SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
Date of Report (Date of earliest event reported): March 31, 1999
ION NETWORKS, INC.
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(Exact Name of Registrant as Specified in Charter)
DELAWARE
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(State of jurisdiction of incorporation)
0-13117 22-2413505
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(Commission File No.) (IRS Employer Identification No.)
21 Meridian Road, Edison, New Jersey 08820
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(Address of Principal Executive Offices) (Zip Code)
732-494-4440
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(Registrant's telephone number, including area code)
MicroFrame, Inc.
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(Former Name or Former Address, if Changed Since Last Report)
<PAGE>
Item 2. Acquisition or Disposition of Assets.
On March 31, 1999, Ion Networks, Inc. (formerly MicroFrame,
Inc., a New Jersey corporation) (the "Registrant") consummated the purchase by
the Registrant of all of the outstanding share capital of SolCom Systems Limited
("SolCom"), a company incorporated under the Companies Act 1985 of the United
Kingdom (the "Transaction"). SolCom is a developer of remote monitoring (RMON)
technology and its business includes customer lists, intellectual property and
computer hardware and software. Consideration for the Transaction consisted of
the issuance to the shareholders of SolCom of an aggregate of (i) 2,200,233
shares of the Registrant's common stock, par value $.001 per share ("Common
Stock"), 1,087,768 shares of which will be held in escrow for a period of one
year from the closing date and (ii) options to purchase an aggregate of 451,188
shares of Common Stock.
The Registrant also agreed, as part of the Transaction, to
grant options to purchase up to (i) 48,369 shares of Common Stock to certain
employees of SolCom (subject to approval of the U.K. Inland Revenue) and (ii)
300,000 shares of Common Stock to certain principals of SolCom in the event that
the Registrant meets specific financial performance objectives. In addition, the
Registrant agreed to pay the costs and expenses of certain advisors to SolCom
aggregating approximately $1.3 million within the twelve-month period from the
closing of the Transaction.
The consideration for the Transaction was determined by
arms-length negotiation between the parties. There are no material relationships
between SolCom and the Registrant or any of its affiliates, directors, officers
or any associate of any such person or entity.
Item 5. Other Events.
Simultaneously with the consummation of the Transaction, the
Registrant changed its name and reincorporated into the State of Delaware in
accordance with an Agreement and Plan of Merger dated as of December 15, 1998 by
and between the Registrant and MicroFrame, Inc. ("MicroFrame") pursuant to which
MicroFrame, the Registrant's successor entity, merged with and into the
Registrant (the "Reincorporation"). As of March 31, 1999, pursuant to the
Reincorporation, each share of MicroFrame common stock became immediately
convertible into the right to receive one share of Common Stock. The effect of
the Reincorporation is a "one-for-one" stock exchange; accordingly, the rights
of the shareholders of MicroFrame prior to the Reincorporation are identical in
all respects to the rights of the shareholders of the Registrant subsequent to
the Reincorporation. In addition, the rights, obligations and liabilities of
MicroFrame prior to the Reincorporation are identical in all material respects
to the rights, obligations and liabilities of the Registrant subsequent to the
Reincorporation.
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Item 7. Financial Statements and Exhibits.
(a)* Financial statements of business acquired:
(i) Unaudited Consolidated Financial Statements
for the period ended December 31, 1998.
(ii) Audited Consolidated Financial Statements
for the fiscal periods ended March 31, 1998
and June 30, 1997.
(b) Pro forma financial information:
Pro forma financial statements for the Registrant.
(c) Exhibits:
7.1 Share Purchase Agreement, as amended, dated
as of December 28, 1998 by and among the
Registrant, SolCom, the shareholders of
SolCom and certain representatives of such
shareholders.
- ----------------
* Incorporated by Reference to Appendix E of the Registrant's
Definitive Information Statement on Schedule 14C filed with
the Securities and Exchange Commission and mailed to
shareholders of the Registrant on March 11, 1999.
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<PAGE>
SIGNATURES
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.
MICROFRAME, INC.
Dated: April 8, 1999 By: /s/ John F. McTigue
-----------------------------------------
John F. McTigue
Chief Financial Officer
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<PAGE>
EXHIBIT INDEX
Exhibit
Number Description
- ------- -----------
**7.1 Share Purchase Agreement, as amended, dated as of December 28, 1998 by
and among the Registrant, SolCom, the shareholders of SolCom and
certain representatives of such shareholders.
