CoAdna Holdings, Inc. and Subsidiaries Consolidated Financial Statements for the Years Ended December 31, 2010 and 2009 and Independent Auditors Report
INDEPENDENT AUDITORS REPORT The Board of Directors and Shareholders CoAdna Holdings, Inc. We have audited the accompanying consolidated balance sheets of CoAdna Holdings, Inc. (the Corporation ) and subsidiaries as of December 31, 2010 and 2009, and the related consolidated statements of income, changes in shareholders equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Corporation s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the Rules Governing the Audit of Financial Statements by Certified Public Accountants and auditing standards generally accepted in the Republic of China. Those rules and standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of CoAdna Holdings, Inc. and subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash flows for the years then ended, in conformity with the Guidelines Governing the Preparation of Financial Reports by Securities Issuers and accounting principles generally accepted in the Republic of China. As disclosed in Note 3 to the consolidated financial statements, effective January 1, 2009, the Corporation and subsidiaries adopted the newly revised Statement of Financial Accounting Standards No. 10 - Inventories. February 25, 2011 Notice to Readers The accompanying consolidated financial statements are intended only to present the consolidated financial position, results of operations and cash flows in accordance with accounting principles and practices generally accepted in the Republic of China and not those of any other jurisdictions. The standards, procedures and practices to audit such consolidated financial statements are those generally accepted and applied in the Republic of China. For the convenience of readers, the auditors report and the accompanying consolidated financial statements have been translated into English from the original Chinese version prepared and used in the Republic of China. If there is any conflict between the English version and the original Chinese version or any difference in the interpretation of the two versions, the Chinese-language Auditors report and consolidated financial statements shall prevail. - 1 -
COADNA HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2010 AND 2009 (In Thousands of United States Dollars, Except Par Value) 2010 2009 2010 2009 ASSETS Amount % Amount % LIABILITIES AND SHAREHOLDERS' EQUITY Amount % Amount % CURRENT ASSETS CURRENT LIABILITIES Cash (Note 4) $ 13,397 35 $ 8,523 45 Short-term loans (Notes 7 and 15) $ 3,974 10 $ - - Accounts receivable (Note 2) 8,398 22 3,554 19 Accounts payable 3,983 11 1,398 7 Inventories, net (Notes 2, 3 and 5) 8,557 23 3,076 16 Accrued expenses (Note 8) 2,800 7 939 5 Prepaid expenses and other current assets (Notes 2 Income taxes payable (Notes 2 and 10) 3,378 9 92 1 and 10) 1,918 5 926 5 Other current liabilities 257 1 139 1 Total current assets 32,270 85 16,079 85 Total current liabilities 14,392 38 2,568 14 PROPERTY AND EQUIPMENT (Notes 2 and 6) OTHER LIABILITIES Cost Deferred income tax liabilities - noncurrent (Notes 2 Machinery 4,465 12 1,872 10 and 10) - - 10 - Computer and communication equipment 56-50 - Research and development equipment 904 2 770 4 Total liabilities 14,392 38 2,578 14 Office equipment 196-192 1 Leasehold improvements 1,750 5 927 5 SHAREHOLDERS' EQUITY (Notes 2 and 9) Other equipment 59-44 - Common stock Total cost 7,430 19 3,855 20 2010: NT$10 par value, 70,000 thousand shares Less: Accumulated depreciation 2,383 6 1,680 9 authorized and 30,653 thousand shares issued; 2009: US$0.01 par value, 45,000 thousand Net property and equipment 5,047 13 2,175 11 shares authorized and 11,207 thousand shares issued 10,523 28 112 1 INTANGIBLE ASSETS (Note 2) Preferred stock, US$0.01 par value Computer software 378 1 506 3 2010: 0 thousand shares authorized and issued; 2009: 19,300 thousand shares authorized and OTHER ASSETS 18,599 thousand shares issued - - 186 1 Refundable deposits 76 1 51 - Capital surplus Others (Notes 2 and 10) 73-79 1 Additional paid-in capital 4,651 12 14,358 76 Stock options 359 1 268 1 Total other assets 149 1 130 1 Retained earnings 7,796 21 1,381 7 Cumulative translation adjustments 123-7 - Total shareholders' equity 23,452 62 16,312 86 TOTAL $ 37,844 100 $ 18,890 100 TOTAL $ 37,844 100 $ 18,890 100 The accompanying notes are an integral part of the consolidated financial statements. (With Deloitte & Touche audit report dated February 25, 2011) - 2 -
COADNA HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 2010 AND 2009 (In Thousands of United States Dollars, Except Earnings Per Share) 2010 2009 Amount % Amount % NET SALES $ 41,234 100 $ 17,206 100 COST OF SALES (Notes 3, 5 and 11) 19,474 47 8,471 49 GROSS PROFIT 21,760 53 8,735 51 OPERATING EXPENSES (Note 11) Marketing expenses 714 2 567 3 General and administrative expenses 4,985 12 2,514 15 Research and development expenses 4,170 10 3,170 19 Total operating expenses 9,869 24 6,251 37 OPERATING INCOME 11,891 29 2,484 14 NON-OPERATING INCOME AND GAINS Interest income 86-125 1 Others 250 1 7 - Total non-operating income and gains 336 1 132 1 NON-OPERATING EXPENSES AND LOSSES Interest expense 9-24 - Loss on disposal of property and equipment (Note 2) 10-14 - Total non-operating expenses and losses 19-38 - INCOME BEFORE INCOME TAX 12,208 30 2,578 15 INCOME TAX EXPENSE (Notes 2 and 10) (5,793) (14) (1,152) (7) CONSOLIDATED NET INCOME $ 6,415 16 $ 1,426 8 Before Income Tax 2010 2009 After Before Income Income Tax Tax After Income Tax EARNINGS PER SHARE (Note 12) Basic $ 1.08 $ 0.57 $ 0.23 $ 0.13 Diluted $ 0.40 $ 0.21 $ 0.08 $ 0.05 The accompanying notes are an integral part of the consolidated financial statements. (With Deloitte & Touche audit report dated February 25, 2011) - 3 -
