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, 1998
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| | 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
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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: $1,890,666
State the aggregate market value of the voting and non-voting common
equity held by non-affiliates computed by reference to the price at which the
common equity was sold, or the average bid and asked price of such common
equity, as of a specified date within the past 60 days:
Approximately $31,643,000 based on the last published sale price
($5-11/32) on The Nasdaq National Market on May 26, 1998.
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 26, 1998 - 7,058,200 shares.
Documents Incorporated by Reference: Portions of the issuer's
definitive proxy statement to be mailed to shareholders in connection with the
issuer's 1998 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
Item No. Page
- -------- ----
Glossary ................................................................... ii
1. Description of Business ........................................... 2
2. Description of Property ........................................... 13
3. Legal Proceedings ................................................. 13
4. Submission of Matters to a Vote of Security Holders ............... 13
5. Market for Common Equity and Related Stockholder Matters .......... 14
6. Management's Discussion and Analysis or Plan of Operations ........ 14
7. Financial Statements .............................................. 23
8. Changes In and Disagreements With Accountants
on Accounting and Financial Disclosure ............................ 24
9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act. ................ 24
10. Executive Compensation. ........................................... 24
11. Security Ownership of Certain Beneficial Owners and Management. ... 24
12. Certain Relationships and Related Transactions. ................... 24
13. Exhibits and Reports on Form 8-K. ................................. 24
Signatures ................................................................. 28
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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 service)
lines).
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.
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.
fps: Frames per second.
Frame Relay: Packet data protocol with less error correction to
speed up communication over high quality
connections.
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.
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 service is expected to replace
certain current telephone lines.
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
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fiber. A LAN permits the sharing of resources and
the exchange of information between work-stations.
Modem: A device for converting digital signals to analog
signals, and vice versa, typically used to connect
digital devices with analog telephone lines.
Network: A group of devices (such as work-stations,
telephones, file servers, etc.) connected by a
communications facility.
Packet: A sequence of digitized information that is
transmitted as a unit.
PC: Personal computer.
POTS: Plain old telephone service - Conventional analog
telephone lines using twisted-pair copper wire.
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.
Unshielded twisted pair: Standard building wiring currently used to
transmit voice (telephone) and data throughout an
office or building.
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 TV-based video
phones and PC-based desktop video conferencing systems. The Company's stand
alone 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). In addition, in March 1998, the Company began
limited shipments of its C-Phone DS 324 TV-based video phone, which operates
over both analog and ISDN digital telephone lines. In May 1998, the Company
introduced C-Phone ITV(TM), a TV-based set top device that provides Internet
access using a standard television set and an analog telephone line. The
Company's PC-based video conferencing systems, which operate over local area
networks ("LANs"), are marketed under the name C-Phone(R).
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 video conferencing products; 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 1994, the Company
completed an initial public offering pursuant to which the Company received net
proceeds of approximately $12,288,000. In March 1997, the Company completed a
private placement pursuant to which it received net proceeds of approximately
$4,370,000. In December 1997, the Company completed a second private placement
pursuant to which it received net proceeds of approximately $4,110,000. In May
1998, the Company received net proceeds of approximately $4,600,000 from the
exercise of outstanding warrants and options. See Item 6 - "Management's
Discussion and Analysis or Plan of Operation - Recent Equity Offerings" and
Notes 6 and 14 of Notes to Financial Statements included in Item 7 "Financial
Statements."
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 its video conferencing systems
and video phones (which initial commercialization is ongoing), the Company
incurred significant losses during the three fiscal years ended February 28,
1998 and expects that it will incur significant losses during its current fiscal
year ending February 28, 1999 ("Fiscal 1999"). The Company anticipates that it
will continue to make significant expenditures for product development and
marketing of its TV-based products during the foreseeable future. See Item 6 -
"Management's Discussion and Analysis or Plan of Operation - Overview." The
Company believes that its TV-based products currently have greater market
potential than its PC-based products and, in light of the lack of significant
industry acceptance for PC-based desktop video conferencing products operating
over a LAN, and the Company's limited financial and other resources, the Company
has decided to shift its resources to its TV-based products, although the
Company will continue to support and provide equipment to its existing customer
base for its PC-based products and to new customers in connection with
specialized applications relating to its PC-based products, if any, that may be
presented to the Company. See "Marketing and Sales - PC-BASED PRODUCTS."
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."
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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 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, desktop 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. However, neither the
DVC market in general nor the Company's PC-based product line in particular has
achieved substantial market acceptance. See "Marketing and Sales - PC-BASED
PRODUCTS." and Item 6 - "Management's Discussion and Analysis or Plan of
Operation - Overview."
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 into the PC processor),
and (iv) the relative amount of audio accompanying the video signal.
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 16 fps under ideal
conditions, as compared to television which delivers a higher resolution video
image at 30 fps) 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
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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.
In 1997, several companies, including the Company, introduced TV-based
"set-top" video phones which allow users to make video calls using their
television sets and an analog telephone line without the need for a PC. As with
PC-based systems, these TV-based systems operate at significantly lower video
frame rates (ranging up to 16 fps under ideal conditions) and often without
fully synchronized audio. Also in 1997, several other companies introduced video
phones containing their own screen which allow users to make video calls using
an ISDN telephone line utilizing the H.320 standard. In 1998, the Company
introduced its TV-based video phone which also operates over an ISDN digital
telephone line utilizing the H.324 standard and is capable of delivering higher
video frame rates (ranging up to 30 fps under ideal conditions). See "The
Company's Products - TV-BASED PRODUCTS."
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.
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 direct dialed
video calls 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 PRODUCTS
TV-BASED PRODUCTS
The Company's TV-based "set-top", video phones allow users to make
video phone calls using their television set and their analog or ISDN telephone
line. The Company believes that a market for its TV-based products exist for (i)
business applications, such as videoconferencing, video surveillance,
recruiting, distance learning and training, tele-maintenance and tele-health,
and (ii) personal use, such as signing by the hearing impaired and video phone
calls between family members, including grandparents and
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their grandchildren, parents and their children away at school, and divorced or
separated parents and their young children.
The Company introduced C-Phone Home at the January 1997 Consumer
Electronics Show and began commercial shipments in March 1997. The Company
introduced C-Phone DS 324 at the January 1998 Consumer Electronics Show and
began limited commercial shipments in March 1998. The Company believes that its
DS 324 video phone is the only product currently on the market which is capable
of using either an analog or ISDN telephone line and is designed to be
compatible with both H.324 and H.320 standards.
C-PHONE HOME. C-Phone Home allows a user to engage in video
conferencing over an analog telephone line using a standard television set
or monitor and is capable of delivering data at rates of up to 16 fps.
C-Phone Home consists of a "set-top" box, a hand-held 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, built-in full-duplex microphone, modem (to connect to the
telephone line), codec and proprietary software. The remote control allows
the users to dial, answer or end a call by pushing one or two buttons. In
addition, C-Phone Home offers easy-to-use on-screen instructions and text
menus to operate and configure the system. C-Phone Home utilizes the H.324
standard and is designed to be compatible with other systems using such
standard. See "Industry Standards."
C-PHONE DS 324. In addition to having all the features of C-Phone Home,
the DS 324 also operates over ISDN digital networks, and is capable of
delivering video data at rates of up to 30 fps when used with an ISDN
digital telephone line. The DS 324 video phone can be used to make video
telephone calls to any other video conferencing device that supports the
H.324 standard (and will support the H.320 standard in the near future),
including PC-based systems, video conferencing rooms and TV-based video
phone using either analog telephone lines or ISDN digital telephone lines.
In addition to the basic C-Phone DS 324, the Company also offers several
enhanced models. The C-Phone DS 324 Pro features an external, higher
quality, pan, tilt and zoom camera with far end control and the C-Phone AV
324 contains multiple jacks for connecting video surveillance equipment.
The Company has no reliable data to assure that there will be
significant market acceptance of TV-based video phones in general, or the
Company's products in particular, and there can be no assurance that the
Company's TV-based video phones will gain sufficient market acceptance to
generate significant commercial sales. In addition, previous efforts to sell
video phones by larger, better known, companies than the Company have been
unsuccessful 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 analog phone line's limited
bandwidth which must be shared with video data. Currently, the Company's
TV-based video phone, when operating over an analog telephone line, 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 frame rate.
These include non-optimal conditions on the 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 the
Company's TV-based video phone will prefer full screen, highest resolution mode,
when frame rates are typically four to eight fps. At these lower frame rates,
there is not enough motion in the lips of the users for video and audio
synchronization to be necessary, and the Company's TV-based video phone
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 result in as much as a one-half
second delay in the audio transmission. Such a delay may not be acceptable by
most 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 the Company's
TV-based video phone within a reasonable period of time, if at all.
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The Company began limited shipments of its DS 324 TV-based video phone in March
1998, which is capable of delivering video data at rates of up to 30 fps when
used with an ISDN digital telephone line. While many of the same factors
mentioned above also impact the audio and video of the Company's video phone
when used with an ISDN digital telephone line, the increased bandwidth afforded
by a digital telephone line significantly increases the quality of the audio and
video as compared to operation over an analog telephone line. However, due to
(i) the higher price of the Company's DS 324 video phone, and (ii) the
installation cost and higher monthly service fee of an ISDN telephone line as
compared to an analog telephone line, there can be no assurance that the
Company's DS 324 video phone will receive market acceptance. See "Marketing and
Sales -TV-BASED PRODUCTS."
The Company recently introduced C-Phone ITV, a self contained set-top
device that provides Internet access, without a PC, using a standard television
and a regular analog phone line. C-Phone ITV consists of a "set-top" box and a
wireless, infrared unit, which also functions as a universal remote control.
C-Phone ITV is capable of connecting to any Internet Service Provider by a
dial-up connection and allows the user complete Internet access, including to
the World Wide Web and for e-mail. The device's hardware key allows easy
configuration, stores the Internet account information for each individual user
and serves as a lock-out device to prevent unauthorized or unsupervised use.
C-Phone ITV, which includes an embedded web browser, offers many of the same
features commonly available on PC web browsers, including Secure Socket Layer
("SSL") protocol for Internet purchases via credit card, and the ability to view
and play a wide range of sound, animation, and graphic file formats which may be
retrieved from the Internet. C-Phone ITV has a printer port with built in
drivers to directly support over 150 different commercially available printers.
