<PAGE>
FINANCIAL STATEMENTS
VPNX.com, INC. (a development stage company)
YEARS ENDED DECEMBER 31, 1998 AND 1999 AND THE PERIOD FROM
JUNE 19, 1996 (INCEPTION) TO DECEMBER 31, 1999
WITH REPORT OF INDEPENDENT AUDITORS
<PAGE>
VPNX.com, Inc.
(a development stage company)
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Ernst & Young LLP, Independent Auditors......................................................F-2
Balance Sheets.........................................................................................F-3
Statements of Operations...............................................................................F-4
Statement of Stockholders' Equity......................................................................F-5
Statements of Cash Flows...............................................................................F-7
Notes to Financial Statements..........................................................................F-8
</TABLE>
F-1
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
VPNX.com, Inc.
We have audited the accompanying balance sheets of VPNX.com, Inc. (a development
stage company) as of December 31, 1998 and 1999, and the related statements of
operations, stockholders' equity (deficit), and cash flows for each of the three
years in the period ended December 31, 1999 and for the period from June 19,
1996 (inception) to December 31, 1999. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of VPNX.com, Inc. at December 31,
1998 and 1999, and the results of its operations and its cash flows for each of
the three years in the period ended December 31, 1999 and for the period from
June 19, 1996 (inception) to December 31, 1999, in conformity with accounting
principles generally accepted in the United States.
The accompanying financial statements have been prepared assuming that VPNX.com,
Inc. will continue as a going concern. As more fully described in Note 1, the
Company has incurred operating losses since inception and has an accumulated
deficit at December 31, 1999 of $7,239,909. These conditions raise substantial
doubt about the Company's ability to continue as a going concern. The financial
statements of VPNX.com, Inc. 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
February 4, 2000
F-2
<PAGE>
VPNX.com, Inc.
(a development stage company)
Balance Sheets
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------ JUNE 30,
1998 1999 2000
------------------------------------------------------
(Unaudited)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 4,146,036 $ 3,390,454 $ 3,946,009
Short-term investments 498,663 - -
Accounts receivable 851,853 - 10,021
Prepaid expenses and other current assets 61,028 137,857 60,136
------------------------------------------------------
Total current assets 5,557,580 3,528,311 4,016,166
Property and equipment:
Computer equipment 578,542 916,776 899,819
Furniture and office equipment 805,803 823,174 823,174
Leasehold improvements 187,275 194,665 202,639
------------------------------------------------------
1,571,620 1,934,615 1,925,632
Accumulated depreciation and amortization 388,698 834,668 1,069,793
------------------------------------------------------
1,182,922 1,099,947 855,839
Deposits and other assets 80,460 116,400 116,400
------------------------------------------------------
Total assets $ 6,820,962 $ 4,744,658 $ 4,988,405
======================================================
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable $53,749 $196,390 $92,170
Accrued payroll and related expenses 240,072 377,683 241,828
Other accrued liabilities 149,273 205,348 345,362
Notes payable, current portion 580,933 528,057 531,430
Deferred revenue 183,333 374,257 4,155,695
Bridge loans - 2,000,000 2,000,000
------------------------------------------------------
Total current liabilities 1,207,360 3,681,735 7,366,485
Notes payable, less current portion 603,716 548,194 290,739
Commitments
Stockholders' equity (deficit):
Series A preferred stock, $0.001 par value:
Authorized shares - 3,131,341
Issued and outstanding shares - 3,131,341
Liquidation preference of $2,600,000 3,131 3,131 3,131
Series B preferred stock, $0.001 par value:
Authorized shares - 3,140,987
Issued and outstanding shares - 3,140,987
Liquidation preference of $3,999,995 3,141 3,141 3,141
Common stock, $0.001 par value:
Authorized shares - 20,000,000
Issued and outstanding shares - 9,966,116 in 1998 and
1999 and 9,990,306 in 2000 9,966 9,966 9,990
Additional paid-in capital 7,741,372 7,741,372 9,538,604
Notes receivable (8,917) (2,972) (2,972)
Deferred compensation - - (1,707,000)
Deficit accumulated during the development stage (2,738,807) (7,239,909) (10,513,713)
------------------------------------------------------
Total stockholders' equity (deficit) 5,009,886 514,729 (2,668,819)
------------------------------------------------------
Total liabilities and stockholders' equity (deficit) $ 6,820,962 $ 4,744,658 $ 4,988,405
======================================================
</TABLE>
See accompanying notes.
F-3
<PAGE>
VPNX.com, Inc.
