U.S. SECURITIES AND EXCHANGE COMMISSION
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, 1998
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
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
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 No
Check if disclosure of delinquent filers in response to Item 405 of the
Regulation S-B is not
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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. [ ]
State issuer's revenues for its most recent fiscal year. $814,159
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Aggregate market value of voting stock held by non-affiliates of
registrant as of March 26, 1999: $3,505,011
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Shares of Common Stock outstanding as of March 26, 1999: 4,349,990
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DOCUMENTS INCORPORATED BY REFERENCE
Items 9, 10, 11, 12 and 13 of Part III are incorporated by reference from
a portion of the registrant's definitive proxy statement to be furnished to
stockholders in connection with the 1999 Annual Meeting of
Stockholders or from an amendment to this Form 10-KSB.
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 15 digital video servers in five countries
(China, Korea, Israel, Taiwan and Canada) on each of the major types of networks
accommodating interactive video services. The Company believes that it has
demonstrated the ability to deploy and operate interactive video systems over
each of the major network types.
Recent Developments
At December 31, 1998, the Company had cash on hand of approximately
$18,000 and a negative working capital of approximately $324,000. Since that
date, the Company has used funds from private financings and operations for
working capital purposes to pay certain outstanding obligations. The Company's
cash position continues to be uncertain and its working capital has declined
since year-end. The Company will not be able to continue as a going concern
unless it receives substantial funds from financings, operations or other
sources. Pending receipt of such funds, the Company has significantly scaled
back its operations. The Company is continuing to seek to arrange financing,
including possible strategic investment or opportunities to sell some or all of
the Company's assets and business. The Company also continues to seek buyers for
all (or portions) of its CD-ROM division, either the Mediator or WorkWare
segments, or both. The Company is taking additional steps to collect accounts
receivable. There can be no assurance that the Company will be able to obtain
any such required additional funds on a timely basis, on favorable terms, or at
all. The following discussion of the
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Company's business and, in particular, its sales and marketing plans, assumes
the Company will continue as a going concern. Depending upon the amount of
proceeds, if any, received by the Company, and the timing of those proceeds, the
Company's ability to continue as a going concern could be seriously affected.
The Company entered into a written lease agreement with Centerpoint Plaza,
L.P., dated November 25, 1997, which was amended on April 1, 1998. The lease was
terminated by the landlord as a result of the Company's breach, effective
January 29, 1999. The Company is currently occupying a portion of its former
premises on a month-to-month basis at a reduced rental. Pursuant to an agreement
between the Company and the landlord, the Company acknowledged breach of the
lease due to its failure to pay the required rental amount, and the landlord
agreed to forego its right to immediate possession of the premises until
February 20, 1999 if the Company performed certain acts. The agreement provided
that any time after February 20, 1999, the landlord could cause its counsel to
(a) file a detainer warrant or complaint and (b) submit the answers and agreed
judgments executed by the Company if the parties did not enter into a written
agreement regarding the portion of the previously leased premises currently
occupied by the Company. The Company and the landlord are still in negotiations
to finalize the new rental terms. No assurance can be given as to the successful
conclusion of these negotiations. See "Description of Property."
The Company has reduced its workforce to approximately 19 employees, due,
in large measure, to its inability to realize sufficient cash flow from
operations. The Company is in arrears in paying compensation to such employees.
The Company will not be able to continue to retain such employees if it does not
obtain additional funds to compensate them. See "Risk Factors--Necessity of
Attracting and Retaining Employees."
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 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.
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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
(DSL), 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, DSL
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
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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 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 DSL 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
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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 (DSL, 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 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.
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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
Digital Set Top Boxes. The Company has developed a new digital set top
box, the T 6000. The T 6000 is designed to work with many transmission networks,
and supports multiple outputs of video, sound, and data. The Company believes
that the T 6000's open architecture and array of functionality and connectivity
make it one of the more advanced of such products in the industry today.
Features include a PentiumTM or Pentium-clone processor, extensive memory, a
wide array of network inputs and system outputs, 2D and 3D graphics, and an
attractive consumer design. The set top box also incorporates hardware and
software that can be utilized
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for home energy management, home security monitoring, and home healthcare
monitoring.
Video Servers. The Company manufactures two different digital video
servers: (i) 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 (ii) a scaled-down ATM server used for trials, focus groups, and similar
groups, which is currently deployed in Canada. The Company has deferred
development if its CTL 8500 analog baseband output digital server, designed to
be used with cable pay-per-view and analog hospitality systems. 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.
Products Manufactured and Developed by Others
Certain products manufactured and developed by others may be provided by
the Company to its customers pursuant to strategic alliances. See "Strategic
Alliances."
Network Equipment. The Company has strategic arrangements, some in the
form of written agreements and some informal, with Nortel, Cisco, and ViaGate
Technologies, to include their network equipment as part of overall bids for
end-to-end interactive video systems, and to be included in end-to-end bids by
those companies. Nortel, for example, has done a number of bids which include
Celerity products. The Company intends to enter into similar arrangements with
other network equipment companies. The Company also has an agreement with Fore
Systems, Inc., a leading manufacturer of ATM switches, which has enabled the
Company to utilize Fore Systems technology and to incorporate Fore Systems
switches with the Company's ATM-based servers, such as those deployed in China
and Taiwan.
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Digital Video Servers. Although the Company manufacturers digital video
servers, the Company is seeking to enter into arrangements with other digital
server manufactures such that they would offer the Company's T 6000 digital set
top boxes as part of end-to-end systems. The Company has tested its digital set
top boxes with two other major digital video servers for such purposes.
Other Equipment. Interactive video services systems also utilize
components such as digital encoders, digital production studio equipment,
digital production software, and other equipment. The Company has entered into
certain arrangements with respect to the resale by the Company of digital
encoders and is seeking to enter into additional arrangements with sellers of
this kind 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-demand application and
some sample applications, such as shopping, as part of its server software;
however, most system operators will require a suite of applications upon
installation of this system, with the potential for adding additional
applications in the future. The Company has entered into certain arrangements to
provide interactive video application 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. The Company has
also entered an agreement with Battelle Laboratories in which Battelle is
providing home energy management software which operates on the T 6000 digital
set top box at no cost to the Company. Upon the sale of such software, the
revenues are shared between the parties.
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. 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
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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.
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
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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 Sales; Limited Marketing and Sales
Experience."
Public Networks
Potential market opportunities for the Company in public networks are:
North American electric and gas utilities, North American telephone companies
and foreign telephone companies.
North American 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
Power Grid System. A number of electric utilities in the United States and in
Canada have expressed an interest in such deployments.
North American 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.
Foreign Telephone Companies. Virtually all of the Company's deployments
have been for Asian entities. 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
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rapidly growing. Potential markets are emerging in Europe, Latin America,
Canada, and Africa, in addition to existing and emerging markets in Asia. The
Company is not currently emphasizing the foreign telephone market. See
"Deployments."
Private Networks
Many hospitals, large apartment and condominium complexes, hotels and
resorts, colleges and universities, and businesses have installed or are
considering installing private networks, utilizing ATM, DSL, 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.
Digital Hospitals. Many domestic and foreign hospitals are already wired
with state-of-the-art, high-speed digital networks (such as ATM or DSL) 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, set top box, 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. The Company is in discussion with
at least three companies which distribute and operate systems in a large number
of hospitals regarding being a distributor for the Company's digital video
servers and set top boxes.
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, DSL, or ATM 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.
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Digital Hospitality. Some hotels, motels, and resorts are already
considering upgrading to a full digital interactive services solution. 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 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.
Corporate. The Company believes that its products and services are
well-suited for point of sale (POS) applications in which a server and multiple
set top boxes would be deployed in a large retail environment to provide
customers with detailed information on products and services, including pricing,
specials, training, and the like.
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
During 1998, the Company had a staff of approximately seven marketing
people, including a Vice President of Sales and Marketing, a Marketing Manager,
a Proposal Writer, and Regional Sales Managers, pursuing business in the US and
abroad. The Company has constructed, in its facility in Knoxville, Tennessee, an
attractive demonstration facility, and participates in trade shows including the
National Association of Broadcasters (NAB), the National Cable
Telecommunications Association (NCTA), and Western Cable Shows. The Company
utilizes sales and product literature and information to communicate with
potential customers. As the Company's cash situation has become more
restrictive, the Company's direct sales organization has been reduced to one
Regional Sales Manager and the Marketing Manager. The CEO also participates in
marketing and sales.
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The Company has entered into arrangements, both formal and informal, with
a wide array of companies with the aim of developing third party sales and
distribution of its products. These parties include the following: Nortel;
Minerva (encoders); Battelle Laboratories (energy management); Fore Systems (ATM
switches); and ViaGate (network providers). The Company has in the past utilized
several agents, such as Bescom, Inc., and TeleMedia International, Inc., in
Korea; Hshanshine International, Ltd., in China, and Tadiran Telecommunications,
Ltd., in Israel. The Company is currently emphasizing North American markets. In
this market, the Company is actively pursuing third party distribution in the
electric, gas, telephone, hospitality, MDU and medical markets.
Deployments
The Company has installed 15 interactive digital video servers in five
countries, consisting of seven servers in Korea, two in Israel, one in Taiwan,
four in China and one in Canada. The Company has deployed these servers on five
different network technologies: (i) FTTC (China), (ii) HFC (Taiwan), (iii)
high-speed data lines (E1 or T1) (Israel), (iv) twisted pair networks using DSL
(Korea), and (v) ATM (Canada). The Company believes that it is the only company
to have implemented interactive video systems on all major network types.
Information concerning these deployments is set forth below.
Korea
The Company installed seven servers as a sub-contractor for interactive
video projects in Korea conducted by a consortium consisting of a
government-sponsored research institute and a number of Korean companies. These
project utilized telephone lines using DSL.
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. The Company received total payments of approximately
$3,790,000 on its Korean projects. The Company has established an allowance for
doubtful accounts of approximately $429,000 which relates 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; Year Ended December 31, 1998 Compared to Year Ended
December 31, 1997."
