<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________________
FORM 8-K/A
CURRENT REPORT
Amendment No. 1
Pursuant to section 13 or 15(d) of the
Securities Exchange Act of 1934
Date of Report (Date of earliest event reported) July 6, 1998
--------------------------------
LEVEL ONE COMMUNICATIONS, INCORPORATED
- --------------------------------------------------------------------------------
California 0-22068 33-0128224
- --------------------------------------------------------------------------------
(State or other (Commission File Number) (IRS Employer
jurisdiction of Inc.) Identification No.)
9750 Goethe Road, Sacramento, CA 95827
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (916) 855-5000
-----------------------------
NOT APPLICABLE
- --------------------------------------------------------------------------------
(Former name or former address, if changed since last report)
<PAGE>
This Amendment No. 1 to the Registrant's Current Report on Form 8-K dated
July 17, 1998 (the "Report") is being filed in connection with the completion of
the Registrant's acquisition of Acclaim Communications, Inc., a Delaware
corporation ("Acclaim"), by way of a merger of Aardvark Acquisition Corp., a
Delaware corporation and wholly owned subsidiary of the Registrant, with and
into Acclaim (the "Merger") with Acclaim being the surviving corporation in the
Merger, pursuant to the terms and conditions set forth in the Agreement and Plan
of Reorganization dated as of June 25, 1998, and previously filed as Exhibit 2.1
to the Report. The purpose of the Amendment to the Report is to (i) add new
item 5 to provide for certain supplementary financial information, and (ii)
amend Item 7 to provide the financial statements of Acclaim required by item
7(a) to the Form 8-K. This financial information is being filed within the
required time period specified in the Form 8-K.
ITEM 5. OTHER EVENTS
The following supplemental unaudited consolidated financial statements of
Level One Communications, Inc. reflecting the pooled operations of Level One
Communications, Incorporated and subsidiaries and Acclaim Communications,
Incorporated, which was acquired by Level One Communications, Incorporated on
July 6, 1998, are filed as part of this report:
Supplemental Unaudited Consolidated Balance Sheets as of December 28,
1997 and December 29, 1996
Supplemental Unaudited Consolidated Statement of Income for Each of the
Years Ending December 28, 1997, December 29, 1996, and December 30,
1995
Supplemental Unaudited Consolidated Statement of Shareholders' Equity for
Each of the Years Ending December 28, 1997, December 29, 1996, and
December 30, 1995
Supplemental Unaudited Consolidated Statement of Cash Flows for Each
of the Years Ending December 28, 1997, December 29, 1996, and
December 30, 1995
2
<PAGE>
LEVEL ONE COMMUNICATIONS, INCORPORATED
SUPPLEMENTAL UNAUDITED CONSOLIDATED BALANCE SHEETS
As of December 28, 1997 and December 29, 1996
<TABLE>
<CAPTION>
(in thousands) 1997 1996
-------- --------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 25,743 $ 23,234
Short-term investments 112,560 10,211
Trade accounts receivable, net of allowance for doubtful accounts
of $343 and $156 for 1997 and 1996, respectively 30,191 17,671
Other receivables 2,473 608
Inventories 26,699 9,990
Deferred tax assets, net 4,050 2,504
Other current assets 2,907 2,423
-------- --------
Total current assets 204,623 66,641
Property and equipment, net 32,893 24,007
Long-term investments 21,559 12,440
Deferred loan origination costs 3,296 -
Foundry deposits 14,000 8,000
Other assets 4,108 4,429
-------- --------
Total assets $280,479 $115,517
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Notes payable $ 5,949 $ -
Current portion of capital lease obligations 1,201 1,129
Accounts payable 22,687 4,992
Accrued payroll costs 4,719 2,198
Income taxes payable - 1,338
Deferred revenue 5,171 3,039
Other accrued liabilities 7,940 2,621
-------- --------
Total current liabilities 47,667 15,317
Convertible subordinated notes 115,000 -
Capital lease obligations, less current portion 2,175 3,194
Deferred lease expense 300 612
-------- --------
Total liabilities 165,142 19,123
Shareholders' Equity:
Common Stock, no par value 96,594 87,330
Authorized - 236,250 shares
Outstanding - 33,615 and 32,276 shares
for 1997 and 1996, respectively
Unrealized gain on investments 18 12
Retained earnings 18,725 9,052
-------- --------
Total shareholders' equity 115,337 96,394
-------- --------
Total liabilities and shareholders' equity $280,479 $115,517
======== ========
</TABLE>
The accompanying notes are an integral part of these supplemental statements.
3
<PAGE>
LEVEL ONE COMMUNICATIONS, INCORPORATED
SUPPLEMENTAL UNAUDITED CONSOLIDATED BALANCE SHEETS
For the Fiscal Years Ended December 28, 1997, December 29, 1996,
and December 30, 1995
<TABLE>
<CAPTION>
(in thousands, except per share amounts) 1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Revenues $156,500 $111,987 $78,018
Cost of revenues 65,582 48,477 33,300
-------- -------- -------
Gross margin 90,918 63,510 44,718
Operating expenses:
Research and development/*/ 35,419 26,793 17,963
Sales and marketing 26,163 17,136 11,414
General and administrative 12,098 7,415 5,839
-------- -------- -------
Total operating expenses 73,680 51,344 35,216
Operating income 17,238 12,166 9,502
Interest income 3,998 1,884 2,115
Interest expense (2,223) (352) (157)
Other income 110 729 113
-------- -------- -------
Income before provision for income taxes 19,123 14,427 11,573
Provision for income taxes 9,450 6,374 1,442
-------- -------- -------
Net income $ 9,673 $ 8,053 $10,131
======== ======== =======
Basic earnings per share $0.29 $0.26 $0.35
======== ======== =======
Diluted earnings per share $0.27 $0.24 $0.33
======== ======== =======
</TABLE>
* Includes one time charges for acquisitions of $2,500 and $750 for 1996 and
1995, respectively.
The accompanying notes are an integral part of these supplemental statements.
4
<PAGE>
LEVEL ONE COMMUNICATIONS, INCORPORATED
SUPPLEMENTAL UNAUDITED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the Fiscal Years Ended December 28, 1997, December 29, 1996,
and December 30, 1995
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------------------
Common Stock Retained
---------------------- Deferred Unrealized Earnings
(In thousands) Shares Amount Compensation Gain (Loss) (Deficit) Total
---------- ---------- ------------ ------------ --------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1994 28,083 $72,442 $(1) $ - $ (9,132) $ 63,309
Shares issued in Acclaim business combination 2,227 720 720
Issuance of common stock under stock option and
purchase plans 492 431 431
Issuance of common stock upon exercise of warrants 9 19 19
Tax benefit of stock option exercises 2,418 2,418
Stock issued in connection with acquisitions 305 2,462 2,462
Unrealized gain on available-for-sale
investments, net of tax 67 67
Amortization of deferred compensation expense 1 1
-------- -------- ------------ --------- -------- --------
Net income 10,131 10,131
Balance at December 30, 1995 31,116 78,492 - 67 999 79,558
Shares issued in Acclaim business combination 537 3,380 3,380
Issuance of common stock under stock option and
purchase plans 423 1,243 1,243
Issuance of common stock upon exercise of warrants 5 10 10
Tax benefit of stock option exercises 1,205 1,205
Stock issued in connection with acquisitions 195 3,000 3,000
Unrealized loss on available-for-sale
investments, net of tax (55) (55)
Net income 8,053 8,053
-------- -------- ------------ --------- ------- --------
Balance at December 29, 1996 32,276 87,330 - 12 9,052 96,394
Shares issued in Acclaim business combination 11 597 597
Issuance of common stock under stock option
and purchase plans 894 3,538 3,538
Issuance of common stock upon exercise of warrants
434 - -
Tax benefit of stock option exercises 5,129 5,129
Unrealized gain on available-for-sale
investments, net of tax 6 6
Net income 9,673 9,673
-------- -------- ------------ --------- ------- --------
Balance at December 28, 1997 33,615 $96,594 $ - $ 18 $18,725 $115,337
======== ======== ============ ========= ======= ========
</TABLE>
The accompanying notes are an integral part of these supplemental statements.