(a development stage company)
Statements of Operations
<TABLE>
<CAPTION>
PERIOD FROM
JUNE 19, 1996
(INCEPTION) TO
YEARS ENDED DECEMBER 31, DECEMBER 31, SIX MONTHS ENDED JUNE 30,
------------------------------------------------------------------------------------------------------
1997 1998 1999 1999 1999 2000
------------------------------------------------------------------------------------------------------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C> <C> <C>
Net revenues $ 1,604,098 $3,866,795 $ 3,866,627 $ 9,337,520 $ 300,050 $ 1,215,214
Operating expenses:
Research and development 1,846,389 2,949,755 6,128,003 11,425,744 2,713,577 3,033,155
General and administrative 646,852 873,779 1,200,870 3,010,778 552,700 726,993
Sales and marketing 396,384 763,599 1,282,618 2,551,899 556,508 738,134
Amortization of deferred
compensation - - - - - 83,000
------------------------------------------------------------------------------------------------------
Total operating expenses 2,889,625 4,587,133 8,611,491 16,988,421 3,822,785 4,581,282
------------------------------------------------------------------------------------------------------
Operating loss (1,285,527) (720,338) (4,744,864) (7,650,901) (3,522,735) (3,366,068)
Interest and other income 51,576 173,518 330,251 546,866 174,169 205,686
Interest expense (7,842) (41,543) (86,489) (135,874) (46,655) (113,422)
------------------------------------------------------------------------------------------------------
Net loss $(1,241,793) $(588,363) $(4,501,102) $(7,239,909) $(3,395,221) $(3,273,804)
======================================================================================================
Basic and diluted net loss
per share $ (0.15) $ (0.07) $ (0.46) $ (0.35) $ (0.33)
======================================================================================================
Shares used to compute basic
and diluted net loss per
share 8,319,357 8,977,842 9,719,583 9,701,276 9,951,128
======================================================================================================
</TABLE>
See accompanying notes.
F-4
<PAGE>
VPNX.com, Inc.
(a development stage company)
Statements of Stockholders' Equity (Deficit)
Period from June 19, 1996 (inception) to December 31, 1999
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK ADDITIONAL
--------------------------------------------------------- PAID-IN
SHARES AMOUNT SHARES AMOUNT CAPITAL
----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Issuance of common stock in July for business plan - $ - 5,635,035 $5,635 $50,715
Sale of common stock in July and August at $0.24 per
share - - 1,934,415 1,934 458,066
Sale of common stock in September at $0.24 per share - - 50,000 50 11,840
Sale of common stock in November at $0.30 per share - - 1,333,333 1,334 398,666
Stock issuance costs - - - - (7,607)
Net loss - - - - -
----------------------------------------------------------------------
Balance at December 31, 1996 - - 8,952,783 8,953 911,680
Sale of common stock in March at $0.30 per share - - 833,333 833 249,167
Sale of Series A preferred stock in April at $0.83 per
share, less issuance costs of $30,856 3,010,905 3,011 - - 2,466,133
Sale of Series A preferred stock in September at $0.83
per share 120,436 120 - - 99,880
Issuance of common stock due to exercise of stock
options at $0.30 per share - - 100,000 100 29,900
Net loss - - - - -
----------------------------------------------------------------------
Balance at December 31, 1997 3,131,341 3,131 9,886,116 9,886 3,756,760
Sale of Series B preferred stock in March at $1.27 per
share, less issuance costs of $35,527 3,140,987 3,141 - - 3,961,327
Issuance of common stock due to exercise of stock
options at $0.24 per share - - 10,208 10 2,417
Issuance of common stock due to exercise of stock
options at $0.30 per share - - 80,000 80 23,920
Repurchase of common stock from employee in March at
$0.30 per share - - (10,208) (10) (3,052)
Payment by stockholder on note - - - - -
Net loss - - - - -
----------------------------------------------------------------------
Balance at December 31, 1998 6,272,328 6,272 9,966,116 9,966 7,741,372
<CAPTION>
DEFICIT
ACCUMULATED
DURING THE TOTAL
NOTES DEVELOPMENT STOCKHOLDERS'
RECEIVABLE STAGE EQUITY (DEFICIT)
--------------------------------------------------
<S> <C> <C> <C>
Issuance of common stock in July for business plan $ - $ - $56,350
Sale of common stock in July and August at $0.24 per
share - - 460,000
Sale of common stock in September at $0.24 per share (11,890) - -
Sale of common stock in November at $0.30 per share - - 400,000
Stock issuance costs - - (7,607)
Net loss - (908,651) (908,651)
--------------------------------------------------
Balance at December 31, 1996 (11,890) (908,651) 92
Sale of common stock in March at $0.30 per share - - 250,000
Sale of Series A preferred stock in April at $0.83 per
share, less issuance costs of $30,856 - - 2,469,144
Sale of Series A preferred stock in September at $0.83
per share - - 100,000
Issuance of common stock due to exercise of stock
options at $0.30 per share - - 30,000
Net loss - (1,241,793) (1,241,793)
--------------------------------------------------
Balance at December 31, 1997 (11,890) (2,150,444) 1,607,443
Sale of Series B preferred stock in March at $1.27 per
share, less issuance costs of $35,527 - - 3,964,468
Issuance of common stock due to exercise of stock
options at $0.24 per share - - 2,427
Issuance of common stock due to exercise of stock
options at $0.30 per share - - 24,000
Repurchase of common stock from employee in March at
$0.30 per share - - (3,062)
Payment by stockholder on note 2,973 - 2,973
Net loss - (588,363) (588,363)
--------------------------------------------------
Balance at December 31, 1998 (8,917) (2,738,807) 5,009,886
</TABLE>
See accompanying notes.
F-5
<PAGE>
VPNX.com, Inc.
