AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON AUGUST 13, 1997
REGISTRATION NO. 333-
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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM SB-2
REGISTRATION STATEMENT
UNDER THE SECURITIES ACT OF 1933
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CELERITY SYSTEMS, INC.
(Name of small business issuer in its charter)
DELAWARE 5045 52-2050585
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(State or jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) (Identification No.)
CELERITY SYSTEMS, INC. KENNETH D. VAN METER
9051 EXECUTIVE PARK DRIVE, SUITE 302 CELERITY SYSTEMS, INC.
KNOXVILLE, TENNESSEE 37923 9051 EXECUTIVE PARK DRIVE, SUITE 302
(423) 539-5300 KNOXVILLE, TENNESSEE 37923
(Address and telephone number of principal (423) 539-5300
executive offices and principal place of (Name, address and telephone number of agent
business) for service)
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COPIES TO:
KENNETH R. KOCH, ESQ. PAUL JACOBS, ESQ.
SQUADRON, ELLENOFF, PLESENT & SHEINFELD, LLP FULBRIGHT AND JAWORSKI L.L.P.
551 FIFTH AVENUE 666 FIFTH AVENUE
NEW YORK, NEW YORK 10176 NEW YORK, NEW YORK 10103-3198
TELEPHONE: (212) 661-6500 TELEPHONE: (212) 318-3000
TELECOPIER: (212) 697-6686 TELECOPIER: (212) 752-5958
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APPROXIMATE DATE OF PROPOSED SALE TO THE PUBLIC: As soon as practicable
after the effective date of this Registration Statement.
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434
under the Securities Act, please check the following box. [ ]
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act,
check the following box [x]
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CALCULATION OF REGISTRATION FEE
PROPOSED MAXIMUM PROPOSED MAXIMUM
TITLE OF EACH CLASS OF AMOUNT TO BE OFFERING PRICE PER AGGREGATE OFFERING AMOUNT OF
SECURITIES TO BE REGISTERED REGISTERED SHARE(1) PRICE(1) REGISTRATION FEE
Common Stock, par value
$0.001 per share 2,300,000(2) $7.50 $17,250,000 $5,227.27
Representative's Warrants (3) 200,000 $.001 $200 $0.06
Common Stock, par value
$0.001 per share (4) 200,000 $9.00 $1,800,000 $545.46
Total $5,772.79
(1) Estimated solely for purposes of calculating the registration fee pursuant
to Rule 457(o) under the Securities Act.
(2) Includes 300,000 shares of Common Stock, par value $0.001 per share, which
the Underwriters have the option to acquire solely to cover over-allotments,
if any.
(3) To be sold to the Representative of the several Underwriters. Each warrant
entitles the Representatives to purchase one share of Common Stock at a
price equal to 120% of the initial public offering price.
(4) Issuable upon the exercise of the Representative's Warrants registered
hereby.
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THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING
PURSUANT TO SECTION 8(A), MAY DETERMINE.
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CROSS REFERENCE SHEET
ITEM NUMBER OF FORM SB-2 LOCATION OR CAPTION IN PROSPECTUS
----------------------------------------------------- -----------------------------------------------------
1. Front of Registration Statement and Outside Front
Cover Page of Prospectus............................. Outside Front Cover Page
2. Inside Front and Outside Back Cover Pages of
Prospectus........................................... Inside Front Cover Page; Outside Back Cover Page
3. Summary Information and Risk Factors................. Prospectus Summary; Risk Factors
4. Use of Proceeds...................................... Use of Proceeds
5. Determination of Offering Price...................... Underwriting
6. Dilution............................................. Dilution
7. Selling Security Holders............................. Not Applicable
8. Plan of Distribution................................. Outside Front Cover Page; Underwriting
9. Legal Proceedings.................................... Business--Legal Proceedings
10. Directors, Executive Officers, Promoters and Control
Persons.............................................. Management--Executive Officers and Directors
11. Security Ownership of Certain Beneficial Owners and
Management........................................... Principal Stockholders
12. Description of Securities............................ Outside Front Cover Page; Description of Securities
13. Interest of Named Experts and Counsel................ Legal Matters; Experts
14. Disclosure of Commission Position on Indemnification
for Securities Act Liabilities....................... Part II
15. Organization Within Last Five Years.................. Management's Discussion and Analysis of Financial
Condition and Results of Operations
16. Description of Business.............................. Business
17. Management's Discussion and Analysis or Plan of
Operation............................................ Management's Discussion and Analysis of Financial
Condition and Results of Operations
18. Description of Property.............................. Business--Properties
19. Certain Relationships and Related Transactions....... Certain Relationships and Related Transactions
20. Market for Common Equity and Related Stockholder
Matters.............................................. Dividend Policy; Description of Securities
21. Executive Compensation............................... Management--Executive Compensation
22. Financial Statements................................. Financial Statements
23. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure.................. Not Applicable
24. Indemnification of Directors and Officers............ Part II
25. Other Expenses of Issuance and Distribution.......... Part II
26. Recent Sales of Unregistered Securities.............. Part II
27. Exhibits............................................. Part II; Exhibits
28. Undertakings......................................... Part II
SUBJECT TO COMPLETION, DATED AUGUST 13, 1997 [LOGO]
PROSPECTUS
2,000,000 SHARES
CELERITY SYSTEMS, INC.
COMMON STOCK
Celerity Systems, Inc. (the "Company") is hereby offering 2,000,000 shares
(the "Shares") of common stock, par value $0.001 per share (the "Common Stock"),
of the Company.
Prior to this offering (the "Offering"), there has been no public market for
the Common Stock. The Company has applied for listing of the Common Stock on the
Nasdaq SmallCap market under the proposed symbol "CLRT." It is currently
anticipated that the initial public offering price of the Common Stock will be
$7.50 per share. See "Underwriting" for information relating to the factors
considered in determining the initial public offering price.
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AN INVESTMENT IN THE SHARES OF COMMON STOCK OFFERED HEREBY INVOLVES A HIGH
DEGREE OF RISK. PROSPECTIVE INVESTORS SHOULD CAREFULLY CONSIDER THE FACTORS
SET FORTH UNDER "RISK FACTORS" BEGINNING ON PAGE 7 HEREIN.
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF
THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
UNDERWRITING DISCOUNTS
PRICE TO PUBLIC AND COMMISSIONS (1) PROCEEDS TO COMPANY (2)
Per Share.............................. $ $ $
Total(3)............................... $ $ $
(1) Does not include additional consideration payable to Hampshire Securities
Corporation, the representative (the "Representative") of the several
underwriters identified elsewhere herein (the "Underwriters"), consisting of
(a) a non-accountable expense allowance equal to 3% of the gross proceeds of
the Offering, and (b) warrants entitling the Representative to purchase up
to an aggregate of 200,000 shares of Common Stock from the Company (the
"Representative's Warrants"). The Company has agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act of 1933, as amended (the "Securities Act"). See
"Underwriting."
(2) Before deducting estimated expenses of the Offering payable by the Company
(including the Representative's non-accountable expense allowance) estimated
at $ , assuming no exercise of the Underwriters' over-allotment
option.
(3) The Company has granted an option to the Underwriters, exercisable within 45
days after the date of this Prospectus, to purchase up to an additional
300,000 shares of Common Stock on the same terms and conditions as set forth
above solely to cover over-allotments, if any. If the Underwriters exercise
this option in full, the total Price to Public, Underwriting Discounts and
Commissions, and Proceeds to Company will be $ , $ , and
$ , respectively. See "Underwriting."
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The Shares are being offered by the Underwriters named herein, subject to
prior sale, when, as, and if delivered to and accepted by them, and subject to
their right to reject orders in whole or in part, and to certain other
conditions. It is expected that delivery of the certificates representing shares
of Common Stock will be made against payment therefor at the offices of
Hampshire Securities Corporation, on or about , 1997.
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HAMPSHIRE SECURITIES CORPORATION
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THE DATE OF THIS PROSPECTUS IS , 1997
[Chart]
CERTAIN PERSONS PARTICIPATING IN THE OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK,
INCLUDING SYNDICATE COVERING TRANSACTIONS, PENALTY BIDS, AND SHORT SALES. FOR A
DESCRIPTION OF THESE ACTIVITIES SEE "UNDERWRITING."
2
PROSPECTUS SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED
INFORMATION AND FINANCIAL STATEMENTS, INCLUDING THE NOTES THERETO, APPEARING
ELSEWHERE IN THIS PROSPECTUS. UNLESS OTHERWISE INDICATED, THE INFORMATION IN
THIS PROSPECTUS (I) GIVES EFFECT TO THE ONE-FOR-TWO-AND-ONE-HALF REVERSE STOCK
SPLIT OF THE COMPANY'S COMMON STOCK EFFECTED IN AUGUST 1997 (THE "STOCK SPLIT"),
(II) ASSUMES THE AUTOMATIC CONVERSION, UPON THE CLOSING OF THE OFFERING, OF THE
COMPANY'S SERIES A PREFERRED STOCK AND SERIES B PREFERRED STOCK INTO
APPROXIMATELY 553,726 SHARES OF COMMON STOCK (THE "CONVERSION"), (III) ASSUMES
AN INITIAL PUBLIC OFFERING PRICE OF $7.50 PER SHARE, AND (IV) ASSUMES NO
EXERCISE OF THE UNDERWRITERS' OVER-ALLOTMENT OPTION. ALL REFERENCES TO
"CELERITY" OR THE "COMPANY" CONTAINED IN THIS PROSPECTUS REFER TO THE COMPANY
AND ITS PREDECESSOR, CELERITY SYSTEMS, INC., A TENNESSEE CORPORATION. THIS
PROSPECTUS CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS MAY DIFFER SIGNIFICANTLY FROM THE
RESULTS DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. FACTORS THAT MIGHT CAUSE,
OR CONTRIBUTE TO, SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE
DISCUSSED IN "RISK FACTORS."
THE COMPANY
Celerity Systems, Inc. ("Celerity" or the "Company") designs, develops,
integrates, installs, operates, and supports interactive video services hardware
and software. The Company also designs, develops, installs, and supports CD-ROM
software products for business applications. In the interactive video services
area, the Company seeks to provide scalable solutions, including products and
services developed by the Company and by strategic partners, that enable
interactive video programming and applications to be provided to a wide variety
of market niches. The Company has installed 11 digital video servers in four
countries (China, Korea, Israel, and Taiwan), on each of the four major types of
networks accommodating interactive video services. The Company believes that its
demonstrated ability to deploy and operate interactive video systems over each
of these four major network types is a significant competitive advantage.
In the CD-ROM area, the Company provides several products for the storage
and rapid retrieval of large amounts of information. The Company believes such
products are faster, easier to use, provide more features, and are operational
on more diverse network architectures than similar products and services. The
Company's CD-ROM customers include the U.S. Navy, Sprint Corp., Unisys Corp.,
Toronto Dominion Bank, and Herzog, Heine & Geduld, Inc. In December 1995, the
Company's VCD MANAGER and VCD WRITER products were each chosen as IMAGING
MAGAZINE'S Product of the Year in their respective product groups for CD-ROM
software. IMAGING MAGAZINE is a leading industry publication for CD-ROM business
software.
INTERACTIVE VIDEO
Celerity's interactive video products include those manufactured by the
Company, including digital video servers, digital set top boxes, authoring
software and workstations, and operating systems software, and those provided by
strategic partners, including bench and real-time digital encoders, digital
production studio equipment, applications and business support software, set top
boxes, and network switches and equipment. These products are used in the
production, storage, transmission, and display of both conventional linear
(non-interactive) transmissions and interactive video and data applications
across (i) fiber to the curb ("FTTC"), (ii) hybrid fiber/coaxial cable ("HFC"),
(iii) high speed data lines (E1 and T1), or (iv) twisted pair networks (standard
telephone lines) using Asymmetric Digital Subscriber Line ("ADSL") equipment.
These networks may be public networks, such as those of telephone and cable
companies, or may be private networks, such as those of college campuses,
hospitals, hotels, apartment complexes, or businesses. These networks provide
large potential markets for interactive entertainment, including
video-on-demand, music, and interactive applications, such as shopping, banking,
travel, education, games, gaming, public services, advertising, and training.
These digital networks offer faster speed,
3
more robust appearance, more diverse options, and better security than is
generally available today on narrowband networks, such as the Internet.
The Company's strategy is to market its interactive video products based on
its demonstrated ability to install digital video systems on each of the major
network types and to enter into strategic alliances with others in the industry
to provide end-to-end interactive video solutions. The Company intends to focus
its sales and marketing efforts on small-to-medium sized public and private
networks. The Company believes that the scalability of its products enables the
Company to provide economically viable solutions to relatively small networks
and to efficiently serve the needs of larger networks.
CD-ROM
Celerity's CD-ROM software products consist of two types: network management
and database management. The Company's products are targeted toward industries,
such as financial services, insurance, health care, government, and
telecommunications, where there is extensive current and potential use of
electronic document imaging and management. The potential markets for these
products are expected to increase to include substantially smaller companies as
the cost of the required hardware decreases and its storage capacity increases.
VIRTUAL CD MANAGER ("VCD MANAGER"), VIRTUAL CD WRITER ("VCD WRITER"), and
MEDIATOR are network management software products which allow CD-ROM hardware
components such as changers, towers, and CD-ROM writers to be accessed and used
by a variety of devices, primarily networked PC clients, and their applications.
CD WORKWARE is a database management software product. CD WORKWARE captures and
stores documents and files, both electronic and scanned, and indexes, stores,
and retrieves information stored on CD-ROM, hard disk, or other compatible
sources. This creates an automated paperless office environment where business
reports, files, or other data may be stored and retrieved quickly and easily. In
1997, the Company developed other enhancements to its CD-ROM products allowing
them to function on both NOVELL and WINDOWS NT based networks or networks
containing elements of both. The Company believes such features currently
provide a valuable competitive advantage.
The Company's CD-ROM strategy is to increase distribution channels of its
CD-ROM products by selling through larger system integrators and value added
resellers ("VARs") and through joint marketing arrangements which will allow it
to approach customers with related products as part of an integrated approach to
meeting their needs.
The Company was incorporated in Tennessee in 1993 and was re-incorporated in
Delaware in August 1997. The Company's executive offices are located at 9051
Executive Park Drive, Suite 302, Knoxville, Tennessee, 37923, and its telephone
number is (423) 539-5300. The Company's website address is www.celerity.com.
4
THE OFFERING
Common Stock offered by the Company............. 2,000,000 shares
Common Stock outstanding prior to the
Offering...................................... 2,082,239 shares
Common Stock to be outstanding after the
Offering...................................... 4,082,239 shares(1)
Use of Proceeds................................. To repay $5,000,000 principal amount of
indebtedness plus accrued interest
thereon, including debt incurred in the
Company's 1996 and 1997 private
placements; to pay approximately $40,000
under an agreement with one of the
Company's former officers; and for
working capital and general corporate
purposes, including sales and marketing
and the hiring of additional personnel.
See "Use of Proceeds."
Risk Factors.................................... The Shares offered hereby involve a high
degree of risk and substantial dilution
and should be purchased only by persons
who can afford to sustain the loss of
their entire investment. See "Risk
Factors" and "Dilution."
Proposed Nasdaq SmallCap Market Symbol.......... "CLRT"
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(1) Includes 553,726 shares of Common Stock issuable in connection with the
Conversion. Does not include (i) up to 300,000 shares of Common Stock
issuable upon exercise of the Underwriters' over-allotment option, (ii)
200,000 shares of Common Stock issuable upon exercise of the
Representative's Warrants, (iii) 657,200 shares of Common Stock underlying
outstanding stock options, (iv) 190,714 shares of Common Stock underlying
warrants (the "1995 Warrants") issued by the Company in connection with its
1995 private placement (the "1995 Placement"), (v) 209,520 shares of Common
Stock underlying warrants (the "1996 Warrants") issued by the Company in
connection with its 1996 private placement (the "1996 Placement"), (vi)
38,852 shares of Common Stock underlying warrants issued to the
Representative (as placement agent) in connection with the private placement
of securities in the 1996 Placement, and (vii) 320,000 shares of Common
Stock underlying warrants (the "Bridge Warrants") issued by the Company in
connection with its 1997 private placement (the "Bridge Financing").
5
SUMMARY FINANCIAL DATA
The summary financial data for the Company set forth below under the caption
"Statement of Operations Data" for the years ended December 31, 1995 and 1996,
and under the caption "Balance Sheet Data" at December 31, 1996, are derived
from the financial statements of the Company, audited by Coopers & Lybrand
L.L.P., independent certified public accountants, included elsewhere in this
Prospectus. The statement of operations data for the six months ended June 30,
1996 and 1997, and the balance sheet data at June 30, 1997, are derived from
unaudited financial statements included elsewhere in this Prospectus, and, in
the opinion of management, include all adjustments (consisting only of normal
recurring adjustments) necessary for the fair presentation of the Company's
financial position and results of operations at the end of and for such periods.
Operating results for the six months ended June 30, 1997 are not necessarily
indicative of results that may be expected for the full year. The summary
financial data should be read in conjunction with the financial statements and
notes thereto included elsewhere in this Prospectus and "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
YEAR ENDED SIX MONTHS
DECEMBER 31, ENDED JUNE 30,
-------------------------- --------------------------
1995 1996 1996 1997
------------ ------------ ------------ ------------
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Revenues................................................. $ 7,703 $ 2,530 $ 1,300 $ 1,255
Cost of revenues......................................... 4,609 3,513 1,252 1,170
Operating expenses....................................... 3,045 4,491 1,787 3,778
Net income (loss)........................................ 10 (5,512) (1,784) (3,825)
Net income (loss) per share.............................. $ 0.01 $ (2.75) $ (1.01) $ (1.61)
Shares used in computing net income(loss) per share...... 1,749,245 2,006,582 1,761,373 2,379,934
AT JUNE 30, 1997
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PRO FORMA
AT DECEMBER 31, AS ADJUSTED
1996 ACTUAL PRO FORMA (1) (2)
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(UNAUDITED)
(IN THOUSANDS)
BALANCE SHEET DATA:
Working capital (deficit)............................ $ 2,105 $ (167) $ 427 $ 9,776
Total assets......................................... 5,650 4,531 5,468 12,622
Total debt........................................... 3,027 3,023 3,023 --
Redeemable, convertible preferred stock.............. 2,746 2,885 -- --
Stockholders' equity (deficit)....................... $ (2,582) $ (5,005) $ (840) $ 10,843
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(1) Pro forma to give effect to (i) the Conversion and (ii) the issuance in
August 1997 of $2,000,000 aggregate principal amount of notes (the "Bridge
Notes") in the Bridge Financing, debt discount of $1,440,000 related to
320,000 Bridge Warrants issued at an exercise price below the assumed
initial public offering price of $7.50 per share, and the application of the
net proceeds therefrom to reacquire 240,000 shares of Common Stock from a
former officer and 80,000 shares of Common Stock from a director of the
Company for aggregate consideration of $160,000 ($0.50 per share). See
"Certain Relationships and Related Transactions" and Note 16 to Notes to
Financial Statements.
(2) Adjusted to give effect to the sale by the Company of the 2,000,000 Shares
offered hereby at an assumed initial public offering price of $7.50 per
share and the application of the estimated net proceeds therefrom to repay
all outstanding indebtedness which will give rise to a loss on early
extinguishment of approximately $960,000 related to unamortized debt
discount. See "Use of Proceeds" and Note 16 to Notes to Financial
Statements.
6
RISK FACTORS
THE SHARES OFFERED HEREBY INVOLVE SUBSTANTIAL RISKS AND SHOULD BE PURCHASED
ONLY BY PERSONS WHO CAN AFFORD TO SUSTAIN THE LOSS OF THEIR ENTIRE INVESTMENT.
THE FOLLOWING RISK FACTORS, IN ADDITION TO THE OTHER INFORMATION AND FINANCIAL
DATA SET FORTH ELSEWHERE IN THIS PROSPECTUS, SHOULD BE CONSIDERED CAREFULLY IN
EVALUATING THE COMPANY AND ITS BUSINESS BEFORE MAKING AN INVESTMENT IN THE
SHARES. THE RISKS DESCRIBED BELOW AND ELSEWHERE IN THIS PROSPECTUS ARE NOT
INTENDED TO BE AN EXHAUSTIVE LIST OF THE GENERAL OR SPECIFIC RISKS INVOLVED, BUT
MERELY IDENTIFY CERTAIN RISKS THAT ARE NOW FORESEEN BY THE COMPANY. IT MUST BE
RECOGNIZED THAT OTHER RISKS, NOT NOW FORESEEN, MIGHT BECOME SIGNIFICANT IN THE
FUTURE AND THAT THE RISKS WHICH ARE NOW FORESEEN MIGHT AFFECT THE COMPANY TO A
GREATER EXTENT THAN IS NOW FORESEEN OR IN A MANNER NOT NOW CONTEMPLATED. EACH
PROSPECTIVE INVESTOR SHOULD CAREFULLY CONSIDER ALL INFORMATION CONTAINED IN THIS
PROSPECTUS AND SHOULD GIVE PARTICULAR CONSIDERATION TO THE FOLLOWING RISK
FACTORS BEFORE DECIDING TO PURCHASE THE SHARES OFFERED HEREBY.
HISTORY OF LOSSES. The Company commenced operations in January 1993 and
incurred net losses of approximately $264,000 and $30,000 for the years ended
December 31, 1993 and 1994, respectively; generated net income of approximately
$9,900 for the year ended December 31, 1995; incurred a net loss of
approximately $5,512,000 for the year ended December 31, 1996; and a net loss of
approximately $3,825,000 for the six months ended June 30, 1997. There can be no
assurance that the Company will operate profitably in the near future or at all.
The Company may experience fluctuations in future operating results as a result
of a number of factors, including delays in digital video product enhancements
and new product introductions. There can be no assurance that the Company will
be able to develop commercially viable products or that the Company will
recognize significant revenues from such products.
PROJECT RISKS. A significant portion of the Company's revenues have been,
and are expected to continue to be, derived from substantial long-term projects
which require significant up-front expense to the Company with no assurance of
realizing revenues until the project is completed or certain significant
milestones are met. For example, suppliers and developers for long-term
interactive video projects such as the Korean, Israeli, Taiwanese, and Chinese
projects in which the Company is participating are required to reach certain
milestones prior to the Company's receipt of significant payments. The Company's
failure, or any failure by a third-party with which the Company has contracted,
to perform services or deliver interactive video products on a timely basis
could result in a substantial loss to the Company. Until recently, the Company
has had difficulty in meeting delivery schedules, which has resulted in customer
dissatisfaction. In addition, difficulty in completing a project could have a
material adverse effect on the Company's reputation, business, and results of
operations. As a result of liquidated damages and "hold back" provisions in
customer contracts, the Company has reserved approximately $555,000, as of June
30, 1997, for potential losses which may result from such contractual
provisions. In many instances, the Company is dependent on the efforts of third
parties to adequately complete their portion of the project and, even if the
Company's digital video servers perform as required, a project may still fail
due to other components of the project supplied by third parties.
EMPHASIS ON FIXED PRICE CONTRACTS AND COMMITMENTS. The Company has entered
into and may in the future enter into fixed price agreements for the sale of its
products and services. Pricing for such commitments is made based upon
development and production effort estimates and estimates of future product
costs. The Company bears the risk of faulty estimates, cost overruns, and
inflation in connection with these commitments; therefore, any fixed price
agreement can become unprofitable and could materially adversely affect the
Company. The Company reserved approximately $673,000 for the year ended December
31, 1996, for potential losses on uncompleted contracts and at June 30, 1997,
the balance of such reserve was $348,000. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations." There can be no
assurance that these risks will not continue to negatively affect the Company's
margins and profitability.
RISKS ASSOCIATED WITH CONTRACTS WITH EN KAY TELECOM CO., LTD. In September
1996, the Company entered into an agreement with En Kay Telecom Co., Ltd., a
Korean company ("En K"), pursuant to which
7
the Company, as licensor, agreed to design a digital set top box which would be
manufactured and sold by En K in the Republic of Korea (the "1996 En K
Agreement"). In February 1997, the Company entered into a second license
agreement with En K for the manufacture and sale by En K of two models of the
Company's servers in Korea, as well as a license to sell those server models on
an exclusive basis in Korea (subject to an exception for the IVISION project)
and on a non-exclusive basis elsewhere (the "1997 En K Agreement"). The Company
has received $600,000 under the 1996 En K Agreement; however, in April 1997, the
Company stopped production under the 1996 En K Agreement pending settlement of
disputes under the 1997 En K Agreement. The 1997 En K Agreement provided for the
payment by En K to the Company of $1,000,000 on each of February 21, 1997 and
May 1, 1997, $4,000,000 during 1998, and minimum annual purchases of $2,000,000
over a five-year period. En K has failed to make the initial two payments under
the 1997 En K Agreement, although En K did pay $200,000 in mid-May. The Company
gave notice of default in April 1997, and placed En K in default in May 1997,
when En K failed to cure the payment default within the agreed thirty-day
period. The Company is considering various options in this matter, including
commencing legal proceedings. There can be no assurance that En K will honor
either of its agreements with the Company, that the Company will prevail in any
legal proceeding, or, if the Company does prevail, that it will collect any
amounts awarded. In addition, although the Company does not believe there is any
basis for such a course of action, it is possible that En K may seek to recover
amounts previously paid by it under the agreements.
NEED FOR STRATEGIC ALLIANCES. The Company believes that there are certain
potential advantages to entering into one or more strategic alliances with major
interactive network or product providers. Although the Company has entered into
certain of such alliances, the Company is actively seeking to enter into more of
such alliances. Certain of the Company's competitors and potential strategic
allies may have entered into or may enter into agreements which may preclude
such potential allies from entering into alliances with the Company. No
assurance can be given that the Company will be successful in entering into any
such strategic alliances on acceptable terms or, if any such strategic alliance
is entered into, that the Company will realize the anticipated benefits from
such strategic alliance. See "Risk Factors-- Competition" and
"Business--Strategic Alliances."
RELIANCE ON KEY CUSTOMERS. For the year ended December 31, 1995, one of the
Company's CD-ROM customers, the U.S. Navy, accounted for approximately 25% of
the Company's revenues. For the year ended December 31, 1996, two of the
Company's CD-ROM customers, the U.S. Navy and Herzog, Heine & Geduld, Inc.,
accounted for approximately 37% and 13% of the Company's revenues, respectively.
The Company's interactive video services revenues to date have been derived
almost exclusively from four telecommunications customers. The loss of any major
customer could have a material adverse effect on the Company. See
"Business--Deployments."
LACK OF PATENT AND COPYRIGHT PROTECTION. The Company holds no patents and
has not filed any patent applications with respect to its technology. The
Company's methods of protecting its proprietary knowledge may not afford
adequate protection and there can be no assurance that any patents will be
applied for or issued, or, if issued, that such patents would provide the
Company with meaningful protection from competition. In Asia and third world
countries, in which the Company does business and has license agreements, the
unauthorized use of technology, whether protected legally or not, is widespread
and it is possible that the Company's technology will be subject to theft and
infringement. Furthermore, pursuant to the Company's current business plan, it
will be necessary for the Company to make its intellectual property available to
vendors, customers, and other companies in the industry, making it even more
difficult to protect its technology.
NO ASSURANCE OF TECHNOLOGICAL SUCCESS. The Company's ability to
commercialize its products is dependent on the advancement of its existing
technology. In order to obtain and maintain a significant market share the
Company will be required continually to make advances in technology. There can
be no assurance that the Company's research and development efforts will result
in the development of such
8
technology on a timely basis or at all. Any failures in such research and
development efforts could result in significant delays in product development
and have a material adverse effect on the Company. There can be no assurance
that the Company will not encounter unanticipated technological obstacles which
either delay or prevent the Company from completing the development of its
products. Moreover, the Company believes there are certain technological
obstacles to be overcome in order to develop future products. These obstacles
include the lack of an electronic data interchange server interface (used for
real-time exchange of data between servers) and enhancements in the ability to
access and utilize information stored on remote servers. In certain cases, the
Company will be dependent upon technological advances which must be made by
third parties. There can be no assurance that the Company or such third parties
will not encounter technological obstacles which either delay or prevent the
Company from completing the development of its future products, which could have
a material adverse effect on the Company.
COMPETITION. The interactive video and CD-ROM industries are highly
competitive. Many of the companies with which the Company currently competes or
may compete in the future have greater financial, technical, marketing, sales
and customer support resources, as well as greater name recognition and better
access to customers, than the Company. There can be no assurance that the
Company will be able to compete successfully with existing or future
competitors. Certain of such competitors have entered into strategic alliances
which may provide them with certain competitive advantages. See "Business--
Interactive Video Services Segment--Competition" and "--CD-ROM
Segment--Competition."
UNCERTAIN MARKET ACCEPTANCE. Since inception, the Company has been engaged
in the design and development of interactive video and CD-ROM products. As with
any new technology, there is a substantial risk that the marketplace may not
accept the technology utilized in the Company's products. Market acceptance of
the Company's products will depend, in large part, upon the ability of the
Company to demonstrate the performance advantages and cost-effectiveness of its
products over competing products and the general acceptance of interactive video
services. In particular, the Company believes that widespread deployment of
interactive video services will depend on a number of factors, including (i)
decreases in the cost per subscriber, (ii) the "user-friendliness" of such
systems, particularly set top boxes and remote controls which are relatively
easy to understand and use, and (iii) improvements in the quantity and quality
of interactive services available. Although recent developments have reduced the
cost per subscriber, and the Company anticipates that such costs will continue
to decrease as interactive video systems are more widely deployed, the current
cost per subscriber may make the system too expensive for a number of potential
network operators. There can be no assurance that the Company will be able to
market its technology successfully or that any of the Company's current or
future products will be accepted in the marketplace.