The device also features stereo audio outputs. Higher resolution VGA computer
monitors can be connected as well, and a mouse or wired keyboard can be used in
place of the wireless keyboard. A variety of additional capabilities, including
network computer functionality and Java(TM) support, can be added to C-Phone ITV
through ROM card upgrades. To date, the Company has supplied only limited
quantities of the device to certain of its business and institutional partners.
Retail distribution plans still are being formulated, and there can be no
assurance that the device will receive market acceptance or that the Company can
successfully negotiate acceptable distribution arrangements. See "Marketing and
Sales - PC-Based Products."
PC-BASED PRODUCTS
The Company's C-Phone video conferencing products primarily are used as
PC-based DVC systems operating over a LAN. 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. 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 "Industry Standards." In addition to its LAN
systems, the Company's video conferencing products can be used in traditional
video conferencing room systems and in small group "roll-about" units.
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MARKETING AND SALES
TV-BASED PRODUCTS
The Company introduced its first TV-based product C-Phone Home, as a
production prototype, at the January 1997 Consumer Electronics Show. 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's net revenues from TV-based products since
commercial introduction in March 1997, through February 28, 1998, have
aggregated approximately $1,027,000.
The Company uses independent manufacturer's representative
organizations to act as the Company's national field sales force for the
Company's TV-based video phones. In addition, the Company has established
relationships with companies operating in 15 countries, including South Africa,
India, Malaysia, Mexico, Canada, Korea and Japan for the foreign distribution of
its TV-based video phones. The Company's international partners are responsible
for establishing a local presence for the product, creating market awareness,
handling local government import and certification requirements, arranging local
technical support and distribution, demonstrating the product at trade shows,
implementing local advertising and marketing programs and translating the
operating system and manual and related materials.
As part of the Company's plan to develop market awareness and
acceptance for its TV-based video phone, the Company has entered into an
agreement (the "Sprint Agreement") with an affiliate of Sprint Corporation
("Sprint") to supply Sprint with its TV-based video phone co-branded with the
C-Phone and Sprint names. However, Sprint is not obligated to purchase any
minimum number of units and, through May 26, 1998, had purchased for resale only
a limited number of units to test market the product in five stores. Pursuant to
the Sprint Agreement, Sprint is entitled to return to the Company any unsold
units (excluding those units that it has already purchased for its test
marketing) that are held in its inventory for more than four months, provided
that no more than one-third of the total number of units purchased by Sprint
during the term of the Sprint Agreement may be returned, and to receive, at its
option, either a cash refund or a credit against future purchase, in an amount
equal to 80% of the original invoice price for such units. At such time, if at
all, as Sprint purchases a significant amount of products from the Company, the
exercise by Sprint of its right to return for cash of a significant number of
units could have a material adverse effect on the Company and its available cash
resources. In addition, pursuant to the Sprint Agreement, in order to permit
Sprint to continue to sell the co-branded TV-based video phone, in the event
that, among other things, (i) the Company is unwilling or unable to provide
upgrades or modifications to the software for the unit, or (ii) the Company
liquidates or becomes insolvent or the subject of a bankruptcy petition, the
Company has agreed, if requested by Sprint, to place in escrow the source codes
(the "Source Codes") for the software related to the unit. Upon the occurrence
of such events, the Source Codes would be released to Sprint on a nonexclusive,
non-transferable basis (and subject to establishment of a reasonable royalty
payment) for so long as any such event is continuing. The Company believes that
a release of the Source Codes, which include non-public, proprietary
information, could have a material adverse effect on the Company.
In addition to the sale of its video phones through telecommunications
companies, through international distributors and special projects, the
Company's marketing strategy includes sales to consumer electronic retailers,
including catalog companies. 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.
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The Company has limited sales, marketing and distribution experience
relating to retail consumer goods. The commercialization of the Company's
TV-based video phones require 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 commercial
market acceptance for the Company's TV-based video phones. The Company is
devoting a material portion of its available resources for the commercialization
of the Company's TV-based video phone, and failure of the Company to establish
the necessary sales, marketing and distribution network for this product will
have a material adverse effect on the Company's financial condition.
PC-BASED PRODUCTS
The Company developed its initial PC-based product in 1993 for desktop
video conferencing over a LAN, and has developed a number of enhancements since
such time. However, the market for this type of 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 resulted in
significant commercial sales. 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. The Company's revenues from PC-based products
during the year ended February 28, 1998 ("Fiscal 1998"), aggregated
approximately $863,000. In light of the Company's shift in focus to its TV-based
products, the lack of significant industry acceptance for PC-based desktop video
conferencing products operating over a LAN, and the Company's limited financial
and other resources, the Company has decided to shift its resources to its
TV-based products, although the Company will continue to support and provide
equipment to its existing customer base for its PC-based products and to new
customers in connection with specialized applications relating to its PC-based
products, if any, that may be presented to the Company.
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 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.
A significant portion of the Company's past revenues have been
dependent on sales to a limited number of customers. During Fiscal 1998, net
revenues from Comtrad Industries and Nobody Beats the Wiz (the "Wiz"), were
11.0% and 10.4%, respectively, of the Company's net revenues from TV-based
products (and 6.0% and 5.6%, respectively, of the Company's total net revenues)
and the Company's ten largest customers for TV-based products accounted for
approximately 73.1% of the Company's net revenues from TV-based products (and
39.7% of the Company's total net revenues). During the year ended February 28,
1997 ("Fiscal 1997"), net revenues from Mirage Resorts, Inc. and C-Phone Europe
NV/SA (the Company's former European distributor) constituted 14.3% and 10.3%,
respectively, of the Company's net revenues (all
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of which was related to the Company's PC-based product). 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 products and, therefore, such customers could reduce
or curtail their purchases at any time. As a result, a substantial reduction in
orders from existing customers (which has occurred from time to time) would have
a material adverse effect on the Company unless the Company is able to attract
orders from new customers, of which there can be no assurance. On December 16,
1997, the Wiz filed for protection under the United States bankruptcy laws and
there can be no assurance as to the amount, if any, that the Company will
receive as payment on its outstanding accounts receivable from the Wiz (which
constitutes all sales to the Wiz during Fiscal 1998), and the Company has
established an allowance for doubtful accounts equal to substantially all of its
Wiz receivables.
During Fiscal 1998, the Company's non-U.S. net sales aggregated
approximately 17.1% of total net sales, and were derived from resellers
primarily located in South Africa, India, Malaysia, Mexico, Canada, Korea and
Japan, 55.6% of which were from TV-based product sales and 44.4% of which were
from PC-based product sales. During Fiscal 1997, the Company's non-U.S. net
sales, all of which were from PC-based products, aggregated approximately 15.0%
of total net sales, and were derived from the Company's former European
distributor and resellers in Canada, Europe and southeastern Asia. A reduction
in the volume of non-U.S. trade or any material restrictions on such trade could
have a material adverse impact on the Company's revenues from its PC-based video
conferencing products. The Company sells to its 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 one or
more 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 products to become relatively more expensive to foreign
customers, which could result in a reduction in foreign sales or profitability
of foreign sales.
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 has been performed at the
Company's facility in Wilmington, North Carolina.
The Company relies on a number 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 and 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
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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 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 contract manufacturers if demand for its products
increase, the Company is in the process of evaluating a third party for the
purpose of providing final assembly of its products. However, there can be no
assurance that such third party will be acceptable or that the parties can agree
on terms that are acceptable to the Company. Furthermore, 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.
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.
TV-BASED PRODUCTS
To date, TV-based video conferencing over analog telephone lines has
received very limited market acceptance and TV-based video phones using ISDN
telephone lines has been confined to more expensive products designed to support
limited business applications. As a result of recent technological advances and
the adoption of the H.324 standard 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 the Company's TV-based
video phones may face substantial competition from many well-known established
suppliers of consumer electronic products, which may include Lucent
Technologies, PictureTel Corporation, Philips Electronics N.V., Sony Corp,
Tandberg and VTEL Corporation; and if any of such companies, among others,
determine to market a competitive product, the Company could have difficulty
obtaining necessary retail display space for its video
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phones. 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. 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
products, sells TV-based video phones which directly compete with the Company's
TV-based video phones. Additionally, 8x8, Inc. sells private label TV-based
video phones to several third parties and has licensed its video phone
technology to other companies, including 3COM Corporation, Kyushu Matsushita
Electric Co., Ltd., Leadtek and Truedox, which companies also are producing
competing products. As a result, 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 are 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 marketing efforts for its
TV-based products 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. The Company has licensed, on a non-exclusive basis, its
utility patent relating to the camera display configuration of its PC-based
desktop video conferencing product.
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, 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, since the Company
does not have the resources to maintain a staff whose primary function is to
investigate the level of protection afforded to third parties on devices which
the Company uses in its products or sub-assemblies, there can be no assurance
that a claim that the Company's
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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 there was a
likelihood of confusion between the marks, and that its failure to file a
required affidavit was inadvertent. 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 and to prevent others from
using 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. 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.
IMPACT OF YEAR 2000 ISSUE
Computer systems may experience problems handling dates beyond the year
1999 because many computer programs use only two digits to identify a year in a
date field. As the Company's products do not include date/time mechanisms in
their operating software, compliance with the Year 2000 issue is not a concern.
During Fiscal 1998, for operational purposes, the Company made the
decision to upgrade its internal financial software system, which is Year 2000
compliant. The Company has substantially completed the identification of other
internal computer-based systems it uses which may require upgrading to insure
operational continuity beyond December 31, 1999, and anticipates that the cost
of bringing these internal minor systems into compliance will not be material.
The Company is assessing the possible effects on the Company's operations of
Year 2000 compliance related to key suppliers, subcontractors and customers. The
Company's reliance on suppliers and subcontractors means that the failure to
address compliance issues by these parties could have an impact on the Company's
business, although the Company believes that such impact, if any, would not be
material.
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.
