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U.S. SECURITIES AND EXCHANGE COMMISSION DRAFT 3/26/98
WASHINGTON, D.C. 20549
FORM 10-KSB
(Mark one)
/X/ ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the fiscal year ended DECEMBER 31, 1997
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/ / TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from ____________ to _______________
COMMISSION FILE NO. 0-23279
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CELERITY SYSTEMS, INC.
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(Name of small business issuer in its charter)
DELAWARE 52-2050585
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
CELERITY SYSTEMS, INC.
1400 CENTERPOINT BOULEVARD
KNOXVILLE, TENNESSEE 37932
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number (423) 539-5300
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Securities registered under Section 12(b) of the Exchange Act:
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Title of each Class Name of each exchange on which registered
Securities registered under Section 12(g) of the Exchange Act:
COMMON STOCK, PAR VALUE $.001 PER SHARE
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(Title of Class)
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(Title of Class)
Check whether the issuer (1) 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
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No
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Check if there is no disclosure of delinquent filers in response to Item
405 of the Regulation S-B is not contained in this form, and no disclosure will
be contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [ ]
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State issuer's revenues for its most recent fiscal year. $3,728,262
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Aggregate market value of voting stock held by non-affiliates of registrant
as of February 28, 1998: $11,596,939.
Shares of Common Stock outstanding as of March 30, 1998: 4,130,369
DOCUMENTS INCORPORATED BY REFERENCE
Not applicable
Transitional Small Business Disclosure Format (check one): Yes ; No X
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UNLESS OTHERWISE INDICATED, THE INFORMATION IN THIS ANNUAL REPORT ON
FORM 10-KSB GIVES EFFECT TO THE ONE-FOR-TWO-AND-ONE-HALF REVERSE STOCK SPLIT
OF THE COMPANY'S COMMON STOCK, PAR VALUE $0.001 PER SHARE (THE "COMMON
STOCK") EFFECTED IN AUGUST 1997. ALL REFERENCES TO "CELERITY" OR THE
"COMPANY" CONTAINED IN THIS ANNUAL REPORT REFER TO THE COMPANY AND ITS
PREDECESSOR, CELERITY SYSTEMS, INC., A TENNESSEE CORPORATION.
THIS ANNUAL REPORT ON FORM 10-KSB 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.
SEE "DESCRIPTION OF BUSINESS--RISK FACTORS--CAUTIONARY STATEMENTS REGARDING
FORWARD-LOOKING STATEMENTS."
PART I
ITEM 1. DESCRIPTION OF BUSINESS.
GENERAL
Celerity Systems, Inc. ("Celerity" or the "Company") was incorporated in
Tennessee in 1993 and was reincorporated in Delaware in August 1997. The
Company designs, develops, integrates, installs, operates, and supports
interactive video services hardware and software. In the interactive video
services area, the Company seeks to provide solutions, including products and
services developed by the Company and by strategic partners, that enable
interactive video programming and applications to be provided to a wide
variety of market niches. The Company has installed 14 digital video servers
in four countries (China, Korea, Israel, and Taiwan), on each of the four
major types of networks accommodating interactive video services. The Company
believes that its demonstrated ability to deploy and operate interactive
video systems over each of these four major network types is a significant
competitive advantage.
RECENT DEVELOPMENT
The Company has also developed and marketed CD-ROM software products for
business applications. 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 has
reduced its personnel in the CD-ROM segment from approximately 13 employees
to fewer than five. The Company is not actively marketing its CD-ROM
products, nor is it developing any new CD-ROM products, product upgrades or
features. The Company is continuing to maintain existing customer
relationships by providing technical support and filling sales orders. The
Company intends to sell or wind down its CD-ROM business. There can be no
assurance that the Company will realize any proceeds from the disposition of
such business. See Note 16 of the "Notes to Financial Statements."
INTERACTIVE VIDEO SEGMENT
INDUSTRY OVERVIEW
LINEAR TELEVISION AND VCR TECHNOLOGY. Until about 25 years ago,
audio-visual home entertainment choices were primarily limited to linear
content (i.e., content that plays in a pre-programmed sequence and which
cannot be controlled by the viewer). In the 1970s, the growing popularity of
videocassette recorders (VCRs) and videocassette tapes provided new choices
to home viewing audiences. VCR and videocassette technology provides viewers
with the ability to view content on demand and to manage content through the
use of pause, resume, fast-forward, rewind, and other features. VCR use,
however, entails the inconvenience of leaving the home to purchase or rent
videocassettes or choosing from among the often limited content available for
recording on television. Many video stores have only a limited selection of
titles, particularly in areas such as educational content and games, and the
most sought after titles are frequently unavailable. The
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proliferation of cable television, satellite television, pay-per-view, and
similar technologies has improved linear television choices, but these
technologies do not offer the ability to select content to be viewed on demand,
rather than on a scheduled basis.
TELECOMMUNICATIONS COMPANIES AND BROADBAND INTERACTIVE SERVICES. In the
early 1990s, large telephone and cable companies and other interested parties,
such as television and motion picture studios, began to experiment with the idea
of providing broadband interactive services. Broadband services are those which
run over high capacity networks such as asynchronous digital subscriber lines
(ADSL), high-speed data lines (T1 and E1), hybrid fiber coaxial (HFC) lines, and
fiber to the curb (FTTC) fiber optic lines. These high-capacity networks, made
possible by breakthroughs in the ability to convert information from analog to
digital form and by improved data compression technologies, have the ability to
deliver vast quantities of data into the home. Broadband networks also have the
capacity to provide for interactivity between the home and the content
providers. Industry sources anticipate that, if broadband networks become widely
deployed, they will usher in a new age of information technology due to the
potential quantity and robustness of content, and the speed, ease of use, and
interactivity of these networks.
Following changes in the regulation of the telecommunications industry in
1992, it was anticipated that the large domestic telephone and cable companies,
and their counterparts abroad, would seek to deploy broadband networks and
interactive services in communities on a widespread basis. The Regional Bell
Operating Companies (RBOCs), for example, successfully sought relief in the
courts to be permitted to become not only network providers for such services,
but content providers as well. Further regulatory changes in 1995 and 1996
reduced the potential cost of deploying broadband networks. A number of
interactive video trials were run by U.S. companies such as Time Warner,
Tele-Communications, Inc. ("TCI"), GTE, Bell Atlantic Corporation, and BellSouth
Corporation, which demonstrated that the technology did work, although in
varying degrees. International telecommunications companies, including Telecom
Italia, Korea Telecom, Hong Kong Telecom, Deutsche Telekom, and British Telecom,
demonstrated similar results abroad. These trials were generally costly, in part
because they were characterized by "trial approaches," including development and
testing of prototype versions of equipment and alpha and beta versions of newly
developed software, and experiments in pricing, content, menus, navigation and
methodologies. Further, these trials occurred during a period of rapid
technological change and improvement, and evolving standards. For example, ADSL
equipment, which now typically costs a few hundred dollars per home, typically
cost a few thousand dollars per home in 1992.
In 1996 and 1997, activity in the broadband services area has been
significantly reduced, and some companies, such as Bell Atlantic and TCI, have
announced reductions or delays in their deployment plans. Reasons given for such
reduction or delays include a change of focus toward local and long distance
competition, the high cost of deploying large broadband networks, business
reorganizations, delays pending the introduction of lower cost, more functional
or industry standard technology, and reduced competitive threats from within the
industry.
NARROWBAND INTERACTIVE SERVICES. Beginning in the 1980s, the proliferation
of home computers and the development of the Internet and Internet service
providers, such as America Online, Prodigy, and CompuServe, has allowed millions
of people to access interactive content and services over telephone lines.
Internet content has become increasingly rich, robust, and interesting. Industry
sources estimate that United States consumers spent more than $620 million for
Internet access in 1996 and project that such expenditures will grow to more
than $15 billion in 2001 and that the number of Internet households will grow
from an estimated 23.4 million in 1996 to 66.6 million by 2000. The Internet has
begun to condition consumers, and younger consumers in particular, to obtaining
information, experiencing content, playing games, and shopping in an interactive
fashion. However, telephony-based services such as the Internet, which are
generically referred to as narrowband services, have constraints on the quantity
of information that can be delivered and are currently unable to download large
files, such as full-length videos, at a satisfactory quality or speed. Computers
tend to be relatively expensive, compared to television sets, and computer
monitors and display technologies are not optimized for viewing video content.
Furthermore, although most people are
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comfortable with television as a medium, many people, especially older
consumers, lack experience with computers and may be uncomfortable with, or are
averse to, computer technology.
Different companies have employed different strategies to address the
shortcomings of narrowband networks in the absence of generally available
broadband networks. For example, WebTV (recently purchased by Microsoft) has
begun offering enhanced graphics and other features over narrowband networks,
with a television, rather than a PC, interface. In order to address the need for
higher-speed services, the cable industry has begun deploying cable modems, and
the telephone industry has begun deploying ADSL equipment, for high-speed data
access, so that the narrowband services can run at the highest possible speed on
metallic telephone or cable lines. For example, @Home Network is deploying as a
high speed internet service provider (ISP) on several cable companies' networks.
The Company believes that, despite these and other initiatives, narrowband
networks are unlikely to achieve the combination of technological accessibility
and speed, security, and robustness of transmission characteristic of broadband
systems. The public access methodology of the Internet and other narrowband
networks, coupled with off-the-shelf modems, make security, both for privacy of
communications and secure commercial transactions, difficult to achieve. The
hardware and software of interactive broadband systems and the architecture of
such networks creates a more secure environment for such transactions. In
addition, although better software, compression methods, and other tools have
enabled improvements in narrowband services, the physical constraints of
narrowband networks are substantial, compared to those of broadband networks.
Many narrowband lines, especially older lines in cities (a preferred market
segment) cannot run at 56 kilobits per second (kbps), the highest
widely-available PC modem rates. This rate does not compare to the 1.5 Megabits
to 25 Megabits per second rates provided via broadband networks.
THE COMPANY'S BROADBAND INTERACTIVE VIDEO SERVICES. The Company
believes that the increase in linear viewing alternatives such as Direct
Broadcast Satellite (DBS) have increased consumer demand for more content
choices and that the development of the Internet has increased consumer
interest in interactive content generally. The Company believes that the
inherent limitations of the Internet and other narrowband networks, as
compared with broadband networks, create a market opportunity for a broadband
technology, such as the Company's, that offers superior speed and robustness,
combined with a "user-friendly," television-based technology. See "User
Experience." In addition, the lack of major deployments by the RBOCs and
other major U.S. telecommunications companies in the broadband network market
has, the Company believes, kept many large companies from actively pursuing
plans to supply hardware and software for broadband networks, thus enhancing
the niche market opportunities for the Company. Even if major domestic
telecommunications companies were to currently undertake such initiatives, it
would take a substantial number of years and a massive capital commitment to
deploy large-scale broadband networks. The Company also believes that
advances in servers, set top boxes, and network equipment enable operators of
small-scale broadband networks to now offer interactive video services to
their subscribers at attractive prices. See "Potential Markets--Marketing
Strategy."
BASIC INTERACTIVE SERVICES CONFIGURATION
An interactive video services network system typically includes the
following components: (i) network equipment, including high speed lines and
switches, for transmission of content; (ii) digital set top boxes, which receive
the content and transmit subscriber requests; (iii) digital video servers, which
store the content and control its transmission over the network; (iv) content
preparation equipment, which prepares content for transmission over the network;
and (v) software which runs user applications, and business support
applications, such as subscriber billing. See "Products."
NETWORK EQUIPMENT
High-speed lines (ADSL, T1/E1, HFC, FTTC) connect the network service
provider's central office or head end to subscribers' homes. High-speed network
switching equipment connects subscribers to content
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furnished by video information providers (VIPs), either locally or
internationally. There are a large number of providers of this network
equipment, including CF Alcatel, BroadBand Technologies, Incorporated, Ericsson,
ViaGate Technologies, ("ViaGate"), Lucent Technologies, Scientific-Atlanta,
Inc., and Siemens Communications.
DIGITAL SET TOP BOXES
In each subscriber's home, one or more digital set top boxes and remote
control devices are associated with each television set or personal computer
that receives the interactive video programming. Digital set top boxes feature
high-speed processors, RAM memory, high- and low-speed output ports and other
computer components.
DIGITAL VIDEO SERVERS
The digital video server is a high-speed computer to which a subscriber is
connected via the network. The basic functions of a digital video server are to
cost-effectively (i) store and rapidly retrieve and transmit large amounts of
content, (ii) provide a large number of input/output ports so that subscribers
can access the system quickly and easily retrieve information, (iii) function
with an operating software system to manage user applications, and (iv) provide
business support systems capability to accumulate and provide data for services
such as billing, customer service, and content management.
CONTENT PREPARATION EQUIPMENT
In order to store content in a digital server, send it over a broadband
network, and interpret the content through a digital set top box, the content
must be encoded (or converted from analog to digital format) and compressed.
Compression standards, primarily Motion Pictures Experts Group 1 and 2 (MPEG 1
and MPEG 2), have been adopted for the preparation and storage of this content.
APPLICATIONS AND BUSINESS SUPPORT SOFTWARE
Operators of interactive video systems require two kinds of software in
addition to the operating system software for servers and set top boxes.
Interactive applications software is designed to offer services, such as
shopping, travel, banking, education, medicine, video-on-demand, karaoke, and
digital music. Business support system (BSS) software includes applications such
as customer service, billing, telemarketing, content management, content
provider management, workforce management, and similar functions. Applications
and BSS software are available from a number of companies, including Arrowsmith,
EDS, IMAKE, Informix, and Strategic Group, and the Company anticipates that the
availability of applications software, in particular, will increase as broadband
networks proliferate.
PRODUCTS
The Company's products for the interactive video services market consist of
products that the Company develops and manufactures and products manufactured by
others that the Company resells and integrates into its systems.
PRODUCTS MANUFACTURED BY THE COMPANY
VIDEO SERVERS. The Company manufactures three different digital video
servers: (i) a server designed to be used with networks utilizing metallic
lines, such as ADSL, E1 and T1, which is currently deployed in Korea and
Israel; (ii) an asynchronous transfer mode (ATM) based server designed to be
used for FTTC and HFC networks, which is currently deployed in Taiwan and
China; and (iii) a scaled down ATM-based server used for trials, focus
groups, and similar uses. The Company is also developing an analog baseband
output digital server, designed to be used with cable pay-per-view and analog
hospitality systems.
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The ATM-based servers include improvements in cost per stream, capacity, and
operating speed over previous models and is designed to simplify connections to
current networks and provide valuable new features, including variable bit rate,
data stream grooming, data flow improvement, and higher bandwidth. The servers
are all scalable, enabling them to be used in small to large-scale deployments.
For large-scale deployments, the servers can be deployed in nodes which can
include one or more servers.
The Company has developed its own digital server operating system, known as
Multimedia Interactive eXchange (MIX). MIX is a compact, fully-featured
comprehensive proprietary operating system that interfaces with standard
software and manages all aspects of the digital server's operations. MIX
interfaces easily with industry standard billing systems and other business
support systems. MIX software is capable of operating on other companies'
servers, and the Company may license MIX to third parties if the opportunity
arises and if the Company determines that it would be strategically
advantageous. The Company has also developed middleware called NAV RT, which
simplifies the creation of basic applications and menus for interactive video
services. As a customer inducement, the Company, unlike many of its competitors,
includes the server license for MIX and NAV RT at no additional charge with each
digital video server sold. The Company's servers also work effectively with
other modern applications software, such as HTML and Java.
DIGITAL SET TOP BOXES. The Company manufactures trial quantities of
digital set top boxes, which it sold to Bezeq Telecom ("Bezeq") for use in
Israel. The Company is also developing a set top box for use with the Company's
ATM-based servers, which is designed to be manufactured in small quantities by
the Company and in large quantities by a third party. The Company expects to
continue to design and develop set top boxes, which may be manufactured by the
Company in trial quantities or manufactured by volume set top box manufacturers
under license from, or contractors of, the Company. The Company's set top boxes
are designed to operate efficiently on the Company's proprietary systems or on
systems utilizing DAVID, a set of widely-used operating system protocols for
digital set top boxes. The Company's set top boxes also operate with the QNX
operating system software. Features include a serial output port for
peripherals and a graphics support package. More advanced designs under
development include Universal Serial Bus (a new hardware feature which allows
computer and set top boxes to connect with a variety of peripheral devices),
three dimensional graphics display, and a faster processor. The Company also
believes that certain features of its current set top box architecture may have
potential value for applications such as energy management and home security
monitoring.
PRODUCTS MANUFACTURED AND DEVELOPED BY OTHERS
Certain of the products manufactured and developed by others described
below are or maybe provided by the Company to its customers pursuant to
strategic alliances. See "Strategic Alliances."
NETWORK EQUIPMENT. The Company has an informal strategic arrangement with
ViaGate to sell network equipment as part of overall bids for end-to-end
interactive video systems. The Company intends to enter into similar
arrangements with other network equipment companies. The Company also has a
preferred technology arrangement with Fore Systems, Inc. ("Fore Systems"), a
leading manufacturer of ATM switches, which has enabled the Company to utilize
Fore System's technology and to incorporate Fore Systems switches with the
Company's ATM-based servers, such as those deployed in China and Taiwan. The
Company believes that this arrangement has the potential to provide additional
joint marketing opportunities.
DIGITAL SET TOP BOXES. Although the Company manufactures small quantities
of digital set top boxes, the Company is seeking to enter into joint marketing
arrangements with high volume manufacturers of digital set top boxes, pursuant
to which the Company would sell these set top boxes as a distributor or on an
original equipment manufacturer basis.
OTHER EQUIPMENT. Interactive video services systems also utilize
components such as digital encoders, digital production studio equipment,
digital production software, and other equipment. The
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Company has entered into certain arrangements with respect to the resale by the
Company of digital encoders and digital production studio equipment and is
seeking to enter into additional arrangements with sellers of these kinds of
equipment, with a view toward enabling the Company to offer a complete
end-to-end system to potential customers on a fully integrated basis.
OTHER SOFTWARE. The Company provides a basic video-on-demand application
at no cost as part of its server software; however, most system operators will
require a suite of applications upon installation of the system, with the
potential for adding additional applications in the future. The Company has
entered into certain arrangements to provide interactive video applications
software and is seeking to enter into additional arrangements to provide
interactive video applications software and business support systems software to
the Company's customers.
SERVICES
Celerity plans to act as an overall systems integrator for interactive
video projects, which may entail integrating the end-to-end system in Celerity's
facility prior to shipment, on-site integration, or both. The scope of work
required for integration will vary widely, depending upon project size and other
variables. Celerity also offers a number of additional services, including
classroom training, documentation, and maintenance.
USER EXPERIENCE
Current subscribers to interactive video services enjoy a broad range of
new content and applications. Korea Telecom subscribers utilizing the Company's
technology are able to obtain movies and other video content, karaoke and
digital music, educational services, and medical information on demand. Content
available "on demand" is stored on a server and may be viewed by any subscriber
at any time chosen by the subscriber through the use of a navigation/menu
system.
The Company anticipates that applications will become more robust and
exciting in the future as new content, applications, and enhanced technical
capabilities become available. For example, travel reservations and
information could be a possible application of interactive video services. A
subscriber equipped with an ordinary television set, a digital set top box
and a hand-held remote control could select a travel company, which would be
a VIP on the system, from an on-screen menu. A typical application might show
major geographic areas, such as Asia, Europe, the United States, and the
Caribbean. A subscriber choosing Europe, for example, would be provided with
a further choice among European countries. Upon choosing a country, e.g.,
Spain, a subscriber could be presented a choice among video, graphic, and
data content relating to that country, such as general interest videos and
information relating to packaged tours, airline options, and hotels. Similar
applications are currently available on narrowband services, such as the
Internet; however, broadband applications such as the Company's products can
accommodate lengthy videos and robust graphics, including three-dimensional
graphics, which cannot currently be as efficiently downloaded or viewed via a
narrowband network. The Company believes that broadband networks could, in
the future, also include applications with an electronic data interchange
(EDI) back end, which would allow the subscriber to ascertain the
availability of and confirm reservations for different products and services
such as hotel or car rental or airline tickets on a near real-time basis.
Customers would typically be billed a monthly fee for access to the
interactive services, a rental fee for the set top box, and additional fees for
the content and applications accessed, although it is anticipated that certain
VIPs would provide applications without a separate charge as a means of
increasing sales of products or services.
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POTENTIAL MARKETS
The markets for interactive video systems may be categorized as public or
private networks. Public networks, such as those of telephone or cable companies
or utilities, are potentially available to all consumers within a given
geographical market. Private networks are those offered in a more limited area,
such as a hotel, hospital, college campus, or business complex.
MARKETING STRATEGY
The Company's marketing strategy is to seek customers in each of the
potential emerging markets, to encourage leading companies and organizations to
adopt its technology, and to position itself as a leading provider of
interactive video services within niche markets. The Company believes that it is
important to achieve market penetration at an early stage in the development of
particular niche markets in order to compete successfully in those markets. The
Company is marketing itself based on its demonstrated ability to install digital
video systems on each of the major network types and its potential to provide
end-to-end interactive video solutions. See "Deployments" and "Strategic
Alliances." In addition, the scalability of the Company's servers provides
flexibility in deploying interactive video services systems varying in size from
systems designed to serve five simultaneous users to those capable of serving
many thousands of users in a variety of markets on a cost-effective basis. The
Company believes that this scalability will be an attractive feature to
potential customers. The Company believes that its diversified marketing
approach provides the Company with flexibility in targeting emerging markets,
enabling it to recognize market opportunities and adapt to perceived changes in
marketing priorities. The Company has limited sales and marketing experience and
there can be no assurance that it will be successful in implementing its
marketing plans. See "Risk Factors--Limited Marketing and Sales Experience."
PUBLIC NETWORKS
Potential market opportunities for the Company in public networks are:
foreign telephone and cable companies, domestic electric and gas utilities,
domestic cable companies, and domestic telephone companies.
FOREIGN TELEPHONE AND CABLE COMPANIES. The Company's current customers are
all foreign telephone or cable companies. Foreign companies have been more
active in deploying interactive video services than domestic U.S. companies. The
Company believes that, in part, this is because, in many countries, the
telephone company is owned or supported directly by the government, which may
see the addition of such services, especially public-interest services, such as
education and health-oriented services, as being beneficial to its citizens.
Because of a lack of name recognition and because the Company has lacked its own
direct sales force, the Company has been limited to responding to customer bids
and has made only limited sales in this market, which is large and rapidly
growing. Potential markets are emerging in Europe, Latin America, Canada, and
Africa, in addition to existing and emerging markets in Asia. See "Deployments."
DOMESTIC ELECTRIC AND GAS UTILITIES. Domestic electric and gas utilities
are now being deregulated and are subject to intense competitive pressures and
the need to find new sources of revenue. Many electric and gas utilities have
installed or are considering installing fiber optic lines in communities for
remote meter-reading and equipment monitoring purposes. These lines could be
used to provide a full menu of video services. Electric and gas utilities are
not currently regulated in the same manner as cable and telephone companies,
typically have long standing relationships with subscribers, and often have pole
and buried cable rights-of-way which could give them a competitive advantage
over other potential entrants into the interactive video services market.
Electric utilities may also see the provision of additional services as a means
of protecting key customers, such as hospitals, from incursion by other electric
utilities outside their operating territory that can now sell to these customers
under the operating principles of the North American
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Power Grid System. A number of electric utilities in the United States and in
Canada have expressed an interest in such deployments.
DOMESTIC TELEPHONE COMPANIES. There are more than 1,300 independent
domestic telephone companies. Major independent local telephone companies
include Sprint Corp., Buena Vista Tel, Southern New England Telephone, and
Cincinnati Bell Inc. The Company believes that the size of local telephone
company networks is well suited to the Company's scalable, cost-efficient
technology solutions. Many of these local telephone companies, as well as
long-distance carriers that are installing local telephone networks, have
installed or are planning to install modern fiber optic networks and may be
seeking new revenue opportunities to offset the costs of installation. The
Company also believes that many independent telephone companies may have more
flexible management styles than the larger telecommunication companies, and
may be quicker to commit to strategic decisions, such as providing
interactive video services to their customers. The Company is not targeting
the large local telephone companies (GTE and the RBOCs), since it believes
that, if these companies choose to enter the interactive video services
market, they will likely pursue these markets independently or through joint
ventures (such as Tele-TV and Americast).
DOMESTIC CABLE COMPANIES. The Company believes that an opportunity exists
for the smaller, well-funded cable companies, such as Cox Enterprises Inc., to
begin implementing interactive TV as they upgrade their networks from coaxial
cable to HFC, which is often the solution of choice for cable companies that
wish to improve the quality of their service and add additional channels. With
the entrance of competitors such as DBS, cable companies are upgrading to HFC to
provide a competitive number of channels at a higher quality. An HFC network
readily supports interactive video services, and these services would represent
an additional revenue opportunity for these cable companies and help offset a
portion of the upgrade costs. The Company is also targeting the domestic cable
market by developing a digital server that has an analog baseband output digital
server which converts digital signals to analog signals for transmission over
coaxial cable and reception through an analog set top box. This server, which is
expected to be introduced within the next six months, is designed to replace the
current VCR-based system as a pay-per-view source for cable companies and for
the analog hospitality market. The Company is not currently targeting major
domestic cable companies. Some of these companies, for example, TCI, expressed
an interest in the interactive video services market initially, but have not
begun widespread deployment, possibly due to the cost of converting large,
diverse cable systems, such as TCI's hundreds of cable systems, from the current
metal coaxial lines to HFC lines.
PRIVATE NETWORKS
Many hotels and resorts, colleges and universities, large apartment and
condominium complexes and businesses have installed or are considering
installing private networks, utilizing ADSL, HFC, or FTTC. Private networks are
limited in geographic size and scope, but could potentially offer a range of
interactive video and data services to their customers, generally on a
for-profit basis. Private networks have the significant advantage of relatively
rapid and low-priced deployment, as compared with large-scale public networks,
and they are well-suited to the Company's scalable technology solutions.
ANALOG HOSPITALITY. Many hotels, motels, and resorts have already
installed pay-per-view video or television systems. These systems generally
consist of small local area networks with video stored on a number of VCR
players connected to a control system. There are a number of problems with these
VCR-based solutions: (i) the VCR equipment breaks frequently and repairs
generally require a site visit; (ii) the content is stored on conventional
cassette tapes, which are vulnerable to illegal copying and which results in
certain first run movies being released by studios to hotels substantially later
than their theatrical release; (iii) the capacity of the system is limited;
(iv) video quality is sometimes poor, especially after a tape has been played a
number of times, since these systems are often not cleaned or serviced on a
regular basis; and (v) video choices are limited, due to the size, complexity,
and cost of the VCR decks and controllers. The Company is developing and expects
to introduce within the next six months a new digital server that
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has an analog baseband output, which is designed for this market and the cable
pay-per-view market. See "Public Networks Domestic Cable Companies." This system
is designed to be relatively inexpensive and to store video content as digital
files in the server, potentially providing higher quality video, a greater
selection, lower cost, fewer security problems and easier maintenance compared
to existing pay-per-view systems. In addition, much of the maintenance could be
performed remotely from a centralized site. Content could be loaded using
computer tape (which is highly resistant to piracy) at the hotel, or could be
downloaded from a central location over telephone lines or an inexpensive
satellite downlink. This system is designed to be compatible with the existing
analog equipment, including inexpensive analog set top boxes, but might also
provide a logical migration path to digital services in the future.
DIGITAL HOSPITALITY. Some hotels, motels, and resorts are already
considering upgrading to a full digital interactive services solution. For
example, the Company is a finalist in the bidding for a digital hospitality
project in Kuala Lumpur, Malaysia. The Company anticipates that certain upscale
hospitality properties, in particular, will install digital systems during
construction or thereafter upgrade to digital systems. These digital systems
have the potential to offer on-demand video programming, games, gaming,
shopping, health, education, and other services, in addition to high quality
digital pay-per-view programming.
COLLEGES AND UNIVERSITIES. Many colleges, including the University of
Maryland, Rutgers, and George Mason University, have begun installing modern,
high-speed networks, usually FTTC, on their campuses. Interactive video services
provide an opportunity to add entertainment, educational, and information
services to these networks both as a source of revenue to help defray the cost
of network installation and for educational purposes. For example, popular
courses could be stored on a server for viewing by large audiences on a
fully-interactive basis, with the potential for interactive test-taking and
homework submissions. Such a system could also aid ill or physically handicapped
students, those who work part-time, and absentees.
MULTIPLE DWELLING UNITS (MDUS). Many large apartment complexes,
condominiums, neighborhoods, and other groups of homes, termed Multiple Dwelling
Units or MDUs, are now installing modern HFC, FTTC, or ADSL systems either
during construction or as an upgrade in order to attract or retain tenants or as
a source of revenue. The Company believes that certain types of MDUs, such as
retirement communities, represent particularly attractive potential markets,
since these networks might offer shopping, education, interactive health, and
entertainment services to the elderly or consumers who have limited mobility.