5
<PAGE>
LEVEL ONE COMMUNICATIONS, INCORPORATED
SUPPLEMENTAL UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Fiscal Years Ended December 28, 1997, December 29, 1996,
and December 30, 1995
<TABLE>
<CAPTION>
(In thousands) 1997 1996 1995
--------- ---------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 9,672 $ 8,054 $ 10,131
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 10,283 7,555 5,222
Purchased research and development - 2,500 750
Changes in assets and liabilities, net of effect of acquisition:
Trade receivables (12,517) (3,259) (8,832)
Other receivables (1,865) 370 (189)
Inventories (16,709) 5,782 (9,268)
Deferred income tax benefit (1,546) 1,785 (977)
Other current assets (466) 236 (1,184)
Accounts payable and accrued liabilities 30,863 (3,510) 11,604
Deferred revenue 506 2,175 -
Deferred lease expense (312) (133) 97
----------- -------- --------
Net cash provided by operating activities 17,909 21,555 7,354
----------- -------- --------
Cash flows from investing activities:
Purchase of short-term investments (155,195) (12,754) (8,042)
Proceeds from sales and maturities of short-term investments 52,852 10,711 31,027
Purchase of long-term investments (42,900) (11,780) (3,681)
Proceeds from sales and maturities of long-term investments 33,781 4,035 2,200
Purchase of property and equipment (18,029) (10,142) (10,166)
Payments (receipts) for related party notes receivable - 1,225 (1,225)
Payments for foundry deposits and other assets (5,998) (6,136) (4,081)
----------- -------- --------
Net cash provided by (used in) investing activities (135,489) (24,841) 6,032
----------- -------- --------
Cash flows from financing activities:
Proceeds from issuance of notes 5,948 - -
Net principal payments under capital lease obligations (947) (550) (569)
Proceeds from issuance of convertible subordinated notes,
net of origination costs 111,539 - -
Proceeds from issuance of stock, net of
repurchases and costs of issuance 3,549 4,566 427
----------- -------- --------
Net cash provided by (used in) financing activities 114,141 4,016 (142)
----------- -------- --------
Net increase in cash and cash equivalents 2,509 730 13,244
Cash and cash equivalents at beginning of year 23,234 22,504 9,260
----------- -------- --------
Cash and cash equivalents at end of year $ 25,743 $ 23,234 $ 22,504
=========== ======== ========
Supplementary disclosure of cash and noncash transactions
Non-cash investing and financing activities:
Issuance of common stock in exchange for marketable securities $ - $ 750 $ -
Issuance of warrants 586 - -
Equipment purchased under capital leases - 726 4,770
Tax benefit related to stock options 5,129 1,205 2,418
Unrealized gain (loss) on available-for-sale securities, net of tax 6 (55) 134
Cash payments for:
Interest 616 351 142
Income taxes 3,861 2,564 1,268
</TABLE>
The accompanying notes are an integral part of these supplemental statements.
6
<PAGE>
LEVEL ONE COMMUNICATIONS, INCORPORATED
NOTES TO SUPPLEMENTAL UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND DESCRIPTION OF BUSINESS
Level One Communications, Incorporated (the "Company") was incorporated in
California on November 26, 1985.
The Company designs, develops and markets application specific standard
product ("ASSP") integrated circuits and custom derivatives for high-speed
digital signal transmission and networking connectivity to systems that
transport information within an office or around the world. Such systems
connect to local area networks ("LANs"), wide area networks ("WANs") and public
telephone transmission networks. LANs, WANs, and telephone transmission
networks make possible such activities as the use of intra-enterprise networking
("intranets") and the use of the Internet and World Wide Web.
On July 6, 1998, the Company completed a business combination with Acclaim
Communications Incorporated ("Acclaim") which is a provider of Fast Ethernet and
Gigabit Ethernet switches and integrated Multi-Service access products. The
combination was a stock for stock merger that was accounted for as a "pooling-
of-interests." In connection with the merger, the Company issued 3,961,374
shares of common stock, 780,278 stock options, and 256,485 warrants for all the
outstanding stock, options and warrants of Acclaim.
The accompanying supplemental unaudited consolidated financial statements
have been restated to include the accounts of Acclaim as if the companies had
combined at the beginning of the first period presented.
There were no significant transactions between the Company and Acclaim prior
to the combination and no adjustments were necessary to conform Acclaim's
accounting policies. The results of operations for the separate companies and
the combined amounts presented in the supplemental unaudited consolidated
statements of income are as follows:
<TABLE>
<CAPTION>
(in thousands) 1997 1996 1995
------------ ---------- --------
<S> <C> <C> <C>
Revenue
The Company $156,262 $111,987 $78,018
Acclaim 238 - -
------------ ---------- --------
$156,500 $111,987 $78,018
============ ========== ========
Net Income (Loss)
The Company $ 19,191 $ 11,213 $10,258
Acclaim (9,518) (3,160) (127)
------------ ---------- --------
$ 9,673 $ 8,053 $10,131
============ ========== ========
</TABLE>
7
<PAGE>
2. RISK FACTORS
The semiconductor industry is characterized by rapid technological change,
intense competitive pressure and cyclical market patterns. The Company's results
of operations are affected by a wide variety of factors, including general
economic conditions, semiconductor industry environment, changes in average
selling prices, the timing of new product introductions (by the Company and its
customers), use of new technologies, the ability to safeguard patents and
intellectual property, and rapid change of demand for products. The level of net
revenues in any specific quarter can also be affected by the level of orders
placed during that quarter. The Company attempts to respond to changes in market
conditions as soon as possible; however, the rapidity of their onset may make
prediction of and reaction to such events difficult. Due to the foregoing and
other factors, past results, such as those described in this report, may not be
predictive of future performance.
The Company does not manufacture the wafers used for its products. The
Company's wafers are manufactured by foundries located in the United States,
Europe and Asia. The Company depends upon these suppliers to produce wafers at
acceptable yields and to deliver them in a timely manner at competitive prices.
The Company may sustain an adverse impact on operating results from problems
with the cost, timeliness, yield and quality of wafer deliveries from suppliers.
From time to time, the available industry-wide foundry capacity can fluctuate
significantly. During periods of constrained supply, the Company may experience
difficulty in securing an adequate supply of wafers, and/or its suppliers may
increase wafer prices. The Company's operating results depend in substantial
part on its ability to maintain or increase the capacity available from its
existing or new foundries. In prior years, the Company has experienced increased
costs and delays in customer shipments as a result of a foundry reducing
shipments to the Company without prior notice, requiring the Company to transfer
products to a new foundry. Although the Company believes that it has planned to
meet customer demand, there can be no assurances that unforeseen demand, current
supplier interruptions or other changes will not have a material impact on the
Company's business.
The Company is also dependent upon third-party assembly companies that
package or test the Company's devices. The Company depends upon these suppliers
to produce in a timely manner and at competitive prices. The Company may
sustain an adverse financial impact from problems with the cost, timeliness,
yield and quality of product deliveries from these suppliers.
The Company relies upon patent, trademark, trade secret and copyright law to
protect its intellectual property. There can be no assurance that such
intellectual property rights can be successfully asserted or will not be
invalidated, circumvented or challenged. Litigation, regardless of its outcome,
could result in substantial cost and diversion of resources for the Company. Any
infringement claim or other litigation against or by the Company could have a
material effect on the Company's financial condition and results of operations.
In November 1995, the Company commenced infringement litigation against a
competitor. There are no other material pending legal proceedings, other than
routine litigation incidental to the Company's business, to which the Company is
a party or of which any of its property is subject.