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EMPLOYEES
As of May 26, 1998, the Company employed 50 persons (all but 3 of whom
were full-time employees), including 19 manufacturing and distribution
employees, 13 product development and engineering employees, four sales and
marketing employees, nine management and administrative employees and five
customer support employees, as compared to 66 persons at May 15, 1997 (all of
whom were full-time employees). The decrease in the number of the Company's
employees was primarily a result of the Company's shift in focus away from
PC-based products. The Company considers that its relationships with its
employees are good. The continued development of the Company's business and
operations is dependent upon the efforts and talents of three of its executive
officers, Daniel Flohr, Tina Jacobs and Stuart Ross, and the services of certain
key technical personnel. The loss of the services of any of these persons, as
well as the inability of the Company to attract and then retain additional
required qualified personnel in connection with the commercialization of the
Company's TV-based video phone, would have a material adverse effect on the
Company.
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, under 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
approximately $345 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. In the event
that the Company needs additional space, 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.
See Note 10 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."
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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, 1998.
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 sales price for
each quarterly period since March 1, 1996 for the Common Stock, as reported by
The Nasdaq Stock Market, Inc.
Fiscal 1997 High Low
----------- ---- ---
1st Quarter (quarter ended May 31, 1996) 8-3/8 6
2nd Quarter (quarter ended August 31, 1996) 6-5/8 2-1/4
3rd Quarter (quarter ended November 30, 1996) 6-5/8 2-3/8
4th Quarter (quarter ended February 28, 1997) 19-3/8 3-1/8
Fiscal 1998 High Low
----------- ---- ---
1st Quarter (quarter ended May 31, 1997) 11-1/2 5-7/8
2nd Quarter (quarter ended August 31, 1997) 10 5
3rd Quarter (quarter ended November 30, 1997) 10-1/2 5
4th Quarter (quarter ended February 28, 1998) 8-3/4 3-13/16
On May 26, 1998, the closing sale price was 5-11/32. As of May 26,
1998, there were 327 holders of record of the Common Stock, including CEDE & Co
and three other institutional holders who held an aggregate of 5,253,859 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. For
information concerning issuances of securities by the Company during Fiscal 1998
and Fiscal 1999, see Item 6 - "Management's Discussion and Analysis or Plan of
Operations - Recent Equity Offerings."
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.
Item 6. Management's Discussion and Analysis or Plan of Operations
----------------------------------------------------------
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.
FORWARD-LOOKING STATEMENTS CAN GENERALLY BE IDENTIFIED AS SUCH BECAUSE
THE CONTEXT OF THE STATEMENT USUALLY WILL INCLUDE WORDS SUCH AS THE
COMPANY "BELIEVES" OR "EXPECTS" OR WORDS OF SIMILAR IMPORT. SIMILARLY,
STATEMENTS THAT DESCRIBE THE COMPANY'S FUTURE PLANS, OBJECTIVES,
ESTIMATES OR GOALS ARE ALSO
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FORWARD-LOOKING STATEMENTS. SUCH STATEMENTS ADDRESS FUTURE EVENTS AND
CONDITIONS CONCERNING CAPITAL EXPENDITURES, EARNINGS, SALES, LIQUIDITY
AND CAPITAL RESOURCES, AND ACCOUNTING MATTERS. 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 BELOW AND IN ITEM 1 - "DESCRIPTION OF BUSINESS" AND ELSEWHERE
IN THIS ANNUAL REPORT ON FORM 10-KSB, AS WELL AS FACTORS SUCH AS FUTURE
ECONOMIC CONDITIONS, ACCEPTANCE BY CUSTOMERS OF THE COMPANY'S PRODUCTS,
CHANGES IN CUSTOMER DEMAND, LEGISLATIVE, REGULATORY AND COMPETITIVE
DEVELOPMENTS IN MARKETS IN WHICH THE COMPANY OPERATES AND OTHER
CIRCUMSTANCES AFFECTING ANTICIPATED REVENUES AND COSTS. 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.
OVERVIEW
The Company has been, and is, primarily engaged in the engineering,
manufacturing and marketing of a line of TV-based and PC-based video
conferencing systems. The Company's stand alone 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. In
addition, in March 1998, the Company began limited shipments of its DS 324
TV-based video phone, which operates over both analog and ISDN digital telephone
lines. In May 1998, the Company introduced C-Phone ITV, a TV-based set top
device that provides Internet access using a standard television set and an
analog telephone line. The Company's PC-based video conferencing systems, which
operate over digital networks, are marketed under the name C-Phone. From time to
time, the Company also has engaged in contractual software development related
to its products.
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 its video
conferencing products, and expects that such investments will continue in the
foreseeable future.
The Company's products are marketed through a variety of channels
depending upon the product. The Company's TV-based video phone is marketed to
end users, distributors, and resellers and to original equipment manufacturers
("OEMs") which integrate the product with other equipment for resale to specific
industries such as health care and security services. During Fiscal 1998, many
retail distributors offered the end user the option to purchase the Company's
TV-based video phone on a stand-alone basis or, similar to the method by which
most cellular telephones are sold, at a lower price when purchased with
telecommunications services offered by the Company. The proceeds to the Company
from units sold under the latter option were less than the Company's cost of the
product and, as 36% of C-Phone Home sales were made under such purchase option
in Fiscal 1998, such sales and the required mark-down of related inventory to
reflect such sale price contributed significantly to the gross loss for that
period. However, the percentage of sales under this option has decreased to the
point that the Company no longer offers a telecommunications option. The Company
is currently exploring the market opportunities for C-Phone ITV and has not at
this time developed a marketing strategy for this product. The Company believes
that its TV-based products currently have greater market potential than its
PC-based products and, in light of the lack of significant industry acceptance
for PC-based desktop video conferencing products operating over a LAN, and the
Company's limited financial and other resources, the Company has decided to
shift its resources to its TV-based products, although the Company will continue
to support and provide equipment to its existing customer
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base for its PC-based products and to new customers in connection with
specialized applications relating to its PC-based products, if any, that may be
presented to the Company. See "Marketing and Sales - PC-BASED PRODUCTS." See
Item 1 - "Description of Business - Marketing and Sales."
As a result of the foregoing and the low volume of sales, the Company
has incurred significant losses during the three fiscal years ended February 28,
1998. The Company expects to continue to incur significant losses in the
foreseeable future due to its significant expenditures for product development
and the commercialization of its TV-based products.
RECENT EQUITY OFFERINGS
MARCH 1997 PRIVATE PLACEMENT. During the week of March 31, 1997, the
Company completed a private placement (the "March Placement") pursuant to which
the Company issued an aggregate of 833,667 shares (the "Original Shares") of the
Company's common stock, par value $0.1 per share (the "Common Stock"), to the
participants in the March Placement and received net proceeds of approximately
$4,370,000 (after payment of fees and expenses of approximately $632,000).
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 Rights, which expire
June 25, 1998, are automatically exercised at the time, and from time to time
as, the Original Shares are first publicly sold through a broker-dealer. 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 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 equals the greater of (x) the average closing bid price per
share of Common Stock on The Nasdaq National Market ("NNM") for the ten trading
days immediately preceding the date of sale of the Original Shares, or (y)
$2.00.
As of February 28, 1998, all the Original Shares had been sold
(although the holder of 30,000 Original Shares has not yet submitted to the
Company the necessary documentation to determine the number, if any, of
additional shares to which he is entitled) and, pursuant to the terms of the
Rights, 136,863 additional shares were issued as a result thereof.
In connection with the March Placement, the Company issued to an
affiliate of the placement agent warrants to acquire an aggregate of 150,000
shares of Common Stock at an exercise price of $9.60 per share, which warrants
have since expired unexercised.
The securities issued in the March Placement were offered for sale, and
were sold, without registration thereof under the Securities Act of 1933 (the
"1933 Act"), pursuant to the exemption from registration provided by Regulation
D under the 1933 Act.
DECEMBER 1997 PRIVATE PLACEMENT. On December 19, 1997, the Company
completed a private placement (the "December Placement") pursuant to which the
Company issued to several participants an aggregate of (i) 4,500 shares (the
"Series A Preferred Shares") of the Company's Series A Convertible Preferred
Stock, par value $.01 per share (the "Series A Preferred Stock") with an initial
stated value of $1,000 per share (which increases at the rate of 5% per annum)
(such amount, as increased from time to time, the "Stated Value"), (ii) warrants
(the "One-Year Warrants") to acquire up to 315,000 shares of Common Stock, and
(iii) warrants (the "Three-Year Warrants" and with the One-Year Warrants,
collectively, the "1997 Warrants") to acquire up to 135,000 shares of Common
Stock, to the participants in the December Placement and received aggregate
proceeds of approximately $4,110,000 (after payment of fees and expenses of
approximately $390,000).
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<PAGE>
The Company has agreed that, without the consent of the holders of
two-thirds of the then outstanding Series A Preferred Shares, it will not (i)
issue any other class or series of preferred stock that would rank senior to the
Series A Preferred Stock, and (ii) on or before December 19, 1998, issue any
other class or series of preferred stock that would rank pari passu with the
Series A Preferred Stock, in either case, as to distribution of assets upon
liquidation.
Each Series A Preferred Share is convertible, from time to time, at the
option of the holder, into such number of shares of Common Stock as is
determined by dividing the Stated Value by the lesser of (i) $7.3575, and (ii)
85% of the average of the closing bid price during such three consecutive
trading day period as may be selected by the holder during the 25 trading day
period preceding the date of conversion. The Series A Preferred Shares cease to
be convertible (the "19.99% Limitation") if, at any time, the aggregate number
of shares of Common Stock then issued upon conversion of the Series A Preferred
Shares would equal 1,068,513 shares of Common Stock (the remaining shares of
Common Stock then issuable upon conversion of the Series A Preferred Shares
being the "Excess Shares"), unless, in accordance with the rules of The Nasdaq
Stock Market, Inc. ("Nasdaq") (on which the Common Stock is traded), the Company
has obtained approval for the issuance of the Excess Shares by a majority of the
total votes cast on such proposal by the holders of the then outstanding Common
Stock (not including any shares of Common Stock held by present or former
holders of the Series A Preferred Shares that were issued upon conversion of the
Series A Preferred Shares), or it has otherwise obtained permission from Nasdaq
to allow such issuances. Any outstanding Series A Preferred Shares on December
19, 1999 automatically will be converted into Common Stock at the conversion
price then in effect. As of May 26, 1998, 2,576 of the Series A Preferred Shares
had been converted into 1,067,217 shares of Common Stock. As a result of the
19.99% Limitation, the remaining Series A Preferred Shares are not presently
convertible. However, if the Series A Preferred Shares remaining outstanding had
not ceased to be convertible and all such remaining shares had been converted as
of May 26, 1998, the Company would have been required to issue 837,743
additional shares of Common Stock (or, with the shares of Common Stock issued
upon the shares of Preferred Stock previously converted, 36% of the number of
shares outstanding on December 19, 1997 (the date of issuance of the Series A
Preferred Stock)).
