SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB/A
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2001
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission File Number: 1-11873
K2 DIGITAL, INC.
(Exact name of registrant as specified in its charter)
Delaware 13-3886065
(State or other jurisdiction of incorporation or (I.R.S. Employer Identification Number)
organization)
30 Broad Street, New York, NY 10004
(Address of principal executive offices, including zip code)
Issuer's telephone number: (212) 785-9402
Securities registered pursuant to Section 12(b) of the Exchange Act:
None.
Securities registered pursuant to Section 12(g) of the Exchange Act:
Common Stock
(Title of Class)
Check whether the issuer: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements for the past
90 days. Yes X No____
Check if there is no disclosure of delinquent filers pursuant to Item
405 of Regulation SB contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [ X ]
State issuer's revenues for its most recent fiscal year:
$0 (adjusted for discontinued operations)
--
As of April 15, 2002, there were 4,982,699 shares (not including
treasury shares) of the Company's common stock outstanding. Based on the closing
sales price of the Company's common stock on April 10, 2002 of $0.05 per share,
the approximate aggregate market value of the Company's common stock held by
non-affiliates was $249,135.
DOCUMENTS INCORPORATED BY REFERENCE
Certain exhibits are incorporated by reference to the Company's
Registration Statement on Form SB-2 and the amendments thereto, as listed in
response to Item 13(a)(2).
Transitional Small Business Disclosure Format (check one):
Yes __ No X
EXPLANATORY NOTE
Historically, K2 Digital, Inc.'s (the "Company") financial statements
have been audited by Arthur Andersen LLP ("Andersen"). On April 10, 2002, the
Board of Directors of the Company made a determination not to engage Andersen,
as its independent public accountants and resolved to appoint Rothstein, Kass &
Company, P.C. ("Rothstein") as its independent public accountants to audit its
financial statements for the fiscal year ended December 31, 2001.
On March 18, 2002, the Securities and Exchange Commission issued a
release adopting certain temporary and final rules intended to assure a
continuing and orderly flow of information to investors and the U.S. capital
markets and to minimize any potential disruptions that might otherwise occur as
a result of the indictment of Andersen.
In the release, the Commission adopted rules pursuant to which the
Commission will accept filings that include unaudited financial statements from
any Andersen client that is unable to obtain from Andersen (or elects not to
have Andersen issue) a manually signed audit report and is therefore unable to
provide timely audited financial statements. The rules adopted by the Commission
require that any Andersen client electing this alternative will generally be
required to amend their filings within 60 days to include audited financial
statements.
In accordance with these rules, the Company filed a report on Form
10-KSB, which included unaudited financial statements, on April 16, 2002. THE
FINANCIAL STATEMENTS INCLUDED IN THIS ANNUAL REPORT ON FORM 10-KSB/A HAVE BEEN
AUDITED AND A DISCUSSION OF MATERIAL CHANGES FROM THE APRIL 16, 2002 FILING HAS
BEEN REFLECTED HEREIN.
The Business section and other parts of this report contain
forward-looking statements that involve risks and uncertainties. The Company's
actual results may differ significantly from the results discussed in the
forward-looking statements. Factors that might cause such a difference include,
but are not limited to, those discussed in the section entitled "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Factors Affecting Operating Results and Market Price of Stock" commencing on
page 7.
PART I
ITEM 1. Description of Business
History
K2 Digital, Inc. (the "Company" or "K2") was founded in 1993 as a
general partnership and initially operated a traditional graphic design
business. In August 1994, the Company shifted its principal business to Web site
design and creation. Thereafter, the Company incorporated as a Delaware
corporation. After the Company's initial public offering on July 26, 1996, the
Company began to develop its business as a full-service digital professional
services company. The Company has historically provided consulting and
development services including analysis, planning, systems design, creative and
implementation. In November 2000, the Company changed its name from K2 Design,
Inc. to K2 Digital, Inc. As discussed below, the Company effectively ceased its
operations in August 2001.
The Company's offices are located at 30 Broad Street, New York, New
York 10004 and its telephone number is (212) 785-9402.
Discontinued Operations
Disposition of Assets
On May 15, 2001, the Company entered into a non-binding letter of
intent with SGI Graphics LLC, a Delaware limited liability company ("SGI")
pursuant to which SGI expressed its interest in purchasing shares of restricted
common stock of the Company that would have represented fifty-one percent (51%)
of the issued and outstanding capital stock of the Company on a fully diluted
basis. Concurrently with the execution of the letter of intent, the Company
borrowed $250,000 from an affiliate of SGI, for working capital purposes
pursuant to a promissory note secured by a first priority security interest in
all of the assets of the Company. The Company and SGI were ultimately not able
to agree on the definitive terms of the transaction and, in July 2001, the
Company and SGI terminated negotiations and the letter of intent.
On August 29, 2001, the Company sold certain of its fixed and
intangible assets to Integrated Information Systems, Inc., a Delaware
corporation ("IIS"), including certain of the Company's customer contracts,
furniture, fixtures, equipment and intellectual property, for an aggregate
purchase price of $444,000, of which $419,000 was paid in cash and $25,000 of
capital lease obligations were assumed by IIS.
Under the terms of the purchase agreement governing the transaction
(the "Purchase Agreement"), IIS assumed the Company's office lease obligations,
took up occupancy in the Company's premises and made offers of employment to
substantially all of the remaining employees of the Company, which offers have
been accepted.
In addition to the purchase price and as consideration of the Company's
release of certain employees from the non-competition restrictions contained in
their agreements with the Company, the Company received from IIS at closing a
recruitment and placement fee of $75,000. In addition, the Purchase Agreement
provided for the Company to receive from IIS an additional placement fee of
$7,500 per key employee and $2,500 per other employee that remained employed by
IIS through December 31, 2001. This additional contingent placement fee was to
be paid by IIS in cash in five monthly installments beginning August 31, 2001,
pro rated monthly for the number of employees retained. As of December 31, 2001,
$31,000 of these contingent fees had been paid to the Company and $36,500 due to
the Company remained unpaid by IIS.
1
Under the Purchase Agreement, the Company also received from IIS a cash
fee of $50,000 in return for entering into certain noncompetition provisions
contained in the Purchase Agreement, which provide that the Company will not,
for a period of five years, (i) engage in any business of substantially the same
character as the business engaged in by the Company prior to the transaction,
(ii) solicit for employment any employee of IIS (including former employees of
the Company), or (iii) solicit any client or customer of IIS (including any
customer transferred to IIS under the Purchase Agreement) to do business with
the Company.
Accordingly, the aggregate cash consideration delivered to the Company
at closing was $544,000, of which approximately $258,000 was paid directly to K2
Holdings LLC, an affiliate of SGI, the Company's principal secured creditor, in
order to release SGI's security interest in the assets of the Company.
Subsequent to the sale of assets to IIS, the Company effectively ceased
operations and has been in the process of liquidating assets, collecting
accounts receivable and paying creditors. The Company does not have any ongoing
business operations or any remaining revenue sources beyond those few remaining
receivables not purchased by IIS and not yet collected by the Company.
Accordingly, the Company's remaining operations will be limited to either a
business combination with an existing business (such as one described below) or
the winding up of the Company's remaining business and operations, subject, in
either case, to the approval of the stockholders of the Company. The proceeds
from the sale of assets plus the additional payment due from IIS (collection of
which is uncertain), together with assets not sold to IIS may not be sufficient
to repay substantially all remaining liabilities of the Company.
Agreement and Plan of Merger
The Board of Directors of the Company has determined that, subject to
stockholder approval of certain actions as described below, the best course of
action for the Company is to complete a business combination with an existing
business. Accordingly, from September 2001 through January 15, 2002, the Company
was involved in structuring and negotiating the general terms and conditions of
a business combination transaction between the Company and First Step
Distribution Network, Inc., a California corporation ("First Step") pursuant to
which the Company plans to exchange newly issued shares of its common stock for
all of the issued and outstanding securities of First Step. On January 15, 2002,
the Company entered into an Agreement and Plan of Merger (the "Merger
Agreement") by and among First Step and its shareholders (the "First Step
Shareholders") and First Step Acquisition Corp., a Delaware corporation and
wholly-owned subsidiary of the Company ("Merger Sub"). Under the terms of the
Merger Agreement, the Company intends to acquire First Step by means of a
triangular merger (the "Merger"), pursuant to which the Merger Sub will merge
with and into First Step in a tax free reorganization within the meaning of
Section 368 of the Internal Revenue Code of 1986, as amended.