DIGITAL HOSPITALS. Many domestic and foreign hospitals are already wired
with state-of-the-art, high-speed digital networks (usually FTTC) which would be
suitable for interactive video services systems, although it is currently
unclear who would fund these systems. The Company is aware of several projects
in which health care providers, such as pharmaceutical companies, have expressed
a willingness to underwrite some or all of the cost of content shown on these
systems in return for strategic positioning of advertising. The Company's
digital server and operating system technology could potentially accommodate an
architecture designed to allow patients to view advertisements targeted to their
condition, which could be attractive to advertisers. Another potential source of
funding is electric power utilities, which value hospitals as high-demand
consumers of electric power. A few power companies have expressed preliminary
interest in the idea of installing the Company's interactive video system in a
mid-sized or large hospital as part of a multi-year power contract. Another
potential source of funding for these systems is the hospitals themselves.
Interactive video systems may be password- and ID-protected, so that the user is
individually identified within the system. The Company believes that systems
could be designed to show patients targeted videos containing medical
information or instructions which they would then electronically "sign" prior to
being allowed to view entertainment services. Such a system could be attractive
to hospitals as a means of patient education and to ensure that patients (or
staff) have read and understood instructions and other information, such as
liability warnings.
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BUSINESS CAMPUSES. The Company believes that broadband digital networks
represent a logical extension of intranets. Business applications, such as
training, data management, communications and public relations, could
potentially be accommodated on broadband digital networks. The availability of
such networks in a corporate campus could also be employed to attract companies
to a particular business complex. The Company believes that a relatively
inexpensive PC plug-in board could be used instead of a set top box to connect
PCS to a broadband network, while television sets and set top boxes could be
used in appropriate settings, such as corporate briefing and board rooms.
SALES AND MARKETING
The Company has developed a comprehensive sales and marketing plan and
is recruiting personnel to establish a larger dedicated interactive video
sales organization. The Company has hired a Vice President of Sales and
Marketing and three regional sales managers. The Company anticipates
furthering its sales efforts under new leadership by engaging in advertising
and public relations activities that create visibility for the Company and
its products. Such activities may include distributing informational
materials to industry professionals, consultants, the press, and prospective
customers, advertising in trade journals, participation in trade shows, and
direct mailing of press releases and marketing materials. By the end of April
1998, the Company plans to have constructed a demonstration room for its
products, as well as demonstration units. The Company intends to market its
products both directly and through third parties, including its strategic
partners (including companies that might include the Company's products and
services in integrated end-to-end interactive video system bids), original
equipment manufacturers, and agents.
The Company utilizes several agents, primarily internationally, where the
use of such agents is customary. These include Bescom, Inc. and TeleMedia
International, Inc. in Korea, Hanshine International, Ltd. in China, Riger
Corporation (M) SDN BHD in Malaysia, and Tadiran Telecommunications Ltd. in
Israel. The Company's current arrangements with its agents are non-exclusive,
except in the case of En K (which is exclusive in Korea as to certain server
models, subject to an exception for the IVISION project) and Bescom (which is
exclusive as to the IVISION project in Korea). See "Deployments--Korea" and
"Description of Business--Risk Factors--Risks Associated with Contracts with En
Kay Telecom Co., Ltd." The Company expects to continue to enter into
arrangements with agents in the future, and some of these arrangements may be
exclusive. In the domestic hospitality market, the Company intends to market its
products to the five largest firms that supply such services to hotels and
motels, such as On Command Corporation. In some cases, however, the Company
expects to encounter opportunities to market its hospitality-targeted products
directly, both within and outside the United States.
DEPLOYMENTS
The Company has installed 14 interactive digital video servers in four
countries, consisting of seven servers in Korea, two in Israel, one in Taiwan,
and four in China. The Company has deployed these servers on four different
network technologies: (i) FTTC (China), (ii) HFC (Taiwan), (iii) high-speed data
lines (E1 or T1) (Israel), and (iv) twisted pair networks using ADSL (Korea).
The Company believes that it is the only company to have implemented interactive
video systems on all four network types. Information concerning these
deployments is set forth below.
KOREA
The interactive video projects in Korea have been conducted by a
consortium consisting of a government-sponsored research institute
(Electronics and Television Research Institute-ETRI), the national telephone
company Korea Telecom ("KT"), and a number of Korean companies (including
Samsung Group ("Samsung"), Hyundai Corporation, Lucky Goldstar International
Corp., Daewoo Corporation, and others).
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Several U.S. companies, including Celerity, have participated as
sub-contractors. The two largest projects are designed to provide interactive
television over telephone and cable lines. In 1994, the Company participated
in a pilot interactive video trial for KT. Other parties to this trial
included ViaGate, which provided the switch and served as project integrator,
and Samsung, which provided the set-top boxes. As part of this project, the
Company received its first order to develop a 40-stream digital video server
and a proprietary digital set top box. The initial phase of this project,
called IVISION, led to an order for six additional digital video servers of a
more advanced design, which have been installed in Seoul, Pusan, Taegu,
Kwangju, Taejon, and Inchon. These systems have been in operation for nearly
two years. Over 2,000 subscribers are receiving services from these systems,
including video-on-demand, movies-on-demand, karaoke, medical programming,
and music. These services are provided over normal telephone lines using
ADSL, which allows rapid and inexpensive deployment without having to install
new lines.
Bescom, Inc. ("Bescom"), a New Jersey-based distributor with business
ties to the Korean market, assisted Celerity in securing the sale of digital
video servers in Korea. To date, Celerity has received approximately
$3,760,000 from Bescom pursuant to an oral distribution agreement; in
addition, approximately $467,000 is now due following the completion in
February 1998, of the sixty-day reliability period. Although systems
acceptance testing has been successfully completed, there can be no assurance
that the Company will receive payment from Bescom. The Company has
established an allowance for doubtful accounts of approximately $567,000, of
which approximately $470,000 related to the Korean contract. See
"Management's Discussion and Analysis or Plan of Operations--Results of
Operations--Year Ended December 31, 1997 Compared to Year Ended
December 31, 1996."
ISRAEL
In 1995, the Company received an order from Bezeq, the Israeli national
telephone company, through Tadiran Telecommunications Ltd. ("Tadiran"), a
major Israeli telecommunications equipment firm. The Company provided two
digital video servers and a quantity of digital set top boxes to Tadiran for
deployment on a European standard (E1) high-speed dedicated copper data line
network. Since late 1996, this project has offered services similar to those
described above to approximately 100 subscribers in Israel. Tadiran has
agreed to make total payments to the Company of approximately $1,044,000 upon
the achievement of certain milestones, of which approximately $770,000 has
been paid to date. The Company received final systems acceptance for this
project during the fourth quarter of 1997 and is in discussions regarding
payment of the balance of the contract price. There can be no assurance that
the Company will receive payment of such balance. Approximately $106,000 of
the Company's $567,000 reserve for doubtful accounts relates to the Israeli
contract. See "Management's Discussion and Analysis or Plan of
Operations--Results of Operations--Year Ended December 31, 1997 Compared to
Year Ended December 31, 1996."
TAIWAN
In 1996, the Company received, from IBM Taiwan Corporation ("IBM Taiwan"),
its first order for its most advanced digital video server, an asynchronous
transfer mode ("ATM") server designed to operate on modern fiber optic networks.
The first server has been deployed in Taiwan for IBM Taiwan for use at the
Computer and Communications Research Laboratories/Industrial Technology Research
Institute ("Taiwan CCL"), under an arrangement with IBM Taiwan, the system
integrator. Under this arrangement, Celerity is entitled to receive payments of
approximately $650,000, of which approximately $610,000 has been paid to date.
This system has been operational since February 1997, serving approximately 50
subscribers. The final systems acceptance test was successfully performed. The
Company is in discussions with the customer regarding the payment of the
remaining receivables, which have been outstanding since the early stages of the
project. This system is deployed on a hybrid fiber/coaxial cable network, of the
type being installed by many cable companies as they upgrade to higher capacity,
higher quality digital networks. This type of network, like FTTC (a widely used
fiber optic network), is able to support new applications, such as video
conferencing, video mail, robust three-dimensional graphics, and gaming.
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CHINA
In 1997, the Company sold, through its strategic alliance with ViaGate, two
of its advanced video servers to Guangdong Public Telecommunications Authority
("GPTA") for deployment in Shenzen and Guangxiaou, China. The Shenzen server is
installed and has passed its beta test, and the Guangxiaou server is being
installed and systems acceptance testing was completed in the fourth quarter of
1997. The aggregate value of this contract is approximately $1,400,000, of
which approximately $1,260,000 has been received to date. In addition, through
ViaGate, the Company received an order to install two servers for the Beijing
Telecom Authority. The aggregate sales price for such order is approximately
$712,000. Completion of the shipments is scheduled for the first quarter of
1998. These are the Company's initial deployments on an FTTC network, which is
the primary type of network which telephone companies, electric and gas utility
companies, colleges, and many business and apartment complexes are installing to
replace aging twisted pair copper networks and to potentially offer emerging
digital video, data, and voice services.
STRATEGIC ALLIANCES
The Company believes that entering into strategic alliances may give it
certain competitive advantages, including the ability to (i) reach a larger and
more diverse group of networks on which to deploy the Company's products and
services; (ii) provide a broader range of products and services; (iii) provide a
series of new and upgraded products and services, such as encoders and
applications software, which could be attractive to customers seeking to
improve, upgrade or extend their systems over an extended period of time;
(iv) offer end-to-end solutions; (v) access resources and information for
utilization in research and product development and design; (vi) test new
Company designs for compatibility with emerging technology developed by others
in order to facilitate cooperative arrangements; and (vii) pursue cooperative
efforts at trade shows and other joint marketing efforts. See "Deployments" and
"Risk Factors--Risks Associated with Contracts with En Kay Telecom Co., Ltd."
The Company is actively seeking additional strategic alliances and has
hired a key executive as Vice President of Business Development to identify,
obtain, and manage these relationships. The Company is seeking additional
alliances with (i) network system providers for technical interconnection and
joint marketing; (ii) hardware manufacturers of real-time encoders,
multiplexers, digital set top boxes, and related equipment; (iii) content
acquisition and management companies; (iv) hospitality system vendors and
distributors; (v) interactive applications software developers; and
(vi) business support systems software developers.
The Company has commenced discussions as to certain of these relationships,
while others are part of the Company's strategic plan, but all are not yet in
progress. No assurance can be given that the Company will be successful in
entering into such strategic alliances on acceptable terms or, if any such
strategic alliances are entered into, that the Company will realize the
anticipated benefits from such strategic alliances. See "Risk Factors--Need for
Strategic Alliances."
The Company has entered into strategic alliances with the following
companies:
VIAGATE TECHNOLOGIES performs joint marketing with the Company related to
ViaGate's network switching equipment. ViaGate was directly responsible for the
Company's participation in projects with GPTA, Beijing Telecom Authority, and
Taiwan CCL, and acted as a subcontractor along with the Company to Bescom in
Korea. The Company has bids in progress with ViaGate in Malaysia and China,
although there can be no assurance that any of such bids will be accepted.
TADIRAN TELECOMMUNICATIONS LTD. is a manufacturer and distributor of
telecommunications equipment in Israel and internationally. Tadiran is also the
agent for the Company's Israel project and is a distributor of the Company's
products.
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FORE SYSTEMS, INC. is a leading manufacturer of ATM switches. The Company's
agreement with Fore Systems provides for joint marketing and technical
cooperation.
The Company also has strategic alliances with MINERVA SYSTEMS, INC.
("Minerva"), a leading manufacturer of digital MPEG encoders, and COMMUNICATIONS
ENGINEERING, INC. ("CEI"), a leading provider of digital production studios,
although, to date, no sales have been made pursuant to these arrangements. The
Company's agreement with Minerva provides for joint marketing, a discounted
distributor sales program, and a discounted laboratory system. The Company's
distribution agreement with CEI allows the Company to bid CEI's systems as part
of Company projects.
COMPETITION
The interactive video services market is highly competitive and
characterized by changing technology and evolving industry standards. In this
area, the Company's competitors include a number of companies, many of which are
significantly larger than the Company and which have greater financial and other
resources or which have entered into strategic alliances with such companies.
Such competition includes numerous companies including (i) developers of
narrowband solutions (for applications like the Internet; (ii) manufacturers of
very large servers (E.G., massively parallel processors, such as those developed
by nCube, Sequent Computer Systems, Inc., Hewlett Packard Co., DEC
International, Inc., AT&T Corp. and IBM) which are generally employed for very
large deployments such as whole cities, but which may not be scalable for
smaller market deployments; (iii) direct competitors to the Company that target
the same niche markets as the Company; (iv) manufacturers of set top boxes, such
as Acorn, General Instrument, Panasonic, Samsung, Scientific Atlantic, Stellar
One, and Zenith; and (v) manufacturers of content preparation equipment, such as
DiviCom, Future Tel, Nuko, Scopus, Vela, Panasonic, Silicon Graphics, and Sony.
Although many manufacturers of large servers have implemented trial deployments
of digital video services, the Company believes that, in almost every case,
these deployments involved general purpose computers which had not been designed
for such interactive video applications. Direct competitors include SeaChange
Systems, Inc., Concurrent Computer Corporation, and IPC. Competitive factors in
the interactive video services market include completeness of features, product
scalability and functionality, network compatibility, product quality,
reliability and price, marketing and sales resources, and customer service and
support. The Company competes on the basis of its demonstrated ability to
install digital video systems on each of the four major types of networks
accommodating interactive video services and its ability to offer economically
viable solutions based on the scalability of its systems. See "Risk
Factors--Competition" and "--Product Obsolescence; Technological Change."
CD-ROM SEGMENT
The Company has scaled back its CD-ROM segment to a maintenance mode of
operations. See "Description of Business--Recent Development."
PRODUCTS
The Company's CD-ROM division has four major products, all of which are
designed to make document and image storage, management, and retrieval easy,
cost-effective, and more useful for businesses. MEDIATOR provides access to
CD-ROM towers and changers for Novell, UNIX, and Windows NT clients. VIRTUAL
CD MANAGER transforms CD-ROM changers into multi-user information libraries
connected to a Novell network. Like MEDIATOR, VIRTUAL CD MANAGER displays all
the CD devices under a single drive letter, enabling fast and simple access
to information. VIRTUAL CD WRITER is a Novell file extension that allows a
large group of users on a Novell network to record data on CD-ROMs in a
streamlined, single-step process. VIRTUAL CD WRITER and VIRTUAL CD MANAGER,
used together, provide a complete CD-ROM recording and retrieval solution for
Novell networks. CD WorkWare is a group of electronic document storage and
imaging tools which provide information management, indexing, and search
capabilities. This product allows mainframes or minicomputers to print, scan,
or tape transfer output onto a Novell network where documents are placed in
an on-line CD-ROM library that can be accessed by any network user. CD
WORKWARE may be sold alone or bundled with the Company's other CD products.
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SALES AND MARKETING
Prior to February 1998, the Company marketed its CD-ROM products through
the Company's direct sales and marketing personnel, principally to industries
where there is extensive use of electronic document and imaging and management
such as financial services, healthcare, government, and telecommunications. In
addition, the Company marketed its CD-ROM products through sales and marketing
materials and brochures, trade show participation, public relations efforts,
speaking engagements and advertising in trade publications.
COMPETITION
The CD-ROM market is competitive and characterized by changing
technology and evolving industry standards. In this area, the Company's
competitors have included a number of companies, many of which are
significantly larger than the Company and have substantially greater
financial and other resources. Competitive factors in the CD-ROM market
include completeness of features, product scalability and functionality,
product quality, reliability and price, marketing and sales resources,
distribution channels, and customer service and support. The Company's
competitors with respect to its CD-ROM products have included Eastman Kodak,
Smart Storage Inc., Optical Technology Grove, IXOS, Axis Technology, TenX,
and Alchemy. See "Risk Factors--Competition."
INTERACTIVE VIDEO AND CD-ROM SEGMENTS
INTELLECTUAL PROPERTY
The Company does not have any patents on its products and has not filed
patent applications on any products. The Company regards the products that it
owns as proprietary and relies primarily on a combination of trade secret laws,
nondisclosure agreements, other technical copy protection methods (such as
embedded coding), and copyright (where applicable) to protect its rights in and
to its products. It is the Company's policy that all employees and third-party
developers sign nondisclosure agreements. However, this may not afford the
Company sufficient protection for its know-how and its proprietary products.
Other parties may develop similar know-how and products, duplicate the Company's
know-how and products or develop patents that would materially and adversely
affect the Company's business, financial condition and results of operations.
Although the Company believes that its products and services do not infringe the
rights of third parties, and although the Company has not received notice of any
infringement claims, third parties may assert infringement claims against the
Company, and such claims may result in the Company being required to enter into
royalty arrangements, pay damages, or defend litigation, any of which could
materially and adversely affect the Company's business, financial condition and
results of operations. See "Risk Factors--Lack of Patent and Copyright
Protection."
MANUFACTURING AND MATERIALS
The Company orders the component parts of its products from a number of
outside suppliers and assembles and tests the products at its own facilities.
The Company purchases certain raw materials, components, and subassemblies
included in the Company's products from a limited group of suppliers and does
not maintain long-term supply contracts with its suppliers. The Company
relies on four principal sole source suppliers, Microware, Pacific Micro
Devices, CMD Technologies and Solaris, for integral parts of the Company's
video servers. The Company relies on three principal sole source suppliers,
Kubik Enterprises, QNX Software Systems and Diamond Head Software for its
CD-ROM products. The disruption or termination of the Company's sources of
supply for its interactive video segment could have a material adverse effect
on the Company's business and results of operations. While the Company is
aware of alternative suppliers for most of these products, there can be no
assurance that any supplier could be replaced in a timely manner. See "Risk
Factors--Dependence on Suppliers; Manufacturing Risks."
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QUALITY CONTROL, SERVICE AND WARRANTIES
The Company's products must successfully pass tests at each important stage
of the manufacturing process. The Company offers maintenance and support
programs for its products that provide maintenance, telephone support,
enhancements, and upgrades.
The Company generally warrants its interactive video servers to be free
from defects in material and workmanship for one year from the completion of the
final acceptance test. At the end of the warranty period, the Company offers
maintenance and support programs. In light of the fact that the Company has only
begun selling limited quantities of its interactive video server products in the
past few years, the Company has no basis on which to predict the likelihood of
substantial warranty claims for such products. In some cases, customers may
require a longer or more extensive warranty as part of the competitive bid
process. See "Risk Factors--Product Liability and Availability of Insurance."
The Company warrants its CD-ROM products for 30 days after purchase, with a
replacement or repair option on such CD-ROM products. There have been no
material warranty claims in connection with the CD-ROM products during the past
several years. The Company also provides its CD-ROM customers with access to a
telephone help desk for one year after purchase.
EMPLOYEES
As of December 31, 1997, the Company had 66 full-time employees,
approximately 47 of whom were employed in the engineering and product
development area, four of whom fulfilled marketing and sales functions and 15
of whom fulfilled management or administrative roles. The Company's employees
are not represented by a union or governed by a collective bargaining
agreement. See "Risk Factors--Attraction and Retention or Employees."
RISK FACTORS
CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING STATEMENTS. Statements in
this Annual Report on Form 10-KSB under the captions "Description of Business,"
"Management's Discussion and Analysis or Plan of Operations," and elsewhere in
this Annual Report, as well as statements made in press releases and oral
statements that may be made by the Company or by officers, directors or
employees of the Company acting on the Company's behalf, that are not statements
of historical fact, constitute "forward-looking statements" within the meaning
of the Private Securities Litigation Reform Act of 1995. Such forward-looking
statements involve known and unknown risks, uncertainties and other factors,
including those described in this 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. In addition to
statements which explicitly describe such risks and uncertainties, readers are
urged to consider statements labeled with the terms "believes," "belief,"
"expects," "plans," "anticipates," or "intends," to be uncertain and forward-
looking. All cautionary statements made in this Annual Report on Form 10-KSB
should be read as being applicable to all related forward-looking statements
wherever they appear. Investors should consider the following risk factors as
well as the risks described elsewhere in this Annual Report on Form 10-KSB.
HISTORY OF LOSSES AND ACCUMULATED DEFICIT. The Company commenced
operations in January 1993 and incurred net losses of approximately $264,000 and
$30,000 for the years ended December 31, 1993 and 1994, respectively; generated
net income of approximately $9,900 for the year ended December 31, 1995;
incurred a net loss of approximately $5,512,100 and $8,675,000 for the years
ended December 31, 1996 and 1997, respectively. At December 31, 1997, the
Company had an accumulated deficit of approximately $14,472,100. There can be no
assurance that the Company will operate profitably in the near
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future or at all. The Company may experience fluctuations in future operating
results as a result of a number of factors, including delays in digital video
product enhancements and new product introductions. There can be no assurance
that the Company will be able to develop commercially viable products or that
the Company will recognize significant revenues from such products.
SUBSTANTIAL UP-FRONT EXPENSES; LIQUIDATED DAMAGES PROVISIONS AND OTHER
PROJECT RISKS. A significant portion of the Company's revenues have been, and
are expected to continue to be, derived from substantial long-term projects
which require significant up-front expense to the Company with no assurance of
realizing revenues until the projects are completed or certain significant
milestones are met. For example, suppliers and developers for long-term
interactive video projects such as the Korean, Israeli, Taiwanese, and Chinese
projects in which the Company is participating are required to reach certain
milestones prior to the Company's receipt of significant payments. The Company's
failure, or any failure by a third-party with which the Company has contracted,
to perform services or deliver interactive video products on a timely basis
could result in a substantial loss to the Company. Until recently, the Company
has had difficulty in meeting delivery schedules, which has resulted in customer
dissatisfaction. In addition, difficulty in completing a project could have a
material adverse effect on the Company's reputation, business, and results of
operations. As a result of liquidated damages and "hold back" provisions in
customer contracts, the Company reserved approximately $570,000, as of December
31, 1997, for potential uncollectible accounts receivable. In many instances,
the Company is dependent on the efforts of third parties to adequately complete
their portion of a project and, even if the Company's digital video servers
perform as required, a project may still fail due to other components of the
project supplied by third parties. See "Management's Discussion and Analysis or
Plan of Operations."
EMPHASIS ON FIXED PRICE CONTRACTS AND COMMITMENTS. The Company has
entered into and may in the future enter into fixed price agreements for the
sale of its products and services. Pricing for such commitments is made based
upon development and production effort estimates and estimates of future
product costs. The Company bears the risk of faulty estimates, cost overruns,
and inflation in connection with these commitments; therefore, any fixed
price agreement can become unprofitable and could materially adversely affect
the Company. The Company reserved approximately $673,000 for the year ended
December 31, 1996 for potential losses on uncompleted contracts. The Company
completed its deliverables on the contracts in the first quarter of 1998,
exhausting the reserves established in 1996 and incurring additional costs of
approximately $190,000. See "Management's Discussion and Analysis or Plan of
Operations." There can be no assurance that these type of risks will not
continue to negatively affect the Company's margins and profitability.
RISKS ASSOCIATED WITH CONTRACTS WITH EN KAY TELECOM CO., LTD. In
September 1996, the Company entered into an agreement with En Kay Telecom Co.,
Ltd., a Korean company ("En K"), pursuant to which the Company, as licensor,
agreed to design a digital set top box which would be manufactured and sold by
En K in the Republic of Korea (the "1996 En K Agreement"). In February 1997, the
Company entered into a second license agreement with En K for the manufacture by
En K of two models of the Company's video servers in Korea, as well as a license
to sell those server models on an exclusive basis in Korea (subject to an
exception for the IVISION project) and on a non-exclusive basis elsewhere (the
"1997 En K Agreement"). The Company has received $600,000 under the 1996 En K
Agreement; however, in April 1997, the Company stopped production under the 1996
En K Agreement pending settlement of disputes under the 1997 En K Agreement. The
1997 En K Agreement provided for the payment by En K to the Company of
$1,000,000 on each of February 21, 1997 and May 1, 1997, $4,000,000 during 1998,
and minimum annual purchases of $2,000,000 over a five-year period. En K has
failed to make the initial two payments under the 1997 En K Agreement, although
En K did pay $200,000 in mid-May. The Company gave notice of default in April
1997, and placed En K in default in May 1997, when En K failed to cure the
payment default within the agreed thirty-day period. The Company is considering
various options in this matter, including commencing legal proceedings. There
can be no assurance that En K will honor either of its agreements with the
Company, that the Company will prevail in any legal proceeding, or, if the
Company does prevail, that it will collect any amounts awarded. In addition,
although the Company does not believe
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there is any basis for such a course of action, it is possible that En K may
seek to recover amounts previously paid by it under the agreements.
NON-CASH CHARGES. As a result of the issuance of an aggregate of
320,000 warrants, each to purchase one share of Common Stock (the "Bridge
Warrants") in the Company's July 1997 private offering (the "Bridge
Financing") without separate consideration and at a price below the price of
$7.50 per share at which the Common Stock was offered in the Company's
initial public offering consummated in November 1997 (the "IPO"),
simultaneously with the issuance of notes in the aggregate principal amount
of $2,000,000 (the "Bridge Notes"), the Company was required to treat the
Bridge Warrants as additional paid in capital. There was non-cash interest
expense associated with the Bridge Notes due to their original discount at
issuance. The amount of the non-cash interest expense is equal to the
difference between the total exercise price of the Bridge Warrants and the
assumed initial public offering price of the number of shares underlying the
Bridge Warrants. This expense was amortized on a monthly basis over the
one-year term of the Bridge Notes. Upon repayment of the Bridge Notes the
Company treated any unamortized discount as a loss on early extinguishment of
debt. The aggregate amount of the non-cash interest expense and the loss on
extinguishment of debt was approximately $1,440,000. Based on the foregoing,
the Bridge Notes had an effective interest rate exceeding 300%. In addition,
the Company incurred a charge of approximately $306,834 related to the
write-off of financing costs previously capitalized in connection with the
Company's 1996 private placement ("1996 Placement") and the Bridge Financing.
The Company also incurred significant non-cash compensation expenses in 1997
related to the difference between the exercise price of certain options
granted and the deemed fair value of the Common Stock underlying such options
amounting to approximately $2,544,775.
NEED FOR STRATEGIC ALLIANCES. The Company believes that there are certain
potential advantages to entering into one or more strategic alliances with major
interactive network or product providers. Although the Company has entered into
certain of such alliances, the Company is actively seeking to enter into more of
such alliances. Certain of the Company's competitors and potential strategic
allies may have entered into or may enter into agreements which may preclude
such potential allies from entering into alliances with the Company. No
assurance can be given that the Company will be successful in entering into any
such strategic alliances on acceptable terms or, if any such strategic alliance
is entered into, that the Company will realize the anticipated benefits from
such strategic alliance. See "--Competition" and "Business--Strategic
Alliances."
LIMITED MARKETING AND SALES EXPERIENCE. The Company has limited resources
and limited experience in marketing and selling its products. Although the
Company has hired a new Vice President of Sales and Marketing and three regional
sales managers, there can be no assurance that the Company will be able to
establish and maintain adequate marketing and sales capabilities or make
arrangements with others to perform such activities. Achieving market
penetration will require significant efforts by the Company to create awareness
of, and demand for, its products. Accordingly, the Company's ability to expand
its customer base will depend upon its marketing efforts, including its ability
to establish an effective internal sales organization or strategic marketing
arrangements with others. The failure by the Company to successfully develop its
marketing and sales capabilities, internally or through others, would have a
material adverse effect on the Company's business. Further, there can be no
assurance that the development of such marketing capabilities will lead to sales
of the Company's current or proposed products.
DEPENDENCE ON SUPPLIERS; MANUFACTURING RISKS. The Company relies primarily
on outside suppliers and subcontractors for substantially all of its parts,
components, and manufacturing supplies. Certain materials are currently
available only from one supplier or a limited number of suppliers. See
"Business--Manufacturing and Materials." The Company does not maintain long-term
supply contracts with its suppliers. The disruption or termination of the
Company's supply or subcontractor arrangements could have a material adverse
effect on the Company's business and results of operations. The Company's
reliance on third parties involves significant risks, including reduced control
over delivery schedules, quality assurance, manufacturing yields and cost, the
potential lack of adequate capacity, and potential misappropriations of the
Company's intellectual property. In addition, vendor delays or quality problems
could also result in lengthy production delays. To obtain manufacturing
resources, the Company may
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contract for manufacturing by third parties or may seek to enter into joint
venture, sublicense, or other arrangements with another party which has
established manufacturing capability, or it may choose to pursue the
commercialization of such products on its own. There can be no assurance that
the Company, either on its own or through arrangements with others, will be able
to obtain such capabilities on acceptable terms.
