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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
--- EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1997
OR
--- TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________ to ______________
Commission File Number: 1-11873
K2 DESIGN, INC.
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(Exact name of registrant as specified in its charter)
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<S> <C>
Delaware 13-3886065
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
30 Broad Street, 16th Fl., New York, NY 10004
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(Address of principal (Zip Code)
executive offices)
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Issuer's telephone number: (212) 301-8800
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Securities registered pursuant to Section 12 (b) of the Act: None
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Securities registered pursuant to Section 12 (g) of the Act:
Common Stock
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(Title of Class)
Redeemable Common Stock Purchase Warrants
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(Title of Class)
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Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
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 there is no disclosure of delinquent filers pursuant to Item
405 of Regulation SB is not contained is 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. Yes No X
--- ---
State issuer's revenues for its most recent fiscal year: $8,397,680.
As of March 16, 1997, there were outstanding 3,585,671 shares of Common
Stock (the "Common Stock") and 1,000,000 Redeemable Common Stock Purchase
Warrants (the "Warrants"). Based on the prices of the Common Stock on that date,
$1.625 per share, the approximate aggregate market value of Common Stock held by
non-affiliates was $3,051,248.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's 1997 Definitive Proxy Statement, which
statement will be filed not later than 120 days after the end of the fiscal year
covered by this Report, are incorporated by reference in Part III hereof.
Certain exhibits are incorporated by reference to the Registrant's
Registration Statement on Form SB-2 and the amendments thereto, as listed in
response to Item 13(a)(2).
Transitional Small Business Disclosure Format (check one):
Yes No X
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[The remainder of this page is intentionally blank.]
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The Business section and other parts of this Report contain forward-looking
statements that involve risks and uncertainties. The Company's actual results
may differ significantly from the results discussed in the forward-looking
statements. Factors that might cause such a difference include, but are not
limited to, those discussed in the section entitled "Management's Discussion and
Analysis of Financial Condition and Results of Operation -- Factors Affecting
Operating Results and Market Price of Stock" commencing on page 14.
PART I
ITEM 1. DESCRIPTION OF BUSINESS
General
K2 Design, Inc. (the "Company" or "K2") primarily provides interactive
marketing and communications services to commercial organizations over the
Internet and World Wide Web (the "Web"). Commencing after the Company's initial
public offering ("IPO") on July 26, 1996, the Company began to develop its
vision to become a full-service interactive marketing and communications
company, largely in response to and in anticipation of demands from its
customers for services complementary to the Company's core Web site design
services. Complementary services the Company now provides include, among others,
development of CD-ROM discs, media placement on Web sites, development and
maintenance of the Company-owned CLIQNOW!(TM) Web site advertising networks,
live Internet broadcasts and the development of brand strategies and print
collateral systems. In 1997 and 1996, approximately 90% of the Company's
revenues were derived from interactive advertising services. Since its
inception, the Company, alone and with others, has designed and created more
than 75 Web sites, including for the corporate customers of MCI
Telecommunications Corporation ("MCI"), a subsidiary of MCI Communications
Corporation, and for Waterhouse Securities Corporation, Bell Communications
Research, Inc. and Wavephore, Inc. See "Marketing--Channel Sources".
The Company's core Web site expertise positioned it to effectively
transition into a full service integrated, interactive marketing and
communication company. The Company's services are used by its customers to
create a new medium for advertisement, promotion and technical support of such
customer's products and services. Web sites can provide commercial organizations
benefits in addition to those available through conventional media, including
the ability to engage and entertain consumers, provide in-depth information,
reduce selling and operating costs, expand distribution channels, promote major
sporting and entertainment events and monitor popularity of content and make
timely changes in response to real-time feedback. Web sites also offer
businesses the ability to obtain certain information about visitors to their
sites.
The Company was founded in 1993 and initially operated a traditional
graphic design business. In August 1994 the Company shifted its principal
business to Web site design and creation but did not begin to generate
significant revenues therefrom until 1995. The Company's principal offices are
located at 30 Broad Street, New York, New York 10004 and its telephone number
is (212) 301-8800. The Company's Web site is located at
http://www.k2design.com.
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K2 SERVICES
The Company provides its customers with an integrated variety of
interactive media services as described by the Company's marketing slogan, "We
Build, We Market, We Measure Success." K2's core creative development team
provides a combination of marketing, communications, advertising, production,
programming and design services. K2 strives to provide comprehensive integrated
interactive marketing services by combining the creativity of its design staff,
the technological expertise of its programmers and the media experience of its
on-line marketing teams.
To be effective, it is essential that an interactive project, whether a
Web site or a CD-ROM, be more than merely attractive and that both the product
and the information therein are easily accessible and well organized. As a
provider of these services, the Company must combine creative and technical
expertise to meet its customers' needs. The Company's services add value to a
customer's project at every stage, from concept development through completion.
The Company's assignments vary significantly in their size and complexity. The
scope of services provided to the Company's customers has ranged from limited
consulting services to complete creative and technical design and construction
of multi-level Web sites, including the capture of live video feeds and audio
feeds from remote locations. The Company also offers numerous integrated
services in addition to those discussed above, including traditional graphic
design services, strategic marketing services, traditional media placement, Web
site and product logo design, brochures, point-of-sale displays and other
collateral marketing materials and print advertisement design and layout.
The Company also offers media placement services intended to generate
qualified leads and sales for an on-line advertiser, as well as to increase
traffic on Web sites. These services are principally comprised of the
identification, negotiation for and purchase of, banners and other
advertisements to be placed on other heavily trafficked Web sites and the
purchase of key words from search engines. Due to the limited yet increasing
information and experience regarding Web advertising and a general unfamiliarity
with the concept of interactive advertising, advertisers require assistance with
the design and placement of advertisements on the Internet. The Company believes
that if businesses increasingly embrace the Web as an advertising vehicle, their
participation will stimulate the creation and expansion of the information and
resources available on the Web, which in turn, is expected to stimulate an
increase in the use of the Web by businesses.* The Company believes that
advertisers will seek to advertise on Web sites that offer a high volume of
traffic and feature flexible advertisement programs capable of reaching targeted
audiences.*
The Company currently provides three different interactive services:
Creative development, media buying and media selling across the CLIQNOW!(TM) Web
site advertising networks maintained by the Company.
Creative Development
Comprised of personnel experienced in advertising, programming and
entertainment, the Company's core creative development team provides
integrated new media services and solutions. When first working with
new customers, the Company will follow a three-step creative and
development
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* This statement is a forward-looking statement reflecting current expectations.
There can be no assurance that the Company's actual future performance will meet
the Company's current expectations. Investors are strongly encouraged to review
the section entitled "Factors Affecting Operating Results and Market Price of
Stock" commencing on page 14, for a discussion of factors that could affect
future performance.
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process: strategic branding and concept development, production and
testing. During the conceptual phase the Company will conduct a needs
assessment analysis with the customer in order to determine the
customer's objectives and functional specifications of the product,
media plan and other requirements. The creative approach is then
developed incorporating the marketing strategy, design, copy and
programming requirements of the customer. During the implementation
phase, all artwork and copy are developed and digitized. The content is
then produced utilizing various development tools and programming
languages. Product testing on all anticipated computer configurations
takes place at various stages of the implementation process. Testing
may continue after the launch of the product or project, through the
Company's reporting and tracking consulting team. Testing services will
be used to determine the project's effectiveness and whether further
development is needed.
Media Buying for Web sites
K2 NetMedia(TM) offers customers full service traditional and new media
planning services aimed at maximizing the effectiveness of a Web
presence. This service primarily plans and executes advertising
campaigns, as well as promotions, advertisements and marketing
initiatives. NetMedia(TM)integrates the core development team's
production, award winning creative, and strategic marketing experience
to provide customers with a diversified communications plan.
NetMedia's(TM) staff is experienced in all media: television, radio,
cable, print, outdoor and direct. However, NetMedia(TM) has principally
engaged in media purchasing on the Web and in print. The Web site
address for K2 NetMedia(TM) is http://www.k2design.com/net.html.
Media Selling from Web site Advertising Networks
To maximize advertisers' return on investment and expand distribution,
CLIQNOW!(TM) develops branded content networks that bundle together
several theme-related Web sites. By bundling theme-related sites, these
networks deliver increased "ad-views" to advertisers as compared to the
individual sites on a stand-alone basis. To date, nine networks have been
developed: CLIQGolf!(TM), CLIQFinancial!(TM), CLIQKids!(TM),
CLIQTech!(TM), CLIQHome!(TM), CLIQSports!(TM), CLIQTravel!(TM), The
Women's Forum and CLIQCollege!(TM). The Company maintains a distinctive
product identity and a separate physical location for the CLIQ networks in
order to preserve the independence of this media selling business from the
media buying business conducted by K2 NetMedia(TM) The Web site addresses
for CLIQNow!(TM) and CLIQGolf!(TM) are http://www.cliqnow.com and
http://www.cliqgolf.com.
K2 STRENGTHS
Creative Expertise
The Company believes that, in addition to the creative elements
required in traditional graphic design, superior interactive advertising
assignments require that the end product be easy-to-use with intuitive
interfaces, seamlessly integrated technologies and an engaging look and feel.
Management believes that the Company's creative staff is fully capable across
the spectrum of expertise required to meet customers' creative needs. In order
to maintain high levels of creativity and quality, the Company intends
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to recruit the best talent available.* However, competition for creative
personnel is especially intense and there can be no assurance that the Company
will attract or retain adequate creative talent to accomplish these goals.
Technological Expertise
The Company believes the creative application of leading technologies
is also crucial to the success of its business. The Company's technical
programming personnel are skilled in various computer operating systems, tools
and languages, including C/C++, Macromedia products, Basic, FORTRAN, UNIX, Perl,
Java, VRML, Real Audio and Video, Windows NT, Netscape server platforms and SUN
and UNIX operating systems, among others. These programmers are responsible for
providing complex computer programming for special features on CD-ROM products
and Web sites as well as periodically assessing new technologies in order to
identify and deploy, directly and through independent contractors, those that
are most promising for enhancing the Company's business and that of its
customers.
Focus on Customers' Business Objectives
The Company has made understanding its customers' business challenges
the primary focus which guides its customer services. The Company often works
with its customers' management to determine how best to integrate Web sites with
the customers' business goals.
