrants.
Below is a table of the approximate purchase price, purchase price
allocation and annual amortization of the intangible assets acquired:
Annual
Amortization Amortization
Life of Intangibles
--------------------------------
F-34
<PAGE>
NOTES TO UNAUDITED PRO FORMA COMBINED
CONDENSED FINANCIAL STATEMENTS -- continued
Approximate Purchase Price:
Purchase price............................ $137,965
Estimated transaction and other direct
costs..................................... 1,929
--------
$139,894
========
Purchase Price Allocation:
Historical net tangible assets of Telegate
at January 2, 2000....................... $(5,682)
Conversion of Telegate convertible
notes and accrued interest............... 12,482
--------
6,800
Intangible assets acquired:
Customer relationship................... 34,580 3 years $11,527
Developed technology.................... 21,100 6 3,517
Assembled workforce..................... 4,200 2 2,100
In-Process Technology................... 6,750
Goodwill................................ 72,452 6 12,075
Deferred tax liability.................. (5,988)
--------
$139,894
========
Tangible assets of Telegate 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.
The value of the customer relationship was determined as the value of the
warrant ($34.6 million) using the Black Scholes model. The warrant is
fully vested, non-forfeitable, and immediately exercisable and has a term
of three years. The value of the customer relationship is being amortized
on a straight-line basis over a three-year period.
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 that 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
F-35
<PAGE>
NOTES TO UNAUDITED PRO FORMA COMBINED
CONDENSED FINANCIAL STATEMENTS -- continued
million for the assembled workforce. The asset is being amortized on a
straight line basis over a two year period.
The goodwill allocation is approximately $72.5 million. Amortization of
goodwill will occur over six years.
The projects identified as in process at Telegate are those that were
underway at the time of the acquisition of Telegate and would, after
consummation of the acquisition, require additional effort to establish
technological feasibility. These projects have identifiable technological
risk factors that indicate that even though successful completion is
expected, it is not assured. Terayon incurred $6.8 million in in-process
research and development write-offs in the six months ended June 30, 2000
as result of the Telegate merger.
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.
15. The pro forma adjustment reflects the amortization of goodwill, developed
technology, trademark and assembled workforce for the twelve month period
ended December 31, 1999.
16. The pro forma adjustment reflects the elimination of $6.8 million of in-
process research and development write-offs incurred by Terayon in the six
months ended June 30, 2000 relating to the Telegate merger.
17. The pro forma adjustment reflects the elimination of intercompany
transactions between Terayon and Telegate prior to the merger.
18. 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 acquisition of Radwiz was completed
on November 22, 1999. The results of Radwiz for the period following
November 22, 1999 are included in Terayon's actual results.
F-36
<PAGE>
NOTES TO UNAUDITED PRO FORMA COMBINED
CONDENSED FINANCIAL STATEMENTS -- continued
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. On the closing, Terayon paid $250,000 in
cash and issued 1,747,164 shares of Terayon common stock to the former
shareholders of Radwiz and issued options to purchase 145,142 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 was included in
the purchase price. The aggregate number of shares of the Company's
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 and the twelve month anniversary. Subsequent
to December 31, 1999, the market valuation specified in the Radwiz
Agreement was reached and Terayon's obligation to issue additional shares
of common stock was eliminated. As a result, no additional consideration
will be issued to the former shareholders and optionholders of Radwiz.
The approximate purchase price was determined to be $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) based on the market value of Terayon's common
stock on the date the acquisition was announced. Proceeds to be received
from the Radwiz optionholders upon exercise of their options are not
significant.
