REPORT OF INDEPENDENT ACCOUNTANTS
TO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF SEACHANGE INTERNATIONAL, INC.
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations, of stockholders' equity and of cash flows
present fairly, in all material respects, the financial position of SeaChange
International, Inc. and its subsidiaries at December 31, 1996 and 1997 and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1997, in conformity with generally accepted
accounting principles. 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 of these
statements in accordance with generally accepted auditing standards which
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, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
/s/ Price Waterhouse LLP
Price Waterhouse LLP
Boston, Massachusetts
January 22, 1998
- ---------------------------------
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT SHARE DATA)
December 31,
1996 1997
ASSETS
Current assets:
Cash and cash equivalents $23,394 $ 2,973
Marketable securities -- 9,310
Accounts receivable, net of allowance for doubtful
accounts of $173 at December 31, 1996 and
$559 at December 31, 1997 7,426 12,535
Inventories 9,153 13,713
Prepaid expenses 250 2,336
Deferred income taxes 575 1,091
---------------------
Total current assets 40,798 41,958
Property and equipment, net 4,705 8,303
Other assets 532 81
Goodwill and intangibles, net -- 1,608
---------------------
$46,035 $51,950
=====================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 7,305 $ 8,765
Accrued expenses 1,809 2,718
Customer deposits 2,899 2,049
Deferred revenue 2,192 3,851
Income taxes payable -- 85
---------------------
Total current liabilities 14,205 17,468
---------------------
Commitments (Note 10)
STOCKHOLDERS' EQUITY
Common stock, $.01 par value; 50,000,000 shares authorized;
12,859,234 shares and 13,593,594 shares issued at
December 31, 1996 and 1997, respectively 129 136
Additional paid-in capital 26,167 31,218
Retained earnings 5,534 3,114
Treasury stock, none and 9,000 shares at
December 31, 1996 and 1997, respectively -- --
Cumulative translation adjustment -- 14
---------------------
Total stockholders' equity 31,830 34,482
---------------------
$46,035 $51,950
=====================
The accompanying notes are an integral part of these consolidated financial
statements.
- ----------------------------------------------
CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Year Ended December 31,
1995 1996 1997
REVENUES
Systems $ 21,999 $ 45,745 $ 60,414
Services 1,204 3,521 7,473
--------------------------------
23,203 49,266 67,887
--------------------------------
COSTS OF REVENUES
Systems 14,917 27,133 34,740
Services 1,641 4,030 7,607
--------------------------------
16,558 31,163 42,347
--------------------------------
Gross profit 6,645 18,103 25,540
--------------------------------
OPERATING EXPENSES
Research and development 2,367 5,393 11,758
Selling and marketing 1,609 4,254 6,049
General and administrative 858 2,064 3,744
Write-off of acquired in-process
research and development -- -- 5,290
--------------------------------
4,834 11,711 26,841
--------------------------------
Income (loss) from operations 1,811 6,392 (1,301)
Interest income, net 113 353 657
--------------------------------
Income (loss) before income taxes 1,924 6,745 (644)
Provision for income taxes 713 2,483 1,776
--------------------------------
Net income (loss) $ 1,211 $ 4,262 $(2,420)
================================
Basic earnings (loss) per share $ .33 $ .82 $ (.24)
================================
Diluted earnings (loss) per share $ .11 $ .36 $ (.24)
================================
Shares used in calculating:
Basic earnings per share 3,654,088 5,187,993 10,276,711
Diluted earnings per share 11,121,157 11,745,866 10,276,711
The accompanying notes are an integral part of these consolidated financial
statements.