RELIANCE ON KEY CUSTOMERS. For the year ended December 31, 1995, one of
the Company's CD-ROM customers, the U.S. Navy, accounted for approximately
25% of the Company's revenues. For the year ended December 31, 1996, two of
the Company's CD-ROM customers, accounted for approximately 37% and 13% of
the Company's revenues, respectively. For the year ended December 31, 1997,
the Company had three interactive video customers that represented 38%, 15%
and 14% of the Company's revenues, respectively. The Company's interactive
video services revenues to date have been derived almost exclusively from
four telecommunications customers. The loss of any major customer could have
a material adverse effect on the Company. See "Business--Deployments."
NEED FOR ADDITIONAL FINANCING; REPAYMENT OF DEBT. Of the approximately
$12,384,000 of net proceeds received by the Company in connection with the
IPO, approximately $5,450,000 or 44.0% of the net proceeds were used to repay
existing indebtedness, including indebtedness incurred in the Company's 1996
Placement and the Bridge Financing. Such proceeds, together with $40,000 to be
paid to a former officer, were not available to fund the future operations of
the Company. In addition, the Company may, in the future, have only limited
funds available to apply to working capital, depending upon the uses of the
proceeds of the IPO, future revenues and expenditures and other factors. See
"Market for Common Equity and Related Stockholder Matters--Use of Proceeds.
"The Company anticipates that the net proceeds of the IPO, together with funds
generated from operations, will be sufficient to satisfy its operations and
capital requirements for approximately the next 12 months. Such belief is based
upon certain assumptions, and there can be no assurance that such assumptions
are correct. The Company may not be able to continue its operations beyond such
time without additional financing. There can be no assurance that such
additional financing will be available when needed on terms acceptable to
the Company, or at all. In addition, in connection with the 1996 Placement,
the Underwriter received a right of first refusal, until July 1999, to act as
placement agent or underwriter in future financings. Such right may impair the
Company's ability to obtain additional financing. See "Management's Discussion
and Analysis or Plan of Operations."
SUBSTANTIAL OPTIONS AND WARRANTS RESERVED. The Company has reserved up
to 178,929 shares of Common Stock for issuance pursuant to its 1995 Stock
Option Plan (the "1995 Plan"). To date, options to purchase an aggregate of
78,400 shares of Common Stock are outstanding under the 1995 Plan at exercise
prices ranging from $0.10 to $4.90 per share, although substantially all of
such options are exercisable at $0.10 per share. Options issued under the
1995 Plan have been exercised. The Company has reserved up to 200,000 shares
of Common Stock for issuance pursuant to its 1997 Stock Option Plan (the
"1997 Plan," and, together with the 1995 Plan, the "Plans"). As of March 31,
1998, options to purchase an aggregate of 182,000 shares of Common Stock are
outstanding under the 1997 Plan at exercise prices ranging from $2.125 to
$7.00 per share, although a majority of such options are exercisable at
$2.125 per share. The existence of options to purchase 78,400 shares of
Common Stock issued under the 1995 Plan, 182,000 shares of Common Stock
issued under the 1997 Plan and the Company's outstanding options and warrants
to purchase an additional 1,051,571 shares of Common Stock, may prove to be a
hindrance to future financings, since the holders of such warrants and
options may be expected to exercise them at a time when the Company will
otherwise be able to obtain equity capital on terms more favorable to the
Company. The existence or exercise of such options and the Company's
outstanding warrants, and subsequent sale of the Common Stock issuable upon
such exercise could adversely affect the market price of the Company's
securities.
RISKS APPLICABLE TO FOREIGN SALES. For the years ended December 31,
1996 and 1997, substantially all of the Company's interactive video revenues
were derived from projects in foreign countries derived from foreign sales.
Foreign projects and product sales are expected to continue to account for a
substantial portion of the Company's revenues in the near future. It may be
difficult to enforce agreements against foreign-based customers. See "--Risks
Associated with Contracts
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with En Kay Telecom Co., Ltd." Foreign sales, whether effected through U.S. or
foreign-based entities, could also expose the Company to certain risks,
including the difficulty and expense of maintaining foreign sales distribution
channels, barriers to trade, potential fluctuations in foreign currency exchange
rates, political and economic instability, unavailability of suitable export
financing, tariff regulations, quotas, shipping delays, foreign taxes, export
restrictions, licensing requirements, changes in duty rates, and other United
States and foreign regulations. In addition, the Company may experience
additional difficulties in providing prompt and cost effective service for its
products in foreign countries. The Company does not carry insurance against any
of these risks. See "Management's Discussion and Analysis or Plan of
Operations--Results of Operations--Year Ended December 31, 1997 Compared to Year
Ended December 31, 1996."
LACK OF PATENT AND COPYRIGHT PROTECTION. The Company holds no patents and
has not filed any patent applications with respect to its technology. The
Company's methods of protecting its proprietary knowledge may not afford
adequate protection and there can be no assurance that any patents will be
applied for or issued, or, if issued, that such patents would provide the
Company with meaningful protection from competition. In Asia and third world
countries, in which the Company does business and has license agreements, the
unauthorized use of technology, whether protected legally or not, is widespread
and it is possible that the Company's technology will be subject to theft and
infringement. Furthermore, pursuant to the Company's current business plan, it
will be necessary for the Company to make its intellectual property available to
vendors, customers, and other companies in the industry, making it even more
difficult to protect its technology.
RISK OF THIRD PARTY CLAIMS OF INFRINGEMENT. Technology-based industries,
such as the Company's, are characterized by an increasing number of patents and
frequent litigation based on allegations of patent infringement. From time to
time, third parties may assert patent, copyright, and other intellectual
property rights to technologies that are important to the Company. While there
currently are no outstanding infringement claims pending by or against the
Company, there can be no assurance that third parties will not assert
infringement claims against the Company in the future, that assertions by such
parties will not result in costly litigation, or that the Company would prevail
in any such litigation or be able to license any valid and infringed patents
from third parties on commercially reasonable terms or, alternatively, be able
to redesign products on a cost-effective basis to avoid infringement. Any
infringement claim or other litigation against or by the Company could have a
material adverse effect on the Company.
NO ASSURANCE OF TECHNOLOGICAL SUCCESS. The Company's ability to
commercialize its products is dependent on the advancement of its existing
technology. In order to obtain and maintain a significant market share the
Company will be required continually to make advances in technology. There can
be no assurance that the Company's research and development efforts will result
in the development of such technology on a timely basis or at all. Any failures
in such research and development efforts could result in significant delays in
product development and have a material adverse effect on the Company. There can
be no assurance that the Company will not encounter unanticipated technological
obstacles which either delay or prevent the Company from completing the
development of its products. Moreover, the Company believes there are certain
technological obstacles to be overcome in order to develop future products.
These obstacles include the lack of an electronic data interchange server
interface (used for real-time exchange of data between servers) and enhancements
in the ability to access and utilize information stored on remote servers. In
certain cases, the Company will be dependent upon technological advances which
must be made by third parties. There can be no assurance that the Company or
such third parties will not encounter technological obstacles which either delay
or prevent the Company from completing the development of its future products,
which could have a material adverse effect on the Company.
COMPETITION. The interactive video and CD-ROM industries are highly
competitive. Many of the companies with which the Company currently competes or
may compete in the future have greater financial, technical, marketing, sales
and customer support resources, as well as greater name recognition and better
access to customers, than the Company. There can be no assurance that the
Company will be able to compete successfully with existing or future
competitors. Certain of such competitors have entered into strategic
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alliances which may provide them with certain competitive advantages. See
"Business--Interactive Video Segment--Competition."
UNCERTAIN MARKET ACCEPTANCE. Since inception, the Company has been engaged
in the design and development of interactive video and CD-ROM products. As with
any new technology, there is a substantial risk that the marketplace may not
accept the technology utilized in the Company's products. Market acceptance of
the Company's products will depend, in large part, upon the ability of the
Company to demonstrate the performance advantages and cost-effectiveness of its
products over competing products and the general acceptance of interactive video
services. In particular, the Company believes that widespread deployment of
interactive video services will depend on a number of factors, including
(i) decreases in the cost per subscriber, (ii) the "user-friendliness" of such
systems, particularly set top boxes and remote controls which are relatively
easy to understand and use, and (iii) improvements in the quantity and quality
of interactive services available. Although recent developments have reduced the
cost per subscriber, and the Company anticipates that such costs will continue
to decrease as interactive video systems are more widely deployed, the current
cost per subscriber may make the system too expensive for a number of potential
network operators. There can be no assurance that the Company will be able to
market its technology successfully or that any of the Company's current or
future products will be accepted in the marketplace.
PRODUCT OBSOLESCENCE; TECHNOLOGICAL CHANGE. The industries in which the
Company operates are characterized by unpredictable and rapid technological
changes and evolving industry standards. The Company will be substantially
dependent on its ability to identify emerging markets and develop products that
satisfy such markets. There can be no assurance that the Company will be able to
accurately identify emerging markets or that any products the Company has or
will develop will not be rendered obsolete as a result of technological
developments. The Company believes that competition in its business may
intensify as technological advances in the field are made and become more widely
known. Many companies with substantially greater resources than the Company are
engaged in the development of products similar to those proposed to be sold by
the Company. Commercial availability of such products could render the Company's
products obsolete, which would have a material adverse effect on the Company.
Moreover, from time to time, the Company may announce new products or
technologies that have the potential to replace the Company's existing product
offerings. There can be no assurance that the announcement or expectation of new
product offerings by the Company or others will not cause customers to defer
purchases of existing Company products, which could materially adversely affect
the Company.
DEPENDENCE ON KEY PERSONNEL. The Company's success depends to a
significant extent on the performance and continued service of its senior
management, particularly Kenneth D. Van Meter, Glenn West, William R. Chambers,
Mark Cromwell, Dennis Smith and James Fultz. In addition, the Company's senior
officers (with the exception of Mr. West) joined the Company in 1997 and 1998
and do not have a long-standing relationship with the Company. The Company's
failure to retain the services of key personnel or to attract additional
qualified employees could adversely affect the Company. The Company has entered
into employment agreements with Messrs. Van Meter and West. Mr. Van Meter's
employment agreement expires on January 20, 2000, unless terminated for cause.
Mr. West's employment agreement expires May 1, 2000, unless terminated for cause
or disability. Each of Messrs. Chambers', Cromwell's, Smith's and Fultz's
employment with the Company may be terminated by them or the Company at any
time. The Company owns and is the beneficiary of key man life insurance policies
on the lives of Messrs. Van Meter and West in the amount of $2,000,000 each.
ATTRACTION AND RETENTION OF EMPLOYEES. The Company's business involves
the delivery of professional services and is labor-intensive. The Company's
success will depend, in large part, upon its ability to attract, develop,
motivate, and retain highly skilled technical and sales personnel, including
managers and other senior personnel. Subject to the availability of funds, in
1998 the Company intends to have hired approximately 50 employees for its
engineering, product development and operations; sales and marketing; and
management and administrative staff. Although the Company intends to utilize
a portion of the remaining proceeds of the IPO for this purpose, there can be
no assurance that such funds will not be reallocated to other uses. See
"Market for Common Equity and Related Stockholder Matters--Use of Proceeds."
Even if funds are available for hiring of
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employees, there can be no assurance that the Company will be able to attract
and retain sufficient numbers of highly skilled technical and sales personnel.
The loss of some or all of the Company's managers and other senior personnel
could have a material adverse effect upon the Company, including its ability to
secure and complete projects in which it is currently engaged. No managers or
other senior personnel (other than Messrs. Van Meter and West) have entered into
employment agreements obligating them to remain in the Company's employ for any
specific term.
INDUSTRY STANDARDS AND COMPATIBILITY WITH EQUIPMENT AND SOFTWARE. The
interactive video and CD-ROM industries are currently characterized by emerging
technological standards. Widespread commercial deployment of the Company's
products will depend on determinations by the industry as to whether such
products will be compatible with the infrastructure equipment and software which
comprise those standards. Failure to comply substantially with industry
standards in a timely manner, either as they exist at a given time or as they
may evolve in the future, could have a material adverse effect on the Company.
In some cases, to be compatible with industry standards, the Company may need to
obtain the cooperation of its suppliers, partners, and competitors, which cannot
be assured.
ERRORS AND OMISSIONS; SOFTWARE AND HARDWARE BUGS. Certain of the Company's
products consist of internally developed software and hardware component sets,
purchased software from third parties, and purchased hardware components.
Additionally, the Company outsources substantially all of the manufacturing of
its products, including the installation and configuration of certain hardware
and software components. There is a substantial risk that these components will
have or could develop certain errors, omissions, or bugs that may render the
Company's products unfit for the purposes for which they were intended. While
there are no such known errors, omissions, or bugs, there can be no assurance
that such errors, omissions, or bugs do not currently exist or will not develop
in the Company's current or future products. Any such error, omission, or bug
found in the Company's products could lead to delays in shipments, recalls of
previously shipped products, damage to the Company's reputation, and other
related problems which would have a material adverse effect on the Company.
GOVERNMENT REGULATION. The Federal Communications Commission and certain
state agencies regulate certain of the Company's products and services and
certain of the users of such products and services. The Company is also subject
to regulations applicable to businesses generally, including regulations
relating to manufacturing. In addition, regulatory authorities in foreign
countries in which the Company sells or may sell its products may impose similar
or more extensive governmental regulations. Although the Company has relied
upon, and contemplates that it will continue to rely upon, its corporate
partners or interactive video system sponsors to comply with applicable
regulatory requirements, there can be no assurance that such regulations will
not materially adversely affect the Company, by jeopardizing the projects in
which the Company is participating, by imposing burdensome regulations on the
users of the products, by imposing sanctions that directly affect the Company,
or otherwise. Changes in the regulatory environment relating to the industries
in which the Company competes could have an adverse effect on the Company. The
Company cannot predict the effect that future regulation or regulatory changes
may have on its business.
PRODUCT LIABILITY AND AVAILABILITY OF INSURANCE. The manufacture and sale
of the Company's products entails the risk of product liability claims. In
addition, many of the telephone, cable, and other large companies with which the
Company does or may do business may require financial assurances of product
reliability. The Company maintains product liability insurance in the amount of
$1,000,000 per occurrence and $2,000,000 in the aggregate. The Company may be
required to obtain additional insurance coverage. Product liability insurance is
expensive and there can be no assurance that additional insurance will be
available on acceptable terms, if at all, or that it will provide adequate
coverage against potential liabilities. The inability to obtain additional
insurance at an acceptable cost or to otherwise protect against potential
product liability could prevent or inhibit commercialization of the Company's
products. A successful claim brought against the Company in excess of its
insurance coverage could have a material adverse effect on the Company.
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VARIABILITY OF QUARTERLY OPERATING RESULTS. Variations in the Company's
revenues and operating results occur from time to time as a result of a number
of factors, such as the number of interactive video projects in which the
Company is engaged, the completion of work or achievement of milestones on
long-term projects, and the timing and progress of the Company's product
development efforts. The timing and realization of revenues is difficult to
forecast, in part, because the Company's sales and product development cycles
for interactive video products can be relatively long and may depend on factors
such as the size and scope of its projects. The Company has not received orders
for any new interactive video projects since June, 1997. Furthermore, as
a result of a variety of other factors, including the introduction of new
products and services by competitors, and pricing pressures and economic
conditions in various geographic areas where the Company's customers and
potential customers do business, the Company's sales and operating results may
vary substantially from year to year and from quarter to quarter. The variation
in sales and operating results may be expected to increase as a result of the
scaling back of the Company's CD-ROM operations. In addition, the timing of
revenue recognition for revenue received from long term projects under the
Company's accounting policies may also contribute to significant variations in
the Company's operating results from quarter to quarter. See "Management's
Discussion and Analysis or Plan of Operations."
CONTROL BY MANAGEMENT. The Company's officers and directors beneficially
own approximately 27% of the outstanding Common Stock. As a result of such
ownership, management may have the ability to control the election of the
directors of the Company and the outcome of issues submitted to a vote of the
stockholders of the Company. See "Principal Stockholders."
LACK OF DIVIDENDS. The Company has never paid any cash or other dividends
on its Common Stock. Management anticipates that, for the foreseeable future,
any earnings that may be generated from operations will be used to support its
internal growth and that dividends will not be paid to stockholders.
LIMITATIONS ON LIABILITY OF DIRECTORS. The Company's Certificate of
Incorporation includes provisions to eliminate, to the full extent permitted by
law as it may from time to time be in effect, the personal liability of
directors of the Company for monetary damages arising from a breach of their
fiduciary duties as directors. The Company's Certificate of Incorporation
includes provisions to the effect that (subject to certain exceptions) the
Company shall indemnify, and upon request shall advance expenses to, any
director in connection with any action related to such a breach of their
fiduciary duties as directors to the extent that such indemnification and
advancement of expenses is permitted under such law as it may from time to time
be in effect. In addition, the Company's Certificate of Incorporation requires
that the Company indemnify, any director, officer, employee or agent of the
Company for acts which such person conducted in good faith. As a result of such
provisions, stockholders may be unable to recover damages against the directors
and officers of the Company for actions taken by them which constitute
negligence, gross negligence, or a violation of their fiduciary duties, which
may reduce the likelihood of stockholders instituting derivative litigation
against directors and officers and may discourage or deter stockholders from
suing directors, officers, employees, and agents of the Company for breaches of
their duty of care, even though such action, if successful, might otherwise
benefit the Company and its stockholders.
GENERAL ECONOMIC CONDITIONS. The industry in which the Company competes
relies in part upon consumer confidence and the availability of discretionary
income, both of which can be adversely affected during a general economic
downturn.
ANTI-TAKEOVER EFFECTS OF CERTAIN PROVISIONS OF CERTIFICATE OF INCORPORATION
AND DELAWARE LAW. The Company's Certificate of Incorporation authorizes the
issuance up to 3,000,000 shares of "blank check" preferred stock, from time to
time, in one or more series, solely on the authorization of its Board of
Directors. Accordingly, the Board of Directors is empowered, without obtaining
stockholder approval, to fix the dividend rights and terms, conversion rights,
voting rights, redemption rights and terms, liquidation preferences, and any
other rights, preferences, privileges, and restrictions applicable to each new
series of preferred stock. The issuance of such stock could, among other
results, adversely affect the voting power of
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the holders of Common Stock and, under certain circumstances, make it more
difficult for a third party to gain control of the Company, discourage bids for
the Common Stock at a premium, or otherwise adversely affect the market price of
the Common Stock. Such provisions may discourage attempts to acquire the
Company. The Company has no current arrangement, commitment or understanding
with respect to the issuance of its preferred stock. There can be no assurance,
however, that the Company will not, in the future, issue shares of preferred
stock. Certain provisions of Delaware law may also discourage third party
attempts to acquire control of the Company.
UNCERTAINTY OF TRADING OF SECURITIES ON THE NASDAQ SMALLCAP MARKET; PENNY
STOCK. The continued trading of the Company's Common Stock on the Nasdaq
SmallCap Market will be conditioned upon the Company meeting certain asset,
capital and surplus, earnings, and stock price requirements. To maintain
eligibility for trading on the Nasdaq SmallCap Market, the Company will be
required to maintain (i) net tangible assets in excess of $2,000,000, market
capitalization in excess of $35,000,000 or net income (in the latest fiscal year
or two of the last three fiscal years) in excess of $500,000; (ii) a market
value of shares held by non-affiliates of the Company in excess of $4,000,000;
and (iii) (subject to certain exceptions) a bid price of $1.00 per share. Upon
completion of the IPO and the receipt of the net proceeds therefrom, the Company
met the respective asset, capital and surplus, and minimum stock price
requirements. However, if the Company fails any of the tests, the Common Stock
may be delisted from trading on the Nasdaq SmallCap Market. The effects of
delisting include the limited release of the market prices of the Company's
Common Stock and limited news coverage of the Company. Delisting may restrict
investors' interest in the Company's securities and materially adversely affect
the trading market and prices for such securities and the Company's ability to
issue additional securities or to secure additional financing. In addition to
the risk of volatile stock prices and possible delisting, low price stocks are
subject to the additional risks of federal and state regulatory requirements and
the potential loss of effective trading markets. In particular, if the Common
Stock were delisted from trading on the Nasdaq SmallCap Market and the trading
price of the Common Stock was less than $5.00 per share, the Common Stock could
be subject to Rule 15g-9 under the Securities Exchange Act of 1934, as amended,
which, among other things, requires that broker/dealers satisfy special sales
practice requirements, including making individualized written suitability
determinations and receiving purchasers' written consent, prior to any
transaction. If the Company's securities could also be deemed penny stocks under
the Securities Enforcement and Penny Stock Reform Act of 1990, this would
require additional disclosure in connection with trades in the Company's
securities, including the delivery of a disclosure schedule explaining the
nature and risks of the penny stock market. Such requirements could severely
limit the liquidity of the Company's securities and the ability of purchasers in
the IPO to sell their securities in the secondary market.
SHARES ELIGIBLE FOR FUTURE SALE. At December 31, 1997, the Company had
4,104,769 shares of Common Stock outstanding. Of these shares, all of the
2,000,000 shares of Common Stock sold in the IPO generally are freely
transferable by persons other than affiliates of the Company, without
restriction or further registration under the Securities Act of 1933, as
amended (the "Securities Act"). The remaining 2,104,769 shares of Common
Stock (the "Restricted Shares") outstanding were sold by the Company in
reliance on exemptions from the registration requirements of the Securities
Act and are "restricted securities" as defined in Rule 144 under the
Securities Act. Of such amount, approximately 2,051,639 of the outstanding
shares of Common Stock may be sold pursuant to Rule 144, not including shares
of Common Stock underlying certain options and warrants which may be sold
under Rule 144 pursuant to Rule 701 under the Securities Act or if "cashless
exercise" provisions are utilized in connection with the exercise thereof.
The sale of a substantial number of shares of Common Stock or the
availability of Common Stock for sale could adversely affect the market price
of the Common Stock prevailing from time to time. The Company, its officers,
directors, and certain stockholders holding an aggregate of 895,552 shares of
Common Stock have entered into agreements with the Underwriter which prohibit
them from offering, issuing, selling, or otherwise disposing of any
securities of the Company for a period of 18 months following the date of the
IPO, without the prior written consent of the Underwriter. In addition,
certain stockholders holding an aggregate of 426,654 and 497,146 shares of
Common Stock have entered into agreements with the Underwriter which prohibit
them from offering, issuing, selling, or otherwise disposing of any
securities of the Company for
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a period of 12 months and six months, respectively, following the date of the
IPO, without the prior written consent of the Underwriter.
POSSIBLE VOLATILITY OF STOCK PRICE. The market prices of equity securities
of computer technology and software companies have experienced extreme price
volatility in recent years for reasons not necessarily related to the individual
performance of specific companies. Accordingly, the market price of the Common
Stock following this IPO may be highly volatile. Factors such as announcements
by the Company or its competitors concerning products, patents, technology,
governmental regulatory actions, other events affecting computer technology and
software companies generally as well as general market and economic conditions
may have a significant effect on the market price of the Common Stock and could
cause it to fluctuate substantially.
RESEARCH AND DEVELOPMENT COSTS
Research and development costs amounted to $357,436 and $479,558 for the
years ended December 31, 1997 and 1996, respectively.
ITEM 2. DESCRIPTION OF PROPERTY.
In 1997, the Company maintained its executive offices in approximately
11,800 square feet of space in Knoxville, Tennessee pursuant to a lease
expiring on February 28, 2000. Monthly lease payments have averaged
approximately $11,000 over the term of the lease. The Company entered into a
lease for new premises in Knoxville, Tennessee effective in January 1998, and
relocated effective March 30, 1998. The Company is seeking to sublet its
former premises; however, there can be no assurance that the Company will not
be required to pay its obligations under the lease for such premises. The
Company is leasing approximately 39,000 square feet of space at its new
premises and the lease term expires on December 31, 2004. Monthly lease and
maintenance payments under the new lease will average approximately $47,000
per month. In addition, under its new lease, the Company is leasing
approximately 5,400 square feet on a temporary basis through June 30, 1998.
ITEM 3. LEGAL PROCEEDINGS.
The Company knows of no material litigation or proceeding pending,
threatened or contemplated to which the Company is or may become a party. See
"Description of Business--Risk Factors--Risks Associated with Contracts with En
Kay Telecom Co., Ltd."
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There were no matters submitted to a vote of stockholders during the fourth
quarter of the fiscal year ended December 31, 1997.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
MARKET INFORMATION.
The Common Stock commenced trading on the Nasdaq SmallCap Market on
November 4, 1997 under the symbol "CLRT." Beginning on November 4, 1997, the
date of the IPO, through December 31, 1997, the high and low bid prices of a
share of Common Stock were $8.25 and $1.625, respectively, as reported by the
Nasdaq SmallCap Market.
As of March 26, 1998 there were approximately 136 holders of record of
the Common Stock.
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The Company has not paid dividends on the Common Stock since inception and
does not intend to pay any dividends to its stockholders in the foreseeable
future. The Company currently intends to retain earnings, if any, for the
development and expansion of its business. The declaration of dividends in the
future will be at the election of the Board of Directors and will depend upon
the earnings, capital requirements, and financial position of the Company,
general economic conditions, and other factors the Board of Directors deems
relevant.
USE OF PROCEEDS
On August 13, 1997, the Company filed a Registration Statement on Form
SB-2 (Registration No. 333-33509 (the "Registration Statement")) registering
the sale in the IPO to 2,300,000 shares of Common Stock with an aggregate
offering price of $17,250,000; 200,000 underwriter's warrants, each to
purchase one share of Common Stock (the "Warrants"), with an aggregate
offering price of $200; and 200,000 shares of Common Stock underlying the
Warrants, with an aggregate offering price of $1,800,000. The Registration
Statement was declared effective on November 4, 1997. On November 7, 1997
the Company consummated its initial public offering and sold, through
Hampshire Securities Corporation ("Hampshire"), acting as underwriter,
2,000,000 shares of Common Stock at $7.50 per share for an aggregate purchase
price of $15,000,000. The Company also issued 168,000 Warrants to Hampshire
at $0.001 each for an aggregate purchase price of $168.
In connection with such offering, the Company incurred $1,162,500 for
underwriting discounts and commissions, $450,000 of expenses paid to or for
the underwriter, and $1,002,742 of other expenses for total expenses of
$2,615,242 (including directors' and officers' insurance for liabilities
under the Securities Act). Such total expenses were approximately $233,000
in excess of the amounts allocated to offering expenses and such insurance in
the Registration Statement. None of such expenses represented direct or
indirect payments to directors, officers or persons owning ten percent or
more of any class of equity securities of the issuer or to any affiliate of
the issuer.
From November 4, 1997 through December 31, 1997, approximately
$5,450,000 of the net proceeds of such offering was applied to repay
indebtedness, $40,000 was applied to payments under a termination agreement
with a former officer, $111,000 was applied to the payment to and cost of
recruiting and relocating additional engineering personnel, and $1,262,000
was applied to working capital, which was approximately $204,000 in excess of
the amount allocated to working capital in the Registration Statement.
Approximately $85,000 of such working capital represented payroll for
officers of the Company. Approximately $4,593,000 of the net proceeds were,
at December 31, 1997, invested in a commercial bank investment account and in
cash equivalents and approximately $1,229,800 was invested in liquid low risk
short-term instruments. As disclosed in the Registration Statement, the
Company has reapportioned, and will continue to reapportion, the proceeds of
the IPO among the categories listed in the Registration Statement or to new
categories in response to, among other things, changes in its plans,
employment needs, industry conditions and future revenues and expenditures.
See "Risk Factors--Attraction and Retention of Employees."
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
OPERATIONS
The following discussion should be read in conjunction with the financial
statements and notes thereto and other financial information appearing elsewhere
in this Annual Report on Form 10-KSB. Statements in this Management's Discussion
and Analysis or Plan of Operation and elsewhere in this Annual Report 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 under "Description of
Business--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. 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 sales, marketing, and research and
development efforts in 1997 on its interactive video segment and intends to
focus on such segment in the future. The Company has scaled
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back its CD-ROM segment to a maintenance mode of operations. See "Description
of Business--Recent Developments." Sales of interactive video products
accounted for 28% and 72% of revenues for the years ended December 31, 1996 and
1997, respectively.
Commencing August 1996, in connection with a change of management, and
until approximately January 1997, when Kenneth D. Van Meter, the Company's
current Chief Executive Officer, began his employment with the Company, the
Company suspended substantially all of its interactive video sales efforts to
permit new management to formulate a new business plan. 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.
The Company entered into one short-term interactive video contract in 1996
and two others in 1997. Due to the short-term nature of these projects, revenues
from these contracts are recorded by the completed contract method of
accounting, which provides for recognition of revenues and related costs upon
completion of each contract. Costs in excess of billings on these uncompleted
short-term contracts are reflected as current assets, while billings in excess
of costs are reflected as current liabilities. The contract entered into in
1996, and one of the contracts entered into in 1997, were completed in the
fourth quarter of 1997. Revenues and related costs were recognized
in that quarter.
The Company's 1996 short-term contract was with IBM Taiwan Corporation.
The value of this contract was approximately $655,000, of which approximately
$125,000, relating to separate deliverable items, was recognized in 1996. The
Company recognized revenues of approximately $530,000 upon completion of the
project during the fourth quarter of 1997. The Company incurred approximately
$493,000 in costs associated with the Taiwan project.