- -----------
** Incorporated by Reference to Appendix A of the Registrant's Definitive
Information Statement on Schedule 14C filed with the Securities and
Exchange Commission and mailed to shareholders of the Registrant on
March 11, 1999.
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<PAGE>
PRO FORMA CONDENSED FINANCIAL STATEMENTS
Unaudited Pro Forma Consolidated Balance Sheet (Note 7)
MicroFrame, Inc.-As of December 31, 1998
SolCom Systems Ltd..-As of December 31, 1998
The following unaudited pro forma consolidated balance sheet and statements of
operations give effect to the share purchase as if it had occurred on December
31, 1998 for balance sheet purposes and April 1, 1997 for statement of
operations purposes, and should be read in conjunction with the consolidated
financial statements of MicroFrame and SolCom for the relevant period and the
related notes thereto included, or incorporated by reference, elsewhere herein.
<TABLE>
<CAPTION>
MicroFrame SolCom Pro Forma Adjustment Pro Forma
ASSETS
<S> <C> <C> <C> <C>
Current assets
Cash and cash equivalents $ 345,892 135,300 $ 481,192
Accounts receivable, less allowance for doubtful
accounts of $95,249 2,823,565 610,500 3,434,065
Inventory, net 2,036,567 358,050 2,394,617
Deferred tax assets 337,512 337,512
Prepaid expenses and other current assets 461,557 207,900 669,457
------------ ----------------------------------- -----------------
Total current assets 6,005,093 1,311,750 7,316,843
Property and equipment, less accumulated depreciation of
$585,015 and $971,903 693,423 234,300 927,723
Capitalized software, less accumulated amortization of
$1,309,856 and $1,054,827 1,426,567 3,855,000(Note 2) 5,281,567
Goodwill, less accumulated amortization of $33,555 and
$26,130 68,055 1,151,636(Note 2) 1,219,691
Other intangible assets 250,000(Note 2) 250,000
Security deposits 39,798 39,798
Other assets 1,026,064 (1,026,064)(Note 2) 0
------------ ----------------------------------- -----------------
Total assets $ 9,259,000 1,546,050 4,230,572 $ 15,035,622
============ =================================== =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Bank borrowings $ 1,100,428 66,000 $ 1,166,428
Accounts payable 1,694,260 1,959,800 3,654,060
Accrued payroll and related liabilities 212,348 212,348
Deferred income 95,673 95,673
Other current liabilities 337,697 994,950 267,400 (Note2) 1,600,047
------------ ----------------------------------- -----------------
Total current liabilities 3,440,406 3,020,750 267,400 6,728,556
------------ ----------------------------------- -----------------
Deferred tax liabilities, net 48,808 48,888
Long-Term debt 500,000 500,000
Other liabilities 85,800 85,800
Commitments and contingencies
Stockholders' equity
Common stock 6,652 701,852 (699,652) (Note 2) 8,852
Preferred stock - par value $10 per share; authorized
200,000 shares, none issued
Additional paid-in capital 7,366,221 1,449,588 4,744,997 (Note 2) 13,560,806
Accumulated deficit (1,886,534) (3,713,639) (80,474) (Note 2) (5,680,647)
Accumulated comprehensive income (9,434) 1,699 (1,699) (9,434)
------------ ----------------------------------- -----------------
Less - Treasury stock, 62,031 shares, at cost (207,199) (207,199)
------------ ----------------------------------- -----------------
Total stockholders' equity 5,269,706 (1,560,500) 3,963,172 7,672,378
------------ ----------------------------------- -----------------
Total liabilities and stockholders' equity $ 9,259,000 1,546,050 4,230,572 $ 15,035,622
============ =================================== =================
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Unaudited Pro Forma Consolidated Statement of Operations (Note 7)
MicroFrame, Inc.-Nine Months Ended December 31, 1998
SolCom Systems, Ltd.-Nine Months Ended December 31, 1998
MicroFrame SolCom Pro Forma Adjustment Pro Forma
<S> <C> <C> <C> <C> <C>
Net Sales $ 9,451,604 $ 2,314,950 $ (350,000) (Note 4) $ 11,416,554
Cost of sales 3,436,590 277,200 3,713,790
------------- ------------- --------------------- ------------------
Gross margin 6,015,014 2,037,750 (350,000) 7,702,764
Research and Development expenses 1,285,809 562,650 (350,000) (Note 4) 1,498,459
Selling, general and administrative
expenses 3,671,247 2,824,000 6,495,647
Depreciation and amortization 454,418 186,450 1,251,659 (Note 3) 1,892,527