The One-Year Warrants expire on December 19, 1998 and have an exercise
price of $8.05 per share (115% of the closing price of the Common Stock on the
NNM on the trading day immediately preceding the closing date of the December
Placement), subject to adjustment under certain circumstances, including upon
the issuance of shares of Common Stock (or securities convertible or
exchangeable into shares of Common Stock) at less than 80% of the then market
price on the NNM for the Common Stock. The One-Year Warrants are redeemable at
the option of the Company at a price of $.01 per warrant if the closing price of
the Common Stock on the NNM is greater than 130% of the exercise price of the
One-Year Warrants then in effect for 10 consecutive trading days. The Three-Year
Warrants expire on December 19, 2000 and have an exercise price of $9.10 per
share (130% of the closing price of the Common Stock on the NNM on the trading
day immediately preceding the closing date of the December Placement), subject
to adjustment under certain circumstances, including upon the issuance of shares
of Common Stock (or securities convertible or exchangeable into shares of Common
Stock) at less than 80% of the then market price on the NNM for the Common
Stock. The Three-Year Warrants are not redeemable. As of May 26, 1998, 325,000
shares of Common Stock had been issued upon exercise of One-Year Warrants
including the warrants issued to the finder in the December Placement) and
60,000 shares had been issued upon exercise of Three-Year Warrants and the
Company has received proceeds of $3,162,250 from the exercise thereof.
Pursuant to certain registration rights granted to the investors in the
December Placement, the Company has registered on a Form S-3 registration
statement (the "Registration Statement") such number of shares of Common Stock
as equals the sum of (i) 30% of the number of outstanding shares of Common Stock
as of the close of business on the third business day immediately preceding the
date of filing of the Registration Statement, plus (ii) the number of shares of
Common Stock issuable upon exercise of the 1997 Warrants issued to the
investors. The Company also has agreed that if the Registration Statement is
17
<PAGE>
insufficient to cover all of the shares of Common Stock issuable upon conversion
of the Series A Preferred Shares (based upon the market price of the Common
Stock and other relevant factors), it will register such additional number of
shares of Common Stock as may be required (collectively, the "Registerable
Securities"). The Company has also agreed use its best efforts to maintain the
effectiveness of the Registration Statement until the earlier of (i) December
19, 2001, or (ii) the time that all the Registerable Securities have been sold
pursuant to the Registration Statement or may be sold under Rule 144 under the
1933 Act without regard to the volume limitations thereof.
The Series A Preferred Shares are subject to redemption at the option
of a holder if, among other things, (i) the effectiveness of the Registration
Statement lapses for more than 30 consecutive days or more than 60 days in any
12 month period, (ii) the Company fails to maintain the listing of the Common
Stock on the NNM or another principal securities exchange or automated quotation
system and such failure continues for more that 30 days, or (iii) the Series A
Preferred Shares cease to be convertible as a result of the 19.99% Limitation
and the Company has not, prior thereto, or within 75 days after notice from
holders of two-thirds of the Series A Preferred Shares (which notice has not yet
been received), obtained approval to issue additional shares of Common Stock.
The Company intends to seek approval to issue the additional shares of Common
Stock at its 1998 Annual Meeting of Shareholders. If the Company does not
receive approval to issue the additional shares of Common Stock and the holders
of the Series A Preferred Shares elect to exercise their redemption rights, the
Company will be required to redeem the remaining outstanding Series A Preferred
Shares at an amount equal to the greater of (a) 118% of the Stated Value of the
Series A Preferred Shares on the date of redemption and (b) the market value of
the Common Stock into which the Series A Preferred Shares would have been
converted on the date of redemption. If the redemption had occurred as of May
26, 1998, the Company would have be required to pay approximately $4,650,000 to
redeem the remaining outstanding Series A Preferred Shares. However, as the
actual redemption amount will be based on the Stated Value or the price of the
Common Stock in effect at the time of redemption, the actual redemption amount
could be higher or lower. There can be no assurance that the Company will have
the financial ability to redeem the Series A Preferred Shares, if required, and,
even if the Company has such ability, such payment could materially adversely
effect the Company's financial condition and deplete its cash resources.
The Company has agreed to pay certain penalties to the holders of the
Series A Preferred Shares in the event that the Company (i) fails to cause
timely delivery of the Common Stock issuable upon conversion of the Series A
Preferred Shares, (ii) is unable to convert Series A Preferred Shares into
Common Stock because the Company does not have a sufficient number of authorized
but unissued shares available for issuance therefor, (iii) permits the
effectiveness of the Registration Statement to lapse for more than 15
consecutive days or more than 30 days in any 12 month period, or (iv) fails to
maintain the listing of the Common Stock on the NNM or other principal
securities exchange or automated quotation system on which the Common Stock is
then trading, and such failure continues for more than 10 days.
In connection with the December Placement, the Company paid a finders
fee of $295,000 and issued to an affiliate of the finder warrants (upon the same
terms as the One-Year Warrants) to acquire an aggregate of 185,000 shares of
Common Stock, which warrants have been exercised.
The securities issued in the December Placement were offered for sale,
and were sold, without registration thereof under the 1933 Act, pursuant to the
exemption from registration provided by regulation D under the 1933 Act.
1994 WARRANT EXERCISES. In connection with the Company's 1994 initial
public offering, the Company had issued to the representative of the
underwriters, warrants (the "1994 Warrants") expiring August 19, 1999 to
purchase 200,000 shares of Common Stock at an exercise price of $8.40 per share.
On May 13, 1998, the Company reduced the exercise price of the 1994 Warrants to
$6.00 per share, in consideration for changing the expiration date thereof to
May 21, 1998. On May 13, 1998, the holders of the 1994 Warrants
18
<PAGE>
irrevocably agreed to exercise all of the 1994 Warrants on or before the close
of business on May 15, 1998. Pursuant thereto, all the 1994 Warrants have been
exercised and the Company received aggregate proceeds of $1,200,000. The shares
of Common Stock issued to the holders upon exercise of the 1994 Warrants (the
"Warrant Shares") were issued pursuant to the exemption from registration
provided by Section 4(2) under the 1933 Act; however, a registration statement
under the 1933 Act is in effect with respect to the resale of the Warrant Shares
by the warrant holders.
RESULTS OF OPERATIONS
FISCAL 1998 AS COMPARED TO FISCAL 1997
REVENUES. Net sales decreased 4% to $1,818,663 in Fiscal 1998 from
$1,890,213 in Fiscal 1997 reflecting an industry-wide slowdown in the continued
acceptance of PC-based desktop video conferencing, partially offset by an
increase in net sales of TV-based products. Other revenue decreased 53% to
$72,003 in Fiscal 1998 from $152,665 in Fiscal 1997 as a result of decreased
revenue from software development. As a result, revenues decreased 7% to
$1,890,666 in Fiscal 1998 from $2,042,878 in Fiscal 1997.
COST OF REVENUE. Cost of revenue consists of cost of goods sold and
cost of 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 the write-down of inventory to net
realizable value). Cost of other revenue consists primarily of the allocation of
salaries and benefits of personnel and the cost of outside services directly
related to such revenue. Cost of goods sold increased 97% to $3,209,875 (176% of
net sales) in Fiscal 1998 from $1,629,287 (86% of net sales) in Fiscal 1997. The
increase in cost of goods sold and the increase in the percentage of cost of
goods sold to net sales reflected the high cost of manufacture of the Company's
TV-based products in its initial production stage, low production runs and the
write-down of related inventory to its current net realizable value based upon
the historical percentage of sales of TV-based video phones below manufactured
cost when sold in conjunction with telecommunications services. Cost of goods
sold also included a $475,824 provision for inventory obsolescence related to
the Company's PC-based desktop video conferencing equipment as a result of the
slowdown in the rate of acceptance of this product line and the Company's
decision to redeploy most of its available resources to other products. See
"Overview." The cost of other revenues ($22,506) in Fiscal 1998 was 31% of
related revenue, while similar costs ($81,079) in Fiscal 1997 was 53% of related
revenue.
GROSS PROFIT (LOSS). The gross loss was $1,341,715 in Fiscal 1998, as
compared to a gross profit of $332,512 (16% of revenues) in Fiscal 1997. The
gross loss in Fiscal 1998 was primarily the result of the high cost of goods
sold due to low volume production, the Company's marketing strategy for its
TV-based products and the provision for inventory obsolescence for the Company's
PC-based inventory. See "Overview."
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and
administrative expenses increased 56% to $3,816,806 (202% of revenues) in Fiscal
1998 from $2,454,337 (120% of revenues) in Fiscal 1997. The primary reason for
the increase was an 73% increase in selling and marketing expenses to
approximately $1,943,000 in Fiscal 1998 from approximately $1,125,000 in Fiscal
1997, substantially all of which increase was directly related to the marketing
launch of C-Phone Home. Other increases in expenses directly related to the
Company's TV-based product were increased personnel costs resulting from
additional customer support and administrative personnel and an increased
reserve for bad debt expenses based upon the Company's historical experience
with the retail industry. In addition, other increases in administrative
expenses were increased legal and accounting expenses, primarily as a result of
the complexities related to the addition of the TV-based product line, the
reallocation of duties of certain personnel from research, development and
engineering, and increased investor relations and other shareholder expenses
resulting from a significant increase in the number of holders of record of the
Common Stock. The Company expects that it will continue
19
<PAGE>
to incur substantial selling, general and administrative expenses during the
Fiscal 1999 as a result of the continued commercialization of the Company's
TV-based products.
