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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
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[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
Commission file number 0-23589
C2I SOLUTIONS, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<CAPTION>
<S> <C>
DELAWARE 33-0775687
(State or other jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
6138 NANCY RIDGE DRIVE, SAN DIEGO, CALIFORNIA 92121
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (619) 812-5800
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, $.001 PAR VALUE
REDEEMABLE WARRANTS
</TABLE>
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the 90 days. Yes X No_____
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Check if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-B is not contained in this form, and no disclosure will be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [_]
The issuer's revenues for its most recent fiscal year were $649,817.
The aggregate market value of the voting and non-voting common equity held by
nonaffiliates of the registrant was approximately $1,738,000 as of March 2,
1999. Shares of common stock held by each officer and director and by each
person or group who owns 5% or more of the outstanding common stock have been
excluded in that such persons or groups may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for other purposes.
As of March 1, 1999, the Registrant had 3,542,171 shares of its $.001 par
value common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
None.
Transitional Small Business Disclosure Format: Yes ____ No X
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PART I
This Annual Report on Form 10-KSB contains certain forward-looking
statements within the meaning of Section 21E of the Securities and Exchange Act
of 1934, as amended, and is subject to the Safe Harbor provisions created by
that statute. In this report, the words "anticipates," "believes," "expects,"
"future," "intends" and similar expressions identify forward-looking statements.
Such statements are subject to certain risks and uncertainties, including, but
not limited to, those discussed herein, and, in particular, those contained in
"Item 6--Management's Discussion and Analysis of Financial Condition and Results
of Operations" under the caption "Business Risks and Uncertainties," that could
cause actual results to differ materially from those projected.
ITEM 1. BUSINESS
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THE COMPANY
C2i Solutions, Inc. ("C2i" or the "Company") provides information
technology (IT) services and solutions to meet the needs of business and
government for information systems transformation and conversion, and
applications re-engineering. In addition, the Company provides a variety of
services for Year 2000 and Euro currency issues, including assessment,
remediation, testing, conversion, and validation. The Company's strategic focus
embraces information technology systems integration and re-engineering in its
entirety, including such tasks as complex software conversions, operating system
migrations, database migrations, programming language upgrades, application
development and maintenance outsourcing, data warehousing and the planning,
development and conversion of existing commercial software to e-commerce
applications. The Company's suite of services also includes project assessment,
feasibility studies, planning, implementation, testing, and independent
verification and validation.
To meet the needs of its clients, C2i employs proven methodologies,
advanced software tools, and highly trained and experienced information
technology professionals to deliver its services, often obtaining required
software, hardware, personnel and other tools via business relationships with
qualified third-party sources, including IBM and Allstate Insurance Corporation.
The Company's re-engineering services address the increasing limitations
of legacy systems and assist clients to plan and implement replacement
strategies before their organization is significantly disadvantaged.
Transforming legacy applications into new language or hardware
environments requires development or deployment of those applications, within
the context of an organization's current information technology infrastructure,
without constraining the organization to use outdated and/or difficult-to-
maintain legacy components. The Company believes this strategy provides the most
flexibility in evolving large information technology infrastructures.
The "Year 2000 problem" arises from widespread use of computer programs
that rely on two-digit date codes to perform computations and decision-making
functions. Many of these computer programs may fail from an inability to
interpret date codes properly. For example, such programs may misinterpret "00"
as the year 1900 rather than 2000. These "date-dependent" programs are found in
computer hardware, software and embedded systems used in many businesses. These
misinterpretations may result in faulty calculations or system failure.
The introduction of the Euro represents one of the largest planned
changes to the European economic system in the past century. The impact on
multinational corporations operating within and from Europe is immense. At a
time when companies are preparing for the Year 2000 issue, the addition of Euro
issues poses a complex business challenge.
The Company's "independent verification and validation" services provide
tools and personnel to run independent tests in the client environment to verify
that the information technology solution selected
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and implemented internally, or by another vendor, is fully functional. This
service is particularly valuable for Year 2000 code validation. C2i does not
warrant the information technology solution tested.
The Company's experience and strategies for analyzing and resolving
information technology issues, such as the Year 2000 and Euro conversions,
enables it to be in a position to leverage an initial client contract into an
ongoing business relationship. This business model focuses on providing
additional and expanded services to a client, thereby creating a long-term
stream of incremental revenue. When commencing a client engagement, C2i
identifies, evaluates and selects specific strategies, software approaches and
tools that it believes will be the most effective. During this process, the
Company gains knowledge about many areas of the client's computer and business
environment, positioning it to be able to provide an additional broad range of
computer consulting services generally characterized as "Applications Re-
Engineering."
C2i has reorganized to focus its primary business on providing new IT
solutions for its existing and new clients. C2i's senior management team has
extensive experience with Internet, e-Business and legacy transformation
solutions. C2i is currently a business partner with IBM, Sun and Oracle. As a
key part of this business restructuring, C2i intends to establish additional
partnerships and actively pursue mergers and acquisitions to strengthen its
offerings or to otherwise enhance stockholder value.
C2i intends to complete existing Y2k contracts but will not actively pursue
new Y2k engagements. As a result of this strategic realignment and
restructuring, approximately 14 positions will eliminated at headquarters in San
Diego and field offices in Atlanta, Chicago, New York and Paris. The Company
expects that these reductions will be made by the end of April 1999 and will
reduce ongoing operating expenses.
THE C2I SOLUTION
To provide its customers with a wide variety of service choices and
alternatives, C2i has developed relationships with leading providers of software
re-engineering tools. These relationships include non-exclusive licensing
agreements, value-added-reseller agreements, consulting agreements and joint-
development agreements. C2i is engaged in a constant process of evaluating
potential relationships with technology providers in order to develop the most
advanced re-engineering solutions and add to its suite of service and product
offerings. Through its access to a number of tools and approaches, C2i is able
to recommend and select solutions that match the customer's specific
requirements. The Company combines its licensed technology with related
consulting services, training and support to deliver re-engineering solutions
across multiple operating environments.
SERVICES
C2i typically provides IT consulting services that may include a variety
of the following engagements:
. Project Management
. Enterprise Assessment
. Analysis & Planning
. Renovation/Replacement
. Testing & Implementation
Each of these steps must be managed and coordinated with the multiple
groups or departments within the client organization.
PROJECT MANAGEMENT
Maintaining tight control of an IT project requires managers to predict
and monitor factors that affect resource consumption, delivery dates and costs
throughout the project. Computer time, personnel time and the need to work
around existing operations are constraints that may directly affect resource
availability and costs. The C2i project manager, who is a specialist in the
environment(s) used in the customer's information systems, allocates assignments
to project personnel and uses a project tracking system to monitor progress
during the complex series of tasks associated with the project.
ENTERPRISE ASSESSMENT
Enterprise assessment forms the information-base upon which significant
decisions are made regarding the nature of proposed re-engineering projects. C2i
project staff members work with representatives of all involved business units
in an organization to compile a comprehensive Enterprise Assessment Report. This
report enables management to select a course of action, deploy resources, and
set time-lines for completion of the project. During the enterprise assessment,
C2i often assists clients to
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inventory and review application systems, subsystems and programs to determine
their inter-relationships, as well as age, usefulness, and size.
ANALYSIS & PLANNING
In Analysis and Planning engagements, C2i works closely with the client
to summarize baseline information, to identify future requirements, and develop
the specific project steps required to achieve the targeted outcome. Findings
are summarized in a detailed project plan.
RENOVATION/REPLACEMENT
Many IT engagements into which the Company may enter involve renovation
or replacement of existing software and/or hardware systems. In some cases, an
existing system may be "retired". If the business function embodied in the
retired system is still required, data conversion is required to bridge the old
and new systems. Such functionality is determined during an Analysis engagement
and the findings incorporated into the project plan.
TESTING AND IMPLEMENTATION
Testing is a significant and critical element of most IT projects. In
testing and implementation engagements, all enterprise-critical systems,
programs, databases, data-feeds, procedures and printed material must meet the
change requirements described in the project plan. C2i technical staff work
closely with the client to develop test data (scripts) that engage all functions
of the changed system(s). The Testing process locates the documents errors
leading to corrective action and subsequent system re-testing. This cycle
continues until no errors are found.
Implementation is the process of putting the tested system back into
"production" in the client environment. Here, C2i technical staff work closely
with client staff to implement the new, or changed, system in a step-wise
manner, monitoring closely the outcome of each program or process to ensure that
the new system performs as expected.
LICENSES AND RELATIONSHIPS
C2i has business relationships and/or VAR Agreements with IBM, Allstate
Insurance, Computer Associates International, Oracle, and Sun Microsystems, as
well as non-exclusive licensing agreements with other technology companies. The
Company continually evaluates potential relationships with other third-parties
in order to provide a broader range of IT solutions, including hardware,
software and consulting services.
INTELLECTUAL PROPERTY
The Company relies on a combination of copyright and trade secret laws
and contractual provisions to establish and protect its rights in its software
products and proprietary technology. Despite these precautions, it may be
possible for unauthorized parties to copy certain portions of the Company's
technologies or to reverse-engineer to obtain and use information that the
Company regards as proprietary. The Company has no patents. Existing copyright
and trade secret laws offer only limited protection. In addition, the laws of
some foreign countries do not protect the Company's proprietary rights to the
same extent as do the laws of the United States.
The Company's competitive position may be affected by its ability to
protect its proprietary information. However, because the software industry is
characterized by rapid technological change, the Company believes that patent,
trademark, copyright, trade secret and other legal protection are less
significant to the Company's success than other factors such as the knowledge,
ability and experience of
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the Company's personnel, new product and service development, frequent product
enhancements, customer service and ongoing product support.
CUSTOMERS
During 1998, the Company expanded its customer base to include multiple
projects for Nicholas Applegate Capital Management, a mutual-fund management
company. Success at Nicholas Applegate was leveraged into an expanding
engagement with a major New York-based capital management firm. Additional
consulting engagements included AIG's unit of United Guaranty Corporation (UGC)
and a major international apparel manufacturer.
SALES AND MARKETING
The C2i sales and marketing strategy is designed to promote and enhance
recognition of the Company's products and services through referrals from
systems integrators, service providers, and parties who have entered into VAR or
other business relationships with C2i, including outside sales agents. Once
identified, potential clients are further introduced to C2i products and
services through direct discussion with the Company's technical staff. The
combination of a commercially oriented sales presentation with technical
validation ultimately leads to an engagement statement-of-work and customer
commitment to proceed with the project.
In 1998, C2i used a direct sales force to follow up with potential
customers identified through the aforementioned business relationships,
referrals, and an aggressive telemarketing campaign. Direct sales force effort
was focused on identifying engagements that leverage the Company's portfolio of
tools and services, creating a track-record of success that may be leveraged
into sales of additional services.
COMPETITION
The market for services relating to IT in general and specifically to the
Year 2000 problem is highly competitive and becoming increasingly so as the Year
2000 approaches. Anticipated growth in this sector has attracted both branded
and new competitors, many of whom may offer complimentary products and services.
Known competitors offering tools and services similar to C2i include
PricewaterhouseCoopers LLP, Ernst & Young LLP, Deloitte & Touche, Anderson
Consulting, KPMG Peat Marwick, Electronic Data Service Corporation, Cambridge
Technology Partners, Computer Horizon Corporation, Crystal Systems Solutions
LTD., Data Dimensions, Inc., Keane, Inc., Platinum Technology, Inc., SEEC, Inc.,
SAIC, Sapiens International Corporation NV, and VIASOFT, Inc. Most competitors
who provide software tools and services for Year 2000 conversion projects and
broader enterprise-oriented IT services are more established, benefit from
greater name recognition and have substantially greater financial, technical and
marketing resources than the Company. As a result, there can be no assurance
that the Company will be able to compete effectively.
The principal competitive factors affecting the market for the Company's
services include product performance and reliability, product functionality,
availability of experienced personnel, price, ability
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to respond in a timely manner to changing customer needs, project management
capabilities, ease of use, training and quality of support.
EMPLOYEES
As of December 31, 1998, the Company had 16 full-time employees and 2
part-time employees.
The Company expects a decrease in the number of employees over the next
twelve months as it aligns its personnel resources to the Company's anticipated
requirements. The actual rate of this decrease is dependent on a number of
factors, including demand for the Company's products and services. Also,
competition for qualified software personnel is intense and there are a limited
number of professionals with the level of knowledge and experience required by
the Company. There can be no assurance that the Company will be successful in
attracting, integrating, training, and retaining such personnel in accordance
with the Company's needs.
ITEM 2. DESCRIPTION OF PROPERTY
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The Company subleases approximately 12,400 square feet of office space in
San Diego, California pursuant to a sublease agreement on a month-to-month
basis. The Company moved into these facilities in January 1998. The Company
believes that its facilities will be adequate for its current needs and is
evaluating suitable alternate space.
ITEM 3. LEGAL PROCEEDINGS
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The Company is not involved in any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
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None.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
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MATTERS
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The Company effected an initial public offering ("IPO") on February 24,
1998 with its Common Stock and Redeemable Warrants traded on the Nasdaq SmallCap
Market under the symbols "CTWO" and "CTWOW," respectively. The following table
sets forth the high and low bid prices for the Company's Common Stock, as
reported on the Nasdaq SmallCap Market for the periods indicated. These reported
prices reflect interdealer prices without adjustments for retail markups
markdowns or commissions.
<TABLE>
<CAPTION>
High Low
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First Quarter 1998 14 1/2 6
(beginning February 24,
1998)
Second Quarter 1998 13 7 1/2
Third Quarter 1998 8 5/8 2 3/8
Fourth Quarter 1998 3 3/4 5/8
</TABLE>
As of March 2, 1999, there were 20 stockholders of record of the
Company's Common Stock. Because many of such shares are held by brokers and
other institutions on behalf of stockholders, the Company is unable to estimate
the total number of stockholders represented by these record holders.
The Company has not paid any cash dividends on its Common Stock. The
Company currently expects that it will retain its future earnings, if any, for
use in the operation and expansion of its business and does not anticipate
paying any cash dividends in the foreseeable future.
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In the last fiscal year, the Company has sold and issued the following
unregistered securities:
During the year ended December 31, 1998, the Company granted options to
purchase an aggregate of 1,259,305 shares of Common Stock at exercise prices
ranging from $1.19 to $8.38 per share to 28 employees and consultants and three
outside directors. No consideration was paid to the Company by any recipient of
any of the foregoing options for the grant of any such options.
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The issuances described above were exempt from registration under the
Securities Act in reliance on Rule 701 promulgated thereunder and on Section
4(2) thereof as transactions pursuant to compensatory benefit plans and
contracts relating to compensation and transactions not involving a public
offering.
The net proceeds to the Company from the sale of the 1,150,000 shares of
Common Stock and 1,150,000 Redeemable Warrants in the initial public offering
(including $100 of proceeds from the Underwriters Warrants) were $5,672,407
after deducting underwriting discounts and commissions and the offering expenses
payable by the Company.
Proceeds of the initial public offering were used to repay the Bridge
Notes and accrued interest thereon, totaling $621,412, $17,920 of which was paid
to a former executive officer of the Company. The Company also used $129,038 to
purchase machinery, equipment and other capital additions, $6,210 to repay
capital leases and accrued interest, $1,233,237 to pay employees' and officers'
salaries and related payroll taxes, $262,929 for occupancy costs, $199,238 for
advertising and promotion, $142,625 for recruiting, $405,103 for other general
corporate purposes and realized and unrealized investment losses totaling
$434,033 net of related interest and dividend income. The remaining proceeds
from the initial public offering have been invested in short-term investments
pending their use.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
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OF OPERATIONS.
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This discussion contains forward-looking statements which involve risks
and uncertainties. The Company's actual results could differ materially from
those anticipated in such forward-looking statements as a result of certain
factors, including those set forth under "Business Risks and Uncertainties'" and
elsewhere in this Form 10-KSB. In this report, the words "anticipates,"
"believes," "expects," "future," "intends," and similar expressions identify
forward-looking statements. The following discussion and analysis should be read
in conjunction with the financial statements and notes thereto contained in Item
7 of this report.
OVERVIEW
C2i Solutions, Inc. ("the Company") is a provider of IT consulting
services. The Company's consulting solutions span a wide variety of platforms,
languages, and services, from client-server to mainframe, from assessment and
remediation to testing and re-implementation. The Company's approach utilizes a
mix of hands-on work by highly experienced technical staff, along with "best of
breed" tools, and focused project management. The desired result for the
Company's clients is reduced project cycle time, lower cost and improved
productivity.