PRODUCT OBSOLESCENCE; TECHNOLOGICAL CHANGE. The industries in which the
Company operates are characterized by unpredictable and rapid technological
changes and evolving industry standards. The Company will be substantially
dependent on its ability to identify emerging markets and develop products that
satisfy such markets. There can be no assurance that the Company will be able to
accurately identify emerging markets or that any products the Company has or
will develop will not be rendered obsolete as a result of technological
developments. The Company believes that competition in its business may
intensify as technological advances in the field are made and become more widely
known. Many companies with substantially greater resources than the Company are
engaged in the development of products similar to those proposed to be sold by
the Company. Commercial availability of such products could render the Company's
products obsolete, which would have a material adverse effect on the Company.
Moreover, from time to time, the Company may announce new products or
technologies that have the potential to replace the Company's existing product
offerings. There can be no assurance that the announcement or expectation of new
product offerings by the Company or others will not cause customers to defer
purchases of existing Company products, which could adversely affect the
Company.
9
DEPENDENCE ON SUPPLIERS; MANUFACTURING RISKS. The Company relies primarily
on outside suppliers and subcontractors for substantially all of its parts,
components, and manufacturing supplies. Certain materials are available from
only a limited number of suppliers. The Company does not maintain long-term
supply contracts with its suppliers. The disruption or termination of the
Company's supply or subcontractor arrangements could have a material adverse
effect on the Company's business and results of operations. The Company's
reliance on third parties involves significant risks, including reduced control
over delivery schedules, quality assurance, manufacturing yields and cost, the
potential lack of adequate capacity, and potential misappropriations of the
Company's intellectual property. In addition, vendor delays or quality problems
could also result in lengthy production delays. To obtain manufacturing
resources, the Company may contract for manufacturing by third parties or may
seek to enter into joint venture, sublicense, or other arrangements with another
party which has established manufacturing capability, or it may choose to pursue
the commercialization of such products on its own. There can no assurance that
the Company, either on its own or through arrangements with others, will be able
to obtain such capabilities on acceptable terms.
LIMITED MARKETING AND SALES EXPERIENCE. The Company has limited resources
and limited experience in marketing and selling its products. There can be no
assurance that the Company will be able to establish and maintain adequate
marketing and sales capabilities or make arrangements with others to perform
such activities. Achieving market penetration will require significant efforts
by the Company to create awareness of, and demand for, its products.
Accordingly, the Company's ability to expand its customer base will depend upon
its marketing efforts, including its ability to establish an effective internal
sales organization or strategic marketing arrangements with others. The failure
by the Company to successfully develop its marketing and sales capabilities,
internally or through others, would have a material adverse effect on the
Company's business. Further, there can be no assurance that the development of
such marketing capabilities will lead to sales of the Company's current or
proposed products.
DEPENDENCE ON KEY PERSONNEL. The Company's success depends to a significant
extent on the performance and continued service of its senior management,
particularly Kenneth D. Van Meter, Glenn West, Doyal H. Hodge, William R.
Chambers, and Mark Cromwell. The Company's failure to retain the services of key
personnel or to attract additional qualified employees could adversely affect
the Company. The Company has entered into employment agreements with Messrs. Van
Meter and West. Mr. Van Meter's employment agreement expires on January 20,
2000, unless terminated for cause. Mr. West's employment agreement expires May
1, 2000, unless terminated for cause or disability. Messrs. Chambers', Hodge's,
and Cromwell's employment with the Company may be terminated by the employee or
the Company at any time. The Company owns and is the beneficiary of a key man
life insurance policy on the life of Mr. West in the amount of $1,000,000, and
intends to seek to obtain a similar policy in the amount of $2,000,000 with
respect to Mr. Van Meter.
ATTRACTION AND RETENTION OF EMPLOYEES. The Company's business involves the
delivery of professional services and is labor-intensive. The Company's success
will depend, in large part, upon its ability to attract, develop, motivate, and
retain highly skilled technical and sales personnel, including managers and
other senior personnel. Subject to the availability of funds, the Company
intends to recruit approximately 60 employees for its engineering, sales, and
operations staff over the next 12 months. Even if funds are available, there can
be no assurance that the Company will be able to attract and retain sufficient
numbers of highly skilled technical and sales personnel. The loss of some or all
of the Company's managers and other senior personnel could have a material
adverse effect upon the Company, including its ability to secure and complete
projects in which it is currently engaged. No managers or other senior personnel
(other than Messrs. Van Meter and West) have entered into employment agreements
obligating them to remain in the Company's employ for any specific term.
RISKS APPLICABLE TO FOREIGN SALES. For the years ended December 31, 1995
and December 31, 1996, substantially all of the Company's interactive video
revenues were derived from projects in foreign
10
countries and a small portion of its CD-ROM revenues were derived from foreign
sales. Foreign projects and product sales are expected to continue to account
for a substantial portion of the Company's revenues in the near future. It may
be difficult to enforce agreements against foreign-based customers. Foreign
sales, whether effected through U.S. or foreign-based entities, could also
expose the Company to certain risks, including the difficulty and expense of
maintaining foreign sales distribution channels, barriers to trade, potential
fluctuations in foreign currency exchange rates, political and economic
instability, unavailability of suitable export financing, tariff regulations,
quotas, shipping delays, foreign taxes, export restrictions, licensing
requirements, changes in duty rates, and other United States and foreign
regulations. In addition, the Company may experience additional difficulties in
providing prompt and cost effective service for its products in foreign
countries. The Company does not carry insurance against any of these risks.
INDUSTRY STANDARDS AND COMPATIBILITY WITH EQUIPMENT AND SOFTWARE. The
interactive video and CD-ROM industries are currently characterized by emerging
technological standards. Widespread commercial deployment of the Company's
products will depend on determinations by the industry as to whether such
products will be compatible with the infrastructure equipment and software which
comprise those standards. Failure to comply substantially with industry
standards in a timely manner, either as they exist at a given time or as they
may evolve in the future, could have a material adverse effect on the Company.
In some cases, to be compatible with industry standards, the Company may need to
obtain the cooperation of its suppliers, partners, and competitors, which cannot
be assured.
ERRORS AND OMISSIONS; SOFTWARE AND HARDWARE BUGS. Certain of the Company's
products consist of internally developed software and hardware component sets,
purchased software from third parties, and purchased hardware components.
Additionally, the Company outsources substantially all of the manufacturing of
its products, including the installation and configuration of certain hardware
and software components. There is a substantial risk that these components will
have or could develop certain errors, omissions, or bugs that may render the
Company's products unfit for the purposes for which they were intended. While
there are no such known errors, omissions, or bugs, there can be no assurance
that such errors, omissions, or bugs do not currently exist or will not develop
in the Company's current or future products. Any such error, omission, or bug
found in the Company's products could lead to delays in shipments, recalls of
previously shipped products, damage to the Company's reputation, and other
related problems which would have a material adverse effect on the Company.
RISK OF THIRD PARTY CLAIMS OF INFRINGEMENT. The technology industry is
characterized by the existence of an increasing number of patents and frequent
litigation based on allegations of patent infringement. From time to time, third
parties may assert patent, copyright, and other intellectual property rights to
technologies that are important to the Company. While there currently are no
outstanding infringement claims pending by or against the Company, there can be
no assurance that third parties will not assert infringement claims against the
Company in the future, that assertions by such parties will not result in costly
litigation, or that the Company would prevail in any such litigation or be able
to license any valid and infringed patents from third parties on commercially
reasonable terms or, alternatively, to redesign products on a cost-effective
basis to avoid infringement. Any infringement claim or other litigation against
or by the Company could have a material adverse effect on the Company.
GOVERNMENT REGULATION. The Federal Communications Commission and certain
state agencies regulate certain of the Company's products and services and
certain of the users of such products and services. The Company is also subject
to regulations applicable to businesses generally, including regulations
relating to manufacturing. In addition, regulatory authorities in foreign
countries in which the Company sells or may sell its products may impose similar
or more extensive governmental regulations. Although the Company has relied
upon, and contemplates that it will continue to rely upon, its corporate
partners or interactive video system sponsors to comply with applicable
regulatory requirements, there can be no assurance that such regulations will
not materially adversely affect the Company, by jeopardizing the projects in
which the Company is participating, by imposing burdensome regulations on the
users of the
11
products, by imposing sanctions that directly affect the Company, or otherwise.
Changes in the regulatory environment relating to the industries in which the
Company competes could have an adverse effect on the Company. The Company cannot
predict the effect that future regulation or regulatory changes may have on its
business.
PRODUCT LIABILITY AND AVAILABILITY OF INSURANCE. The manufacture and sale
of the Company's products entails the risk of product liability claims. In
addition, many of the telephone, cable, and other large companies with which the
Company does or may do business may require financial assurances of product
reliability. The Company has product liability insurance, but may be required to
pay higher premiums associated with new product development. Product liability
insurance is expensive and there can be no assurance that additional insurance
will be available on acceptable terms, if at all, or that it will provide
adequate coverage against potential liabilities. The inability to obtain
additional insurance at an acceptable cost or to otherwise protect against
potential product liability could prevent or inhibit commercialization of the
Company's products. A successful claim brought against the Company in excess of
its insurance coverage could have a material adverse effect on the Company.
VARIABILITY OF QUARTERLY OPERATING RESULTS. Variations in the Company's
revenues and operating results occur from time to time as a result of a number
of factors, such as the number of interactive video projects in which the
Company is engaged, the completion of work or achievement of milestones on long-
term projects, and the timing and progress of the Company's product development
efforts. The timing of revenues is difficult to forecast because the Company's
sales and product development cycles for interactive video products can be
relatively long and may depend on factors such as the size and scope of its
projects. Furthermore, as a result of a variety of other factors, including the
introduction of new products and services by competitors, and pricing pressures
and economic conditions in various geographic areas where the Company's
customers and potential customers do business, the Company's sales and operating
results may vary substantially from year to year and from quarter to quarter. In
addition, the timing of revenue recognition for revenue received from long term
projects under the Company's accounting policies may also contribute to
significant variations in the Company's operating results from quarter to
quarter. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
ANTICIPATED NON-CASH CHARGES. As a result of the issuance of the Bridge
Warrants in connection with the Bridge Financing at a price below the
anticipated offering price, the Company will record non-cash interest expense
and loss on early extinguishment of debt in the aggregate amount of
approximately $1,440,000. The Company will also incur significant non-cash
compensation expenses in the third quarter of 1997 related to the difference
between the exercise price of certain options and the deemed fair value of the
Common Stock underlying such options amounting to approximately $1,215,000.
CONTROL BY EXISTING STOCKHOLDERS. Upon the completion of the Offering, the
Company's existing stockholders will own approximately 51% of the outstanding
shares of Common Stock (including 27.5% beneficially owed by all directors and
executive officers as a group). As a result of such ownership, the existing
stockholders of the Company will have the ability to control the election of the
directors of the Company and the outcome of all issues submitted to a vote of
the stockholders of the Company. See "Principal Stockholders."
DILUTION. The assumed initial public offering price per Share exceeds the
book value per share of the Common Stock. Investors in the Offering will
therefore incur immediate and substantial dilution of $5.12, or 68% per Share,
from the initial public offering price. See "Dilution." Following the Offering,
the executive officers and directors of the Company will beneficially own
approximately 27.5% of the Company's issued and outstanding Common Stock, having
purchased their interest at a cost per share which is substantially below and
wholly unrelated to that which investors in the Offering will pay.
RECENT SALES BELOW OFFERING PRICE. In April, June, and July 1997, the
Company granted options to purchase an aggregate of 251,800 shares of Common
Stock at $1.38 per share, granted options to purchase
12
an aggregate of 270,000 shares of Common Stock at $3.00 per share and sold, in
connection with the Bridge Financing, Bridge Warrants to purchase an aggregate
of 320,000 shares of Common Stock at $3.00 per share. In July 1997, the Company
sold to an officer of the Company, 15,000 shares of Common Stock for nominal
consideration plus the cancellation of certain anti-dilution rights. In August
1997, a former officer of the Company and a director of the Company sold 240,000
and 80,000 shares of Common Stock, respectively, to the Company for $0.50 per
share. See "Description of Securities--Options and Warrants" and "Certain
Relationships and Related Transactions."
SUBSTANTIAL OPTIONS AND WARRANTS RESERVED. The Company has reserved up to
178,929 shares of Common Stock for issuance pursuant to its 1995 Stock Option
Plan (the "1995 Plan"). To date, options to purchase an aggregate of 144,000
shares of Common Stock are authorized and outstanding under the 1995 Plan at
exercise prices ranging from $0.10 to $4.90 per share, although substantially
all of such options are exercisable at $0.10 per share. The Company has reserved
up to 200,000 shares of Common Stock for issuance pursuant to its 1997 Stock
Option Plan (the "1997 Plan," and, together with the 1995 Plan, the "Plans"). To
date, no options have been issued under the 1997 Plan. The existence of 144,000
options issued under the 1995 Plan and the Company's additional 1,272,286
outstanding options and warrants, may prove to be a hindrance to future
financings, since the holders of such warrants and options may be expected to
exercise them at a time when the Company will otherwise be able to obtain equity
capital on terms more favorable to the Company. In addition, 553,726 shares of
Common Stock are issuable upon the Conversion. The existence or exercise of such
options and the Company's outstanding warrants, and subsequent sale of the
Common Stock issuable upon such exercise and the Conversion could adversely
affect the market price of the Company's securities. See "Description of
Securities--Options and Warrants."
LACK OF DIVIDENDS. The Company has never paid any cash or other dividends
on its Common Stock. Management anticipates that, for the foreseeable future,
any earnings that may be generated from operations will be used to support its
internal growth and that dividends will not be paid to stockholders. See
"Dividend Policy."
LIMITATIONS ON LIABILITY OF DIRECTORS. The Company's Certificate of
Incorporation includes provisions to eliminate, to the full extent permitted by
law as it may from time to time be in effect, the personal liability of
directors of the Company for monetary damages arising from a breach of their
fiduciary duties as directors. The Company's Certificate of Incorporation
includes provisions to the effect that (subject to certain exceptions) the
Company shall indemnify, and upon request shall advance expenses to, any
director in connection with any action related to such a breach of their
fiduciary duties as directors to the extent that such indemnification and
advancement of expenses is permitted under such law as it may from time to time
be in effect. In addition, the Company's Certificate of Incorporation requires
that the Company indemnify, any director, officer, employee or agent of the
Company for acts which such person conducted in good faith. As a result of such
provisions, stockholders may be unable to recover damages against the directors
and officers of the Company for actions taken by them which constitute
negligence, gross negligence, or a violation of their fiduciary duties, which
may reduce the likelihood of stockholders instituting derivative litigation
against directors and officers and may discourage or deter stockholders from
suing directors, officers, employees, and agents of the Company for breaches of
their duty of care, even though such action, if successful, might otherwise
benefit the Company and its stockholders.
GENERAL ECONOMIC CONDITIONS. The industry in which the Company competes
relies in part upon consumer confidence and the availability of discretionary
income, both of which can be adversely affected during a general economic
downturn.
ANTI-TAKEOVER EFFECTS OF CERTAIN PROVISIONS OR CERTIFICATE OF INCORPORATION
AND DELAWARE LAW. The Company's Certificate of Incorporation authorizes the
issuance up to 3,000,000 shares of "blank check" preferred stock, from time to
time, in one or more series, solely on the authorization of its Board of
Directors. Accordingly, the Board of Directors is empowered, without obtaining
stockholder approval, to
13
fix the dividend rights and terms, conversion rights, voting rights, redemption
rights and terms, liquidation preferences, and any other rights, preferences,
privileges, and restrictions applicable to each new series of preferred stock.
The issuance of such stock could, among other results, adversely affect the
voting power of the holders of Common Stock and, under certain circumstances,
make it more difficult for a third party to gain control of the Company,
discourage bids for the Common Stock at a premium, or otherwise adversely affect
the market price of the Common Stock. Such provisions may discourage attempts to
acquire the Company. Certain provisions of Delaware law may also discourage
third party attempts to acquire control of the Company.
BROAD DISCRETION OF PROCEEDS. A significant portion of the net proceeds of
the Offering has been allocated to working capital and general corporate
purposes, including sales and marketing and the hiring of additional personnel,
and will be used for such specific purposes as management may determine.
Accordingly, management will have broad discretion with respect to the
expenditure of that portion of the net proceeds of the Offering. The amount and
timing of expenditures will vary depending upon a number of factors, including
the progress of the Company's product development and marketing efforts,
changing competitive conditions, and general economic conditions. Accordingly,
investors in the Offering will rely upon the judgment of the Company's
management with respect to a significant portion of the use of proceeds, with
only limited information concerning management's specific intentions. See "Use
of Proceeds."
NEED FOR ADDITIONAL FINANCING. The Company anticipates that the net
proceeds of the Offering, together with its existing working capital and
anticipated funds generated from operations, will be sufficient to satisfy its
operating and capital requirements for the next 18 months. Such belief is based
upon certain assumptions, and there can be no assurance that such assumptions
are correct. However, the Company may not be able to continue its operations
beyond such time without additional financing. There can be no assurance that
such additional financing will be available when needed on terms acceptable to
the Company, or at all. In addition, in connection with the 1996 Placement, the
Representative received a right of first refusal, until July 1999, to act as
placement agent or underwriter in future financings. Such right may impair the
Company's ability to obtain additional financing. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
ABSENCE OF PUBLIC MARKET; NEGOTIATED OFFERING PRICE. Prior to the Offering,
there has been no public market for the Common Stock, and there can be no
assurance that any trading market therefor will develop or, if any such market
develops, that it will be sustained. Accordingly, purchasers of the Shares may
experience difficulty selling or otherwise disposing of their Shares. The public
offering price of the Shares has been established by negotiation between the
Company and the Representative and does not bear any relationship to the
Company's book value, assets, past operating results, financial condition, or
other established criteria of value.
DELISTING OF SECURITIES FROM NASDAQ SMALLCAP MARKET; LOW STOCK PRICE. The
trading of the Company's Common Stock on the Nasdaq SmallCap Market will be
conditioned upon the Company meeting certain asset, capital and surplus,
earnings, and stock price requirements. To maintain eligibility for trading on
the Nasdaq SmallCap Market, the Company will be required to maintain total
assets in excess of $2,000,000, capital and surplus in excess of $1,000,000, and
(subject to certain exceptions) a bid price of $1.00 per share. In addition,
there are existing proposals to make such maintenance requirements more
stringent. Upon completion of the Offering and the receipt of the net proceeds
therefrom, the Company believes that it will meet the respective asset, capital
and surplus, and minimum stock price requirements. However, if the Company fails
any of the tests, the Common Stock may be delisted from trading on the Nasdaq
SmallCap Market. The effects of delisting include the limited release of the
market prices of the Company's Common Stock and limited news coverage of the
Company. Delisting may restrict investors' interest in the Company's securities
and materially adversely affect the trading market and prices for such
securities and the Company's ability to issue additional securities or to secure
additional financing. In
14
addition to the risk of volatile stock prices and possible delisting, low price
stocks are subject to the additional risks of federal and state regulatory
requirements and the potential loss of effective trading markets. In particular,
if the Common Stock were delisted from trading on the Nasdaq SmallCap Market and
the trading price of the Common Stock was less than $5.00 per share, the Common
Stock could be subject to Rule 15g-9 under the Securities Exchange Act of 1934,
as amended, which, among other things, requires that broker/dealers satisfy
special sales practice requirements, including making individualized written
suitability determinations and receiving purchasers' written consent, prior to
any transaction. If the Company's securities could also be deemed penny stocks
under the Securities Enforcement and Penny Stock Reform Act of 1990, this would
require additional disclosure in connection with trades in the Company's
securities, including the delivery of a disclosure schedule explaining the
nature and risks of the penny stock market. Such requirements could severely
limit the liquidity of the Company's securities and the ability of purchasers in
the Offering to sell their securities in the secondary market.
SHARES ELIGIBLE FOR FUTURE SALE. Upon the completion of the Offering, the
Company will have 4,082,239 shares of Common Stock outstanding (4,382,239, if
the Underwriters' over-allotment option is exercised in full). Of these shares,
all of the 2,000,000 shares of Common Stock sold in the Offering (2,300,000, if
the Underwriters' over-allotment option is exercised in full) generally will be
freely transferable by persons other than affiliates of the Company, without
restriction or further registration under the Securities Act. The remaining
2,082,239 shares of Common Stock (the "Restricted Shares") outstanding were sold
by the Company in reliance on exemptions from the registration requirements of
the Securities Act and are "restricted securities" as defined in Rule 144 under
the Securities Act. Of such amount, approximately 2,051,639 of the outstanding
shares of Common Stock may be sold pursuant to Rule 144, not including shares of
Common Stock underlying certain options and warrants which may be sold under
Rule 144 pursuant to Rule 701 under the Securities Act or if "cashless exercise"
provisions are utilized in connection with the exercise thereof. The sale of a
substantial number of shares of Common Stock or the availability of Common Stock
for sale could adversely affect the market price of the Common Stock prevailing
from time to time. The Company, its officers, directors, and certain
stockholders holding an aggregate of 895,552 shares of Common Stock have entered
into agreements with the Representative which prohibit them from offering,
issuing, selling, or otherwise disposing of any securities of the Company for a
period of 18 months following the date of this Prospectus, without the prior
written consent of the Representative. In addition, certain stockholders holding
an aggregate of 426,654 shares of Common Stock have entered into agreements with
the Representative which prohibit them from offering, issuing, selling, or
otherwise disposing of any securities of the Company for a period of 12 months
following the date of this Prospectus, without the prior written consent of the
Representative. See "Principal Stockholders," "Shares Eligible for Future Sale,"
and "Underwriting."
POSSIBLE VOLATILITY OF STOCK PRICE. The market prices of equity securities
of computer technology and software companies have experienced extreme price
volatility in recent years for reasons not necessarily related to the individual
performance of specific companies. Accordingly, the market price of the Common
Stock following this Offering may be highly volatile. Factors such as
announcements by the Company or its competitors concerning products, patents,
technology, governmental regulatory actions, other events affecting computer
technology and software companies generally as well as general market and
economic conditions may have a significant effect on the market price of the
Common Stock and could cause it to fluctuate substantially.
15
USE OF PROCEEDS
The net proceeds from the sale of the Shares offered hereby, at an assumed
initial public offering price of $7.50 per share, and, after deducting
underwriting discounts and commissions and other expenses of the Offering,
estimated to be, in the aggregate $2,357,600, are estimated to be approximately
$12,642,400 ($14,667,400 if the Underwriters' over-allotment option is exercised
in full).
Approximately $5,450,000 of the net proceeds of the Offering will be used to
repay the principal amount of the 1996 Notes and the Bridge Notes, along with
estimated accrued interest thereon through the estimated closing date of the
Offering. Each of the 1996 Notes and Bridge Notes bears interest at a rate of
10% per annum, compounded annually, and are due upon the earlier of (i) the
closing of the Offering or (ii) in June and July 1998, in the case of the 1996
Notes and August 8, 1998, in the case of the Bridge Notes. The 1996 Notes and
Bridge Notes were each sold as units along with warrants in the Company's 1996
Placement and Bridge Financing. As a result of the Bridge Financing, the Company
realized approximately $1,700,000 of net proceeds which funds are being used to
finance the Company's short term working capital needs and to fund expenses of
the Company in connection with the Offering.
Approximately $40,000 of the net proceeds will be used to pay obligations
under a repurchase agreement entered into with Mahmoud Youssefi, a co-founder
and former officer of the Company. Pursuant to such agreement, the Company
purchased 240,000 shares of Common Stock from Mr. Youssefi for $0.50 per share
in August 1997 and agreed, upon the consummation of the Offering, to extinguish
approximately $25,000 of lease obligations guaranteed by Mr. Youssefi and to pay
Mr. Youssefi the remaining balance (approximately $15,000) under a termination
agreement relating to the termination of Mr. Youssefi's employment with the
Company. See "Certain Relationships and Related Transactions."
The balance of the net proceeds of the Offering are intended to be used for
general corporate and working capital purposes, including sales and marketing
and the hiring of additional personnel. Any net proceeds received by the Company
from the exercise of the Underwriters' over-allotment option or the
Representative's Warrants will be added to working capital.
Pending application of the net proceeds, the Company intends to invest the
net proceeds from the Offering in short-term, interest bearing, investment
grade, debt securities, money market accounts, certificates of deposit, or
direct or guaranteed obligations of the United States government.
DIVIDEND POLICY
The Company has not paid dividends on the Common Stock since inception and
does not intend to pay any dividends to its stockholders in the foreseeable
future. The Company currently intends to retain earnings, if any, for the
development and expansion of its business. The declaration of dividends in the
future will be at the election of the Board of Directors and will depend upon
the earnings, capital requirements, and financial position of the Company,
general economic conditions, and other factors the Board of Directors deems
relevant.
16
DILUTION
As of June 30, 1997, the Company had a pro forma net tangible book deficit
of approximately ($1,320,000), or ($0.63) per share of Common Stock, after
giving pro forma effect to the Conversion and the repurchase of an aggregate of
320,000 shares of Common Stock for an aggregate of $160,000 as if such
transactions had occurred on June 30, 1997. Without taking into account any
other changes in the pro forma net tangible book value of the Company after June
30, 1997, other than to give effect to the sale by the Company of the Shares
offered hereby at an assumed initial public offering price of $7.50 per share
and the receipt and application of the estimated net proceeds therefrom
(including repayment of the 1996 Notes and the Bridge Notes and accrued cash
interest thereon), the pro forma net tangible book value would have been
approximately $9,732,000, or $2.38 per share, which represents an immediate
increase in the pro forma net tangible book value of $3.01 per share to present
stockholders and an immediate dilution of $5.12 or 68% per share, to new
investors. The following table illustrates this dilution per share.
Assumed initial public offering price per share............................. $ 7.50
Pro forma net tangible book value (deficit) per share at June 30, 1997.... $ (0.63)
Increase in pro forma net tangible book value per share attributable
to purchase of Shares by new investors.................................. $ 3.01
---------
Pro forma net tangible book value per share to investors after the
Offering.................................................................. $ 2.38
---------
Dilution per share to new investors......................................... $ 5.12
---------
---------
The following table sets forth, on a pro forma basis at June 30, 1997, the
number of shares of Common Stock purchased, the percentage of total shares of
Common Stock purchased, the total consideration paid, the percentage of total
consideration paid, and the average price per share of Common Stock paid by the
existing stockholders of the Company and by new investors in the Offering
(before deducting the estimated underwriting discounts and offering expenses
payable by the Company).
SHARES PURCHASED(1) TOTAL CONSIDERATION(1)
----------------------- -------------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
---------- ----------- ------------- ----------- ---------------
Existing stockholders(2)(3)......................... 2,082,239 51.0% $ 5,905,000 28.2% $ 2.84
New investors....................................... 2,000,000 49.0% $ 15,000,000 71.8% $ 7.50
---------- --- ------------- ---
Total(3).......................................... 4,082,239 100% $ 20,905,000 100%
---------- --- ------------- ---
---------- --- ------------- ---
- ------------------------
(1) If the Underwriters' over-allotment option is exercised in full, the number
of shares of Common Stock held by new investors after the Offering will
increase to 2,300,000 or 52.5% of the total number of shares of Common Stock
to be outstanding after the Offering, the percentage of such shares
outstanding held by all current stockholders will correspondingly decrease
to 47.5%, the total cash consideration from new investors will increase to
$17,250,000, or 74.5% of the total cash consideration, and the percentage of
total cash consideration paid by existing stockholders will decrease to
25.5%.
(2) Includes 553,726 shares of Common Stock issuable in connection with the
Conversion.
(3) Does not include (i) 300,000 shares of Common Stock issuable upon exercise
of the Underwriters' over-allotment option, (ii) 200,000 shares of Common
Stock issuable upon exercise of the Representative's Warrants, at an
exercise price equal to $9.00 per share (iii) 320,000 shares of Common Stock
issuable upon exercise of the Bridge Warrants, at an exercise price of $3.00
per share; (iv) 209,520 shares of Common Stock issuable upon the exercise of
the 1996 Warrants at an exercise price of $8.46 per share, (v) 38,852 shares
of Common Stock issuable upon the exercise of the Hampshire Warrant at an
exercise price of $9.44 per share, (vi) 190,714 shares of Common Stock
issuable upon the exercise of the 1995 Warrants at an exercise of $4.90 per
share, (vii) 200,000 shares of Common Stock reserved for issuance under the
1997 Plan, (viii) 178,929 shares of Common Stock reserved for issuance under
the 1995 Plan, of which options to purchase 144,000 shares of Common Stock
are outstanding,
17
including options to purchase 111,000 shares of Common Stock exercisable at
$0.10 per share, options to purchase 22,600 shares of Common Stock
exercisable at $1.38 per share, and options to purchase 10,400 shares of
Common Stock exercisable at $4.90 per share granted to certain of the
Company's employees and executive officers, and (ix) 513,200 shares of
Common Stock issuable upon the exercise of options granted to a director and
certain executive officers of the Company outside the Plans, including
options to purchase 14,000 shares of Common Stock exercisable at $0.10 per
share, options to purchase 229,200 shares of Common Stock exercisable at
$1.38 per share, and options to purchase 270,000 shares of Common Stock
exercisable at $3.00 per share. The exercise of any such options and
warrants may have a dilutive effect upon investors in the Offering. See
"Management--Stock Option Plans," "Certain Relationships and Related
Transactions," and "Description of Securities."
