FORM 10-QSB
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(MARK ONE)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 1998
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
Commission File No. 1-11873
K2 DESIGN, INC.
(Exact name of small business issuer as specified in its charter)
DELAWARE 13-3886065
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification
Number
30 Broad Street, 16th Floor
New York, New York 10004
(Address of principal executive offices)
Issuer's telephone number: (212) 301-8800
Check whether the issuer (1) filed all reports required 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
Applicable only to Corporate Issuers:
State the number of shares outstanding of each of the issuer's
classes of common equity, as of the latest practicable date:
CLASS OUTSTANDING AT MARCH 31, 1998
Common stock, par value $.01 3,680,671
Common stock redeemable purchase warrants 1,000,000
Transitional Small Business Disclosure Format (check one):
Yes___ No X
1
K2 DESIGN, INC. AND SUBSIDIARY
INDEX
Page
PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated balance sheet - March 31, 1998 (unaudited).......................................................3
Consolidated statements of operations - three months ended
March 31, 1998 (unaudited) and March 31, 1997 (unaudited)............................................4
Consolidated statements of cash flows - three months ended
March 31, 1998 (unaudited) and March 31, 1997 (unaudited)............................................5
Notes to consolidated financial statements (unaudited)........................................................7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations and Financial ....................................................................................8
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form ........................................................................12
SIGNATURES...................................................................................................12
2
K2 DESIGN, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
March 31,
ASSETS 1998
-----------
(unaudited)
CURRENT ASSETS:
Cash $ 3,543,818
Accounts receivable, net of allowance for doubtful accounts of
$156,704 1,595,792
Prepaid expenses and other current assets 723,334
-----------
Total current assets 5,862,944
-----------
EQUIPMENT AND LEASEHOLD IMPROVEMENTS 911,137
RESTRICTED CASH 150,711
OTHER ASSETS 9,572
-----------
Total assets $ 6,934,364
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of capital lease obligations $ 56,786
Accounts payable 1,169,861
Accrued compensation and payroll taxes 133,277
Other accrued expenses 1,077,810
Deferred revenue 620,087
Customer advances 63,549
-----------
Total current liabilities 3,121,370
-----------
LONG-TERM CAPITAL LEASE OBLIGATIONS 31,876
-----------
Total liabilities 3,153,246
STOCKHOLDERS' EQUITY (DEFICIT):
Preferred stock, $0.01 par value, 1,000,000 shares authorized;
0 shares issued and outstanding 0
Common stock , $0.01 par value, 9,000,000 shares authorized;
3,680,671 shares issued and outstanding 36,807
Treasury Stock (75,266)
Additional paid-in capital 6,380,325
Accumulated deficit (2,560,748)
-----------
Total stockholders' equity 3,781,118
-----------
Total liabilities and stockholders' equity $ 6,934,364
===========
3
K2 DESIGN, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended
March 31,
-----------------------------
1998 1997
----------- -----------
(unaudited)
REVENUES $ 2,640,941 $ 1,665,398
DIRECT SALARIES AND COSTS 1,769,470 1,191,390
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 776,207 781,281
DEPRECIATION 92,814 56,932
----------- -----------
Income (loss) from operations 2,450 (364,205)
INTEREST AND OTHER INCOME, net 40,763 37,386
----------- -----------
Income (loss) before provision for income taxes 43,213 (326,819)
PROVISION FOR INCOME TAXES 5,294 1,036
----------- -----------
Net income (loss) $ 37,919 $ (327,855)
=========== ===========
Net Income (loss) per share -
basic and diluted $ 0.01 $ (0.09)
=========== ===========
WEIGHTED AVERAGE BASIC COMMON SHARES
OUTSTANDING 3,680,671 3,645,421
=========== ===========
WEIGHTED AVERAGE DILUTED
COMMON SHARES OUTSTANDING 3,716,841 3,645,421
=========== ===========
4
K2 DESIGN, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended
March 31,
------------------------------
1998 1997
----------- -----------
(unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 37,919 $ (327,855)
Adjustments to reconcile net income (loss) to net cash provided
by (used in) operating activities-
Recognition of deferred compensation 31,385 0
Depreciation 92,814 56,932
Changes in-
Accounts receivable 1,837,361 (313,024)
Prepaid and other assets (2,515) (60,320)
Restricted Cash 0 (1,300)
Costs in excess of billing (50,765) 0
Other assets 501 0
Accounts payable (740,518) 82,107
Accrued compensation and payroll taxes (27,472) 44,339
Other accrued expenses 276,307 (137,396)
Deferred revenue and customer advances 10,477 (6,853)
----------- -----------
Net cash provided by (used in) operating activities 1,465,494 (663,370)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES --
Purchase of fixed assets (73,037) (50,455)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Purchase of Treasury Stock (75,266) 0
Principal payments on capital lease obligations (16,361) (15,822)
----------- -----------
Net cash used in financing activities (91,627) (15,822)
----------- -----------
Net increase (decrease) in cash 1,300,830 (729,647)
CASH, beginning of period 2,242,988 3,867,430
----------- -----------
CASH, end of period $ 3,543,818 $ 3,137,783
=========== ===========
5
K2 DESIGN, INC. AND SUBSIDIARY
Three Months Ended
March 31,
---------------------
1998 1997
------- -------
(unaudited)
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION:
Cash paid during the period for-
Interest $ 7,287 $ 3,324
Income taxes $ 5,297 $ 1,036
======= =======
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING
AND FINANCING ACTIVITIES:
Assets acquired under capital lease obligations $ 0 $26,231
======= =======
6
K2 DESIGN, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
March 31, 1998 AND 1997
1. ORGANIZATION AND BUSINESS
K2 Design, Inc. ("K2" or the "Company") commenced operations on March 1, 1993
as a partnership. In January 1995 the Partnership contributed its capital into
a newly formed corporation and elected S Corporation status.