COADNA HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 2010 AND 2009 (In Thousands of United States Dollars) Capital Surplus Retained Earnings Cumulative Total Capital Stock Additional (Accumulated Translation Shareholders' Common Stock Preferred Stock Paid-in Capital Stock Options Warrants Deficit) Adjustments Equity BALANCE, JANUARY 1, 2009 $ 111 $ 185 $ 14,135 $ 211 $ 12 $ (45) $ 5 $ 14,614 Exercise of preferred stock warrants - 1 91 - (12) - - 80 Vesting of early exercised stock options 1-132 - - - - 133 Stock-based compensation - - - 57 - - - 57 Consolidated net income in 2009 - - - - - 1,426-1,426 Changes in translation adjustments - - - - - - 2 2 BALANCE, DECEMBER 31, 2009 112 186 14,358 268-1,381 7 16,312 Exercise of stock options 9-509 (98) - - - 420 Stock-based compensation - - - 189 - - - 189 Consolidated net income in 2010 - - - - - 6,415-6,415 Recapitalization - record date on December 31, 2010 10,402 (186) (10,216) - - - - - Changes in translation adjustments - - - - - - 116 116 BALANCE, DECEMBER 31, 2010 $ 10,523 $ - $ 4,651 $ 359 $ - $ 7,796 $ 123 $ 23,452 The accompanying notes are an integral part of the consolidated financial statements. (With Deloitte & Touche audit report dated February 25, 2011) - 4 -
COADNA HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2010 AND 2009 (In Thousands of United States Dollars) 2010 2009 CASH FLOWS FROM OPERATING ACTIVITIES Consolidated net income $ 6,415 $ 1,426 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,098 802 Deferred income tax (418) 207 Provision (reversal of provision) for loss on inventories 242 (782) Stock-based compensation 189 57 Loss on disposal of property and equipment 10 14 Loss on disposal of intangible assets 2 - Reversal of bad debts allowance - (9) Net changes in operating assets and liabilities: Accounts receivable (4,844) (628) Inventories (5,723) 958 Prepaid expenses and other current assets (577) 207 Other assets (1) - Accounts payable 2,431 157 Accrued expenses 1,861 460 Income taxes payable 3,286 92 Other current liabilities 119 (16) Net cash provided by operating activities 4,090 2,945 CASH FLOWS FROM INVESTING ACTIVITIES Acquisition of property and equipment (3,566) (269) Increase in refundable deposits (25) (8) Acquisition of intangible assets (11) (73) Decrease in restricted assets - 500 Increase in other assets - (5) Net cash (used in) provided by investing activities (3,602) 145 CASH FLOWS FROM FINANCING ACTIVITIES Increase in short-term loans 3,974 - Exercise of warrants 420 80 Repayment of long-term debt - (535) Net cash provided by (used in) financing activities 4,394 (455) EFFECT OF EXCHANGE RATE CHANGES (8) 2 NET INCREASE IN CASH 4,874 2,637 CASH, BEGINNING OF YEAR 8,523 5,886 CASH, END OF YEAR $ 13,397 $ 8,523 (Continued) - 5 -
COADNA HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2010 AND 2009 (In Thousands of United States Dollars) 2010 2009 SUPPLEMENTARY CASH FLOW INFORMATION Interest paid $ 2 $ 24 Income taxes paid $ 2,925 $ 853 INVESTING ACTIVITIES AFFECTING BOTH CASH AND NON-CASH ITEMS Acquisition of property and equipment $ 3,720 $ 255 (Increase) decrease in payable for equipment purchased (154) 14 Cash paid for acquisition of property and equipment $ 3,566 $ 269 NON-CASH INVESTING AND FINANCING ACTIVITIES Vesting of early exercised stock options $ - $ 133 Recapitalization $ 10,402 $ - The accompanying notes are an integral part of the consolidated financial statements. (With Deloitte & Touche audit report dated February 25, 2011) (Concluded) - 6 -
COADNA HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2010 AND 2009 (In Thousands of United States Dollars, Unless Stated Otherwise) 1. ORGANIZATION AND OPERATIONS CoAdna Holdings, Inc. (the Corporation ) was incorporated on November 24, 2008 in the Cayman Islands for the purpose of reorganizing CoAdna Photonics, Inc. ( CoAdna US ) and its subsidiaries. The reorganization was completed on December 18, 2008 pursuant to a share swap agreement (the share swap ), under which the Corporation issued one common share, one Series A preferred share, and one Series B preferred share (each of US$0.01 par value) in exchange for one common share, one Series A preferred share, and one Series B preferred share, respectively, of CoAdna US. Following the reorganization, CoAdna US became a wholly-owned subsidiary of the Corporation. On December 31, 2010, the Corporation decided to recapitalize its capital. According to the recapitalization agreement, the Corporation issued one common share with the par value of NT$10 in exchange for each of the outstanding common shares, Series A preferred shares and Series B preferred shares (each of US$0.01 par value). The Corporation and its subsidiaries, mainly design, manufacture and sell fiber optic components and modules for telecommunication networks. As of December 31, 2010 and 2009, the Corporation and its subsidiaries had 292 and 158 employees, respectively. 2. SIGNIFICANT ACCOUNTING POLICIES The accompanying consolidated financial statements have been prepared in conformity with the Regulations Governing the Preparation of Financial Reports by Securities Issuers (the Regulation ) and accounting principles generally accepted in the Republic of China (ROC). In conformity with these guidelines and principles, the Corporation and subsidiaries (hereinafter referred to as the Group ) are required to make certain estimates and assumptions that could affect the amounts of allowance for doubtful accounts, provision for loss on inventories, warranty, income tax, bonuses to directors, depreciation and amortization, impairment on assets, etc. Actual results may differ from these estimates. For readers convenience, the accompanying consolidated financial statements have been translated into English from the original Chinese version prepared and used in the ROC. If inconsistencies arise between the English version and the Chinese version or if differences arise in the interpretations between the two versions, the Chinese version of the consolidated financial statements shall prevail. Consolidation a. Basis of consolidation The consolidated financial statements have been prepared in accordance with Statement of Financial Accounting Standards (SFAS) No. 7 - Consolidated Financial Statements, and included the financial statements of the Corporation and its direct and indirect subsidiaries with at least 50% shareholding and other investees controlled by the Corporation. The Corporation s financial statements are prepared using its functional currency of U.S. dollars, and the financial statements of the consolidated subsidiaries are prepared using their respective functional currencies. Foreign currencies are translated into U.S. dollars at the following exchange rates: 1) Assets and liabilities - at exchange rates prevailing on the balance sheet date; 2) Shareholders equity - at historical exchange rates; - 7 -
