DOLPHIN INTERCONNECT
SOLUTIONS, INC.
AND SUBSIDIARIES
Consolidated
Financial Statements
December 31, 2001 and 2000
TABLE OF CONTENTS
Page
Independent Auditors’ Report1
Consolidated Balance Sheets
as of December 31, 2001 and 20002-3
Consolidated Statements of Operations and Comprehensive (Loss) Income
for the years ended December 31, 2001 and 20004
Consolidated Statements of Stockholders’ Equity
for the years ended December 31, 2001 and 20005
Consolidated Statements of Cash Flows
for the years ended December 31, 2001 and 20006-7
Notes to Consolidated Financial Statements
as of December 31, 2001 and 20008-21
INDEPENDENT AUDITORS’ REPORT
To the Board of Directors
Dolphin Interconnect Solutions, Inc. and subsidiaries
We have audited the accompanying consolidated balance sheet of Dolphin Interconnect Solutions, Inc. and subsidiaries (the Company) as of December 31, 2001, and the related consolidated statements of operations and comprehensive (loss) income, stockholders’ equity, and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit. We did not audit the financial statements of Dolphin Interconnect Solutions A.S., a wholly owned subsidiary, which statements reflect total assets constituting approximately 60% of consolidated assets as of December 31, 2001. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included by Dolphin Interconnect Solutions, A.S., is based solely on the report of other auditors. The financial statements of Dolphin Interconnect Solutions, Inc. and subsidiaries as of and for the year ended December 31, 2000, were audited by other auditors whose report dated June 18, 2001 expressed an unqualified opinion on those statements.
We conducted our audit in accordance with U.S. 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 audit provides a reasonable basis for our opinion.
In our opinion, the accompanying consolidated financial statements, present fairly in all material respects, the financial position of Dolphin Interconnect Solutions, Inc. and subsidiaries as of December 31, 2001 and the results of its operations and cash flows for the year then ended, in conformity with U.S. generally accepted accounting principles.
June 3, 2002
CERTIFIED PUBLIC ACCOUNTANTS
CHESTNUT GREEN, TEN CEDAR STREET
WOBURN, MA 01801-6365
TELEPHONE (781) 933-1120
FAX (781) 933-8986
E-MAIL ADDRESS:
See notes to consolidated financial statements.
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DOLPHIN INTERCONNECT SOLUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2001 and 2000
ASSETS
2001 2000
Current assets:
Cash and cash equivalents$ 1,187,120$ 6,141,223
Accounts receivable, net 2,879,687 3,070,787
Dividend tax withholding receivable, net 695,586 -
Inventories, net 2,383,696 1,413,992
Prepaids and other current assets 177,838 1,149,628
Total current assets 7,323,927 11,775,630
Restricted cash 2,494,304 2,019,722
Equipment and improvements, net 455,857 339,092
Other assets 366,272 256,677
$10,640,360$ 14,391,121
DOLPHIN INTERCONNECT SOLUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS – CONTINUED
December 31, 2001 and 2000
LIABILITIES AND STOCKHOLDERS’ EQUITY
2001 2000
Current liabilities:
Accounts payable$1,504,531$ 795,707
Dividend tax withholding payable1,460,769 -
Accrued expenses1,283,992 999,873
Deferred revenue 1,012,314 914,450
Total current liabilities 5,261,606 2,710,030
Long term deferred revenue 281,685 181,529
Deferred income tax liability 65,375 978,432
347,060 1,159,961
Commitments and contingencies
Stockholders’ equity:
Preferred stock, $0.0001 par value; 5,000,000 shares
authorized; none issued - -
Common stock, $0.0001 par value; 10,000,000 shares
authorized; 5,628,502 shares issued and outstanding 563 563
Additional paid-in capital28,284,708 28,258,515
Accumulated deficit (23,114,749) (17,866,072)
Accumulated other comprehensive (loss) income (138,828) 128,124
Total stockholders’ equity 5,031,694 10,521,130
$ 10,640,360$ 14,391,121
DOLPHIN INTERCONNECT SOLUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE
(LOSS) INCOME
For the Years Ended December 31, 2001 and 2000
20012000
REVENUES$ 10,465,614 $ 12,274,561
COST OF GOODS SOLD 4,052,136 2,646,139
GROSS PROFIT 6,413,478 9,628,422
OPERATING EXPENSES:
General and administrative 5,479,707 3,702,441
Research and development 4,685,828 4,744,986
Sales and marketing 2,499,179 2,262,949
Incentive compensation - 1,695,000
Write off note receivable and investment
in a technology company - 1,150,000
Total operating expenses 12,664,714 13,555,376
OTHER INCOME (EXPENSE):
Interest income, net 212,466 151,080
Gain on marketable securities - 98,488
Foreign currency transaction (loss) gain (24,969) 266,388
Rental and other income, net 3,064 59,277
Miscellaneous expense (10,740) -
Total other income, net 179,821 575,233
OPERATING LOSS (6,071,415) (3,351,721)
GAIN ON TECHNOLOGY TRANSFER AND
LICENSE AGREEMENT - 18,513,550
(LOSS) INCOME BEFORE INCOME TAX
(BENEFIT) PROVISION (6,071,415) 15,161,829
INCOME TAX (BENEFIT) PROVISION (872,056) 1,120,250
NET (LOSS) INCOME (5,199,359) 14,041,579
OTHER COMPREHENSIVE INCOME (LOSS):
Foreign currency translation adjustments (266,952) (249,902)
Unrealized holding losses on marketable securities:
Unrealized holding losses arising during period - (8,900)
Less reclassification adjustment for losses
included in net loss - 8,900 Other comprehensive loss (266,952) (249,902)
COMPREHENSIVE (LOSS) INCOME $ (5,466,311) $ 13,791,677
See notes to consolidated financial statements.
