EXHIBIT 99.2
Audited Financial Statements
Orologic, Inc.
Years ended December 31, 1999 and 1998
with Report of Independent Auditors
5
<PAGE>
Orologic, Inc.
Audited Financial Statements
Years ended December 31, 1999 and 1998
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TABLE OF CONTENTS
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Page
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Report of Independent Auditors.............................................. 7
Audited Financial Statements................................................
Balance Sheets.............................................................. 8
Statements of Operations.................................................... 10
Statements of Redeemable Preferred Stock and Shareholders' Deficit ......... 11
Statements of Cash Flows.................................................... 12
Notes to Financial Statements............................................... 13
6
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Report of Independent Auditors
Board of Directors
Orologic, Inc.
We have audited the accompanying balance sheets of Orologic, Inc. as of
December 31, 1999 and 1998, and the related statements of operations,
redeemable preferred stock and shareholders' deficit, and cash flows for the
years then ended. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our 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 audits 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 Orologic, Inc., at December
31, 1999 and 1998, and the results of its operations and its cash flows for the
years then ended in conformity with accounting principles generally accepted in
the United States.
The accompanying financial statements have been prepared assuming that
Orologic, Inc., will continue as a going concern. As more fully described in
Note 2, the Company has incurred operating losses since inception and requires
additional capital to continue operations. Without additional financing, these
conditions raise substantial doubt about the Company's ability to continue as a
going concern. Management's plans as to these matters are also described in
Note 2. 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
Raleigh, North Carolina
January 14, 2000
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Orologic, Inc.
Balance Sheets
Year ended December 31
----------------------
1999 1998
---------- ----------
Assets
Current assets:
Cash...................................................$1,177,987 $ 88,716
Short-term investments................................. 35,600 --
Other current assets................................... 23,828 13,674
---------- ---------
Total current assets...................................... 1,237,415 102,390
Equipment and furniture, at cost:
Computers.............................................. 222,542 42,820
Software............................................... 495,527 67,784
Furniture, fixtures and equipment...................... 66,877 3,612
---------- ---------
784,946 114,216
Less accumulated depreciation.......................... (140,925) (14,449)
---------- ---------
644,021 99,767
Technology license ....................................... 300,000 --
Other assets, net of amortization......................... 830 1,106
---------- ---------
Total assets $2,182,266 $ 203,263
========== =========
See accompanying notes.
8
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Orologic, Inc.
Balance Sheets
Year ended December 31
----------------------
1999 1998
---------- ----------
Liabilities, redeemable preferred stock and shareholders' deficit
Current liabilities:
Accounts payable.......................................$ 77,381 $ 13,436
Accrued interest....................................... -- 33,112
Amount due to software vendor.......................... 136,540 74,487
Accrued license and development fee.................... 240,000 --
Notes payable to shareholder........................... -- 500,000
Current maturities of long-term debt................... 59,655 --
---------- ---------
Total current liabilities................................. 513,576 621,035
Long-term debt, net of current portion.................... 110,084 --
Series A convertible, redeemable preferred stock at $0.001
par value per share, 4,031,602 authorized, 3,031,602
and 0 shares issued and outstanding in 1999 and 1998,
respectively (aggregate liquidation preference of
$3,789,503 at December 31, 1999)....................... 3,749,487 --
Shareholders' deficit:
Common stock at $0.001 par value per share, 12,000,000
shares authorized, 2,326,316 issued and outstanding in
1999, 10,000,000 shares authorized, 2,192,600 issued
and outstanding in 1998............................... 2,326 2,193
Additional paid-in capital............................. 246,414 5,235
Deferred compensation expense.......................... (217,989) --
Accumulated deficit....................................(2,221,632) (425,200)
---------- ---------
Total shareholders' deficit...............................(2,190,881) (417,772)
---------- ---------
Total liabilities, redeemable preferred stock and
shareholders' deficit...................................$2,182,266 $ 203,263
========== =========
See accompanying notes.
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Orologic, Inc.