3) Income and expenses - at average exchange rates for the year. Exchange differences arising from the translation of the financial statements of foreign subsidiaries are recognized as a separate component of shareholders equity. Such exchange differences are recognized in profit or loss in the year of disposal. b. Under the above basis of consolidation, the consolidated entities were as follows: Percentage of Ownership as of December 31 Investor Subsidiary Nature of Business 2010 2009 Other Remarks Corporation CoAdna US Research, manufacture and sale of products, administrative support and intellectual property licensing 100% 100% Acquired all shares by share swap on December 18, 2008 CoAdna US CoAdna (Cayman) Ltd. Intellectual property licensing 100% 100% Incorporated on April 29, 2008 CoAdna (Cayman) CoAdna (British Virgin Sale of products 100% 100% Incorporated on May 22, 2009 Ltd. Islands) Ltd. CoAdna (Cayman) CoAdna (HK) Ltd. Sale of products 100% 100% Incorporated on April 23, 2008 Ltd. CoAdna (HK) Ltd. CoAdna (Suzhou) Ltd. Manufacture and sale of products, sales support and development service 100% 100% Incorporated on June 30, 2008 All significant intercompany balances and transactions have been eliminated upon consolidation. Current and Noncurrent Assets and Liabilities Current assets include cash and those assets held primarily for trading purposes or to be realized or sold within one year from the balance sheet date. All other assets such as property and equipment, intangible assets and other assets are classified as noncurrent. Current liabilities are obligations incurred for trading purposes or to be settled within one year from the balance sheet date. All other liabilities are classified as noncurrent. Revenue Recognition, Trade Receivables and Allowance for Doubtful Accounts Revenue from sales of goods is recognized when the Group has transferred to the buyer the significant risks and rewards of ownership of the goods, because the earnings process has been completed and the economic benefits associated with the transaction have been realized or are realizable. Revenue is measured at the fair value of the consideration received or receivable and represents amounts agreed between the Group and the customers for goods sold in the normal course of business, net of sales discounts and volume rebates. For trade receivables due within one year from the balance sheet date, as the nominal values of the considerations to be received approximate their fair values and transactions are frequent, the fair values of the considerations are not determined by discounting all future receipts using an imputed rate of interest. An allowance for doubtful accounts is provided on the basis of a review of the collectability of accounts receivable. The Group assesses the probability of collections of accounts receivable by examining the aging analysis of the outstanding receivables. Inventories Inventories consist of raw materials, work-in-process and finished goods and inventories are stated at the lower of cost or net realizable value. Inventory write-downs are made item by item, except where it may be appropriate to group similar or related items. Net realizable value is the estimated selling price of inventories less all estimated costs of completion and costs necessary to make the sale. Inventories are recorded at standard cost and adjusted to approximate weighted-average cost on the balance sheet date. - 8 -
Property and Equipment Property and equipment are stated at cost less accumulated depreciation. Major additions and improvements to property and equipment are capitalized, while costs of repairs and maintenance are expensed currently. Depreciation is provided on a straight-line basis over estimated useful lives as follows: Machinery - 5 years, computer and communication equipment - 3 years, research and development equipment - 5 years, office equipment - 3 to 5 years, leasehold improvements - shorter of the estimated useful lives of the assets or the term of the related lease, and other equipment - 3 years. The related cost and accumulated depreciation are derecognized from the balance sheet upon asset disposal. Any gain or loss on disposal of the asset is included in non-operating gains or losses in the year of disposal. Intangible Assets Computer software acquired is initially recorded at cost and is amortized on a straight-line basis over 5 years. Impairment of Assets If the recoverable amount of an asset (mainly property and equipment and intangible assets) is estimated to be less than its carrying amount, the carrying amount of the asset is reduced to its recoverable amount. An impairment loss is charged to earnings. If an impairment loss subsequently reverses, the carrying amount of the asset is increased accordingly, but the increased carrying amount may not exceed the carrying amount that would have been determined had no impairment loss been recognized for the asset in prior years. A reversal of an impairment loss is recognized in earnings. Stock-based Compensation Stock options granted between January 1, 2004 and December 31, 2007 were accounted for under the interpretations issued by the Accounting Research and Development Foundation ( ARDF ). The Company adopted the intrinsic value method, under which compensation cost was recognized on a straight-line basis over the vesting period. Fair value of the stock at the grant date is determined at the net asset value of the latest balance sheet date before the grant date. Stock options granted between January 1, 2008 and