- ----------------------------------------------
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
Series A convertible
preferred stock Common stock
-------------------------- ----------------------------------
Additional
Number Number Par paid-in
of shares Amount of shares value capital
Balance at
December 31, 1994 11,808 $ -- 9,309,615 $ 93 $ 367
Sale of common stock -- -- 316,125 3 7
Loans to stockholders -- -- -- -- --
Net income -- -- -- -- --
---------------------------------------------------------------
Balance at
December 31, 1995 11,808 -- 9,625,740 96 374
Purchase of treasury stock -- -- -- -- --
Sale of common stock, net
of stock issuance costs -- -- 1,810,000 18 24,052
Conversion of preferred
stock into common stock (11,808) -- 2,260,856 23 3,985
Issuance of common stock
pursuant to to exercise
of stock options -- -- 9,223 -- 9
Compensation expense
associated with
stock issuance -- -- -- -- 126
Issuance of common
stock pursuant to purchased
research and development -- -- 9,615 -- 144
Retirement of treasury stock -- -- (856,200) (8) (2,523)
Net income -- -- -- -- --
---------------------------------------------------------------
Balance at
December 31, 1996 -- -- 12,859,234 129 26,167
Purchase of treasury stock -- -- (9,000) -- --
Compensation expense
associated with stock issuance -- -- -- -- 45
of common stock pursuant to
exercise of stock options -- -- 88,999 1 203
Issuance of common stock
in connection with employee
stock purchase plan -- -- 29,361 -- 479
Issuance of common stock in
connection with acquisition
of IPC Interactive Pte. Ltd. -- -- 625,000 6 4,324
Translation adjustment -- -- -- -- --
Net loss -- -- -- -- --
---------------------------------------------------------------
Balance at
December 31, 1997 -- $ -- 13,593,594 $ 136 $31,218
===============================================================
Retained
earnings and Notes
currency receivable Total
translation Treasury from stockholders'
adjustment stock stockholders equity
Balance at
December 31, 1994 $ 61 $ (4) $ -- $ 517
Sale of common stock -- -- -- 10
Loans to stockholders -- -- (795) (795)
Net income 1,211 -- -- 1,211
-------------------------------------------------------
Balance at
December 31, 1995 1,272 (4) (795) 943
Purchase of treasury stock -- (2,527) 795 (1,732)
Sale of common stock, net
of stock issuance costs -- -- -- 24,070
Conversion of preferred
stock into common stock -- -- -- 4,008
Issuance of common stock
pursuant to to exercise
of stock options -- -- -- 9
Compensation expense
associated with
stock issuance -- -- -- 126
Issuance of common
stock pursuant to purchased
research and development -- -- -- 144
Retirement of treasury stock -- 2,531 -- --
Net income 4,262 -- -- 4,262
-------------------------------------------------------
Balance at
December 31, 1996 5,534 -- -- 31,830
Purchase of treasury stock -- -- -- --
Compensation expense
associated with stock issuance -- -- -- 45
of common stock pursuant to
exercise of stock options -- -- -- 204
Issuance of common stock
in connection with employee
stock purchase plan -- -- -- 479
Issuance of common stock in
connection with acquisition
of IPC Interactive Pte. Ltd. -- -- -- 4,330
Translation adjustment 14 -- -- 14
Net loss (2,420) -- -- (2,420)
-------------------------------------------------------
Balance at
December 31, 1997 $ 3,128 $ -- $ -- $ 34,482
======================================================
The accompanying notes are an integral part of these consolidated financial
statements.
- --------------------------------------------------------------
CONSOLIDATED STATEMENT OF CASH FLOWS
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (IN THOUSANDS)
Year Ended December 31,
1995 1996 1997
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 1,211 $ 4,262 $(2,420)
Adjustments to reconcile net income (loss)
to net cash provided by (used in) operating activities:
Depreciation and amortization 230 1,436 2,802
Inventory valuation allowance 56 694 1,730
Compensation expense associated
with stock and stock options -- 126 45
Write-off of acquired in-process research and development -- -- 5,290
Research and development expense associated with
common stock issuance -- 144 --
Deferred income taxes (85) (424) (516)
Changes in assets and liabilities, net of the effect of the
acquisition of IPC Interactive Pte. Ltd.:
Accounts receivable (2,035) (4,091) (4,381)
Inventories (2,280) (9,134) (7,069)
Prepaid expenses and other assets (15) (468) (1,470)
Accounts payable 2,069 4,165 (1,164)
Accrued expenses 1,693 (126) (109)
Customer deposits 700 817 (3,260)
Deferred revenue 615 1,425 1,273
Income taxes payable 599 (720) 85
------------------------------------
Net cash provided by (used in) operating activities 2,758 (1,894) (9,164)
------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of software -- (450) --
Purchases of property and equipment (659) (2,792) (2,158)
Proceeds from sale and maturity of marketable securities -- -- 8,966
Purchases of marketable securities -- -- (18,276)
Cash acquired related to the acquisition of IPC
Interactive Pte. Ltd., net of transaction costs -- -- 665
------------------------------------
Net cash used in investing activities (659) (3,242) (10,803)
------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Repayment of notes payable (8) -- --
Repayment of line of credit -- -- (700)
Proceeds from sale of convertible preferred stock, net 4,008 -- --
Proceeds from sale of common stock, net 10 24,079 683
Purchase of treasury stock -- (2,023) --
Payment of loans to related parties -- -- (437)
(Loans to) repayments from stockholders (795) 290 --
------------------------------------
Net cash provided by (used in) financing activities 3,215 22,346 (454)
------------------------------------
Net increase (decrease) in cash and cash equivalents 5,314 17,210 (20,421)
Cash and cash equivalents, beginning of year 870 6,184 23,394
------------------------------------
Cash and cash equivalents, end of year $ 6,184 $23,394 $ 2,973
====================================
The accompanying notes are an integral part of these consolidated financial
statements.