(a development stage company)
Statements of Stockholders' Equity (Deficit) (continued)
Period from June 19, 1996 (inception) to December 31, 1999
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK ADDITIONAL
---------------------------------------------------------- PAID-IN NOTES
SHARES AMOUNT SHARES AMOUNT CAPITAL RECEIVABLE
-------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1998 6,272,328 $6,272 9,966,116 $9,966 $7,741,372 $(8,917)
Payment by stockholder on note - - - - - 5,945
Net loss - - - - - -
-------------------------------------------------------------------------------------
Balance at December 31, 1999 6,272,328 6,272 9,966,116 9,966 7,741,372 (2,972)
Exercise of Stock options/warrants
(unaudited) - - 24,190 24 7,232 -
Deferred compensation (unaudited) - - - - 1,790,000 -
Amortization of deferred compensation
(unaudited) - - - - - -
Net loss (unaudited) - - - - - -
-------------------------------------------------------------------------------------
Balance at June 30, 2000 (unaudited) 6,272,328 $6,272 9,990,306 $9,990 $9,538,604 $(2,972)
=====================================================================================
<CAPTION>
DEFICIT
ACCUMULATED
DURING THE TOTAL
DEFERRED DEVELOPMENT STOCKHOLDERS'
COMPENSATION STAGE EQUITY (DEFICIT)
----------------------------------------------------
<S> <C> <C> <C>
Balance at December 31, 1998 $ - $(2,738,807) $5,009,886
Payment by stockholder on note - - 5,945
Net loss - (4,501,102) (4,501,102)
----------------------------------------------------
Balance at December 31, 1999 - (7,239,909) 514,729
Exercise of Stock options/warrants
(unaudited) - - 7,256
Deferred compensation (unaudited) (1,790,000) - -
Amortization of deferred compensation
(unaudited) 83,000 - 83,000
Net loss (unaudited) - (3,273,804) (3,273,804)
----------------------------------------------------
Balance at June 30, 2000 (unaudited) $(1,707,00) $(10,513,713) $(2,668,819)
====================================================
</TABLE>
See accompanying notes.
F-6
<PAGE>
VPNX.com, Inc.
(a development stage company)
Statements of Cash Flows
<TABLE>
<CAPTION>
PERIOD FROM
JUNE 19, 1996
(INCEPTION) TO
YEARS ENDED DECEMBER 31, DECEMBER 31, SIX MONTHS ENDED JUNE 30,
--------------------------------------------------------------------------------------
1997 1998 1999 1999 1999 2000
--------------------------------------------------------------------------------------
(Unaudited)
<S> <C> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net loss $(1,241,793) $(588,363) $(4,501,102) $(7,239,909) $(3,395,221) $(3,273,804)
Adjustments to reconcile net loss to net
cash provided by (used in) operating
activities:
Depreciation and amortization 169,558 155,628 445,970 834,668 220,421 235,125
Write-off of technology and licensing 85,000 - - 149,754 - -
agreement
Amortization of deferred compensation - - - - - 83,000
Changes in assets and liabilities:
Accounts receivable-trade (833,138) (1,853) 851,853 - 851,853 (10,021)
Prepaid expenses and other current (42,052) (8,756) (76,829) (81,507) (61,832) 77,721
assets
Account payable 10,412 26,642 142,641 196,390 (38,602) (104,220)
Accrued payroll and related expenses 43,010 112,073 137,611 377,683 24,907 (135,855)
Other accrued liabilities 25,084 110,189 56,075 214,115 (15,005) 140,014
Deferred revenue (76,000) 183,333 190,924 374,257 3,150,000 3,781,438
--------------------------------------------------------------------------------------
Net cash provided by (used in) operating (1,859,919) (11,107) (2,752,857) (5,174,549) 736,521 793,398
activities
INVESTING ACTIVITIES
Acquisition of property, plant, and equipment (177,946) (1,193,272) (362,995) (1,749,369) (225,084) -
Proceeds from (purchases of) short-term - (498,663) 498,663 - 498,663 -
investments
Proceeds from sales of equipment - - - - - $ 8,983
Other assets (34,133) (44,890) (35,940) (116,400) (30,417) -
--------------------------------------------------------------------------------------
Net cash provided by (used in) investing (212,079) (1,736,825) 99,728 (1,865,769) 243,162 8,983
activities
FINANCING ACTIVITIES
Proceeds from issuance of Series A preferred 2,569,144 - - 2,569,144 - -
stock
Proceeds from issuance of Series B preferred - 3,964,468 - 3,964,468 - -
stock
Proceeds from issuance of common stock, net
of repurchases 280,000 23,365 - 1,155,758 - 7,256
Proceeds from payment of stockholder notes - 2,973 5,945 8,918 - -
Proceeds from issuance of notes payable, net 483,572 753,788 621,832 1,859,192 306,764 -
Repayments of notes payable (280,000) (116,478) (730,230) (1,126,708) (345,286) (254,082)
Proceeds from bridge loans - - 2,000,000 2,000,000 - -
---------------------------------------------------------------------------------------
Net cash provided by (used in) financing
activities 3,052,716 4,628,116 1,897,547 10,430,772 (38,522) (246,826)
---------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash 980,718 2,880,184 (755,582) 3,390,454 941,161 555,555
equivalents
Cash and cash equivalents at beginning of
period 285,134 1,265,852 4,146,036 - 4,146,036 3,390,454
---------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $1,265,852 $4,146,036 $3,390,454 $3,390,454 $5,087,197 $3,946,009
=======================================================================================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION
Note payable issued in exchange for
technology, royalty considerations, and $85,000 $ - $ - $ 335,000 $ - $ -
fixed assets
Common stock issued in exchange for note $ - $ - $ - $ 11,890 $ - $ -
Common stock issued in exchange for business $ - $ - $ - $ 56,350 $ - $ -
plan
Interest paid $ - $ 41,543 $86,489 $ 135,874 $ 46,655 $ 113,422
</TABLE>
See accompanying notes.