December 31, 2009 were accounted for in accordance with Rule No. 0960065898 issued by the Financial Supervisory Commission (FSC) under the Executive Yuan on December 12, 2007. Thus, the stock options granted were initially measured at their intrinsic value and then adjusted at each reporting date for any change in intrinsic value until the date of final settlement. Stock options granted on or after January 1, 2010 are accounted for in accordance with Rule No. 0990006370 issued by FSC on March 15, 2010, which superseded Rule No. 0960065898. Under the FSC s requirement, the value of the stock options granted, which is equal to the best available estimate of the number of stock options expected to vest multiplied by the grant-date fair value, is expensed on a straight-line basis over the vesting period, with a corresponding adjustment to capital surplus - stock options. The estimate is revised if subsequent information indicates that the number of stock options expected to vest differs from previous estimates. Pension Cost Contributions made under a defined contribution plan are recognized as pension cost during the year in which employees render services. - 9 -
Income Tax The Group applies intra-year and inter-year allocations for its income tax, whereby deferred income tax assets and liabilities are recognized for the tax effects of temporary differences, unused loss carryforward and unused tax credits. Valuation allowance is provided to the extent, if any, that it is more likely than not that deferred income tax assets will not be realized. A deferred tax asset or liability is classified as current or noncurrent in accordance with the classification of its related asset or liability. However, if a deferred income tax asset or liability does not relate to an asset or liability in the financial statements, then it is classified as either current or noncurrent based on the expected length of time before it is realized or settled. Tax credits for research and development expenditures are recognized using the flow-through method. Adjustments of prior years tax liabilities are added to or deducted from the current year s tax provision. Foreign Currencies Non-derivative foreign-currency transactions are recorded in U.S. dollars at the rates of exchange in effect when the transactions occur. Exchange differences arising from settlement of foreign-currency assets and liabilities are recognized in profit or loss. At the balance sheet date, foreign-currency monetary assets and liabilities are revalued using prevailing exchange rates and the exchange differences are recognized in profit or loss. 3. EFFECTS OF CHANGE IN ACCOUNTING PRINCIPLES Accounting for Stock-based Compensation Stock options granted on or after January 1, 2010 are accounted for in accordance with Rule No. 0990006370, which was issued by the Financial Supervisory Commission (FSC) in March 2010. Under the FSC s requirement, the value of the stock options granted, which is equal to the best available estimate of the number of stock options expected to vest multiplied by the grant-date fair value, is expensed on a straight-line basis over the vesting period, with a corresponding adjustment to capital surplus - stock options. The estimate is revised if subsequent information indicates that the number of stock options expected to vest differs from previous estimates. Stock options granted between January 1, 2008 and December 31, 2009 continue to be accounted for in accordance with Rule No. 0960065898, which was issued by the FSC in December 2007; thus, the stock options granted were initially measured at their intrinsic value and then adjusted at each reporting date for any change in intrinsic value until the date of final settlement. The change resulted in a decrease of US$20 thousand in consolidated net income from continuing operations and no effect on after income tax basic earnings per share for the year ended December 31, 2010. Accounting for Inventories On January 1, 2009, the Group adopted the newly revised SFAS No. 10 - Accounting for Inventories. The main revisions are (1) inventories are stated at the lower of cost or net realizable value, and inventories are written down to net realizable value item-by-item except when the grouping of similar or related items is appropriate; (2) unallocated overheads are recognized as expenses in the period in which they are incurred; and (3) abnormal costs, write-downs of inventories and any reversal of write-downs are recorded as cost of goods sold for the period. This accounting change had no effect on the consolidated net income for the year ended December 31, 2009. - 10 -
4. CASH December 31 2010 2009 Checking accounts and demand deposits $ 13,391 $ 8,004 Cash on hand 6 4 Time deposits - 515 $ 13,397 $ 8,523 5. INVENTORIES, NET December 31 2010 2009 Finished goods $ 2,189 $ 456 Work-in-process 2,233 850 Raw materials 4,135 1,770 $ 8,557 $ 3,076 As of December 31, 2010 and 2009, the allowance for loss on inventories was $1,026 thousand and $784 thousand, respectively. The cost of inventories recognized as cost of goods sold for the year ended December 31, 2010 included $242 thousand write-downs of inventories. The cost of inventories recognized as cost of goods sold for the year ended December 31, 2009 included $782 thousand reversal of write-downs of inventories. Previous write-downs had been reversed as a result of better sales in market. 6. PROPERTY AND EQUIPMENT - ACCUMULATED DEPRECIATION December 31 2010 2009 Machinery $ 1,252 $ 740 Computer and communication equipment 37 18 Research and development equipment 494 589 Office equipment 129 130 Leasehold improvements 437 186 Other equipment 34 17 $ 2,383 $ 1,680 7. SHORT-TERM LOAN December 31, 2010 Bank loan principal $3,974 Interest rate 3.25% Maturity date December 31, 2011-11 -