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DOLPHIN INTERCONNECT SOLUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
For the Years Ended December 31, 2001 and 2000
Accumulated
Additional Other
Common Stock Paid-inAccumulated Comprehensive Shares Amount Capital Deficit (Loss) Income Total
Balance at January 1, 2000 5,464,550 $ 546$ 27,949,042 $ (23,466,398)$ 378,026$ 4,861,216
Proceeds from exercise of stock options 163,952 17 164,315 - - 164,332
Compensation cost recorded for
compensatory stock options - - 145,158 - - 145,158
Net income--- 14,041,579 - 14,041,579
Dividends - - - (8,441,253) - (8,441,253)
Foreign currency translation adjustments - - - - (249,902) (249,902)
Balance at December 31, 20005,628,502 563 28,258,515 (17,866,072) 128,124 10,521,130
Compensation costs recorded for
compensatory stock options - - 26,193 - - 26,193
Net loss--- (5,199,359)- (5,199,359)
Foreign currency translation adjustments--- - (266,952) (266,952)
Repurchase of preferred stock rights - - - (49,318) - (49,318)
Balance at December 31, 2001 5,628,502 $ 563$ 28,284,708 $ (23,114,749) $ (138,828) $ 5,031,694
See notes to consolidated financial statements.
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DOLPHIN INTERCONNECT SOLUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2001 and 2000
2001 2000
Cash flows from operating activities:
Net (loss) income$(5,199,359)$ 14,041,579
Adjustments to reconcile net (loss) income to net cash
used in operating activities:
Depreciation and amortization 248,816 452,323
Loss on asset disposal 9,899 -
Gain on transfer of technology and licensing agreement - (18,513,550)
Allowance reserve for dividend tax withholding receivable 250,000 -
Write off note receivable and investment in a
technology company - 1,150,000
Stock compensation 26,193 145,158
Realized gain on sale of securities - (98,488)
Deferred taxes (885,941) 978,432
Change in assets and liabilities:
Accounts receivable 143,262 (1,261,966)
Dividend tax withholding receivable (945,586) -
Inventories(1,011,258) (408,681)
Prepaids and other current assets 712,270 (822,310)
Accounts payable and accrued expenses 1,134,788 (1,345)
Deferred revenue 202,606 587,577
Dividend tax withholding payable 1,460,769 -
Total adjustments 1,345,818 (17,792,850)
Net cash used in operating activities (3,853,541) (3,751,271)
Cash flows from investing activities:
Purchase of equipment and improvements, net (378,785) (294,633)
Proceeds from sales of marketable securities - 11,694,613
Purchase of marketable securities - (10,970,900)
Net proceeds from transfer of technology and
licensing agreements - 18,513,550
Increase in restricted cash (529,687) (2,020,922)
Advances to and investment in technology company - (1,150,000)
Net cash (used in) provided by investing activities (908,472) 15,771,708
Cash flows from financing activities:
Purchase of preferred stock rights (49,318) -
Dividends paid - (8,441,253)
Proceeds from exercise of stock options - 164,332
Net cash used in financing activities (49,318) (8,276,921)
DOLPHIN INTERCONNECT SOLUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS – CONTINUED
For the Years Ended December 31, 2001 and 2000
2001 2000
Effect of exchange rate changes on cash
and cash equivalents (142,772) (56,878)
(Decrease) increase in cash and cash equivalents (4,954,103)3,686,638
Cash and cash equivalents, beginning of year 6,141,223 2,454,585
Cash and cash equivalents, end of year $ 1,187,120 $ 6,141,223
Supplemental disclosures:
Cash paid during the year for:
Interest $ - $ 7,588
Income taxes $ 86,477 $ 250,000
See notes to consolidated financial statements.
