SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-KSB
(Mark One)
|X| ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934: For the fiscal year ended FEBRUARY 28, 1997
| | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934: For the transition period from ---------- to ----------
Commission file number 0-24426
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C-PHONE CORPORATION
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(Name of small business issuer in its charter)
NEW YORK 06-1170506
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(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification No.)
6714 NETHERLANDS DRIVE, WILMINGTON, NORTH CAROLINA 28405
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (910) 395-6100
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Securities registered under Section 12(b) of the Exchange Act: NONE
Securities registered under Section 12(g) of the Exchange Act:
COMMON STOCK, $.01 PAR VALUE
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(Title of class)
Check whether the issuer: (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months
(or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes [X] No [ ]
Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [ ]
State issuer's revenues for its most recent fiscal year: $2,042,878
State the aggregate market value of the voting stock held by
non-affiliates computed by reference to the price at which the stock was sold,
or the average bid and asked prices of such stock, as of a specified date within
the past 60 days:
Approximately $36,710,000, based on the last published sale
price ($9-1/8) on The Nasdaq National Market on May 20, 1997.
State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date:
As of May 20, 1997 - 5,202,786 shares.
Documents Incorporated by Reference: Portions of the issuer's
definitive proxy statement to be mailed to shareholders in connection with the
issuer's 1997 Annual Meeting are incorporated by reference into Part III of this
Annual Report on Form 10-KSB.
Transitional Small Business Disclosure Format (check one) Yes [ ] No [X]
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TABLE OF CONTENTS
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ITEM NO. PAGE
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Glossary......................................................................... ii
PART I
1. Description of Business........................................... 2
2. Description of Property........................................... 18
3. Legal Proceedings................................................. 19
4. Submission of Matters to a Vote of Security Holders............... 19
PART II
5. Market for Common Equity and Related Stockholder Matters.......... 19
6. Management's Discussion and Analysis or Plan of Operations........ 20
7. Financial Statements.............................................. 26
8. Changes In and Disagreements With Accountants on Accounting
and Financial Disclosure.......................................... 44
PART III
9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act................. 44
10. Executive Compensation............................................ 44
11. Security Ownership of Certain Beneficial Owners and Management.... 44
12. Certain Relationships and Related Transactions.................... 44
13. Exhibits and Reports on Form 8-K.................................. 44
Signatures.............................................................. 48
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GLOSSARY
Algorithm: A step-by-step problem solving procedure.
Analog telephone lines: Standard telephone lines in use in most home
(also known as POTS (plain old telephone
lines)).
Asynchronous: Lacking in synchronization. A method of
transmitting data over a network. The time
interval between characters may be of
varying lengths. A video signal is
asynchronous when its timing differs from
that of the system reference signal.
ATM: Asynchronous transfer mode - A developmental
high-speed, high-bandwidth, low-delay
transport technology, integrating voice,
video and data.
Bandwidth: The amount of data a medium can transmit in
a given amount of time. The greater the
bandwidth, the faster the rate of data
transmission.
bps: Bits per second - A unit of measurement of
the speed of data transmission.
Broadband: Networks having bandwidths significantly
greater than that found in regular telephone
networks. Broadband systems are capable of
transmitting a vast quantity of data
simultaneously, and usually depend on
coaxial or fiber-optic cable for
transmissions.
CCD: Charged coupled device - CCDs are
specialized semi-conductors, consist of an
array of hundreds of thousands of light
sensitive photo-diodes, and are used in
cameras as an optical scanning mechanism.
Codec: Compression/decompression hardware providing
digital compression and decompression of
analog video signals so that they can be
efficiently transmitted.
Compression: Reducing the size of a data file by
eliminating unnecessary information, such as
blanks and repeating or redundant characters
or information. Compressing video
information also can be accomplished by
sending fewer frames per second or reducing
the quality (by displaying the information
in a smaller window).
Digital telephone lines: Telephone lines, such as ISDN, T-1, Switched
56, Frame Relay and Sonet, which transmit
data in a digital format through the use of
codecs and compression algorithms. Use of
digital telephone service may require the
installation of special wiring.
DVC: Desktop video conferencing, also sometimes
called PC-based video conferencing.
Ethernet: A protocol for medium and higher speed
transmission of data over a LAN.
fps: Frames per second.
Frame Relay: Packet data protocol with less error
correction to speed up communication over
high quality connections.
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H.320 The industry standard for video conferencing
over digital telephone lines.
H.323 The industry standard for video conferencing
on a LAN.
H.324 The industry standard for video conferencing
over analog telephone lines using a modem.
Intranet: A private Internet.
Internet: A network of computer networks using TCP/IP
protocol.
ISDN: Integrated Services Digital Network - A set
of protocol and interface standards that
effectively provide 3 separate, integrated,
transmission channels. ISDN is expected to
replace current telephone lines.
Kilobits: A thousand bits; a measure of the rate of
data transmission.
LAN: Local Area Network - A private computer
network connecting work-stations, file
servers, printers and other devices in a
local area, such as within an office,
building or campus using coaxial cable,
twisted pair or multimode fiber. A LAN
permits the sharing of resources and the
exchange of information between
work-stations.
MCU: Multipoint control unit - A device that
bridges together multiple inputs so that
more than two parties can participate in a
video conference.
Modem: A device for converting digital signals to
analog signals, and vice versa, typically
used to connect digital devices with analog
telephone lines.
Multimedia: A combination of multiple digitized data
types: text, sound, computer-generated
graphics and animations, photographs and
video.
Multipoint: A communications configuration in which
several terminals or stations are connected.
Network: A group of devices (such as work-stations,
telephones, file servers, etc.) connected by
a communications facility.
NTSC: The standard for scanning television signals
in the US, Canada and Korea.
Packet: A sequence of digitized information that is
transmitted as a unit.
PAL: The standard for scanning television signals
in most of Europe and Japan.
PBX: Private branch exchange - A telephone
switch, usually located on the users's
premises, connected to the telephone
network, but operated by the users. A PBX
provides pooled access to a number of the
user's inside telephone lines of a smaller
number of outside telephone lines.
PC: Personal computer.
POTS: Plain old telephone service - Conventional
analog telephone lines using twisted-pair
copper wire.
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Protocol: A set of rules for data communications; a
set of rules and procedures for establishing
and controlling the exchange of data between
computers.
Roll-About System: A mobile video conferencing system which
allows the video conferencing equipment to
be moved between rooms.
Sonet: Synchronous optical network - An interface
standard for transmitting data over fiber
optic lines.
Switched 56: A switched digital telephone service which
permits users to transmit up to 56,000 bits
of digital information per second.
T-1: A point-to-point high-speed digital
telephone transmission service.
TCP/IP: Transmission Control Protocol/Internet
Protocol - the protocol used for packet
oriented communication between networked
computers.
Token Ring: A protocol for transmitting data over a LAN.
Unshielded twisted pair: Standard building wiring currently used to
transmit voice (telephone) and data
throughout an office or building.
WAN: Wide Area Network - A computer network
covering a geographic area larger than a
campus, generally linking multiple LANs.
Whiteboard: A shared document session which offers the
capability of two or more users to
simultaneously view and modify the document.
World Wide Web: A very large collection of linked Internet
servers using a standard linking and display
language.
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
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GENERAL
C-Phone Corporation (the "Company") has been, and is, primarily engaged
in the engineering, manufacturing and marketing of a line of PC-based video
conferencing systems. Since the second half of its fiscal year ended February
28, 1997 ("Fiscal 1997"), the Company has been engaged in contractual software
development related to its PC-based video conferencing systems. In addition,
during Fiscal 1997, the Company engaged in the engineering of a TV-based video
conferencing system, which was introduced in January 1997. The Company's
PC-based video conferencing systems, which communicate over digital networks,
are marketed under the name C-Phone(R) . The Company's recently introduced
TV-based video conferencing system or "video phone", which operates over regular
analog telephone lines using a standard television set, is marketed under the
name C-Phone Home(TM).
Since 1993, the Company has invested significant resources in product
development, engineering and marketing activities for its video conferencing
systems and related products. As a result of these activities and the low volume
of sales during the initial commercialization of C-Phone, the Company incurred
significant losses during the three fiscal years ended February 28, 1997 and
expects that it will incur significant losses during its current fiscal year
ending February 28, 1998. The Company anticipates that it will continue to make
significant expenditures for product development and marketing in the
foreseeable future.
The Company was incorporated in New York in 1986 under the name Target
Tuning, Inc., as a manufacturer of promotional radios. In 1990, the Company
developed data/fax modems under the name "TWINCOM" and changed its name to
Target Technologies, Inc. In early 1993, because of continued price pressures,
shrinking margins and for competitive reasons, the Company shifted its primary
focus from modems to the development of C-Phone; and, during the fiscal year
ended February 28, 1995, the Company phased out its modem product line as it was
no longer profitable. In August 1996, in order to more closely identify the
Company with its C-Phone product line, and to eliminate confusion among
investors, the Company changed its name to C-Phone Corporation.
In August 1994, the Company completed an initial public offering (the
"1994 Public Offering") of 2,000,000 shares of its common stock, par value $.01
per share ("Common Stock"), at a price of $7.00 per share, pursuant to which the
Company received net proceeds of approximately $12,288,000. In connection with
the 1994 Public Offering, the Company issued to Josephthal Lyon & Ross
Incorporated ("JLR"), the representative of the underwriters, warrants (the
"1994 Warrants") to purchase 200,000 shares of Common Stock, at a price of $8.40
per share exercisable through August 18, 1998. See Item 6 - "Management's
Discussion and Analysis or Plan of Operations" and Notes 6 and 7 of Notes to
Financial Statements included in Item 7 - "Financial Statements."
RECENT DEVELOPMENTS
During the week of March 31, 1997, the Company completed a private
placement (the "1997 Placement"), through JLR as the placement agent, pursuant
to which the Company issued an aggregate of 833,667 shares of Common Stock (the
"Original Shares") to the participants (the "Investors") in the 1997 Placement.
Accompanying each of the Original Shares was the right, under certain
circumstances, to receive additional shares of Common Stock in accordance with
the terms of a "contingent value right" (the "Rights"). The Company sold the
Original Shares and Rights at a price of $6.00 per Original Share and received
net proceeds of approximately $4,370,000 (after payment of fees and expenses of
approximately $632,000).
The Investors have the right to register, under the Securities Act of
1933 (the "1933 Act"), the Original Shares and the shares of Common Stock
issuable upon exercise of the Rights. In accordance with
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the terms of such registration right, the Company prepared at its expense, and
filed on April 16, 1997 with the Securities and Exchange Commission (the "SEC"),
a registration statement on Form S-3 (the "Registration Statement") under the
1933 Act covering the Original Shares and the maximum number of shares of Common
Stock issuable upon exercise of the Rights. The Company has agreed to use its
reasonable best efforts to (i) have the Registration Statement declared
effective by the SEC, and (ii) maintain the Registration Statement current for
the lesser of one year after the date that the Registration Statement is
declared effective (the "Effective Date"), or until the securities included in
the Registration Statement have been sold thereunder. In connection with the
1997 Placement, Daniel Flohr, Chairman, President and Chief Executive Officer of
the Company, delivered to JLR, as escrow agent for the Investors, an aggregate
of 250,000 of his own shares of Common Stock, which shares will be forfeited, at
the rate of 1,000 shares a day, if the Effective Date does not occur on or
before July 19, 1997; and, in the event that the Effective Date does not occur
on or before October 17, 1997, the remaining escrowed shares will be forfeited.
In accordance with the rules of The Nasdaq National Market, upon which
the Common Stock is listed and traded, the Company is required to obtain
shareholder approval prior to the issuance of any shares of Common Stock, in
excess of approximately 870,000 shares of Common Stock, issued or issuable to
the Investors in connection with the 1997 Placement. The Company has agreed with
the Investors to include a proposal for approval of the issuance of the shares
of Common Stock issuable upon exercise of the Rights on the agenda for its 1997
Annual Meeting of Shareholders, currently scheduled for early August.
The Rights are automatically exercised at the time, and from time to
time, as the Original Shares are first publicly sold through a broker dealer
after the Effective Date, and expire one year after the Effective Date. The
terms of the Rights provide that, upon the first such sale of any Original
Shares at a price of less than $8.00 per share, the seller of the Original
Shares will automatically receive, for each such Original Share sold, and
without the payment of any additional consideration, such additional number of
shares of Common Stock as equals (i) $8.00 divided by the Adjusted Price, minus
(ii) one; where the Adjusted Price will equal the greater of (x) the average
closing bid price per share of Common Stock on The Nasdaq National Market for
the ten trading days immediately preceding the date of sale of the Original
Shares, or (y) $2.00.
In consideration for JLR's services as placement agent in the 1997
Placement, the Company (i) paid JLR a fee of $450,180 (or 9% of the gross
proceeds received by the Company in the 1997 Placement), (ii) agreed to
reimburse JLR for its out-of-pocket expenses (not to exceed $25,000), and (iii)
issued to an affiliate of JLR, warrants (the "1997 Warrants") to acquire an
aggregate of 150,000 shares of Common Stock at an exercise price of $9.60 per
share (120% of the closing bid price for the Common Stock on The Nasdaq National
Market on the trading day immediately prior to the first closing of the 1997
Placement). The 1997 Warrants expire 90 days after the Effective Date. The
shares of Common Stock issuable upon exercise of the 1994 Warrants and the 1997
Warrants have been included in the Registration Statement.
VIDEO CONFERENCING
INDUSTRY BACKGROUND
Video conferencing was introduced in the late 1970s with video
conferencing rooms located in office parks or office buildings. These rooms were
outfitted with expensive video conferencing equipment requiring trained
operators. Using special leased digital telephone lines, these systems could
only conference with other compatible facilities. While early video conferencing
rooms cost between $200,000 and $400,000, technological improvements and
increased production volumes have lowered the present total cost of a room-based
corporate video conferencing system to between $50,000 and $90,000, with certain
lower-cost, lesser-function systems selling below $20,000. Video conferencing
rooms are typically used by large corporations primarily for intra-company
communications between distant locations, although within the past several
years, telecommunication companies, as an adjunct to their other services,
hotels offering business conference facilities and other third parties in major
metropolitan areas have made video conference room facilities publicly
available, at an hourly fee of several hundred dollars. The Company believes
that there are
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in excess of 25,000 installed video conference rooms worldwide, but that the
high costs of video conferencing rooms, the logistical difficulties in
scheduling their simultaneous availability and the need for trained operators
have limited their growth.
During the last several years, mobile video conferencing systems, known
as "roll-about" systems, have become available at prices generally ranging from
$15,000 to $30,000, which allow the video conferencing equipment to be moved
between locations. In addition, desk-top video conferencing ("DVC") systems
using a personal computer ("PC") have been developed, some of which offer
advantages over video conferencing rooms and "roll-about" systems. A DVC system
improves productivity by offering the ease of operation of a telephone, avoiding
the need for special scheduling, and allowing the video conferencing
participants to share software applications. In addition, a DVC system is
substantially less expensive than a video conferencing room or "roll-about"
system, with a system price, excluding the cost of the PC, of typically less
than $5,000, with prices of certain available systems as low as $1,200 to
$2,000. The Company believes that the DVC market is expanding and the number of
DVC systems will increase similar to the manner in which PC-based operating
systems increased the overall market for computer systems and increased their
market share relative to main frame based computer systems. However, and despite
this belief, the DVC market has not yet achieved substantial market acceptance.
The Company believes that DVC systems facilitate external and internal
communications and allow users at different locations to combine the
effectiveness of face-to-face meetings with the convenience of the telephone,
without the need for trained operators. In addition, DVC also can improve worker
productivity and reduce or eliminate travel costs, accelerate the exchange of
information and leverage the use of limited resources. The Company believes that
applications of video conferencing systems will continue to expand as users
become increasingly dependent on immediate access to data and other information
to remain competitive.
Historically, video conferencing systems have used digital telephone
lines to interconnect users. In order to transmit a real-time video image over a
digital telephone line, the electronic video and accompanying audio signal
(which, in its original form, may contain over 130 million bits of data per
second) must first be "digitized" and then reduced or "compressed" to fit the
capacity of the digital telephone line. The video signal is compressed by
eliminating data, which typically causes the quality of the video image to
degrade. After transmission, the video image is then reconstructed or
"decompressed." The quality of the reconstructed image is a function of (i) the
sophistication of the compression algorithm (which determines the information to
be eliminated), (ii) the amount (expressed as bits per second ("bps")) of
real-time data which can be transmitted over the digital telephone line, (iii)
the power, speed and sophistication of the codec (which ranges in price from
$1,000 to $25,000, unless a lower quality codec is built in to the pc
processor), and (iv) the relative amount of audio accompanying the video signal.
As compression algorithms continue to be refined, video and audio quality are
expected to improve. With the recent adoption of standards for video
conferencing over a LAN, the increased power and speed of PCs, the increased and
wider-spread availability of digital telephone services (such as ISDN) and the
decreased charges for such services by the telecommunications service provider,
as well as the slowly decreasing prices for DVC systems, the Company believes
that use of PC-based video conferencing systems will increase, although there
can be no assurance of how long a period of time will be needed for such
increase to occur.
Presently, most DVC systems employ one of three methods to connect
users to each other digital telephone lines, cross point switches or a PC-based
LAN:
DIGITAL TELEPHONE LINES. Most DVC systems in use are PC-based
and operate over digital telephone lines, although some systems are
TV-based. These systems require a codec and other hardware to be
installed in each PC (or the set-top box, in the case of a TV-based
systems) and one or more separate dedicated telephone lines for each PC
or TV. Video conferencing conducted from this type of system requires a
toll call to be placed over the digital telephone line, even when the
video conferencing is within the same office. These systems do not
allow sharing of in-bound and
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out-bound telephone lines, call transfer, multi-party connections and
other features common to a typical office phone system. In addition,
these systems may use up to three of the PC's expansion slots.
CROSS POINT SWITCHES. Some DVC systems connect users with
shielded or unshielded twisted pair wire and utilize cross point
switching hardware similar to a standard internal PBX phone system
arrangement. These systems, which may cost in excess of $5,000 per user
(excluding the cost of the additional equipment necessary to connect to
off-site systems), provide high quality video, but are limited in the
number of users that they can accommodate and may require additional
wiring.