F-7
<PAGE>
VPNX.com, Inc.
(a development stage company)
Notes to Financial Statements
(Information as of June 30, 2000 and for the six months ended
June 30, 1999 and 2000 is unaudited)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BUSINESS
VPNX.com, Inc. (VPNX or the Company) was incorporated on June 19, 1996 in the
state of Delaware. The Company conducts its business within one industry segment
and was formed for the purpose of developing and marketing policy software for
controlling network infrastructure. In the later part of 1999, the Company began
shifting its focus to the virtual private network market. In 1999, the product
was in the development stage with a product launch scheduled for 2000. Since
inception, the Company has primarily been involved in performing research and
development activities, establishing development contracts, and raising capital.
Accordingly, the Company is in the development stage.
GOING CONCERN
The Company has incurred losses since inception and will require additional
financing in order for the Company to continue its operations. Management
believes it will be able to secure additional sources of funding through a
private stock offering and intends to pursue this course of action. There can be
no assurance that the Company will be able to secure the necessary financing to
continue operations. 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 may differ from these estimates.
F-8
<PAGE>
VPNX.com, Inc.
(a development stage company)
Notes to Financial Statements (continued)
(Information as of June 30, 2000 and for the six months ended
June 30, 1999 and 2000 is unaudited)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
The Company considers as a cash equivalent any highly liquid investment that
matures within three months of its purchase date. At December 31, 1999 and June
30, 2000, cash equivalents consisted of money market funds. The Company
considers as a short-term investment any highly liquid investment with an
original maturity greater than three months but less than one year. The Company
considers all short-term investments as "available-for-sale." No adjustments
have been made to the carrying value of short-term investments as the carrying
value at December 31, 1998 approximated fair market value. In addition, no
realized gains or losses were recognized from the sale of short-term investments
in 1997, 1998, or 1999.
Estimated fair values of financial instruments are based on quoted market
prices. The following is a summary of available-for-sale securities (in
thousands) at December 31, 1998. At December 31, 1998, the fair value of
securities approximated cost.
<TABLE>
<CAPTION>
DECEMBER 31,
1998
-----------------
<S> <C>
Money market fund $3,043,018
Commercial paper 979,893
Corporate bonds 500,000
-----------------
$4,522,911
=================
Classified as:
Cash equivalents $4,024,248
Short-term investments 498,663
-----------------
$4,522,911
=================
</TABLE>
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is computed using the
straight-line method over the estimated useful lives of the assets, which are
generally two to five years. Leasehold improvements are amortized over the
shorter of their useful lives or the term of the lease.
F-9
<PAGE>
VPNX.com, Inc.
(a development stage company)
Notes to Financial Statements (continued
(Information as of June 30, 2000 and for the six months ended
June 30, 1999 and 2000 is unaudited)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REVENUE RECOGNITION
Substantially all of the Company's revenue relates to research and development
work performed under development contracts. The Company recognizes this
revenue when earned, which generally occurs when agreed upon deliverables are
provided or milestones are met and confirmed by customers, and in any case
not in excess of the amount that would be recognized using the percentage of
completion method. Due to technological risk factors, the costs of these
contracts are expensed as incurred. Costs incurred under development
contracts of $483,000, $1,265,000, $4,242,000 and $6,095,000 in 1997, 1998,
1999 and for the period from June 19, 1996 (inception) to December 31, 1999
respectively are included in research and developments in the statements of
operations.
INTERIM FINANCIAL INFORMATION
The interim financial information at June 30, 2000 and for the six-month periods
ended June 30, 1999 and 2000 is unaudited but, in the opinion of management,
includes all adjustments, consisting only of normal recurring accruals, which
the Company considers necessary for a fair presentation of the financial
position and results of operations for the interim periods. The results of
operations for the six-month period ended June 30, 2000 are not necessarily
indicative of the results to be expected for the full fiscal year.
F-10
<PAGE>
VPNX.com, Inc.
(a development stage company)
Notes to Financial Statements (continued)
(Information as of June 30, 2000 and for the six months ended
June 30, 1999 and 2000 is unaudited)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CONCENTRATION OF CREDIT RISK
A limited number of customers have historically accounted for a substantial
portion of the Company's revenue. The following table summarizes the Company's
significant customers:
<TABLE>
<CAPTION>
YEARS ENDED SIX MONTHS ENDED
DECEMBER 31, JUNE 30,
----------------------------------------- ----------------------------
CUSTOMER 1997 1998 1999 1999 2000
--------------------- -------------- ------------- ------------ ------------- -------------
<S> <C> <C> <C> <C> <C>
A -% 65% 10% 33% 83%
B 87% 35% 16% 67% -%
C -% -% 80% -% -%
</TABLE>
The Company performs ongoing credit evaluations of its customers and considers
reserves for potential credit losses, and such losses have been within
management's expectations. The Company generally does not require collateral
from its customers.