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The Company was founded in late 1996 and has a limited operating
history. From Inception (September 17, 1996) through mid 1997, the majority of
the Company's activities involved raising capital, research, developing the
business plan, establishing relationships and recruiting personnel. As a result,
the Company's operations to date have not produced significant revenues and the
Company is considered to be in the development stage.
In view of the early stage of development and the extremely competitive
market in which the Company operates, there can be no assurance that the Company
will achieve or maintain profitable operations. The Company expects to continue
to incur operating losses through December 1999 at a minimum.
The Company began its workforce expansion in the third quarter of 1997,
which it continued throughout 1998. Also, in December 1997, the Company
commenced payment of salaries to its officers. Prior to December 1997, the
Company had not incurred any significant cash compensation to its officers since
Inception. Additionally, the Company recognized a charge of approximately $1.2
million in 1997 for non-cash compensation expense to officers, as a result of
issuance of Common Stock to these officers at deemed values which exceeded the
total consideration (cash and capital subscriptions receivable) received by the
Company.
In late September 1997, the Company hired its first two regional sales
representatives and began selling activities. In early 1998, the Company refined
its sales efforts based on its experience to date. That experience suggested
that initial expectations regarding the timing of revenue related to Year 2000
compliance efforts were underestimated. Actual compliance efforts to date by
potential customers involving outside resources have fallen short of
expectations, negatively impacting the Company's projections of revenue. This
appears to be consistent with general industry trends noted by analysts,
experts, and competitors. As a result of the Company's experience to date, the
complex nature of the sales cycle, and the expected length of time typically
required for a potential customer to conclude its purchase decision related to a
comprehensive Year 2000 solution, the Company currently has no backlog of signed
customer orders. The Company does not expect to realize any significant revenues
prior to the end of 1999. There can be no assurance that the Company will
realize any additional revenues from existing or new potential customers.
The Company believes that a very limited demand for its Year 2000
solution exists today and will continue to exist for a brief period after the
Year 2000. This limited demand will diminish significantly over time and will
eventually disappear. The Company plans to continue actively pursuing business
opportunities unrelated to the Year 2000 problem in the computer consulting
market, with a focus on the conversion marketplace, and to develop products and
services to take advantage of these opportunities. However, there can be no
assurance that the Company will be able to successfully expand its business
beyond the Year 2000 conversion market. The Company's failure to diversify and
develop additional products and services would materially adversely affect the
Company's business, operating results and financial condition. See "Risk
Factors--Need to Develop New Products and Technologies."
C2i has reorganized to focus its primary business on providing new IT
solutions for its existing and new clients. C2i's senior management team has
extensive experience with Internet, e-Business and legacy transformation
solutions. C2i is currently a business partner with IBM, Sun and Oracle. As a
key part of this business restructuring, C2i intends to establish additional
partnerships and actively pursue mergers and acquisitions to strengthen its
offerings or to otherwise enhance stockholder value.
C2i intends to complete existing Y2k contracts but will not actively
pursue new Y2k engagements. As a result of this strategic realignment and
restructuring, approximately 14 positions will be eliminated at headquarters in
San Diego and field offices in Atlanta, Chicago, New York, and Paris. The
Company expects that these reductions will be made by the end of April 1999 and
will reduce ongoing operating expenses.
Revenue associated with performance under contracts to provide Year 2000
consulting and reengineering services is recognized utilizing the percentage-of-
completion method, in the ratio that labor-hours incurred to date bear to
estimated total labor-hours at completion, provided that collection of the
related receivable is probable. Adjustments to contract cost estimates are made
in the periods in which the facts requiring such revisions become known. If the
revised estimates indicate a loss, such loss will be provided for currently in
its entirety. The costs of providing warranty and follow-on customer support are
currently non-existent. In the future such costs are not expected to be
significant and would be accrued if appropriate.
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The Company recognizes revenue from the sale of software and hardware
products upon delivery of the product to customers. Revenues on sales of
software products to customers, which require significant continued obligation
from the Company, are deferred until such obligations are no longer significant.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain items
from the Company's statements of operations as a percentage of total revenues:
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION
(SEPTEMBER 17,
YEAR ENDED YEAR ENDED 1996) THROUGH
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1997 1998 1998
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<S> <C> <C> <C>
Revenues 100.0% 100.0% 100.0%
Cost of revenues 59.1% 45.7% 47.4%
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Gross profit 40.9% 54.3% 52.6%
Selling, general and administrative expenses 2283.8% 442.4% 640.5%
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Operating loss (2242.9%) (388.1%) (587.9%)
Other (income) expense, net 31.3% 88.6% 81.3%
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Loss before taxes (2274.2%) (476.7%) (669.2%)
Provision for income taxes 4.3% 0.8% 1.2%
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Net loss (2278.5%) (477.5%) (670.4%)
======= ====== ======
</TABLE>
FISCAL YEAR ENDED DECEMBER 31, 1998.
Revenues. Total revenues for the year ended December 31, 1998 were
$649,817 an increase of 720% over the prior year, in which revenues totaled
$79,283. This increase in revenues resulted from additional projects the Company
undertook for its customers. For the year ended December 31, 1998 service
revenues accounted for 88% of total revenues and product sales represented 12%.
Total revenues for the year ended December 31, 1997 consisted of service
revenues of 59% and revenues from product sales of 41%.
Two customers accounted for 92% of the Company's revenues for the year
ended December 31, 1998 (73% and 19%). Three customers accounted for 91% of the
Company's revenues for the year ended December 31, 1997 (62%, 19% and 10%).
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Cost of Revenues. Cost of revenues were 46% ($296,685) of total revenues
for the year ended December 31, 1998. These costs consisted primarily of
personnel related costs of providing consulting services and the costs of
products sold. Cost of revenues were 59% ($46,894) of total revenues for the
year ended December 31, 1997 representing the costs of products and services
sold, including third party royalties relating to licensed technology.
For the year ended December 31, 1998 the gross margin percentage was 54%
compared to the prior year gross margin percentage of 41% which reflects a more
favorable mix of service revenues relative to product revenues in 1998.
Selling, general and administrative expenses. The Company incurred selling,
general and administrative expenses for year ended December 31, 1998 totaling
$2,874,866, compared with $1,810,623, for the prior year. This increase in 1998
over 1997 resulted primarily from increased personnel and related expenses due
to a greater number of employees, increased facilities expenses in connection
with the relocation to larger offices, the establishment of regional offices,
expansion of operations, increased travel and marketing expenses incurred in
connection with the overall scale-up of Company's operations and business
development efforts, and higher legal, accounting and other general and
administrative expenses associated with becoming a public company. The Company
believes that its selling, general and administrative expenses will decrease as
a result of the restructuring being implemented in March and April 1999.
Other Income and Expenses. Interest and dividend income was $220,728 for
the year ended December 31, 1998, compared with $0 for the year ended December
31, 1997. This increase in 1998 reflects interest and dividends earned from the
short-term investment of the net proceeds from the Company's initial public
offering, which closed on February 27, 1998. Interest expense totaling $21,827
and $24,804 for the years ended December 31, 1998 and 1997, respectively, was
related to capital lease obligations and the debt financing completed in October
1997.
The Company invested the net proceeds from its initial public offering, net
of anticipated near-term working capital requirements, in a mutual fund (the
"Short-Term Investment"). The proceeds that the Company anticipated would be
used to satisfy near-term working capital requirements were invested in money
market accounts. The Short-Term Investment is a publicly held mutual fund traded
on the New York Stock Exchange, which invests in interesting-bearing, debt
instruments. During the year ended December 31, 1998, the Short-Term Investment
was impacted by unusual financial market events, which caused its fair market
value to decline. During the year ended December 31, 1998, the Company realized
losses of $161,098 and experienced declines in fair value of $493,663 on the
Short-Term Investment that were judged to be other than temporary.
During the year ended December 31, 1998, the Company recognized a charge of
approximately $111,950, related to repayment of the Bridge Financing, which is
included in other expense in the statements of operations. This charge
represents the write-off of the unamortized balances of the debt discount and
deferred finance charges remaining upon repayment of the Bridge Notes.
FISCAL YEAR ENDED DECEMBER 31, 1997.
Revenues. The Company's revenues of $79,283 consist of fees for consulting
services provided ($47,033) and fees received for the sale, license or use of
software and hardware products ($32,250).
Cost of Revenues. Cost of revenues consists primarily of personnel-related
costs of providing consulting services. Cost of revenues also includes third
party royalties relating to licensed technology, and cost of products sold. Cost
of revenues for the year ended December 31, 1997 was approximately 59% of
revenues.
Selling, general and administrative expenses. Selling, general
administrative expenses were $1,810,623 for the period ended December 31, 1997
and primarily related to costs incurred to establish the Company's basic
infrastructure and internal operations.
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LIQUIDITY AND CAPITAL RESOURCES
From Inception (September 17, 1996) through February 1998, the Company
financed its operations primarily through the proceeds from the issuance of
Common Stock and a bridge financing, completed in October 1997, resulting in an
aggregate of approximately $958,000 from the sale and issuance of debt and
equity securities, including warrants. In February 1998, the Company completed
an initial public offering of its Common Stock. This offering provided the
Company with the net proceeds of $5,672,407, including proceeds from the
exercise of the underwriter's overallotment option received in March 1998. Funds
from these sources have been and are expected to continue to be used as working
capital to fund the Company's infrastructure and internal operations, including
purchases of capital equipment and the hiring of personnel.
The Company's operating activities used net cash of $2,427,294 and $275,389
during the year ended December 31, 1998 and 1997, respectively. This increase in
cash used for operating activities in 1998 compared to 1997 results primarily
from the larger net loss for the 1998 period as a result of the Company's
continued expansion of its operations, as well as an increase in accounts
receivable and prepaid expenses and a decrease in accounts payable.
The Company's investing activities used cash of $3,064,650 and $42,205
during the year ended December 31, 1998 and 1997, respectively. This increase in
cash used for investing activities in 1998 compared to 1997 results from the
purchase of $4,000,000 of short-term investments with the excess net proceeds
from the Company's initial public offering which was offset by proceeds from the
sale of short term investments totaling $1,115,992. During the year ended
December 31, 1998, the Company used $131,173 to purchase property and equipment,
compared to $39,400 during the same period in 1997.
The Company's financing activities provided net cash of $5,329,075 and
$599,950 during the year ended December 31, 1998 and 1997, respectively. This
increase in cash provided by financing activities in 1998 compared to 1997
results from an increase in net proceeds from the sale of common stock and
redeemable warrants totaling $5,934,396 during 1998 (of which $5,932,313 related
to the Company's initial public offering). The net cash increase during the year
ended December 31, 1998 was partially offset by cash used to repay the bridge
notes ($600,000) and capital lease obligations ($5,321) in 1998. This compares
with net proceeds from the sale of equity securities of $200,000, collection of
a capital subscription receivable of $97,500, and proceeds from the Bridge
financing of $600,000 during 1997. These sources were partially offset by cash
used for deferred offering costs ($259,906), deferred finance charges ($26,820),
repayment of advances from a former stockholder, ($10,126), and repayment of
capital lease obligations ($698).
As of December 31, 1998, the Company had cash and short-term investments,
net, of $2,365,201 and working capital of $2,344,639 compared with cash of
$298,823 and a working capital deficit of ($491,588) at December 31, 1997. Based
on management's current restructuring plan and anticipated personnel decreases,
the Company believes that its existing resources will be sufficient to fund
operations through approximately March 2000. However, the Company expects to
continue to experience operating losses and to use cash in operations through at
least December 1999.
Subsequent to December 31, 1998, the Company sold the entire balance of the
Short-Term Investment it held at December 31, 1998. The Company received net
proceeds aggregating $2,180,702 and realized additional losses of $48,545.
The Company has invested the proceeds from the sale of this Short-Term
Investment in fully insured, money market accounts and short-term U.S.
government treasury bills. The Company is reviewing various possible courses of
action to recover its investment losses, although there can be no assurance that
any of this loss will ultimately be recovered.
The Company's ability to achieve sustained profitability will be dependent
upon a number of factors, including its ability to generate future revenues.
Although the Company is pursuing business
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12
<PAGE>
development opportunities, which it hopes will produce future revenues, there
can be no assurance that the Company will be able to successfully negotiate any
additional contracts, that any such current or future contracts will provide
the Company with expected benefits, or that the Company can perform its
contracted operations at a profit sufficient to cover its other expenses.
If the Company cannot generate sufficient revenues and profits from current
and future contacts, of which there can be no assurance, the Company will be
required to raise capital from the sale of equity securities or the issuance of
indebtedness. There is no assurance that such sales or issuances can be effected
at favorable terms, if at all.
The timing and amount of the Company's capital requirements will depend on
a number of factors, including demand for the Company's products and services,
the need to develop new or enhanced products and services, competitive
pressures, the effect and costs of the restructuring being implemented, and the
availability of complementary businesses or technologies that the Company may
wish to acquire. If additional funds are raised through the issuance of equity
securities, the percentage ownership of the Company's stockholders will be
diluted and such equity securities may have rights, preferences or privileges
senior to those of the holders of the Company's Common Stock. There can be no
assurance that additional financing will be available when needed or, that if
available, such financing will include terms favorable to the Company or its
stockholders. If adequate funds are not available on acceptable terms, the
Company may be unable to develop or enhance its products and services, take
advantage of opportunities or respond to competition, any of which could have a
material adverse effect on the Company's business, financial condition and
results of operations.
Interest Rate Risk
The Company is exposed to changes in interest rates primarily from its
short-term investments in certain available for sale securities. Under its
current policies, the Company does not use interest rate derivative instruments
to manage exposure to interest rate changes. During the year ended December 31,
1998, the Company realized losses on its short-term investments totaling
$654,761. In January and February 1999, the Company sold all investments held
at December 31, 1998 and realized additional losses totaling $48,545. The
Company invested the proceeds aggregating $2,180,702 in fully-insured money
market accounts and short-term U.S. Government treasury bills. The Company
believes a hypothetical 100 basis point adverse move in interest rates along the
entire interest rate yield curve would not materially effect the fair value of
interest sensitive financial instruments purchased in February 1999.
YEAR 2000 COMPLIANCE
Many currently installed computer systems and software products are not
capable of distinguishing 20th century dates from 21st century dates. As a
result, in less than two years, computer systems and/or software used by many
companies in a very wide variety of applications will experience operating
difficulties unless they are modified or upgraded to adequately process
information involving, related to or dependent upon the century change.
Significant uncertainty exists in the software and information services
industries concerning the scope and magnitude of problems associated with the
century change. In light of the potentially broad effects of the Year 2000 on a
wide range of business systems, the Company's products and services may be
affected.
The Company utilizes and is dependent upon data processing computer
hardware and software to conduct its business. The Company has completed its
assessment of its own computer systems and based upon this assessment, the
Company believes its computer systems are "Year 2000 compliant;" this is,
capable of adequately distinguishing 21st century dates from 20th century dates.
However, there can be no assurance that the Company has or will timely identify
and remediate all significant Year 2000 problems in its own computer systems,
that remedial efforts subsequently made will not involve significant time and
expense, or that such problems will not have a material adverse effect on the
Company's business, operating results and financial condition. If unforeseen
internal disruptions occur, the Company believes that its existing disaster
recovery program, which includes the manual processing of certain key
transactions, would significantly mitigate the impact.
The Company has made only limited efforts to determine the extent of and
minimize the risk that the computer systems of the Company's suppliers are not
Year 2000 compliant, or will not become compliant on a timely basis. The Company
expects that the process of making inquiries with these suppliers will be
ongoing through the end of 1999. If Year 2000 problems prevent any of the
Company's suppliers from timely delivery of products or services required by the
Company, the Company's operating results could be materially adversely affected.
However, the Company estimates that its costs to address the Year 2000 issues
relating to its suppliers will not be material, and that these costs will be
funded from its operating cash flows or existing capital resources. The Company
has identified and will continue to identify alternative suppliers in the event
its preferred suppliers become incapable of timely delivery of products and
services required by the Company. The Company's suppliers are generally locally
or regionally based, which tends to lessen the Company's exposure from the lack
of readiness of any single
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13
<PAGE>
supplier. The Company's estimates of Year 2000 costs relating to its suppliers
are management's best estimates, which were derived from numerous assumptions of
future events, including the continued availability of certain resources, third
party remediation plans with regard to Year 2000 issues, and other factors.
There can be no assurance that these estimates are correct and actual results
could differ materially from these estimates.