- --------------------------------------------------------------
CONSOLIDATED STATEMENT OF CASH FLOWS
INCREASE(DECREASE) IN CASH AND CASH EQUIVALENTS (IN THOUSANDS)
(CONTINUED)
Year Ended December 31,
1995 1996 1997
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Income taxes paid $180 $3,854 $ 1,691
SUPPLEMENTAL DISCLOSURE OF NONCASH ACTIVITY
Receipt of computer equipment in lieu of cash payment
of accounts receivable from customer $ 75 $ -- $ --
Transfer of items originally classified as inventories
to fixed assets $576 $1,726 $ 1,829
Purchase of treasury stock in lieu of cash payment of
notes receivable from stockholders $ -- $ 505 $ --
Acquisition of all of the outstanding
shares of IPC Interactive Pte. Ltd. (Note 3)
Fair value of assets acquired (including
intangible assets and in-process
research and development) $12,396
Fair value of common shares issued (4,330)
Transaction costs (475)
--------
Liabilities assumed $ 7,591
========
The accompanying notes are an integral part of these consolidated financial
statements.
- ------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1 | NATURE OF BUSINESS
The Company develops computer systems to digitally manage, store and distribute
video. Through December 31, 1997, substantially all of the Company's revenues
were derived from the sale of digital video insertion systems, movie systems and
related services to cable television operators and telecommunications companies
in the United States and internationally.
On December 10, 1997, the Company acquired all of the outstanding capital stock
of IPC Interactive Pte. Ltd. ("IPC"). IPC, together with the Company's
centralized video server platform, provides interactive television network
systems to the hospitality and commercial property markets. Additionally, IPC
deploys and operates its interactive network television systems at customer
locations and charges fees for providing services and content, primarily movies.
2 | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Significant accounting policies followed in the preparation of the accompanying
consolidated financial statements are as follows:
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated.
REVENUE RECOGNITION
Revenues from the sales of systems are recognized upon shipment provided that
there are no uncertainties regarding customer acceptance and collection of the
related receivables is probable. If such uncertainties exist, such as
performance criteria beyond the Company's standard terms and conditions, revenue
is recognized upon customer acceptance. Installation and training revenue is
deferred and recognized as these services are performed. Revenue from technical
support and maintenance contracts is deferred and recognized ratably over the
period of the related agreements, generally twelve months, if billed in advance.
Customer deposits represent advance payments from customers for systems. Revenue
from content fees, primarily movies, are recognized in the period earned based
on noncancelable agreements.
CONCENTRATION OF CREDIT RISK, SIGNIFICANT CUSTOMERS AND EXPORT SALES
Financial instruments which potentially expose the Company to concentrations of
credit risk include trade accounts receivable and marketable securities. To
minimize this risk, the Company evaluates customers' financial condition and
requires advance payments from certain of its customers. At December 31, 1996
and 1997, the Company had an allowance for doubtful accounts of $173,000 and
$559,000, respectively, to provide for potential credit losses and such losses
to date have not exceeded management's expectations. The Company invests its
excess cash in marketable securities, primarily municipal securities with strong
credit ratings.
For the years ended December 31, 1995, 1996 and 1997, certain customers
accounted for more than 10% of the Company's revenues. Individual customers
accounted for 29%, 29%, 16% and 12% of revenues in 1995; 29%, 17%, 13% and 12%
in 1996; and 24%, 18% and 10% in 1997.
Sales to international customers accounted for 12% of total revenues in the year
ended December 31, 1997. In 1997, international sales to significant geographic
areas were approximately $2,696,000 in North and South America, $4,211,000 in
Europe and $1,125,000 in the rest of the world.
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 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 these estimates.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with an original
maturity of three months or less to be cash equivalents. The Company invests its
excess cash in money market funds, municipal securities and corporate debt
securities that are subject to minimal credit and market risk. Cash equivalents
are classified as available-for-sale and are carried at market value, and any
unrealized gains or losses are recorded as a part of stockholders' equity.
PROPERTY AND EQUIPMENT
Property and equipment consist of office and computer equipment, leasehold
improvements, demonstration equipment, deployed assets and spare components and
assemblies used to service the Company's installed base. Demonstration equipment
consists of systems manufactured by the Company for use in marketing and
selling. Property and equipment are recorded at cost and depreciated using the
straight-line method over their estimated useful lives. Leasehold improvements
are amortized over the shorter of their estimated useful lives or the term of
the respective leases by use of the straight-line method. Deployed assets
consist primarily of hardware owned and operated by the Company and installed at
customer locations. Deployed assets are depreciated over the life of the related
service agreements ranging from 2 to 5 years. Maintenance and repair costs are
expensed as incurred.
- ------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
INVENTORIES
Inventories are stated at the lower of cost or market. Cost is determined using
the first-in, first-out (FIFO) method. Inventories consist primarily of
components and subassemblies and finished products held for sale. Rapid
technological change and new product introductions and enhancements could result
in excess or obsolete inventory. To minimize this risk, the Company evaluates
inventory levels and expected usage on a periodic basis and records valuation
allowances as required.
The Company is dependent upon certain vendors for the manufacture of significant
components of its digital advertising insertion system and its movie systems.
If these vendors were to become unwilling or unable to continue to manufacture
these products in required volumes, the Company would have to identify and
qualify acceptable alternative vendors. The inability to develop alternative
sources, if required in the future, could result in delays or reductions in
product shipments.