K2 STRATEGY
Capitalize on Accomplishments and Market Opportunities
The Company believes that the proliferation of the Internet will
continue to provide substantial opportunities to the Company and that its
successfully completed projects will continue to enhance its marketing efforts.*
The Company's management does not, however, believe that the Company's primary
business will always be limited to the Internet.* The Company produces digital
content which may be carried over a variety of emerging technologies such as
Vertical Blanking Interval, digital satellite and interactive television.*
Although there is no assurance that any of these technologies will achieve
acceptance in the marketplace, the Company believes its services could be
utilized over these channels as well.
Leverage Development Efforts
In the course of developing customized Web sites for certain customers,
the Company may gain technical know-how that can be applied in other efforts.
The Company believes that its experience has the potential to reduce future
development costs.*
- --------
* This statement is a forward-looking statement reflecting current expectations.
There can be no assurance that the Company's actual future performance will meet
the Company's current expectations. Investors are strongly encouraged to review
the section entitled "Factors Affecting Operating Results and Market Price of
Stock" commencing on page 14, for a discussion of factors that could affect
future performance.
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Deploy Leading Technologies
One of the Company's objectives is to apply both proven and emerging
technologies as they become available in order to maximize the effectiveness of
its Web site services. The Company has formed informal non-exclusive
relationships with key technology providers in an effort to gain access to, and
influence the features of, the Company's utilization of their technologies.
Channel Marketing
The Company will continue to focus on developing strategic
relationships with Channel Sources (defined below) that seek to augment their
businesses by making available the Company's services to their own customer
base. See "--Marketing; Channel Sources."
MARKETING
General
The Company markets its services directly and seeks to form strategic marketing
relationships with third parties. At December 31, 1997, the Company had two
employees dedicated to sales and marketing. Additionally, each of the Company's
executive officers spend a portion of their time marketing the Company's
services. The Company also seeks to attract new customers through other methods,
including referrals from existing customers. The Company seeks to cross-sell
its various services to its customers and prospective customers through sales
presentations that encourage customers to utilize all of the Company's services.
Channel Sources
The Company's marketing efforts to date have focused in part on
developing strategic relationships with other companies, such as advertising
agencies, hardware and software companies and Internet service providers
("Channel Sources") that seek to augment their businesses by making available
interactive advertising and Web site design and creation services provided by
the Company and other third parties. The Company therefore targets advertising
agencies that do not offer Web site related services, providers of other
Internet services (e.g., access, connectivity and Web site hosting) and other
businesses whose customers are likely to require the services that the Company
provides.
CUSTOMERS
The Company's four largest sources of revenues during 1997 were Cox
Interactive Media, Inc. (http://www.cimedia.com/), Wavephore, Inc.
(http://www.wavephore.com), Bell Communications Research Inc.,
(http://www.bellcore.com/), and Planet Direct, Inc.
(http://www.planetdirect.com), which accounted for approximately 15.3%, 11.8%,
6.0% and 6.0%, respectively, of the Company's revenues during that year (or an
aggregate of approximately 39%). The Company has continued to provide services
to these customers in the first quarter of 1998. In 1996, the Company's four
largest sources of revenues were America Online Incorporated, Toys 'R' Us
Corporation, Chase Manhattan Bank and International Business Machines Corp.,
which accounted for approximately 20%, 15%, 14% and 12%, respectively, of the
Company's revenues during that year (or an aggregate of approximately 61%).
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As of December 31, 1997, the Company has completed more than 75 Web
site design and creation projects, generating gross revenue per project ranging
from $1,500 to more than $700,000, in addition to consulting engagements and
interactive projects other than on the Web. The Company provides extensive and
varied services, including traditional and interactive strategic product
branding and advertising services and Web site development.
Because the Company's projects are generally completed in a relatively
short period of time, the Company has not experienced significant backlog.
TRADEMARKS
The Company applied to the U.S. Patent and Trademark Office for several
trademarks, which are all in examination but have not yet been published for
opposition. There can be no assurance that any of these trademarks will be
granted. Trademarks for which the Company has applied include K2(TM) and K2
Design(TM).
GOVERNMENT REGULATION
The Company is not currently subject to direct regulation by any
government agency, other than regulations applicable to businesses generally,
and there are currently few laws or regulations directly applicable to Web site
service companies and marketing and communications firms. However, due to the
increasing media attention focused on the Internet, it is possible that a number
of laws and regulations may be adopted with respect to the Internet, covering
issues such as user privacy, pricing and characteristics and quality of products
and services. The adoption of any such laws or regulations may decrease the
growth of the Internet, which could in turn decrease the demand for the
Company's services and products and increase the Company's cost of doing
business or cause the Company to modify its operations, or otherwise have an
adverse effect on the Company's business, operating results or financial
condition. Moreover, the applicability to the Internet of existing laws
governing issues such as property ownership, libel and personal privacy is
uncertain. The Company cannot predict the impact, if any, that future regulation
or regulatory changes may have on its business. In addition, Web site developers
such as the Company face potential liability for the actions of customers and
others using their services, including liability for infringement of
intellectual property rights, rights of publicity, defamation, libel and
criminal activity under the laws of the U.S. and foreign jurisdictions. Although
the Company maintains $1 million of errors and omissions insurance and $1
million of general liability insurance, any imposition of liability in excess of
such policies limits or if not covered by such policies could have a material
adverse effect on the Company.
COMPETITION
The markets for the Company's services are highly competitive and are
characterized by pressures to incorporate new technologies accelerate completion
schedules and reduce prices. The Company expects competition for its services to
intensify in the future, partly because there are no substantial barriers to
entry into the Company's business. The Company faces competition from a number
of sources, including potential customers that perform interactive marketing and
communications services and Web site development services in-house. These
sources also include other Web site service boutique firms, communications,
telephone and telecommunications companies, computer hardware and software
companies, established online services companies, advertising agencies,
Internet-services and access providers as well as specialized and integrated
marketing communication companies such as CKS Group, Inc., all of which are
entering the Web site design and creation market in varying degrees and are
competing with the Company. Many of the
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Company's competitors or potential competitors have longer operating histories,
longer customer relationships and significantly greater financial, management,
technological, development, sales, marketing and other resources than the
Company. The Company's ability to retain relationships with Channel Sources and
its existing customers and generate new customers and relationships with Channel
Sources depends to a significant degree on the quality of its services and its
reputation, as compared with the quality of services provided by and the
reputations of, the Company's competitors. The Company also competes on the
basis of creative reputation, price, reliability of services and responsiveness.
There can be no assurance that the Company will be able to compete and its
inability to do so would have a material adverse impact on the Company's
business, financial condition and operating results.
EMPLOYEES
At December 31, 1997, the Company had 55 employees, of which 54 are
full-time employees. Full-time employees include 2 salespeople, 17 account
managers and producers, 12 media sales personnel and 13 creative and production
personnel, in addition to executive management and support staff.
ITEM 2. DESCRIPTION OF PROPERTY
The Company's chief executive offices occupy approximately 13,000
square feet of an office building in New York City at an annual rent ranging,
over the term of the lease, from approximately $226,100 to $246,600 payable in
equal monthly installments, plus the Company's allocable share of certain real
property taxes and building operating expenses in excess of fixed levels as
provided in the lease. The lease has a six-year term and expires April 18, 2003.
The Company leases additional office space in New York City consisting
of 1,976 square feet of office space located at 50 Broad Street, New York, New
York at an annual rent ranging, over the term of the lease, from $34,580 to
$38,532, payable in equal monthly installments, plus the Company's allocable
share of certain real property taxes and building operating expenses in excess
of fixed levels as provided in the lease. The lease has a term expiring on
January 31, 2002. The Company has sublet the space to a third party for an
annual rent ranging from $27,900 to $35,100 for the remainder of the lease term.
The Company also leases office space in Baltimore, Maryland consisting
of 1,897 square feet, at an annual rent of $30,127, payable in equal monthly
installments, plus the Company's allocable share of certain real property taxes
and building operating expenses in excess of fixed levels as provided in the
lease. The lease has a term of three years and expires November 30, 1999,
excluding the Company's option to extend for an additional three years. In
December 1997, the Company sublet this space to a third party for the one year
period ending December 31, 1998 for $24,661.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material pending legal proceedings as
of the date hereof.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company did not submit any matters to a vote of its stockholders,
through the solicitation of proxies or otherwise, during the fourth quarter of
fiscal 1997.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCK-
HOLDER MATTERS
The Company's Common Stock is traded on the NASDAQ SmallCap(TM) Market
("NASDAQ") under the symbol "KTWO". The following table sets forth, for the
periods indicated, the range of high and low bid prices of the Common Stock as
reported by NASDAQ from July 26, 1996, the effective date of the Company's
registration statement in connection with its initial public offering, through
December 31, 1997. These quotations reflect inter-dealer prices, without retail
mark-up, mark-down or commission, and may not necessarily represent actual
transactions.
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Fiscal Quarter Ended High Low
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September 1996 (commenced July 26, 1996).................. 7 3/4 6 1/2
December 31, 1996 ........................................ 6 1/2 5 3/4
March 31, 1997............................................ 7 1/8 5 5/16
June 30, 1997............................................. 6 1/4 3
September 30, 1997........................................ 5 1/4 3 1/8
December 31, 1997......................................... 4 23/32 1 9/16
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The approximate number of record holders of the Common Stock at
December 31, 1997 was 39, not including beneficial owners whose shares are held
by banks, brokers and other nominees.
The Company has not paid any dividends. The Company does not expect to
pay cash dividends on its Common Stock in the foreseeable future as any earnings
are expected to be retained to finance the Company's operations. Declaration of
dividends in the future will remain within the discretion of the Company's Board
of Directors.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION
The following presentation of management's discussion and analysis of
the Company's financial condition and results of operations should be read in
conjunction with the Company's Consolidated Financial Statements, the
accompanying notes thereto and other financial information appearing elsewhere
in this Report. This section and other parts of this Report contain
forward-looking statements that involve risks and uncertainties. The Company's
actual results may differ significantly from the results discussed in the
forward-looking statements. Factors that might cause such a difference include,
but are not limited to, those discussed in the section entitled "Management's
Discussion and Analysis of Financial Condition and Results of Operation --
Factors Affecting Operating Results and Market Price of Stock" commencing on
page 14.