BUSINESS RISKS AND UNCERTAINTIES
C2i has a Limited Operating History and Limited Experience in Year 2000 and
Information Technology Solutions
C2i was founded in September 1996, has a limited operating history and is
in the development stage. As a result, C2i's operations to date have not
produced significant revenues. C2i may not generate any future revenues from the
sale of its services or products.
C2i has limited experience in providing information technology solutions.
Although C2i has completed its initial assessment projects, C2i has not
completed a large scale Year 2000 conversion project. There can be no assurance
that C2i will be successful in completing large scale conversions, that C2i will
not experience delays or failures in providing its Year 2000 solutions or that
the Year 2000 solutions will be effective. The failure of C2i's Year 2000
solutions to function properly or the existence of errors or bugs following
completion of a Year 2000 conversion project could necessitate significant
expenditures by C2i in order to attempt to remedy the problems. The consequences
of failures, errors and bugs could have a material adverse effect on C2i's
business, operating results and financial condition.
History of Operating Losses; Need for Additional Financing; Possible Delisting
from Nasdaq
C2i has experienced significant operating losses since its inception in
September 1996. As of December 31, 1998, C2i's accumulated deficit was
approximately $4,954,000, which includes a non-cash charge of approximately $1.2
million in 1997, as a result of sales of equity securities to key employees at
less than deemed value for financial statement purposes. Losses have been
principally the result of the various costs associated with C2i's selling,
general and administrative expenses as C2i commenced operations, and began
marketing activities and losses on investments. C2i expects that it will incur
operating losses through at least December 1999. C2i believes that its existing
capital resources will enable it to fund its operations until approximately
December 31, 1999. C2i will be required to seek additional capital to continue
its operations beyond that time. C2i has no commitments for any future funding,
and C2i may not be able to obtain additional capital in the future. If C2i is
unable to obtain the necessary capital, it will be required to significantly
curtail its activities or cease operations.
C2i is required to meet certain financial tests (including net tangible
assets of $2 million and a minimum bid price of the common stock of $1.00) to
maintain its listing on the Nasdaq SmallCap Market. If continued losses by C2i
cause C2i to fail to meet such continued listing requirements, C2i's securities
may be delisted from the Nasdaq SmallCap Market and the liquidity of C2i's
securities would be impaired.
Intense Industry Competition in the Information Technology Services Industry;
Competitive Disadvantages
The market for information technology service providers is highly
competitive. C2i's lack of resources and limited experience compared to other
providers makes it extremely vulnerable to competition from larger companies,
all of which benefit from greater recognition, larger lists of reference clients
and significantly greater financial, technical and marketing resources. Leading
competitors have proven products which can provide them with a significant
advantage over C2i because C2i's services have not been widely deployed and
therefore present potential customers with uncertainty not associated with
existing solutions from larger companies. In addition, many of C2i's potential
clients are reluctant to choose small companies as key suppliers or service
providers due to concerns about long term viability
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14
<PAGE>
and, especially with respect to Year 2000 conversion projects, the consequences
to the organization of a failure of a proposed solution. There can be no
assurance that C2i will overcome these disadvantages.
Competitors may develop new products or services or improve their existing
products or services which, when combined with their existing market presence,
would make C2i's solutions obsolete or unmarketable. Any such development would
have a material adverse effect on C2i. C2i also expects that competition will
arise from new competitors and from new technological approaches adopted by new
and existing competitors. Competitive technologies may be developed which could
make C2i's services obsolete or of diminished utility, thereby materially
adversely affecting C2i. If C2i is unable to respond to the challenges of
competition, it would be unable to achieve or maintain profitability at a level
required to support its survival or growth.
Uncertain and Undeveloped Market
The primary focus of C2i's services to date has been resolving the Year
2000 problem. Although C2i believes that the demand for Year 2000 consulting
services may grow as the year 2000 approaches, this demand may not increase to
the extent anticipated by C2i, if at all. To date, companies have generally not
been willing or able to allocate the resources to outside service providers to
address this problem in a timely manner. Most companies appear to be attempting
to resolve the problem internally rather than contracting with firms such as
C2i. As a result, demand for C2i's Year 2000 solutions is uncertain and
unpredictable. If the demand for C2i's Year 2000 solutions fails to grow, or
grows more slowly than anticipated, C2i's business, operating results and
financial condition would be materially adversely affected.
Fluctuations in Quarterly Operating Results
For at least the near term, C2i expects to derive a substantial portion of
its revenues from a relatively small number of contracts. As a result, a small
delay during a quarter in the achievement of milestones triggering payment to
C2i could have a material adverse effect on C2i's revenues and results of
operations for that quarter. In addition, the need for continued investment by
C2i in customer service and support capabilities will limit C2i's ability to
reduce expenses in response to any such decrease in sales. Moreover, because
customer purchase orders are subject to cancellation or rescheduling by the
customer, backlog at any particular date is not necessarily representative of
actual revenues for any succeeding period. If C2i's anticipated level of
revenues is not achieved for a particular period, C2i's operating results could
be adversely affected by its inability to reduce costs. C2i cannot accurately
forecast the impact of these and other factors on C2i's operating results in any
future period.
Resource and Time-Intensive Sales Process
Sales of C2i's services and solutions are characterized by a relatively
complex sales cycle due to such factors as the magnitude of the expenses
associated with implementation of a comprehensive solution at most
organizations, the substantial time required by potential customers to evaluate
C2i's solutions and those of competitors, and the potential consequences to the
organization of a wrong decision. These factors suggest that the decision will
ultimately be made at a level in an organization that is relatively higher than
would otherwise be involved in information system matters. As a result, C2i will
likely continue to be required to devote additional sales and marketing efforts
to concluding sales decisions.
Need to Develop New Products and Services Unrelated to Year 2000 Solutions
C2i currently generates substantially all of its revenues from, and devotes
most of its resources to, its Year 2000 solutions. C2i believes that a very
limited demand for its Year 2000 solutions exists today and will continue to
exist for a brief period of time after the Year 2000. This limited demand will
diminish significantly over time and will eventually disappear. Therefore, C2i
plans to actively pursue business opportunities unrelated to the Year 2000
problem in the information technology consulting services market, and to develop
products and services to take advantage of those opportunities. C2i believes
that its future success will depend upon its
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15
<PAGE>
ability to develop and enhance its relationships with customers so that it will
continue to be called upon to assist in data conversion projects following the
year 2000. To the extent product offerings and services provided by C2i are
based upon anticipated changes, sales of such products and services may be
adversely affected if other technologies become accepted in the industry. If C2i
does not successfully introduce new products or services in a timely manner, any
competitive position C2i may develop would be lost and C2i's sales would be
reduced. C2i may be unable to develop and introduce enhanced or new products or
services which satisfy customer needs and achieve market acceptance. The failure
of C2i to implement a successful new business development program would have a
material adverse effect upon its business and prospects.
Dependence on Licenses and Third Party Technology
Substantially all of the tools that C2i uses to provide its Year 2000
solutions are licensed from third parties. C2i's proprietary software, as well
as licensed software, is designed to work on or in conjunction with certain
third party hardware and/or software products. If any of these licensors or
third party vendors were to discontinue making their products available to C2i,
or to increase materially the cost to C2i to acquire, license or purchase the
products, or if a material problem were to arise in connection with the ability
of C2i to use and operate with third party hardware and/or software products,
C2i would be required to redesign its solutions to function with or on
alternative third party products or attempt to develop internally a replacement
for the third party products. In such an event, interruptions in the
availability or functioning in C2i's Year 2000 solutions and delays in the
introduction of new products and services may occur until replacement technology
is obtained. There can be no assurance that alternative sources of suitable
technology would be available or that C2i would be able to develop an
alternative product in sufficient time or at a reasonable cost. The failure of
C2i to obtain or develop alternative technologies or products on a timely basis
and at a reasonable cost could have a material adverse effect on C2i's business,
financial condition and results of operations.
Customer and Supplier Concentration; Uncertainty of Follow-On Business
A large portion of C2i's revenues have been dependent on a few customer
projects. C2i derived approximately 92% of its revenues for the year ended
December 31, 1998 from two customers and 91% of its revenues for the year ended
December 31, 1997 from three customers. As of December 31, 1998, 100% of the
accounts receivable balance related to two customers. In addition, C2i has
experienced a supplier concentration, with 99% of its total cost of revenues for
the year ended December 31, 1997 resulting from purchases from three suppliers,
and 32% of its total cost of revenues for the year ended December 31, 1998
resulting from purchases from two suppliers. C2i expects that as it continues to
develop, it will continue to derive a majority of its revenues from a small
number of customers and to incur the majority of its costs with a small number
of suppliers. Therefore, a loss of any significant customer or supplier would
have a material adverse effect on C2i's business, financial condition and
results of operations.
At the conclusion of a project by C2i, a particular customer may not have
an immediate need for follow-on services or additional projects. C2i does not
enter into long term or volume service contracts with its customers, and
customers may discontinue further purchases of C2i's services with little or no
advance notice. There can be no assurance that any of C2i's limited number of
past or current customers will require C2i's services or products in the future,
or if they do, that they will engage C2i to perform such services or provide
such products. The failure of any of C2i's significant customers to meet their
obligations to C2i would have a material adverse effect on its business,
financial condition and results of operations. To generate future revenues, C2i
must identify and obtain business from companies in its existing base of
customers or with new customers. There can be no assurance that any of C2i's
current customers will engage C2i for projects in the future or that C2i will be
able to obtain additional new customers.
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16
<PAGE>
Dependence on Proprietary Technology
C2i relies on trade secret and copyright protection for its products and
technology. C2i believes that its licensors use similar means of protecting
their technologies.
In the absence of significant proprietary protection, competitors may be
able to copy C2i's technology or design approaches, replicate its processes or
gain access to its trade secrets. Moreover, there can be no assurance that
competitors will not be able to develop technologies similar to or more advanced
than those used by C2i or design around any protected aspects of C2i's
technology rights. No assurance can be given that C2i's current or future
products or services will not infringe on the rights of others.
There has been substantial litigation regarding intellectual property
rights in computer software related industries. In the future, litigation may be
necessary to enforce technological rights of C2i, to protect trade secrets or
know-how owned or licensed by C2i or to defend C2i against claimed infringement
of the rights of others and to determine the scope and validity of the
proprietary rights of others. Any such litigation would likely result in
substantial cost and diversion of effort by C2i, which by itself could have a
material adverse effect on C2i's business, financial condition and operating
results. Further, adverse determinations in such litigation could result in
C2i's loss of proprietary rights, subject C2i to significant liabilities to
third parties, require C2i to seek licenses from third parties or prevent C2i
from providing its services, any of which could have a material adverse effect
on C2i's business, financial condition and results of operations.
C2i also relies on trade secrets and proprietary technology that it seeks
to protect, in part, through confidentiality agreements with employees,
consultants and other parties. There can be no assurance that these agreements
will not be breached, that C2i will have adequate remedies for any breach, or
that C2i's trade secrets will not otherwise become known to or independently
developed by others.
Dependence on Key Personnel; Management of Restructuring of Information
Technology Operations
C2i's success will, to a large extent, depend upon the continued services
of its executive officers who have limited experience at managing a business
like C2i's. Although one of C2i's four executive officers has only been with C2i
since January 1999, the loss of services of any of these four executive officers
may materially and adversely affect C2i. C2i's employment agreements with its
key personnel may be terminated by either party, with or without cause, with the
exception of its agreement with Mr. Whalen. Mr. Whalen's employment agreement
has a term of five years, expiring in May 2002, and limits C2i's ability to
terminate him, except for cause, and provides for six months severance pay,
unless Mr. Whalen voluntarily resigns his position. C2i's Board of Directors has
approved the following changes to the employment agreements with its other three
executive officers, for which agreements are expected to be executed in the
first quarter of 1999. Mr. Wooten's and Ms. Hessler's employment agreements are
terminable at will, but if either individual's employment with C2i is terminated
prior to March 2004 for any reason, other than cause, that individual will
receive two years severance pay unless that individual voluntarily resigns his
or her position. If Mr. Wooten or Ms. Hessler are terminated prior to March 2004
for cause, they will receive six months severance. Mr. Hartman's employment
agreement is terminable at will, but if his employment with C2i is terminated
prior to March 2004 for any reason other than cause, Mr. Hartman will receive
six months severance pay unless he voluntarily resigns his position. C2i has key
man life insurance in the amount of $1,000,000 on Mr. Whalen.
C2i's plans to restructure its business are expected to place a significant
strain on C2i's management, operational and financial resources and systems. To
manage its restructured operations, C2i must, among other things, improve its
operational, financial and management information systems, including its
billing, accounts receivable and payable tracking, fixed assets and other
financial management systems.
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17
<PAGE>
C2i May Not Find Adequate Alternative Facilities
C2i currently leases its headquarters facility at 6138 Nancy Ridge Drive in
San Diego, California on a month-to-month basis. As a result, C2i's tenancy at
this facility may be terminated by its landlord upon 30 days written notice. C2i
is seeking an adequate facility elsewhere in San Diego County, which currently
has a relative shortage of viable commercial space. If C2i's tenancy is
terminated by its landlord before C2i finds an adequate facility, C2i may need
to relocate to temporary facilities at above-market costs or suspend its
headquarters' operations, either of which may have a material adverse impact on
its business, operating results, and financial condition.
Risks Associated with Potential Unspecified Acquisitions
C2i plans to acquire assets or businesses complimentary to its operations,
although no specific acquisitions are currently in negotiation or planned. Any
such future acquisitions would be accompanied by the risks commonly encountered
in acquisitions of companies. Such risks include, among other things:
. The assumption of unforeseen liabilities;
. The difficulty of assimilating the operations and personnel of the
acquired companies;
. The potential disruption of C2i's business;
. The inability of C2i's management to maximize the financial and
strategic position of C2i by the incorporation of acquired technology or
business into C2i's service offerings;
. The difficulty of maintaining uniform standards, controls, procedures
and policies;
. The potential loss of key employees of the acquiring or acquired
companies; and
. The impairment of relationships with employees consultants, customers,
and suppliers as a result of changes in management.
No assurance can be given that C2i will undertake acquisition activities, will
complete any acquisitions, or that if an acquisition does occur it will not
materially and adversely affect C2i or will be successful in enhancing C2i's
business. If C2i proceeds with one or more significant acquisitions, a
substantial portion of C2i's available cash could be used to consummate those
transactions. Alternatively, C2i might issue equity securities as consideration
for an acquisition which might result in significant dilution of the
stockholders' ownership interest in C2i, or C2i could issue debt securities to
finance an acquisition, which might reduce the book value and earnings per share
of C2i common stock. The accounting for business acquisitions by C2i is likely
to involve the recognition of significant goodwill and intangible assets in
connection with the acquisition and, as a result, would typically result in
substantial charges against C2i's reported future operating results.
Risks Associated with International Expansion
A key component of C2i's long-term strategy is its expansion into
international markets. C2i has very limited previous experience in operating
outside of the United States and C2i may not be able to successfully market,
sell and deliver its products and services in the international marketplace. In
addition to the uncertainty as to C2i's ability to create an international
presence, there are risks inherent in doing business on an international level,
including:
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<PAGE>
. More diverse, complex, unfamiliar and unexpectedly changing regulatory
requirements;
. Export restrictions, export controls, tariffs and other trade barriers
including cultural and structural impediments to trade;
. Difficulties in staffing and managing foreign operations;
. Longer payment cycles;
. Problems in collecting accounts receivable;
. Political instability;
. Fluctuations in currency exchange rates; and
. Potential adverse tax consequences that could adversely affect C2i's
international operations.
Any of these factors could have a material adverse effect on C2i's business,
financial conditions and results of operations.
Potential Liabilities Associated with Year 2000 Services
C2i's Year 2000 solutions involve key aspects of its client's computer
systems. A failure in a client's system could result in a claim for substantial
damages against C2i, regardless of C2i's responsibility for such failure. C2i
attempts to limit by contract, both with its customers and with the parties that
license technology to C2i, its liability for damages arising in rendering its
products and services. Despite this precaution, there can be no assurance that
the limitations of liabilities set forth in its contracts would be enforceable
or would otherwise protect C2i from liability for damages. There can be no
assurance that C2i will be able to obtain or maintain insurance coverage for
such liabilities, that such coverage will continue to be available on acceptable
terms, or that such coverage will be available in amounts to cover one or more
large claims. The assertion of claims against C2i that exceed available
insurance coverage, or changes in C2i's insurance policies, including premium
increases or the imposition of large deductible or co-insurance requirements,
could have a material adverse effect on C2i's business, financial condition and
results of operation. Furthermore, litigation, regardless of its outcome, could
result in substantial cost to C2i and divert management's attention from C2i's
operations. Any contract liability claim or litigation against C2i could,
therefore, have a material adverse effect on C2i's business, financial condition
or results of operations.
