<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
SCHEDULE 14A
(Rule 14a-101)
INFORMATION REQUIRED IN PROXY STATEMENT
SCHEDULE 14A INFORMATION
Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Act of 1934
(Amendment No. )
Filed by the Registrant /X/
Filed by a Party other than the Registrant /_/
Check the appropriate box:
/_/ Preliminary Proxy Statement
/_/ Confidential, For Use of the Commission Only
(as permitted by Rule 14a-6(e)(2)
/X/ Definitive Proxy Statement
/_/ Definitive Additional Materials
/_/ Soliciting Material Pursuant to Rule 14a-11(c) or Rule 14a-12
K2 DESIGN, INC.
- --------------------------------------------------------------------------------
(Name of Registrant as Specified in Its Character)
- --------------------------------------------------------------------------------
(Name of Person(s) Filing Proxy Statement, if Other Than the Registrant)
- --------------------------------------------------------------------------------
Payment of Filing Fee (Check the appropriate box):
/X/ No fee required.
/_/ Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and 0-11.
1. Title of each class of securities to which transaction applies:
----------------------------------------------------------------------------
2. Aggregate number of securities to which transaction applies:
----------------------------------------------------------------------------
3. Per unit price or other underlying value of transaction computed pursuant to
Exchange Act Rule 0-11 (set forth the amount on which the filing fee is
calculated and state how it was determined):
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4. Proposed maximum aggregate value of transaction:
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5. Total fee paid:
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/_/ Fee paid previously with preliminary materials:
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/_/ Check box if any part of the fee is offset as provided by Exchange Act Rule
0-11(a)(2) and identify the filing for which the offsetting fee was paid
previously. Identify the previous filing by registration number, or the form
or schedule and the date of its filing.
1. Amount previously Paid: ____________________________________________________
2. Form, Schedule or Registration Statement no.: ______________________________
3. Filing Party: ______________________________________________________________
4. Date Filed: ________________________________________________________________
<PAGE>
April 29, 1999
TO OUR STOCKHOLDERS:
1998 was a transitional year for K2 Design, highlighted by the
repositioning of our Company and restructuring of our executive management team
to be better able to gain insights into our clients' needs and provide tailored
solutions to enhance their Web commerce. These changes have positioned K2 for
growth in our core specialty of developing online business, sales and marketing
strategies.
To help implement our strategy and achieve our goals, Lynn Fantom
joined K2 as President and Chief Executive Officer last November. Ms. Fantom
came to us with a successful agency management career, including over fifteen
years with two Interpublic Group companies. In the short time she has been with
us, Ms. Fantom has already been instrumental in significantly increasing our
revenue base.
During 1998, K2 was chosen as the interactive agency-of-record for NCR
Corporation, a leader of information technology solutions for business building
one-to-one relationships with customers. In addition to NCR, Sony Online
Entertainment, Inc. and VarsityBooks.com, the creator of and leader in the
college textbook e-commerce category, among others, have utilized the services
of K2 to help develop their online communications strategies, develop national
radio advertisements and place media nationwide, as well as implement their
offline brand building strategies.
In 1998, we worked with S&P to create a new advertising strategy for
their interactive investment advisory site, S&P Personal Wealth
(www.personalwealth.com). Our strategy generated more than a 200 percent
increase in the number of new trial subscribers, and at the same time, cut
subscriber costs in half. Our new strategy involves extensive use of rich media
and co-marketing partnerships to achieve dramatic results. We also provided
direct response banners based on @Home Network's Enliven(Trademark) technologies
to enable prospects to sign up for trial subscriptions within the banner and
eliminate the need for users to leave their host site.
Our work has not gone unnoticed. In 1998, K2 won a Coalition for
Advertiser Sponsored Information and Entertainment (CASIE) Award, and in early
1999, we also won an award for our work with Sony Online Entertainment, Inc.
On June 1, 1998, we sold our CLIQNOW! Division to 24/7 Media, Inc. for
a combination of cash and common stock of 24/7. As of April 27, 1999, the market
value of the common stock received was approximately $9 million. This added
financial strength provides K2 with an additional resource for future growth.
The management restructuring implemented in the second half of 1998
impacted revenues and earnings for the year. Since then, K2 has won several new
accounts. For the year, revenues, adjusted for the sale of CLIQNOW!, were
$6,419,967, compared with $7,501,253 in 1997. Net income, adjusted for the sale
of CLIQNOW!, was $1,237,081, or 35 cents per basic and diluted share, compared
with a net loss of $1,703,250, or 46 cents per basic and diluted share in 1997.
The gain in net income was principally the result of the $2,994,204 gain on the
sale of CLIQNOW!
2
<PAGE>
As we look to the year ahead, we are very optimistic. Our strategy for
1999 is to leverage the agency's core strength and leverage our unique insight
on the interactive landscape. We are doing this by rolling out proprietary
processes and services based on our work with clients. One such service is K2's
W Organizational Modeling(Trademark). Through years of experience working with
corporations, K2 has developed a unique insight on how to modify an
organization's use of the Web as a worldwide publishing tool. More than mere
process, K2 has merged organizational principles of workflow with marketing and
communications strategies, integrating this into a technology foundation. This
methodology creates a multi-dimensional framework for guiding corporate Web use.
We expect that our growth will be both internal and, if opportunities develop,
through strategic acquisitions.
I thank you for your continued interest and support of K2 Design, and
look forward to the challenges ahead.
Sincerely,
/s/ Matthew G. de Ganon
---------------------------------
Matthew G. de Ganon
Chairman of the Board
3
<PAGE>
K2 DESIGN, INC.
30 Broad Street, 16th Floor
New York, NY 10004
----------------------------------------
NOTICE OF ANNUAL MEETING OF STOCKHOLDERS
To Be Held on Wednesday, June 16, 1999
----------------------------------------
To the Stockholders of
K2 DESIGN, INC.:
NOTICE IS HEREBY GIVEN that the 1999 Annual Meeting of Stockholders of
K2 Design, Inc., a Delaware corporation (the "Company"), will be held at 10:30
a.m. (Eastern Standard Time) on Wednesday, June 16, 1999, at the offices of
Proskauer Rose LLP, 1585 Broadway, 27th floor, New York, New York 10036 to
consider and vote upon:
(a) Election of six directors for a one-year term.
(b) Approval and ratification of an amendment to the Company's
1997 Stock Incentive Plan to increase the number of shares of Common
Stock available under such plan.
(c) Approval and ratification of the selection by the Board of
Directors of Arthur Andersen LLP as independent public accountants for
the Company's 1999 fiscal year.
(d) Any other business that may properly come before the
meeting.
The Board of Directors has fixed the close of business on April 23,
1999 as the record date for the determination of stockholders entitled to
receive notice of and to vote at said meeting. Stock transfer books will not be
closed.
To assure representation of your shares, YOU ARE REQUESTED, WHETHER OR
NOT YOU PLAN TO BE PRESENT AT THE MEETING, TO COMPLETE, DATE, SIGN AND RETURN
THE ACCOMPANYING PROXY IN THE ENCLOSED POSTAGE PREPAID ENVELOPE.
If your shares are held of record by a broker, bank, or other nominee
and you wish to vote your shares at the meeting, you must obtain and bring to
the meeting a letter from the broker, bank, or other nominee confirming your
beneficial ownership of the shares.
By Order of the Board of Directors
/s/ Seth Bressman
------------------------------------------
Seth Bressman
Secretary
New York, New York
April 29, 1999
4
<PAGE>
K2 DESIGN, INC.
---------------
PROXY STATEMENT
---------------
ANNUAL MEETING OF STOCKHOLDERS
The proxy accompanying this Proxy Statement is solicited by the Board
of Directors of K2 Design, Inc. (the "Company"). All proxies in the accompanying
form, which are properly executed and duly returned, will be voted at the Annual
Meeting of Stockholders of the Company (the "Annual Meeting") to be held on
Wednesday, June 16, 1999, at 10:30 a.m. at the offices of Proskauer Rose LLP,
1585 Broadway, 27th floor, New York, New York 10036, for the purposes set forth
in the accompanying Notice of Annual Meeting. The Company's mailing address is
30 Broad Street, 16th Floor, New York, New York 10004, except as otherwise
noted.
This Proxy Statement and the enclosed form of proxy are being mailed to
stockholders on or about April 29, 1999.
VOTING AND SOLICITATION OF PROXIES
Only holders of record of the Company's common stock, par value $.01
per share (the "Common Stock"), at the close of business on April 23, 1999, will
be entitled to notice of and to vote at the Annual Meeting. On that date there
were issued and outstanding 3,484,415 shares of Common Stock (not including
treasury shares). Each outstanding share of Common Stock is entitled to one vote
on all matters to come before the Annual Meeting. As of April 23, 1999, members
of management of the Company beneficially held an aggregate of 1,567,588 shares
of Common Stock (not including currently exercisable options to purchase shares
of Common Stock), or 45.0% of the total outstanding shares of Common Stock
entitled to vote at the Annual Meeting.
The cost of soliciting proxies will be borne by the Company. In
addition to the use of traditional mailings, officers, directors and regular
employees of the Company may solicit proxies personally or by telephone,
electronic mail or facsimile transmission. The Company also intends to request
that brokerage houses, banks, custodians, nominees and fiduciaries forward
soliciting material to the beneficial owners of Common Stock held of record by
such persons, and will reimburse such persons for their reasonable expenses in
forwarding such material.
The holders of a majority of the total shares of Common Stock issued
and outstanding, whether present in person or represented by proxy, will
constitute a quorum for the transaction of business at the Annual Meeting. The
affirmative vote of a plurality of the total shares of Common Stock represented
in person or by proxy at the Annual Meeting is required for the election of
directors. The affirmative vote of a majority of the total shares of Common
Stock represented in person or by proxy at the Annual Meeting is required for
approval of the proposal to amend the Company's 1997 Stock Incentive Plan (the
"1997 Plan") and for approval and ratification of the appointment of independent
public accountants. Stockholders who execute proxies retain the right to revoke
them at any time by notice in writing to the Secretary of the Company, by
revocation in person at the Annual Meeting or by presenting a later dated proxy.