OVERVIEW
The Company was founded in 1993 as a general partnership and initially
operated a traditional graphic design business. The Company was hired to design
a graphical user interface in March 1994 for Sierra Magazine Online, a
proprietary online service, and in August 1994 for NetMarket Inc., the first
company to perform a secure online transaction on the Internet, at which time
the Company shifted its principal business to Web site design and creation.
After the Company's initial public offering ("IPO") on
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July 26, 1996, the Company began to develop its vision to become a full-service
interactive marketing and communications company, largely in anticipation of
demands from its customers for additional complementary services. The Company
now provides such services as development of online brand, communications and
technical strategies, development of CD-ROM discs, media placement on Web sites,
consulting services regarding Web site usage and user characteristics,
development and maintenance of Company-owned Web site advertising networks, live
Internet broadcasts and the development of brand strategies and print collateral
systems.
As a result of the expansion of the Company's services beyond Web site
design and creation, the Company incurred significant expenses in 1996 in
anticipation of future revenues. Since the Company has engaged in Web site
design and creation only for approximately two years, and has been providing a
full range of interactive advertising services for less than one year, the
Company has a limited operating history upon which an evaluation of the Company
and its prospects can be based. Management therefore believes that
period-to-period comparisons of the Company's results of operations are not
indicative of future results.
In January 1995, the Company was reorganized as a New York corporation
that elected to be treated as an S corporation for tax purposes. In January
1996, the Company was reorganized as a Delaware holding company and the New York
corporation became a wholly-owned operating subsidiary thereof and thus ceased
to be an S corporation for tax purposes. For financial reporting purposes, the
Company's Consolidated Financial Statements include the Company and its
wholly-owned subsidiary.
RESULTS OF OPERATIONS
General
Revenues are recognized on a percentage of completion basis. Provisions
for any estimated losses on uncompleted projects are made in the period in which
such losses are determinable. A portion of the Company's revenues has been
generated on a fixed fee or cap fee basis. The Company also provides ongoing
services to certain customers, including one customer for which the Company is
agency-of-record.
Prior to November 1997, the Company increased its expense levels to
accommodate anticipated growth in its business. These expenses are related to,
among other things, a substantial increase in the number of employees, the
relocation of the Company's principal office, the opening of two additional
offices, and investing in equipment. Since November 1997, the Company changed
its policy and began to reduce expenses in an effort to bring them in line with
revenue levels. Accordingly, the Company has implemented several cost cutting
measures, including reduction in personnel, consolidation of offices and
sublease of excess space. In addition, the Company's executive officers
voluntarily agreed to reduce their salaries on a temporary basis aggregating
$73,500 in savings per year. Nevertheless, the Company's failure to expand its
business in an efficient manner could have a material adverse effect on the
Company's business, operating results and financial condition. In addition,
there can be no assurance that the Company's future revenues will be sufficient
to support its existing and anticipated expense levels or that the Company will
be able to maintain these reduced expense levels.
The changes in the various line-items discussed below result from the
increase in the Company's expenses since it consummated a series of securities
offerings in 1996 and began to apply the proceeds to expand services in
anticipation of future revenues.
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<CAPTION>
Percentage of Revenues
Year Ended December 31,
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1997 1996
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<S> <C> <C>
Revenues 100.0% 100.0%
Operating Expenses
Direct Salaries and Costs 73.0 79.7
Selling, General and Administrative Expenses 43.4 42.2
Depreciation 4.1 2.2
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Total Operating Expenses 120.5 124.1
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Operating Loss (20.5) (24.1)
Other Income 0.4 2.1
----- -----
Loss before taxes (20.1) (22.0)
Income taxes 0.2 -
----- ------
Net Loss (20.3)% (22.0)%
====== ======
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Revenues
Revenues for the years ended December 31, 1997 and 1996 were $8,397,680
and $4,077,792, respectively, or an increase of 105.9% in 1997 as compared to
1996. The increase in revenues is due principally to the increase in volume,
which management believes is a result of increased market acceptance of the
Internet during 1997. In fiscal 1997, approximately 90% of revenues were
generated from interactive advertising services and traditional graphic
services, and approximately 10% from CLIQNOW!(TM) services. In fiscal 1996,
approximately 90% of revenues were generated from interactive advertising
services, and 10% from one CD-ROM project.
Direct Salaries and Costs
Direct salaries and costs include all direct labor costs and other
direct costs related to project performance, such as independent contractors,
freelance labor, supplies, and printing and equipment costs. As a percentage of
revenues, direct salaries and costs decreased in fiscal 1997 as compared to
fiscal 1996 from 79.7% to 73.0%. In absolute dollars, the Company's direct
salaries and costs for fiscal 1997 increased to $6,125,373 from $3,249,717 in
fiscal 1996, reflecting the Company's rapid expansion during those periods. In
fiscal 1997, direct salaries and costs consisted primarily of approximately
$2,609,000 of media costs, $2,088,000 of direct salary costs and approximately
$574,000 paid to freelance artists and other independent contractors, and
$351,000 of bad debt expenses. The remainder consisted of reimbursable and
non-reimbursable project expenses and supplies. In 1996, direct salaries and
costs consisted primarily of approximately $1,200,000 of direct salary costs and
$1,200,000 paid to freelance artists and other independent contractors (half of
which was incurred in the fourth quarter principally in respect of two
projects), and the remainder consisted of media placement costs and supplies and
printing.
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Selling, General and Administrative Expenses
Selling, general and administrative expenses for fiscal 1997 increased
to $3,644,728 (43.4% of revenues) from $1,720,503 in 1996 (42.2% of revenues),
and in each period consisted of salaries, professional fees, occupancy costs,
marketing and advertising and travel and office expenses and supplies, among
other things. The increase in absolute dollars reflects the continued
application of the proceeds from the Company's private placements and initial
public offering during fiscal 1997, consistent with the Company's expansion
strategy in place prior to November 1997. The increase as a percentage of
revenues in fiscal 1997 reflects the increase in expenses as the Company
continued to expand the scope of its services in anticipation of future revenues
and prior to implementing its cost reduction program in late 1997.
Depreciation
Depreciation expense was $347,346 and $92,167 for fiscal 1997 and
fiscal 1996, respectively, and related primarily to depreciation of equipment
and leasehold improvements. The expense in fiscal 1997 was principally the
result of depreciation of the Company's equipment and leasehold improvements in
connection with the acquisition of computer equipment and the relocation of its
offices, as well as the accelerated writeoff of the leasehold improvements at
the 55 Broad Street office which the Company no longer leases as of December 31,
1997. The Company has received a complete release from any and all future
liabilities in connection with the 55 Broad Street location from the landlord.
The landlord has also returned the $30,000 restricted letter of credit
previously held for security to the Company as of December 31, 1997.
Interest Income, Net
The net proceeds from the Company's securities offerings earned
interest income net of interest expense of $105,383 for the year ended December
31, 1997. The Company incurred interest income net of interest expense of
$89,178 for the year ended December 31, 1996.
Other Expenses
The Company incurred other expenses, of $68,296 consisting primarily of
the Company's obligations on real property it no longer uses, net of rental
income receive under various subleases.
Selected Quarterly Operating Results (Unaudited)
The following table presents unaudited quarterly financial information
for the period from January 1, 1996 to December 31, 1997. The information has
been derived from the Company's unaudited Consolidated Financial Statements. The
unaudited quarterly financial information has been prepared on the same basis as
the audited Consolidated Financial Statements and includes all adjustments,
consisting only of normal recurring adjustments, that the Company considers
necessary for a fair presentation of such information when read in conjunction
with the Company's audited Consolidated Financial Statements and the
accompanying notes thereto appearing elsewhere in this Report. These results are
not indicative of results for any future period.
11
<PAGE>
<TABLE>
<CAPTION>
September December September December
March 31, June 30, 30, 31, March 31, June 30, 30, 31,
1996 1996 1996 1996 1997 1997 1997 1997
---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues.............. $ 512,434 $498,050 $825,348 $2,241,960 $ 1,665,398 $1,162,902 $1,794,498 $3,774,882
--------- -------- -------- ---------- ----------- ---------- ---------- ----------
Operating Expenses:
Direct salaries and costs 499,109 607,066 785,245 1,358,297 1,191,390 856,825 1,331,665 2,745,493
Selling, general and
administrative expenses 125,958 262,823 234,303 1,097,419 781,281 745,114 984,926 1,133,407
Depreciation.......... 9,113 14,221 23,626 45,207 56,932 61,876 88,881 139,657
-------- -------- --------- --------- --------- -------- --------- ----------
Total operating expenses 634,180 884,110 1,043,174 2,500,923 2,029,603 1,663,815 2,405,472 4,018,557
-------- -------- --------- ---------- ----------- ---------- ---------- ----------
Operating loss $(121,746) $(386,060) $(217,826) $(258,963) $(364,205) $ (500,913) $(610,974) $ (243,675)
========== ========== ========== ========== ========== =========== ========== ===========
</TABLE>
- -----------------
Quarterly revenues and operating results have fluctuated and will
fluctuate as a result of a variety of factors. These factors, some of which have
affected the Company and some of which are beyond the Company's control, include
the timing of the completion, material reduction or cancellation of major
projects, the loss of a major customer or the termination of a relationship with
a Channel Source, timing of the receipt of new business, timing of the hiring or
loss of personnel, changes in the pricing strategies and business focus of the
Company or its competitors, capital expenditures, operating expenses and other
costs relating to the expansion of operations, general economic conditions and
acceptance and use of the Internet. The Company's quarterly operating margins
may also fluctuate from period to period depending on the relative mix of lower
cost full time employees versus higher cost independent contractors. Revenues
and operating results are difficult to forecast because of these fluctuations.
In November 1997, the Company began to reduce expenses in an effort to bring
them in line with current and anticipated revenue levels. The Company may be
unable to adjust spending in a timely manner to compensate for any unexpected
revenue shortfall, which event may have a material adverse effect on the
Company's operations for such period.