------------- ------------- --------------------- ------------------
Income (loss) from operations 603,540 (1,535,750) (1,251,659) (2,183,869)
Interest income 5,139 1,656 6,795
Interest expense (55,725) (34,650) (90,375)
------------- ------------- --------------------- ------------------
Income (loss) before income tax provision 552,954 (1,568,744) (1,251,659) (2,267,449)
(benefit)
------------- ------------- --------------------- ------------------
Income tax provision (benefit) 207,850 0 (140,000) 67,850
------------- ------------- --------------------- ------------------
Net income (loss) $ 345,104 $ (1,568,744) $ (1,111,659) $ (2,335,299)
============= ============= ===================== ==================
Per share data (Note 5)
Net income (loss) per share
Basic $ 0.06 $ (0.30)
Diluted $ 0.05 $ (0.30)
Weighted average number of common
shares outstanding basic 5,490,922 7,690,922
Weighted average number of common
shares outstanding diluted 6,455,398 7,690,922
</TABLE>
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<TABLE>
<CAPTION>
Unaudited Pro Forma Consolidated Statement of Operations (Note 7)
MicroFrame, Inc.-Year ended March 31, 1998
SolCom Systems Ltd..-Year ended March 31, 1998
SolCom
MicroFrame (Note 6) Pro Forma Adjustments Pro Forma
<S> <C> <C> <C> <C>
Net sales $ 10,217,911 $ 2,168,313 $ $ 12,386,224
Cost of sales 4,285,134 456,225 4,741,359
-------------- ----------- ------------------- ----------------
Gross Margin 5,932,777 1,712,088 7,644,865
Research and development expenses 1,117,151 562,401 1,679,552
Selling, general and administrative expenses 3,933,783 2,002,727 5,936,510
Depreciation and amortization 485,738 76,000 1,918,879 (Note 3) 2,480,617
-------------- ----------- ------------------- ----------------
Income (loss) from operations 396,105 (929,040) (1,918,879) (2,451,814)
Interest income 14,888 1,659 16,547
Interest expense (4,344) (43,134) (47,478)
-------------- ----------- ------------------- ----------------
Income (loss) before income tax provision (benefit) 406,649 (970,515) (1,918,879) (2,482,745)
Income tax provision (benefit) (304,661) 0 (304,661)
-------------- ----------- ------------------- ----------------
Net income (loss) $ 711,310 $ (970,515) $ (1,918,879$ (2,178,084)
============== =========== =================== ================
Per share data (Note 5)
Net income (loss) per share
Basic $ 0.15 $ (0.31)
-------------- ----------------
Diluted $ 0.14 $ (0.31)
-------------- ----------------
Weighted average number of common shares
outstanding basic 4,840,357 7,040,357
-------------- -----------------
Weighted average number of common shares
outstanding diluted 5,195,357 7,040,357
-------------- -----------------
</TABLE>
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<PAGE>
MicroFrame, Inc.
SolCom Systems, Ltd.
Notes to Unaudited Pro Forma Combined Financial Statements
1 Basis of Presentation
---------------------
MicroFrame and SolCom entered into a definitive agreement that provides
for the purchase of all outstanding share capital of SolCom by
MicroFrame. The transaction will be accounted for by the "purchase"
method of accounting with MicroFrame as the purchaser of SolCom.
2 Application of Purchase of SolCom
---------------------------------
The revised purchase agreement specifies that MicroFrame will acquire
all of the outstanding shares of SolCom in exchange for a maximum of
3,000,000 MicroFrame equity units, 2,700,000 of which will be comprised
of common shares and stock options subject to a formula contained in
the Revised Purchase Agreement. Included in the 3,000,000 equity units
is a grant of 300,000 performance-based options that will occur at
consummation to certain key management members of SolCom, 150,000 of
which will vest if the newly-combined entity achieves revenues of at
least $30 million in fiscal year 2000 and the remaining 150,000 of
which will vest if the newly-combined entity achieves revenues of $60
million in fiscal year 2001. All of the aformentioned options (except
for the performance-based options) will vest immediately and have an
average exercise price of approximately $1.65 per share. The
performance-based options will vest upon reaching the above-mentioned
targets and, based upon the current market value of the Common Stock
(subject to fluctuations in the Common Stock), have an average exericse
price of approximately $2.25 per share.