The interest rate of short-term loan was floating rate, and the loan agreement required the Group to maintain certain financial ratios. 8. ACCRUED EXPENSES December 31 2010 2009 Bonus $ 1,573 $ 280 Salaries 238 143 Accrued vacation 162 104 Others 827 412 $ 2,800 $ 939 9. SHAREHOLDERS EQUITY a. Preferred shares The information of the Corporation s convertible preferred shares on December 31, 2009 is summarized as below: Shares Authorized (In Thousands) Shares Outstanding (In Thousands) Issuance Price (In US$) Capital Amount Series A 15,300 14,939 $ 0.41 $ 149 Series B 4,000 3,660 0.75 37 19,300 18,599 $ 186 The holders of Series A and Series B preferred shares shall be entitled to receive dividends at a rate of 8% per annum of their respective original issuance prices, when and if declared by the Board of Directors. The Corporation may not make a distribution to common stockholders until the preferred share dividends have been paid in full. For any other dividends or similar distributions, the preferred shares participate with common shares on an as-converted basis. The preferred shares have no maturity and the conversion prices are initially set to be the original issuance price, but would be subject to adjustment under the Corporation s Articles of Association. The holders of each share of Series A or Series B preferred shares are entitled to a number of votes equal to the number of common shares into which preferred shares can be converted. The Series A and B shares are not redeemable at the option of the holder but are convertible, at the option of the holder, into newly issued common shares as is determined by the respective conversion price of each share of Series A and B shares at any time after the date of issuance. The preferred shares are automatically converted into common shares upon (a) the closing of an underwritten public offering, with aggregate proceeds to the Corporation of not less than $15,000 thousand and per-share price at least US$2.25, or (b) the written approval of at least a majority of preferred shareholders voting to convert their shares at the effective conversion price. - 12 -
In the event of any liquidation, dissolution or winding up of the Corporation, the holders of Series A and B preferred shares are entitled to receive an amount equal to the original purchase price plus any declared but unpaid dividends (the liquidation preference ), prior to and in preference to any distribution to the holders of common shares. Upon completion of the distribution of the liquidation preference to the holders of the preferred shares, the remaining proceeds will be distributed ratably to the holders of the common shares and the preferred shares on a common equivalent basis until such time as the holders of Series A and B preferred shares have received an aggregate amount per share of preferred equal to three times the original issue price (as adjusted for any stock dividends, combinations, splits, recapitalizations and the like with respect to those shares), plus the amount of any declared but unpaid dividends on preferred stock. Thereafter, the remaining assets available for distribution shall be distributed ratably to the holders of common stock. According to the recapitalization agreement, the Corporation issued one common share with the par value of NT$10 in exchange for each of the outstanding common shares, Series A preferred shares and Series B preferred shares (each of US$0.01 par value). b. Warrants Pursuant to the loan agreement, CoAdna US issued 160 thousand units of warrants to the lender in 2006. Due to the reorganization on December 18, 2008, pursuant to the merger agreement, the Corporation modified each outstanding warrant to be exercisable for the purchase of the Corporation s Series B preferred shares equal to the number of exercisable warrant of CoAdna US. Each unit entitles the holder to subscribe for one Series B preferred share of the Corporation. The warrants which have an exercise price of US$0.75 per unit are exercisable upon grant and such warrants, if unexercised expire in 2009. As of December 31, 2009, all preferred stock warrants had been exercised. c. Stock option plan CoAdna US adopted the 2001 Stock Option Plan (the Plan ) resolved by the Board of Directors in March 2001. The Plan had 6,965 thousand units of options available for issuance. Due to the reorganization on December 18, 2008, pursuant to the share swap agreement, the Corporation modified each outstanding stock option to be exercisable to subscribe for one common share of the Corporation. The options were granted to qualified employees, advisory board members and service providers of the Group. The options granted are valid for 10 years and vest 25% one year after the date of grant and the remaining balance vests 1/48 in equal monthly installments over the following 36 months. The options were granted at an exercise price equal to the fair value of the Corporation s common shares on the grant date. For any subsequent changes in the Corporation s common shares, the exercise price and the number of options will be adjusted accordingly. According to the Plan, certain options can be exercised prior to vesting. However, the unvested shares are subject to the Corporation s repurchase right at the lower of the fair market value at the time of repurchase or the original purchase price. - 13 -
Information about stock options was as follows: Year Ended December 31 2010 2009 Weighted- Weightedaverage average Number of Exercise Number of Exercise Options Price Options Price (In Thousands) (US$) (In Thousands) (US$) Balance, beginning of year 3,439 $ 0.72 3,699 $ 0.68 Options granted 616 0.56 166 0.40 Options exercised (847) 0.50 - - Options expired (73) 0.39 (426) 0.30 Balance, end of year 3,135 0.75 3,439 0.72 Options exercisable, end of year 1,682 0.75 1,774 0.58 Information about outstanding options as of December 31, 2010 and 2009 was as follows: Range of Exercise Price (US$) 2010 2009 Weighted-average Remaining Contractual Life Range of Exercise (Years) Price (US$) Weighted-average Remaining Contractual Life (Years) $0.05 1.42 $0.05 2.88 0.10 5.01 0.10 6.20 0.20 5.49 0.20 6.46 0.40 8.06 0.40 8.94 0.48 6.13 0.48 7.13 0.58 9.63 0.75 7.66 0.75 6.66 1.33 8.30 1.33 7.30 Options granted during the year ended December 31, 2010 were priced using Black-Scholes pricing model and the inputs to the model were as follows: Grant-date share price US$0.30-US$0.58 Exercise price US$0.40-US$0.58 Expected volatility 83.44% Expected life 10 years Expected dividend yield 0% Risk-free interest rate 1.87%-2.79% Stock-based compensation costs recognized were $189 thousand and $57 thousand for the years ended December 31, 2010 and 2009, respectively. As of December 31, 2010 and 2009, the estimated forfeiture rate due to termination of employment over the remaining vesting period was both 8%. - 14 -