Statements of Operations
Year ended December 31
-------------------------
1999 1998
----------- ----------
Engineering revenues...................................$ 350,000 $ 37,633
Operating expenses:
Research and development............................ 1,272,740 294,335
Selling, general and administrative................. 777,511 118,589
Depreciation and amortization....................... 126,752 14,726
----------- ----------
Total operating expenses............................... 2,177,003 427,650
----------- ----------
Operating loss......................................... (1,827,003) (390,017)
Other income (expense):
Interest income..................................... 40,381 8,704
Interest expense.................................... (9,810) (29,478)
----------- ----------
30,571 (20,774)
----------- ----------
Net loss...............................................$(1,796,432) $ (410,791)
----------- ----------
Basic and diluted loss per share.......................$ (.81) $ (.19)
----------- ----------
Weighted average shares outstanding....................$ 2,214,257 $2,220,386
=========== ==========
See accompanying notes.
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Orologic, Inc.
Statements of Redeemable Preferred Stock and Shareholders' Deficit
<TABLE>
Series A
Redeemable Total
Convertible Additional Shareholders'
Preferred Common Paid-In Deferred Accumulated Equity
Stock Stock Capital Compensation Deficit (Deficit)
----------- ------ ---------- ------------ ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1997........... $ -- $2,200 $ 3,725 $ $ (14,409) $ (8,484)
Issuance of common stock............ -- 250 2,250 -- -- 2,500
Repurchase of common stock.......... -- (257) (740) -- -- (997)
Net loss............................ -- -- -- -- (410,791) (410,791)
----------- ------ ---------- ------------ ----------- ------------
Balance at December 31, 1998........... -- 2,193 5,235 -- (425,200) (417,772)
Issuance of preferred stock, net of
issuance costs................... 3,749,487 -- -- -- -- --
Exercise of stock options........... -- 133 1,204 -- -- 1,337
Deferred compensation related to
grant of stock options........... -- -- 239,975 (239,975) -- --
Amortization of deferred compensation -- -- -- 21,986 -- 21,986
Net loss............................ -- -- -- -- (1,796,432) (1,796,432)
----------- ------ ---------- ------------ ----------- ------------
Balance at December 31, 1999........... $ 3,749,487 $2,326 $ 246,414 $ (217,989) $(2,221,632) $ (2,190,881)
=========== ====== ========= ============ ============ ============
See accompanying notes.
</TABLE>
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Orologic, Inc.
Statements of Cash Flows
Year ended December 31
-------------------------
1999 1998
----------- -----------
Operating activities
Net loss...............................................$(1,796,432) $ (410,791)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization....................... 126,752 14,726
Non-cash interest expense........................... 6,391 29,478
Amortization of deferred compensation............... 21,986 --
Changes in operating assets and liabilities:
Other current assets................................ (10,154) (11,819)
Accounts payable.................................... 63,945 13,436
Amount due to software vendor....................... 62,053 74,487
Accrued license and development fee................. 240,000 --
----------- ----------
Net cash used in operating activities.................. (1,285,459) (290,483)
Investing activities
Purchase of short-term investments..................... (35,600) --
Purchases of equipment and furniture................... (670,730) (114,216)
Purchase of technology license......................... (300,000) --
----------- ----------
Net cash used in investing activities.................. (1,006,330) (114,216)
Financing activities
Proceeds from issuance of common and preferred stock,
net of issuance costs................................. 3,161,321 2,500
Repurchase of common stock............................. -- (997)
Proceeds from debt..................................... 239,836 300,000
Payments on debt....................................... (20,097) --
----------- ----------
Net cash provided by financing activities.............. 3,381,060 301,503
----------- ----------
Net increase (decrease) in cash........................ 1,089,271 (103,196)
Cash at beginning of year.............................. 88,716 191,912
Cash at end of year....................................$ 1,177,987 $ 88,716
----------- ----------
Supplemental disclosure of cash flow information
Cash paid during period for interest...................$ 3,419 $ --
=========== ==========
Supplemental schedule of noncash investing and
financing activities
Financing - conversion of convertible debt and accrued
interest to preferred stock..........................$ 589,503 $ --
=========== ==========
See accompanying notes.
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Orologic, Inc.
Notes to Financial Statements
December 31, 1999
1. Business Description and Summary of Significant Accounting Policies
Business Description
Orologic, Inc. (the "Company") was incorporated in September 1997 under the
laws of the State of Delaware. Orologic Inc. is a fabless semiconductor company
that plans to provide highly integrated, system-on-a-chip solutions to Internet
infrastructure equipment manufacturers. The Company's products enable the high
speed processing of data packets for the next generation of switches and
routers. Prior to 1999, the Company was considered a development stage company.