Effective January 1, 1996, the Company was reorganized as a Delaware Holding C
corporation having a wholly owned operating subsidiary incorporated in New
York. The reorganized corporation is authorized to issue 9,000,000 shares of
common stock, par value $.01 per share, and 1,000,000 shares of Preferred
Stock, par value $.01 per share.
K2 is a full service interactive communications, design and technology
company, engaged primarily in the business of interactive advertising. The
Company also provides various other information delivery services. The
Company's customers are primarily U.S.-based corporations operating in a wide
variety of industries.
Private Placements
On February 29, 1996, the Company consummated a private placement offering in
which it sold 200,000 shares of its common stock at $1.25 per share. On May 9,
1996, the Company consummated a second private placement offering in which it
sold 400,002 additional shares of its common stock at $1.75 per share.
Initial Public Offering
On July 26, 1996, the Company consummated an initial public offering in which
1,149,939 units of the Company's securities were sold to the public (the
"Public Units") at $6.00 per unit, each consisting of one share of Common
Stock and two warrants to purchase one share of Common Stock at $7.50. The net
proceeds from this offering of approximately $5,600,000 were used for working
capital and general corporate purposes.
2. Net Loss Per Share of Common Stock
SFAS 128, "Earnings per Share" establishes new standards for computing and
presenting earnings per share (EPS). The new standard requires the
presentation of basic EPS and diluted EPS. Basic EPS is calculated by dividing
income available to common shareholders by the weighted average number of
shares of common stock outstanding during the period. Diluted EPS is
calculated by dividing income available to common shareholders by the weighted
average number of common shares outstanding adjusted to reflect potentially
dilutive securities.
In accordance with SFAS 128, the following table reconciles net income (loss)
and share amounts used to calculate basic and diluted income (loss) per share:
7
March 31,
-----------------------------
1998 1997
----------- -----------
Numerator:
Net Income (loss) Basic and Diluted $ 37,919 $ (327,855)
Denominator:
Weighted average number of common
shares outstanding - Basic 3,680,671 3,645,421
Weighted average number of common
shares outstanding - Diluted 3,716,841 3,645,421
Net income (loss) per common share - Basic and Diluted $ 0.01 $ (0.09)
Outstanding stock options as of March 31, 1997 have been excluded from the
above calculations as they are antidilutive.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
The following presentation of management's discussion and analysis of
the Company's financial condition and results of operations should be read in
conjunction with the Company's Consolidated Financial Statements, the
accompanying notes thereto and other financial information appearing elsewhere
in this Report. This section and other parts of the Report contain
forward-looking statements that involve risks and uncertainties. The Company's
actual results may differ significantly from the results discussed in the
forward-looking statements.
Readers are encouraged to review "Factors Affecting Operating Results
and Market Price of Stock" commencing on page 14 of the Company's 1997 form
10-K for a discussion of these risks and uncertainties.
OVERVIEW
The Company was founded in 1993 as a general partnership and
initially operated a traditional graphic design business. The Company was
hired to design a graphical user interface in March 1994 for Sierra Magazine
Online, a proprietary online service, and in August 1994 for NetMarket Inc.,
the first company to perform a secure online transaction on the Internet, at
which time the Company shifted its principal business to Web site design and
creation. After the Company's initial public offering ("IPO") on July 26,
1996, the Company began to develop its vision to become a full-service
interactive marketing and communications company, largely in anticipation of
demands from its customers for additional complementary services. The Company
now provides such services as development of online brand, communications and
technical strategies, media placement on Web sites, consulting services
regarding Web site usage and user characteristics, development and maintenance
of Company-owned Web site advertising networks, live Internet broadcasts,
development of CD-ROM discs, and print collateral systems.