The trading prices of the Common Stock and its Redeemable Common Stock
Purchase Warrants are subject to fluctuation in response to quarterly variations
in operating results, announcements of technological innovations or new products
or services by the Company or its competitors, as well as other events or
factors. In addition, the stock market has from time to time experienced price
and volume fluctuations which have particularly affected the market price of
technology-oriented and media companies, which often have been unrelated to the
operating performance of these companies. These broad market fluctuations may
adversely affect the market price of the Common Stock and the Redeemable Common
Stock Purchase Warrants.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash increased by approximately $496,000, or 28%, from
$1,746,917 at September 30, 1997 to $2,242,988 at December 31, 1997. This
increase in cash was principally due to the Company's focus on collecting its
accounts receivables and actively managing its accounts payables.
The Company is dependent on its current cash balance of approximately
$2.2 million (at December 31, 1997), together with cash generated by operations,
if any, for working capital in order to be competitive, to meet the increasing
demands for service, quality and pricing and for expansion of its business.
While the Company believes that its cash position together with cash expected to
be generated by operations will be sufficient to finance its operations for at
least one year, the Company may nevertheless require future substantial
alternative financing in order to satisfy its working capital needs, which may
be
12
<PAGE>
unavailable or prohibitively expensive since the Company's only assets available
to secure additional financing are accounts receivable.* See "-- Factors
Affecting Operating Results and Market Price of Stock --Cash Flow Deficit; Need
for Additional Financing." Accounts payable increased by 56.6% to
$1,910,379 at December 31, 1998 from $744,563 at December 31, 1996, due
primarily to increased media placement revenues. Deferred revenues increased
186.7% to $642,605 at December 31, 1997 from $166,169 at December 31, 1996, due
primarily to increased invoicing relating to work to be performed in subsequent
periods.
Cash used in the Company's operating activities of $(791,955) in the
year ended December 31, 1997 related primarily to a substantial increase in
accounts receivable, which was partially offset by an increase in accounts
payable, and also related to the loss incurred during the year.
In 1997, the Company spent approximately $711,000 on capital
expenditures, consisting of computer equipment, as well as furniture, fixtures
and leasehold improvements in connection with the Company's recent relocation of
its principal offices to 30 Broad Street. The Company presently intends to make
capital expenditures of between $150,000 and $200,000 in 1998, consisting of
furniture, fixtures and equipment.
In March 1996, the Company consummated a private placement in which it
sold 200,000 shares of Common Stock for an aggregate of $250,000 ($1.25 per
share) and in May 1996, the Company consummated a second private placement in
which it sold an additional 400,002 shares of Common Stock for an aggregate of
$700,000 ($1.75 per share). Only accredited investors purchased Common Stock in
these private placements. With respect to the private placements, Donald & Co.
Securities Inc. acted as Placement Agent and received $47,000 in commissions and
$9,500 in non-accountable expenses. In 1996, the Company's primary source of
liquidity was from these two private placements and its initial public offering,
which yielded approximately $6,300,000 of net proceeds. In addition the Company
financed the purchase of certain equipment through capital leases. The principal
balance of such leases was $105,023 at December 31, 1997 and is payable in
varying installments through the year 2000.
Factors Affecting Operating Results and Market Price of Stock
Cash Flow Deficit; Need for Additional Financing
The Company's focus is on increasing the volume of all of its services.
As a result, the Company has hired and will continue to hire additional
personnel and has incurred and will continue to incur substantial expenses
related to administration, production, technical resources, marketing, customer
support and infrastructure in order to enhance and expand its operations. The
Company had an operating cash flow deficit of $(1,925,081) in fiscal 1996 and of
$(791,955) in fiscal 1997. Notwithstanding the aforementioned cost reduction
program, the Company may require substantial additional financing in order to
satisfy its working capital needs, which may be unavailable or prohibitively
expensive since the Company's only assets available to secure additional
financing are accounts receivable. Should such financing be unavailable or
prohibitively expensive when the Company requires it, the Company would not be
able to finance any
- --------
* This statement is a forward-looking statement reflecting current expectations.
There can be no assurance that the Company's actual future performance will meet
the Company's current expectations. Investors are strongly encouraged to review
the section entitled "Factors Affecting Operating Results and Market Price of
Stock" commencing on page 14, for a discussion of factors that could affect
future performance.
13
<PAGE>
expansion of its business and may not be able to satisfy its working capital
needs, either of which would have a material adverse effect on the Company's
business, operating results and financial condition.
Recent Operating Losses; Early Stage of Development
The Company's revenues for the years ended December 31, 1996 and 1997
were $4,077,792 and $8,397,680, respectively, with net loss of $(895,417) in
1996 and a net loss of $(1,703,250) in 1997. There can be no assurance that the
Company will be profitable in the future or that revenue growth, if any, can be
sustained.
The prospects of the Company must be considered in light of the risks,
expenses and difficulties frequently encountered by companies in their early
stage of development, particularly companies in new and rapidly evolving markets
and especially those in Internet and other computer related markets. There can
be no assurance that the Company will be successful in addressing these risks.
Ability to Manage Growth
Prior to November 1997, the Company experienced substantial growth in
the number of the Company's employees, and since the beginning of 1996 there has
been increased (i) responsibility for both existing and new management
personnel, (ii) strain on the Company's existing management, administrative,
operational, financial and technical resources and (iii) increased demands on
its management information systems and controls. There can be no assurance that
the Company will effectively develop and implement systems, procedures or
controls adequate to support the Company's operations or that management will be
able to achieve the rapid execution necessary to fully exploit all opportunities
for the Company's services. To manage its business and any growth, the Company
must continue to implement and improve its operational and financial systems and
continue to expand, train and manage its employees. If the Company is unable to
manage its business effectively, the Company's business, operating results and
financial condition will be materially adversely affected.
Evolving Marketing Strategy
The Company's marketing efforts have expanded as the range of services
which the Company offers has increased. In addition to developing strategic
relationships with other companies and Channel Sources that seek to augment
their businesses by directly or indirectly offering to their customers Web site
services provided by the Company and other third parties, the Company also
directly markets its core creative services as well as the services of
NetMedia(TM) and CLIQNOW!(TM).
To try to avoid any conflict with a Channel Source, the Company does
not intend to offer services to customers referred by a particular Channel
Source that could be provided to those customers by that Channel Source. Since
the Company does not expect to offer its full range of services to these
customers, projects for them may be less profitable than full-service production
projects for other customers. Should a Channel Source favor other providers of
similar services, fail to effectively market the Company's services as a result
of the Channel Source's competitive position or otherwise, or not utilize the
Company's services to the extent anticipated by the Company, the Company may
also be adversely affected. The inability to recruit, manage or retain
additional Channel Sources, or their inability to market the Company's services
effectively or provide timely and cost-effective customer support and service,
could materially adversely affect the Company's business, operating results and
financial condition.
14
<PAGE>
One-Time Customers; Concentration of Revenues
Since many of the Company's direct customers (and certain Channel
Sources) have retained the Company on a single project basis, customers from
whom the Company generated substantial revenue in one period have not
necessarily been a substantial source of revenue in a subsequent period. During
fiscal 1996, single customers accounted for the percentages revenues as follows:
20% (America Online Incorporated), 15% (Toys 'R' Us), 14% (Chase Manhattan Bank)
and 12% (International Business Machines Corp.). During fiscal 1997, single
customers accounted for the percentages of revenues as follows: 15% (Cox
Interactive Media, Inc.) and 12% ( Wavephore, Inc.). Due to the Company's
limited operating history and the emerging nature of the Internet, the Company
generally cannot be sure whether its relationships with customers will continue
to be on a one project per customer basis, although the Company continued to
provide services in 1997 to the 1996 customers named above. To the extent the
Company does not generate repeat or ongoing business from its customers, it will
incur the higher sales and marketing expenses associated with attracting new
customers as compared to those in attracting additional business from existing
customers.
Risk of System Failures
The Company's success largely depends on the uninterrupted operation of
its computer and communications hardware systems. The Company's systems and
operations are vulnerable to damage or interruption from fire, flood, power
loss, telecommunications failure, break-ins, earthquake and similar events. The
Company presently has very limited redundant systems. The Company does not have
a formal disaster recovery plan and carries limited business interruption
insurance to compensate for any losses that may occur. The Company's servers are
also vulnerable to computer viruses, physical or electronic break-ins, and
similar disruptions, which could materially and adversely affect the Company.
Uncertain Adoption of Internet as a Medium of Commerce and Communications;
Dependence on Internet
Demand and market acceptance for recently introduced services and
products like those offered by the Company are subject to a high level of
uncertainty. The use of the Internet in marketing and advertising and otherwise,
particularly by those individuals and enterprises that have historically relied
upon traditional means of marketing and advertising, generally requires the
acceptance of a new way of conducting business and exchanging information.
Enterprises that have already invested substantial resources in other means of
conducting business and exchanging information may be particularly reluctant or
slow to adopt a new strategy that may make their existing resources and
infrastructure less useful. There can be no assurance that the market for the
Company's services will develop and if it fails to develop, develops more slowly
than expected or becomes saturated with competitors, or if the Company's
services do not achieve market acceptance, the Company's business, operating
results and financial condition will be materially adversely affected.
The Company's ability to derive revenues will also depend upon a robust
industry and the infrastructure for providing Internet access and carrying
Internet traffic. The Internet may not prove to be a viable commercial
marketplace because of inadequate development of the necessary infrastructure or
timely development of complementary products, such as high speed modems.
Moreover, other critical issues concerning the commercial use of the Internet
(including security, reliability, cost, ease of use and access, and quality of
service) remain unresolved and may impact the growth of Internet use. Because
global commerce and online exchange of information on the Internet and other
similar open wide area networks are new and evolving, it is difficult to predict
with any assurance whether the Internet will prove to be and remain a viable
commercial marketplace. If the infrastructure necessary to support the
Internet's commercial
15
<PAGE>
viability is not developed, or if the Internet does not become a viable
marketplace, the Company's business, operating results and financial condition
would be materially and adversely affected.