18
CAPITALIZATION
The following table sets forth the short term debt and capitalization of the
Company (i) as of June 30, 1997, (ii) as of June 30, 1997 on a pro forma basis
reflecting the issuance of $2,000,000 aggregate principal amount of Bridge Notes
and (iii) on a pro forma as adjusted basis to reflect (a) the sale of 2,000,000
shares of Common Stock by the Company offered hereby at an assumed initial
public offering price of $7.50 per share and the application of the estimated
net proceeds therefrom and (b) the Conversion. See "Use of Proceeds." This table
should be read in conjunction with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the financial statements of
the Company and notes thereto appearing elsewhere in this Prospectus.
JUNE 30, 1997
--------------------------------------------
PRO FORMA
ACTUAL PRO FORMA(1) AS ADJUSTED(2)
------------- ------------- --------------
Short term debt (pro forma net of debt discount), including capital
lease obligations................................................. $ 3,502 $ 563,502 $ --
------------- ------------- --------------
------------- ------------- --------------
Long term notes payable and capital lease obligations............... 3,019,009 3,019,009 --
Preferred stock, $0.01 par value, 3,553,736 shares authorized,
including 390,344 Series A shares authorized and 163,392 Series B
shares authorized; 390,344 Series A shares issued and outstanding
actual and 163,392 Series B shares issued and outstanding actual;
no shares issued and outstanding pro forma and as adjusted........ 2,885,221 -- --
Stockholders equity:
Common stock, $0.001 par value, 15,000,000 shares authorized;
1,836,476 shares issued and 1,819,113 shares outstanding actual;
2,390,202 shares issued and 2,052,839 shares outstanding, pro
forma; and 4,390,202 shares issued and 4,052,839 shares
outstanding, pro forma as adjusted.............................. 1,836 2,390 4,390
Additional paid-in capital.......................................... 4,682,883 9,007,550 21,647,950
Treasury stock, at cost............................................. (67,500) (227,500) (227,500)
Accumulated deficit................................................. (9,622,180) (9,622,180) (10,582,180)
------------- ------------- --------------
Total stockholders' equity (deficit)............................ (5,004,961) (839,740) 10,842,660
------------- ------------- --------------
Total capitalization............................................ $ (1,982,450) $ 2,742,771 $ 10,842,660
------------- ------------- --------------
------------- ------------- --------------
- ------------------------
(1) Pro forma to give effect to (i) the Conversion and (ii) the issuance in
August 1997 of $2,000,000 aggregate principal amount of the Bridge Notes in
the Bridge Financing, debt discount of $1,440,000 related to 320,000 Bridge
Warrants issued at an exercise price below the assumed initial public
offering price of $7.50 per share, and the application of the net proceeds
therefrom to reacquire 240,000 shares of Common Stock from a former officer
and 80,000 shares of Common Stock from a director of the Company for
aggregate consideration of $160,000 ($0.50 per share). See "Certain
Relationships and Related Transactions" and Note 16 to Notes to Financial
Statements.
(2) Adjusted to give effect to the sale by the Company of the 2,000,000 Shares
offered hereby at an assumed initial public offering price of $7.50 per
share and the application of the estimated net proceeds therefrom to repay
all outstanding indebtedness which will give rise to a loss on early
extinguishment of approximately $960,000 related to unamortized debt
discount. See "Use of Proceeds" and Note 16 to Notes to Financial
Statements.
19
SELECTED FINANCIAL DATA
The following table sets forth selected financial data concerning the
Company and is qualified in its entirety by the more detailed information and
financial statements, including the notes thereto, included herein. The selected
financial data as of December 31, 1995 and 1996 and for each of the years then
ended are derived from the financial statements of the Company, which financial
statements have been audited by Coopers & Lybrand L.L.P., independent
accountants. The selected financial data presented below as of June 30, 1996 and
1997 and for each of the six month periods then ended are derived from unaudited
financial statements. The unaudited financial statements include all
adjustments, consisting of normal recurring accruals, which the Company
considers necessary for a fair presentation of the financial position and the
results of operations for these periods, applied on a basis consistent with the
audited financial statements. Operating results for the six months ended June
30, 1997 are not necessarily indicative of the results that may be expected for
the entire year ending December 31, 1997. The financial statements as of
December 31, 1996 and for each of the years in the two-year period ended
December 31, 1996, and the report of Coopers & Lybrand L.L.P. thereon, are
included elsewhere in this Prospectus.
YEAR ENDED SIX MONTHS
DECEMBER 31, ENDED JUNE 30,
-------------------- --------------------
1995 1996 1996 1997
--------- --------- --------- ---------
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Revenues................................................................ $ 7,703 $ 2,530 $ 1,300 $ 1,255
Costs of revenues....................................................... 4,609 3,513 1,252 1,170
--------- --------- --------- ---------
Gross margin (loss)..................................................... 3,094 (983) 48 85
Operating expenses...................................................... 3,045 4,491 1,787 3,778
Income (loss) from operations........................................... 50 (5,474) (1,739) (3,693)
--------- --------- --------- ---------
Net income (loss)....................................................... $ 10 $ (5,512) $ (1,784) $ (3,825)
--------- --------- --------- ---------
--------- --------- --------- ---------
Net income (loss) per share............................................. $ 0.01 $ (2.75) $ (1.01) $ (1.61)
--------- --------- --------- ---------
--------- --------- --------- ---------
BALANCE SHEET DATA:
Working capital (deficit)............................................... $ 2,527 $ 2,105 $ 829 $ (167)
Total assets............................................................ 5,800 5,650 4,900 4,531
Total debt.............................................................. 1,070 3,027 640 3,023
Redeemable, convertible preferred stock................................. 2,468 2,746 2,537 2,885
Stockholders' equity (deficit).......................................... (260) (2,582) (1,624) (5,005)
20
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the financial
statements and notes thereto and other financial information appearing elsewhere
in this Prospectus. Statements in this Management's Discussion and Analysis of
Financial Condition and Results of Operations and elsewhere in this Prospectus
that are not statements of historical or current fact constitute
"forward-looking statements." Such forward-looking statements involve known and
unknown risks, uncertainties, and other factors including those set forth under
"Risk Factors" that could cause the actual results of the Company to be
materially different from the historical results or from any future results
expressed or implied by such forward-looking statements. In addition to
statements which explicitly describe such risks and uncertainties, prospective
investors are urged to consider statements labeled with the terms "believes,"
"belief," "expects," "intends," "anticipates," or "plans" to be uncertain and
forward-looking.
OVERVIEW
Sales of interactive video products accounted for approximately 28.4% and
60.2% of revenues for the year ended December 31, 1996 and the six months ended
June 30, 1997, respectively. Although sales of CD-ROM products accounted for
most of the Company's revenues in 1996, the Company has focused most of its
sales, marketing, and research and development efforts in 1997 on its
interactive video products and intends to continue to focus primarily on such
segment in the future.
Commencing August 1996, in connection with a change of management, and until
approximately January 1997, when Kenneth D. Van Meter, the Company's current
Chief Executive Officer, began his employment with the Company, the Company
ceased substantially all of its sales efforts to permit new management to
formulate a new business plan. Accordingly, the period-to-period comparison set
forth below may not be meaningful and may not necessarily be indicative of the
results that may be expected for future periods.
Currently, the principal markets for the Company's interactive video
products are Korea, Israel, Taiwan, and China. The Company has three customers
that represented in excess of 75% of the Company's revenues for the six months
ended June 30, 1997, seven customers that represented in excess of 50% of the
Company's revenues for the year ended December 31, 1996, and four customers that
represented in excess of 90% of the Company's revenues for the year ended
December 31, 1995.
RESULTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 1997 COMPARED TO SIX MONTHS ENDED JUNE 30, 1996
REVENUES. Revenues for the six months ended June 30, 1997 were
approximately $1,254,500 compared to $1,299,900 for the same period in 1996.
Revenues from interactive video products were approximately $755,900 for the six
months ended June 30, 1997 as compared to $461,400 for the same period in 1996.
The increase in revenues from interactive video products reflects $560,000 of
revenue recognized under a design contract with En K in 1997. See "Risk
Factors--Risks Associated with Contracts with En Kay Telecom Co., Ltd." Revenues
for the same period in 1996 related to progress on the Company's two existing
long term interactive video contracts. Revenues from CD-ROM products were
$498,600 for the six months ended June 30, 1997 as compared to $838,500 for the
same period in 1996. The decrease was primarily due to the Company's focus on
Mediator and CD Workware sales rather than on the VCD Manager and Writer
products. The CD Workware products generate larger revenues than the Company's
other CD-ROM products but have a longer sales cycle. The Mediator product's main
customer is the U.S. Navy and it requested certain additional specifications
which the Company did not anticipate. Accordingly, most U.S. Navy sales were
deferred until late 1997.
21
COST OF REVENUES. Costs of revenues for the six months ended June 30, 1997
were approximately $1,170,000, or 93% of revenues, as compared to approximately
$1,251,700, or 96% of revenues, in the same period in 1996 principally due to
higher labor costs for the first half of 1997, which were offset by lower direct
material costs. As a result of the above factors, the Company recorded a gross
margin of $85,000 in the first half of 1997, compared to a gross margin of
$48,000 in the first half of 1996.
OPERATING EXPENSES. Operating expenses for the six months ended June 30,
1997 were approximately $3,777,900 as compared to approximately $1,786,600 for
the same period in 1996. The increase was primarily due to non-cash compensation
expense of approximately $1,541,000 related to the issuance of options in April,
June, and July 1997 substantially below the anticipated initial public offering
price. In addition, the Company incurred costs totaling approximately $262,000
associated with hiring personnel during the six months ended June 30, 1997
including professional consultants and contract labor to assist in the Company's
operations. Depreciation and amortization for the first six months of 1997
increased by approximately $130,000 as compared to the same period in 1996. The
remaining increase in operating expenses related to incidental expenses incurred
related to the additional personnel, such as employee benefits, rent, and
supplies.
NET LOSS. As a result of the above factors, net loss for the six months
ended June 30, 1997 was $3,825,115 as compared to a net loss of $1,783,600 for
the same period in 1996. The Company expects to incur additional net losses
during the second half of 1997 as a result of certain non-cash expenses as well
as increased expenses associated with hiring additional personnel.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
REVENUES. Revenues for the year ended December 31, 1996 were approximately
$2,530,100 as compared to approximately $7,703,400 for the same period in 1995.
Revenues from interactive video products were $720,700 for the year ended
December 31, 1996 as compared to $4,800,000 in 1995. The decrease in revenues
from interactive video products was primarily due to the Company's inability to
complete its existing projects in Korea and Israel. The Company's focus on these
two existing projects limited the Company's ability to pursue new business.
Revenues from CD-ROM products were approximately $1,809,400 for the year ended
December 31, 1996 as compared to approximately $2,900,000 for the same period in
1995. The decrease was primarily due to a reduced focus on selling VCD Manager
related products. The Company analyzed the market and decided to use more of its
resources in selling its Mediator and CD Workware products since the VCD Manager
products were encountering increased competition and lower margins. As a result
of the change in the Company's sales focus, sales to potential customers were
slower. The Mediator product's largest customer is the U.S. Navy. The division
of the U.S. Navy responsible for the majority of the U.S. Navy's purchases
lacked federal funding, and changed its required specifications of the product.
The effort required to meet specifications to the product added to the decreased
revenues in the latter part of 1996.
COSTS OF REVENUES. Costs of revenues for the year ended December 31, 1996
were approximately $3,513,000 as compared to approximately $4,609,200 for the
same period in 1995. The majority of the decrease was attributable to a decrease
in costs of materials offset in part by an increase in labor costs associated
with the completion of long term contracts. As a result of the matters discussed
above, the Company's gross margin decreased from approximately $3,094,100 in
1995 to a loss of approximately $982,900 in 1996.
OPERATING EXPENSES. Operating expenses for the year ended December 31, 1996
were approximately $4,491,400 as compared to $3,044,600 for the same period in
1995. The increase was primarily due to reserves established for accounts
receivable, an increase in depreciation expense, and a severance package for one
of the former officers of the Company, which in the aggregate accounted for
approximately $850,000 of such costs. The remaining increases in 1996 as
compared to 1995 related to direct salaries and
22
incidental expenses associated with the hiring of additional personnel, such as
employee benefits, rent, and supplies.
NET INCOME (LOSS). As a result of the above factors, net loss for the year
ended December 31, 1996 was $(5,512,000) as compared to net income of $10,000
for the same period in 1995.
LIQUIDITY AND CAPITAL RESOURCES
The primary source of financing for the Company since its inception has been
through the issuance of common and preferred stocks and debt to accredited
investors, some of which are customers or principals of the Company's customers.
One of the Company's founders funded the initial operations through equity
infusions totaling $155,000 in 1993. In 1994, the founder loaned the Company an
additional $75,000 which, together with $12,784 in accrued interest, was
converted to 17,915 shares of Common Stock on December 31, 1995. During 1995,
the Company received net proceeds in the aggregate amount of $3,252,619 through
the issuance for approximately $1,517,500 of 390,334 shares of Series A
Preferred Stock and warrants to purchase 163,392 shares of Series B Preferred
Stock (the "Series B Warrants"). During 1995, the Company also received
approximately $800,600 of net proceeds from the exercise of the Series B
Warrants and $934,500 of net proceeds from the sale of convertible notes and
warrants. During year 1996, the Company received net proceeds of approximately
$5,404,300 through a private placement of units consisting of Common Stock,
notes, and warrants. Also in 1996, the Company converted the debt issued in
1995, to Common Stock at a rate of $4.90 per share. In August 1997, the Company
received net proceeds of approximately $1,700,000 through a private placement of
$2,000,000 principal amount of Bridge Notes and Bridge Warrants. In connection
with such private placement the Company repurchased 240,000 shares of Common
Stock from a former officer and 80,000 shares of Common Stock from a director of
the Company for aggregate consideration of $160,000 ($0.50 per share).
Additionally, the Company entered into certain capital leases for various office
equipment. The outstanding principal balance under capital lease obligations at
June 30, 1997 amounted to approximately $25,000, all of which is guaranteed by a
former officer and is to be extinguished using a portion of the net proceeds of
the Offering.
At June 30, 1997, the Company had cash and cash equivalents totaling
approximately $461,300 and a net working capital deficit of approximately
$(167,000). The Company had no significant capital spending or purchase
commitments at June 30, 1997 other than certain facility leases and inventory
component purchase commitments required in the ordinary course of its business.
The Company has no existing lines of credit or other financing arrangements
with lending institutions.
The Company anticipates that the net proceeds of the Offering, together with
its existing working capital and anticipated funds generated from operations,
will be sufficient to satisfy its operating and capital requirements for the
next 18 months.
23
BUSINESS
GENERAL
The Company designs, develops, integrates, installs, operates, and supports
interactive video services hardware and software. The Company also designs,
develops, installs, and supports CD-ROM software products for business
applications. In the interactive video services area, the Company seeks to
provide solutions, including products and services developed by the Company and
by strategic partners, that enable interactive video programming and
applications to be provided to a wide variety of market niches. The Company has
installed 11 digital video servers in four countries (China, Korea, Israel, and
Taiwan), on each of the four major types of networks accommodating interactive
video services. The Company believes that its demonstrated ability to deploy and
operate interactive video systems over each of these four major network types is
a significant competitive advantage.
In the CD-ROM area, the Company provides several products for the storage
and rapid retrieval of large amounts of information. The Company believes such
products are faster, easier to use, provide more features and are operational on
more diverse network architectures than similar products and services. The
Company's CD-ROM customers include the U.S. Navy, Sprint Corp., Unisys Corp.,
Toronto Dominion Bank, and Herzog, Heine & Geduld, Inc. In December 1995, two of
the Company's products, VCD MANAGER and VCD WRITER were each chosen as IMAGING
MAGAZINE's Product of the Year in their respective product groups for CD-ROM
software. IMAGING MAGAZINE is a leading industry publication for CD-ROM business
software.
INTERACTIVE VIDEO SERVICES SEGMENT
INDUSTRY OVERVIEW
LINEAR TELEVISION AND VCR TECHNOLOGY. Until about 25 years ago,
audio-visual home entertainment choices were primarily limited to linear content
(i.e., content that plays in a pre-programmed sequence and which cannot be
controlled by the viewer). In the 1970s, the growing popularity of videocassette
recorders (VCRs) and videocassette tapes provided new choices to home viewing
audiences. VCR and videocassette technology provides viewers with the ability to
view content on demand and to manage content through the use of pause, resume,
fast-forward, rewind, and other features. VCR use, however, entails the
inconvenience of leaving the home to purchase or rent videocassettes or choosing
from among the limited content available for recording on television. Many video
stores have only a limited selection of titles, particularly in areas such as
educational content and games, and the most sought after titles are frequently
unavailable. The proliferation of cable television, satellite television,
pay-per-view, and similar technologies has improved linear television choices,
but these technologies do not offer the ability to select content to be viewed
on demand, rather than on a scheduled basis.
TELECOMMUNICATIONS COMPANIES AND BROADBAND INTERACTIVE SERVICES. In the
early 1990s, large telephone and cable companies and other interested parties,
such as television and motion picture studios, began to experiment with the idea
of providing broadband interactive services. Broadband services are those which
run over high capacity networks such as asynchronous digital subscriber lines
(ADSL), high-speed data lines (T1 and E1), hybrid fiber coaxial (HFC) lines, and
fiber to the curb (FTTC) fiber optic lines. These high-capacity networks, made
possible by breakthroughs in the ability to convert information from analog to
digital form and by improved data compression technologies, have the ability to
deliver vast quantities of data into the home. Broadband networks also have the
capacity to provide for interactivity between the home and the content
providers. Industry sources anticipate that, if broadband networks become widely
deployed, they will usher in a new age of information technology due to the
potential quantity and robustness of content, and the speed, ease of use, and
interactivity of these networks.
Following changes in the regulation of the telecommunications industry in
1992, it was anticipated that the large domestic telephone and cable companies,
and their counterparts abroad, would seek to
24
deploy broadband networks and interactive services in communities on a
widespread basis. The Regional Bell Operating Companies (RBOCs), for example,
successfully sought relief in the courts to be permitted to become not only
network providers for such services, but content providers as well. Further
regulatory changes in 1995 and 1996 reduced the potential cost of deploying
broadband networks. A number of interactive video trials were run by U.S.
companies such as Time Warner, Tele-Communications, Inc. ("TCI"), GTE, Bell
Atlantic Corporation, and BellSouth Corporation, which demonstrated that the
technology did work, although in varying degrees. International
telecommunications companies, including Telecom Italia, Korea Telecom, Hong Kong
Telecom, Deutsche Telekom, and British Telecom, demonstrated similar results
abroad. These trials were generally costly, in part because they were
characterized by "trial approaches," including development and testing of
prototype versions of equipment and alpha and beta versions of newly developed
software, and experiments in pricing, content, menus, navigation and
methodologies. Further, these trials occurred during a period of rapid
technological change and improvement, and evolving standards. For example, ADSL
equipment which now typically costs a few hundred dollars per home typically
cost a few thousand dollars per home in 1992.
In 1996 and 1997, activity in the broadband services area has been
significantly reduced, and some companies, such as Bell Atlantic and TCI, have
announced reductions or delays in their deployment plans. Reasons given for such
reduction or delays include a change of focus toward local and long distance
competition, the high cost of deploying large broadband networks, business
reorganizations, delays pending the introduction of lower cost, more functional
or industry standard technology, and reduced competitive threats from within the
industry.
NARROWBAND INTERACTIVE SERVICES. Beginning in the 1980s, the proliferation
of home computers and the development of the Internet and Internet service
providers, such as America Online, Prodigy, and CompuServe, has allowed millions
of people to access interactive content and services over telephone lines.
Internet content has become increasingly rich, robust, and interesting. Industry
sources estimate that United States consumers spent more than $620 million for
Internet access in 1996 and project that such expenditures will grow to more
than $15 billion in 2001 and that the number of Internet households will grow
from an estimated 23.4 million in 1996 to 66.6 million by 2000. The Internet has
begun to condition consumers, and younger consumers in particular, to obtaining
information, experiencing content, playing games, and shopping in an interactive
fashion. However, telephony-based services such as the Internet, which are
generically referred to as narrowband services, have constraints on the quantity
of information that can be delivered and are currently unable to download large
files, such as full-length videos, at a satisfactory quality or speed. Computers
tend to be relatively expensive, compared to television sets, and computer
monitors and display technologies are not optimized for viewing video content.
Furthermore, although most people are comfortable with television as a medium,
many people, especially older consumers, lack experience with computers and may
be uncomfortable with, or are averse to, computer technology.
Different companies have employed different strategies to address the
shortcomings of narrowband networks in the absence of generally available
broadband networks. For example, WebTV (recently purchased by Microsoft) has
begun offering enhanced graphics and other features over narrowband networks,
with a television, rather than a PC, interface. In order to address the need for
higher-speed services, the cable industry has begun deploying cable modems, and
the telephone industry has begun deploying ADSL equipment, for high-speed data
access, so that the narrowband services can run at the highest possible speed on
metallic telephone or cable lines. For example, @Home Network is deploying as a
high speed internet service provider (ISP) on several cable companies' networks.
The Company believes that, despite these and other initiatives, narrowband
networks are unlikely to achieve the combination of technological accessibility
and speed, security, and robustness of transmission characteristic of broadband
systems. The public access methodology of Internet and other narrowband
networks, coupled with off-the-shelf modems, make security, both for privacy of
communications and secure commercial transactions, difficult to achieve. The
hardware and software of interactive broadband
25
systems and the architecture of such networks creates a more secure environment
for such transactions. In addition, although better software, compression
methods, and other tools have enabled improvements in narrowband services, the
physical constraints of narrowband networks are substantial, compared to those
of broadband networks. Many narrowband lines, especially older lines in cities
(a preferred market segment) cannot run at 56 kilobits per second (kbps), the
highest widely-available PC modem rates. This rate does not compare to the 1.5
Megabits to 25 Megabits per second rates provided via broadband networks.
THE COMPANY'S BROADBAND INTERACTIVE VIDEO SERVICES. The Company believes
that the increase in linear viewing alternatives such as DBS have increased
consumer demand for more content choices and that the development of the
Internet has increased consumer interest in interactive content generally. The
Company believes that the inherent limitations of the Internet and other
narrowband networks, as compared with broadband networks, create a market
opportunity for a broadband technology such as the Company's that offers
superior speed and robustness, combined with a "user-friendly," television-based
technology. See "User Experience." In addition, the lack of major deployments by
the RBOCs and other major U.S. telecommunications companies in the broadband
network market has, the Company believes, kept many large companies from
actively pursuing plans to supply hardware and software for broadband networks,
thus enhancing the niche market opportunities for the Company. Even if major
domestic telecommunications companies were to currently undertake such
initiatives, it would take a substantial number of years and a massive capital
commitment to deploy large-scale broadband networks. The Company also believes
that advances in servers, set top boxes, and network equipment enable operators
of small-scale broadband networks to now offer interactive video services to
their subscribers at attractive prices. See "Potential Markets -- Marketing
Strategy."
BASIC INTERACTIVE SERVICES CONFIGURATION
An interactive video services network system typically includes the
following components: (i) network equipment, including high speed lines and
switches, for transmission of content; (ii) digital set top boxes, which receive
the content and transmit subscriber requests; (iii) digital video servers, which
store the content and control its transmission over the network; (iv) content
preparation equipment, which prepares content for transmission over the network;
and (v) software which runs user applications, and business support
applications, such as subscriber billing. See "Products."
NETWORK EQUIPMENT
High-speed lines (ADSL, T1/E1, HFC, FTTC) connect the network service
provider's central office or head end to subscribers' homes. High-speed network
switching equipment connects subscribers to content furnished by video
information providers (VIPs), either locally or internationally. There are a
large number of providers of this network equipment, including CF Alcatel,
BroadBand Technologies, Incorporated, Ericsson, Integrated Network Corporation,
Lucent Technologies, Scientific-Atlanta, Inc., and Siemens Communications.
DIGITAL SET TOP BOXES
In each subscriber's home, one or more digital set top boxes and remote
control devices are associated with each television set or personal computer
that receives the interactive video programming. Digital set top boxes feature
high-speed processors, RAM memory, high- and low-speed output ports and other
computer components.
DIGITAL VIDEO SERVERS
The digital video server is a high-speed computer to which a subscriber is
connected via the network. The basic functions of a digital video server are to
cost-effectively (i) store and rapidly retrieve and
26
transmit large amounts of content, (ii) provide a large number of input/output
ports so that subscribers can access the system quickly and easily retrieve
information, (iii) function with an operating software system to manage user
applications, and (iv) provide business support systems capability to accumulate
and provide data for services such as billing, customer service, and content
management.
CONTENT PREPARATION EQUIPMENT
In order to store content in a digital server, send it over a broadband
network, and interpret the content through a digital set top box, the content
must be encoded (or converted from analog to digital format) and compressed.
Compression standards, primarily Motion Pictures Experts Group 1 and 2 (MPEG 1
and MPEG 2), have been adopted for the preparation and storage of this content.
APPLICATIONS AND BUSINESS SUPPORT SOFTWARE
Operators of interactive video systems require two kinds of software in
addition to the operating system software for servers and set top boxes.
Interactive applications software is designed to offer services, such as
shopping, travel, banking, education, medicine, video-on-demand, karaoke, and
digital music. Business support system (BSS) software includes applications such
as customer service, billing, telemarketing, content management, content
provider management, workforce management, and similar functions. Applications
and BSS software are available from a number of companies, including Arrowsmith,
EDS, IMAKE, Informix, and Strategic Group, and the Company anticipates that the
availability of applications software, in particular, will increase as broadband
networks proliferate.
PRODUCTS
The Company's products for the interactive video services market consist of
products that the Company develops and manufactures and products manufactured by
others that the Company resells and integrates into its systems.
PRODUCTS MANUFACTURED BY THE COMPANY
VIDEO SERVERS. The Company manufactures two different digital video
servers: (i) a server designed to be used with networks utilizing metallic
lines, such as ADSL, E1 and T1, which is currently deployed in Korea and Israel;
and (ii) an asynchronous transfer mode (ATM) based server designed to be used
for FTTC and HFC networks, which is currently deployed in Taiwan and China. The
Company is also developing an analog baseband output digital server, designed to
be used with cable pay-per-view and analog hospitality systems. The ATM-based
server includes improvements in cost per stream, capacity, and operating speed
over previous models and is designed to simplify connections to current networks
and provide valuable new features, including variable bit rate, data stream
grooming, data flow improvement, and higher bandwidth. The servers are all
scalable, enabling them to be used in small to large-scale deployments. For
large-scale deployments, the servers can be deployed in nodes which can include
one or more servers.
The Company has developed its own digital server operating system, known as
Multimedia Interactive eXchange (MIX). MIX is a compact, fully-featured
comprehensive proprietary operating system that interfaces with standard
software and manages all aspects of the digital server's operations. MIX
interfaces easily with industry standard billing systems and other business
support systems. MIX software is capable of operating on other companies'
servers, and the Company may license MIX to third parties if the opportunity
arises and if the Company determines that it would be strategically
advantageous. The Company has also developed middleware called NAV RT, which
simplifies the creation of basic applications and menus for interactive video
services. As a customer inducement, the Company, unlike many of its competitors,
includes the server license for MIX and NAV RT at no additional charge with each
digital video server sold.
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DIGITAL SET TOP BOXES. The Company manufactures trial quantities of digital
set top boxes, which it sold to Bezeq Telecom ("Bezeq") for use in Israel. The
Company is also developing a set top box for use with the Company's ATM-based
server, which is designed to be manufactured by a third party. The Company
expects to continue to design and develop set top boxes, which may be
manufactured by the Company in trial quantities or manufactured by volume set
top box manufacturers under license from the Company. The Company's set top
boxes are designed to operate efficiently on the Company's proprietary systems
or on systems utilizing DAVID, a set of widely-used operating system protocols
for digital set top boxes. Features include a serial output port for peripherals
and a graphics support package. More advanced designs under development include
Universal Serial Bus (a new hardware feature which allows computer and set top
boxes to connect with a variety of peripheral devices), three dimensional
graphics display, and a faster processor. The Company also believes that certain
features of its current set top box architecture may have potential value for
applications such as energy management and home security monitoring.
PRODUCTS MANUFACTURED AND DEVELOPED BY OTHERS
Certain of the products manufactured and developed by others described below
are provided pursuant to strategic alliances. See "Strategic Alliances."
NETWORK EQUIPMENT. The Company has an informal strategic arrangement with
Integrated Network Corporation ("INC") to sell INC's network equipment as part
of overall bids for end-to-end interactive video systems. The Company intends to
enter into similar arrangements with other network equipment companies. The
Company also has a preferred technology arrangement with Fore Systems, Inc.
("Fore
Systems"), a leading manufacturer of ATM switches, which has enabled the Company
to utilize Fore System's technology and to incorporate Fore Systems switches
with the Company's ATM-based servers, such as those deployed in China and
Taiwan. The Company believes that this arrangement has the potential to provide
additional joint marketing opportunities.
DIGITAL SET TOP BOXES. Although the Company manufactures trial quantities
of digital set top boxes, the Company is seeking to enter into joint marketing
arrangements with high volume manufacturers of digital set top boxes, pursuant
to which the Company would sell these set top boxes as a distributor or on an
original equipment manufacturer basis.