The following tables detail the estimated purchase price calculation
and the estimated purchase price allocation that was utilized in the
pro forma financial statements:
Calculation of Purchase Price
Number of shares to be issued by MicroFrame 2,200,000
Average stock price for three days before and after
November 27, 1998 2.46 $5,401,786
Number of options to be issued in the Transaction 500,000
Estimate fair value using Black Scholes model 1.59 795,000
Total value of equity consideration $ 6,196,786
Estimated transaction costs of MicroFrame 999,350
SolCom deficit at December 31, 1998 1,560,500
---------
Total Consideration $ 8,756,636
===========
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<PAGE>
Purchase Price Allocation
- -------------------------
Existing and core technology products $ 3,855,000
Covenant not to compete 250,000
In-process research and development 3,500,000
Goodwill 1,151,636
-----------
Total Purchase Price $ 8,756,636
===========
For purposes of the pro forma financials, the Company has split the
equity units into the following classes of equity to determine the
consideration in the transaction:
o 2,200,000 common shares
o 500,000 stock options
o 300,000 performance-based options
The Company has utilized an average stock price for a short period (3
days)prior to and after the announcement of the newly negotiated terms
to the public that occurred on November 27, 1998. The average, as
computed, is $2.46 per share. This average was applied to the 2,200,000
common shares to arrive at the applicable value for consideration
exchanged. In addition, the Company has estimated the value of the
500,000 stock options using a Black Scholes option valuation model. The
estimated value per option was $1.59. The assumption utilized in the
model include an expected validity of 80%; a dividend yield of 0, a
risk free interest rate of 5.33% and an expected option term of 5
years. The Company has not included the value of the 300,000
performance-based options in its consideration, as the options are
contingent upon the realization of the future revenues as noted above.
If the contingency is resolved, additional purchase price consideration
will be recorded at that time.
The consideration will be adjusted at consummation as the composition
of shares and options will then be known. However, the Company believes
that the consideration utilized in the calculations underlying the pro
forma financial statements will not change materially.
In addition to the consideration noted above, the Company has estimated
that transaction costs will be $1,000,000. The costs are primarily
comprised of professional fees and other incremental costs directly
related to the transaction. The Company had incurred $1,026,064 of
costs directly related to the transaction as of December 31, 1998. This
amount has been reclassed in the pro forma adjustment column to become
part of the estimated purchase price allocation. Additionally, the
Company will assume approximately $950,000 of liabilities related to
SolCom in connection with the transaction. These amounts have been
recorded on SolCom's historical balance sheet as of December 31, 1998
and accordingly, have been reflected as additional purchase price.
The preliminary purchase price allocation results in a value for
existing and core technology of $3,855,000, which has been classified
as capitalized software, covenants not to compete of $250,000, and
IPR&D of $3,490,177. These estimates will be refined upon
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<PAGE>
the final purchase price allocation. Management believes that these are
reasonable estimates for pro forma purposes, as it knows of no events
that would currently cause a material change to preliminary estimates.
In-process research and development, which is not expected to have
reached technological feasibility by the consummation date of the
Transaction and which will have no alternative future use, includes
certain of the research and development projects currently underway at
SolCom. The projects fall into two broad categories: "NetworX" products
and Application Specific Integrated Circuit ("ASIC") products.
"Modular" and "Sentinel III" products, although categorized and valued
separately due to the nature of the lifecycle and expense assumptions,
falls under the NetworX technology as defined. NetworX products will
allow network managers to evaluate and control all aspects of their
networks. The ASIC projects underway are likely to create products
where all the application hardware and software necessary to carry out
specific tasks will be resident on a single computer chip. The chips
will have substantial increases in processing speed and a lower cost to
the consumer. This will lead to increased benefits to the SolCom
product set.