RESEARCH, DEVELOPMENT AND ENGINEERING. Research, development and
engineering expenses decreased 4% to $973,210 (51% of revenues) in Fiscal 1998
from $1,016,293 (50% of revenues) in Fiscal 1997. The decrease was primarily the
result of a decrease in personnel costs resulting from a partial change in
duties of certain personnel to selling, general and administrative, partially
offset by development and engineering expenses related to the development of
enhancements to the Company's TV-based products. 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 increased 95% to $6,131,731 in Fiscal 1998 from
$3,138,118 in Fiscal 1997.
INTEREST. Interest income increased 19% to $157,350 in Fiscal 1998 from
$132,405 in Fiscal 1997 as a result of the receipt of proceeds from the March
Placement and the December Placement, partially offset by the continued use of
the Company's cash and cash equivalents to fund operations.
INCOME TAXES. The Company's losses for Fiscal 1998 and Fiscal 1997 may
be utilized as an offset against future earnings, although there is no assurance
that future operations will produce taxable earnings.
FISCAL 1997 AS COMPARED TO FISCAL 1996
REVENUES. Revenues increased 14% to $2,042,878 in Fiscal 1997 from
$1,786,115 in the year ended February 28, 1996 ("Fiscal 1996"). The revenues for
Fiscal 1997 included $150,000 of other revenue related to software developed by
the Company at two customers' requests for use with PC-based products and
$1,890,213 of sales of PC-based products, while the revenues for Fiscal 1996
consisted only of sales of PC-based products. As a result, net sales of PC-based
products increased 6% in Fiscal 1997 as compared to Fiscal 1996. The Company
believes that such minimal increase was primarily related to a change in sales
and marketing personnel.
COST OF REVENUE. Cost of revenue consists of cost of goods sold and
cost of 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
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 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 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
20
<PAGE>
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 first quarter of Fiscal 1996. 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 the Company's
TV-based products. 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.
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 other 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
of 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.
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.
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 PC-based products.
INCOME TAXES. The Company's losses for Fiscal 1996 may be utilized as
an offset against future 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 from the
proceeds of the 1994 Public Offering, which raised net proceeds of approximately
$12,288,000, the March Placement, which raised net proceeds of approximately
$4,370,000, and the December Placement, which raised net proceeds of
approximately $4,110,000. In addition, during May 1998, the Company received
approximately $4,600,000 from the exercise of previously issued warrants and
options. See "Recent Equity Offerings."
At February 28, 1998, the Company had working capital of $5,170,505 (an
increase of $2,851,739 from $2,318,766 at February 28, 1997) and cash and cash
equivalents of $4,200,231 (as compared to $1,398,049 at February 28, 1997). The
Company's invested funds consisted primarily of overnight repurchase agreements
for discount notes issued by the United States Treasury or United States
government agencies. During Fiscal 1998, operating activities used $5,681,467 of
net cash, primarily to fund operating activities, investing activities used
$43,492 of net cash for equipment purchases, and financing activities provided
$8,527,141 of net cash primarily from the March Placement and the December
Placement. Due to the technical nature of the Company's business and the
anticipated expansion of its video conferencing 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 March Placement, the December Placement and the
exercise, in May 1998, of previously issued warrants and options,
21
<PAGE>
together with anticipated funds from operations, will be sufficient to meet the
Company's projected operating needs and capital expenditures, including the
continued development and commercialization of its TV-based products, at least
through the end of fiscal year 1999. However, if any of the Company's TV-based
products gain significant market acceptance, of which there can be no assurance,
the very substantial investment which would then be required by the Company for
manufacturing, inventory and marketing expenditures and carrying of accounts
receivable related to the commercialization of such TV-based products, would
require the Company to obtain even more working capital. The Company anticipates
that such additional funds should be available through one or more possible
sources, including through (i) a private placement of (a) its debt securities,
including debt securities convertible into Common Stock, and/or (b) its Common
Stock or preferred stock, (ii) the exercise of the Company's remaining
outstanding 1997 Warrants, if the market price of the Common Stock were to
exceed the exercise price of such warrants, of which there can be no assurance,
and/or (iii) a public offering of Common Stock. Unless adequate income relating
to sales of TV-based products is attained, the timing or receipt of which cannot
be predicted, the Company may require additional cash resources for the
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.
The development and recent introduction, of TV-based products 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 owns its manufacturing equipment
free from encumbrances. As of February 28, 1998, the Company had no material
commitments for capital expenditures.
At February 28, 1998, the Company estimates that it had available net
operating loss carryforwards of approximately $15,125,000 for Federal purposes
and net economic loss carryforwards of approximately $15,337,000 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 Company's products, and components and sub-assemblies used by the
Company in its products, 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.
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 June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 130 ("SFAS No. 130"), "Reporting
Comprehensive Income". SFAS No. 130 establishes standards for the reporting and
displaying of comprehensive income and its components (revenues, expenses, gains
and losses) in a full set of general purpose financial statements. SFAS No. 130
22
<PAGE>
requires the disclosure of an amount that represents total comprehensive income
and the components of comprehensive income in a financial statement. The
pronouncement is effective for fiscal years beginning after December 15, 1997,
and is not expected to have a material impact on the Company's financial
statements.
In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 131 ("SFAS No. 131"), "Disclosures about
Segments of an Enterprise and Related Information". SFAS No. 131 establishes
standards for determining an entity's operating segments and the type and level
of financial information to be disclosed in both annual and interim financial
statements. SFAS No. 131 also establishes standards for related disclosures
about products and services, geographic areas and major customers. The
pronouncement is effective for periods beginning after December 15, 1997, and is
not expected to have a material impact on the Company's financial statements.
In February 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 132 ("SFAS No. 132"),
"Employers' Disclosures about Pensions and Other Postretirement Benefits". SFAS
No. 132 revises employers' disclosures about pension and other postretirement
benefit plans. The pronouncement is effective for periods beginning after
December 15, 1997 and, as the Company does not presently have a pension or other
postretirement benefit plan, is not expected to have a material impact on the
Company's financial statements.
Item 7. Financial Statements Page
-------------------- ----
Table of Contents
- -----------------
Report of Independent Accountants F-1
Balance Sheets as of February 28, 1998 and February 28, 1997 F-2
Statements of Operations for the years ended
February 28, 1998, February 28, 1997 and February 29, 1996 F-3
Statements of Shareholders' Equity for the years ended
February 28, 1998, February 28, 1997 and February 29, 1996 F-4
Statements of Cash Flows for the years ended
February 28, 1998, February 28, 1997 and February 29, 1996 F-5
Notes to Financial Statements F-6
23
<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, 1998 and 1997, and the related statements of operations,
shareholders' equity and cash flows for each of the three years in the period
ended February 28, 1998. 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, 1998 and 1997, and the results of its operations and its cash flows
for each of the three years in the period ended February 28, 1998, in conformity
with generally accepted accounting principles.
Coopers & Lybrand L.L.P.
Raleigh, North Carolina
May 8, 1998, except as to the information
presented in Note 14, for which the date
is May 15, 1998
F-1
<PAGE>
C-PHONE CORPORATION
BALANCE SHEETS
FEBRUARY 28, 1998 AND 1997
<TABLE>
<CAPTION>
ASSETS 1998 1997
------------ ------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 4,200,231 $ 1,398,049
Accounts receivable, net of allowance for doubtful
accounts of $173,227 and $120,000 at February
28, 1998 and 1997, respectively 346,684 422,042
Inventories 1,641,528 1,341,931
Prepaid expenses and other current assets 73,728 82,066
------------ ------------
Total current assets 6,262,171 3,244,088
Property and equipment, net 164,174 251,913
Other assets 42,686 154,246
------------ ------------
Total assets $ 6,469,031 $ 3,650,247
============ ============
LIABILITIES, PREFERRED STOCK AND
SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable, trade $ 796,019 $ 587,877
Accrued expenses 295,647 325,938
Current obligations under capital leases -- 11,507
------------ ------------
Total current liabilities 1,091,666 925,322
Commitments and Contingencies (Notes 10 and 12)
Series A Convertible Preferred Stock, $1,000 stated amount;
5,000 shares designated; 4,500 shares issued and outstanding
at February 28, 1998 (Note 6) 4,543,767 --
Shareholders' equity:
Common stock, $.01 par value; 20,000,000 and 10,000,000 shares
authorized at February 28, 1998 and 1997, respectively;
5,348,234 and 4,355,393 shares issued and outstanding at
February 28, 1998 and 1997, respectively 53,482 43,554
Paid-in capital - common stock 18,038,006 13,530,208
Paid-in capital - preferred stock 1,318,350 --
Accumulated deficit (18,576,240) (10,848,837)
------------ ------------
Total shareholders' equity 833,598 2,724,925
------------ ------------
Total liabilities, preferred stock and shareholders' equity $ 6,469,031 $ 3,650,247
============ ============
The accompanying notes are an integral part of the financial statements.
F-2
</TABLE>
<PAGE>
C-PHONE CORPORATION
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED FEBRUARY 28, 1998,
FEBRUARY 28, 1997 AND FEBRUARY 29, 1996
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Net sales $ 1,818,663 $ 1,890,213 $ 1,786,115
Other revenue 72,003 152,665 --
----------- ----------- -----------
Total revenue 1,890,666 2,042,878 1,786,115
----------- ----------- -----------
Cost of goods sold 3,209,875 1,629,287 1,556,353
Cost of other revenue 22,506 81,079 --
----------- ----------- -----------
Total cost of revenue 3,232,381 1,710,366 1,556,353
----------- ----------- -----------
Gross profit (loss) (1,341,715) 332,512 229,762
----------- ----------- -----------
Operating expenses:
Selling, general and administrative 3,816,806 2,454,337 3,662,679
Research, development and engineering 973,210 1,016,293 1,102,737
----------- ----------- -----------
Total operating expenses 4,790,016 3,470,630 4,765,416
----------- ----------- -----------
Operating loss (6,131,731) (3,138,118) (4,535,654)
Interest expense (447) (2,511) (4,614)
Interest income 157,350 132,405 378,932
----------- ----------- -----------
Net loss $(5,974,828) $(3,008,224) $(4,161,336)
=========== =========== ===========
Per-share data:
Basic and diluted net loss per common share $ (1.49) $ (0.69) $ (0.96)
=========== =========== ===========
Weighted average number of common
shares and common share
equivalents outstanding 5,202,608 4,347,968 4,347,293
=========== =========== ===========
The accompanying notes are an integral part of the financial statements.