PC-BASED LAN. Other DVC systems connect individual PCs
together using a LAN. Most of these systems have attempted to transmit
the video and audio as compressed digital information in the same
packet format that other data is transmitted. However, LAN based
networks can transmit only a finite capacity of data within a given
period and the transmission of even a single continuous video image
uses a substantial portion of this capacity. As a result, these systems
currently tend to have a debilitating effect on the performance of the
LAN and the PC and limit the number of simultaneous calls. In addition,
these systems have small picture size and less than television quality
image. Certain major telecommunications companies, including Lucent
Technologies, are currently working on LAN based systems which would
offer improved picture size and quality, but require networking systems
using technologies that have not yet been widely deployed. By contrast,
other LAN-based systems, such as the Company's C-Phone system, transmit
the video and audio information in a different format and outside the
bandwidth conventionally used to transmit data packets; as a result,
such systems do not degrade the performance of the LAN or PC.
During the past several years, AT&T and MCI, as well as several other
companies, have unsuccessfully introduced proprietary consumer video phones
which operate over standard analog telephone lines. These video phones
transmitted a low resolution video image at a rate of between one-half and ten
frames per second ("fps"), as compared to television which delivers a higher
resolution video image at 30 fps. In addition, the video image was small and not
completely synchronized with the audio portion of the transmission. Other
companies, such as Creative Labs Inc., also have introduced PC-based systems
which can operate over analog telephone lines. With the widespread availability
of modems which permit the transmission of data over analog telephone lines at
rates of up to 33,600 bits of data per second, as well as the recent adoption of
the H.324 standard for video conferencing over analog telephone lines, several
companies, including the Company, have announced or introduced products to allow
video conferencing using modems over analog telephone lines. While these systems
operate at a significantly lower video frame rates (ranging up to 15 fps under
ideal conditions) and often without fully synchronized audio, such products are
designed to appeal to non-commercial home users and small businesses, and are
less expensive to own and operate than video conferencing products requiring a
digital telephone line. During the past two years, a number of companies have
introduced products which, when connected to a PC, allow video telephone calls
to be made through analog telephone lines over the internet. Although video
conferencing over the internet may eliminate long distance telephone charges,
the fps rate is less than with a direct telephone connection, the lack of
industry standards requires the use by the parties of comparable equipment,
portions of the conference may be "lost" in the transmission and delays in the
receipt of the transmission may occur. As a result, the Company does not expect
that internet video conferencing will materially affect the market for direct
video conferencing over analog telephone lines.
INDUSTRY STANDARDS
Historically, a factor that limited the growth of video conferencing
was the lack of uniform protocols so that proprietary video conferencing systems
could only communicate with similar systems of the same manufacturer. Video
conferencing has become more widespread as a result of the emergence of
international industry standards designed to allow video conferencing systems
manufactured by different vendors to be compatible.
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The Company's business video conferencing systems are designed to be
compatible with all standard and proprietary protocols by connecting with the
appropriate codec as a network peripheral. As a result, a C-Phone user, calling
outside a LAN, may connect to any other video conferencing system, provided that
the systems have compatible codecs.
In 1990, the Telecommunication Standardization Sector of the
International Telecommunication Union ("ITU"), a United Nations agency which
develops international standards for telecommunications equipment, formally
adopted the H.320 standard for video conferencing, which includes standards for
video and audio transmission and data transfers. While other protocols exist,
H.320 has achieved the most widespread acceptance, and has been adopted by the
Company and substantially all of its competitors.
The ITU formally adopted the H.324 standard in March 1996 for video
conferencing over analog telephone lines. The Company believes that adoption of
the H.324 standard will permit a broad acceptance of analog telephone video
conferencing using products such as C-Phone Home. C-Phone Home has been designed
to be compatible with other H.324 compatible equipment.
The ITU formally adopted the H.323 standard in November 1996 for video
conferencing over a LAN. Although the Company believes that adoption of the
H.323 standard may lead to wider use of video conferencing over a LAN, the
quality of such video conferencing will not be as high as with C-Phone and it is
uncertain as to whether managers of LAN systems will find the increased amount
of LAN traffic acceptable to their systems.
THE COMPANY'S STRATEGY
BUSINESS PRODUCTS
The Company believes that PC-based systems can expand the market for
video conferencing and that the Company can gain commercial advantage by being
among the few vendors to offer a high-quality PC-based video conferencing system
specifically designed for a customer's needs and which provides long-term cost
effectiveness. However, the historical cost, as well as the un-scalable and
inflexible nature of video conferencing systems, combined with the negative
impact of PC-based systems when used on a LAN have limited market acceptance,
and there can be no assurance that PC-based systems generally, or the Company's
C-Phone system particularly, will gain widespread market acceptance.
Although a number of the Company's competitors are capable of wide area
connectivity over ISDN digital phone lines, the Company believes that C-Phone is
one of a few available systems that also operates over a variety of switched and
dedicated digital phone services, and should easily accommodate new digital
phone services as they come into being. The Company believes that this
"broadband-ready" feature is an important element to make C-Phone a long-term
solution, which should not become obsolete as new broadband telecommunication
services become available. The Company's C-Phone video conferencing products are
used in traditional video conferencing room systems, in small group "roll-about"
units and as PC-based DVC systems. Users of a C-Phone system can participate in
real-time, high quality video phone calls to other people within their building,
as well as to anyone with a standards based compatible video conferencing
system, anywhere else in the world.
The C-Phone system is modeled on a typical office (PBX) phone system
providing features and functions such as call screening, call transfer, hold,
caller ID, free calling within the facility and shared access to outside phone
lines. C-Phone video quality within a building, campus or metropolitan area
network is based on the NTSC TV quality standard in the US, Canada and Korea and
the PAL TV quality standard in Europe and Japan. C-Phone calls made over outside
digital telephone lines are based on the H.320 video conferencing standard. The
C-Phone system operates over a wide variety of digital phone services such as
Basic and Primary Rate ISDN, T-1, Switched 56, Frame Relay and Sonet.
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The C-Phone system currently operates under the Microsoft(R)
Windows(TM) operating system and is compatible with Ethernet and Token Ring
network operating systems running a variety of network protocols including IPX,
TCP/IP and netBios(R). Together, these network operating systems presently
account for the majority of the installed base of PC networks. The C-Phone
system is designed to operate with the ease and full functionality of the
typical office telephone network, while permitting other simultaneous unimpeded
uses of the LAN and PC.
The C-Phone system, when operating on a LAN, must be interconnected by
coaxial cable, Category 4 or 5 unshielded twisted wire, or a fiber optic line,
which wiring is not always available in existing LANs, and there can be no
assurance that customers will be willing, where necessary, to install any
requisite internal wiring in order to permit the C-Phone system to function.
When functioning over presently available switched digital telephone lines (such
as ISDN), the C-Phone system uses the industry standard H.320 protocols, thereby
offering picture quality equal to or exceeding that of other presently available
video conferencing systems.
Since the C-Phone system allows digital telephone lines and peripheral
devices, such as codecs, to be shared resources, it has an operating cost
advantage compared to PC-based systems that require each PC to have its own
codec and digital telephone line. The Company believes that this design,
combined with the Company's pricing of its C-Phone systems, makes the C-Phone
system one of the more affordable systems currently available.
The Company believes that the success of DVC systems will be contingent
upon greater market acceptance of PC-based video conferencing systems which, in
turn, will depend, in part, on the ability of such systems to deliver the
following elements that C-Phone technology offers:
TELEVISION QUALITY VIDEO WITH FULLY SYNCHRONIZED AUDIO. The
C-Phone system permits two or more persons using PCs linked by a LAN to
engage in real-time, full-color, television-quality video calls with
fully synchronized audio. The video image of the participants appears
on the computer monitor, and the audio is produced from the
camera/speaker/microphone unit mounted on the monitor or through a
conventional telephone handset. Within the LAN, C-Phone's video image
is displayed at a rate of 30 fps regardless of image size. C-Phone
users also can call outside of their LAN to other C-Phones, PC-based
systems or video conferencing rooms, with picture quality equal to that
of other presently available video conferencing systems, which
typically offer less than television quality picture, depending on the
type of codec and the type and number of digital telephone lines used.
LOW PRICE PER USER. The Company presently markets three basic
C-Phone systems that are priced at the low to mid price range of
existing similar systems. In addition, the C-Phone system treats
digital telephone lines and codecs (which are needed by the C-Phone
system to connect outside the LAN), as shared network peripherals,
similar to a file server or laser printer, which allow a number of PCs
to share the same resources, thereby providing an operating cost
advantage compared to systems that require each PC to have its own
digital telephone lines and codec. See "The Company's Products -
BUSINESS PRODUCTS" and "Marketing and Sales - BUSINESS PRODUCTS."
NO DEGRADATION OF PC OR LAN PERFORMANCE. The C-Phone system
operates in a manner that does not degrade the performance of the LAN
or the PC, regardless of the number of users or simultaneous video
phone calls taking place.
CAPACITY TO HANDLE NUMEROUS SIMULTANEOUS CALLS. The C-Phone
system operates much like a PBX phone system in a typical office
environment. The current C-Phone LAN system can accommodate up to 64
simultaneous video phone lines in a LAN work group, either as two-way
calls, one-way broadcasts or, using the Company's optional multipoint
control unit ("MCU"), multi-party conference calls. Additional capacity
can be achieved as LAN work groups are connected to work
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groups in other LANs. Through its broadcast and conferencing modes, the
C-Phone system permits all users to actively participate in a single
conference.
STANDARD COMMUNICATION PROTOCOLS. The C-Phone system is
designed to be compatible with all PC-based codecs, whether they
contain standard or proprietary protocols, provided that the codec
manufacturer provides the requisite developmental software. As a
result, a C-Phone user calling outside the LAN is able to connect to
any other video conferencing system, provided the systems have
compatible codecs. See "Video Conferencing - INDUSTRY STANDARDS."
MULTIPOINT CAPABILITIES. A C-Phone optional feature includes a
MCU, in which up to 4 users (which may be expanded to additional
users), whether within a LAN or connected by digital telephone lines,
may be simultaneously displayed on the PC monitor, with each
participant actively participating in the video call.
EASE OF OPERATION WITH FULL TELEPHONE FUNCTIONALITY. The
C-Phone system is designed to operate with the ease and full
functionality of the typical office PBX telephone network. The C-Phone
system features, among other things, call transferring, call waiting,
caller ID, hold, conferencing and a "vanity mode" for a user to view
his or her own video image before going on-line or at any time during a
video call. The C-Phone system also operates as an audio answering
machine and includes a photo- based phone directory.
HOME PRODUCTS
The Company's C-Phone Home is a consumer oriented TV-based, "set-top",
video phone which allows users to make video phone calls using their television
set and their analog telephone line.
The Company believes that a commercial consumer market for C-Phone Home
exists involving users such as grandparents and their grandchildren, parents and
their children away at school, working parents and their children in day care,
divorced or separated parents and their young children, and families with aging
relatives. However, the Company has no reliable data to assure that there will
be significant market acceptance of TV-based video phones, and there can be no
assurance that C-Phone Home will gain sufficient market acceptance to generate
significant commercial sales. Previous efforts to sell video phones by larger
better known companies than the Company have been unsuccessful.
The Company believes that the success of C-Phone Home will be
contingent upon its ability to deliver the following elements:
QUALITY OF VIDEO WITH THE FEEL OF A TELEPHONE. Previous
efforts to sell video phones by other companies have been unsuccessful.
This has been due, in part, to the inability of such systems to deliver
video data at the rate of greater than between one-half to ten fps and
to the inability of such systems to emulate a normal telephone call,
primarily as the result of lower audio quality associated with the
phone line's limited bandwidth which must be shared with video data.
Currently, C-Phone Home is capable of delivering video data at rates of
up to 16 fps under ideal circumstances. Many factors, taken either
singularly or together, will lower the video frame rate. These include
non- optimal conditions on the analog phone line to the user's
premises, the presence of noise on the phone line and substantial
movement in the video being transmitted, especially when transmitting
in a high resolution mode. In the instance when any or all of these
factors are present, frame rate may be reduced to as low as one fps.
The Company believes that most users of C-Phone Home will prefer full
screen, highest resolution mode, when frame rates are typically four to
eight fps. At these frame rates, there is not enough motion in the lips
of the users for video and audio synchronization to be necessary, and
C-Phone Home transmits the audio with as little processing delay as
possible in an attempt to make the users feel as if they are
participating in a regular phone call. In other conditions, where over
ten to twelve fps are transmitted, lip synchronization may be more
desirable and may
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result in as much as a one-half second delay in the audio transmission.
Such a delay may not be deemed acceptable by consumers and, as a
result, there can be no assurance that the Company will be able to
achieve a satisfactory level of consumer acceptance of C-Phone Home
within a reasonable period of time, if at all. See "Marketing and Sales
- HOME PRODUCTS."
EASE OF USE. C-Phone Home, which is operated by a wireless
remote control containing a microphone unit, operates with any standard
television set. A video phone call can be dialed or answered by pushing
one or two buttons on the hand-held remote control. In addition,
C-Phone Home offers easy-to-use on-screen instructions and text menus
to operate and configure the system. See "The Company's Products - HOME
PRODUCTS."
REASONABLE COST. The suggested list price of C-Phone Home is
$995.95, which will enable the Company to recapture its full costs and
a per unit profit. The Company recognizes that such price may be too
high for C-Phone Home to penetrate the home market. The Company,
therefor, has arranged for its resellers to offer C-Phone Home at a
suggested list price of $349.95 when purchased with a
telecommunications service contract offered by the Company, which will
enable the Company to obtain a profit from monthly subscription fees
and the resale of long-distance telephone usage, similar to the method
by which most cellular telephones are sold. However, there can be no
assurance that such marketing strategy will enable C-Phone Home to gain
widespread consumer acceptance. See "Marketing and Sales - HOME
PRODUCTS."
COMPATIBILITY. C-Phone Home uses H.324 standards and is
designed to be compatible with other systems using such standard. See
"Video Conferencing - INDUSTRY STANDARDS."
THE COMPANY'S PRODUCTS
BUSINESS PRODUCTS
The Company currently has six core products in its C-Phone product
line. The Company's principal core products consist of the PC-based C-Phone LAN
system, the C-Phone C-Station system and the C-Phone RollAbout system. The
Company also offers a substantial number of additional components and features
which complement its core products.
THE C-PHONE LAN SYSTEM. The C-Phone LAN system allows
networked PC users to engage in real-time, full color, full screen,
television quality video conferencing. The C-Phone LAN system consists
of three main hardware components (a camera/speaker/microphone ("CSM")
unit, an external network video interface module and a host interface
card), as well as a handset and proprietary system software. The CSM
unit rests on top of the PC monitor and is designed so that the camera
projects out over the monitor to just above the screen, minimizing the
face-to-lens divergence angle and thereby giving the sense of a
face-to-face conversation. The video interface module links together
the CSM, the circuit board controller and the network and handles the
video protocols and switching. The host interface card, which has its
own processor, contains a proprietary configuration of circuitry,
components and firmware and is installed within the PC. The C-Phone LAN
system has a suggested list price of $1,995.
THE C-PHONE C-STATION SYSTEM. The C-Phone C-Station system
allows a stand-alone PC user running Microsoft's(R) Windows(TM)
operating software to engage in video conferencing over digital
telephone lines. The C-Phone C-Station system consists of the CSM unit,
an external video interface module, a host interface card and a codec
(which will vary based on the type and speed of the digital telephone
line), as well as a handset and proprietary system software. The
C-Phone C-Station system has a suggested list price ranging from $2,495
to $7,995, depending on the specific features included.
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THE C-PHONE ROLLABOUT SYSTEM. The C-Phone RollAbout system is
a self-contained moveable group video conferencing system, which
currently includes a 32" high-resolution monitor and a PC and is
available in either a LAN or WAN configuration. The LAN configuration
connects to a LAN and can share codecs and digital telephone lines for
video conferencing outside of the LAN. The WAN configuration is a
stand-alone unit and contains hardware similar to that contained in the
C-Phone C-Station system. The C-Phone RollAbout system has a suggested
list price ranging from $9,995 to $19,995, depending on the specific
features included.
WAN SERVER. The WAN Server allows those C-Phone PC-based
systems which do not contain a built in codec to connect to other
C-Phone systems outside of the LAN or other video conferencing systems
over telephone lines providing digital services such as ISDN, T-1 or
Switched 56. The WAN Server is comprised of one or more codecs and
appropriate interfaces to digital telephone lines. See "Video
Conferencing - INDUSTRY STANDARDS."
MULTIPOINT CONTROL UNIT. The MCU allows multiple parties,
whether within a LAN or connected by digital telephone lines, to
participate in a video conference call and be simultaneously displayed
on the PC monitor. Each MCU displays four simultaneous videos on the PC
monitor and has the capability, by interconnecting five MCUs, to
conference up to 16 users.
C-LINK. C-Link allows a C-Phone PC-based system to be
connected to other video sources, such as a video camera, VCR or cable
or broadcast television. Possible uses can include a VCR for
transmitting training films, television for viewing news and financial
programming and a video camera for recording meetings and surveillance.
The Company has developed and markets its own codec and ISDN adaptor.
The Company also offers products in configurations for coaxial cable, unshielded
twisted pair wire, network and fiber optic links. Other devices in various
stages of planning or development by the Company include equipment to allow
various LAN work groups within a building or campus to be interconnected and
interfaces which will allow a C-Phone system to accept telephone calls from
conventional telephones.
From time to time in response to customer requests, the Company has
developed specialized software applications for use as enhancements to its
C-Phone business products. During Fiscal 1997, the Company had software
development revenue of approximately $150,000, substantially all of which was
derived from software development for Mirage Resorts, Inc.
HOME PRODUCTS
The Company's home product line currently consists of a single product
- - C-Phone Home, a TV-based video phone, which allows a user to engage in video
conferencing over an analog telephone line using a standard television set or
monitor. C-Phone Home consists of a "set-top" box, a remote control and an AC
power adapter. The set-top box, which weighs less than five pounds, connects to
the television's RF or audio and video inputs and includes a color camera, modem
(to connect to the telephone line), codec and proprietary software. The remote
control contains a built-in wireless full-duplex microphone and allows the users
to make, answer or end a call and otherwise configure and operate C-Phone Home
through the touch of a button. C-Phone Home has a suggested list price of
$995.95 when sold through independent consumer electronic retailers. The Company
also has arranged for C-Phone Home to be sold at a lower price and to be resold
by retailers at a suggested list price of $349.95 when purchased with a
telecommunications services contract offered by the Company. The Company's
telecommunications services contracts are for various terms, the shortest being
for 12 months, and require the payment of monthly access charges which aggregate
at least $239.40 during the life of the contract. In addition, such contracts
require the payment of per minute interconnect usage fees, the amount of which
depends upon the monthly usage. See "Marketing and Sales - HOME PRODUCTS."