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DOLPHIN INTERCONNECT SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001 and 2000
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NOTE 1:ORGANIZATION
Nature of Operations
Dolphin Interconnect Solutions, Inc. (Dolphin) and subsidiaries, (collectively, the Company) provide computer technology, products and consulting services for the emerging scalable multiprocessor marketplace. Additionally, the Company through its subsidiary, Etnus LLC, develops and markets debugging software to major computer manufacturers and system integrators. The Company has sales in North America, Europe and Asia.
Principles of Consolidation
The consolidated financial statements include the accounts of Dolphin and its wholly owned Norwegian subsidiary, Dolphin Interconnect Solutions A.S. (Dolphin A.S.) and its subsidiary, Dolphin Interconnect Solutions North America, Inc. (Dolphin NA) and Etnus LLC. All intercompany balances and transactions have been eliminated in the accompanying consolidated financial statements.
NOTE 2:SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles.
Use of Estimates
The preparation of the Company’s consolidated financial statements in conformity with U.S. 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 balance sheet dates and the reported amounts of revenues and expenses during the reported periods. Actual results could differ from those estimates.
DOLPHIN INTERCONNECT SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001 and 2000
NOTE 2:SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued
Foreign Currency Translation
The Company measures the financial statements of the Company’s foreign subsidiary using the local currency as the functional currency. Assets and liabilities of foreign operations are translated into U.S. dollars at the exchange rate on the balance sheet date. Revenues, costs and expenses are translated at the rates of exchange prevailing during the year. Translation adjustments resulting from this process are recorded as a separate component of stockholders’ equity in accumulated other comprehensive (loss) income, net of tax. Gains and losses from foreign currency transactions are included in other income, net.
Cash and Cash Equivalents
Cash and cash equivalents represent highly liquid investments with original maturities of less than 90 days primarily held in two banks in the United States and one bank in Norway. Included in cash and cash equivalents is $55,128 and $62,531 in restricted cash related to payroll tax withholdings for Dolphin A.S. at December 31, 2001 and 2000, respectively.
Concentration of Credit Risk
The company sells its products and provides services to larger computer manufacturers and system integrators located primarily in the U.S. and Germany. Collateral is generally not required from customers.
Customer Concentration
Sales to one customer represented 23% and 44% of consolidated revenues during the years ended December 31, 2001 and 2000, respectively.
Inventories
Inventories, net of reserves for obsolescence of $1,624,555 and $81,574 at December 31, 2001 and 2000, respectively, consist of finished computer equipment and parts which are stated at the lower of cost or market, using the first in, first out method.
DOLPHIN INTERCONNECT SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001 and 2000
NOTE 2:SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued
Equipment and Improvements
Equipment and improvements are carried at cost, less accumulated depreciation and amortization. Depreciation is provided using the straight line method over the estimated useful life of the related assets, as follows:
Computer equipment3 Years
Furniture and fixtures5 to 7 Years
Leasehold improvements are amortized using the straight line method over the lesser of the lease term or the asset’s useful life.
Revenue Recognition
The Company derives a significant portion of its revenue through licensing agreements with recipients who may use, modify and /or distribute proprietary computer technology and products. Licensing fee revenues are recognized upon completion of contract phases as specified in the licensing agreement. Revenues of $150,319 and $105,348 for the years ended December 31, 2001 and 2000, respectively, from European and Norwegian government research and development grants are recognized on a percentage of completion basis and are recorded as a reduction of research and development expense. Unearned grants and deferred contract revenues are recorded as current and long term liabilities.
The Company records software revenue pursuant to the provisions of Statement of Position (SOP) NO. 97-2, Software Revenue Recognition, whereby revenue from software license sales is recognized when persuasive evidence of an arrangement exists, delivery of the product has been made, the fee is fixed, and collectibility is reasonably assured; to the extent that obligations exist for other services, the Company allocates revenue between the license and the services based upon vendor-specific objective evidence of their relative fair value. Revenue from customer maintenance support agreements is deferred and recognized ratably over the term of the agreements.