As stated above, none of these projects has met technological
feasibility. If, as a result of the uncertainties surrounding the
successful completion of these projects, the Company is unable to
establish technological feasibility and is unable to produce a
commercially viable product, then the anticipated incremental future
cash flows attributable to expected sales and profits from the NetworX
and ASIC products will not be realized. This could have a material
adverse effect on the combined Company's future financial position,
results of operations and cash flows.
The Company does believe, however, that it will be able to complete
these projects and produce commercially viable products using the new
NetworX and ASIC technologies that are currently being developed.
3 Pro Forma Statement of Operations
---------------------------------
The statement of operations for the year ended March 31, 1998 reflects
pro forma adjustments for the annual amortization of existing
technology, covenants not to compete and goodwill. Based on the
estimated lives of the technology that is being acquired, the Company
has assigned a three-year life to these assets and to the goodwill for
amortization purposes. The covenants not to compete will be amortized
over one year, the contractual life of the restriction. Amortization
expense was $1,285,000, $250,000 and $383,879, respectively for the
capitalized software, the covenant not to compete, and the goodwill for
the year ended March 31, 1998. The statement of operations for the nine
months ended December 31, 1998 reflects pro forma adjustments for nine
months of amortization expense of existing technology and goodwill of
$963,750 and $287,909, respectively.
4 Inter-Company Transactions
--------------------------
All inter-company transactions between MicroFrame and SolCom during the
periods presented have been properly eliminated.
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<PAGE>
5 Weighted Average Shares and Earnings Per Share
----------------------------------------------
The weighted average shares outstanding has been adjusted to reflect
the issuance of 2,200,000 shares of MicroFrame's common stock. The
500,000 options to purchase MicroFrame's common stock as a result of
this transaction have not been included, as to include such shares
would be anti-dilutive. All of the 2,200,000 shares have been reflected
as outstanding despite the transaction provision that stipulates that
50% of the shares are to be held in escrow for up to one year after
consummation, as the Company believes beyond any reasonable doubt that
the shares will be issued.
6 Foreign Currency Translation
----------------------------
The financial statements of SolCom were prepared in local currency
(British pounds sterling) and translated into U.S. dollars based on the
current exchange rate at the end of the period (December 31, 1998) for
the balance sheet and weighted average rate for the periods presented
on the statements of operations (nine months ended December 31, 1998
and the year ended March 31, 1998).
7 In-Process Research and Development
-----------------------------------
SolCom is in the process of developing products with two new
technologies, NetworX technology and ASIC technology, and several new
products that are categorized as Modular, NetworX, Sentinel III or ASIC
products.
Description of Products
SolCom's Modular product line, although valued separately, falls under
the NetworX technology as defined below. SolCom is developing NetworX
as the industry's first comprehensive management tool. NetworX will be
the industry's first integrated platform for proactive, remote, secure
management and monitoring of voice, data and video networks. It uses
Dial up, Telnet or SNMP connections so that managers can monitor,
evaluate and control all aspects of their network from a single, remote
point.
Sentinel products offer a range of comprehensive site management tools
for centralized remote maintenance of large distributed voice and data
networks. All Sentinel products will feature Alarm & Fault Management,
PBX Toll Fraud Detection, Environmental Monitoring and Control as well
as Security Access Management. Sentinel III is an intelligent port
controller that will secure remote access to voice and data network
node maintenance ports. The technology will combine remote monitoring
and Sentinel network device management, allowing control of a network
as well as a comprehensive picture of its activities. It is expected to
be a low cost integrated platform for proactive, remote, secure
management and monitoring of voice, data and video networks. Sentinel
III has all the security features of Sentinel and Sentinel Slimline,
combined with the remote monitoring capabilities of NetworX.
An ASIC is an Application Specific Integrated Circuit that incorporates
all the hardware and software required to carry out specific tasks on a
single chip. This will lead to a substantial increase in processing
speed and reduction in build cost. Designing the ASIC
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requires the Company to experience a learning curve while the engineers
become familiar with this technology. Initially there will be one ASIC
but once the initial ASIC has been developed, there will be an ongoing
development to introduce more capabilities and features into ASICs.
In general, the major risks for the IPR&D products consists of: Time to
market; meeting anticipated sales and COGS levels; and providing
competitive products. On a more specific level, each IPR&D product
still needs developments to be completed prior to commercial release.
The remaining risks for the Modular products are ensuring that the
cards operate as expected when fitted to the "RMON" Engine.