The accompanying notes are an integral part of these statements.
8
<PAGE>
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation. The Company prepares financial statements on a 52-53
week year. During the 3/rd/ Quarter of Fiscal 1996, the Company changed its
fiscal year end from the last Saturday nearest to the calendar year end to the
last Sunday nearest the calendar year end.
The unaudited supplemental consolidated financial statements include the
accounts of the Company and its wholly owned subsidiaries. Significant
intercompany accounts and transactions have been eliminated.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
All share and per share numbers in this Report reflect the effect of a 3-for-
2 stock split effected on March 30, 1998.
Cash and Cash Equivalents. For purposes of the unaudited supplemental
consolidated balance sheets and statements of cash flows, the Company considers
all highly liquid debt instruments purchased with an original maturity of three
months or less to be cash equivalents. Cash and cash equvalents consist of cash
deposited with financial institutions and securities investment companies.
Investments. The Company accounts for investments pursuant to Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments in
Debt and Equity Securities" ("SFAS 115"). SFAS 115 requires that investments be
classified into one of three categories: held-to-maturity, available-for-sale,
or trading. It requires that investments classified as held-to-maturity be
reported at amortized cost, that investments classified as available-for-sale be
reported at fair value with unrealized gains and losses, net of related tax,
reported as a separate component of shareholders' equity, and that investments
classified as trading be reported at fair value with unrealized gains and losses
included in earnings. As of December 28, 1997 and December 29, 1996, all of the
Company's investments are classified as available-for-sale and are carried at
fair value. As of December 28, 1997, and December 29, 1996, the Company's
stockholders' equity reflected an unrealized gain, net of applicable taxes, of
$18,000 and $12,000, respectively.
The accompanying notes are an integral part of these statements.
9
<PAGE>
The amortized cost and market values of the Company's available-for-sale
investments as of December 28, 1997 and December 29, 1996, were as follows:
<TABLE>
<CAPTION>
December 28, 1997
(in thousands)
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
----------- ----------- ---------- ---------
<S> <C> <C> <C> <C>
Municipal bonds $ 11,528 $24 $ - $ 11,552
Corporate debt and equity securities 122,561 36 30 122,567
----------- ----------- ---------- ---------
$134,089 $60 $30 $134,119
=========== =========== ========== =========
December 29, 1996
(in thousands) Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------------------------------------------
Municipal bonds $ 20,531 $29 $ 3 $ 20,557
Corporate debt and equity securities 2,100 - 6 2,094
--------------------------------------------
$ 22,631 $29 $ 9 $ 22,651
============================================
</TABLE>
The amortized cost and market values of the Company's available-for-sale
investments, by maturity, at December 28, 1997, was as follows:
<TABLE>
<CAPTION>
December 28, 1997
------------- -------------
(in thousands) Amortized Market Value
Cost
<S> <C> <C>
Due in one year or less $112,536 $112,560
Due after one year through five years 21,553 21,559
------------- -------------
$134,089 $134,119
============= =============
</TABLE>
Proceeds from the sale of available-for-sale investments during fiscal 1997
and 1996 were $86.6 million and $14.7 million, respectively. The cost basis
used in determining realized gains and losses is specific identification.
During 1997, gross gains of $20,000 with no losses were realized, and gross
gains of $1,000 and gross losses of $32,000 were realized in 1996.
Financial Instruments. The following methods and assumptions were used by
the Company in estimating its fair value disclosures for financial instruments:
For cash and cash equivalents, accounts receivable, trade accounts payable,
notes payable and convertible subordinated notes, the carrying value is a
reasonable estimate of fair value. For investments, fair values are based on
quoted market prices or dealer quotes.
10
<PAGE>
Inventories. Inventories are stated at the lower of cost (first in, first
out method) or market and include materials, labor and manufacturing overhead
costs. Inventories as of December 28, 1997 and December 29, 1996 consisted of:
<TABLE>
<CAPTION>
(in thousands) 1997 1996
---------- -------
<S> <C> <C>
Raw materials $ 9,133 $ 32
Work-in-process 13,412 7,948
Finished goods 4,154 2,010
---------- -------
Total inventories $26,699 $9,990
========== =======
</TABLE>
Property and Equipment. Property and equipment are recorded at cost.
Depreciation is provided on a straight-line basis over the following estimated
useful lives:
Machinery and equipment 3-5 years
Furniture and fixtures 3-5 years
Leasehold improvements 3-10 years
Property and equipment, net, is comprised of the following:
<TABLE>
<CAPTION>
(in thousands) 1997 1996
----------- ---------
<S> <C> <C>
Machinery and equipment $ 37,067 $ 25,529
Furniture and fixtures 18,632 12,061
Leasehold improvements 3,407 3,485
----------- ---------
59,106 41,075
Less-Accumulated depreciation (26,213) (17,068)
----------- ---------
$ 32,893 $ 24,007
=========== =========
</TABLE>
Deferred Lease Expense. Lease payments for certain equipment are recognized
as expense on a straight-line basis over the term of the lease.
Patent Costs. Patent costs include direct costs of obtaining the patents.
Upon patent approval, patent costs are amortized over the estimated useful life
of the patent using the straight-line method.
Revenue Recognition. Product sales are generally recognized upon shipment of
product. However, the Company defers recognition of revenues and gross margin
from sales to stocking distributors until such distributors resell the related
products to their customers. The Company has deferred recognition of gross
margin amounting to $2,490,000, $864,000, and $1,300,000 as of December 28,
1997, December 29, 1996, and December 30, 1995, respectively. During 1997
11
<PAGE>
and 1995 no single customer accounted for more than 10% of revenues. In 1996,
sales to Hewlett-Packard were 11.2% of total sales.
Export sales as a percentage of revenues were 35%, 39%, and 33% for 1997,
1996, and 1995, respectively.
The Company from time to time enters into development and license agreements
with certain customers related to customer-specific applications. Related costs
are expensed as incurred and are included in research and development expenses,
while revenue for non-recurring engineering contracts is deferred until contract
milestones are met. During 1997, 1996, and 1995, the Company recognized
revenues of $56,000, $398,000, and $289,000, respectively, in accordance with
the contract milestones in the Company's agreements.
In 1996, the Company entered into a four year development and license
agreement with a company to develop certain technologies and receive license,
development and royalty fees through the term of the agreement. As of December
31, 1997, the Company has received payments totaling $2,675,000 under this
development and license agreement. The agreement called for certain performance
milestones which have not been met as of December 28, 1997. Disputes among the
parties have arisen as to who is responsible for not meeting the required
milestones. Development on this project has ceased. The agreement includes
certain provisions which could require refunding of all proceeds received to
date. The parties are negotiating a settlement of these matters. No revenue is
being recognized under this agreement until such time as the dispute is
resolved. This matter was settled on September 9, 1998 with a payment of
$750,000 by the company and a mutual release.
The Company earns royalty income under certain contracts and recognizes that
income in the period that income is earned.
Revenues are comprised of the following:
<TABLE>
<CAPTION>
(in thousands) 1997 1996 1996
------------ ---------- --------
<S> <C> <C> <C>
Product sales $155,457 $111,392 $77,417
Royalties, licenses and non-recurring
engineering revenue 1,043 595 601
------------ ---------- --------
Total revenues $156,500 $111,987 $78,018
============ ========== ========
</TABLE>
Income Taxes. The Company accounts for income taxes pursuant to Statement
of Financial Accounting Standards No. 109, "Accounting for Income Taxes." This
statement provides for a liability approach under which deferred income taxes
are provided based upon enacted tax laws and rates applicable to the periods in
which the taxes become payable.
Stock Based Compensation. As of December 31, 1995, the Company adopted
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation"
12
<PAGE>
("SFAS 123"). SFAS 123 defines a fair-value-based method of accounting for
stock-based compensation. As permitted by SFAS 123, the Company has not changed
its method of accounting for stock options but has provided the additional
required disclosures. The Company recognized no compensation expense related to
stock options in 1997.