Risk of Changing Technology
The services the Company offers, and the services and products the
Company expects to offer in the future, are impacted by rapidly changing
technology, evolving industry standards, emerging competition and frequent new
service, software and other product introductions. There can be no assurance
that the Company can successfully identify new business opportunities and
develop and bring new services or products to market in a timely and
cost-effective manner, or that services, products or technologies developed by
others will not render the Company's services or products noncompetitive or
obsolete. In addition, there can be no assurance that services, products or
enhancements introduced by the Company will achieve or sustain market acceptance
or be able to effectively address compatibility, inoperability or other issues
raised by technological changes or new industry standards. The Company's pursuit
of technological advances may also require the Company to seek assistance from
third parties.
Intellectual Property Rights; Risk of Infringement; Possible Litigation
The Company believes that its success in its core business of
interactive advertising is not dependent upon patents, copyrights or trademarks
and the Company does not currently have any registered patents, copyrights or
trademarks, although applications for various trademarks have been made.
Consequently, the Company relies principally on a combination of common-law and
statutory law to protect its proprietary information and know-how. The Company
also utilizes technology owned by third parties. There can be no assurance that
licenses for any technology developed by third parties that might be required
for the Company's services would be available on reasonable terms, if at all.
See "Business -- Trademarks."
Although the Company does not believe that its services infringe the
proprietary rights of any third parties, there can be no assurance that third
parties will not assert claims based on these services against the Company in
the future or that any of those claims would not be successful. In addition,
many of the Company's competitors rely upon trade secret law. Litigation may be
necessary in the future to enforce the Company's intellectual property rights
and to protect its proprietary information, to determine the validity and scope
of the proprietary rights of others, or to defend against claims of infringement
or invalidity. Litigation of this nature, whether or not successful, could
result in substantial costs and diversions of resources, either of which could
have a material adverse effect on the Company's business, financial condition
and operating results. Furthermore, parties making claims against the Company
could secure a judgment awarding substantial damages, as well as injunctive or
other equitable relief which could directly or indirectly prohibit the Company
from providing certain services and products. A judgment of this nature could
have a material adverse effect on the Company's business, financial condition
and results of operations.
Conflicts of Interest; Restrictions
The Company has been precluded and may be precluded in the future from
pursuing opportunities that require it to provide services to direct competitors
of existing customers or Channel Sources. In addition, the Company risks
alienating or straining relationships with customers and Channel Sources each
time the Company agrees to provide services to even indirect competitors of
existing customers or Channel Sources. Conflicts of interest may jeopardize the
stability of revenues generated from existing customers and Channel Sources and
preclude access to business prospects, either of which could have a material
adverse effect on the Company's business, financial condition and operating
results.
16
<PAGE>
ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Item 13(a)(1) in Part IV.
ITEM 8. CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
Not Applicable
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL
PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
The information required for this item is incorporated by reference to
the Company's 1998 Definitive Proxy Statement which the Company will file with
the Securities and Exchange Commission no later than 120 days subsequent to
December 31, 1997.
ITEM 10. EXECUTIVE COMPENSATION
The information required for this item is incorporated by reference to
the Company's 1998 Definitive Proxy Statement which the Company will file with
the Securities and Exchange Commission no later than 120 days subsequent to
December 31, 1997.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The information required for this item is incorporated by reference to
the Company's 1998 Definitive Proxy Statement which the Company will file with
the Securities and Exchange Commission no later than 120 days subsequent to
December 31, 1997.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required for this item is incorporated by reference to
the Company's 1998 Definitive Proxy Statement which the Company will file with
the Securities and Exchange Commission no later than 120 days subsequent to
December 31, 1997.
17
<PAGE>
PART IV
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
(a) Documents filed as part of this report.
1. Financial Statements (appearing at end of this report)
Report of Independent Public Accountants F-1
Consolidated Balance Sheet - December 31, 1997 F-2
Consolidated Statements of Operations - For the years ended December 31, 1997 and 1996 F-3
Consolidated Statements of Changes in Stockholders' Equity - For the years ended
December 31, 1997 and 1996 F-4
Consolidated Statements of Cash Flows - For the years ended December 31, 1997 and 1996 F-5
Notes to Consolidated Financial Statements F-6
2. Exhibits
3.1 Certificate of Incorporation of the Registrant*
3.1(a) Amendment to Certificate of Incorporation*
3.2 By-laws of the Registrant*
4.1 Common Stock Certificate*
4.2 Warrant Certificate*
4.4 Warrant Agreement by and between Continental Stock Transfer & Trust Company and the
Registrant*
4.5 Voting Agreement among Messrs. Centner, de Ganon, Cleek and Szollose*
10.1 1996 Stock Incentive Plan and Rules Relating thereto*
10.2 1997 Stock Option Plan**
10.3 Consulting Agreement with Harvey Berlent*
10.4 Employment Agreement with David J. Centner*
</TABLE>
18
<PAGE>
<TABLE>
<S> <C> <C>
10.5 Employment Agreement with Matthew G. de Ganon*
10.6 Employment Agreement with Bradley K. Szollose*
10.7 Employment Agreement with Douglas E. Cleek*
10.8 Agreement of Lease - 55 Broad Street, New York, New York*
10.9 Agreement of Lease - 50 Broad Street, New York, New York**
10.10 Agreement of Lease - Baltimore, Maryland**
10.11 Employment Agreement with Robert Burke
21.1 Subsidiary List*
27.1 Financial Data Schedule
</TABLE>
- --------------
* Incorporated by reference from the Registrant's Registration Statement on
Form SB-2, No. 333-4319.
** Incorporated by reference from the Registrant's Form 10-KSB for its fiscal
year ended 12/31/96.
(b) The Company did not file any Current Reports on Form 8-K during the last
quarter of the period covered by this Report.
19
<PAGE>
SIGNATURES
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.
K2 DESIGN, INC.
By: /s/ Matthew G. de Ganon Dated: March 30, 1998
----------------------------------
Matthew G. de Ganon, President
POWER OF ATTORNEY
Each of the undersigned hereby appoints Matthew G. de Ganon, as his
attorneys-in-fact to sign his or her name, in any and all capacities, to any
amendments to this Form 10-KSB and any other documents filed in connection
therewith to be filed with the Securities and Exchange Commission.
In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the registrant and in the capacities and
on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
- --------------------------------------- -------------------------------------- -----------------------------
<S> <C> <C>
Director
- ---------------------------------------
David J. Centner
/s/ Matthew G. de Ganon Principal Executive Officer March 30, 1998
- --------------------------------------- and Director
Matthew G. de Ganon
/s/ Douglas E. Cleek Director March 30, 1998
- ---------------------------------------
Douglas E. Cleek
/s/ James A. Favia Director March 30, 1998
- ---------------------------------------
James A. Favia
/s/ Steven N. Goldstein Director March 30, 1998
- ---------------------------------------
Steven N. Goldstein
</TABLE>
20
<PAGE>
<TABLE>
<S> <C> <C>
/s/ Bradley K. Szollose Director March 30, 1998
- ---------------------------------------
Bradley K. Szollose
/s/ Robert Burke Chief Operating Officer March 30, 1998
- ---------------------------------------
Robert Burke (principal financial and
accounting officer)
</TABLE>
21
<PAGE>
K2 DESIGN, INC.
AND SUBSIDIARY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Financial Statements of K2 Design, Inc. and Subsidiary
Report of Independent Public Accountants......................................................F-1
Consolidated Balance Sheet - December 31, 1997................................................F-2
Consolidated Statements of Operations - For the years
ended December 31, 1997 and 1996.....................................................F-3
Consolidated Statements of Changes in Stockholders'
Equity - For the years ended December 31, 1997 and 1996..............................F-4
Consolidated Statements of Cash Flows - For the years
ended December 31, 1997 and 1996.....................................................F-5
Notes to Consolidated Financial Statements....................................................F-6
</TABLE>
22
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To K2 Design, Inc:
We have audited the accompanying consolidated balance sheet of K2 Design, Inc.
(a Delaware corporation) and its subsidiary (a New York corporation) as of
December 31, 1997, and the related consolidated statements of operations,
changes in stockholders' equity and cash flows for the years ended December 31,
1997 and 1996. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of K2 Design, Inc. and its
subsidiary as of December 31, 1997, and the results of their operations and
their cash flows for the years ended December 31, 1997 and 1996, in conformity
with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in the index to the
financial statements is presented for the purpose of complying with the
Securities and Exchange Commission's rules and is not part of the basic
financial statements. The schedule has been subjected to the auditing procedures
applied in our audits of the basic financial statements, and in our opinion,
fairly states in all material respects the financial data required to be set
forth therein in relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Roseland, New Jersey
February 26, 1998
F-1
<PAGE>
K2 DESIGN, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 1997
<TABLE>
<CAPTION>
<S> <C>
ASSETS
------
CURRENT ASSETS:
Cash $ 2,242,988
Accounts receivable net of allowance for doubtful accounts of $213,204 (Note 2) 3,433,153
Prepaid expenses and other current assets 670,054
--------------------
Total current assets 6,346,195
FIXED ASSETS, net (Note 3) 930,914
RESTRICTED CASH 150,711
OTHER ASSETS 10,073
--------------------
Total assets $ 7,437,893
====================
CURRENT LIABILITIES:
Current portion of capital lease obligations (Note 4) $ 61,257
Accounts payable 1,910,379
Accrued compensation & payroll taxes 160,749
Other accrued expenses 801,503
Deferred revenue (Note 2) 642,605
Customer advances 30,554
-----------------------
Total current liabilities 3,607,047
LONG-TERM CAPITAL LEASE OBLIGATIONS (Note 4) 43,766
-----------------------
Total liabilities 3,650,813
-----------------------
COMMITMENTS AND CONTINGENCIES (Note 5)
STOCKHOLDERS' EQUITY (Notes 2 and 7):
Preferred stock, $.01 par value, 1,000,000 shares authorized; 0 shares issued
and outstanding --
Common stock, $.01 par value, 9,000,000 shares authorized; 3,680,671 shares
issued and outstanding 36,807
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
<S> <C>
Additional paid-in capital 6,348,940
Accumulated deficit (2,598,667)
-----------------------
Total stockholders' equity 3,787,080
-----------------------
Total liabilities and stockholders' equity $ 7,437,893
=======================
The accompanying notes are an integral part of this consolidated balance sheet.