Below is a table of the approximate purchase price, purchase price
allocation and annual amortization of the intangible assets acquired (in
thousands):
<TABLE>
<CAPTION>
Annual
Amortization Amortization
Life of Intangibles
-------------------------------
<S> <C> <C> <C>
Approximate Purchase Price:
Purchase price.......................... $52,667
Estimated transaction and other direct
costs................................... 902
-------
$53,569
=======
Purchase Price Allocation:
Historical net tangible assets of Radwiz
at November 22, 1999.................. $3,058
Intangible assets acquired:
Developed technology.................... 29,850 6 years $4,975
Assembled workforce..................... 2,800 2 1,400
Trademark............................... 1,150 6 192
</TABLE>
F-37
<PAGE>
NOTES TO UNAUDITED PRO FORMA COMBINED
CONDENSED FINANCIAL STATEMENTS -- continued
In-Process technology............... 3,600
Goodwill............................ 23,860 6 3,977
Deferred tax liability.............. (10,749)
-------
$53,569
=======
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 that 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 goodwill allocation is approximately $23.9 million. Amortization of
goodwill will occur over six years.
The projects identified as in process at Radwiz are those that were
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 that indicate that even though successful completion is
expected, it is not assured. Terayon incurred $3.6 million in in-process
research and development write-offs in the year ended December 31, 1999 as
result of the Radwiz merger.
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,
F-38
<PAGE>
NOTES TO UNAUDITED PRO FORMA COMBINED
CONDENSED FINANCIAL STATEMENTS -- continued
there remain significant technical challenges that must be resolved in
order to complete the in-process technology.
19. The pro forma adjustment reflects the amortization of goodwill, developed
technology, trademark and assembled workforce for the period from January
1, 1999 to November 22, 1999.
20. The pro forma adjustment reflects the elimination of $3.6 million of in-
process research and development write-offs incurred by Terayon in the year
ended December 31, 1999 relating to the Radwiz merger.
21. 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. In general, the shareholders, vested optionholders and
warrantholders received shares of Terayon common stock, options and
warrants to purchase shares of Terayon common stock. 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
1,654,814 shares of common stock on the closing of the Imedia merger.
Subsequent to December 31, 1999, the valuation formulae specified in the
Agreement were satisfied, and, accordingly, the Company's obligation to
issue additional common stock or options and warrants to purchase common
stock beyond those issued at the Closing was eliminated. As a result, no
additional consideration will be issued in the future to the former
stockholders, optionholders and warrantholders of Imedia.
The purchase price of approximately $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 that will be received from the optionholders and warrantholders
upon exercise (approximately $3.1 million). The purchase price was
allocated to the assets acquired and liabilities assumed based on a
determination from an independent appraisal of their respective fair
values.
The unaudited pro forma combined condensed financial statements have been
prepared on the basis of assumptions described in the notes thereto. Below
is a table
F-39
<PAGE>
NOTES TO UNAUDITED PRO FORMA COMBINED
CONDENSED FINANCIAL STATEMENTS -- continued
of the approximate purchase price, purchase price allocation and annual
amortization of the intangible assets acquired:
<TABLE>
<CAPTION>
Annual
Amortization Amortization
Life of Intangibles
-------------------------------
<S> <C> <C> <C>
Approximate Purchase Price:
Purchase price........................... $106,347
Estimated transaction and other direct
costs.................................... 2,631
--------
$108,978
========
Purchase Price Allocation:
Historical net tangible assets of Imedia
at September 16, 1999.................. $(355)
Forgiveness of Imedia note payable....... 1,000
--------
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
--------
$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 at 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 that 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 $2.5
F-40
<PAGE>
NOTES TO UNAUDITED PRO FORMA COMBINED
CONDENSED FINANCIAL STATEMENTS -- continued
million for the assembled workforce. The asset is being amortized on a
straight line basis over a two year period.
The goodwill allocation is approximately $63.8 million. Amortization of
goodwill will occur over six years.
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 that indicate, 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.
22. The pro forma adjustment reflects the amortization of goodwill, developed
technology, trademark and assembled workforce for the period from January
1, 1999 to September 16, 1999.
23. The pro forma adjustment reflects 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.
F-41
<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: October 18, 2000 By: /s/ Zaki Rakib
-------------------------------------
Zaki Rakib
Chief Executive Officer and Secretary