Concentration of Share Ownership and Voting Power Among Directors and Officers
The directors and officers of C2i control approximately 50.3% of the voting
power and therefore have all the votes required to elect all of C2i's directors
and, hence, will be able to control the affairs of C2i. In addition, the
directors and officers of C2i will have a substantial portion of all the votes
required to amend C2i's Certificate of Incorporation and By-laws and effect or
preclude fundamental corporate transactions involving C2i, including the
acceptance or rejection of any proposals relating to a merger of C2i or an
acquisition of C2i by another entity, in each case without the approval of any
of C2i's other stockholders.
Risk of Shares Being Characterized as Penny Stocks; Impaired Liquidity of the
Shares
The SEC has adopted regulations which define a "penny stock" to be any
equity security that has a market price (as therein defined) less than $5.00 per
share or with an exercise price of less than $5.00 per share, subject to certain
exceptions. For any transaction involving a penny stock, unless exempt, the
rules require delivery, prior to any transaction in a penny stock, of a
disclosure schedule prepared by the SEC relating to the penny stock market.
Disclosure is also required to be made about current quotations for the
securities and about commissions payable to both the broker-dealer and the
registered representative.
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<PAGE>
Finally, broker-dealers must send monthly statements to purchasers of penny
stocks disclosing recent price information for the penny stock held in the
account and information on the limited market in penny stocks.
The foregoing penny stock restrictions will not apply to the Shares if:
. They continue to be listed on the Nasdaq SmallCap Market;
. Certain price and volume information is publicly available on a current
and continuing basis; and,
. C2i meets certain minimum net tangible assets or average revenue
criteria.
There can be no assurance that C2i's securities will qualify for exemption
from the penny stock restrictions. If the Shares were subject to the rules on
penny stocks, the market liquidity for Shares could be severely adversely
affected.
ITEM 7. FINANCIAL STATEMENTS.
- ----------------------------
The financial statements and related notes thereto required by this item
are listed and set forth in a separate section of this report following the
index to exhibits.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
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FINANCIAL DISCLOSURE.
- --------------------
None.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
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COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.
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The directors and executive officers of the Company and their ages are as
follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
John Anthony Whalen, Jr. 56 Chairman of the Board of Directors;
President and Chief Executive Officer
Clyde Wooten 56 Senior Vice President and Chief
Technology Officer
Thomas M. Hartman 40 Senior Vice President, Sales, Marketing,
and Operations
Diane E. Hessler 38 Vice President, Finance, Secretary and
Chief Financial Officer
Hal H. Beretz (2) 63 Director
Kim P. Goh 56 Director
William J. Kaffer (1) 69 Director
James A. Lonergan (2) 59 Director
David Tendler (1) 61 Director
</TABLE>
- --------------------------------------------------------------------------------
20
<PAGE>
(1) Member of the Compensation Committee.
(2) Member of the Audit Committee.
Mr. Whalen founded the Company in 1996. Prior to joining the Company he
served from February 1994 through October 1994 as President and Chief Operating
Officer of NETCOM On-line Communication Services, Inc., an Internet service
provider and software developer, and from October 1986 through May 1990 as
Executive Vice President of Optimum Care Corporation, a company operating
behavioral medicine programs in healthcare facilities. From May 1990 to February
1994 and from October 1994 to February 1996, Mr. Whalen was a private investor.
Mr. Whalen holds a B.A. in English literature and American History from St.
Mary's College of California and an M.B.A. from California State University. Mr.
Whalen was licensed as a Certified Public Accountant by the State of California.
Mr. Wooten joined the Company in June 1997 as Senior Vice President,
Operations and Chief Technology Officer. From July 1995 through May 1997, Mr.
Wooten served as Vice President of Image Products of Excalibur Technologies, a
software company, and from October 1992 to June 1995 he served as Senior
Director of New Technology Development at Knight-Ridder Information, an
electronic publishing company. Prior to that he served for a total of 26 years
in various software and product development management positions with IBM
Corporation, Reference Technology, Inc., and Amdahl Corporation. Mr. Wooten
holds a B.Sc. degree in Aerospace Engineering and a M.S. degree in Aerospace
Engineering from Massachusetts Institute of Technology.
Mr. Hartman joined the Company in January 1999 as Senior Vice President,
Sales, Marketing and Operations with 18 years of experience in management,
sales, and marketing. From 1994 to 1997, he served as the Vice President of
Operations at Disguise, Inc., a consumer product company. From 1991 to 1994 he
held the position of both Sales and Marketing Development Manager at Waldorf,
Inc., and from 1990 to 1991 he was a Senior Consultant at Deloitte & Touche. He
graduated with a B.S. in Electrical Engineering from Pennsylvania State
University. He also holds a M.B.A. with an emphasis in Finance and Management
from the Wharton School of the University of Pennsylvania.
Ms. Hessler joined the Company in September 1997 as Chief Financial
Officer. From May 1994 through March 1997, Ms. Hessler served in various senior
financial and accounting positions with AlphaNet Telecom, Inc., a
telecommunications company. From June 1991 through February 1994 she served as
Chief Financial Officer and Controller at Bluebird Systems, a software
development company, and from August 1989 through May 1991 she served as a
Manager of Accounting and Business Consulting at Steres, Alpert & Carne, a
public accounting firm. Prior to that, she served for a total of eight years in
various positions with public accounting firms, including Deloitte Haskins &
Sells, Breedlove & Co., P.C. and Fairall, Quindt & Cummins, Inc., P.C. Ms.
Hessler holds a B.B.A. in Accountancy from Western Michigan University, and is
licensed as a Certified Public Accountant by the State of Texas.
Mr. Beretz was elected to the Board in September 1997. Mr. Beretz has been
a partner in the international consulting firm of Tendler Beretz LLC since
January 1985. Prior to forming Tendler Beretz LLC, Mr. Beretz served as
President and Chief Operating Officer of Phibro-Salomon, Inc., currently known
as Salomon, Inc., and was also a Director from May 1981 until leaving the firm
in December 1984. Mr. Beretz serves on the Boards of several institutions and is
active in various philanthropic organizations. Mr. Beretz holds a B.B.A. from
City College of New York.
Mr. Goh was elected to the Board in September 1997. Mr. Goh is an
independent consultant. From 1993 to 1996, he was Executive Vice President of
MIS at Merck/Medco. From 1988 to 1993, Mr. Goh was Senior Vice President, Head
of GeoService Technology and Senior Vice President, Head of Retail
- --------------------------------------------------------------------------------
21
<PAGE>
Operations Division for Chemical Banking Corporation, New York. From 1970 to
1988 he held several senior executive positions at Citibank, N.A., New York,
including several of Citicorp's information business subsidiaries. Mr. Goh has a
B.A. from Southhampton College of Long Island University, an M.A. in Economics
from the New School for Social Research, New York, and an AMP from Harvard
University Business School.
Mr. Kaffer was elected to the Board in 1998. He has served with Theodore
Barry & Associates for 25 years, most recently as Managing Director. He was
employed by IBM from 1956 to 1974 in a variety of sales, marketing, planning and
general management positions. From 1947 to 1952 he was employed as a sales
engineer by Johnson Service Company (now Johnson Controls) and as a field
engineer for the architects, Voorhees, Walker, Foley & Smith. He received his
B.M.E. from Marquette University.
Dr. Lonergan was elected to the Board in 1998. Dr. Lonergan has over 30
years experience in senior management, project management, technical and
financial management, and marketing of contract research and consulting
engineering services. From 1969 to 1998 he was Division Manager, Group Manager,
Deputy Sector Manager and Senior Vice President at SAIC, where he organized
corporate marketing activities in a number of business areas, including nuclear
power and waste management, environmental and permitting, marine science, and
geotechnology. Dr. Lonergan holds a B.S. from Santa Clara University and a M.S.
and Ph.D. from the University of Arizona.
Mr. Tendler was elected to the Board in September 1997. Mr. Tendler has
been a partner in the international consulting firm of Tendler Beretz LLC since
January 1985. Prior to forming Tendler Beretz LLC, Mr. Tendler served as Co-
Chairman and Chief Executive Officer of Phibro-Salomon, Inc., currently known as
Salomon, Inc. Mr. Tendler has almost forty years of experience in the commodity
and investment banking industries, including twenty years in senior executive
positions. Mr. Tendler serves as Chairman of V.I. Technologies, Inc. and as a
director of Bio-Technology General Corporation. Mr. Tendler has also served on
the Boards of various philanthropic organizations. Mr. Tendler holds a B.B.A.
from City College of New York.
The Company's Certificate of Incorporation provides that the Board of
Directors is divided into three classes. Each class of directors consists of one
or two directors, who will serve for a one, two or three year period or until
their successors are elected and qualified. Thereafter, directors will serve
staggered three year terms. The Class I directors, whose terms will end in 2001,
are Mr. Beretz and Mr. Goh; the Class II directors, whose terms will end in
1999, are Mr. Tendler and Mr. Lonergan; and the Class III directors, whose terms
will end in 2000, are Mr. Whalen and Mr. Kaffer.
Officers are elected by and serve at the discretion of the Board of
Directors. There are no family relationships among the directors or officers of
the Company.
Section 16(a) Beneficial Ownership Reporting Compliance. Section 16(a) of
the Securities Exchange Act of 1934 (the "Exchange Act") requires the Company's
directors and executive officers, and persons who own more than ten percent of a
registered class of the Company's equity securities to file with the Securities
and Exchange Commission (the "SEC") initial reports of ownership and reports of
changes in ownership of Common Stock and other equity securities of the Company.
Officers, directors and greater than ten percent shareholders are required by
SEC regulation to furnish the Company with copies of all Section 16(a) reports
they file.
With the exception of the inadvertent failure to timely file initial Form
3S by Messrs. Beretz, Frigon, Goh, Tendler, Vukmanic, Whalen, Wooten and Witt
and by Ms. Hessler, which failures were subsequently corrected within a few days
to the Company's knowledge, based solely upon review of the copies of such
reports furnished to the Company and written representations that no other
reports were required, during the fiscal year ended December 31, 1998, all
- --------------------------------------------------------------------------------
22
<PAGE>
Section 16(a) filing requirements applicable to its officers, directors and
greater than ten percent beneficial owners were timely met.
ITEM 10. EXECUTIVE COMPENSATION.
- -------------------------------
The following table sets forth the compensation paid by the Company during
the fiscal year ended December 31, 1998 to the Company's Chief Executive Officer
and the other executive officer of the Company who received total salary and
bonus in excess of $100,000 during the year ended December 31, 1998.
Summary Compensation Table
--------------------------
<TABLE>
<CAPTION>
Long-Term
Compensation
------------
Name and Principal Position Year Annual Compensation Securities
- ---------------------------- ---- ------------------- Underlying All other
Salary Bonus Options Compensation
------ ----- ---------- ------------
<S> <C> <C> <C> <C>
John Anthony Whalen, Jr. 1998 $150,000 $0 100,000 $0
President and CEO 1997 $ 12,500 $0 62,000 $0
Clyde Wooten 1998 $120,000 $0 91,800 $0
Senior Vice President, 1997(1)
Operations and CTO
</TABLE>
(1) Information is not required.
The following table sets forth, as to the Company's Chief Executive Officer
and the other executive officer of the Company who received total salary and
bonus in excess of $100,000 during the year ended December 31, 1998 ,
information concerning stock options granted during the fiscal year ended
December 31, 1998.
Option Grants in Last Fiscal Year
---------------------------------
<TABLE>
<CAPTION>
Individual Grants
------------------------------------------------------
Potential Realization
Value
at Assumed Annual Rates
Number of Percent of of Stock Purchase
Securities Total Options Appreciation for
Underlying Granted to Exercise Option Term/1/
Options Employees in Price Per Expiration -----------------------
Name Granted Fiscal Year Share Date 5% 10%
- --------------------------- ------------- --------------- --------- ------------ ----------- --------
<S> <C> <C> <C> <C> <C> <C>
John Anthony Whalen, Jr. 100,000 8% $1.31 12/17/08 $82,149 $208,183
Clyde Wooten 91,800 7% $1.19 12/17/08 $68,557 $173,738
</TABLE>
______________________________
/1/ The 5% and 10% assumed compounded annual rates of stock price appreciation
are mandated by rules of the Securities and Exchange Commission. There can be no
assurance that the actual stock price appreciation over the ten-year option term
will be at the assumed 5% and 10% levels or at any other defined level. Unless
the market price of the Common Stock appreciates over the option term, no value
will be realized from the option grants.
- --------------------------------------------------------------------------------
23
<PAGE>
Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option
--------------------------------------------------------------------------
Values.
- ------
The following table sets forth, as to the Company's Chief Executive Officer
and the other executive officer of the Company who received total salary and
bonus in excess of $100,000 during the year ended December 31, 1998, certain
stock option information concerning the number of shares subject to both
exercisable and unexercisable stock options and the value of unexercised options
as of December 31, 1998. No options were exercised by the named individuals
during the fiscal year ended December 31, 1998.
<TABLE>
<CAPTION>
Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money Options
Options at Fiscal Year End at Fiscal Year End ($)/1/
------------------------------------------ -----------------------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
- ---------- --------------- ---------------- ------------------- ----------------
<S> <C> <C> <C> <C>
John Anthony Whalen, Jr. 31,000 131,000 $ ---- $19,000
Clyde Wooten 27,000 118,800 $ ---- $28,458
</TABLE>
_________________________
/1/ Based on the difference between the closing price of the Company's Common
Stock on the Nasdaq SmallCap Market on the last trading day of fiscal 1998,
which was $1.50 per share and the exercise price.
A
STOCK PLANS
1997 Stock Option Plan. In January 1998, the Company's Board of Directors
and stockholders approved the 1997 Stock Option Plan which had an initial share
reserve of 82,500 shares of Common Stock (the "Option Plan"). Under the Option
Plan, options may be granted to employees, including officers, consultants,
advisors and directors, although only employees and directors and officers who
are also employees may receive "incentive stock options" intended to qualify for
certain tax treatment. The exercise price of all nonqualified stock options must
equal at least 85% of the fair market value of the Common Stock on the date of
grant, and the exercise price of incentive stock options must be no less than
the fair market value on the date of grant. Options granted under the Option
Plan are generally immediately exercisable, vest over periods ranging from one
to four years and must be exercised within ten years.
In June 1998, the Company's stockholders approved an amendment to the
Option Plan to (a) increase by 2,650,000 the maximum number of shares of the
Company's Common Stock reserved for issuance under the Option Plan, (b) increase
the limit on the number of share issuable on exercise of outstanding options
under the Option Plan to no more than 90% of the outstanding shares of the
Company's Common Stock, and (c) to limit to 100,000 the maximum number of shares
for which options may be granted to any employee in any fiscal year.
Prior to the adoption of the Option Plan, during the period from June 1997
through December 1997, the Company granted nonqualified options to purchase an
aggregate of 625,000 shares of the Company's Common Stock, at exercise prices
ranging from $2.50 to $5.40 per share, to employees, consultants and directors
of the Company. These options vest over periods ranging from one to four years,
are exercisable at various dates and expire five to ten years from the date of
grant, or earlier in the even of termination of employment, directorship or
consulting engagement.
At December 31, 1998, the Company had outstanding options to purchase an
aggregate of 1,590,305 shares of the Company's common stock with an average
exercise price of $3.03 per share.
- --------------------------------------------------------------------------------
24
<PAGE>
COMPENSATION OF DIRECTORS
Directors of the Company who are not employees of the Company do not
receive any compensation for attending meetings of the Board of Directors,
although directors are reimbursed for their expenses in attending such meetings.
From time to time, directors have received grants of options to purchase the
Company's Common Stock. The Company does not pay additional amounts for
committee participation or special assignments of the Board of Directors. The
Company has agreed to pay to Messrs. Beretz, Goh, Kaffer, Lonergan and Tendler,
certain referral fees based on sales by the Company to customers introduced to
the Company by such director. See "Certain Transactions."
LIMITATION OF LIABILITY AND INDEMNIFICATION
Pursuant to the provisions of the Delaware General Corporation Law, the
Company has adopted provisions in its Certificate of Incorporation which provide
that directors of the Company shall not be personally liable for monetary
damages to the Company or its stockholders for a breach of fiduciary duty as a
director, except for liability as a result of (i) a breach of the director's
duty of loyalty to the Company or its stockholders; (ii) acts or omissions not
in good faith or which involve intentional misconduct or knowing violation of
law; (iii) an act related to the unlawful stock repurchase or payment of a
dividend under Section 174 of Delaware General Corporation Law; and (iv)
transactions from which the director derived an improper personal benefit. Such
limitation of liability does not affect the availability of equitable remedies
such as injunctive relief or rescission.