The Company has also completed the short-term contract entered into with
the Guangdong Public Telecommunications Authority ("GPTA") in 1997. The value
of the GPTA contract was approximately $1,404,000. The Company recognized all
of the revenues relating to the GPTA contract upon the project's completion,
in the fourth quarter of 1997. The Company incurred approximately $810,000 in
costs associated with the GPTA project. The other short-term contract the
Company entered into during 1997 was with the Beijing Telecom Authority
("BTA") and valued at approximately $712,000. In the first quarter of 1998,
the project was completed and the Company recognized all of the revenues
relating to the BTA contract. The Company had capitalized approximately
$587,000 in costs associated with the BTA project and recognized those costs
upon completion.
The Company had two interactive video customers and one CD-ROM customer
that represented 13%, 13% and 51%, respectively, of its revenues in 1996. The
Company had three interactive video customers that represented 38%, 15% and
14%, respectively, of its revenues in 1997.
Currently, the principal markets for the Company's interactive video
products are Korea, Israel, Taiwan, and China. Export sales for the years
ended December 31, 1996 and 1997 were approximately $878,500, and $2,654,800,
respectively. Export sales represented 35% and 71% of revenues for the years
ended December 31, 1996 and 1997, respectively. Sales to a Korean customer
represented 41%, and 15% of revenues, while sales to an Israeli customer
represented 36%, and 3% of revenues, for the years ended December 31, 1996
and 1997, respectively. All revenues associated with the Company's long-term
Korean and Israeli projects have been recognized by the Company. During
1997, export sales to China and Taiwan were 38% and 14% of revenues,
respectively.
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. See "Description of Business--Risk Factors--Risk Applicable to
Foreign
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Sales" and "--Risks Associated with Contracts with En Kay Telecom Co., Ltd." In
addition, the Company has experienced difficulties with respect to certain of
its foreign deployments. See "--Results of Operations."
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
REVENUES. Revenues for the year ended December 31, 1997 were approximately
$3,728,300 as compared to approximately $2,530,100 for the prior year.
Revenues for the interactive video segment were approximately $2,689,400
for the year ended December 31, 1997 as compared to approximately $720,700 for
the prior year. The increase in revenues for the interactive video segment was
primarily due to the Company's completion of the GPTA and Taiwan contracts
during the fourth quarter of 1997. The Company recognized approximated
$1,403,000 and $530,000 of revenues from the GPTA and Taiwan contracts,
respectively, in 1997.
The Company continued its efforts to complete its existing long-term
projects in Korea and Israel throughout 1997. The Company was unable to
complete its Korean and Israeli projects in 1996 primarily because of
difficulties associated with the initial deployments of advanced new
technologies and prototype products (the Company's initial model of its
digital video server in Korea and Israel and its initial set top box model in
Israel), including a lack of experienced staff at the Company, its prime
contractors, co-vendors and customers. These difficulties were exacerbated by
changing customer requirements, the long distances involved, and cultural
factors. Further, products and services provided by the other vendors, such
as the set top boxes for the Korean project, network equipment and system
software, were also at a prototypical stage and experienced numerous
operational problems.
The Company has undertaken a number of initiatives to address these
difficulties. Improvements, including enhancements in speed, capacity,
reliability, and fault recovery, have been made to the Company's digital video
servers, which have moved these units from near-prototype to production status.
The Company has instituted a practice of semi-annual major software and hardware
releases for each product to enhance their stability. The Company has also
become more experienced and adept in international operations, and has
implemented numerous new policies and procedures, including (i) the provision of
full-time Company technical personnel at each deployment site, (ii) the
retention of in-country support sub-contractors, (iii) the provision of
replacement parts at deployment sites to avoid shipping delays, and (iv) the
institution of a product life cycle management program, which are intended to
enhance the Company's management of the deployment process, including
international deployments, and to improve communications with customers,
contractors and co-vendors. The Company believes that these changes will improve
the quality and serviceability of its products and potentially reduce the costs
and prices of those products. For information regarding the current status of
the Company's interactive video deployments, see "Description of
Business--Interactive Video Segment--Deployments."
The Company received the final acceptance certificate from Korea Telecom
in the first quarter of 1998. This indicates that the project passed its
reliability period. The Company is currently in discussions with its Korean
liaison regarding the collection of its receivables on the contract. The
Company received final systems acceptance and is in discussions with Tadiran
Telecommunications regarding the collection of its receivables on that
contract. The Company does not anticipate incurring any additional
significant costs related to the two contracts, other than warranty
obligations. The Company has established a $235,000 warranty reserve to
cover costs incurred by the Company during the warranty periods.
The Company has hired new management, including a Chief Executive
Officer, Vice President of Engineering, Vice President of Sales and
Marketing, Vice President of Operations, and Director of Training and
Documentation, with years of
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relevant experience, and intends to continue to hire additional qualified
personnel. See "Market for Common Equity and Related Stockholder Matters--Use of
Proceeds."
Revenues for the CD-ROM segment were approximately $1,038,900 for the
year ended December 31, 1997 as compared to approximately $1,809,400 for the
same period in 1996. This decrease was largely due to the lack of qualified
general management and sales management expertise in the CD-ROM segment.
COSTS OF REVENUES. Costs of revenues for the year ended December 31, 1997
were approximately $3,344,400, or 90% of revenues, as compared to approximately
$3,513,000, or 139% of revenues, for the prior year. The decrease was due in
large part to the fact that in the prior year, the Company had recorded a
$672,600 estimated loss on the Korean project. During 1997, the costs
associated with that project were taken against the reserve rather than being
recognized as losses.
The reserve for estimated losses was established at the end of 1996,
based upon management's determination that substantial costs, such as wages,
contractor costs, and travel expenses, would be incurred through September
1997, which was the expected completion date of the Korean project. The
reserve was exhausted in October 1997. The Company incurred an additional
$107,000 in costs, relating to the Korean project in the fourth quarter of
1997. In addition, the Company incurred approximately $31,700 in cost
relating to the contract by the end of February 1998. The Company received
the final acceptance certificate from the customer in February 1998. The
Company does not intend to incur any additional significant costs regarding
the completion of the contract. The Company incurred an additional $49,000 in
costs through December 31, 1997 in efforts to complete its Israel contract.
The Company has completed the contract and has received final systems
acceptance. The Company does not anticipate any significant additional costs
relating to the Israeli contract. The Company does have warranty obligations
but believes the reserve established at the end of 1996 and increased to
$235,000 by the end of 1997 is adequate in covering those expenses.
Costs of revenues for the interactive video segment were $2,620,900 or
97% of interactive video revenues, for the year ended December 31, 1997 as
compared to $2,418,300, or 336% of interactive video revenues, for the prior
year. The increase was due to increased interactive video materials costs of
approximately $336,000 for the year ended December 31, 1997 as compared to
the prior year. The higher materials costs in 1997 were due to the completion
of two of the Company's short-term projects. The costs of materials
associated with the GPTA and Taiwan contracts, which were recognized upon
completion of the two projects, approximated $520,800 and $265,700,
respectively. Direct labor costs increased by $560,000 for the year ended
December 31, 1997 as compared to the prior year, primarily due to an increase
of approximately $313,000 in engineering salaries. Thus, more of the salaries
were classified as a cost of revenue in 1997. The increases in materials
costs and direct labor costs were partially offset by the reserve established
for the estimated loss on the Company's long-term contracts in 1996 amounting
to $672,600.
Costs of revenues for the CD-ROM segment were approximately $723,500, or
70% of CD-ROM revenues, for the year ended December 31, 1997 as compared to
approximately $1,094,800, or 60% of CD-ROM revenues, for the same period in
1996. The decrease is due to the decrease in CD-ROM revenues,
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as discussed above. The increase in the costs of revenues as a percentage of
sales is due to the change in the product mix of hardware and software.
Hardware revenues constituted 55% of CD-ROM revenues in 1997 as compared to 43%
of such revenues in 1996.
As a result of the factors discussed above, the Company's gross margin
increased from a loss of approximately $982,900 in 1996 to a profit of
approximately $383,900 in 1997.
OPERATING EXPENSES. Operating expenses for the year ended December 31,
1997 were approximately $7,087,300 as compared to approximately $4,491,400
for the same period in 1996. The increase was primarily due to non-cash
compensation expense approximating $2,544,800 recognized in the year ended
December 31, 1997. The non-cash charges are related to options to purchase
common stock that were issued below the public offering price in the IPO.
Although the operating expenses would appear to be consistent after deducting
the non-cash charges, the nature of a large portion of the operating expenses
between the two years was different due to the establishment in 1996 of
reserves for doubtful accounts, an accrual for inventory obsolescence, and an
accrual for amounts owed to one of the company's former founders, which in
the aggregate approximated $1,115,600.
Operating expenses for the interactive video segment were approximately
$5,315,500 for the year ended December 31, 1997 as compared to approximately
$3,365,000 for the prior year. The increase was due primarily to the non-cash
compensation expenses amounting to approximately $1,908,600 allocated to the
interactive video segment, as discussed above. Operating expenses in 1996
included an accounts receivable reserve of $555,000 related to the
interactive video segment. The reserve was established at December 31, 1996
because management determined that, due to missed deadlines relating to the
Company's Korean and Israeli projects, receivables relating to those projects
were doubtful as to collection. The Company anticipates that the Korean and
Israeli receivables will be settled not later than the end of the second
quarter of 1998. As of December 31, 1997, the Company had approximately
$467,000 and $308,000 in accounts receivable outstanding relating to the
Korean and Israeli projects, respectively. There were increases in various
areas during 1997 to offset the decrease due to establishment of the accounts
receivable reserve in 1996. Administrative wages allocated to the
interactive video segment increased approximately $123,000 due to added
positions in the corporate department. There were approximately $748,000 of
operating expenses charged to the interactive video segment for consultants,
contractors, recruiting, and relocation of skilled personnel during 1997 as
compared to $160,000 of such expenses for the prior year.
Operating expenses for the CD-ROM segment were approximately $1,771,800 for
the year ended December 31, 1997 as compared to approximately $1,126,000 for the
same period in 1996. The increase was due to the non-cash compensation charges
allocated to the segment approximating $636,200. Other operating expenses
remained consistent for the two years.
NET INCOME (LOSS). As a result of the factors discussed above, net loss
for the year ended December 31, 1997 was approximately $8,675,030 as compared
to a net loss of approximately $5,512,100 for the same period in 1996. The
interactive video segment had net losses of approximately $5,062,900 and
$5,228,300 for the years ended December 31, 1996 and 1997, respectively. The
CD-ROM segment had net losses of approximately $411,500 and $1,444,900 for
the years ended December 31, 1996 and 1997, respectively.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
REVENUES. Revenues for the year ended December 31, 1996 were approximately
$2,530,100 as compared to approximately $7,703,400 for the prior year.
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Revenues for the interactive video segment were approximately $720,700 for
the year ended December 31, 1996 as compared to approximately $4,807,100 for the
same period in 1995. The decrease in revenues for the interactive video segment
was primarily due to the Company's inability to complete its existing projects
in Korea and Israel, which limited the Company's ability to pursue new business
and resulted in the suspension of substantially all of the Company's
interactive video sales efforts from August 1996 until approximately January
1997.
Revenues for the CD-ROM segment were approximately $1,809,400 for the
year ended December 31, 1996 as compared to approximately $2,896,300 for the
prior year. The decrease was primarily due to a reduced focus on selling the
VCD Manager and VCD Writer products. The Company analyzed the market and
decided to devote greater resources to selling its Mediator and CD Workware
products since the VCD Manager and VCD Writer products were encountering
increased competition and lower margins. The CD Workware products generate
greater revenues per
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sale than the Company's other CD-ROM products, but have a longer sales cycle. As
a result of the change in the Company's sales focus, sales to potential
customers were slower. The Mediator product's largest customer is the U.S. Navy.
The division of the U.S. Navy responsible for the majority of the U.S. Navy's
purchases lacked federal funding, and changed its required specifications for
the product. The effort required to meet specifications to the product added to
the decreased revenues in the latter part of 1996.
COSTS OF REVENUES. Costs of revenues for the year ended December 31,
1996 were approximately $3,513,000, or 139% of revenues, as compared to
approximately $4,609,300, or 60% of revenues, for the prior year. The
majority of the decrease was attributable to a decrease in materials costs
for both the interactive video and CD-ROM segments.
Costs of revenues for the interactive video segment were $2,418,300, or
336% of interactive video revenues, for the year ended December 31, 1996 as
compared to $2,815,700, or 59% of interactive video revenues, for the prior
year. The decrease was due to decreased interactive video materials costs of
approximately $1,913,000 for the year ended December 31, 1996 as compared to
the same period in 1995. The higher costs in 1995 were due to the
expenditures associated with the initial phases of the Korean and Israeli
projects. The decreased materials costs in the year ended December 31, 1996
were partially offset by reserves for estimated losses to be incurred during
1997 for the completion of the Korean project amounting to $672,600, and
reserves for inventory obsolescence amounting to $500,000, as well as
increased direct labor costs of approximately $390,000.
The reserve for estimated losses was established based upon management's
determination that substantial costs, such as wages, contractor costs, and
travel expenses, would be incurred through September 1997, which was the
expected completion date of the Korean project. Approximately $348,000 remained
in the reserve at June 30, 1997, of which approximately $250,000 and $98,000
related to the estimated costs of completion of the Korean and Israeli projects,
respectively.
The inventory obsolescence reserve was establisted based upon management's
review of the inventory balances of certain items during the closing process of
the year ended December 31, 1996. Management evaluated those items based on
planned utilization. A large part of the Company's inventory consists of printed
circuit boards and items which make up those boards, such as integrated
circuits. Management determined that carrying costs of this inventory were
overstated due to
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obsolescence. The Company plans to complete disposal of the obsolete
inventory during the second quarter of 1998.
Costs of revenues for the CD-ROM segment were approximately $1,094,800, or
60% of CD-ROM revenues, for the year ended December 31, 1996 as compared to
approximately $1,793,500, or 62% of CD-ROM revenues, for the same period in
1995.
As a result of the factors discussed above, the Company's gross margin
decreased from approximately $3,094,100 in 1995 to a loss of approximately
$982,900 in 1996.
OPERATING EXPENSES. Operating expenses for the year ended December 31,
1996 were approximately $4,491,400 as compared to approximately $3,044,600
for the prior year. The increase was primarily due to reserves established
for potentially uncollectible accounts receivable, an increase in
depreciation expense in the interactive video segment, and a severance
package for one of the former officers of the Company, which in the aggregate
accounted for approximately $850,000 of such costs. The remainder of the
increase was due to increased general corporate expenses.
Operating expenses for the interactive video segment were approximately
$3,365,000 for the year ended December 31, 1996 as compared to approximately
$2,318,000 for the prior year. The increase was principally due to the
accounts receivable reserve of $555,000 related to the interactive video
segment. The reserve was established at December 31, 1996 because management
determined that, due to missed deadlines relating to the Company's Korean and
Israeli projects, receivables relating to those projects were doubtful as to
collection. The Company anticipates that the Korean and Israeli receivables
will be settled not later than the end of the second quarter of 1998.
Approximately $110,000 of the increase was due to increased depreciation of
fixed assets and approximately $100,000 of the increase was due to the
portion of the management compensation reserve allocated to the segment. The
remainder of the increase was due to increased general corporate expenses
allocated to the segment.
Operating expenses for the CD-ROM segment were approximately $1,126,000
for the year ended December 31, 1996 as compared to approximately $726,600
for the prior year. The increase was due to increased corporate expenses
allocated to the CD-ROM segment, including insurance, telephone,
administrative staff, computer expenses and office rent.
Research and development expenses were approximately $479,000 in the
year ended December 31, 1996 as compared to approximately $810,800 for the
prior year. The 1995 research and development expenses consisted of both
material and labor costs amounting to approximately $448,000 and $362,000,
respectively. Further materials expenditures were not required during 1996
because the Company maintained its focus on its existing projects during the
year. Labor costs were consistent between the two years.
NET INCOME (LOSS). As a result of the factors discussed above, net loss
for the year ended December 31, 1996 was approximately $5,512,100 as compared
to net income of approximately $9,900 for the prior year. The interactive
video segment had net losses of approximately $326,600 and $5,062,900 for the
years ended December 31, 1995 and 1996, respectively. The
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CD-ROM segment had net income of approximately $376,100 and a net loss of
approximately $411,500 for the years ended December 31, 1995 and 1996,
respectively.
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. These
securities where issued to accredited investors, some of which are customers
or principals of the Company's customers, prior to the Company's IPO. 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 approximately
$3,252,000 consisting of (i) approximately $1,517,500 through the issuance of
390,334 shares of Series A Preferred Stock and warrants to purchase 163,392
shares of Series B Preferred Stock (the "Series B Warrants") (ii)
approximately $800,600 from the exercise of the Series B Warrants and (iii)
approximately $934,500 from the sale of convertible notes and warrants. The
Company's Series A and B Preferred Stock converted into 553,726 shares of the
Company's Common Stock upon the closing of the Company's initial public
offering in November 1997. 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 $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 recognized non-cash interest expense and loss on early
extinguishment of debt of approximately $1,440,000 upon the repayment of the
Bridge Notes upon consummation of the IPO. In addition, the Company will be
required to recognize non-cash expenses of approximately $306,800 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 of 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 the net proceeds of the IPO, together with funds generated
from operations, will be sufficient to satisfy its operating and capital
requirements for the next 12 months. Such belief is based on certain
assumptions, and there can be no assurance that such assumptions are correct.
The Company may be required to raise substantial additional capital in the
future in order to carry out its business plan. In addition, contingencies may
arise which may require the Company to obtain additional capital. Accordingly,
there can be no assurance that such resources will be sufficient to satisfy the
Company's capital requirements. 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.
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Since its inception in January 1993 and through December 31, 1997 the
Company had an accumulated deficit of approximately $14,472,100. The Company
expects to continue to incur operating losses through at least the next
several quarters as it continues to implement its plan to add staff and other
resources and to increase its sales efforts. In addition, new products,
including the T6000 digital set top box and the CTL 8500 server, will not be
achieving any significant sales until at least such third quarter. There can
be no assurance, however, as to the receipt or timing of revenues from
operations.
The Company's accounts receivable turnover ratio for the year ended
December 31, 1997 was 2.61 as compared to .93 for the same period in 1996.
The increase in the ratio is due to the increased sales in 1997 resulting
mainly from the Company's completion of two of its short-term contracts in
the latter part of 1997. The Company's receivable balance maintains a
consistent level due to the company's lack of sales volume, as well as the
outstanding receivables related to the Company's Korean and Israeli projects.
The receivables turnover ratio is still being adversely affected due to those
outstanding receivables. The accounts receivable turnover ratios for the
years ended December 31, 1995 and 1996 were 3.5 and .93 respectively, which
resulted from the larger sales volume in 1995 than in 1996 with a consistent
receivable balance.
The inventory turnover ratio for the year ended December 31, 1997 was
2.01 as compared to 3.02 for the same period in 1996. The average inventory
balance for 1997 was significantly higher than the average inventory for the
same period in 1996 while the costs of goods sold between the two periods
remained consistent. The average inventory balance was lower in 1996 because
the beginning balance was approximately $500,000, while the beginning balance
for 1997 was approximately $1,800,000. The nature of the Company's
interactive video sales and production processes requires that inventory be
on hand for extended periods of time. The Company maintains working units in
inventory that are similar to units that have been installed in the field.
Therefore, as the Company has sold more video servers, the amount of the
inventory has increased.
At December 31, 1997, the Company had cash and cash equivalents totaling
approximately $4,593,000 and a net working capital of approximately
$6,705,300. The Company also had $1,229,800 invested in liquid, low-risk
short-term investments as of December 31, 1997. The Company had no
significant capital spending or purchase commitments at December 31, 1997
other than certain facility leases and inventory component purchase
commitments required in the ordinary course of its business. The Company's
facility lease obligations have increased significantly in 1998. See
"Description of Property."
The Company has no existing lines of credit or other financing arrangements
with lending institutions.
ITEM 7. FINANCIAL STATEMENTS.
The Financial Statements and Notes thereto can be found beginning on page
F-1, "Index to Financial Statements," following Item 13 of this Annual Report on
Form 10-KSB.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable
36
<PAGE>
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.
EXECUTIVE OFFICERS AND DIRECTORS
The executive officers and directors of the Company are as follows:
NAME AGE POSITION
Kenneth D. Van Meter 51 President, Chief Executive Officer and
Chairman of the Board
Glenn West 35 Executive Vice-President, Director of
Technology and Director
William R. Chambers 46 Vice-President of Business Development and
Secretary
Mark Cromwell 44 Vice-President of Engineering
Dennis Smith 47 Vice-President of Operations
James Fultz 38 Vice-President of Sales and Marketing
Thomas E. Welch 28 Controller
Fenton Scruggs(1)(2) 60 Director
Donald Greenhouse(1)(2) 62 Director
Stephen Portch(2) 47 Director
Mark Braunstein 49 Director
___________
(1) Member of the Audit Committee.
(2) Member of the Compensation Committee.
37
<PAGE>
KENNETH D. VAN METER. Mr. Van Meter has been the President and Chief
Executive Officer of the Company since January 20, 1997. He was elected Chairman
of the Board on March 25, 1997. From May 1995 to January 1997, Mr. Van Meter
served as Sr. Vice President, Operations, for Tele-TV Systems, a limited
partnership owned by Bell Atlantic Corporation ("Bell Atlantic"), NYNEX, and
Pacific Telesis, which was engaged in providing systems, software, and services
for its three parents in the interactive digital services industry. From June
1994 to May 1995, Mr. Van Meter was President of Bell Atlantic Video Services
Interactive Multimedia Platforms, a wholly-owned subsidiary of Bell Atlantic.
From April 1993 to June 1994, Mr. Van Meter was Vice President of Bell Atlantic
Video Services. Prior to joining Bell Atlantic, from 1991 to 1993, Mr. Van Meter
was Vice President and General Manager for Thomas Cook Limited, a travel
services company. From 1989 to 1991, Mr. Van Meter was Group Vice President for
two divisions of National Data Corporation ("NDC"). From 1984 to 1989, Mr. Van
Meter was Director and General Manager of two businesses for Sprint Corp.,
United Business Communications (shared tenant services), and the Meeting Channel
(2-way digital video teleconferencing). Mr. Van Meter holds an MBA with highest
honors in management and marketing from the University of Georgia, and a B.S.
with high honors in Chemistry from West Virginia University.
GLENN WEST. Mr. West, a founder of the Company, has served as Executive
Vice-President, Director of Technology and a member of the Board of Directors
since the Company's inception in 1993. Prior to founding the Company, from 1987
to 1993, Mr. West served as Senior Systems Engineer for Data Research and
Applications, a software company.
WILLIAM R. CHAMBERS. Mr. Chambers has been Vice President of Business
Development of the Company since April 1997 and Secretary since October 1997.
From June 1996 to April 1997, Mr. Chambers was Senior Counsel at Tele-TV
Systems. Prior to joining Tele-TV Systems, Mr. Chambers spent 20 years in
private law practice in the Washington, D.C. area at Verner, Liipfert, Bernhard,
MacPherson & Hand, from May 1995 to June 1996, and at Watt, Tieder & Hoffar,
from 1978 to 1995. Mr. Chambers also serves as Chief Counsel of the Company.
Mr. Chambers received a B.A. degree, with honors, in Economics from Princeton
University and a J.D., with honors, from the National Law Center, George
Washington University.
MARK CROMWELL. Mr. Cromwell joined the Company as Vice President of
Engineering in August, 1997. Prior to joining the Company, Mr. Cromwell was Vice
President of Transmission Product Engineering with DSC Communications
Corporation, where he worked from July 1984 to August 1997. Mr. Cromwell also
held engineering positions with Mostek Corporation, the Electronics Division of
the Chrysler Corporation and General Dynamics. He holds an M.S. in Electrical
Engineering from Southern Methodist University and a B.S. in Physics from the
University of Tennessee, and has done postgraduate work in Management at the
University of Texas in Dallas.
DENNIS SMITH. Mr. Smith joined the Company and shortly thereafter was
elected Vice President of Operations in October 1997. Prior to joining the
Company, Mr. Smith was a Director of the Transmission Products Division of
DSC Communications Corporation, where he worked from 1995 to 1997. Mr. Smith
was the owner of DKS Systems, a consulting firm, from 1989 to 1995. Mr.
Smith holds an M.S. and B.S. in Electrical Engineering from the University of
Texas at Austin and has done post-graduate work in Computer Science at
Southern Methodist University in Dallas, Texas.
JAMES FULTZ. Mr. Fultz joined the Company as Vice President of Sales
and Marketing in January 1998. From June of 1992 to October 1997, Mr. Fultz
served as Chairman and CEO of MediaMax Asia
38
<PAGE>
Pacific, Ltd., a leading CD-ROM publisher and distributor in the People's
Republic of China, Hong Kong and Singapore. From February 1987 to June 1992,
Mr. Fultz served as Director of National Sales for Federal Sign, a division
of Federal Signal Corporation. Mr. Fultz holds a B.S. in Communications from
Northwestern University in Evanston, Illinois.
THOMAS E. WELCH. Mr. Welch has been Controller of the Company since January
15, 1996. Before joining the Company, Mr. Welch, a certified public accountant,
was a senior associate with Coopers & Lybrand L.L.P., where he was employed from
August 1992 to January 1996. Mr. Welch received a B.S. in Business
Administration Accounting from the University of Tennessee in May 1992.
FENTON SCRUGGS. Dr. Scruggs, a founder of the Company, funded the initial
start-up of the Company, and has been a member of the Company's Board of
Directors since the Company's inception in 1993. Dr. Scruggs is a Board
Certified Pathologist from Chattanooga, Tennessee, who has been in private
practice since 1969. Dr. Scruggs received his undergraduate degree from
University of Virginia in 1959 and his graduate degree from the University of
Tennessee in 1962. Dr. Scruggs completed his residency at Memphis Methodist
Hospital and was a General Medical Officer in the U.S. Air Force from 1963 to
1965.
DONALD GREENHOUSE. Mr. Greenhouse has been a member of the Company's Board
of Directors, as the designee of the holders of the Company's preferred stock,
since 1995. Mr. Greenhouse also served as interim Chief Executive Officer of the
Company from August 1996 until January 1997. Mr. Greenhouse is President and
Chief Executive Officer of Seneca Point Associates, Inc., a consulting firm
founded by him in November 1989. Mr. Greenhouse has approximately 40 years of
management experience in manufacturing, technology and service industries.
Seneca Point Associates, Inc. is a non-traditional consulting firm engaged by
clients nationally to fill full-time senior management positions.
STEPHEN PORTCH. Dr. Portch has been a member of the Company's Board of
Directors since December 1, 1997. Dr. Portch has been Chancellor of the
University System of Georgia since 1994. He oversees 30,600 employees, a $3.65
billion dollar budget and 206,000 students. Previously, Dr. Portch was Senior
Vice President of the University of Wisconsin System. Dr. Portch holds a Ph.D.
and M.A. from the Pennsylvania State University, and he received his B.S., with
honors, from the University of Reading (England).
MARK BRAUNSTEIN. Dr. Braunstein has been a member of the Company's Board of
Directors since January 8, 1998. Since February 1991, Dr. Braunstein has been
the Chairman and Chief Executive Officer of Patient Care Technologies, Inc.,
which is in the clinical information systems business.
Each director holds office until the Company's annual meeting of
stockholders and until his successor is duly elected and qualified. Officers are
elected by the Board of Directors and hold office at the discretion of the Board
of Directors. There are no family relationships between any of the directors or
executive officers of the Company.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE.
Section 16(a) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), requires the Company's directors and executive officers, and
persons who beneficially own more than ten percent of a registered class of
the Company's equity securities, to file with the Securities and Exchange
Commission (the "Commission") initial reports of ownership and reports of
changes in ownership of Common Stock and the other equity securities of the
Company. Officers, directors, and persons who beneficially own more than ten
percent of a registered class of the Company's equities are required by the
regulations of the Commission to furnish the Company with copies of all
Section 16(a) forms they file. To the Company's knowledge, based solely on
review of the copies of such reports furnished to the Company, during the
fiscal year ended December 31, 1997, all Section 16(a) filing requirements
applicable to its officers, directors, and greater than ten percent
beneficial owners were complied with, except that a Form 3 was filed late by
each of Messrs. Mark Cromwell, Stephen Portch, Dennis Smith and Thomas Welch.
39
<PAGE>
ITEM 10. EXECUTIVE COMPENSATION.