Unless so revoked, the shares represented by proxies will be voted at the Annual
Meeting in accordance with the directions given therein. Stockholders vote at
the Annual Meeting by casting ballots (in person or by proxy) which are
tabulated by a person who is appointed by the Board of Directors before the
Annual Meeting to serve as inspector of election at the Annual Meeting and who
has executed and verified an oath of office. Abstentions and broker "non-votes"
are included in the determination of the number of shares present at the Annual
Meeting for quorum purposes. An abstention will have the same effect as a
negative vote except with respect to the election of directors, in which case
<PAGE>
an abstention will have no effect since directors are elected by a plurality
vote. Broker "non-votes" are not counted in the tabulations of the votes cast on
proposals presented to stockholders because shares held by a broker are not
considered to be entitled to vote on matters as to which broker authority is
withheld. A broker "non-vote" occurs when a nominee holding shares for a
beneficial owner does not vote on a particular proposal because the nominee does
not have discretionary voting power with respect to that item and has not
received instructions from the beneficial owner.
It is important that proxies be returned promptly. Therefore, whether
or not you plan to attend in person, you are urged to execute and return your
proxy in the enclosed envelope, to which no postage need be affixed if mailed in
the United States.
BENEFICIAL OWNERSHIP
The following table sets forth information, as of April 23, 1999, as to
the beneficial ownership of Common Stock (including shares which may be acquired
within sixty days pursuant to stock options) of each director of the Company,
the Chief Executive Officer of the Company, all directors and executive officers
as a group and persons known by the Company to beneficially own 5% or more of
the Common Stock. Except as set forth below, each of the listed persons has sole
voting and investment power with respect to the shares beneficially owned by
such person. The address of each person included in the table is care of the
Company, 30 Broad Street, 16th Floor, New York, New York 10004.
Shares of Common Stock Percent of
Name of Owner Beneficially Owned Class(1)
------------- -------------------- --------
Matthew G. de Ganon 1,597,188(2)(3) 45.4
Douglas E. Cleek 487,051(2)(3) 13.9
Lynn Fantom 400,000(4) 11.5
David J. Centner 323,870(3)(5) 9.3
21 Barstow Road
Great Neck, NY 11021
Bradley K. Szollose 299,216(2)(3) 8.6
504 Howard Avenue, Apt. 2B
Staten Island, NY 10301
Robert W. Burke 286,000(5)(6) 8.2
14 Vom Eigen Drive
Convent Station, NJ 07960
Seth Bressman 30,400(7) *
Steven N. Goldstein 5,000(8) *
All Directors and Executive Officers 1,632,588(9) 46.0
as a group (6 persons)
- ----------
* Less than one percent.
2
<PAGE>
(1) Does not give effect to shares of Common Stock held in treasury or
500,000 shares of Common Stock issuable upon exercise of the Company's
Redeemable Common Stock Purchase Warrants (the "Warrants"). Two
Warrants entitle the holder to purchase one share of Common Stock for
$7.50.
(2) Includes 10,000 shares underlying presently exercisable stock options,
exercisable in increments of 3,750 shares for $1.75, $3.50 and $6.75
per share. Excludes 3,750 shares of Common Stock underlying stock
options that are not presently exercisable.
(3) Includes 68,750 shares of Common Stock which are subject to an option
(the "Option Shares") held by Robert Burke. Pursuant to a 10-year
voting agreement entered into by Messrs. Centner, de Ganon, Cleek and
Szollose, effective July 26, 1996 (the "Voting Agreement"), the voting
control over all of these shares, and the Option Shares, are vested in
Mr. de Ganon. Such shares subject to the Voting Agreement must be voted
in favor of the election as directors of Messrs. de Ganon, Cleek and
Szollose. In addition, the Voting Agreement grants each party thereto a
right of first refusal as to the sale of the others' Common Stock.
Messrs. Centner, de Ganon, Cleek and Szollose each disclaim beneficial
ownership of those shares with respect to which they are not record
owners. Mr. de Ganon's holdings also include an aggregate of 45,000
shares underlying presently exercisable stock options held by Messrs.
de Ganon, Cleek and Szollose.
(4) Reflects shares of Common Stock subject to stock options which vest as
follows: 50% on October 22, 1999 and 50% on October 22, 2000.
(5) Ownership information was derived from reports filed with the
Securities and Exchange Commission.
(6) Includes the Option Shares (an aggregate of 275,000 shares of Common
Stock) at an exercise price of $1.75 per share. Upon exercise, the
Option Shares are subject to a proxy granted in favor of Mr. de Ganon
so long as the Voting Agreement remains in place.
(7) Includes 22,500 shares of Common Stock subject to currently exercisable
stock options and stock options to purchase 7,500 shares of Common
Stock which become exercisable on June 30, 1999.
(8) Reflects shares of Common Stock underlying stock options that are
currently exercisable.
(9) Includes 65,000 shares of Common Stock underlying presently exercisable
stock options and excludes 411,250 shares of Common Stock underlying
stock options that are not presently exercisable.
3
<PAGE>
PROPOSAL 1
ELECTION OF DIRECTORS
The Company's Directors have terms expiring at the 1999 Annual Meeting,
and until their respective successors are duly elected and qualified. The
officers of the Company are appointed by the Board of Directors to hold office
until their successors are duly elected and qualified. Vacancies on the Board of
Directors are filled by the remaining directors.
Certain information regarding the nominees for election as Directors at
this year's Annual Meeting is set forth below:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Matthew G. de Ganon 36 Executive Chairman of the Board of
Directors
Lynn Fantom 46 Chief Executive Officer, President and
Director
Douglas E. Cleek 36 Executive Vice President--Chief Creative
Officer and Director
Bradley K. Szollose 36 Director
Steven N. Goldstein 59 Director
David R. Sklaver 47 Director Nominee
</TABLE>
Matthew G. de Ganon has been the Company's Vice Chairman and a Director
since he joined the Company in July 1995 and has been President since June 1996.
He was also the Chief Operating Officer of the Company from July 1995 to
November 1997. For the two years prior to joining the Company, Mr. de Ganon
operated a business that created CD-ROM products and offered consulting services
regarding the use of electronic delivery to publishers of newsletters and
directories. Mr. de Ganon is co-author of the essay, "Overcoming Future Shock on
the Superhighway: Suggestions for Providers and Technocrats," published and
presented in the 1994 National Online Conference Proceedings. From August 1992
to July 1993, Mr. de Ganon was the Vice President of New Media of SCS, a
software developer. Mr. de Ganon's work focused on UNIX based 4GL accounting
software customization for corporate clients. From May 1991 to July 1992, Mr. de
Ganon was involved in casting administration for the Motion Picture Group of
Universal Studios, Inc. Prior thereto, Mr. de Ganon was a franchised theatrical
agent with the Stone Manners Agency in Los Angeles, California from August 1987
to May 1991.
Lynn Fantom has been the Company's President and Chief Executive
Officer and a director since November 1998. Prior to joining the Company, Ms.
Fantom was an independent consultant from September 1997 to November 1998. She
was the Chief Executive Officer of Lowe Direct (now Lowe Fox Pavlika), a direct
marketing company and subsidiary of The Lowe Group, from October 1996 to
September 1997. Ms. Fantom served in various positions for Draft Worldwide, a
marketing company, from October 1982 to October 1996, being named president in
1991 and Vice Chairman in 1996.
4
<PAGE>
Douglas E. Cleek, who co-founded the Company in 1993, has been the
Company's Executive Vice President--Chief Creative Officer and a Director of the
Company since it was reorganized as a corporation in January 1995. From 1993
until then, Mr. Cleek was a general partner of the Company. For more than five
years prior thereto, Mr. Cleek was an art director for William Allen & Co. and
its successor, A.J. Bart & Sons, graphic design firms specializing in graphic
promotional materials for the hospitality industry.
Bradley K. Szollose, who co-founded the Company in 1993, has been a
Director since January 1995 and was the Company's Executive Vice
President--Marketing, Treasurer and Secretary of the Company from January 1995
until November 1997. From 1993 until then, Mr. Szollose was a general partner of
the Company. For more than five years prior thereto, Mr. Szollose was a
freelance art director for the Caribiner Group, producers of corporate theater
and related promotional/entertainment events, where he managed a team of artists
and photographers to coordinate film shooting and art preparation under the
direction of senior designers.
Dr. Steven N. Goldstein has been a Director of the Company since 1996.
Mr. Goldstein has been Program Director, Inter-Agency and International
(Networking) Coordination Director of Network Services at the National Science
Foundation ("NSF") since June 1989 and is responsible for the international
networking coordination in support of the communication needs of the United
States research and education community. Dr. Goldstein has directed NSF's
International Connections Management ("ICM") project which, in the past five
years, has assisted in connecting approximately 20 countries to the Internet.
Dr. Goldstein has also collaborated with Japanese networkers in the formation of
academic Internet service in Japan. Presently, Dr. Goldstein is also the U.S.
coordinator for the G-7 Global Information Society initiative's theme, "Global
Interoperability of Broadband Networks," under which he coordinates closely with
Japan's high performance networking projects. Dr. Goldstein has a Bachelor of
Science and Master degrees in Physics from the Massachusetts Institute of
Technology and a Doctorate degree in Engineering and Public Policy from Carnegie
Mellon University. Dr. Goldstein is also a member of the Institute of Electrical
and Electronics Engineers, the Association for Computing Machinery and the
Internet Society.
David R. Sklaver has been nominated for election to the Board to
succeed Mr. Jack Favia, whose term expires upon completion of the election of
directors at the Annual Meeting. Since 1996, Mr. Sklaver has been a General
Partner, founder and CEO of Artustry Partnership, a strategic and creative
marketing company. From 1993 to 1995, Mr. Sklaver served as President of Wells
Rich Greene DDB, an advertising agency handling Fortune 500 clients. Prior to
being promoted to President, Mr. Sklaver served as Executive Vice President,
Director of Client Services of Wells Rich Greene from 1989 to 1993. From 1986 to
1988, Mr. Sklaver was Executive Vice President, Account Group Head, at
advertising agency BBD Needham, New York. From 1984 to 1985 Mr. Sklaver was
Managing Director of DDB's Sydney office. From 1978 to 1984 he served in Account
Management at DDB New York. Prior to 1978, Mr. Sklaver held positions at Foote,
Cone & Belding Advertising and Standard Brands, both advertising agencies.