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MARKETING AND SALES
BUSINESS PRODUCTS
The Company developed its initial C-Phone video conferencing product in
1993, and has developed a number of enhancements since such time. However, the
market for PC-based video conferencing has not matured as rapidly as expected.
In order to expedite the commercial introduction of its video conferencing
products, the Company's initial sales and marketing strategy was to attempt to
form alliances with strategic partners, primarily nationally recognized system
integrators, resellers, telecommunication service companies and original
equipment manufacturers, to assist the Company in identifying, developing and
exploiting specific high-volume market applications which would incorporate the
Company's video conferencing products into larger information management and
communication systems. Although the Company has entered into several such
alliances, none of such alliances have yet resulted in significant commercial
sales and there can be no assurance that significant commercial sales will
result from the Company's relationship with any of its strategic partners.
During 1996, the Company reoriented the emphasis of its sales and marketing
strategy and focused on sales to regional resellers, including systems
integrators, telephone system dealers and audio/visual specialists, and selected
large potential customers with needs for customized video conferencing
capabilities. During Fiscal 1997, U.S. resellers accounted for approximately
64.9% of the Company's net sales of C-Phone products, which were resold
primarily to the U.S. Department of Defense and other Federal, state and local
governments or governmental agencies, hospitals and educational facilities, as
well as to corporate users. During Fiscal 1997, approximately 18.9% of the
Company's net sales of C-Phone products were sold directly by the Company, a
significant portion of which were sales to Mirage Resorts, Inc. See "Competition
- - BUSINESS PRODUCTS." The Company's video conferencing revenues since commercial
introduction in 1994 through February 28, 1997 have aggregated approximately
$4,165,000.
The Company provides marketing support to its resellers by (i)
participation with its resellers in selected trade shows, particularly those
directed to the video conferencing, teleconferencing and computer industries,
(ii) developing and distributing marketing literature at trade shows and in
response to potential customer inquiries, (iii) developing and maintaining
public relations and targeted advertising programs to increase awareness of the
Company and the C-Phone product line, (iv) offering training to resellers' sales
staffs, (v) supporting resellers' end-user demonstrations, and (vi) providing
resellers with the names of potential customers who have contacted the Company.
Technical support consists of providing resellers with assistance in designing
and configuring applications for specific business solutions. In addition to
management, the Company has 12 full-time employees dedicated to marketing and
sales of its business products.
A significant portion of the Company's recent revenues, all of which
have related to the Company's business products, have been dependent on sales to
a limited number of customers. During Fiscal 1997, net revenues from Mirage
Resorts, Inc. and C-Phone Europe NV/SA (the Company's European distributor)
constituted 14.3% and 10.3%, respectively, of the Company's net revenues. During
Fiscal 1996, net revenues from TRW, Inc. and Venisoft Computer Solutions, Inc.
(a U. S. reseller) constituted 10.5% and 10.3%, respectively, of the Company's
net revenues. Although the Company requires its non North American distributors
to purchase a minimum annual amount of products to maintain their exclusive
distributorships, the Company does not have written agreements with any of its
customers which require the purchase of any minimum quantities of C-Phone
products and, therefore, such customers could reduce or curtail their purchases
at any time. Therefore, a substantial reduction in orders from the Company's
C-Phone customers or the inability to attract orders from new customers would
have a material adverse effect on the Company's current business.
During Fiscal 1997 and Fiscal 1996, the Company's revenues from
non-U.S. sales of video conferencing products aggregated approximately 15.0% and
16.2%, respectively, of net revenues, which revenues were derived from sales to
its European distributor and resellers in Canada, Europe and southeastern Asia.
As a result, a reduction in the volume of non-U.S. trade or any material
restrictions on such trade could
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have a material adverse impact on the Company's revenues from business video
conferencing products. The Company sells to its European distributor and
Canadian reseller on credit terms and usually makes its other foreign sales on a
prepaid basis due to the difficulty in collecting foreign accounts receivable;
and any change in such policy which may be occasioned by the potential of larger
orders from foreign customers could expose the Company to increased credit
risks. Foreign sales are denominated in U.S. dollars and the Company does not
incur any foreign currency risks; however, fluctuations in currency exchange
rates could cause the Company's business video conferencing products to become
relatively more expensive to foreign customers, which could result in a
reduction in foreign sales or profitability of any such sales.
HOME PRODUCTS
The Company introduced C-Phone Home, as a production prototype, at the
January 1997 Consumer Electronics Show in Las Vegas, Nevada. At the time of such
introduction, the Company had engaged in only preliminary marketing for C-Phone
Home and had not obtained any orders for consumer resale. Based upon perceived
enthusiasm from the trade for C-Phone Home, the Company determined that a viable
market for the product existed, and that its marketing strategy should be to
make initial sales of C- Phone Home through one or more large consumer
electronics retail chains, assuming that the Company could convince such chains
that C-Phone Home was a credible product deserving retail store display space.
The Company has appointed a national network of independent
manufacturer's representative organizations to act as the Company's national
field sales force for C-Phone Home, and recently hired a full-time National
Sales Director to manage such effort. The Company also has retained the services
of a consultant to assist in the marketing of C-Phone Home to larger consumer
electronic retail chains.
In March 1997, Nobody Beats The Wiz, Inc. (the "Wiz"), a large
northeastern U.S. consumer electronics retail chain, agreed to carry C-Phone
Home in its stores. Shipments to the Wiz began in April 1997, the Wiz first
announced availability of C-Phone Home in its weekly sales circular distributed
the weekend of May 9 and, as of May 15, dealer display demonstration units have
been installed in 57 of the Wiz stores. The Company has no long-term arrangement
with the Wiz, which purchases C-Phone Home through regular purchase orders.
Since March 1997, the Company has entered into arrangements with several
additional consumer electronics retailers to carry C-Phone Home, has received
initial stocking orders from such retailers and is actively negotiating with
other retailers.
The Company has had only limited prior experience in marketing and
selling its products to consumer electronic retailers, some of whom have special
problems, such as inadequate working capital, which may affect their ability to
timely pay for their purchases from the Company and may require the Company to
grant extended credit terms. Such retailers typically require that their vendors
pay advertising expense prior to consumer resale and payment to the vendor.
Furthermore, and irrespective of the contracted payment terms negotiated with
such retailers, such retailers generally do not pay for their merchandise unless
and until such merchandise "sells through" to the consumer, thereby creating
higher payment risks.
C-Phone Home is sold to consumer electronic retailers for resale at a
suggested list price of $995.95. The Company recognizes that such price may be
too high for C-Phone Home to penetrate the mass consumer market. The Company,
therefore, has determined to also sell C-Phone Home in the same manner that most
cellular telephones are sold, by offering retailers the opportunity to purchase
and resell C-Phone Home at a suggested list price of $349.95 when purchased and
resold with telecommunications services offered directly by the Company. The
Company anticipates that substantially all of its initial sales of C-Phone Home
to consumer electronic retailers will be made under the latter purchase option.
See "The Company's Products - HOME PRODUCTS."
The Company's ability to provide inter-exchange telecommunications
services is dependent, among other things, upon the Company maintaining a
suitable arrangement with one or more long distance telecommunications services
companies, which will enable the Company to purchase telecommunications
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services for resale to third parties. The Company's current telecommunications
services arrangement is with MCI Telecommunications Corporation ("MCI"), which
provides telecommunications services for resale to a large number of companies.
Pursuant to its investment customer arrangement with MCI, which expires in March
1998 unless terminated earlier, the Company has deposited a letter of credit
with MCI to cover its anticipated monthly charges and is required to increase
such letter of credit if it appears that such monthly charges will exceed the
amount of the letter of credit. The Company has been advised that its
arrangement with MCI is MCI's normal arrangement for customers such as the
Company, except that the arrangement offers the Company a credit against future
MCI services if the Company applies, and is approved, for an upgraded
minimum-term arrangement with MCI. There are a number of long distance
telecommunications services companies which provide telecommunications services
for resale and the Company believes that, if its current arrangement with MCI
expires without being renewed or is terminated, or the Company determines not to
continue its relationship with MCI, the Company could replace its MCI services
with similar services offered by another services provider.
As a condition to reselling intra-state, interstate and international
telecommunications services, the Company is required to obtain and maintain
certain approvals from the Federal Communications Commission (the "FCC") and
from certain State regulatory authorities, and to comply with various applicable
regulatory provisions imposed by such authorities. See "Government Regulation."
The Company has obtained FCC approval to provide inter-state long distance
telecommunications services; however, due to the timing of obtaining certain
State approvals, the Company will be unable to initially offer inter-exchange
telecommunications services for making intra-state video phone calls within
certain States until it has applied for and received appropriate regulatory
approvals from such States. As of May 15, 1997, the Company has obtained
appropriate regulatory approval from ten States and has applications pending or
in the process of being prepared for filing in a number of additional States,
and the Company does not believe that such limitation should have a significant
effect on its ability to sell C-Phone Home.
Until such time, if at all, as the Company attains sufficient
manufacturing volume or can utilize less costly components in the manufacture of
C-Phone Home to enable the Company to reduce its manufactured cost, the Company
may not be able to sell sufficient quantities of C-Phone Home for such sales to
be profitable. To the extent that the consumer electronic retail chains which
purchase C-Phone Home purchase the product for resale with telecommunications
services, the Company's initially required monthly telecommunications access fee
will not be sufficient for the Company to recoup the remainder of its current
manufactured cost. Unless the purchasers of C-Phone Home, who purchase the
product with telecommunications services, renew their initial subscriptions for
telecommunications services or purchase a material amount of telephone usage
from the Company, of which there can be no assurance, the Company will be unable
to recoup from such sales all of its manufacturing costs and its related
expenditures for development and marketing of C-Phone Home.
The Company has limited sales, marketing and distribution experience in
retail consumer goods. The introduction of C-Phone Home requires certain sales,
marketing and distribution capabilities, some of which the Company does not
currently possess, and there can be no assurance that the Company will be able
to establish and retain a sales and marketing capability which would be
successful in gaining market acceptance for C-Phone Home. The Company is
devoting a material portion of its available resources for the commercialization
of C-Phone Home, and failure of the Company to establish the necessary sales,
marketing and distribution network for C-Phone Home will have a material adverse
effect on the Company's financial condition.
GENERAL
The Company's success will depend, in part, upon its ability to provide
its customers, either directly or through others, technical support and customer
service for its products. The Company presently provides support services
directly for its U.S. customers, but relies on its foreign strategic partners to
supply support services outside of the United States. If the Company's business
expands, of which there can be no
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certainty, there can be no assurance that the Company can continue to directly
provide such services to its U.S. customers, in which event it would be required
to negotiate third-party support services on acceptable terms, of which there
can be no assurance. Failure to provide such support services would have a
material adverse effect on the Company.
MANUFACTURING
The Company's products are comprised primarily of components
manufactured on a batch basis by the Company, sub-assemblies and parts
manufactured to the Company's specifications by third parties and certain other
"off the shelf" electronic components purchased from third parties. To date, a
substantial portion of the Company's manufacturing, as well as the final
assembly, testing and packaging of all of its products is performed at the
Company's facility in Wilmington, North Carolina.
The Company relies on a variety of small and large manufacturers that
supply a wide variety of off-the-shelf semiconductor integrated circuit chips
and specialized electronic components, several of which manufacturers are the
sole source of supply. The Company also relies on third party manufacturers and
assemblers to manufacture and/or assemble certain components and sub-assemblies
for the Company's products that are built to the Company's specifications and
which require fabrication equipment the Company does not presently possess.
Further, the Company relies on third party manufacturers for specialized
sub-assemblies, including the charged coupled device color camera presently used
by the Company which, although not built to Company specifications, are
manufactured outside of the United States and are inventoried by the
manufacturers in limited quantities. While the Company believes that all these
components could be obtained elsewhere if needed or that the Company's products
could be redesigned to use alternative components, no assurance can be given
that other sources of supply would be available without significant delay or
increased cost, and the use of alternative available components could require
re-engineering by the Company of portions of its products, which could impose
additional cost and significant delay on the Company.
In addition, the Company's reliance on third parties to manufacture and
sub-assemble certain components involve significant risks, including reduced
control over delivery schedules, the inability to ship product under
"just-in-time" arrangements and quality assurance. Furthermore, certain of the
Company's manufacturers, sub-assemblers and suppliers, including suppliers of
components made outside the United States, may require the Company to make firm
scheduling and delivery commitments and deliver secure financing arrangements,
such as letters of credit, as a condition to fulfillment of their contractual
obligations to the Company. Failure to obtain an adequate supply of components
and required sub-assembler services on a timely basis would have a material
adverse effect on the Company. As a result, the Company anticipates that, if it
is successful in the commercialization of its products, so that larger
quantities of its products can be sold, the Company will become even more
dependent on a timely supply of purchased inventory, and will be required to
devote significant capital to its inventory. The Company currently does not have
the significant financial resources necessary to fully fund such level of
commercialization. See Item 6 - "Management's Discussion and Analysis or Plan of
Operations - Liquidity and Capital Resources."
While the Company has been manufacturing certain video conferencing
components since 1994, sales volume to date has kept production at relatively
low and inefficient levels. In order to be profitable, the Company must be able
to manufacture its products at acceptable costs and there can be no assurance
that the Company will be able to make the transition to higher production volume
successfully or within acceptable profit margins. As the Company only has
limited experience in manufacturing commercial quantities of its products, and
anticipates heavy reliance on third party contract manufacturers if demand for
its products increase, there can be no assurance that unforeseen technical or
other difficulties will not arise which could interfere with the development or
manufacture of its products, or prevent, or create delays in, marketing of its
products.
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COMPETITION
GENERAL
The technology underlying video conferencing products is subject to
rapid change, including potential introduction of new products and technologies
which may have a material adverse impact on the Company's products. The Company
needs to maintain an on-going research, development and engineering program and
its success, if any, will depend in part on its ability to respond quickly to
technological advances by developing and introducing new products or features.
There can be no assurance that the Company will have the financial ability to
maintain an appropriate on-going research, development and engineering program,
and if it has such ability whether the Company will be able to foresee and
respond to technological advances in a timely manner, if at all. In addition,
even though the open architecture of the Company's products allow components to
be replaced as new technologies develop, there can be no assurance that the
development of technologies and products by competitors will not render the
Company's products non-competitive or obsolete.
BUSINESS PRODUCTS
Video conferencing products have received only limited market
acceptance and penetration. A number of the companies which now compete with the
Company, or which are expected to offer products that may compete with the
Company's products, are more established, benefit from greater market
recognition with national marketing programs, and have significantly greater
financial, technological, manufacturing, and marketing resources than the
Company. The Company's competitors for its business video conferencing products
include video conferencing companies and major telecommunications and electronic
companies such as British Telecom, BT Visual Images L.L.C., Compression Labs,
Inc., Corel Corp., Creative Labs Inc., Intel Corp., PictureTel Corporation and
VTEL Corporation. In addition, numerous other companies have announced PC-based
video conferencing systems and this number is expected to increase rapidly.
Intel Corp., a major computer chip manufacturer, has recently commenced shipment
of chips with telephony applications with the intention of making video
conferencing a standard part of the PC computing environment. Several computer
manufacturers, such as Compaq Computer Corp and Packard Bell have incorporated
video conferencing features into their equipment. Several telephone companies
have entered into strategic alliances with one or more manufacturers of video
conferencing equipment to increase the usage of their digital telephone lines,
which in turn, if they are successful, will increase their competitive image in
the marketplace for video conferencing products. Furthermore, as expected
advances in data compression and higher speed LANs are achieved, new video
conferencing products utilizing these advances will compete with the Company's
products. As a result of the Company's limited marketing resources, the Company
has been utilizing regional resellers, supported by the Company's internal
marketing staff, as the Company's marketing arm. Such regional resellers have
not had the broad marketing contacts, national sales support and resources and
internal backup support to enable the Company to penetrate the base of larger
potential broad-based multiple-location users of video conferencing who have not
yet integrated video conferencing into their organizations. The Company is
continuing to try to define its niche in the video conferencing marketplace for
its products, and there can be no assurance that the Company will be able to
compete successfully in the business video conferencing market.
The Company believes that the principal competitive factors in the
current business video conferencing market are perceived quality and
availability of national sales and follow-up support services, quality of video,
price, effect on the PC and LAN capacity, compatibility with standard
communication protocols, multipoint conferencing capabilities and ease of use.
The Company's marketing efforts have emphasized the Company's ability to offer
customized and scalable video conferencing products, with picture quality equal
to or greater than competing products and priced at the low to mid range of
similar systems.
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HOME PRODUCTS
To date, video conferencing over analog telephone lines has received
very limited market acceptance. As a result of recent technological advances and
the adoption of the H.324 standards for video telephony over analog telephone
lines, consumer video phones are being developed by a number of companies, some
of which are more established, benefit from greater market recognition and have
significantly greater financial, technological, manufacturing and marketing
resources than the Company. The Company expects that C-Phone Home may face
substantial competition from many well-known established suppliers of consumer
electronic products, which may include Compression Labs, Inc., Lucent
Technologies, PictureTel Corporation, Philips Electronics N.V. and Sony Corp.
Many of these potential competitors sell television and telephone products into
which they may integrate video phone systems, thereby eliminating the need to
purchase a separate video phone system. Additionally, as discussed above, the
recent introduction by Intel Corp. of chips with telephony applications have
enabled computer manufacturers to incorporate video conferencing features into
their equipment, which features may include video phone capabilities. 8x8, Inc.,
a manufacturer of integrated video compression semiconductors and associated
software, from whom the Company previously had purchased integrated circuits for
the Company's video conferencing products and C-Phone Home, has commenced
production and sale of the first product in an announced planned family of video
phones, which product is intended to directly compete with C-Phone Home.
Additionally, 8x8, Inc. has licensed its video phone technology to U.S. Robotics
Access Corporation and Kyushu Matsushita Electric Co., Ltd., and the Company
anticipates that such companies also may announce competing products. As a
result, and even though the Company believes that it is the first company to
bring to market a consumer-acceptable TV-based video phone, there can be no
assurance that the Company will be able to compete successfully in the video
phone market.
The Company believes that the principal competitive factors in the
TV-based video phone market will be quality of video and audio, price,
compatibility with standard communication protocols, ease of use, strength of
distribution channels, ability to timely fulfill order requests, customer
support, reliability and brand-name recognition. The Company's initial marketing
efforts for C-Phone Home have emphasized the Company being one of the first to
offer a product for home use which is easy to use and has acceptable picture
quality.