RESEARCH AND DEVELOPMENT
Research and development expenditures are generally charged to operations as
incurred. Statement of Financial Accounting Standards No. 86, "Accounting for
the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed,"
requires the capitalization of certain software development costs subsequent to
the establishment of technological feasibility. Based on the Company's product
development process, technological feasibility is established upon the
completion of a working model. To date, no costs have qualified for
capitalization, and accordingly, the Company has charged all such costs to
research and development expense in the accompanying statements of operations.
COMPREHENSIVE INCOME
Effective January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" (FAS 130). The Company's
comprehensive net loss was the same as its net loss for all periods presented.
F-11
<PAGE>
VPNX.com, Inc.
(a development stage company)
Notes to Financial Statements (continued)
(Information as of June 30, 2000 and for the six months ended
June 30, 1999 and 2000 is unaudited)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ADVERTISING COSTS
Advertising costs are expensed as incurred and have been immaterial through June
30, 2000.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of the Company's long-term debt is estimated using a discounted
cash flow analysis based on the Company's current incremental borrowing rate for
similar types of borrowing arrangements. The carrying value of the Company's
long-term debt approximates fair value.
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 Opinion No. 25), and has adopted
the disclosure-only alternative of Statement of Financial Accounting Standards
No. 123, "Accounting for Stock-Based Compensation" (FAS 123).
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board (FASB) issued 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. In June 1999, the FASB issued FAS 137, "Accounting for
Derivative Instruments and Hedging Activities - Deferral of the Effective Date
of FASB Statement No. 133," which deferred the effective date of FAS 133 until
fiscal years beginning after June 15, 2000. The Company believes that the
adoption of FAS 133 will not have a significant impact on the Company's
operating results or cash flows.
In December 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 101 "Revenue Recognition in Financial Statements" (SAB 101). SAB
101 provides guidance on the recognition, presentation, and disclosure of
revenue in financial statements. SAB 101 is effective for years beginning after
December 15, 1999 and is required to be reported beginning in the quarter ended
December 31, 2000. SAB 101 is not expected to have a significant effect on the
Company's consolidated results of
F-12
<PAGE>
VPNX.com, Inc.
(a development stage company)
Notes to Financial Statements (continued)
(Information as of June 30, 2000 and for the six months ended
June 30, 1999 and 2000 is unaudited)
operations, financial position, or cash flows.
F-13
<PAGE>
VPNX.com, Inc.
(a development stage company)
Notes to Financial Statements (continued)
(Information as of June 30, 2000 and for the six months ended
June 30, 1999 and 2000 is unaudited)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECENT ACCOUNTING PRONOUNCEMENTS (CONTINUED)
In March 2000, the FASB issued FASB Interpretation No. 44, "Accounting for
Certain Transactions Involving Stock Compensation - an Interpretation of APB
Opinion No. 25" (FIN 44). FIN 44 clarifies the application of APB Opinion No. 25
and, among other issues, clarifies the following: the definition of an employee
for purposes of applying APB Opinion No. 25, the criteria for determining
whether a plan qualifies as a noncompensatory plan, the accounting consequences
of various modifications to the terms of the previously fixed stock options or
awards, and the accounting for an exchange of stock compensation awards in a
business combination. FIN 44 is effective July 1, 2000, but certain conclusions
in FIN 44 cover specific events that occurred after either December 15, 1998 or
January 12, 2000. The Company does not expect the application of FIN 44 to have
a material impact on the Company's results of operations, financial position, or
cash flows.
2. NOTES PAYABLE
Notes payable consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------- ----------------- JUNE 30,
1998 1999 2000
---------------- ----------------- ----------------
<S> <C> <C> <C>
Notes payable to Phoenix Leasing, Inc., due in monthly
installments through 2001 secured by the Company's
equipment $748,539 $984,561 $761,042
Note payable to bank, due in monthly installments
through 2001 with interest at prime (8.5%), some of
which is secured by the Company's equipment 436,110 91,690 61,127
---------------- ----------------- ----------------
1,184,649 1,076,251 822,169
Less current portion 580,933 528,057 531,430
---------------- ----------------- ----------------
$603,716 $548,194 $290,739
================ ================= ================
</TABLE>
In June 1999, the Company's $1,200,000 equipment line with Phoenix Leasing, Inc.
expired. In September 1999, the Company entered into an agreement for an
additional equipment line of $1,500,000. The total outstanding obligations under
the combined credit lines cannot exceed $2,000,000. At December 31, 1999, the
Company had borrowed approximately $1,376,000 under these arrangements of which
$984,561 remains outstanding and is reflected in the notes payable balance.
F-14
<PAGE>
VPNX.com, Inc.
(a development stage company)
Notes to Financial Statements (continued)
(Information as of June 30, 2000 and for the six months ended
June 30, 1999 and 2000 is unaudited)
2. NOTES PAYABLE (CONTINUED)
At December 31, 1999, future minimum principal payments on notes payable are as
follows:
<TABLE>
<S> <C>
2000 $528,057
2001 485,012
2002 63,182
----------
$1,076,251
==========
</TABLE>
3. BRIDGE LOAN
In December 1999, the Company received $2,000,000 in funding from some of its
current investors in the form of a Promissory Note. The term of the note is six
months and includes warrants for 471,149 shares of common stock at an exercise
price of $1.273 per share. The warrants are exercisable through December 2004.