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. The
Company has received total payments of approximately $1,044,000 from Bezeq and
this project is now completed. See "Management's
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Discussion and Analysis or Plan of Operations--Results of Operations--Year Ended
December 31, 1997 Compared to Year Ended December 31, 1996; Year Ended December
31, 1998 Compared to Year Ended December 31, 1997."
Taiwan
In 1996, the Company received, from IBM Taiwan Corporation ("IBM Taiwan"),
its first order for an asynchronous transfer mode ("ATM") server designed to
operate on modern fiber optic networks. The Company received payments of
approximately $650,000, under this contract. The system was 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.
China
In 1997, the Company sold, through its strategic alliance with ViaGate,
two video servers to Guangdong Public Telecommunications Authority ("GPTA") for
deployment in Shenzen and Guangxiaou, China. The aggregate sale price of this
contract is approximately $1,400,000. In addition, through ViaGate (a wholly
owned subsidiary of Integrated Network Corporation), the Company sold two
servers for the Beijing Telecom Authority. The aggregate sales price for this
order is approximately $712,000. These are the Company's initial deployments on
an FTTC network, which is the primary type of network which telephone companies
and electric and gas utility companies 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 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
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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:
Nortel (formerly Norther Telecom) markets the Company's servers and set
top boxes to telephone companies and other applications throughout North
America.
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.
The Company has entered an agreement with Battelle Laboratories in which
Battelle is providing home energy management software which operates on the T
6000 digital set top box at no cost to the Company. Upon the sale of such
software, the revenues are shared between the parties. There is also provision
in the agreement for joint marketing activities.
Fore Systems, Inc. is a leading manufacturer of ATM switches. The
Company's agreement with Fore Systems provides for joint marketing and technical
cooperation.
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.
The Company has strategic arrangements with such companies to be included
in end-to-end bids by those companies. Nortel, for example, has done a number of
bids which
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includes Celerity products.
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.
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 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."
Intellectual Property
The Company does not have any patents on its products but has filed a
provisional patent application on a number of its more recent inventions,
primarily those related to the T 6000 digital set top box. 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
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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 QNX, Intel, Oak Technologies, IGS, and Lambda as the primary
suppliers for its digital set top boxes. 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."
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 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 generally warrants its digital set top boxes on a similar
basis, but for a period which is the later of 90 days from shipment or 60 days
from installation.
CD-ROM Segment
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
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resources on the interactive video segment. The Company has reduced its
personnel in the CD-ROM segment from approximately 13 employees to fewer than
three. 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 4 of the "Notes to
Financial Statements."
The Company's CD-ROM division has two major product groups. MEDIATOR
provides access to CD-ROM towers and changers for Novell, UNIX, and Windows NT
clients. 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.
The Company warrants its CD-ROM products for 30 days after purchase, with
a replacement or repair option on such CD-ROM products. The Company also
provides its CD-ROM customers with access to a telephone help desk for one year
after purchase.
Employees
As of March 29, 1999, the Company had 19 full-time employees,
approximately 16 of whom were employed in the engineering and product
development area, one of whom fulfilled marketing and sales functions and 2 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--Necessity of Attracting and Retaining Employees."
Risk Factors
Cautionary Statements Regarding Forward-Looking Statements
Certain statements that are not statements of historical fact may
constitute "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995, and include:
o certain statements in this Form 10-KSB;
o statements made in press releases; and
o oral statements made by our officers, directors or employees acting
on our behalf.
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All such forward-looking statements involve known and unknown risks,
uncertainties and other factors which may cause the actual results, performance
or achievements of the Company, or industry results, to be materially different
from any future results, performance or achievements expressed or implied by
such forward-looking statements. In addition to statements which explicitly
describe such risks and uncertainties, you are urged to consider statements
labeled with the terms "believes," "belief," "expects," "plans," "anticipates"
or "intends," to be uncertain and forward-looking.
Need for Additional Financing
As of December 31, 1998, we had cash and cash equivalents of approximately
$18,000 and a negative working capital of approximately $324,000. Our cash and
working capital positions have declined since that date, and we are dependent
upon the receipt of additional financing in order to continue as a viable
entity.
In the first quarter of 1999, we sold $600,000 aggregate principal amount
of convertible debentures in a private offering. The net proceeds from such
sales have been applied to our outstanding obligations.
The Company will not be able to continue operations without additional
financing. The receipt of any additional net proceeds will be applied to our
working capital needs and outstanding obligations. We cannot assure you that
such additional financing will be available when needed on acceptable terms, or
at all.
In addition, in connection with the our private placement consummated in
1996, Gruntal & Co. has received a right of first refusal, until July 1999, to
act as placement agent or underwriter in future financings. Such right may
impair our ability to obtain additional financing.
History of Losses and Accumulated Deficit
We had net losses of approximately $8,675,000 for fiscal 1997 and
$6,955,800 for fiscal 1998. We had an accumulated deficit of approximately
$14,472,100 at December 31, 1997 and $21,428,000 at December 31, 1998. We cannot
assure you that the Company will continue as a going concern or ever operate
profitably. 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. We cannot assure you that we will be
able to develop commercially successful products or that the we will recognize
significant revenues from such products.
Ability to Continue as a Going Concern; Scaled-Back Operations
The report of our accountants with respect to our December 31, 1998
financial statements contains an explanatory paragraph regarding the uncertainty
resulting from our recurring losses, and cash flow and working capital problems.
The Company has also significantly scaled back its operations as a result of
these factors. The lack of sales or a significant financial
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commitment raises substantial doubt about our ability to continue as a going
concern or to operate our business on a full-scale basis. There can be no
assurance that the Company will ever receive the funds necessary for us to
continue as a going concern or to operate our business on a full-scale basis.
Limited Sales; Limited Marketing and Sales Experience
We have limited resources and limited experience in marketing and selling
our products. The Company's sales efforts are currently being supervised by our
President. We cannot assure you that we will be able to establish and maintain
adequate marketing and sales opportunities or make arrangements with others to
perform such activities.
We have not received any material new orders, other than an order in
September 1998 for $96,000 and an order in January 1999 for $1,253,000 ($13,000
of which has been recognized in the first quarter of 1999), for interactive
video projects since June 1997. We have reduced our CD-ROM segment to a
maintenance mode of operations, although we have received a number of orders for
CD-ROM products in the fourth quarter of 1998 and continue to receive orders in
1999.
Achieving market penetration will require significant efforts to create
awareness of, and demand for, our products. Accordingly, our ability to expand
our customer base will depend upon our marketing efforts, including our ability
to establish an effective internal sales organization or strategic marketing
arrangements with others. Our failure to successfully develop marketing and
sales opportunities will have a material adverse effect on our business.
Further, we cannot assure you that such development will lead to sales of our
current or proposed products.
Lack of Dividends
The Company has never paid any dividends on its common stock. We
anticipate that, for the foreseeable future, any earnings that may be generated
from operations will be used to support internal growth and that dividends will
not be paid to stockholders.
Necessity of Attracting and Retaining Employees
Upon consummation of our initial pubic offering in November 1997, we
intended, subject to the availability of funds, to hire approximately 50
employees (in addition to our more than 60 then current employees) for
engineering, product development and operations; sales and marketing; and
management and administrative staff. Due, in large measure, to our inability to
realize sufficient cash flow from operations, we have been unable to implement
our hiring plans. We have reduced our workforce to approximately 19 employees,
which includes the departure of our Vice President of Sales and Marketing in
October 1998 and our Controller in January 1999.
The Company, in 1998, did hire approximately 30 additional staff, but
based on the lack of new sales in the interactive video area, and the Company's
heavy requirement for cash related to the development and initial manufacture of
the T 6000 digital set top box, the Company was required to layoff a small
number of employees, and a larger number left the company
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voluntarily, especially during the final six months of the year, resulting in a
reduction of approximately 45 staff from its peak number in July 1998.
We are in arrears in paying compensation to our employees and we will not
be able to continue to retain them if we do not obtain additional funds to pay
them.
Dependence on Key Personnel
Our success depends to a significant extent on the performance and
continued service of senior management, particularly Kenneth D. Van Meter,
William R. Chambers, Mark Cromwell and Dennis Smith. In addition, our senior
officers (with the exception of Mr. West, who is on an extended leave of
absence) joined us in 1997 and 1998 and do not have a long-standing relationship
with the Company. Our failure to retain the services of key personnel or to
attract additional qualified employees could adversely affect the Company.
We have 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, and
has been amended to provide for a voluntary leave of absence continuing through
the end of the term of his employment agreement. Each of Messrs. Chambers',
Cromwell's and Smith's employment 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 life of Mr. Van Meter in the amount of $2,000,000.
Uncertainty of Trading of Securities on the Nasdaq SmallCap Market; Penny
Stock
The continued trading of our common stock on the Nasdaq SmallCap Market is
conditioned upon meeting certain asset, capital and surplus, earnings, and stock
price requirements. To maintain eligibility for trading, we will be required to
maintain the following:
o 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;
o a market value of shares held by non-affiliates of the Company in
excess of $1,000,000;
o a bid price of $1.00 per share; and
o at least 300 round lot holders of the common stock.
If we fail any of the tests, the common stock may be delisted from trading on
the Nasdaq SmallCap Market. As of March 29, 1999, we have not met the
alternative asset, capitalization or income requirements and may not currently
meet the bid price requirement.
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The effects of delisting include the limited release of the market prices
of our common stock and limited news coverage of the Company. Delisting may
restrict investors' interest in our securities and materially adversely affect
the trading market and prices for such securities and our 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 which, among other things, requires that broker/dealers
satisfy special sales practice requirements. These requirements include making
individualized written suitability determinations and receiving purchasers'
written consent, prior to any transaction.
If our securities are deemed penny stocks under the Securities Enforcement
and Penny Stock Reform Act of 1990, this would require additional disclosure in
connection with trades in our securities. Such disclosure includes the delivery
of a disclosure schedule explaining the nature and risks of the penny stock
market.
The foregoing requirements could severely limit the liquidity of the
Company's securities and materially adversely affect our ability to issue
additional securities or to secure additional financing.