The First Step Shareholders will exchange their respective shares of
common stock, no par value per share, of First Step (the "First Step Common
Stock") for shares of common stock, par value $.01 per share of the Company's
common stock. Each share of First Step Common Stock will be converted into the
right to receive 16.609 shares of Company's common stock. Pursuant to the Merger
Agreement, the aggregate number of shares of the Company's common stock issuable
to the First Step Shareholders by virtue of the Merger as of the date of the
Merger Agreement will equal approximately ninety percent (90%) of the Company's
issued and outstanding common stock on a fully-diluted basis.
After the effective date of the Merger, the Merger Sub will cease its
separate legal existence and First Step will continue as the surviving
corporation. As a condition to the Merger, the Company is required to implement
a 3 for 1 reverse split (the "Reverse Stock Split") of the Company's common
stock, thereby reducing its outstanding shares of common stock from 4,982,699
shares to approximately 1,660,900 shares. In the Reverse Stock Split, fractional
shares will be rounded up to the nearest whole share. The implementation of the
Reverse Stock Split is subject to the approval of the stockholders of the
Company. The Board of Directors of the Company has approved the Reverse Stock
Split and intends to submit the Reverse Stock Split to the stockholders of the
Company for their approval.
2
Upon consummation of the transactions contemplated by the Merger
Agreement and the Reverse Stock Split, the Company's current stockholders will
experience immediate and severe dilution and will own an aggregate of
approximately 1,660,900 shares of Company's common stock, or approximately 10%
of the outstanding voting securities of the Company on a fully diluted basis.
The First Step Shareholders will own an aggregate of 14,948,100 or approximately
90% of the outstanding voting securities of the Company on a fully-diluted
basis.
The Merger Agreement contains a provision for termination of the Merger
Agreement by either the Company or First Step if the Merger is not consummated
by April 30, 2002. On April 8, 2002, the Company and First Step entered into a
side letter under which the Company agreed to waive its right to terminate the
Merger Agreement until June 30, 2002; provided that First Step has delivered to
the Company a true and correct copy of First Step's financial statements (as
described in the Merger Agreement) on or before May 8, 2002. The Company
accepted delivery of the financial statements subsequent to May 8, 2002 and
waived the late delivery of First Step's financial statements.
There can be no assurance that the Merger will in fact be consummated,
or that the shares of the Company's common stock will have any value following
the Merger.
Government Regulation
Having effectively ceased operations in August 2001, the Company is not
currently subject to direct regulation by any government agency, other than
regulations applicable to businesses generally. Web site developers such as the
Company face potential liability for the actions of clients and others using
their services, including liability for infringement of intellectual property
rights, rights of publicity, defamation, libel and criminal activity under the
laws of the U.S. and foreign jurisdictions. Any imposition of liability from the
Company's prior operations could have a material adverse effect on the Company.
Employees
As a result of the transaction entered into with IIS in August 2001 and
the fact that the Company has effectively ceased operations, at December 31,
2001, the Company had only one full time employee, Gary Brown, the Company's
current President, Chief Operating Officer, Chief Financial Officer and
Secretary. Since August 2001, Mr. Brown's employment with the Company has been
limited to structuring and negotiating the transactions contemplated by the
Merger Agreement and the Reverse Stock Split, as well as liquidating assets,
collecting accounts receivable and paying creditors. Since December 31, 2001,
Mr. Brown has taken no salary.
ITEM 2. Description of Property
Under the terms of the Purchase Agreement, IIS now occupies the
Company's premises and has assumed the Company's office lease obligations.
Pursuant to an arrangement with IIS and the landlord for its premises at 30
Broad Street, New York, New York, the Company continues to occupy a small office
space in the premises now occupied by IIS.
ITEM 3. Legal Proceedings
The Company is not a party to any material pending legal proceedings as
of the date hereof.
ITEM 4. Submission of Matters to a Vote of Security Holders
The Company did not submit any matters to a vote of its stockholders,
through the solicitation of proxies or otherwise, during the fourth quarter of
fiscal 2001.
3
PART II
ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters
The Company's common stock was delisted from the Nasdaq SmallCap Market
("NASDAQ") effective August 15, 2001 and currently trades in the
over-the-counter market under the symbol "KTWO.OB." Prior to its delisting, the
Company's common stock was traded on NASDAQ under the symbol "KTWO." The
following table sets forth, for the periods indicated, the range of high and low
price quotes of the Company's common stock as reported by the over-the-counter
bulletin board (for periods subsequent to the delisting) and NASDAQ (for periods
prior to the delisting) from the quarter ended March 31, 2000 through December
31, 2001. These quotations reflect inter-dealer prices, without retail mark-up,
mark-down or commission, and may not necessarily represent actual transactions.
Fiscal Quarter Ended High Low
-------------------- ---- ---
March 31, 2000 $ 10.50 $ 5.13
June 30, 2000 $ 6.94 $ 4.13
September 30, 2000 $ 6.75 $ 3.06
December 31, 2000 $ 4.25 $ 0.44
March 31, 2001 $ 1.06 $ 0.28
June 30, 2001 $ 0.46 $ 0.26
September 30, 2001 $ 0.29 $ 0.02
December 31, 2001 $ 0.05 $ 0.02
The approximate number of record holders of the Company's common stock
at December 31, 2001 was 26, not including beneficial owners whose shares are
held by banks, brokers and other nominees.
There were no repurchases by the Company of its common stock on the
open market or from any of its stockholders in fiscal year 2000 or 2001. At
December 31, 2001, the Company held a total of 417,417 shares of treasury stock
at a cost of $819,296.
On December 11, 2000, the Company entered into a common stock purchase
agreement (the "Fusion Facility") with Fusion Capital Fund II, LLC ("Fusion
Capital"), a Chicago-based institutional investor. On January 26, 2001, the
Company issued to Fusion Capital, as a commitment fee for the Fusion Facility,
380,485 shares of common stock, as well as warrants to purchase 297,162 shares
of common stock at an exercise price of $.01 per share, exercisable at any time
over a five year period. In May 2001, the Company issued 862,069 shares of
common stock under the Fusion Facility to an officer of the Company, in exchange
for net proceeds of $250,000. On August 14, 2001, Fusion Capital exercised a
warrant to purchase an additional 297,162 shares of the Company's common stock
at an exercise price of $.01 per share. After applying the net exercise
provisions of the warrant, based upon the closing sale price of the Company's
common stock of $0.15 per share on August 13, 2001, Fusion Capital received
277,351 shares of common stock upon exercise of the warrant. The shares of
common stock and warrants issued to Fusion Capital were sold pursuant to the
exemption from registration provided by Section 4 (2) of the Securities Act of
1933, as amended, as an offering not involving any public offering. Because the
common stock and warrants were issued to Fusion Capital as a commitment fee
under the Fusion Facility, no proceeds were received by the Company upon
issuance of such common stock and warrants.
The Company has not paid any dividends. The Company does not expect to
pay cash dividends on its common stock in the foreseeable future. Declaration of
dividends in the future will remain within the discretion of the Company's Board
of Directors.
4
ITEM 6. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following presentation of management's discussion and analysis of
the Company's financial condition and results of operations should be read in
conjunction with the Company's consolidated financial statements, the
accompanying notes thereto and other financial information appearing elsewhere
in this report. This section and other parts of this report contain
forward-looking statements that involve risks and uncertainties. The Company's
actual results may differ significantly from the results discussed in the
forward-looking statements. Factors that might cause such a difference include,
but are not limited to, those discussed in the section entitled "Management's
Discussion and Analysis of Financial Condition and Results of Operations-Factors
Affecting Operating Results and Market Price of Stock" commencing on page 7.
Overview
Founded in 1993, the Company is a digital professional services company
that, until August 2001, has historically provided consulting and development
services, including analysis, planning, systems design, creative and
implementation. In August 2001, the Company effectively ceased operations as
described below.
Restatement (discussion of material changes from the unaudited financial
statements previously filed)
As discussed in the introductory Explanation Note, in March 2002, the
Securities and Exchange Commission ("SEC") issued a release (the "March 2002 SEC
release") adopting certain temporary and final rules due to the indictment of
Arthur Andersen LLP ("Andersen"), the Company's former auditor. The Company, in
compliance with the March 2002 SEC release, filed its annual report on April 16,
2002 which included unaudited financial statements and is subsequently amending
its annual report to include financial statements audited by the Company's new
auditor, Rothstein, Kass & Company, P.C. Further, as allowed by the March 2002
SEC release, this annual report makes use of the Company's financial statements
for the year ended December 31, 2000 which were audited by Andersen and have not
been reissued by Andersen for use in this report.