EXECUTIVE COMPENSATION
The following table sets forth the annual and long-term compensation for
services in all capacities for the fiscal years ended December 31, 1997, 1996
and 1995 paid to Kenneth D. Van Meter, the Company's Chairman of the Board,
President, and Chief Executive Officer, to Glenn West, the Company's
Executive Vice President and Director of Technology, and Mahmoud Youssefi,
the Company's former Chief Executive Officer (Messrs. Van Meter, West, and
Youssefi, together the "Named Executive Officers"). No other executive
officer received compensation exceeding $100,000 during the fiscal years
ended December 31, 1997, 1996, or 1995.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM COMPENSATION
ANNUAL COMPENSATION AWARDS
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS RESTRICTED SECURITIES
STOCK UNDERLYING ALL OTHER
AWARD(s) OPTIONS COMPENSATION
<S> <C> <C> <C> <C> <C> <C>
Kenneth D. Van Meter 1997 $154,731 71,810(1) _ 413,000 _
Chairman of the Board, 1996 _ _ _ _ _
Chief Executive Officer, 1995 _ _ _ _ _
and President
Glenn West................. 1997 $148,954 _ _ _ _
Executive Vice President 1996 $134,372 _ _ _ _
and Director 1995 $134,199 _ _ _ _
Mahmoud Youssefi........... 1997 $ 34,375 _ _ _ $118,582(2)
Former Chief Executive 1996 $134,372 _ _ _ _
Officer and former Director 1995 $131,167 _ _ _ _
</TABLE>
___________
(1) Includes $17,864 paid in the first quarter of 1998 and $26,973 to be paid
on each of January 20, 1999 and January 20, 2000.
(2) Paid pursuant to Mr. Youssefi's termination agreement. See "Certain
Relationships and Related Transactions."
40
<PAGE>
The following table sets forth certain information concerning options
granted to the Named Executive Officers during the fiscal year ended
December 31, 1997.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
---------------------------------------------------------------
NUMBER OF PERCENTAGE OF
SECURITIES TOTAL OPTIONS
UNDERLYING GRANTED TO EXERCISE OR
OPTIONS INDIVIDUALS IN BASE PRICE EXPIRATION
NAME GRANTED FISCAL YEAR PER SHARE DATE
- ---- ---------- -------------- ------------ ----------
<S> <C> <C> <C> <C>
Kenneth D. Van Meter.................. 183,200 32.2% $1.38 4/4/07
230,000 40.4% $3.00 7/18/07
Glenn West............................ -- -- -- --
Mahmoud Youssefi...................... -- -- -- --
</TABLE>
__________
The following table sets forth certain information concerning the number
and value of securities underlying exercisable and unexercisable stock options
as of the fiscal year ended December 31, 1997 by the Named Executive Officers.
<TABLE>
<CAPTION>
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL
YEAR-END OPTION VALUES
NUMBER OF SECURITIES
NUMBER OF UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
SHARES OPTIONS AT IN-THE-MONEY OPTIONS AT
ACQUIRED ON VALUE DECEMBER 31, 1997 DECEMBER 31, 1997(1)
NAME EXERCISE REALIZED EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
- ---- -------- -------- ------------------------- -------------------------
<S> <C> <C> <C> <C> <C> <C>
Kenneth D. Van Meter _ _ 413,200 0 $296,784 0
Glenn West _ _ _ _
Mahmoud Youssefi _ _ _ _
</TABLE>
___________
(1) Amount reflects the market value of the underlying shares of Common Stock
at the closing price reported on the Nasdaq SmallCap Market on December
31, 1997 ($3.00 per share), less the exercise price of each option.
DIRECTOR COMPENSATION
Directors did not receive compensation for serving on the Board of
Directors or fees for attending meetings of the Board of Directors in 1997;
however, they were reimbursed for related expenses. The Company reconsidered its
policies on director compensation in connection with its efforts to recruit
additional outside directors. Beginning in 1998, the Company's policy is for
each outside director to receive nonqualified stock options for 20,000 shares in
addition to $2,500 per quarter.
41
<PAGE>
STOCK OPTION PLANS
On August 10, 1995, the Board of Directors and stockholders adopted the
Company's 1995 Stock Option Plan (the "1995 Plan"). The 1995 Plan provides for
the grant of options to purchase up to 178,929 shares of Common Stock to
employees and officers of the Company. In August, 1997, the Board of Directors
and the stockholders adopted the Company's 1997 Stock Option Plan (the "1997
Plan," and, together with the 1995 Plan, the "Plans"). The 1997 Plan provides
for the grant of options to purchase up to 200,000 shares of Common Stock to
employees, directors, and officers of the Company. Options granted under the
Plans may be either "incentive stock options" within the meaning of Section 422A
of the Internal Revenue Code of 1986, as amended (the "Code"), or non-qualified
options.
The Plans are administered by the Board of Directors which serves as the
stock option committee and which determines, among other things, those
individuals who receive options, the time period during which the options may be
partially or fully exercised, the number of shares of Common Stock issuable upon
the exercise of each option, and the option exercise price.
The exercise price per share of Common Stock subject to an incentive
stock option may not be less than the fair market value per share of Common
Stock on the date the option is granted. The per share exercise price of the
Common Stock subject to a non-qualified option may be established by the
Board of Directors, but may not be less than 85% of the fair market value of
the Common Stock on the date of the grant. The aggregate fair market value
(determined as of the date the option is granted) of Common Stock for which
any person may be granted incentive stock options which first become
exercisable in any calendar year may not exceed $100,000. No person who owns,
directly or indirectly, at the time of the granting of an incentive stock
option to such person, more than 10% of the total combined voting power of
all classes of capital stock of the Company (a "10% Stockholder") shall be
eligible to receive any incentive stock options under the Plan unless the
exercise price is at least 110% of the fair market value of the shares of
Common Stock subject to the option, determined on the date of grant.
No stock option may be transferred by an optionee other than by will or the
laws of descent and distribution and, during the lifetime of an optionee, the
option will be exercisable only by the optionee or a representative of such
optionee. In the event of termination of employment other than by death or
disability, the optionee will have no more than three months after such
termination during which the optionee shall be entitled to exercise the option,
unless otherwise determined by the stock option committee. Upon termination of
employment of an optionee by reason of death, such optionee's options remain
exercisable for one year thereafter to the extent such options were exercisable
on the date of such termination. Under the 1997 Plan, upon termination of
employment of an optionee by reason of total disability (as defined in the 1997
Plan) such optionee's options remain exercisable for one year thereafter.
Options under the 1995 Plan must be issued within 10 years from August 10,
1995, the effective date of the 1995 Plan. Options under the 1997 Plan must be
issued within 10 years from August 6, 1997, the effective date of the 1997 Plan.
Incentive stock options granted under the Plans cannot be exercised more than 10
years from the date of grant. Incentive stock options issued to a 10%
Stockholder are limited to five-year terms. Payment of the exercise price for
options granted under the Plans may be made in cash or, if approved by the Board
of Directors of the Company, by delivery to
42
<PAGE>
the Company of shares of Common Stock already owned by the optionee having a
fair market value equal to the exercise price of the options being exercised, or
by a combination of such methods. Therefore, an optionee may be able to tender
shares of Common Stock to purchase additional shares of Common Stock and may
theoretically exercise all of such optionee's stock options with no additional
investment other than the purchase of the original shares.
Any unexercised options that expire or that terminate upon an employee's
ceasing to be employed by the Company become available again for issuance under
the Plan from which they were granted.
Options to purchase 78,400 shares of Common Stock are outstanding under
the 1995 Plan at exercise prices ranging from $0.10 to $4.90 per share,
although substantially all of such options are exercisable at $0.10 per
share. Of such optionees, William Chambers, an officer of the Company, has
options to purchase 10,000 shares of Common Stock at $1.38 per share. Options
to purchase 182,000 shares of Common Stock are outstanding under the 1997
Plan at exercise prices ranging from $2.125 to $7.00 per share, although a
majority of such options are exercisable at $2.125 per share. Options granted
to directors of the Company under the 1997 Plan consist of: (i) options
granted to each of Mark Braunstein, Donald Greenhouse and Fenton Scruggs to
purchase 20,000 shares of Common Stock at an exercise price of $2.125 per
share; and (ii) options granted to Stephen Portch to purchase 20,000 shares
of Common Stock at an exercise price of $2.625 per share. Options granted to
officers of the Company under the 1997 Plan consist of: (i) options granted
to James Fultz and Thomas Welch to purchase 24,000 and 4,000 shares of Common
Stock, respectively, at an exercise price of $2.125 per share; (ii) options
granted to William Chambers to purchase 10,000 shares of Common Stock at an
exercise price of $3.875 per share; and (iii) options granted to each of Mark
Cromwell and Dennis Smith to purchase 24,000 shares of Common Stock at an
exercise price of $7.00 per share.
OPTIONS GRANTED OUTSIDE THE PLANS
In addition to the options which may be granted under the Plans, the
Company has granted options to purchase 483,200 shares of Common Stock outside
of the Plans, including: (i) options granted to Donald Greenhouse, a director of
the Company to purchase (x) 14,000 shares of Common Stock at an exercise price
of $0.10 per share and (y) 26,000 shares of Common Stock at an exercise price of
$1.38 per share; (ii) options to purchase 193,200 shares of Common Stock granted
to officers of the Company, including 183,200 to Kenneth Van Meter and 10,000 to
William Chambers at an exercise price of $1.38 per share; and (iii) options to
purchase 230,000 shares of Common Stock granted to Kenneth Van Meter and options
to purchase 20,000 shares of Common Stock granted to William Chambers at an
exercise price of $3.00 per share.
401(K) PROFIT SHARING PLAN
The Company has a 401(k) profit sharing plan (the "401(k) Plan"), pursuant
to which the Company, at its discretion each year, may make contributions to
such plan which match a certain percentage, as determined by the Company, of the
contributions made by each employee. The Company may elect not to make matching
contributions to the 401(k) Plan in any given year. The Company made matching
contributions with respect to fiscal 1996 (an aggregate of approximately
$29,000) and has approved an aggregate of approximately $35,000 of matching
contributions with respect to fiscal 1997.
EMPLOYMENT AGREEMENTS
The Company has entered into an employment agreement with Mr. Van Meter, as
amended, which expires January 20, 2000. Pursuant to his employment agreement,
Mr. Van Meter receives an annual base salary of $162,000 and may, at the
discretion of the Board of Directors, receive an annual incentive bonus equal to
up to 99% of Mr. Van Meter's base salary if he and the Company reach certain
milestones. Up to two-thirds of such incentive bonus is to be awarded and paid
within thirty days following the end of each calendar year and up to the
remaining one third of such bonus is to be
43
<PAGE>
awarded at the end of each calendar year and vest in two equal installments on
the first and second anniversaries of the date of the award. In connection with
his employment, Mr. Van Meter purchased 15,000 shares of Common Stock for
nominal consideration plus the cancellation of certain anti-dilution rights and
received options to purchase 183,200 shares of Common Stock at $1.38 per share
and options to purchase 230,000 shares of Common Stock at $3.00 per share.
Additionally, Mr. Van Meter is entitled to reimbursement of up to $45,000 for
expenses incurred as a result of his relocation.
The Company has entered into an employment agreement with Mr. West which
expires on May 1, 2000. Pursuant to his employment agreement, Mr. West received
a base salary of $148,954 in 1997. Such base salary is subject to increase at
the discretion of the Board of Directors based upon, among other things, the
performance of the Company and the performance, duties, and responsibilities of
Mr. West. The employment agreement also provides that Mr. West will not compete
with the Company for two years after the termination of his employment. A state
court, however, may determine not to enforce such non-compete clause as against
public policy. The employment agreement is terminable by the Company for cause
upon the occurrence of certain events, or upon physical or mental disability or
incapacity.
Pursuant to employment agreements with the Company, William Chambers,
Mark Cromwell and Dennis Smith are each receiving salaries of $125,000 per
annum. Pursuant to Mr. Chambers' agreement with the Company, he received
reimbursement for expenses incurred as a result of his relocation in the
approximate amount of $20,600 and is eligible to receive, at the discretion
of the Board of Directors of the Company, a bonus of up to twenty five
percent (25%) of his annual salary. Mr. Chambers received a bonus of $9,766
for 1997. Pursuant to Mr. Cromwell's agreement with the Company, he received
reimbursement for expenses incurred as a result of his relocation in the
amount of $30,000 and is eligible to receive at the discretion of the Board
of Directors of the Company, a bonus of up to twenty-five percent (25%) of
his annual salary. Mr. Cromwell received a bonus of $3,281 for 1997. Pursuant
to Mr. Smith's agreement with the Company, he is eligible to receive, at the
discretion of the Board of Directors, a bonus of up to twenty five percent
(25%) of his annual salary, and reimbursement of up to $30,000 for expenses
incurred as a result of his relocation. Mr. Smith received a bonus of $1,328
for 1997. In connection with his employment, Mr. Chambers also received
options to purchase 20,000 shares of Common Stock at an exercise price of
$1.38 and options to purchase 20,000 shares of Common Stock at an exercise
price of $3.00 per share. In connection with their employment, each of
Messrs. Cromwell and Smith received options to purchase 24,000 shares of
Common Stock at an exercise price of $7.00 per share. Messrs. Chambers',
Cromwell's and Smith's employment with the Company may be terminated by
either the employee or the Company at any time.
Pursuant to an employment agreement with the Company, James Fultz is
receiving a salary of $135,000 per annum. Pursuant to Mr. Fultz's agreement
with the Company, he is eligible to receive, (i) commissions of up to 0.75%
of interactive video segment sales, (ii) a $25,000 signing bonus, and (iii)
six months base salary as termination pay if Mr. Fultz is terminated during
the first 18 months' of employment for reasons other than for just cause. In
connection with his employment, Mr Fultz also received options to purchase
24,000 shares of Common Stock at an exercise price of $2.125 per share. Mr.
Fultz's employment with the Company may be terminated by him or the Company
at any time.
44
<PAGE>
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information known to the Company
regarding the beneficial ownership of the Company's voting securities by
(i) each person who is known by the Company to own of record or beneficially
more than 5% of the outstanding Common Stock, (ii) each of the Company's
directors and the Named Executive Officers and (iii) all directors and executive
officers of the Company as a group. Unless otherwise indicated, each of the
stockholders listed in the table below has sole voting and dispositive power
with respect to the shares beneficially owned by such stockholder.
<TABLE>
<CAPTION>
NUMBER OF SHARES
NAME OF BENEFICIAL OWNER(1) BENEFICIALLY OWNED PERCENT OF CLASS(2)
- --------------------------- ------------------ -------------------
<S> <C> <C>
Glenn West 382,636 9.4%
Dr. Fenton Scruggs 277,915(3) 6.8%
Donald Greenhouse(4) 40,000(5) 1.0%
Mellon Bank Corporation (6) 360,000(7) 8.8%
Kenneth D. Van Meter 428,200(8) 9.5%
Mahmoud Youssefi(9) 160,000 3.9%
All directors and executive
officers as a group (11 persons) (3)(5)(8)(10) 1,178,639 25.7%
</TABLE>
______________
(1) The address for Messrs. West, Greenhouse, Van Meter, and Dr. Scruggs is c/o
Celerity Systems, Inc., 1400 Centerpoint Boulevard, Knoxville, Tennessee
37932.
(2) For each beneficial owner, shares of Common Stock subject to securities
exercisable or convertible within 60 days of the date of this Form 10-KSB
are deemed outstanding for computing the percentage of such beneficial
owner.
(3) Dr. Scruggs disclaims beneficial ownership of 60,000 shares owned by his
adult children.
(4) Mr. Greenhouse is the father of David Greenhouse who is the Vice President
of AWM Investment Company, Inc. Mr. Greenhouse disclaims beneficial
ownership of the shares owned by such fund.
(5) Includes 40,000 shares of Common Stock which are subject to currently
exercisable stock options.
(6) The address of Mellon Bank Corporation is One Mellon Bank Center,
Pittsburgh, Pennsylvania, 15228.
(7) The shares are beneficially owned by the Mellon Bank Corporation and the
following direct or indirect subsidiaries of Mellon Bank Corporation:
Mellon Bank, N.A. (also parent holding company of the Dreyfus Corporation
and Mellon Equity Associates; and the Dreyfus Corporation (also parent
holding company of Dreyfus Investment Advisors, Inc.). The Premier
Aggressive Growth Fund, a beneficial owner of certain of such shares, is
managed by Dreyfus Corporation.
(8) Includes 413,200 shares of Common Stock which are subject to currently
exercisable stock options. Also includes an aggregate of 10,000 shares of
Common Stock owned by Mr. Van Meter's children.
45
<PAGE>
(9) The address of Mr. Youssefi is 211 Flynn Road, Walland, Tennessee 37886.
(10) Includes options issued to executive officers of the Company to purchase an
aggregate of 44,000 shares of Common Stock which are currently exercisable
and 5,888 shares of Common Stock purchased by executive officers.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The Company was initially capitalized by Dr. Fenton Scruggs, a founder and
director of the Company, who contributed $155,000 in capital from January to
June 1993. In June 1993, Mahmoud Youssefi, a founder of the Company and a
principal officer until April 1997, loaned the Company $30,000 in the form of an
unsecured loan bearing interest at the rate of 29.2% per annum. The balance of
the loan, together with accrued interest thereon, was paid in full in
December 1995.
In April 1994, the Company received a secured loan from Herzog, Heine &
Geduld, Inc., a customer of the Company, in the principal amount of $250,000 and
bearing interest at a rate of 9.75% per annum. The loan was converted into
160,764 shares of Series A Preferred Stock in May 1995, and was converted into
64,305 shares of Common Stock upon the closing of the IPO.
In November 1994, the Company received an unsecured loan from Dr. Scruggs
in the principal amount of $75,000 and bearing interest at a rate of 9% per
annum. Dr. Scruggs converted the outstanding balance, including accrued interest
thereon, into 17,915 shares of the Company's Common Stock at $4.90 per share on
December 31, 1995.
In May 1995, the Company sold 975,836 shares of Series A Preferred Stock at
$1.55 per share and warrants to purchase 408,479 Series B Preferred Stock at
$1.96 per share. The warrants to purchase the Series B Preferred Stock were
exercised in August 1995. The Preferred Stock, voting together as a single
class, had the right to elect one member of the Company's Board of Directors.
Donald Greenhouse has served as the designee of the holders of the preferred
stock.
In May 1995, the Company redeemed 17,364 shares of Common Stock from Glenn
West, the Company's Executive Vice President, Director of Technology, and a
member of the Board of Directors, for an aggregate purchase price of $67,500. As
a founder of the Company, Mr. West purchased for nominal consideration the
shares that were redeemed.
In November 1995, the Company issued 12-month promissory notes under an
arrangement with certain parties, including a number of holders of the Series A
and B Preferred Stock. The purchasers of such notes also received warrants to
purchase 190,714 shares of the Company's Common Stock at an exercise price of
$4.90 per share. The warrants expire upon the earlier of (i) May 31, 1998 or
(ii) the issuance by the Company of shares of its Common Stock in a public
offering at an aggregate purchase price of $5,000,000 or more, and at a Company
valuation of at least $10,000,000. The IPO met this criteria. The principal
amount of the promissory notes was $934,500 and interest accrued at a fixed
rate of 10% per annum. When payments on such notes were not made by November 30,
1996, they automatically converted, at a rate of $4.90 per share, into an
aggregate of 190,714 shares of Common Stock. The interest which had accrued on
the debt was forgiven.
During the years ended December 31, 1996 and 1997 the Company paid
approximately $87,000 and $47,000, respectively, in consulting fees to Seneca
Point Associates, Inc., a management consulting firm of which Donald Greenhouse,
a member of the Board of Directors, is President and Chief Executive Officer.
Seneca Point Associates, Inc., does not have an ongoing consulting arrangement
with the Company. In addition, Mr. Greenhouse's son, David Greenhouse, is the
Vice President of AWN Investment Company, Inc., which indirectly controls the
Special Situations Fund III, L.P., a stockholder of the Company's securities and
an investor in the Company's November 1995 private placement of promissory notes
and warrants.
46
<PAGE>
In July 1996, the Company completed the 1996 Placement, pursuant to which
the Underwriter acted as placement agent in such offering and received sales
commissions of $480,000, was reimbursed a total of $120,000 for certain
expenses, and was issued the Hampshire Warrant.
On April 4, 1997, Donald Greenhouse was granted an option to purchase
26,000 shares of Common Stock at an exercise price of $1.38 per share. The
options were granted in consideration for Mr. Greenhouse's service as Chief
Executive Officer of the Company from mid-1996 until he was succeeded by Mr. Van
Meter in January 1997.
On April 5, 1997, the Company entered into an agreement with Mr. Youssefi
pursuant to which Mr. Youssefi's employment as President of the Company was
terminated (the "Termination Agreement"). Pursuant to the Termination Agreement,
Mr. Youssefi agreed, among other things, (i) not to compete with the Company for
a three-year period (although such provision may be deemed unenforceable by a
state court), (ii) to waive all claims and rights against the Company, (iii) to
cooperate with the Company in its business endeavors and (iv) to assist with the
Company's efforts in an initial public offering. Under the Termination
Agreement, the Company agreed to pay Mr. Youssefi $4,000 in April 1997,
$11,458.33 from May 1997 to and including April 1998; $7,458.33 on or before
May, 1, 1998, and $11,458.33 from June 1998 to May 1, 2000. The Termination
Agreement included a clause which conditioned certain of these obligations upon
payment by En K to the Company of $2,000,000 on or prior to May 5, 1997 because
Mr. Youssefi's compensation under such agreement was premised, in part, on the
continued success of the Company's relationship with En K. The Company did not
receive En K's May 5, 1997 payment and was therefore only obligated to provide
Mr. Youssefi the $11,458 monthly payments through December 1997. The Company
paid all sums due Youssefi upon the consummation of the Bridge Financing in
August 1997.
As a condition to proceeding with the Bridge Financing and the IPO, the
Company deemed it necessary for it to repurchase a portion of its outstanding
Common Stock in order for the Common Stock to be sold in the IPO at the
appropriate valuation. Mr. Youssefi and Dr. Scruggs, who were in a position to
benefit substantially from the consummation of the IPO, agreed to sell 240,000
and 80,000 shares of Common Stock, respectively, to the Company at a purchase
price of $0.50 per share.
Pursuant to a letter agreement, dated July 15, 1997, between the Company
and Mahmoud Youssefi (the "Youssefi Repurchase Agreement"), Mr. Youssefi sold to
the Company 240,000 shares of the Company's Common Stock held by him at a
purchase price of $0.50 per share concurrently with the closing of the Bridge
Financing. Additionally, pursuant to the Youssefi Repurchase Agreement, in
exchange for Mr. Youssefi's execution of an agreement (the "Youssefi Lock-Up"),
pursuant to which he promised not to sell any securities of the Company owned by
him for a period of 18 months following the Company's initial public offering,
the Company agreed to pay Mr. Youssefi (i) upon the Company's receipt of the
Youssefi Lock-Up, (a) $11,458.33 allegedly owed to Mr. Youssefi at such time
under the Termination Agreement and (b) approximately $7,400 for reimbursable
credit card and business expenses; (ii) concurrently with the closing of the
Bridge Financing, $53,291.65 as payment in full (except for $15,458.33) for the
Company's remaining obligations under the Termination Agreement; and (iii) the
remaining $15,458.33 upon the earlier of (a) 150 days after the closing of the
Bridge Financing or (b) the closing of the IPO. Finally, the Company agreed,
within 30 days following the closing of the IPO, to pay off approximately
$25,000 of leases guaranteed by Mr. Youssefi.
Pursuant to a letter agreement, dated July 15, 1997, between the Company
and Dr. Fenton Scruggs, Dr. Scruggs sold to the Company 80,000 shares of the
Company's Common Stock held by him at a purchase price of $0.50 per share
concurrently with the closing of the Bridge Financing.
In connection with his employment agreement, in July 1997, Kenneth D. Van
Meter purchased 15,000 shares of Common Stock for nominal consideration plus the
termination of certain anti-dilution rights.
47
<PAGE>
In August 1997, the Company completed the Bridge Financing, pursuant to
which the Underwriter acted as placement agent in such offering and received
sales commissions of $200,000, as well as a non-accountable expense allowance of
$60,000.
The Company believes that each of the above referenced transactions was
made on terms no less favorable to the Company than could have been obtained
from an unaffiliated third party. Furthermore, any future transactions or loans
between the Company and officers, directors, principal stockholders or
affiliates and, any forgiveness of such loans, will be on terms no less
favorable to the Company than could be obtained from an unaffiliated third
party, and will be approved by a majority of the Company's directors, including
a majority of the Company's independent and disinterested directors who have
access at the Company's expense to the Company's legal counsel.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
EXHIBIT NO. DESCRIPTION
3.1 Certificate of Incorporation of Celerity Systems, Inc.*
3.2 By laws of Celerity Systems, Inc.*
4.1 Form of Underwriter's Warrant*
4.2 1995 Stock Option Plan*
4.3 1997 Stock Option Plan*
4.4 Form of Stock Certificate*
4.5 Form of Bridge Warrant*
4.6 Form of 1996 Warrant*
4.7 Form of Hampshire Warrant*
4.8 Form of 1995 Warrant*
4.9 Letter Agreement dated July 15, 1997, between the Company and Mahmoud
Youssefi, including exhibits*
4.10 Letter Agreement, dated July 11, 1997, between the Company and Dr.
Fenton Scruggs*
10.1 Employment Agreement, dated January 7, 1997, as amended, between the
Company and Kenneth D. Van Meter*
10.2 Employment, Non-Solicitation, Confidentiality and Non-Competition
Agreement, dated as of May 1, 1996, between the Company and Glenn
West*
10.3 Termination Agreement, dated as of April 5, 1997, between the Company
and Mahmoud Youssefi*
10.4 [Reserved]
10.5 Letter Agreement, dated March 13, 1997, between the Company and
William Chambers*
10.6 Letter Agreement, dated July 24, 1997, between the Company and Mark
C. Cromwell*
10.7 Exclusive OEM/Distribution Agreement, dated March 10, 1995, between
the Company and InterSystem Multimedia, Inc.*
10.8 Purchase Order Agreement, dated June 26, 1995, between Tadiran
Telecommunications Ltd. and the Company*
10.9 License Agreement, dated as of September 26, 1996, between the Company
and En Kay Telecom Co., Ltd.*
10.10 License Agreement, dated as of February 21, 1997, between the Company
and En Kay Telecom Co., Ltd.*
10.11 Remarketer Agreement, dated as of June 15, 1997, between the Company
and Minerva Systems, Inc.*
10.12 Memorandum of Understanding, dated April 25, 1996, between Integrated
Network Corporation and the Company*
10.13 Letter of Agreement, dated March 31, 1993, between the Company and
Herzog, Heine & Geduld, Inc. and Development Agreement attached
thereto*
48
<PAGE>
10.14 Subcontract Agreement, dated June 26, 1997, between Unisys Corporation
and the Company*
10.15 Lease Agreement for Crossroad Commons, dated November 25, 1996, as
amended, between Lincoln Investment Management, Inc., as attorney in
fact for the Lincoln National Life Insurance Company, and the Company*
10.16 Lease Agreement, dated November 25, 1997, between Centerpoint Plaza,
L.P. and the Company**
10.17 Letter Agreement, dated October 3, 1997, between Dennis Smith and the
Company**
10.18 Letter Agreement, dated January 8, 1998, between James Fultz and the
Company**
11 Statement re: computation of per share earnings (included in Note
12 to the "Notes to Financial Statements")
27 Financial Data Schedule**
___________
* Filed as an Exhibit to the Registration Statement on Form SB-2
(Registration No. 333-33509).
** Filed herewith.
49
<PAGE>
INDEX TO FINANCIAL STATEMENTS
CELERITY SYSTEMS, INC.
PAGE
Report of Independent Accountants.......................................... 51
Balance Sheets............................................................. 52
Statements of Operations................................................... 54
Statements of Stockholders' Equity......................................... 55
Statements of Cash Flows................................................... 56
Notes to Financial Statements.............................................. 57
50
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
Celerity Systems, Inc.
We have audited the accompanying balance sheets of Celerity Systems, Inc. (the
"Company") as of December 31, 1996 and 1997, and the related statements of
operations, stockholders' equity and cash flows for each of the two years in the
period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Celerity Systems, Inc. as of
December 31, 1996 and 1997, and the results of its operations and its cash flows
for each of the two years in the period ended December 31, 1997, in conformity
with generally accepted accounting principles.
COOPERS & LYBRAND L.L.P.