OTHER EXECUTIVE OFFICERS
Seth Bressman, age 45, joined the Company in April 1996 as Controller
and was subsequently promoted to Chief Financial Officer in August 1998. Prior
to joining the Company, Mr. Bressman was a consultant to various architectural
design and engineering firms from December 1995 to March 1996. Mr. Bressman was
the Controller for Brennan Beer Gorman Architects, an architectural design
company, from November 1994 through November 1995, Chief Financial Officer for
Emery Roth & Sons, an architectural design company, from August 1993 through
October 1994, and Controller for SCR Design Organization, an interior
design/facilities management company, from December 1985 through July 1993, all
based in New York City. Mr. Bressman also worked in public accounting for 7
years and has over 21 years of experience in accounting and finance since
receiving his MBA in Accounting in June 1977.
5
<PAGE>
DIRECTORS' MEETINGS
The Board of Directors met nine times during fiscal 1998. Each Director
attended more than 75% of the combined number of meetings of both the Board of
Directors and of any committees of the Board on which the Director served.
COMMITTEES OF THE BOARD OF DIRECTORS
In fiscal 1998, each of the Audit Committee, the Compensation Committee
and the Option Committee consisted of Messrs. Favia and Goldstein. Mr. Favia
will not stand for reelection to the Board and will be replaced on the foregoing
committees by David Sklaver upon his election to the Board. The Audit Committee
did not meet formally in fiscal 1998. The Option Committee acted by unanimous
written consent in lieu of a meeting thirteen times in fiscal 1998. The
Compensation Committee met two times in fiscal 1998.
The Audit Committee reviews and examines detailed reports of the
Company's independent public accountants; consults with the independent public
accountants regarding internal accounting controls, audit results and financial
reporting procedures; recommends the engagement and continuation of engagement
of the Company's independent public accountants; and meets with, and reviews and
considers recommendations of, the independent public accountants.
The Compensation Committee reviews the performance of senior management
and key employees whose compensation is the subject of review and approval by
the Committee; periodically reviews and recommends to the Board of Directors
compensation arrangements for senior management and key employees; and
periodically reviews the main elements of and administers the Company's
compensation and benefit programs, with the exception of the Company's 1996
Stock Option Plan and 1997 Stock Incentive Plan (together, the "Plans").
The Option Committee administers the Plans and, to the extent provided
thereby, determines the persons to whom options are granted, the exercise price
thereof, the term and number of shares covered by each option grant and the type
of option to be granted. In addition, the Option Committee exercises all
discretionary power regarding the operation of the Plans.
DIRECTOR FEES
Directors who are employees of the Company receive no additional
compensation for services as Directors. Directors not so employed are entitled
to be reimbursed for expenses incurred in connection with meeting attendance. In
addition, each of the Company's non-employee Directors are granted options to
acquire 5,000 shares of Common Stock upon their election or reelection to the
Board.
EXECUTIVE COMPENSATION
The following table sets forth the total annual compensation paid or
accrued by the Company for services in all capacities for Ms. Fantom, the Chief
Executive Officer, Mr. Centner, the former Chief Executive Officer and those
6
<PAGE>
executive officers (the "Named Executives") who served in executive capacities
at the end of fiscal 1998 and had aggregate compensation in excess of $100,000.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
Annual Long Term
Compensation(1) Compensation
-------------------------- --------------
Name and Principal Position Year Salary($) Bonus($) Option Awards
--------------------------- ---- --------- -------- -------------
<S> <C> <C> <C> <C>
Lynn Fantom, Chief Executive Officer 1998 24,038(2) -- 400,000
and President
David J. Centner, Former Chief 1998 67,981 -- --
Executive Officer (3) 1997 113,982 -- --
1996 84,000 29,000 18,750
Matthew G. de Ganon, Executive 1998 130,924 -- --
Chairman of the Board 1997 115,623 -- --
1996 84,000 31,000 18,750
Douglas Cleek, Executive Vice 1998 117,978 -- --
President--Chief Creative Officer 1997 115,623 -- --
1996 83,473 -- 18,750
Robert Burke, Chief Operating 1998 216,210 -- 125,000
Officer (4)
Seth Bressman, Chief Financial Officer 1998 93,748 -- 25,000
</TABLE>
- -----------------
(1) The value of perquisites and other personal benefits does not exceed
10% of the Officer's salary.
(2) Joined the Company in November 1998.
(3) Resigned from the Company effective as of August 10, 1998. See "Certain
Relationships and Related Transactions."
(4) Resigned from the Company effective as of January 4, 1999. See "Certain
Relationships and Related Transactions."
Employment Contracts for Executive Officers
Lynn Fantom, Matthew G. de Ganon, Douglas E. Cleek and Seth Bressman,
the current executive officers of the Company, have each executed employment
contracts. The contracts of each of Messrs. de Ganon and Cleek, which were to
expire on December 31, 1998, were renewed for an additional three year period
and provide for minimum annual salaries of $153,000 with 20% increases for each
successive year. Such contracts also include bonuses equal to 1.88% of the
Company's pre-tax profit. Messrs. de Ganon and Cleek are prohibited from
competing with the Company through December 31, 2001. The Company entered into a
two year employment contract with Lynn Fantom as Chief Executive Officer and
President providing for an annual salary of $250,000 and a bonus equal to 10% of
the Company's pre-tax profit not to exceed $75,000, provided that the Company's
pre-tax profits for fiscal 1999 is at least $250,000 and for fiscal 2000 is at
least $500,000. Ms. Fantom's contract also contains a non-compete provision for
the term of the contract plus one year and a severance provision entitling Ms.
Fantom to up to $300,000 in the event
7
<PAGE>
of termination without cause and, in certain circumstances upon a change of
control, an additional $300,000 payment. The Company also entered into a one
year employment contract with Seth Bressman as Chief Financial Officer expiring
January 31, 2000, subject to automatic renewals, providing for an annual salary
of $125,000 and a bonus equal to $50,000 in the event of a Change of Control (as
defined in the contract). Mr. Bressman is also subject to a non-compete
restriction for six months beyond the termination date of his employment.
Option Grants in Fiscal 1998
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
Number of Percent Of Total
Securities Options Granted
Underlying Options To Employees In Exercise or Base
Name Granted Fiscal Year Price ($/Sh) Expiration Date
---- ------- ----------- ------------ ---------------
<S> <C> <C> <C> <C>
Lynn Fantom (1) 400,000 85.0% $1.50 10/21/08
David Centner (2) - - - -
Matthew de Ganon - - - -
Douglas Cleek - - - -
Robert Burke (3) - - - -
Seth Bressman 10,000 2.1% $1.75 2/17/08
15,000 3.2% $1.75 9/7/08
</TABLE>
- -----------------
(1) Such options vest as follows: 50% on October 22, 1999 and 50% on
October 22, 2000.
(2) Resigned from the Company effective as of August 10, 1998. See "Certain
Relationships and Related Transactions."
(3) Resigned from the Company effective as of January 4, 1999. See "Certain
Relationships and Related Transactions."
An aggregate of 425,000 stock options were granted to all executive
officers and directors as a group during the fiscal year ended December 31,
1998. Such options are exercisable at prices per share ranging from $1.50 to
$1.75, which reflects the fair market value on the dates of grant. None of such
options were exercised during fiscal 1998.
Option Exercises and Year-End Value Table
The table set forth below shows the value of unexercised options held
on December 31, 1998 by Ms. Fantom, Mr. Centner and each of the Named
Executives.
8
<PAGE>
<TABLE>
<CAPTION>
Number of Unexercised Value of Unexercised In-the-Money
Options at December 31, 1998 Options held on December 31, 1998 ($)(1)
---------------------------- ----------------------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Lynn Fantom 0 400,000 - $452,000
David J. Centner (2) 0 0 - -
Matthew G. de Ganon 11,250 7,500 $3,300 $2,200
Douglas Cleek 11,250 7,500 $3,300 $2,200
Robert Burke (3) 62,500 62,500 $57,679 $57,679
Seth Bressman 15,000 15,000 $13,200 $13,200
</TABLE>
- -----------------
(1) Based on the closing price of the Common Stock on December 31, 1998,
which was $2.63.
(2) Resigned from the Company effective as of August 10, 1998. Accordingly,
all outstanding options expired in November 1998. See "Certain
Relationships and Related Transactions."
(3) 100,000 of such options terminated in connection with an agreement
described below. Mr. Burke exercised his remaining options on a
cashless basis subsequent to year end and received 11,000 shares of
Common Stock. See "Certain Relationships and Related Transactions."
Filing Requirements
The Company believes that all filing requirements under Section 16(a)
of the Securities Act of 1934, as amended, applicable to its officers, directors
and greater than 10% beneficial owners were complied with during the fiscal year
ended December 31, 1998, except that Mr. Szollose is delinquent in the filing of
a Form 4 in respect of the private sale of 95,000 shares of Common Stock for an
aggregate purchase price of $76,000 in March 1998. Appropriate Forms 4 will be
filed promptly hereafter.
Certain Relationships and Related Transactions
In March 1998, the Company purchased 95,000 shares of Common Stock from
Bradley Szollose, a director of the Company, for an aggregate purchase price of
$76,000 (or $.80 per share). The Company believes that the terms of this
transaction were negotiated at arms length and were on terms no less favorable
to the Company than could have been obtained from an unaffiliated party.
In August 1998, the Company repurchased 150,000 shares of Common Stock
held by David Centner, the Company's former Chief Executive Officer, for an
aggregate of $307,765, in connection with Mr. Centner's separation from the
Company. The purchase price for the shares represented a 34% discount below the
market price per share on the date of purchase. The Company believes that the
terms of this transaction were negotiated at arms length and were on terms no
less favorable to the Company than could have been obtained from an unaffiliated
party.