Following is a reconciliation of 2001 net loss as previously reported
in the Company's annual report, filed on April 16, 2002, to 2001 net loss as
reported in the accompanying consolidated statement of operations:
Net Loss, as previously filed $(4,923,679)
Additional impairment adjustment related to available-for-sale
securities deemed permanently impaired (84,700)
Asset reserves and accruals (102,955)
Noncash consulting charge (options granted to a vendor) (28,000)
-----------
Net loss, per accompanying consolidated statement of operations $(5,139,334)
Results of Operations
Sale of Assets and Discontinued Operations
On August 29, 2001, the Company sold certain fixed and intangible
assets of the Company to IIS, including certain of the Company's customer
contracts, furniture, fixtures, equipment and intellectual property, for an
aggregate purchase price of $444,000, of which $419,000 was paid in cash and
$25,000 of capital lease obligations were assumed by IIS.
Under the terms of the Purchase Agreement, IIS assumed the Company's
office lease obligations, took up occupancy in the Company's premises and made
offers of employment to substantially all of the remaining employees of the
Company, which offers have been accepted.
In addition to the purchase price and as consideration of the Company's
release of certain employees from the non-competition restrictions contained in
their agreements with the Company, the Company received from IIS at closing a
recruitment and placement fee of $75,000. In addition, the Purchase Agreement
provided for the Company to receive from IIS an additional placement fee of
$7,500 per key employee and $2,500 per other employee that remained employed by
IIS through December 31, 2001. This additional contingent placement fee was to
be paid by IIS in cash in five monthly installments beginning August 31, 2001,
pro rated monthly for the number of employees retained. As of December 31, 2001,
$31,000 of these contingent fees had been paid to the Company and $36,500 due to
the Company remains unpaid by IIS. Collection of the amounts due is uncertain.
Under the Purchase Agreement, the Company also received from IIS a cash
fee of $50,000 in return for entering into certain noncompetition provisions
contained in the Purchase Agreement, which provide that the Company will not,
for a period of five years, (i) engage in any business of substantially the same
character as the business engaged in by the Company prior to the transaction,
(ii) solicit for employment any employee of IIS (including former employees of
the Company), or (iii) solicit any client or customer of IIS (including any
customer transferred to IIS under the Purchase Agreement) to do business with
the Company.
Accordingly, the aggregate cash consideration delivered to the Company
at closing was $544,000, of which approximately $258,000 was paid directly to K2
Holdings LLC, an affiliate of SGI, the Company's principal secured creditor, in
order to release SGI's security interest in the assets of the Company.
Subsequent to the sale of assets to IIS, the Company effectively ceased
operations and has been in the process of liquidating assets, collecting
accounts receivable and paying creditors. The Company does not have any ongoing
business operations or any remaining revenue sources beyond those few remaining
receivables not purchased by IIS and not yet collected by the Company.
Accordingly, the Company's remaining operations will be limited to either the
sale of the Company or the winding up of the Company's remaining business and
operations, subject, in either case, to the approval of the stockholders of the
Company. The proceeds from the sale of assets plus the additional payment due
from IIS (collection of the which is uncertain), together with assets not sold
to IIS may not be sufficient to repay substantially all remaining liabilities of
the Company. The Company has entered into negotiations with certain creditors to
settle specific obligations for amounts less than reflected in the financial
statements reported herein. If these negotiations are unsuccessful, there will
not be sufficient cash to repay all of the obligations of the Company.
5
Summary of results
As a result of the August 2001 sale of assets, operating results from
discontinued operations have been segregated from continuing operation and
reported as a separate line item on the consolidated financial statements. The
year ended December 31, 2000 consolidated financial statements were restated to
conform to the 2001 presentation. Following is a summary of the Company's
operations for the years ended December 31, 2001 and 2000:
2001 2000
----------- -----------
Revenues $ -- $ --
General and administrative expenses 570,459 450,349
Impairment of available-for-sale securities 1,412,747
----------- -----------
Loss from continuing operations (1,983,206) (450,349)
----------- -----------
Discontinued operations
Loss from operations (3,374,238) (1,475,194)
Gain on disposal 218,110
----------- -----------
(3,156,128) (1,475,194)
----------- -----------
Net loss $(5,139,334) $(1,925,543)
General and administrative expenses primarily represent cash and
noncash compensation to the Company's remaining officer, professional fees and
ongoing ancillary costs. Impairment of available-for-sale securities represents
the permanent decline in market value of the Company's investment in 110,000
shares of common stock of 24/7 Media, Inc. The decline was previously reflected
in "accumulated other comprehensive income" in the stockholders' equity section
of the December 31, 2000 consolidated balance sheet.
See Note 3 of "Item 7 - Consolidated Financial Statements" for further
detail of discontinued operations for the years ended December 31, 2001 and
2000. Since the Company has ceased this operation, no further discussion has
been presented in this discussion and analysis.
Continuing Operations, Liquidity and Capital Resources
Subsequent to the sale of assets to IIS, the Company effectively ceased
operations and has been in the process of liquidating assets, collecting
accounts receivable and paying creditors. The Company does not have any ongoing
business operations or revenue sources beyond those assets not purchased by IIS.
Accordingly, the Company's remaining operations will be limited to either a
busines combination with an existing business or the winding up of the Company's
remaining business and operations, subject, in either case, to the approval of
the stockholders of the Company. The proceeds from the sale of assets plus the
additional contingent payments from IIS, together with assets not sold to IIS
may not be sufficient to repay substantially all of the liabilities of the
Company. These, among other matters, raise substantial doubt about the Company's
ability to continue as a going concern.
The Board of Directors of the Company has determined that, subject to
stockholder approval, the best course of action for the Company is to complete a
business combination with an existing business. On January 15, 2002, the Company
entered into the Merger Agreement described above. Under the terms of the Merger
Agreement, the Company intends to acquire First Step by means of a triangular
merger, pursuant to which a subsidiary of the Company will merge with and into
First Step in a tax free reorganization within the meaning of Section 368 of the
Internal Revenue Code of 1986, as amended.
As a condition to the Merger, the Company is required to implement the
Reverse Stock Split described above. The implementation of the Reverse Stock
Split is subject to the approval of the stockholders of the Company. The Board
of Directors of the Company has approved the Reverse Stock Split and will submit
the Reverse Stock Split to the stockholders of the Company for their approval.
In the event that the transactions contemplated by the Merger Agreement
are not consummated for any reason, the Company's remaining assets will not be
sufficient to meet its ongoing liabilities and the Company's remaining
operations will be wound up subject to the approval of the stockholders of the
Company. The anticipated closing date for the Merger has been postponed due to
delays in First Step's ability to secure the financing for the transaction that
is required pursuant to the terms and conditions of the Merger Agreement, as
well as delays in the preparation and finalization of the requisite financial
and other information about First Step that will be included in the Company's
proxy statement being prepared in connection with the solicitation of
stockholder approval for the Reverse Stock Split. The Company has been informed
by representatives of First Step that First Step has made significant progress
in securing the necessary financing and financial statements and that First Step
expects to be able to consummate the Merger during the third quarter of 2002,
subject to the requisite stockholder approval.
6
The Company's cash balance of $5,380 at December 31, 2001, decreased by
$730,226 or 99% compared to the $735,606 cash balance at December 31, 2000. This
decrease is primarily due to the fact that the Company effectively ceased its
operations as of August 1, 2001.
Factors Affecting Operating Results and Market Price of Stock
The Company has effectively discontinued its operations.
In August 2001, the Company sold certain fixed and intangible assets
essential to its business operations and entered into a purchase agreement
containing provisions restricting the Company's ability to continue to engage in
the business engaged in by the Company prior to the transaction. Accordingly,
the Company's remaining operations have been limited to liquidating assets,
collecting accounts receivable, paying creditors, and negotiating and
structuring the transactions contemplated by the Merger Agreement or the winding
up of the Company's remaining business and operations, subject, in either case,
to the approval of the stockholders of the Company.
The transactions contemplated by the Merger Agreement may never be consummated.