d. Capital surplus Except as may otherwise be provided by law, under the Corporation s Articles of Association, the capital surplus from share issued in excess of par, capital redemption and earning reserves may be capitalized. e. Dividend policy Under the Corporation s Articles of Association, by the resolution of the shareholders in their meeting, the Corporation may declare and pay dividends and other appropriation of earnings, out of any assets legally available. The Corporation shall not pay any dividends or bonuses if the Corporation does not have earnings, or has not yet recovered its losses. When making appropriation of the earnings for each fiscal year, after offsetting losses from previous years and after paying taxes, the Corporation may set aside not more than 3% of the balance as bonus to directors and may further set aside any reserve by the resolution in the shareholders meeting. The appropriation of the remaining balance as bonuses, dividends, or other distributions, should be proposed by the Board and resolved by the shareholders in their meeting. As of December 31, 2010, the Corporation had not declared any earnings appropriation. f. Reversion back to shares before recapitalization As a guarantee to the rights of the common share, preferred Series A and Series B shareholders before the recapitalization, the reversion of common and preferred shareholders swap is stated in the recapitalization agreement. The Corporation shall repurchase its existing common shares back at the cost of issuing Corporation s shares at the original numbers and classes before recapitalization, that is, transferring back to the shareholding pattern before the recapitalization, if the Corporation either fails to complete an initial public offering before June 30, 2012, or terminates the application in Taiwan capital market under consideration of the operating situation. The new shares issued after the recapitalization may choose to participate in the conversion into CoAdna Holding s common share at par value of US$0.01 in order to remain as the beneficiaries of the Group s earnings. 10. INCOME TAX A reconciliation of income tax expense based on income before income tax at the statutory rate and income tax expense was as follows: Year Ended December 31 2010 2009 Income tax expense at the statutory rate $ 4,808 $ 1,124 Tax effect on adjusting items: Permanent differences 58 11 Temporary differences 271 (197) Investment tax credits used (302) (185) Others 1,277 192 Current income tax expense 6,112 945 Deferred income tax expense (418) 207 Adjustment for prior years tax 99 - $ 5,793 $ 1,152-15 -
Deferred income tax assets and liabilities were as follows: December 31 2010 2009 Current Deferred income tax assets (recognized under prepaid expenses and other current assets) Unrealized allowance for loss on inventories $ 233 $ 299 Accrued vacation 46 41 Others 697 223 $ 976 $ 563 Noncurrent Deferred income tax assets (recognized under other assets) Others $ 52 $ 58 Deferred income tax liabilities Depreciation $ - $ (215) Others - 205 $ - $ (10) 11. PERSONNEL, DEPRECIATION AND AMORTIZATION EXPENSES Year Ended December 31 2010 2009 Classified Classified Classified Classified as as as as Operating Operating Operating Operating Cost Expenses Total Cost Expenses Total Personnel Salary $ 3,006 $ 3,692 $ 6,698 $ 1,963 $ 3,081 $ 5,044 Insurance 319 218 537 186 170 356 Others 526 1,459 1,985 230 1,387 1,617 $ 3,851 $ 5,369 $ 9,220 $ 2,379 $ 4,638 $ 7,017 Depreciation $ 774 $ 183 $ 957 $ 539 $ 134 $ 673 Amortization $ - $ 141 $ 141 $ - $ 129 $ 129-16 -
12. EARNINGS PER SHARE ( EPS ) Amounts (Numerator) EPS (US$) Before After Shares Before After Income Income (Denominator) Income Income Tax Tax (In Thousands) Tax Tax Year ended December 31, 2010 Basic EPS Income for the year attributable to common shareholders $ 12,208 $ 6,415 11,356 $ 1.08 $ 0.57 Effect of dilutive potential common shares Convertible preferred shares - - 18,599 Stock options - - 808 Diluted EPS Income for the year attributable to common shareholders plus effect of potential dilutive common shares $ 12,208 $ 6,415 30,763 $ 0.40 $ 0.21 Year ended December 31, 2009 Basic EPS Income for the year attributable to common shareholders $ 2,578 $ 1,426 11,157 $ 0.23 $ 0.13 Effect of dilutive potential common shares Convertible preferred shares - - 18,560 Stock options - - 1,128 Diluted EPS Income for the year attributable to common shareholders plus effect of potential dilutive common shares $ 2,578 $ 1,426 30,845 $ 0.08 $ 0.05 13. FINANCIAL INSTRUMENTS a. Fair values of financial instruments Please refer to audited consolidated balance sheets. b. The carrying amounts of the following short-term financial instruments approximate their fair values because of their short maturities: Cash, accounts receivable, accounts payable and accrued expenses. c. The fair values of financial assets and liabilities were not simultaneously determined by quoted prices in active markets and by estimations using valuation technique. d. As of December 31, 2010 and 2009, financial assets exposed to fair value interest rate risk amounted to zero and $515 thousand, respectively, financial assets exposed to cash flow interest rate risk amounted to $12,374 thousand and $6,748 thousand, respectively, and financial liabilities exposed to cash flow interest rate risk amounted to $3,974 thousand and zero, respectively. - 17 -