OTHER EQUIPMENT. Interactive video services systems also utilize components
such as digital encoders, digital production studio equipment, digital
production software, and other equipment. The Company has entered into certain
arrangements with respect to the resale by the Company of digital encoders and
digital production studio equipment and is seeking to enter into additional
arrangements with sellers of these kinds of equipment, with a view toward
enabling the Company to offer a complete end-to-end system to potential
customers on a fully integrated basis.
OTHER SOFTWARE. The Company provides a basic video-on-demand application at
no cost as part of its server software; however, most system operators will
require a suite of applications upon installation of the system, with the
potential for adding additional applications in the future. The Company has
entered into certain arrangements to provide interactive video applications
software and is seeking to enter into additional arrangements to provide
interactive video applications software and business support systems software to
the Company's customers.
SERVICES
Celerity plans to act as an overall systems integrator for interactive video
projects, which may entail integrating the end-to-end system in Celerity's
facility prior to shipment, on-site integration, or both. The scope of work
required for integration will vary widely, depending upon project size and other
variables.
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Celerity also offers a number of additional services, including classroom
training, documentation, and maintenance.
USER EXPERIENCE
Current subscribers to interactive video services enjoy a broad range of new
content and applications. Korea Telecom subscribers utilizing the Company's
technology are able to obtain movies and other video content, karaoke and
digital music, educational services, and medical information on demand. Content
available "on demand" is stored on a server and may be viewed by any subscriber
at any time chosen by the subscriber through the use of a navigation/menu
system.
The Company anticipates that applications will become more robust and
exciting in the future as new content, applications, and enhanced technical
capabilities become available. For example, travel reservations and information
could be a possible application of interactive video services. A subscriber
equipped with an ordinary television set, a digital set top box, and hand-held
remote control could select a travel company, which would be a VIP on the
system, from an on-screen menu. A typical application might show major
geographic areas, such as Asia, Europe, the United States, and the Caribbean. A
subscriber choosing Europe, for example, would be provided with a further choice
among European countries. Upon choosing a country, e.g., Spain, a subscriber
could be presented a choice among video, graphic, and data content relating to
that country, such as general interest videos and information relating to
packaged tours, airline options, and hotels. Similar applications are currently
available on narrowband services, such as the Internet; however, broadband
applications can accommodate lengthy videos and robust graphics, including
three-dimensional graphics, which cannot currently be as efficiently downloaded
or viewed via a narrowband network. The Company believes that broadband networks
could, in the future, also include applications with an electronic data
interchange (EDI) back end, which would allow the subscriber to ascertain the
availability of and confirm reservations for different products and services
such as hotel or car rental or airline tickets on a near real-time basis.
Customers would typically be billed a monthly fee for access to the
interactive services, a rental fee for the set top box, and additional fees for
the content and applications accessed, although it is anticipated that certain
VIPs would provide applications without a separate charge as a means of
increasing sales of products or services.
POTENTIAL MARKETS
The markets for interactive video systems may be categorized as public or
private networks. Public networks, such as those of telephone or cable companies
or utilities, are potentially available to all consumers within a given
geographical market. Private networks are those offered in a more limited area,
such as a hotel, hospital, college campus, or business complex.
MARKETING STRATEGY
The Company's marketing strategy is to seek customers in each of the
potential emerging markets, to encourage leading companies and organizations to
adopt its technology, and to position itself as a leading provider of
interactive video services within niche markets. The Company believes that it is
important to achieve market penetration at an early stage in the development of
particular niche markets in order to compete successfully in those markets. The
Company is marketing itself based on its demonstrated ability to install digital
video systems on each of the major network types and its potential to provide
end-to-end interactive video solutions. See "Deployments" and "Strategic
Alliances." In addition, the scalability of the Company's servers provides
flexibility in deploying interactive video services systems varying in size from
systems designed to serve five simultaneous users to those capable of serving
many thousands of users in a variety of markets on a cost-effective basis. The
Company believes that this scalability will be an attractive feature to
potential customers. The Company believes that its diversified marketing
approach provides the
29
Company with flexibility in targeting emerging markets, enabling it to recognize
market opportunities and adapt to perceived changes in marketing priorities. The
Company has limited sales and marketing experience and there can be no assurance
that it will be successful in implementing its marketing plans. See "Risk
Factors -- Limited Marketing and Sales Experience."
PUBLIC NETWORKS
Potential market opportunities for the Company in public networks are:
foreign telephone and cable companies, domestic electric and gas utilities,
domestic cable companies, and domestic telephone companies.
FOREIGN TELEPHONE AND CABLE COMPANIES. The Company's current customers are
all foreign telephone or cable companies. Foreign companies have been more
active in deploying interactive video services than domestic U.S. companies. The
Company believes that, in part, this is because, in many countries, the
telephone company is owned or supported directly by the government, which may
see the addition of such services, especially public-interest services, such as
education and health-oriented services, as being beneficial to its citizens.
Because of a lack of name recognition and because the Company has lacked its own
direct sales force, the Company has been limited to responding to customer bids
and has made only limited sales in this market, which is large and rapidly
growing. Potential markets are emerging in Europe, Latin America, Canada, and
Africa, in addition to existing and emerging markets in Asia. See "Deployments."
The Company intends to hire a direct sales force and to enter into additional
strategic alliances to target these markets.
DOMESTIC ELECTRIC AND GAS UTILITIES. Domestic electric and gas utilities
are now being deregulated and are subject to intense competitive pressures and
the need to find new sources of revenue. Many electric and gas utilities have
installed or are considering installing fiber optic lines in communities for
remote meter-reading and equipment monitoring purposes. These lines could be
used to provide a full menu of video services. Electric and gas utilities are
not currently regulated in the same manner as cable and telephone companies,
typically have long standing relationships with subscribers, and often have pole
and buried cable rights-of-way which could give them a competitive advantage
over other potential entrants into the interactive video services market.
Electric utilities may also see the provision of additional services as a means
of protecting key customers, such as hospitals, from incursion by other electric
utilities outside their operating territory that can now sell to these customers
under the operating principles of the North American Power Grid System. A number
of electric utilities in the United States and in Canada have expressed an
interest in such deployments.
DOMESTIC TELEPHONE COMPANIES. The Company intends to market to independent
domestic telephone companies, of which there are more than 1,300. Major
independent local telephone companies include Sprint Corp., Buena Vista Tel,
Southern New England Telephone, and Cincinnati Bell Inc. The Company believes
that the size of local telephone company networks is well suited to the
Company's scalable, cost-efficient technology solutions. Many of these local
telephone companies, as well as long-distance carriers that are installing local
telephone networks, have installed or are planning to install modern fiber optic
networks and may be seeking new revenue opportunities to offset the costs of
installation. The Company also believes that many independent telephone
companies may have more flexible management styles than the larger
telecommunication companies, and may be quicker to commit to strategic
decisions, such as providing interactive video services to their customers. The
Company is not targeting the large local telephone companies (GTE and the
RBOCs), since it believes that, if these companies choose to enter the
interactive video services market, they will likely pursue these markets
independently or through joint ventures (such as Tele-TV and Americast).
DOMESTIC CABLE COMPANIES. The Company believes that an opportunity exists
for the smaller, well-funded cable companies, such as Cox Enterprises Inc., to
begin implementing interactive TV as they upgrade their networks from coaxial
cable to HFC, which is often the solution of choice for cable
30
companies that wish to improve the quality of their service and add additional
channels. With the entrance of competitors such as DBS, cable companies are
upgrading to HFC to provide a competitive number of channels at a higher
quality. An HFC network readily supports interactive video services, and these
services would represent an additional revenue opportunity for these cable
companies and help offset a portion of the upgrade costs. The Company is also
targeting the domestic cable market by developing a digital server that has an
analog baseband output digital server which converts digital signals to analog
signals for transmission over coaxial cable and reception through an analog set
top box. This server, which is expected to be introduced within the next three
to six months, is designed to replace the current VCR-based system as a
pay-per-view source for cable companies and for the analog hospitality market.
The Company is not currently targeting major domestic cable companies. Some of
these companies, for example, TCI, expressed an interest in the interactive
video services market initially, but have not begun widespread deployment,
possibly due to the cost of converting large, diverse cable systems, such as
TCI's hundreds of cable systems, from the current metal coaxial lines to HFC
lines.
PRIVATE NETWORKS
Many hotels and resorts, colleges and universities, large apartment and
condominium complexes and businesses have installed or are considering
installing private networks, utilizing ADSL, HFC, or FTTC. Private networks are
limited in geographic size and scope, but could potentially offer a range of
interactive video and data services to their customers, generally on a
for-profit basis. Private networks have the significant advantage of relatively
rapid and low-priced deployment, as compared with large-scale public networks,
and they are well-suited to the Company's scalable technology solutions.
ANALOG HOSPITALITY. Many hotels, motels, and resorts have already installed
pay-per-view video or television systems. These systems generally consist of
small local area networks with video stored on a number of VCR players connected
to a control system. There are a number of problems with these VCR-based
solutions: (i) the VCR equipment breaks frequently and repairs generally require
a site visit; (ii) the content is stored on conventional cassette tapes, which
are vulnerable to illegal copying and which results in certain first run movies
being released by studios to hotels substantially later than their theatrical
release; (iii) the capacity of the system is limited; (iv) video quality is
sometimes poor, especially after a tape has been played a number of times, since
these systems are often not cleaned or serviced on a regular basis; and (v)
video choices are limited, due to the size, complexity, and cost of the VCR
decks and controllers. The Company is developing and expects to introduce within
the next three to six months a new digital server that has an analog baseband
output, which is designed for this market and the cable pay-per-view market. See
"Public Networks--Domestic Cable Companies." This system is designed to be
relatively inexpensive and to store video content as digital files in the
server, potentially providing higher quality video, a greater selection, lower
cost, fewer security problems and easier maintenance compared to existing
pay-per-view systems. In addition, much of the maintenance could be performed
remotely from a centralized site. Content could be loaded using computer tape
(which is highly resistant to piracy) at the hotel, or could be downloaded from
a central location over telephone lines or an inexpensive satellite downlink.
This system is designed to be compatible with the existing analog equipment,
including inexpensive analog set top boxes, but might also provide a logical
migration path to digital services in the future.
DIGITAL HOSPITALITY. Some hotels, motels, and resorts are already
considering upgrading to a full digital interactive services solution. For
example, the Company is a finalist in the bidding for a digital hospitality
project in Kuala Lumpur, Malaysia. The Company anticipates that certain upscale
hospitality properties, in particular, will install digital systems during
construction or thereafter upgrade to digital systems. These digital systems
have the potential to offer on-demand video programming, games, gaming,
shopping, health, education, and other services, in addition to high quality
digital pay-per-view programming.
31
COLLEGES AND UNIVERSITIES. Many colleges, including the University of
Maryland, Rutgers, and George Mason University, have begun installing modern,
high-speed networks, usually FTTC, on their campuses. Interactive video services
provide an opportunity to add entertainment, educational, and information
services to these networks both as a source of revenue to help defray the cost
of network installation and for educational purposes. For example, popular
courses could be stored on a server for viewing by large audiences on a
fully-interactive basis, with the potential for interactive test-taking and
homework submissions. Such a system could also aid ill or physically handicapped
students, those who work part-time, and absentees.
MULTIPLE DWELLING UNITS (MDUS). Many large apartment complexes,
condominiums, neighborhoods, and other groups of homes, termed Multiple Dwelling
Units or MDUs, are now installing modern HFC, FTTC, or ADSL systems either
during construction or as an upgrade in order to attract or retain tenants or as
a source of revenue. The Company believes that certain types of MDUs, such as
retirement communities, represent particularly attractive potential markets,
since these networks might offer shopping, education, interactive health, and
entertainment services to the elderly or consumers who have limited mobility.
DIGITAL HOSPITALS. Many domestic and foreign hospitals are already wired
with state-of-the-art, high-speed digital networks (usually FTTC) which would be
suitable for interactive video services systems, although it is currently
unclear who would fund these systems. The Company is aware of at least one
project in which health care providers, such as pharmaceutical companies, have
expressed a willingness to underwrite some or all of the cost of content shown
on these systems in return for strategic positioning of advertising. The
Company's digital server and operating system technology could potentially
accommodate an architecture designed to allow patients to view advertisements
targeted to their condition, which could be attractive to advertisers. Another
potential source of funding is electric power utilities, which value hospitals
as high-demand consumers of electric power. At least one power company has
expressed preliminary interest in the idea of installing the Company's
interactive video system in a mid-sized or large hospital as part of a
multi-year power contract. Another potential source of funding for these systems
is the hospitals themselves. Interactive video systems may be password- and
ID-protected, so that the user is individually identified within the system. The
Company believes that systems could be designed to show patients targeted videos
containing medical information or instructions which they would then
electronically "sign" prior to being allowed to view entertainment services.
Such a system could be attractive to hospitals as a means of patient education
and to ensure that patients (or staff) have read and understood instructions and
other information, such as liability warnings.
BUSINESS CAMPUSES. The Company believes that broadband digital networks
represent a logical extension of intranets. Business applications, such as
training, data management, communications and public relations, could
potentially be accommodated on broadband digital networks. The availability of
such networks in a corporate campus could also be employed to attract companies
to a particular business complex. The Company believes that a relatively
inexpensive PC plug-in board could be used instead of a set top box to connect
PCs to a broadband network, while television sets and set top boxes could be
used in appropriate settings, such as corporate briefing and board rooms.
SALES AND MARKETING
The Company currently has only limited internal sales and marketing
personnel for its interactive video business. The Company is developing a
comprehensive sales and marketing plan and intends to recruit personnel to
establish a larger dedicated sales organization following the completion of the
Offering. The Company intends to market its products both directly and through
third parties, including its strategic partners (including companies that might
include the Company's products and services in integrated end-to-end interactive
video system bids), original equipment manufacturers, and agents.
32
The Company utilizes several agents, primarily internationally, where the
use of such agents is customary. These include Bescom, Inc. and TeleMedia
International, Inc. in Korea, Hanshine International, Ltd. in China, WarpDrive
Marketing PTE LTD in Singapore, Riger Corporation (M) SDN BHD in Malaysia, and
Tadiran Telecommunications Limited in Israel. The Company's current arrangements
with its agents are non-exclusive, except in the case of En K (which is
exclusive in Korea as to certain server models, subject to an exception for the
IVISION project) and Bescom (which is exclusive as to the IVISION project in
Korea). See "Deployments--Korea" and "Risk Factors--Risks Associated with
Contracts with En Kay Telecom, Inc." The Company expects to continue to enter
into arrangements with agents in the future, and some of these arrangements may
be exclusive. In the domestic hospitality market, the Company intends to market
its products to the five largest firms that supply such services to hotels and
motels, such as On Command Corporation. In some cases, however, the Company may
encounter opportunities to market its hospitality-targeted products directly,
especially outside the United States.
The Company also intends to utilize diverse marketing tools, such as
development of sales and marketing materials and brochures, trade show
participation, public relations efforts, speaking engagements, magazine
articles, and advertising in trade publications.
DEPLOYMENTS
The Company has installed 11 interactive digital video servers in four
countries, consisting of seven servers in Korea, two in Israel, and one each in
Taiwan, and China. Two additional servers are being manufactured and a third is
undergoing systems integration for installation in China. The Company has
deployed these servers on four different network technologies: (i) FTTC (China),
(ii) HFC (Taiwan), (iii) high-speed data lines (E1 or T1) (Israel), and (iv)
twisted pair networks using ADSL (Korea). The Company believes that it is the
only company to have implemented interactive video systems on all four network
types. Information concerning these deployments is set forth below.
KOREA
The Republic of Korea has embarked on a project to provide fully interactive
television ("ITV") services to many of its citizens and companies. The project
is being conducted by a consortium consisting of a government-sponsored research
institute (Electronics and Television Research Institute--ETRI), the national
telephone company (Korea Telecom), and a number of Korean companies (including
Samsung Group ("Samsung"), Hyundai Corporation, Lucky Goldstar International
Corp., Daewoo Corporation, and others). Several U.S. companies, including
Celerity, participate as sub-contractors. The two largest projects are designed
to provide ITV over telephone and cable lines. In 1994, the Company participated
in a pilot interactive video trial for Korea Telecom ("KT"). Other parties to
this trial included INC, which provided the switch and served as project
integrator, and Samsung, which provided the set-top boxes. As part of this
project, the Company received its first order to develop a 40-stream digital
video server and a proprietary digital set top box. The initial phase of this
project, called IVISION, led to an order for six additional digital video
servers of a more advanced design, which have been installed in Seoul, Pusan,
Taegu, Kwangju, Taejon, and Inchon. These systems have been in operation for
nearly two years. Over 2,000 subscribers are receiving services from these
systems, including video-on-demand, movies-on-demand, karaoke, medical
programming, and music. These services are provided over normal telephone lines
using ADSL, which allows rapid and inexpensive deployment without having to
install new lines.
Bescom, Inc. ("Bescom"), a New Jersey-based distributor with business ties
to the Korean market, assisted Celerity in securing the sale of digital video
servers in Korea. To date, Celerity has received approximately $3,780,000 from
Bescom pursuant to an oral distribution agreement; in addition, approximately
$467,000 is due following successful system acceptance testing in August 1997
and subsequent completion of a reliability period. There can be no assurance
that the system acceptance or reliability testing will be successfully
completed, or that the Company will receive payment from Bescom.
33
ISRAEL
In 1995, the Company received an order from Bezeq, the Israeli national
telephone company, through Tadiran Telecommunications Limited ("Tadiran"), a
major Israeli telecommunications equipment firm. The Company provided two
digital video servers and a quantity of digital set top boxes to Tadiran for
deployment on a European standard (E1) high-speed dedicated copper data line
network. Since late 1996, this project has offered services similar to those
described above to approximately 100 subscribers in Israel. Tadiran has agreed
to make total payments to the Company of approximately $1,044,000 upon the
achievement of certain milestones, of which approximately $770,000 has been paid
to date. Celerity is currently in discussions with Bezeq with respect to Phase
II of Bezeq's video server contract. There can be no assurance that Celerity
will be selected to participate in Phase II.
TAIWAN
In 1996, the Company received, from IBM Taiwan Corporation ("IBM Taiwan"),
its first order for its most advanced digital video server, an asynchronous
transfer mode ("ATM") server designed to operate on modern fiber optic networks.
The first server has been deployed in Taiwan for IBM Taiwan for use at the
Computer and Communications Research Laboratories/Industrial Technology Research
Institute ("Taiwan CCL"), under an arrangement with IBM Taiwan, the system
integrator. Under this arrangement Celerity is entitled to receive payments of
approximately $650,000 (of which approximately $400,000 has been paid to date
and the balance is to be paid upon the completion of a systems acceptance test).
This system has been operational since February 1997, serving approximately 50
subscribers. The final systems acceptance test was successfully performed. This
system is deployed on a hybrid fiber/coaxial cable network, of the type being
installed by many cable companies as they upgrade to higher capacity, higher
quality digital networks. This type of network, like FTTC (a widely used fiber
optic network), is able to support new applications, such as video conferencing,
video mail, robust three-dimensional graphics, and gaming.
CHINA
In 1997, the Company sold, through its strategic alliance with INC, two of
its advanced video servers to Guangdong Public Telecommunications Authority
("GPTA") for deployment in Shenzen and Guangxiaou, China. The Shenzen server is
installed and has passed its beta test, and the Guangxiaou server was completed
in May 1997 and is at INC's facility undergoing system integration for
anticipated shipment in August 1997. The aggregate value of this contract is
$1,400,000, of which approximately $570,000 has been received to date. In
addition, through INC, the Company has received an order to install two servers
for the Beijing Telecom Authority in late 1997. The aggregate sales price for
such order is $712,000. These are the Company's initial deployments on an FTTC
network, which is the primary type of network which telephone companies,
electric and gas utility companies, colleges, and many business and apartment
complexes are installing to replace aging twisted pair copper networks and to
potentially offer emerging digital video, data, and voice services.
34
STRATEGIC ALLIANCES
The Company believes that entering into strategic alliances may give it
certain competitive advantages, including the ability to (i) reach a larger and
more diverse group of networks on which to deploy the Company's products and
services; (ii) provide a broader range of products and services; (iii) provide a
series of new and upgraded products and services, such as encoders and
applications software, which could be attractive to customers seeking to
improve, upgrade or extend their systems over an extended period of time; (iv)
offer end-to-end solutions; (v) access resources and information for utilization
in research and product development and design; (vi) test new Company designs
for compatibility with emerging technology developed by others in order to
facilitate cooperative arrangements; and (vii) pursue cooperative efforts at
trade shows and other joint marketing efforts. See "Deployments" and "Risk
Factors--Risks Associated with Contracts with En Kay Telecom Co., Ltd."
The Company is actively seeking additional strategic alliances and has hired
a key executive as Vice President of Business Development to identify, obtain,
and manage these relationships. The Company is seeking additional alliances with
(i) network system providers for technical interconnection and joint marketing;
(ii) hardware manufacturers of real-time encoders, multiplexers, digital set top
boxes, and related equipment; (iii) content acquisition and management
companies; (iv) hospitality system vendors and distributors; (v) interactive
applications software developers; and (vi) business support systems software
developers.
The Company has commenced discussions as to certain of these relationships,
while others are part of the Company's strategic plan, but are not yet in
progress. No assurance can be given that the Company will be successful in
entering into such strategic alliances on acceptable terms or, if any such
strategic alliances are entered into, that the Company will realize the
anticipated benefits from such strategic alliances. See "Risk Factors--Need for
Strategic Alliances."
The Company has entered into strategic alliances with the following
companies:
INTEGRATED NETWORK CORPORATION does joint marketing with the Company related
to INC's network switching equipment. INC was directly responsible for the
Company's participation in projects with Guangdong PTA, Beijing Telecom
Authority, and Taiwan CCL, and acted as a subcontractor along with the Company
to Bescom in Korea. The Company has bids in progress with INC in Israel,
Malaysia, and Singapore, although there can be no assurance that any of such
bids will be accepted.
TADIRAN TELECOMMUNICATIONS LIMITED is a manufacturer and distributor of
telecommunications equipment in Israel and internationally. Tadiran is also the
agent for the Company's Israel project and is a distributor of the Company's
products.
FORE SYSTEMS is a leading manufacturer of ATM switches. The Company's
agreement with Fore Systems provides for joint marketing and technical
cooperation.
The Company also has strategic alliances with MINERVA SYSTEMS INC.
("Minerva"), a leading manufacturer of digital MPEG encoders, and COMMUNICATIONS
ENGINEERING, INC. ("CEI"), a leading provider of digital production studios,
although, to date, no sales have been made pursuant to these arrangements. The
Company's agreement with Minerva provides for joint marketing, a discounted
distributor sales program, and a discounted laboratory system. The Company's
distribution agreement with CEI allows the Company to bid CEI's systems as part
of Company projects.
COMPETITION
The interactive video services market is highly competitive and
characterized by changing technology and evolving industry standards. In this
area, the Company's competitors include a number of companies, many of which are
significantly larger than the Company and which have greater financial and other
resources or which have entered into strategic alliances with such companies.
Such competition includes
35
numerous companies including (i) developers of narrowband solutions (for
applications like the Internet; (ii) manufacturers of very large servers (E.G.,
massively parallel processors, such as those developed by nCube, Sequent
Computer Systems, Inc., Hewlett Packard Co., DEC International, Inc., AT&T Corp.
and IBM) which are generally employed for very large deployments such as whole
cities, but which may not be scalable for smaller market deployments; (iii)
direct competitors to the Company that target the same niche markets as the
Company; (iv) manufacturers of set top boxes, such as Acorn, General Instrument,
Panasonic, Samsung, Scientific Atlantic, Stellar One, and Zenith; and (v)
manufacturers of content preparation equipment, such as DiviCom, Future Tel,
Nuko, Scopus, Vela, Panasonic, Silicon Graphics, and Sony. Although many
manufacturers of large servers have implemented trial deployments of digital
video services, the Company believes that, in almost every case, these
deployments involved general purpose computers which had not been designed for
such interactive video applications. Direct competitors include SeaChange
Systems, Inc., Concurrent Computer Corporation, and IPC. Competitive factors in
the interactive video services market include completeness of features, product
scalability and functionality, network compatibility, product quality,
reliability and price, marketing and sales resources, and customer service and
support. The Company competes on the basis of its demonstrated ability to
install digital video systems on each of the four major types of networks
accomodating interactive video services and its ability to offer economically
viable solutions based on the scalability of its systems. See "Risk
Factors--Competition" and "--Product Obsolescence; Technological Change."
CD-ROM SEGMENT
Industry Overview
Many businesses and other organizations today create, receive and process
large quantities of documents, images, and other records. Some businesses and
organizations, including government units and finance and telecommunications
firms, have begun storing records on CD-ROM disks, disk drives, changers, or
larger CD-ROM systems that include towers and jukeboxes. These systems have many
advantages compared to paper records, including lower costs, compactness,
accuracy and ease of search and retrieval. Although other types of paperless
storage media are available, including RAM, microfilm computer hard disk,
WORM/magneto and tape, CD-ROM offers a standard storage format, enormous storage
capacity, reliability, and random access to the stored data. In order to
optimize use of such systems, they are normally connected to a number of users
via local area networks (LANs) or even at remote locations. Various kinds of
CD-ROM software, such as that offered by the Company, is required to process
information for storage, route it to the proper storage device, archive it, and
search for and retrieve it as needed.
The growing popularity of CD-ROM information storage method is attested by
the increased sales of CD changers that can accomodate 100 to 150 disks, the
most popular type in use. Shipments of these units grew from 1,000 units in 1994
to more than 3,500 units in 1995, according to Disk Trend Magazine. The
electronic document imaging market has also continued to grow, with much of the
growth due to increased acceptance of CD-ROM applications and computer output to
laser disk (COLD) systems. The Company's hardware and software products have
application in both CD-ROM and COLD systems.
The data networks for these systems are commonly configured using one of
three standard operating systems: (i) NetWare, a Novell product used for PC
applications; (ii) NFS, used on larger UNIX-based systems; and (iii) Windows NT,
the fastest growing network operating system. The Company's software products
function on each of these operating systems, and on a wide range of hardware
including scanners, PCs, minicomputers, mainframe computers, and CD jukeboxes.
36
PRODUCTS
The Company's CD-ROM division has four major products, all of which are
designed to make document and image storage, management, and retrieval easy,
cost-effective, and more useful for businesses. MEDIATOR provides access to
CD-ROM towers and changers for Novell, UNIX, and Windows NT clients. VIRTUAL CD
MANAGER transforms CD-ROM changers into multi-user information libraries
connected to a Novell network. Like MEDIATOR, VIRTUAL CD MANAGER displays all
the CD devices under a single drive letter, enabling fast and simple access to
information. VIRTUAL CD WRITER is a Novell file extension that allows a large
group of users on a Novell network to record data on CD-ROMs in a streamlined,
single-step process. VIRTUAL CD WRITER and VIRTUAL CD MANAGER, used together,
provide a complete CD-ROM recording and retrieval solution for Novell networks.
CD WorkWare is a group of electronic document storage and imaging tools which
provide information management, indexing, and search capabilities. This product
allows mainframes or minicomputers to print, scan, or tape transfer output onto
a Novell network where documents are placed in an on-line CD-ROM library that
can be accessed by any network user. CD WORKWARE is sold alone or bundled with
the Company's other CD products.
SALES AND MARKETING
The Company's markets its CD-ROM products through the Company's direct sales
and marketing personnel, principally to industries where there is extensive use
of electronic document and imaging and management such as financial services,
healthcare, government, and telecommunications. In addition, the Company markets
its CD-ROM products through sales and marketing materials and brochures, trade
show participation, public relations efforts, speaking engagements and
advertising in trade publications.
COMPETITION
The CD-ROM market is competitive and characterized by changing technology
and evolving industry standards. In this area, the Company's competitors include
a number of companies, many of which are significantly larger than the Company
and have substantially greater financial and other resources. Competitive
factors in the CD-ROM market include completeness of features, product
scalability and functionality, product quality, reliability and price, marketing
and sales resources, distribution channels, and customer service and support.
The Company's competitors with respect to its CD-ROM products include Eastman
Kodak, Smart Storage Inc., Optical Technology Grove, IXOS, Axis Technology,
TenX, and Alchemy. See "Risk Factors--Competition."
INTERACTIVE VIDEO AND CD-ROM SEGMENTS
INTELLECTUAL PROPERTY
The Company does not have any patents on its products and has not filed
patent applications on any products. The Company regards the products that it
owns as proprietary and relies primarily on a combination of trade secret laws,
nondisclosure agreements, other technical copy protection methods (such as
embedded coding), and copyright (where applicable) to protect its rights in and
to its products. It is the Company's policy that all employees and third-party
developers sign nondisclosure agreements. However, this may not afford the
Company sufficient protection for its know-how and its proprietary products.
Other parties may develop similar know-how and products, duplicate the Company's
know-how and products or develop patents that would materially and adversely
affect the Company's business, financial condition and results of operations.
Although the Company believes that its products and services do not infringe the
rights of third parties, and although the Company has not received notice of any
infringement claims, third parties may assert infringement claims against the
Company, and such claims may result in the Company being required to enter into
royalty arrangements, pay damages, or defend litigation, any of which could
materially and adversely affect the Company's business, financial condition and
results of operations. See "Risk Factors--Lack of Patent and Copyright
Protection."
37
MANUFACTURING AND MATERIALS
The Company orders the component parts of its products from a number of
outside suppliers and assembles and tests the products at its own facilities.
