<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-QSB
(MARK ONE)
/X/ QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED
JUNE 30, 1998
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NUMBER: 0-23279
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CELERITY SYSTEMS, INC.
(Exact name of Registrant as specified in its Charter)
DELAWARE 52-2050585
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) No.)
1400 CENTERPOINT BOULEVARD
KNOXVILLE, TENNESSEE 37932
(Address of principal executive offices)
(423) 539-5300
(Registrant's telephone number)
(Former Name, Former Address and Former Fiscal Year, if changed since last
Report)
------------------------
Check whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15 (d) of the Exchange Act during the past 12 months (or for
such shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days. Yes
/X/ No / /
As of August 12, 1998, 4,139,169 shares of the issuer's common stock were
outstanding.
Transitional Small Business Disclosure Format (check one): Yes / / No /X/
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<PAGE>
CELERITY SYSTEMS, INC.
FORM 10-QSB
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1998
INDEX
<TABLE>
<CAPTION>
PAGE
-----
<S> <C> <C>
PART I FINANCIAL INFORMATION
Item 1. Financial Statements....................................................................... 3
Condensed Balance Sheets as of June 30, 1998 (unaudited) and December 31, 1997..................... 3
Condensed Statements of Operations (unaudited) for the three months ended June 30, 1998 and 1997
and the six months ended June 30, 1998 and 1997................................................... 4
Condensed Statement of Stockholders' Equity as of June 30, 1998 (unaudited) and January 1, 1998....
5
Condensed Statements of Cash Flows (unaudited) for the six months ended June 30, 1998 and 1997.....
6
Notes to Unaudited Financial Statements............................................................. 7
Item 2. Management's Discussion and Analysis or Plan of Operation.................................. 9
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds.................................................. 14
Item 6. Exhibits and Reports on Form 8-K........................................................... 14
Signatures.......................................................................................... 15
</TABLE>
2
<PAGE>
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CELERITY SYSTEMS, INC.
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1997 1998
------------- -------------
<S> <C> <C>
(UNAUDITED)
ASSETS
Cash and cash equivalents........................................................... $ 4,592,975 $ 1,014,670
Short-term investments.............................................................. 1,229,788 --
Accounts receivable, less allowance for doubtful accounts of $567,024 in 1997 and
1998, respectively................................................................ 1,022,283 638,950
Interest receivable................................................................. 4,954 --
Inventory........................................................................... 1,161,356 1,562,681
Prepaid expenses.................................................................... 103,340 91,528
Costs in excess of billings on uncompleted contracts................................ 20,963 --
------------- -------------
Total current assets............................................................ 8,135,659 3,307,829
Property and equipment, net......................................................... 999,245 1,880,642
------------- -------------
Total assets.................................................................... $ 9,134,904 $ 5,188,471
------------- -------------
------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable.................................................................... $ 806,305 $ 234,585
Accrued liabilities................................................................. 389,060 337,854
Warranty reserve.................................................................... 235,000 232,087
Current portion of leases payable................................................... -- 70,264
------------- -------------
Total current liabilities....................................................... 1,430,365 874,790
Long-term leases payable............................................................ -- 188,503
Common stock, $0.001 par value, 15,000,000 shares authorized, 4,442,134 issued and
4,104,769 outstanding at December 31,1997 and 4,476,534 issued and 4,139,169
outstanding at June 30, 1998, respectively........................................ 4,442 4,476
Additional paid-in capital.......................................................... 22,399,692 22,403,098
Treasury stock, at cost............................................................. (227,500) (227,500)
Accumulated deficit................................................................. (14,472,095) (18,054,896)
------------- -------------
Total liabilities and stockholders' equity...................................... $ 9,134,904 $ 5,188,471
------------- -------------
------------- -------------
</TABLE>
The accompanying notes are an integral part of these unaudited condensed
financial statements.
3
<PAGE>
CELERITY SYSTEMS, INC.