In the event that the transactions contemplated by the Merger Agreement
are not consummated for any reason, the Company's remaining assets will not be
sufficient to meet its ongoing liabilities and the Company's remaining
operations will be wound up subject to the approval of the stockholders of the
Company. The anticipated closing date for the Merger has been postponed due to
delays in First Step's ability to secure the financing for the transaction that
is required pursuant to the terms and conditions of the Merger Agreement, as
well as delays in the preparation and finalization of the requisite financial
and other information about First Step that will be included in the Company's
proxy statement being prepared in connection with the solicitation of
stockholder approval for the Reverse Stock Split. The Company has been informed
by representatives of First Step that First Step has made significant progress
in securing the necessary financing and financial statements and that First Step
expects to be able to consummate the Merger during the third quarter of 2002,
subject to the requisite stockholder approval. Although First Step has assured
the Company that First Step remains committed to the consummation of the
transaction, the transaction is subject to the satisfaction of a number of
conditions and there can be no assurance that the transaction will be
consummated.
The Company's stock has been delisted from the Nasdaq SmallCap Market
The Company's common stock was delisted from the Nasdaq SmallCap Market
effective August 15, 2001 and currently trades in the over-the-counter market.
On March 13, 2001, the Staff of the Nasdaq Stock Market notified the Company
that it had failed to demonstrate a closing bid price of at least $1.00 per
share for 30 consecutive trading days and was in violation of Nasdaq Marketplace
Rule 4310(c)(4). In accordance with applicable Nasdaq Marketplace rules, the
Company was provided a 90-day grace period, through June 11, 2001, during which
to regain compliance. On June 20, 2001, the Company requested a hearing, which
effectively stayed the delisting. However, after submission of materials in
support of the Company's position to the Panel, the Panel decided to delist the
Company's common stock from the Nasdaq SmallCap Market as of the open of
business on August 15, 2001. The delisting of the Company's common stock from
The Nasdaq SmallCap Market is likely to materially and adversely decrease the
already limited liquidity and market price of the common stock, and may increase
both volatility and the "spread" between bid and asked prices of the common
stock.
ITEM 7. Financial Statements and Supplementary Data
See Item 13(a)(2) in Part IV.
ITEM 8. Changes in and Disagreements on Accounting and Financial Disclosure
As discussed above, on April 10, 2002, the Board of Directors of the
Company made a determination not to engage Andersen, as its independent public
accountants and resolved to appoint Rothstein, as its independent public
accountants to audit its financial statements for the fiscal year ended December
31, 2001.
7
During the two most recent fiscal years, and through April 10, 2002,
there were no disagreements with Andersen on any matter of accounting principles
or practices, financial statement disclosure, or auditing scope or procedure,
which disagreements, if not resolved to Andersen's satisfaction, would have
caused Andersen to make reference to the subject matter of the disagreement in
connection with its reports.
Andersen added an explanatory paragraph to their audit opinion issued
in connection with the Company's financial statements for the fiscal year ended
December 31, 2000 which states that the Company's losses since inception and
dependence on outside financing raise substantial doubt about its ability to
continue as a going concern. The Company's financial statements for the fiscal
year ended December 31, 2000 did not include any adjustments that might result
from the outcome of that uncertainty. With the exception of the foregoing, the
audit reports of Andersen on the consolidated financial statements of the
Company as of and for each of the two fiscal years ended December 31, 2000 did
not contain any adverse opinion or disclaimer of opinion, nor were they
qualified or modified as to uncertainty, audit scope or accounting principles.
None of the reportable events described under Item 304(a)(1)(iv) of
Regulation S-B occurred within the two most recent fiscal years and through
April 10, 2002.
The Company provided Andersen with a copy of the above disclosures. A
letter dated April 10, 2002, from Andersen stating its agreement with our
statements is listed under Item 13(a)(2) in Part IV as Exhibit 16.1 and is
incorporated herein by reference to the Company's Form 8-K filed with the
Securities and Exchange Commission on April 16, 2002.
During the two most recent fiscal years ended December 31, 2001, and
the subsequent interim period through April 10, 2002, the Company did not
consult with Rothstein regarding any of the matters or events set forth in Item
304(a)(2)(i) and (ii) of Regulation S-B.
8
PART III
ITEM 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act
Directors of the Company
Since December 31, 2000, three directors have tendered their
resignations from the Company's Board of Directors. P. Scott Munro resigned
effective June 2001, Lynn Fantom resigned effective November 6, 2001 and Dr.
Steven N. Goldstein resigned effective March 31, 2002. Set forth below are the
current directors of the Company.
Matthew G. de Ganon, age 39, has been a director since he joined the
Company in July 1995. Mr. de Ganon resigned from his position as an executive
officer of the Company effective August 1, 2001. From that time until April
2002, Mr. de Ganon was employed by Integrated Information Systems, Inc., which
purchased certain assets of the Company in August 2001. He was President of the
Company from June 1996 to November 1998 and was also the Chief Operating Officer
of the Company from July 1995 to November 1997. For the two years prior to
joining the Company, Mr. de Ganon operated a business that created CD-ROM
products and offered consulting services regarding the use of electronic
delivery to publishers of newsletters and directories. Mr. de Ganon is co-author
of the essay, "Overcoming Future Shock on the Superhighway: Suggestions for
Providers and Technocrats," published and presented in the 1994 National Online
Conference Proceedings. From August 1992 to July 1993, Mr. de Ganon was the Vice
President of New Media of Superior Computer Systems, Inc., a software developer.
Mr. de Ganon's work focused on UNIX-based 4GL accounting software customization
for corporate clients. From May 1991 to July 1992, Mr. de Ganon was involved in
casting administration for the Motion Picture Group of Universal Studios, Inc.
He was a franchised theatrical agent with the Stone Manners Agency in Los
Angeles, California from August 1987 to May 1991.
Douglas E. Cleek, age 39, who co-founded the Company in 1993, has been
a director of the Company since it was reorganized as a corporation in January
1995. From January 1995 until August 2001, Mr. Cleek served as the Company's
Executive Vice President--Chief Creative Officer. From 1993 until 1995, Mr.
Cleek was a general partner of the Company. For more than five years prior to
that, Mr. Cleek was an art director for William Allen & Co. and its successor,
A.J. Bart & Sons, specializing in graphic promotional materials for the
hospitality industry.
Gary W. Brown, age 49, has been a director of the Company since
February 2000 and joined the Company in April 2000 as Executive Vice President
and Chief Operating Officer. Since August 31, 2001, Mr. Brown has served as
President, Secretary, Chief Financial Officer and Chief Operating Officer of the
Company. Since November 14, 2001, Mr. Brown has served as Vice President and
Managing Director of the Risk Management Division of Canadian Imperial Bank of
Commerce (CIBC World Markets). Prior to that, Mr. Brown was employed from July
1980 through June 1999 in various management roles with UBS AG, the successor
organization to Union Bank of Switzerland, including the role of New York Branch
Manager. There he served as Division Head for Structured Finance, one of UBS's
six operating divisions in the Americas prior to the merger of UBS with Swiss
Bank Corporation in 1998. Post-merger, Mr. Brown was designated Chief Credit
Officer-Americas for UBS's investment banking division, Warburg, Dillon Read,
where he was responsible for capital commitments of the firm. Mr. Brown held
various business development and risk management positions throughout his
19-year career at UBS. He also served as President of the New York Chapter of
Robert Morris Associates, the trade association for the financial services risk
management industry, and as an ex-officio member of the RMA National Board.
Since 1991, he has served on the Board of Directors of Sefar Americas, a
subsidiary of Sefar AG, a manufacturer of Swiss synthetic fabrics. Prior to
joining UBS in 1980, Mr. Brown was employed from June 1976 through June 1980
with The Chase Manhattan Bank, having served in various business development
functions. Mr. Brown received a Bachelor of Science degree in Business
Administration from Oral Roberts University in May 1976.
David R. Sklaver, age 50, has been a director of the Company since
1999. Since October 2001, Mr. Sklaver has been President and Chief Executive
Officer of UPOC, Inc., a marketing company. From June 1997 to October 2001, Mr.
Sklaver was a General Partner and Chief Executive Officer of Artustry
Partnership, a strategic and creative marketing company, of which he was a
founder. Since October 1995, Mr. Sklaver has also served as President of Phase
2, Inc. From 1993 to 1995, Mr. Sklaver served as President of Wells Rich Greene
DDB, an advertising agency handling Fortune 500 clients. Prior to being promoted
to President, Mr. Sklaver served as Executive Vice President, Director of Client
Services of Wells Rich Greene from 1989 to 1993. From 1986 to 1988, Mr. Sklaver
was Executive Vice President, Account Group Head, at advertising agency BBD
Needham, New York. From 1984 to 1985, Mr. Sklaver was Managing Director of DDB's
Sydney office. From 1978 to 1984, he served in Account Management at DDB New
York. Prior to 1978, Mr. Sklaver held positions at Foote, Cone & Belding
Advertising and Standard Brands, both advertising agencies.