The Company is subject to the risks associated with early stage companies such
as the risks of raising adequate capital, product development and introduction
costs, and future profitable 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 disclosures
made in the accompanying notes to the financial statements. Actual results
could differ from those estimates.
Revenue Recognition
Engineering revenue is recognized as services are performed.
Concentration of Credit Risk
One customer accounted for approximately 86% and 100% of revenues in 1999 and
1998, respectively.
Research and Development
Research and development expenses are charged to operations as incurred.
Research and development expenses include direct casts and allocated salaries,
employee benefits and applicable indirect costs.
Equipment and Furniture
Equipment and furniture is stated at cost. Depreciation is computed using the
straight-line method based on the estimated useful lives of the respective
assets. Estimated useful lives are as follows:
Equipment - 3 to 5 years
Computer software - 3 years
Furniture and fixtures - 5 years
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Orologic, Inc.
Notes to Financial Statements (continued)
Technology License
Technology license consists of purchased technology rights to be used in
certain of the Company's future products. Amortization will be recorded as
networking chips are produced at a rate based upon the expected number of
networking chips to be produced using this technology.
Accounting for Stock Options
In 1997, the Company adopted Statement of Financial Accounting Standards No.
123, "Accounting for Stock- Based Compensation" ("SFAS 123"), which gives
companies the option to adopt the fair value method for expense recognition of
employee stock options and other stock-based awards or to continue to account
for such items using the intrinsic value method as outlined under Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB 25") with pro forma disclosures of net income (loss) as if the fair value
method had been applied. The Company has elected to continue to apply APB 25
for stock options and other stock based awards for employees and has disclosed
pro forma net loss as if the fair value method had been applied.
Income Taxes
Deferred income tax assets and liabilities are computed annually for
differences between the financial statement and tax bases of assets and
liabilities that will result in taxable or deductible amounts in the future
based on enacted tax laws and rates applicable to the periods in which the
differences are expected to affect taxable income. Valuation allowances are
established when necessary to reduce deferred tax assets to the amount expected
to be realized.
Net Loss Per Share
The Company accounts for net loss per share in accordance with SFAS No. 128
"Earnings Per Share." In accordance with SFAS No. 128, net loss per share is
computed by dividing net loss by the weighted average number of common shares
outstanding during the period.
Had the Company been in a net income position, diluted earnings per share would
have been presented and would have included the shares issuable through the
conversion of preferred stock as well as additional potential common shares
related to outstanding options and warrants. The diluted earnings per share
computation is not included, as the inclusion of all potential common shares is
antidilutive.
2. Basis of Presentation
The accompanying financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. The Company incurred a net loss
of $1,796,432 during the year ended December 31, 1999 and has an accumulated
deficit of $2,221,632 through December 31, 1999. These factors indicate that
the Company's continuation as a going concern is dependent upon its ability to
obtain adequate financing necessary to continue development and
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Orologic, Inc.
Notes to Financial Statements (continued)
growth of its services and to satisfy its obligations. In this regard,
management intends to raise additional financing in the near future. However,
there can be no assurances that management will be successful in executing its
plans.
3. Long-Term Debt
In August 1999, the Company entered into a loan agreement with a bank to
provide up to $750,000 to finance equipment purchases. The commitment to
provide financing of equipment purchases expires in August 2000, and advances
are subject to certain requirements under the terms of the agreement.
In 1999, the Company borrowed $189,836 under the loan agreement. Outstanding
balances accrue interest at a rate of 7.63% per annum, and the Company is
required to make monthly payments of $5,879, which includes interest. At
December 31, 1999, $169,739 is outstanding under the loan agreement. The loan
is secured by substantially all assets of the Company, and the Company is
required to maintain a Remaining Months Liquidity, as defined in the agreement,
of equal to or greater than three months. Additionally, the loan agreement
provides for a warrant for the purchase of the greater of 12,766 shares of a
future Series B Preferred stock or 4% warrant coverage. Warrant coverage is
defined as $750,000 divided by the applicable initial exercise price multiplied
by 4%. The exercise price for the warrant is the lesser of the per share price
given at the Series B Preferred valuation or $2.35 per share. This warrant
expires in August 2006.
The aggregate principal maturities of long-term debt at December 31, 1999 are
as follows:
2000 $ 59,655
2001 64,365
2002 45,719
-----------
$ 169,739
===========
At December 31, 1998, the Company had $500,000 in demand notes payable to a
shareholder. These notes, along with accrued interest, were converted into
Series A Preferred Stock in 1999.