Earnings Per Share. In February 1997, the Financial Accounting Standards
Board (the "FASB") issued SFAS 128, "Earnings Per Share," which establishes
standards for computing and presenting earnings per share ("EPS"). It replaces
the presentation of primary EPS with a presentation of basic EPS. It also
requires dual presentation of basic and diluted EPS on the face of the income
statement for all entities with complex capital structures and requires
reconciliation of the numerator and denominator of the basic EPS computation to
the numerator and denominator of the diluted EPS computation. The statement is
effective for financial statements issued for periods ending after December 15,
1997, and requires restatement for all periods presented.
Financial Presentation. Certain prior year amounts in the unaudited
supplemental consolidated financial statements have been reclassified to conform
to the fiscal 1997 presentation.
4. SHORT-TERM BORROWINGS
The Company has a $10 million revolving line of credit with a bank. The
Company compensates the bank for credit facilities by paying annual
administrative fees. The balance of the Company's short-term borrowings against
this line as of December 28, 1997, and December 29, 1996, was zero.
<TABLE>
<CAPTION>
Notes Payable consist of:
(in thousands)
<S> <C>
Note payable to bank with interest at prime plus 1%
(9.5% at December 31, 1997) due July 31, 1998. This
note is personally guaranteed by the Chairman of the
Board of Directors of Acclaim. In connection with
this guarantee, 100,000 warrants to purchase Acclaim
Series C preferred stock at $3.00 per share were issued.
These warrants were converted into Company warrants in
the business combination. $2,000
Notes payable primarily to common and preferred
shareholders with interest at 7%, due on demand, and
unsecured. In connection with these loans, 231,150 warrants
to purchase Acclaim Series C preferred stock at $3.00 per
share were issued. These warrants were converted into Company
common stock in the business combination. 3,949
-------
Total $5,949
=======
</TABLE>
13
<PAGE>
5. LONG-TERM DEBT
The Company sold $115 million of 4% convertible subordinated notes during
1997. The notes will mature on September 1, 2004. Unless previously redeemed or
repurchased, the notes are convertible, at any time through the close of
business on the final maturity date of the notes, into common stock of the
Company, at a conversion price of $26.67 per share. Interest on the notes is
payable semi-annually, commencing March 1, 1998. Total interest accrued on the
convertible subordinated notes at December 28, 1997 was approximately
$1,550,000.
After September 2000, the notes are redeemable at the option of the Company,
in whole or in part. The notes may be redeemed for either cash or common stock
at a repurchase price of 105% of the principal amount of the notes to be
repurchased plus accrued and unpaid interest to the repurchase date.
The notes are unsecured obligations of the Company and are subordinated to
all existing and future senior indebtedness of the Company. The indenture
contains no limitations on the incurrence of additional indebtedness or other
liabilities by the Company.
6. LEASES
The Company conducts its operations using leased facilities and equipment
under both capital and operating leases. Minimum future lease payments as of
December 28, 1997, are as follows:
<TABLE>
<CAPTION>
Operating
(in thousands) Capital Leases Leases
----------------- ---------
Year Ending
<S> <C> <C>
1998 $ 1,415 $13,453
1999 1,252 14,059
2000 974 12,070
2001 74 9,049
2002 - 7,212
Thereafter - 29,852
----------------- ---------
$ 3,715 $85,695
=========
Less-Interest portion (7.38% to 12%) (339)
----------------
Capital lease obligations 3,376
Less-Current portion (1,201)
----------------
Long-term portion $ 2,175
================
</TABLE>
Rent expense for operating leases was approximately $9.0 million, $7.4
million, and $3.5 million for the years ended December 28, 1997, December 29,
1996, and December 30, 1995, respectively.
14
<PAGE>
7. INCOME TAXES
The provision for income taxes consists of:
<TABLE>
<CAPTION>
(in thousands) 1997 1996 1995
-------- ------- -------
<S> <C> <C> <C>
Current income taxes:
State $ 1,098 $ 282 $ 1,333
Federal 9,603 4,309 2,580
Deferred income taxes:
State 245 694 (676)
Federal (1,496) 1,089 (1,795)
-------- ------- -------
Provision for income taxes $ 9,450 $6,374 $ 1,442
======== ======= =======
</TABLE>
The tax benefits associated with non-qualified stock options reduced taxes
currently payable by $5,129,000, $1,205,000, and $2,418,000 in 1997, 1996, and
1995, respectively. Such benefits were recorded as an increase to common stock.
Deferred tax assets and liabilities are determined based on the differences
between the financial reporting and tax bases of assets and liabilities. They
are measured by applying the enacted tax rates and laws in effect for the years
in which such differences are expected to reverse.
The significant components of the Company's deferred tax assets and
liabilities as of December 28, 1997, and December 29, 1996, are as follows:
<TABLE>
<CAPTION>
(in thousands) 1997 1996
---------- -------
<S> <C> <C>
Deferred tax assets:
Inventory reserves $ 1,893 $ 397
Deferred income 1,822 1,244
Allowance for doubtful accounts 134 93
Deferred lease expense 151 265
Inventory Unicap adjustment 796 345
Accrued vacation 484 273
AMT credit carryforwards 365 365
Research and development credit carryforwards 872 537
Net operating loss carryforwards 3,738 46
Other (4) 346
---------- -------
Total deferred tax assets 10,251 3,911
Deferred tax liabilities:
Accelerated depreciation (356) (393)
Unrealized loss on Section 475 securities (681) -
---------- -------
Total deferred tax liabilities (1,037) (393)
Valuation allowance (5,164) (1,014)
---------- -------
Deferred tax assets, net $ 4,050 $ 2,504
========== =======
</TABLE>
15
<PAGE>
The reconciliation of the federal statutory tax rate to the effective tax
rate is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------- ----- -----
<S> <C> <C> <C>
Statutory federal tax rate 35.0% 34.0% 34.0%
Valuation allowance 16.0 6.4 -
Reversal of valuation allowance - - (21.0)
Foreign taxes & foreign sales corporation (2.6) (4.7) (3.0)
State taxes 4.9 3.3 5.7
Non-deductible acquisition costs 0.6 5.5 2.2
Research and development credits (3.7) - -
Other (1.2) (0.5) (5.9)
------- ----- -----
Effective income tax rate 49.0% 44.0% 12.0%
======= ===== =====
</TABLE>
8. SHAREHOLDERS' EQUITY AND EARNINGS PER SHARE
In July 1997, the Board of Directors authorized a 3 for 2 stock split,
which was effective on August 26, 1997. The stock split was declared on July 7,
1997, to shareholders of record on August 5, 1997. All common stock amounts
and per share amounts have been retroactively adjusted to reflect the stock
split.
On February 23, 1998, the Board of Directors authorized a 3 for 2 stock
split effective on March 30, 1998 to shareholders of record on March 9, 1998.
All common stock amounts and per share amounts have been adjusted retroactively
to reflect the stock split.
16
<PAGE>
The Company adopted Statement on Financial Accounting Standards No. 128,
"Earnings per Share," effective December 15, 1997. As a result, the Company's
earnings per share for all prior periods have been restated. The following
table reconciles the numerator and denominator of the basic and diluted earnings
per share computations.
<TABLE>
<CAPTION>
(in thousands, except per share amounts) Per Share
Income Shares Amount
--------- -------- ---------
<S> <C> <C> <C>
YEAR ENDING:
Net income:
1997 $ 9,673
1996 8,053
1995 10,131
BASIC EPS: income available to
common shareholders
1997 $ 9,673 33,117 $0.29
1996 8,053 31,538 0.26
1995 10,131 29,159 0.35
Options and warrants:
1997 2,485
1996 1,804
1995 1,389
DILUTED EPS: income available to common
stockholders plus assumed conversions
1997 $ 9,673 35,602 $0.27
1996 8,053 33,342 0.24
1995 10,131 30,548 0.33
</TABLE>
No conversion is assumed for the convertible subordinated notes issued in
1997 because it would have an anti-dilutive effect on earnings per share.