As a result of the expansion of the Company's services beyond Web
site design and creation, the Company incurred significant expenses in 1996 in
anticipation of future revenues. Since the Company has engaged in Web site
design and creation only for approximately two years, and has been providing a
full range of interactive advertising services for less than one year, the
Company has a limited operating history upon which an evaluation of the
Company and its prospects can be based. Management therefore believes that
period-to-period comparisons of the Company's results of operations are not
indicative of future results.
8
In January 1995, the Company was reorganized as a New York
corporation that elected to be treated as an S corporation for tax purposes.
In January 1996, the Company was reorganized as a Delaware holding company and
the New York corporation became a wholly-owned operating subsidiary thereof
and thus ceased to be an S corporation for tax purposes. For financial
reporting purposes, the Company's Consolidated Financial Statements include
the Company and its wholly-owned subsidiary.
RESULTS OF OPERATIONS
General
Revenues are recognized on a percentage of completion basis.
Provisions for any estimated losses on uncompleted projects are made in the
period in which such losses are determinable. A portion of the Company's
revenues has been generated on a fixed fee or cap fee basis. The Company also
provides ongoing services to certain customers, including one customer for
which the Company is agency-of-record.
Since November 1997, the Company has begun to reduce expenses in an
effort to bring them in line with revenue levels. Accordingly, the Company
implemented cost cutting measures, including a reduction in selling, general
and administrative personnel, consolidation of offices and a reduction in
usage of independent contractors. Nevertheless, the Company's failure to
expand its business in an efficient manner could have a material adverse
effect on the Company's business, operating results and financial condition.
In addition, there can be no assurance that the Company's future revenues will
be sufficient to support its existing and anticipated expense levels or that
the Company will be able to maintain these reduced expense levels.
The changes in the various line-items discussed below reflect the
impact of the Company's cost cutting measures implemented commencing in November
1997.
Percentage of Revenues
For the Three Months Ended March 31,
1998 1997
------------- -------------
(Unaudited) (Unaudited)
Revenues 100.0% 100.0%
Operating Expenses
Direct Salaries and Costs 67.0 71.5
Selling, General and Administrative 29.4 46.9
Depreciation 3.5 3.4
------------- -------------
Total Operating Expenses 99.9 121.8
------------- -------------
Operating Income (Loss) 0.1 (21.8)
Other Income 1.5 2.2
------------- -------------
Income (Loss) Before Taxes 1.6 (19.6)
Income taxes 0.2 --
------------- -------------
Net Income (Loss) 1.4% (19.7)%
============= =============
Revenues
Revenues for the three months ended March 31, 1998 and 1997 were
$2,640,941 and $1,665,398, respectively, or an increase of 58.6%. The increase
in revenues in the quarter ended March 31, 1998 as compared to that ended
March 31, 1997 resulted primarily from the expansion of the Company's media
buying services and the Company's CLIQNOW!(Trademark) media selling services
business. In the first quarter of 1998, approximately 81% of revenues were
generated from interactive advertising services (including media buying) and
traditional graphic design services, and the remainder was attributable to the
Company's CLIQNOW!(Trademark) media selling business. In the first
9
quarter of 1997, all of the Company's revenue was attributable to interactive
advertising and traditional graphic design services. Since the Company's
transition from a Web site design company into an integrated interactive
marketing and communications company is ongoing, the Company is unable to
predict the relative percentage of its revenues that will be generated from
each of its various services. During the three months ended March 31, 1998,
Standard & Poors, Bell Atlantic and Planet Direct, Inc., accounted for
approximately 19%, 10% and 10% of the Company's revenues, respectively. During
the three months ended March 31, 1997, WavePhore and Toys "R" Us Corporation
accounted for approximately 41% and 14% of the Company's revenues,
respectively.
The increase in revenues in the three months ended March 31, 1998 as
compared to the three months ended March 31, 1997 resulted primarily because
(i) the Company's executive management devoted substantially more time to
sales and marketing in the 1998 quarter and (ii) the Company increased its
account management initiatives during the 1998 quarter.
Direct Salaries and Costs
Direct salaries and costs include all direct labor costs and other
direct costs related to project performance, such as independent contractors,
freelance labor, supplies, and printing and equipment costs. As a percentage
of revenues, direct salaries and costs decreased by more than 4% in the three
months ended March 31, 1998, as compared to the same period in 1997. In
absolute dollars, direct salaries and costs increased by $578,080 from
$1,191,390 in the 1997 quarter to $1,769,470 in the 1998 quarter. In the 1998
period, direct salaries and costs consisted primarily of $907,000 of media
placement costs, $258,000 of payments to CLIQNOW!(Trademark) affiliate web sites
and $378,000 paid as direct salaries. In the 1997 period, direct salaries and
costs consisted primarily of approximately $373,662 paid as direct salaries and
$327,000 paid to freelance artists and other independent contractors
(approximately $118,000 of which, was paid to vendors of complex computer
programming services required for special features on Web site).