CONDENSED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------------- ----------------------------
1997 1998 1997 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
(UNAUDITED) (UNAUDITED)
Revenues.............................................. $ 512,083 $ 0 $ 755,692 $ 722,786
Cost of revenues...................................... 447,332 91,830 933,098 796,964
------------- ------------- ------------- -------------
Gross margin (loss)................................. 64,751 (91,830) (177,406) (74,178)
Operating expenses.................................... 783,607 1,807,479 1,494,440 3,464,456
Non-cash compensation expense......................... 1,541,050 -- 1,541,050 --
------------- ------------- ------------- -------------
Loss from operations.................................. (2,259,906) (1,899,309) (3,212,896) (3,538,634)
Interest expense...................................... (76,540) ( --) (153,386) (13)
Interest income....................................... 4,962 42,241 21,651 84,763
------------- ------------- ------------- -------------
Loss from continuing operations..................... (2,331,484) (1,857,068) (3,344,631) (3,453,884)
Discontinued operations (Note 5):
Income(loss) from operations of discontinued CD-ROM
segment........................................... (212,053) 118,160 (480,462) (113,559)
Loss on disposal.................................... -- (15,358) -- (15,358)
------------- ------------- ------------- -------------
Net loss.............................................. (2,543,537) (1,754,266) (3,825,093) (3,582,801)
Accretion of premiums on preferred stocks........... 69,543 -- 139,086 --
------------- ------------- ------------- -------------
Net loss applicable to common stock................... $ (2,613,080) $ (1,754,266) $ (3,964,179) $ (3,582,801)
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
Basic and diluted loss per common share
(Note 4):
Loss before discontinued operations................. $ (1.32) $ (.45) $ (1.92) $ (.84)
Discontinued operations............................. (.12) .02 (.26) (.03)
------------- ------------- ------------- -------------
Loss per common share............................... $ (1.44) $ (.43) $ (2.18) $ (.87)
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
</TABLE>
The accompanying notes are an integral part of these unaudited condensed
financial statements.
4
<PAGE>
CELERITY SYSTEMS, INC.
CONDENSED STATEMENT OF STOCKHOLDERS' EQUITY
UNAUDITED
<TABLE>
<CAPTION>
ADDITIONAL
COMMON PAID-IN ACCUMULATED
STOCK CAPITAL TREASURY STOCK DEFICIT
----------- ------------- -------------- --------------
<S> <C> <C> <C> <C>
Balances, January 1, 1998............................... $ 4,442 $ 22,399,692 $ (227,500) $ (14,472,095)
Exercise of employee stock options...................... 34 3,406 -- --
Net Loss................................................ -- -- -- (3,582,801)
----------- ------------- -------------- --------------
Balances, June 30, 1998................................. $ 4,476 $ 22,403,098 $ (227,500) $ (18,054,896)
----------- ------------- -------------- --------------
----------- ------------- -------------- --------------
</TABLE>
The accompanying notes are an integral part of these unaudited condensed
financial statements.
5
<PAGE>
CELERITY SYSTEMS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
----------------------------
<S> <C> <C>
(UNAUDITED)
<CAPTION>
1997 1998
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net loss.......................................................................... $ (3,825,093) $ (3,582,801)
Adjustments to reconcile net loss to net cash used by operating activities:
Depreciation and amortization..................................................... 214,636 219,396
Loss on disposal of fixed assets.................................................. -- 29,623
Compensation expense for issuance of stock options................................ 1,541,050 --
Warranty reserve.................................................................. -- (2,913)
Provision for doubtful accounts receivable........................................ 15,000 --
Changes in current assets and liabilities:
Accounts receivable............................................................. (928,853) 397,681
Prepaid expenses................................................................ (61,843) 11,812
Inventory....................................................................... 11,388 (401,326)
Costs in excess of billings on uncompleted contracts............................ 187,749 20,963
Accounts payable................................................................ 1,069,639 (571,720)
Accrued expenses................................................................ 91,008 (51,206)
Deferred revenue................................................................ (359,970) --
Interest payable................................................................ 150,000 --
Reserve for management compensation............................................. (30,916) --
Allowance for estimated losses on uncompleted contracts......................... (324,600) --
Billings in excess of costs and estimated earnings on uncompleted contracts..... 574,381 --
------------- -------------
Net cash used by operating activities......................................... (1,676,424) (3,930,491)
Cash flows from investing activities:
Purchases of property and equipment............................................... (202,603) (871,648)
Proceeds from maturity of short-term instruments.................................. -- 1,220,394
------------- -------------
Net cash provided by (used in) investing activities........................... (202,603) 348,746
Cash flows from financing activities:
Principal payments on long-term debt, notes payable and capital leases............ (4,319) --
Net proceeds from issuance of common stock........................................ -- 3,440
------------- -------------
Net cash provided by (used in) financing activities........................... (4,319) 3,440
Net decrease in cash and cash equivalents........................................... (1,883,346) (3,578,305)
Cash and cash equivalents, beginning of period...................................... 2,344,666 4,592,975
------------- -------------
Cash and cash equivalents, end of period............................................ $ 461,320 $ 1,014,670
------------- -------------
------------- -------------
Non-cash investing activities:
Capital lease obligations of $247,975 were incurred when the Company entered into
leases for new furniture and fixtures in 1998.