During 1998, the Company completed its restructuring plan to improve
and stabilize finances and increase its cash position to enable the Company to
focus on long term goals, which plan was spearheaded by Robert Burke, the
Company's Chief Operating Officer. As a result of the successful completion of
the restructuring, Mr. Burke's assignment as Chief Operating Officer was
completed. Accordingly, subsequent to year end, the Company entered into an
agreement with Mr. Burke, which agreement provided for payments aggregating
$400,000, canceled options to purchase 100,000 shares of Common Stock of the
Company held by Mr. Burke (but did not affect the Option Shares and other
options held by Mr. Burke as described under "Beneficial Ownership" and "Option
Exercises and Year-End
9
<PAGE>
Value Table"), terminated all prior agreements between Mr. Burke and the Company
and provided for Mr. Burke's resignation from the Company effective as of
January 4, 1999. Such payments to Mr. Burke will be made during 1999 over a
period of ten months or earlier upon the sale by the Company of any of its
holdings of common stock of 24/7 Media, Inc., a portion of which secures such
payments.
PROPOSAL 2
1997 STOCK INCENTIVE PLAN PROPOSAL
The Board of Directors approved the amendment to the 1997 Plan in April
1999, subject to the approval of the stockholders, to provide (i) that the
aggregate number of shares of Common Stock subject to options or awards under
the 1997 Plan be increased from 500,000 to 900,000 and accordingly, (ii) that
the number of shares reserved for the future issuance of shares of Common stock
upon the exercise of options under the 1997 Plan be increased from 500,000
shares to 900,000 shares. The affirmative vote of the holders of at least a
majority of the outstanding shares of Common Stock present and entitled to vote
at the Annual Meeting is required to approve the amendment to the 1997 Plan.
Currently, shares subject to options granted under the 1997 Plan exceed
available shares under the 1997 Plan by approximately 25,000 shares.
Additionally, the Board of Directors deems it advisable and in the best
interests of the Company to provide for a sufficient number of shares under the
1997 Plan to induce, attract and retain talented persons to work at the Company.
In the event such proposal is not approved by the stockholders, the Company will
be unable to honor its commitments to current employees and will not be able to
issue all shares subject to outstanding options (assuming full vesting and
exercise).
THE BOARD OF DIRECTORS RECOMMENDS THAT THE STOCKHOLDERS VOTE THEIR SHARES FOR
THE PROPOSAL TO APPROVE THE AMENDMENT TO THE 1997 PLAN.
Summary of the 1997 Plan
The following summary of the 1997 Plan is qualified in its entirety by
reference to the 1997 Plan, a copy of which is attached to the Company's public
reports or available upon request in writing directed to the President of the
Company. Attention is particularly directed to the description therein of the
material terms and conditions of the award of stock options ("Options") or
restricted shares ("Restricted Shares"), or any combination thereof
(collectively, the "Awards").
All employees (including Officers and Directors) of the Company and its
Subsidiaries or independent contractors or consultants shall be eligible to
participate in the 1997 Plan. The Option Committee may grant Awards to such
persons to purchase the number of shares as the Option Committee may determine.
Options granted under the 1997 Plan may either be Incentive Stock
Options ("ISOs") pursuant to which the recipient receives certain tax benefits
or non-ISOs. The price at which shares may be purchased upon exercise of an
Option shall be fixed by the Option Committee and may be more than, less than or
equal to the fair market value of the Common Stock as of the date the Option is
granted. Subject to the provisions of the 1997 Plan with respect to death,
retirement and termination of employment, the term of each Option shall be for
such period as the Option Committee shall determine as set forth in an
applicable agreement.
The method of payment of the purchase price of an Option, and the
amount required to satisfy applicable federal, state and local withholding tax
requirements, will be determined by the Option Committee and may consist of
cash, a check, a promissory note, whole shares of Common Stock already owned by
the optionee, the withholding of shares of Common Stock issuable upon such
exercise of the Option, the delivery of a properly executed exercise notice and
irrevocable instructions to a broker to deliver promptly to the Company the
amount of sale or loan proceeds required
10
<PAGE>
to pay the purchase price, any combination of the foregoing methods of payment
or such other consideration and method of payment as may be permitted for the
issuance of shares under the Delaware General Corporation Law.
At the time of any Award of Restricted Shares, the Option Committee
will designate a period of time which must elapse (the "Restriction Period") and
may impose such other restrictions, terms and conditions that must be fulfilled
before the Restricted Shares will become vested. The Option Committee may
determine that (i) Restricted Shares will be issued at the beginning of the
Restriction Period, in which case such shares will constitute issued and
outstanding shares of Common Stock for all corporate purposes, or (ii)
Restricted Shares will not be issued until the end of the Restriction Period, in
which case the holder will have none of the rights of a stockholder with respect
to the shares of Common Stock covered by such Award until such shares shall have
been issued to such holder at the end of the Restriction Period.
If a holder's employment with the Company or a Subsidiary shall be
terminated by the Company or such Subsidiary during the Restriction Period with
respect to any Restricted Shares, or prior to the exercise of any Option, for
cause, then (i) all Options held by such holder shall immediately terminate and
(ii) such holder's rights to all Restricted Shares, Retained Distributions, any
unpaid Dividend Equivalents and any cash awards shall be forfeited immediately.
All shares available under the 1997 Plan are subject to adjustments
that may be made for a merger, recapitalization, stock dividend, stock split or
other similar change affecting the number of outstanding shares of Common Stock.
Shares of Common Stock that are subject to any Award granted under the 1997 Plan
that expires, terminates or is annulled for any reason without having been
exercised and any Award of Restricted Shares that is forfeited prior to becoming
vested will return to the pool of such shares available for grant under the 1997
Plan.
The Board of Directors may at any time amend, suspend or discontinue
the 1997 Plan; provided, however, that certain amendments may not be made by the
Board of Directors without approval of the stockholders. Amendments may not
alter an outstanding Option without the consent of the optionee.
The Option Committee may require in an applicable agreement that if the
optionee acquires any shares of Common Stock through the exercise of Options or
through the vesting of Restricted Shares granted pursuant to an Award, then
prior to selling any such shares, such holder must offer to sell such shares to
the Company at their fair market value pursuant to a right of first refusal.
The obligations of the Company with respect to Awards granted under the
1997 Plan are subject to all applicable laws.
PROPOSAL 3
RATIFICATION OF SELECTION OF INDEPENDENT PUBLIC ACCOUNTANTS
The Board of Directors has selected Arthur Andersen LLP, independent
auditors, to serve as auditors of the Company for the fiscal year ending
December 31, 1999. Although stockholder ratification of the Board of Directors'
action in this respect is not required, the Board considers it desirable for
stockholders to pass upon the selection of auditors and, if the stockholders
disapprove of the selection, intends to consider the selection of other auditors
for the current fiscal year.
Representatives of Arthur Andersen LLP are expected to be present at
the Annual Meeting, will have an opportunity to make a statement if they so
desire, and will be available to respond to appropriate questions from
stockholders.
11
<PAGE>
The affirmative vote of the holders of a majority of the shares of
Common Stock present in person and by proxy at the Annual Meeting and entitled
to vote thereon is necessary for the ratification of the appointment of the
auditors. Proxies received in response to this solicitation will be voted FOR
the ratification of the appointment of the auditors, unless otherwise specified
in the proxy.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE IN FAVOR OF RATIFICATION OF THE
APPOINTMENT OF ARTHUR ANDERSEN LLP.
ANNUAL REPORT
A copy of the Company's Annual Report on Form 10-KSB for the fiscal
year ended December 31, 1998, as filed with the Securities and Exchange
Commission, is included as Appendix A hereto. Additional copies are available
without charge upon written request directed to: K2 Design, Inc., 30 Broad
Street, New York, New York 10004; Attention: Seth Bressman, Chief Financial
Officer.
OTHER MATTERS
Management is not aware of any matters to come before the Annual
Meeting which will require the vote of stockholders other than those matters
indicated in the Notice of Meeting and this Proxy Statement. However, if any
other matter calling for stockholder action should properly come before the
Annual Meeting or any adjournments thereof, those persons named as proxies in
the enclosed proxy form will vote thereon according to their best judgment.
ADVANCE NOTICE FOR STOCKHOLDER PROPOSALS
FOR THE 2000 ANNUAL MEETING
The Company's By-laws provide that in order for a stockholder to
nominate a candidate for election as a director at an annual meeting of
stockholders or to propose business for consideration at such meeting, notice
must be delivered to the Secretary of the Company not less than 60 days nor more
than 90 days prior to the annual meeting; provided, however, that in the event
that less than 70 days' notice or prior public disclosure of the date of the
meeting is given or made to stockholders, notice by the stockholder to be timely
must be received no later than the close of business on the 10th day following
the day on which notice of the date of the meeting was mailed or public
disclosure thereof was made, whichever occurs first. In addition, the
regulations under the Securities Exchange Act require stockholder proposals to
be received by the Company at least 120 days prior to the mailing of the proxy
statement relating to the next annual meeting of stockholders. Accordingly,
stockholder proposals for the 2000 Annual Meeting must be received in writing by
the Company no later than December 31, 1999 in order to be considered for
inclusion in the Company's proxy materials for such meeting. Any stockholder
desiring a copy of the Company's By-laws will be furnished one without charge
upon written request to the President.
By Order of the Board of Directors
/s/ Seth Bressman
---------------------------
Seth Bressman
Secretary
New York, New York
April 29, 1999
12
<PAGE>
K2 DESIGN, INC.
PROXY FOR ANNUAL MEETING OF STOCKHOLDERS
June 16, 1999
This Proxy is Solicited by the Board of Directors.
The undersigned stockholder of K2 Design, Inc. (the "Company") hereby
appoints each of Matthew G. de Ganon and Seth Bressman, attorneys and proxies,
each with full power of substitution, to represent the undersigned and vote all
shares of the Common Stock of the Company which the undersigned is entitled to
vote, with all powers the undersigned would possess if personally present, at
the Annual Meeting of Stockholders (the "Meeting") of the Company to be held at
the offices of Proskauer Rose LLP, 1585 Broadway, 27th floor, New York, New York
10036 at 10:30 A.M., on June 16, 1999, and at any adjournments thereof, with
respect to the proposals hereinafter set forth and upon such other matters as
may properly come before the Meeting and any adjournments thereof.