The fair value of the warrants issued was immaterial.
If the Company enters into an agreement to issue new securities for an aggregate
amount of not less than $5,000,000 before the maturity date of the note, the
investor may convert the principal and interest of the note into the new
securities. If the new securities are issued at more than one equity closing,
conversion shall occur at the first equity closing where at least $2,000,000 in
new securities are issued. If elected, the note shall be converted into new
securities by dividing the principal and interest by the unit price of the new
securities.
If the Company does not enter into an agreement to issue new securities for an
aggregate current value amount of not less than $5,000,000 before the maturity
date of the note, the investor may elect to convert the principal and interest
of the note into Series B preferred stock at a price per share of $1.273.
If the Company enters into an agreement to sell, merge, or consolidate its
assets with another corporation before the maturity date of the loan, the
investor may elect to convert the principal and interest of the note into Series
B preferred stock at a price per share of $1.273.
In June 2000, the bridge loan was extended for an additional six months.
F-15
<PAGE>
VPNX.com, Inc.
(a development stage company)
Notes to Financial Statements (continued)
(Information as of June 30, 2000 and for the six months ended
June 30, 1999 and 2000 is unaudited)
4. COMMITMENTS
The Company currently leases its two facilities under noncancelable operating
leases that expire in July 2000 and September 2003. Future minimum lease
payments under the operating leases at December 31, 1999 are as follows:
<TABLE>
<S> <C>
2000 $ 576,455
2001 548,335
2002 563,393
2003 431,204
----------
Total minimum lease payments $2,119,387
==========
</TABLE>
Rental expense under operating leases was approximately $89,000, $255,000,
$616,000, and $979,000 for the years ended December 31, 1997, 1998, 1999, and
for the period from June 19, 1996 (inception) to December 31, 1999,
respectively, and $307,000 for each of the six months ended June 30, 1999 and
2000.
5. STOCKHOLDERS' EQUITY
CONVERTIBLE PREFERRED STOCK
The holders of Series A and B preferred stock are entitled to annual
noncumulative cash dividends out of legally available funds, when and if
declared by the Board of Directors, in the amounts of $0.07 and $0.10 per share,
respectively. As of December 31, 1999, there were no dividends paid or declared
by the Company.
F-16
<PAGE>
VPNX.com, Inc.
(a development stage company)
Notes to Financial Statements (continued)
(Information as of June 30, 2000 and for the six months ended
June 30, 1999 and 2000 is unaudited)
5. STOCKHOLDERS' EQUITY (CONTINUED)
CONVERTIBLE PREFERRED STOCK (CONTINUED)
In the event of any liquidation, dissolution, or winding up of the Company,
whether voluntary or not, the holders of each share of preferred stock shall be
entitled to be paid out of the Company's assets that are available for
distribution to its stockholders before any payment or declaration shall be made
with respect to the holders of common stock. Series A and B stockholders are
entitled to a liquidation preference of $0.830 and $1.273 per share,
respectively, plus all declared but unpaid dividends (collectively, the
Preference Amount). The remaining balance of proceeds is paid equally to the
common stockholders and to the holders of Series A and B preferred stock until
the holders of preferred stock have received an aggregate of three times their
preference amount. Any remaining funds shall then be distributed entirely to the
holders of common stock. Additionally, preferred stockholders have voting rights
equal to the number of common shares that would be held upon conversion.
The holders of Series A and B preferred stock have the right, at the option of
the holder, at any time, to convert their shares into common stock at a price of
$0.830 and $1.273 per share, respectively, subject to adjustments for future
dilution. Series A and B preferred stock automatically convert into common stock
at the then applicable conversion rate (currently one-for-one) upon a public
offering of the Company's common stock at a per share price of not less than
$4.00, subject to adjustments for future dilution, with aggregate proceeds in
excess of $10,000,000.
STOCK OPTION PLANS
The Company adopted the Founders' 1996 Stock Option Plan (the Founders' Plan)
and the 1997 Stock Option Plan (the 1997 Plan), under which officers, employees,
directors, and consultants may be granted Incentive Stock Options (ISOs) and
Nonstatutory Stock Options (NSOs) to purchase shares of the Company's common
stock. The Founders' Plan and the 1997 Plan permit ISOs and NSOs to be granted
at exercise prices of not less than 100% and 85%, respectively, of the fair
value on the date of grant as determined by the Board of Directors. Options that
expire (generally ten years from the grant date) or are canceled are returned to
the respective plan. The options generally vest 25% upon completion of one year
and 1/48 per month thereafter.
F-17
<PAGE>
VPNX.com, Inc.