The Company purchases certain raw materials, components, and subassemblies
included in the Company's products from a limited group of suppliers and does
not maintain long-term supply contracts with its suppliers. The disruption or
termination of the Company's sources of supply could have a material adverse
effect on the Company's business and results of operations. While the Company is
aware of alternative suppliers for most of these products, there can be no
assurance that any supplier could be replaced in a timely manner. See "Risk
Factors--Dependence on Suppliers; Marketing Risks."
QUALITY CONTROL, SERVICE AND WARRANTIES
The Company's products must successfully pass tests at each important stage
of the manufacturing process. The Company offers maintenance and support
programs for its products that provide maintenance, telephone support,
enhancements, and upgrades.
The Company generally warrants its interactive video servers to be free from
defects in material and workmanship for one year from the completion of the
final acceptance test. At the end of the warranty period, the Company offers
maintenance and support programs. In light of the fact that the Company has only
begun selling limited quantities of its interactive video server products in the
past few years, the Company has no basis on which to predict the likelihood of
substantial warranty claims for such products. In some cases, customers may
require a longer or more extensive warranty as part of the competitive bid
process. See "Risk Factors--Product Liability and Availability of Insurance."
The Company warrants its CD-ROM products for 30 days after purchase, with a
replacement or repair option on such CD-ROM products. There have been no
material warranty claims in connection with the CD-ROM products during the past
several years. The Company also provides its CD-ROM customers with access to a
telephone help desk for one year after purchase.
EMPLOYEES
As of June 30, 1997, the Company had 62 full-time employees, approximately
38 of whom were employed in the engineering and product development area, seven
of whom fulfilled marketing and sales functions and 17 of whom fulfilled
management or administrative roles. Subject to the availability of funds, the
Company intends to recruit approximately 60 employees for its engineering,
sales, and operations staff over the next 12 months. The Company's employees are
not represented by a union or governed by a collective bargaining agreement.
PROPERTIES
The Company maintains its executive offices in approximately 11,800 square
feet of space in Knoxville, Tennessee pursuant to a lease expiring in February
28, 2000. Monthly lease payments average approximately $11,000 over the term of
the lease.
LEGAL PROCEEDINGS
The Company knows of no material litigation or proceeding pending,
threatened or contemplated to which the Company is or may become a party. See
"Risk Factors--Risks Associated with Contracts with En Kay Telecom Co., Ltd."
38
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The executive officers and directors of the Company are as follows:
NAME AGE POSITION
- ----------------------------------------------------- --- -----------------------------------------------------
Kenneth D. Van Meter................................. 50 President, Chief Executive Officer and Chairman of
the Board
Glenn West........................................... 38 Executive Vice-President, Director of Technology, and
Director
William R. Chambers.................................. 45 Vice-President of Business Development
Doyal H. Hodge....................................... 43 Vice-President and Chief Financial Officer
Mark Cromwell........................................ 43 Vice-President of Engineering
Fenton Scruggs(1).................................... 59 Director
Donald Greenhouse(1)................................. 61 Director
- ------------------------
(1) Member of the Compensation Committee
KENNETH D. VAN METER--Mr. Van Meter has been the President and Chief
Executive Officer of the Company since January 20, 1997. He was elected Chairman
of the Board on March 25, 1997. From May 1995 to January 1997, Mr. Van Meter
served as Vice President, Operations, for Tele-TV Systems, a limited partnership
owned by Bell Atlantic Corporation ("Bell Atlantic"), NYNEX, and Pacific
Telesis, which was engaged in providing systems, software, and services for its
three parents in the interactive digital services industry. From June 1994 to
May 1995, Mr. Van Meter was President of Bell Atlantic Video Services
Interactive Multimedia Platforms, a wholly-owned subsidiary of Bell Atlantic.
From April 1993 to June 1994, Mr. Van Meter was Vice President of Bell Atlantic
Video Services. Prior to joining Bell Atlantic, from 1991 to 1993, Mr. Van Meter
was Vice President and General Manager for Thomas Cook Limited, a travel
services company. From 1989 to 1991, Mr. Van Meter was Group Vice President for
two divisions of National Data Corporation ("NDC"). From 1984 to 1989, Mr. Van
Meter was Director and General Manager of two businesses for Sprint Corp.,
United Business Communications (shared tenant services), and the Meeting Channel
(2-way digital video teleconferencing). Mr. Van Meter holds an MBA with highest
honors in management and marketing from the University of Georgia, and a B.S.
with high honors in Chemistry from West Virginia University.
GLENN WEST--Mr. West co-founded the Company in 1993 and has served as
Executive Vice-President and Director of Technology since its inception. Prior
to co-founding the Company, from 1987 to 1993, Mr. West served as Senior Systems
Engineer for Data Research and Applications, a software company.
WILLIAM R. CHAMBERS--Mr. Chambers has been Vice President of Business
Development of the Company since April 1997. From June 1996 to April 1997, Mr.
Chambers was Senior Counsel at Tele-TV Systems. Prior to joining Tele-TV
Systems, Mr. Chambers spent 20 years in private law practice in the Washington,
D.C. area at Verner, Liipfert, Bernhard, MacPherson & Hand, from May 1995 to
June 1996, and at Watt, Tiedorf & Hoffer, from 1978 to 1995. Mr. Chambers also
serves as Chief Counsel of the Company. Mr. Chambers received a B.A. degree,
with honors, in Economics from Princeton University and a J.D., with honors,
from the National Law Center, George Washington University.
DOYAL H. HODGE--Mr. Hodge has been Vice President and Chief Financial
Officer of the Company since January 20, 1997. Mr. Hodge, a certified public
accountant, has over 20 years of experience in accounting and financial
management. Prior to joining the Company, from July 1993 to January 1997, Mr.
Hodge was Vice President and General Manager of Theta Systems, Inc., a computer
distribution company. Before joining Theta Systems, from April 1988 until July
1993, Mr. Hodge was a controller of two divisions for Quadrex Corporation
("Quadrex"), an engineering support and environmental company in the utility
39
industry. Mr. Hodge held positions of Chief Financial Officer, Controller, and
Financial Manager at various companies. In April 1996, Mr. Hodge was named as a
defendant in a lawsuit brought against certain of the former officers and
directors of Quadrex, Price Waterhouse LLP (Quadrex' auditors), and Mr. Hodge
alleging violations of federal and state securities laws in connection with the
issuance by Quadrex of its common stock in connection with the acquisition of
the plaintiff's business. Mr. Hodge, who was only the controller of two
divisions of Quadrex during the relevant period, has advised the Company that he
believes the allegations against him are without merit. He holds a B.S. in
Business Administration, Accounting, from the University of Tennessee, and has
two years of post-graduate study in Law.
MARK CROMWELL--Mr. Cromwell joined the Company as Vice President of
Engineering in August, 1997. Prior to joining the Company, Mr. Cromwell was Vice
President of Transmission Product Engineering with DSC Communications
Corporation, where he worked from June 1984 to August 1997. Mr. Cromwell also
held engineering positions with Mostek Corporation, the Electronics Division of
the Chrysler Corporation and General Dynamics. He holds an MSEE from Southern
Methodist University and a B.S. in Physics from the University of Tennessee, and
has done postgraduate work in Management at the University of Texas in Dallas.
FENTON SCRUGGS--Dr. Scruggs funded the initial start-up of the Company, and
has been a member of the Company's Board of Directors since the Company's
inception in 1993. Dr. Scruggs is a Board Certified Pathologist from
Chattanooga, Tennessee, who has been in private practice since 1965. Dr. Scruggs
received his undergraduate degree from University of Virginia in 1959 and his
graduate degree from the University of Tennessee in 1962. Dr. Scruggs completed
his residency at Memphis Memorial Hospital and was a General Medical Officer in
the U.S. Air Force from 1963 to 1965.
DONALD GREENHOUSE--Mr. Greenhouse has been a member of the Company's Board
of Directors, as the designee of the holders of the Company's preferred stock,
since 1995. Mr. Greenhouse also served as interim Chief Executive Officer of the
Company from August 1996 until January 1997. Mr. Greenhouse is President and
Chief Executive Officer of Seneca Point Associates, Inc., a consulting firm
founded by him in November 1989. Mr. Greenhouse has approximately 40 years of
management experience in manufacturing, technology and service industries.
Seneca Point Associates, Inc. is a non-traditional consulting firm engaged by
clients nationally to fill full-time senior management positions.
Each director holds office until the Company's annual meeting of
stockholders and until his successor is duly elected and qualified. The Company
intends to establish an Audit Committee following completion of the Offering.
Officers are elected by the Board of Directors and hold office at the discretion
of the Board of Directors. There are no family relationships between any of the
directors or executive officers of the Company.
DIRECTOR COMPENSATION
Directors do not receive compensation for serving on the Board of Directors
or fees for attending meetings of the Board of Directors; however, they are
reimbursed for related expenses. The Company expects to reconsider its policies
on director compensation in connection with its efforts to recruit additional
outside directors.
40
EXECUTIVE COMPENSATION
The following table sets forth the annual and long-term compensation for
services in all capacities for the fiscal years ended December 31, 1996, 1995
and 1994 paid to Kenneth D. Van Meter, the Company's Chairman of the Board,
President, and Chief Executive Officer, to Glenn West, Executive Vice President
and Director of Technology, and Mahmoud Youssefi, the Company's former Chief
Executive Officer (Messrs. Van Meter, West, and Youssefi, together the "Named
Executive Officers"). No other executive officer received compensation exceeding
$100,000 during the fiscal year ended December 31, 1996, 1995, or 1994.
SUMMARY COMPENSATION TABLE
LONG TERM COMPENSATION
-----------------------------------------
ANNUAL COMPENSATION AWARDS PAYOUTS
---------------------------------------------- -------------------------- -------------
OTHER RESTRICTED SECURITIES LONG-TERM
ANNUAL STOCK UNDERLYING INCENTIVE
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION AWARD(S) OPTIONS PLAN PAYOUT
- ------------------------------- --------- --------- --------- ------------- ----------- ------------- -------------
Kenneth D. Van Meter(1)........ 1996 -- -- -- -- -- --
Chairman of the Board, Chief 1995 -- -- -- -- -- --
Executive Officer, and 1994 -- -- -- -- -- --
President
Glenn West..................... 1996 $ 134,372 -- -- -- -- --
Executive Vice President and 1995 $ 134,198 -- -- -- -- --
Director 1994 $ 72,000 -- -- -- -- --
Mahmoud Youssefi............... 1996 $ 134,372 -- -- -- -- --
Former Chief Executive 1995 $ 131,166 -- -- -- -- --
Officer and former Director 1994 $ 66,000 -- -- -- -- --
ALL OTHER
NAME AND PRINCIPAL POSITION COMPENSATION
- ------------------------------- -------------
Kenneth D. Van Meter(1)........ --
Chairman of the Board, Chief --
Executive Officer, and --
President
Glenn West..................... --
Executive Vice President and --
Director --
Mahmoud Youssefi............... --
Former Chief Executive --
Officer and former Director --
- ------------------------
(1) Mr. Van Meter joined the Company on January 20, 1997. Pursuant to his
employment agreement, Mr. Van Meter is entitled to receive a salary of
$162,000 for the 1997 fiscal year and a bonus equal to up to 99% of his base
salary. See "Employment Agreements" below.
The following table sets forth certain information concerning options
granted to the Named Executive Officers during the fiscal year ended December
31, 1996.
OPTION GRANTS IN LAST FISCAL YEAR
INDIVIDUAL GRANTS
------------------------------------------------------
NUMBER OF PERCENTAGE OF
SECURITIES TOTAL OPTIONS
UNDERLYING GRANTED TO EXERCISE OR
OPTIONS INDIVIDUALS IN BASE PRICE EXPIRATION
NAME GRANTED FISCAL YEAR PER SHARE DATE
- -------------------------------------------------------------- ----------- --------------- ----------- -----------
Kenneth D. Van Meter (1)...................................... -- -- -- --
Glenn West.................................................... -- -- -- --
Mahmoud Youssefi.............................................. -- -- -- --
- ------------------------
(1) For a discussion with respect to options granted to Mr. Van Meter in 1997,
see "Management--Stock Option Plans; Options Granted Outside the Plans."
41
The following table sets forth certain information concerning the number and
value of securities underlying exercisable and unexercisable stock options as of
the fiscal year ended December 31, 1996 by the Named Executive Officers.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL
YEAR-END OPTION VALUES
NUMBER OF SECURITIES
NUMBER OF UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
SHARES OPTIONS AT IN-THE-MONEY OPTIONS AT
ACQUIRED ON VALUE DECEMBER 31, 1996 DECEMBER 31, 1996
NAME EXERCISE REALIZED EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
- ------------------------------------- ----------- ---------- ----------------------- -----------------------
Kenneth D. Van Meter................. -- -- -- --
Glenn West........................... -- -- -- --
Mahmoud Youssefi..................... -- -- -- --
STOCK OPTION PLANS
On August 10, 1995, the Board of Directors and stockholders adopted the
Company's 1995 Stock Option Plan (the "1995 Plan"). The 1995 Plan provides for
the grant of options to purchase up to 178,929 shares of Common Stock to
employees and officers of the Company. In August, 1997, the Board of Directors
and the stockholders adopted the Company's 1997 Stock Option Plan (the "1997
Plan," and, together with the 1995 Plan, the "Plans"). The 1997 Plan provides
for the grant of options to purchase up to 200,000 shares of Common Stock to
employees, directors, and officers of the Company. Options granted under the
Plans may be either "incentive stock options" within the meaning of Section 422A
of the Internal Revenue Code of 1986, as amended (the "Code"), or non-qualified
options.
The Plans are administered by the Board of Directors which serves as the
stock option committee and which determines, among other things, those
individuals who receive options, the time period during which the options may be
partially or fully exercised, the number of shares of Common Stock issuable upon
the exercise of each option, and the option exercise price.
The exercise price per share of Common Stock subject to an incentive stock
option may not be less than the fair market value per share of Common Stock on
the date the option is granted. The per share exercise price of the Common Stock
subject to a non-qualified option may be established by the Board of Directors.
The aggregate fair market value (determined as of the date the option is
granted) of Common Stock for which any person may be granted incentive stock
options which first become exercisable in any calendar year may not exceed
$100,000. No person who owns, directly or indirectly, at the time of the
granting of an incentive stock option to such person, more than 10% of the total
combined voting power of all classes of capital stock of the Company (a "10%
Stockholder") shall be eligible to receive any incentive stock options under the
Plan unless the exercise price is at least 110% of the fair market value of the
shares of Common Stock subject to the option, determined on the date of grant.
No stock option may be transferred by an optionee other than by will or the
laws of descent and distribution and, during the lifetime of an optionee, the
option will be exercisable only by the optionee or a representative of such
optionee. In the event of termination of employment other than by death or
disability, the optionee will have no more than three months after such
termination during which the optionee shall be entitled to exercise the option,
unless otherwise determined by the stock option committee. Upon termination of
employment of an optionee by reason of death, such optionee's options remain
exercisable for one year thereafter to the extent such options were exercisable
on the date of such termination. Under the 1997 Plan, upon termination of
employment of an optionee by reason of total disability (as defined in the 1997
Plan) such optionee's options remain exercisable for one year thereafter.
42
Options under the 1995 Plan must be issued within 10 years from August 10,
1995, the effective date of the 1995 Plan. Options under the 1997 Plan must be
issued within 10 years from August 6, 1997, the effective date of the 1997 Plan.
Incentive stock options granted under the Plans cannot be exercised more than 10
years from the date of grant. Incentive stock options issued to a 10%
Stockholder are limited to five-year terms. Payment of the exercise price for
options granted under the Plans may be made in cash or, if approved by the Board
of Directors of the Company, by delivery to the Company of shares of Common
Stock already owned by the optionee having a fair market value equal to the
exercise price of the options being exercised, or by a combination of such
methods. Therefore, an optionee may be able to tender shares of Common Stock to
purchase additional shares of Common Stock and may theoretically exercise all of
such optionee's stock options with no additional investment other than the
purchase of the original shares.
Any unexercised options that expire or that terminate upon an employee's
ceasing to be employed by the Company become available again for issuance under
the Plan from which they were granted.
Options to purchase 144,000 shares of Common Stock are outstanding under the
1995 Plan at exercise prices ranging from $0.10 to $4.90 per share, although
substantially all of such options are exercisable at $0.10 per share. Of such
optionees, Messrs. Hodge and Chambers, officers of the Company, each have
options to purchase 10,000 shares of Common Stock at $1.38 per share. No options
are outstanding under the 1997 Plan; however, the Company has agreed to grant
Mark Cromwell, an officer of the Company, options to purchase 24,000 shares of
Common Stock by December 31, 1997 at an exercise price equal to the market price
of the Common Stock on the date of grant.
OPTIONS GRANTED OUTSIDE THE PLANS
In addition to the options which may be granted under the Plans, the Company
has granted options to purchase 513,200 shares of Common Stock outside of the
Plans, including: (i) options granted to Donald Greenhouse, a director of the
Company to purchase (x) 14,000 shares of Common Stock at an exercise price of
$0.10 per share and (y) 26,000 shares of Common Stock at an exercise price of
$1.38 per share; (ii) options to purchase 203,200 shares of Common Stock granted
to officers of the Company, including 183,200 to Kenneth Van Meter and 10,000 to
each of Doyal Hodge and William Chambers at an exercise price of $1.38 per
share; and (iii) options to purchase 230,000 shares of Common Stock granted to
Kenneth Van Meter and options to purchase 20,000 shares of Common Stock granted
to each of Doyal Hodge and William Chambers at an exercise price of $3.00 per
share.
401(K) PROFIT SHARING PLAN
The Company has a 401(k) profit sharing plan (the "401(k) Plan"), pursuant
to which the Company, at its discretion each year, may make contributions to
such plan which match a certain percentage, as determined by the Company, of the
contributions made by each employee. The Company may elect not to make matching
contributions to the 401(k) Plan in any given year. The Company made matching
contributions with respect to fiscal 1996 (an aggregate of approximately
$29,000) and has not yet made any determinations with respect to fiscal 1997.
EMPLOYMENT AGREEMENTS
The Company has entered into an employment agreement with Mr. Van Meter, as
amended, which expires January 20, 2000. Pursuant to his employment agreement,
Mr. Van Meter receives an annual base salary of $162,000 and may, at the
discretion of the Board of Directors, receive an annual incentive bonus equal to
up to 99% of Mr. Van Meter's base salary if he and the Company reach certain
milestones. Up to two-thirds of such incentive bonus is to be awarded and paid
within thirty days following the end of each calendar year and up to the
remaining one third of such bonus is to be awarded at the end of each calendar
year and vest in two equal installments on the first and second anniversaries of
the date of the award. In connection with his employment, Mr. Van Meter
purchased 15,000 shares of Common Stock for nominal
43
consideration plus the cancellation of certain anti-dilution rights and received
options to purchase 183,200 shares of Common Stock at $1.38 per share and
options to purchase 230,000 shares of Common Stock at $3.00 per share.
Additionally, Mr. Van Meter is entitled to reimbursement of up to $45,000 for
expenses incurred as a result of his relocation.
The Company has entered into an employment agreement with Mr. West which
expires on May 1, 2000. Pursuant to his employment agreement, Mr. West received
a base salary of $134,372 in 1996. Such base salary is subject to increase at
the discretion of the Board of Directors based upon, among other things, the
performance of the Company and the performance, duties, and responsibilities of
Mr. West. The employment agreement also provides that Mr. West will not compete
with the Company for two years after the termination of his employment. The
employment agreement is terminable by the Company for cause upon the occurrence
of certain events, or upon physical or mental disability or incapacity.
Pursuant to employment agreements with the Company, William Chambers, Mark
Cromwell, and Doyal Hodge are receiving salaries of $125,000, $125,000, and
$80,000 per annum, respectively. Pursuant to Mr. Chambers' agreement with the
Company, he is eligible to receive, (i) at the discretion of the Board of
Directors of the Company, a bonus of up to twenty five percent (25%) of his
annual salary, and (ii) reimbursement in the amount of $25,000 for expenses
incurred as a result of his relocation. Pursuant to Mr. Cromwell's agreement
with the Company, he is eligible to receive (i) at the discretion of the Board
of Directors of the Company, a bonus of up to twenty-five percent (25%) of his
annual salary, and (ii) reimbursement of up to $30,000 for expenses incurred in
his relocation. Pursuant to Mr. Hodge's agreement with the Company, he is
eligible to receive, at the discretion of the Board of Directors of the Company,
up to $32,000 per annum in incentive compensation. In connection with their
employment, Messrs. Chambers and Hodge have also each received options to
purchase 20,000 shares of Common Stock at an exercise price of $1.38 and options
to purchase 20,000 shares of Common Stock at an exercise price of $3.00 per
share and, by December 31, 1997, subject to the approval of the Board of
Directors of the Company, Mr. Cromwell will receive an option to purchase 24,000
shares of Common Stock at an exercise price per share equal to the market price
of the Common Stock on the date of grant. Messrs. Chamber's, Cromwell's, and
Hodge's employment with the Company may be terminated by either the employee or
the Company at any time.
44
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information known to the Company
regarding the beneficial ownership of the Company's voting securities as of the
date of this Prospectus and as adjusted to reflect the sale of 2,000,000 shares
of Common Stock offered hereby by (i) each person who is known by the Company to
own of record or beneficially more than 5% of the outstanding Common Stock, (ii)
each of the Company's directors and the Named Executive Officers and (iii) all
directors and executive officers of the Company as a group. Unless otherwise
indicated, each of the stockholders listed in the table below has sole voting
and dispositive power with respect to the shares beneficially owned by such
stockholder.
PERCENT OF CLASS(1)
-------------------------------
NUMBER OF SHARES
BENEFICIALLY BEFORE
NAME OF BENEFICIAL OWNER(2) OWNED OFFERING AFTER OFFERING
- ----------------------------------------------------- --------------------------- -------------- ---------------
Glenn West........................................... 382,636 18.4% 9.4%
Dr. Fenton Scruggs................................... 337,915 16.2% 8.3%
Donald Greenhouse(3)................................. 40,000(4) 1.9% 1.0%
Kenneth D. Van Meter................................. 428,200(5) 17.2% 9.5%
Mahmoud Youssefi(6).................................. 160,000 7.7% 3.9%
Special Situations Fund.............................. 198,064(7) 9.3% 4.8%
All directors and executive officers as a group (six
persons) (3)(4)(5)(8).............................. 1,268,752 48.5% 27.5%
- ------------------------
(1) For each beneficial owner, shares of Common Stock subject to securities
exercisable or convertible within 60 days of the date of this Prospectus are
deemed outstanding for computing the percentage of such beneficial owner.
(2) The address for Messrs. West, Greenhouse, Van Meter, and Dr. Scruggs is c/o
Celerity Systems, Inc., 9051 Executive Park Drive, Suite 302, Knoxville,
Tennessee 37932.
(3) Mr. Greenhouse is the father of David Greenhouse who is a principal of the
Special Situations Fund. Mr. Greenhouse disclaims beneficial ownership of
the shares owned by such fund.
(4) Includes options to purchase 40,000 shares of Common Stock which will be
exercisable upon consummation of the Offering.
(5) Includes 413,200 shares of Common Stock which are either subject to
currently exercisable stock options or will be exercisable upon consummation
of the Offering. Also includes an aggregate of 10,000 shares of Common Stock
owned by Mr. Van Meter's children.
(6) The address of Mr. Youssefi is 211 Flynn Road, Walland, Tennessee 37886.
(7) Includes warrants to purchase 51,020 shares of Common Stock which are
currently exercisable. The address of Special Situations Fund is 153 East
53rd Street, New York, New York 10022.
(8) Includes options issued to executive officers of the Company to purchase an
aggregate of 80,000 shares of Common Stock which will be exercisable upon
consummation of the Offering.
45
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company was initially capitalized by Dr. Fenton Scruggs, a director of
the Company, who contributed $155,000 in capital from January to June 1993. In
June 1993, Mahmoud Youssefi, a co-founder of the Company and a principal officer
until April 1997, loaned the Company $30,000 in the form of an unsecured loan
bearing interest at the rate of 0.4% per five-day period. The balance of the
loan, together with accrued interest thereon, was paid in full in December 1995.
In April 1994, the Company received a secured loan from Herzog, Heine &
Geduld, Inc., a customer of the Company, in the principal amount of $250,000 and
bearing interest at a rate of 9.75% per annum. The loan was converted into
181,290 shares of Series A Preferred Stock in May 1995, which will be converted
into 72,516 shares of Common Stock upon the closing of the Offering.
In November 1994, the Company received an unsecured loan from Dr. Scruggs in
the principal amount of $75,000 and bearing interest at a rate of 9% per annum.
Dr. Scruggs converted the outstanding balance, including accrued interest
thereon, into 17,915 shares of the Company's Common Stock at $4.90 per share on
December 31, 1995.
In May 1995, the Company sold 390,334 shares of Series A Preferred Stock at
$3.88 per share and warrants to purchase 163,392 Series B Preferred Stock at
$4.90 per share. The warrants to purchase the Series B Preferred Stock were
exercised in August 1995. The Preferred Stock, voting together as a single
class, had the right to elect one member of the Company's Board of Directors.
Donald Greenhouse has served as the designee of the holders of the preferred
stock.
In May 1995, the Company redeemed 17,364 shares of Common Stock from Glenn
West, the Company's Executive Vice President, Director of Technology, and a
member of the Board of Directors, for an aggregate purchase price of $67,500.
In November 1995, the Company issued 12-month promissory notes under an
arrangement with certain parties, including a number of holders of the Series A
and B Preferred Stock. The purchasers of such notes also received warrants to
purchase 190,714 shares of the Company's Common Stock at an exercise price of
$4.90 per share. The warrants expire upon the earlier of (i) May 1998 or (ii)
the issuance by the Company of shares of its Common Stock in a public offering
at an aggregate purchase price of $5,000,000 or more, and at a Company valuation
of at least $10,000,000. The Offering would meet this criteria. The principal
amount of the promissory notes was $934,500 and interest accrued at a fixed rate
of 10% per annum. When payments on such notes were not made by November 30,
1996, they automatically converted, at a rate of $4.90 per share, into an
aggregate of 190,714 shares of Common Stock. The interest which had accrued on
the debt was forgiven.
During the year ended December 31, 1996, the Company paid approximately
$35,000 in consulting fees to Seneca Point Associates, Inc., a management
consulting firm of which Donald Greenhouse, a member of the Board of Directors,
is President and Chief Executive Officer. In addition, Mr. Greenhouse's son,
David Greenhouse, is a principal of Special Situations Fund, a principal
stockholder of the Company's securities and an investor in the Company's
November 1995 private placement of promissory notes and warrants.
In July 1996, the Company completed the 1996 Placement, pursuant to which
the Representative acted as placement agent in such offering and received sales
commissions of $480,000, was reimbursed a total of $120,000 for certain
expenses, and was issued the Hampshire Warrant.
On April 5, 1997, the Company entered into an agreement with Mr. Youssefi
pursuant to which Mr. Youssefi's employment as President of the Company was
terminated (the "Termination Agreement"). Pursuant to the Termination Agreement,
Mr. Youssefi agreed, among other things, (i) not to compete with the Company for
a three-year period (ii) to waive all claims and rights against the Company,
(iii) to cooperate with the Company in its business endeavors and (iv) to assist
with the Company's efforts in an
46
initial public offering. Under the Termination Agreement, the Company agreed to
pay Mr. Youssefi $4,000 in April 1997, $11,458.33 from May 1997 to and including
April 1998; $7,458.33 on or before May, 1, 1998, and $11,458.33 from June 1998
to May 1, 2000. The Termination Agreement included a clause which conditioned
these obligations upon a May 5, 1997 payment by En K to the Company. The Company
did not receive En K's May 5, 1997 payment and was therefore only obligated to
provide Mr. Youssefi the $11,458 monthly payments through December 1997.
Pursuant to a letter agreement, dated July 15, 1997, between the Company and
Mahmoud Youssefi (the "Youssefi Repurchase Agreement"), Mr. Youssefi sold to the
Company 240,000 shares of the Company's Common Stock held by him at a purchase
price of $0.50 per share concurrently with the closing of the Bridge Financing.
Additionally, pursuant to the Youssefi Repurchase Agreement, in exchange for Mr.
Youssefi's execution of an agreement (the "Youssefi Lock-Up"), pursuant to which
he promised not to sell any securities of the Company owned by him for a period
of 18 months following the Company's initial public offering, the Company agreed
to pay Mr. Youssefi (i) upon the Company's receipt of the Youssefi Lock-Up, (a)
$11,458.33 allegedly owed to Mr. Youssefi at such time under the Termination
Agreement and (b) approximately $7,400 for reimbursable credit card and business
expenses; (ii) concurrently with the closing of the Bridge Financing, $53,291.65
as payment in full (except for $15,458.33) for the Company's remaining
obligations under the Termination Agreement; and (iii) the remaining $15,458.33
upon the earlier of (a) 150 days after the closing of the Bridge Financing or
(b) the closing of this Offering. Finally, the Company agreed, within 30 days
following the closing of the Offering, to pay off approximately $25,000 of
leases guaranteed by Mr. Youssefi "See Use of Proceeds."
Pursuant to a letter agreement, dated July 15, 1997, between the Company and
Dr. Fenton Scruggs, Dr. Scruggs sold to the Company 80,000 shares of the
Company's Common Stock held by him at a purchase price of $0.50 per share
concurrently with the closing of the Bridge Financing.
In connection with his employment agreement, in July 1997, Kenneth D. Van
Meter purchased 15,000 shares of Common Stock for nominal consideration plus the
termination of certain anti-dilution rights. See "Management--Employment
Agreements."