Knoxville, Tennessee
February 27, 1998
51
<PAGE>
CELERITY SYSTEMS, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1996 1997
ASSETS
<S> <C> <C>
Cash and cash equivalents $2,344,666 $4,592,975
Short-term investments - 1,229,788
Accounts receivable, less allowance for doubtful accounts of
$555,050 and $567,024 in 1996 and 1997, respectively 713,232 1,022,283
Interest receivable - 4,954
Inventory 1,325,903 1,161,356
Prepaid expenses - 103,340
Costs in excess of billings on uncompleted contracts 187,749 20,963
---------- ----------
Total current assets 4,571,550 8,135,659
Property and equipment, net 813,290 999,245
Other assets 264,955 -
---------- -----------
Total assets $5,649,795 $9,134,904
---------- ----------
---------- ----------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
52
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1996 1997
LIABILITIES AND STOCKHOLDERS' EQUITY
<S> <C> <C>
Accounts payable $ 315,832 $ 806,305
Accrued liabilities 472,740 389,060
Warranty reserve 200,000 235,000
Deferred revenue 359,970 -
Interest payable 150,000 -
Current portion of leases payable 7,821 -
Accrued management compensation 137,500 -
Allowance for estimated losses on uncompleted contracts 672,600 -
Billings in excess of costs and estimated earnings on
uncompleted contracts 150,000 -
----------- ------------
Total current liabilities 2,466,463 1,430,365
Long-term notes payable 3,000,000 -
Long-term leases payable 19,009 -
Commitments and contingencies (Notes 5, 15 and 16)
Preferred stock, Series A, noncumulative, redeemable,
convertible, $0.01 par value, 975,836 and zero shares
authorized, issued and outstanding at December 31, 1996
and 1997, respectively 1,813,412 -
Preferred stock, Series B, noncumulative, redeemable,
convertible, $0.01 par value, 408,479 and zero
shares authorized, issued and outstanding at December 31,
1996 and 1997, respectively 932,720 -
Common stock, $0.001 par value, 15,000,000 shares authorized,
1,836,476 issued and 1,819,113 outstanding, and 4,442,134
issued and 4,104,769 outstanding at December 31, 1996 and
1997, respectively 1,836 4,442
Additional paid-in capital 3,280,920 22,399,692
Treasury stock, at cost, 17,364 and 337,364 at December 31,
1996 and 1997, respectively (67,500) (227,500)
Accumulated deficit (5,797,065) (14,472,095)
----------- -----------
Total liabilities and stockholders' equity $5,649,795 $ 9,134,904
----------- -----------
----------- -----------
</TABLE>
53
<PAGE>
CELERITY SYSTEMS, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1996 1997
<S> <C> <C>
Revenues $2,530,097 $3,728,262
Cost of revenues 3,513,023 3,344,412
---------- ----------
Gross margin (982,926) 383,850
Operating expenses 4,491,433 4,542,542
Non-cash compensation expense - 2,544,775
---------- ----------
Loss from operations (5,474,359) (6,703,467)
Interest expense (150,042) (664,687)
Interest income 96,888 79,958
---------- ----------
Loss before income taxes (5,527,513) (7,288,196)
Income tax benefit 15,400 -
---------- ----------
Net loss before extraordinary item (5,512,113) (7,288,196)
Loss on early extinguishment of debt - 1,386,834
---------- ----------
Net loss (5,512,113) (8,675,030)
Accretion of premiums on preferred stocks 278,174 208,629
---------- ----------
Net loss applicable to common stock $(5,790,287) $(8,883,659)
----------- -----------
----------- -----------
Basic and diluted loss per common share (Note 12):
Loss before extraordinary charge $(4.03) $(3.59)
Extraordinary charge - (.66)
------- -------
Loss per common share $(4.03) $(4.25)
------ ------
------ ------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
54
<PAGE>
CELERITY SYSTEMS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
ADDITIONAL
COMMON PAID-IN TREASURY ACCUMULATED
STOCK CAPITAL STOCK DEFICIT
----- ----------- ---------- ------------
<S> <C> <C> <C> <C>
Balances, January 1, 1996 $1,217 $ 91,728 $ (67,500) $ (284,952)
Issuance of 426,648 shares of
common stock for private
placement offering 427 2,532,938 - -
Conversion of note payable to
190,714 shares of common
stock 191 934,309 - -
Issuance of 1,200 shares of common
stock under stock option plan 1 119 - -
Accretion of premiums on
preferred stocks - (278,174) - -
Net loss - - - (5,512,113)
------- ----------- ---------- ----------
Balances, December 31, 1996 1,836 3,280,920 (67,500) (5,797,065)
Grant of stock to officer 15 - - -
Exercise of employee stock options 38 3,662 - -
Acquisition of 320,000 shares of
common stock held in treasury - - (160,000) -
Issuance of common stock warrants - 1,440,000 - -
Grant of stock options at below the
initial public offering price - 2,544,775 - -
Issuance of 2,000,000 shares of
common stock in initial public
offering, net of offering expenses 2,000 12,384,758 - -
Accretion of premiums on
preferred stock - (208,629) - -
Conversion of 553,726 shares of
preferred stock to common stock
in conjunction with the initial
public offering 553 2,954,206 - -
Net loss - - - (8,675,030)
------ ----------- ---------- ------------
Balances, December 31, 1997 $4,442 $22,399,692 $(227,500) $(14,472,095)
------ ----------- ---------- ------------
------ ----------- ---------- ------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
55
<PAGE>
CELERITY SYSTEMS, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------
1996 1997
<S> <C> <C>
Cash flows from operating activities:
Net loss $(5,512,113) $(8,675,030)
Adjustments to reconcile net loss to
net cash used by operating activities:
Depreciation and amortization 277,312 493,757
Accretion of interest on notes payable - 360,000
Loss on disposal of fixed assets - 1,358
Extraordinary loss on early extinguishment of debt - 1,386,834
Compensation expense for issuance of stock options - 2,544,775
Warranty reserve 200,000 35,000
Provision for doubtful accounts receivable 555,050 11,974
Provision for inventory obsolescence 500,000 (155,919)
Deferred income taxes (15,400) -
Changes in current assets and liabilities:
Accounts receivable 2,887,635 (321,025)
Interest receivable - (4,954)
Prepaid expenses - (103,340)
Inventory (1,383,416) 149,303
Costs in excess of billings on uncompleted contracts (187,749) 166,786
Accounts payable (1,526,213) 490,473
Accrued expenses 168,451 (83,680)
Deferred revenue 359,970 (359,970)
Interest payable 139,508 (150,000)
Accrued management compensation 137,500 (137,500)
Allowance for estimated losses on uncompleted contracts 672,600 (672,600)
Billings in excess of costs and estimated earnings on
uncompleted contracts (200,000) (150,000)
----------- -----------
Net cash used by operating activities (2,926,865) (5,173,758)
Cash flows from investing activities:
Purchases of property and equipment (300,577) (286,929)
Investments in short-term instruments - (1,229,788)
----------- -----------
Net cash used in investing activities (300,577) (1,516,717)
Cash flows from financing activities:
Proceeds from notes payable 3,000,000 2,000,000
Principal payments on long-term debt, notes payable
and capital leases (108,243) (5,026,830)
Proceeds from issuance of common stock 2,533,485 15,003,918
Repurchase of common stock - (160,000)
Financing and debt issue costs (338,910) (2,878,304)
----------- -----------
Net cash provided by financing activities 5,086,332 8,938,784
Net increase in cash and cash equivalents 1,858,890 2,248,309
Cash and cash equivalents, beginning of year 485,776 2,344,666
----------- -----------
Cash and cash equivalents, end of year $ 2,344,666 $ 4,592,975
----------- -----------
----------- -----------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
56
<PAGE>
CELERITY SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION AND NATURE OF BUSINESS
Celerity Systems, Inc., a Tennessee corporation founded in 1993, designs,
develops, integrates, installs, operates and supports interactive video
services hardware and software ("interactive video"). The Company also
designed, developed, installed, and supported CD-ROM software products for
business applications. In February 1998, the Company began to scale back
CD-ROM operations to a maintenance mode (Note 16). In the interactive
video services area, the Company seeks to provide solutions, including
products and services developed by the Company and by strategic partners,
that enable interactive video programming and applications to be provided
to a wide variety of market niches. The sales of interactive video products
are principally made on a contract by contract basis. Currently, the
principal markets for the Company's interactive video products are Korea,
Israel, Taiwan and China. In the CD-ROM area, the Company provides several
products for the storage and rapid retrieval of large amounts of
information. The majority of the Company's existing CD-ROM customer base is
in the security brokerage industry and in U.S. Government applications.
The Company was founded under Subchapter S Corporation status. In
conjunction with an equity infusion from certain outside investors in May
1995, the Company elected to become a C Corporation. Subsequent to June
30, 1997, Celerity Systems, Inc., a Delaware corporation, was formed. The
Tennessee corporation was merged with the Delaware corporation in August
1997.
The Company had two CD-ROM customers and one interactive video customer
that represented 37%, 13% and 13% of its revenues in 1996, respectively.
The Company had three interactive video customers and one CD-ROM customer
that represented 15%, 38%, 14% and 6%, respectively, of its revenues for
the year ended 1997. Export sales for the years ended December 31, 1996
and 1997, were approximately $878,450 and $2,654,796, respectively. The
export sales represented 35% and 71% of revenues for the years ended
December 31, 1996 and 1997, respectively. Sales related to Korea
represented 41% in 1996 and 15% in 1997, while sales related to Israel were
36% in 1996 and 3% in 1997. During 1997, export sales to China and Taiwan
were 38% and 14%, respectively.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH AND CASH EQUIVALENTS - The Company considers all highly liquid debt
instruments with an original maturity of three months or less to be cash
equivalents. The Company places its temporary cash investments principally
in bank repurchase agreements, money market accounts and certificates of
deposit with one bank. The Company does not obtain collateral on its
investment or deposit accounts.
SHORT-TERM INVESTMENTS - The Company invests in debt securities and
certificates of deposit with original maturities of greater than three
months, principally with one financial institution. The debt securities
are classified as held to maturity and are recorded at amortized cost which
approximates market.
ACCOUNTS RECEIVABLE - The Company does not require collateral or other
security to support customer receivables.
INVENTORY - Inventory, consisting primarily of electronic components for
interactive video servers, is stated at the lower of cost or market, with
cost being determined using the first-in first-out (FIFO) method.
57
<PAGE>
NOTES TO FINANCIAL STATEMENTS, CONTINUED
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
REVENUE RECOGNITION - Long-term contracts related to the Company's
interactive video segment are accounted for under the percentage of
completion method as these contracts extend over relatively long periods of
time. The Company measures the percentage complete by contract based upon
the costs incurred to date in relation to the total estimated costs for
each contract. Costs are charged to contracts as incurred based upon
material costs, hours dedicated to the contract, and allocations of
overhead costs based on predetermined overhead rates.
The Company entered into one short-term interactive video contract in 1996
and two others in 1997. Due to the short-term nature of these projects,
revenue from these contracts is recorded by the completed contract method
of accounting which provides for recognition of revenue and related costs
upon completion of each contract. Costs in excess of billings on these
uncompleted short-term contracts are reflected as a current asset in the
accompanying balance sheet while billings in excess of costs are reflected
as a current liability.
The Company records sales of products not under contract when the related
products are shipped.
PROPERTY AND EQUIPMENT - Property and equipment are stated at cost.
Depreciation is computed using the straight-line method over the estimated
useful lives of the underlying assets, generally five years. Routine repair
and maintenance costs are expensed as incurred. Costs of major additions,
replacements and improvements are capitalized. Gains and losses from
disposals are included in income or expense.
SEGMENT INFORMATION REPORTING - In June 1997, the Financial Accounting
Standards Board (FASB) issued Statement of Financial Accounting Standards
(SFAS) No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED
INFORMATION. In accordance with this Statement, the Company has presented
segment information for the CD-ROM and interactive video segments for the
years ended December 31, 1996 and 1997.
OTHER ASSETS - Other assets consist of debt offering costs related to
private placements in 1996 and 1997. The costs were amortized straight-line
over the term of the related debt. Amortization expense in 1996 and 1997
was $84,726 and $210,850, respectively. The Company realized an
extraordinary loss of $306,834 due to the write-off of offering costs when
it paid its debt obligations upon the completion of its initial public
offering (Note 8).
RESEARCH AND DEVELOPMENT COSTS - Research and development costs are
expensed as incurred and amounted to $479,558 and $357,436 for the years
ended December 31, 1996 and 1997, respectively. These amounts are included
in operating expenses in the accompanying statements of operations.
INCOME TAXES - The Company accounts for income taxes under the provisions
of Statement of Financial Accounting Standards No. 109, ACCOUNTING FOR
INCOME TAXES (SFAS 109). Under SFAS 109, the asset and liability method is
used in accounting for income taxes, whereby deferred tax assets and
liabilities are determined based upon the differences between financial
reporting and tax bases of assets and liabilities and are measured using
the enacted tax rates and laws that will be in effect when the differences
are expected to reverse. Tax credits are accounted for as a reduction of
tax expense in the year in which the credits reduce taxes payable.
58
<PAGE>
NOTES TO FINANCIAL STATEMENTS, CONTINUED
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
REVERSE STOCK SPLIT - In August 1997, the Board of Directors approved a
1-for-2 1/2 reverse stock split of the Company's common stock for
shareholders of record. All common share and per share amounts included in
the accompanying financial statements have been restated to retroactively
reflect the reverse split.
STOCK BASED COMPENSATION - On January 1, 1996, the Company adopted SFAS
123, ACCOUNTING FOR STOCK BASED COMPENSATION. As permitted by SFAS 123, the
Company has chosen to apply APB Opinion No. 25, ACCOUNTING FOR STOCK ISSUED
TO EMPLOYEES (APB 25) and related interpretations in accounting for its
Plans. The pro forma disclosures of the impact of SFAS 123 are described in
Note 11 of the financial statements.
ESTIMATES - The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from
those estimates. The significant areas of estimation included in the
accompanying financial statements relate principally to the collection of
accounts receivable, inventory valuation and estimates of cost to
complete contracts in progress.
IMPACT OF SFAS 129 AND 130 - In February 1997, the FASB issued Statement of
Financial Accounting Standards (SFAS) 129, DISCLOSURE OF INFORMATION ABOUT
CAPITAL STRUCTURE, which is effective for periods ending after December 15,
1997. In June 1997, the FASB issued SFAS 130, REPORTING COMPREHENSIVE
INCOME, which is effective for fiscal years beginning after December 15,
1997. The Company expects that SFAS 129 and 130 will have no material
impact on the financial statements of the Company.
3. INVENTORY
Inventory at December 31, 1996 and 1997, consists of:
1996 1997
Raw materials $1,045,530 $ 876,829
Finished goods 780,373 628,606
---------- ----------
1,825,903 1,505,435
Reserve for inventory valuation (500,000) (344,081)
---------- ----------
$1,325,903 $1,161,354
---------- ----------
---------- ----------
59
<PAGE>
4. PROPERTY AND EQUIPMENT
Substantially all property and equipment of the Company is comprised of
computers and computer related equipment, therefore all property and
equipment is included in one category entitled "Property and equipment,
net." Following is a schedule of the cost and related accumulated
depreciation for December 31, 1996 and 1997.
1996 1997
Property and equipment $1,181,552 $1,639,644
Accumulated depreciation (368,262) (640,399)
---------- ----------
Property and equipment, net $ 813,290 $ 999,245
---------- ----------
---------- ----------
5. CONTRACTS
The Company was awarded two projects during 1995 that were accounted for
under the percentage of completion method for long-term contracts.
The Korea project had a fixed contract price of $4,227,280. The Company had
recognized all of the revenue related to the Korean project prior to 1997.
The Company recognized $379,000 in the year ended December 31, 1996. The
Company incurred losses related to the project of $318,000 during the year
ended December 31, 1996, which it recorded as they occurred. At
December 31, 1996, management estimated that it would cost an additional
$672,600 to complete the project in 1997 and recorded an allowance for
estimated losses on uncompleted contracts and increased costs of revenues
by this amount. The effect of the change in estimated costs to complete the
Korean project was to increase the net loss by $672,600 and the loss per
share by $0.47 for the year ended December 31, 1996. The Company incurred
costs of $779,600 related to the project in 1997. The Company received the
final acceptance certificate in the first quarter of 1998.
The Israeli project had a fixed price of $1,044,000. The Company
recognized the final $118,500 in revenue related to the Israeli project
during 1997 and recognized $298,960 in 1996. The Company incurred
additional costs relating to the project of approximately $205,000 during
1997 and received final acceptance on the project in the fourth quarter.
Both long-term projects are now in the warranty period and the Company
anticipates future costs will be nominal.
The Company has recorded costs in excess of billings of $187,749 and
$20,963 at December 31, 1996 and 1997, respectively, each related to one of
the Company's short-term contracts accounted for under the completed
contract method.
The Company recognized $1,934,000 of revenues during 1997 upon the
completion of two of its short-term contracts in Taiwan and China.
60
<PAGE>
NOTES TO FINANCIAL STATEMENTS, CONTINUED
6. INCOME TAXES
The tax effects of temporary differences giving rise to the Company's
deferred tax assets (liabilities) at December 31, 1996 and 1997, are as
follows:
1996 1997
Current:
Allowance for doubtful accounts $ 211,000 $ 215,000
Inventory reserve 190,000 131,000
Warranty reserve 76,000 89,000
Relocation reserve - 21,000
Other - 43,000
Deferred revenue 137,000 -
Accrued management compensation 52,000 -
-------- --------
666,000 499,000
Valuation allowance for net current
deferred tax assets (666,000) (499,000)
-------- --------
Total net current deferred tax asset $ - $ -
-------- --------
-------- --------
Noncurrent:
Net operating loss and research
credit carryforwards $1,467,000 $3,971,000
Stock based compensation - 967,000
Property and equipment (72,000) (100,000)
-------- --------
1,395,000 4,838,000
Valuation allowance for net noncurrent
deferred tax assets (1,395,000) (4,838,000)
---------- ----------
Total net noncurrent deferred tax asset $ - $ -
---------- ----------
---------- ----------
As a result of the significant pretax losses in fiscal 1996 and 1997,
management can not conclude that it is more likely than not that the
deferred tax asset will be realized. Accordingly, a valuation allowance has
been established against the total net deferred tax asset.
The December 31, 1996 and 1997 provisions for income taxes consist of the
following:
<TABLE>
<CAPTION>
1996 1997
<S> <C> <C>
Federal:
Current tax expense $ - $ -
Deferred tax expense attributable to change in valuation allowance 1,844,100 2,460,000
Deferred tax expense (benefit) attributable to temporary differences (564,100) (687,000)
Deferred tax benefit attributable to net operating loss and research credit carryforwards (1,293,700) (1,773,000)
State:
Current tax expense - -
Deferred tax expense attributable to change in valuation allowance 216,900 289,000
Deferred tax expense (benefit) attributable to temporary differences (66,400) (86,000)
Deferred tax benefit attributable to net operating loss carryforwards (152,200) (203,000)
------------ ------------
$ (15,400) $ -
------------ ------------
------------ ------------
</TABLE>
Income tax benefit allocated to the extraordinary item was $527,000 for
which the Company has a full valuation allowance.
61
<PAGE>
NOTES TO FINANCIAL STATEMENTS, CONTINUED
6. INCOME TAXES, CONTINUED
The Company's income tax benefit differs from that obtained by using the
statutory rate of 34% as a result of the following:
<TABLE>
<CAPTION>
1996 1997
<S> <C> <C>
Computed "expected" tax benefit $(1,879,000) $(2,478,000)
State income tax benefit, net of federal income tax effect (221,000) (292,000)
Change in valuation allowance 2,061,000 2,749,000
Permanent differences 18,000 16,000
Other 5,600 5,000
----------- -----------
$ (15,400) $ -
----------- -----------
----------- -----------
</TABLE>
At December 31, 1997, the Company had approximately $10,450,000 of net
operating loss carryforwards and $45,000 in research credit carryforwards.
These amounts are available to reduce the Company's future taxable income
and expire in the years 2010 through 2012.
7. INITIAL PUBLIC OFFERING
On November 7, 1997, the Company closed its initial public offering of
2,000,000 shares of common stock at the purchase price of $7.50 per share,
which resulted in net proceeds to the Company of approximately $12,385,000.
A portion of the proceeds of the offering was used to repay indebtedness
incurred in the Company's 1996 and 1997 private placements, and the
remainder is intended to be used for the hiring of additional personnel, to
fund the Company's sales and marketing efforts, and for working capital and
general corporate purposes. In connection with the offering, 168,000
warrants were issued to purchase Common Stock at an exercise price of
$12.38 with an expiration date of November 4, 2002.
8. NOTES PAYABLE
In June and July 1996, the Company sold 60 units for $100,000 per unit in a
private placement offering to outside investors. The units consisted of one
10% Note (the "1996 Notes") in the principal amount of $50,000, 7,111
shares of common stock, and warrants to purchase 2,625 shares of common
stock. Additionally, the agent received warrants to purchase 35,556 shares
of common stock at $10.31 per share, sales commissions of $480,000 and
reimbursement of expenses totaling $120,000. In November 1996, the Company
issued an additional 867 warrants for each unit held by the outside
investors in connection with the Company's default on previously
outstanding investor debt, and subsequent conversion of the principal to
common stock (see Note 9). All warrants issued in the 1996 placement now
have an exercise price of $8.46 and will expire on the earlier of the fifth
anniversary of the date of issuance of the warrant or the third anniversary
of the closing of the initial public offering of the Company's securities.
The warrants issued to the agent were increased to 38,852 in connection
with the default and the exercise price was decreased to $9.44. These will
expire five years from the date of grant.
62
<PAGE>
NOTES TO FINANCIAL STATEMENTS, CONTINUED
8. NOTES PAYABLE, CONTINUED
In August 1997, the Company sold 20 units, each consisting of a 10% Note in
the principal amount of $100,000 and warrants to purchase 16,000 shares of
common stock at $3.00 per share. This private placement provided
approximately $1,700,000 in net proceeds to the Company. The proceeds were
used principally to pay outstanding trade payables and provide working
capital. Additionally, the agent received commissions of $200,000 and a
$60,000 expense allowance. In connection with this placement, the Company
entered into stock repurchase agreements with one of the Company's former
officers and with a director. The Company paid $0.50 per share for a
combined total of 320,000 shares held by the two individuals, using a
portion of the funds from the private placement.
The Company recorded debt discount and additional paid-in capital for the
fair value of the warrants which was $1,440,000. The fair value of the
warrants was determined based on the difference between the $7.50 public
offering price and the $3.00 exercise price of the warrants. Based upon the
recording of the debt discount, the notes' effective interest rate was in
excess of 300%.
Upon the initial public offering, the Company paid amounts due under both
placements creating a charge of $1,386,834 in 1997 related to loss on early
extinguishment of debt including write-off of capitalized financing costs.
9. INVESTOR DEBT WITH DETACHABLE WARRANTS
In November 1995, the Company issued twelve month promissory notes under an
arrangement with certain third parties, including a number of previous
investors in the Company's Series A and B Preferred Stock. The purchasers
of the notes also received warrants to purchase 190,714 shares of the
Company's common stock at an exercise price of $4.90 per share. When
interest payments on such notes were not made by November 30, 1996, the
notes automatically converted, at a rate of $4.90 per share, into an
aggregate of 190,714 shares of common stock. The interest, which had been
accrued on the debt, was forgiven.
The related warrant agreements contained certain provisions which included
the expiration of the warrants upon the earlier of May 31, 1998 or the
issuance of shares of the Company's common stock in a public offering with
an aggregate price of $5 million or more and at a Company valuation of at
least $10 million. These warrants expired in November 1997 upon the
effective date of the Company's initial public offering.
10. REDEEMABLE CONVERTIBLE PREFERRED STOCK
The Board of Directors authorized the issuance of 975,836 shares of
Series A Preferred Stock at $1.55 per share and 408,479 shares of Series B
Preferred Stock at $1.96 per share in May 1995. Upon the effective date of
the initial public offering, all of the Company's issued and outstanding
classes of preferred stock were converted into 553,726 shares of common
stock. Each class of preferred stock included certain privileges, including
the accrual of premiums of 12% annually. The accretion of the premiums has
been reflected as a reduction in additional paid-in capital in the
accompanying financial statements.
63
<PAGE>
NOTES TO FINANCIAL STATEMENTS, CONTINUED
11. STOCK OPTIONS
The Company established a stock option plan in 1995 to provide additional
incentives to its officers and employees. Eligible persons are all
employees employed on the date of grant. Management may vary the terms,
provisions and exercise price of individual options granted, with both
incentive stock options and non-qualified options authorized for grant.
Each option granted under the plan shall be exercisable only during a fixed
term from the date of grant as specified by management, but generally equal
to 10 years. Options are vested upon completion of three full years of
service with the Company or upon the Company's issuance of at least $5
million of capital. In 1995, the Board of Directors approved the issuance
of up to 178,929 options to acquire common shares of which 164,800 options
were granted. In 1997, the Company established an additional stock option
plan under which 200,000 options to acquire common shares may be granted.
There were 70,600 shares granted under the 1997 plan during 1997.
During 1997, the Company granted options to acquire 499,200 common shares
to a member of the Company's Board and members of management outside the
1995 plan. These options are fully vested and are exercisable at $1.38 and
$3.00 per share and expire ten years from the date of grant.
A summary of outstanding options as of December 31, 1996 and 1997, and
changes during the years ended on those dates is presented below:
<TABLE>
<CAPTION>
WEIGHTED-AVERAGE WEIGHTED-AVERAGE
OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE
1996 1997
------------------------ -----------------------
<S> <C> <C> <C> <C>
Outstanding at beginning of year(1) 178,800 $0.10 185,800 $0.43
Granted 14,800 4.90 569,800(2) 2.62
Exercised (1,200) 0.10 (37,000) 0.10
Forfeited (6,600) 0.10 (81,400) 1.26
------- ----- ------- -----
Outstanding at end of year 185,800 $0.43 637,200 $2.30
------- ----- ------- -----
------- ----- ------- -----
Options exercisable at year end 74,400 $0.10 589,200 $1.92
Weighted-average fair value per share of
options granted during the year 14,800 $0.53 569,800 $1.56
</TABLE>
(1) Includes 14,000 options granted to an outside director. These
options were granted outside the 1995 plan.
(2) Includes 499,200 options granted to an outside director and members of
management. These options were granted outside the 1995 and 1997
plans.
64
<PAGE>
NOTES TO FINANCIAL STATEMENTS, CONTINUED
11. STOCK OPTIONS, CONTINUED
The following table summarizes information about stock options at
December 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------- -------------------------------
NUMBER WEIGHTED-AVERAGE NUMBER WEIGHTED
RANGE OF OUTSTANDING REMAINING EXERCISABLE AVERAGE
EXERCISE PRICES AT 12/31/97 CONTRACTUAL LIFE AT 12/31/97 EXERCISE PRICE
--------------- ------------- ---------------- ----------- --------------
<S> <C> <C> <C> <C>
$0.10 96,800 7.99 96,800 $0.10
$1.38 231,800 9.40 231,800 $1.38
$3.00 250,000 9.58 250,000 $3.00
$4.90 10,600 8.33 10,600 $4.90
$7.00 48,000 9.92 - -
</TABLE>
The Company recorded compensation expense of $2,544,775 related to options
granted in April, June and July 1997, as the exercise price of the options
was less than the initial public offering price of the Company's common
stock at grant dates.
The Company recorded no compensation expense related to the options granted
in 1996, or subsequent to the initial public offering as the exercise price
of the options was equal to the fair market value of the Company's common
stock at grant dates. Had compensation cost for the option grants been
determined based on the fair value at the grant dates for awards under the
Plan consistent with the method of SFAS 123, the Company's net loss would
have been adjusted to the pro forma amounts indicated below at December 31:
<TABLE>
<CAPTION>
1996 1997
------------------------ --------------------------
AS AS
REPORTED PRO FORMA REPORTED PRO FORMA
<S> <C> <C> <C> <C>
Net loss $(5,512,113) $(5,519,984) $(8,675,030) $(8,684,585)
Net loss per share $4.03 $4.03 $4.25 $4.25
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions: dividend growth rate of 0% for both 1996 and 1997, expected
volatility of zero in 1996 and .696 in 1997, risk-free interest rate of
6.46% in 1996 and 5.71% in 1997, and expected lives of 10 years.
12. LOSS PER SHARE
Effective December 31, 1997, the Company adopted SFAS 128, EARNINGS PER
SHARE. Under SFAS 128, basic and diluted loss per share were $4.03 and
$4.25 for the years ended December 31, 1996 and 1997, respectively. Basic
loss per share were 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.
65
<PAGE>
NOTES TO FINANCIAL STATEMENTS, CONTINUED
12. LOSS PER SHARE, CONTINUED
Following is a reconciliation of the numerators and denominators of the
basic and diluted earnings per share:
1996 1997
LOSS
Basic and diluted:
Loss available to common stockholders $(5,790,297) $(8,883,659)
----------- ----------
----------- ----------
SHARES
Basic and diluted:
Weighted average common shares outstanding 1,437,767 2,090,320
----------- ----------
----------- ----------
13. SEGMENT INFORMATION
At December 31, 1996 and 1997, the Company had two reportable segments:
CD-ROM and interactive video. The CD-ROM segment includes the design,
development, installation and support of CD-ROM storage and imaging
software products for business applications. The interactive video segment
includes the design, development, integration, installation, operation and
support of interactive video services hardware and software. The Company's
two reportable segments offer different products and services and market
such products to different customer bases. The two segments are managed
separately because each business requires different technology and
marketing strategies. The two segments evolved over the life of the Company
and have specifically identifiable tangible assets. The segments share
certain corporate assets and, as such, those are not specifically
identified in the segment information.