Options to purchase approximately 92,000, 147,000, and 192,000 shares of common
stock in 1997, 1996, and 1995, respectively, were not included in the
computation of diluted EPS because the options' exercise price was greater than
the average market price of the common shares, making the shares anti-dilutive.
9. STOCK OPTION AND PURCHASE PLANS AND EMPLOYEE BENEFIT PLAN
Stock-based Compensation Plans. The Company has four stock option plans:
the 1985 Stock Option Plan (the "1985 Plan"), the 1993 Stock Option Plan (the
"1993 Plan"), the San Francisco Telecom Stock Option Plan (the "SFT Plan"), the
Acclaim Communications Stock Option Plan (the "ACCL Plan") and an employee stock
purchase plan (the "ESPP"). No further options may be granted under either the
1985 Plan or the SFT Plan, and 517,698 options previously granted under these
plans remain outstanding. The Company applies Accounting Principles Board
Opinion No. 25 and related interpretations in accounting for its plans.
Accordingly, no compensation cost has been recognized for its stock option
plans. Had
17
<PAGE>
compensation cost for these plans been determined consistent with SFAS 123, the
Company's net income and net income per common share would have been reduced to
the following pro forma amounts:
<TABLE>
<CAPTION>
(in thousands, except share data) 1997 1996 1995
--------- -------- ---------
<S> <C> <C> <C>
Net Income
As reported $9,673 $8,053 $10,131
Pro forma 5,670 6,138 9,422
Earnings per share, as reported
Basic 0.29 0.26 0.35
Diluted 0.27 0.24 0.33
Pro-forma earnings per share
Basic 0.17 0.19 0.32
Diluted 0.17 0.19 0.32
</TABLE>
The fair value of each option grant has been estimated on the date of the
grant using the Black-Scholes option-pricing model with the following weighted
average assumptions used for grants in 1997, 1996, and 1995. In calculating
compensation cost: risk-free interest rates of 6.12, 6.15, and 5.90 percent,
and expected stock price volatility of 70%, an expected life of six years and no
dividend payments for 1997, 1996, and 1995, respectively.
Because the SFAS 123 method of accounting has not been applied to options
granted prior to January 1, 1995, and due to the nature and timing of option
grants, the resulting pro forma compensation cost may not be representative of
that to be expected in future years.
The Company has authorized the issuance of up to 1,012,500 shares of stock
to its full-time employees under the ESPP. The Company has sold 67,487 shares
and 49,808 shares as of December 28, 1997 and December 29, 1996, respectively,
and has sold a total of 168,650 shares through December 28, 1997. The Company
sells shares at 85% of the stock's market price, which is either the market
price at the beginning or at the end of offering period, whichever is lower.
The Company may grant options for up to 6,862,500 shares under the 1993
Plan. The Company had 1,076,081 shares available for grant at December 28,
1997. Under the 1993 Option Plan, the option exercise price equals the market
price on date of grant.
All options previously granted under the ACCL Plan have been converted into
options of the Company's common stock. Each Acclaim option was converted into
.362859 of the Company's options at exercise prices of $0.69 to $1.38. There
were approximately 740,000 shares outstanding and 163,000 exercisable at
December 28, 1997.
18
<PAGE>
The following table presents the aggregate options granted, forfeited, and
exercised under the 1985 Plan, 1993 Plan, SFT Plan, and the ACCL Plan for the
years ended December 28, 1997, December 29, 1996, and December 30, 1995, at
their respective weighted average exercise prices.
<TABLE>
<CAPTION>
1997 1996 1995
-----------------------------------------------------------------
(shares in thousands) Wtd. Avg. Wtd. Avg. Wtd. Avg.
Shares Exer. Price Shares Exer. Price Shares Exer. Price
-------- ----------- ------- ----------- ------ -----------
<S> <C> <C> <C> <C> <C> <C>
Outstanding, beginning of year 4,836 $ 6.05 3,342 $5.06 2,454 $2.29
Granted
Price = Fair Value 2,552 15.31 1,624 9.56 1,542 7.99
Price (less than) Fair Value 295 1.38 566 0.88 57 0.30
Exercised (704) 3.70 (391) 2.47 (489) 0.62
Canceled (418 7.10 (305) 8.96 (222) 3.33
----- ------ ----- ----- ----- -----
Outstanding, end of year 6,561 $ 9.63 4,836 $6.05 3,342 $5.06
===== ====== ===== ===== ===== =====
Exercisable, end of year 1,948 1,650 826
======== ====== =======
</TABLE>
The following table summarizes information about options outstanding under
the 1985, Plan, 1993 Plan, SFT Plan, and ACCL Plan at December 28, 1997.
<TABLE>
<CAPTION>
(in thousands) Options Outstanding Options Exercisable
-------------------------------------------------- -----------------------------
Shares Wtd. Avg. Wtd. Avg.
Range of Exercise Outstanding as of Remaining Wtd. Avg. Shares Exercisable Exercise
Prices 12/31/97 Contractual Life Exercise Price as of 12/31/97 Price
- ----------------- ---------------- ---------------- -------------- ------------------ ---------
<S> <C> <C> <C> <C> <C> <C>
$ 0.17 $ 7.17 1,703 7.22 $ 2.09 1,397 $ 1.34
7.33 9.78 1,716 7.70 7.94 395 8.02
10.00 13.22 1,651 8.74 10.95 144 10.87
13.33 27.17 1,491 9.67 18.70 12 15.74
------ ------ ----- ---- ------ ----- ------
$ 0.17 $27.17 6,561 8.29 $ 9.63 1,948 $ 3.49
====== ====== ===== ==== ====== ===== ======
</TABLE>
Options for all plans are exercisable in installments at intervals
determined by the Board of Directors, not to exceed ten years and one day.
401(k) Tax Deferred Savings Plan. The Company has a 401(k) Tax Deferred
Savings Plan (the "401(k) Plan") under which eligible employees may elect to
have a portion of their salary deferred and contributed to their accounts under
the 401(k) Plan. Under the 401(k) Plan, the Company will contribute at least 1%
(and up to a maximum of 3%) of an eligible employee's annual gross salary to the
employee's account under the 401(k) Plan. For the fiscal years ended December
28, 1997, December 29, 1996, and December 30, 1995, the Company contributed
$490,000, $420,000, and $315,000, respectively, to the 401(k) Plan.
19
<PAGE>
10. INCENTIVE PLANS
The Company has reserved 202,500 shares of Common Stock for issuance to
employees pursuant to a stock bonus plan to be agreed upon by the Board of
Directors. As of December 28, 1997, no shares had been issued.
Beginning in January 1994, the Company implemented an incentive compensation
plan. The Company's incentive compensation plan provides for incentive
compensation for substantially all employees of the Company based upon the
achievement of specified operating and performance results. Incentive
compensation totaled $3,739,000, $1,791,000, and $833,000 for 1997, 1996 and
1995, respectively.
11. STOCK WARRANTS
The Company has issued warrants to independent sales representatives to
purchase up to 95,625 shares of its Common Stock with exercise prices ranging
from $1.03 to $9.33 per share. As of December 28, 1997, an aggregate of 45,155
shares has been issued upon exercise of warrants.
In connection with securing a loan from investors in 1992, the Company issued
warrants to purchase 456,179 shares of Common Stock with an exercise price of
$0.67 per share. The warrants were exercised January 16, 1997, for 433,697
shares, and the balance was surrendered, on a net appreciation basis, in an
amount equal to the exercise price.