9
Filing Requirements
The Company believes that all filing requirements under Section 16(a)
of the Securities Act of 1934, as amended, applicable to its officers, directors
and greater than 10% beneficial owners were complied with during the fiscal year
ended December 31, 2001.
ITEM 10. Executive Compensation
Director Fees
Directors who are employees of the Company receive no additional
compensation for their service as directors. Directors not so employed are
entitled to receive $25,000 in compensation annually and are entitled to be
reimbursed for expenses incurred in connection with meeting attendance. In
addition, each of the Company's non-employee Directors are granted options to
acquire 5,000 shares of the Company's common stock upon their election or
reelection to the Board.
Advisor Fees
All nonemployees serving as members of the Company's Board of Advisors
receive options to purchase up to 5,000 shares of the Company's common stock
upon their election to the Board of Advisors. There are two members of the Board
of Advisors.
Executive Compensation
The following table sets forth, for the last three completed fiscal
years, the total annual compensation paid or accrued by the Company for services
in all capacities for the Chief Executive Officer, and those other executive
officers (the "Named Executives") who served in executive capacities during
fiscal 2001 and had aggregate compensation in excess of $100,000. Except for Mr.
Brown, each of the Named Executives has resigned his or her position as an
officer of the Company, effective August 2001.
10
Annual Compensation(1) Long Term Compensation
---------------------- ----------------------
Restricted
Bonus Stock Option
Name and Principal Position Year Salary ($) ($) Awards Awards
--------------------------- ---- ---------- ----- ---------- ------
Lynn Fantom, Chief Executive 2001 144,173 -- -- 200,000
Officer and President (2) 2000 250,000 -- -- --
1999 250,000 -- -- --
Matthew G. de Ganon, Executive Officer 2001 164,231 -- -- --
and
Chairman of the Board (2) 2000 228,392 -- -- --
1999 175,613 25,000 -- --
Douglas E. Cleek, Executive 2001 115,837 -- -- --
Vice President--Chief Creative 2000 182,423 -- -- --
Officer (2) 1999 166,794 25,000 -- --
Gary W. Brown, President, 2001 192,539(4) -- -- 100,000
Chief Operating Officer, 2000 151,442 -- 100,000(5) 268,000
Secretary and Chief Financial
Officer (3)
------------
(1) The value of perquisites and other personal benefits does not exceed 10% of
the officer's salary.
(2) Resigned as an officer of the Company effective November 6, 2001.
(3) Joined the Company in April 2000 and remains as an officer and director.
(4) Mr. Brown accepted compensation less than provided for in his employment
agreement during 2001, and has received no salary since December 31, 2001.
(5) 50,000 shares vested on April 14, 2001 and the remaining 50,000 shares
vested on April 14, 2002. Based on the closing price of the Company's
common stock on April 14, 2000 of $5.00 per share, the fair market value of
the restricted stock awards on the date of grant was $500,000.
Employment Contracts for Executive Officers
Matthew G. de Ganon, Lynn Fantom and Douglas E. Cleek resigned from
their positions as officers of the Company effective August 1, 2001. In
connection with their resignations, Mr. de Gannon and Mr. Cleek executed
releases, releasing the Company from any further liability under their
employment agreements with the Company.
The employment contract between the Company and Lynn Fantom, as Chief
Executive Officer and President of the Company, terminated on December 31, 2000
and a new employment contract between the Company and Ms. Fantom as Chief
Executive Office and President of the Company was entered into on February 13,
2001 and was scheduled to terminate on December 31, 2002. Ms. Fantom resigned
from her position as Chief Executive Officer and President of the Company
effective August 1, 2001. Pursuant to her employment contract, Ms. Fantom is
subject to a non-compete restriction for twelve months after the termination of
her employment.
Gary W. Brown joined the Company as Executive Vice President and Chief
Operating Officer on April 14, 2000 and is currently the Company's President,
Chief Financial Officer, Chief Operating Officer and Secretary. Mr. Brown signed
an employment contract with the Company that expired on March 31, 2002. The
employment contract provided for an annual salary of $225,000 and a
discretionary annual bonus in the form of stock options up to a maximum of
100,000 shares of the Company's common stock per year. Upon joining the Company,
Mr. Brown also received 100,000 shares of restricted stock and options to
purchase up to 263,000 shares of the Company's common stock, all of which had
vested as of April 14, 2002. In the event of a change of control of the Company,
all of Mr. Brown's unvested stock options were to immediately vest pursuant to
his employment contract and if,
11
within 180 days after a change of control, Mr. Brown is dismissed from the
Company for any reason other than "Cause" or if Mr. Brown were to resign from
the Company for "Good Reason" (as each term is defined in his employment
contract), Mr. Brown was to be entitled to a payment equal to the greater of
$225,000 or his base salary for the remainder of his employment term. Pursuant
to his employment contract, Mr. Brown is also subject to a non-compete
restriction for twelve months after the termination of his employment.
Option Grants in Fiscal 2001
The following table sets forth individual grants of stock options made
under the Company's 1996 Stock Incentive Plan (the "1996 Plan") and the 1997
Stock Incentive Plan (the "1997 Plan") during the fiscal year ended December 31,
2001 for the Chief Executive Officer of the Company and each of the Named
Executives.
Percent of Total
Number of Securities Options Granted to
Underlying Options Employees in Fiscal Exercise or Base
Name Granted Year(1) Price ($/Sh) Expiration Date
---- -------------------- ------------------- ---------------- ---------------
Lynn Fantom 200,000(2)(3) 67% $0.75 January 2, 2011
Matthew G. de -- -- -- --
Ganon
Douglas E. Cleek -- -- -- --
Gary W. Brown 100,000(2) 33% $0.75 January 2, 2011
----------------
(1) Calculated as a percentage of total options granted to all employees under
both the 1996 Plan and the 1997 Plan.
(2) Such options were granted under the 1997 Plan.
(3) All unvested options granted to Ms. Fantom were cancelled upon her
resignation from the Board of Directors effective November 6, 2001.
No stock options were granted under the 1996 Plan and 300,000 stock
options were granted under the 1997 Plan to all executive officers and directors
as a group during the fiscal year ended December 31, 2001. Such options are
exercisable at prices per share (reflecting the fair market value on the dates
of grant) of $0.75 under the 1997 Plan. None of such options were exercised
during fiscal 2001.
12
Option Exercises and Year-End Option Value Table
The table set forth below shows the value of unexercised options under
the 1996 Plan and the 1997 Plan held on December 31, 2001 by Ms. Fantom and each
of the Named Executives.
Value of
Number of Securities Unexercised In-the-Money
Shares Underlying Unexercised Options held on December 31,
Acquired Options at December 31, 2001 2001 ($)(1)
on Value ---------------------------- -----------------------------
Name Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
-------------------------------------------------------------------------------------------------------------------
Lynn Fantom -- -- 400,000(2) -- -- --
Matthew G. de Ganon -- -- 6,250(3) -- -- --
Douglas E. Cleek -- -- 6,250(3) -- -- --
Gary W. Brown -- -- 268,000(4) 100,000(2) -- --
--------------------
(1) Based on the closing price of the Company's common stock on December 31,
2001, the last day in fiscal 2001 on which the markets were open for
business, which was $0.03.
(2) Represents grants made under the 1997 Plan.
(3) Represents grants made under the 1996 Plan.
(4) Represents 246,000 options granted under the 1997 Plan and 22,000 options
granted under the 1996 Plan.
13
ITEM 11. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
Beneficial Ownership
The following table sets forth information, as of April 15, 2002 as to
the beneficial ownership of common stock (including shares which may be acquired
within 60 days pursuant to stock options) of Lynn Fantom and each director of
the Company, the Chief Executive Officer of the Company, all directors and
executive officers as a group and persons known by the Company to beneficially
own 5% or more of the common stock. Except as set forth below, each of the
listed persons has sole voting and investment power with respect to the shares
beneficially owned by such person. Except as otherwise indicated, the address of
each person included in the table is c/o the Company, 30 Broad Street, 15th
Floor, New York, New York 10004.
Shares of Common Stock
Name of Owner Beneficially Owned Percent of Class (1)
------------- ------------------ ----------------
Matthew G. de Ganon 936,993(2) 18.8
Douglas E. Cleek 430,531(2)(3) 8.6
Lynn Fantom 405,000(4) 8.1
Gary W. Brown 1,348,069(5) 27.1
Steven N. Goldstein 15,000(6) *
David Sklaver 15,000(6) *
All Directors and Executive 2,720,062(7) 54.6
Officers as a group (6 persons)
--------------------------------------------------------------------------------
*Less than one percent.