In August 1997, the Company completed the Bridge Financing, pursuant to
which the Representative acted as placement agent in such offering and received
sales commissions of $200,000, as well as a non-accountable expense allowance of
$60,000.
47
DESCRIPTION OF SECURITIES
The following summary description of the Company's capital stock, other
securities, and selected provisions of its Certificate of Incorporation and
Bylaws is qualified in its entirety by reference to the Company's Certificate of
Incorporation, Bylaws, and warrants, copies of which have been filed with the
Securities and Exchange Commission as exhibits to the Registration Statement of
which this Prospectus is a part.
COMMON STOCK
The Company is authorized to issue up to 15,000,000 shares of Common Stock,
par value $0.001 per share, of which 2,082,239 shares are issued and outstanding
as of the date hereof, after giving effect to the Conversion.
Holders of shares of the Common Stock are entitled to one vote per share on
all matters to be voted upon by the stockholders. Subject to preferences which
may be applicable to preferred stock outstanding at any time, holders of shares
of Common Stock are entitled to receive ratably such dividends, if any, as may
be declared from time to time by the Board of Directors out of funds legally
available therefor. See "Dividend Policy."
In the event of any liquidation, dissolution, or winding up of the Company,
the holders of shares of Common Stock are entitled to share ratably in all
assets remaining after payment of liabilities, subject to prior rights of
preferred stock, if any, then outstanding. Shares of Common Stock have no
preemptive, conversion, or other subscription rights and there are no repurchase
or sinking fund provisions applicable to the Common Stock. As of the date
hereof, there are approximately 105 record holders of Common Stock, after giving
effect to the Conversion.
PREFERRED STOCK
After giving effect to the Conversion, the Company is authorized to issue up
to 3,000,000 shares of preferred stock, par value $0.01 per share, of which no
shares are outstanding as of the date hereof. The preferred stock may be issued
in one or more series, the terms of which may be determined at the time of
issuance by the Board of Directors, without further action by stockholders, and
may include voting rights (including the right to vote as a series on particular
matters), preferences as to dividends and liquidation, conversion rights,
redemption rights, and sinking fund provisions. The issuance of any such
preferred stock could adversely affect the rights of the holders of Common Stock
and, therefore, reduce the value of the Common Stock. The ability of the Board
of Directors to issue preferred stock could discourage, delay, or prevent a
takeover of the Company. See "Risk Factors--Anti-Takeover Effects of Certain
Provisions of Certificate of Incorporation and Delaware Law."
REPRESENTATIVE'S WARRANTS
In connection with this Offering, the Company has agreed to issue to the
Representative and its designees Representative's Warrants to purchase up to
200,000 shares of Common Stock. The Representative's Warrants will be
exercisable, at a price equal to 120% of the public offering price, for a period
of four years commencing one year after the closing of this Offering. The
Representative and its designees are entitled to certain registration rights
under the Securities Act relating to the shares of Common Stock received upon
the exercise of the Representative's Warrants. The Representative's Warrants may
not be sold or transferred during the first year after issuance, except to
members of the selling group and persons who are officers and partners of the
Representative or members of the selling group or by operation of law. The
Representative's Warrants contain anti-dilution provisions providing for
adjustment to the exercise price and number of shares of Common Stock issuable
upon exercise of the Representative's Warrants (the "Warrant Shares") upon the
occurrence of certain events, including stock dividends, stock splits and
recapitalizations.
48
The Company has agreed that, at the request of the holders of a majority of
the Representative's Warrants and Warrant Shares (and on no more than one
occasion), the Company will file a registration statement under the Securities
Act for an offering of the Representative's Warrants and the Warrant Shares
during the four-year period beginning on the first anniversary of the date of
this Prospectus, and the Company has agreed to use its best efforts to cause
each such registration statement to be declared effective under the Securities
Act at the Company's expense (subject to certain limitations). In addition, the
Company has agreed to give advance notice to holders of the Representative's
Warrants and Warrant Shares of its intention to file a registration statement,
and in one such case, holders of the Representative's Warrants and the Warrant
Shares will have the right to require the Company to include the
Representative's Warrants and the Warrant Shares in such registration statement
at the Company's expense (subject to certain limitations).
OPTIONS AND WARRANTS
1995 WARRANTS
In connection with the Company's November 1995 private placement of 12-month
promissory notes, the Company issued the 1995 Warrants to purchase 190,714
shares of Common Stock at an exercise price of $4.90 per share. Such warrants
may be exercised in whole or in part any time prior to the earlier of (i) May
31, 1998 and (ii) the issuance by the Company of at least $5,000,000 in
additional capital based on a valuation of the Company of at least $10,000,000
through a public offering, including the Offering.
1996 WARRANTS
The 1996 Warrants entitle the holders thereof to purchase, in the aggregate,
up to 209,520 shares of Common Stock, at an exercise price of $8.46 per share.
The 1996 Warrants may be exercised at any time and expire on the earlier of (i)
five years from the date of the issuance of such warrant or (ii) the third
anniversary of the closing of the Offering.
HAMPSHIRE WARRANT
The Hampshire Warrant is exercisable for 38,852 shares of Common Stock at an
exercise price of $9.44. The Hampshire Warrant may be exercised in whole or in
part at any time and expire on the earlier of (i) five years from the date of
the issuance of such warrant or (ii) the third anniversary of the closing of the
Offering.
BRIDGE WARRANTS
In connection with the Company's Bridge Financing, the Company issued the
Bridge Warrants to purchase 320,000 shares of the Common Stock at an exercise
price of $3.00 per share. Such warrants may be exercised at any time after
August 8, 1998 and expire on August 8, 2001.
STOCK OPTIONS
In addition to the 1995 Warrants, the 1996 Warrants, the Hampshire Warrant,
and the Bridge Warrants, the Company has outstanding 657,200 options for the
purchase of the Common Stock, 144,000 of which have been issued under the 1995
Plan. See "Management--Stock Option Plans."
STOCKHOLDER REPORTS
The Company intends to furnish its stockholders with annual reports
containing audited financial statements and such other periodic reports as the
Company may deem appropriate and as may be required by law.
49
TRANSFER AGENT
American Stock Transfer & Trust Company, New York, New York is the Transfer
Agent for the Company's Common Stock.
DIRECTORS' LIMITATION OF LIABILITY AND INDEMNIFICATION
The Company's Certificate of Incorporation includes provisions which (a)
eliminate the personal liability of directors for monetary damages resulting
from breaches of their fiduciary duty (except for liability for breaches of the
duty of loyalty, acts, or omissions not in good faith or which involve
intentional misconduct or a knowing violation of law, violations under Section
174 of the Delaware General Corporation Law ("DGCL"), or for any transaction
from which the director derived an improper personal benefit and (b) states that
damages shall, to the extent permitted by law, include, without limitation, any
judgment, fine, amount paid in settlement, penalty, punitive damages, excise, or
other tax, including, without limitation, any of the foregoing incurred or
assessed with respect to an employee benefit plan, or expense of any nature
(including, without limitation, counsel fees and disbursements) The Company
believes that these provisions are necessary to attract and retain qualified
persons as directors and officers.
Section 145 of the DGCL permits indemnification by a corporation of certain
officers, directors, employees, and agents. Consistent therewith, the Company's
Certificate of incorporation requires that the Company indemnify all persons who
it may indemnify pursuant thereto to the fullest extent permitted by Section
145.
The Company's Certificate of Incorporation and Bylaws provide that the
Company will indemnify each of its directors and officers to the fullest extent
permitted by law with respect to all liability and loss suffered and expenses
incurred by such person in any action, suit, or proceeding in which such person
was or is made or threatened to be made a party or is otherwise involved by
reason of the fact that such person is or was a director or officer of the
Company. The Company is also obligated to pay the expenses of the directors and
officers incurred in defending such proceedings, subject to reimbursement if it
is subsequently determined that such person is not entitled to indemnification.
In addition, the Company's Certificate of Incorporation provides that the
Company's directors shall not be liable to the Company or its stockholders for
monetary damages for breaches of their fiduciary duties to the Company and its
stockholders except to the extent such exemption from liability or limitation
thereof is not permitted under the DGCL. This provision in the Certificate of
Incorporation does not eliminate the duty of care, and in appropriate
circumstances equitable remedies such as injunctive or other forms of
nonmonetary relief will remain available under the DGCL. In addition, each
director will continue to be subject to liability for monetary damages for
misappropriation of any corporate opportunity in violation of the director's
duties, for acts or omissions involving intentional misconduct, for knowing
violations of law, for actions leading to improper personal benefit to the
director, and for distributions (including payment of dividends or stock
repurchases or redemptions) that are unlawful under the DGCL. The provision does
not affect a director's responsibilities under any other law, such as the
federal securities laws. The Certificate of Incorporation further provides that
if the DGCL is amended to authorize corporate action further eliminating or
limiting the personal liability of directors then the liability of a director of
the Company shall be eliminated or limited to the fullest extent permitted by
the DGCL as amended or supplemented.
The Company maintains a policy of insurance under which the directors and
officers of the Company will be insured, subject to the limits of the policy,
against certain losses arising from claims made against such directors and
officers by reason of any acts or omissions covered under such policy in their
respective capacities as directors or officers, including liabilities under the
Securities Act. Insofar as indemnification for liabilities arising under the
Securities Act may be permitted to directors, officers, and controlling persons
of the Company pursuant to the foregoing provisions, or otherwise, the Company
has been advised
50
that, in the opinion of the Commission, such indemnification is against public
policy as expressed in the Securities Act and is, therefore, unenforceable.
DELAWARE ANTI-TAKEOVER LAW
The Company is subject to Section 203 of the DGCL ("Section 203") which,
subject to certain exceptions and limitations, prohibits a Delaware corporation
from engaging in any "business combination" with any "interested stockholder"
for a period of three years following the date that such stockholder became an
interested stockholder, unless: (i) prior to such time, the board of directors
of the corporation approved either the business combination or the transaction
which resulted in the stockholder becoming an interested stockholder; (ii) upon
consummation of the transaction which resulted in the stockholder becoming an
interested stockholder, the interested stockholder owned at least 85% of the
voting stock of the corporation outstanding at the time the transaction
commenced (excluding, for the purposes of determining the number of shares
outstanding at the time the transaction commenced, those shares owned (x) by
persons who are directors and also officers and (y) by employee stock plans in
which employee participants do not have the right to determine confidentially
whether shares held subject to the plan will be tendered in a tender or exchange
offer are excluded from the calculation); or (iii) on or subsequent to such
time, the business combination is approved by the board of directors and
authorized at an annual or special meeting of stockholders, and not by written
consent, by the affirmative vote of at least 66- 2/3% of the outstanding voting
stock which is not owned by the interested stockholder.
For purposes of Section 203, "a business combination" includes (i) any
merger or consolidation involving the corporation and the interested
stockholder; (ii) any sale, transfer, pledge or other disposition of 10% or more
of the assets of the corporation involving the interested stockholder; (iii)
subject to certain exceptions, any transaction which results in the issuance or
transfer by the corporation of any stock of the corporation to the interested
stockholder; (iv) any transaction involving the corporation which has the effect
of increasing the proportionate share of the stock of any class or series of the
corporation beneficially owned by the interested stockholder; or (v) the receipt
by the interested stockholder of the benefit of any loans, advances, guarantees,
pledges or other financial benefits provided by or through the corporation.
Section 203 defines an "interested stockholder" as any entity or person
beneficially owning 15% or more of the outstanding voting stock of the
corporation and any entity or person affiliated with or controlling or
controlled by such entity or person.
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of the Offering, the Company will have 4,082,239 shares of
Common Stock outstanding (4,382,239 shares of Common Stock outstanding if the
Underwriters' over-allotment option is exercised in full). Of these shares, the
2,000,000 Shares offered hereby (2,300,000 shares if the Underwriters'
over-allotment option is exercised in full) will be freely tradeable without
further registration under the Securities Act.
All of the presently outstanding 2,082,239 shares of Common Stock are, and
the 1,416,286 shares of Common Stock issuable upon exercise of the Company's
outstanding options and warrants, will be, "restricted securities" within the
meaning of Rule 144 and, if held for at least one year would be eligible for
sale in the public market in reliance upon, and in accordance with, the
provisions of Rule 144 following the expiration of such one-year period. In
general, under Rule 144 as currently in effect, a person or persons whose shares
are aggregated, including a person who may be deemed to be an "affiliate" of the
Company as that term is defined under the Securities Act, would be entitled to
sell within any three-month period a number of shares beneficially owned for at
least one year that does not exceed the greater of (i) 1% of the then
outstanding shares of Common Stock, or (ii) the average weekly trading volume in
the Common Stock during the four calendar weeks preceding such sale. Sales under
Rule 144 are also subject to certain requirements as to the manner of sale,
notice, and the availability of current public information about the Company.
However, a person who is not deemed to have been an affiliate of the Company
51
during the 90 days preceding a sale by such person and who has beneficially
owned shares of Common Stock for at least two years may sell such shares without
regard to the volume, manner of sale, or notice requirements of Rule 144.
Up to 200,000 additional shares of Common Stock may be purchased by the
Representative through the exercise of the Representative's Warrants during the
period commencing one year from the date of the closing of the Offering and
terminating on the fourth anniversary of such date. The holders of the
Representative's Warrants have certain demand and "piggyback" registration
rights as to such warrants and the underlying shares of Common Stock. Such
warrants and any and all shares of Common Stock purchased upon the exercise of
the Representative's Warrants may be freely tradeable, provided that the Company
satisfies certain securities registration and qualification requirements in
accordance with the terms of the Representative's Warrants. See "Description of
Securities--Representative's Warrants" and "Underwriting."
The Company intends to file a registration statement covering the shares of
Common Stock underlying options which have been, or may be, granted under the
Plans and options granted outside the Plans. In addition, the holders of (i)
553,726 shares of Common Stock have certain demand and "piggyback" registration
rights as to such shares commencing immediately upon the consummation of the
Offering, (ii) 426,648 shares of Common Stock have certain demand and
"piggyback" registration rights as to such shares commencing 6 months after
consummation of the Offering, (iii) the holders of 880,551 shares of Common
Stock have certain "piggyback" registration rights as to such shares commencing
immediately upon consummation of the Offering, (iv) 190,714 shares of Common
Stock underlying the 1995 Warrants have "piggyback" registration rights
commencing immediately upon the consummation of the Offering and (v) 209,520
shares of Common Stock underlying the 1996 Warrants and 320,000 shares of Common
Stock underlying the Bridge Warrants have certain demand and "piggyback"
registration rights commencing six months and 12 months respectively, after
consummation of the Offering. The Company, its officers, directors, and certain
stockholders holding an aggregate of 895,552 shares of Common Stock have entered
into agreements with the Representative which prohibit them from offering,
issuing, selling, or otherwise disposing of any securities of the Company for a
period of 18 months following the date of this Prospectus, without the prior
written consent of the Representative. In addition, certain stockholders holding
an aggregate of 426,654 shares of Common Stock have entered into agreements with
the Representative which prohibit them from offering, issuing, selling, or
otherwise disposing of any securities of the Company for a period of 12 months
following the date of this Prospectus, without the prior written consent of the
Representative. See "Principal Stockholders" and "Underwriting."
Prior to the Offering, there has been no public market for the Company's
securities. Following the Offering, the Company cannot predict the effect, if
any, that sales of shares of Common Stock pursuant to Rule 144, registration
rights, or otherwise, or the availability of such shares for sale, will have on
the market price prevailing from time to time. In addition, sales by the current
stockholders of a substantial number of shares of Common Stock in the public
market could materially adversely affect prevailing market prices for the Common
Stock. The availability for sale of a substantial number of shares of Common
Stock acquired through the exercise of the options or warrants could also
materially adversely affect prevailing market prices for the Common Stock. See
"Risk Factors--Shares Eligible for Future Sale."
52
UNDERWRITING
Subject to the terms and conditions set forth in the underwriting agreement
(the "Underwriting Agreement"), the Company has agreed to sell to each of the
Underwriters named below, and each of the Underwriters, for whom Hampshire
Securities Corporation is acting as Representative, has severally agreed to
purchase, the respective number of Shares set forth opposite its name below:
UNDERWRITERS NUMBER OF SHARES
- ------------------------------------------------------------------------------------- -----------------
Hampshire Securities Corporation.....................................................
-----------------
Total.................................................................... 2,000,000
-----------------
-----------------
A copy of the Underwriting Agreement has been filed as an exhibit to the
Registration Statement, to which reference is hereby made. The Underwriting
Agreement provides that the obligation of the Underwriters to purchase the
Shares is subject to certain conditions. The Underwriters are committed to
purchase all of the Shares (other than those covered by the Underwriters'
over-allotment option described below), if any are purchased.
The Representative has advised the Company that the Underwriters propose to
offer the Common Stock to the public at the initial public offering price set
forth on the cover page of this Prospectus, and that they may allow to certain
dealers who are members of the National Association of Securities Dealers, Inc.
("NASD") and to certain foreign dealers, concessions not in excess of $
per Share, of which amount a sum not in excess of $ per Share may in
turn be reallowed by such dealers to other dealers who are members of the NASD
and to certain foreign dealers. After the initial public offering, the offering
price, the concession to selected dealers and the reallowance to other dealers
may be changed by the Representative.
The Company has agreed to pay the Representative an expense allowance, on a
non-accountable basis, equal to 3% of the gross proceeds received by the Company
from the sale of the 2,000,000 Shares offered hereby (and any shares sold upon
the exercise of the Underwriters' over-allotment option). The Company has also
granted to the Representative and its designees, for nominal consideration,
Representative's Warrants to purchase from the Company up to 200,000 shares of
Common Stock at an exercise price per share equal to 120% of the public offering
price per share. See "Description of Securities-- Representative's Warrants."
The Company has granted the Representative the right, for a period of three
years commencing on the closing date of the Offering, to appoint an observer to
attend all meetings of the Board of Directors of the Company and receive
reimbursement for all out-of-pocket expenses incurred in attending such
meetings. In addition, the observer will be entitled to indemnification, to the
same extent as the Company directors.
The Representative has advised the Company that the Underwriters do not
intend to confirm sales of the Shares offered hereby to any account over which
they exercise discretionary authority.
The Company has also granted to the Underwriters, exercisable for 45 days
from the date of this Prospectus, to purchase up to 300,000 additional shares of
Common Stock at the public offering price less the underwriting discounts and
commissions. To the extent such option is exercised, each Underwriter will
53
become obligated, subject to certain conditions, to purchase additional shares
of Common Stock proportionate to such Underwriter's initial commitment as
indicated in the preceding table. The Underwriters may exercise such right of
purchase only for the purpose of covering over-allotments, if any, made in
connection with the sale of the Shares. Purchases of shares of Common Stock upon
exercise of the over-allotment option will result in the realization of
additional compensation by the Underwriters.
The Company has agreed to indemnify the Underwriters against certain
liabilities, including civil liabilities under the Securities Act, or will
contribute to payments the Underwriters may be required to make in respect
thereof.
The Company, its officers, directors, and certain stockholders holding an
aggregate of 895,552 shares of Common Stock have entered into agreements with
the Representative which prohibit them from offering, issuing, selling, or
otherwise disposing of any securities of the Company for a period of 18 months
following the date of this Prospectus, without the prior written consent of the
Representative. In addition, certain stockholders holding an aggregate of
426,654 shares of Common Stock have entered into agreements with the
Representative which prohibit them from offering, issuing, selling, or otherwise
disposing of any securities of the Company for a period of 12 months following
the date of this Prospectus, without the prior written consent of the
Representative. See "Principal Stockholders" and "Shares Eligible for Future
Sale."
Prior to the Offering, there has been no public trading market for the
Common Stock. The initial public offering price of the Common Stock has been
determined by arms-length negotiation between the Company and the Representative
and does not necessarily bear any relationship to the Company's book value,
assets, past operating results, financial condition, or other established
criteria of value. Factors considered in determining the offering price, in
addition to prevailing market conditions, included the history of and prospects
for the Company and the industry in which the Company competes, an assessment of
the Company's management, its capital structure and such other factors as were
deemed relevant.
During and after the Offering, the Underwriters may purchase and sell Common
Stock in the open market. These transactions may include over-allotment and
stabilizing transactions and purchases to cover syndicate short positions
created in connection with the Offering. The Underwriters also may impose a
penalty bid, whereby selling concessions allowed to syndicate members or other
broker-dealers in respect of the Common Stock sold in the Offering for their
account may be reclaimed by the syndicate if such shares are repurchased by the
syndicate in stabilizing or covering transactions. These activities may
stabilize, maintain or otherwise affect the market price of the Common Stock
which may be higher than the price that might otherwise prevail in the open
market. Neither the Company nor any of the Underwriters makes any representation
or prediction as to the direction or magnitude of any effect that the
transactions described above may have on the price of the Common Stock. In
addition, neither the Company nor any of the Underwriters makes any
representation that the Underwriters will engage in such transactions or that
such transactions, once commenced, will not be discontinued at any time.
The Representative acted as the placement agent in connection with the 1996
Placement and the Bridge Financing. See "Certain Relationships and Related
Transactions."
LEGAL MATTERS
The validity of the shares of Common Stock offered hereby and certain other
legal matters will be passed upon for the Company by Squadron, Ellenoff, Plesent
& Sheinfeld, LLP, New York, New York. Certain legal matters in connection with
the Offering will be passed upon for the Underwriters by Fulbright & Jaworski
L.L.P., New York, New York.
54
EXPERTS
The balance sheet as of December 31, 1996 and the statements of operations,
stockholders' equity and cash flows for the two years in the period ended
December 31, 1996, included in this prospectus, have been included herein in
reliance on the report, which report includes an explanatory paragraph relating
to the removal of a going concern explanation paragraph included in a previously
issued report, of Coopers & Lybrand L.L.P. independent certified public
accountants, given on the authority of that firm as experts in accounting and
auditing.
AVAILABLE INFORMATION
The Company has filed with the Commission, 450 Fifth Street, N.W.,
Washington D.C. 20549, a registration statement on Form SB-2 (the "Registration
Statement") under the Securities Act, with respect to the Common Stock offered
hereby. This Prospectus does not contain all the information set forth in the
Registration Statement and the exhibits thereto, as permitted by rules and
regulations of the Commission. For further information, reference is made to the
Registration Statement and to the exhibits filed therewith. Statements contained
in this Prospectus as to the content of any contract or other document which has
been filed as an exhibit to the Registration Statement are qualified in their
entirety by reference to such exhibits for a complete statement of their terms
and conditions. The Registration Statement and the exhibits thereto may be
inspected without charge at the offices of the Commission and copies of all or
any part thereof may be obtained from the Commission's Public Reference Section
at 450 Fifth Street, N.W., Washington, D.C. 20549 or at certain of the regional
offices of the Commission located at 7 World Trade Center, 13th Floor, New York,
New York 10048 and 500 West Madison Street, Suite 1400, Chicago, Illinois 60661,
upon payment of the fees prescribed by the Commission. The Commission maintains
a World Wide Web site on the Internet at http://www.sec.gov that contains
reports, proxy and information statements, and other information regarding
registrants that file electronically with the Commission. In addition, following
approval of the Common Stock for quotation on the Nasdaq SmallCap Maraket,
reports and other information concerning the Company may be inspected at the
offices of the NASD, 1801 K Street, N.W., Washington, D.C. 20006.
55
INDEX TO FINANCIAL STATEMENTS
CELERITY SYSTEMS, INC.
PAGE
-----
Report of Coopers & Lybrand L.L.P.......................................................................... F-1
Balance Sheets............................................................................................. F-2
Statements of Operations................................................................................... F-3
Statements of Stockholders' Equity......................................................................... F-4
Statements of Cash Flows................................................................................... F-5
Notes to Financial Statements.............................................................................. F-6
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
Celerity Systems, Inc.
We have audited the accompanying balance sheet of Celerity Systems, Inc.
(the "Company") as of December 31, 1996, and the related statements of
operations, stockholders' equity and cash flows for each of the two years in the
period ended December 31, 1996. 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.
Since the date of completion of our audit of the accompanying financial
statements and initial issuance of our report thereon dated March 7, 1997,
except for Notes 1, 7, 16 and 17 as to which the date is July 18, 1997, which
report contained an explanatory paragraph regarding the Company's ability to
continue as a going concern, the Company has received proceeds from a private
placement which, along with generated revenues, has alleviated the Company's
working capital shortage. Additionally, the Company obtained waivers of default
from certain debt holders regarding a late interest payment. In light of the
Company's improved financial condition, the conditions that raised substantial
doubt about whether the Company will continue as a going concern no longer
exist.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Celerity Systems, Inc. as of
December 31, 1996, and the results of its operations and its cash flows for each
of the two years in the period ended December 31, 1996, in conformity with
generally accepted accounting principles.
COOPERS & LYBRAND L.L.P.
Knoxville, Tennessee
March 7, 1997, except for Notes 1, 7, 11
and 16 for which the date is August 8, 1997
F-1
CELERITY SYSTEMS, INC.
BALANCE SHEETS
DECEMBER 31, JUNE 30,
1996 1997
------------------ ------------
(UNAUDITED)
ASSETS
Cash and cash equivalents....................................................... $ 2,344,666 $ 461,320
Accounts receivable, less allowance for doubtful accounts of $555,050 and
$570,050 in 1996 and 1997, respectively....................................... 713,232 1,627,063
Inventory....................................................................... 1,325,903 1,314,515
Prepaid expenses................................................................ -- 61,843
Costs in excess of billings on uncompleted contracts............................ 187,749 --
------------------ ------------
Total current assets...................................................... 4,571,550 3,464,741
Property and equipment, net..................................................... 813,290 885,983
Other assets.................................................................... 264,955 180,231
------------------ ------------
$ 5,649,795 $ 4,530,955
------------------ ------------
------------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable................................................................ $ 315,832 $ 1,385,471
Accrued liabilities............................................................. 672,740 763,748
Deferred revenue................................................................ 359,970 --
Interest payable................................................................ 150,000 300,000
Current portion of leases payable............................................... 7,821 3,502
Reserve for management compensation............................................. 137,500 106,584
Allowance for estimated losses on uncompleted contracts......................... 672,600 348,000
Billings in excess of costs and estimated earnings on uncompleted contracts..... 150,000 724,381
------------------ ------------
Total current liabilities................................................. 2,466,463 3,631,686
Long term notes payable......................................................... 3,000,000 3,000,000
Long term leases payable........................................................ 19,009 19,009
Commitments and contingencies (Notes 1, 5, 6 and 16)
Preferred stock, Series A, noncumulative, redeemable, convertible, $0.01 par
value, 390,334 shares authorized, issued and outstanding at December 31, 1996
and June 30, 1997, respectively............................................... 1,813,412 1,904,462
Preferred stock, Series B, noncumulative, redeemable, convertible, $0.01 par
value, 163,392 shares authorized, issued and outstanding at December 31, 1996
and June 30, 1997, respectively............................................... 932,720 980,759
Common stock, $0.001 par value, 15,000,000 shares authorized, 1,836,476 issued
and 1,819,113 outstanding at December 31, 1996 and June 30, 1997.............. 1,836 1,836
Additional paid-in capital...................................................... 3,280,920 4,682,883
Treasury stock, at cost......................................................... (67,500) (67,500)
Accumulated deficit............................................................. (5,797,065) (9,622,180)
------------------ ------------
Total liabilities and stockholders' equity................................ $ 5,649,795 $ 4,530,955
------------------ ------------
------------------ ------------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-2
CELERITY SYSTEMS, INC.
STATEMENTS OF OPERATIONS
YEAR ENDED SIX MONTHS ENDED
DECEMBER 31, JUNE 30,
--------------------------- ----------------------------
1995 1996 1996 1997
------------ ------------- ------------- -------------
(UNAUDITED)
Revenues............................................... $ 7,703,386 $ 2,530,097 $ 1,299,900 $ 1,254,503
Cost of revenues....................................... 4,609,262 3,513,023 1,251,746 1,169,978
------------ ------------- ------------- -------------
Gross margin......................................... 3,094,124 (982,926) 48,154 84,525
Operating expenses..................................... 3,044,584 4,491,433 1,786,648 3,777,905
------------ ------------- ------------- -------------
Income (loss) from operations........................ 49,540 (5,474,359) (1,738,494) (3,693,380)
Interest expense....................................... (34,889) (150,042) (53,770) (153,386)
Interest income........................................ 10,641 96,888 8,663 21,651
------------ ------------- ------------- -------------
Income (loss) before income taxes.................... 25,292 (5,527,513) (1,783,601) (3,825,115)
Income tax provision (benefit)......................... 15,400 (15,400) -- --
------------ ------------- ------------- -------------
Net income (loss).................................... $ 9,892 $ (5,512,113) $ (1,783,601) $ (3,825,115)
------------ ------------- ------------- -------------
------------ ------------- ------------- -------------
Income (loss) per common share (Note 12):
Primary income (loss) per share...................... $ .01 $ (2.75) $ (1.01) $ (1.61)
------------ ------------- ------------- -------------
------------ ------------- ------------- -------------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-3
CELERITY SYSTEMS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
ADDITIONAL
COMMON PAID-IN TREASURY ACCUMULATED
STOCK CAPITAL STOCK DEFICIT
----------- ------------ ---------- -------------
Balances, January 1, 1995..................................... $ 1,200 $ 153,800 $ -- $ (294,844)
Conversion of amounts due to stockholder to 17,915 shares of
common stock................................................ 17 87,767 -- --
Acquisition of 17,364 shares of common stock held in
treasury.................................................... -- -- (67,500) --
Accretion of premiums on preferred stocks..................... -- (149,839) -- --
Net income.................................................... -- -- -- 9,892
----------- ------------ ---------- -------------
Balances, December 31, 1995................................... 1,217 91,728 (67,500) (284,952)
Issuance of 426,648 shares of common stock for private
placement offering.......................................... 427 2,532,938 -- --
Conversion of note payable to 190,714 shares of common
stock....................................................... 191 934,309 -- --
Issuance of 1,200 shares of common stock under stock option
plan........................................................ 1 119 -- --
Accretion of premiums on preferred stocks..................... -- (278,174) -- --
Net loss...................................................... -- -- -- (5,512,113)
----------- ------------ ---------- -------------
Balances, December 31, 1996................................... 1,836 3,280,920 (67,500) (5,797,065)
Accretion of premiums on preferred stocks (unaudited)......... -- (139,087) -- --
Grant of stock options at below the assumed offering price
(unaudited)................................................. -- 1,541,050 -- --
Net loss (unaudited).......................................... -- -- -- (3,825,115)
----------- ------------ ---------- -------------
Balances, June 30, 1997 (unaudited)........................... $ 1,836 $ 4,682,883 $ (67,500) $ (9,622,180)
----------- ------------ ---------- -------------
----------- ------------ ---------- -------------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-4
CELERITY SYSTEMS, INC.