Control By Management
The Company's officers and directors beneficially own approximately 28.3%
of the outstanding common stock. As a result of such ownership, management may
have the ability to control both the election of the directors and the outcome
of issues submitted to a vote of stockholders.
Limitations on Liability of Officers and Directors
Our Certificate of Incorporation includes provisions to eliminate, to the
extent permitted by law, the personal liability of directors for monetary
damages arising from a breach of their fiduciary duties as directors. Our
Certificate of Incorporation also includes provisions to the effect that
(subject to certain exceptions) we 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 permitted by law.
In addition, our Certificate of Incorporation requires that we 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
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the directors and officers for actions taken by them which constitute
negligence, gross negligence, or a violation of their fiduciary duties. This may
reduce the likelihood of stockholders instituting derivative litigation against
directors and officers. This may also 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 stockholders.
Shares Eligible for Future Sale
Other than certain shares held by affiliates of the Company, substantially
all of our shares of common stock are freely transferable without restriction or
further registration under the Securities Act. The remaining shares are
"restricted securities" as that term is defined in Rule 144 under the Securities
Act. These restricted securities may be sold pursuant to Rule 144, other than
shares of common stock underlying certain options, warrants and convertible
securities 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 their exercise. 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.
Effect of Previously Issued Options, Warrants and Convertible Debentures
As of December 31, 1998 options to purchase an aggregate of 71,400 shares
of common stock were outstanding under our 1995 stock option plan. These options
are exercisable at prices ranging from $0.10 to $4.90 per share, although
substantially all of such options are exercisable at $0.10 per share. In
addition, options to purchase an aggregate of 187,520 shares of common stock
were outstanding under our 1997 stock option plan. These options are exercisable
at prices ranging from $0.688 to $2.938 per share, although a majority of such
options are exercisable at $0.688 per share. We also have additional outstanding
options and warrants to purchase approximately 1,300,000 shares of common stock.
The foregoing is in addition to the shares which are issuable upon conversion of
the Company's $600,000 aggregate principal amount of convertible debentures.
Based on the market price of the common stock on March 25, 1999, approximately
941,176 shares would be issuable upon conversion of the convertible debentures,
which are currently convertible at a 25% discount to the market price of the
common stock. Additional shares are issuable for interest and liquidated damages
due on the debentures and as a result of the triggering of anti-dilution
provisions of other instruments and agreements.
The outstanding options, warrants and convertible debentures may hinder
future financings, since the holders of such securities may be expected to
exercise them at a time when we will otherwise be able to obtain equity capital
on more favorable terms. The existence or exercise of the outstanding options,
warrants and convertible debentures, and subsequent sale of the common stock
issuable upon such exercise could adversely affect the market price of the
Company's securities.
Obligations in Connection with the Issuance of the Convertible Debentures
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We are obligated to register the underlying common stock issuable upon
conversion of our $600,000 aggregate principal amount of convertible debentures
under a registration rights agreement. We anticipate that we will not timely
fulfill our registration obligations in respect of some, and perhaps all, of the
convertible debentures. We will be required to pay liquidated damages in the
form of increased interest on the convertible debentures as a result of our
failure to timely file such registration statement and have it declared
effective by the Securities and Exchange Commission.
In addition, we have agreed to obtain (within 90 days following the
issuance of the convertible debentures) stockholder approval, in compliance with
applicable Nasdaq SmallCap requirements. The approval is for the possible
issuance upon conversion of the convertible debentures of shares of common stock
representing in excess of 20% of the outstanding shares of common stock. We will
not timely obtain such approval with respect to some, and perhaps all, of the
convertible debentures. In addition, although we believe that such approval will
be obtained, we will be required to pay liquidated damages in the form of
increased interest on the convertible debentures as a result of our failure to
timely obtain stockholder approval.
Risks Applicable to Foreign Sales
For the years ended December 31, 1996, 1997 and 1998, substantially all of
our interactive video revenues were derived from projects in foreign countries
from foreign sales. However, nearly all of the Company's current proposals are
for projects in North America.
It may be difficult to enforce agreements against foreign-based customers.
We may also face difficulties in collecting payments from foreign customers.
Other risks applicable to foreign sales include 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, we may experience additional difficulties in providing
prompt and cost effective service for our products in foreign countries.
Finally, we believe that potential sales opportunities have been adversely
affected by the current Asian general economic downturn. We do not carry
insurance against any of these risks.
Substantial Up-front Expenses; Liquidated Damages Provisions and Other
Project Risks
A significant portion of our 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. There can be no assurance that
revenues will be realized 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
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in which we participated, are required to reach certain milestones prior to the
Company's receipt of significant payments. Our failure, or any failure by a
third-party with which we may contract, to perform services or deliver
interactive video products on a timely basis could result in a substantial loss
to the Company.
Until recently, we have 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 our reputation,
business, and results of operations. In many instances, we are dependent on the
efforts of third parties to adequately complete their portion of a project and,
even if our digital video servers perform as required, a project may still fail
due to other components of the project supplied by third parties. As a result of
liquidated damages and "hold-back" provisions in customer contracts, we reserved
approximately $570,000, as of December 31, 1997 (of which approximately $429,000
continues to be reserved as of December 31, 1998), for potential uncollectible
accounts receivable.
Consequences of Fixed Price Contracts and Commitments
We have entered into and may in the future enter into fixed price
agreements for the sale of our products and services. Pricing for such
commitments is made based upon estimates of development and production effort
and estimates of future product costs. We bear 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.
We reserved approximately $673,000 for the year ended December 31, 1996
for potential losses on uncompleted contracts. We completed our deliverables on
the contracts in the first quarter of 1998, exhausting the reserves established
in 1996 and incurring additional costs of approximately $190,000. We cannot
assure you that these type of risks will not continue to negatively affect the
Company's margins and profitability.
Competition
The interactive video industry is highly competitive. Many of the
companies with which we currently compete 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. In addition, certain of such competitors have entered into strategic
alliances which may provide them with certain competitive advantages. We can not
assure you that the Company will be able to compete successfully with existing
or future competitors.
Uncertain Market Acceptance
We are engaged in the design and development of interactive video
products. As with any new technology, there is a substantial risk that the
marketplace may not accept the technology
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utilized in our products. Market acceptance of our products will depend, in
large part, upon our ability to demonstrate the performance advantages and
cost-effectiveness of our products over competing products and the general
acceptance of interactive video services. In particular, we believe that
widespread deployment of interactive video systems will depend on a number of
factors, including:
o decreases in the cost per subscriber;
o the "user-friendliness" of such systems, particularly set top boxes
and remote controls which are relatively easy to understand and use;
and
o improvements in the quantity and quality of interactive services
available.
Although recent developments have reduced the cost per subscriber, and we
anticipate 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. We cannot
assure you that we will be able to market our technology successfully or that
any of our current or future products will be accepted in the marketplace.
Risks Associated with Contracts with En Kay Telecom Co., Ltd.
In September 1996, we entered into an agreement with En Kay Telecom Co.,
Ltd., a Korean company, pursuant to which we, as licensor, agreed to design a
digital set top box which would be manufactured and sold by En K in the Republic
of Korea. In February 1997, we entered into a second license agreement with En K
for the manufacture by En K of two models of our 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 another project) and on a non-exclusive basis elsewhere.
We received $600,000 under the 1996 agreement. However, in April 1997, we
stopped production under the 1996 agreement pending settlement of disputes under
the 1997 agreement. The 1997 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 agreement,
although En K did pay $200,000 in mid-May 1997.
We 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. To date, En K has not honored either of its agreements with the Company.
We are continuing to consider various options in this matter, including
commencing legal proceedings. We cannot assure you that we would prevail in any
legal proceeding, or, if we do prevail, that we would collect any amounts
awarded. In addition, although we do not believe there is any basis for such a
course of action, it is possible that En K may seek to recover amounts
previously paid by us under the agreements.
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Need for Strategic Alliances
We believe that there are certain potential advantages to entering into
one or more strategic alliances with major interactive network or product
providers. Although we have entered into certain of such alliances, we are
actively seeking to enter into more of such alliances. Certain of our
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 us. We cannot assure you that we will be successful in entering
into any such strategic alliances on acceptable terms or, if any such strategic
alliance is entered into, that we will realize the anticipated benefits from
such strategic alliance.
Dependence on Suppliers; Manufacturing Risks
We rely primarily on outside suppliers and subcontractors for
substantially all of our parts, components and manufacturing supplies. Certain
materials are currently available only from one supplier or a limited number of
suppliers. We do not maintain long-term supply contracts with our suppliers. The
disruption or termination of our supply or subcontractor arrangements could have
a material adverse effect on the Company's business and results of operations.
Our 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, we may 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.
Alternatively, we may choose to pursue the commercialization of such products on
our own. We cannot assure you that, either on our own or through arrangements
with others, we will be able to obtain such arrangements on acceptable terms.
Reliance on Key Customers
Our interactive video services revenues to date had been derived almost
exclusively from five telecommunications customers, none of whom have placed a
new order with the Company since June 1997. The lack of new projects and major
customers has had, and may continue to have, a material adverse effect on the
Company.
Lack of Patent and Copyright Protection
Although we have filed a provisional patent application with respect to
certain technology, we hold no patents and have not generally filed patent
applications. Our methods of protecting our proprietary knowledge may not afford
adequate protection. We cannot assure you that any patents applied for will be
issued, or, if issued, that such patents would provide us with
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meaningful protection from competition.
In Asia and third world countries, in which we do business and have had
license agreements, the unauthorized use of technology, whether protected
legally or not, is widespread. It is possible that our technology will be
subject to theft and infringement. Furthermore, in accordance with our current
business plan, it will be necessary for us to make our intellectual property
available to vendors, customers, and other companies in the industry, making it
even more difficult to protect our technology.
Risk of Third Party Claims of Infringement
Technology-based industries, such as ours, 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 us, we cannot assure you that third parties will
not assert infringement claims against us in the future, that assertions by such
parties will not result in costly litigation, or that we would prevail in any
such litigation. In addition, we cannot assure you that we would 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 us could have a material adverse effect on the Company.