PATENTS AND OTHER INTELLECTUAL PROPERTY
The Company has four United States patents (one of which is a design
patent) and has pending five United States patent applications and one foreign
patent application, all of which relate to technology incorporated in its video
conferencing products and the design of various related components. The
inventions which are the subject of these patent and patent applications were
created jointly by Daniel Flohr and certain other employees of, or consultants
to, the Company and, in each case, all rights to such inventions have been
assigned to the Company.
Patents and patent applications involve complex legal and factual
issues. Moreover, the technology applicable to the Company's products is
developing rapidly. A number of companies have filed applications for, or have
been issued, patents relating to products or technology that are similar to some
of the products or technology being developed or used by the Company. The scope
and validity of these patents, the extent to which the Company may be required
to obtain licenses thereunder or under other proprietary rights and the cost and
availability of licenses, are unknown. There can be no assurance that the
Company's patent applications will result in patents being issued or that, if
issued, the patents will afford protection against competitors developing
similar or related technologies. Although the earliest patent owned by the
Company was granted in 1995, and patents generally have a seventeen year life,
due to rapidly developing technology the Company contemplates that alternative
technological solutions will be devised to accomplish the purposes of its
patents substantially before the Company's patents expire, but that such patents
may offer short-term protection from third parties. There can be no assurance
that other parties have not applied for,
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or will not obtain, patents under which the Company would need to be granted a
license or around which the Company would be forced to redesign its products.
The Company seeks to protect its intellectual property rights through a
combination of trade secret, nondisclosure and other contractual arrangements,
and patent, copyright and trademark laws. The Company generally enters into
confidentiality agreements with its employees, consultants, sales
representatives and certain potential customers and limits access to and
distribution of its proprietary information. However, there can be no assurance
that these actions will be adequate to deter misappropriation of the Company's
proprietary information, that the Company will be able to detect unauthorized
use of its intellectual property rights, or that the Company can afford the high
cost required to enforce, through litigation, its intellectual property rights.
Moreover, any such litigation could result in substantial diversion of
managerial time and resources, which could be better and more fruitfully
utilized on other activities. Furthermore, there can be no assurance that a
claim that the Company's services and products infringe on the intellectual
property rights of others will not be asserted successfully against the Company
in the future.
In 1995, the U.S. Patent and Trademark Office (the "PTO") registered
the "C-Phone" trademark to the Company. In 1996, in order to more closely
identify the Company with its products, all of which utilize the C-Phone name,
and in an attempt to eliminate confusion among investors, the Company changed
its name to C-Phone Corporation. In August 1996, the Company was advised by the
PTO that a former registered owner of the C-Phone trademark (which the PTO
canceled in 1993 for failure to submit a required affidavit), had filed a
petition to cancel the Company's registration, alleging that the PTO canceled
the prior registration "inadvertently". The former owner had used, and continues
to use, the C-Phone name for marine telephone products, and may have certain
"common law" rights to continued use of the name. A proceeding with respect to
the matter is pending before the PTO's Trademark Trial and Appeal Board, who
will determine whether the conflicting use by the Company is so confusingly
similar that a registration should not have been granted to the Company.
Discussions to resolve the matter by a mutual co-existence agreement have been
initiated; however, there can be no assurance that such discussions will result
in a successful resolution. If the matter is not resolved between the parties
and the Company is not successful in the current PTO proceedings, the Company
may need to change the identifying name on its products, may determine that it
is appropriate to change its corporate name and may be subject to damages if it
could be shown that the Company had infringed the former owner's common law
rights. Any change in the use by the Company of the C-Phone name would result in
a loss of good will and identification which the Company has been promoting
since 1993, and could have a temporary adverse impact on the Company's marketing
plans.
GOVERNMENT REGULATION
The Company's products must comply with certain requirements and
specifications set forth in regulations adopted by the FCC regulating
electromagnetic radiation and the connection of terminal equipment to the public
switched telephone network. These regulations, among other things, require that
the Company's products be in compliance with such regulations as a prerequisite
to marketing them. Although the Company's products are currently in compliance
with such regulations, if the Company redesigns or otherwise modifies its
products, or if current regulations or industry standards are revised, there can
be no assurance as to when, if ever, the Company's redesigned or modified
products will be in compliance with applicable governmental regulations and
evolving industry standards. In addition, the Company must comply with certain
similar requirements of various foreign government agencies to effect its
foreign sales. The Company's foreign distributors, as part of the Company's
distribution agreements, are responsible for ensuring compliance with, and
obtaining any necessary permits from, such foreign government agencies.
The Company, in marketing C-Phone Home, is offering consumer electronic
retail chains the option to purchase the product, at a reduced price, when
purchased with telecommunications services. As a condition to reselling
intra-state and interstate telecommunications services, the Company is required
to obtain and maintain certain approvals from the FCC and from various State
regulatory authorities, and to comply with various applicable regulatory
provisions imposed by such authorities, noncompliance with which could
17
<PAGE>
subject the Company to possible forfeitures, damages and other sanctions.
Various applicable regulatory provisions include, among other things, approval
as a non-dominant long distance carrier, requirements for the filing and
following of tariffs and that equipment and service offerings be separate and
distinct and prohibitions against unjust, unreasonable or discriminatory rates,
against preferences and against the making of direct or indirect rebates of
amounts paid for tariffed services. Although the Company believes that its
offering of inter-exchange telecommunications services complies with applicable
regulatory requirements, there can be no assurance that the Company will obtain
and retain all required regulatory approvals, that all of such approvals will be
obtained timely or that a regulatory authority may not impose conditions which
the Company may not be able to fulfill. Furthermore, there can be no assurance
that compliance with the requirements imposed by any regulatory authority would
not require modifications to the Company's business plan for C- Phone Home or
that regulatory requirements will not change in such a way as will materially
adversely affect the Company's business operations. The Company has obtained FCC
approval to resell inter-state telecommunications services; however, due to the
timing of obtaining certain State approvals, the Company will be unable to
initially offer inter-exchange telecommunications services for making
intra-state video phone calls within certain States until it has applied for and
received appropriate regulatory approvals from such States. See "Marketing and
Sales - "HOME PRODUCTS."
EMPLOYEES
As of May 15, 1997, the Company employed 66 persons (all of whom were
full-time employees), including 18 manufacturing and distribution employees, 17
product development and engineering employees, 13 sales and marketing employees,
8 management and administrative employees and 10 technical support employees. As
the Company proceeds with full scale production and marketing of its products,
it will need to increase substantially the number of its employees, and there
can be no assurance that the Company will be able to do so in a timely manner,
if at all. The Company considers that its relationships with its employees are
good.
ITEM 2. DESCRIPTION OF PROPERTY
-----------------------
The Company conducts all of its operations from its 14,420 square foot
Wilmington, North Carolina facility, approximately 17% of which is used for
engineering, approximately 23% of which is used for administration and the
balance of which is used for production, inventory, shipping and receiving.
The Company leases its facility, which was built in 1993 to the
Company's specifications, from its two principal executive officers, Daniel
Flohr and Tina Jacobs, pursuant to a triple net lease pursuant to which the
Company is responsible for all costs and expenses, including applicable taxes,
relating to the facility. The current lease for the facility expires April 30,
1999 and has a three-year renewal option at a renewal rent no greater than the
fair market value of the rented space at the beginning of the renewal term. The
current base annual rent for the facility is $75,360, which was no greater than
the fair market rental for the facility at the commencement of the current term.
Mr. Flohr and Ms. Jacobs allow the Company to use approximately 9,000 square
feet of a 1.4 acre adjacent tract of land owned by them (the "Adjacent Tract")
as a parking area for the Company's employees and customers, in consideration
for which the Company provides minimal maintenance of the parking area and pays
$330 per year of real estate taxes on the tract of land. The Company believes
that the terms and conditions of the lease are no less favorable to the Company
than those available from unaffiliated third parties.
The Company's present facility is being fully utilized. Mr. Flohr and
Ms. Jacobs have offered to construct an additional building on the Adjacent
Tract to the Company's specifications and to lease such building, when
constructed, to the Company on terms similar to the lease for the present
facility, including at a rental no greater than fair market value at the
commencement of the lease term. Plans for the additional facility are being
discussed.
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See Note 12 of Notes to Financial Statements included in Item 7 -
"Financial Statements."
ITEM 3. LEGAL PROCEEDINGS
-----------------
The Company is involved in various legal proceedings which are
incidental to the conduct of its business. None of such proceedings are expected
to have a material adverse effect on the Company's financial position or results
of operations; however, see Item 1. - "Description of Business - Patents and
Other Intellectual Property."
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
---------------------------------------------------
No matter was submitted to a vote of securities holders of the Company
during the fiscal quarter ended February 28, 1997.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
--------------------------------------------------------
The Common Stock is traded on The Nasdaq National Market under
the symbol "CFON." The following table sets forth the high and low closing sales
price for each quarterly period since March 1, 1995 for the Common Stock, as
reported by The Nasdaq Stock Market, Inc.
<TABLE>
<CAPTION>
FISCAL 1996 HIGH LOW
----------- ---- ---
<S> <C> <C> <C>
1st Quarter (quarter ended May 31, 1995) 8-1/4 7
2nd Quarter (quarter ended August 31, 1995) 9 6-1/4
3rd Quarter (quarter ended November 30, 1995) 8-1/4 5-5/8
4th Quarter (quarter ended February 29, 1996) 8-1/4 5-1/4
FISCAL 1997 HIGH LOW
1st Quarter (quarter ended May 31, 1996) 8-1/4 6
2nd Quarter (quarter ended August 31, 1996) 6-3/8 2-3/8
3rd Quarter (quarter ended November 30, 1996) 6-1/16 2-3/8
4th Quarter (quarter ended February 28, 1997) 16-1/4 3-1/8
</TABLE>
As of May 22, 1997, there were 323 holders of record of the Common
Stock, including CEDE & Co and four other institutional holders who held an
aggregate of 3,102,892 shares of Common Stock as nominees for an undisclosed
number of beneficial holders. The Company estimates that it has in excess of
2,000 beneficial holders.
The Company has never paid any dividends and, for the foreseeable
future, the Company expects to retain earnings, if any, to finance the expansion
and development of its business. Any future payment of dividends will be within
the discretion of the Company's Board of Directors, which may be deemed to be
controlled by the Company's principal shareholders, and will depend, among other
factors, on the earnings, capital requirements and operating and financial
condition of the Company.
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<PAGE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS
----------------------------------------------------------
OVERVIEW
Since 1993, the Company has been primarily engaged in the engineering,
manufacturing and marketing of C-Phone, a line of PC-based video conferencing
systems. During Fiscal 1997, the Company commenced third-party contractual
software development related to its PC-based video conferencing systems and
substantially completed development of C-Phone Home, a TV-based video phone. See
"Financial Condition".
In August 1994, the Company completed its initial public offering of
2,000,000 shares of Common Stock, pursuant to which it received net proceeds of
approximately $12,288,000, of which approximately $1,947,000 was used for the
repayment of indebtedness and accrued interest thereon.
During the week of March 31, 1997, the Company completed a private
placement of 833,667 shares of Common Stock, subject to the issuance, for no
further consideration, of up to 2,500,001 additional shares of Common Stock,
pursuant to which it received net proceeds of approximately $4,370,000. See Item
1 - "Description of Business - Recent Developments." The Company expects to use
such proceeds for sales and marketing of C-Phone Home, the continued development
of additional C-Phone products and features and related products, for sales and
marketing of C-Phone, and working capital, including funding anticipated
increases in inventories and receivables.
The Company commenced operations in 1986 as a manufacturer of
promotional radios and, in 1990, developed data/fax modems under the name
"TWINCOM". In early 1993, because of continued price pressures, shrinking
margins and for competitive reasons, the Company shifted its primary focus from
modems to the development of C-Phone and, during the fiscal year ended February
28, 1995, the Company phased out its modem product line as it was no longer
profitable. Since 1993, the Company has invested significant resources in
product development, engineering and marketing activities for C-Phone and
related products. As a result of these activities and the low volume of sales,
the Company has incurred significant losses during the three fiscal years ended
February 28, 1997. The Company expects to continue to make significant
expenditures for product development and marketing in the foreseeable future.
This Annual Report on Form 10-KSB contains, in addition to historical
information, certain forward-looking statements that involve significant risks
and uncertainties. Such forward-looking statements are based on management's
belief as well as assumptions made by, and information currently available to,
management pursuant to the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995. The Company's actual results could differ
materially from those expressed in or implied by the forward-looking statements
contained herein. Factors that could cause or contribute to such differences
include, but are not limited to, those discussed in Item 1 - "Description of
Business", in "Liquidity and Capital Resources" in this Item 6, and elsewhere in
this Annual Report on Form 10-KSB. The Company undertakes no obligation to
release publicly the result of any revisions to these forward looking statements
that may be made to reflect events or circumstances after the date of this
Annual Report on Form 10-KSB or to reflect the occurrence of other unanticipated
events.
RESULTS OF OPERATIONS
FISCAL 1997 AS COMPARED TO FISCAL 1996
REVENUES. Revenues increased 14% to $2,042,878 in Fiscal 1997 from
$1,786,115 in Fiscal 1996. The revenues for Fiscal 1997 included $150,000 of
software development revenue related to software developed by the Company at two
customers' requests for use with C-Phone products and $1,890,213 of sales of
C-Phone products, while the revenues for Fiscal 1996 consisted only of sales of
C-Phone products. As a result, net sales of C-Phone products increased 6% in
Fiscal 1997 as compared to Fiscal 1996. The Company
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believes that such minimal increase was primarily related to a change in sales
and marketing personnel. While the Company hired a new Vice President of Sales
and Marketing in September 1996 and replaced several sales and marketing
personnel in November 1996, appropriate indoctrination, integration and training
of such persons and the required lead-time for such persons to generate sales
was not sufficient to produce significant tangible results during Fiscal 1997.
COST OF REVENUE. Cost of revenue consists of cost of goods sold and
cost of software development and other revenue. Cost of goods sold includes
labor, materials and other manufacturing costs (such as salaries, supplies,
leasing costs, depreciation related to production operations and write-off of
obsolete inventory). Cost of software development and other revenue includes the
allocation of salaries and benefits of personnel and the cost of outside
services directly related to such revenue. Cost of goods sold increased 5% to
$1,629,287 (86% of net sales) in Fiscal 1997 from $1,556,353 (87% of net sales)
in Fiscal 1996. The increase in cost of goods sold and the decrease in the
percentage of cost of goods sold to net sales were both primarily related to the
moderate increase in sales. The cost of software development and other revenue
($81,079) was 53% of the related revenue; the Company had no similar revenue in
Fiscal 1996.
GROSS PROFIT. Gross profit increased to $332,512 (16% of revenues) in
Fiscal 1997 from $229,762 (13% of revenues) in Fiscal 1996. The gross profit
produced from sales of goods was $260,926 (14% of net sales) in Fiscal 1997, as
compared to $229,762 (13% of net sales) in Fiscal 1996. The gross profit
percentage related to software development and other revenue was $71,586 (47% of
such revenue) in Fiscal 1997; the Company did not have any such revenue in
Fiscal 1996. The increase in gross profit and gross profit percentage related to
sales was directly related to the increase in sales.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and
administrative expenses decreased 33% to $2,454,337 (or 120% of revenues) in
Fiscal 1997 from $3,662,679 (or 205% of revenues) in Fiscal 1996. The primary
reason for the decrease was a 50% reduction in selling and marketing expenses to
approximately $1,125,000 in Fiscal 1997 from approximately $2,230,000 in Fiscal
1996, of which approximately $1,200,000 was directly related to a nationwide
advertising and marketing campaign which ran for most of the three months ended
May 31, 1995 ("1st Quarter 96"). While the Company's trade show expenses
decreased to approximately $230,000 in Fiscal 1997 from approximately $425,000
in Fiscal 1996 as a result of the Company's decision not to participate in the
1996 Las Vegas Comdex trade show, this decrease was mostly offset by additional
marketing expenses related to the initial marketing launch of C-Phone Home. In
additional, general and administrative expenses increased as a result of
increased personnel costs resulting from additional customer support personnel
and a reallocation of duties of certain personnel from research, development and
engineering. The Company expects that it will continue to incur substantial
selling, general and administrative expenses for Fiscal 1998 as a result of the
commercialization of C-Phone Home.
RESEARCH, DEVELOPMENT AND ENGINEERING. Research, development and
engineering expenses decreased 8% to $1,016,293 (50% of revenue) in Fiscal 1997
from $1,102,737 (62% of revenue) in Fiscal 1996. The decrease was primarily the
result of the reallocation of approximately $76,000 of certain personnel and
benefit costs to the cost of software development revenue and a decrease in
personnel costs resulting from a partial change in duties of certain personnel
to selling, general and administrative. Without the reallocation of personnel
costs to cost software development, research, development and engineering
expenses for Fiscal 1997 would be approximately the same amount as such expenses
for Fiscal 1996, as the majority of these allocated costs were for permanent
personnel. All of these costs were charged to operations as incurred and were
funded by the Company's cash reserves. The Company expects to continue to invest
significant resources during the foreseeable future in new product development
and engineering.
OPERATING LOSS. As a result of the factors discussed above, the
Company's operating loss decreased 31% to $3,138,118 in Fiscal 1997 from
$4,535,654 in Fiscal 1996.
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<PAGE>
INTEREST. Interest income decreased 65% to $132,405 in Fiscal 1997 from
$378,932 in Fiscal 1996 as a result of decreased investments, as the Company
utilized the net proceeds of the 1994 Public Offering for the continuing
development and commercialization of C-Phone products.
INCOME TAXES. The Company's losses for Fiscal 1997 and Fiscal 1996 may
be utilized as an offset against future earnings, although there is no assurance
that future operations will produce taxable earnings.
FISCAL 1996 AS COMPARED TO FISCAL 1995
REVENUES. Revenues increased 89% to $1,786,115 in Fiscal 1996 from
$945,035 in Fiscal 1995. All revenues in Fiscal 1996 were from sales of C-Phone
products compared to revenues of $338,121 from C-Phone sales during Fiscal 1995.
The balance of revenues in Fiscal 1995 ($606,914) were from sales of the modem
product line phased out during Fiscal 1995.
COST OF REVENUE. Cost of revenue consists of cost of goods sold. Cost
of goods sold includes labor, materials and other manufacturing costs (such as
salaries, supplies, leasing costs and depreciation costs related to production
operations). Cost of goods sold increased 40% to $1,556,353 in Fiscal 1996 from
$1,110,642 in Fiscal 1995. All of the costs of goods sold in Fiscal 1996 were
related to the C-Phone product line while 27% ($297,679) of the costs of goods
sold in Fiscal 1995 were related to C-Phone and 73% ($812,963) were related to
the modem product line.