</TABLE>
The accompanying notes are an integral part of these unaudited condensed
financial statements.
6
<PAGE>
CELERITY SYSTEMS, INC.
NOTES TO UNAUDITED FINANCIAL STATEMENTS
1. PRESENTATION OF UNAUDITED INTERIM FINANCIAL STATEMENTS
Information in the accompanying interim financial statements and notes to
the financial statements for the interim periods as of June 30, 1997 and 1998
and for the three months and six months periods then ended, is unaudited. The
accompanying interim unaudited financial statements have been prepared by the
Company in accordance with generally accepted accounting principles and
Regulation S-B. Accordingly, they do not include all the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the six month period ended June 30, 1998,
are not necessarily indicative of the results that may be expected for the year
ending December 31, 1998. The condensed financial statements should be read in
conjunction with the financial statements and notes thereto included in the
audited financial statements of the Company as and for the period ended December
31, 1997.
2. IMPACT OF SFAS 132 AND 133
In February 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 132, "Employer's
Disclosure About Pensions and Other Post Retirement Benefits," which will be
effective for fiscal years beginning after December 31, 1997. In June 1998, the
FASB issued SFAS 133, "Accounting for Derivative Instruments and Hedging
Activities," which will be effective for fiscal quarters of fiscal years
beginning after June 15, 1999. These Standards will have no material impact on
the Company.
3. CONTRACTS
The Company received final customer acceptance on its Korean long-term
project in the first quarter of 1998. The Company is still seeking payment of
approximately 10% or approximately $467,000 of the contract amount, and has
limited its support of the project, pending collection of the outstanding
receivable, by removing its support personnel from Korea in the second quarter.
The Company recognized approximately $710,000 of revenues during the first
quarter of 1998 upon the completion of one of its short-term China projects. The
Company recognized $594,000 in costs of goods sold related to this project, that
had been capitalized over the life of the project.
4. LOSS PER SHARE
Effective December 31, 1997, the Company adopted SFAS 128, Earnings Per
Share. Under SFAS 128, basic and diluted loss per share was $(2.18) and $(.87)
for the six months ended June 30, 1997 and 1998, respectively, and $(1.44) and
$(.43) for the three months ended June 30, 1997 and 1998, respectively. Basic
loss per share was computed by dividing net loss applicable to common stock by
the weighted average common shares outstanding during each period. Potential
common shares are not included in the computation of per share amounts in the
periods because the Company reported a loss and inclusion of equivalents would
be anti-dilutive.
7
<PAGE>
CELERITY SYSTEMS, INC.
NOTES TO UNAUDITED FINANCIAL STATEMENTS (CONTINUED)
4. LOSS PER SHARE (CONTINUED)
Following is a reconciliation of the numerators and denominators of the
basic and diluted earnings per share:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------------- ----------------------------
<S> <C> <C> <C> <C>
1997 1998 1997 1998
------------- ------------- ------------- -------------
LOSS
Basic and diluted:
Loss available to common stockholders............... $ (2,613,080) $ (1,754,266) $ (3,964,179) $ (3,582,801)
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
SHARES
Basic and diluted:
Weighted average common shares outstanding.......... 1,819,113 4,136,110 1,819,113 4,126,588
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
</TABLE>
5. DISCONTINUED SEGMENT
In February 1998, the Company decided to scale back its CD-ROM segment to a
maintenance mode of operations. The Company developed a formal plan of disposal
which became effective in May 1998. The Company anticipates selling the segment
within the next eight months. The Company believes the most valuable assets for
sale are the segment's customer list and product source code which have no
recorded value. Inventory on hand is available for sale; however, the Company
continues to sell the inventory as existing customers request such merchandise.