Selling, General and Administrative Expenses
Selling, general and administrative expenses for the three months
ended March 31, 1998 and 1997 were approximately $776,000 (29.4% of revenues)
and $781,000 (46.9% of revenues), respectively, and consisted primarily of
labor costs, professional fees, occupancy costs, travel, office expenses and
supplies and marketing and advertising, among other things. The decrease in
both absolute dollars and as a percentage of revenues reflects the application
of tighter controls in connection with the Company's cost reduction plan.
Depreciation
Depreciation expense was $92,814 and $56,932 in the three months
ended March 31, 1998 and 1997, respectively, and related to depreciation of
equipment and leasehold improvements. The Company's depreciation expenses in
1998 have increased significantly as a result of depreciation of the Company's
equipment and leasehold improvement in connection with the acquisition of
computer equipment and the relocation of its offices.
Income Taxes
Effective January 1995, the Company elected to be treated as an S
Corporation for federal income tax purposes. As a result, the shareholders
were individually liable for federal income tax on the Company's taxable
income. In January 1996, the Company began to be treated as a C corporation
for federal and state income tax purposes. The Company is also liable for New
York state and city income taxes, as well as Delaware corporation taxes.
Fluctuations in Quarterly Operating Results
Quarterly revenues and operating results have fluctuated and will
fluctuate as a result of a variety of factors. These factors, some of which
have affected the Company and some of which are beyond the Company's control,
include the timing of the completion, material reduction or cancellation of
major projects, the loss of a major customer or the termination of a
relationship with a channel source, timing of the receipt of new business,
timing of the hiring or loss of personnel, changes in the pricing strategies
and business focus of the Company or its competitors, capital expenditures,
operating expenses and other costs relating to the expansion of operations,
general economic conditions and acceptance and use of the Internet.
10
The Company's quarterly operating margins may also fluctuate from
period to period depending on the relative mix of lower cost full time
employees versus higher cost independent contractors. In November 1997, the
Company began to reduce expenses in an effort to bring them in line with
current and anticipated revenue levels.
Liquidity and Capital Resources
The Company's cash increased by $1,300,830, or 58% from $2,242,988 at
December 31, 1997. The increase was principally due to the Company's continued
focus on collection of accounts receivables and actively managing accounts
payables.
The Company is dependent on its cash of approximately $3.5 million
(at March 31, 1998), together with cash generated by operations for working
capital in order to be competitive, to meet the increasing demands of service,
quality and pricing and for any expansion of its business. While the Company
believes that its cash position together with cash expected to be generated by
operations will be sufficient to finance its operations for at least one year,
the Company may nevertheless require future financing in order to satisfy its
working capital needs, which may be unavailable or prohibitively expensive
since the Company's only assets available to secure additional financing are
accounts receivables.1 Accordingly, the Company may not have the funds to
relieve any liquidity problems, should they arise, or to finance any expansion
of its business.
Net cash provided by the Company's operating activities was
$1,465,494 in the quarter ended March 31, 1998 and related primarily to a
substantial decrease in accounts receivables, which was partially offset by an
increase in accounts payables and accrued expenses payable as is indicated in
the statement of cash flows.
In the quarter ended March 31, 1998 the Company spent approximately
$73,000 on capital expenditures, consisting of furniture, fixtures and
leasehold improvements acquired and made in connection with the Company's
recent relocation of its principal offices. Additional capital expenditures
are expected to be made in connection with office leasehold improvements.
- ------------------
1 This statement is a forward-looking statement reflecting current
expectations. There can be no assurance that the Company's actual
future performance will meet the Company's current expectations. See
"Factors Affecting the Company's Annual Report on Form 10-KSB for the
fiscal year ended December 31, 1997 for a discussion of the risks and
uncertainties which may affect this statement.
11
K2 DESIGN, INC. AND SUBSIDIARY
PART II - OTHER INFORMATION
Items 1.- 5. Not applicable
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits - Exhibit 27.1 - Final Data Schedule (included only in the
electronic filing with the Securities and Exchange Commission)
(b) No reports on Form 8-K have been filed during the quarter for which
this report is filed.
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
K2 DESIGN, INC.
Date: May 18, 1998 By: /s/ Matthew G. de Ganon
------------------------------------------
Matthew G. de Ganon
Principal Executive Officer
By: /s/ Robert W. Burke
------------------------------------------
Robert W. Burke
Principal Financial and Accounting Officer
12