Summarized financial information by business segment for the year ended
December 31, 1996 and 1997, approximates the following:
<TABLE>
<CAPTION>
INTERACTIVE
CD-ROM VIDEO TOTALS
1996
<S> <C> <C> <C>
Revenues from external customers $1,809,400 $ 720,697 $2,530,097
Depreciation and amortization 71,700 187,200 258,900
Segment operating loss (411,477) (5,062,882) (5,474,359)
Other significant noncash items:
Bad debt provision - 555,050 555,050
Inventory valuation provision - 500,000 500,000
Segment assets 530,900 2,432,500 2,963,400
Expenditures for segment long-lived assets 66,800 214,900 281,700
</TABLE>
66
<PAGE>
NOTES TO FINANCIAL STATEMENTS, CONTINUED
13. SEGMENT INFORMATION, CONTINUED
<TABLE>
<CAPTION>
INTERACTIVE
CD-ROM VIDEO TOTALS
1997
<S> <C> <C> <C>
Revenues from external customers $1,038,869 $2,689,393 $3,728,262
Depreciation and amortization 110,177 346,421 456,598
Segment operating loss (1,444,924) (5,228,328) (6,673,252)
Segment assets 390,186 2,694,493 3,084,679
Expenditures for segment long-lived assets 26,951 172,100 199,051
</TABLE>
The total of the segment assets reported above varies from the total assets
of the Company due to the inability to allocate corporate assets. The
corporate assets consist of cash, fixed assets, offering costs, and other
assets. The following is a reconciliation of the Company's total assets,
depreciation and amortization expense, and cash expenditures for assets to
the totals of the segments' reported above:
<TABLE>
<CAPTION>
1996 1997
<S> <C> <C>
ASSETS
Total assets of the segments $2,963,400 $3,084,679
Unallocated corporate assets 2,686,395 6,050,225
---------- ----------
Total assets $5,649,795 $9,134,904
---------- ----------
---------- ----------
DEPRECIATION AND AMORTIZATION EXPENSE
Segment depreciation and amortization $258,900 $456,598
Unallocated corporate depreciation 18,412 37,159
---------- ----------
Total depreciation and amortization expense $277,312 $493,757
---------- ----------
---------- ----------
SEGMENT LOSS
Total segment loss $(5,474,359) $(6,673,252)
Unallocated corporate interest and extraordinary loss (37,754) (2,001,778)
---------- ----------
Total net loss $(5,512,113) $(8,675,030)
---------- ----------
---------- ----------
EXPENDITURES FOR LONG-LIVED ASSETS
Segment expenditures for long-lived assets $281,700 $199,051
Unallocated corporate expenditures for long-lived assets 18,877 87,878
---------- ----------
Total expenditures for long-lived assets $300,577 $286,929
---------- ----------
---------- ----------
</TABLE>
67
<PAGE>
NOTES TO FINANCIAL STATEMENTS, CONTINUED
13. SEGMENT INFORMATION, CONTINUED
The accounting policies of the segments are the same as those described in
the summary of significant accounting policies. The segment information
provided contains allocations of certain corporate assets and expenses
which are shared by each of the segments. The allocations are generally
based on a 25%/75% basis for the CD-ROM and interactive video segments,
respectively. Neither of the segments have financial operations and,
therefore, there are no material amounts of interest revenue or expense
generated. There was a net interest expense for the Company of $53,154 and
$584,729 for the years ended December 31, 1996 and 1997, respectively. The
segment profit (loss) amounts do not contain amounts attributable to the
Company's net interest expense, corporate income tax benefit, extraordinary
loss or accretion of premiums on preferred stock.
14. CASH FLOWS
Supplemental disclosure of cash flow information for the years ended
December 31, 1996 and 1997 is as follows:
1996 1997
Cash paid during the year for:
Interest $9,973 $454,687
Noncash investing and financing activities:
The Company recorded $278,174 and $208,629 and for accretion of
interest on preferred stocks in 1996 and 1997, respectively. The
preferred stock was converted to 553,726 shares of common stock upon
the closing of the Company's initial public offering in November 1997.
Notes payable of $934,500 were converted to the Company's common stock
in 1996.
15. LEASES
Operating leases - The Company leases office space and certain equipment
under operating leases. In the fourth quarter of 1997, the Company
entered into a new lease for office space into which the Company moved in
the first quarter of 1998. Future minimum lease payments by year, and in
the aggregate, under noncancellable operating leases with initial or
remaining terms of one year or more at December 31, 1997, are as follows:
1998 $ 548,244
1999 646,629
2000 504,440
2001 513,488
2002 511,819
Thereafter 1,038,314
----------
$3,762,934
----------
----------
Rent expense for operating leases was $126,903 and $158,353 in 1996 and
1997, respectively.
68
<PAGE>
NOTES TO FINANCIAL STATEMENTS, CONTINUED
16. SUBSEQUENT EVENT
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 has reduced its
personnel in the CD-ROM segment from approximately 13 employees to fewer
than five. The Company is not actively marketing its CD-ROM products,
nor is it developing any new CD-ROM products, product upgrades or
features. The Company is continuing to maintain existing customer
relationships by providing technical support and filling sales orders.
While the Company has not developed a formal plan for disposal,
management intends to sell or wind down its CD-ROM business, including
the technology and the customer list relating to the CD-ROM segment,
which have no recorded value. Management believes that the recorded value
of furniture, equipment and inventory relating to the CD-ROM segment will
be fully recovered and no write-down for impairment is necessary.
69
<PAGE>
SIGNATURE
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
CELERITY SYSTEMS, INC.
/s/ Kenneth D. Van Meter President and
- ------------------------- Chief Executive Officer March 30, 1998
Kenneth D. Van Meter
In accordance with the Exchange Act of 1934, this report has been signed
below by the following persons on behalf of the registrant in the capacities and
on the dates indicated.
Signature Title Date
/s/ Kenneth D. Van Meter President, Chief Executive Officer March 30, 1998
- ------------------------ and Chairman of the Board
Kenneth D. Van Meter (Principal Executive Officer)
/s/ Thomas E. Welch Controller (Principal March 30, 1998
- -------------------- Financial Officer)
Thomas E. Welch
/s/ Glenn West Executive Vice President and March 31, 1998
- -------------------- Director
Glenn West
/s/ Fenton Scruggs Director March 31, 1998
- --------------------
Fenton Scruggs
/s/ Mark Braunstein Director March 31, 1998
- ---------------------
Mark Braunstein
<PAGE>
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
3.1 Certificate of Incorporation of Celerity Systems, Inc.*
3.2 By laws of Celerity Systems, Inc.*
4.1 Form of Underwriter's Warrant*
4.2 1995 Stock Option Plan*
4.3 1997 Stock Option Plan*
4.4 Form of Stock Certificate*
4.5 Form of Bridge Warrant*
4.6 Form of 1996 Warrant*
4.7 Form of Hampshire Warrant*
4.8 Form of 1995 Warrant*
4.9 Letter Agreement dated July 15, 1997, between the Company and Mahmoud
Youssefi, including exhibits*
4.10 Letter Agreement, dated July 11, 1997, between the Company and Dr.
Fenton Scruggs*
10.1 Employment Agreement, dated January 7, 1997, as amended, between the
Company and Kenneth D. Van Meter*
10.2 Employment, Non-Solicitation, Confidentiality and Non-Competition
Agreement, dated as of May 1, 1996, between the Company and Glenn
West*
10.3 Termination Agreement, dated as of April 5, 1997, between the Company
and Mahmoud Youssefi*
10.4 [Reserved]
10.5 Letter Agreement, dated March 13, 1997, between the Company and
William Chambers*
10.6 Letter Agreement, dated July 24, 1997, between the Company and Mark
C. Cromwell*
10.7 Exclusive OEM/Distribution Agreement, dated March 10, 1995, between
the Company and InterSystem Multimedia, Inc.*
10.8 Purchase Order Agreement, dated June 26, 1995, between Tadiran
Telecommunications Ltd. and the Company*
10.9 License Agreement, dated as of September 26, 1996, between the Company
and En Kay Telecom Co., Ltd.*
10.10 License Agreement, dated as of February 21, 1997, between the Company
and En Kay Telecom Co., Ltd.*
10.11 Remarketer Agreement, dated as of June 15, 1997, between the Company
and Minerva Systems, Inc.*
10.12 Memorandum of Understanding, dated April 25, 1996, between Integrated
Network Corporation and the Company*
10.13 Letter of Agreement, dated March 31, 1993, between the Company and
Herzog, Heine & Geduld, Inc. and Development Agreement attached
thereto*
10.14 Subcontract Agreement, dated June 26, 1997, between Unisys Corporation
and the Company*
10.15 Lease Agreement for Crossroad Commons, dated November 25, 1996, as
amended, between Lincoln Investment Management, Inc., as attorney in
fact for the Lincoln National Life Insurance Company, and the Company*
10.16 Lease Agreement, dated November 25, 1997, between Centerpoint Plaza,
L.P. and the Company**
10.17 Letter Agreement, dated October 3, 1997, between Dennis Smith and the
Company**
10.18 Letter Agreement, dated January 8, 1998, between James Fultz and the
Company**
11 Statement re: computation of per share earnings (included in Note
12 to the "Notes to Financial Statements")
27 Financial Data Schedule**
___________
* Filed as an Exhibit to the Registration Statement on Form SB-2
(Registration No. 333-33509).
** Filed herewith.
<PAGE>
Exhibit 10.16
LEASE AGREEMENT
THIS LEASE AGREEMENT made and entered into this 25th day of November, 1997
by and between CENTERPOINT PLAZA, L.P. or assigns ("Landlord"), the owner of a
portion of Centerpoint Plaza located at Pellissippi Parkway and Lovell Road,
Knox County, Tennessee ("Plaza") and CELERITY SYSTEMS, INC. ("Tenant").
ARTICLE 1: PREMISES
1.1 DESCRIPTION: Subject to the terms, conditions and limitations
contained herein, Landlord hereby leases to Tenant the premises located in the
Plaza consisting of approximately thirty-eight thousand nine hundred forty-eight
(38,948) square feet, known as Suite 100, as more fully described on Exhibit A
attached hereto ("Premises"). Tenant has inspected the Premises and
acknowledges the Premises are in good condition and fit for Tenant's purposes.
1.2 TEMPORARY SPACE: From January 1, 1998 through June 30, 1998,
Landlord will also lease to Tenant an area in the Plaza consisting of
approximately five thousand four hundred three (5,403) square feet, as more
fully described on Exhibit B attached hereto (the "Temporary Space"). Tenant
shall pay the common area maintenance charges attributable to such Temporary
Space in accordance with Article IV but Tenant shall not otherwise be required
to pay rent on such Temporary Space. From January 1, 1998 through June 1, 1998,
provided Tenant is not then in default under the terms, covenants, and
conditions of this Lease, Tenant shall have the option to lease the Temporary
Space on the same terms and conditions as set forth in this Lease. Such option
may be exercised by providing written notice to Landlord at any time prior to
June 1, 1998.
1.3 EXPANSION PREMISES: From and after June 1, 1998, provided Tenant
is not then in default under the terms, covenants, and conditions of this Lease,
Tenant shall have the right to lease the Temporary Space and other contiguous
space in the building that becomes available to the public (the "Expansion
Premises"), at such time as the Expansion Premises become available for lease,
on the following terms and conditions. In such event, Landlord shall give
written notice to Tenant of the availability of the Expansion Space and the
terms and conditions on which Landlord intends to offer it to the public.
Tenant shall have a period of five (5) business days following such notice
within which to exercise Tenant's right to lease the Expansion Premises. If
Tenant does not exercise its right to lease the Expansion Premises, Landlord may
lease the Expansion Premises without restriction and Tenant shall have no
further rights with respect to the Expansion Premises. The terms on which the
Tenant may lease the Expansion Premises shall be the greater of: (i) the per
square foot rental due pursuant to the terms of this Lease at such time; or (ii)
the terms set forth in the notice provided by Landlord to Tenant regarding the
availability of the Expansion Premises. The Expansion Premises shall be leased
on an "as is" basis and Landlord shall have no obligation to improve the
Expansion Premises or grant Tenant any improvement allowance thereon. If
requested by Landlord, Tenant shall, prior to the beginning of the term for the
Expansion Premises, execute a written memorandum confirming the inclusion of the
Expansion Premises and the Base Rent for the Expansion Premises.
ARTICLE II: TERM
2.1 TERM: This Lease shall continue in force for a term of seven (7)
years commencing on the first day of January, 1998 ("Commencement Date"), and
terminating on the last day of December, 2004 (the "Base Term"), unless sooner
terminated as provided herein. This Lease shall automatically be extended for a
two-year term and for successive two-year terms thereafter unless either
Landlord or Tenant provides written notice to the other of its intent not to
extend for any such two-year term at least six (6) months but not more than
twelve (12) months prior to the expiration of the then current term.
2.2 COMMENCEMENT DATE: Unless otherwise provided herein, the payment
of rental shall commence on the Commencement Date. If possession of the
Premises is taken by Tenant before the Commencement Date, the payment of rent
shall commence on the date possession is taken.
ARTICLE III: RENT AND OTHER TENANT CONTRIBUTIONS
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3.1 Rent: Tenant shall and hereby agrees to pay to Landlord at
Landlord's office or at such place as Landlord may from time to time designate
in writing an annual base rental of four hundred ninety-six thousand five
hundred eighty-seven dollars ($496,587.00) per annum in equal monthly
installments of forty-one thousand three hundred eighty-two dollars and 25/100
($41,382.25) per month (the "Base Rent"), to be paid without notice or demand,
at the address of Landlord set forth herein, on the first day of each month, in
advance. In the event the term of this Lease commences on a day other than the
first day of a calendar month, then the base rental for the fractional month of
the term hereof shall be proportionately reduced. Provided, however, the Base
Rent payable shall be ten thousand dollars ($10,000.00) per month through
March 31, 1998.
3.2 Beginning with the first day of the thirty-seventh (37th) month
(the "Adjustment Date") after the Commencement Date, the annual Base Rent shall
be increased by the lesser of (a) a percentage equal to any increase in the
Consumer Price Index for All Urban Consumers, all items, (1982-84 = 100) ("CPI")
from the Commencement Date to the Adjustment Date, or (b) three percent (3%) per
year. A like calculation and adjustment will be made every thirty-six (36)
months thereafter with the changes in the CPI being calculated from the CPI in
effect on the preceding Adjustment date. If the CPI is discontinued, the
parties agree to use in its place any substitute index which may be established
by the United States Government or any agency thereof
3.3 [INTENTIONALLY DELETED].
3.4 Tenant's covenant to pay rent when due is independent of any and
all other covenants contained in this lease and rent shall be due in full
without set-off or deduction.
3.5 If rent is not paid by the fifth (5th) day of each month, Landlord
may collect as a late charge five percent (5%) of the delinquent amounts, plus
interest at prime rate plus three percent (3%) per annum on the delinquent
amount
3.6 Tenant further agrees to pay to Landlord a twenty-five dollar
($25.00) fee for each check returned for any reason by the Tenant's bank.
ARTICLE IV: ADDITIONAL RENTS
4.1 COMMON AREA MAINTENANCE: Tenant shall pay as additional rent its
pro rata share of the Common Area Maintenance expense to include, without
limitation, the management and upkeep of all Common Areas, including but not
limited to landscaping and grounds keeping, the maintenance, repairing,
replacing and striping of the parking lot, Landlord's public liability and fire
and extended coverage insurance, filter service to all HVAC systems, security,
sanitary control, snow removal, trash and garbage removal, garbage collection
container rental (dumpsters), Common Area lighting, and the cost of personnel to
implement such services. The proportion of the Common Area Maintenance charges
payable by Tenant shall be determined by multiplying the total Common Area
Maintenance charges by a fraction, the numerator of which is the square footage
of the Premises and the denominator of which is the total square footage of the
building, both as determined by the building architect.
The term "Common Area" herein shall include parking areas, driveways,
entrances and exits thereto, service roads, loading facilities, sidewalks,
ramps, landscaped areas, exterior stairways, exterior walls and roofs, and all
other areas constructed or to be constructed for use in common by the Tenant and
all other tenants in the Plaza.
4.2 TAXES AND ASSESSMENTS: Tenant shall pay as additional rent its pro
rata share of the taxes (including, but not limited to, ad valorem taxes,
special assessments and any other governmental charges) on the Plaza for each
tax year or any fraction thereof during the term of this lease.
4.3 WATER, SEWAGE, AND UTILITIES: Tenant shall pay Landlord its pro
rata share of water and sewage charges and all taxes imposed thereon incurred by
Landlord. Tenant agrees to pay all charges for electricity, sewer, water, and
all other utilities, and all taxes or charges on such utility services, which
are separately metered and which are attributable to the Premises.
4.4 TENANT'S ESTIMATED SHARE: Landlord shall estimate for each calendar
year Tenant's pro rata share of the expenses enumerated in Sections 4.1, 4.2 and
4.3 hereof (the "Tenant's Estimated Share"). Tenant shall pay, with each
monthly installment of rent, one-twelfth (1/12) of Tenant's Estimated Share.
Tenant's pro rata share is based on the ratio the square footage of the Premises
bears to the square footage of all leasable square footage in the Plaza (the
"Tenant's Actual Share"). After the expiration of each such calendar year, the
Landlord shall forward to the Tenant a statement showing Tenant's Actual Share
of the expenses enumerated in Sections 4.1, 4.2 and 4.3 hereof. Should Tenant's
Actual Share differ from Tenant's Estimated Share, then, within thirty (30) days
after the date of Landlord's statement, Landlord shall either refund to Tenant
any amount paid
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in excess of Tenant's Actual Share, or Tenant shall remit to Landlord, as
additional rent, any amount by which Tenant's Estimated Share was deficient.
Tenant, at its sole cost, shall have the right to audit the books and records of
the Landlord, to the extent necessary to determine whether the Tenant has been
charged its allocable share of Common Area Maintenance charges. (The estimated
CAM charges for the Premises for 1997 is approximately $1.50 per square foot.)
ARTICLE V: USE OF PREMISES
5.1 TENANT'S USE: The Premises shall be used and occupied by Tenant
solely as general office space for use by marketing, executive, engineering,
light assembly and manufacturing, clerical, and accounting activities and for no
other use without Landlord's prior written consent. Tenant agrees to maintain a
going business on the Premises throughout the full term of this Lease or any
extensions or renewals thereof.
5.2 SIGNS: Tenant agrees not to display any signs or any other
advertising material either outside the Premises or which may be viewed from the
outside of the Premises except as approved in writing by Landlord. Provided,
however, Landlord will permit Tenant to utilize a sign of the same quality and
type used by "ABB", subject to Tenant obtaining all necessary permits and
governmental approvals, all at Tenant's sole cost.
5.3 RULES AND REGULATIONS: Tenant shall observe the rules and
regulations as from time to time may be put in effect by Landlord for the
general safety, comfort and convenience of Landlord, occupants and Tenants of
the Plaza. Any failure by Landlord to enforce any rules and regulations against
either Tenant or any other tenant in the Plaza shall not constitute a waiver
thereof. Landlord shall not be liable for any failure to enforce any rules or
regulations against other tenants in the Plaza.
ARTICLE VI: MAINTENANCE, REPAIRS AND COMPLIANCE WITH LAWS
6.1 ACCEPTANCE AND IMPROVEMENT OF PREMISES: Tenant has had adequate
opportunity to inspect the Premises and acknowledges that the Premises are in
good condition and fit for Tenant's purposes. Tenant will improve the Premises,
at its sole cost, except that Landlord will provide Tenant with architectural
and engineering drawings reasonably suitable for use in making such
improvements.
6.2 TENANT'S DUTY TO REPAIR AND MAINTAIN: The following shall apply
except as provided for in paragraph 6.4 herein:
(a) Tenant shall keep and maintain in good order, condition and repair
(including any such replacement and restoration as is required for that purpose)
the Premises and every part thereof and any and all appurtenances thereto
wherever located, including, without limitation, the exterior and interior
portion of all doors, locks, windows, interior plate glass, all plumbing and
sewage facilities within the Premises including free flow up to the main sewer
line, fixtures, heating and air conditioning and electrical systems, walls,
floors and ceilings, meters applicable to the Premises, and all installations
made by Tenant under the terms of this Lease and any exhibits hereto, as herein
provided. Provided, however, for one (1) year from the Commencement Date,
Landlord will be responsible for the replacement of capital items (heating and
air conditioning, electrical systems, plumbing, sewage, and similar items), to
the extent the replacement cost per item exceeds one thousand one hundred
dollars ($1,100.00) ("Capital Replacements"), and from January 1, 1999 through
December 31, 1999, Landlord will be responsible for one-half (1/2) of the costs
associated with such Capital Replacements.
(b) Tenant shall keep, operate and maintain the Premises in clean,
sanitary and safe condition and in accordance with all directives, rules and
regulations of the proper official of the government agencies having
jurisdiction, at the sole cost and expense of Tenant, and Tenant shall comply
with all requirements of law, by statute, ordinance or otherwise, including but
not limited to environmental laws, affecting the Premises and all appurtenances
thereto. If Tenant refuses or neglects to commence and to complete repairs
promptly and adequately, Landlord may, but shall not be required to, make and
complete said repairs and Tenant shall pay the cost thereof to Landlord as
additional rent upon demand. Tenant shall allow no nuisance to exist with
respect to the Premises and Tenant shall not interfere with the quiet enjoyment
or use of the Plaza by Landlord or any other Tenant.
6.3 SURRENDER OF PREMISES: At the termination or expiration of this
Lease or any renewal term thereof, the Tenant agrees to deliver the Premises to
Landlord in the same condition as received by it on the Commencement Date
(subject to the removals hereinafter required), reasonable
<PAGE>
wear and tear excepted. Tenant shall promptly remove all its trade fixtures,
and, to the extent required by Landlord by written notice, any other
installation, alterations or improvements (except for the initial improvements
to be made by Tenant and approved by Landlord), before surrendering the Premises
as aforesaid and shall repair any damage to the Premises caused by removal of
such items. Tenant's obligation to observe or perform this covenant shall
survive the expiration or other termination of the lease term. Any items
remaining on the Premises as of the termination date of this Lease shall be
deemed abandoned for all purposes and shall become the property of Landlord and
the latter may dispose of the same without liability of any type or nature.
6.4 LANDLORD'S DUTY TO REPAIR: Landlord shall keep and maintain the
foundation, exterior walls and roof of the building in which the Premises are
located and the structural portions of the Premises which were installed by
Landlord, exclusive of doors, door frames, locks, windows, and window frames
located in exterior building walls, in good repair. Landlord shall not be
required to make any such repairs occasioned by the act or neglect of Tenant,
its agents, employees, invitees, licensees or contractors. Landlord shall not
be required to make any other improvements or repairs of any kind upon the
Premises and appurtenances. Any of the foregoing repairs required to be made by
reason of the negligence of Tenant, its agents, etc., as above described, shall
be the responsibility of the Tenant notwithstanding the provisions contained in
this paragraph. Provided, however, Landlord shall have no obligations under
this Paragraph 6.4 unless and until the Tenant has paid its proportionate share
of the Landlord's costs and expenses incurred in fulfilling the obligations set
forth herein.
Anything contained herein to the contrary notwithstanding, Landlord shall
not be liable or responsible to Tenant for any inconvenience or any loss or
damage either to Tenant or Tenant's property or to any other person or his
property occasioned by any matter, either: (a) which is beyond the control of
Landlord; or (b) which may arise through or is in any way connected with repair
of any part of the premises or failure to effect repairs which are its
responsibility, if Landlord undertakes such repairs within a reasonable time
following written notice by Tenant to Landlord of need of same.
6.5 TENANT'S ALTERATIONS: Tenant shall not alter the Premises (but
shall perform required repairs), and shall not install any fixtures or equipment
which are attached to the Premises which affect the Premises in any manner
without first obtaining the written approval of Landlord to such improvements,
and the Landlord's written approval of the manner in which said fixtures and
equipment are to be installed and located in the Premises.
6.6 MECHANIC'S LIENS: Tenant shall, at its own expense, cause to be
discharged within ten (10) days of the filing thereof, any mechanic's lien filed
against the Premises or the building of which it is a part for worked claimed to
have been done for or materials claimed to have been furnished to Tenant.
Tenant will indemnify and save Landlord harmless from and against all loss,
claim, damage, cost or expense suffered by Landlord by reason of any repairs,
installations or improvement made by Tenant, including but not limited to
Landlord's reasonable attorney's fees and litigation expenses.
ARTICLE VII: INSURANCE
7.1 LIABILITY OF Tenant: Tenant shall protect, indemnify and save
Landlord harmless from and against any and all liability and expense of any
kind, including without limitation Landlord's reasonable attorney's fees and
litigation expenses relating in any way to injuries or damages to persons or
property in, on or about the Premises arising out of or resulting in any way
from any act or omission of Tenant, its agents, invitees, servants and/or
employees, in any way relating to the use of the Premises. This indemnity shall
survive the termination of this Lease.
7.2 Notice of Claim or Suit: Tenant agrees to promptly notify Landlord
of any claim, action, proceeding or suit instituted or threatened against the
Landlord. In the event Landlord is made a party to any action for damages which
Tenant has herewith agreed to indemnify Landlord against, then Tenant shall pay
all costs and shall provide effective counsel in such litigation or shall pay,
at Landlord's option, the attorneys' fees and costs incurred in connection with
said litigation by Landlord.
7.3 LIABILITY INSURANCE: Tenant agrees to maintain at its expense at
all times during the lease term, and any renewal thereof, full general liability
insurance (on an occurrence basis) properly protecting and indemnifying Landlord
and naming Landlord and Landlord's lender as additional insureds in an amount
not less than two million dollars ($2,000,000) per person and two million
dollars ($2,000,000) per accident for injuries or damages to persons, and not
less than one
<PAGE>
million dollars ($1,000,000) for damages to or destruction of property, written
by insurers licensed to do business in Tennessee and reasonably satisfactory to
Landlord. Tenant shall deliver to Landlord certificates of such insurance,
which shall declare that the respective insurer may not cancel the same in whole
or in part without giving Landlord and Landlord's lender written notice of its
intention so to do at least thirty (30) days in advance. All public liability
and property damage policies shall contain a provision that the Landlord,
although named as an additional insured, shall nevertheless be entitled to
recover under such policies for any losses occasioned to Landlord by reason of
the negligence of Tenant. Tenant agrees that it will cause their insurance
carriers to include a waiver of subrogation clause or endorsement.
7.4 INCREASE IN INSURANCE PREMIUMS: Tenant shall not overload, damage
or deface the Premises or do any other act which may make void or voidable any
insurance on the Premises or the Plaza or which may render an increased risk
and/or extra premium payable for insurance.
7.5 PROPERTV OF TENANT: Tenant agrees that all property owned by it on
or about the Premises shall be at the sole risk and hazard of Tenant and that
Landlord shall not be liable or responsible for any loss of or damage to Tenant,
or anyone claiming under or through Tenant, or otherwise. Tenant shall obtain
and maintain appropriate amounts of insurance on leasehold improvements and
contents owned or under the responsibility of Tenant.
ARTICLE VIII: FIRE AND OTHER CASUALTY; HAZARDOUS SUBSTANCES
8.1 PARTIAL DESTRUCTION: In the event of the partial destruction of
the Premises by fire or any other casualty, Landlord shall restore or repair the
Premises with reasonable diligence.
8.2 SUBSTANTIAL DESTRUCTION: If the Premises shall be so damaged by
fire or other casualty or happening as to be substantially destroyed, then
Landlord shall have the option to terminate this Lease as provided in Section
8.3 herein. If Landlord does not elect to cancel this Lease as aforesaid, then
the same shall remain in full force and effect and Landlord shall proceed with
all reasonable diligence to repair and replace the Premises.
8.3 RIGHT OF TERMINATION: Landlord, at its option, may terminate this
Lease on thirty (30) days notice to Tenant given at any time within one hundred
eighty (180) days after the occurrence of any one of the following: (a) the
Premises and/or the building in which the Premises are located shall be
substantially damaged or destroyed as a result of an occurrence that is not
covered by Landlord's insurance; or (b) the Premises and/or building in which
the Premises are located shall be damaged or destroyed and the cost to repair
the same shall amount to more than twenty-five percent (25%) of the cost of
replacement thereof-, or (c) the Premises shall be damaged or destroyed during
the last twelve (12) months of the Base Term or extended term; or (d) all or any
portion of the buildings or common areas of the Plaza are damaged (whether or
not the Premises are damaged) to such an extent that in the sole judgment of the
Landlord, the Plaza cannot be operated as an economically viable unit. Upon
such termination any paid but unearned rent will be returned to Tenant.
If, following the occurrence of one of the events described in paragraph
8.3(a)-(d) above, Landlord does not commence repairs within twelve (12) months
following such occurrence, and if such repairs are not diligently pursued, then
Tenant shall have the right to terminate this Lease on thirty (30) days notice
to Landlord.