GROSS PROFIT (LOSS). Gross profit increased to $229,762 (13% of
revenues) for Fiscal 1996 from a gross loss of $165,607 (18% of revenues) for
Fiscal 1995. The gross loss for Fiscal 1995 was primarily the result of a
$97,491 write-down of inventory related to the phase out of the modem product
line.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and
administrative expenses increased 122% to $3,662,679 (205% of revenues) in
Fiscal 1996 from $1,649,336 (175% of revenues) in Fiscal 1995. Decreased
expenses from the phase out of the modem product line were more than offset by
the increased marketing and other expenses related to the commercialization of
C-Phone. Selling and marketing expenses included approximately $1,174,000 for
advertising, approximately $563,000 for trade shows, approximately $352,000 for
salaries and benefits for marketing personnel and approximately $141,000 for
brochures, materials and mailing costs. Of these expenses, approximately
$1,200,000 was directly related to a nationwide advertising and marketing
campaign that ran for most of the first quarter of Fiscal 1996. While the
Company does not anticipate continuing advertising expenditures at such level,
it does expect that it will incur substantial selling, general and
administrative expenses during the fiscal year ending February 28, 1997 ("Fiscal
1997") as a result of the continuing commercialization of the C-Phone product
line. In addition, the Company's bad debt expense increased to $164,554 (9% of
revenues) in Fiscal 1996 from $54,856 (6% of revenues) for Fiscal 1995,
primarily as a result of the change in the Company's business from modems to
C-Phone, resulting in a change in the type and mix of customers for the
Company's products during C-Phone's initial introductory phase combined with the
increase in sales volume in Fiscal 1996 over Fiscal 1995. See Item 1 - "Business
- - Video Conferencing - MARKETING AND SALES."
RESEARCH, DEVELOPMENT AND ENGINEERING. Research, development and
engineering expenses increased 35% to $1,102,737 (62% of revenues) in Fiscal
1996 from $814,413 (86% of revenues) in Fiscal 1995, due to the engineering
effort to continue the development of C-Phone and to add C-Phone products. The
Company's research, development and engineering expenses for C-Phone in Fiscal
1996 consisted primarily of salaries and benefit costs for engineering personnel
of approximately $819,000, parts and supplies of approximately $122,000, and
outside consulting services of approximately $65,000. All of these costs were
charged to operations as incurred and were funded by the Company's cash
reserves. The Company expects to continue to invest significant resources during
the foreseeable future in new product development and engineering.
22
<PAGE>
OPERATING LOSS. As a result of the factors discussed above, the
Company's operating loss increased 73% to $4,535,654 in Fiscal 1996 from
$2,629,356 in Fiscal 1995.
INTEREST. Interest expense in Fiscal 1996 was $4,614 as compared to
$1,116,237 in Fiscal 1995. This decrease was due to the repayment in Fiscal 1995
of the 7% Notes from the net proceeds of the 1994 Public Offering. Interest
income increased to $378,932 in Fiscal 1996 from $275,068 in Fiscal 1995, due to
higher average levels of investments as a result of the proceeds received from
the 1994 Public Offering.
INCOME TAXES. The Company's losses in Fiscal 1996 may be utilized as an
offset against future taxable earnings, although there is no assurance that
future operations will produce taxable earnings.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its recent operations primarily through the
1994 Public Offering, which raised net proceeds of approximately $12,288,000 and
the 1997 Placement, which raised net proceeds of approximately $4,370,000 during
the week of March 31, 1997.
At February 28, 1997, the Company had working capital of $2,318,766 (a
decline from $5,334,175 at February 29, 1996) and cash and cash equivalents
(including short-term investments) of $1,398,049 (as compared to $4,279,223 at
February 29, 1996). The Company's invested funds consist primarily of United
States Treasury Bills and obligations of United States government agencies.
During Fiscal 1997, operating activities used $2,812,517 of net cash, primarily
to fund operating activities, investing activities provided $2,348,536 of net
cash, primarily from maturities of short-term investments, and financing
activities provided $9,210 of net cash. Due to the technical nature of the
Company's business and the anticipated expansion of its C-Phone technology into
new applications, management expects to continue to expend significant resources
for continued development and engineering as well as selling and marketing
expenses.
The Company believes that its current working capital, which includes
the net proceeds from the 1997 Placement, together with anticipated funds from
operations, will be sufficient to meet the Company's projected operating needs
and capital expenditures, including the initial commercialization of C-Phone
Home, through the end of the Company's fiscal year ending February 28, 1998
("Fiscal 1998"). However, if C-Phone Home gains any market acceptance, of which
there can be no assurance, the Company's pricing strategy (as discussed above
under Item 1 - "Description of Business - Marketing and Sales"), and the very
substantial investment which would then be required by the Company for
manufacturing, inventory build-up and marketing expenditures related to the
commercialization of C-Phone Home, would require the Company to obtain
additional working capital by the third fiscal quarter of Fiscal 1998. The
Company has commenced the planning process to raise such funds. The Company
anticipates that such funds should be available through a private placement of
(i) its debt securities, (ii) authorized, but unissued, shares of its Common
Stock, or (iii) its debt securities which would be convertible into such shares;
and if and when still further funds are needed, that such funds may be available
through a possible public offering of its authorized, but unissued, shares of
Common Stock. There can be no assurance that additional funds needed by the
Company will be available when needed or, if available, that the terms of such
fundings will be favorable or acceptable to the Company.
Assuming acceptance of C-Phone Home by the marketplace, the Company
anticipates that it may take in excess of two years to obtain positive cash flow
from the Company's anticipated operations, during which time the Company may be
required to obtain still more financing. If the Company is unable to timely
obtain any of its required funds, its C-Phone Home marketing strategy may not be
attainable and its business could be materially adversely affected. Unless
adequate income from sales of C-Phone Home is attained, the timing or receipt of
which cannot be predicted, the Company may require additional cash resources to
finance receivables and for development of alternative products. There can be no
assurance that additional funds needed by the Company will be available when
needed or, if available, that the terms of such fundings will be favorable or
acceptable to the Company.
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In connection with the 1994 Public Offering, the Company issued the
1994 Warrants to JLR pursuant to a Representative's Warrant Agreement. On or
about January 13, 1997, the Company received from the holders of a majority of
the 1994 Warrants, most of whom are officers of JLR, a request to register the
shares of Common Stock issuable upon exercise of the 1994 Warrants. Although the
Company filed a registration statement with the Securities and Exchange
Commission to register such shares on April 16, 1997, the Company's failure to
file such a registration statement within 45 days after January 13, 1997 may
give the holders of a majority of the 1994 Warrants the right to require the
Company to repurchase the 1994 Warrants for an aggregate of up to $1,370,000 at
any time prior to the sale of a majority of such shares pursuant to the
prospectus included in such registration statement. If such holders successfully
assert such right, the Company may not have the financial ability to make such
payment; and, in the event that such right is successfully asserted at a time
when the Company has the financial ability to make such payment, such payment
could materially adversely affect the Company's financial condition and may
deplete all of its necessary cash resources for the continuation of its
operations. The possible existence of this repurchase right, and the possibility
of its exercise, will increase the difficulty of the Company raising its
required additional working capital on terms acceptable to the Company.
The development during Fiscal 1997, and the recent introduction, of
C-Phone Home has placed a significant strain on the Company's limited personnel,
management and other resources. The Company's ability to manage any future
growth effectively will require it to continue to attract, train, motivate and
manage its employees successfully and to continue to improve its operational,
financial and management systems. The Company's failure to effectively manage
its growth could have a material adverse effect on the Company's business and
operating results.
The Company leases its facility and has financed a portion of its
manufacturing equipment expenditures through capital leases. As of February 28,
1997, the Company had no material commitments for capital expenditures.
At February 28, 1997, the Company estimates that it had available net
operating loss carryforwards of approximately $10,233,000 for Federal purposes
and net economic loss carryforwards of approximately $10,482,000 for state
purposes, which may be used to reduce future taxable income, if any. The Federal
carryforwards will expire starting in 2009 and the state carryforwards will
expire starting in 1999.
The Company believes that, during the past three years, inflation has
not had a significant impact on the Company's sales or operating results.
Certain of the components and sub-assemblies used by the Company in its
products, such as the CCD color camera presently used in C-Phone, are
manufactured outside of the United States and represents a material portion of
the unit cost of the Company's basic products. Although the Company has not
experienced any significant price increases to date as a result of changes in
foreign currency rates, there can be no assurance that, in the future, changes
in foreign currency rates will not affect the cost of its foreign purchased
components and sub-assemblies. See Item 1 "Description of Business -
Manufacturing."
The Company's foreign sales are denominated in U.S. dollars and the
Company does not incur any foreign currency risks; however, fluctuations in
currency exchange rates could cause the Company's products to become relatively
more expensive to foreign customers, which would result in a reduction in
foreign sales or the profitability of any of such sales.
NEW ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board (the "FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings
Per Share". SFAS No. 128 is designed to improve the earnings per share
information provided in financial statements by simplifying the existing
computational guidelines, revising the disclosure requirements and increasing
comparability of earnings per
24
<PAGE>
share data on an international basis. The pronouncement is effective for periods
ending after December 15, 1997 and is not expected to have a material impact on
the Company's financial statements.
In October 1995, the FASB issued SFAS No. 123, "Accounting and
Disclosure of Stock-Based Compensation". SFAS No. 123 introduces a fair-value
based method of accounting for stock-based compensation, and encourages, but
does not require, companies to recognize compensation expense for grants of
stock, stock options and other equity instruments to employees based on their
estimated fair market value on the date of grant. SFAS No. 123 is effective for
fiscal years beginning after December 15, 1995. The Company will not adopt the
new fair value accounting rules provided under SFAS No. 123, except for the fair
value of options granted to consultants as required under the provisions of SFAS
No. 123. As a result, SFAS No. 123 will not have any effect on the Company's
financial statements, except for the fair value of options granted to
consultants.
25
<PAGE>
ITEM 7. FINANCIAL STATEMENTS
--------------------
PAGE
----
TABLE OF CONTENTS
- -----------------
Report of Independent Accountants 28
Balance Sheets as of February 28, 1997 and February 29, 1996 29
Statements of Operations for the years ended
February 28, 1997, February 29, 1996 and February 28, 1995 30
Statements of Shareholders' Equity for the years ended
February 28, 1997, February 29, 1996 and February 28, 1995 31
Statements of Cash Flows for the years ended
February 28, 1997, February 29, 1996 and February 28, 1995 32
Notes to Financial Statements 33
26
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of C-Phone Corporation:
We have audited the accompanying balance sheets of C-Phone Corporation as of
February 28, 1997 and February 29, 1996, and the related statements of
operations, shareholders' equity and cash flows for each of the three years in
the period ended February 28, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of C-Phone Corporation as of
February 28, 1997 and February 29, 1996, and the results of its operations and
its cash flows for each of the three years in the period ended February 28,
1997, in conformity with generally accepted accounting principles.
Coopers & Lybrand L.L.P.
Raleigh, North Carolina
May 8, 1997
27
<PAGE>
C-PHONE CORPORATION
BALANCE SHEETS
FEBRUARY 28, 1997 AND FEBRUARY 29, 1996
<TABLE>
<CAPTION>
ASSETS 1997 1996
---- ----
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 1,398,049 $ 1,852,820
Short-term investments -- 2,426,403
Accounts receivable, net of allowance for doubtful
accounts of $120,000 and $170,000 at February
28, 1997 and February 29, 1996, respectively 422,042 398,004
Inventories 1,341,931 1,061,496
Prepaid expenses and other current assets 82,066 123,915
------------------- -------------------
Total current assets 3,244,088 5,862,638
Property and equipment, net 251,913 308,248
------------------- -------------------
Other assets 154,246 67,320
------------------- -------------------
Total assets $ 3,650,247 $ 6,238,206
=================== ===================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable, trade $ 587,877 $ 289,362
Accrued expenses 325,938 222,998
Current obligations under capital leases 11,507 16,103
------------------- -------------------
Total current liabilities 925,322 528,463
Long-term obligations under capital leases -- 11,507
------------------- -------------------
Total liabilities 925,322 539,970
------------------- -------------------
Commitments and Contingencies (Notes 12 and 14)
Shareholders' equity:
Common stock, $.01 par value; 10,000,000 shares authorized;
4,355,393 and 4,347,293 shares issued and outstanding at February
28, 1997 and February 29, 1996, respectively 43,554 43,473
Paid-in capital 13,530,208 13,495,376
Accumulated deficit (10,848,837) (7,840,613)
------------------- -------------------
Total shareholders' equity 2,724,925 5,698,236
------------------- -------------------
Total liabilities and shareholders' equity $ 3,650,247 $ 6,238,206
=================== ===================
</TABLE>
The accompanying notes are an integral part of the financial statements.
28
<PAGE>
C-PHONE CORPORATION
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED FEBRUARY 28, 1997,
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Net sales $ 1,890,213 $ 1,786,115 $ 945,035
Software development and
other revenue 152,665 -- --
----------------- ----------------- ------------------
Total revenue 2,042,878 1,786,115 945,035
----------------- ----------------- ------------------
Cost of goods sold 1,629,287 1,556,353 1,110,642
Cost of software development and
other revenue 81,079 -- --
----------------- ----------------- ------------------
Total cost of revenue 1,710,366 1,556,353 1,110,642
----------------- ----------------- ------------------
Gross profit (loss) 332,512 229,762 (165,607)
----------------- ----------------- ------------------
Operating expenses:
Selling, general and administrative 2,454,337 3,662,679 1,649,336
Research, development and engineering 1,016,293 1,102,737 814,413
----------------- ----------------- ------------------
Total operating expenses 3,470,630 4,765,416 2,463,749
----------------- ----------------- ------------------
Operating loss (3,138,118) (4,535,654) (2,629,356)
Interest expense (including amortization
of original issue discount and deferred
financing costs totalling $1,043,050
in 1995) (Note 6) (2,511) (4,614) (1,116,237)
Interest income 132,405 378,932 275,068
----------------- ----------------- ------------------
Net loss $(3,008,224) $(4,161,336) $(3,470,525)
================= ================= ==================
Per-share data:
Net loss per share $ (0.69) $ (0.96) $ (1.03)
================= ================= ==================
Weighted average number of common
shares and common share
equivalents outstanding 4,347,968 4,347,293 3,366,497
================= ================= ==================
</TABLE>
The accompanying notes are an integral part of the financial statements.
29
<PAGE>
C-PHONE CORPORATION
STAT MENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED FEBRUARY 28, 1997,
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
<TABLE>
<CAPTION>
TOTAL
COMMON STOCK ACCUMULATED SHAREHOLDERS'
SHARES AMOUNT PAID-IN CAPITAL DEFICIT EQUITY
------ ------ --------------- ----------- -------------
<S> <C> <C> <C> <C> <C>
Balance, February 28, 1994 2,185,559 $ 21,856 $ 501,605 $ (208,752) $ 314,709
Issuance of common stock as
part of bridge financing, net
of placement costs of $124,036 146,281 1,463 617,704 619,167
Issuance of common stock as a
result of initial public offering 2,000,000 20,000 12,268,051 12,288,051
Issuance of additional shares of
common stock as a part of the
bridge financing due to the
initial public offering price
per share 15,504 155 108,373 108,528
Purchase of fractional shares (51) (1) (357) (358)
Net loss (3,470,525) (3,470,525)
----------------------- ----------- ---------------- --------------- ---------------
Balance, February 28, 1995 4,347,293 43,473 13,495,376 (3,679,277) 9,859,572
Net loss (4,161,336) (4,161,336)
----------------------- ----------- ---------------- --------------- ---------------
Balance, February 29, 1996 4,347,293 43,473 13,495,376 (7,840,613) 5,698,236
Exercise of employee stock
options 8,100 81 25,232 25,313
Expense of stock options
granted to consultant 9,600 9,600
Net loss (3,008,224) (3,008,224)
----------------------- ----------- ---------------- --------------- ---------------
Balance, February 28, 1997 4,355,393 $ 43,554 $ 13,530,208 $ (10,848,837) $ 2,724,925
======================= =========== ================ =============== ===============
</TABLE>
The accompanying notes are an integral part of the financial statements.
30
<PAGE>
C-PHONE CORPORATION
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED FEBRUARY 28, 1997,
FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $ (3,008,224) $ (4,161,336) $ (3,470,525)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 134,202 182,803 191,282
Amortization of deferred financing costs and
original issue discount -- -- 1,043,050
Provision for inventory obsolescence -- 70,227 97,491
Provision for doubtful accounts 90,831 164,554 54,856
Compensation expense of stock options 9,600 -- --
Changes in operating assets and liabilities:
Restricted cash -- -- 18,625
Accounts receivable (114,879) (391,124) (99,534)
Inventories (280,435) (535,997) (178,065)
Customer deposits -- -- (31,880)
Prepaid expenses and other current assets 41,849 145,740 (253,730)
Other assets (86,926) (64,318) 9,472
Accounts payable 298,515 (191,229) (346,567)
Accrued expenses 102,940 42,249 159,011
Income taxes payable -- -- 233,283
------------ ------------ ------------
Net cash used in operating activities (2,812,517) (4,738,431) (2,573,231)
------------ ------------ ------------
Cash flows from investing activities:
Equipment purchases (77,867) (92,334) (325,789)
Purchases of short-term investments (1,647,371) (8,319,464) (7,775,522)
Maturities of short-term investments 4,073,774 9,763,943 3,904,640
Repayment of note receivable from shareholders -- -- 71,463
------------ ------------ ------------
Net cash provided by (used in) investing activities 2,348,536 1,352,145 (4,125,208)
------------ ------------ ------------
Cash flows from financing activities:
Proceeds from exercise of stock options 25,313 -- --
Proceeds from debt and equity private placement -- -- 1,583,395
Proceeds from public issuance of common stock -- -- 12,288,051
Payment of note payable, bank -- -- (41,671)
Payment of note payable, debt private placement -- -- (1,898,750)
Payment of capital lease obligations (16,103) (21,999) (27,408)
Payments of note payable to shareholder -- -- (90,590)
Purchase of fractional shares of common stock -- -- (358)
Proceeds from prepayment of private placement fees -- -- 59,415
------------ ------------ ------------
Net cash provided by (used in) financing activities 9,210 (21,999) 11,872,084
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents (454,771) (3,408,285) 5,173,645
Cash and cash equivalents, beginning of year 1,852,820 5,261,105 87,460
------------ ------------ ------------
Cash and cash equivalents, end of year $ 1,398,049 $ 1,852,820 $ 5,261,105
============ ============ ============
Supplemental disclosure of cash flow information:
Interest paid $ 2,511 $ 4,614 $ 73,187
============ ============ ============
Income taxes paid $ -- $ -- $ --
============ ============ ============
</TABLE>
The accompanying notes are an integral part of the financial statements.