Thus, management cannot determine which assets will be remaining at the time of
the disposal. There was approximately $65,000 of CD-ROM inventory on hand as of
June 30, 1998. The Company anticipates that it will have a gain on disposal of
the segment which is not reflected in the accompanying financial statements;
however, there can be no assurance that the Company will realize any proceeds
from the disposition of the segment.
8
<PAGE>
THIS QUARTERLY REPORT ON FORM 10-QSB CONTAINS FORWARD LOOKING STATEMENTS
THAT INVOLVE CERTAIN RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS COULD
DIFFER MATERIALLY FROM THE RESULTS DISCUSSED IN THE FORWARD LOOKING STATEMENTS.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS
The following discussion should be read in conjunction with the financial
statements and notes thereto and other financial information appearing elsewhere
in this Form 10-QSB. Statements in this Management's Discussion and Analysis or
Plan of Operations and elsewhere in this Form 10-QSB that are not statements of
historical or current fact constitute "forward-looking statements." Such
forward-looking statements involve known and unknown risks, uncertainties, and
other factors including those set forth herein and in the Company's Annual
Report on Form 10-KSB under the caption "Risk Factors" that could cause the
actual results of the Company to be materially different from the historical
results or from any future results expressed or implied by such forward-looking
statements. Such risks include, without limitation, the Company's history of
losses and accumulated deficit, and need for additional financing; risks
applicable to foreign sales, the lack of assurance of the Company's
technological success, competition and others. In addition to statements which
explicitly describe such risks and uncertainties, prospective investors are
urged to consider statements labeled with the terms "believes," "belief,"
"expects," "intends," "anticipates," or "plans" to be uncertain and
forward-looking.
OVERVIEW
The Company has focused most of its development and production efforts
during the three months ended June 30, 1998 on its new digital set top box, the
T 6000, while also seeking new projects for the Company's digital video servers
which could be deployed with the T 6000 and with other compatible set top boxes.
In addition to the development efforts undertaken by the Company's engineering
staff, the Company has ordered pre-production prototypes of the T 6000 from
Taylor-White, LLC, of Greeneville, Tennessee ("Taylor White"). The Company is in
discussions with Taylor White to do volume production to fulfill U.S. market and
possibly international orders for the T 6000. Taylor White's Five Rivers
Electronic Innovations Plant has the capacity to enable the Company to meet
demand as soon as the set top box is ready for mass volume production. No
assurance can be given that any agreement will be entered into between the
Company and Taylor White.
The Company has also spent substantial time and effort in establishing
relationships that would give it greater opportunities and avenues to establish
itself in the marketplace, and in creating and implementing a marketing plan,
which has provided the Company exposure throughout the interactive video
services industry. The Company hired a Vice President of Sales and Marketing in
January 1998 who, together with other sales and marketing personnel, including
outside consultants, focused the Company's efforts to pursue sales opportunities
in the Company's international and domestic target markets. Due to the nature of
the Company's products and the new technology of the Company's digital set top
box, the T 6000, the sales cycle has been longer than the Company had
anticipated. Furthermore, the Company's key market segments now being targeted
by the Company -- energy companies, telephone companies, cable companies, health
care, education, and hospitality -- have required longer and more complex
decision cycles than expected. The Company has also experienced price
sensitivity related to its digital set top box in some of the international
markets it is attempting to penetrate. As with any new technology, if volumes
increases, the Company's technology may become less expensive, with potential
for increased profit margins. The Company is continuing to develop pricing
strategies related to both its digital video servers and its digital set top
box. Accordingly, the period-to-period comparison set forth below may not be
meaningful and may not necessarily be indicative of the results that may be
expected for future periods. As a result of the marketing plan, management
believes that the Company is now well positioned to become an important player
in many of its key market segments.
9
<PAGE>
In February 1998, following the unsuccessful conclusion of the Company's
efforts to retain a qualified general manager for its CD-ROM segment, the
Company decided to scale back the segment to a maintenance mode of operations.