4. Lease Commitments
The Company leases its facilities and certain equipment under operating leases.
Certain leases contain escalation clauses and renewal provisions. Future
minimum lease payments under the various operating leases, which have remaining
terms in excess of one year, are as follows at December 31, 1999:
2000 $ 84,798
2001 71,802
2002 29,533
===========
Total minimum lease payments $ 186,133
===========
Rent expense was approximately $55,880 and $14,400 in 1999 and 1998,
respectively.
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Orologic, Inc.
Notes to Financial Statements (continued)
5. Income Taxes
Because of its losses to date, the Company has not recorded any provision for
income taxes. Components of the Company's deferred tax assets and liabilities
are as follows at December 31:
1999 1998
----------- ----------
Deferred tax assets:
Net operating loss carryforwards $ 819,500 $ 140,900
Research tax credit carryforwards 144,500 29,400
Difference in cash versus accrual basis of
accounting 12,000 18,000
----------- ----------
Total deferred tax assets 976,000 188,300
Less valuation allowance (975,200) (187,900)
----------- ----------
Deferred tax assets, net of valuation allowance 800 400
----------- ----------
Deferred tax liabilities:
Depreciation and amortization (800) ( 400)
----------- ----------
Total deferred tax liabilities (800) (400)
----------- ----------
Net deferred taxes $ -- $ --
=========== ==========
At December 31, 1999 and 1998, the Company had net operating loss carryforwards
of approximately $2,080,000 and $345,000 and research and experimental credit
carryforwards of $144,479 and $29,436 for income tax purposes, respectively.
The tax benefits of these items are reflected in the accompanying table of
deferred tax assets and liabilities. If not used, these carryforwards begin to
expire in 2018 for federal tax purposes and 2003 for state tax purposes. U.S.
tax rules impose limitations on the use of net operating losses following
certain changes in ownership. If such a change occurs, the limitation could
reduce the amount of these benefits that would be available to offset future
taxable income each year, starting with the year of ownership change.
6. Shareholders' Deficit
Capital Structure
The Company has authorized 12,000,000 shares of common stock and 4,031,602
shares of preferred stock.
Preferred Stock - Series A
Dividends - Holders of the Series A preferred stock are entitled to receive
dividends if declared by the board of directors on a pro rata basis. Such
dividends are not cumulative.
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Orologic, Inc.
Notes to Financial Statements (continued)
Liquidation - Upon any liquidation, dissolution, or winding up of the Company,
holders of the Series A preferred stock shall be entitled, prior and in
preference to any distribution to the holders of common stock, to be paid an
amount equal to $1.25 per share, plus any or all accrued but unpaid dividends.
If the assets to be distributed are insufficient to permit full payment to the
preferred stockholders, then the assets of the Company shall be distributed on
a pro rata basis to the preferred stockholders.
Conversion - Holders of Series A preferred stock have the right, at any time,
to convert into such number of shares of common stock as is obtained by
multiplying the number of shares to be converted by the preferred stock's
subscription price plus any declared and unpaid dividends and dividing such
amount by the preferred stock's conversion price in effect at the time of
conversion.
The preferred stock conversion price as of December 31, 1999 was $1.25. The
preferred stock conversion price will be reduced in the event of the Company's
issuing any shares of its common stock (or instruments convertible into common
stock) without consideration or for a consideration per share less than the
conversion price of any series of preferred stock in effect immediately prior
to the time of such issue or sale.
Each outstanding share of preferred stock shall be automatically converted into
a common share at the conversion price then in effect upon the closing of a
public offering in which the aggregate net proceeds equal or exceed $15 million
and price per share of at least $6.25.
The Company shall at all times reserve and keep available out of its authorized
common stock, such number of common shares sufficient to cover the conversion
of all outstanding preferred stock.
Voting - Each holder of preferred stock shall be entitled to one vote for each
share of common stock which would be issuable to holder upon conversion. Each
holder of common stock is entitled to one vote per share. Preferred and common
stockholders shall vote together as a class.
Restrictions - The Company cannot, without the consent of the preferred
stockholders: (1) authorize any new classes of stock unless that class ranks
junior to the preferred stock, (2) increase the authorized amount of preferred
stock, or (3) authorize any obligation or security which is convertible into
preferred stock.