In connection with the issuance of notes in 1996, warrants were granted to
purchase 27,000 shares of Series B convertible preferred stock at $5.00 per
share. The warrants became exercisable upon the closing of the Series B
convertible preferred stock financing during 1996 and expire in ten years. The
fair value of such warrants, aggregating approximately $66,600, was recorded as
additional interest expense during 1996. These warrants have been converted into
warrants to purchase 21,936 shares of the Company's common stock at $6.16 per
share.
In connection with the issuance of notes in 1997, warrants were granted by
Acclaim to purchase 331,150 shares of Series C convertible preferred stock at
$3.00 per share. The warrants became exercisable upon the closing of the Series
C convertible preferred stock financing during 1998 and expire in ten years.
The fair value of such warrants, approximately $586,000, was recorded as
additional paid in capital. The related issuance cost of $585,000 was recorded
in other assets and is being amortized to interest expense over the life of the
recorded debt. Interest expense includes amortization of these issuance costs
totaling $331,000. These warrants have subsequently been converted into warrants
to purchase 234,549 shares of the company's common stock at $6.16 per share.
12. PREFERRED STOCK
No shares of Preferred Stock are currently outstanding. The Company's Board
of Directors is authorized to issue up to 10,000,000 shares of Preferred Stock.
20
<PAGE>
13. RELATED PARTY TRANSACTIONS
During 1997, 1996 and 1995, the Company paid consulting and/or directors'
fees of approximately $117,000, $129,600, and $130,000 respectively, to three
members of the Board of Directors.
During the third quarter of 1996, in connection with a third-party financing
for Maker Communications, Inc. ("Maker"), the Company sold a portion of its
minority interest in Maker for an aggregate of approximately $675,000 in cash.
This sale was accounted as a one-time gain recorded as "Other Income" in the
accompanying Unaudited Supplemental Consolidated Statements of Income. The
Company continues to hold a minority interest in Maker and license certain Maker
technology. Other contractual rights and obligations, including the Company's
obligation to provide certain loan financing to Maker, were terminated in the
transaction. Following the transaction, Maker repaid the Company approximately
$2.9 million, the total balance under an outstanding note.
14. BUSINESS AND TECHNOLOGY ACQUISITIONS
During December 1996, the Company acquired Silicon Design Experts, Inc.
("SDE"). In connection with the transaction, the Company issued an aggregate of
195,143 shares of its common stock valued at $3,000,000 to SDE's shareholders,
and agreed to issue additional shares of Common Stock in the future to SDE's
shareholders and employees, with the amount to be contingent upon the extent of
sales of products developed by SDE and Level One's stock price. The total
purchase price of $3,000,000 was allocated as follows: $500,000 to goodwill, and
$2,500,000 for purchased research and development. The purchased research and
development of $2,500,000 was expensed. The transaction was accounted for under
the purchase method of accounting. Accordingly, SDE's operating results after
the date of acquisition are included in the Unaudited Supplemental Consolidated
Statements of Income.
On June 6, 1995, the Company acquired San Francisco Telecom, Inc. ("SFT").
SFT operates as a wholly-owned subsidiary of the Company. In connection with
the transaction, the Company issued an aggregate 304,560 shares of its common
stock to SFT's shareholders, assumed existing SFT stock options, which will be
exercisable for a total of 56,139 shares of Common Stock, and agreed to issue
additional shares of Common Stock in the future to SFT's shareholders and
employees, with the amount to be contingent upon the extent of sales of products
developed by SFT. The transaction was accounted for under the purchase method
of accounting. Accordingly, SFT's operating results after the date of the
acquisition are included in the Unaudited Supplemental Consolidated Statements
of Income.
15. FOUNDRY COMMITMENTS
The Company's current wafer requirements are supplied primarily by six
foundries. During 1995, the Company entered into five-year agreements with
three of its suppliers for committed foundry capacity in consideration of
equipment financing or cash deposits. At December 28, 1997, the Company had
provided an aggregate of $20.6 million in capital equipment financing and/or
cash deposits to these foundries to obtain committed foundry capacity. During
the first
21
<PAGE>
quarter of 1998, the Company paid an aggregate $1.3 million in additional
deposits as required by its agreements. There are no additional deposits due
under the Company's existing foundry agreements.
ITEM 7 FINANCIAL STATEMENTS AND EXHIBITS
The following financial statements of Acclaim Communications, Incorporated,
are contained on pages 23 to 35 of this report:
Report of Independent Certified Public Accountants
Balance Sheet for the year ended December 31, 1997
Statement of Operations for the year ended December 31, 1997
Statement of Shareholders' Deficit for the year ended December 31,
1997
Statement of Cash Flows for the year ended December 31, 1997
Notes to the Financial Statements
22
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Acclaim Communications, Incorporated:
We have audited the accompanying balance sheet of Acclaim Communications,
Incorporated (a Delaware corporation) as of December 31, 1997, and the related
statements of operations, shareholders' deficit and cash flows for the year 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 generally accepted auditing
standards. 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 Acclaim Communications,
Incorporated as of December 31, 1997 and the results of its operations and its
cash flows for the year then ended in conformity with generally accepted
accounting principles.
Arthur Andersen LLP
Sacramento, California
August 27, 1998
23
<PAGE>
<TABLE>
<CAPTION>
ACCLAIM COMMUNICATIONS, INCORPORATED
BALANCE SHEET
As of December 31, 1997
<S> <C>
Assets
Current Assets:
Cash $ 508,921
Trade accounts receivable 111,988
Inventories 581,238
Deferred Origination Loan Costs 369,807
Other current assets 35,408
--------------
Total current assets 1,607,362
Property and equipment, net 1,097,466
Other assets 76,796
--------------
Total assets $ 2,781,624
==============
Liabilities and Shareholders' Deficit
Current Liabilities:
Notes payable $ 5,948,450
Accounts payable 2,073,354
Other accrued liabilities 187,020
Deferred revenue 2,681,028
--------------
Total current liabilities 10,889,852
Shareholders' Deficit:
Convertible preferred stock:
Series A - $0.001 par value (aggregate liquidation preference of 3,000
$1,200,000); 3,000,000 shares authorized and outstanding in 1997
Series B - $0.001 par value (aggregate liquidation preference of 661
$3,305,000); 688,000 shares authorized, 661,000 shares
outstanding in 1997
Series C - $0.001 par value; 6,700,000 shares authorized,
0 shares outstanding;
Common stock - $0.001 par value; 20,000,000 shares authorized; 3,031
3,031,116 shares outstanding in 1997
Additional paid-in capital 4,690,294
Accumulated deficit (12,805,214)
--------------
Total shareholders' deficit (8,108,228)
--------------
Total liabilities and shareholders' deficit $ 2,781,624
==============
</TABLE>
The accompanying notes are an integral part of these statements.
24
<PAGE>
ACCLAIM COMMUNICATIONS, INCORPORATED
STATEMENT OF OPERATIONS
For the Year ended December 31, 1997
<TABLE>
<CAPTION>
<S> <C>
Revenues $ 238,280
Cost of revenues 283,544
--------------
(45,264)
Operating expenses:
Research and development 5,020,846
Sales and marketing 2,184,763
General and administrative 1,886,569
--------------
Total operating expenses 9,092,178
Loss from operations (9,137,442)
Interest income 38,843
Interest expense (416,910)
--------------
Loss before provision for income taxes (9,515,509)
Provision for income taxes 2,915
--------------
Net loss $(9,518,424)
==============
</TABLE>
The accompanying notes are an integral part of these statements.