F-3
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
C-PHONE CORPORATION
STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED FEBRUARY 28, 1998,
FEBRUARY 28, 1997 AND FEBRUARY 29, 1996
Common Stock Paid-in Capital Total
------------ Paid-in Capital Preferred Accumulated Shareholders'
Shares Amount Common Stock Stock Deficit Equity
---------- -------- --------------- --------------- ------------ --------------
<S> <C> <C> <C> <C> <C> <C>
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 8,100 81 25,232 25,313
options
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
Exercise of employee stock
options 17,571 176 59,412 59,588
Expense of stock options
granted to consultant 74,400 74,400
Stock issued to consultant 4,740 47 14,173 14,220
Issuance of common stock in
March 1997 private placement 833,667 8,336 4,361,182 4,369,518
Issuance of common stock
pursuant to contingent value
rights issued in March 1997
private placement 136,863 1,369 (1,369)
Issuance of preferred stock
in December 1997 private
placement $ (390,458) (390,458)
To reflect beneficial conversion
feature of preferred stock 1,708,808 (1,708,808) 0
Accretion of preferred stock (43,767) (43,767)
Net loss (5,974,828) (5,974,828)
---------- -------- ------------ ------------ ------------ -----------
Balance, February 28, 1998 5,348,234 $ 53,482 $ 18,038,006 $ 1,318,350 $(18,576,240) $ 833,598
========== ======== ============ =========== ============ ===========
The accompanying notes are an integral part of the financial statements.
</TABLE>
F-4
<PAGE>
C-PHONE CORPORATION
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED FEBRUARY 28, 1998,
FEBRUARY 28, 1997 AND FEBRUARY 29, 1996
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $(5,974,828) $(3,008,224) $(4,161,336)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 131,231 134,202 182,803
Provision for inventory obsolescence 515,431 -- 70,227
Bad debt expense 178,773 90,831 164,554
Compensation expense of stock options 74,400 9,600 --
Compensation expense of stock issued 14,220 -- --
Changes in operating assets and liabilities:
Accounts receivable (103,415) (114,869) (391,124)
Inventories (815,028) (280,435) (535,997)
Prepaid expenses and other current assets 8,338 41,849 145,740
Other assets 111,560 (86,926) (64,318)
Accounts payable 208,142 298,515 (191,229)
Accrued expenses (30,291) 102,940 42,249
----------- ----------- -----------
Net cash used in operating activities (5,681,467) (2,812,517) (4,738,431)
----------- ----------- -----------
Cash flows from investing activities:
Equipment purchases (43,492) (77,867) (92,334)
Purchases of short-term investments -- (1,647,371) (8,319,464)
Maturities of short-term investments -- 4,073,774 9,763,943
----------- ----------- -----------
Net cash (used in) provided by investing activities (43,492) 2,348,536 1,352,145
----------- ----------- -----------
Cash flows from financing activities:
Proceeds from exercise of stock options 59,588 25,313 --
Proceeds from private placement of common stock 4,369,518 -- --
Proceeds from private placement of preferred stock 4,109,542 -- --
Payment of capital lease obligations (11,507) (16,103) (21,999)
----------- ----------- -----------
Net cash provided by (used in) financing activities 8,527,141 9,210 (21,999)
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents 2,802,182 (454,771) (3,408,285)
Cash and cash equivalents, beginning of year 1,398,049 1,852,820 5,261,105
----------- ----------- -----------
Cash and cash equivalents, end of year $ 4,200,231 $ 1,398,049 $ 1,852,820
=========== =========== ===========
Supplemental disclosure of cash flow information:
Interest paid $ 447 $ 2,511 $ 4,614
=========== =========== ===========
The accompanying notes are an integral part of the financial statements.
</TABLE>
F-5
<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, and is, primarily engaged in
the engineering, manufacturing and marketing of a line of TV-based and
PC-based video conferencing systems. The Company's stand alone 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). In January 1998, the Company introduced its
C-Phone DS 324 TV-based video phone, which operates over both analog and
ISDN digital telephone lines. In May 1998, the Company announced
development of C-Phone ITV(TM), a TV-based set-top device that provides
Internet access using a standard television set and analog telephone line.
The Company's PC-based video conferencing systems, which operate over
digital networks, are marketed under the name C-Phone(R). From time to
time, the Company also has engaged in contractual software development
related to its products.
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 11. 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, 1998, February 28, 1997, and
February 29, 1996, approximates the fair value because of the short
maturities of these instruments.
F-6
<PAGE>
C-PHONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Inventories
-----------
Inventories are stated at the lower of cost (first-in, first-out "FIFO "
basis) or market. Inventories reflect valuation allowances necessary to
reduce inventories to their net realizable value.
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 life of the assets, which range from three to seven
years. Leasehold improvements are amortized over the remaining term of the
lease or the useful life, if shorter. 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.
F-7
<PAGE>
C-PHONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Research and Development Costs
------------------------------
Research and development expenditures are charged to expense in the year
incurred.
Preferred Stock
---------------
In December 1997, the Company issued 4,500 shares (the "Preferred Shares")
of its Series A Preferred Stock (the "Preferred Stock") with an initial
stated value of $1,000 per share, which increases at the rate of 5% per
annum (such amount, as increased from time to time, the "Stated Value").
Each Preferred Share is convertible into shares of the Company's common
stock, par value $.01 per share (the "Common Stock"), from time to time at
the option of the holder, into such number of shares of Common Stock as is
determined by dividing the Stated Value by the lesser of (a) $7.3575 and
(b) 85% of the average of the closing bid price during such three
consecutive trading day period as may be selected by the holder during the
25 day trading period preceding the date of conversion. Any outstanding
Preferred Shares on December 19, 1999 automatically will be converted into
Common Stock at the conversion price then in effect. The Preferred Shares
cease to be convertible if the aggregate number of shares of Common Stock
then issued upon conversion of the Preferred Shares would equal 1,068,513
shares of Common Stock (the "19.99% Limitation") unless and until the
Company receives approval from its shareholders or otherwise to issue
additional shares of Common Stock. See Note 6.
In its November 7,1997 Current Issues and Rulemaking Projects, the
Securities and Exchange Commission (the "SEC") addressed the issue of a
"beneficial conversion feature", where securities may be convertible into
common stock at the lower of a conversion rate fixed at the date of issue
or a fixed discount to the common stock's market price at the date of
conversion. The beneficial conversion feature of the Preferred Stock is
recognized and measured by allocating a portion of the proceeds equal to
the intrinsic value of the feature to additional paid-in-capital. The
beneficial conversion feature of $1,708,808 was calculated at the date of
issue as the difference between the conversion price and the fair value of
the Common Stock. This amount is recognized as a return to the preferred
shareholders over the minimum period in which the shareholders can realize
the return. As there are no time restraints on the conversion, the full
amount of the feature was amortized on the date of issuance.
SEC regulations require that all issues of mandatorily redeemable stock be
excluded from the shareholders' equity section of the balance sheet and be
presented separately. One of the characteristics of a mandatorily
redeemable stock is that it contains conditions for redemption which are
not solely within the control of the issuer. The Preferred Stock is subject
to redemption at the option of the holder if (a) the Company fails to
maintain an effective registration statement with respect to the shares of
Common Stock issuable upon exercise of the Preferred Shares, (b) the
Preferred Shares cease to be convertible due to the 19.99% Limitation and
the Company does not obtain shareholder approval within 75 days after
requested by the holders, or (c) the Company fails to maintain listing of
the Common Stock on the Nasdaq National Market or other principal
securities exchange. Since there is the possibility that the occurrence of
an event outside the control of the Company could cause redemption, the
Preferred Stock has been classified separately from shareholders' equity on
the balance sheet. See Notes 6 and 14.
F-8
<PAGE>
C-PHONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Net Loss per Share
------------------
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128 ("SFAS No. 128"), "Earnings Per
Share", which established new standards for computation of earnings per
share. SFAS No. 128 requires the presentation on the face of the income
statement of "basic" earnings per share and "diluted" earnings per share.
Basic earnings per share is computed by dividing the net income (loss)
available to common shareholders by the weighted average number of
outstanding common shares. The calculation of diluted earnings per share is
similar to basic earnings per share except the denominator includes
dilutive common stock equivalents such as stock options and warrants.
Common stock options and warrants are not included for the years ended
February 28, 1998 ("Fiscal 1998"), February 28, 1997 ("Fiscal 1997") and
February 29, 1996 ('Fiscal 1996') as they would be anti-dilutive. The
amortization of the beneficial conversion feature and the accretion of the
5% annual increase in stated value of the Preferred Stock totalling
$1,752,575 increased the net loss attributable to common shareholders for
the purposes of the calculation of net loss per share in Fiscal 1998.
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 Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" and related interpretations in accounting for the C-Phone
Corporation Amended and Restated 1994 Stock Option Plan (the "Stock Option
Plan"). Accordingly, no compensation cost has been recognized for options
granted under the Stock Option Plan except for $74,400 for Fiscal 1998 and
$9,600 for Fiscal 1997 related to the fair value of services rendered in
exchange for options granted to consultants. However, the Company has
disclosed in Note 7 the pro forma effects had compensation cost been
determined based on the fair value of the options at the grant date.
New Accounting Pronouncements
-----------------------------
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130 ("SFAS No. 130"), "Reporting
Comprehensive Income". SFAS No. 130 establishes standards for the reporting
and displaying of comprehensive income and its components (revenues,
expenses, gains and losses) in a full set of general purpose financial
statements. SFAS No. 130 requires the disclosure of an amount that
represents total comprehensive income and the components of comprehensive
income in a financial statement. The pronouncement is effective for fiscal
years beginning after December 15, 1997, and is not expected to have a
material impact on the Company's financial statements.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131 ("SFAS No. 131"), "Disclosures about
Segments of an Enterprise and Related Information". SFAS No. 131
establishes standards for determining an entity's operating segments and
the type and level of financial information to be disclosed in both annual
and interim financial statements. SFAS No. 131 also establishes standards
for related disclosures about products and services, geographic areas and
major customers. The pronouncement is effective for periods beginning after
December 15, 1997, and is not expected to have a material impact on the
Company's financial statements.