No Assurance of Technological Success
Our ability to commercialize our products is dependent on the advancement
of our existing technology. In order to obtain and maintain a significant market
share we will continually be required to make advances in technology. We cannot
assure you that our 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. We cannot assure
you that we will not encounter unanticipated technological obstacles which
either delay or prevent us from completing the development of our products.
We believe 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, we will be dependent
upon technological advances which must be made by third parties. We cannot
assure you that we or such third parties will not encounter technological
obstacles which either delay or prevent us from completing the development of
our future products. Such obstacles could have a material adverse effect on the
Company.
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Product Obsolescence; Technological Change
The industries in which we operate are characterized by unpredictable and
rapid technological changes and evolving industry standards. We will be
substantially dependent on our ability to identify emerging markets and develop
products that satisfy such markets. We cannot assure you that we will be able to
accurately identify emerging markets or that any products we have or will
develop will not be rendered obsolete as a result of technological developments.
We believe that competition in our 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 us. Commercial availability
of such products could render our products obsolete, which would have a material
adverse effect on the Company.
From time to time, the Company may announce new products or technologies
that have the potential to replace our existing products offerings. We cannot
assure you that the announcement or expectation of new product offerings by us
or others will not cause customers to defer purchases of existing Company
products, which could materially adversely affect the Company.
Effect of Industry Standards and Compatibility with Equipment and Software
The interactive video industry is currently characterized by emerging
technological standards. Widespread commercial deployment of our 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, we may need to obtain the cooperation of
its suppliers, partners, and competitors, which we cannot assure.
Errors and Omissions; Software and Hardware Bugs
Certain of our products consist of internally developed software and
hardware component sets, purchased software from third parties and purchased
hardware components. Additionally, we outsource substantially all of the
manufacturing of our 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 our products unfit for the purposes for which they were intended. While
there are no such known errors, omissions or bugs, we cannot assure you that
such errors, omissions or bugs do not currently exist or will not develop in our
current or future products. Any such error, omission or bug found in our
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
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material adverse effect on the Company.
Government Regulation
The Federal Communications Commission and certain state agencies regulate
certain of our products and services and certain of the users of such products
and services. We are also subject to regulations applicable to businesses
generally, including regulations relating to manufacturing. In addition,
regulatory authorities in foreign countries in which we sell or may sell our
products may impose similar or more extensive governmental regulations.
We have relied upon, and contemplate that we will continue to rely upon,
our corporate partners or interactive video system sponsors to comply with
applicable regulatory requirements. We cannot assure you that such regulations
will not materially adversely affect the Company by jeopardizing the projects in
which we are participating, by imposing burdensome regulations on the users of
the products, by imposing sanctions that directly affect us, or otherwise.
Changes in the regulatory environment relating to the industries in which we
compete could have an adverse effect on the Company. We cannot predict the
effect that future regulation or regulatory changes may have on our business.
Product Liability and Availability of Insurance
The manufacture and sale of our products entail the risk of product
liability claims. In addition, many of the telephone, cable, and other large
companies with which we do or may do business may require financial assurances
of product reliability. We maintain product liability insurance in the amount of
$1,000,000 per occurrence and $2,000,000 in the aggregate. We may be required to
obtain additional insurance coverage. Product liability insurance is expensive
and we cannot assure you 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 our products. A successful claim
brought against us in excess of our insurance coverage could have a material
adverse effect on the Company.
Variability of Quarterly Operating Results
Variations in our 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 we are engaged, the completion of work or achievement of
milestones on long-term projects, and the timing and progress of our product
development efforts. The timing and realization of revenues is difficult to
forecast, in part, because our 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 our projects.
We have not received material new orders, other than an order in September
1998 for
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$96,000 and an order in January 1999 for $1,253,000 ($13,000 of which has been
recognized in the first quarter of 1999) for interactive video projects since
June 1997, although we received a number of orders for CD-ROM products in the
fourth quarter of 1998. 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 our
customers and potential customers do business, our 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 our CD-ROM operations. In addition, the
timing of revenue recognition for revenue received from long term projects under
our accounting policies may also contribute to significant variations in our
operating results from quarter to quarter.
Anti-takeover Effects Associated with the Issuance of "Blank Check"
Preferred Stock and Delaware Law
Our Certificate of Incorporation authorizes our Board of Directors to
issue up to 3,000,000 shares of "blank check" preferred stock. The Board of
Directors, without stockholder approval, may fix all the rights of the preferred
stock. The issuance of such stock could, among other results, negatively affect
the voting power of the holders of common stock.
Under certain circumstances, the issuance of the preferred stock would
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. In addition, certain provisions of Delaware law may also
discourage third party attempts to acquire control of the Company.
We have no current arrangement, commitment or understanding with respect
to the issuance of our preferred stock. We cannot assure you, however, that we
will not, in the future, issue shares of preferred stock.
Non-Cash Charges
As a result of our issuance of convertible debentures in the first quarter
of fiscal 1999, we will be required to reflect the difference between the
aggregate conversion price of all of the convertible debentures and the current
fair market value (on the date of issuance of the convertible debentures) of the
shares underlying the convertible debentures as a discount on the convertible
debentures as additional paid in capital. Based on the market price of the
common stock on March 25, 1999, the discount and paid in capital would be
approximately $194,000. Such amount will be amortized as a non-cash interest
expense over a 90-day period (the period between the date of issuance of the
convertible debentures and the date the convertible debentures first become
exercisable).
As a result of our issuance of certain warrants in July 1997, as well as
the repayment of
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notes issued in July 1997, we had an aggregate amount of non-cash interest
expense and loss on extinguishment of debt of approximately $1,440,000. We also
incurred a charge of approximately $306,834 related to the write-off of
financing costs previously capitalized in connection with our private placements
in 1996 and 1997. In addition, we 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 $2,544,755.
General Economic Conditions
The industry in which we compete relies in part upon consumer confidence
and the availability of discretionary income. Both of these can be adversely
affected during a general economic downturn. In addition, potential customers
may not be willing or able to commit funds to interactive video projects during
such a downturn.
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 may be highly volatile. The
market price of the common stock may be significantly affected or may fluctuate
substantially due to factors such as the following:
o announcements by the Company or its competitors concerning products,
patents, technology and governmental regulatory actions;
o other events affecting computer technology and software companies
generally; and
o general market and economic conditions.
Research and Development Costs
Research and development costs amounted to $357,436 and $912,045 for the
years ended December 31, 1997 and 1998, 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. The Company has sublet such premises, and there is no
further obligation under that lease. The Company entered into a lease for new
premises in Knoxville, Tennessee effective in January 1998, and relocated
effective March 30, 1998. The new lease was terminated by the landlord as
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a result of the Company's breach, effective January 29, 1999. Pursuant to an
agreement between the Company and the landlord, the landlord agreed to forego
its right to immediate possession of the premises until February 20, 1999 if the
Company (i) vacated the second floor of the premises by February 8, 1999, (ii)
paid a total of approximately $79,000 by February 20, 1999, and (iii) no later
than February 10, 1999, delivered a first priority security interest in all
personal property of the Company to secure the obligations of the Company set
forth in the lease. The agreement provided that any time after February 20,
1999, the landlord could cause its counsel to (a) file a detainer warrant or
complaint and (b) submit the answers and agreed judgments executed by the
Company if the parties did not enter into a written agreement regarding the
portion of the previously leased premises currently occupied by the Company. The
Company and the landlord are still in negotiations to finalize the new rental
terms. No assurance can be given as to the successful conclusion of these
negotiations. The Company is currently leasing approximately 20,000 square feet
of space on a month-to-month basis for lease and maintenance payments of
approximately $24,000 per month.
Item 3. Legal Proceedings.
The Company is not a party to any pending legal proceeding. See
"Description of Property," and "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, 1998.
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."
The following table sets forth, for the fiscal periods indicated, the high
and low bid prices of a share of Common Stock as reported by the Nasdaq SmallCap
Market for periods on and subsequent to November 4, 1997, the date of the
Company's Initial Public Offering (the "IPO"). Such quotations reflect
inter-dealer prices, without retail mark-up, mark-down or commission and may not
necessarily represent actual transactions.
High Low
---- ---
Fiscal Year 1997
4th Quarter (commencing November 4, 1997).............. $8.25 $1.625
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Fiscal Year 1998
1st Quarter....................................... $4.375 $1.375
2nd Quarter....................................... $3.875 $1.312
3rd Quarter....................................... $2.5 $0.938
4th Quarter....................................... $2.688 $0.656
As of March 29, 1999 there were approximately 130 holders of record of the
Common Stock.
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.
Item 6. Management's Discussion and Analysis or Plan of Operation.
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.
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Overview
Prior to 1998, the Company's major activity was selling digital video
servers in the interactive video services market. All sales were in Korea,
Israel, Taiwan and China. However, beginning in 1998, the Company has focused
its sales efforts in North America, and developed and sold the first production
units of a new digital set top box, the T 6000.
The Company has continued to focus most of its development and production
efforts during the twelve months ended December 31, 1998 on the T 6000, while
also seeking new projects for the Company's digital video servers, which could
be deployed with the T 6000 or other compatible set top boxes. The Company has
produced its initial trial run of the T 6000 set top boxes, which were
manufactured by Taylor-White, LLC, of Greeneville, Tennessee ("Taylor White").
The Company sold 13 of these trial run boxes to Northern Telecom ("Nortel") in
September 1998 for use in their demonstration facility in Ottawa, Canada. In
addition, Nortel purchased a CTL 7000 digital video server.
Management has also focused on attempting to obtain the necessary capital
to maintain the Company's operations. The Company is continuing to seek to
arrange financing, including possible strategic investment or opportunities to
sell some or all of the Company's assets and business, while continuing to
pursue sales opportunities. The Company has narrowed its sales efforts to those
which, the Company believes, have the best chance of closing in the near term.