GOODWILL AND INTANGIBLE ASSETS
Goodwill and assembled workforce acquired in connection with the acquisition of
IPC (Note 3) are amortized on a straight-line basis over five to seven years.
Software acquired in connection with the acquisition is amortized over the
greater of the amount computed using (a) the ratio that current gross revenues
for related products bear to total current and anticipated future gross revenues
for that product or (b) on a straight-line basis over the remaining estimated
life of three years.
RESEARCH AND DEVELOPMENT AND SOFTWARE DEVELOPMENT COSTS
Costs incurred in the research and development of the Company's products are
expensed as incurred, except for certain software development costs. Costs
associated with the development of computer software are expensed prior to
establishing technological feasibility and capitalized thereafter until the
product is released for sale. Software development costs eligible for
capitalization to date have not been material to the Company's financial
statements. Costs associated with acquired software rights are capitalized if
technological feasibility of the software has been established.
STOCK COMPENSATION
Employee stock awards under the Company's compensation plans are accounted for
in accordance with Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" (APB 25). In January 1996, the Company adopted the
disclosure requirements of Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" (SFAS 123). Nonemployee stock awards
are accounted for in accordance with SFAS 123.
FOREIGN CURRENCY TRANSLATION
The Company has determined that the functional currency of its foreign
subsidiaries is the local currency. Accordingly, assets and liabilities are
translated to U.S. dollars at current exchange rates as of each balance sheet
date. Income and expense items are translated using average exchange rates
during the year. Cumulative currency translation adjustments are presented as a
separate component of stockholders' equity. Transaction gains and losses and
unrealized gains and losses on intercompany receivables have not been material
to date.
ADVERTISING COSTS
Advertising costs are charged to expense as incurred. Advertising costs were
$174,000, $328,000 and $659,000 for the years ended December 31, 1995, 1996 and
1997, respectively.
EARNINGS PER SHARE
Statement of Financial Accounting Standards No. 128, "Earnings Per Share" (SFAS
128), became effective for financial statements issued for fiscal periods ending
after December 15, 1997 and requires restatement of all prior period earnings
per share data. SFAS 128 replaced Accounting Principles Board Opinion No. 15 and
requires the presentation of "basic" earnings per share and "diluted" earnings
per share. Basic earnings per share is computed by dividing income available to
common shareholders by the weighted average shares of common stock outstanding
during the period. For the purposes of calculating diluted earnings per share
the denominator includes both the weighted average number of shares of common
stock outstanding during the period and the weighted average number of potential
common stock, such as stock options and restricted stock.
In addition, on February 3, 1998 the Securities and Exchange Commission issued
Staff Accounting Bulletin (SAB) No. 98, which supersedes SAB No. 83, includes
new guidance with respect to historical earnings per share computations in an
initial public offering and is effective upon a company's adoption of SFAS 128.
Pursuant to SAB No. 98, nominal issuances of common stock during the period
January 1, 1995 through the effective date of the initial public offering would
be included in computing basic earnings per share as if outstanding for all
periods presented. In computing diluted earnings per share for such periods,
nominal issuances of common stock and potential common stock would be included
as if outstanding for all periods presented. During the period January 1, 1995
through the effective date of the initial public offering, the Company had no
nominal issuance of any common stock or potential common stock as defined by SAB
No. 98.
The Company adopted SFAS 128 and SAB No. 98 in the fourth quarter of 1997 and
has restated earnings per share for all periods presented, as required.
For the year ended December 31, 1997, potential common stock of 468,311 common
shares issuable upon the exercise of stock options and 2,661,825 shares of
unvested restricted common stock are antidilutive because the Company recorded a
net loss for the year and therefore have been excluded from the diluted earnings
per share computation.
- ------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
Below is a summary of the shares used in calculating basic and diluted earnings
per share for the years indicated:
Year Ended December 31,
1995 1996 1997
Weighted average number of shares outstanding 3,654,088 5,187,993 10,276,711
Shares attributable to Series A redeemable
convertible preferred stock 1,771,200 1,476,000 --
Shares attributable to Series B redeemable
convertible preferred stock 170,582 568,607 --
Shares attributable to unvested restricted
common stock 5,471,500 4,109,925 --
Dilutive stock options 53,787 403,341 --
----------------------------------
Shares used in calculating diluted
earnings per share 11,121,157 11,745,866 10,276,711
==================================
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS
130) and Statement of Financial Accounting Standards No. 131, "Disclosures about
Segments of an Enterprise and Related Information" (SFAS 131). SFAS 130
establishes standards for reporting comprehensive income and its components in
the consolidated financial statements. SFAS 131 establishes standards for
reporting information on operating segments in interim and annual financial
statements. SFAS 130 and SFAS 131 require disclosure only and will have no
impact on the Company's consolidated financial position or results of
operations.