The decision was also based on the continued decline in the segment's revenues,
and the Company's need to focus its efforts and resources on the interactive
video segment. The Company then developed a formal plan of disposal which became
effective in May 1998, and the Company now accounts for the CD-ROM segment as a
discontinued operation. The Company has continued to pursue potential purchasers
of the division during the three months ended June 30, 1998. There was net
income from operations of the segment of approximately $118,000 for the three
months ended June 30, 1998 and a loss on disposal of the segment of
approximately $15,000 for the same period. The operations of the segment began
to be accounted for as a loss on disposal in May 1998 when the Board of
Directors adopted the formal plan of disposal. The segment generated a net loss
from operations of approximately $212,000 for the three months ended June 30,
1997. The CD-ROM segment had a net loss from operations of approximately
$114,000 for the six months ended June 30, 1998 and a loss on disposal of the
segment of $15,000 for the same period. The CD-ROM segment generated income from
operations of $480,000 for the six months ended June 30, 1997. There can be no
assurance that the Company will realize any proceeds from the disposition of the
segment. Due to the discontinued status of the segment, the remainder of
management's discussion of the Company's financial results does not include the
CD-ROM segment.
There are inherent risks associated with foreign sales, including the
difficulty of enforcing agreements against foreign-based customers, political
and economic instability, shipping delays, foreign taxes, and export
restrictions. However, the Company has significant experience in international
business and sees this as a continuing market for the Company.
The Company also continued research and development efforts related to the
CTL 8500 digital baseband server. The CTL 8500 will be aimed at the analog
hospitality and cable markets, and is expected to be in production during the
first quarter of 1999. Furthermore, the Company continued development on its CTL
7000 and CTL 9000 digital video servers and software to add functionality and
reduce costs.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 1998, COMPARED TO THREE MONTHS ENDED JUNE 30, 1997
REVENUES. The Company had no revenues for the three months ended June 30,
1998 as compared to approximately $512,000 for the same period in 1997. The
decrease was due to the Company recognizing all of the revenue associated with
its projects that had been in progress prior to 1998 and the long sales cycle
related to the Company's products. Revenues for the three months ended June 30,
1997 consisted mainly of revenues under the Company's 1996 and 1997 agreements
with En Kay Telecom Co., Ltd. ("EnK") of approximately $380,000, and
approximately $107,000 related to sales of its T 3000 set top box for the
Israeli project.
COSTS OF REVENUES. Costs of revenues for the three months ended June 30,
1998 were approximately $92,000, as compared to approximately $447,000 or 87% of
revenues, for the same period in 1997. The Company's lack of revenue resulted in
a negative gross margin of approximately $92,000 for the three months ended June
30, 1998, as compared to a gross margin of approximately $65,000 for the same
period in 1997.
Costs of revenues for the three months ended June 30, 1998 were attributable
to costs incurred while concluding and supporting the Company's projects. The
Company continued to incur labor costs and some travel expenses while providing
additional support on its two China projects and its Korean project. Labor costs
related to revenues for the three months ended June 30, 1998 were approximately
$31,000 as compared to approximately $390,000 for the same period in 1997. The
Company removed its sole field technician from Korea in late May pending the
collection of outstanding receivables of approximately $467,000 which were fully
reserved in 1996. The Company also had a technician in China who has also
10
<PAGE>
since returned to the Company after concluding final support efforts. Revenues
during the three month period ended June 30, 1997, consisted primarily of
revenue recognized from the Company's agreements with EnK. The costs associated
with that revenue were almost entirely labor costs. The remainder of the costs
of revenues for the three months ended June 30, 1997 were also labor costs
associated with the Company's efforts to complete its long-term projects.
Materials costs for the three months ended June 30, 1998 were approximately
$19,000 as compared to approximately $96,000 for the same period in 1997.
Materials costs during the period in 1998 were primarily related to production
supplies while the 1997 costs were almost entirely related to the T 3000 set top
boxes sent to Israel.
OPERATING EXPENSES. Operating expenses for the three months ended June 30,
1998, were approximately $1,807,000 as compared to approximately $784,000 for
the same period in 1997.