The Company's Certificate of Incorporation also authorizes the Company to
indemnify its officers, directors and other agents, by bylaws, agreements or
otherwise, to the full extent permitted under Delaware law. The Company has
entered into separate indemnification agreements with its directors and officers
which may, in some cases, be broader than the specific indemnification
provisions contained in the Delaware General Corporation Law. The
indemnification agreements require the Company, among other things, to indemnify
such officers and directors against certain liabilities that may arise by reason
of their status or service as directors or officers (other than liabilities
arising from willful misconduct of a culpable nature), to advance their expenses
incurred as a result of any proceeding against them as to which they could be
indemnified, and to obtain directors' and officers' insurance if available on
reasonable terms.
At present, there is no pending litigation or proceeding involving a
director, officer, employee or agent of the Company where indemnification will
be required or permitted. The Company is not aware of any threatened litigation
or proceeding which may result in a claim for such indemnification.
- --------------------------------------------------------------------------------
25
<PAGE>
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
- -----------------------------------------------------------------------
The following table sets forth certain information regarding the beneficial
ownership of the Company's capital stock as of March 1, 1999, (i) by each person
who is known by the Company to own beneficially more than 5% of the Company's
capital stock, (ii) by each of the executive officers named in the tables under
"Executive Compensation" and by each of the Company's directors, and (iii) by
all officers and directors as a group.
<TABLE>
<CAPTION>
Number of
Shares Beneficially Percentage
Beneficial Owner Owned (1) Beneficially Owned(2)
---------------------- ----------------- ---------------------
<S> <C> <C>
John Anthony Whalen, Jr. (3) 1,530,305 42.2%
Clyde Wooten (4) 396,433 11.0%
Frank Vukmanic (5) 333,333 9.4%
Konrad Witt 267,750 7.6%
Hal H. Beretz( 6) 36,458 1.0%
David Tendler (10) 36,458 1.0%
Kim P. Goh (7) 31,615 *
William J. Kaffer (8) 7,292 *
James A. Lonergan (9) 7,292 *
All directors and executive 2,102,409 54.4%
officers as a group (9 persons)
</TABLE>
__________________________________________
* Represents less than one percent.
(1) Except pursuant to applicable community property laws or as otherwise
noted, all shares are beneficially owned and sole voting and investment
power is held by the persons named.
(2) Based on 3,542,171 shares of Common Stock outstanding as of March 1, 1999.
(3) Includes 81,289 shares subject to options exercisable within 60 days of
March 1, 1999. Includes 266,666 held indirectly by Mr. Whalen as Trustee
for the benefit of certain family members.
(4) Includes 63,600 shares subject to options exercisable within 60 days of
March 1, 1999.
(5) Mr. Vukmanic was formerly the Senior Vice President, Sales and Marketing,
of the Company.
(6) Includes 36,458 shares subject to options exercisable within 60 days of
March 1, 1999.
(7) Includes 31,615 shares subject to options exercisable within 60 days of
March 1, 1999.
(8) Includes 7,292 shares subject to options exercisable within 60 days of
March 1, 1999.
(9) Includes 7,292 shares subject to options exercisable within 60 days of
March 1, 1999.
- --------------------------------------------------------------------------------
26
<PAGE>
(10) Includes 36,458 shares subject to options exercisable within 60 days of
March 1, 1999.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
- --------------------------------------------------------
During the period from January 1, 1997 to September 30, 1997, the limited
liability company that was the predecessor to the Company sold Owner Units to
certain of its officers, directors and holders of 5% of the outstanding equity
of the Company, as described below.
In June 1997, the Company issued 666,666 Owner Units to John A. Whalen,
Jr., for cash consideration of $.15 per Owner Unit, for total cash consideration
of $100,000.
In June 1997, the Company issued 333,333 Owner Units to Frank J. Vukmanic,
former Senior Vice President, Sales and Marketing for $.15 per Owner Unit, for
total consideration of $50,000. Mr. Vukmanic gave the Company a noninterest
bearing, 90 day promissory note as consideration for these Owner Units. Mr.
Vukmanic paid this promissory note in full in August, 1997.
In June 1997, the Company issued 333,333 Owner Units to Clyde Wooten,
Senior Vice President, Operations and Chief Technology Officer for $.15 per
Owner Unit, for total consideration of $50,000. Mr. Wooten gave the Company a
noninterest bearing 90 day promissory note as consideration for these Owner
Units. Mr. Wooten paid this promissory note in full in September, 1997.
In July, August and September 1997, the Company agreed to pay to each of
David Tendler, Hal Beretz and Kim Goh, directors of the Company, referral fees
of four and one-half percent for sales by the Company that are consummated
without the Company participating in a "Request for Proposal" process (an "RFP")
with a customer, provided the engagement of the Company by the customer resulted
from an introduction by the director, and two percent of sales by the Company
that are consummated following the participation in an RFP with a customer, if
the entrance of the Company in the RFP resulted from an introduction by the
director. These referral fees are payable by the Company on all revenue
generated from such customers during the period that the director serves as a
director. In December 1998, the Company entered into similar agreements with
each of James A. Lonergan and William J. Kaffer. Such fees are payable within 30
days after receipt of payment from the customer. No such fees were paid to or
earned by any of these directors as of December 31, 1997. Fees totaling $5,443
were earned by Messrs, Tendler and Beretz during the year ended December 31,
1998, which fees were outstanding as of that date.
Also in August 1997, the Company issued to each of Messrs. Tendler and
Beretz options to purchase 87,500 Owner Units of the Company at an exercise
price of $2.50 per share. In August, Mr. Goh was granted options to purchase
10,000 Owner Units of the Company, and in November 1997, he was granted options
to purchase an additional 77,500 shares of Common Stock all at an exercise price
of $2.50 per share. Such options vest in equal monthly amounts over a four year
period, for as long as they remain directors.
- --------------------------------------------------------------------------------
27
<PAGE>
On September 30, 1997, the Company exchanged each Owner Unit for one share
of its Common Stock, and converted options to acquire Owner Units to options to
acquire Common Stock, in connection with its reorganization from a California
LLC to a Delaware corporation.
In December 1998, the Company issued to each of Messrs Lonergan and Kaffer
options to purchase 87,500 shares of Common Stock of the Company at an exercise
price of $1.38 per share. Such options vest in equal monthly amounts over a four
year period, for as long as they remain directors.
The Company believes that all transactions with affiliates described above
were made on terms no less favorable to the Company than could have been
obtained from unaffiliated third parties. The Company intends to submit all
future transactions, including loans, between the Company and affiliates of the
Company, to the Company's Board of Directors for approval by its disinterested
members, to ensure that such future transactions are for a bona fide business
purpose and on terms no less favorable to the Company than could be obtained
from independent parties. The Company intends to maintain at least two
independent directors on its Board of Directors.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
- -----------------------------------------
(a) Exhibits.
Exhibit
Number Description of Document
------ -----------------------
3.1* Certificate of Incorporation (previously filed as an exhibit to
C2i's Quarterly Report on Form 10-QSB filed on May 15, 1998).
3.2* Bylaws
4.1* Form of Warrant Agreement between C2i and the Warrant Agent,
including the form of Warrants
4.2* Form of Representative Warrant
10.1* Form of Indemnity Agreement for officers and directors
10.2* Form of Stock Option Plan and Agreements thereunder
10.3 Amendment to the C2i Solutions, Inc. 1997 Stock Option Plan
10.4* Form of Bridge Note and accompanying Bridge Warrant
10.5* Employment Agreement dated June 1, 1997 between C2i and John
Anthony Whalen, Jr.
10.6* Letter Agreement dated August 4, 1997 between C2i, David Tendler
and Hal Beretz
10.7* Letter Agreement dated August 20, 1997 between C2i and Kim P. Goh
10.8* Letter Agreement dated November 3, 1997 between C2i and Kim P. Goh
10.9* Sublease Agreement dated December 16, 1997 between C2i and Road
Runner Sports, Inc. (previously filed as an exhibit to C2i's
Annual Report on Form 10-KSB for the year ended December 31,
1997.)
10.10* Master Services Agreement dated January 16, 1998 by and between
C2i and United Guaranty Corporation (previously filed as an
exhibit to C2i's Annual Report on Form 10-KSB for the year ended
December 31, 1997.)
10.11* Letter Agreement dated May 1998 by and between C2i and Henry J.
Frigon (previously filed as an exhibit to C2i's Quarterly Report
on Form 10-QSB filed on November 13, 1998.)
10.12* Amendment to Employment Agreement dated July 14, 1998 by and
between C2i and Diane E. Hessler
- --------------------------------------------------------------------------------
28
<PAGE>
Exhibit
Number Description of Document
------ -----------------------
(previously filed as an exhibit to C2i's Quarterly Report on Form
10-QSB filed on November 13, 1998.)
10.13* Letter Agreement dated December, 1998 by and between C2i and James
A. Lonergan
10.14* Letter Agreement dated December, 1998 by and between C2i and
William J. Kaffer
23.1 Consent of Ernst & Young LLP, Independent Auditors
27.1 Financial Data Schedule
________________
*Previously filed. Unless otherwise indicated, all previously filed
exhibits were filed as exhibits to the Company's Registration Statement on Form
SB-2, as amended, initially filed on November 4, 1997.
(b) Reports on Form 8-K.
On December 31, 1998, the Company filed a Current Report on Form 8-K to report
its exercise of its right, pursuant to the Warrant Agreement dated February 24,
1998, by and between the Company and American Stock Transfer & Trust Company,
the warrant agent for the Redeemable Warrants of the Company, to reduce the
purchase price to be paid upon exercise of its outstanding Redeemable Warrants
from $7.50 to $2.00 per Redeemable Warrant. Subject to compliance with
applicable federal and state securities laws, each of the Company's outstanding
Redeemable Warrants may be exercised by the registered holder thereof to
purchase one share of the Common Stock of the Company until the earlier of (i)
February 24, 2003, or (ii) the date the outstanding Redeemable Warrants are
redeemed by the Company.
- --------------------------------------------------------------------------------
29
<PAGE>
C2i Solutions, Inc.
(a development stage company)
Index to Financial Statements
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Ernst & Young LLP, Independent Auditors........................................... F-2
Balance Sheets as of December 31, 1997 and 1998............................................. F-3
Statements of Operations for the years ending December 31, 1997 and 1998 and for the
period from Inception (September 17, 1996) through December 31, 1998........................ F-4
Statements of Stockholders' Equity (Deficit) for the periods ended December 31, 1996,
1997 and 1998............................................................................... F-5
Statements of Cash Flows for the years ended December 31, 1997 and 1998 and for the period
from Inception (September 17, 1996) through December 31, 1998............................... F-6
Notes to Financial Statements............................................................... F-7
</TABLE>
F-1
- --------------------------------------------------------------------------------
30
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
THE BOARD OF DIRECTORS AND STOCKHOLDERS
C2i SOLUTIONS, INC.
We have audited the accompanying balance sheets of C2i Solutions, Inc. (a
development stage company) as of December 31, 1997 and 1998, and the related
statements of operations, stockholders' equity (deficit), and cash flows for the
years ended December 31, 1997 and 1998 and for the period from Inception
(September 17, 1996) through December 31, 1998. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on the 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 C2i Solutions, Inc. at December
31, 1997 and 1998, and the results of its operations and its cash flows for the
years ended December 31, 1997 and 1998 and for the period from Inception
(September 17, 1996) through December 31, 1998, in conformity with generally
accepted accounting principles.
The accompanying financial statements have been prepared assuming the Company
will continue as a going concern. As more fully described in Note 1, the
Company has incurred recurring operating losses and has limited working capital.
These conditions raise substantial doubt about the Company's ability to continue
as a going concern. The accompanying financial statements do not include any
adjustments to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classification of liabilities that
may result from the outcome of this uncertainty.
ERNST & YOUNG LLP
San Diego, California
February 19, 1999
F-2
- --------------------------------------------------------------------------------
31
<PAGE>
C2I SOLUTIONS, INC.
(A DEVELOPMENT STAGE COMPANY)
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1997 1998
------------- -------------
<S> <C> <C>
ASSETS
Current assets:
Cash $ 298,823 $ 135,954
Short-term investment ---- 2,229,247
Accounts receivable ---- 116,805
Prepaid expenses and other 40,702 69,475
----------- -----------
Total current assets 339,525 2,551,481
Property and equipment, net 64,065 117,534
Deferred offering costs 259,906 ----
Deferred finance charges, net 24,412 ----
Other assets, net 2,775 54,379
----------- -----------
Total assets $ 690,683 $ 2,723,394
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Bridge notes payable, net $ 438,397 $ ----
Bridge notes payable to employees, net 63,301 ----
Current portion of capital lease obligations 5,326 6,110
Accounts payable 247,942 136,401
Accrued payroll and related 59,276 35,455
Accrued interest payable (including $1,577 to employees) 12,500 ----
Accrued royalty due to former stockholder 1,345 ----
Other current liabilities 3,026 28,876
----------- -----------
Total current liabilities 831,113 206,842
----------- -----------
Capital lease obligations, net of current portion 12,251 6,146
----------- -----------
Commitments
Stockholders' equity (deficit):
Preferred Stock - $.001 par value; 1,000,000 shares
authorized; no shares issued and outstanding ---- ----
Common Stock - $.001 par value; 10,000,000 shares
authorized; 2,391,338 and 3,542,171 shares issued
and outstanding in 1997 and 1998, respectively 2,391 3,542
Additional paid-in capital 1,910,516 7,466,970
Warrants to acquire common stock 108,000 223,100
Deficit accumulated during the development stage (1,850,776) (4,953,906)
Deferred compensation (322,812) (229,300)
----------- -----------
Total stockholders' equity (deficit) (152,681) 2,510,406
----------- -----------
Total liabilities and stockholders' equity (deficit) $ 690,683 $ 2,723,394
=========== ===========
</TABLE>
See accompanying notes.
F-3
- --------------------------------------------------------------------------------
32
<PAGE>
C2I SOLUTIONS, INC.
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION
(SEPTEMBER 17,
YEAR ENDED YEAR ENDED 1996) THROUGH
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1997 1998 1998
------------ ------------ --------------
<S> <C> <C> <C>
Revenues:
Products $ 32,250 $ 76,800 $ 118,848
Services 47,033 573,017 620,050
-------------- -------------- --------------
Total revenues 79,283 649,817 738,898
-------------- -------------- --------------
Cost of revenues:
Products:
Customers 10,613 54,239 64,852
Former stockholder 11,352 --- 17,652
Services 24,929 242,446 267,375
-------------- -------------- --------------
Total cost of revenues 46,894 296,685 349,879
-------------- -------------- --------------
Gross profit 32,389 353,132 389,019
Selling, general and administrative expenses 1,810,623 2,874,866 4,733,325
-------------- -------------- --------------
Operating loss (1,778,234) (2,521,734) (4,344,306)
Interest and dividend income ---- (220,728) (220,728)
Interest expense 21,699 21,827 43,526
Interest expense to employees 3,105 --- 3,105
Loss realized on sale of short-term investments --- 654,761 654,761
Other expense --- 120,196 120,196
-------------- -------------- --------------
Loss before income taxes (1,803,038) (3,097,790) (4,945,166)
Provision for income taxes 3,400 5,340 8,740
-------------- -------------- --------------
Net loss $ (1,806,438) $ (3,103,130) $ (4,953,906)
============== ============== ==============
Loss per share (basic and diluted) $ (1.03) $ (0.92)
============== ==============
Shares used in computing loss per share 1,753,141 3,360,493
============== ==============
</TABLE>
See accompanying notes.
F-4
- --------------------------------------------------------------------------------
33
<PAGE>
C2I SOLUTIONS, INC.