In October 1997, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants (AcSEC) issued Statement of Position
97-2, "Software Revenue Recognition" (SOP 97-2), which will become effective on
January 1, 1988. Management does not expect SOP 97-2 to have a material effect
on the Company's results of operations as the Company's revenue recognition
policy is substantially consistent with the provisions of SOP 97-2.
3 | ACQUISITION
On December 10, 1997, the Company exchanged 625,000 shares of its common stock
for all of the outstanding capital stock of IPC. IPC provides interactive
television network systems to the hospitality and commercial property markets.
The total purchase price, including transaction costs, was $4,805,000. The
acquisition was accounted for under the purchase method. Accordingly, the
purchase price was allocated to the estimated fair value of the acquired assets
and liabilities based upon an independent appraisal. A portion of the purchase
price was allocated to in-process research and development, resulting in an
immediate charge to the Company's operations of $5,290,000 at the date of
acquisition. The amount allocated to in-process research and development
represented technology which had not reached technological feasability and had
no alternative future use. The appraisal also valued intangibles, including
assembled workforce and software. Goodwill and intangibles, net of related
accumulated amortization of $27,000, at December 31, 1997 totaled $1,608,000.
The consolidated results of operations include the operating results of IPC from
the date of acquisition.
The purchase price was allocated to the acquired assets and liabilities as
follows:
Tangible assets $ 5,471,000
Assumed liabilities (7,591,000)
Intangible assets:
In-process research and development $ 5,290,000
Software 850,000
Assembled workforce 280,000
Goodwill 505,000
----------
$ 4,805,000
==========
Included in assumed liabilities were a line of credit of $700,000 and notes
payable to related parties of $437,000. The notes payable to related parties
were due to two companies owned by new shareholders as a result of the
acquisition. The Company paid these assumed liabilities in full and cancelled
the line of credit prior to December 31, 1997.
The Company has renamed IPC to GuestServe Networks.
- ------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
The following unaudited pro forma data summarizes the consolidated results of
the Company and IPC as if the acquisition had occurred on February 1, 1996
(inception of IPC) and excludes the $5,290,000 charge for in-process research
and development. The unaudited pro forma information is not necessarily
indicative either of results of operations that would have occurred had the
purchase been made at the beginning of the periods presented, or of future
results of operations of the combined companies.
Pro forma for the year ended December 31,
1996 1997
(unaudited) (unaudited)
Revenues $60,372,000 $75,573,000
Net income (loss) $ 1,085,000 $(3,403,000)
Basic earnings (loss) per share $ .19 $ (.31)
Diluted earnings (loss) per share $ .09 $ (.31)
4 | CONSOLIDATED BALANCE SHEET DETAIL
Cash equivalents and marketable securities consist of the following:
December 31,
1996 1997
Cash equivalents:
Money market funds $ 297,000 $ 506,000
Municipal securities 12,600,000 1,550,000
Corporate debt securities 9,485,000 --
--------------------------
22,382,000 2,056,000
Marketable securities:
Municipal securities -- 9,310,000
--------------------------
$22,382,000 $11,366,000
==========================
Marketable securities are classified as available-for-sale securities and are
carried at fair market value, which approximates amortized cost. The
contractual maturities of all available-for-sale securities classified as cash
equivalents are less than three months. Gross unrealized gains and losses on
securities for the years ended December 31, 1996 and 1997, the cost of which is
based upon the specific identification method, were not significant.
Inventories consist of the following:
December 31,
1996 1997
Components and assemblies $6,524,000 $11,932,000
Finished products 2,629,000 1,781,000
--------------------------
$9,153,000 $13,713,000
==========================
Property and equipment consist of the following:
Estimated
useful life December 31,
(years) 1996 1997
Office furniture and equipment 5 $ 432,000 $ 1,332,000
Computer and demonstration equipment 3 4,571,000 8,140,000
Deployed assets 3 - 497,000
Service and spare components 5 1,050,000 2,000,000
Leasehold improvements 1-3 107,000 304,000
---------------------------------------
6,160,000 12,273,000
Less - Accumulated depreciation 1,455,000 3,970,000
---------------------------------------
$ 4,705,000 $ 8,303,000
=======================================
Depreciation expense was $230,000, $1,246,000 and $2,515,000 for the years ended
December 31, 1995, 1996 and 1997 respectively.