(a development stage company)
Notes to Financial Statements (continued)
(Information as of June 30, 2000 and for the six months ended
June 30, 1999 and 2000 is unaudited)
5. STOCKHOLDERS' EQUITY (CONTINUED)
STOCK OPTION PLANS (CONTINUED)
A summary of activity under the option plans is as follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING WEIGHTED
SHARES ----------------------------------- AVERAGE
AVAILABLE NUMBER OF PRICE PER EXERCISE
FOR GRANT SHARES SHARE PRICE
----------------- ---------------- ------------------ ---------------
<S> <C> <C> <C> <C>
Authorized 941,050 - $ - $ -
Granted (832,500) 832,500 $0.24 - $0.30 $0.24
----------------- ----------------
Balance at December 31, 1996 108,550 832,500 $0.24 - $0.30 $0.24
Authorized 1,146,450 - $ - $ -
Granted (485,000) 485,000 $0.30 $0.30
Exercised - (100,000) $0.30 $0.30
Canceled 37,500 (37,500) $0.24 - $0.30 $0.29
----------------- ----------------
Balance at December 31, 1997 807,500 1,180,000 $0.24 - $0.30 $0.26
Authorized 700,000 - $ - $ -
Granted (750,500) 750,500 $0.30 $0.30
Exercised - (90,208) $0.24 - $0.30 $0.29
Canceled 24,792 (24,792) $0.24 $0.24
----------------- ----------------
Balance at December 31, 1998 781,792 1,815,500 $0.24 - $0.30 $0.27
Granted (808,944) 808,944 $0.30 $0.30
Canceled 364,665 (364,665) $0.30 $0.30
----------------- ----------------
Balance at December 31, 1999 337,513 2,259,779 $0.24 - $0.30 $0.28
================= ================
</TABLE>
At December 31, 1997, 1998, and 1999, $344,375, 661,479, and 1,150,206 options,
respectively, were exercisable. The weighted average remaining contractual life
of outstanding options was 8.15 years at December 31, 1999. The weighted average
fair value of options granted during 1997, 1998, and 1999 was $0.08, $0.07, and
$0.07, respectively.
F-18
<PAGE>
VPNX.com, Inc.
(a development stage company)
Notes to Financial Statements (continued)
(Information as of June 30, 2000 and for the six months ended
June 30, 1999 and 2000 is unaudited)
5. STOCKHOLDERS' EQUITY (CONTINUED)
VALUATION OF STOCK OPTIONS
The Company has elected to follow APB Opinion No. 25 and related interpretations
in accounting for its employee stock options because the alternative fair value
accounting provided for under Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation" (FAS 123), requires use of option
valuation models that were not developed for use in valuing employee stock
options. Under APB Opinion No. 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 by FAS 123 which also
requires that the information be determined as if the Company has accounted for
its employee stock options under the fair value method of FAS 123. The fair
value for these options was estimated at the date of grant using the minimum
value method with the following weighted average assumptions:
<TABLE>
<CAPTION>
1997 1998 1999
----------------- ----------------- ----------------
<S> <C> <C> <C>
Risk-free interest rate 6.5% 5.2% 5.5%
Dividend yield - - -
Weighted average expected life 5 years 5 years 5 years
</TABLE>
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. If compensation cost
for the Company's stock-based compensation plan had been determined based on the
fair value at the grant dates for awards under this plan consistent with the
method provided for under FAS 123, then the Company's net loss would have been
as indicated in the pro forma amount below:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------------------
1997 1998 1999
----------------- ----------------- ----------------
<S> <C> <C> <C>
Net loss as reported $(1,241,793) $588,363 $(4,501,102)
Pro forma net loss $(1,258,093) $611,828 $4,532,551
Net loss per share as reported, basic and diluted $(0.15) $(0.07) $(0.46)
Pro forma net loss per share, basic and diluted $(0.15) $(0.07) $(0.47)
</TABLE>
F-19
<PAGE>
VPNX.com, Inc.
(a development stage company)
Notes to Financial Statements (continued)
(Information as of June 30, 2000 and for the six months ended
June 30, 1999 and 2000 is unaudited)
5. STOCKHOLDERS' EQUITY (CONTINUED)
VALUATION OF STOCK OPTIONS (CONTINUED)
The pro forma impact of FAS 123 will not be fully reflected until 2000 and is
not expected to be indicative of the effects on net income (loss) in future
years.
STOCK SUBJECT TO REPURCHASE
In 1996 and 1997, the Company issued 2,083,340 shares of common stock to its
President and 150,000 shares of common stock to other members of the Board of
Directors, which are subject to repurchase should the individuals discontinue
service to the Company. The Company's repurchase rights for these shares expire
at various times through 2001. At December 31, 1999, 54,167 of the shares issued
to the Company's Board of Directors were subject to repurchase by the Company.
DEFERRED COMPENSATION
During the six-month period ended June 30, 2000, the Company recorded aggregate
deferred compensation of $1,790,000 representing the difference between the
exercise price of stock options granted and the then deemed fair value of the
Company's common stock. These amounts are being amortized as charges to
operations, using the straight-line method, over the vesting periods of the
individual stock options, generally four years. For the six-month period ended
June 30, 2000, the Company amortized $83,000 of deferred compensation.
F-20
<PAGE>
VPNX.com, Inc.