25
<PAGE>
ACCLAIM COMMUNICATIONS, INCORPORATED
STATEMENT OF SHAREHOLDERS' DEFICIT
For the Year Ended December 31, 1997
<TABLE>
<CAPTION>
Convertible Preferred Stock
------------------------------------------
Series A Series B Common Stock Additional Total
-------------------- -------------------- ------------------ Paid-In Accumulated Shareholders'
Shares Amount Shares Amount Shares Amount Capital Deficit Deficit
----------- ------- --------- -------- ---------- ------- ---------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balances, December 31,1996 3,000,000 $3,000 661,000 $ 661 3,000,000 $ 3,000 $4,093,266 $ (3,286,790) $ 813,137
Common stock issued from
exercise of stock options 31,116 31 11,257 11,288
Detachable warrants issued
with promissory notes 585,771 585,771
Net loss (9,518,424) (9,518,424)
----------- ------ ------- -------- ---------- -------- ----------- ------------- -----------
Balances, December 31,1997 3,000,000 $3,000 661,000 $ 661 3,031,116 $ 3,031 $ 4,690,294 $ (12,805,214) $(8,108,228)
=========== ====== ======= ======== ========== ======== =========== ============= ===========
</TABLE>
The accompanying notes are an integral part of these statements.
26
<PAGE>
ACCLAIM COMMUNICATIONS, INCORPORATED
STATEMENT OF CASH FLOWS
For the Year Ended December 31, 1997
<TABLE>
<CAPTION>
<S> <C>
Cash flows from operating activities:
Net loss $(9,518,424)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation 237,701
Amortization of debt issuance costs 331,243
Changes in assets and liabilities:
Accounts receivable (109,377)
Inventories (581,238)
Other current assets (88,910)
Accounts payable and accrued liabilities 1,832,951
Deferred revenue 506,028
--------------
Net cash used in operating activities (7,390,026)
--------------
Cash flows from investing activities:
Net capital expenditures (996,773)
Payments for other assets (47,406)
--------------
Net cash used in investing activities (1,044,179)
--------------
Cash flows from financing activities:
Proceeds from issuance of notes 5,948,450
Proceeds from issuance of common stock 11,288
--------------
Net cash provided by financing activities 5,959,738
--------------
Net decrease in cash (2,474,467)
Cash at beginning of year 2,983,388
--------------
Cash at end of year $ 508,921
==============
Non cash investing and financing activities:
Issuance of preferred stock warrants $ 585,771
Supplementary disclosure of cash and noncash transactions:
Cash payments for:
Interest 159,851
</TABLE>
The accompanying notes are an integral part of these statements.
27
<PAGE>
ACCLAIM COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
1. ORGANIZATION AND DESCRIPTION OF BUSINESS
Acclaim Communications, Inc. (the "Company") was incorporated in Delaware
on August 16, 1995 to develop and market remote access and broadband switch
networking products. The Company was incorporated under the name Hydra
Communications, Inc. and changed its name in April 1996. The Company was
previously a development stage company.
2. RISK FACTORS
The Company operates in a dynamic high-technology industry, and
accordingly, can be affected by a variety of factors. Management of the Company
believes that changes in any of the following areas could have a material
adverse effect on the Company's future financial position or results of
operations: ability to obtain additional financing; regulatory changes,
fundamental changes in the technology underlying the data communications
industry; competition, including, but not limited to, pricing and products or
product features and services; litigation or other claims against the Company;
and the Company's ability to attract and retain employees necessary to support
its growth and product development.
The Company is also dependent upon third-party assembly companies that
package or test the Company's devices. The Company depends upon these suppliers
to produce in a timely manner and at competitive prices. The Company may
sustain an adverse financial impact from problems with the cost, timeliness,
yield and quality of product deliveries from these suppliers.
The Company relies upon patent, trademark, trade secret and copyright law
to protect its intellectual property. There can be no assurance that such
intellectual property rights can be successfully asserted or will not be
invalidated, circumvented or challenged. Litigation, regardless of its outcome,
could result in substantial cost and diversion of resources for the Company.
Any infringement claim or other litigation against or by the Company could have
a material effect on the Company's financial condition and results of
operations.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation. The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that effect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Such management estimates include certain accrued
28
<PAGE>
liabilities and a valuation allowance for net deferred tax assets. Actual
results could differ from those estimates.
Organization Costs. The Company has expensed all previously capitalized
organization costs resulting in a charge of $9,024 to General and Administrative
expense in 1997.
Financial Instruments. The following methods and assumptions were used by
the Company in estimating its fair value disclosures for financial instruments:
For accounts receivable, accounts payable, and notes payable, the carrying value
is a reasonable estimate of fair value.
Inventories. Inventories are stated at the lower of cost (first-in, first-
out method) or market and include direct materials costs. Inventories as of
December 31, 1997 consisted of the following:
<TABLE>
<CAPTION>
<S> <C>
Raw Materials $303,918
Work-in-Process 277,320
-----------
Total Inventories $581,238
===========
</TABLE>
Property and Equipment. Property and equipment are recorded at cost.
Depreciation is computed using the straight-line method over estimated useful
lives of three to five years. Property and equipment at December 31, 1997
consist of:
<TABLE>
<CAPTION>
<S> <C>
Machinery and equipment $ 843,697
Furniture and fixtures 566,303
Leasehold improvements 24,171
-------------
1,434,171
Less-Accumulated depreciation (336,705)
-------------
$1,097,466
=============
</TABLE>
Revenue Recognition. Product sales are generally recognized upon shipment
of product. Revenue related to development agreements is recognized upon
completion of contract milestones. Revenue related to licensing agreements is
recognized over the life of the agreement or when it is probable that the
royalty will be received.
Income Taxes. The Company accounts for income taxes pursuant to Statement
of Financial Accounting Standards No. 109 ("SFAS 109"). "Accounting for Income
Taxes." SFAS
29
<PAGE>
109 provides for a liability approach under which deferred income taxes are
provided based upon enacted tax laws and rates applicable to the periods in
which the taxes become payable.
Stock-Based Compensation. The Company accounts for stock-based awards to
employees using the intrinsic value method in accordance with Statement of
Financial Accounting Standards No. 123, "Accounting for stock-based
compensation" ("SFAS 123"). As permitted by SFAS 123, the Company has not
changed its method of accounting for stock options but has provided the
additional required disclosures. The Company recognized no compensation expense
related to stock options in 1997.
4. NOTES PAYABLE
<TABLE>
<CAPTION>
Notes Payable as of December 31, 1997 consist of:
<S> <C>
Note payable to bank with interest at prime plus 1% (9.5% at
December 31, 1997) due July 31, 1998. This note is personally
guaranteed by the Chairman of the Board of Directors. In
connection with this guarantee, 100,000 warrants to purchase
Series C preferred stock at $3.00 per share were issued (see Note 7). $2,000,000
Notes payable primarily to common and preferred shareholders
with interest at 7%, due on demand, and unsecured. In connection
with these loans, 231,150 warrants to purchase Series C preferred
stock at $3.00 per share were issued (see Note 7). 3,948,000
----------
Total $5,948,000
==========
</TABLE>
The warrants issued in connection with these notes became exercisable on
February 28, 1998 and expire in ten years. The fair value of such warrants
approximately $585,771 was recorded as additional paid-in capital. The related
issuance cost of $585,771 was recorded as deferred organization loan costs and
is being amortized to interest expense over the life of the related debt.
Interest expense includes amortization of these issuance costs totaling
$331,000.
5. COMMITMENTS
Deferred Revenue. In October 1996, the Company entered into a four year
development and license agreement with a company, one of whose founders is the
Chairman of the Company's Board, to develop certain technologies and receive
license, development and royalty fees through the term of the agreement. As of
December 31, 1997, the Company has received payments totaling $2,675,000 under
this development and license agreement. The agreement called for certain
performance milestones which have not been met as of December 31, 1997.
Disputes among the parties have arisen as to who is responsible for not meeting
the required milestones. Development on this project has ceased. The agreement
includes certain provisions which could require refunding of all proceeds
received to date. The parties are negotiating a
30
<PAGE>
settlement of these matters. No revenue is being recognized under this agreement
until such time as the dispute is resolved. This matter was settled on September
9, 1998 with a payment of $750,000 by the Company and a mutual release. Other
deferred revenues totaled $6,000.
Leases. The Company conducts its operations using leased facilities and
equipment under operating leases. Minimum future lease payments as of December
31, 1997, are as follows.