31
<PAGE>
C-PHONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------
1. NATURE OF BUSINESS
C-Phone Corporation (the "Company") was incorporated in the State of New
York on March 28, 1986. The Company has been primarily engaged in the
engineering, manufacturing and marketing of C-Phone, a line of PC-based
video conferencing systems. During the year ended February 28, 1997, the
Company has engaged in contractual software development related to its
PC-based video conferencing systems. In addition, the Company has
recently completed development of C-Phone Home(TM), a television
"set-top" box video system which allows video telephone calls to be made
over regular telephone lines using a standard television set. The
Company phased out its data/fax modem product line during the year ended
February 28, 1995.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
-----------------------------------------------------------
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amount of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amount of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
CASH AND CASH EQUIVALENTS
-------------------------
Cash and cash equivalents includes all cash balances and highly liquid
investments with a maturity of three months or less from the date of
purchase.
SHORT-TERM INVESTMENTS
----------------------
Short-term investments include highly liquid investments with a maturity
of more than three months and not more than one year from the date of
purchase.
CONCENTRATION OF CREDIT RISK
----------------------------
Concentrations of credit risk that arise from financial instruments
exist for groups of counterparties when they have similar economic
characteristics that would cause their ability to meet contractual
obligations to be similarly affected by changes in economic or other
conditions.
Significant customers and concentrations of credit risk are discussed in
Note 13. As discussed in Note 3, the Company maintains its cash in bank
deposit accounts which, at times, may exceed federally insured limits.
FAIR VALUE OF FINANCIAL INSTRUMENTS
-----------------------------------
The carrying value of the Company's financial instruments, which consist
of cash and cash equivalents at February 28, 1997 and February 29, 1996
and short-term investments at February 29, 1996, approximates the fair
value because of the short maturities of these instruments.
INVENTORIES
-----------
Inventories are valued at the lower of cost or market on a first-in,
first-out basis.
32
<PAGE>
C-PHONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
PROPERTY AND EQUIPMENT
----------------------
Property and equipment is stated at cost and is depreciated, including
equipment under capital leases, by the double-declining-balance method
over the estimated useful lives of the assets, which range from three to
seven years. Leasehold improvements are amortized over the estimated
useful life of the asset. Major tooling costs are capitalized and
amortized over the expected life of the tooling or the expected life of
the related product, whichever is less. Expenditures for minor tooling,
maintenance and repairs are charged to expense as incurred.
Significant expenditures for betterments and renewals are capitalized.
The cost and related accumulated depreciation of property and equipment
are removed from the accounts upon retirement or other disposition, and
any gain or loss is reflected in operations.
The Company assesses the impairment of its long-lived assets, including
property, plant and equipment, whenever economic events or changes in
circumstances indicate that the carrying value of the assets may not be
recoverable. Long-lived assets are considered to be impaired when the
sum of the expected future operating cash flows, undiscounted and
without interest charges, is less than the carrying values of the
related assets.
INCOME TAXES
------------
The Company provides for income taxes in accordance with Statement of
Financial Accounting Standards No. 109 ("SFAS No. 109"), "Accounting for
Income Taxes". SFAS No. 109 requires that all deferred tax asset and
liability balances be determined by application to temporary differences
of the tax rate expected to be in effect when taxes will become payable
or receivable. Temporary differences are differences between the tax
basis of assets and liabilities and their reported amounts in the
financial statements that will result in taxable or deductible amounts
in future years. The Company's temporary differences consist primarily
of depreciation, allowance for doubtful accounts receivable and
inventory valuation reserves.
REVENUE RECOGNITION
-------------------
Product revenues are recognized when the product is shipped, collection
of the purchase price is probable and the Company has no significant
further obligation to the customer. Software development revenue is
recognized under the completed contract method when the software
development is completed or substantially completed. Costs of remaining
insignificant Company obligations, if any, are accrued as costs of
revenue at the time of revenue recognition.
WARRANTY
--------
The Company generally provides a one-year warranty on its products.
Estimated warranty expenses are accrued and charged to cost of goods
sold when the related revenues are recognized.
RESEARCH AND DEVELOPMENT COSTS
------------------------------
Research and development expenditures are charged to expense in the year
incurred.
33
<PAGE>
C-PHONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
DEFERRED FINANCING COSTS AND ORIGINAL ISSUE DISCOUNT
----------------------------------------------------
In March 1994, the Company completed a private placement of the
Company's common stock and extendable one-year promissory notes (Note
6). The portion of the costs of the private placement related to the
promissory notes and the original issue discount related to the issuance
of common stock were amortized over the term of the notes. As the notes
were repaid on August 26, 1994 in conjunction with the Company's initial
public offering of stock (Note 7), all of the deferred finance costs and
original issue discount were amortized during the year ended February
28, 1995 ("Fiscal 1995").
NET LOSS PER SHARE
------------------
Per-share data has been computed on the basis of the weighted average
number of shares of common stock outstanding during the year adjusted
for the August 1994 stock split of one additional share for each 30
shares of common stock. Common stock options and warrants are not
included for the years ended February 28, 1997 ("Fiscal 1997") and
February 29, 1996 ("Fiscal 1996") as they would be anti-dilutive.
Pursuant to Securities and Exchange Commission Staff Accounting
Bulletins, common stock and common stock options and warrants issued
during the twelve months immediately preceding the initial filing date
of the public offering have been included in the calculations as if they
were outstanding for all periods presented (using the Treasury Stock
Method and the initial public offering price).
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128 ("SFAS No. 128"),
"Earnings Per Share". SFAS No. 128 is designed to improve the earnings
per share information provided in financial statements by simplifying
the existing computational guidelines, revising the disclosure
requirements and increasing comparability of earnings per share data on
an international basis. This pronouncement is effective for periods
ending after December 15, 1997, and is not expected to have a material
impact on the Company's financial statements.
ACCOUNTING FOR STOCK OPTIONS
----------------------------
As permitted by Statement of Financial Accounting Standards No. 123
("SFAS No. 123"), "Accounting for Stock Based Compensation", the
Company applies Accounting Principals Board Opinion No. 25, "Accounting
for Stock Issued to Employees" and related interpretations in
accounting for the 1994 Stock Option Plan (the "Plan"). Accordingly, no
compensation cost has been recognized for options granted under the
Plan except for $9,600 related to the fair value of services received
in exchange for options granted to a consultant. However, the Company
has disclosed in Note 9 the pro forma effects had compensation cost
been determined based on the fair value of the options at the grant
date.
RECLASSIFICATIONS
-----------------
Certain amounts in the Fiscal 1996 and Fiscal 1995 financial statements
have been reclassified to conform to the Fiscal 1997 presentation, which
had no effect on previously reported net loss or shareholders' equity.
34
<PAGE>
C-PHONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------
3. CASH AND SHORT-TERM INVESTMENTS
The Company places a portion of its cash and cash equivalents with
various financial institutions. At times, such cash and cash equivalents
may be in excess of the FDIC insurance limits. At February 28, 1997, the
Company's cash equivalents consisted primarily of discount notes issued
by the United States Treasury or United States government agencies.
These investments all mature in less than 90 days from the date of
purchase and it is the Company's intention to hold them until maturity.
The aggregate fair value of these investments approximated the amortized
cost at February 28, 1997.
4. INVENTORIES
Inventories consist of the following at February 28, 1997 and February
29, 1996:
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Raw materials $ 985,914 $ 765,784
Work in process 304,839 162,127
Finished goods 51,178 133,585
-------------------- --------------------
$1,341,931 $1,061,496
==================== ====================
</TABLE>
All of the above inventories are C-Phone related. All data/fax modem
inventory was liquidated, written off, or fully reserved in Fiscal 1995.
5. PROPERTY AND EQUIPMENT
Property and equipment consist of the following at February 28, 1997 and
February 29, 1996:
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Machinery and equipment $ 965,711 $ 897,448
Furniture and fixtures 49,084 45,851
Leasehold improvements 71,895 69,743
------------------ ------------------
1,086,690 1,013,042
Less accumulated depreciation
and amortization 834,777 704,794
------------------ ------------------
$ 251,913 $ 308,248
================== ==================
</TABLE>
Depreciation and amortization expense was $134,202, $182,803 and
$191,282 for Fiscal 1997, Fiscal 1996 and Fiscal 1995, respectively.
6. BRIDGE FINANCING
In March 1994, the Company issued 38 units (the "Units") of extendable
one-year promissory notes and common stock in a private placement (the
"Bridge Financing"). Each unit consisted of a $50,000 extendable
one-year 7% promissory note ("7% Notes") with interest payable at
maturity and 3,875
35
<PAGE>
C-PHONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------
6. BRIDGE FINANCING (Continued)
shares of common stock, which was subject to adjustment depending upon
the terms of certain additional financing. The Company received
$1,583,395 in cash from the Bridge Financing, net of $316,605 in
expenses. In August 1994, the Company repurchased one-quarter (1/4) of
one Unit for $11,250. The 7% Notes were collateralized by substantially
all of the Company's assets and restricted the payment of dividends and
the incurrence of additional indebtedness.
As required under their terms, the 7% Notes were repaid on August 26,
1994 after completion of the Company's initial public offering (Note 7).
At that time, the number of shares of common stock included in each Unit
was adjusted to 4,286 shares to provide for a value of $30,000, based
upon the initial public offering price of $7.00 per share of common
stock.
The original issue discount on the 7% Notes of $743,203, representing
the value assigned by management to the shares of common stock issued
with each Unit, and deferred financing fees of $191,319, net of $124,036
of expenses related to the issuance of the common stock, totaling
$934,522, was amortized over the term of the 7% Notes. Upon the
repayment of the 7% Notes, an additional $108,528 of original issue
discount was expensed, based upon the value of the additional shares
issued to the Unit holders as a result of the initial public offering.
7. INITIAL PUBLIC OFFERING
On August 26, 1994, the Company completed the sale of 2,000,000 shares
of common stock at an initial offering price of $7.00 per share,
resulting in net proceeds to the Company of $12,288,051 after expenses
of the offering totalling $1,711,949. The Company used $1,946,923 of the
proceeds to repay principal ($1,887,500) of, and accrued interest
($59,423) on, the 7% Notes (Note 6).
8. SHAREHOLDERS' EQUITY
In August 1994, the Company effected a stock split of one additional
share for each 30 shares of common stock. All numbers of shares of
common stock and the per share amounts in the accompanying financial
statements have been retroactively adjusted to reflect the
aforementioned stock splits.
In connection with the initial public offering, the Company granted to
the managing underwriter warrants to purchase 200,000 shares of common
stock at $8.40 per share. The warrants may be exercised at any time
until expiration on August 18, 1999.
During Fiscal 1997, the Company granted to a consultant a five-year
option to purchase 25,000 shares of common stock at a price of $3.375
per share (the market price of the common stock on the date of grant).
The right to exercise certain of the shares subject to the option may be
forfeited if the Company terminates the consultant during the first six
months of a one-year consulting agreement. The option was granted in
partial payment for services to be rendered by the consultant under the
agreement, which services the Company has valued at $38,400. During
Fiscal 1997, $9,600 of this amount was expensed and, as a result,
paid-in capital was increased by such amount.
36
<PAGE>
C-PHONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------
9. STOCK OPTION PLAN
In connection with the initial public offering, the Board of Directors
of the Company, subject to shareholder approval, adopted the Plan, which
provides for the grant of options to officers, directors, employees and
consultants. Options may be either incentive stock options or
non-qualified stock options, except that only employees may be granted
incentive stock options. In addition, the Plan provided for a one-time
grant to each outside director of non-qualified options to purchase
5,000 shares of common stock when such a director initially joins the
Board. The Board of Directors has granted additional non-qualified
options to the outside directors as part of their annual compensation.
The maximum number of shares of common stock with respect to which
options may be granted under the Plan is 500,000 shares. Options
generally vest over a period of three years. The maximum term of an
option is ten years. The Plan will terminate in August 2004, though
options granted prior to termination may expire after that date.
Had compensation cost for the Plan been determined based on the fair
value at the grant dates for awards under the Plan, excluding the grant
to the consultant discussed in Note 8 above, consistent with the method
of SFAS No. 123, the Company's net loss and net loss per share would
have increased to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
1997 1996
--------------------------- ----------------------
AS PRO AS PRO
REPORTED FORMA REPORTED FORMA
-------- ----- -------- -----
<S> <C> <C> <C> <C>
Net loss (in thousands) $3,008 $3,108 $4,161 $4,191
Net loss per share $ 0.69 $ 0.71 $ 0.96 $ 0.96
</TABLE>
The fair value of each option grant is estimated on the date of grant
using the Black Scholes option- pricing method with the following
weighted average assumptions used for grants. The weighted average fair
value of options granted during Fiscal 1997 and Fiscal 1996 was $2.85
and $3.51 per share, respectively.
1997 1996
---- ----
Dividend yield 0% 0%
Expected volatility 138.8% 43.3%
Risk-free interest rate 6.25% 6.25%
Expected lives, in years 5 5
37
<PAGE>
C-PHONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------
9. STOCK OPTION PLAN (Continued)
A summary of the status of the Plan at February 28, 1997 and February
29, 1996 and the changes during the years then ended is presented below:
<TABLE>
<CAPTION>
1997 1996
--------------------------------- ------------------------------
WEIGHTED WEIGHTED
SHARES AVERAGE SHARES AVERAGE
UNDERLYING EXERCISE UNDERLYING EXERCISE
OPTIONS PRICE OPTIONS PRICE
------------- ----------- ------------- -----------
<S> <C> <C> <C> <C>
Outstanding at beginning of year 116,500 $7.34 106,950 $7.13
Granted 189,150 3.18 47,050 7.45
Exercised (8,100) 3.13 0 --
Forfeited (22,350) 6.39 (37,500) 7.03
------------- -------------
Outstanding at end of year 275,200 $4.66 116,500 $7.34
============= ========= ============= =========
Exercisable at end of year 85,967 $6.01 30,583 $7.21
============= ========= ============= =========
</TABLE>
The following table summarizes information about stock options under the
Plan at February 28, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------------------- -----------------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
EXERCISE PRICE OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- ------------------- ----------------- ------------------ ------------- ----------------- ---------------
<C> <C> <C> <C> <C> <C> <C>
$2.38 - $3.38 170,900 4.6 years $3.07 26,100 $3.18
$6.75 - $7.50 104,300 2.9 years $7.23 59,867 $7.23
----------------- ----------------
275,200 85,967
================= ================
</TABLE>
10. RELATED PARTY TRANSACTIONS
In September 1994, the Company repaid a note payable to a shareholder.
The note was a demand note with interest at a rate of 8% per annum. In
connection with this note, the Company recognized interest expense of
approximately $3,700 in Fiscal 1995.
In March 1994, the Company received a repayment in full of a loan made
in February 1993 to two of its executive officers, who are also
directors of the Company, in the original principal amount of $126,575.
Interest on the outstanding balance accrued at a rate of 8% per annum
and was collateralized by the shareholders' common stock in the Company.
The Company recognized interest income of $132 during Fiscal 1995 on
this loan.
The Company leases its office, manufacturing and warehouse space from
two of its executive officers who also are directors of the Company
(Note 12).
38
<PAGE>
C-PHONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------
11. OBLIGATIONS UNDER CAPITAL LEASES
The Company leases certain manufacturing equipment, with an aggregate
cost of $68,674 and accumulated depreciation of $66,413 at February 28,
1997 and an aggregate cost of $76,008 and accumulated depreciation of
$65,559 at February 29, 1996.
Obligations under the capital leases consist of the following at
February 28, 1997 and February 29, 1996:
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Capital leases payable in monthly installments of
$1,506 and $1,682 for Fiscal 1997 and 1996,
respectively, including interest, collateralized
by manufacturing equipment having a net book
value of $2,261 at February 28, 1997 and $10,449
at February 29, 1996 $11,507 $27,610
Less current maturities 11,507 16,103
------------------ ------------------
$ -- $11,507
================== ==================
</TABLE>
The following is a schedule of future minimum lease payments under the
capital lease at February 28, 1997:
Fiscal year ending February 28, 1998 $12,046
Less amounts representing interest 539
-----------------
Present value of future minimum lease payments $11,507
=================
12. COMMITMENTS
The Company leases office, manufacturing and warehouse space totaling
approximately 14,420 square feet from two of its executive officers who
also are directors of the Company. The initial term of the lease was
for three years commencing on May 1, 1993 with monthly rental payments
of $5,000. The Company exercised its option to renew for a three year
period ending April 30, 1999 and, according to the terms of the option,
the monthly rental payments were increased beginning May 1, 1996 to
$6,280. Under the lease, the Company is required to pay all real estate
taxes and maintenance costs, and maintain property and liability
insurance on the leased property.
The Company, at its option, may extend the lease term to April 2002 by
exercising the remaining three-year renewal option and, in that event,
the monthly rental payment would be adjusted to the then current market
rate, as defined, of similar space at the time of renewal.
39
<PAGE>
C-PHONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------
12. COMMITMENTS (Continued)
The future minimum aggregate lease payments under noncancelable
operating leases are as follows at February 28, 1997:
FISCAL YEAR ENDING FEBRUARY 28,
1998 $ 75,360
1999 75,360
2000 12,560
-----------------
$163,280
=================
Rent expense was $72,800, $60,000 and $60,000 in Fiscal 1997, Fiscal
1996, and Fiscal 1995, respectively.
13. SIGNIFICANT CUSTOMERS AND CONCENTRATION OF CREDIT RISK
At February 28, 1997 and February 29, 1996, the Company had outstanding
trade accounts receivable from 33 and 51 customers, respectively. The
Company monitors the granting of credit to all its customers and,
generally, no collateral is required.