8.4 RIGHTS OF THE LANDLORD'S LENDER: Notwithstanding anything
contained in this article to the contrary, the obligation of the Landlord with
respect to repairing or rebuilding the Premises is subject to the prior right of
the Landlord's lender to receive insurance proceeds as a result of a fire or
other casualty, with any obligation of the Landlord to be limited to the extent
insurance proceeds are received by the Landlord for such repair or rebuilding.
8.5 NOTICE/DAMAGE CAUSED BY TENANT: Tenant shall give immediate notice
to Landlord of any damage to the Premises by fire or other casualty. Anything
contained in this Lease to the contrary notwithstanding, in the event that
damage to the Premises resulted from or was contributed to by the act, fault or
neglect of Tenant, Tenant's employees, invitees, licensees, or agents, there
shall be no abatement of rent, and Tenant shall be liable to Landlord for all
loss and expense suffered or incurred by Landlord as a result of such damage,
with any sums due hereunder being payable on demand, and whether Landlord
repairs such damage as provided above, or exercises its right not to repair or
rebuild and terminate this Lease on account of such damage, except to the extent
the Landlord or its agents proximately caused such damage.
8.6 HAZARDOUS SUBSTANCES: Tenant shall not store or transport onto the
Plaza or the Premises any Hazardous Substances, as that term is herein defined.
In the event Hazardous
<PAGE>
Substances, as that term is hereinafter defined, are discovered on, in, or under
the Premises as of the date of commencement of this Lease or hereafter, except
as a direct result of any affirmative act or omission of Landlord or a third
party wholly unrelated to Tenant or its agents of affiliates. Tenant, at it's
sole expense, shall immediately institute and complete, on an emergency basis
and without interference with Landlord's other tenants, all proper, requisite,
and thorough procedures for the removal of such Hazardous Substances in
accordance with all applicable laws, rules, ordinances, and regulations
("Removal"). Unless such Hazardous Substances are deposited in, on, or under
the Premises by an act or omission of Landlord or a third party wholly unrelated
to Tenant or its agents or affiliates, Tenant shall indemnify and hold Landlord
harmless from and against any claims arising out of such Hazardous Substances or
as a result of the presence of such Hazardous Substances, including all of
Landlord's attorney fees and costs ("Indemnity"), which Indemnity shall survive
the termination of this Lease. In the event Hazardous Substances are deposited
on, in, or under the Premises solely as a direct result of any affirmative act
or omission of Landlord, Landlord shall be obligated to conduct the Removal with
respect to and to provide the Indemnity to Tenant as to claims arising out of
such Hazardous Substances. For the purposes hereof, "Hazardous Substances"
means pollutants, contaminants, toxic or hazardous substances or wastes, oil or
petroleum products, flammables, or any other substances the nature and/or
quantity of existence, use, release, manufacture, or effect of which renders it
subject to clean-up, remediation, or any corrective action under any Federal,
state, or local environmental health, community awareness or safety laws or
regulations, now or hereafter enacted or promulgated by any governmental
authority or court ruling, or any investigation, remediation, or removal.
ARTICLE IX: ASSIGNMENT AND SUBLETTING
9.1 TENANT ASSIGNMENT: Tenant shall not assign, transfer, or encumber
this Lease without the prior written consent of Landlord and Landlord's lender,
and Tenant shall not sublet or allow any other tenant to come in, with, or under
Tenant without like written consent. Any assignment or subletting,
notwithstanding the consent of the Landlord shall not in any manner release the
Tenant from its continued liability for the performance of the provisions of
this Lease and any amendments or modifications hereto. The acceptance of any
rental payments by the Landlord from any alleged assignee shall not constitute
approval of the assignment of this Lease by the Landlord.
ARTICLE X: DEFAULT AND REMEDIES
10.1 EVENTS OF DEFAULT: The occurrence of any of the events described in
subparagraphs 10.1.1 through 10.1.3 shall be and constitute an "Event of
Default" under this agreement.
10.1.1 Failure by Tenant to pay in full any rental or other sum payable
hereunder within five (5) days of the date such payment is due.
10.1.2 Failure by Tenant to observe or perform any of the terms,
covenants, agreements or conditions contained in this Lease, other than as
specified in subparagraph 10.1.1, for a period of ten (10) days after notice
thereof to Tenant by Landlord. Provided, however, failure of Tenant to abide by
the provisions of Paragraphs 6.5, 6.6, 7.3, 8.6 or 9.1 shall be an immediate
event of default without any prior notice or opportunity to cure.
10.1.3 The filing by or against Tenant of a voluntary or involuntary
petition in bankruptcy or a voluntary petition or answer seeking reorganization,
arrangement, or readjustment of the debts of Tenant or for any other relief
under the Bankruptcy Code, as amended, or under any other insolvency act, law,
rule or regulation, state or federal, now or hereafter existing, or any action
by tenant indicating consent to, approval of, or acquiescence in any such
petition or proceeding; the application by Tenant for, or the appointment with
Tenant's consent or acquiescence of, a receiver or trustee of Tenant, or for all
or a substantial part of the property of Tenant; the making by Tenant of any
general assignment for the benefit of creditors of Tenant; or the inability of
Tenant, or the admission of Tenant of the inability thereof, generally to pay
the debts of Tenant as such mature; the insolvency of Tenant; or the attachment
of all or substantially all of Tenant's assets.
10.2 REMEDIES: Whenever a default occurs, Landlord may, to the extent
permitted by law, take any one or more of the remedial steps described in
subparagraph 10.2.1 through 10.2.3 inclusive, of this paragraph 10.2, subject,
however, to the right, title and interest of any lender of the Landlord.
<PAGE>
10.2.1 Landlord may, at its option, declare all installments of base rent
and additional rents due for the remainder of the lease term to be immediately
due and payable.
10.2.2 Landlord may re-enter and take possession of the Premises and
improvements without terminating this Lease and sublease the same for the
account of Tenant, holding Tenant liable for all rents and other amounts payable
by Tenant hereunder.
10.2.3 Landlord may terminate this Lease, exclude Tenant from possession
of the Premises and improvements and will use Landlord's reasonable efforts to
lease the same to another for the account of Tenant, holding Tenant liable for
all rent and other amounts payable by Tenant hereunder, including all expenses
and costs associated with re-letting the Premises. Landlord shall have no duty
to relet the premises.
10.3 No Remedy Exclusive: No remedy conferred upon or reserved to
Landlord under this Lease is intended to be exclusive of any other available
remedy or remedies, but each and every such remedy shall be cumulative, and
shall be in addition to every other remedy given under this Lease or now or
hereafter existing at law or in equity or by statute. No delay or omission by
Landlord to exercise any right or power accruing upon any default of Tenant
shall impair any such right or power or shall be construed to be a waiver
thereof, but any such right and power may be exercised by Landlord at any time,
from time to time and as often as my be deemed expedient. In order to entitle
Landlord to exercise any remedy reserved to it in this Article X, it shall not
be necessary to give any notice, other than such notice as is expressly required
by this Lease.
10.4 ATTORNEY'S FEES AND EXPENSES: In the event that either party shall
be required to engage outside legal counsel for the enforcement of any of the
terms of this Lease, whether such employment shall require institution of suit
or other legal services deemed necessary to secure compliance on the part of the
other party, such defaulting party shall be responsible for and shall promptly
pay to the other party said attorneys' fees and any other expenses incurred by
the non-defaulting party as a result of such default. The provisions of this
Section 10.4 shall survive the termination of this Lease.
ARTICLE XI: COMMON AREAS
11.1 CONTROL OF COMMON AREAS: The Common Areas shall at all times be
subject to the exclusive control and management of Landlord, and Landlord shall
have the right to operate and maintain the same in such manner as Landlord, in
its sole discretion, shall determine from time to time, including, without
limitation, the right to employ all personnel and to make all rules and
regulations pertaining to and necessary for the proper operation and maintenance
of the Common Areas and facilities. Landlord shall have the exclusive right at
any and all times to close any portion of the Common Areas for the purpose of
making repairs, changes or additions thereto, and to change the size, area or
arrangement of the parking areas or the lighting thereof within or adjacent to
the existing areas, and to enter into agreements with adjacent owners for
cross-easements for parking, ingress, egress, delivery, and the installation of
utility lines. In the event that the lighting controls for the Common Areas
shall be located in the Premises, then Landlord shall have the right to enter
the Premises for the purpose of adjusting or otherwise dealing with the said
controls as required. Provided, however, to the extent reasonable under the
circumstances, Landlord will provide notice to Tenant regarding any closure of
the common areas and Landlord will use its good faith efforts to avoid any
material impact on Tenant's use of the Premises and to minimize the time of such
closure.
11.2 PARKING AREA: Tenant is granted as an appurtenance to the Premises
the right to use a fair and equitable portion of available parking spaces in the
Plaza for the use of its employees, guests, clients, customers, and invitees.
There shall be no loading or unloading of vehicles except in those areas
designated by Landlord for such purpose. Such vehicles may not be parked in
excess of the time reasonably required to load/unload. Tenant agrees that there
will be no outside storage by Tenant without the prior written consent of
Landlord. Tenant agrees to supervise the use of all such loading/unloading,
parking areas and parking spaces by its employees, guests, customers, clients
and invitees in accordance with the rules, regulations and requirements of
Landlord. Tenant for himself, his employees, guests, customers, clients and
invitees agrees that Landlord shall have the right to take, move, impound and
tow off vehicles violating Landlord's rules and regulations, blocking streets
and aisles, parked in unauthorized areas, parked in unauthorized spaces or
otherwise improperly parked, and Tenant for himself, his employees, guests,
customers, clients and invitees agrees to indemnify and hold harmless Landlord
for all claims, loss or liability arising from Landlord's exercise of this
power.
<PAGE>
ARTICLE XII: EMINENT DOMAIN
12.1 If all or any part of the Premises, the building of which it is a
part, or the Plaza shall be condemned or taken in any manner, then Landlord
(whether or not the Premises be affected) may, at its option, terminate this
Lease as of the date of the taking of possession for such use or purpose by
notifying Tenant in writing of such termination. Upon any such taking or
condemnation and the continuing in force of this Lease as to any part of the
Premises, the base rent shall be diminished by an amount representing the part
of the said rent properly applicable to the portion of the Premises which may be
so condemned or taken and Landlord shall, at its expense, proceed with
reasonable diligence to repair, alter and restore the remaining part of the
building and the Premises to substantially their former condition to the extent
that the same may be feasible. Landlord shall be entitled to receive the entire
award in any condemnation proceeding, including any award for the value of any
unexpired term of this Lease, and Tenant shall have no claim against Landlord or
against the proceeds of the condemnation, except to the extent a specific,
identifiable portion of the proceeds are specifically attributable to the
expenses of Tenant which result from the condemnation. If more than fifty
percent (50%) of the Premises are condemned, Tenant shall have the right to
terminate this Lease upon one hundred eighty (180) days prior written notice to
Landlord.
ARTICLE XIII: GENERAL PROVISIONS
13.1 LANDLORD'S RIGHT OR ENTRY: Landlord reserves the right at all
reasonable times during the term of this Lease for Landlord or Landlord's agents
to enter the Premises for the purpose of inspecting and examining the same, and
to show the same to prospective purchasers or tenants, and to make such repairs,
alterations, improvements or additions as Landlord may deem necessary or
desirable. Landlord will use reasonable efforts to provide notice to Tenant
that Landlord intends to enter the Premises, except in emergencies. During the
ninety (90) days prior to the expiration of the term of this Lease or any
renewal term, Landlord may place upon the Premises the usual notices advertising
the Premises for sale or lease, which notices Tenant shall permit to remain
thereon without interference. If Tenant shall not be personally present to open
and permit an entry into the Premises, at any time, when for any reason an entry
therein shall be necessary or permissible, Landlord or Landlord's agents may
enter the same, or may forcibly enter same, without rendering Landlord or such
agents liable therefor, and without in any manner affecting the obligations and
covenants of this Lease. Nothing herein contained, however, shall be deemed or
construed to impose upon Landlord any obligation, responsibility or liability
whatsoever for the care, maintenance or repair of the Premises or any part
thereof, except as otherwise herein specifically provided.
13.2 QUIET ENJOYMENT: Landlord agrees that if the covenants and
obligations of the Tenant are being all and singularly kept, fulfilled and
performed, Tenant shall lawfully and peaceably have, hold, possess, use and
occupy and enjoy the Premises so long as this Lease remains in force, without
disturbance from Landlord, subject to the specific provisions of this Lease.
13.3 [INTENTIONALLY DELETED].
13.4 WAIVER: Waiver by Landlord of any default, breach or failure of
Tenant under this Lease shall not be constituted as a waiver of any subsequent
or different default, breach or failure. In case of a breach by Tenant of any
of the covenants or undertakings of Tenant, Landlord nevertheless may accept
from Tenant any payment or payments hereunder without in any way waiving
Landlord's right to exercise the right of re-entry hereinbefore provided for by
reason of any other breach or lapse which was in existence at the time such
payment or payments were actually accepted by Landlord.
13.5 SUBORDINATION: Tenant hereby subordinates all of its right, title
and interest in and under this Lease to the lien of any mortgage or mortgages,
or the lien resulting from any other method of financing or refinancing, now or
hereafter in force against the real estate and/or buildings hereafter placed
upon real estate of which the Premises are a part. Tenant further agrees to
execute any and all documents requested by Landlord or Landlord's lender to
evidence such subordination or otherwise effectuate the intent and purpose of
this Lease. In the event of any act or omission by Landlord which would give
Tenant the right to terminate this lease or to claim a partial or total
eviction, Tenant win not exercise any such right until (a) it has notified in
writing the mortgagee(s) of such act or omission, and (b) a reasonable period,
not exceeding thirty (30) days, for commencing the remedying of such act or
omission shall have elapsed following the giving of such notice, and (c) the
mortgagee(s), with reasonable diligence, shall not have so
<PAGE>
commenced and continued to remedy such act or omission, or to cause the same to
be remedied. The mortgagee(s) shall have the right, at its election (which
election may be exercised unilaterally by mortgagee filing a notice thereof for
record with the Knox County Register's Office at any time prior to mortgagee's
commencing foreclosure proceedings pursuant to the deed(s) of trust or
instituting sale procedures pursuant to the power of sale therein contained), to
subordinate the lien of the deed of trust to the Lease. Tenant shall attorn to
any purchaser of the Premises at foreclosure and the Lease shall continue in
full force and effect as a direct lease between Tenant and Landlord's lender or
any purchaser at foreclosure. In such event, neither the mortgagee nor any
purchaser at foreclosure shall be responsible for any defaults by the Landlord
or for the return of any security deposit (unless such deposit has actually been
received by Landlord's lender). In no event shall Landlord's lender or a
purchaser at foreclosure be bound by any payment of rent made more than one (1)
month in advance, bound by an amendment or modification or termination of the
Lease made without the written consent of Landlord's lender (if any), liable for
any act or omission of any prior landlord (including Landlord), or liable for
any offsets, credits, or other claims against rentals for any prior periods
and/or against any other party or landlord.
13.6 RECORDING: Tenant, upon request of the Landlord, shall join in the
execution of a memorandum of this Lease for the purpose of recordation. Such
memorandum shall describe the parties, the Premises, and the term of this Lease,
and shall incorporate this Lease by reference and include such other provisions
as Landlord deems appropriate to effectuate the purpose of such recordation.
Tenant shall execute other documents in recordable form as requested by Landlord
or Landlord's lender which furthers the purpose and intent of this Lease.
13.7 AMENDMENT: All amendments to this Lease shall be in writing and
executed by the parties or their respective successors in interest.
13.8 HOLDING OVER: Any holding over after the expiration of the Base
Term or any renewal term pursuant to paragraph 2.1 shall be deemed to be a
tenancy at will and rent payable during any hold-over period shall be at a rate
determined by Landlord. All other obligations of Tenant under this Lease shall
survive during any hold-over period.
13.9 MISCELLANEOUS: TIME IS OF THE ESSENCE. This Lease shall inure to
the benefit of all and shall be binding, upon Landlord, Tenant and their
respective heirs, executors, administrators, and assigns, subject to all the
terms, conditions, and contingencies set forth. If any provision of this Lease
be held invalid or unenforceable by any court of competent jurisdiction, such
holding shall not operate to invalidate any other provision hereof. This Lease
shall be construed without reference to titles of sections or clauses, which are
inserted for convenient reference only. This Lease contains the entire
agreement between the parties hereto with respect to the transactions
contemplated by this Lease and supersedes all prior written or unwritten
arrangements or understandings with respect thereto. All parties represent that
they are not relying on any representation, statement, or action by any other
party. The descriptive headings of this Lease are for convenience only. This
Lease may be executed in any number of counterparts, and each such counterpart
hereof shall be deemed to be an original instrument. This Lease shall be
governed by and in accordance with the substantive, internal laws of the State
of Tennessee. This Lease may not be modified, amended or revoked, except in a
writing signed by all parties. This provision may not be orally waived.
Landlord shall not be bound by this agreement and shall have no duty to Tenant
until this agreement has been duly executed by Landlord.
13.10 LANDLORD'S LIEN: The Tenant hereby pledges, assigns, and grants a
security interest to the Landlord in all of the furniture, fixtures, and other
personal property of the Tenant which are or may be put in, on and about the
Premises as security for the payment of the rent herein reserved. The lien
hereby created may be enforced by distress, foreclosure or otherwise, at the
election of the Landlord. The Tenant hereby waives all right of homestead or
exemption in such furniture, fixtures and other personal property to which it
may be entitled under the constitution and laws of Tennessee.
13.11 FORCE MAJEURE: During the term of this Agreement, neither Landlord
nor Tenant shall be considered in breach or default of the obligations (other
than obligations of the Tenant to pay rents payable hereunder) under this Lease
in the event of any delay in the performance of or inability to perform such
obligation due to unforeseeable causes beyond the control and without the fault
or negligence thereof, including, but not limited to, acts of God, acts of the
public enemy, acts of the other party, fires, floods, epidemics, quarantine
restrictions, strikes, freight embargoes, and unusually severe weather or delays
of the contractor or subcontractors due to such causes; it being the purpose and
intent of this Section 13.11 that in the event of the occurrences of any such
delay, the time or times for performance of the obligations of Landlord or
Tenant, as the case may be, with respect to this Lease shall be extended, for
the period of the enforced delay;
<PAGE>
provided that except as otherwise provided herein, the parties seeking benefit
of this Section 13.11 shall, within ten (10) days after the beginning of any
such delay, have first notified the other party in writing of the cause or
causes thereof, and requested an extension for the period of the delay.
13.12 DOCUMENTATION: Tenant shall execute and deliver to Landlord within
ten (10) days from date of request such supplemental documents as may be
required by any current or subsequent lender of the Landlord in connection with
this Lease, including estoppel certificates in such form as may be required by
Landlord's lender, which certificate may include information as to any
modifications of this Lease, dates of commencement of term and termination date
of Lease, and whether or not Landlord is in default hereunder. Any such
certificate may be relied upon by any prospective purchaser or lessee of the
demised Premises or any mortgagee or prospective mortgagee, or any prospective
assignee of any mortgagee thereof. If Tenant fails or refuses to furnish such
certificate within the time provided, it will be conclusively presumed that this
Lease is in full force and effect in accordance with its terms and the Landlord
is not in default.
13.13 AGENCY: The parties agree that Wood Properties, Inc. is the agent
for Landlord. Landlord agrees that it shall be solely responsible for any
commission or fee payable to Wood Properties, Inc. The parties agree there are
no other agents or brokers entitled to any fee or commission in connection with
this Lease.
13.14 EXCEPTION AND RESERVATION: Landlord reserves and excepts the roof
from the Premises and further reserves the right to install, maintain, use,
repair and replace pipes, duct work, conduits, utility lines and wires through
the space above the suspended ceiling, column space, and partitions in or
beneath the floor slab or about or below the Premises or other part of the
Plaza, and such right in, over and upon the Premises or other parts of the Plaza
as may be reasonably necessary for the servicing of the Premises or of other
portions of the Plaza.
13.15 TRANSFER BY LANDLORD:
(a) Landlord shall have the right to transfer and assign, in whole or
in part, all and every feature of its rights and obligations under this Lease,
in the Building and/or in the Property. Such transfers or assignments may be
made to any person, and howsoever made, are to be in all things respected and
recognized by Tenant; and upon such transfer or assignment the Landlord who is
the Landlord immediately prior to said transfer or assignment shall be relieved
of all future liabilities and obligations under this Lease, but not as to any
then-existing or continuing liability.
(b) As to the Plaza, Landlord will maintain comprehensive and
commercial general liability policies with reputable insurors and Landlord will
request such insurors to: (i) name Tenant as an additional insured; and (ii)
provide Tenant with a certificate of insurance evidencing the insurance and that
such coverage will be not canceled without advance notice to Tenant.
13.16 NOTICES: All notices required or permitted under this Agreement
shall be in writing and shall be deemed properly served if.- delivered in
person; sent by registered or certified mail, with postage prepaid, return
receipt requested; sent by a nationally recognized overnight courier service; or
sent by facsimile transmittal, to the address of the other party, as shown on
the signature page(s) hereof, or to such other addresses as the parties may
subsequently designate in writing to the other party. For purposes of this
Agreement, all notices, demands, deliveries, or other communications required
hereunder shall be deemed made: on the date actually delivered in person, as
evidenced by a receipt by the recipient or an affidavit of the courier; the date
of sending by facsimile (provided it is confirmed by simultaneously giving of
notice by one of the other permitted means of giving notice hereunder); three
(3) days after mailing, if mailed in the manner specified above; or on the date
of delivery, if sent by overnight courier.
IN WITNESS WHEREOF, the parties hereto have executed this Lease as of the
day and date first above written.
CENTERPOINT PLAZA, L.P. CELERITY SYSTEMS, INC.
By Wood Properties, Inc., Its Agent By: /s/ Kenneth D. Van Meter
By: /s/ Gerald S. Daves Its: President/CEO
Its: President
Individually
<PAGE>
-----------------------------------
Address: 900 S. Gay Street
Suite 1600, Riverview Tower
Knoxville, Tennessee 37902 Address:
Telecopy: (423) 549-7400
1400 Centerpoint Boulevard
Knoxville, Tennessee 37932
Telecopy: (423) 539-5300
<PAGE>
EXHIBIT 10.17
October 3, 1997
Mr. Dennis K. Smith
4205 Shadow Ridge Drive
Colleyville, TX 76034
Dear Dennis:
It is our pleasure to offer you employment with Celerity systems, Inc. in the
position of Vice President of Operations, reporting to Ken Van Meter - CEO,
starting no later than October 20, 1997. If you accept this offer, your duties
will include field project management, customer service, laboratory technicians,
field installation and support technicians, production, training and
documentation, and such other duties, tasks and work as may be assigned.
The position will pay $10,416.67 per month, payable in accordance with Celerity
Systems' normal payroll schedule.
You will also be eligible for a bonus of up to twenty-five percent (25%) of your
annual compensation, prorated based on number of months worked in the calendar
year. One-half of the bonus will be based upon the degree of achievement of
your management business objective. These objectives will be mutually agreed
upon by yourself and the CEO within ninety (90) days of your employment. The
balance of the bonus will be based upon overall company performance. This will
be evaluated in January and will be determined solely by management, whose
decision is final.
You will be reimbursed for up to $30,000 in relocation expenses (receipts and
other applicable documentation required).
Additionally, on December 31, 1997, subject to approval of the Board of
directors and your status as a full-time employee on such date; you will be
awarded stock options to purchase 24,000 shares of the Company's common stock
pursuant to the Employee Stock Option Plan as in effect on that date.
The exercise price will be determined at the time of the issuance of these
options, and the requirements of the Plan and related tax laws.
You will be eligible to receive standard Celerity Systems employee benefits
provided to full-time employees in accordance with the specific provisions
and/or plans of the various benefits.
All of us at Celerity Systems expect a smooth transition and look forward to the
contributions you can make to our mutual success. Since there can be no
guarantees, however, it is understood that your employment is at will and for no
specific length of time. That is, Celerity Systems may terminate your
employment at any time with or without cause, and with or without notice, and
you may do the same.
<PAGE>
Mr. Dennis K. Smith
October 3, 1997
Page 2
Human Resources will assist you in completing the necessary payroll procedures
and personnel forms.
This offer of employment will remain open until October 10, 1997, unless
rescinded or modified. In order for you to accept this offer you must also
accept the attached CELERITY SYSTEMS, INC. CONFIDENTIALITY, NON-DISCLOSURE, NON-
COMPETE AND INVENTIONS AGREEMENT.
Please accept our congratulations. We certainly hope that you will accept this
offer and join our organization.
Sincerely,
Kenneth D. Van Meter
President and CEO
cc: Dwight Cook HR
Please acknowledge below your acceptance of this offer and return one of the
two originals to me for our records. The other is for your files.
Accepted: /s/ Dennis K. Smith 10/17/97
------------------------- ---------------
Dennis K. Smith Date
<PAGE>
EXHIBIT 10.18
January, 1998
Mr. James R. Fultz
5820 South Walnut
Downers Grove, IL 60516
Dear Jim:
It is our pleasure to offer you employment with Celerity Systems, Inc. in the
position of Vice President - Sales and Marketing- Interactive Video Services
Division, reporting to the President/CEO, starting as soon as possible but no
later than January 12, 1998. If you accept this offer, your duties will include
sales of the IVS Division products and services, supervision of the Regional
Sales Managers, and other such duties, tasks, and work as may be assigned.
The position will pay $11,250 per month, payable in accordance with Celerity
Systems' normal payroll schedule. You will also receive 24,000 options, subject
to approval by the Board of Directors, and will be eligible to receive standard
Celerity Systems' employee benefits provided to full-time employees in
accordance with the specific provisions and/or plans of the various benefits.
You will be subject to our 1998 Sales Compensation Plan for the IVS Division, a
copy of which is enclosed.
You will receive a $25,000 signing bonus, which includes reimbursement for
relocation expenses (receipts and other applicable documentation required).
During the first 18 months of your employment with Celerity Systems, should you
be terminated for reasons other than for just cause, including unsatisfactory
performance, you would receive 6 month's base salary as termination pay.
All of us at Celerity Systems look forward to the contributions you can make to
our mutual success. Since there can be no guarantees, however, it is understood
that your employment is at will and for no specific length of time. That is,
Celerity Systems may terminate your employment at any time with or without
cause, and with or without notice, and you may do the same. Please Contact the
Human Resources Department at the beginning of your first day to complete the
necessary payroll procedures and personnel forms.
This offer of employment will remain open until January 12, 1998, unless
rescinded or modified. In order for you to accept this offer you must also sign
the attached CELERITY SYSTEMS, INC. CONFIDENTIALITY, NON-DISCLOSURE, NON-COMPETE
AND INVENTIONS AGREEMENT. We certainly hope that you will accept this offer and
join us.
Best Regards,
Kenneth D. Van Meter
President and CEO
cc: Dwight Cook, Tom Welch
Please acknowledge below your acceptance of this offer and return one of the two
originals to me for our records. The other is for your files.
Accepted /s/ James R. Fultz Date 1/12/98
------------------------ -------------------
James R. Fultz
<PAGE>
CELERITY SYSTEMS, INC.
TARGET SALES PLAN
1. ELIGIBLE EMPLOYEE.
Name: James R. Fultz
Position: Vice President of Sales and Marketing
2. PLAN YEAR.
- 1/1/98 through 12/31/98
3. ELIGIBLE SALES TARGET.
- $25,000,000.
4. Commissions.
- 0.25% if Eligible Sales are $25,000,000 or less
- 0.5% if Eligible Sales are $25,000,001 to $37,500,000
- 0.75% if Eligible Sales exceed $37,500,000
5. OTHER TERMS. This Target Sales Plan is issued in conjunction with the
Celerity Systems, Inc. Sales Commission Plan and shall be interpreted
in accordance with the terms and conditions of the Sales Commission
Plan. Capitalized terms herein have the meaning set forth in the
Sales Commission Plan.
CELERITY SYSTEMS, INC. ELIGIBLE EMPLOYEE
By: /s/ Kenneth D. Van Meter /s/ James R. Fultz
------------------------- --------------------------
Signature - James R. Fultz
Title: President/CEO
----------------------
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<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 4,593
<SECURITIES> 1,230
<RECEIVABLES> 1,594
<ALLOWANCES> 567
<INVENTORY> 1,161
<CURRENT-ASSETS> 8,136
<PP&E> 1,639
<DEPRECIATION> 640
<TOTAL-ASSETS> 9,135
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<BONDS> 0
0
0
<COMMON> 4
<OTHER-SE> 7,700
<TOTAL-LIABILITY-AND-EQUITY> 9,135
<SALES> 3,728
<TOTAL-REVENUES> 3,728
<CGS> 3,344
<TOTAL-COSTS> 10,432
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 585
<INCOME-PRETAX> (7,288)
<INCOME-TAX> 0
<INCOME-CONTINUING> (7,288)
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<EXTRAORDINARY> 1,387
<CHANGES> 0
<NET-INCOME> (8,675)
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