e. For the years ended December 31, 2010 and 2009, the interest income associated with financial assets (liabilities) other than those at fair value through profit or loss ( FVTPL ) amounted to $86 thousand and $125 thousand, respectively, and the interest expense amounted to $9 thousand and $24 thousand, respectively. f. Financial risks 1) Market risk The Group is neither exposed to material interest rate risk nor fair value interest rate risk. Therefore, market risk is not material. 2) Credit risk Credit risk represents the potential loss that would be incurred by the Group if the counter-parties breached contracts. Financial instruments with positive fair values at the balance sheet date are evaluated for credit risk. The counter-parties to the foregoing financial instruments are reputable financial institutions and business organizations. Management does not expect the Group s exposure to default by those parties to be material. 3) Liquidity risk The Group s operating funds are deemed sufficient to meet cash flow demand; therefore, liquidity risk is not considered to be significant. 4) Cash flow interest rate risk The Group is not exposed to material floating-rate risk; therefore, cash flow interest rate risk is not considered to be significant. 14. COMPENSATION OF DIRECTORS AND MANAGEMENT PERSONNEL Year Ended December 31 2010 2009 Salaries $ 1,221 $ 1,042 Bonus 19 45 $ 1,240 $ 1,087 15. MORTGAGED OR PLEDGED ASSETS The tangible assets, including intercompany receivables and long-term investments, of CoAdna US, Inc. and Coadna (HK) Ltd. were pledged as collaterals for credit line of bank loans. As of December 31, 2010, the assets of CoAdna US and Coadna (HK) Ltd. pledged as collaterals amounted to $32,966 thousand and $11,577 thousand, respectively. - 18 -
16. SIGNIFICANT COMMITMENTS AND CONTINGENCIES The Group entered into several operating lease agreements for its office premises. These operating leases will expire in October 2013. As of December 31, 2010, the future minimum lease payments were as follows: Year Amount 2011 $ 355 2012 370 2013 132 $ 857 17. FOREIGN-CURRENCY FINANCIAL ASSETS AND LIABILITIES The material monetary assets and liabilities denominated in foreign currencies included in the consolidated financial statements were as follows: (In Foreign Currencies and U.S. Dollars) Foreign Currencies December 31 2010 2009 Exchange Foreign Exchange Rate U.S. Dollars Currencies Rate U.S. Dollars Financial assets Monetary items RMB $ 574,639 0.151752 $ 87,203 $ 421,286 0.146477 $ 61,709 HKD 128,961 0.128665 16,593-0.128978 - Financial liabilities Monetary items RMB 5,180,237 0.151752 786,111 1,788,949 0.146477 262,040 18. ADDITIONAL DISCLOSURES Following are the additional disclosures required by the Securities and Futures Bureau for the Company and its investees: a. Financings provided: Table 1 (attached) b. Endorsements/guarantees provided: Table 2 (attached) c. Marketable securities held: Table 3 (attached) d. Marketable securities acquired or disposed of at costs or prices of at least NT$100 million or 20% of the paid-in capital: Table 4 (attached) e. Acquisition of individual real estate at costs of at least NT$100 million or 20% of the paid-in capital: None f. Disposal of individual real estate at prices of at least NT$100 million or 20% of the paid-in capital: None - 19 -
g. Total purchases from or sales to related parties of at least NT$100 million or 20% of the paid-in capital: Table 5 (attached) h. Receivables from related parties amounting to at least NT$100 million or 20% of the paid-in capital: Table 6 (attached) i. Names, locations, and related information of investees over which the Company exercises significant influence: Table 7 (attached) j. Derivative transactions of investees over which the Company has a controlling interest: None k. Investments in Mainland China 1) Name of the investees in Mainland China, main businesses and products, paid-in capital, method of investment, information on inflow or outflow of capital, percentage of ownership, investment income or loss, ending balance of investment, dividends remitted by the investee, and the limit of investment in Mainland China: Table 8 (attached) 2) Significant direct or indirect transactions with the investees, prices and terms of payment, unrealized gain or loss: Tables 9 and 10 (attached) l. Business relationships and significant details between parent company and subsidiaries: Tables 9 and 10 (attached). 19. SEGMENT INFORMATION a. Industry financial information The Group designs, manufactures, and sells fiber optic components and modules for telecommunication networks. Such segment revenue, income and identifiable assets occupied more than 90% of all business segments, and therefore, the disclosure of the industry financial information is not applicable to the Group. b. Geographic information Year Ended December 31, 2010 North America Asia Others Adjustment and Elimination Consolidated Net sales to third-party customers $ 10,378 $ 30,856 $ - $ - $ 41,234 Net sales to consolidated entities 21,322 10,598 41,625 (73,545) - Total operating revenues $ 31,700 $ 41,454 $ 41,625 $ (73,545) $ 41,234 Segment income (loss) $ 11,326 $ 1,049 $ (808) $ 324 $ 11,891 Interest income 86 General gains and income 250 Interest expense (9) General losses and expenses (10) Income before income tax $ 12,208 Identifiable assets $ 29,361 $ 17,857 $ 8,398 $ (17,772) $ 37,844-20 -
Year Ended December 31, 2009 North America Asia Others Adjustment and Elimination Consolidated Net sales to third-party customers $ 15,041 $ 2,165 $ - $ - $ 17,206 Net sales to consolidated entities 1,287 3,065 3,032 (7,384) - Total operating revenues $ 16,328 $ 5,230 $ 3,032 $ (7,384) $ 17,206 Segment income (loss) $ 3,656 $ 199 $ (1,347) $ (24) $ 2,484 Interest income 125 General gains and income 7 Interest expense (24) General losses and expenses (14) Income before income tax $ 2,578 Identifiable assets $ 19,359 $ 9,070 $ 2,028 $ (11,567) $ 18,890 c. Export sales information Year Ended December 31 Geography 2010 2009 Asia $ 29,129 $ 7,129 North America 10,518 9,637 Europe 1,587 440 d. Customers accounting for at least 10% of the total revenues were as follows: $ 41,234 $ 17,206 Customer Year Ended December 31 2010 2009 % to Net Operating Amount Revenue Amount % to Net Operating Revenue A $ 28,155 68 $ 8,909 52 B 9,535 23 6,472 38-21 -