This proxy when properly executed, will be voted in the manner directed
herein by the undersigned stockholder.
Unless otherwise specified, this proxy will be voted "FOR" the election
of all nominees as directors of the Company, "FOR" the ratification of the
amendment to the 1997 Stock Incentive Plan, "FOR" the ratification of Arthur
Andersen LLP as auditors of the Company and in the discretion of the proxies
with respect to all other matters which may properly come before the Meeting and
any adjournments thereof. The undersigned acknowledges receipt of the
accompanying Notice of Annual Meeting and Proxy Statement.
Please mark boxes |X| in blue or black ink.
1. Election of Directors
|_| FOR all nominees listed |_| WITHHOLD AUTHORITY to
below (except as marked vote for all nominees listed below
to the contrary below)
Nominees: Matthew G. de Ganon, Lynn Fantom, Douglas E. Cleek,
Bradley K. Szollose, Steven N. Goldstein and David R. Sklaver
Instruction: To withhold authority to vote for any individual nominee,
write that nominee's name in the space provided below.
_____________________________________________________________________
2. Ratification of the amendments to the 1997 Stock Incentive Plan.
|_| FOR |_| AGAINST |_| ABSTAIN
<PAGE>
3. Ratification of the selection of Arthur Andersen LLP
as auditors of the Company for the year ending
December 31, 1999.
|_| FOR |_| AGAINST |_| ABSTAIN
4. In their discretion, on any other matters that may properly
come before the Meeting and any adjournments thereof.
Dated: ________________, 1999
_______________________________________
Signature of Stockholder(s)
_______________________________________
Name of Stockholder(s)
NOTE: When shares are held by joint tenants, both
should sign. When signing as attorney, executor,
administrator, trustee, custodian, guardian or
corporate officer, please give your full title as
such. If a corporation, please sign full corporate
name by authorized officer. If a partnership, please
sign in partnership name by authorized person.
PLEASE COMPLETE, DATE, SIGN AND MAIL THIS PROXY CARD PROMPTLY USING THE
ENCLOSED ENVELOPE.
<PAGE>
Appendix A
Annual Report on Form 10-KSB
For the Fiscal Year Ended December 31, 1998
<PAGE>
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, 1998
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.
---------------
(Exact name of registrant as specified in its charter)
Delaware 13-3886065
- ------------------------------- ----------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
30 Broad Street, 16th Fl., New York, NY 10004
- --------------------------------------- ------------
(Address of principal (Zip Code)
executive offices)
Issuer's telephone number: (212) 301-8800
- -----------------------------------------
Securities registered pursuant to Section 12(b) of the Act:
Common Stock
----------------
(Title of Class)
Redeemable Common Stock Purchase Warrants
-----------------------------------------
(Title of Class)
Securities registered pursuant to Section 12(g) of the Act:
Common Stock
----------------
(Title of Class)
Redeemable Common Stock Purchase Warrants
-----------------------------------------
(Title of Class)
<PAGE>
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: $6,419,967.
As of March 26, 1999, there were outstanding 3,469,176, shares (not
including treasury shares) of Common Stock (the "Common Stock") and Redeemable
Common Stock Purchase Warrants to purchase an aggregate of 1,000,000 shares of
Common Stock (the "Warrants"). Based on the closing sales price of the Common
Stock on March 26, 1999 of $3.375 per share, the approximate aggregate market
value of Common Stock held by non-affiliates was $7,506,965.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's 1999 Definitive Proxy Statement, which
statement will be filed with the Securities and Exchange Commission 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
[The remainder of this page is intentionally blank.]
<PAGE>
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 Operations -- 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 clients
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, live Internet
broadcasts and the development of brand and direct response strategies and
offline media services. In 1998 and 1997, 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 80 Web sites, including MCI Telecommunications Corporation ("MCI"), a
subsidiary of MCI Communications Corporation, and for Waterhouse Securities
Corporation, Bell Communications Research, Inc., American Express Company, Bayer
Corporation, Wavephore, Inc. and Lexis-Nexis. 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 clients 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 enhance a corporate brand, engage and entertain consumers,
provide in-depth information, reduce selling and operating costs, generate leads
and build retail traffic, expand distribution channels (e-commerce), promote
major sporting and entertainment events and monitor popularity of content,
conduct research, and build databases for on-going marketing efforts.
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.
1
<PAGE>
K2 SERVICES
K2 partners with clients to focus on how new and emerging technologies
can help them build one-to-one customer relationships. Tapping into superior
strategic expertise, media know-how, creative talent and technical excellence,
we guide our clients to achieving a favorable return on investment from
Web-based marketing.
The scope of K2's services has ranged from consulting services to
complete marketing-driven 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, particularly offline media planning and buying related to
building online businesses. These services are principally comprised of the
identification, negotiation for and purchase of banners, sponsorship and
proprietary partnerships on Web sites and the purchase of key words from search
engines.
The Company currently provides interactive services, including:
qualitative and quantitative research, Web usability labs, positioning studies
for online branding, strategic planning, e-commerce planning, online and
traditional media planning and buying, proprietary media partnerships, marketing
strategies, Web design, creative services for offline and online advertising
(banners, rich media, interstitials), technical strategies, requirements
specifications and programming.
K2 STRENGTHS
Focus on Clients' Business Objectives
The Company has made understanding its clients' business challenges the
primary focus that guides its customer services. The Company often works with
its clients' management to determine how best to integrate Web sites with the
clients' business 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, Visual Basic, Relational
Databases, Fortran, Unix, Linux, Perl, PHP, Java, VRML, Real Audio and Video,
Windows NT, Netscape server, Apache server, Director, Enliven, Flash, Quicktime,
Microsoft's streaming video format-ASF, 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 clients.
2
<PAGE>
Creative Expertise
The Company believes that, in addition to the creative elements
required in traditional graphic design, superior interactive development
requires that the end product is easy-to-use, contains intuitive interfaces and
seamless integrated technologies and has an engaging look and feel. Management
believes that the Company's creative staff possesses a broad spectrum of
expertise to meet clients' creative needs. In order to maintain high levels of
creativity and quality, the Company intends 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.
Media Planning and Buying
The Company has determined through testing and ongoing results
monitoring that media planning is critical to the success of an online
advertising program. The K2 approach involves classic media research, planning,
negotiation of buys, results audits, and optimization of media plans based on
analysis of those results. K2 media plans have also included television, radio
and print vehicles when these media are the most effective in reaching the
target audience to create awareness of a Web site and to drive traffic to it.
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 clients,
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.
3
<PAGE>
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, 1998, the Company
had two employees dedicated to business development. Additionally, two of the
Company's executive officers spend a portion of their time marketing the
Company's services. The Company also seeks to attract new clients through other
methods, including referrals from existing clients. The Company seeks to
cross-sell its various services to its clients and prospective clients through
sales presentations that encourage clients 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 creative 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), consultants
and systems integrators, and other businesses whose clients are likely to
require the services that the Company provides.
CLIENTS
K2's client relationships have ranged from Fortune 500 companies to
entrepreneurial Web related start-ups. In fiscal 1998, the Company's four
largest clients, WavePhore (approximately 23.4%), Standard & Poor's
(approximately 18.5%), Bell Atlantic Network Services (approximately 6.0%) and
Lexis-Nexis (approximately 5.8%) accounted for approximately 30.3% of total
revenue. In fiscal 1997, the Company's four largest clients Cox, Interactive
Media (approximately 15.3%), WavePhore (approximately 11.8%), Bell
Communications (approximately 6.0%) and Planet Direct
4
<PAGE>
(approximately 6.0%) accounted for approximately 39.0% of total revenue.
However, WavePhore terminated its relationship with the Company at the end of
the third quarter of 1998. Although WavePhore accounted for a material portion
of revenue during the past two fiscal years, the Company's revenues are project
oriented and, thus, the Company is dependent on its ability to replace and
attract new clients upon the completion of existing projects. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
In the past, Web design businesses have tended to be project-oriented
engagements, with the completion of the project occurring over a 3 to 5 month
period. Although such assignments comprise an important part of K2's consulting
and creative business, our current marketing-driven business model includes a
dedicated effort to continue and cultivate existing relationships with clients,
most of which use media placement as a central part of their strategic activity.
For example, Standard & Poor's initially engaged the Company in 1997, accounted
for approximately 18.5% of revenue in 1998 and has continued to use K2's
services in 1999.
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 clients 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, a $1 million
of general liability insurance, and a $1 million umbrella policy, 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.
5
<PAGE>
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 clients 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 Think New Ideas, 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 Company's competitors or
potential competitors have significantly greater financial, sales, marketing and
other resources than the Company. The Company's ability to retain relationships
with Channel Sources and its existing clients and generate new clients 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, 1998, the Company had 38 employees, of which 34 are
full-time employees. Full-time employees include 4 in strategic planning,
executive management, business development; 4 account managers; 3 media
planning/buying personnel; 13 creative and production personnel; and 4
programmers, in addition to administrative staff.
ITEM 2. DESCRIPTION OF PROPERTY
The Company's offices occupy approximately 13,700 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 ($16.50 to $18.00 per square
foot) 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 believes that its current rental payment per square
foot is significantly below the average rental for comparable office space in
New York City.
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
6
<PAGE>
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 no longer leases office space in Baltimore, Maryland. The
landlord had executed a lease termination agreement with the Company on December
23, 1998. The Company has no future liability for the office space at that
location.
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 1998.
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 Market
("NASDAQ") under the symbol "KTWO" and on the Boston Stock Exchange under the
symbol "KTOO". 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
the quarter ended March 31, 1997, through December 31, 1998. These quotations
reflect inter-dealer prices, without retail mark-up, mark-down or commission,
and may not necessarily represent actual transactions.