(a development stage company)
Notes to Financial Statements (continued)
(Information as of June 30, 2000 and for the six months ended
June 30, 1999 and 2000 is unaudited)
5. STOCKHOLDERS' EQUITY (CONTINUED)
SHARES RESERVED
Common stock reserved for future issuance is as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1999 JUNE 30, 2000
------------------- ----------------
<S> <C> <C>
Stock option plans (the 1996 Founders' Plan and the 1997 Plan):
Outstanding 2,259,779 2,544,490
Reserved for future grants 337,513 751,007
------------------- ----------------
2,597,292 3,295,497
Conversion of preferred stock 6,272,328 6,272,328
Warrants issued to note holders 471,149 471,149
------------------- ----------------
Total common stock reserved for future issuance 9,340,769 10,038,974
=================== ================
</TABLE>
6. EMPLOYEE BENEFIT PLAN
The Company has a Savings Plan that qualifies under Section 401(k) of the
Internal Revenue Code. Under the plan, participating employees may defer up
to 15% of their pretax salary but not more than statutory limits. The Company
may elect to make matching contributions to the plan. For the fiscal year
ending December 31, 1999, the Company matched employees' contributions,
dollar for dollar, up to $500. The total cost of the contribution was
$26,000. For the fiscal years ended December 31, 1998 and before, the Company
made no matching contributions. Expenses related to the plan are immaterial.
F-21
<PAGE>
VPNX.com, Inc.
(a development stage company)
Notes to Financial Statements (continued)
(Information as of June 30, 2000 and for the six months ended
June 30, 1999 and 2000 is unaudited)
7. INCOME TAXES
Due to operating losses and the inability to recognize benefits therefrom, there
is no provision for income taxes for the periods ended December 31, 1998, 1999,
and the period from April 10, 1997 through December 31, 1997.
Deferred income taxes reflect the net 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 are as follows (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------
1998 1999
---------------- ---------------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards $ 383 $1,586
Tax credit carryforwards 125 4000
Deferred revenue 62 128
Other accruals and reserves not currently deductible 130 689
---------------- -----------------
Total deferred tax assets 700 2,800
Valuation allowances (700) (2,800)
================ =================
Net deferred tax assets $ - $ -
================ =================
</TABLE>
Realization of deferred tax assets is dependent on future earnings, if any, the
timing and amount of which are uncertain. Accordingly, a valuation allowance, in
an amount equal to the net deferred tax asset as of December 31, 1999 and 1998
has been established to reflect these uncertainties. The change in valuation was
a net increase of approximately $400,000 and $2,100,000 for the fiscal years
ended December 31, 1998 and 1999, respectively.
As of December 31, 1999, the Company had federal and California net operating
loss carryforwards of approximately $4,100,000 and $3,300,000, respectively. The
Company also had federal research and development tax credit carryforwards of
approximately $400,000. The net operating loss and credit carryforwards will
expire at various dates beginning in 2003 through 2019, if not utilized.
Utilization of the net operating losses and credits may be subject to a
substantial annual limitation due to the ownership change limitations provided
by the Internal Revenue Code of 1986 and similar state provisions. The annual
limitation may result in the expiration of net operating losses and credits
before utilization.
F-22
<PAGE>
VPNX.com, Inc.
(a development stage company)
Notes to Financial Statements (continued)
(Information as of June 30, 2000 and for the six months ended
June 30, 1999 and 2000 is unaudited)
7. INCOME TAXES (CONTINUED)
Through April 9, 1997, the Company was a Subchapter S corporation, and as such,
all items of income and expense were taxed directly to its stockholders.
8. RELATED PARTY TRANSACTION
The Company received legal services of approximately $30,000, $72,000, $51,000,
and $172,000 in 1997, 1998, 1999, and the period from June 19, 1996 (inception)
to December 31, 1999, respectively, from a stockholder's law firm. In addition,
the Company received legal services for approximately $34,000 and $56,000 for
the six months ended June 30, 1999 and 2000, respectively, from the same
stockholder's law firm.
9. NET LOSS PER SHARE
The Company follows the provisions of Statement of Financial Accounting
Standards No. 128, "Earnings Per Share." Basic and diluted net loss per share
are computed by dividing the net loss by the weighted average number of common
shares outstanding during the period less outstanding nonvested shares.
Outstanding nonvested shares are not included in the computation of basic net
loss per share until the time-based vesting restrictions have lapsed.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30,
----------------------------------------------- ------------------------------
1997 1998 1999 1999 2000
--------------- --------------- --------------- --------------- --------------
<S> <C> <C> <C> <C> <C>
Net loss (numerator) $(1,241,793) $(588,363) $(4,501,102) $(3,395,221) $(3,273,804)
=============== =============== =============== =============== ==============
Shares used in computing basic
and diluted net loss per
share (denominator):
Weighted average common
shares outstanding
9,672,227 9,959,449 9,966,116 9,966,116 9,978,211
Less shares subject to
repurchase (1,352,870) (981,607) (246,533) (264,840) (27,083)
--------------- --------------- --------------- --------------- --------------
Denominator for basic and
diluted net loss per
share 8,319,357 8,977,842 9,719,583 9,701,276 9,951,128
=============== =============== =============== =============== ==============
</TABLE>
F-23
<PAGE>
VPNX.com, Inc.
(a development stage company)
Notes to Financial Statements (continued)
(Information as of June 30, 2000 and for the six months ended
June 30, 1999 and 2000 is unaudited)
10. SUBSEQUENT EVENTS
On July 6, 2000, the Company signed a definitive agreement to be acquired by
InterNAP Network Services. The transaction closed on July 31, 2000.
F-24