In each of Fiscal 1997, Fiscal 1996 and Fiscal 1995, there were net
revenues from two major customers that exceeded 10% of total net
revenues. Net revenues from these customers were as follows:
<TABLE>
<CAPTION>
NET REVENUES
-------------------------------------------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Customer A -- -- $ 402,802
Customer B $ 31,678 $ 187,119 108,980
Customer C 291,710 -- --
Customer D 5,864 184,063 --
Customer E 211,224 58,325 --
----------------- ------------------ -----------------
$ 540,476 $ 429,507 $ 511,782
================= ================== =================
</TABLE>
40
<PAGE>
C-PHONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------
13. SIGNIFICANT CUSTOMERS AND CONCENTRATION OF CREDIT RISK (Continued)
Accounts receivable from these customers were as follows at February 28,
1997 and February 29, 1996:
ACCOUNTS RECEIVABLE
--------------------------------------------
1997 1996
---- ----
Customer A -- --
Customer B $17,417 $ 57,375
Customer C 30,066 --
Customer D -- 63,769
Customer E 51,938 22,670
------------------ -----------------
$99,421 $143,814
================== =================
Customer A in the tables above was a purchaser of the Company's data/fax
modems, which product line was phased out during Fiscal 1995. Customers
B, C, D and E are purchasers of the Company's C-Phone product line.
Sales to customers located outside of North America, principally Europe,
comprised approximately $294,000, $103,000 and $556,000 of net revenues
during Fiscal 1997, 1996 and 1995, respectively. The Company's sales of
C-Phone related products during Fiscal 1995 were $245,206 in North
America and $92,915 in Europe. All sales in Fiscal 1996 and Fiscal 1997
were sales of C-Phone related products.
14. CONTINGENCIES
The Company is involved in various legal proceedings which are
incidental to the conduct of its business. Although the final resolution
of these matters cannot be determined, it is management's opinion that
the final outcome of these matters will not have a material adverse
effect on the Company's financial position or results of operations.
15. INCOME TAXES
The components of the net deferred tax asset were as follows at February
28, 1997 and February 29, 1996:
<TABLE>
<CAPTION>
1997 1996
------------------ ---------------
<S> <C> <C>
Net operating loss carryforwards $ 4,034,541 $ 2,885,553
Alternative minimum tax credit carryforwards 5,924 5,924
Allowance for doubtful accounts 46,938 66,496
Research and development tax credit 118,550 102,186
Other 164,302 97,870
Valuation allowance (4,370,255) (3,158,029)
------------------ ---------------
Net deferred tax asset $ -- $ --
================== ===============
</TABLE>
41
<PAGE>
C-PHONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------
15. INCOME TAXES (Continued)
The Company provides a valuation allowance for deferred tax assets that
are not expected to be realized. Due to the recent net losses incurred
by the Company, a valuation allowance has been established for all
deferred tax assets.
Reconciliation of differences between the statutory U.S. Federal income
tax rate and the Company's effective tax rate follows:
<TABLE>
<CAPTION>
1997 1996 1995
------------- ------------- -----------
<S> <C> <C> <C>
Federal statutory income tax rate (34)% (34)% (34)%
State income taxes, net of federal benefit (5) (7) (2)
Valuation allowance increase 39 41 37
Research and development tax credit -- -- (1)
------------- ------------- -----------
0% 0% 0%
============= ============= ===========
</TABLE>
The net operating loss carryforwards for Federal tax purposes as of
February 28, 1997 are estimated to be $10,233,000. The net economic loss
carryforwards for state tax purposes as of February 28, 1997 are
estimated to be $10,482,000. The Federal net operating loss
carryforwards expire in 2009 through 2012 and the state net economic
loss carryforwards expire in 1999 through 2002. The equity transactions
in Fiscal 1995 (Notes 6 and 7) resulted in a change in ownership which
limits the utilization of $1,658,436 of the Company's Federal net
operating loss carryforwards to an annual amount determined under
Section 382 of the Internal Revenue Code of 1986, as amended. As the
Company incurred losses during Fiscal 1995, Fiscal 1996, and Fiscal
1997, the unused annual limitations for such periods will be added to
the annual limitation for Fiscal 1998.
16. SUBSEQUENT EVENT
During the week of March 31, 1997, the Company completed a private
placement (the "1997 Placement"), through Josephthal Lyon & Ross
Incorporated ("JLR"), as the placement agent, pursuant to which the
Company issued an aggregate of 833,667 shares of common stock (the
"Original Shares") to the participants (the "Investors") in the 1997
Placement. Accompanying each of the Original Shares was the right, under
certain circumstances, to receive additional shares of common stock in
accordance with the terms of a "contingent value right" (the "Rights").
The Company sold the Original Shares and Rights at a price of $6.00 per
Original Share and received net proceeds of approximately $4,370,000
(net of fees and expenses of approximately $632,000).
The Rights are automatically exercised at the time, and from time to
time as, the Original Shares are first publicly sold through a broker
dealer after the effective date (the "Effective Date") of the
Registration Statement on Form S-3 filed by the Company with the
Securities and Exchange Commission on April 16, 1997 covering the
Original Shares and the maximum number of shares of common stock
issuable upon exercise of the Rights, and expire one year after the
Effective Date. The terms of the Rights provide that, upon the first
such sale of any Original Shares at a price of less than $8.00 per
share, the seller of the Original Shares will automatically receive, for
each such Original
42
<PAGE>
C-PHONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------
16. SUBSEQUENT EVENT (Continued)
Share sold, and without the payment of any additional consideration,
such additional number of shares of common stock as equals (i) $8.00
divided by the Adjusted Price, minus (ii) one; where the Adjusted Price
will equal the greater of (x) the average closing bid price per share of
common stock on The Nasdaq National Market for the ten trading days
immediately preceding the date of sale of the Original Shares, or (y)
$2.00.
In consideration for JLR's services as placement agent in the 1997
Placement, the Company (i) paid JLR a fee of $450,180 (or 9% of the
gross proceeds received by the Company in the 1997 Placement), (ii)
agreed to reimburse JLR for its out-of-pocket expenses (not to exceed
$25,000), and (iii) issued to an affiliate of JLR, warrants (the "1997
Warrants") to acquire an aggregate of 150,000 shares of common stock at
an exercise price of $9.60 per share (120% of the closing bid price for
the common stock on The Nasdaq National Market on the trading day
immediately prior to the first closing of the 1997 Placement). The 1997
Warrants expire 90 days after the Effective Date. The shares of common
stock issuable upon exercise of the 1994 Warrants and the 1997 Warrants
have been included in the Registration Statement.
The pro forma balances as of February 28, 1997, assuming the 1997
Placement had been completed as of such date, would have reflected an
increase in cash and cash equivalents and shareholders' equity of
$4,370,000.
43
<PAGE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
-----------------------------------------------------------------------
Coopers & Lybrand L.L.P., independent accountants, currently is, and
for more than the Company's last two fiscal years has been, the Company's
independent auditors. Since the beginning of such two fiscal year period, (i)
Coopers & Lybrand L.L.P. has not expressed reliance, in its audit report, on the
audit services of any other accounting firm, and (ii) there have been no
reported disagreements between the Company and Coopers & Lybrand L.L.P. on any
matter of accounting principles or practices, financial statement disclosure or
auditing scope or procedure.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.
------------------------------------------------------------
The information required for this Item 9 is incorporated by reference
from the Company's definitive proxy statement to be filed with the Securities
and Exchange Commission (the "Commission") pursuant to Regulation 14A under the
Securities Exchange Act of 1934 ("Regulation 14A") within 120 days after the end
of the Company's fiscal year covered by this Annual Report on Form 10-KSB.
ITEM 10. EXECUTIVE COMPENSATION.
----------------------
The information required for this Item 10 is incorporated by reference
from the Company's definitive proxy statement to be filed with the Commission
pursuant to Regulation 14A within 120 days after the end of the Company's fiscal
year covered by this Annual Report on Form 10-KSB.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
--------------------------------------------------------------
The information required for this Item 11 is incorporated by reference
from the Company's definitive proxy statement to be filed with the Commission
pursuant to Regulation 14A within 120 days after the end of the Company's fiscal
year covered by this Annual Report on Form 10-KSB.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
----------------------------------------------
The information required for this Item 12 is incorporated by reference
from the Company's definitive proxy statement to be filed with the Commission
pursuant to Regulation 14A within 120 days after the end of the Company's fiscal
year covered by this Annual Report on Form 10-KSB.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
--------------------------------
(a) EXHIBITS.
--------
3. Articles of incorporation and by-laws.
3(i) (a) Restated Certificate of Incorporation of the Company,
as filed with the Secretary of State of the State of
New York on February 24, 1994(1)
(b) Certificate of Amendment to Certificate of
Incorporation, as filed with the Secretary of State
of the State of New York on August 9, 1996(5)
3(ii) By-laws of the Company, as currently in effect(1)
44
<PAGE>
4. Instruments defining the rights of security holders, including
indentures.
4.1 Form of certificate representing shares of the Common Stock(2)
4.2 Warrant Agreement, dated August 20, 1994, between the Company
and Josephthal Lyon & Ross Incorporated and form of Warrant
Certificate(2)
4.3 Placement Agent Warrant Agreement, dated March 31, 1997,
between the Company and Josephthal Lyon & Ross Incorporated
and form of Warrant Certificate(6)
9. Voting trust agreement and amendments - None.
10. Material contracts.
10.1 (a) Lease, dated May 1, 1993, between the Company and
Daniel Flohr and Tina Jacobs(1)
(b) Addendum, dated as of May 1, 1996, to Indenture of
Lease, between the Company and Daniel Flohr and Tina
Jacobs(4)
10.2 (a) Employment Agreement, dated as of March 1, 1994,
between the Company and Daniel Flohr, as amended(3)
(b) Amendment No. 2 to Employment Agreement, dated as of
March 1, 1996, between the Company and Daniel
Flohr(4)
10.3 (a) Employment Agreement, dated as of March 1, 1994,
between the Company and Tina Jacobs, as amended(3)
(b) Amendment No. 2 to Employment Agreement, dated as of
March 1, 1996, between the Company and Tina Jacobs(4)
10.4 Employment Agreement, dated as of December 30, 1993, between
the Company and Stuart Ross(1)
10.5 Employment Agreement, dated as of August 15, 1996, between the
Company and David DeSimone
10.6 C-Phone Corporation Amended and Restated 1994 Stock Option
Plan and form of Option Agreement(4)
10.7 Exclusive Marketing and Distribution Agreement, dated as of
October 1, 1995 between the Company and C-Phone Europe NV/SA,
as amended(4)
10.8 Standard Form of Reseller Agreement(4)
10.9 (a) Placement Agent Agreement, dated March 31, 1997,
between the Company and Josephthal Lyon & Ross
Incorporated(6)
(b) Form of Securities Purchase Agreement, dated March
31, 1997, between the Company and each subscriber
party thereto, with terms of Contingent Value Rights
granted thereby attached thereto(6)
45
<PAGE>
(c) Form of Registration Rights Agreement, dated March
31, 1997, between the Company and each subscriber
party thereto(6)
(d) Stock Pledge Agreement, dated March 31, 1997, between
Daniel Flohr and Josephthal Lyon & Ross Incorporated,
as agent(6)
11. Statement re computation of per share earnings - Not required since
such computation can be clearly determined from the material contained
in this report on Form 10-KSB.
13. Annual report to security holders for the last fiscal year, Form 10-Q
or 10-QSB or quarterly report to security holders, if incorporated by
reference in the filing - Not applicable.
16. Letter on change in certifying accountant - Not applicable.
18. Letter on change in accounting principles - Not applicable.
21. Subsidiaries of the small business issuer - None.
22. Published report regarding matters submitted to vote of security
holders - Not applicable.
23. Consent of experts and counsel
23.1 Consent of Coopers & Lybrand L.L.P.
24. Power of attorney - Not applicable.
27. Financial Data Schedule
28. Information from reports furnished to state regulatory authorities -
Not applicable.
99. Additional Exhibits - Not applicable.
- --------------------
(1) Incorporated by reference to an Exhibit filed as part of the Company's
Registration Statement on Form S-1 (the "S-1 Registration Statement")
(Registration No. 33-80280), filed on June 14, 1994.
(2) Incorporated by reference to an Exhibit filed as part of Amendment No.
2 to the S-1 Registration Statement, filed on August 11, 1994.
(3) Incorporated by reference to an Exhibit filed as part of Amendment No.
1 to the S-1 Registration Statement, filed on July 21, 1994.
(4) Incorporated by reference to an Exhibit filed as part of the Company's
Annual Report on Form 10-KSB for the fiscal year ended February 29,
1996.
(5) Incorporated by reference to an Exhibit filed as part of the Company's
Quarterly Report on Form 10-QSB for the fiscal quarter ended August 30,
1996.
(6) Incorporated by reference to an Exhibit filed as part of the Company's
Current Report on Form 8-K, dated April 1, 1997.
46
<PAGE>
(b) REPORTS ON FORM 8-K. No Reports on Form 8-K were filed by the Company during
the fiscal quarter ended February 28, 1997; although a report on Form 8-K
(responding to Item 5 - "Other Events") was filed by the Company in April 1997.
47
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act,
the registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
Dated: May 28, 1997
C-PHONE CORPORATION
By: /s/ DANIEL P. FLOHR
-----------------------------------
Daniel P. Flohr, President and
Chief Executive Officer
In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the registrant and in the capacities and
on the dates indicated:
Dated:
May 28, 1997 /s/ DANIEL P. FLOHR
-----------------------------------
Daniel P. Flohr
President, Chief Executive Officer and
Director
(Principal Executive Officer)
May 28, 1997 /s/ TINA L. JACOBS
-----------------------------------
Tina L. Jacobs
Director
May 28, 1997 /s/ SEYMOUR L. GARTENBERG
-----------------------------------
Seymour L. Gartenberg
Director
May 28, 1997 /s/ E. HENRY MIZE
-----------------------------------
E. Henry Mize
Director
May 28, 1997 /s/ DONALD S. MCCOY
-----------------------------------
Donald S. McCoy
Director
May 28, 1997 /s/ STUART E. ROSS
-----------------------------------
Stuart E. Ross
Director
May 28, 1997 /s/ PAUL H. ALBRITTON
-----------------------------------
Paul H. Albritton
Vice President and
Chief Financial Officer
(Principal Financial and
Accounting Officer)
48
Exhibit 10.5
EMPLOYMENT AGREEMENT
AGREEMENT, dated as of the 15th day of August, 1996, between C-PHONE
CORPORATION (formerly Target Technologies, Inc.), a New York corporation having
its executive office at 6714 Netherlands Drive, Wilmington, North Carolina 28405
(the "Company"), and David DeSimone, residing at 2365 Kimbrough Court, Dunwoody,
GA 30350 (the "Employee").
The Company desires to employ the Employee on the terms and conditions set
forth herein, and the Employee desires to accept such employment.
In consideration of the undertakings set forth in this Agreement, and
intending to be legally bound, the parties agree as follows:
1. GENERAL AGREEMENT FOR SERVICES. The Company employs the Employee and the
Employee accepts employment, upon the terms and conditions of this Agreement.
2. TERM OF EMPLOYMENT. The Employee shall be available to commence and
shall commence full-time employment on September 3, 1996. Subject to any
provisions of this Agreement governing extension or early termination of this
Agreement, the term of employment shall be two years (the "Initial Term"). After
the Initial Term, this Agreement shall continue for successive terms of one year
unless terminated by either party giving notice of intention not to renew this
Agreement at least 90 days prior to the end of the Initial Term or the renewal
term then in effect.
3. DUTIES.
------
(a) The Employee shall devote the Employee's attention and energies to the
business of the Company and its affiliates, if any, on a full-time basis, and
shall not, during the term of this Agreement, be engaged in any other business
activity, whether or not such business activity is pursued for gain, profit or
other pecuniary advantage; but this shall not be construed as preventing the
Employee from investing the Employee's assets in such manner as will not require
the Employee to expend any time or effort in regard thereto or to perform any
services in connection therewith.
1
<PAGE>
(b) The Employee shall serve the Company and its affiliates faithfully,
diligently and in good faith.
(c) The Employee shall perform such services as may be required of the
Employee by the Company and its affiliates, under and subject to the
instructions, directions and control of the Board of Directors and the senior
executives of the Company, including without limitation the Company's chief
executive officer and the Company's chief operating officer. The Employee shall
serve initially as the Vice President of Sales & Marketing of the Company. The
Employee's primary responsibility shall be to perform those duties reasonably
required of, and related to, the Employee's position and such other duties as
may be assigned to the Employee from time to time which are not inconsistent
with those customarily assigned to senior employees of the Company. If the
Employee is elected as a director of the Company or is promoted to a more senior
position within the Company, during the term of this Agreement, the Employee
shall serve in such capacities without further remuneration.
(d) At all times during the term of this Agreement, the Employee shall
adhere to all rules and regulations that have been or that hereafter may be
established by the Company for the conduct of its employees.
(e) The Employee shall be based at the Company's principal executive
office. Travel and temporary work assignments at other locations may be
required, but shall be of a kind and frequency common for the Employee's
position or shall result from periodic assignment to tasks appropriate for the
Employee.
(f) The Employee affirms that the Employee is in good health, with no
chronic or recurring illness, and is insurable at normal rates. If requested by
the Company, the Employee shall cooperate in applying for and obtaining, at the
Company's expense, key-man insurance for the benefit of the Company.
4. COMPENSATION. As and for full and complete compensation to the Employee
for the services the Employee agrees to render pursuant hereto, the Company
agrees to pay to the Employee and the Employee agrees to accept the following:
2
<PAGE>
(a) The Company shall pay the Employee during the term of this Agreement an
annual salary of no less than $100,000.00 (the "Base Salary") payable in equal
bi-weekly installments, or as otherwise may be the practice of the Company in
making salary payments.
(b) The Employee shall be granted stock options to purchase shares of the
Company's stock under the Company's 1994 Stock Option Plan as set forth on
Schedule A - Employee Stock Options (which schedule is hereby made a part of
this agreement).
(c) During the term of this Agreement, the Employee shall receive a cash
bonus based upon sales performance as set forth on Schedule B - Cash Bonus
(which schedule is hereby made a part of this agreement). During the first year
of employment, the Employee shall have the right to receive advances against the
cash bonus in the amount of $7,500 per three month period. The advance shall be
payable at the end of each three month period during such first year of
employment. If earned cash bonuses are less than the total advances, the deficit
shall be repaid by the Employee and, if not repaid, may be deducted from future
compensation payments.
(d) In consideration for the Employee's relocation to the Wilmington area,
the Employee shall receive a non-accountable relocation expense payment as set
forth on Schedule C - Relocation Package (which schedule is hereby made a part
of this agreement).
(e) The Company, in its sole and absolute discretion, at any time and from
time to time, may increase the compensation to be paid to the Employee, either
permanently or for a limited period, or pay to the Employee such bonus
compensation as the Company may determine in its sole discretion.
(f) All compensation paid to the Employee shall be subject to withholding
and deductions to the extent required by applicable law.