Fiscal Quarter Ended High Low
- -------------------- -------- -------
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
7
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March 31, 1998 2 1/16 1 3/8
June 30, 1998 5 1/8 2 1/4
September 30, 1998 4 3/8 1 11/16
December 31, 1998 4 3/8 1 1/4
The approximate number of record holders of the Common Stock at
December 31, 1998 was 43, not including beneficial owners whose shares are held
by banks, brokers and other nominees.
During 1998, the Company repurchased an aggregate of 246,250 shares of
its Common Stock from three of its stockholders for $386,781. These shares are
reflected on the Company's books as treasury stock as of December 31, 1998.
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 OPERATIONS
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 Operations-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 IPO on 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 clients for additional
complementary services. The Company now provides such services as development of
online brand, direct response, communications and technical strategies,
development of CD-ROM discs, media placement on Web sites, consulting services
regarding Web site usage and
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user characteristics, development and maintenance of Company-owned Web site
advertising networks, live Internet broadcasts and offline media services.
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. The Company implemented several cost-cutting
measures in 1997 in an effort to control expenses and bring them in line with
anticipated revenue levels. The Company remains sensitive to its high ratio of
expenses as compared to revenues and is committed to continuing to control and
reduce costs, salaries and other overhead items.
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 have been
generated on a fixed fee or cap fee basis.
On June 1, 1998, the Company sold its CLIQNOW! Division to 24/7 Media
Inc. and received both cash and common stock of 24/7 Media, Inc. At December 31,
1998, the Company owned 196,492 shares of common stock of 24/7 Media, Inc.,
valued on the Company's books at approximately $2.6 million, the value ascribed
to such shares in connection with the sale. As a result of management's decision
to discontinue the CLIQNOW! Division in May 1998 prior to the sale, the 1998 and
1997 statements of operations reflect the CLIQNOW! Division as a discontinued
operation.
<TABLE>
<CAPTION>
Percentage of Revenues
Year Ended December 31,
----------------------------
1998 1997
------- -------
<S> <C> <C>
Revenues 100.0% 100.0%
Operating expenses
Direct salaries and costs 75.5% 75.3%
Selling, general and administrative expenses 46.9% 37.0%
Depreciation 5.5% 4.5%
------- -------
Total operating expenses 127.9% 116.8%
------- -------
Operating loss
(27.9)% (16.8)%
Interest and other income, net 2.5% 0.5%
------- -------
Loss before income tax provision and discontinued
operations (25.4)% (16.3)%
Provision for income tax 0.6% 0.3%
------- -------
</TABLE>
9
<PAGE>
<TABLE>
<CAPTION>
Percentage of Revenues
Year Ended December 31,
----------------------------
1998 1997
------- -------
<S> <C> <C>
Loss from continuing operations (26.0)% (16.6)%
Loss from discontinued operations (1.3)% (6.1)%
Gain from sale of discontinued operations 46.6% --
------- -------
Net income (loss) 19.3% (22.7)%
======= =======
</TABLE>
Revenues
Revenues for the years ended December 31, 1998 and 1997 were $6,420,000
and $7,501,000, respectively, or a decrease of 14.4% in 1998 as compared to
1997. The decrease in revenues was due principally to a decrease in sales
volume, which management believes was primarily a result of changes in
management during the third and fourth quarters of 1998 and the loss of two
large clients, WavePhore, Inc. and Audio Book Club, Inc. in the third quarter,
which were not immediately replaced. In 1998 and 1997, revenues from continuing
operations were primarily generated from interactive advertising services and
traditional graphic services.
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 increased in 1998 as compared to 1997 from
75.3% to 75.5%. In absolute dollars, the Company's direct salaries and costs for
1998 decreased to $4,848,000 from $5,646,000 in 1997, reflecting reduced sales
and direct labor in 1998. In 1998, direct salaries and costs consisted primarily
of $2,596,000 of media costs, $1,735,000 of direct salary costs and $145,000
paid to freelance artists and other independent contractors, $44,000 of bad debt
expenses, and $38,000 paid for printing and photography. The remainder consisted
of various project costs. In 1997, direct salaries and costs consisted primarily
of $2,143,000 of media costs, $2,008,000 of direct salary costs and $574,000
paid to freelance artists and other independent contractors, $351,000 of bad
debt expenses, and $245,000 paid for printing and photography. The remainder
consisted of various project costs.
Selling, General and Administrative Expenses
Selling, general and administrative expenses for 1998 increased to
$3,009,000 (46.9% of revenues) from $2,775,000 in 1997 (37.0% 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 1998 is also due in part to severance expense in
the amount of $400,000, which amount was expensed in the fourth quarter of 1998,
but will be paid in 1999. As a result of the Company's management
reorganization, overall executive salaries have decreased due to the
restructuring of certain executive positions.
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<PAGE>
Depreciation
Depreciation expense was $357,000 and $339,000 for fiscal 1998 and
fiscal 1997, respectively, and related primarily to depreciation of equipment
and leasehold improvements. The depreciation expense in fiscal 1998 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.
Interest and Other Income, Net
The Company's cash investments earned interest and other income net of
interest expense and other expenses of $161,000 for the year ended December 31,
1998. The Company incurred interest and other income net of interest expense and
other expenses of $37,000 for the year ended December 31, 1997.
Operating Loss
Excluding the gain on sale from discontinued operations, the Company
incurred a net loss from operations in 1998 of $(1,672,000) as compared to a net
loss from operations in 1997 of $(1,241,000). The increased net loss from
operations in 1998 as compared to 1997 is attributable to reduced revenues in
the fourth quarter without a corresponding reduction in labor costs and a
$400,000 severance charge.
Selected Quarterly Operating Results (Unaudited)
The following table presents unaudited quarterly financial information
for the period from January 1, 1997 to December 31, 1998. 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,
including adjustments to remove discontinued operations from operating results
and 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.
<TABLE>
<CAPTION>
1997 1998
March 31, June 30, September 30, December 31, March 31, June 30, September 30, December 31,
--------- -------- ------------- ------------ ----------- ----------- ------------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues $ 1,650,103 $ 1,097,373 $ 1,636,991 $ 3,116,786 $ 2,140,382 $ 1,895,232 $ 1,901,265 $ 483,088
--------- -------- ------------- ------------ ----------- ----------- ------------- ------------
Operating
Direct salaries
and costs 1,186,774 834,567 1,225,886 2,398,402 1,465,601 1,202,492 1,448,140 731,539
Selling, general
and administrative 645,166 583,331 737,674 808,519 534,220 686,894 655,281 1,132,369
expenses
</TABLE>
11
<PAGE>
<TABLE>
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Depreciation 55,280 60,426 86,305 136,527 89,008 88,271 86,539 93,061
--------- -------- ----------- ----------- ----------- ----------- ------------- -----------
Total operating
expenses 1,887,220 1,478,324 2,049,865 3,343,448 2,088,829 1,977,657 2,189,960 1,956,969
--------- --------- ----------- ----------- ----------- ----------- ------------- -----------
Operating income
(loss) $ (237,117) $ (380,951) $ (412,874) $ (226,662) $ 51,553 $ (82,425) $ (288,695) $(1,473,881)
--------- -------- ------------- ------------ ----------- ----------- ------------- ------------
</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.
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 the Warrants are subject to
fluctuations 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 Warrants.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash increased by approximately $587,000, or 26%, from
$2,243,000 at December 31, 1997 to $2,830,000 at December 31, 1998. This
increase in cash was principally due to the Company's focus on collecting its
accounts receivables, the receipt of approximately $782,000 of net proceeds from
the sale of the CLIQNOW! Division and the Company's active management of its
accounts payables.
The Company is dependent on its current cash balance of $2,830,000
million (at December 31, 1998), together with cash generated by operations, 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 unavailable or prohibitively expensive since the Company's only assets
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<PAGE>
available to secure additional financing are accounts receivable and its
ownership of shares of common stock of 24/7 Media, Inc.* See "-- Factors
Affecting Operating Results and Market Price of Stock--Cash Flow Deficit; Need
for Additional Financing." Accounts payable decreased by 59.0% to $783,000 at
December 31, 1998 from $1,910,000 at December 31, 1997, due primarily to
decreased media placement revenues. Deferred revenues at December 31, 1997 were
$643,000. There were no deferred revenues at December 31, 1998 due to lower
sales volume at year end.
Cash provided by the Company's operating activities of $474,000 in the
year ended December 31, 1998 related primarily to a substantial increase in
collection of accounts receivable, which was partially offset by a decrease in
accounts payable and the decrease in deferred revenue.
In 1998, the Company spent $210,000 on capital expenditures, consisting
of computer equipment, as well as furniture, fixtures and leasehold
improvements. The Company presently intends to make capital expenditures of
$275,000 in 1999, consisting of equipment, furniture and fixtures and leasehold
improvements.
The Company's cash position was further impacted in 1998 as a result of
the repurchase of 246,250 shares of the Company's common stock from three
stockholders for an aggregate of approximately $387,000. The Company's cash
position will be impacted in 1999 as a result of severance payments in the
amount of $400,000.
Year 2000 Compliance
There are issues associated with the programming code in existing
computer systems as the year 2000 approaches. The "year 2000 problem" is
pervasive and complex, as virtually every computer operation will be affected in
some way by the rollover of the two digit year value of 00. The issue is whether
computer systems will properly recognize date sensitive information when the
year changes to 2000. Systems that do not properly recognize such information
could generate erroneous data or cause a system to fail. Management believes
that after testing all internal hardware and software, it is Year 2000
compliant. The Company's router has been replaced in order to be year 2000
compliant and a special Year 2000 compliant test software has been run on the
Company's hardware to ascertain that the Company hardware is compliant. The
Company is not aware of any programming created by the Company on behalf of a
client that is not year 2000 compliant. The Company is not responsible for
outside modes of communication, sites or facilities over which client media
campaigns or placements occur; however, the Company is not currently aware of
any such delivery vendors that are not year 2000 compliant. However,
significant uncertainty exists concerning the potential costs and effects with
year 2000 compliance. Any year 2000 compliance problems of either the Company or
its clients or vendors could have a material adverse effect on the Company's
business, results of operations and financial condition.