Operating expenses were significantly greater in all categories in the three
months ended June 30, 1998 as compared to the same period during 1997, due to
the Company's efforts in 1998 to achieve better performance and prepare for
potential growth. Subject to the availability of funds, this will be a continued
trend as the Company prepares for potential growth. The greatest increase in
operating expenses consisted of an increase of approximately $635,000 in wages
expense for the three months ended June 30, 1998 as compared to the same period
in 1997. Consistent with its business plan, the Company added positions in top
management, as well as lower level staff positions. Overall, the payroll of the
Company has increased by approximately $298,000 for the three months ended June
30, 1998 as compared to the same period in 1997. Another component of the
increased operating expenses during the three months ended June 30, 1998 was an
increase in facilities rent expense of approximately $132,000. This was due
mainly to the new facility the Company leased beginning at the end of March
1998. The new facility provides the additional space needed to support the
current activities and potential growth of the Company. Materials and tooling
costs incurred by the Company relating to the T 6000 digital set top box
research and development efforts also contributed to the increase in operating
costs between the two periods of approximately $96,000.
During the three months ended June 30, 1997, the Company incurred a non-cash
compensation expense approximating $1,541,000 relating to the issuance of common
stock options during the period at an exercise price below the initial public
offering price of $7.50 per share consummated in November 1997 ("IPO"). There
was no similar expense during the three months ended June 30, 1998.
NET LOSS. As a result of the above factors, net loss for the three months
ended June 30, 1998 was approximately $1,754,000 as compared to a net loss of
approximately $2,544,000 for the same period in 1997.
SIX MONTHS ENDED JUNE 30, 1998, COMPARED TO SIX MONTHS ENDED JUNE 30, 1997
REVENUES. Revenues for the six months ended June 30, 1998 were
approximately $723,000 as compared to $757,000 for the same period in 1997. The
revenue for the 1998 period was due to the Company's completion of its Beijing
Telecom Authority ("BTA") project in China. The Company achieved substantial
completion of the project at the end of March 1998. The majority of the revenue
for the six months ended June 30, 1997 was recognized under the Company's 1996
and 1997 agreements with EnK.
COSTS OF REVENUES. Costs of revenues for the six months ended June 30, 1998
were approximately $797,000 as compared to $933,000 for the same period in 1997.
The Company's negative gross margin was approximately $74,000 for the six months
ended June 30, 1998 as compared to a negative gross margin of approximately
$177,000 for the same period ended in 1997.
The decrease in costs of revenues was primarily due to the fact that the
Company booked no revenue during the second quarter of 1998 and therefore had no
costs associated with revenues for that quarter. The majority of the costs of
revenues for the six months ended June 30, 1998 was due to the completion of the
Company's BTA project and the recognition of the related costs on the project of
approximately
11
<PAGE>
$594,000, which had been capitalized over the life of the project. The remainder
of the costs for 1998 was related to the Company's efforts to conclude projects
for which revenue had previously been recognized. Materials costs for the period
ended June 30, 1998 were approximately $487,000 as compared to approximately
$100,000 for the same period in 1997. This increase was due to the fact that the
revenues recognized during the six months ended June 30, 1997 were related to
the 1996 and 1997 EnK agreements that were not materials intensive. However,
direct labor costs for the six months ended June 30, 1998 were approximately
$134,000 as compared to approximately $773,000 for the same period in 1997. This
decrease was due to the lack of revenues during the three months ended June 30,
1998 and to the fact that the work in the period ended June 30, 1997 related to
the 1996 and 1997 EnK agreements and other long-term projects was labor
intensive.
OPERATING EXPENSES. Operating expenses for the six months ended June 30,
1998 were approximately $3,464,000 as compared to $1,494,000 for the same period
in 1997. As mentioned previously, operating expenses were significantly greater
in all areas during 1998 due to the Company's efforts to achieve better
performance and prepare for anticipated future growth. The majority of the
increase consisted of an increase in operating wages expense of approximately
$1,083,000 for the six-month period ended June 30, 1998 as compared to the same
period in 1997. This increase reflects the difference in the amount of labor
costs classified as costs of revenues between the two periods as mentioned
above. The overall payroll increase for the Company for the six months ended
June 30, 1998 was approximately $634,000 as compared to the same period in 1997.
Another component of the increase in operating expenses was an increase in
facility rental expense of approximately $184,000 during the six month period
ended June 30, 1998 as compared to the same period in 1997. Expenses incurred
for the use of contractors, consultants and recruiting efforts also increased by
approximately $180,000 in the 1998 period due to the Company's need for quality
personnel.