Furthermore, SolCom must make sure that the Modular products reach the
expected performance levels during testing.
NetworX requires that the hardware development is complete with all of
the associated drivers. The new operating system has to be running
correctly and the developed code needs to be completed, ported to
NetworX and launched. Daughter cards for the NetworX system have to be
completed along with all associated drivers. The software needs to be
completed for the daughter cards and then the daughter cards need to be
tested in the NetworX platform.
Sentinel III requires that the hardware development is completed and
the associated software drivers are completed and operational.
The new ASIC-based products need much more extensive development
efforts. First, since the technology is so new, the engineers need to
complete their familiarization with the technology. SolCom needs to
find a chip manufacturer with which to work. The cards have to have
their design verified and have to be tested both with the NetworX
motherboard and the new NetworX operating system, with many expected
refinements. Finally, the chip will need to be manufactured. ASIC then
needs to be tested to verify that it will meet the required performance
levels prior to releasing the technology.
Modular products have been in development since early fiscal year 1999
and $230,928 will have been spent on Modular products at the time of
closing. Another $57,732 will need to be spent in order to release the
Modular products by their expected release date of April 1999. The
Sentinel III product is expected to be released in the market in June
1999. To date, SolCom has spent $67,354 on research and development and
expects to spend an additional $15,395 prior to release. Management has
projected revenues for Sentinel III beginning in 2000. As of March 31,
1999, $250,172 was spent on research and development for the NetworX
products. Another $45,395 of research and development expenses has been
budgeted to complete these products. NetworX products are expected to
be commercially released in June of 1999 but management has projected
NetworX products to start generating revenues in fiscal year 2000.
ASIC-based products are less complete than NetworX. As of consummation
of the Transaction, only $105,842 in research and development expenses
will have been spent and ASIC products will need another $350,000 in
order to become technologically and commercially feasible. ASIC is
expected to be launched in the first half of fiscal year 2001 and
management has projected revenues beginning in fiscal year 2001.
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<PAGE>
Analysis of Products/IPR&D
SolCom was analyzed on a stand-alone basis. The analysis was adjusted
so that any projections for products that were known to include the
Company's technology and/or know-how were reduced to reflect only
SolCom's efforts and contributions as appropriate. The Company is
contributing technology to both Sentinel III and the NetworX
Motherboard product of 30% and 20%, respectively. The percentage
attributable to the Company's technology was eliminated from the
product's value in the analysis. For example, the present value of cash
flow for Sentinel III is approximately $2.1 million. After adjusting
the cash flows to exclude the Company's portion of those cash flows,
the SolCom value decreases to $1.5 million. After adjusting for the
stage of completion, Sentinel III value accounted for as IPR&D is $1.2
million.
The Company's professional appraisal firm has updated the valuation
models to comply with the stage of completion and multiple discount
rate guidance that has been issued by the Staff. The analysis that has
been performed by the Company's professional appraisal firm concluded
an IPR&D value of $3,490,177. The IPR&D is comprised of $77,062 for
Modular Products, $2,043,539 for NetworX products, $1,224,702 for
Sentinel III and $144,874 for ASIC-based products. The following
discussion provides information regarding the expected revenue to be
generated by these projects, associated costs of the projects, the
period over which the revenues will be generated and the stage of
completion of each project at the time of acquisition.
The value allocated to acquired IPR&D for the Transaction as of March
31, 1999, the closing date, was determined utilizing the income
approach via an excess earnings analysis. This methodology requires the
projection of revenues and expense that will arise as a result of the
successful completion of the IPR&D project. The operating income
attributable to each IPR&D project was calculated as projected revenues
less the projected operating expenses. Net operating income is
calculated after applying the projected effective tax rate for the
Company.
A charge was taken to reflect the economic rent related to the net
assets required to run the business and support future growth. This
return on the requisite assets was based on industry comparable
companies and company specific information. Where it was determined
that core technology of the existing technology would be utilized by
the IPR&D, a charge was applied against IPR&D revenues. Core technology
was identified for all of the IPR&D projects. A core technology charge
of 30% of operating profit was applied for each of the IPR&D projects.
The charge for use of the core technology and the return on requisite
assets was subtracted from net income.