- --------
* 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>
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 $(792,000) in fiscal 1997 and an
operating cash flow of $474,000 in fiscal 1998. 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 and its
ownership of shares of common stock of 24/7 Media, Inc. Should such financing be
unavailable or prohibitively expensive when the Company requires it, the Company
would not be able to finance any 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, 1998 and 1997
were $6,420,000 and $7,501,000, respectively, with losses from continuing
operations of $(1,672,000) and $(1,241,000), respectively, and a net income of
$1,237,000 in 1998 and a net loss of $(1,703,000) in 1997. The net income of
$1,237,000 in fiscal 1998 was due to the gain on the sale of discontinued
operations. 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
14
<PAGE>
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 clients 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 its media
group.
To try to avoid any conflict with a Channel Source, the Company does
not intend to offer services to clients referred by a particular Channel Source
that could be provided to those clients by that Channel Source. Since the
Company does not expect to offer its full range of services to these clients,
projects for them may be less profitable than full-service production projects
for other clients. 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.
Project-Oriented Clients; Concentration of Revenues
Since many of the Company's clients engage the Company on a single
project basis, clients from whom the Company generated substantial revenue in
one period have not necessarily been a substantial source of revenue in a
subsequent period. Additionally, costs are significantly higher with respect to
single projects as compared to servicing a client on a multiple project or
continuous basis. For example, during 1998, WavePhore, Inc. and Standard &
Poor's Inc. accounted for approximately 23.4% and 18.5%, respectively, of
revenues. Also in 1998, WavePhore, Inc. and one other large client terminated
their relationships with the Company; however, Standard & Poor's continues to be
an active and significant client of the Company. 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 clients will be on a project basis
or on a longer term relationship basis. To the extent the Company does not
generate repeat or ongoing business from its clients, it will incur the higher
sales and marketing expenses associated with attracting new clients as compared
to those in attracting additional business from existing clients.
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
15
<PAGE>
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 and
bandwidths. 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 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
16
<PAGE>
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 clients or Channel Sources. In addition, the Company risks
alienating or straining relationships with clients and Channel Sources each time
the Company agrees to provide services to even indirect competitors of existing
clients or Channel Sources. Conflicts of interest may jeopardize the stability
of revenues generated from existing clients 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.
ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Item 13(a)(1) in Part IV.
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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 1999 Definitive Proxy Statement which the Company will file with
the Securities and Exchange Commission no later than 120 days subsequent to
December 31, 1998.
ITEM 10. EXECUTIVE COMPENSATION
The information required for this item is incorporated by reference to
the Company's 1999 Definitive Proxy Statement which the Company will file with
the Securities and Exchange Commission no later than 120 days subsequent to
December 31, 1998.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The information required for this item is incorporated by reference to
the Company's 1999 Definitive Proxy Statement which the Company will file with
the Securities and Exchange Commission no later than 120 days subsequent to
December 31, 1998.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required for this item is incorporated by reference to
the Company's 1999 Definitive Proxy Statement which the Company will file with
the Securities and Exchange Commission no later than 120 days subsequent to
December 31, 1998.
18
<PAGE>
PART IV
<TABLE>
<CAPTION>
ITEM 13. AND REPORTS ON FORM 8-K
Page
<S> <C> <C>
(a) Documents filed as part of this report.
1. Financial Statements and Schedule
Report of Independent Public Accountants......................... F-1
Consolidated Balance Sheet - December 31, 1998................... F-2
Consolidated Statements of Operations - For the years ended
December 31, 1998 and 1997....................................... F-3
Consolidated Statements of Changes in Stockholders' Equity -
For the years ended December 31, 1998 and 1998.................. F-4
Consolidated Statements of Cash Flows - For the years ended
December 31, 1998 and 1997....................................... F-5
Notes to Consolidated Financial Statements....................... F-7
Schedule II...................................................... F-15
2. Exhibits
3.1 Certificate of Incorporation of the Company*
3.1(a) Amendment to Certificate of Incorporation of the
Company*
3.2 By-laws of the Company*
3.2(b) Amendment to By-laws of the Company*
4.1 Common Stock Certificate*
4.2 Warrant Certificate*
4.4 Warrant Agreement by and between Continental Stock
Transfer & Trust Company and the Company*
</TABLE>
19
<PAGE>
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 Matthew G. de Ganon*
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 Lease Agreement of - Baltimore, Maryland**
10.12 Employment Agreement with Lynn Fantom dated
October 22, 1998
10.13 Extension of Employment Agreement with Matthew G.
de Ganon dated November 2, 1998
10.14 Extension of Employment Agreement with Douglas E.
Cleek dated January 15, 1999
10.15 Employment Agreement with Seth Bressman dated
February 11, 1999
10.16 Lease Termination Agreement - Baltimore, Maryland
21.1 Subsidiary List*
27.1 Financial Data Schedule
- --------------
* 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.
20
<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.
Dated: March 26, 1998
By: /s/ Matthew G. de Ganon
-----------------------------
Matthew G. de Ganon, Chairman
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>
/s/ Matthew G. de Ganon Chairman of the Board March 26, 1999
- ---------------------------------
Matthew G. de Ganon
Chief Executive Officer, President and March 26, 1999
/s/ Lynn Fantom Director
- ---------------------------------
Lynn Fantom
Chief Financial Officer (Principal March 26, 1999
/s/ Seth Bressman Financial and Accounting Officer
- ---------------------------------
Seth Bressman
/s/ Douglas E. Cleek Executive Vice President and Director March 26, 1999
- ---------------------------------
Douglas E. Cleek
/s/ James A. Favia Director March 26, 1999
- ---------------------------------
</TABLE>
21
<PAGE>
<TABLE>
<S> <C> <C>
James A. Favia
/s/ Steven N. Goldstein Director March 26, 1999
- ---------------------------------
Steven N. Goldstein
/s/ Bradley K. Szollose Director March 26, 1999
- ---------------------------------
Bradley K. Szollose
</TABLE>
22
<PAGE>
K2 DESIGN, INC.
AND SUBSIDIARY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Financial Statements of K2 Design, Inc. and Subsidiary
Report of Independent Public Accountants........................... F-1
Consolidated Balance Sheet - December 31, 1998..................... F-2
Consolidated Statements of Operations - For the years
ended December 31, 1998 and 1997................................. F-3
Consolidated Statements of Changes in Stockholders'
Equity - For the years ended December 31, 1998 and 1997.......... F-4
Consolidated Statements of Cash Flows - For the years
ended December 31, 1998 and 1997................................. F-5
Notes to Consolidated Financial Statements......................... F-7
Schedule II - Valuation and Qualifying Accounts.................... F-13
<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, 1998, and the related consolidated statements of operations,
stockholders' equity and cash flows for the years ended December 31, 1998 and
1997. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of K2 Design, Inc. and its
subsidiary as of December 31, 1998, and the results of their operations and
their cash flows for the years ended December 31, 1998 and 1997, 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 of
financial statements is presented for the purpose of complying with the
Securities and Exchange Commissions rules and is not part of the basic financial
statements. This schedule has been subjected to the auditing procedures applied
in the audit 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
New York, New York
February 19, 1999
F-1
<PAGE>
K2 DESIGN, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 1998
ASSETS
<TABLE>
<CAPTION>
CURRENT ASSETS:
<S> <C>
Cash and cash equivalents (Note 2) $ 2,829,628
Accounts receivable, net of allowance for doubtful accounts of $25,000 269,173
Prepaid expenses and other current assets 118,298
-----------
Total current assets 3,217,099
INVESTMENT IN RESTRICTED SECURITIES, AT COST (Note 8) 2,558,300
FIXED ASSETS, net (Note 3) 745,388
RESTRICTED CASH 150,711
OTHER ASSETS 9,172
-----------
Total assets $ 6,680,670
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of capital lease obligations (Note 4) $ 30,379
Accounts payable 783,216
Accrued compensation and payroll taxes 96,642
Accrued expenses 999,899
Customer advances 51,288
-----------
Total current liabilities 1,961,424
LONG-TERM CAPITAL LEASE OBLIGATIONS (Note 4) 1,722
-----------
Total liabilities 1,963,146
-----------
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; 3,692,817 36,928
shares issued and 3,446,567 shares outstanding
Treasury Stock, 246,250 shares at cost
(386,781)
Additional paid-in capital 6,428,963
Accumulated deficit (1,361,586)
-----------
Total stockholders' equity 4,717,524
-----------
Total liabilities and stockholders' equity $ 6,680,670
===========
</TABLE>
The accompanying notes are an integral part of this consolidated
balance sheet.