The Company's sales efforts are now being supervised by its President due to the
departure of its Vice President of Sales and Marketing in October 1998. The
Company continues to encounter a longer and more complex sales cycle and to
realize fewer sales than previously anticipated. Although the T 6000 is in
production, the Company continues to add and improve functionality and may be
required to do so for certain deployments. However, management believes that the
Company is now better positioned to become an important participant in many of
its key market segments. There can be no assurance that this will be the case.
Because of the Company's long-term sales cycle, 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.
In February 1998, following the unsuccessful conclusion of the Company's
efforts to retain a qualified general manager for its CD-ROM segment, the
Company decided to scale back the segment to a maintenance mode of operations.
The decision was also based on the continued decline in the segment's revenues,
and the Company's need to focus its efforts and resources on the interactive
video segment. The Company then developed a formal plan of disposal which became
effective in May 1998, and the Company now accounts for the CD-ROM segment as a
discontinued operation. The Company continued to seek potential purchasers of
the division in 1998. The operations of the segment have been accounted for as a
loss on disposal since May 1998. The segment had a net loss from operations of
approximately $114,000 for the twelve months ended December 31, 1998 and a loss
on disposal of the segment of approximately $22,000 for the same period. The
CD-ROM segment generated a net loss from operations of approximately $744,000
for the twelve months ended December 31, 1997. There can be no assurance that
the Company will realize any proceeds from the disposition of the segment. Due
to the discontinued status of the segment, the remainder of management's
discussion of the Company's financial results does not include the CD-ROM
segment.
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The Company has indefinitely postponed any continued research and
development efforts related to the CTL 8500 digital baseband server, aimed at
the analog hospitality and cable markets, and the CTL 10000, aimed at larger
system deployments. Future research and development efforts are being delayed
indefinitely. The Company has continued limited development on its CTL 7000 and
CTL 9000 digital video servers and software to add functionality and reduce
costs.
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 $594,000 in costs associated
with the BTA project and recognized those costs upon completion. There is still
a receivable balance due from ViaGate Technologies, the prime contractor for
these two projects, of approximately $230,000.
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--Risks Applicable to
Foreign 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."
The Company had three interactive video customers that represented 15%,
38% and 14%, respectively, of the Company's revenues in 1997 and one that
represented 56% of the Company's revenues in 1998. Export sales represented 71%
and 56% for 1997 and 1998, respectively.
Results of Operations
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
Revenues. The Company had revenues of $814,159 for the year ended December
31, 1998, as compared to $2,716,939 for the same period in 1997. Primary reasons
for this difference were the lack of interactive video sales due to the weak
Asian economy, discontinuance of the Company's CD-ROM division and constrained
marketing activities due to the Company's cash situation. Sales of interactive
video services in 1998 were to Beijing Telecom Authority (BTA) in China and to
Nortel in Canada.
Costs of Revenues. Costs of revenues were $879,280 in 1998 as compared to
$2,972,328 in 1997. The Company had a gross loss of $65,121 in 1998 as compared
to $255,389 for the same
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period in 1997. Costs of revenues in 1998 were related to the completion of the
BTA project and the cost of the initial T 6000 production units sold to Nortel.
The costs of revenues in 1997 were primarily due to the Company's efforts to
complete long-term projects and the costs of production design and tooling for
several major vendors, including Taylor-White, Knoxville Industrial Design,
Philips and Lambda, to prepare for T 6000 initial production.
The decrease in costs of revenues was primarily due to the fact that the
Company had virtually no revenue during the second, third, and fourth quarters
of 1998, and therefore had few costs associated with revenues for those
quarters. The majority of the costs of revenue for the twelve months ended
December 31, 1998 was due to the completion of the Company's BTA project and the
recognition of the related costs on the project of approximately $594,000, which
had been capitalized over the life of the project. The remainder of the costs
for 1998 were related to the Company's efforts to complete projects for which
revenue had previously been recognized.
Operating Expenses. Operating expenses for the twelve months ended
December 31, 1998, were $6,810,757, as compared to $3,158,909 for the same
period in 1997. As mentioned previously, operating expenses were significantly
greater in all areas during 1998 due to the Company's efforts to achieve better
performance and prepare for anticipated future growth. The majority of the
increase consisted of an increase in operating wages expenses and associated
payroll taxes and other employee benefits due to the hiring of additional
personnel early in 1998. Another component of the increase in operating expenses
was an increase in facility rental expense during 1998 as compared to the same
period in 1997 with the Company's move to a new facility. The Company also began
developing more sophisticated marketing materials and incurred expenses for
other marketing efforts in 1998. Expenses incurred for the use of contractors,
consultants, and recruiting efforts also increased in the 1998 period due to the
Company's increased need for quality personnel.
The Company also recognized $2,544,775 in non-cash compensation expense
during the twelve month period ended December 31, 1997 due to the fact that it
had granted stock options at an exercise price below the initial public offering
of $7.50 per share in the IPO. There were no similar expenses in 1998.
Interest Expense and Income. Due to the Company's repayment of debt in
late 1997, following receipt of proceeds from the IPO, interest expense for 1998
was $35,056, as compared to $664,687 in 1997. Interest income was similar at
$90,219 in 1998 versus $79,958 in 1997.
39
<PAGE>
Net Loss. As a result of the above factors, net loss from continuing
operations before extraordinary item for the twelve months ended December 31,
1998 was $6,820,715 as compared to $6,543,802 for the same period in 1997.
Liquidity and Capital Resources
The primary source of financing for the Company since its inception has
been through the issuance of common and preferred stock and debt and related
accrued interest.
In November 1997, the Company consummated the IPO in which 2,000,000
shares of Common Stock were sold at a purchase price of $7.50 per share. The
Company realized net proceeds of approximately $12,386,800 from the IPO, of
which approximately $5,446,000 was used to pay its outstanding debt and related
accrued interest.
In August 1998, the Company's President loaned the Company $55,000 on a
short term basis for working capital needs. In September 1998, one of the
Company's directors loaned the company an additional $100,000 for working
capital uses. In October 1998, the Company amended its 401(k) plan to allow
participants in the plan to invest in the Company's common stock. The Company's
president allocated the entirety of his investments into the Company's common
stock in the approximate amount of $136,000 and the plan purchased 155,028
shares on his behalf. Some additional employees purchased substantially smaller
amounts through their 401(k) plan under this program. The Company has used these
proceeds for working capital. In October and November 1998, the Company received
aggregate gross proceeds of $450,000 from a private placement. Such proceeds
included cancellation of $150,000 of indebtedness to a director and the
President of the Company (see above). Each investor in the private placement
received a seven percent promissory note with a principal amount equal to the
amount of the investment with a term of one, two, or three years. Principal and
interest are payable by the Company at maturity. In addition, each investor
received the right to a royalty payment of fifty cents per $100,000 invested
(pro rated for lesser investments), for each T 6000 digital set top box sold
during a period of up to five years following the closing. The $450,000 received
represents the entire amount received in the private placement. Investors in the
private placement included certain directors and officers of the company, as
well as outside investors. The funds were used for general operating expenses of
the Company.
The Company had cash balances on hand as of December 31, 1998 of
approximately $18,000. The Company's cash position continues to be uncertain. In
efforts to control cash outflow, the Company's officers have elected to defer
portions of their salaries since August of 1998 and until such time as the
financial position of the company will allow those deferrals to be repaid. The
Company's President has not taken any salary since the July pay period and the
Company is in arrears in paying compensation to its employees. The Company has
lost employees either voluntarily or involuntarily in the second half of 1998
due to its financial position and has significantly scaled back its operations.
The Company has raised $600,000 between January 1999 and March 1999 in a
private placement. The Company is looking at several other options in terms of
improving its cash
40
<PAGE>
situation. The Company is continuing to seek to arrange financing, including
possible strategic investment or opportunities to sell some or all of the
Company's assets and business, while continuing to pursue sales opportunities.
The Company has granted a security interest in its property to its landlord and
has granted a security interest in its personal property to one of its legal
counsel. Such security interest may hinder the Company's efforts to obtain
financing. The Company also continues to seek buyers for the CD-ROM division,
either the Mediator or WorkWare segments, or both. The Company is taking
additional steps to collect accounts receivable which have been reserved in 1996
and 1997, including $429,000 from Korea Telecom/Bescom. There can be no
assurance that the Company will be able to obtain any such required additional
funds from any source on a timely basis, on favorable terms, or at all. The lack
of sales or a significant financial commitment raises substantial doubt about
the Company's ability to continue as a going concern or to resume a full-scale
level of operations.
Since its inception in January, 1993 and through December 31, 1998, the
Company has an accumulated deficit of $21,427,942. The Company expects to incur
operating losses for the indefinite future as it continues to solidify its
technology and achieve some sales success. The Company is also continuing to
pursue its sales efforts and endeavoring to offer attractive pricing to close
sales in a timely manner. Since January 1, 1999, the Company has received new
interactive services orders and new CD-ROM orders from Hopkinsville Electric
Service, Optelecom, and the United States Navy, respectively. There can be no
assurance, however, as to the receipt or timing of revenues from operations,
including, in particular, revenues from products currently under development.
As of December 31, 1998, the Company had a negative net working capital of
approximately $324,000. The Company had no significant capital spending or
purchase commitments at December 31, 1998 other than certain facility leases and
inventory component purchase commitments required in the ordinary course of its
business.
The Company has no existing lines of credit.
Year 2000 Issues
Background. Some computers, software and other equipment include programming
code in which the calendar year date is abbreviated to only two digits. As a
result of this design decision, some of these systems could fail to operate or
produce correct results if "00" is interpreted to mean 1900, rather than 2000.
These problems are widely expected to increase in frequency and severity as the
year 2000 approaches, and are commonly referred to as the "Millenium Bug" or
"Year 2000 Problem."
Assessment The Year 2000 Problem could affect computers, software, and other
equipment used, operated or maintained by the Company. Accordingly, the Company
is reviewing its internal computer programs and systems to ensure that the
programs and systems will accurately process date data (including, but not
limited to, calculating, comparing and sequencing dates) in connection with the
year change from December 31, 1999 to January 1, 2000, or be "Year 2000 Ready."