STATEMENTS OF CASH FLOWS
YEAR ENDED SIX MONTHS ENDED
DECEMBER 31, JUNE 30,
------------------------- --------------------------
1995 1996 1996 1997
----------- ------------ ------------ ------------
(UNAUDITED)
Net cash flows from operating activities:
Net income (loss)..................................... $ 9,892 $ (5,512,113) $ (1,783,601) $ (3,825,115)
Adjustments to reconcile net income (loss) to net cash
provided (used) by operating activities:
Depreciation and amortization....................... 124,078 277,287 84,734 214,636
Compensation expense for issuance of stock
options........................................... -- -- -- 1,541,050
Provision for doubtful accounts receivable.......... -- 555,050 30,000 15,000
Provision for inventory obsolescence................ -- 500,000 106,298 --
Reserve for management compensation................. -- 137,500 -- (30,916)
Deferred income taxes............................... 15,400 (15,400) -- --
Changes in current assets and liabilities:
Accounts receivable............................... (3,963,973) 2,887,635 2,867,644 (928,831)
Prepaid expenses.................................. -- -- -- (61,843)
Inventory......................................... (348,463) (1,383,416) (980,792) 11,388
Costs in excess of billings on uncompleted
contracts....................................... -- (187,749) -- 187,749
Accounts payable.................................. 1,632,096 (1,526,213) (440,203) 1,069,639
Accrued expenses.................................. 174,271 368,451 33,068 91,008
Deferred revenue.................................. -- 359,970 -- (359,970)
Interest payable.................................. (1,722) 139,508 46,736 150,000
Allowance for estimated losses on uncompleted
contracts....................................... -- 672,600 -- (324,600)
Billings in excess of costs and estimated earnings
on uncompleted contracts........................ 350,000 (200,000) 96,385 574,381
----------- ------------ ------------ ------------
Net cash provided (used) by operating
activities.................................... (2,008,421) (2,926,890) 60,269 (1,676,424)
----------- ------------ ------------ ------------
Cash flows from investing activities:
Purchases of property and equipment................... (506,637) (300,577) (166,245) (202,603)
Additions to other assets............................. (1,171) 25 25 --
----------- ------------ ------------ ------------
Net cash used in investing activities........... (507,808) (300,552) (166,220) (202,603)
----------- ------------ ------------ ------------
Cash flows from financing activities:
Proceeds from notes payable........................... 934,500 3,000,000 607,500 --
Principal payments on long-term debt, notes payable
and capital leases.................................. (8,000) (108,243) (22,546) (4,319)
Change in amounts due stockholders.................... (21,000) -- -- --
Proceeds from issuance of common stock................ -- 2,533,485 489,159 -
Repurchase of common stock............................ (67,500) -- -- --
Proceeds from issuance of preferred stock............. 2,068,119 -- -- --
Debt offering costs................................... -- (338,910) (60,750) --
----------- ------------ ------------ ------------
Net cash provided (used) by financing
activities.................................... 2,906,119 5,086,332 1,013,363 (4,319)
----------- ------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents.... 389,890 1,858,890 907,412 (1,883,346)
Cash and cash equivalents, beginning of period.......... 95,886 485,776 485,776 2,344,666
----------- ------------ ------------ ------------
Cash and cash equivalents, end of period................ $ 485,776 $ 2,344,666 $ 1,393,188 $ 461,320
----------- ------------ ------------ ------------
----------- ------------ ------------ ------------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-5
CELERITY SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION AND NATURE OF BUSINESS
Celerity Systems, Inc., a Tennessee corporation founded in 1993, designs,
develops, integrates, installs, operates and supports interactive video services
hardware and software ("interactive video"). The Company also designs, develops,
installs, and supports CD-ROM software products for business applications. In
the interactive video services area, the Company seeks to provide solutions,
including products and services developed by the Company and by strategic
partners, that enable interactive video programming and applications to be
provided to a wide variety of market niches. The sales of interactive video
products are principally made on a contract by contract basis. Currently, the
principal markets for the Company's interactive video products are Korea,
Israel, Taiwan and China. In the CD-ROM area, the Company provides several
products for the storage and rapid retrieval of large amounts of information.
The majority of the Company's existing CD-ROM customer base is in the security
brokerage industry and in U.S. Government applications.
The Company was founded under Subchapter S corporation status. In
conjunction with an equity infusion from certain outside investors in May of
1995, the Company elected to become a C corporation. Subsequent to June 30,
1997, Celerity Systems, Inc., a Delaware corporation, was formed. The Tennessee
corporation will be merged with the Delaware corporation during the third
quarter of 1997.
The Company is currently preparing a registration statement under Regulation
SB-2. Management anticipates that the registration statement will be filed with
the Securities and Exchange Commission (SEC) in August 1997.
The Company had seven customers that in the aggregate represented in excess
of 50% of its revenues in 1996 and four customers represented in excess of 90%
of its revenues in 1995. The Company had three customers that in the aggregate
represented in excess of 75% of its revenues for the six month period ended June
30, 1997.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
INTERIM FINANCIAL STATEMENTS--Information in the accompanying financial
statements and notes to the financial statements for the interim periods as of
and for the six months ended June 30, 1995 and 1996, is unaudited. The
accompanying unaudited financial statements have been prepared in accordance
with generally accepted accounting principles and Regulation S-B. Accordingly,
they do not include all the information and footnotes required by generally
accepted accounting principles for complete financial statements. In the opinion
of management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. Operating
results for the six month period ended June 30, 1997, are not necessarily
indicative of the results that may be expected for the year ending December 31,
1997.
CASH AND CASH EQUIVALENTS--The Company considers all highly liquid debt
instruments with an original maturity of three months or less as cash
equivalents. The Company places its temporary cash investments principally in
bank repurchase agreements with one bank. The Company does not obtain collateral
on its investment or deposit accounts.
ACCOUNTS RECEIVABLE--The Company does not require collateral or other
security to support customer receivables.
F-6
CELERITY SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INVENTORY--Inventory, consisting primarily of electronic components for
interactive video servers, is stated at the lower of cost or market, with cost
being determined using the first-in first-out (FIFO) method.
REVENUE RECOGNITION--Long-term contracts related to the Company's
interactive video segment are accounted for under the percentage of completion
method as these contracts extend over relatively long periods of time. The
Company measures the percentage complete by contract based upon the costs
incurred to date in relation to the total estimated costs for the contract.
Costs are charged to contracts as incurred based upon material costs, hours
dedicated to the contract, and allocations of overhead costs based on
predetermined overhead rates. Billings in excess of costs and estimated earnings
on uncompleted contracts are reflected as liabilities in the accompanying
balance sheet. The Company has established an allowance for estimated losses on
uncompleted contracts to record management's estimates of losses that have been
projected on certain contracts in progress. The Company entered into one
short-term contract related to the interactive video segment in 1996 and another
in 1997, and income from these contracts is recorded by the completed contract
method of accounting. Billings in excess of costs are recorded net as a current
liability related to these two contracts. The Company records sales of products
not under contract when the related products are shipped.
RECLASSIFICATION--Certain amounts presented in the December 31, 1995 and
1996 financial statements have been reclassified from amounts previously
reported to conform to Regulation S-B requirements.
PROPERTY AND EQUIPMENT--Property and equipment are stated at cost.
Depreciation is computed using the straight-line method over the estimated
useful lives of the underlying assets, generally five years. Routine repair and
maintenance costs are expensed as incurred. Costs of major additions,
replacements and improvements are capitalized. Gains and losses from disposals
are included in income.
SEGMENT INFORMATION REPORTING--In June 1997, the FASB issued Statement of
Financial Accounting Standards (SFAS) No. 131, DISCLOSURES ABOUT SEGMENTS OF AN
ENTERPRISE AND RELATED INFORMATION. In accordance with this Statement, the
Company has presented segment information for the CD-ROM and interactive video
segments for the year ended December 31, 1996, and for the interim periods ended
June 30, 1996 and 1997 (unaudited). In accordance with SFAS 131, the interim
information is condensed in comparison with the audited period presented.
OTHER ASSETS--Other assets consist of debt offering costs related to a
private placement offering in 1996. The costs are being amortized straight-line
over the term of the related debt. Amortization expense in 1996 was $84,726.
RESEARCH AND DEVELOPMENT COSTS--Research and development costs are expensed
as incurred and amounted to $810,772 and $479,558 for the years ended December
31, 1995 and 1996, respectively. These amounts are included in operating
expenses in the accompanying statements of operations.
INCOME TAXES--The Company accounts for income taxes under the provisions of
Statement of Financial Accounting Standards No. 109, ACCOUNTING FOR INCOME TAXES
(FAS 109). Under FAS 109, the asset and liability method is used in accounting
for income taxes, whereby deferred tax assets and liabilities are determined
based upon the differences between financial reporting and tax bases of assets
and liabilities and are measured using the enacted tax rates and laws that will
be in effect when the differences are expected to reverse.
F-7
CELERITY SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REVERSE STOCK SPLIT--In August 1997, the Board of Directors approved a
1-for-2 1/2 reverse stock split of the Company's common stock for shareholders
of record. All common share and per share amounts included in the accompanying
financial statements have been restated to retroactively reflect the reverse
split.
STOCK BASED COMPENSATION--On January 1, 1996, the Company adopted SFAS 123,
ACCOUNTING FOR STOCK BASED COMPENSATION. As permitted by SFAS 123, the Company
has chosen to apply APB Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES
(APB 25) and related interpretations in accounting for its Plans. The pro forma
disclosures of the impact of SFAS 123 are described in Note 11 of the financial
statements.
ESTIMATES--The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. The
significant areas of estimation included in the accompanying financial
statements relate principally to the percentage of completion calculations for
long-term contracts, the collection of accounts receivable and inventory
valuation.
IMPACT OF SFAS 128--In February 1997, the FASB issued SFAS 128, EARNINGS PER
SHARE. The Statement simplifies the standards for computing earnings per share
(EPS). Additionally, the Statement requires dual presentation of basic and
diluted EPS on the face of the income statement and requires a reconciliation of
the numerator and denominator of the diluted EPS calculation. The Company plans
to adopt the provisions of SFAS 128 for the fiscal year ended December 31, 1998.
Had the pronouncement been in effect at June 30, 1996 and 1997, basic EPS would
have been $(1.49) and $(2.10). Basic EPS at December 31, 1995 and 1996, would
have been $.01 and $(3.81), respectively. The diluted EPS for the six month
periods ended June 30, 1996 and 1997, and for the years ended December 31, 1995
and 1996, would have been $(1.01), $(1.61), $.01 and $(2.75), respectively.
IMPACT OF SFAS 130--In June 1997, the FASB issued SFAS 130, REPORTING
COMPREHENSIVE INCOME, which will be effective for fiscal years beginning after
December 15, 1997. This standard will have no material impact on the Company.
3. INVENTORY
Inventory at December 31, 1996, consists of:
Raw materials................................................... $1,045,530
Finished goods.................................................. 780,373
---------
1,825,903
Reserve for inventory valuation................................. 500,000
---------
$1,325,903
---------
---------
F-8
CELERITY SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
4. PROPERTY AND EQUIPMENT
Substantially all property and equipment of the Company is comprised of
computers and computer related equipment, therefore all property and equipment
is included in one category entitled "Property and equipment, net." Following is
a schedule of the cost and related accumulated depreciation for December 31,
1996.
Property and equipment.......................................... $1,181,552
Accumulated depreciation........................................ 368,262
---------
Property and equipment, net..................................... $ 813,290
---------
---------
5. LONG-TERM CONTRACTS
The Company was awarded two projects during 1995 that are being accounted
for under the percentage of completion method for long-term contracts. These
contracts generate a significant amount of revenues and future revenue potential
for the Company as well as providing the funding mechanism for the related
product's development.
The following summary delineates the costs incurred, estimated earnings and
billings through December 31, 1996, for the Israel project (Project #1).
Contract revenues............................................... $1,044,004
---------
---------
Costs incurred through December 31.............................. $ 436,005
Estimated costs to complete..................................... 133,000
---------
Total estimated costs....................................... $ 569,005
---------
---------
Percentage complete............................................. 76.63%
Contract billings............................................... $ 949,977
Costs and estimated earnings to be recognized................... 799,977
---------
Billings in excess of costs and estimated earnings.............. $ 150,000
---------
---------
The Korea project (Project #2) began to incur losses during fiscal year
1996, and the Company recorded the losses as they occurred. Management estimates
that the project will lose an additional $672,600 prior to completion of the
project in 1997 and has recorded an allowance and increased cost of revenues by
this amount for the year ended December 31, 1996. The effect of the change in
estimate for the fiscal year ending December 31, 1996, was to increase the net
loss by $672,600 and the loss per share by $.34.
Amounts included in BILLINGS IN EXCESS OF COSTS AND ESTIMATED EARNINGS ON
UNCOMPLETED CONTRACTS represent billings in excess of costs and estimated
earnings on Project #1 and on contracts recorded under the completed contract
method.
At June 30, 1997, the balance of the allowance for estimated losses on
uncompleted contracts was $348,000 and these projects remain in progress with no
additional losses expected.
F-9
CELERITY SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
6. MANAGEMENT COMPENSATION RESERVE
On April 5, 1997, the Company entered into a termination agreement with one
of the Company's original founders, whereby the individual would no longer be an
employee or board member of the Company. The Company agreed to certain payment
schedules in accordance with the individual's prior employment contract. The
Company's obligations under the termination agreement could be eliminated or
reduced dependant upon the occurrence of certain events. One provision was the
timeliness and amounts of cash receipts from a customer with which the Company
had a signed contract (Note 16). That customer defaulted which resulted in a
decrease in the number of payments the Company was required to pay under the
terms of the agreement. As of December 31, 1996, the Company accrued $137,500
for management compensation relating to this agreement.
7. INCOME TAXES
The tax effects of temporary differences giving rise to the Company's
deferred tax assets (liabilities) at December 31, 1996, are as follows:
Current:
Allowance for doubtful accounts............................... $ 211,000
Inventory reserve............................................. 190,000
Warranty reserve.............................................. 76,000
Deferred revenue.............................................. 137,000
Management compensation reserve............................... 52,000
---------
666,000
Valuation allowance for net current deferred tax assets....... (666,000)
---------
Total net current deferred tax asset.......................... $ --
---------
---------
Noncurrent:
Net operating loss carryforwards.............................. $1,467,000
Property and equipment........................................ (72,000)
---------
1,395,000
Valuation allowance for net non-current deferred tax assets... (1,395,000)
---------
Total net non-current deferred tax asset...................... $ --
---------
---------
As a result of the significant pretax loss in fiscal 1996, management can
not conclude that it is more likely than not that the deferred tax asset will be
realized. Accordingly, a valuation allowance has been established against the
total net deferred tax assets.
F-10
CELERITY SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
7. INCOME TAXES (CONTINUED)
The December 31, 1995 and 1996 provisions for income taxes consist of the
following:
1995 1996
--------- -----------
Federal:
Current tax expense..................................................................... $ -- $ --
Deferred tax expense attributable to change in valuation allowance...................... -- 1,844,100
Deferred tax (benefit) attributable to temporary differences............................ 32,700 (564,100)
Deferred tax (benefit) attributable to net operating loss carryforwards................. (18,900) (1,293,700)
State:
Current tax expense..................................................................... -- --
Deferred tax expense attributable to change in valuation allowance...................... -- 216,900
Deferred tax (benefit) attributable to temporary differences............................ 3,800 (66,400)
Deferred tax (benefit) attributable to net operating loss carryforwards................. (2,200) (152,200)
--------- -----------
$ 15,400 $ (15,400)
--------- -----------
--------- -----------
The Company's income tax benefit differs from that obtained by using the
statutory rate of 34% as a result of the following:
1995 1996
--------- -------------
Computed "expected" tax expense (benefit)............................................... $ 8,600 $ (1,879,000)
State income taxes, net of federal income tax benefit................................... 1,000 (221,000)
Change in valuation allowance........................................................... -- 2,061,000
Permanent differences................................................................... 5,000 18,000
Other................................................................................... 800 5,600
--------- -------------
$ 15,400 $ (15,400)
--------- -------------
--------- -------------
At December 31, 1996, the Company had approximately $3,800,000 of net
operating loss carryforwards. These amounts are available to reduce the
Company's future taxable income and expire in the years 2010 through 2011.
8. NOTES PAYABLE
In June and July 1996, the Company sold 60 units in a private placement
offering to outside investors. The units consisted of one 10% Note (the "1996
Notes") in the principal amount of $50,000, 7,111 shares of common stock, and
warrants to purchase 2,625 shares of common stock. Additionally, the agent
received warrants to purchase 35,556 shares of common stock at $10.31 per share.
In November 1996, the Company issued an additional 867 warrants for each unit
held by the outside investors in connection with the Company's default on
previously outstanding investor debt, and subsequent conversion of the principal
to common stock (see Note 9). All warrants issued in the 1996 placement now have
an exercise price of $8.46 and will expire on the earlier of the fifth
anniversary of the date of issuance of the warrant or the third anniversary of
the closing of the initial public offering of the Company's securities. The
warrants issued to the agent were increased to 38,852 in connection with the
default and the exercise price was decreased to $9.44. These will expire five
years from the date of grant.
F-11
CELERITY SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
8. NOTES PAYABLE (CONTINUED)
Notes payable at December 31, 1996, consisted of the $3,000,000 unsecured
promissory notes payable to outside investors due June 1998, bearing interest at
10% per annum. The Company missed an interest payment due June 30, 1997, with
respect to the 1996 Notes, however, the Company has received waivers as to such
defaults through the date of the earlier of an initial public offering or the
maturity date of the 1996 Notes.
9. INVESTOR DEBT WITH DETACHABLE WARRANTS
In November of 1995, the Company issued twelve month promissory notes under
an arrangement with certain third parties, including a number of previous
investors in the Company's Series A and B Preferred Stock. The purchasers of the
notes also received warrants to purchase 190,714 shares of the Company's common
stock at an exercise price of $4.90 per share.
The related warrant agreements contain certain provisions which include the
expiration of the warrants upon the earlier of May 31, 1998 or the issuance of
shares of the Company's common stock in a public offering with an aggregate
price of $5 million or more and at a Company valuation of at least $10 million.
The outstanding principal balance at December 31, 1995, was $934,500.
Interest accrued at a fixed rate of 10% and was payable at the end of the notes'
term. When interest payments on such notes were not made by November 30, 1996,
the notes automatically converted, at a rate of $4.90 per share, into an
aggregate of 190,714 shares of common stock. The interest, which had been
accrued on the debt, was forgiven.
10. REDEEMABLE CONVERTIBLE PREFERRED STOCK
The Board of Directors authorized the issuance of 390,334 shares of Series A
Preferred Stock at $3.88 per share and 163,392 shares of Series B Preferred
Stock at $4.90 per share in May 1995. The Company issued the Series A Preferred
Stock on May 17, 1995, and the Series B Preferred Stock on August 20, 1995. The
holders of the preferred stock have generally the same voting rights as those of
the common stockholders. Each class of preferred stock has a redemption feature
available to the holders thereof at any time after April 1, 2000, or upon
default by the Company of certain provisions included in the stock purchase
agreements. Additionally, the holders of the preferred stock have appointed a
member of the Board of Directors of the Company.
Each class of preferred stock includes certain conversion, liquidation and
redemption privileges, including the accrual of premiums of 12% annually. The
accretion of the premiums which has been reflected as a reduction in additional
paid-in capital in the accompanying financial statements. Each share of
preferred stock is convertible into one share of common stock, adjusted for
dilution, if any, for the issuance of the Company's common stock at purchase
prices below those of the respective preferred share issuances. Each class of
the preferred stock automatically converts to common stock upon the issuance of
a minimum of $5 million, net of underwriters fees, through an initial public
offering of the Company's stock under the Securities Act of 1933. Upon the
effective date of a registration statement for an initial public offering, all
of the Company's issued and outstanding classes of preferred stock will be
converted into 553,726 shares of common stock.
F-12
CELERITY SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
11. STOCK OPTIONS
The Company established a stock option plan in 1995 to provide additional
incentives to its officers and employees. Eligible persons are all employees
employed on the date of grant. Management may vary the terms, provisions and
exercise price of individual options granted, with both incentive stock options
and non-qualified options authorized for grant. Each option granted under the
plan shall be exercisable only during a fixed term from the date of grant as
specified by management, but generally equal to 10 years. Options are vested
upon completion of three full years of service with the Company or upon the
Company's issuance of at least $5 million of capital. In 1995, the Board of
Directors approved the issuance of up to 178,929 options to acquire common
shares of which 164,800 options were granted. In 1997, the Company established
an additional stock option plan under which 200,000 options to acquire common
shares may be granted. There have been no shares granted under this plan.
In December 1995, the Company granted options to acquire 14,000 common
shares to a member of the Company's Board outside the 1995 plan. These options
vest over a three year period, are exercisable at $0.10 per share and expire
upon the earlier of (a) three months after the board member ceases to be a
member, (b) twelve months from the board member's death, or (c) ten years from
date of grant.
A summary of outstanding options as of December 31, 1995 and 1996, and
changes during the years ended on those dates is presented below:
1995 1996
-------------------------- --------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE
--------- --------------- --------- ---------------
Outstanding at beginning of year(1).......................... -- $ -- 178,800 $ 0.10
Granted...................................................... 178,800(1) 0.10 14,800 4.90
Exercised.................................................... -- -- (1,200) 0.10
Forfeited.................................................... -- -- (6,600) 0.10
--------- ----- --------- -----
Outstanding at end of year................................... 178,800 $ 0.10 185,800 $ 0.43
--------- ----- --------- -----
--------- ----- --------- -----
Options exercisable at year end.............................. -- $ -- 74,400 $ 0.10
--------- ----- --------- -----
--------- ----- --------- -----
Weighted-average fair value of options granted during the
year....................................................... 178,800 $ 0.03 14,800 $ 0.53
--------- ----- --------- -----
--------- ----- --------- -----
- ------------------------
(1) Includes 14,000 options granted to an outside director. These options were
granted outside the 1995 plan.
The following table summarizes information about stock options at December
31, 1996:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------------- ----------------------------
NUMBER WEIGHTED-AVERAGE WEIGHTED NUMBER WEIGHTED
RANGE OF OUTSTANDING REMAINING AVERAGE EXERCISABLE AVERAGE
EXERCISE PRICE AT 12/31/96 CONTRACTUAL LIFE EXERCISE PRICE AT 12/31/96 EXERCISE PRICE
- --------------- ----------- ---------------- --------------- ----------- ---------------
$ 0.10 173,000 8.58 years $ 0.10 74,400 $ 0.10
$ 4.90 12,800 9.25 years $ 4.90 -- $ --
F-13
CELERITY SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
11. STOCK OPTIONS (CONTINUED)
Had compensation cost for the option grants been determined based on the
fair value at the grant dates for awards under the Plan consistent with the
method of SFAS 123, the Company's net income (loss) would have been reduced to
the pro forma amounts indicated below at December 31:
1995 1996
------------------------ ----------------------------
AS AS
REPORTED PRO FORMA REPORTED PRO FORMA
----------- ----------- ------------- -------------
Net income................................................... $ 9,892 $ 7,490 $ (5,512,113) $ (5,519,984)
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in 1995 and 1996: risk-free interest rate of 6.46%
and expected lives of 10 years.
The Company expects to recognize approximately $1,215,000 of compensation
expense in the third quarter of fiscal 1997, related to options granted from
July 1, 1997 to August 8, 1997.
12. INCOME (LOSS) PER SHARE
Income (loss) per share has been computed by dividing net income (loss) by
the weighted average number of common and common equivalent shares outstanding
during each period. Common equivalent shares relating to options issued during
the twelve month period preceding the filing of a registration statement at a
price below the estimated offering price have been calculated using the treasury
stock method assuming that the options were outstanding during each period
presented and that the fair value of the Company's common stock during each
period was equal to the assumed initial public offering price of $7.50 per
share. Remaining warrants, options, and preferred stock granted prior to the one
year period before the filing of the initial public offering were considered
common stock equivalents but were not included for purposes of calculating
primary income (loss) per share because they were anti-dilutive.
After giving effect to the items described above, income (loss) per common
share have been computed based on the assumed weighted average number of shares
outstanding in each period (1,749,245 shares in fiscal year 1995; 2,006,582
shares in fiscal year 1996; 1,761,373 and 2,379,934 shares for the six months
ended June 30, 1996 and 1997 (unaudited), respectively).
13. SEGMENT INFORMATION
The Company has two reportable segments: CD-ROM and interactive video. The
CD-ROM segment includes the design, development, installation and support of
CD-ROM storage and imaging software products for business applications. The
interactive video segment includes the design, development, integration,
installation, operation and support of interactive video services hardware and
software. The Company's two reportable segments offer different products and
services and market such products to different customer bases. The two segments
are managed separately because each business requires different technology and
marketing strategies. The two segments evolved over the life of the Company and
have specifically identifiable tangible assets. The segments share certain
corporate assets and, as such, those are not specifically identified in the
segment information.
F-14
CELERITY SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
13. SEGMENT INFORMATION (CONTINUED)
Summarized financial information by business segment for the year ended
December 31, 1996, approximates the following:
INTERACTIVE
CD-ROM VIDEO TOTALS
------------ ----------- ------------
Revenues from external customers........................................ $ 1,809,400 $ 720,697 $ 2,530,097
Depreciation and amortization........................................... 71,700 187,200 258,900
Segment loss............................................................ (820,400) (4,691,700) (5,512,100)
Other significant noncash items:
Bad debt provision.................................................... -- 555,050 555,050
Inventory valuation provision......................................... -- 500,000 500,000
Segment long-lived assets............................................... 530,900 2,432,500 2,963,400
Expenditures for segment long-lived assets.............................. 66,800 214,900 281,700
The total of the segment assets reported above varies from the total assets
of the Company due to the inability to allocate corporate assets. The corporate
assets consist of cash, fixed assets, offering costs, and other assets. The
following is a reconciliation of the Company's total assets, depreciation and
amortization expense, and cash expenditures for assets to the totals of the
segments' reported above:
ASSETS
Total assets of the segments.................................................. $2,963,400
Unallocated corporate assets.................................................. 2,686,395
---------
Total assets.............................................................. $5,649,795
---------
---------
DEPRECIATION AND AMORTIZATION EXPENSE
Segment depreciation and amortization......................................... $ 258,900
Unallocated corporate depreciation............................................ 18,387
---------
Total depreciation and amortization expense............................... $ 277,287
---------
---------
EXPENDITURES FOR LONG-LIVED ASSETS
Segment expenditures for long-lived assets.................................... $ 281,700
Unallocated corporate expenditures for long-lived assets...................... 18,852
---------
Total expenditures for assets............................................. $ 300,552
---------
---------
F-15
CELERITY SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
13. SEGMENT INFORMATION (CONTINUED)
The segment information for the six month periods ending June 30, 1996 and
1997, is as follows:
JUNE 30, JUNE 30,
1996 1997
---------------- ----------------
(UNAUDITED) (UNAUDITED)
REVENUES FROM EXTERNAL CUSTOMERS
CD-ROM..................................................................... $ 838,500 $ 498,600
Interactive video.......................................................... 461,400 755,903
---------------- ----------------
Total.................................................................. $ 1,299,900 $ 1,254,503
---------------- ----------------
---------------- ----------------
SEGMENT PROFIT (LOSS)
CD-ROM..................................................................... $ (233,300) $ 727,500
Interactive video.......................................................... (1,550,301) 1,556,565
---------------- ----------------
Total.................................................................. $ (1,783,601) $ 2,284,065
---------------- ----------------
---------------- ----------------
SEGMENT ASSETS
CD-ROM..................................................................... Not applicable $ 517,600
Interactive video.......................................................... Not applicable 3,245,800
---------------- ----------------
Total.................................................................. Not applicable $ 3,763,400
---------------- ----------------
---------------- ----------------
The change in the asset balance at June 30, 1997, for the interactive video
segment when compared to the aforementioned December 31, 1996 segment
information is approximately $813,300. This change is due to an increase in
interactive video segment accounts receivable relating to one of the Company's
current short-term contracts. There were no significant changes in the CD-ROM
segment assets between the audited financial statements and June 30, 1997. The
segment asset information for the period ended June 30, 1996, is not presented
as no balance sheet is presented for this period.