The Company also recognized approximately $1,541,000 in non-cash
compensation expense during the six months ended June 30, 1997 due to the fact
that it had granted stock options at an exercise price below the initial public
offering price of $7.50 per share in the IPO. There were no similar expenses for
the period ended June 30, 1998.
NET LOSS. As a result of the above factors, net loss for the six months
ended June 30, 1998 was approximately $3,583,000 as compared to a net loss of
approximately $3,825,000 for the same period in 1997.
LIQUIDITY AND CAPITAL RESOURCES
The primary source of financing for the Company since its inception has been
through the issuance of common and preferred stock and debt. The private
placements were offered to accredited investors, some of which are customers or
principals of the Company's customers. One of the Company's founders funded the
initial operations through equity infusions totaling $155,000 in 1993. In 1994,
that founder loaned the Company an additional $75,000 which, together with
$12,784 in accrued interest, was converted to 17,915 shares of Common Stock on
December 31, 1995. During 1995, the Company received net proceeds in the
aggregate amount of $3,252,619 through (i) the issuance for approximately
$1,517,500 of 975,836 shares of Series A Preferred Stock and warrants to
purchase 408,479 shares of Series B Preferred Stock (the "Series B Warrants"),
(ii) the receipt of approximately $800,600 of net proceeds from the exercise of
the Series B Warrants, and (iii) the receipt of $934,500 of net proceeds from
the sale of convertible notes and warrants. During 1996, in connection with the
1996 Placement, the Company received net proceeds of approximately $5,404,300
through the private placement of units consisting of Common Stock, notes, and
warrants consummated on June 30 and July 17, 1996. The net proceeds from the
1996 Placement were used to pay overdue trade accounts payable, fund the
Company's long-term projects, and fund the Company's working capital needs. Also
in 1996, the Company converted the debt issued in 1995 into shares of Common
Stock at a conversion rate of $4.90 per share. In August 1997, the Company
received net proceeds of approximately $1,700,000 from the Bridge Financing,
consisting of a private placement of
12
<PAGE>
$2,000,000 principal amount of the Bridge Notes and Bridge Warrants, which was
consummated on August 8, 1997. The effective interest rate of the Bridge Notes
was in excess of 300%, and the Company was required to recognize non-cash
interest expense and loss on early extinguishment of debt of approximately
$1,440,000 upon the anticipated repayment of the Bridge Notes upon consummation
of the IPO. In addition, the Company recognized non-cash expenses of
approximately $307,000 consisting of the write-off of previously capitalized
expenses incurred in connection with the Bridge Financing and the 1996
Placement. In connection with the Bridge Financing, the Company repurchased
240,000 shares of Common Stock from a former officer and 80,000 shares of Common
Stock from a director of the Company for aggregate consideration of $160,000
($0.50 per share).
In November 1997, the Company consummated the IPO, in which 2,000,000 shares
of Common Stock were sold at a purchase price of $7.50 per share. The Company
realized net proceeds of approximately $12,386,800 from the IPO, of which
approximately $5,446,000 was used to repay the principal amount of the 1996
Notes and Bridge notes, together with accrued interest thereon. The Company
believes that cash balances on hand as of June 30, 1998 approximating
$1,015,000, together with funds generated from operations, will be sufficient to
satisfy its operating and capital requirements until the end of the third
quarter. Such belief is based on certain assumptions, and there can be no
assurance that such resources will be sufficient to satisfy the Company's cash
requirements for such period. The Company is looking at several options in terms
of improving its cash situation. The Company entered into an agreement with one
of the members of its Board of Directors, who was also one of the original
founders of the Company, under which the Director would open a personal line of
credit in the amount of $500,000, which the Company could draw against. The
Company's draw down on the line of credit would be secured by firm purchase
commitments received by the Company or other mutually agreed upon receivables.
The Company would need prior approval from the Director for each specific draw
and would be obligated to use the designated contract receipts or other
designated receivables to repay the loan upon receipt by the Company. The
Company continues to seek possible buyers of its CD-ROM division, as well as
taking additional steps to collect accounts receivable which have been reserved
in 1996. The Company has had discussions with potential investors in the Company
to arrange debt and/or equity financing. The Company has not yet determined
whether it will attempt to consummate any such financing, pending the outcome of
its efforts to obtain cash from operations or other sources. There can be no
assurance that the Company will be able to obtain any such required additional
capital on a timely basis, on favorable terms, or at all.