(1) Does not give effect to: (i) shares held in treasury and (ii) options held
by persons other than the persons named above.
(2) Messrs. de Ganon and Cleek resigned from their positions as officers of the
Company effective August 1, 2001. Pursuant to a 10-year voting agreement
entered into by Messrs. de Ganon, Cleek, David Centner (a former Chief
Operating Officer and Director of the Company) and Bradley Szollose (a
former Secretary and Director of the Company), effective July 26, 1996 (the
"Voting Agreement"), the voting control over 498,158 shares held by Messrs.
Cleek, Centner and Szollose and 6,250 shares underlying presently
exercisable stock options held by Mr. Cleek are vested in Mr. de Ganon.
Such shares subject to the Voting Agreement must be voted in favor of the
election of Mr. de Ganon. In addition, the Voting Agreement grants each
party thereto a right of first refusal as to the sale of the others' common
stock. Messrs. de Ganon, Cleek, Centner and Szollose each disclaim
beneficial ownership of those shares with respect to which they are not
record owners. Mr. de Ganon's holdings also include 6,250 shares underlying
presently exercisable stock options held by him.
(3) Includes 6,250 shares underlying presently exercisable stock options.
(4) Ms. Fantom resigned from her position as an officer of the Company
effective August 1, 2001 and resigned as a director of the Company
effective November 6, 2001. Includes 400,000 shares underlying
presently exercisable stock options. Ms. Fantom disclaims beneficial
ownership of all such shares underlying unexercised options.
14
(5) Includes: (i) 136,500 shares underlying presently exercisable stock
options; (ii) 131,500 shares underlying options which vested on April 14,
2002, 50,000 shares underlying options which vested on January 2, 2002 and
50,000 shares underlying unvested stock options which will vest on January
2, 2003 and upon the occurrence of certain change of control transactions;
and (iii) 50,000 shares of restricted common stock which vested on April
14, 2002. Mr. Brown disclaims beneficial ownership of all shares underlying
unexercised and/or unvested options.
(6) Includes 15,000 shares underlying presently exercisable stock options.
(7) Includes 760,500 shares underlying presently exercisable stock options and
50,000 shares underlying unvested stock options, all of which vest upon the
occurrence of certain change of control transactions. Note that 430,531 of
the 2,720,062 shares are subject to the Voting Agreement described above
and are therefore listed as beneficially owned by both Mr. de Ganon and Mr.
Cleek. These shares are counted only once for purposes of the aggregate
number of shares of common stock beneficially owned by all directors and
executive officers as a group.
ITEM 12. Certain Relationships and Related Transactions
Certain Related Transactions
On May 15, 2001, Mr. Brown acquired 862,069 shares of common stock of
the Company for an aggregate purchase price of $250,000. Mr. Brown purchased the
shares through the Fusion Facility described above. Mr. Brown acquired the
shares for personal investment purposes and to further demonstrate to a
potential investor in the Company his confidence in the Company and the
alignment of his interests, as an officer and director of the Company, with the
interests of the stockholders of the Company.
15
PART IV
ITEM 13. Exhibit List and Reports on Form 8-K
(a) Documents filed as part of this report: Page
1. Independent Auditors' Report....................................F-1 - 2
2. Consolidated Financial Statements
Consolidated Balance Sheet - December 31, 2001......................F-3
Consolidated Statements of Operations and Comprehensive Loss - For the
years ended December 31, 2001 and 2000..............................F-4
Consolidated Statements of Stockholders' Equity (Deficit) - For the
years ended December 31, 2001 and 2000..............................F-5
Consolidated Statements of Cash Flows - For the years ended
December 31, 2001 and 2000......................................F-6 - 7
Notes to Consolidated Financial Statements.....................F-8 - 16
Schedule II - Valuation and Qualifying Accounts....................F-17
3. Exhibits
3.1 Certificate of Incorporation of the Company*
3.1(a) Amendment to Certificate of Incorporation of the Company*
3.1(b) Amendment to Certificate of Incorporation of the Company
(incorporated by reference from the Registrant's Form 10-KSB
for its fiscal year ended 12/31/00).
3.2 By-laws of the Company*
3.2(b) Amendment to By-laws of the Company*
4.1 Common Stock Certificate*
4.2 Warrant Certificate*
4.4 Warrant Agreement by and between Continental Stock Transfer &
Trust Company and the Company*
4.5 Voting Agreement among Messrs. Centner, de Ganon, Cleek and
Szollose*
10.1 1996 Stock Incentive Plan and Rules Relating thereto*
10.2 1997 Stock Option Plan (incorporated by reference from the
Registrant's Form 10-KSB for its fiscal year ended 12/31/96).
10.3 Amendment to 1997 Stock Option Plan (incorporated by
reference from the Registrant's Form 10-KSB for its
fiscal year ended 12/31/00).
10.4 Consulting Agreement with Harvey Berlent*
10.5 Employment Agreement with Matthew G. de Ganon*
16
10.6 Extension of Employment Agreement with Matthew G. de Ganon
dated November 2, 1998 (incorporated by reference from the
Registrant's Form 10-KSB for its fiscal year ended 12/31/98).
10.7 Amendment to Employment Agreement of Matthew G. de Ganon dated
April 14, 2000 (incorporated by reference from the
Registrant's Form 10-QSB for the quarterly period ended
03/31/00).
10.8 Employment Agreement with Douglas E. Cleek*
10.9 Extension of Employment Agreement with Douglas E. Cleek dated
January 15, 1999 (incorporated by reference from the
Registrant's Form 10-KSB for its fiscal year ended 12/31/98).
10.10 Employment Agreement with Gary W. Brown dated April 14, 2000
(incorporated by reference from the Registrant's Form 10-QSB
for the quarterly period ended 03/31/00).
10.11 Restricted Stock Agreement of Gary W. Brown (incorporated by
reference from the Registrant's Form 10-QSB for the quarterly
period ended 03/31/00).
10.12 Employment Agreement with Lynn Fantom dated February 13, 2001
(incorporated by reference from the Registrant's Form 10-KSB
for its fiscal year ended 12/31/00).
10.13 Agreement of Lease dated as of April 18, 1997, between
30 Broad Associates, L.P., as landlord, and the Company, as
tenant, relating to 30 Broad Street, New York, New York
(incorporated by reference from the Registrant's Form 10-KSB
for its fiscal year ended 12/31/00).
10.14 Amendment to Lease dated as of April 1, 1998, between 30 Broad
Associates, L.P., as landlord, and the Company, as tenant,
relating to 30 Broad Street, New York, New York (incorporated
by reference from the Registrant's Form 10-KSB for its fiscal
year ended 12/31/00).
10.15 Second Amendment to Lease dated as of July 10, 2000, between
ASC-CSFB 30 Broad, LLC, as landlord, and the Company, as
tenant, relating to 30 Broad Street, New York, New York
(incorporated by reference from the Registrant's Form 10-QSB
for the quarterly period ended 06/30/00).
10.16 Common Stock Purchase Agreement dated as of December 11, 2000
between the Company and Fusion Capital Fund II, LLC
(incorporated by reference from the Registrant's Current
Report on Form 8-K filed 12/11/00).
10.17 Form of Registration Rights Agreement between the Company and
Fusion Capital Fund II, LLC (incorporated by reference from
the Registrant's Current Report on Form 8-K filed 12/11/00).
10.18 Master Transaction Agreement, dated as of August 20, 2001,
between the Company and Integrated Information Systems, Inc.
(incorporated by reference from the Registrant's Current
Report on Form 8-K filed 8/30/01).
10.19 Agreement and Plan of Merger, dated as of January 15, 2002, by
and among First Step Distribution Network, Inc. and its
shareholders, First Step Acquisition Corp. and the Company
(incorporated by reference from the Registrant's Current
Report on Form 8-K filed 01/17/02).
10.20 Side Letter dated April 8, 2002, by and between the Company
and First Step Distribution Network, Inc. (incorporated by
reference from the Registrant's Annual Report on Form 10-KSB
filed 04/16/02).
17
16.1 Letter from Arthur Andersen LLP regarding change in certifying
accountant (incorporated by reference from the Registrant's
Current Report on Form 8-K filed 04/16/02).
21.1 Subsidiary List*
* Incorporated by reference from the Company's Registration Statement on
Form SB-2, No. 333-4319.