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
COMMON STOCK
----------------------------- WARRANTS
ADDITIONAL TO ACQUIRE
SHARES Amount PAID-IN CAPITAL COMMON STOCK
------------ ------------ ------------------- --------------
<S> <C> <C> <C> <C>
Balance at Inception, September 17, 1996 ---- $ ---- $ ---- $ ----
Issuance of common stock for cash and
capital subscriptions receivable 1,050,000 1,050 156,450 ----
Net loss and comprehensive loss ---- ---- ---- ----
--------- -------- ---------- --------
Balance at December 31, 1996 1,050,000 1,050 156,450 ----
Issuance of common stock for cash and
capital subscriptions receivable 1,333,332 1,333 1,398,666 ----
Issuance of common stock for services
rendered 8,006 8 9,075 ----
Deferred compensation ---- ---- 346,325 ----
Issuance of warrants ---- ---- ---- 108,000
Net loss and comprehensive loss ---- ---- ---- ----
--------- -------- ---------- --------
Balance at December 31, 1997 2,391,338 2,391 1,910,516 108,000
Issuance of common stock and warrants 1,150,000 1,150 5,556,157 115,100
Exercise of common stock options 833 1 2,082 ----
Deferred compensation ---- ---- (1,785) ----
Net loss and comprehensive loss ---- ---- ---- ----
--------- -------- ---------- --------
Balance at December 31, 1998 3,542,171 $3,542 $7,466,970 $223,100
========= ======== ========== ========
</TABLE>
<TABLE>
<CAPTION>
DEFICIT
ACCUMULATED TOTAL
DURING THE STOCKHOLDERS'
DEVELOPMENT DEFERRED EQUITY
STAGE COMPENSATION (DEFICIT)
--------------- ----------------- ------------
<S> <C> <C> <C>
Balance at Inception, September 17, 1996 $ ---- $ ---- $ ----
Issuance of common stock for cash and
capital subscriptions receivable ---- ---- 157,500
Net loss and comprehensive loss (44,338) ---- (44,338)
----------- --------- ----------
Balance at December 31, 1996 (44,338) ---- 113,162
Issuance of common stock for cash and
capital subscriptions receivable ---- ---- 1,399,999
Issuance of common stock for services
rendered ---- ---- 9,083
Deferred compensation ---- (322,812) 23,513
Issuance of warrants ---- ---- 108,000
Net loss and comprehensive loss (1,806,438) ---- (1,806,438)
----------- --------- ----------
Balance at December 31, 1997 (1,850,776) (322,812) (152,681)
Issuance of common stock and warrants ---- ---- 5,672,407
Exercise of common stock options ---- ---- 2,083
Deferred compensation ---- 93,512 91,727
Net loss and comprehensive loss (3,103,130) ---- (3,103,130)
----------- --------- -----------
Balance at December 31, 1998 $(4,953,906) $(229,300) $ 2,510,406
=========== ========= ===========
</TABLE>
See accompanying notes.
F-5
- -------------------------------------------------------------------------------
34
<PAGE>
C2I SOLUTIONS, INC.
(A DEVELOPMENT STAGE COMPANY)
STATMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION
(SEPTEMBER 17,
YEAR ENDED YEAR ENDED 1996) THROUGH
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1997 1998 1998
------------- ---------------- -------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net loss $(1,806,438) $(3,103,130) $(4,953,906)
Adjustments to reconcile net loss to net cash
used for operating activities:
Depreciation and amortization 24,556 86,333 115,107
Amortization of deferred compensation 23,513 91,727 115,240
Non-cash compensation and other expenses 1,198,370 111,950 1,310,320
Loss realized on sale of short-term
investments ---- 654,761 654,761
Changes in operating assets and liabilities:
Accounts receivable 9,797 (116,805) (116,805)
Prepaid expenses and other (38,879) (28,773) (69,475)
Accounts payable 244,987 (111,541) 136,401
Accrued payroll and related 58,134 (23,821) 35,455
Accrued interest payable 12,500 (12,500) ---
Accrued royalty due to former stockholder (4,955) (1,345) ---
Other current liabilities 3,026 25,850 28,876
----------- ----------- ------------
Net cash used for operating activities (275,389) (2,427,294) (2,744,026)
----------- ----------- ------------
INVESTING ACTIVITIES
Purchases of short-term investments --- (4,000,000) (4,000,000)
Proceeds from sales of short-term investments --- 1,115,992 1,115,992
Purchases of property and equipment, net (39,400) (129,038) (190,071)
Other assets (2,805) (51,604) (55,804)
----------- ----------- ------------
Net cash used for investing activities (42,205) (3,064,650) (3,129,883)
----------- ----------- ------------
FINANCING ACTIVITIES
Proceeds from initial public offerings, net of
deferred offering costs (259,906) 5,932,313 5,672,407
Proceeds from issuance of common stock 200,000 2,083 262,083
Proceeds from issuance of Bridge Notes and warrants 600,000 --- 600,000
Repayment of Bridge Notes payable ---- (600,000) (600,000)
Repayment of capital lease obligations (698) (5,321) (6,019)
Deferred finance charges (26,820) --- (26,820)
Advance from former stockholder 586 --- 45,586
Repayment of advance from former stockholder (10,712) --- (34,874)
Collection of capital subscriptions receivable from stockholders 97,500 --- 97,500
------------- ------------ -------------
Net cash provided by financing activities 599,950 5,329,075 6,009,863
------------- ------------ -------------
Net increase in cash 282,356 (162,869) 135,954
Cash at beginning of period 16,467 298,823 ----
-------------- ------------ --------------
Cash at end of period $ 298,823 $ 135,954 $ 135,954
============== ============ ==============
SUPPLEMENTAL DISCLOSURES NON-CASH FINANCING
ACTIVITIES:
Capital subscriptions receivable from
stockholders $ 100,000 $ --- $ 197,500
Equipment acquired under capital lease
obligations 18,276 --- 18,276
OTHER CASH FLOW INFORMATION:
Interest paid 198 23,563 23,761
Income taxes paid 2,400 1,824 4,224
</TABLE>
See accompanying notes.
F-6
- --------------------------------------------------------------------------------
35
<PAGE>
C2I SOLUTIONS, INC.
(A DEVELOPMENT STAGE COMPANY)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
- -----------------------
C2i Solutions, Inc. (the "Company") was incorporated in the State of Delaware on
September 30, 1997. The Company was initially organized as a California limited
liability company under the name of Challenge 2000 International, LLC ("LLC") on
September 17, 1996 ("Inception"). From Inception through September 30, 1997,
the Company operated under the name of the LLC. On September 30, 1997, the
Company reorganized as a Delaware corporation and changed its name to C2i
Solutions, Inc. On September 30, 1997, all LLC Owner Units were converted into
2,391,338 shares of the Delaware corporation's common stock and all Owner
options were converted into options to acquire 547,500 shares of common stock.
Concurrent with the formation of the Delaware corporation, the LLC was
dissolved.
The accompanying financial statements have been adjusted to give retroactive
effect to the reorganization and capital structure of the Delaware corporation
from Inception.
The Company is a provider of information technology consulting services. Its
consulting solutions span a wide variety of platforms, languages and services,
from client-server to mainframe, from assessment and remediation, to testing and
re-implementation. The Company's approach utilizes a mix of hands-on work by
highly experienced technical staff along with "best of breed" tools, and focused
project management. The desired result for the Company's clients is reduced
project cycle time, lower costs and improved productivity.
Basis of Presentation
- ---------------------
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. This basis of accounting contemplates
the recovery of the Company's assets and the satisfaction of its liabilities in
the normal course of conducting business. Since Inception, the Company has been
primarily engaged in organizational activities, including raising capital,
recruiting personnel, and the marketing of its products and services. As of
December 31, 1998, the Company has not realized significant revenues and
therefore, is considered to be in the development stage.
The Company's ability to transition from the development stage, and ultimately
to attain profitable operations, is dependent upon its ability to raise
additional capital through debt or equity financing and the successful market
acceptance of its products and services. There can be no assurances that the
Company's products and services or its efforts to raise additional capital will
be successful. The accompanying financial statements do not include any
adjustments to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classification of liabilities that
may result from the outcome of this uncertainty.
Fiscal Year End
- ---------------
The Company's fiscal year end is December 31.
Fair Value of Financial Instruments
- -----------------------------------
Pursuant to Statement of Financial Accounting Standards (SFAS) No. 107,
"Disclosures about Fair Value of Financial Instruments," the Company is required
to estimate fair value of all financial instruments included on its balance
sheets at December 31, 1997 and 1998. The Company's financial instruments
consist of cash, short-term investments, accounts receivable, accounts payable,
accrued expenses and other current liabilities, capital lease obligations and
Bridge Notes payable, (none of which are held or issued for trading purposes).
The carrying amounts of these instruments at December 31, 1997 and 1998, except
for short-term investments (See Note 2) approximate their fair values because of
the relatively short maturity of these instruments.
F-7
- --------------------------------------------------------------------------------
36
<PAGE>
C2I SOLUTIONS, INC.
(A DEVELOPMENT STAGE COMPANY)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Comprehensive Income (Loss)
- ---------------------------
Pursuant to Statement of Financial Accounting Standards (SFAS) No. 130,
"Reporting Comprehensive Income," the Company has reported comprehensive loss
in the Statements of Stockholders' Equity (Deficit). Comprehensive income
(loss) is defined as the change in stockholders' equity during a period
resulting from transactions and other events and circumstances from non-owner
sources. For the years ended December 31, 1997 and 1998 the Company did not have
any components of comprehensive income (loss) as defined in SFAS No. 130.
Concentration of Credit Risk
- ----------------------------
Financial instruments which potentially expose the Company to concentrations of
credit risk include short-term investments and accounts receivable. Credit is
extended based on an evaluation of the customer's financial condition and
generally, collateral is not required. The Company from time to time maintains
a substantial portion of its short-term investments in money market accounts
with one financial institution. The Company invests its excess cash in a mutual
fund that holds debt instruments of corporations. The Company has established
guidelines relative to diversification and maturities that attempt to maintain
safety and liquidity. In 1998, the Company experienced realized and unrealized
losses on its short-term investments. (Note 2)
Significant Customers
- ---------------------
Revenue from three domestic customers accounted for 62%, 19% and 10%,
respectively, of the Company's total revenue for the year ended December 31,
1997, none of which was outstanding at December 31, 1997. Revenue from two
domestic customers accounted for 73% and 19%, respectively of the Company's
total revenue for the year ended December 31, 1998. At December 31, 1998, 68% of
the total accounts receivable balance relates to the Company's largest customer;
one other customer represents 32% of the total accounts receivable balance.
Significant Suppliers
- ---------------------
Purchases from three suppliers, one of whom is a former stockholder, accounted
for 60%, 24% and 15% of the Company's total cost of revenues for the year ended
December 31, 1997. At December 31, 1997, $1,345 of these costs were outstanding
and have been included in accrued royalty due to former stockholder in the
accompanying balance sheets.
Purchases from two suppliers accounted for 21% and 11% of the Company's total
cost of revenues for the year ended December 31, 1998. At December 31, 1998,
$10,308 of these costs were outstanding and have been included in accounts
payable in the accompanying balance sheets.
Cash and Cash Equivalents
- -------------------------
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalent.
Short-Term Investments
- ----------------------
Short-term investments are accounted for in accordance with SFAS No. 115,
"Accounting for Certain Investments in Debt and Equity Securities." Management
determines the appropriate classification of such securities at the time of
purchase and reevaluates such classification as of each balance sheet date.
Based on its intent, the Company's investments are classified as available-for-
sale and are carried at fair value, with unrealized holding gains and losses,
net of tax, included in accumulated other comprehensive income (loss) in
stockholders' equity.
F-8
- --------------------------------------------------------------------------------
37
<PAGE>
C2I SOLUTIONS, INC.
(A DEVELOPMENT STAGE COMPANY)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Realized gains and losses and declines in value judged to be other than
temporary are determined based on the specific identification method and are
reported in the statements of operations.
Property and Equipment
- ----------------------
Property and equipment are stated at cost. Equipment under capital leases is
stated at the present value of future minimum lease payments at the inception of
the lease. Depreciation and amortization are calculated using the straight-line
method over the estimated useful lives or lease terms of the property and
equipment which range from three to seven years. Leasehold improvements are
amortized over the shorter of their estimated useful life or the term of the
underlying lease agreement, which is six months.
Deferred Offering Costs
- -----------------------
The Company has deferred certain legal, accounting, and other costs incurred
during 1997 associated with its initial public offering. These items are stated
at cost and were netted with the proceeds of the offering upon its completion,
in February 1998 (See Note 5).
Deferred Finance Charges
- ------------------------
The Company incurred certain costs totaling $26,820 in 1997, in connection with
a Bridge Financing, which it has capitalized. These charges were stated at
cost, and were being charged to expense using the interest method over the term
of the Bridge Notes (approximately 24 months). Amortization expense was $2,408,
$2,141 and $4,549 for the years ended December 31, 1997 and 1998, and for the
period from Inception (September 17, 1996) through December 31, 1998,
respectively, and has been included in interest expense in the accompanying
statements of operations. Accumulated amortization totaled $2,408 at December
31, 1997. In 1998, in connection with the retirement of the Bridge Notes, the
unamortized deferred finance charge balance of $22,271 was charged to other
expense in the accompanying statements of operations.
Discount on Bridge Notes Payable
- --------------------------------
In 1997, the Company recorded a discount of $108,000 on the Bridge Notes it
issued in connection with a Bridge Financing. This discount was being amortized
using the interest method over the term of the Bridge Notes (approximately 24
months). Amortization expense was $9,698, $8,623 and $18,321 for the years
ended December 31, 1997 and 1998, and for the period from Inception (September
17, 1996) through December 31, 1998, respectively, and has been included in
interest expense in the accompanying statements of operations. Accumulated
amortization totaled $9,698 of December 31, 1997. In 1998, in connection with
the retirement of the Bridge Notes, the unamortized debt discount balance of
$89,679 was charged to other expense in the accompanying statements of
operations.
Use of Estimates
- ----------------
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the balance sheet. Actual
results could differ from those estimates.
F-9
- --------------------------------------------------------------------------------
38
<PAGE>
C2I SOLUTIONS, INC.
(A DEVELOPMENT STAGE COMPANY)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Revenue Recognition
- -------------------
Revenue associated with performance under contracts to provide Year 2000
computer consulting and reengineering services is recognized utilizing the
percentage-of-completion method in the ratio that labor-hours incurred to date
bear to estimated total labor-hours at completion, provided that collection of
the related receivable is probable. Adjustments to contract cost estimates are
made in the periods in which the facts which require such revisions become
known. When the revised estimates indicate a loss, such loss is provided for
currently in its entirety. The costs of providing warranty and follow-on
customer support related to services performed are not significant and have been
accrued.
The Company recognizes revenue from the sale of software and hardware products
upon delivery of the product to the customers when collection is assured.
Revenues on sales of software products to customers which require significant
continued obligation from the Company are deferred until such obligations are no
longer significant.
Accounting for Stock-Based Compensation
- ---------------------------------------
Awards by the Company of stock options are accounted for in accordance with
Accounting Principles Board Opinion No. 25 and related interpretations ("APB
25"). The Company has adopted the disclosure requirements of Statement of
Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based
Compensation" (See Note 5).
Income Taxes
- ------------
Prior to September 30, 1997, the Company elected to be treated as a Limited
Liability Corporation ("LLC") for tax purposes. In lieu of corporate income
taxes, all taxable income or loss of the Company is included in the income tax
returns of the individual stockholders. Accordingly, the accompanying
historical financial statements do not include a provision for federal income
taxes, but reflect a provision for the California minimum franchise tax. On
September 30, 1997, the Company elected to terminate its LLC status and
thereafter become taxable as a "C" corporation.
Effective with its change to a "C" corporation, the Company adopted the
provisions of Statement of Financial Accounting Standards (SFAS) No. 109,
"Accounting for Income Taxes". SFAS No. 109 utilizes the liability method, and
deferred taxes are determined based on the estimated future tax effects of
differences between financial statement and tax bases of assets and liabilities
given the provisions of the enacted tax laws.
Loss Per Share
- --------------
In 1997, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards (SFAS) No. 128, "Earnings per Share". SFAS No. 128
replaced the calculation of primary and fully diluted earnings per share with
basic and diluted earnings per share. Unlike primary earnings per share, basic
earnings per share excludes any dilutive effects of options, warrants and
convertible securities. Diluted earnings per share is very similar to the
previously reported fully diluted earnings per share. Earnings (loss) per share
amounts for all periods presented have been restated to conform to the SFAS 128
requirements.
F-10
- --------------------------------------------------------------------------------
39
<PAGE>
C2i Solutions,Inc.