- ------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
Accrued expenses consist of the following:
December 31,
1996 1997
Accrued software license fees $ 367,000 $ 630,000
Accrued sales and use taxes 608,000 338,000
Other accrued expenses 834,000 1,750,000
-------------------------
$1,809,000 $2,718,000
=========================
5 | INCOME TAXES
The components of the provision for income taxes are as follows:
Year ended December 31,
1995 1996 1997
Current provision:
Federal $652,000 $2,346,000 $1,920,000
State 146,000 561,000 371,000
-------------------------------------
798,000 2,907,000 2,291,000
-------------------------------------
Deferred benefit:
Federal (65,000) (324,000) (394,000)
State (20,000) (100,000) (121,000)
-------------------------------------
(85,000) (424,000) (515,000)
-------------------------------------
$713,000 $2,483,000 $1,776,000
=====================================
The components of deferred income taxes are as follows:
December 31,
1996 1997
Deferred tax assets:
Inventories $366,000 $ 769,000
Allowance for doubtful accounts 66,000 209,000
Deferred revenue 118,000 96,000
Software 122,000 176,000
Acquired net operating loss carryforward and basis differences -- 3,361,000
------------------------
672,000 4,611,000
Valuation allowance -- (3,361,000)
------------------------
Total deferred tax assets 672,000 1,250,000
------------------------
Deferred tax liabilities:
Property and equipment 83,000 157,000
Other 14,000 2,000
------------------------
Total deferred tax liabilities 97,000 159,000
------------------------
Net deferred income taxes $575,000 $ 1,091,000
========================
Deferred income taxes reflect the tax impact of temporary differences between
the amount of assets and liabilities for financial reporting purposes and such
amounts as measured by tax laws and regulations. Under Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes" the benefit
associated with future deductible temporary differences is recognized if it is
more likely than not that the benefit will be realized.
The valuation allowance of $3,361,000 relates to net operating loss
carryforwards and tax basis differences acquired in the Company's purchase of
IPC. These acquired deferred tax assets may only be utilized to offset future
taxable income attributable to IPC. In addition, the recognition of these
deferred tax assets are subject to Internal Revenue Code change in ownership
rules which may limit the amount that can be utilized to offset future taxable
income. The Company believes that the valuation allowance is appropriate given
the weight of objective evidence, including the historical operating results of
IPC. Any tax benefits subsequently recognized related to these assets will
first reduce the remaining balance in goodwill and then other acquired
intangible assets.
- ------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
Based on the weight of available evidence, the Company believes its remaining
deferred tax assets will be realizable. The amount of the deferred tax asset
considered realizable is subject to change based on future events. The Company
will assess the need for the valuation allowance at each balance sheet date
based on all available evidence.
At December 31, 1997, the Company had federal and state net operating loss
carryforwards of approximately $5,980,000 which expire at various dates through
2012 and foreign net operating loss carryforwards of approximately $1,436,000
which do not expire.
The income tax provision computed using the federal statutory income tax rate
differs from the Company's effective tax rate primarily due to the following:
Year ended December 31,
1995 1996 1997
Statutory U.S. federal tax rate $654,000 $2,293,000 $ (91,000)
State taxes, net of federal tax benefits 85,000 304,000 165,000
Other -- -- 145,000
Research and development tax credits (54,000) (135,000) (334,000)
Foreign Sales Corporation exempt income -- (20,000) --
Nondeductible expenses, including write-off of acquired
in-process research and development in 1997 28,000 41,000 1,891,000
----------------------------------
$713,000 $2,483,000 $1,776,000
==================================
The Company's effective tax rates were 37.1% and 36.8% in 1995 and 1996,
respectively. The Company's effective tax rate for 1997 was significantly
impacted by the write-off of the acquired in-process research and development
which, due to the tax-free nature of the transaction to IPC stockholders, is not
deductible for tax purposes by the Company. Accordingly, in 1997 the Company
recorded a tax provision of $1,776,000 despite a book pre-tax operating loss.
6 | CONVERTIBLE PREFERRED STOCK
SERIES B CONVERTIBLE PREFERRED STOCK
In October and November 1995, the Company sold 650,487 shares of Series B
Redeemable Convertible Preferred Stock for $4,008,000, net of issuance costs of
$86,000.
CONVERSION
Upon closing of the initial public offering in November 1996, the convertible
preferred stock automatically converted into a total of 2,260,856 shares of
common stock.
STOCK AUTHORIZATION
The Board of Directors is authorized to issue from time to time up to an
aggregate of 5,000,000 shares of preferred stock, in one or more series. Each
such series of preferred stock shall have the number of shares, designations,
preferences, voting powers, qualifications and special or relative rights or
privileges to be determined by the Board of Directors, including dividend
rights, voting rights, redemption rights and sinking fund provisions,
liquidation preferences, conversion rights and preemptive rights.
7 | COMMON STOCK
INITIAL PUBLIC OFFERING
On November 5, 1996, the Company sold 1,810,000 shares of common stock to the
public in the Company's initial public offering at a price of $15.00 per share.
Proceeds to the Company, net of offering expenses, amounted to $24,070,000.
STOCK SPLITS
Effective August 3, 1995, the Company's Board of Directors approved a 100-for-1
stock split of the Company's common stock. On September 6, 1996, the Board of
Directors authorized a 3-for-2 stock split of the Company's common stock, which
became effective on October 30, 1996. All shares of common stock, common stock
options, preferred stock conversion ratios and per share amounts included in the
accompanying consolidated financial statements have been adjusted to give
retroactive effect to the stock splits for all years presented.