The Company presently believes that its computer systems will be Year 2000 Ready
in a timely manner. While the estimated costs of these efforts are not expected
to be material to the Company's financial position or any year's results of
operations, there can be no assurance to this effect.
Software Sold to Consumers. The Company believes that it has substantially
identified and
41
<PAGE>
resolved all potential Year 2000 Problems with any of the software products,
which it develops and markets. However, management also believes that it is not
possible to determine with complete certainty that all Year 2000 Problems
affecting the Company's software products have been identified or corrected due
to the complexity of these products, the fact that they incorporate third-party
software and the fact that these products interact with third-party vendor
products and operate on computer systems which an not under the Company's
control.
Internal Infrastructure. The Company has begun to identify the major computers,
software applications and related equipment used in connection with its internal
operations that must be modified, upgraded or replaced to minimize the
possibility of a material disruption to its business. The Company has identified
major systems which, if affected by the Year 2000 Problem, might adversely
affect the Company's operations, and expects to have the systems updated or
modified by the middle of 1999.
Systems Other than Information Technology Systems. In addition to computers and
related systems, the operation of office and facilities equipment, such as fax
machines, photocopiers, telephone switches, security systems, elevators, and
other common devices may be affected by the Year 2000 Problem; however, the
Company does not believe that the Year 2000 Problem will have a significant
effect on its office and facilities equipment.
The Company estimates the total cost to the Company of completing any required
modifications, upgrades, or replacements of these internal systems will not have
a material adverse effect on the Company's business or results of operations.
This estimate will be revised, if required, should additional information become
available.
Suppliers. The Company has initiated communications with third party suppliers
of the major computers, software, and other equipment used, operated, or
maintained by the Company to identify and, to the extent possible, to resolve
issues involving the Year 2000 Problem. However, the Company has limited or no
control over the actions of these third-party suppliers. Thus, while the Company
expects that it will be able to resolve any significant Year 2000 Problems with
these systems, there can be no assurance that these suppliers will resolve any
or all Year 2000 Problems before the occurrence of a material disruption to the
business of the Company or any of its customers. Any failure of these
third-parties to resolve Year 2000 Problems in a timely manner could have a
material adverse effect on the Company's business, financial condition and
results of operations.
Most Likely Consequences of Year 2000 Problems. The Company expects to identify
and resolve all Year 2000 Problems that could materially adversely affect its
business operations in a timely manner. However, management believes that it is
not possible to determine with complete certainty that all Year 2000 Problems
affecting the Company have been identified or corrected. The number of devices
that could be affected and the interactions among these devices are too numerous
to identify specifically. In addition, one cannot accurately predict how many
Year 2000 Problem-related failures will occur or the severity, duration, or
financial consequences of such failures. As a result, management expects that
the Company could encounter a number of operational inefficiencies and
inconveniences that may divert management's time and attention, as well as
financial and human resources from its ordinary business activities. It may also
encounter a number of serious system failures that may require significant
efforts by the
42
<PAGE>
Company or its clients to prevent or alleviate material business disruptions.
Contingency Plans. The Company is currently developing contingency plans to be
implemented as part of its efforts to identify and correct Year 2000 Problems
affecting its internal systems. The Company expects to complete its contingency
plans by the middle of 1999. Depending on the systems affected, these plans
could include accelerated replacement of affected equipment or software, short
to medium term use of backup equipment and software, increased work hours for
Company personnel or use of contract personnel to correct on an accelerated
schedule any Year 2000 Problems that arise or to provide manual workarounds for
information systems, and similar approaches. If the Company is required to
implement any of these contingency plans, it could have a material adverse
effect on the Company's financial condition and results of operations.
Based on the activities described above, the Company does not believe that the
Year 2000 Problem will have a material adverse effect on the Company's business
or results of operations. However, the Company's ability to achieve Year 2000
readiness, and the level of incremental costs associated therewith, could be
adversely impacted by, among other things, the availability and cost of
programming and testing resources, vendors' ability to modify proprietary
software, and unanticipated problems identified in the ongoing readiness review.
43
<PAGE>
Item 7. Financial Statements.
The Financial Statements and Notes thereto can be found beginning with
"Index to Financial Statements," following Part III of this Annual Report on
Form 10-KSB.
Item 8. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure.
Not applicable
PART III
The information called for by Items 9, 10, 11, 12 and 13 is hereby
incorporated by reference from the Company's definitive proxy statement to be
filed pursuant to Regulation 14A for the 1999 Annual Meeting of Stockholders or
from an amendment to this Form 10-KSB.
44
<PAGE>
CELERITY SYSTEMS, INC.
Financial Statements
December 31, 1998 and 1997
with
Report of Independent Accountants
<PAGE>
Report of Independent Accountants
To the Board of Directors
Celerity Systems, Inc.
In our opinion, the accompanying balance sheets and the related statements of
operations, stockholders' equity and of cash flows present fairly, in all
material respects, the financial position of Celerity Systems, Inc. (the
"Company") at December 31, 1997 and 1998, and the results of its operations and
its cash flows for each of the years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 3 to the
financial statements, the Company has suffered recurring losses from operations
that raise substantial doubt about its ability to continue as a going concern.
Management's plans in regard to these matters are also described in Note 3. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
PricewaterhouseCoopers LLP
February 26, 1999
Knoxville, Tennessee
F-1
<PAGE>
CELERITY SYSTEMS, INC.
Balance Sheets
December 31, 1997 and 1998
<TABLE>
<CAPTION>
1997 1998
<S> <C> <C>
Assets
Cash and cash equivalents $ 4,592,975 $ 18,273
Short-term investments 1,229,788 --
Accounts receivable, less allowance for doubtful accounts
of $567,024 and $436,472 in 1997 and 1998, respectively 1,022,283 280,315
Interest receivable 4,954 --
Inventory 1,161,356 1,206,611
Prepaid expenses 103,340 63,150
Costs in excess of billings on uncompleted contracts 20,963 --
------------ ------------
Total current assets 8,135,659 1,568,349
Property and equipment, net 999,245 1,697,367
------------ ------------
Total assets $ 9,134,904 $ 3,265,716
============ ============
Liabilities and Stockholders' Equity
Accounts payable $ 806,305 $ 821,814
Accrued wages and related taxes 102,828 626,389
Other accrued liabilities 286,232 172,140
Current maturities of long-term debt and capital lease obligations -- 271,937
Warranty reserve 235,000 --
------------ ------------
Total current liabilities 1,430,365 1,892,280
Long-term debt and capital lease obligations, less current maturities -- 397,955
------------ ------------
Total liabilities 1,430,365 2,290,235
Common stock, $0.001 par value, 15,000,000 shares authorized,
4,442,134 issued and 4,104,770 outstanding, and 4,748,847
issued and 4,411,483 outstanding at December 31, 1997
and 1998, respectively 4,442 4,749
Additional paid-in capital 22,399,692 22,626,174
Treasury stock, at cost, 337,364 at December 31, 1997 and 1998 (227,500) (227,500)
Accumulated deficit (14,472,095) (21,427,942)
------------ ------------
Total stockholders' equity 7,704,539 975,481
------------ ------------
Total liabilities and stockholders' equity $ 9,134,904 $ 3,265,716
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-2
<PAGE>
CELERITY SYSTEMS, INC.
Statements of Operations
For the years ended December 31, 1997 and 1998
<TABLE>
<CAPTION>
1997 1998
<S> <C> <C>
Revenues $ 2,716,939 $ 814,159
Cost of revenues 2,972,328 879,280
----------- -----------
Gross margin (255,389) (65,121)
Operating expenses 3,158,909 6,810,757
Noncash compensation expense 2,544,775 --
----------- -----------
Loss from operations (5,959,073) (6,875,878)
Interest expense (664,687) (35,056)
Interest income 79,958 90,219
----------- -----------
Net loss from continuing operations before extraordinary item (6,543,802) (6,820,715)
Discontinued operations (Note 4):
Loss from operations of discontinued CD-ROM segment 744,394 113,559
Loss on disposal of discontinued CD-ROM segment -- 21,573
----------- -----------
Net loss before extraordinary item (7,288,196) (6,955,847)
Loss on early extinguishment of debt 1,386,834 --
----------- -----------
Net loss (8,675,030) (6,955,847)
Accretion of premiums on preferred stocks 208,529 --
----------- -----------
Net loss applicable to common stock $(8,883,559) $(6,955,847)
=========== ===========
Basic and diluted loss per common share (Note 12):
Loss from continuing operations before extraordinary charge $ (3.23) $ (1.60)
Discontinued operations (0.36) (0.03)
Extraordinary charge (0.66) --
----------- -----------
Loss per share $ (4.25) $ (1.63)
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
CELERITY SYSTEMS, INC.
Statement of Stockholders' Equity
<TABLE>
<CAPTION>
Additional
Common Paid-in Treasury Accumulated
Stock Capital Stock Deficit
<S> <C> <C> <C> <C>
Balances, January 1, 1997 $ 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 -- (208,529) -- --
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 22,399,792 (227,500) (14,472,095)
Issuance of stock to employee benefit plan 156 135,766 -- --
Exercise of employee stock options 47 4,796 -- --
Conversion of accounts and notes payable to stock 104 85,920 -- --
Net loss -- -- -- (6,955,847)
------------ ------------ ------------ ------------
Balances, December 31, 1998 $ 4,749 $ 22,626,274 $ (227,500) $(21,427,942)
============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
CELERITY SYSTEMS, INC.