(a development stage company)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Loss Per Share (continued)
- --------------------------
Year Ended Year Ended
December 31, December 31,
1997 1998
----------------- -----------------
Numerator:
Net loss and numerator for EPS $ (1,806,438) $ (3,103,130)
----------------- -----------------
Denominator:
Weighted average shares and
denominator for EPS 1,753,141 3,360,493
----------------- -----------------
Loss per share (basic and diluted) $ (1.03) $ (0.92)
================= =================
The above calculations do not reflect any potential shares relating to options
or warrants totaling 1,225,000 and 3,540,305 in 1997 and 1998, respectively, due
to the Company's losses for these periods. The assumed issuance of any
additional shares would be anti-dilutive.
New Accounting Standards
- ------------------------
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 131 "Disclosures about Segments of an
Enterprise and Related Information". This standard defines segments of an
enterprise as the components of the company whose operations are reviewed
regularly by the chief operating decision-maker in deciding how to allocate
resources and in assessing performance. It requires disclosures about products
and services, geographic areas and major customers. The Company adopted this
standard during 1998 and determined that it operated in one segment.
Implementation of this standard did not affect the Company's financial position
or results of operations.
2. SHORT-TERM INVESTMENTS
Short-term investments as of December 31, 1998 are summarized as follows:
Gross
Revised Unrealized
Cost Loss Fair Value
---------- ---------- ----------
Mutual Funds $2,229,247 $ - $2,229,247
The Company realized losses of $161,098 on short-term investments during the
year ended December 31, 1998. In addition, the Company included declines in
fair value totaling $493,663 in its statements of operations in 1998 that were
judged to be other than temporary. The Company sold all short-term investments
subsequent to December 31, 1998 and realized additional losses totaling $48,545
on disposition. (See Note 8)
F-11
- -------------------------------------------------------------------------------
40
<PAGE>
C2i Solutions, Inc.
(a development stage company)
3. PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
<TABLE>
<CAPTION>
Estimated
useful lives December 31,
----------------------------------------
(Years) 1997 1998
------------------ ------------------ ------------------
<S> <C> <C> <C>
Equipment 3-7 $ 49,347 $ 98,904
Furniture and fixtures .5-7 29,962 109,443
------------------ ------------------
79,309 208,347
Accumulated depreciation and amortization (15,244) (90,813)
------------------ ------------------
$ 64,065 $117,534
================== ==================
</TABLE>
At December 31, 1997 and 1998 gross equipment under capital leases totaled
$18,276 and $13,983, respectively, with related accumulated depreciation of $834
and $3,760, respectively. This equipment was subject to related capital lease
obligations of $17,577 and $12,256 at December 31, 1997 and 1998, respectively.
(See Note 6).
Depreciation expense was $11,096, $75,569 and $90,813 for the years ended
December 31, 1997 and 1998 and for the period from Inception (September 17,
1996) through December 31, 1998, respectively, including equipment under capital
leases.
4. BRIDGE FINANCING
In October 1997, the Company completed a Bridge Financing in which it sold, to
36 accredited investors, an aggregate of $600,000 face value, unsecured
promissory notes ("Bridge Notes") and 600,000 warrants ("Bridge Warrants") and
received net proceeds of $573,180, after expenses of the offering. For
financial statement purposes, the Bridge Financing has been allocated $108,000
to warrants, $492,000 to Bridge Notes payable and $26,820 to deferred finance
charges (See Notes 1 and 5).
The Bridge Notes were payable, together with interest at the rate of 10% per
annum, on the earlier of September 30, 1999 or the closing of an initial public
offering. The Bridge Warrants entitle the holders thereof to purchase, during
the one-year period beginning February 24, 1999, one share of common stock at a
purchase price of $4.00 per share. The $134,820 of combined debt discount and
deferred finance charges were being charged to expense using the interest method
over the term of the Bridge Notes (approximately 24 months).
The bridge investors included four former employees of the Company, one of whom
was an executive officer of the Company. The face value of the Bridge Notes
payable to these four individuals totaled $75,704.
Bridge Notes payable consisted of the following at December 31, 1997:
<TABLE>
<CAPTION>
Unrelated Former
Third Employees and
Parties Officers Total
------------ ------------- -----------
<S> <C> <C> <C>
Face value of Bridge Notes payable $524,296 $ 75,704 $ 600,000
Less Debt Discount:
Original debt discount (94,373) (13,627) (108,000)
Accumulated amortization 8,474 1,224 9,698
-------------- ------------- -------------
Net Debt Discount (85,899) (12,403) (98,302)
-------------- ------------- -------------
Bridge Notes payable, net $438,397 $ 63,301 $ 501,698
============== ============= =============
</TABLE>
F-12
- --------------------------------------------------------------------------------
41
<PAGE>
C2i Solutions, Inc.
(a development stage company)
4. BRIDGE FINANCING (CONTINUED)
Interest expense related to the Bridge Financing included amortization of the
debt discount ($9,698) and deferred finance charges ($2,408), plus accrued
interest ($12,500) and totaled $24,606 for the year ended December 31, 1997.
Interest expense related to the Bridge Financing includes amortization of the
debt discount ($8,623) and deferred finance charges ($2,141) plus accrued
interest ($8,913) and totaled $19,677 for the year ended December 31, 1998. The
effective interest rate on the Bridge Notes payable was 20.27%.
In February 1998, the Company completed its initial public offering and repaid
the Bridge Notes including all interest accrued thereon. In connection with
this retirement, the Company recognized a loss of $111,950 which represents the
unamortized balances of deferred finance charges ($22,271) and debt discount
($89,679), which is included in other expense in the accompanying statements of
operations.
5. STOCKHOLDERS' EQUITY (DEFICIT)
Description of Capital Stock
- ----------------------------
General. The Company's authorized capital stock consists of 10,000,000 shares
of common stock, par value $.001 per share ("Common Stock"), and 1,000,000
shares of preferred stock, par value $.001 per share ("Preferred Stock").
Common Stock. The holders of Common Stock are entitled to one vote for each
share held of record on all matters submitted to a vote of the holders of Common
Stock. The Certificate does not provide for cumulative voting, and accordingly,
the holders of a majority of the shares of Common Stock entitled to vote in any
election of directors may elect all of the directors standing for election.
Warrants. The holder of each warrant issued in connection with the initial
public offering ("Warrant") is entitled, upon payment of the exercise price of
$2.00, to purchase one share of Common Stock. At December 31, 1998, the
original exercise price of the warrants ($7.50) was adjusted to $2.00 per share
in accordance with the agreement which required a reduction of the original
exercise price by $.25 per share for every $200,000 that the Company's pre-tax
earnings from operations for the year ending December 31, 1998 were less than
$3,000,000 but in no event was the reduction to result in an exercise price of
less than $2.00 per share. Unless previously redeemed, the Warrants are
exercisable at any time during the four year period commencing February 24,
1999, provided that at such time a current prospectus relating to the
underlying Common Stock is in effect and the underlying shares of Common Stock
are qualified for sale or exempt from qualification under applicable state
securities laws. The Warrants are subject to redemption, as described below.
The Warrants expire on February 24, 2003.
Redemption. Commencing February 24, 1999, the Warrants are subject to
redemption by the Company, on not less than 30 days written notice, at a price
of $.01 per Warrant, if the closing bid price of the Common Stock is at least
150% of the then current exercise price of the Warrants for any 20 consecutive
business days ending on the third day prior to the date on which the notice of
redemption is given. Holders of Warrants will automatically forfeit their
rights to purchase the shares of Common Stock issuable upon exercise of such
Warrants unless the Warrants are exercised before the close of business on the
business day immediately prior to the date set for redemption. All of the
outstanding Warrants, except for the underwriter's warrants, must be redeemed if
any of that class are redeemed.
The Warrants contain provisions that protect the holders thereof against
dilution by adjustment of the exercise price in certain events, such as stock
dividends, stock splits, mergers, sale of substantially all of the Company's
assets, and for other extraordinary events in order to enable the holders of the
Warrants to obtain the same or equivalent rights which they would have obtained
if the Warrants had been exercised prior to the event.
Underwriter's Warrants. The Company agreed to grant to the underwriter, upon
the closing of it's initial public offering in February 1998, warrants
("Underwriter's Warrants") to purchase up to 100,000 shares of Common Stock
and/or 100,000 Warrants. These shares and Warrants will be identical to the
shares and Warrants offered to the public. The
F-13
- --------------------------------------------------------------------------------
42
<PAGE>
C2i Solutions,Inc.
(a development stage company)
5. STOCKHOLDER'S EQUITY (DEFICIT) (CONTINUED)
Underwriter's Warrants cannot be transferred, sold, assigned or hypothecated for
one year, except to officers of the Underwriter or members of the selling group.
The Underwriter's Warrants are exercisable during the four-year period
commencing February 13, 1999, at an exercise price of $8.10 per share of Common
Stock and $0.135 per Warrant, subject to adjustment in certain events to protect
against dilution. The holders of the Underwriter's Warrants and underlying
securities have certain demand and piggyback registration rights. The existence
of the Underwriter's Warrants and the inability of the Company to redeem the
Warrants may hinder the Company's future financing or business transactions.
Bridge Warrants. Each Bridge Warrant issued by the Company in connection with
the Bridge Financing entitles the holder to purchase one share of Common Stock
of the Company at an exercise price of $4.00 per share. The Bridge Warrants are
exercisable for a one-year period beginning February 24, 1999 and expire on
February 24, 2000.
Preferred Stock. The Preferred Stock may be issued in series, and shares of
each series will have such rights and preferences as are fixed by the Board in
the resolutions authorizing the issuance of that particular series. In
designating any series of Preferred Stock, the Board may, without further action
by the holders of Common Stock, fix the number of shares constituting that
series and fix the dividend rights, dividend rate, conversion rights, voting
rights (which may be greater or lesser than the voting rights of the Common
Stock), rights and terms of redemption (including any sinking fund provisions),
and the liquidation preferences of the series of Preferred Stock. It is to be
expected that the holders of any series of Preferred Stock, when and if issued,
will have priority claims to dividends and to any distributions upon liquidation
of the Company, and that they may have other preferences over the holders of the
Common Stock. Before issuing any Preferred Stock the Company will obtain
approval of a majority of its independent directors who do not have an interest
in the transaction and who have access to legal counsel.
The Board may issue series of Preferred Stock without action of the stockholders
of the Company. Accordingly, the issuance of Preferred Stock may adversely
affect the rights of the holders of the Common Stock. In addition, the issuance
of Preferred Stock may be used as an "anti-takeover" device without further
action on the part of the stockholders. Issuance of Preferred Stock may dilute
the voting power of holders of Common Stock (such as by issuing Preferred Stock
with super-voting rights) and may render more difficult the removal of current
management, even if such removal may be in the stockholders' best interests.
The Company has no current plans to issue any of the Preferred Stock. In the
event that the Company issues Preferred Stock in the future, it will only permit
executive officers, directors or promoters to purchase shares on the same terms
as other purchasers.
Delaware Section 203. As a Delaware corporation, the Company is subject to
Section 203 of the Delaware General Corporation Law ("Section 203"), which
regulates large accumulations of shares, including those made by tender offers.
Section 203 may have the effect of significantly delaying a purchaser's ability
to acquire the entire interest in the Company if such acquisition is not
approved by the Company's Board. In general, Section 203 prevents an
"Interested Stockholder" (defined generally as a person with 15% or more of a
corporation's outstanding voting stock) from engaging in a "Business
Combination" (defined below) with a Delaware corporation for three years
following the date such person became an Interested Stockholder. For purposes
of Section 203, the term "Business Combination" is defined broadly to include
mergers and certain other transactions with or caused by the Interested
Stockholder; sales or other dispositions to the Interested Stockholder (except
proportionately with the corporation's other stockholders) of assets of the
corporation or a subsidiary equal to ten percent or more of the aggregate market
value of the corporation's consolidated assets or its outstanding stock; the
issuance or transfer by the corporation or a subsidiary of stock of the
corporation or such subsidiary to the Interested Stockholder (except for
transfers in a conversion or exchange or a pro rata distribution or certain
other transactions, none of which increase the Interested Stockholder's
proportionate ownership of any class or series of the corporation's or such
subsidiary's stock); or receipt by the Interested Stockholder (except
proportionately as a stockholder), directly or indirectly, of any loans,
advances, guarantees, pledges or other financial benefits provided by or through
the corporation or a subsidiary.
F-14
- --------------------------------------------------------------------------------
43
<PAGE>
C2i Solutions, Inc.
(a development stage company)
5. STOCKHOLDERS' EQUITY (DEFICIT) (CONTINUED)
Capital Transactions
- --------------------
In 1996, the Company issued 1,050,000 shares of Common Stock to three
individuals. In accordance with the Operating Agreement (the "Agreement"),
these individuals were required to contribute total capital of $157,500, of
which $60,000 had been received by the Company as of December 31, 1996. The
Company recorded the remaining $97,500 to be received as capital subscriptions
receivable in the accompanying balance sheet. The subscription amounts were
received in January 1997.
In June 1997, the Company issued an additional 1,333,332 shares of Common Stock
to existing and new stockholders. In exchange for these shares, the Company
received a $100,000 cash payment and $100,000 was recorded as capital
subscriptions receivable. These subscription amounts were received $50,000 in
August 1997, and $50,000 in September 1997. The Company recognized $1,199,999 of
compensation expense, which is included in selling, general and administrative
expenses in the accompanying statement of operations, related to the issuance of
these shares, representing the difference between the deemed value of the shares
of Common Stock and the cash consideration received.
In addition, from June 1997 to September 30, 1997, the Company issued 8,006
shares of Common Stock valued at $9,083 to consultants in exchange for services
received.
In March 1998, the Company issued 833 shares of its Common Stock to a former
employee of the Company for total cash consideration of $2,083 as a result of
the exercise of stock options.
Initial Public Offering
- -----------------------
In February 1998, the Company completed an initial public offering of 1,000,000
shares of Common Stock and 1,150,000 Warrants (which included 150,000 Warrants
pursuant to the underwriter's over-allotment option) of the Company. The
Company received net proceeds of $5,365,150, after deducting an underwriting
discount of 10% of the gross proceeds of the offering and a non-accountable
expense allowance of 3% of the gross proceeds of the offering, and before
deducting expenses of $475,743 related to the offering (net of $45,000
previously paid by the Company).
In March 1998, the underwriter exercised its over-allotment option with respect
to 150,000 shares of Common Stock of the Company. The Company received
additional net proceeds of $783,000, after deducting an underwriting discount of
10% of the gross proceeds of the offering and a non-accountable expense
allowance of 3% of the gross proceeds of the offering.
Common Stock Reserved For Future Issuance
- -----------------------------------------
At December 31, 1998, the Company had an aggregate of 5,113,500 shares of
Common Stock reserved for future issuance as follows:
Number of Shares
--------------------
Existing stock options 1,590,305
1997 Stock Option Plan 1,573,195
Bridge Warrants 600,000
Initial Public Offering:
Common Stock and Warrants 1,150,000
Underwriter's Warrants (Common Stock and Warrants) 200,000
--------------------
5,113,500
====================
F-15
- --------------------------------------------------------------------------------
44
<PAGE>
C2i Solutions, Inc.
(a development stage company)
5. STOCKHOLDERS' EQUITY (DEFICIT) (CONTINUED)
Stock Plan
- ----------
In January 1998, the Company's Board of Directors and stockholders approved the
1997 Stock Option Plan ("Option Plan"), which had an initial share reserve of
82,500 shares of Common Stock. Under the Option Plan, options may be granted to
employees, including officers, consultants, advisors and directors, although
only employees and directors and officers who are also employees may receive
"incentive stock options" ("ISO's") intended to qualify for certain tax
treatment. The exercise price of all nonqualified stock options ("NSO's") must
equal at least 85% of the fair market value of Common Stock on the date of
grant, and the exercise price of incentive stock options must be no less than
the fair market value on the date of grant. Options granted under the Option
Plan are generally immediately exercisable, vest over periods ranging from one
to four years and must be exercised within ten years.
In June 1998, the Company's stockholders approved an amendment to the Option
Plan to (a) increase by 2,650,000 the maximum number of shares of the Company's
Common Stock reserved for issuance under the Option Plan, (b) increase the limit
on the number of shares issuable on exercise of outstanding options under the
Option Plan to no more than 90% of the outstanding shares of the Company's
Common Stock, and (c) to limit to 100,000 the maximum number of shares for which
options may be granted to any employee in any fiscal year.
Stock Options
- -------------
During the period from June 1997 through December 1997, the Company granted
nonqualified options to purchase an aggregate of 625,000 shares of the Company's
Common Stock, at exercise prices ranging from $2.50 to $5.40 per share, to
employees, consultants and directors of the Company. These options vest over
periods ranging from one to four years, are exercisable at various dates and
expire five to ten years from the date of grant, or earlier in the event of
termination of employment, directorship or consulting engagement.