F-2
</TABLE>
<PAGE>
K2 DESIGN, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
1997 1996
------------------ ---------------
<S> <C> <C>
REVENUES $ 8,397,680 $ 4,077,792
DIRECT SALARIES AND COSTS 6,125,373 3,249,717
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 3,644,728 1,720,503
DEPRECIATION 347,346 92,167
----------------- ---------------
Loss from operations (1,719,767) (984,595)
INTEREST AND OTHER INCOME, net 37,087 89,178
----------------- ---------------
Loss before provision for income taxes (1,682,680) (895,417)
PROVISION FOR INCOME TAXES 20,570 --
----------------- ---------------
Net loss $ (1,703,250) $ (895,417)
================= ===============
Net loss per common share-basic and diluted $ (0.46) $ (0.32)
=================== =================
WEIGHTED AVERAGE BASIC AND DILUTED COMMON
SHARES OUTSTANDING 3,663,046 2,820,182
=================== =================
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-3
<PAGE>
K2 DESIGN, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
Common Stock
----------------------------- Additional
Number of Paid-in Accumulated
Shares Amount Capital Deficit Total
--------------- ------------ -------------- ------------- --------------
<S> <C> <C> <C> <C> <C>
BALANCE, December 31, 1995 1,895,480 $18,955 $(62,376) $11,896 $(31,525)
Termination of S Corporation -- -- 11,896 (11,896) --
Private placement of common stock at $1.25 per
share, net of expenses 200,000 2,000 153,230 -- 155,230
Private placement of common stock at $1.75 per
share, net of expenses 400,002 4,000 617,755 -- 621,755
Initial public offering of common stock at $6.00
per share, net of expenses 1,149,939 11,499 5,560,678 -- 5,572,177
Net loss -- -- -- (895,417) (895,417)
--------------- ------------ -------------- ------------- --------------
BALANCE, December 31, 1996 3,645,421 36,454 6,281,183 (895,417) 5,422,220
35,250 shares common stock issued 35,250 353 67,757 -- 68,110
Net loss -- -- -- (1,703,250) (1,703,250)
---------------- ------------- --------------- -------------- --------------
BALANCE, December 31, 1997 3,680,671 $36,807 $6,348,940 $(2,598,667) $3,787,080
=============== ============ ============== ============= ==============
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-4
<PAGE>
K2 DESIGN, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
1997 1996
----------------- --------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(1,703,250) $(895,417)
Adjustments to reconcile net loss to net cash used in
operating activities-
Recognition of deferred compensation 67,757 --
Depreciation 347,346 92,167
Loss from disposal of fixed assets 16,438 --
Changes in-
Accounts receivable, net (1,365,438) (1,934,021)
Prepaid expenses and other current assets (358,573) (311,481)
Other assets 549 (36,217)
Accounts payable 1,165,816 649,623
Accrued compensation and payroll taxes 35,956 97,114
Other accrued expenses 494,454 276,839
Deferred revenue and customer advances 506,990 136,312
---------------- -----------------
Net cash used in operating activities (791,955) (1,925,081)
---------------- -----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of fixed assets (711,253) (502,152)
Restricted cash (120,711) --
Proceeds from sale of fixed assets 63,200 --
---------------- -----------------
Net cash used in investing activities (768,764) (502,152)
---------------- -----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock 353 6,349,162
Principal payments on capital lease obligations ( 64,076) (37,255)
Principal payments on note payable -- (25,000)
Principal payments on line of credit -- (10,000)
Net cash provided by (used in) financing activities (63,723) 6,276,907
---------------- ----------------
Net increase (decrease) in cash (1,624,442) 3,849,674
CASH, beginning of year 3,867,430 17,756
---------------- -----------------
CASH, end of year $ 2,242,988 $ 3,867,430
================ =================
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
1997 1996
----------------- ---------------
<S> <C> <C>
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION:
Cash paid during the year for-
Interest $ 32,802 $ 16,260
Income taxes 20,570 1,000
Noncash investing activities-
Equipment acquired under capital lease obligations $ 39,212 $ 128,334
================ =================
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-5
<PAGE>
K2 DESIGN, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996
1. ORGANIZATION AND BUSINESS
-------------------------
K2 Design, Inc. ("K2" or the "Company") commenced operations on March 1, 1993 as
a partnership. In January 1995 the Partnership contributed its capital into a
newly formed corporation and elected S Corporation status.
Effective January 1, 1996, the Company was reorganized as a Delaware Holding C
corporation having a wholly owned operating subsidiary incorporated in New York.
The reorganized corporation is authorized to issue 9,000,000 shares of common
stock, par value $.01 per share, and 1,000,000 shares of Preferred Stock, par
value $.01 per share.
K2 is a full service interactive communications, design and technology company,
engaged primarily in the business of interactive advertising. The Company also
provides various other information delivery services. The Company's customers
are primarily U.S.-based corporations operating in a wide variety of industries.
Private Placements
- ------------------
On February 29, 1996, the Company consummated a private placement offering in
which it sold 200,000 shares of its common stock at $1.25 per share. On May 9,
1996, the Company consummated a second private placement offering in which it
sold 400,002 additional shares of its common stock at $1.75 per share.
Initial Public Offering
- -----------------------
On July 26, 1996, the Company consummated an initial public offering in which
1,149,939 units of the Company's securities were sold to the public ( the
"Public Units") at $6.00 per unit, each consisting of one share of Common Stock
and two warrants to purchase one share of Common Stock at $7.50. The net
proceeds from this offering of approximately $5,600,000 are being used for
working capital and general corporate purposes.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
------------------------------------------
Use of Estimates in the
Preparation of Financial Statements
- -----------------------------------
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.
F-6
<PAGE>
Revenue Recognition
- -------------------
Revenues are recognized on the percentage of completion method based upon the
ratio of costs incurred to total estimated costs incurred and anticipated
profits earned on projects in progress in excess of amounts billed. Deferred
revenue and customer advances represent amounts billed in excess of costs
incurred and estimated profit earned. Such billings generally occur at the
beginning of contract periods, and are in accordance with contract provisions.
Provisions for any estimated losses on uncompleted contracts are made in the
period in which such losses are determinable. A portion of the Company's
revenues has been generated on a fixed fee for service basis.
Allowance for Doubtful Accounts
- -------------------------------
At December 31, 1997, the Company's allowance for doubtful accounts was
approximately six percent of the gross accounts receivable balance which the
Company believes is adequate based upon its experience.
Fixed Assets
- ------------
Fixed assets are carried at cost and depreciated using the straight-line method
over their estimated useful lives. Leasehold improvements are amortized over the
shorter of their estimated useful lives or the term of the underlying lease.
Estimated useful lives by class of assets are as follows:
Computers and Equipment 3 years
Furniture and fixtures 5 years
Leasehold improvements Life of lease
Assets purchased under capital leases are depreciated over their estimated
useful lives.
Fair Value of Financial Instruments
- -----------------------------------
The carrying amounts of the Company's cash, accounts receivable, and accounts
payable approximate fair market value based upon the relatively short-term
nature of these financial instruments.
Concentration of Credit
- -----------------------
Financial instruments which potentially subject the Company to concentration of
credit risk consist principally of trade accounts receivable. The Company
performs ongoing credit evaluations of its customers' financial condition and
generally requires no collateral from its customers. The Company's sales to its
two largest customers constituted approximately 15% and 12%, for the year ended
December 31, 1997. The Company had accounts receivable from these customers
amounting to $736,727 at December 31, 1997. The Company's sales to its four
largest customers for the year ended December 31, 1996 constituted approximately
20%, 15%, 14% and 12% of revenue.
Income Taxes
- ------------
Effective January 1996, the Company elected to be treated as a C Corporation. As
a result, the Company is subject to Federal, New York State and City income
taxes on the Company's taxable income.
The Company provides Federal, state and city income tax in accordance with
Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes" (SFAS 109). Under the asset and liability method of SFAS 109, deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities
F-7
<PAGE>
and their respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years on
which those temporary differences are expected to be recovered or settled.
Deferred taxes were not significant for the year ended December 31, 1997.
Net Loss per Share of Common Stock
- ----------------------------------
SFAS 128, "Earnings per Share" which is effective for the year ending December
31, 1997, establishes new standards for computing and presenting earnings per
share (EPS). The new standard requires the presentation of basic EPS and diluted
EPS. Basic EPS is calculated by dividing income available to common shareholders
by the weighted average number of shares of common stock outstanding during the
period. Diluted EPS is calculated by dividing income available to common
shareholders by the weighted average number of common shares outstanding
adjusted to reflect potentially dilutive securities.
In accordance with the SFAS 128, the following table reconciles net loss and
share amounts used to calculate basic and diluted loss per share:
<TABLE>
<CAPTION>
December 31,
1997 1996
---------------------- -------------------
<S> <C> <C>
Numerator:
Net loss - Basic and Diluted $ (1,703,250) $ (895,417)
============ ==========
Denominator:
Weighted average number of common shares outstanding -Basic and Diluted 3,663,046 2,820,182
============= ===========
Net loss per common share - Basic and diluted $ (0.46) $ (0.32)
============= ===========
</TABLE>
Outstanding stock options of 464,950 and 118,500 as of December 31, 1997 and
1996, respectively, have been excluded from the above calculations as they are
antidilutive for all periods presented.
Stock-Based Compensation
In 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 123, "Accounting for Stock Based Compensation"
(SFAS 123). This statement establishes financial accounting and reporting
standards for stock-based employee compensation plans. SFAS 123 encourages
entities to adopt a fair value based method of accounting for stock compensation
plans. However, SFAS 123 also permits entities to continue to measure
compensation costs under pre-existing accounting pronouncements with the
requirement that pro forma disclosures of net income and earnings per share be
included in the notes to the financial statements. The Company has elected to
adopt the disclosure requirements of SFAS 123 (see Note 7).
3. FIXED ASSETS
------------
Fixed assets, at cost, including capital leases (see Note 4), summarized by
major categories at December 31, 1997, consist of the following:
<TABLE>
<CAPTION>
<S> <C>
Computers and Equipment $ 810,901
Furniture and fixtures 280,315
Leasehold improvements 212,188
-----------------
1,303,404
Less- Accumulated depreciation 372,490
-------------------
Fixed assets, net $ 930,914
===================
</TABLE>
F-8
<PAGE>
4. CAPITAL LEASE OBLIGATIONS
-------------------------
The Company is a lessee in noncancelable leasing agreements for certain
computers and equipment. Included in fixed assets is $105,023 of computers and
equipment held under capital leases.