(g) The Employee shall be eligible to participate in and to be covered by
each life insurance, accident insurance, health insurance and hospitalization,
or other plan or benefit, if any, effective generally (and not only with respect
to a specific individual or individuals) with respect to employees of the
3
<PAGE>
Company, if the Employee shall be eligible under the terms of such plan, without
restriction or limitation by reason of this Agreement. Nothing contained herein,
however, shall be construed to require the Company to establish any plans not in
existence on the date hereof, to continue any plans in existence on the date
hereof, or to prevent the Company from modifying and/or terminating any of the
plans in existence on the date hereof, and no such act or omission shall be
deemed to affect this Agreement or any of the provisions contained herein.
(h) Each full year of this Agreement, the Employee shall be entitled to a
vacation of two weeks with full compensation. The Employee shall also be
entitled to all paid holidays given by the Company to its senior employees.
Vacation days not taken shall not accumulate and shall not be available to the
Employee in subsequent years of this Agreement, unless the Employee is
restricted from taking any planned vacation at the written request of the
Company. Vacations shall be coordinated with the chief executive officer or
chief operating officer of the Company, shall be scheduled by the Employee with
due regard to the Employee's activities and responsibilities for the Company and
shall not be for a continuous period of more than two weeks.
(i) The Employee shall be entitled to reimbursement for all reasonable
out-of-pocket expenses incurred in performing the Employee's services hereunder,
within the limits of authority which may be established by the Company from time
to time, provided that the Employee properly accounts for such expenses in
accordance with the Company policy.
5. CONFIDENTIALITY.
---------------
(a) The Employee shall treat as confidential any proprietary, confidential
or non-public information relating to the business or interests of the Company
or any affiliate of the Company, including, without limitation, business plans
or technical projects of the Company or any affiliate, and any research datum or
result, invention, customer list, process or other work product developed by or
for the Company or any affiliate, whether on the premises of the Company or
elsewhere ("Confidential Information"). The Employee shall not disclose, utilize
or make accessible in any manner or in any form any Confidential Information
other than in connection with performing the services required of the Employee
under this Agreement, without the prior consent of the Company. Notwithstanding
4
<PAGE>
the foregoing, the provisions of this Section 5(a) shall not apply to any
Confidential Information which is, or at some later date becomes, publicly known
under circumstances involving no breach of this Agreement or which is required
to be disclosed pursuant to order or requirement of a court, administrative
agency or other governmental body, provided that the Company has been given
appropriate notice of such proceeding and an opportunity to contest such
disclosure.
(b) All business and technical records, information relating to the
business of the Company and its affiliates, papers, documents, correspondence,
or studies containing information relating to the Company and its affiliates, in
all cases irrespective of the manner in which such information is kept or stored
("business records"), made or kept by the Employee or under the Employee's
possession or control shall be and remain the property of the Company, and shall
be surrendered to the Company upon the termination of the Employee's employment.
Upon such termination, the Employee shall not take with him, publish, or
disclose, or otherwise use, without the consent of the chief executive officer
of the Company, any business records.
(c) The Employee agrees that during the period of the Employee's employment
hereunder and for a period of two years following the date upon which such
employment shall terminate, the Employee shall not, in any capacity, compete or
attempt to compete with the business of the Company; and the Employee
acknowledges that a portion of the payments being made to the Employee hereunder
are being made, in part, as consideration for such noncompetition agreement. The
Employee represents and agrees that in the event of the termination of the
Employee's employment hereunder, the Employee's experiences and capabilities are
such that the Employee can obtain employment in a non-competing business, and
that the enforcement of a remedy by way of injunction will not prevent the
Employee from earning a livelihood. The Employee further represents and agrees
that the covenants contained in this Section 5(c) are necessary for the
protection of the Company's legitimate business interests and are reasonable in
scope and content.
(d) The provisions of this Section 5 on the part of the Employee shall be
construed as an agreement independent of any other provision contained in this
Agreement and shall be enforceable in both law and equity, including by
5
<PAGE>
temporary or permanent restraining order, notwithstanding the existence of any
claim or cause of action of the Employee against the Company or any affiliate of
the Company, whether predicated on this Section 5 or otherwise.
(e) The Employee agrees that all processes, technologies and inventions,
including new contributions, improvements, ideas or discoveries, whether
patentable or not, conceived, developed, invented or made by or under the
supervision of the Employee (collectively, "Inventions" ) during the period of
the Employee's employment by the Company, shall belong to the Company, provided
that the Inventions grow out of the Employee's work with the Company or are
related in any manner to any business (commercial or experimental) of the
Company. The Employee agrees that the Employee shall promptly (i) disclose all
Inventions to the Company, (ii) assign to the Company, without additional
compensation, all patents and other rights to all Inventions for the United
States and all foreign countries, (iii) sign all papers necessary to carry out
the above, and (iv) give testimony (but without expense to the Employee) in
support of the Employee's inventorship. In the event that any Invention is
described in a patent application or is disclosed to third parties by the
Employee, directly or indirectly, within one year after leaving the employ of
the Company, it is to be presumed that the Invention was conceived or made
during the period of the Employee's employment by the Company. The Employee
agrees that the Company shall be entitled to shop rights with respect to any
Invention conceived or made by the Employee during the period of the Employee's
employment by the Company that is not related in any manner to any business
(commercial or experimental) of the Company but which was conceived or made on
the Company's time or with the use of the Company's facilities or materials.
Attached as an exhibit to this Agreement is a complete list of any Inventions,
patented or unpatented (including a brief description thereof), which the
Employee conceived or made prior to the Employee's employment by the Company,
and which the Employee desires to exclude from this Agreement. There is no other
contract to assign Inventions that is now in existence between the Employee and
any other person, firm or corporation, unless indicated on the exhibit, if any,
attached to this Agreement, and unless a copy of any such other contract is
attached to such exhibit.
6
<PAGE>
6. TERMINATION.
-----------
(a) DEATH. In the event that the Employee shall die during the term of this
Agreement, then, notwithstanding any other provisions hereof, the Employee's
employment hereunder and the term of this Agreement shall terminate forthwith.
In addition to any unpaid compensation then accrued, the Employee's Estate shall
be entitled to receive the proceeds of any life insurance on the Employee's life
if and to the extent then maintained by the Company for the Employee's specific
benefit.
(b) DISABILITY. If the Employee shall become incapacitated during the term
of this Agreement to such an extent that the Employee shall be unable to perform
the Employee's duties hereunder, and such incapacity shall continue for at least
six consecutive weeks or for at least 60 days in any twelve month period, the
Company may, at or at any time thereafter, and during the continuance of such
incapacity, give notice to the Employee of the termination of the Employee's
employment hereunder on an date stated in such notice, and, in such event, the
Employee's employment hereunder and the term of this Agreement shall terminate
on such date; PROVIDED, HOWEVER, that such termination shall not affect any
disability payments otherwise due hereunder to the Employee. Irrespective of the
foregoing, the Employee also may be terminated by the Company at such time as
the Employee becomes unable to perform any duties hereunder by reason of
disability, as defined in the Employer's disability insurance coverage, if any,
if the Employee is then entitled to disability payments under such coverage at a
rate at least equal to two-thirds of the Employee's Base Salary.
(c) FOR CAUSE. If, during the term of this Agreement, the employment of the
Employee by the Company should terminate by reason of the Employee's voluntary
action, or by the Company for "Cause", then the Company's obligations for
payment or delivery of salary, incentive bonus, if any, and other entitlements
under this Agreement with respect to any future period shall thereupon
terminate. Written notice of termination for Cause shall be given by the Company
to the Employee and shall be effective upon receipt. For purposes of this
Agreement, Cause includes (i) the Employee's (a) willful refusal to carry out
specific lawful directions of the Board of Directors, the chief executive
officer of the Company or the chief operating officer of the Company, which
directions shall be consistent with the provisions of this Agreement, or (b)
refusal, failure or inability to perform part of the Employee's duties or
7
<PAGE>
responsibilities to the Company and its affiliates, which refusal, failure or
inability, whether under subclause (a) or subclause (b) of this clause (i), is
not remedied promptly, but in no event later than, five days after notice
thereof to the Employee, (ii) the Employee's commission of an act of fraud,
misappropriation or dishonesty (including falsification of information (such as
with respect to the Employee's prior experience or ability, among other things)
given to the Company in connection with the Employee's hire) to the Company or
any of its affiliates or falsification of a written document delivered to the
Company or any of its affiliates or on the Company's or such affiliate's behalf,
(iii) the Employee's commission of a crime with respect to which, in the
reasonable judgment of the Company, the Employee is likely to be incarcerated or
as a result of which the Company, in its reasonable judgment, determines it
would be inappropriate for the Employee to continue as an employee of the
Company, and (iv) notice of intention to breach any of the terms or conditions
of this Agreement.
(d) WITHOUT CAUSE. If, during the term of this Agreement, the employment of
the Employee shall be terminated by the Company without Cause, then the Company
shall continue to pay the Employee the Employee's Base Salary, during the lesser
of (I) the balance of the current term of this Agreement, or (ii) two months, on
the normal salary payment dates. The Employee shall have no duty to attempt to
mitigate such obligation of the Company; PROVIDED, HOWEVER, that any
compensation thereafter earned by the Employee from any other source during the
foregoing period shall be offset against such obligation of the Company. In the
event of such termination, all other obligations of the Company to the Employee
under this Agreement arising and accruing after the date of the Employee's
termination shall terminate, except as otherwise specifically provided to the
contrary under this Agreement or by applicable law. The Employee shall have the
right to elect to terminate this Agreement, and treat such termination as
non-voluntary by the Employee and a termination without Cause by the Company, if
the Employee does not receive from the Company any compensation or other payment
due to the Employee (pursuant to this Agreement) within ten days after such
compensation or other payment is due; PROVIDED, HOWEVER, that the Company does
not remedy such action within fifteen days after notice thereof by the Employee
to the Company.
8
<PAGE>
7. INDEMNITY OF EMPLOYEE FOR GOOD FAITH ACTS AND OMISSIONS. The Company
agrees to indemnify, defend and hold the Employee harmless of and from any
liability, loss, expense, claim, cost, or other damage whatsoever arising out of
or in connection with any act or omission of the Employee, taken or omitted in
good faith in any capacity in which the Employee is acting for, or at the
request of, the Company, to the extent permitted by applicable law.
8. MISCELLANEOUS PROVISIONS.
------------------------
(a) ENTIRE AGREEMENT. This Agreement sets forth the entire agreement and
understanding between the parties with respect to the employment of the Employee
by the Company and supersedes all prior agreements, arrangements and
understandings between the parties with respect thereto.
(b) MODIFICATION. This Agreement may be amended, modified, superseded,
canceled, renewed or extended, and the terms or covenants hereof may be waived,
only by an instrument executed by the party to be charged, or in the case of a
waiver, by the party waiving compliance.
(c) WAIVER. The failure of either party at any time or times to require
performance of any provision of this Agreement in no manner shall affect the
right at a later time to enforce the same. No waiver by either party of a breach
of any term or covenant contained in this Agreement, whether by conduct or
otherwise, in any one or more instances, shall be deemed to be or construed as a
further or continuing waiver of any such breach, or a waiver of any other term
or covenant contained in this Agreement.
(d) NOTICES. All notices, demands, consents, waivers and other
communications ("Communications") given under this Agreement may be in writing
and shall be given (and shall be deemed to have been duly given) upon the
earlier of actual receipt, one business day after being sent by telegram or
telecopier or three business days after being sent by registered or certified
mail to the parties at the addresses set forth above or to such other address as
either party may hereafter specify by notice to the other party. Simultaneously
with sending a Communication to the Company, a copy of the Communication shall
be sent to Warshaw Burstein Cohen Schlesinger & Kuh, LLP, 555 Fifth Avenue, New
York, New York 10017, Attention: Arthur A. Katz, Esq. Irrespective of the
foregoing, notice of change of address shall be effective only upon receipt.
9
<PAGE>
(e) GOVERNING LAW. This Agreement and any supplemental agreements hereto
shall be construed in accordance with and governed by the laws of the State of
North Carolina applicable to contracts made and to be performed wholly within
such state and the courts of said state, including the federal courts therein,
shall have sole and exclusive jurisdiction of the parties and of the subject
matter of their respective agreements. Venue for any legal action shall be in
New Hanover County, North Carolina and in any legal action between the parties,
service of process may be accomplished by certified mail..
(f) ATTORNEYS' FEES AND DISBURSEMENTS. In the event that either party takes
legal action to enforce any of the provisions of this Agreement, the prevailing
party shall be entitled to recover all reasonable expenses incurred in
connection therewith.
(g) ASSIGNABILITY. This Agreement, and the Employee's rights and
obligations hereunder, may not be assigned by the Employee. The Company may
assign its rights, together with its obligations hereunder, to a successor by
merger or to a purchaser of substantially all of its assets, and such rights and
obligations shall inure to, and be binding upon, any such successor.
(h) BINDING EFFECT. This Agreement shall be binding upon and inure to the
benefit of the parties and their respective legal representatives, heirs,
successors and permitted assigns.
(i) INVALIDITY. The invalidity of any part of this Agreement is not
intended to render invalid the remainder of this Agreement. If any provision of
this Agreement is so broad as to be unenforceable, such provision is intended to
be interpreted to be only so broad as is enforceable.
10
<PAGE>
IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement as
of the day and year first written above.
C-PHONE CORPORATION
By: /s/ DANIEL FLOHR
----------------------------------
Daniel Flohr, President and
Chief Executive Officer
EMPLOYEE
/s/ DAVID DESIMONE
----------------------------------
David DeSimone
11
<PAGE>
SCHEDULE A
EMPLOYEE STOCK OPTIONS
- ----------------------
Stock Options under the Company's 1994 Stock Option Plan to acquire 40,000
shares of the Company's common stock shall be granted as of the date of
commencement of employment (option price is determined by market price at that
time) and shall be exercisable in accordance with the terms of the plan as
follows:
10,000 shares after one year from date of grant
10,000 shares after two years from date of grant
10,000 shares after three years from date of grant
5,000 shares after six months from date of grant if C-Phone sales
(excluding the set top box) equal or exceed $3,000,000 for the six
month period beginning September 1, 1996 through February 28, 1997.
5,000 shares after one year from date of grant if C-Phone sales
(excluding the set top box) equal or exceed $6,000,000 for the six
month period beginning March 1, 1997 through August 31, 1997.
Additional stock options under the Company's 1994 Stock Option Plan to acquire a
minimum of 20,000 shares of the Company's common stock shall be granted on terms
and conditions established by the Compensation Committee of the Board of
Directors at the time of the grant (option price to be determined by market
price at the time of grant) as follows:
a minimum of 10,000 shares at the first meeting of the Compensation
Committee of the Board of Directors occurring after February 28, 1997,
which shall be exercisable based upon achieving performance goals
during the twelve month period ending February 28, 1998 ("Fiscal 1998")
to be established by the Compensation Committee of the Board of
Directors at that time.
a minimum of 10,000 shares at the first meeting of the Compensation
Committee of the Board of Directors occurring after February 28, 1998,
which shall be exercisable based upon achieving performance goals
during the twelve month period ending February 28, 1999 ("Fiscal 1999")
to be established by the Compensation Committee of the Board of
Directors at that time.
12
<PAGE>
SCHEDULE B
ANNUAL CASH BONUS FOR C-PHONE SALES ONLY (EXCLUDING SET TOP BOX)
- ----------------------------------------------------------------
FOR PERIOD 09/01/96 - 02/28/97
------------------------------
$15,000 bonus if period sales are $2 million, but less than $3 million
$30,000 bonus if period sales are $3 million, but less than $4 million
$50,000 bonus if period sales are $4 million, but less than $5 million
$75,000 bonus if period sales are $5 million, but less than $6 million
$100,000 bonus if period sales are or exceed $6 million
FOR FISCAL 1998 & 1999
----------------------
$30,000 bonus if annual sales are $4 million, but less than $6 million
$60,000 bonus if annual sales are $6 million, but less than $8 million
$100,000 bonus if annual sales are $8 million, but less than $10
million
$150,000 bonus if annual sales are $10 million, but less than $12
million
$200,000 bonus if annual sales are $12 million, but less than $15
million
$300,000 bonus if annual sales are $15 million
If annual sales exceed $15 million, bonus will be determined in good
faith by the Compensation Committee of the Board of Directors.
13
<PAGE>
SCHEDULE C
RELOCATION PACKAGE
- ------------------
Payment aggregating $35,000 will be made on the following schedule:
$5,000 At the signing of the Employment Agreement
$7,500 October 1, 1996
$22,500 Upon closing of the sale of the DeSimone residence at 2365
Kimbrough Court, Dunwoody, GA, 30350
14
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the registration statement of
C-Phone Corporation (formerly "Target Technologies, Inc.") on Form S-8 (File No.
33-95306) of our report dated May 8, 1997, on our audits of the financial
statements of C-Phone Corporation as of February 28, 1997 and February 29, 1996,
and for the three years in the period ended February 28, 1997, which report is
included in this Annual Report on Form 10-KSB.
Raleigh, North Carolina
May 27, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
REGISTRANT'S BALANCE SHEET AS OF FEBRUARY 28, 1997 AND THE STATEMENTS
OF OPERATIONS AND STATEMENTS OF CASH FLOWS FOR THE YEAR THEN ENDED AND
IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<CIK> 0000835585
<NAME> C-Phone Corporation
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> FEB-28-1997
<PERIOD-START> MAR-01-1996
<PERIOD-END> FEB-28-1997
<CASH> 1,398,049
<SECURITIES> 0
<RECEIVABLES> 542,042
<ALLOWANCES> 120,000
<INVENTORY> 1,341,931
<CURRENT-ASSETS> 3,244,088
<PP&E> 1,086,690
<DEPRECIATION> 834,777
<TOTAL-ASSETS> 3,650,247
<CURRENT-LIABILITIES> 925,322
<BONDS> 0
0
0
<COMMON> 43,554
<OTHER-SE> 2,681,371
<TOTAL-LIABILITY-AND-EQUITY> 3,650,247
<SALES> 1,890,213
<TOTAL-REVENUES> 2,042,878
<CGS> 1,628,287
<TOTAL-COSTS> 1,710,366
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 90,831
<INTEREST-EXPENSE> 2,511
<INCOME-PRETAX> (3,008,224)
<INCOME-TAX> 0
<INCOME-CONTINUING> (3,008,224)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,008,224)
<EPS-PRIMARY> (0.69)
<EPS-DILUTED> (0.69)
</TABLE>