F-16
- --------------------------------------------------------------------------------
45
<PAGE>
C2I SOLUTIONS, INC.
(a development stage company)
5. STOCKHOLDERS' EQUITY (DEFICIT) (CONTINUED)
The following table summarizes certain information regarding stock options
during the year ended December 31, 1998:
<TABLE>
<CAPTION>
Weighted average
Shares exercise price
------------- ------------------
<S> <C> <C>
Outstanding at beginning of year 625,000 $ 2.96
Granted 1,259,305 3.57
Exercised (833) 2.50
Forfeited (293,167) 5.19
------------- -------------
Outstanding at end of year 1,590,305 $ 3.03
============= =============
Options exercisable at end of year 218,122 $ 3.52
============= =============
</TABLE>
The following summarizes information regarding options outstanding at December
31, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
-------------------------- ---------------------------
Weighted Weighted
average Weighted average Weighted
remaining average Exercise remaining average Exercise
Number contractual exercise price Number contractual exercise price
Outstanding life (years) price range Exercisable life (years) price range
- ------------------------------------------------------------------- --------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
723,305 9.4 $1.27 $1.19-$2.00 2,111 9.9 $1.34 $1.19-$2.00
471,000 8.0 $2.55 $2.50-$3.38 164,198 8.6 $2.51 $2.50-$3.38
145,500 6.3 $5.56 $5.13-$6.50 19,420 6.7 $5.60 $5.13-$6.50
250,500 1.7 $7.55 $7.38-$8.38 32,392 2.2 $7.57 $7.38-$8.38
</TABLE>
In accordance with APB 25, the Company recognized $23,513, $91,727 and $115,240
of compensation expense during the years ended December 31, 1997 and 1998, and
for the period from Inception (September 17, 1996) through December 31, 1998,
respectively, related to the grant of options, as the exercise price of options
granted was below the deemed fair value on the date of grant. Had compensation
cost related to the options been determined based upon the fair value of options
at their grant dates, as prescribed in SFAS 123, the Company's net loss would
have been as follows:
<TABLE>
<CAPTION>
Period From
Inception
Year Ended Year Ended through
December 31, December 31 December 31,
As Reported 1997 1998 1998
------------- --------------- ----------------------------------------------
<S> <C> <C> <C>
Total $(1,806,438) $(3,103,130) $(4,953,906)
Per Share $ (1.03) $ (0.92) ----
As Adjusted
-------------
Total $(1,819,999) $(3,568,622) $(5,432,959)
Per Share $ (1.04) $ (1.06)
</TABLE>
F-17
- --------------------------------------------------------------------------------
46
<PAGE>
C2I SOLUTIONS, INC.
(A DEVELOPMENT STAGE COMPANY)
5. STOCKHOLDERS' EQUITY (DEFICIT) (CONTINUED)
The fair value of options at date of grant was estimated using the minimum value
method for all options granted from Inception (September 17, 1996) through
February 13, 1998, the date the Company became a public reporting entity. The
fair value of options at date of grant for all options granted subsequent to
February 13, 1998 was estimated using the Black-Scholes method. The following
weighted average assumption were used:
<TABLE>
<CAPTION>
Year Ended
December 31,
1997 1998
---- ----
<S> <C> <C>
Expected life (years)................................................................................4.0 to 5.0. 4.0 to 5.0.
Risk-free interest rate..............................................................................5.5% 4.75% to 5.50%
Dividend yield.......................................................................................0.0% 0.0%
Fair value of option grants -- exercise price less than the fair value of the related stock..........$1.55 $0.00
Fair value of option grants -- exercise price equal to the fair value of the related stock...........$0.00 $2.54
Fair value of option grants -- exercise price greater than the fair value of the related stock.......$0.00 $0.84
Expected volatility..................................................................................N/A 1.0
</TABLE>
Because options vest over several years and additional option grants are
expected to be made in future years, the above pro forma results applying the
provisions of SFAS 123 are not representative of pro forma results for future
years.
6. COMMITMENTS
Licensing Agreements
- --------------------
In 1996, the Company entered into an exclusive technology licensing agreement
with a former stockholder through which it obtained world-wide marketing rights
to certain software products sold by the Company. Under this agreement, the
Company was obligated to pay a royalty on sales of the product ranging from 50%
to 70%. The accompanying balance sheets include $1,345 of accrued royalties due
under this agreement at December 31, 1997. In 1997, the Company terminated this
licensing agreement and no longer uses these software products.
Subsequent to December 31, 1996, the Company entered into several non-exclusive
license agreements. These agreements generally allow the Company to utilize and
resell to its customers certain software products, in exchange for royalty
payments by the Company which generally range from 10% to 50%.
Obligations Under Capital Leases
- --------------------------------
During the year ended December 31, 1997, the Company entered into agreements to
lease certain computer and office equipment under lease agreements which are
classified as capital leases. The lease terms are for thirty-six month periods,
with minimum lease payments as follows as of December 31, 1998:
<TABLE>
<S> <C>
Year Ending December 31:
1999 $ 7,447
2000 6,551
----------------
13,998
Less amount representing interest (1,742)
Less current portion of capital lease obligations (6,110)
----------------
Capital lease obligations, net of current portion $ 6,146
================
</TABLE>
F-18
- --------------------------------------------------------------------------------
47
<PAGE>
C2I SOLUTIONS, INC.
(A DEVELOPMENT STAGE COMPANY)
6. COMMITMENTS (CONTINUED)
These obligations are collateralized by the related equipment, which had a net
value of $17,442 and $10,223 at December 31, 1997 and 1998, respectively. (See
Note 3).
Operating Lease Commitments
- ---------------------------
The Company leases its office facilities and certain computer equipment under
lease agreements which are classified as operating leases. At December 31,
1998, future minimum payments under these noncancelable operating leases total
$11,491, all of which is to be paid in 1999.
Rent expense totaled $30,779, $191,546, and $227,968 for the years ended
December 31, 1997 and 1998, and for the period from Inception (September 17,
1996) through December 31, 1998, respectively, and has been included in selling,
general and administrative expenses in the accompanying statements of
operations.
7. Income Taxes
Deferred income taxes reflect the net tax effects of temporary difference
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax liabilities and assets as of December 31, 1997 and
1998 are shown below. At December 31, 1998, a valuation allowance of $ 1,379,000
has been recognized to offset the amount of net deferred tax assets, as
realization of such assets is uncertain.
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1998
-------------------- --------------------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforward $ 137,000 $ 1,110,000
Other, net 9,000 269,000
-------------------- --------------------
Total deferred tax assets 146,000 1,379,000
Valuation allowance (146,000) (1,379,000)
-------------------- --------------------
Net deferred tax asset $ ---- $ ----
==================== ====================
</TABLE>
Significant components of the provision for income taxes attributable to
continuing operations are as follows:
<TABLE>
<CAPTION>
<S> <C> <C>
Current: December 31, 1997 December 31, 1998
--------------------- ---------------------
Federal $ ---- $ ----
State 3,400 5,340
--------------------- ---------------------
3,400 $ 5,340
===================== =====================
</TABLE>
The reconciliation of income tax attributable to continuing operations computed
at the U.S. statutory rate to income tax expense is as follows:
<TABLE>
<CAPTION>
1997 1998
----------------- -----------------
<S> <C> <C>
Loss before income taxes at statutory rate $ 613,000 $ 1,239,000
Loss of LLC through September 30,
1997, not subject to taxes (487,000) ----
Permanent differences 20,000 (6,000)
Change in deferred tax asset valuation (146,000) (1,233,000)
allowance
State income taxes 3,400 5,340
----------------- -----------------
$ 3,400 $ 5,340
================= =================
</TABLE>
F-19
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48
<PAGE>
C2I SOLUTIONS, INC.
(A DEVELOPMENT STAGE COMPANY)
7. INCOME TAXES (CONTINUED)
At December 31, 1998, the Company had federal and California tax net operating
loss carryforwards of approximately $2,770,000. These federal and California tax
net operating loss carryforwards begin expiring in 2012 and 2002, respectively,
unless previously utilized.
Pursuant to Internal Revenue Code Sections 382 and 383, use of the Company's net
operating loss carryforwards may be limited if a cumulative change in ownership
of more than 50% occurs within any three-year period.
8. SUBSEQUENT EVENTS (UNAUDITED)
Short-term Investment
- ---------------------
Subsequent to December 31, 1998, the Company sold the entire balance of the
short-term investment it held at December 31, 1998 and realized additional
losses totaling $48,545 in 1999. The Company received net proceeds aggregating
$2,180,702. The Company has invested the proceeds from the sale of this short-
term investment in fully-insured, money market accounts and short-term U.S.
government treasury bills.
Restructuring
- -------------
In March 1999, the Company's Board of Directors approved a plan of
reorganization. The Company estimates changes associated with the
reorganization will approximate $15,000 and will consist primarily of costs
associated with office closings. The Company expects to record these charges in
the quarter ending March 31, 1999.
C2i has reorganized to focus its primary business on providing new IT solutions
for its existing and new clients. C2i's senior management team has extensive
experience with Internet, e-Business and legacy transformation solutions. C2i
is currently a business partner with IBM, Sun and Oracle. As a key part of this
business restructuring, C2i intends to establish additional partnerships and
actively pursue mergers and acquisitions to strengthen its offerings or to
otherwise enhance stockholder value.
C2i intends to complete existing Y2k contracts but will not actively pursue new
Y2k engagements. As a result of this strategic realignment and restructuring,
approximately 14 positions will be eliminated at headquarters in San Diego and
field offices in Atlanta, Chicago, New York, and Paris.
F-20
- --------------------------------------------------------------------------------
49
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of
1934, the Registrant has duly caused this Report to be signed on its behalf by
the undersigned, thereto duly authorized, on the 25th day of March, 1999.
C2i SOLUTIONS, INC.
By: /s/ JOHN ANTHONY WHALEN, JR.
-----------------------------------------
John Anthony Whalen, Jr.
President and Chief Executive Officer
(Principal Executive Officer)
In accordance with the Securities Exchange Act of 1934, this Report has
been signed by the following persons in the capacities and on the dates
indicated.
<TABLE>
<CAPTION>
Signature Title Date
---------- ----- ----
<S> <C> <C>
/s/ JOHN ANTHONY WHALEN, JR. Chief Executive Officer and March 25, 1999
- ----------------------------
John Anthony Whalen, Jr. Director (Principal Executive
Officer)
/s/ DIANE E. HESSLER Chief Financial Officer March 25, 1999
- ----------------------------
Diane E. Hessler (Principal Financial and
Accounting Officer)
/s/ HAL H. BERETZ
- ----------------------------
Hal H. Beretz Director March 25, 1999
/s/ KIM P. GOH
- ----------------------------
Kim P. Goh Director March 25, 1999
/s/ WILLIAM J. KAFFER
- ----------------------------
William J. Kaffer Director March 25, 1999
/s/ JAMES A. LONERGAN
- ----------------------------
James A. Lonergan Director March 25, 1999
/s/ DAVID TENDLER
- ----------------------------
David Tendler Director March 25, 1999
</TABLE>
- --------------------------------------------------------------------------------
50
<PAGE>
EXHIBIT 10.3
AMENDMENT TO THE
C2i SOLUTIONS, INC.
STOCK OPTION PLAN
This Amendment No. 1 to the C2i Solutions, Inc. 1997 Stock Option Plan (the
"Plan") is effective as of June 26, 1998.
Section 4.1 of the Plan shall be amended to state in its entirety as
follows:
"4.1 Maximum Number of Shares Issuable. Subject to adjustment as provided
in Section 4.2, the maximum aggregate number of shares of Stock that may be
issued under the Plan shall be Two Million Seven Hundred Thirty Two Thousand
Five Hundred (2,732,500) and shall consist of authorized but unissued or
reacquired shares of Stock or any combination thereof. If an outstanding Option
for any reason expires or is terminated or canceled or shares of Stock acquired,
subject to repurchase, upon the exercise of an Option are repurchased by the
Company, the shares of Stock allocable to the unexercised portion of such
Option, or such repurchased shares of Stock, shall again be available for
issuance under the Plan. Notwithstanding the foregoing, at any such time as the
offer and sale of securities pursuant to the Plan is subject to compliance with
Section 260.140.45 of Title 10 of the California Code of Regulations ("Section
260.140.45"), the total number of shares of Stock issuable upon the exercise of
all outstanding Options (together with options outstanding under any other stock
option plan of the Company) and the total number of shares provided for under
any stock bonus or similar plan of the Company shall not exceed ninety percent
(90%) (or such other higher percentage limitation as may be approved by the
stockholders of the Company pursuant to Section 260.140.45) of the then
outstanding shares of the Company as calculated in accordance with the
conditions and exclusions of Section 260.140.45."
Section 4.2 of the Plan shall be amended to state in its entirety as
follows:
"4.2 Adjustments for Changes in Capital Structure. In the event of any
stock dividend, stock split, reverse stock split, recapitalization, combination,
reclassification or similar change in the capital structure of the Company,
appropriate adjustments shall be made in the number and class of shares subject
to the Plan, the Section 162(m) Grant Limit set forth in Section 5.4, and to any
outstanding Options and in the exercise price per share of any outstanding
Options. If a majority of the shares which are of the same class as the shares
that are subject to outstanding Options are exchanged for, converted into, or
otherwise become (whether or not pursuant to an Ownership Change Event, as
defined in Section 8.1) shares of another corporation (the "New Shares"), the
Board may unilaterally amend the outstanding Options to provide that such
Options are exercisable for New Shares. In the event of any such amendment, the
number of shares subject to, and the exercise price per share of, the
outstanding Options shall be adjusted in a fair and equitable manner as
determined by the Board, in its sole discretion. Notwithstanding the foregoing,
any fractional share resulting from an adjustment pursuant to this Section 4.2
shall be rounded up or down to the nearest whole number, as determined by the
Board, and in no event may the exercise price of any Option be decreased to an
amount less than the par value, if any, of the stock subject to the Option. The
adjustments determined by the Board pursuant to this Section 4.2 shall be final,
binding and conclusive."
Section 5.4 shall be added to the Plan, which shall state in its entirety
as follows:
"5.4 Section 162(m) Grant Limit. Subject to adjustment as provided in
Section 4.2, at any such time as a Participating Company is a "publicly held
corporation" within the meaning of Section 162(m), no Employee shall be granted
one or more Options within any fiscal year of the Company which in the aggregate
are for the purchase of more than one hundred thousand (100,000) shares of Stock
(the "Section 162(m) Grant Limit"). An Option
<PAGE>
which is canceled in the same fiscal year of the Company in which it was granted
shall continue to be counted against the Section 162(m) Grant Limit for such
period."
IN WITNESS OF THE FOREGOING, the undersigned Secretary of C2i Solutions,
Inc. (the "Company") certifies that the foregoing amendment to the C2i
Solutions, Inc. 1997 Stock Option Plan was duly adopted by the Board of
Directors of the Company on May 12, 1998, and approved by the stockholders of
the Company on June 26, 1998.
C2i Solutions, Inc.
By: /S/ DIANE E. HESSLER
---------------------------
Diane E. Hessler, Secretary
<PAGE>
EXHIBIT 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement on
Post Effective Amendment No. 1 on Form S-3 to Form SB-2 (No. 333-39425), of our
report dated February 19, 1999 with respect to the financial statements of C2i
Solutions, Inc. included in the Annual Report (Form 10-KSB) for the year ended
December 31, 1998.
/S/ ERNST & YOUNG LLP
---------------------
ERNST & YOUNG LLP
San Diego, California
March 25, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM AUDITED
FINANCIAL STATEMENTS FOR THE YEAR ENDED DECEMBER 31, 1998 AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 135,954
<SECURITIES> 2,229,247
<RECEIVABLES> 116,805
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 2,551,481
<PP&E> 208,347
<DEPRECIATION> 90,813
<TOTAL-ASSETS> 2,723,394
<CURRENT-LIABILITIES> 206,842
<BONDS> 6,146
0
0
<COMMON> 3,542
<OTHER-SE> 2,506,864
<TOTAL-LIABILITY-AND-EQUITY> 2,723,394
<SALES> 76,800
<TOTAL-REVENUES> 649,817
<CGS> 54,239
<TOTAL-COSTS> 296,685
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 21,827
<INCOME-PRETAX> (3,097,790)
<INCOME-TAX> 5,340
<INCOME-CONTINUING> (3,103,130)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,103,130)
<EPS-PRIMARY> (0.92)
<EPS-DILUTED> (0.92)
</TABLE>