Future minimum lease payments for fixed assets under capital lease at December
31, 1997, are as follows:
<TABLE>
<S> <C>
1998 $ 73,054
1999 45,131
2000 6,005
------------------
Total minimum lease payments 124,190
Less-Imputed interest (19,167)
-------------------
Capital lease obligation $ 105,023
===================
</TABLE>
5. COMMITMENTS AND CONTINGENCIES
-----------------------------
Leases
- ------
The Company leases certain office space and automobiles for varying periods. At
December 31, 1997, approximate future minimum rental commitments under all
noncancellable operating leases are as follows:
<TABLE>
<CAPTION>
Fiscal Year:
-----------
<S> <C>
1998 $ 351,789
1999 342,951
2000 302,319
2001 294,031
2002 260,003
Thereafter 76,017
</TABLE>
Rental expense for the Company's premises amounted to $254,679 in 1997 and
$78,687 in 1996.
Employment contracts
- --------------------
The Company has employment contracts with certain of its executives which expire
as of December 31, 1998. Such agreements provide for minimum salary levels and,
in certain of these agreements, bonuses which are payable based on 1.88% of the
Company's pre-tax income. The aggregate commitment for future salaries,
excluding bonuses, at December 31, 1997 was approximately $705,000.
6. INCOME TAXES
------------
F-9
<PAGE>
As described in Note 2, the Company previously elected "S" corporation status
under the provisions of the Internal Revenue Code. In January, 1996 the Company
reorganized as a Delaware Holding C corporation in contemplation of the initial
public offering.
At December 31, 1997, the Company had net operating loss carryforwards of
approximately $4,300,000 which expire in 2012. The Company has recorded a
deferred tax asset of approximately $1,462,000 related to the net operating loss
carryforwards and a corresponding valuation allowance due to the uncertainty of
the realization of the asset.
The provision for income taxes on the net loss for the years ended December 31,
1997 and 1996 differs from the amount computed by applying the Federal statutory
rate due to the following:
<TABLE>
<CAPTION>
1997 1996
------------------- --------------------
<S> <C> <C>
Statutory Federal income tax rate (34.0)% (34.0)%
State and local taxes, net (4.8) (6.0)
Valuation Allowance 40.0 40.0
------------------- --------------------
Effective Tax Rate 1.2% 0.0%
=================== ====================
</TABLE>
7. STOCK OPTION PLAN
-----------------
Effective January 1996, the Company adopted the 1996 Stock Option Plan (the
"1996 Plan"), and in June 1997, the 1997 Stock Incentive Plan (the "1997
Plan", and together with the 1996 Plan, the "Plans"). Pursuant to the Plans,
designated employees, including officers and directors of the Company and
certain outside consultants, will be entitled to receive nonqualified stock
options and qualified stock incentive compensation. An aggregate of 575,000
shares of common stock are available for grant under the Plans.
The 1996 Plan expires on January 1, 2006 and the 1997 Plan expires on June 12,
2007. Under the terms of the Plans, the minimum exercise price of options
granted cannot be less than 100% of the fair market value of the common stock of
the Company on the option grant date, unless otherwise determined by the Board
of Directors or a Committee thereof that administered the Plan. Options granted
under the Plan generally expire ten years after the option grant date. For
incentive stock options granted to such persons who would be deemed to have in
excess of a 10% ownership interest in the Company, the option price shall not be
less than 110% of such fair market value for all options granted, and the
options expire five years after the option grant date.
A summary of the Plans at December 31, 1997 and 1996 is presented in the table
below:
F-10
Page>
<TABLE>
<CAPTION>
Weighted
Average
Exercise
Shares Price
----------------- ---------------
<S> <C> <C>
Outstanding at January 1, 1996 -- $ --
Granted 118,500 4.03
Exercised -- --
Forfeited -- --
----------------- --------------
Outstanding at December 31, 1996 118,500 4.03
Granted 364,950 1.57
Exercised -- --
Forfeited (18,500) 4.03
----------------- ---------------
Outstanding at December 31, 1997 464,950 $ 2.10
=================== ===============
<CAPTION>
The Company accounts for the Plans under APB 25, under which no compensation
cost is recognized for stock options granted with an exercise price at or above
the prevailing market price on the date of the grant. Had compensation cost for
this plan been determined consistent with the fair value approach required by
SFAS 123, the Company's net loss and net loss per common share would have been
increased to the following pro forma amounts:
</TABLE>
<TABLE>
<CAPTION>
1997 1996
----------------- ---------------
<S> <C> <S>
Net loss:
As reported $ (1,703,250) $ (895,417)
=================== ===============
Pro forma $ (1,748,231) $ (919,926)
=================== ===============
Net loss per common share
As reported $ (0.46) $ (0.32)
=================== ===============
Pro forma $ (0.48) $ (0.33)
=================== ===============
</TABLE>
The fair value of each option granted is estimated on the date of the grant
using the Black-Scholes option pricing model with the following assumptions:
risk-free interest rates of 5.5% and 6.1% in 1997 and 1996, respectively; no
expected dividend yields for options granted; expected lives of 5 years;
expected stock price volatility of 157% and 75% in 1997 and 1996, respectively.
The weighted average fair value of options granted during 1997 and 1996 was
$1.09 and $1.18, respectively.
The effects of applying SFAS 123 in this pro forma disclosure may not be
indicative of future amounts because anticipated stock option grants are
anticipated in future years.
<PAGE>
Under SFAS 123, options granted to external consultants must be accounted for at
fair value on the date of grant utilizing the Black-Scholes option pricing
model. The options granted to such individual during 1996 did not have a
material effect on the Company's December 31, 1996 financial statements.
F-11
<PAGE>
EXHIBIT 10.11
EMPLOYMENT AGREEMENT
AGREEMENT dated as of the 16th day of December, 1997 between K2 DESIGN,
INC., a Delaware corporation, with offices at The New York Information and
Technology Center, 30 Broad Street, New York, New York 10004 (the
"Corporation"), and Robert W. Burke (the "Executive");
In consideration of the mutual covenants and promises contained herein,
and other good and valuable consideration, the receipt and sufficiency of which
are hereby acknowledged, it is agreed as follows:
1. Duties. The Corporation hereby employs the Executive in the
executive capacity as Chief Operating Officer. The specific duties to be
performed by the Executive for the Corporation and each of its subsidiaries
shall principally be defining and implementing systems and controls, managing
the Corporation's finances and developing and implementing the Corporation's
strategic plan to expand worldwide via acquisitions. In addition, the Executive
shall perform such other reasonable executive, administrative and managerial
services consistent with his position, to the Corporation and each of its
subsidiaries as the Board of Directors of the Corporation (the "Board") may from
time to time prescribe. The Executive accepts such employment and agrees to
devote his full time and effort to the services of the Corporation. Without
Executive's prior written consent, Executive's base of operations shall not be
changed from New York City (where Executive's duties shall be principally
performed), although Executive may be required to travel outside of the New York
tri-state area for reasonable periods of time to perform his duties.
2. Term. The term of this Agreement shall commence as of October 21,
1997, and shall end on December 31, 2000, unless otherwise extended by mutual
agreement of the Executive and the Corporation.
3. Compensation and Benefits. (a) During the first year of the Term,
the Corporation shall pay to the Executive a base salary of $200,000 in
accordance with the Corporation's normal payroll policies. In each succeeding
year during the Term, Executive's base salary shall be increased by 10% above
Executive's base salary during the prior year.
(b) In addition, upon the commencement date of the term,
Executive and the Corporation shall enter into the Stock Option Agreements
attached hereto as Exhibit A, pursuant to which
-1-
<PAGE>
Executive shall be granted options to acquire 100,000 shares of the
Corporation's common stock, par value $.01 per share ("Common Stock") at
exercise prices of $1.625 and $1.75 per share.
(c) In addition to the foregoing payments, Executive shall:
(i) be eligible to participate in all fringe
benefits, bonus and any pension and/or profit sharing plans that may be provided
by the Corporation or any subsidiary for its key executive employees in
accordance with the provisions of any such programs or plans;
(ii) be eligible to participate in any life or
other similar insurance plans, medical and health plans or other employee
welfare benefit plans that may be provided by the Corporation or any subsidiary
for its key executive employees in accordance with the provisions of any such
plans. The Corporation shall also bear the cost of premiums of (X) the
Executive's whole life insurance policy now in effect, up to a maximum of $2,000
per year and (Y) an individual disability policy, selected by Executive. The
aggregate monthly benefit of this additional policy and the Corporation's
existing disability insurance shall be not less than $12,500. The Corporation
shall also use its reasonable efforts to cause its health and its dental
insurers to provide health and dental insurance to Executive and his family
commencing on the first day of the Term through the end of the Term. The
Corporation shall bear the cost of all such health and dental insurance
premiums;
(iii) be entitled to three weeks paid vacation during
the first year of the Term and four weeks paid vacation during each of the
second and third years of the Term; provided, that without the consent of the
Corporation's Chief Executive Officer, Chief Operating Officer or President,
Executive shall not take more than two consecutive vacation weeks;
(iv) be entitled to sick leave and sick pay in
accordance with the policy of the Corporation or any subsidiary that may be
applicable to key executive employees;
(v) be entitled to such other bonuses as the Board
may award from time to time in its discretion (it being understood that although
the Board is not obligated to award any bonuses, it shall in good faith consider
whether to grant bonuses to Executive not less frequently than annually);
(vi) be entitled to reimbursement of all ordinary and
necessary business expenses against presentation of invoices or receipts and
otherwise in accordance with the Corporation's
-2-
<PAGE>
policies in effect from time to time applicable to senior executives of the
Corporation; and
(vii) be entitled to a car allowance of $450 per
month.
4. Conflict of Interest. The Executive agrees that during his
employment with the Corporation, the Executive will not, directly or indirectly,
engage in or have a substantial interest in any business which at the time shall
be in whole or substantial part competitive with any substantial part of the
business carried on by the Corporation now or at the time until this Agreement
shall be terminated, either for the Executive's own benefit or for or with any
person, firm or corporation whatsoever other than the Corporation.