Redemption Option - Beginning in February 2004, preferred shareholders have the
option to sell all or any portion of their shares to the Company at the
liquidation price (currently $1.25 per share), subject to certain net income
requirements, as outlined in the agreement. The Company shall redeem such
shares by paying the holders of the Series A Preferred stock an amount equal to
the liquidation price, plus accrued interest thereon from the Redemption Date
at the rate of eight percent (8%) per annum, in equal monthly installments over
the thirty-six (36) months following the Redemption Date.
Common Stock
Dividends - The holders of common stock shall be entitled to receive dividends
as from time to time may be declared by the board of directors taking into
account the rights of the preferred stockholders.
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Orologic, Inc.
Notes to Financial Statements (continued)
Liquidation - After payment to the preferred stockholders, holders of common
stock shall be entitled, together with the holders of preferred stock, to share
ratably according to the number of shares held by them, its all remaining
assets of the Company available for distribution.
7. Stock Option Plan
The Company has elected to follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" (APB 25) and related Interpretations
in accounting for its employee stock options. The Company has recorded deferred
compensation expense of $239,975 for the difference between the grant price and
the deemed fair value of certain of the Company's common stock options granted
in 1999. Of this deferred compensation amount, $21,986 was amortized during
1999.
The Company's 1997 Stock Plan has authorized the grant of options to eligible
employees, officers, directors and consultants for up to 1,800,000 shares of
the Company's common stock. Terms of the stock option agreements, including
vesting requirements are determined by the Board of Directors. The exercise
price of incentive stock options, must equal at least fair market value on the
date of grant and the maximum term of options granted is ten years.
Pro forma information regarding net loss is required by SFAS No. 123 to be
determined as if the Company has accounted for its employee stock options under
the fair value method of that Statement. The fair value for these options was
estimated at the date of grant using a minimum value option pricing model with
the following weighted-average assumptions: risk-free interest rate of 6.0%, a
dividend yield of 0%; and a weighted-average expected life of the option of 8
years.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. The Company's pro
forma information follows for the year ended December 31:
1999 1998
----------- ----------
Net income as reported $(1,796,432) $ (410,791)
Pro forma net income (1,828,640) (410,791)
Basic and diluted loss per share:
As reported $ (.81) $ (.19)
Pro forma (.83) (.19)
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Orologic, Inc.
Notes to Financial Statements (continued)
7. Stock Option Plan (continued)
A summary of the Company's stock option activity, and related information for
the year ended December 31, 1999 follows:
<TABLE>
Option Price
Number of Shares Range per Share Expiration Date
---------------- --------------- ---------------
<S> <C> <C> <C>
Balance at December 31, 1997, outstanding options --
Granted 298,500 $0.01 2007 - 2008
--------
Balance at December 31, 1998, outstanding options 298,500 $0.01 2007 - 2008
Granted 342,500 $0.01 - $0.15 2009
Exercised (133,716) $0.01
--------
Balance at December 31, 1999, outstanding options 507,284 $0.01 - $0.15 2007 - 2009
========
Exercisable at end of year 17,649
Weighted-average fair value of options granted $.81
during the year
Exercise prices for options outstanding under the plan as of December 31, 1999
ranged from $0.01 to $0.15. The weighted-average remaining contractual life of
those options is approximately 9 years.
8. Common Stock Reserved for Future Issuance
At December 31, 1999, the Company had reserved a total of 4,697,886 of its
authorized 12,000,000 shares of common stock for future issuance as follows;
For conversion of Series A preferred stock 3,031,602
Outstanding stock options under the plan 507,284
Possible future issuance under stock option plans 1,159,000
=========
Total shares reserved 4,697,886
=========
</TABLE>
9. Retirement Plans
The Company has a 401(k) savings plan whereby substantially all employees may
elect to make contributions pursuant to a salary reduction agreement upon
meeting certain age and length-of-service requirements. The Company does not
provide matching contributions. The Company paid $1,280 and $0 of
administrative expenses related to the plan in 1999 and 1998, respectively.
10. Year 2000 Consideration (Unaudited)
The Company determined that it would not be required to modify or replace any
portion of its software, hardware and equipment so that its systems and
equipment would function properly with respect to dates in the year 2000 and
thereafter. Since January 1, 2000, the Company has experienced no significant
19
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Orologic, Inc.
Notes to Financial Statements (continued)
disruption in its computer systems or those of third parties, or other problems
as a result of processing dates beyond 1999.