DOLPHIN INTERCONNECT SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001 and 2000
NOTE 2:SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued
Revenue Recognition - continued
In December 1998, the American Institute of Certified Public Accountants released SOP No. 98-9, Modification of SOP 97-2, "Software Revenue Recognition," with respect to Certain Transactions. SOP 98-9 amends SOP 97-2 to require that an entity recognize revenue for multiple element arrangements by means of the "residual method" when (1) there is vendor-specific objective evidence (VSOE) of the fair values of all the undelivered elements that are not accounted for by means of long term contract accounting, (2) VSOE of fair value does not exist for one or more of the delivered elements and (3) all revenue recognition criteria of SOP 97-2 (other than the requirement for VSOE of the fair value of each delivered element) are satisfied.
The provisions of SOP 98-9 that extend the deferral of certain paragraphs of SOP 97-2 became effective December 15, 1998. All other paragraphs of SOP 97-2 and SOP 98-9 will be effective for transactions that are entered into in fiscal years beginning after March 15, 1999. Retroactive application is prohibited. The adoption of SOP 98-9 did not have a material effect of the Company’s consolidated financial position.
Stock Based Compensation
The Company accounts for stock-based awards to employees using the intrinsic value method. In March 2000, the Financial Accounting Standards Board (FASB) issued Interpretation No. 44 of Accounting Principles Board Opinion No. 25, Accounting for Certain Transactions Involving Stock Compensation, which among other things, addresses accounting consequences of a modification that reduces the exercise price of a fixed stock option award (otherwise known as a repricing). If the exercise price of a fixed stock option award is reduced, the award shall be accounted for as variable from the date of the modification to the date the award is exercised, is forfeited, or expires unexercised. The exercise price of an option award has been reduced if the fair value of the consideration required to be remitted by the grantee upon exercise is less than or potentially less than the fair value of the consideration that was required to be remitted pursuant to the award’s original terms. The requirements about modifications to fixed stock option awards that directly or indirectly reduce the exercise price of an award apply to modifications made after December 15, 1998, and shall be applied prospectively as of July 1, 2000 (Note 6).
DOLPHIN INTERCONNECT SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001 and 2000
NOTE 2:SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued
Income Taxes
Deferred tax assets and liabilities are provided for the expected future tax consequences of differences between the book and tax basis of the Company’s assets and liabilities and for the loss and credit carryforwards. Deferred taxes are provided using currently enacted rates. Valuation allowances are provided to the extent recoverability is unlikely.
Comprehensive Income
Comprehensive income is defined as all changes in a company’s net assets, except changes resulting from transactions with stockholders. It differs from net income in that certain items currently recorded through equity are included in comprehensive income. Comprehensive income includes net income (loss), the change in cumulative translation adjustments and unrealized gains or losses on marketable securities. Substantially all of the other comprehensive income relates to foreign currency translation.
Reclassifications
Certain prior year expense amounts have been reclassified to conform with the current year presentation.
NOTE 3:EMPLOYEE BENEFIT PLANS
Defined Benefit Plan
Dolphin A.S. maintains a defined benefit pension plan covering substantially all of its employees. U.S. employees of Dolphin are not eligible to participate in the plan. Future benefits are based on years of service and a percentage of the employee’s qualifying compensation during the final years of employment. Contributions are intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future. There is no additional minimum pension liability required to be recognized. The following table sets forth Dolphin A.S. pension plan's funded status and amounts recognized in the Company’s consolidated balance sheet at December 31:
DOLPHIN INTERCONNECT SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001 and 2000
NOTE 3:EMPLOYEE BENEFIT PLANS - continued
Defined Benefit Plan - continued
2001 2000
Change in benefit obligation:
Benefit obligation, beginning of year$ 251,335$ 815,677
Effect of exchange rate changes (7,565) (45,519)
Service cost 43,020 31,353
Interest cost 18,307 15,138
Termination of benefits paid - (396,324)
Actuarial loss (gain) 17,136 (168,990)
Benefit obligation, end of year$ 322,233 $ 251,335
Change in plan assets:
Fair value of plan assets, beginning of year$ 516,045 $ 812,326
Effect of exchange rate changes (20,460) (63,966)
Actual return on plan assets 30,362 37,705
Termination benefits paid (183,315) (396,324)
Employer contribution 58,023 126,304
Fair value of plan assets, end of year$ 400,655 $ 516,045
Funded status$ (78,422) $ (261,967)
Unrecognized net actuarial (loss) gain (44,423) 85,309
Unamortized transition amount (30,879) (79,542)
Prepaid benefit cost (included in other assets)$ (153,724) $ (256,200)
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DOLPHIN INTERCONNECT SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001 and 2000