Statements of Cash Flows
For the years ended December 31, 1997 and 1998
<TABLE>
<CAPTION>
1997 1998
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (8,675,030) $ (6,955,847)
Adjustments to reconcile net loss to net
cash used by operating activities:
Depreciation and amortization 493,757 515,233
Accretion of interest on notes payable 360,000 --
Loss on disposal of fixed assets 1,358 41,197
Extraordinary loss on early extinguishment of debt 1,386,834 --
Expense for issuance of stock options and common stock 2,544,775 17,205
Warranty reserve 35,000 (235,000)
Provision for doubtful accounts receivable 11,974 152,129
Provision for inventory obsolescence (155,919) (273,544)
Changes in current assets and liabilities:
Accounts receivable (321,025) 594,793
Interest receivable (4,954) --
Prepaid expenses (103,340) 40,189
Inventory 149,303 111,998
Costs in excess of billings on uncompleted contracts 16,786 20,963
Accounts payable 490,473 15,509
Other current liabilities (371,180) 478,289
Deferred revenue (359,970) --
Allowance for estimated losses on uncompleted contracts (672,600) --
------------ ------------
Net cash used in operating activities (5,173,758) (5,476,886)
Cash flows from investing activities:
Purchases of property and equipment (286,929) (879,494)
Investments in short-term instruments (1,229,788) 1,229,788
------------ ------------
Net cash provided (used) in investing activities (1,516,717) 350,294
Cash flows from financing activities:
Proceeds from long-term debt 2,000,000 450,000
Principal payments on long-term debt and capital lease obligations (5,026,830) (38,875)
Proceeds from issuance of common stock 15,003,918 140,765
Repurchase of common stock (160,000) --
Financing and debt issue costs (2,878,304) --
------------ ------------
Net cash provided in financing activities 8,938,784 551,890
Net increase (decrease) in cash and cash equivalents 2,248,309 (4,574,702)
Cash and cash equivalents, beginning of year 2,344,666 4,592,975
------------ ------------
Cash and cash equivalents, end of year $ 4,592,975 $ 18,273
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
CELERITY SYSTEMS, INC.
Notes to Financial Statements
1. Organization and Nature of Business
Celerity Systems, Inc. (the "Company"), a Delaware corporation, 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
the CD-ROM segment to a maintenance mode of operations (Note 4). 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 basis. The majority of
the Company's remaining CD-ROM customer base is in the security brokerage
industry and in U.S. Government applications.
In 1993, Celerity Systems, Inc., a Tennessee corporation, was formed and,
in 1997, the Tennessee corporation was merged with a newly-formed Delaware
corporation.
The Company had three interactive video customers that represented 15%,
38% and 14%, respectively, of the Company's revenues in 1997, and one that
represented 56% of the Company's revenues in 1998. Export sales
represented 71% and 56% of revenues for 1997 and 1998, respectively. Sales
to Korean companies represented 15% in 1997. Sales to Chinese companies
represented 38% and 56% in 1997 and 1998, respectively. Sales to Taiwanese
companies were 14% of total revenues in 1997.
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 when
purchased as 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. At December 31, 1997,
the debt securities were classified as held to maturity and were recorded
at amortized cost which approximated market.
F-6
<PAGE>
Notes to Financial Statements, Continued
2. Summary of Significant Accounting Policies, continued
Accounts Receivable - The Company does not require collateral or other
security to support customer receivables.
Inventory - Inventory is stated at the lower of cost or market, with cost
being determined using the first-in first-out (FIFO) method.
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.
Revenue from short-term 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 uncompleted short-term contracts at December 31, 1997, are
reflected as a current asset in the accompanying balance sheet.
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. The Company periodically evaluates
the carrying value by considering the future cash flows generated by the
assets. Management believes that the carrying value reflected in the
financial statements is fairly stated based on this criteria.
Segment Information Reporting - In June 1997, the 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 year ended December 31, 1997.
Other Assets - Other assets, which consisted of debt offering costs
related to private placements in 1996 and 1997, were being amortized on a
straight-line basis over the term of the related debt. Amortization
expense in 1997 was $210,850. The Company realized an extraordinary loss
of $1,386,834 in 1997 due to the write-off of the unamortized offering
costs when it repaid 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 $357,436 and $912,045 for the years
ended December 31, 1997 and 1998, respectively. These amounts are included
in operating expenses in the accompanying statements of operations.
F-7
<PAGE>
Notes to Financial Statements, Continued
2. Summary of Significant Accounting Policies, continued
Income Taxes - The Company accounts for income taxes under the provisions
of Statement of Financial Accounting Standards (SFAS) No. 109, Accounting
for Income Taxes. Under SFAS 109, the asset and liability method is used,
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.
Reverse Stock Split - In August 1997, the Board of Directors approved a
1-for-2.5 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 and inventory valuation.
Impact of SFAS 133 - In June 1998, the Financial Accounting Standards
Board (FASB) issued SFAS 133, Accounting for Derivative Instruments and
Hedging Activities, which will be effective for fiscal quarters of fiscal
years beginning after June 15, 1999. This Standard will have no material
impact on the Company.
Reclassifications - Certain amounts in the 1997 financial statements have
been reclassified to conform to the 1998 presentation.
3. Going Concern
The Company's financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and the settlement of
liabilities and commitments in the normal course of business. The Company
has had recurring losses and continues to suffer cash flow and working
capital problems. Additionally, the lack of sales or a significant
financial commitment raises substantial doubt about the Company's ability
to continue as a going concern.
F-8
<PAGE>
Notes to Financial Statements, Continued
3. Going Concern, continued
In the first quarter of 1999, the Company received gross proceeds from a
private placement of convertible debt totaling $600,000. In addition, the
Company is attempting to obtain additional financing. The Company also
received purchase orders subsequent to year-end totaling approximately
$1.2 million in revenues to the Company through 1999 and into 2000.
Finally, management is seeking a buyer for its discontinued CD-ROM segment
and is actively seeking one or more strategic investors.
4. Discontinued Segment
In February 1998, the Company decided to scale back its CD-ROM segment to
a maintenance mode of operations. The Company developed a formal plan of
disposal that became effective in May 1998. The Company is actively
seeking a buyer for the segment which had revenues of $1,011,323 and
$460,955 in 1997 and 1998, respectively. The Company believes the most
valuable assets for sale are the segment's customer list and product
source code which have no recorded value. Inventory of $39,113 is
available for sale and the Company continues to sell the inventory as
existing customers request such merchandise. As of December 31, 1998,
equipment (net of accumulated depreciation) and payables related to the
CD-ROM segment were $81,410 and $364,733, respectively. Management cannot
determine which assets will remain at the time of disposal. 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.
5. Inventory
Inventory at December 31, 1997 and 1998, consists of:
1997 1998
Raw materials $ 876,829 $ 774,257
Finished goods 628,608 502,891
----------- -----------
1,505,437 1,277,148
Reserve for inventory obsolescence (344,081) (70,537)
----------- -----------
$ 1,161,356 $ 1,206,611
=========== ===========
6. 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." Cost and related accumulated depreciation for December 31, 1997 and
1998, are as follows.
1997 1998
Property and equipment $ 1,639,644 $ 2,811,861
Accumulated depreciation (640,399) (1,114,494)
----------- -----------
Property and equipment, net $ 999,245 $ 1,697,367
=========== ===========
F-9
<PAGE>
Notes to Financial Statements, Continued
7. Income Taxes
The tax effects of temporary differences giving rise to the Company's
deferred tax assets (liabilities) at December 31, 1997 and 1998, are as
follows:
<TABLE>
<CAPTION>
1997 1998
<S> <C> <C>
Current:
Allowance for doubtful accounts $ 215,000 $ 166,000
Accrued wages -- 223,000
Inventory reserve 131,000 26,000
Warranty reserve 89,000 --
Relocation reserve 21,000 --
Other 43,000 35,000
----------- -----------
499,000 450,000
Valuation allowance for net current deferred tax assets (499,000) (450,000)
----------- -----------
Total net current deferred tax asset $ -- $ --
=========== ===========
Noncurrent:
Net operating loss and research credit carryforwards $ 3,971,000 $ 6,690,000
Stock based compensation 967,000 966,000
Property and equipment (100,000) (127,000)
----------- -----------
4,838,000 7,529,000
Valuation allowance for net noncurrent deferred tax assets (4,838,000) (7,529,000)
----------- -----------
Total net noncurrent deferred tax asset $ -- $ --
=========== ===========
</TABLE>
As a result of the significant pretax losses in fiscal 1997 and 1998,
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.
F-10
<PAGE>
7. Income Taxes, continued
The December 31, 1997 and 1998 provisions for income taxes consist of the
following:
<TABLE>
<CAPTION>
1997 1998
<S> <C> <C>
Federal
Current tax expense $ -- $ --
Deferred tax expense attributable to change
in valuation allowance 2,460,000 2,370,000
Deferred tax expense (benefit) attributable
to temporary differences (687,000) 264,000
Deferred tax benefit attributable to net operating loss
and research credit carryforwards (1,773,000) (2,634,000)
State
Current tax expense -- --
Deferred tax expense attributable to change
in valuation allowance 289,000 272,000
Deferred tax expense (benefit) attributable
to temporary differences (86,000) 37,000
Deferred tax benefit attributable to net operating loss
and research credit carryforwards (203,000) (309,000)
----------- -----------
$ -- $ --
=========== ===========
</TABLE>
Income tax benefit allocated to the extraordinary item in 1997 was
$527,000. In 1998, income tax benefit allocated to discontinued operations
was $51,000. The Company recorded a full valuation allowance for both
items.
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>
1997 1998
<S> <C> <C>
Computed "expected" tax benefit,
continuing operations $(2,225,000) $(2,319,000)
Computed "expected" tax benefit,
discontinued operations (253,000) (45,000)
State income tax benefit, net of federal income tax benefit (292,000) (275,000)
Change in valuation allowance 2,749,000 2,642,000
Permanent differences 16,000 25,000
Other 5,000 (28,000)
----------- -----------
$ -- $ --
=========== ===========
</TABLE>
At December 31, 1998, the Company had approximately $17,400,000 of net
operating loss carryforwards. These amounts are available to reduce the
Company's future taxable income and expire in the years 2010 through 2013.
F-11
<PAGE>
Notes to Financial Statements, Continued
8. 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
$12,386,800. A portion of the proceeds of the offering was used to repay
indebtedness incurred in earlier private placements, and the remainder was
used for the hiring of additional personnel, to fund the Company's sales
and marketing efforts, and for working capital and general corporate
purposes.