TABLE 1 COADNA HOLDINGS, INC. AND SUBSIDIARIES FINANCING PROVIDED YEAR ENDED DECEMBER 31, 2010 (In Thousands of United States Dollars) Lending Company Borrowing Company Financial Statement Account Maximum Balance for the Period Ending Balance Interest Rate Financing Purpose Transaction Amounts Reasons for Short-term Financing Allowance for Doubtful Accounts Item Collateral Value Lending Limit for Each Borrowing Company Lending Company s Lending Amount Limits CoAdna US CoAdna (HK) Ltd. Other receivables $ 3,005 $ 3,005 2% Financing for long-term investment CoAdna (Cayman) Ltd. Other receivables 2,000 68 1% Operational revolving fund $ - - $ - - - Note Note 13,305 - - - - Note Note Note: Based on the amounts approved by the Board of Directors. - 22 -
TABLE 2 COADNA HOLDINGS, INC. AND SUBSIDIARIES ENDORSEMENT/GUARANTEE PROVIDED YEAR ENDED DECEMBER 31, 2010 (In Thousands of United States Dollars) Endorsement/Guarantee Provider Name Guaranteed Party Nature of Relationship (Note 1) Limits on Endorsement/ Guarantee Amount Provided to Each Guaranteed Party Maximum Balance for the Year Ending Balance Amount of Endorsement/ Guarantee Collateralized by Properties Ratio of Accumulated Endorsement/ Guarantee to Net Equity Per Latest Financial Statements (%) Maximum Endorsement/ Guarantee Amount Allowable CoAdna Holdings, Inc. CoAdna US 1 (Note 2) (Note 3) (Note 3) $ - 21 (Note 2) CoAdna (HK) Ltd. CoAdna US 2 (Note 2) (Note 3) (Note 3) - 532 (Note 2) CoAdna (Suzhou) Ltd. CoAdna US 2 (Note 2) (Note 3) (Note 3) - 147 (Note 2) CoAdna Holdings, Inc. CoAdna (HK) Ltd. 1 (Note 2) (Note 4) (Note 4) - 21 (Note 2) CoAdna (Suzhou) Ltd. CoAdna (HK) Ltd. 2 (Note 2) (Note 4) (Note 4) - 147 (Note 2) CoAdna US CoAdna (HK) Ltd. 1 (Note 2) (Note 4) (Note 4) - 22 (Note 2) Note 1: 1. Parent to subsidiary. 2. Subsidiary to parent. 3. Between subsidiaries. Note 2: Based on the amounts approved by the Board of Directors. Note 3: Joint guarantee of bank line of credit, US$5,000 thousand, for CoAdna US Note 4: Joint guarantee of bank line of credit, US$5,000 thousand, for CoAdna (HK), Ltd. - 23 -
TABLE 3 COADNA HOLDINGS, INC. AND SUBSIDIARIES MARKETABLE SECURITIES HELD DECEMBER 31, 2010 (In Thousands of United States Dollars) Investing Company Marketable Securities Type and Name Relationship with the Investing Company Financial Statement Account Shares/Units (Thousands) Carrying Value December 31, 2010 Percentage of Ownership (%) Market Value or Net Asset Value (Note) CoAdna Holdings, Inc. Stock CoAdna US Subsidiary Long-term investments - equity method - $ 23,119 100 $ 23,119 CoAdna US Stock CoAdna (Cayman) Ltd. Subsidiary Long-term investments - equity method - 3,891 100 3,891 CoAdna (Cayman) Ltd. Stock CoAdna (HK) Ltd. Subsidiary Long-term investments - equity method 1 939 100 939 CoAdna (British Virgin Islands) Ltd. Subsidiary Long-term investments - equity method - 330 100 330 CoAdna (HK) Ltd. Stock CoAdna (Suzhou) Ltd. Subsidiary Long-term investments - equity method - 3,395 100 3,395 Note: The calculation of net asset value was based on audited financial statements for the year ended December 31, 2010. - 24 -
TABLE 4 COADNA HOLDINGS, INC. AND SUBSIDIARIES MARKETABLE SECURITIES ACQUIRED OR DISPOSED OF AT COSTS OR PRICES OF AT LEAST NT$100 MILLION OR 20% OF THE PAID-IN CAPITAL YEAR ENDED DECEMBER 31, 2010 (In Thousands of United States Dollars) Company Name Marketable Securities Type and Name Financial Statement Account Counter-party Nature of Relationship Beginning Balance Acquisition Disposal Investment Income Shares/Units Shares/Units Shares/Units Carrying Gain (Loss) on Amount Amount Amount (Equity (Thousands) (Thousands) (Thousands) Value Disposal Method) Shares/Units (Thousands) Ending Balance Amount CoAdna US Stock CoAdna (Cayman) Ltd. Long-term investments - equity method CoAdna (Cayman) Ltd. Subsidiary - $ (1,392) - $ 5,000 - $ - $ - $ - $ 283 - $ 3,891-25 -
TABLE 5 COADNA HOLDINGS, INC. AND SUBSIDIARIES TOTAL PURCHASE FROM OR SALE TO RELATED PARTIES AMOUNTING TO AT LEAST NT$100 MILLION OR 20% OF THE PAID-IN CAPITAL YEAR ENDED DECEMBER 31, 2010 (In Thousands of United States Dollars) Company Name Related Party Nature of Relationship (Note) Purchase/ Sale Transaction Details Transactions with Terms Different from Others Notes/Accounts Payable or Receivable Amount % to Total Payment Terms Unit Price Payment terms Ending Balance % to Total CoAdna US CoAdna (British Virgin Islands) Ltd. 1 Sale $ 8,017 28 Based on contract terms - - $ 1,864 18 CoAdna (Suzhou) Ltd. 1 Purchase 2,850 22 Based on contract terms - - 1,738 16 CoAdna (British Virgin Islands) Ltd. CoAdna (HK) Ltd. 3 Sale 29,267 100 Based on contract terms 3,094 100 CoAdna US 1 Purchase 8,017 51 Based on contract terms - - (1,864) 30 CoAdna (Suzhou) Ltd. 3 Purchase 7,748 49 Based on contract terms - - (159) 3 CoAdna (HK) Ltd. CoAdna (British Virgin Islands) Ltd. 3 Purchase 29,267 100 Based on contract terms - - (3,094) 48 CoAdna (Suzhou) Ltd. CoAdna US 2 Sale 2,850 27 Based on contract terms - - (1,738) 53 CoAdna (British Virgin Islands) Ltd. 2 Sale 7,748 73 Based on contract terms - - 159 53 Note: 1. Parent to subsidiary. 2. Subsidiary to parent. 3. Between subsidiaries. - 26 -
TABLE 6 COADNA HOLDINGS, INC. AND SUBSIDIARIES RECEIVABLES FROM RELATED PARTIES AMOUNTING TO AT LEAST NT$100 MILLION OR 20% OF THE PAID-IN CAPITAL YEAR ENDED DECEMBER 31, 2010 (In Thousands of United States Dollars) Company Name Related Party Nature of Relationship Financial Statement Account Ending Balance Turnover Rate Amount Overdue Action Taken Amount Received in Subsequent Period Allowance for Bad Debts CoAdna US CoAdna (HK) Ltd. 1 Account receivables - related parties $ 323 3.07 $ - - $ 323 $ - 1 Other receivables - related parties 3,005 - - - 5 - CoAdna (Cayman) Ltd. CoAdna (British Virgin Islands) Ltd. 1 Account receivables - related parties 2,801 7.01 - - 2,000 - CoAdna (British Virgin Islands) Ltd. CoAdna (HK) Ltd. 3 Account receivables - related parties 3,094 11.83 - - 3,094 - Note: 1. Parent to subsidiary. 2. Subsidiary to parent. 3. Between subsidiaries. - 27 -