Since its inception in January 1993 and through June 30, 1998 the Company
had an accumulated deficit of approximately $18,055,000. The Company expects to
incur operating losses for the indefinite future as it continues to add staff
and other resources and to increase its sales efforts. The Company has not
received orders for any new interactive video projects since June 1997. The
Company is also continuing to pursue its sales efforts and endeavoring to offer
attractive pricing to close sales in a timely manner. There can be no assurance,
however, as to the receipt or timing of revenues from operations, including, in
particular, revenues from products currently under development.
The Company's accounts receivable turnover ratio for the six months ended
June 30, 1998, was .44 as compared to .52 for the same period in 1997. Revenue
amounts between the two periods were comparable while there was a decrease in
the average receivable balance due principally to collections by the Company on
receivables related to its China projects that had been outstanding at June 30,
1997. The receivable turnover continues to be adversely affected due to the
Company's long outstanding receivables related to its long-term projects in
Korea and Israel. The Korea receivable was fully reserved in 1996, but efforts
continue to collect some portion of it. As mentioned previously, the Company has
removed its field technician from Korea who had been providing support because
the Company has not been paid the final amounts due on the project. The Company
is continuing to make efforts to collect the final amounts due on its Israeli
project as well.
The Company's inventory turnover ratio for the six months ended June 30,
1998 was .59 as compared to .71 for the same period in 1997. The average
inventory balance between the two periods remained
13
<PAGE>
consistent at approximately $1,300,000. The cost of goods sold decreased
slightly for the six months ended June 30, 1998, due to the lack of revenues
during the second quarter. The lack of sales volume has adversely affected the
inventory turnover ratio.
At June 30, 1998, the Company had cash and cash equivalents totaling
approximately $1,015,000, and net working capital of approximately $2,433,000.
The Company had no significant capital spending or purchase commitments at June
30, 1998 other than certain facility leases and inventory component purchase
commitments required in the ordinary course of its business.
The Company has no existing lines of credit or other financing arrangements
with lending institutions.
PART II
OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
From November 4, 1997, when the Company's Registration Statement on Form
SB-2 (the "Registration Statement") was declared effective, through June 30,
1998, approximately $5,450,000 of the net proceeds of the IPO was applied to
repay indebtedness, $413,000 was applied to the payment to and cost of
recruiting and relocating additional engineering personnel, $264,000 was used
for the recruitment and relocation of sales and marketing personnel, as well as
used in sales and marketing promotion, approximately $152,000 was used for the
recruitment and pay to additional administrative personnel and $40,000 was
applied to payments under a termination agreement with a former officer. The
Company spent approximately $623,000 in connection with its move into the new
facility. Approximately $5,397,000 was applied to working capital purposes since
the close of the IPO, which is approximately $4,339,000 in excess of the amount
allocated to working capital in the Registration Statement. Approximately
$326,000 of the proceeds represented payroll for officers of the Company. The
Company has utilized all of the proceeds from the IPO as of the end of the three
month period ending June 30, 1998, however, the Company had approximately
$1,015,000 invested in a commercial bank account at June 30, 1998.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
Exhibit 11 Statement re: computation of per share earnings (included in Note
4 of the "Notes to Unaudited Financial Statements")
Exhibit 27 Financial Data Schedule
(b) Reports on Form 8-K (None)
14
<PAGE>
SIGNATURE
In accordance with the requirements of the Securities Exchange Act of 1934,
the registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
Dated: August 14, 1998
CELERITY SYSTEMS, INC.
(Registrant)
<TABLE>
<S> <C> <C>
By: /s/ KENNETH D. VAN METER
-----------------------------------------
Kenneth D. Van Meter
PRESIDENT AND CHIEF EXECUTIVE OFFICER
AND CHAIRMAN OF THE BOARD
(PRINCIPAL EXECUTIVE OFFICER)
By: /s/ THOMAS E. WELCH
-----------------------------------------
Thomas E. Welch
CONTROLLER
(PRINCIPAL FINANCIAL OFFICER)
</TABLE>
15
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