9. Notes Payable and Common Stock Warrants
In June and July 1996, the Company sold units in a private placement
offering to outside investors. The 60 units consisted of one 10% Note 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. 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. 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.
In October and November 1998, the Company agreed to issue $86,024 in
common stock at a 20% discount. This triggered the antidilution provisions
of the 1996 warrant agreements. An additional 29 warrants were issued for
each unit and the exercise price was lowered to $8.39. All warrants issued
in the 1996 placement will expire on the third anniversary of the closing
of the initial public offering. The warrants issued to the agent were
further increased to 39,184 in connection with the 1998 antidilution and
the exercise price was decreased to $9.36. These will expire five years
from the date of grant.
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. 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 previously mentioned
1998 discounted stock issuance also triggered the antidilution provisions
of the 1997-warrant agreement. However, no adjustment was necessary under
the agreement.
The Company recorded debt discount and additional paid-in capital for the
fair value of the 1997 warrants, which was $1,440,000. The fair value of
the warrants was determined based on the difference between the $7.50
estimated 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.
F-12
<PAGE>
Notes to Financial Statements, Continued
9. Notes Payable, continued
In October and November 1998, the Company placed $450,000 of 7% notes.
Each note holder is entitled to royalties of fifty cents per $100,000
invested (pro rated for lesser investments) for each T 6000 set top box
sold during a period of up to five years. Of the total notes placed,
$200,000 are due in one year and the remainder are due through October
2001. Interest is paid in full on the maturity date. Four individuals,
three members of management and one director, were among those investors.
Of the total, $200,000 related to these individuals.
The maturities of the Company's long-term debt as of December 31, 1998,
are as follows:
1999 $ 200,000
2000 --
2001 250,000
---------
450,000
Less current portion (200,000)
---------
Total long-term debt $ 250,000
=========
In April 1998, the Company incurred capital lease obligations of
approximately $259,000 for certain equipment. Monthly payments of
principal and interest of $9,541 are due through June 2001.
The payments related to capital lease obligations as of December 31, 1998,
are as follows:
1999 $ 114,492
2000 114,492
2001 57,246
---------
286,230
Less interest portion (66,338)
---------
Total capital lease obligation $ 219,892
=========
Current portion $ 71,937
=========
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 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 through the conversion date has been reflected as a reduction in
additional paid-in capital in the accompanying financial statements.
F-13
<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. In
1995, the Board of Directors approved the issuance of up to 178,929
options to acquire common shares of which 106,000 and 71,400 were
outstanding at December 31, 1997 and 1998, respectively. In 1997, the
Company established an additional stock option plan under which 200,000
options to acquire common shares could be granted. There were 48,000 and
187,520 shares outstanding under the 1997 plan at December 31, 1997 and
1998, respectively.
Options granted under these plans subsequent to the 1997 initial public
offering generally vest over three years and expire ten years from the
date of grant.
During 1997, the Company granted options to acquire 26,000 common shares
to a member of the Company's Board and 499,200 to members of management
outside the 1995 and 1997 plans. The 483,200 options which remain
outstanding at December 31, 1998 are fully vested and and expire ten years
from the date of grant.
A summary of outstanding options as of December 31, 1997 and 1998, and
changes during the years ended on those dates is presented below:
<TABLE>
<CAPTION>
1997 1998
------------------------------ --------------------------------
Weighted-Average Weighted-Average
Options Exercise Price Options Exercise Price
<S> <C> <C> <C> <C>
Outstanding at beginning of year(1) 185,800 $ 0.43 637,200 $ 2.30
Granted 569,800 (2) 2.62 192,420 1.02
Exercised (37,000) 0.10 (46,600) 0.10
Forfeited (81,400) 1.26 (40,900) 1.21
------- -------- ------- --------
Outstanding at end of year 637,200 $ 2.30 742,120 $ 0.78
======= ======== ======= ========
Options exercisable at year end 589,200 $ 1.92 534,600 $ 0.69
Weighted-average fair value per
option granted during the year 569,800 $ 1.56 192,420 $ 0.65
</TABLE>
(1) Includes 14,000 options granted to an outside director. These options were
granted outside the 1995 and 1997 plans.
(2) Includes 26,000 options granted to an outside director and 499,200 options
granted to members of management. These options were granted outside the
1995 and 1997 plans.
F-14
<PAGE>
Notes to Financial Statements, Continued
11. Stock Options, continued
The following table summarizes information about stock options at December
31, 1997 and 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
--------------------------------- ------------------------------
Weighted-Average
Number Remaining Number Weighted-Average
Exercise Prices Outstanding Contractual Life Exercisable Exercise Price
<S> <C> <C> <C> <C>
December 31, 1997
$ 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 -- $ --
December 31, 1998
$ 0.10 47,600 6.65 47,600 $ 0.10
$ 0.69 620,342 9.21 457,800 $ 0.69
$ 1.13 200 9.92 -- $ --
$ 1.38 26,200 8.21 26,200 $ 1.38
$ 1.63 3,076 9.33 -- $ --
$ 2.13 40,000 9.00 -- $ --
$ 2.94 1,702 9.42 -- $ --
$ 4.90 3,000 7.25 3,000 $ 4.90
</TABLE>
In 1997, 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 other options
granted, 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>
1997 1998
---------------------------------- ----------------------------------
As As
Reported Pro Forma Reported Pro Forma
<S> <C> <C> <C> <C>
Net loss $ (8,675,030) $ (8,684,585) $ (6,955,847) $ (7,098,413)
Net loss per share $ 4.25 $ 4.25 $ 1.63 $ 1.67
</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 used for grants in 1997 and 1998: risk-free
interest rate of 5.71% in 1997 and 6.00% in 1998, and expected lives up to
ten years.
F-15
<PAGE>
Notes to Financial Statements, Continued
12. Loss Per Share
Basic and diluted 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 equivalent shares of
435,181 and 454,411 at December 31, 1997 and 1998, respectively, are not
included in the computation of per share amounts in the periods because
the Company reported a loss.
Following is a reconciliation of the numerators and denominators of the
basic and diluted earnings per share:
1997 1998
Loss
Basic and diluted:
Loss available to common stockholders $(8,883,559) $(6,955,847)
Shares
Basic and diluted:
Weighted-average common shares outstanding 2,090,320 4,260,327
13. Segment Information
At December 31, 1997, the Company had two reportable segments: CD-ROM and
interactive video. The CD-ROM segment, which was discontinued in early
1998 (Note 4), included 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
offered different products and services and market such products to
different customer bases. The two segments were managed separately because
each business required different technology and marketing strategies. The
two segments evolved over the life of the Company and had specifically
identifiable tangible assets. The segments shared 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, 1997, approximates the following:
<TABLE>
<CAPTION>
Interactive
CD-ROM Video Totals
<S> <C> <C> <C>
Revenues from external customers $ 1,011,323 $ 2,716,939 $ 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>
F-16
<PAGE>
Notes to Financial Statements, Continued
13. Segment Information, continued
The total of the segment assets reported for 1997 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 for 1997
above:
Assets
Total assets of the segments $ 3,084,679
Unallocated corporate assets 6,050,225
-----------
Total assets $ 9,134,904
===========
Depreciation and amortization expense
Segment depreciation and amortization $ 456,598
Unallocated corporate depreciation 37,159
-----------
Total depreciation and amortization expense $ 493,757
===========
Segment loss
Total segment loss $(6,673,252)
Unallocated corporate intererst and extraordinary loss (2,001,778)
-----------
Total net loss $(8,675,030)
===========
Expenditures for long-lived assets
Segment expenditures for long-lived assets $ 199,051
Unallocated corporate expenditures for long-lived assets 87,878
-----------
Total expenditures for long-lived assets $ 286,929
===========
The accounting policies of the segments were 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 were shared by each of the segments. The allocations were generally
based on a 25%/75% basis for the CD-ROM and interactive video segments,
respectively. Neither of the segments had financial operations and,
therefore, there were no material amounts of interest revenue or expense
generated. There was a net interest expense for the Company of $584,729
for the year ended December 31, 1997. The segment loss amounts do not
contain amounts attributable to the Company's net interest expense,
extraordinary loss or accretion of premiums on preferred stock.
F-17
<PAGE>
Notes to Financial Statements, Continued
14. Cash Flows
Supplemental disclosure of cash flow information for the years ended
December 31, 1997 and 1998, is as follows:
1997 1998
Cash paid during the year for:
Interest $ 454,687 $ 29,806
Noncash investing and financing activities:
1997
The Company recorded $208,529 for accretion of premiums on preferred
stocks in 1997. 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.
1998
The Company converted $68,820 in accounts and notes payable into $86,024
common stock. The difference was recorded as a noncash expense.
The Company reclassified $278,870 of inventory to equipment.
The Company incurred capital lease obligations of $258,770 for equipment.
15. Commitments and Contingencies
The Company leases office space and certain equipment under operating
leases. Future minimum lease payments by year, and in the aggregate, under
noncancelable operating leases with initial or remaining terms of one year
or more at December 31, 1998, are as follows:
1999 $ 38,715
2000 34,971
2001 11,451
Thereafter --
--------
$ 85,137
========
Rent expense for operating leases was $158,353 and $572,437 in 1997 and
1998, respectively.
Subsequent to year-end, the Company defaulted on its lease for office
space. Management is currently negotiating a new arrangement and is making
month-to-month payments until a new agreement is reached.
F-18
<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 March 30, 1999
Kenneth D. Van Meter Chief Executive Officer
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, 1999
- ------------------------ and Chairman of the Board
Kenneth D. Van Meter (Principal Executive Officer)
(Principal Financial Officer)
/s/ Glenn West Executive Vice President and March 30, 1999
- ----------------------- Director
Glenn West
/s/ Fenton Scruggs
- ----------------------- Director March 30, 1999
Fenton Scruggs
/s/ Donald Greenhouse Director March 30, 1999
- -----------------------
Donald Greenhouse
/s/ Stephen Portch Director March 30, 1999
- -----------------------
Stephen Portch