The accounting policies of the segments are the same as those described in
the summary of significant accounting policies. The segment information provided
contains allocations of certain corporate assets and expenses which are shared
by each of the segments. The allocations are generally based on a 25%/75% basis
for the CD-ROM and interactive video segments, respectively. Neither of the
segments have financial operations and, therefore, there are no material amounts
of interest revenue or expense generated. There was a net interest expense for
the Company of $53,154 for the year ended December 31, 1996.
14. CASH FLOWS:
Supplemental disclosure of cash flow information for the years ended
December 31:
1995 1996
--------- ---------
Cash paid during year for:
Interest..................................................................................... $ 38,010 $ 9,973
Taxes........................................................................................ -- --
Noncash investing and financing activities:
Capital lease obligations of $34,973 were incurred when the Company
entered into leases for new equipment in 1995.
Amounts due to stockholders and related interest payable totaling
$87,784 were converted into the Company's common stock in 1995.
F-16
CELERITY SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
14. CASH FLOWS: (CONTINUED)
The Company recorded $149,839 and $278,174 for accretion of interest on
preferred stocks in 1995 and 1996, respectively.
Notes payable of $250,000 were converted to the Company's Series A
Preferred Stock in 1995.
Notes payable of $934,500 were converted to the Company's common stock
in 1996.
15. LEASES
Operating leases -- The Company leases office space and certain equipment
under operating leases. Future minimum lease payments by year, and in the
aggregate, under noncancellable operating leases with remaining terms of one
year or more at December 31, 1996, are as follows:
1997.............................................................................. $ 125,646
1998.............................................................................. 136,592
1999.............................................................................. 139,423
2000.............................................................................. 48,857
---------
Total minimum lease payments.................................................. $ 450,518
---------
---------
Rent expense for operating leases was $70,957 and $126,903 in 1995 and 1996,
respectively.
16. SUBSEQUENT EVENTS
PRIVATE PLACEMENT
In August 1997, the Company sold 20 units, each consisting of a 10% Note in
the principal amount of $100,000 and warrants to purchase 16,000 shares of
common stock at $3.00 per share. This private placement provided approximately
$1,700,000 in net proceeds to the Company. The proceeds will be used principally
to pay outstanding trade payables and provide working capital. In connection
with this placement, the Company entered into stock repurchase agreements with
one of the Company's former officers and with a director. The Company is to pay
$0.50 per share for a combined total of 320,000 shares currently held by the two
individuals, using a portion of the funds from the private placement.
The Company recorded debt discount and additional paid in capital for the
fair value of the warrants which was $1,440,000. The fair value of the warrants
was determined based on the difference between the $7.50 estimated offering
price and the $3.00 exercise price of the warrants.
Upon the initial public offering, the Company expects that it will repay
amounts due under the placement creating a charge of $1,440,000 in the third
quarter of fiscal 1997, related to interest expense and loss on early
extinguishment of debt.
LICENSE AGREEMENT
In September 1996, the Company entered into an agreement with En Kay Telecom
Co., Ltd. a Korean company ("En K"), pursuant to which the Company, as licensor,
agreed to design a digital set top box which would be manufactured and sold by
En K in the Republic of Korea (the "1996 En K Agreement"). In February 1997, the
Company entered into a second license agreement with En K for the manufacture
and sale by En K of additional Company products in Korea (the "1997 En K
Agreement"). The Company
F-17
CELERITY SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
16. SUBSEQUENT EVENTS (CONTINUED)
has stopped production under the 1996 En K Agreement under which it has received
$600,000, pending settlement of disputes under the 1997 En K Agreement. The 1997
En K Agreement provided for the payment by En K to the Company of $1,000,000 on
each of February 19, 1997, and May 1, 1997, and $4,000,000 during 1998. En K
failed to make the initial two payments under the 1997 En K Agreement, although
it did pay $200,000 in mid-May, and promised to pay an additional $1,800,000 due
by June 30, 1997 (which it failed to do). The Company gave notice of default on
April 5, 1997, and placed En K in default on May 5, 1997, when En K failed to
cure within the agreed thirty-day period. The Company is considering various
options in this matter, including commencing legal proceedings. There can be no
assurance that En K will honor either of its agreements with the Company, that
the Company will prevail in any legal proceedings, or, if the Company does
prevail, that it will collect any amounts awarded. In addition, although the
Company does not believe there is any basis for such a course of action, it is
possible that En K may seek to recover amounts previously paid by it under the
agreements.
EMPLOYMENT AGREEMENTS
The Company has entered into employment agreements with two key employees.
One of the agreements provides for a base salary of approximately $162,000,
opportunity for an annual incentive bonus of up to 99% of the base salary
dependent upon reaching certain milestones, up to $45,000 in expense
reimbursement related to relocation, and grants of common stock and options to
purchase common stock. This employee has been granted 413,200 options which are
non-qualified. Options totaling 183,200 which were granted in April and June
1997, with an exercise price of $1.38 per share, are vested over the sooner of
(a) a two year period or (b) an initial public offering raising $5 million or
more in capital, with the remaining 230,000 options which were granted in July
1997, being 100 percent vested with an exercise price of $3.00 per share. The
413,200 options expire ten years from the date of grant. The Company has
recorded compensation expense for the six months ended June 30, 1997, totaling
approximately $1,122,000 relating to the 183,200 options granted in April and
June 1997. In addition, in July 1997, the employee purchased 15,000 shares of
common stock for payment of $.001 per share as well as for giving up certain
anti-dilution rights. This agreement expires January 20, 2000 and may not be
terminated without cause.
Under the other employment agreement, which can be terminated only for cause
or disability, the employee receives a base salary of approximately $134,000
subject to increases to be approved by the Board. This agreement expires May 1,
2000.
F-18
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NO DEALER, SALES REPRESENTATIVE OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE
ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS,
AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED
UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR THE UNDERWRITERS. THIS
PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER
TO BUY, ANY OF THE SECURITIES OFFERED HEREBY IN ANY JURISDICTION TO ANY PERSON
TO WHOM IT IS UNLAWFUL TO MAKE SUCH AN OFFER OR SOLICITATION IN SUCH
JURISDICTION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE
INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE
HEREOF.
------------------------
TABLE OF CONTENTS
PAGE
---------
Prospectus Summary.............................. 3
Risk Factors.................................... 7
Use of Proceeds................................. 16
Dividend Policy................................. 16
Dilution........................................ 17
Capitalization.................................. 19
Selected Financial Data......................... 20
Management's Discussion and Analysis of
Financial Condition and Results of
Operations.................................... 21
Business........................................ 24
Management...................................... 39
Principal Stockholders.......................... 45
Certain Relationships and Related
Transactions.................................. 46
Description of Securities....................... 48
Shares Eligible for Future Sale................. 51
Underwriting.................................... 53
Legal Matters................................... 54
Experts......................................... 55
Available Information........................... 55
Index to Financial Statements................... F-1
------------------------
UNTIL , 1997 (25 DAYS AFTER THE DATE HEREOF), ALL DEALERS
EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES, WHETHER OR NOT
PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS.
THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN
ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OF
SUBSCRIPTIONS.
2,000,000 SHARES
CELERITY SYSTEMS,
INC.
COMMON STOCK
------------------
PROSPECTUS
------------------
HAMPSHIRE SECURITIES CORPORATION
, 1997
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 24. INDEMNIFICATION OF OFFICERS AND DIRECTORS
Delaware General Corporation Law, Section 102(b)(7), enables a corporation
in its original certificate of incorporation, or an amendment thereto validly
approved by stockholders, to eliminate or limit personal liability of members of
its Board of Directors for violations of a director's fiduciary duty of care.
However, the elimination or limitation shall not apply where there has been a
breach of the duty of loyalty, failure to act in good faith, intentional
misconduct or a knowing violation of a law, the payment of a dividend or
approval of a stock repurchase which is deemed illegal or an improper personal
benefit is obtained. The Company's Certificate of Incorporation includes the
following language:
"No director of the Corporation shall be liable to the Corporation or any of
its stockholders for monetary damages for breach of fiduciary duty as a
director, provided that this provision does not eliminate or limit the liability
of the director (i) for any breach of the director's duty of loyalty to the
Corporation or its stockholders, (ii) for acts or omissions not in good faith or
which involve intentional misconduct or a knowing violation of law, (iii) under
Section 174 of Title 8 of the Delaware Code, or (iv) for any transaction from
which the director derived an improper personal benefit. For purposes of the
prior sentence, the term "damages" shall, to the extent permitted by law,
include, without limitation, any judgment, fine, amount paid in settlement,
penalty, punitive damages, excise, or other tax, including, without limitation,
any of the foregoing incurred or assessed with respect to an employee benefit
plan, or expense of any nature (including, without limitation, counsel fees and
disbursements)." According to the Certificate of Incorporation, the limitations
of liability discussed in this provision cannot be limited by a modification of
the Certificate of Incorporation for acts that occurred prior to that
modification.
Article NINTH of the Certificate of Incorporation of the Company, permits
indemnification of, and advancement of expenses to, among others, officers and
directors of the Corporation. Such Article provides as follows:
"A. Each person who was or is made a party or is threatened to be made a
party to or is otherwise involved in any action, suit, or proceeding, whether
civil, criminal, administrative, or investigative (hereinafter a "proceeding"),
by reason of the fact that he or she is or was a director, officer, employee, or
agent of the Corporation or any of its direct or indirect subsidiaries or is or
was serving at the request of the Corporation as a director, officer, employee,
or agent of any other corporation or of a partnership, joint venture, trust, or
other enterprise, including service with respect to an employee benefit plan
(hereinafter an "indemnitee"), whether the basis of such proceeding is alleged
action in an official capacity as a director, officer, employee, or agent or in
any other capacity while serving as a director, officer, employee, or agent,
shall be indemnified and held harmless by the Corporation to the fullest extent
authorized by the Delaware Code, as the same exists or may hereafter be amended
(but, in the case of any such amendment, only to the extent that such amendment
permits the Corporation to provide broader indemnification rights than permitted
prior thereto), against all expense, liability, and loss (including attorneys'
fees, judgments, fines, excise or other taxes assessed with respect to an
employee benefit plan, penalties, and amounts paid in settlement) reasonably
incurred or suffered by such indemnitee in connection therewith, and such
indemnification shall continue as to an indemnitee who has ceased to be a
director, officer, employee, or agent and shall inure to the benefit of the
indemnitee's heirs, executors, and administrators; provided, however, that,
except as provided in Paragraph C of this Article Ninth with respect to
proceedings to enforce rights to indemnification, the Corporation shall
indemnify any such indemnitee in connection with a proceeding (or part thereof)
initiated by such indemnitee only if such proceeding (or part thereof) was
authorized by the Board of Directors of the Corporation."
"B. The right to indemnification conferred in paragraph A of this Article
Ninth shall include the right to be paid by the Corporation the expenses
incurred in defending any proceeding for which such right to indemnification is
applicable in advance of its final disposition (hereinafter an "advancement of
II-1
expenses"); PROVIDED, HOWEVER, that, if the Delaware Code so requires, an
advancement of expenses incurred by an indemnitee in his or her capacity as a
director or officer (and not in any other capacity in which service was or is
rendered by such indemnitee, including, without limitation, service to an
employee benefit plan) shall be made only upon delivery to the Corporation of an
undertaking (hereinafter an "undertaking"), by or on behalf of such indemnitee,
to repay all amounts so advanced if it shall ultimately be determined by final
judicial decision from which there is no further right to appeal (hereinafter a
"final adjudication") that such indemnitee is not entitled to be indemnified for
such expenses under this Article Ninth or otherwise."
"C. The rights to indemnification and to the advancement of expenses
conferred in paragraphs A and B of this Article Ninth shall be contract rights.
If a claim under paragraph A or B of this Article Ninth is not paid in full by
the Corporation within 60 days after a written claim has been received by the
Corporation, except in the case of a claim for an advancement of expenses, in
which case the applicable period shall be 20 days, the indemnitee may at any
time thereafter bring suit against the Corporation to recover the unpaid amount
of the claim. If successful in whole or in part in any such suit, or in a suit
brought by the Corporation to recover an advancement of expenses pursuant to the
terms of an undertaking, the indemnitee shall be entitled to be paid also the
expense of prosecuting or defending such suit. In (i) any suit brought by the
indemnitee to enforce a right to indemnification hereunder (but not in a suit
brought by an indemnitee to enforce a right to an advancement of expenses) it
shall be a defense that, the indemnitee has not met any applicable standard for
indemnification set forth in the Delaware Code, and (ii) any suit by the
Corporation to recover an advancement of expenses pursuant to the terms of an
undertaking, the Corporation shall be entitled to recover such expenses upon a
final adjudication that, the indemnitee has not met any applicable standard for
indemnification set forth in the Delaware Code. Neither the failure of the
Corporation (including its Board of Directors, independent legal counsel, or its
stockholders) to have made a determination prior to the commencement of such
suit that indemnification of the indemnitee is proper in the circumstances
because the indemnitee has met the applicable standard of conduct set forth in
the Delaware Code, nor an actual determination by the Corporation (including its
Board of Directors, independent legal counsel, or its stockholders) that the
indemnitee has not met such applicable standard of conduct, shall create a
presumption that the indemnitee has not met the applicable standard of conduct
or, in the case of such a suit brought by the indemnitee, be a defense to such
suit. In any suit brought by the indemnitee to enforce a right to
indemnification or to an advancement of expenses hereunder, or by the
Corporation to recover an advancement of expenses pursuant to the terms of an
undertaking, the burden of proving that the indemnitee is not entitled to be
indemnified, or to such advancement of expenses, under this Article Ninth or
otherwise, shall be on the Corporation."
"D. The rights to indemnification and to the advancement of expenses
conferred in this Article Ninth shall not be exclusive of any other right which
any person may have or hereafter acquire under any statute, this certificate of
incorporation, by-law, agreement, vote of stockholders or disinterested
directors, or otherwise."
"E. The Corporation may maintain insurance, at its expense, to protect
itself and any director, officer, employee, or agent of the Corporation or
another corporation, partnership, joint venture, trust, or other enterprise
against any expense, liability, or loss, whether or not the Corporation would
have the power to indemnify such person against such expense, liability, or loss
under the Delaware Code."
"F. The Corporation's obligation, if any, to indemnify any person who was or
is serving as a director, officer, employee, or agent of any direct or indirect
subsidiary of the Corporation or, at the request of the Corporation, of any
other corporation or of a partnership, joint venture, trust, or other enterprise
shall be reduced by any amount such person may collect as indemnification from
such other corporation, partnership, joint venture, trust, or other enterprise."
"G. Any repeal or modification of the foregoing provisions of this Article
Ninth shall not adversely affect any right or protection hereunder of any person
in respect of any act or omission occurring prior to the time of such repeal or
modification."
II-2
ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following is an itemization of all expenses (subject to future
contingencies) incurred or expected to be incurred by the Company in connection
with the issuance and distribution of the securities being offered hereby (items
marked with an asterisk (*) represent estimated expenses):
SEC Registration Fee............................................... $ 5,773
---------
Legal Fees and Expenses............................................ ---------
Blue Sky Fees (including counsel fees)............................. ---------
NASD Filing Fees................................................... 2,405
---------
Listing and Nasdaq SmallCap Market fees............................ 25,020
---------
Accounting Fees and Expenses....................................... ---------
Transfer Agent and Registrar Fees.................................. ---------
Printing and Engraving Expenses.................................... ---------
Underwriting Non-Accountable Expense Allowance..................... ---------
Miscellaneous...................................................... ---------
Total.............................................................. $
---------
---------
ITEM 26. RECENT SALES OF UNREGISTERED SECURITIES
In the past three years, the Registrant has made the following sales of
unregistered securities, all of which sales were exempt from the registration
requirements of the Securities Act pursuant to Section 4(2) thereof or as
otherwise indicated herein. The following section gives effect to the
one-for-two-and-one-half reverse stock split of the Company's Common Stock
effected in August 1997.
In May 1995, the Company sold 390,334 shares of Series A Preferred Stock at
$3.88 per share (including 181,290 shares of Series A Preferred Stock to Herzog,
Heine & Geduld, Inc., a customer of the Company, as a result of the conversion
of a loan in the principal amount of $250,000 received from such customer in
April 1994) and warrants to purchase 163,392 shares of Series B Preferred Stock
at $4.90 per share for an aggregate purchase price of $1,517,500. The warrants
to purchase the shares of Series B Preferred Stock were exercised in August 1995
and the Company issued 163,392 shares of Series B Preferred Stock to certain
accredited investors. The Company believes that the issuance and sale of such
securities was exempt from registration pursuant to Section 4(2) of the
Securities Act and/or Rule 506 promulgated thereunder.
In November 1995, the Company issued subordinated debt in the principal
amount of $934,500 to certain accredited investors, many of which had
participated in the previous preferred stock offerings. Such debt bore interest
at 10% per annum and, if not paid by November 30, 1996, automatically converted
to Common Stock at a rate of $4.90 per share. Purchasers of the debt received
the 1995 Warrants to purchase 476,876 shares of the Company's Common Stock for
an aggregate purchase price equal to the principal amount of the debt
($934,500). The 1995 Warrants expire on the earlier of (i) May 31, 1998 and (ii)
the closing of the Offering. Accordingly, such warrants will expire if not
exercised prior to the consummation of the Offering. The debt was automatically
converted to 190,714 shares of Common Stock in November 1996. All interest,
which had been accrued on the debt, was forgiven. The Company believes that each
issuance and sale of such securities was exempt from registration pursuant to
Section 4(2) of the Securities Act and/or Rule 506 promulgated thereunder.
In December 1995, the Company issued 17,915 shares of Common Stock to Dr.
Fenton Scruggs, a director of the Company, as a result of the conversion of a
loan in the principal amount of $75,000 received from Dr. Scruggs in November
1994. The Company believes that such issuance and sale was exempt from
registration pursuant to Section 4(2) of the Securities Act and/or Rule 506
promulgated thereunder.
II-3
In June 1996, the Company, through Hampshire Securities Corporation, acting
as placement agent, issued and sold 60 units of its securities, each consisting
of 7,111 shares of Common Stock, one 10% Note in the principal amount of $50,000
and one three-year 1996 Warrant to purchase 2,625 shares of Common Stock at an
exercise price equal to $8.46 per share, at $100,000 per unit ($6,000,000 total)
solely to accredited investors. The Company believes that each issuance and sale
of such securities was exempt from registration pursuant to Section 4(2) of the
Securities Act and/or Rule 506 promulgated thereunder. Hampshire Securities
Corporation received, for its services, a placement fee of 8% of the gross
proceeds from the sale of such securities, a warrant to purchase 38,852 shares
of Common Stock at an exercise price of $9.44 per share, and reimbursement of
certain other expenses.
In July 1997, the Company, through Hampshire Securities Corporation, acting
as placement agent, issued and sold 20 units of its securities, each consisting
of one 10% Note in the principal amount of $100,000 and one four-year Warrant to
purchase 16,000 shares of Common Stock at an exercise price equal to $3.00 per
share, at $100,000 per unit ($2,000,000 total) solely to accredited investors.
The Company believes that such issuance and sale of such securities was exempt
from registration pursuant to Section 4(2) of the Securities Act and/or Rule 506
promulgated thereunder. Hampshire Securities Corporation received, for its
services, a placement fee of 10% of the gross proceeds from the sale of such
securities and reimbursement of certain other expenses.
Options to purchase 144,000 shares of Common Stock are outstanding under the
1995 Plan at exercise prices ranging from $0.10 to $4.90 per share, although
substantially all of such options are exercisable at $0.10 per share. In
addition to the options granted under the 1995 Plan, the Company has granted
options to purchase 513,200 shares of Common Stock outside of the 1995 Plan at
exercise prices ranging from $0.10 to $3.00. The Company believes that each such
issuance and sale of securities was exempt from registration pursuant to Section
4(2) of the Securities Act.
II-4
ITEM 16. EXHIBITS
(a) The following exhibits, unless otherwise indicated are filed herewith:
EXHIBIT NO. DESCRIPTION
- ------------- -----------------------------------------------------------------------------------------------------
1 Form of Underwriting Agreement*
3.1 Certificate of Incorporation of Celerity Systems, Inc.
3.2 By laws of Celerity Systems, Inc.
4.1 Form of Representative's Warrant*
4.2 1995 Stock Option Plan
4.3 1997 Stock Option Plan
4.4 Form of Stock Certificate*
4.5 Form of Bridge Warrant
4.6 Form of 1996 Warrant*
4.7 Form of Hampshire Warrant*
4.8 Form of 1995 Warrant
4.9 Letter Agreement dated July 15, 1997, between the Company and Mahmoud Youssefi, including exhibits
4.10 Letter Agreement, dated July 11, 1997, between the Company and Dr. Fenton Scruggs
5.1 Opinion of Squadron, Ellenoff, Plesent & Sheinfeld, LLP*
10.1 Employment Agreement, dated January 7, 1997, as amended, between the Company and Kenneth D. Van
Meter*
10.2 Employment, Non-Solicitation, Confidentiality and Non-Competition Agreement, dated as of May 1, 1996,
between the Company and Glenn West
10.3 Termination Agreement, dated as of April 5, 1997, between the Company and Mahmoud Youssefi
10.4 Letter Agreement, dated January 3, 1997, between the Company and Doyal H. Hodge*
10.5 Letter Agreement, dated March 7, 1997, between the Company and William Chambers*
10.6 Letter Agreement, dated July 22, 1997, between the Company and Mark. C. Cromwell*
10.7 Exclusive OEM/Distribution Agreement, dated March 10, 1995, between the Company and InterSystem
Multimedia, Inc.
10.8 Purchase Order Agreement, dated June 26, 1995, between Tadiran Telecommunications Ltd. and the
Company
10.9 License Agreement, dated as of September 26, 1996, between the Company and En Kay Telecom Co., Ltd.
10.10 License Agreement, dated as of February 21, 1997, between the Company and En Kay Telecom Co., Ltd.
10.11 Remarketer Agreement, dated as of June 15, 1997, between the Company and Minerva Systems, Inc.
10.12 Memorandum of Understanding, dated April 25, 1996, between Integrated Network Corporation and the
Company
10.13 Letter of Agreement, dated March 31, 1993, between the Company and Herzog, Heine & Geduld, Inc. and
Development Agreement attached thereto
10.14 Subcontract Agreement, dated June 26, 1997, between Unisys Corporation and the Company
11 Statement re: computation of per share earnings
23.1 Consent of Coopers & Lybrand L.L.P
23.2 Consent of Squadron, Ellenoff, Plesent & Sheinfeld, LLP (contained in the Opinion filed as Exhibit
5.1)
24 Power of Attorney (included in signature page)
27 Financial Data Schedule
- ------------------------
* To be filed by amendment.
II-5
ITEM 28. UNDERTAKINGS
(a) The undersigned Registrant hereby undertakes:
(1) to file, during any period in which it offers or sells securities, a
post-effective amendment to this registration statement to
(i) include any prospectus required by section 10(a)(3) of the
Securities Act;
(ii) to reflect in the prospectus any facts or events which,
individually or together, represent a fundamental change in the information
in the registration statement;
(iii) to include any additional or changed material information on the
plan of distribution;
(2) for determining liability under the Securities Act, treat each
post-effective amendment as a new registration statement of securities
offered, and the offering of such securities at that time be the initial
bona fide offering thereof; and
(3) file a post-effective amendment to remove from registration any of
the securities that remain unsold at the termination of the offering.
(d) The Registrant hereby undertakes that it will provide to the
Underwriters at the closing specified in the underwriting agreement certificates
in such denominations and registered in such names as required by the
underwriter to permit prompt delivery to each purchaser.
(e) Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers, and controlling persons of the
Registrant pursuant to the foregoing provisions, or otherwise, the Registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities Act
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the Registrant of expenses
incurred or paid by a director, officer, or controlling person of the Registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
(f) The undersigned Registrant hereby undertakes that it will:
(1) for determining any liability under the Securities Act, treat the
information omitted from the form of prospectus filed as part of this
registration statement in reliance upon Rule 430A and contained in a form of
prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or
497(h) under the Securities Act as part of this registration statement as of
the time the Commission declared it effective; and
(2) determining any liability under the Securities Act, treat each
post-effective amendment that contains a form of prospectus as a new
registration statement for the securities offered therein, and the offering
of such securities at that time as the initial bona fide offering thereof.
II-6
SIGNATURES
In accordance with the requirements of the Securities Act of 1933, the
Registrant certifies that it has reasonable grounds to believe that it meets all
of the requirements for filing on Form SB-2 and authorized this Registration
Statement to be signed on its behalf by the undersigned, in the City of New
York, New York on August 13, 1997.
CELERITY SYSTEMS, INC.
BY: /S/ KENNETH D. VAN METER
-----------------------------------------
Name: Kenneth D. Van Meter
Title: President and Chief Executive
Officer
POWER OF ATTORNEY
Know all men by these presents, that the Registrant and each person whose
signature appears below constitutes and appoints Kenneth D. Van Meter and Doyal
H. Hodge, and each of them, his, her or its true and lawful attorney-in-fact and
agents, with full power of substitution and resubstitution for him, her or it
and in his, her, or its name, place and stead, in any and all capacities, to
sign and file (i) any and all amendments (including post-effective amendments)
to this Registration Statement, with all exhibits thereto, and all other
documents in connection therewith, and (ii) any registration statement, and any
and all amendments thereto, relating to the offering covered hereby filed
pursuant to Rule 462(b) under the Securities Act of 1933, with the Securities
and Exchange Commission, granting unto said attorneys-in-fact and agents, and
each of them, full power and authority to do and perform each and every act and
thing requisite or necessary to be done in and about the premises, as fully to
all intents and purposes as he, she, or it might or could do in person, hereby
ratifying and confirming all that said attorney-in-fact and agrees or any of
them, or their or his substitute or substitutes, may lawfully do or cause to be
done by virtue hereof.
In accordance with to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the dates stated.
SIGNATURE TITLE DATE
- ------------------------------ --------------------------- -------------------
President, Chief Executive
/s/ KENNETH D. VAN METER Officer and Chairman of
- ------------------------------ the Board (Principal August 13, 1997
Kenneth D. Van Meter Executive Officer)
Vice President and Chief
/s/ DOYAL H. HODGE Financial Officer
- ------------------------------ (Principal Financial and August 13, 1997
Doyal H. Hodge Principal Accounting
Officer)
/s/ GLENN WEST
- ------------------------------ Executive Vice President August 13, 1997
Glenn West and Director
II-7
SIGNATURE TITLE DATE
- ------------------------------ --------------------------- -------------------
/s/ FENTON SCRUGGS
- ------------------------------ Director August 13, 1997
Fenton Scruggs
/s/ DONALD GREENHOUSE
- ------------------------------ Director August 13, 1997
Donald Greenhouse
II-8
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION PAGE
- ------------- ---------------------------------------------------------------------------------------------- -----
1 Form of Underwriting Agreement*
3.1 Certificate of Incorporation of Celerity Systems, Inc.
3.2 By laws of Celerity Systems, Inc.
4.1 Form of Representative's Warrant*
4.2 1995 Stock Option Plan
4.3 1997 Stock Option Plan
4.4 Form of Stock Certificate*
4.5 Form of Bridge Warrant
4.6 Form of 1996 Warrant*
4.7 Form of Hampshire Warrant*
4.8 Form of 1995 Warrant
4.9 Letter Agreement, dated July 15, 1997, between the Company and Mahmoud Youssefi, including
exhibits
4.10 Letter Agreement, dated July 11, 1997, between the Company and Dr. Fenton Scruggs
5.1 Opinion of Squadron, Ellenoff, Plesent & Sheinfeld, LLP*
10.1 Employment Agreement, dated January 7, 1997, as amended, between the Company and Kenneth D.
Van Meter*
10.2 Employment, Non-Solicitation, Confidentiality and Non-Competition Agreement, dated as of May
1, 1996, between the Company and Glenn West
10.3 Termination Agreement, dated as of April 5, 1997, between the Company and Mahmoud Youssefi
10.4 Letter Agreement, dated January 3, 1997, between the Company and Doyal H. Hodge*
10.5 Letter Agreement, dated March 7, 1997, between the Company and William Chambers*
10.6 Letter Agreement, dated July 22, 1997, between the Company and Mark. C. Cromwell*
10.7 Exclusive OEM/Distribution Agreement, dated March 10, 1995, between the Company and
InterSystem Multimedia, Inc.
10.8 Purchase Order Agreement, dated June 26, 1995, between Tadiran Telecommunications Ltd. and the
Company
10.9 License Agreement, dated as of September 26, 1996, between the Company and En Kay Telecom Co.,
Ltd.
10.10 License Agreement, dated as of February 21, 1997, between the Company and En Kay Telecom Co.,
Ltd.
10.11 Remarketer Agreement, dated as of June 15, 1997, between the Company and Minerva Systems, Inc.
10.12 Memorandum of Understanding, dated April 25, 1996, between Integrated Network Corporation and
the Company
10.13 Letter of Agreement, dated March 31, 1993, between the Company and Herzog, Heine & Geduld,
Inc. and Development Agreement attached thereto
10.14 Subcontract Agreement, dated June 26, 1997, between Unisys Corporation and the Company
11 Statement re: computation of per share earnings
23.1 Consent of Coopers & Lybrand L.L.P
23.2 Consent of Squadron, Ellenoff, Plesent & Sheinfeld, LLP (contained in the Opinion filed as
Exhibit 5.1)
24 Power of Attorney (included in signature page)
27 Financial Data Schedule
- ------------------------
* To be filed by amendment.