(b) The Company did not file any reports on Form 8-K during the last
quarter of the period covered by this report.
18
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
K2 DIGITAL, INC.
Dated: May 31, 2002
By: /s/ Gary W. Brown
------------------------------------
Gary W. Brown, President
Signature Title Date
--------- ----- ----
/s/ Matthew G. de Ganon* Chairman of the Board May 31, 2002
------------------------------
Matthew G. de Ganon
/s/ Gary W. Brown* Chief Operating Officer, Secretary, Chief Financial May 31, 2002
------------------------------ Officer (Principal Financial and Accounting Officer), and
Gary W. Brown Director
/s/ Douglas E. Cleek* Director May 31, 2002
------------------------------
Douglas E. Cleek
/s/ David R. Sklaver* Director May 31, 2002
------------------------------
David R. Sklaver
*By Gary W. Brown, Attorney-in-fact
19
K2 DIGITAL, INC.
AND SUBSIDIARY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Independent Auditors' Reports F-1-2
Consolidated Financial Statements
Consolidated Balance Sheet F-3
December 31, 2001
Consolidated Statements of Operations and Comprehensive Loss F-4
For the Years Ended December 31, 2001 and 2000
Consolidated Statements of Stockholders' Equity (Deficit) F-5
For the Years Ended December 31, 2001 and 2000
Consolidated Statements of Cash Flows F-6 - 7
For the Years Ended December 31, 2001 and 2000
Notes to Consolidated Financial Statements F-8 - 16
Schedule II - Valuation and Qualifying Accounts F-17
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
K2 Digital, Inc. and Subsidiary
We have audited the accompanying consolidated balance sheet of K2 Digital, Inc.
and Subsidiary as of December 31, 2001, and the related consolidated statements
of operations and comprehensive loss, stockholders' equity (deficit) and cash
flows for the year then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the consolidated
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
audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of K2
Digital, Inc. and Subsidiary as of December 31, 2001, and the results of their
operations and their cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company sold fixed and intangible assets
essential to its business operation and effectively became a "shell" company
with no revenues and continuing general and administrative expenses. Further, at
December 31, 2001, the Company had significant cumulative losses, a diminutive
cash balance and working capital and stockholders' deficits. These conditions
raise substantial doubt about the Company's ability to continue as a going
concern. Management's plans regarding those matters are also described in Note
1. The consolidated financial statements do not include any adjustments that
might result from the outcome of this uncertainty.
Our audit was made for the purpose of forming an opinion on the basic financial
statements taken as a whole. The schedule listed in the index to consolidated
financial statements is presented for the purpose of complying with the
Securities and Exchange Commission's rules and is not part of the basic
financial statements. This schedule has been subjected to our auditing
procedures applied in the audit of the basic financial statements and, in our
opinion, fairly states in all material respects the financial data required to
be set forth therein in relation to the basic financial statements taken as a
whole.
/s/ ROTHSTEIN, KASS & COMPANY, P.C.
Roseland, New Jersey
May 15, 2002
F-1
INDEPENDENT AUDITORS' REPORT
To K2 Digital, Inc.:
We have audited the accompanying consolidated balance sheet of K2 Digital, Inc.
(a Delaware corporation) and subsidiary (a New York corporation) as of December
31, 2000, and the related consolidated statements of income, comprehensive
income, changes in stockholders' equity and cash flows for the years ended
December 31, 2000 and 1999. 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 auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of K2 Digital, Inc. and subsidiary
as of December 31, 2000, and the results of their operations and their cash
flows for the years ended December 31, 2000 and 1999, in conformity with
accounting principles generally accepted in the United States.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company has suffered recurring losses
from operations that raises substantial doubt about its ability to continue as a
going concern. Management's plans in regard to these matters are also described
in Note 1. The consolidated financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in the index to
consolidated financial statements is presented for the purpose of complying with
the Securities and Exchange Commission's rules and is not part of the basic
financial statements. This schedule has been subjected to our auditing
procedures applied in the audits of the basic financial statements and, in our
opinion, fairly states in all material respects the financial data required to
be set forth therein in relation to the basic financial statements taken as a
whole.
/s/ ARTHUR ANDERSEN LLP
New York, New York
February 26, 2001
THE FOREGOING REPORT HAS NOT BEEN REISSUED BY ARTHUR ANDERSEN LLP (SEE NOTE 2 TO
THE CONSOLIDATED FINANCIAL STATEMENTS)
F-2
K2 DIGITAL, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
December 31, 2001
ASSETS
Current assets
Cash $ 5,380
Accounts receivable, net of allowance for
doubtful accounts of $71,650 68,807
Investment in available-for-sale-securities 25,300
----------------
$ 99,487
================
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities
Accounts payable $ 205,727
Accrued expenses and other current liabilities 94,806
----------------
Total current liabilities 300,533
----------------
Commitments and contingencies
Stockholders' deficit
Preferred stock, $0.01 par value,
authorized 1,000,000 shares,
issued and outstanding nil shares
Common stock, $0.01 par value,
authorized 25,000,000 shares,
issued 5,400,116 shares,
outstanding 4,982,699 shares 54,001
Treasury stock, 417,417 shares at cost (819,296)
Additional paid-in capital 8,313,410
Deferred compensation (72,355)
Accumulated deficit (7,676,806)
----------------
Total stockholders' deficit (201,046)
----------------
$ 99,487
================
See accompanying notes to consolidated financial
statements.
F-3
K2 DIGITAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
Year Ended Year Ended
December 31, December 31,
2001 2000
----------------------------------------
Revenues $ - $ -
General and administrative expenses 570,459 450,349
Impairment of available-for-sale securities 1,412,747
----------------------------------------
Loss from continuing operations (1,983,206) (450,349)
----------------------------------------
Discontinued operations
Loss from operations (3,374,238) (1,475,194)
Gain on disposal 218,110
----------------------------------------
(3,156,128) (1,475,194)
----------------------------------------
Net loss $ (5,139,334) $ (1,925,543)
========================================
Net loss per common share, basic and diluted
Loss from continuing operations $ (0.45) $ (0.13)
Loss from discontinued operations (0.71) (0.44)
----------------------------------------
Net loss $ (1.16) $ (0.57)
========================================
Weighted average common shares outstanding,
basic and diluted 4,440,836 3,371,579
========================================
Comprehensive loss:
Net loss $ (5,139,334) $ (1,925,543)
Other comprehensive income (loss)
Unrealized loss on available-for-sale securities (36,043) (4,229,900)
Reclassification adjustment in light of permanent
decline in investment in available-for-sale securities 1,412,747
----------------------------------------
Comprehensive loss $ (3,762,630) $ (6,155,443)
========================================
See accompanying notes to consolidated financial
statements.
F-4
K2 DIGITAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
Years Ended December 31, 2001 and 2000
Accumulated
Other
Common Stock Treasury Additional Comprehensive
Shares Amount Stock Paid-in Capital Income (Loss)
------ ------ -------- --------------- -------------
Balances, January 1, 2000 3,750,582 $37,505 $(819,296) $6,908,220 $2,853,196
Net Loss
Issuance of restricted stock 100,000 1,000 499,000
Amortization of deferred compensation
Cashless exercise of stock options 19,379 194 147,516
Proceeds from stock options exercised 10,250 102 27,507
Change in fair value of securities
available for sale (4,229,900)
-----------------------------------------------------------------------------------
Balances, December 31, 2000 3,880,211 $38,801 $(819,296) $7,582,243 $(1,376,704)
-----------------------------------------------------------------------------------
Fusion Capital transactions (see Note 7):
Issuance of common stock and warrants
as commitment fee 380,485 3,805 714,562
Issuance of Stock to Fusion Capital 862,069 8,621 (8,621)
Exercise of warrants by Fusion Capital 277,351 2,774 (2,774)
Write-off of deferred issuance costs
Amortization of deferred compensation
Unrealized loss on
available-for-sale securities (36,043)
Reclassification adjustment in light of
permanent decline in investment in
available-for-sale securities 1,412,747
Issuance of options for consulting
services 28,000
Net loss
-----------------------------------------------------------------------------------
Balances, December 31, 2001 5,400,116 $54,001 $(819,296) $8,313,410 $ -
===================================================================================
Total
Stock-
Accumulated holders'
Deferred Deferred Equity Equity
Compensation Issuance Costs (Deficit) (Deficit)
------------ -------------- ----------- ---------
Balances, January 1, 2000 $ - $ - $ (611,929) $ 8,367,696
Net Loss (1,925,543) (1,925,543)
Issuance of restricted stock (500,000) -
Amortization of deferred compensation 177,649 177,649
Cashless exercise of stock options 147,710
Proceeds from stock options exercised 27,609
Change in fair value of securities
available for sale (4,229,900)
--------------------------------------------------------------------------
Balances, December 31, 2000 $(322,351) $ - $(2,537,472) $2,565,221
--------------------------------------------------------------------------
Fusion Capital transactions (see Note 7):
Issuance of common stock and warrants
as commitment fee (718,367)
Issuance of Stock to Fusion Capital 250,000 250,000
Exercise of warrants by Fusion Capital
Write-off of deferred issuance costs 468,367 468,367
Amortization of deferred compensation 249,996 249,996
Unrealized loss on
available-for-sale securities (36,043)
Reclassification adjustment in light of
permanent decline in investment in
available-for-sale securities 1,412,747
Issuance of options for consulting
services 28,000
Net loss (5,139,334) (5,139,334)
--------------------------------------------------------------------------
Balances, December 31, 2001 $(72,355) $ - $(7,676,806) $(201,046)
==========================================================================
See accompanying notes to consolidated financial statements.