5. Confidentiality. The Executive agrees that the Executive will not,
at any time during or after the termination of employment with the Corporation,
reveal, divulge or make known to any person, firm, corporation, or other
business organization (other than the Corporation), or use for its account, any
information that relates to the Corporation's existing or reasonably foreseeable
business which is not readily disclosed by inspection of the Corporation's
products, including, but not limited to, ideas, inventions, discoveries, trade
secrets, confidential information, good will, improvements, information
contained in or relating to the Corporation's product designs, manufacturing
processes and techniques, marketing plans or proposals, sources and prices of
inventory, equipment and all other business related items, financial
information, personnel information and customer information (collectively,
"Proprietary Information"). Proprietary Information includes any such
information, whether or not obtained by the Executive with the knowledge and
permission of the Corporation, whether or not developed, devised or otherwise
created in whole or in part by the Executive's efforts, and whether or not a
matter of public knowledge unless as a result of authorized disclosure. The
Executive further agrees to retain such knowledge and information which the
Executive acquires and develops during the Executive's employment respecting
such Proprietary Information in trust for the sole benefit of the Corporation
and its successors and assigns.
6. Non-Competition. (a) The Executive agrees to not (i) at any time
during employment with the Corporation, and (ii) if Executive's employment with
the Corporation is terminated pursuant to Section 7(a) or (b) or Executive
terminates his employment hereunder other than for Good Reason, then through
December 31, 2000 (the "Prohibited Period"), directly or indirectly enter into,
participate in or engage in any business, or the solicitation of any business,
which is competitive with
-3-
<PAGE>
the business of the Corporation within the territories in which the Corporation
now or during the Term conducts marketing or operational activities, whether as
an individual on the Executive's own account, as a partner or joint venturer, as
the owner of an interest in, or as a director or officer of, any entity, as an
executive, agent, salesman or consultant of any person or entity, or otherwise;
and (b) the Executive further agrees to not, at any time during or after the
termination of the Executive's employment with the Corporation (i) induce or
attempt to induce any employee of the Corporation to leave the Corporation's
employ, or (ii) interfere with the relationship of the Corporation with any
person or entity who or which at any time during his employment with the
Corporation was an employee or customer of, or in the habit of dealing with the
Corporation.
Anything to the contrary in this Agreement notwithstanding, upon
termination of his employment for any reason, Executive shall be permitted to
engage in the practice of law; provided, however, that during the Prohibited
Period, Executive shall not act as in-house counsel for a competitor (it being
understood that Executive may act as outside counsel for a competitor during the
Prohibited Period, so long as Executive complies with all applicable legal and
ethical obligations and does not violate Section 5 hereof in connection with
such representation).
7. Termination for Cause, Death or Disability. The Corporation shall
have the right to immediately terminate this Agreement by written notice to the
Executive (which notice shall specify the effective date of termination; the
"Termination Date"), and this Agreement shall terminate and the obligations and
covenants of the Corporation and the Executive hereunder (except those pursuant
to Sections 5 and 6, which shall survive termination of this Agreement, and
except as otherwise provided in this Agreement) shall be of no further force and
effect upon the Termination Date if any of the following occur: (a) the repeated
failure by the Executive to follow the reasonable written directives of the
Board of Directors of the Corporation that are not inconsistent with the
provisions of this Agreement; (b) the commission by the Executive of a (i)
felony, or (ii) fraud against the Corporation or any customer of, supplier to or
other person or entity which has regular dealings with, the Corporation; for
purposes of this (b), in the absence of a plea of guilty or nolo contendere by
the Executive, or a conviction (in the case of a felony) or a judgment (in the
case of a fraud) after the exhaustion of all available appeals, the Executive
will be conclusively presumed not to have committed any such felony or fraud;
and (c) the permanent disability of the Executive ("permanent disability" shall
mean the Executive's inability to perform the duties and responsibilities
hereunder by reason of physical or mental injury or illness for any 9 months in
any
-4-
<PAGE>
consecutive 12 month period). This Agreement shall terminate in the event of
Executive's death effective as of the date of death.
8. Other Termination. (a) Except as may otherwise be provided in the
Stock Option Agreements attached hereto as Exhibit A, if Executive dies, becomes
permanently disabled or terminates this Agreement other than for Good Reason,
the Corporation shall have no further liability to Executive for compensation or
benefits, except as may otherwise be provided in the applicable benefit plan or
as may otherwise be required by law (e.g., COBRA) and that Executive shall be
paid accrued salary upon termination of this Agreement.
(b) In the event Executive's employment is terminated by the
Corporation other than pursuant to Section 7(a) or 7(b), or the Executive
initiates the termination for Good Reason, the Corporation will pay severance
(in addition to the amounts outlined in Section 8(a) of this Agreement) to the
Executive (or to Executive's surviving spouse, or if Executive has no surviving
spouse, then to Executive's estate) as follows: (i) the salary for the unexpired
Term of this Agreement; (ii) if equity-based incentives are held by the
Executive or otherwise accrue to him but the Corporation's stock is not publicly
traded, Executive shall receive in cash the fair market value of such
equity-based incentives, which shall be determined in good faith by the
Corporation on the basis of such considerations as it reasonably deems
appropriate; and (iii) all benefits as described in Section 3(c)(ii) for which
Executive would otherwise have been eligible to receive as of the effective date
of Executive's termination of employment for the unexpired Term of this
Agreement. Notwithstanding the foregoing, if Executive becomes employed during
the unexpired Term, (X) there shall be credited against the amount payable by
the Corporation pursuant to clause (b)(i) of this Section 8, the amount paid to
Executive during such period in salary and fixed bonus not based on performance
and (Y) the Corporation's obligations pursuant to clause (b)(iii) of this
Section 8 shall terminate, except as may otherwise be provided in the
Corporation's benefit plans or as may otherwise be required by law.
(c) For purposes of this Agreement, the term (i) "Good Reason"
shall mean (A) reduction in any component of compensation below that which is
required to be paid hereunder, (B) a material difference in benefits below the
level of other senior executives, (C) material diminution in status, office or
title, or assignment of inconsistent duties to be performed on a regular basis,
or (D) any material breach of any material provision of this Agreement,
including, without limitation, the last sentence of Section 1 hereof and (ii)
"Cause" shall mean the occurrence of the events described in clauses (a) and (b)
of Section 7.
-5-
<PAGE>
9. Arbitration. Any controversy or claim arising out of, or relating to
this Agreement, or the breach thereof, shall be settled by arbitration in New
York, New York, in accordance with the Rules of the American Arbitration
Association, and judgment upon the award rendered by the arbitrator or
arbitrators may be entered in any court having jurisdiction thereof.
10. Miscellaneous. (a) All notices, requests, offers, demands and other
communications hereunder shall be in writing and shall be effectively given or
made when mailed by registered or certified mail, return receipt requested, and
directed to the party at the address given herein or to such address as either
party may hereafter designate in writing; (b) this Agreement is being delivered
and executed in the State of New York and shall be construed in accordance with
and governed by its laws; (c) this Agreement shall be binding upon and inure to
the benefit of the parties hereto, their heirs, executors, successors and
assigns and the Corporation shall cause its obligations hereunder to be assumed
by any person, corporation or other entity (1) resulting from the
reorganization, merger or consolidation of the Corporation with any other
corporation or entity or (2) any corporation or other entity to which the
Corporation may sell all or substantially all of its assets (and in either case,
if requested by Executive should Executive reasonably deem himself insecure,
such corporation's or other entity's ultimate parent), (d) this Agreement shall
not be assignable by the Executive, (e) this Agreement constitutes the entire
understanding between the parties hereto and may not be modified, amended,
altered or changed except in writing signed by the parties. To the extent that
any provision of this Agreement conflicts with the Corporation's employee
handbook, the provisions of this Agreement shall govern; (f) if any provision of
this Agreement or the application thereof to any person(s) or circumstance(s)
shall be invalid or unenforceable to any extent, (1) the remainder of this
Agreement and the application of such provision to other person(s) or
circumstance(s) shall not be affected thereby, and (2) each such provision shall
be enforced to the greatest extent permitted by law; (g) no waiver or any breach
or failure to perform the terms, covenants and conditions of this Agreement
shall be binding upon the parties hereto unless the same shall be in writing and
any such waiver shall be for one time only and shall not be for any future
breach or failure to perform under the terms of this Agreement; (h) preparation
of this Agreement has been a joint effort of the parties and this Agreement
shall not be construed more severely against either party; and (i) it is
understood, agreed and acknowledged by the Executive and the Corporation that
any threatened or actual breach by the Executive of any of the agreements
contained in this Agreement may cause irreparable damage to the Corporation and
that the remedy at law therefor may be inadequate and that the Corporation shall
be entitled to injunctive and other equitable relief (as well as
-6-
<PAGE>
damages, if applicable) in the case of any threatened or actual breach thereof.
The Corporation may in its sole discretion apply for specific performance and/or
injunctive relief in order to enforce or prevent any violations of the
provisions of Section 5 and 6 of this Agreement.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the
day and year first above written.
K2 DESIGN, INC.
By: /s/Matthew G. de Ganon /s/ Robert W. Burke
-------------------------- ----------------------------
President Executive
-7-
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<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 2,242,988
<SECURITIES> 0
<RECEIVABLES> 3,646,357
<ALLOWANCES> 213,204
<INVENTORY> 0
<CURRENT-ASSETS> 6,346,195
<PP&E> 1,303,404
<DEPRECIATION> 372,490
<TOTAL-ASSETS> 7,437,893
<CURRENT-LIABILITIES> 3,607,047
<BONDS> 0
0
0
<COMMON> 36,807
<OTHER-SE> 3,750,273
<TOTAL-LIABILITY-AND-EQUITY> 7,437,893
<SALES> 0
<TOTAL-REVENUES> 8,397,680
<CGS> 0
<TOTAL-COSTS> 6,125,373
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 188,204
<INTEREST-EXPENSE> 32,802
<INCOME-PRETAX> (1,703,250)
<INCOME-TAX> 20,570
<INCOME-CONTINUING> (1,703,250)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,703,250)
<EPS-PRIMARY> (.46)
<EPS-DILUTED> (.46)
</TABLE>