F-9
<PAGE>
C-PHONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
In February 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 132 ("SFAS No. 132"), "Employers'
Disclosures about Pensions and Other Postretirement Benefits". SFAS No. 132
revises employers' disclosures about pension and other postretirement
benefit plans. The pronouncement is effective for periods beginning after
December 15, 1997 and, as the Company does not presently have a pension or
other postretirement benefit plan, is not expected to have a material
impact on the Company's 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, 1998, the Company's
cash equivalents consisted primarily of overnight repurchase agreements for
discount notes issued by the United States Treasury or United States
government agencies. The aggregate fair value of these investments
approximated the amortized cost at February 28, 1998.
4. INVENTORIES
Inventories consist of the following at February 28, 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Raw materials $ 881,095 $ 985,914
Work in process 486,335 304,839
Finished goods 274,098 51,178
---------- ----------
$1,641,528 $1,341,931
========== ==========
</TABLE>
5. PROPERTY AND EQUIPMENT
Property and equipment consist of the following at February 28, 1998 and
1997:
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Machinery and equipment $ 997,210 $ 965,711
Furniture and fixtures 50,940 49,084
Leasehold improvements 82,032 71,895
---------- ----------
1,130,182 1,086,690
Less accumulated depreciation
and amortization 966,008 834,777
---------- ----------
$ 164,174 $ 251,913
========== ==========
</TABLE>
F-10
<PAGE>
C-PHONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------
6. SHAREHOLDERS' EQUITY
In connection with the Company's initial public offering in August 1994,
the Company granted to the managing underwriter warrants (the "1994
Warrants") to purchase 200,000 shares of Common Stock at $8.40 per share.
The 1994 Warrants may be exercised at any time until expiration on August
18, 1999. See Note 14.
During Fiscal 1997, in conjunction with a one-year consulting agreement,
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 agreement was extended during
Fiscal 1998 for another year and the Company granted the consultant another
five-year option to purchase 24,000 shares at a price of $5.95 per share.
The agreement was terminated in May 1998 and options to purchase 10,000
shares of Common Stock under the option granted in Fiscal 1998 were
forfeited pursuant to the terms of the option. The options were granted in
partial payment for services to be rendered by the consultant under the
agreement, which services the Company valued at $38,400 for Fiscal 1998 and
$9,600 for Fiscal 1997. Also during Fiscal 1998, the Company granted to
another consultant a five-year option to purchase 18,000 shares of Common
Stock at $7.8125 per share (the market price of the Common Stock on the
date of grant). The relationship with this other consultant was terminated
prior to the end of its six-months term and the right to exercise one-third
of the option was forfeited pursuant to the terms of the option. The option
was granted in partial payment for services to be rendered by the
consultant, which services the Company valued at $36,000 for Fiscal 1998.
All of these amounts were expensed and, as a result, paid-in capital was
increased by such amounts.
During the week of March 31, 1997, the Company completed a private
placement (the "March Placement"), through a 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 March
Placement and received net proceeds of approximately $4,370,000 (after
payment, or accrual, of fees and expenses of approximately $632,000).
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 Rights,
which expire June 25, 1998, are automatically exercised at the time, and
from time to time as, the Original Shares are first publicly sold through a
broker-dealer. 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 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 equals 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. As of February 28,
1998, all the Original Shares had been sold (although the holder of 30,000
Original Shares has not yet submitted to the Company the necessary
documentation to determine the number, if any, of additional shares to
which he is entitled) and, pursuant to the terms of the Rights, 136,863
additional shares were issued as a result thereof. In connection with the
March Placement, the Company issued to an affiliate of the placement agent
warrants to acquire an aggregate of 150,000 shares of Common Stock at an
exercise price of $9.60 per share, which warrants have expired.
F-11
<PAGE>
C-PHONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------
6. SHAREHOLDERS' EQUITY (Continued)
On December 19, 1997, the Company completed a private placement (the
"December Placement") pursuant to which the Company issued to the several
participants an aggregate of (a) 4,500 Preferred Shares, (b) warrants (the
"One-Year Warrants") to acquire up to 315,000 shares of Common Stock, and
(c) warrants (the "Three-Year Warrants") to acquire up to 135,000 shares of
Common Stock. The Company received net proceeds of approximately $4,110,000
(after payment, or accrual, of fees (including finders fees) and related
expenses of approximately $390,000). Each Preferred Share is convertible,
from time to time, at the option of the holder, into such number of shares
of Common Stock as is determined by dividing the Stated Value by the lesser
of (a) $7.3575, and (b) 85% of the average of the closing bid price during
such three consecutive trading day period as may be selected by the holder
during the 25 day trading period preceding the date of conversion. Any
outstanding Preferred Shares on December 19, 1999 automatically will be
converted into Common Stock at the conversion price then in effect. The
Preferred Shares are subject to redemption at the option of the holder if,
among other things, (a) the Company fails to maintain an effective
registration statement with respect to the shares of Common Stock issuable
upon exercise of the Preferred Shares for more than 30 consecutive days or
more than 60 days in any 12 month period, (b) the Company fails to maintain
the listing of the Common Stock on the Nasdaq National Market or another
principal securities exchange or automated quotation system, or (c) the
Preferred Shares cease to be convertible due to the 19.99% Limitation (see
Note 2) and the Company has not, prior thereto or within 75 days after
notice from holders of two-thirds of the Preferred Shares (which notice has
not yet been received), obtained approval to issue additional shares of
Common Stock. If the Company does not receive approval to issue the
additional shares of Common Stock and the holders of the Preferred Shares
elect to exercise their redemption rights, the Company will be required to
redeem the remaining outstanding Preferred Shares at an amount equal to the
greater of (a) 118% of the Stated Value of the Preferred Shares and (b) the
market value of the Common Stock into which the Preferred Shares would have
been converted on the date of redemption. The One-Year Warrants expire on
December 19, 1998, have an exercise price of $8.05 per share and are
redeemable at the option of the Company at a price of $.01 per warrant if
the closing price of the Common Stock is greater than 130% of the exercise
price of the One-Year Warrants for 10 consecutive trading days. The
Three-Year Warrants expire on December 19, 2000, have an exercise price of
$9.10 per share and are not redeemable. In connection with the December
Placement, the Company paid a finders fee of $295,000 and issued to an
affiliate of the finder warrants (upon the same terms as the One-Year
Warrants) to acquire an aggregate of 185,000 shares of Common Stock. See
Notes 2 and 14.
7. STOCK OPTION PLAN
The Stock Option Plan 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. The maximum number of shares of Common
Stock with respect to which options may be granted under the Stock Option
Plan is 500,000 shares. Options generally vest over a period of three
years. The maximum term of an option is ten years. The Stock Option Plan
will terminate in August 2004, though options granted prior to termination
may expire after that date.
Had compensation cost for the Stock Option Plan been determined based on
the fair value at the grant dates for awards under the Stock Option Plan,
excluding the grants to consultants discussed in Note 6, consistent with
the method of SFAS No. 123 (see Note 2), the Company's net loss and net
loss per share would have increased to the pro forma amounts indicated
below:
F-12
<PAGE>
C-PHONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------
7. STOCK OPTION PLAN (Continued)
<TABLE>
<CAPTION>
Fiscal 1998 Fiscal 1997 Fiscal 1996
--------------------- --------------------- ---------------------
As Pro As Pro As Pro
Reported Forma Reported Forma Reported Forma
--------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Net loss (in thousands) $ 5,975 $ 6,247 $ 3,008 $ 3,108 $ 4,161 $ 4,191
Net loss per share $ 1.49 $ 1.54 $ 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.
1998 1997 1996
---- ---- ----
Dividend yield 0% 0% 0%
Expected volatility 81.4% 138.8% 43.3%
Risk-free interest rate 6.25% 6.25% 6.25%
Expected lives, in years 5 5 5
The weighted average fair value of options granted during Fiscal 1998,
Fiscal 1997 and Fiscal 1996 was $4.16, $2.85 and $3.51 per share,
respectively.
A summary of the status of the Stock Option Plan at February 28, 1998,
February 28, 1997 and February 29, 1996 and the changes during the years
then ended is presented below:
<TABLE>
<CAPTION>
1998 1997 1996
--------------------- -------------------- ---------------------
Weighted Weighted Weighted
Shares Average Shares Average Shares Average
Underlying Exercise Underlying Exercise Underlying Exercise
Options Price Options Price Options Price
----------- -------- ---------- -------- ---------- --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year 275,200 $ 4.66 116,500 $ 7.34 106,950 $ 7.13
Granted 134,650 $ 8.11 189,150 $ 3.18 47,050 $ 7.45
Exercised (17,571) $ 3.39 (8,100) $ 3.13 0 --
Forfeited (54,552) $ 4.86 (22,350) $ 6.39 (37,500) $ 7.03
------- ------- ------
Outstanding at end of year 337,727 $ 6.07 275,200 $ 4.66 116,500 $ 7.34
======= ======= =======
Exercisable at end of year 188,401 $ 5.47 85,967 $ 6.01 30,583 $ 7.21
======= ======= =======
</TABLE>
F-13
<PAGE>
C-PHONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------
7. STOCK OPTION PLAN (Continued)
The following table summarizes information about stock options under the
Stock Option Plan at February 28, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
---------------------------------------------- -----------------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Range of Number Contractual Exercise Number Exercisable
Exercise Price Outstanding Life Price Exercisable Price
--------------- ----------- ----------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C>
$ 2.38 - $ 3.38 117,850 3.5 $ 3.21 81,342 $ 3.13
$ 5.95 - $ 6.99 46,617 4.6 $ 6.21 8,334 $ 6.14
$ 7.00 - $ 7.99 110,060 2.2 $ 7.35 98,725 $ 7.34
$ 8.00 - $ 8.99 41.200 4.7 $ 8.38 0 --
$10.00 - $10.99 22,000 4.2 $ 10.38 0 --
---------- ---------
337,727 188,401
========== =========
</TABLE>
8. RELATED PARTY TRANSACTIONS
The Company leases its office, manufacturing and warehouse space from two
of its executive officers who also are directors of the Company (Note 10).