RESTRICTION AGREEMENTS
Certain common shares are subject to stock restriction and repurchase agreements
under which the Company may repurchase unvested common shares at the original
issuance price and vested common shares at fair value upon termination of a
business relationship with the Company. Common shares subject to these
agreements vest ratably over a five-year period and, at December 31, 1997,
2,109,300 of such shares are unvested.
TREASURY STOCK
In January 1996, the Company repurchased 431,250 shares of its common stock and
1,286 shares of Series A Stock from certain employees and directors of the
Company. Of the common stock repurchased, 21,750 shares were held by the
stockholders for less than six months from the time the shares became vested.
Accordingly, compensation expense was recorded for the difference between the
repurchase price and the original purchase price paid by the stockholders.
Compensation expense recorded as a result of this transaction was $91,000. In
December 1996, the Board of Directors voted to retire all shares of treasury
stock held at December 31, 1996.
- ------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
In 1997, the Company repurchased 9,000 shares of its common stock from an
employee of the Company. The shares were held for less than six months from the
time the shares became vested. Accordingly, compensation expense was recorded
for the difference between the repurchase price and the original purchase price
paid by the stockholder. Compensation expense recorded as a result of this
transaction was $45,000.
NOTES RECEIVABLE FROM STOCKHOLDERS
Interest on the principal amount outstanding of the notes receivable from
stockholders accrued at a rate of 5.9% per annum. These loans were secured by
common stock held by the noteholders and, consequently, the loans are reflected
as an offset to stockholders' equity at December 31, 1995. In January 1996, the
notes were settled in connection with the repurchase by the Company of the
common shares and Series A preferred shares noted above.
RESERVED SHARES
At December 31, 1997, the Company had 2,152,417 shares of common stock reserved
for issuance upon the exercise of common stock options and the purchase of stock
under the Employee Stock Purchase Plan.
8 | STOCK PLANS
EMPLOYEE STOCK PURCHASE PLAN
In September 1996, the Company's Board of Directors adopted and the stockholders
approved an employee stock purchase plan (the "Stock Purchase Plan"), effective
January 1, 1997, which provides for the issuance of a maximum of 300,000 shares
of common stock to participating employees who meet eligibility requirements.
Employees who would immediately after the grant own 5% or more of the total
combined voting power or value of the Company's stock and directors or who are
not employees of the Company may not participate in the Stock Purchase Plan.
The purchase price of the stock is 85% of the lesser of the market price of the
common stock on the first or last business day of each six-month plan period.
During 1997, 29,361 shares were issued under the Stock Purchase Plan.
1995 STOCK OPTION PLAN
The 1995 Stock Option Plan (the "1995 Stock Option Plan") provides for the grant
of incentive stock options and nonqualified stock options for the purchase of up
to an aggregate of 1,950,000 shares of the Company's common stock by officers,
employees, consultants and directors of the Company. The Board of Directors is
responsible for administration of the 1995 Stock Option Plan. The Board of
Directors determines the term of each option, option exercise price, number of
shares for which each option is granted and the rate at which each option is
exercisable. Options generally vest ratably over five years. The Company may
not grant an employee incentive stock options with a fair value in excess of
$100,000 that are first exercisable during any one calendar year.
Incentive stock options may be granted to employees at an exercise price per
share of not less than the fair value per common share on the date of the grant
(not less than 110% of the fair value in the case of holders of more than 10% of
the Company's voting stock). Nonqualified stock options may be granted to any
officer, employee, director or consultant at an exercise price per share as
determined by the Company's Board of Directors.
Options granted under the 1995 Stock Option Plan generally expire ten years from
the date of the grant (five years for incentive stock options granted to holders
of more than 10% of the Company's voting stock).
DIRECTOR STOCK OPTION PLAN
In June 1996, the Company's Board of Directors adopted and the stockholders
approved a director stock option plan (the "Director Option Plan") which
provides for the grant of options to full-time directors of the Company to
purchase a maximum of 30,000 shares of common stock. Under the Director Option
Plan, participating directors receive an option to purchase 3,375 shares of
common stock. Options granted under the Director Option Plan vest as to 33-1/3%
of the shares underlying the option immediately upon the date of the grant, and
vest as to an additional 8-1/3% of the shares underlying the option at the end
of each of the next 8 quarters, provided that the optionee remains a director.
Directors will also receive, on each three-year anniversary of such director's
option grant date, an additional option to purchase 3,375 shares of common
stock, provided that such director continues to serve on the Board of Directors.
All options granted under the Director Option Plan have an exercise price equal
to the fair value of the common stock on the date of grant and a term of ten
years from the date of grant.