The value allocated to acquired IPR&D was determined utilizing the
Stage of Completion methodology. This methodology utilizes the same
cash flows as the excess earnings analysis, but removes all research
and development costs to complete the identified project. In addition,
the discounted value of these cash flows is reduced to represent the
percentage of which the project has been completed as of the estimated
Transaction closing date. The determination of the percentage completed
is based primarily on the amount of effort (cost or time) expended to
date and remaining until completion.
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Consideration is also given to the amount of risk and effort
incorporated in the development steps in relation to the development
steps remaining to complete the project.
New Modular products that will replace the current Modular products are
expected to be released in April-May 1999. Based on the risk and effort
to date, it has been determined that the Modular products will be 80%
complete. Based on historical research and development expenditures as
a percentage of total research and development costs to bring the
products to market, the percentage complete is calculated to be 85%.
Sentinel III is expected to be released in June 1999. Based on the risk
and effort to date, it has been determined that Sentinel III is 80%
complete as of March 31,1999. Based on research and developments spent
to date as a percentage of total budgeted costs until release, the
percent complete is 80%. The NetworX products are expected to be
released in June 1999. Two of these NetworX products are considered to
be 70% completed and two are considered to be 80% complete. The new
ASIC based products were determined to be approximately 20% complete
and are expected to be released in the first half of fiscal year 2001.
Based on research and development expenditures as a percentage of total
research and development costs needed to complete the project, the
percentage complete is calculated to be 23%.
The resulting cash flows were then discounted at an appropriate rate
based on the risk profile and the nature of each project and the
market. Due to the stage of each product, the expected release date and
the reliability of the projections, a range of 30% to 40% for the
discount rates was selected as appropriate. Specifically, Modular
products, NetworX and Sentinel III were discounted at 30% and ASIC was
discounted at 40%. According to the Handbook of Modern Finance by
Dennis E. Logue, 1997 Edition, the required rate of return by venture
capitalists generally ranged between 20% and 60%. We considered these
projects to be similar to a late stage venture capital or a mezzanine
financing company at a 20% to 40% range.
Modular products are expected to have a one-year life cycle. The
Company started to develop the Modular products in fiscal year 1999.
They will fully replace the existing Modular products that were
developed in fiscal year 1998. Total revenues, including product,
warranty and Hewlett Packard revenue, are expected to be approximately
$590,000 in fiscal year 2000 and zero in fiscal year 2001. The
associated expected costs of goods sold ("COGS") are 5% of expected
sales. Other operating expenses (sales, marketing, administrative,
internal support, maintenance research and development, etc.) are
attributed to each IPR&D product based on the overall Company expense
margins. Those operating expenses are expected to be approximately 48%.
Research and development costs to complete were determined to be
$57,732.
NetworX products are expected to have a seven-year life cycle, with its
peak after three years. Total revenue growth, including product,
warranty and Hewlett Packard revenue is expected to increase by
approximately 200% in fiscal year 2001 and then to 80% by fiscal year
2002. Revenue growth will then decrease over the life of the products.
The associated expected COGS are 15% of expected sales. Other operating
expenses (sales, marketing, administrative, internal support,
maintenance research and development, etc.) are attributed to each
IPR&D product based on the overall Company expense margins.
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Those operating expenses are expected to be approximately 48%. Research
and development costs to complete were determined to be $49,244.
Sentinel III is expected to have an eight-year life cycle, with its
peak after four years. Total revenue growth, including product,
warranty and Hewlett Packard revenue is expected to increase by
approximately 200% in 2001 and then to 80% by fiscal year 2003. Revenue
growth will then decrease over the life of the products. The associated
expected COGS are 14% of expected sales. Other operating expenses
(sales, marketing, administrative, internal support, maintenance
research and development, etc.) are attributed to each IPR&D product
based on the overall Company expense margins. Those operating expenses
are expected to be approximately 48%. Research and development costs to
complete were determined to be $15,395.
ASIC based products are expected to have a seven-year life cycle, with
its peak after three years. Total revenue growth, including product,
warranty and Hewlett Packard revenue is expected to increase to 80% by
fiscal year 2003. Revenue growth will then decrease over the life of
the products. The associated expected COGS are 9% of expected sales.
Other operating expenses (sales, marketing, administrative, internal
support, maintenance research and development, etc.) are attributed to
each IPR&D product based on the overall Company expense margins. Those
operating expenses are expected to be approximately 48%. Research and
development costs to complete were determined to be $350,000.
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