<TABLE>
<CAPTION>
Year Ending
<S> <C>
1998 $ 706,148
1999 578,511
----------
$1,284,659
==========
</TABLE>
Rent expense for operating leases was approximately $216,000 for the year
ended December 31, 1997.
6. INCOME TAXES
The provision for income taxes at December 31, 1997, consists of the
following:
<TABLE>
<CAPTION>
<S> <C>
Current income taxes
State $2,915
Federal -
Deferred income taxes
State -
Federal -
---------
Provision for income taxes $2,915
=========
</TABLE>
The effective tax rate for fiscal 1997 is lower than the statutory rate due
to the Company's inability to utilize net operating losses.
Deferred tax assets and liabilities are determined based on the differences
between the financial reporting and tax bases of assets and liabilities. The
Company has elected a tax fiscal year ending July 31. Deferred income taxes and
amounts payable represent the Company's tax position at December 31, 1997. They
are measured by applying the enacted tax rates and laws in effect for the years
in which such differences are expected to reverse.
At December 31, 1997, the Company had net operating loss carryforwards of
approximately $9,345,000 and $9,343,000 available to offset future federal and
California taxable income, respectively. Such federal and California
carryforwards expire through 2012
31
<PAGE>
and 2005, respectively. The extent to which the loss carryforwards can be used
to offset future taxable income may be limited, depending on the extent of
ownership changes within any three-year period as provided in the Tax Reform Act
of 1986 and the California Conformity Act of 1987.
The significant components of the Company's deferred tax assets and
liabilities as of December 31, 1997 are:
<TABLE>
<CAPTION>
<S> <C>
Deferred tax assets (liabilities):
Deferred income $ 1,072,400
Accrued vacation 39,040
Net operating loss carryforwards 3,738,000
Research and development credit
carryforwards 299,937
Other 15,504
Valuation reserve (5,164,881)
-----------
Net deferred income tax asset $ -
===========
</TABLE>
The reconciliation of the federal tax rate to the effective tax rate at
December 31, 1997, is as follows:
Statutory federal tax rate 34.0%
Valuation allowance (34.0%)
------
Effective income tax rate 0.0%
======
7. SHAREHOLDERS' EQUITY
Convertible Preferred Stock. The Company is authorized to issue 20,000,000
shares of convertible preferred stock (shares), of which 3,000,000 shares are
designated for Series A convertible preferred stock (Series A), all of which are
issued and outstanding and 688,000 are designated for Series B convertible
preferred stock (Series B), 661,000 of which are issued and outstanding and
6,700,000 authorized shares of Series C convertible preferred stock (Series C),
336,750 of which have been reserved for issuance upon exercise of outstanding
Series C preferred stock warrants. Significant terms of the convertible
preferred stock are as follows:
. Each share is convertible at the option of the holder, into one
share of common stock (subject to certain other events). Shares will
automatically be converted into common stock upon the closing of a
public offering in excess of $5,000,000 and $10,000,000
respectively, and at a price equal to or greater than $3.00 and
$10.00 per share respectively. Shares of will automatically convert
upon approval (by vote or written consent) of the holders of a
majority of the outstanding shares of each series of preferred
stock.
. Each share has the same voting rights as the number of shares of
common stock to which it is convertible.
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<PAGE>
. In the event of liquidation, dissolution or winding up of the
Company, the preferred shareholders of Series A, B and C shall
receive an amount equal to $0.40, $5.00 and $3.00 per share,
respectively, plus an amount equal to all declared but unpaid
dividends on each share. Any remaining assets will be distributed
among the holders of Series A, B and C preferred stock and common
stock, pro rata, based on the number of shares of common stock held
by each shareholder on an as converted basis.
. Holders of preferred stock are entitled to annual non cumulative
dividends of $0.04 per share for Series A, $0.50 for Series B and
$0.30 for Series C, if declared by the Board of Directors, before
any dividend declared on common stock. No dividends were declared
since inception through December 31, 1997.
8. STOCK OPTION PLAN
Under the Company's 1996 Stock Incentive Plan (the Plan), the Board of
Directors is authorized to grant up to 3,400,000 shares of common stock to
employees, directors and consultants at prices not less than the fair market
value at date of grant for incentive stock options and not less than 85% of fair
market value for non-statutory stock options. Options become exercisable over
four years and expire ten years from the date of grant. The company applies
Accounting Principles Board Opinion No. 25 and related interpretations in
accounting for the Plan. Accordingly, no compensation cost has been recognized.
Had compensation cost for the Plan been determined consistent with SFAS 123, the
Company's pro forma net loss would have been ($9,731,088) for fiscal 1997.
The fair value of each option grant has been estimated on the date of
grant using the Black-Scholes option-pricing model using the minimum value
method with the following weighted average assumptions: risk-free interest
rates of 6.1 percent, an expected option life of four years following vesting,
and no dividends during the expected term. The resulting pro forma compensation
cost may not be representative of that to be expected in future years.
The following table presents the aggregate options granted, forfeited, and
exercised under the Plan for the year ending December 31, 1997, at their
respective weighted average exercise prices.
<TABLE>
<CAPTION>
Wtd. Avg.
Shares Exer. Price
------------ ------------
<S> <C> <C>
Outstanding beginning of year 1,560,470 $0.32
Granted: Price = Fair Value 788,000 0.50
Exercised (31,116) 0.36
Canceled (278,990) 0.43
------------ ------------
Outstanding end of year 2,038,364 0.38
============ ============
Exercisable, December 31, 1997 448,131
===========
</TABLE>
33
<PAGE>
Additional information regarding options outstanding as of December 31, 1997 is
as follows:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
--------------------------------------------------- ---------------------------
Range of Shares Wtd. Avg. Wtd. Avg. Shares Wtd. Avg.
Exercise Prices Outstanding Remaining Exercise Exercisable Exercise
as of 12/31/97 Contractual Live Price as of 12/31/97 Price
- ----------------- ----------------- ----------------- ------------ ---------------- ---------
<S> <C> <C> <C> <C> <C>
$ 0.25 993,240 8.46 $0.25 379,439 $0.25
$ 0.50 1,045,124 9.32 0.50 68,692 0.50
- ----------------- ----------------- ----------------- ------------ ---------------- ---------
$ 0.25 - $ 0.50 2,038,364 8.90 $0.38 448,131 $0.29
================= ================= ================= ============ ================ =========
</TABLE>
9. EMPLOYEE BENEFIT PLAN
The Company has a 401(k) Tax Deferred Savings Plan (the "401(k) Plan")
under which eligible employees may elect to have a portion of their salary
deferred and contributed to their accounts under the 401(k) Plan. Participants
may contribute between 1% and 20% of their annual compensation on a before-tax
basis, but not to exceed the amount allowable as a deferral for federal income
tax purposes. Participants vest immediately in their contributions. The
Company is not required to contribute, nor has it contributed, to the 401(k)
Plan for the fiscal year ended December 31, 1997.
10. SUBSEQUENT EVENT
On July 6, 1998, the Company completed a business combination with Level
One Communications, Incorporated ("Level One") which designs, develops and
markets application specific standard product integrated circuits and custom
derivatives for high-speed digital signal transmission and networking
connectivity. The combination was a stock for stock merger that will be
accounted for as a "pooling-of-interests." Accordingly, the Company's
historical consolidated financial statements presented in the future will be
restated to include the financial position and results of operations of Level
One. As a result of the merger, the outstanding shares of Acclaim capital
stock and options and warrants to purchase Acclaim capital stock were converted
into the right to receive an aggregate of 5,000,000 shares of the Level One's
common.
34
<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 hereunto duly authorized.
LEVEL ONE COMMUNICATIONS, INCORPORATED
Date: September 21, 1998 /s/ JOHN KEHOE
-------------------------
John Kehoe
Senior Vice President and
Chief Financial Officer
35