- ------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
Transactions under the 1995 Stock Option Plan and the Director Option Plan
during the years ended December 31, 1995, 1996 and 1997 are summarized as
follows:
Year ended December 31,
1995 1996 1997
Weighted Weighted Weighted
average average average
Shares exercise price Shares exercise price Shares exercise price
Outstanding at
beginning of period 327,120 $ .92 327,120 $ .92 739,334 $ 5.87
Granted -- -- 472,510 $8.79 585,536 $18.03
Exercised -- -- (9,223) $ .85 (88,999) $ 2.30
Cancelled -- -- (51,073) $2.22 (92,814) $17.81
------- ------- ---------
Outstanding at end of period 327,120 $ .92 739,334 $5.87 1,143,057 $11.40
======= ======= =========
Options exercisable at period end -- 115,224 205,198
Weighted average fair value of
options granted during the period $ .32 $4.33 $11.00
The following table summarizes information about employee and director stock
options outstanding at December 31, 1997:
Options outstanding at December 31, 1997
---------------------------------------------
Weighted
average
remaining Weighted
contractual Number average
Range of exercise prices life (years) outstanding exercise price
$ .50 7.65 78,753 $ 0.50
$ 1.23 to 1.36 5.61 134,773 $ 1.29
$ 4.20 to 5.00 8.10 74,700 $ 4.42
$ 6.67 to 9.38 9.01 401,275 $ 7.76
$10.19 to 15.00 9.43 125,213 $11.94
$15.50 to 22.00 9.30 172,018 $19.73
$24.63 to 33.75 8.98 156,325 $28.69
-----------
1,143,057
===========
Options exercisable at December 31, 1997
---------------------------------------
Weighted
Number average
Range of exercise prices exercisable exercise price
$ .50 26,783 $ 0.50
$ 1.23 to 1.36 44,435 $ 1.30
$ 4.20 to 5.00 21,391 $ 4.50
$ 6.67 to 9.38 94,919 $ 7.32
$10.19 to 15.00 10,402 $12.39
$15.50 to 22.00 4,378 $17.16
$24.63 to 33.75 2,890 $33.06
-----------
205,198
===========
- ------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
The Company applies APB 25 in accounting for employee stock awards. Compensation
expense of $0, $126,000 and $45,000 have been recorded for the years ended
December 31, 1995, 1996 and 1997, respectively. Had compensation expense for the
Company's employee stock plans been determined based on the fair value at the
grant dates, as prescribed in SFAS 123, the Company's net income (loss) and net
income (loss) per share would have been as follows:
Year ended December 31,
1995 1996 1997
Net income (loss)
As reported $1,211,000 $4,262,000 $(2,420,000)
Pro forma $1,208,000 $4,205,000 $(3,290,000)
Basic earnings (loss) per share
As reported $ .33 $ .82 $ (.24)
Pro forma $ .33 $ .81 $ (.32)
Diluted earnings (loss) per share
As reported $ .11 $ .36 $ (.24)
Pro forma $ .11 $ .36 $ (.32)
For options granted prior to the Company's initial filing of its Registration
Statement on Form S-1 on September 18, 1996, the fair value of each option grant
was estimated on the date of grant using the minimum value method. The fair
value of each option granted subsequent to the initial filing was estimated on
the date of grant assuming a weighted average volatility factor of 67%.
Additional weighted average assumptions used for grants during the years ended
December 31, 1995, 1996 and 1997 included: dividend yield of 0.0% for all
periods; risk-free interest rates of 5.89% to 6.00% for options granted during
the year ended December 31, 1995, 5.36% to 6.49% for options granted during the
year ended December 31, 1996 and 5.70% to 6.75% for options granted during the
year ended December 31, 1997; and an expected option term of 5 years for all
periods.
Because additional option grants are expected to be made each year, the above
pro forma disclosures are not representative of pro forma effects of reported
net income for future years.
9 | LINE OF CREDIT
The Company has a $6.0 million revolving line of credit which expires in
September 1998. Borrowings under the line of credit are secured by substantially
all of the Company's assets. Loans made under the revolving line of credit will
bear interest at a rate per annum equal to, at the Company's option, the bank's
base rate or LIBOR, plus an applicable margin. The loan agreement relating to
the line of credit requires that the Company provide the bank with certain
periodic financial reports and comply with certain financial ratios. As of
December 31, 1997, the Company had not borrowed against the line of credit.
10 | COMMITMENTS
The Company leases its operating facilities and certain office equipment under
noncancelable operating leases which expire at various dates. Rental expense
under operating leases was approximately $154,000, $251,000 and $542,000 for the
years ended December 31, 1995, 1996 and 1997, respectively. Future minimum lease
payments as of December 31, 1997 are as follows:
Year ended December 31, 1998 $ 806,000
1999 645,000
2000 588,000
2001 360,000
2002 65,000
----------
$2,464,000
==========
The Company had noncancelable purchase commitments for inventories of
approximately $1,000,000 at December 31, 1997.
11 | EMPLOYEE BENEFIT PLAN
The Company sponsors a 401(k) retirement savings plan (the "Plan").
Participation in the Plan is available to full-time employees who meet
eligibility requirements. Eligible employees may contribute up to 15% of their
annual salary, subject to certain limitations. The Company matches contributions
up to 25% of the first 6% of compensation contributed by the employee to the
Plan. During 1997, the Company contributed $68,000 to the Plan. Prior to 1997,
the Company did not make contributions to the Plan.