F-2
<PAGE>
K2 DESIGN, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
REVENUES $ 6,419,967 $ 7,501,253
DIRECT SALARIES AND COSTS 4,847,772 5,645,629
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 3,008,764 2,774,690
DEPRECIATION 356,879 338,538
------------ ------------
Loss from continuing operations before interest
and other income, net, income taxes and
discontinued operations (1,793,448) (1,257,604)
INTEREST AND OTHER INCOME, net 160,777 37,087
------------ ------------
Loss before provision for income taxes and
discontinued operations (1,632,671) (1,220,517)
PROVISION FOR INCOME TAXES 39,143 20,570
------------ ------------
Loss from continuing operations (1,671,814) (1,241,087)
Loss from discontinued operations (85,309) (462,163)
GAIN ON SALE FROM DISCONTINUED OPERATIONS,
net of income taxes 2,994,204 --
----------- ------------
Net income (loss) $ 1,237,081 $(1,703,250)
=========== ============
Loss per share from continuing operations -
Basic and diluted $ (0.47) $ (0.34)
Loss per share from discontinued operations -
Basic and diluted (0.02) (0.12)
Income per share from gain on sale of
discontinued operations -
Basic and diluted 0.84 --
----------- ------------
Net income (loss) per share
Basic and diluted $ 0.35 $ (0.46)
=========== ============
WEIGHTED AVERAGE BASIC AND DILUTED COMMON
SHARES OUTSTANDING 3,553,861 3,663,046
=========== ============
</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, 1998 AND 1997
<TABLE>
<CAPTION>
Number of Treasury
Number of Additional Accumulated Treasury Stock
Shares Amount Paid-in Capital Deficit Shares Amount Total
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, January 1, 1997 3,645,421 $ 36,454 $ 6,281,183 $ (895,417) - $ - $ 5,422,220
Stock issued for options 35,250 353 - - - - 353
Compensation expense - - 67,757 - - - 67,757
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
Repurchase of Treasury Stock - - - - (246,250) (386,781) (386,781)
Net Income - - - 1,237,081 - - 1,237,081
Compensation expense 12,146 121 80,023 - - - 80,144
BALANCE, December 31, 1998 3,692,817 $ 36,928 $ 6,428,963 $(1,361,586) (246,250) $(386,781) $ 4,717,524
========= ======== ============ =========== ======== ========= ============
</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, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
----------- ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $1,237,081 $(1,703,250)
Net gain from sale of discontinued operation (2,994,204) --
Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities-
Non cash compensation expense 80,144 67,757
Depreciation 356,879 347,346
Loss from disposal of fixed assets -- 16,438
Changes in-
Accounts receivable, net 3,163,980 (1,365,438)
Prepaid expenses and other current assets 37,893 (358,573)
Unbilled revenue 265,869 --
Other assets 901 549
Accounts payable (1,127,163) 1,165,816
Accrued compensation and payroll taxes (64,107) 35,956
Other accrued expenses 138,396 494,454
Deferred revenue and customer advances (621,871) 506,990
----------- -----------
Net cash provided by (used in) operating activities 473,798 (791,955)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of discontinued operation 782,459 --
Restricted cash -- (120,711)
Proceeds from sale of fixed assets -- 63,200
Purchase of fixed assets (209,914) (711,253)
----------- -----------
Net cash provided by (used in) investing activities 572,545 (768,764)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock -- 353
Purchase of common stock for treasury (386,781) --
Principal payments on capital lease obligations (72,922) (64,076)
----------- -----------
Net cash used in financing activities (459,703) (63,723)
----------- -----------
586,640 (1,624,442)
Net increase (decrease) in cash
CASH AND CASH EQUIVALENTS beginning of year 2,242,988 3,867,430
----------- -----------
CASH AND CASH EQUIVALENTS end of year $ 2,829,628 $ 2,242,988
----------- -----------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for-
Interest $ 28,575 $ 32,802
Income taxes $ 25,609 $ 20,570
Non cash investing activities-
Investment in restricted securities, at cost $ 2,558,300 $ --
Equipment acquired under capital lease obligations $ - $ 39,212
</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, 1998 AND 1997
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 clients are
primarily U.S.-based corporations operating in a wide variety of industries.
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.
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. 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.
Cash and Cash Equivalents
The Company considers all short term investments having a maturity of three
months or less to be cash equivalents.
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
F-6
<PAGE>
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
Accrued Expenses
Accrued expenses are comprised of the following as of December 31, 1998.
Accrued Severance $400,000
Accrued Media Planning and Ad Servicing 315,664
Accrued Expenses - other 284,235
--------
$999,899
========
Fair Value of Financial Instruments
The carrying amounts of the Company's cash and cash equivalents, accounts
receivable, and accounts payable approximate fair market value based upon the
relatively short-term nature of these financial instruments.
Concentration of Revenue
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 clients' financial condition and
generally requires no collateral from its clients. Sales to the Company's two
largest clients constituted approximately 23% and 19% of revenue for the year
ended December 31, 1998. The Company had accounts receivable from these clients
amounting to $113,164 at December 31, 1998. Sales to the Company's two largest
clients for the year ended December 31, 1997 constituted approximately 15% 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 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 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.
F-7
<PAGE>
Net Income (Loss) per Share of Common Stock
Statement of Financial Accounting Standards No. 128, "Earnings Per Share"
establishes new standards for computing and presenting earnings per share (EPS).
The 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. Outstanding stock options of 810,200 and
464,950 as of December 31, 1998 and 1997 respectively, have been excluded from
the above calculations as they are antidilutive.
Stock-Based Compensation
Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based
Compensation" (SFAS 123) 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).
New Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Reporting on Segments") ("SFAS 131").
SFAS requires companies to disclose certain information related to the various
segments in which it operates. The Company believes that it operates in one
segment.
3. FIXED ASSETS
Fixed assets, at cost, including capital leases (see Note 4), summarized by
major categories at December 31, 1998, consist of the following:
Computers and Equipment $ 936,525
Furniture and fixtures 280,315
Leasehold improvements 248,362
-----------
1,465,202
Less: Accumulated depreciation (719,814)
-----------
Fixed assets, net $ 745,388
===========
4. CAPITAL LEASE OBLIGATIONS
The Company is a lessee in non cancelable leasing agreements for certain
computers and equipment. Included in fixed assets is $32,101 of computers and
equipment held under capital leases.
Future minimum lease payments for fixed assets under capital lease at December
31, 1998, are as follows:
1999 $ 37,085
2000 1,916
-----------
Total minimum lease payments 39,001
Less-Imputed interest (6,900)
-----------
Total capital lease obligation $ 32,101
-----------
F-8
<PAGE>
5. COMMITMENTS AND CONTINGENCIES
Leases
The Company leases certain office space and automobiles for varying periods. At
December 31, 1998, approximate future minimum rental commitments under all non
cancelable operating leases are as follows:
Fiscal Year:
------------
1999 $ 302,733
2000 294,030
2001 294,031
2002 260,003
2003 76,017
Rental expense under the above leases amounted to $225,893 in 1998 and $254,679
in 1997.
An aggregate of $400,000 of severance payments will be made during 1999, which
amount has already been accrued and reflected in selling, general and
administrative expenses on the consolidated statement of operations for the year
ended December 31, 1998.
Employment contracts
The Company has employment contracts with each of its executives. Two contracts
which were to expire on December 31, 1998 were renewed for an additional three
year period and provide for minimum annual salaries of $153,000 with 20%
increases for each successive year. Such contracts also include bonuses equal to
1.88% of the Company's pre-tax profit. The Company entered into a two year
employment contract with an executive officer providing for an annual salary of
$250,000 and a bonus equal to 10% of the Company's pre-tax profit not to exceed
$75,000, provided that the Company's pre-tax profits for fiscal 1999 are at
least $250,000 and for fiscal 2000 are at least $500,000. The Company also
entered into a one year employment contract with an executive officer expiring
January 31, 2000, subject to automatic renewals, providing for an annual salary
of $125,000 and a bonus equal to $50,000 in the event of a Change of Control
Event (as defined in the contract).
6. INCOME TAXES
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.
The provision for income taxes on the net income (loss) for the years ended
December 31, 1998 and 1997 differs from the amount computed by applying the
Federal statutory rate due to the following:
1998 1997
------ ------
Statutory Federal income tax rate 34.0% (34.0)%
State and local taxes, net 4.8 (4.8)
Valuation Allowance (utilization of NOL) (31.4) 40.0
------ ------
Effective Tax Rate 7.4% 1.2%
------ ------
7. STOCK OPTION PLAN
The Company has two stock plans, the 1996 Stock Option Plan (the "1996 Plan"),
and 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
F-9
<PAGE>
nonqualified stock options and qualified stock incentive compensation. As of
December 31, 1998, there were no shares of common stock 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. 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, 1998 and 1997 is presented in the table
below:
<TABLE>
<CAPTION>
Weighted Average
Shares Exercise Price
----------- ----------------
<S> <C> <C>
Outstanding at January 1, 1997 118,500 $4.03
Granted 364,950 1.57
Exercised -- --
Forfeited (18,500) 4.03
--------- -----
Outstanding at December 31, 1997 464,950 2.10
Granted 474,500 1.54
Exercised (56,750) .71
Forfeited (72,500) 1.75
--------- -----
Outstanding at December 31, 1998 810,200 $1.83
========= =====
Shares exercisable at December 31, 1998 217,101 $2.20
========= =====
</TABLE>
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 income (loss) and net income (loss) per common share
would have been increased to the following pro forma amounts:
1998 1997
------------- ---------------
Net income (loss):
As reported $ 1,237,081 $ (1,703,250)
============= ===============
Pro forma $ 885,766 $ (1,748,231)
============= ===============
Net income (loss) per common share
As reported $ 0.35 $ (0.46)
============= ===============
Pro forma $ 0.25 $ (0.48)
============= ===============
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 5.2% and 5.5% in 1998 and 1997, respectively; no
expected dividend yields for options granted; expected lives of 4 and 5 years in
1998 and 1997, respectively; expected stock price volatility of 120% and 157% in
1998 and 1997, respectively. The weighted average fair value of options granted
during 1998 and
F-10
<PAGE>
1997 was $1.22 and $1.09, 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.
8. INVESTMENT IN RESTRICTED SECURITIES
In May 1998, the Company decided to discontinue the CLIQNOW! Division.
Accordingly, this business has been reflected as a discontinued operation for
the years ended December 31, 1998 and 1997. On June 1, 1998, the Company sold
its CLIQNOW! Division to 24/7 Media, Inc. ("TFSM") for gross proceeds of $4
million, consisting of $1 million of cash and $3 million of TFSM Convertible
Redeemable Preferred Stock. The sale resulted in a net gain of approximately
$2,994,000. On August 13, 1998, TFSM's registration statement for its initial
public offering was declared effective by the Securities and Exchange
Commission. As a result, the Convertible Redeemable Preferred Stock of TFSM
automatically converted on that date into shares of common stock of TFSM, of
which the Company retained 196,492 shares. These shares are being carried at a
cost of $2,558,300 (approximately $13.02 per share) on the Company's
consolidated balance sheet at December 31, 1998.
F-11
<PAGE>
SCHEDULE II
K2 DESIGN, INC. AND SUBSIDIARY
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
Allowance for doubtful accounts, January 1, 1997 $ 25,000
Add: Increase in allowance for doubtful accounts 188,204
Allowance for doubtful accounts, December 31, 1997 213,204
Less: Decrease to allowance for doubtful accounts (188,204)
-----------
Allowance for doubtful accounts, December 31, 1998 $ 25,000
===========
F-12