9. OBLIGATIONS UNDER CAPITAL LEASES
The Company leased certain manufacturing equipment, with an aggregate cost
of $68,674 and accumulated depreciation of $66,413, at February 28, 1997.
Obligations under the capital leases totalled $11,507 at February 28, 1997.
These capital leases were payable in monthly installments of $1,506 for
Fiscal 1997, including interest, and were collateralized by manufacturing
equipment having a net book value of $2,261 at February 28, 1997.
10. 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 lease currently expires on April 30,
1999 with monthly rental payments of $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.
F-14
<PAGE>
C-PHONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------
10. COMMITMENTS (Continued)
The future minimum aggregate lease payments under noncancelable operating
leases are as follows at February 28, 1998:
Fiscal year ending February 28,
-------------------------------
1999 $75,360
2000 12,560
-------
$87,920
=======
Rent expense was $75,360, $72,800, and $60,000 in Fiscal 1998, Fiscal 1997,
and Fiscal 1996, respectively.
11. SIGNIFICANT CUSTOMERS AND CONCENTRATION OF CREDIT RISK
At February 28, 1998 and 1997, the Company had outstanding trade accounts
receivable from 64 and 33 customers, respectively. The Company monitors the
granting of credit to all its customers and, generally, no collateral is
required.
For Fiscal 1998, the Company did not have any revenues from any single
customer that exceeded 10% of total net revenues. In each of Fiscal 1997
and Fiscal 1996, there were net revenues from two major customers that
exceeded 10% of total net revenues. Net revenues from these customers were
as follows:
1998 1997 1996
-------- -------- --------
Customer A $ 52,518 $ 31,678 $187,119
Customer B -- 291,710 --
Customer C -- 5,864 184,063
Customer D -- 211,224 58,325
-------- -------- --------
$ 52,518 $540,476 $429,507
======== ======== ========
Accounts receivable from these customers were as follows at February 28,
1998 and 1997:
1998 1997
------- -------
Customer A $ -- $17,417
Customer B -- 30,066
Customer C -- --
Customer D -- 51,938
------- -------
$ -- $99,421
======= =======
The Company had net revenues from customers located outside of the United
States of $314,000, $308,000 and $299,000 during Fiscal 1998, Fiscal 1997
and Fiscal 1996, respectively.
F-15
<PAGE>
C-PHONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------
12. 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.
13. INCOME TAXES
The components of the net deferred tax asset were as follows at February
28, 1998 and 1997:
1998 1997
----------- -----------
Net operating loss
carryforwards $ 5,926,262 $ 4,034,541
Alternative minimum tax
credit carryforwards 5,924 5,924
Allowance for doubtful
accounts 164,782 46,938
Research and development
tax credit 135,529 118,550
Inventory reserve 404,663 --
Other 83,469 164,302
Valuation allowance (6,720,629) (4,370,255)
----------- -----------
Net deferred tax asset $ -- $ --
=========== ===========
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.
F-16
<PAGE>
C-PHONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------
13. INCOME TAXES (Continued)
Reconciliation of differences between the statutory U.S. Federal income tax
rate and the Company's effective tax rate are as follows:
1998 1997 1996
-------- --------- --------
Federal statutory income
tax rate (34)% (34)% (34)%
State income taxes, net
of federal benefit (5) (5) (7)
Valuation allowance
increase 39 39 41
Research and development
tax credit -- -- --
-------- --------- --------
0% 0% 0%
======== ========= ========
The net operating loss carryforwards for Federal tax purposes as of
February 28, 1998 are estimated to be $15,125,000. The net economic loss
carryforwards for state tax purposes as of February 28, 1998 are estimated
to be $15,337,000. The Federal net operating loss carryforwards expire in
2009 through 2013 and the state net economic loss carryforwards expire in
1999 through 2003.
14. SUBSEQUENT EVENT
On May 13, 1998, the Company reduced the exercise price of the 1994
Warrants from $8.40 to $6.00 per share, in consideration for changing the
expiration date thereof from August 18, 1999 to May 21, 1998. The holders
of the 1994 Warrants then exercised all of the 1994 Warrants on or before
the close of business on May 15, 1998. In addition, as of May 15, 1998,
One-Year Warrants (including the warrants issued to the finder) to purchase
325,000 shares of Common Stock and Three-Year Warrants to purchase 60,000
shares of Common Stock also had been exercised. As a result, the Company
received aggregate proceeds of $4,362,250 subsequent to the end of Fiscal
1998. As of May 15, 1998, 2,576 Preferred Shares had been converted into
1,067,217 shares of Common Stock. See Note 6.
The pro forma balances as of February 28, 1998, assuming the exercise of
the above warrants and conversion of the Preferred Shares, would have
reflected cash and cash equivalents of $8,562,481, Preferred Stock of
$1,942,713 and total shareholders' equity of $7,796,902.
F-17
<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)
(c) Certificate of Amendment to Certificate of
Incorporation, as filed with the Secretary of State of
the State of New York on August 12, 1997(7)
24
<PAGE>
(d) Certificate of Amendment of the Certificate of
Incorporation, as filed with the Department of State of
the State of New York on December 18, 1997(8)
3(ii) By-laws of the Company, as currently in effect(1)
4. Instruments defining the rights of security holders, including
indentures.
4.1 Form of certificate representing shares of the Common Stock(2)
4.2 Form of certificate representing shares of the Series A
Preferred Stock
4.3 Warrant Agreement, dated August 20, 1994, between the Company
and Josephthal Lyon & Ross Incorporated and form of Warrant
Certificate(2)
4.4 Placement Agent Warrant Agreement, dated March 31, 1997,
between the Company and Josephthal Lyon & Ross Incorporated and
form of Warrant Certificate(6)
4.5 Form of One-Year Warrant, dated December 19, 1997, of C-Phone
Corporation(8)
4.6 Form of Three-Year Warrant, dated December 19, 1997, of C-Phone
Corporation(8)
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 C-Phone Corporation Amended and Restated 1994 Stock Option Plan
and form of Option Agreement(4)
10.6 (a) Placement Agent Agreement, dated March 31, 1997,
between the Company and Josephthal Lyon & Ross
Incorporated(6)
25
<PAGE>
(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)
(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)
10.7 (a) Form of Securities Purchase Agreement, dated as of
December 17, 1997, between C-Phone Corporation and each
purchaser party thereto(8)
(b) Form of Registration Rights Agreement, dated December
19, 1997, between C-Phone Corporation and each
purchaser party thereto(8)
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.
26
<PAGE>
(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.
(7) 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,
1997.
(8) Incorporated by reference to an Exhibit filed as part of the Company's
Current Report on Form 8-K, dated December 31, 1997.
(b) Reports on Form 8-K. A Current Report on Form 8-K (responding to Item 5 -
"Other Events") was filed by the Company on December 31, 1997 and a Current
Report on Form 8-K (responding to Item 5 - "Other Events") was filed by the
Company on May 14, 1998.
27
<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, 1998
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, 1998 /s/ Daniel P. Flohr
---------------------------------------------------
Daniel P. Flohr
President, Chief Executive Officer and Director
(Principal Executive Officer)
May 28, 1998 /s/ Tina L. Jacobs
---------------------------------------------------
Tina L. Jacobs
Director
May 28, 1998 /s/ Seymour L. Gartenberg
---------------------------------------------------
Seymour L. Gartenberg
Director
May 28, 1998 /s/ E. Henry Mize
---------------------------------------------------
E. Henry Mize
Director
May 28, 1998 /s/ Donald S. McCoy
---------------------------------------------------
Donald S. McCoy
Director
May 28, 1998 /s/ Stuart E. Ross
---------------------------------------------------
Stuart E. Ross
Director
May 28, 1998 /s/ Paul H. Albritton
---------------------------------------------------
Paul H. Albritton
Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
28
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANT
We consent to the incorporation by reference in C-Phone Corporation's
registration statement on Form S-8 (registration no. 33-95306), registration
statement on Form S-3 (registration no. 333-25273) and registration statement on
Form S-3 (registration no. 333-46309) of our report dated May 8, 1998, except as
to the information presented in Note 14, for which the date is May 15, 1998, on
our audits of the financial statements of C-Phone Corporation as of February 28,
1998 and 1997, and for the three years in the period ended February 28, 1998,
which report is included in this Annual Report on Form 10-KSB.
Raleigh, North Carolina
May 28, 1998
29
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
REGISTRANT'S BALANCE SHEET AS OF FEBRUARY 28, 1998 AND THE STATEMENTS OF
OPERATION AND STATEMENTS OF CASH FLOW 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
<CURRENCY> USD
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> FEB-28-1998
<PERIOD-START> MAR-01-1997
<PERIOD-END> FEB-28-1998
<EXCHANGE-RATE> 1
<CASH> 4,200,231
<SECURITIES> 0
<RECEIVABLES> 519,911
<ALLOWANCES> (173,227)
<INVENTORY> 1,641,528
<CURRENT-ASSETS> 6,262,171
<PP&E> 1,130,182
<DEPRECIATION> (966,008)
<TOTAL-ASSETS> 6,469,031
<CURRENT-LIABILITIES> 1,091,666
<BONDS> 0
4,543,767
0
<COMMON> 53,482
<OTHER-SE> 780,116
<TOTAL-LIABILITY-AND-EQUITY> 6,469,031
<SALES> 1,818,663
<TOTAL-REVENUES> 1,890,666
<CGS> 3,209,875
<TOTAL-COSTS> 3,232,381
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 178,773
<INTEREST-EXPENSE> 447
<INCOME-PRETAX> (5,974,828)
<INCOME-TAX> 0
<INCOME-CONTINUING> (5,974,828)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (5,974,828)
<EPS-PRIMARY> (1.49)
<EPS-DILUTED> (1.49)
</TABLE>