F-5
K2 DIGITAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended Year Ended
December 31, December 31,
2001 2000
----------------------------------------
Cash flows from operating activities
Net loss $ (5,139,334) $ (1,925,543)
Adjustments to reconcile net loss to net cash
used in operating activities:
Impairment of investment in available-for-sale securities 1,412,747
Noncash consulting and compensation expenses 277,996 325,359
Write-off of deferred issuance and financing costs 722,861
Gain on disposal of discontinued operations (218,110)
Depreciation and amortization 210,640 332,281
Changes in operating assets and liabilities:
Accounts receivable, net 1,601,342 (744,584)
Prepaid expenses and other current assets 40,825 (73,073)
Unbilled revenue 482,773 189,817
Other assets 2,882
Accounts payable (572,134) 300,714
Accrued expenses and other current liabilities (639,264) 72,880
Deferred revenue and customer advances (129,954) 238,358
Deferred rent 121,926 107,950
Restricted cash 250,000 (99,289)
----------------------------------------
Net cash used in operating activities (1,577,686) (1,272,248)
----------------------------------------
Cash flows from investing activities
Net proceeds from disposal of discontinued operations 528,500
Gross proceeds from sale of available-for-sale securities 94,127
Purchase of equipment (8,074) (298,899)
Software development costs (274,567)
Advances for proposed transaction (254,494)
Investments in available-for-sale securities (100,000)
----------------------------------------
Net cash provided by (used in) investing activities 614,553 (927,960)
----------------------------------------
Cash flows from financing activities
Principal payments on note payable 250,000
Proceeds from note payable (250,000)
Principal payments on capital lease obligations (17,093) (28,712)
Proceeds from the issuance of common stock 250,000
Options exercised for cash 27,609
----------------------------------------
Net cash provided by (used in) financing activities 232,907 (1,103)
----------------------------------------
Net decrease in cash (730,226) (2,201,311)
Cash, beginning of year 735,606 2,936,917
----------------------------------------
Cash, end of year $ 5,380 $ 735,606
========================================
See accompanying notes to consolidated financial
statements.
F-6
K2 DIGITAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Year Ended Year Ended
December 31, December 31,
2001 2000
-------------------------------------------
Supplemental disclosure of cash flow information:
Approximate cash paid during the year for interest $ 10,000 $ 4,000
=========================================
Supplemental disclosure of noncash investing and
financing activities:
Common stock and warrants issued for financing costs $ 718,367 $ -
=========================================
See accompanying notes to consolidated financial
statements.
F-7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Prior business and going concern consideration
Through August 2001, K2 Digital, Inc. (together with its wholly-owned
subsidiary, the "Company") was a strategic digital services company that
provided consulting and development services including analysis, planning,
systems design and implementation. In August 2001, the Company completed the
sale of fixed and intangible assets essential to its business operations to
Integrated Information Systems, Inc. ("IIS") (see Note 3).
The accompanying consolidated financial statements have been prepared assuming
the Company will continue as a going concern. As discussed above and in Note 3,
the Company sold fixed and intangible assets essential to its business
operations to IIS and effectively became a "shell" company with no revenues and
continuing general and administrative expenses. Further, at December 31, 2001,
the Company has cumulative losses of approximately $7.7 million, a diminutive
cash balance and working capital and stockholders' deficits of approximately
$201,000. These conditions raise substantial doubt about the Company's ability
to continue as a going concern. The consolidated financial statements do not
include any adjustments that might result from the outcome of this uncertainty.
Management's plan includes a proposed business combination with First Step
Distribution Network, Inc. ("First Step"), a California-based business
consulting firm, in a reverse merger transaction (see Note 8). If the Company is
unsuccessful in completing the preceding transaction, management's alternative
plan may include a further search for a similar business combination or
strategic alliance. There can be no assurances that the transaction described
above or management's alternative plan will be realized.
2. Summary of significant accounting policies
Restatements
Certain prior year amounts have been restated to conform to the 2001
discontinued operations presentation (see Note 3).
In March 2002, the Securities and Exchange Commission ("SEC") issued a release
(the "March 2002 SEC release") adopting certain temporary and final rules
intended to assure a continuing and orderly flow of information to investors and
the U.S. capital markets and to minimize any potential disruptions that might
otherwise occur as a result of the indictment of Arthur Andersen LLP
("Andersen"), the Company's former auditor.
In the March 2002 SEC release, the SEC adopted rules pursuant to which the SEC
will accept filings that include unaudited financial statements from any
Andersen client that is unable to obtain from Andersen (or elects not to have
Andersen issue) a manually signed audit report and is therefore unable to
provide timely audited financial statements. The rules adopted by the SEC
require that any Andersen client electing this alternative will generally be
required to amend their filings within 60 days to include audited financial
statements.
F-8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Summary of significant accounting policies (continued)
In light of the foregoing and in connection with its April 2002 appointment of a
new auditor for the year ended December 31, 2001, the Company filed its December
31, 2001 Form 10-KSB, which included unaudited financial statements, on April
16, 2002 (the "April 16, 2002 filing"). Following is a reconciliation of 2001
net loss as previously reported in the April 16, 2002 filing to 2001 net loss as
reported in the accompanying consolidated statement of operations:
Net Loss, as previously filed $(4,923,679)
Additional impairment adjustment related to
available-for-sale securities deemed
permanently impaired (84,700)
Asset reserves and accruals (102,955)
Noncash consulting charge (options
granted to a vendor) (28,000)
-----------
Net loss, per accompanying consolidated
statement of operations $(5,139,334)
===========
Year Ended December 31, 2000
The Company's consolidated financial statements for the year ended December 31,
2000 were audited by Andersen.
In the March 2002 SEC release, the SEC amended Rule 2-02 of Regulation S-X to
provide that those issuers that cannot obtain an accountants' report from
Andersen after reasonable efforts may file a copy of the latest signed and dated
accountants' report issued by Andersen for such period, for which the Company
has done. Hence, Andersen's independent auditors' report on the consolidated
financial statements of the Company for the year ended December 31, 2000, dated
February 26, 2001, has not been reissued by Andersen.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of K2
Digital, Inc. and its wholly-owned subsidiary. All significant intercompany
balances and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America 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.
F-9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Summary of significant accounting policies (continued)
Revenue Recognition (of discontinued operations)
Revenues were recognized on the percentage of completion method based upon the
ratio of costs incurred to total estimated costs. Unbilled revenues represented
costs incurred and anticipated profits earned on projects in progress in excess
of amounts billed. Deferred revenues and customer advances represented amounts
billed in excess of costs incurred and estimated profit earned. Such billings
generally occurred at the beginning of contract periods, and were in accordance
with contract provisions. Provisions for any estimated losses on uncompleted
contracts were made in the period in which such losses were determinable. A
portion of the Company's revenues were generated on a fixed fee for service
basis.
Investment in Available-For-Sale Securities
As of December 31, 2001, the Company held 110,000 shares of common stock of 24/7
Media, Inc. These shares have been classified as "investment in
available-for-sale securities" as a result of the Company's ability and intent
to sell such shares in the near future. In accordance with Statement of
Financial Accounting Standards ("SFAS") No. 115, the shares are stated at fair
market value of $25,300 on the accompanying December 31, 2001 consolidated
balance sheet. Management believes that the decline of approximately $1.4
million in value of such investment is permanent. Accordingly, such amount,
which previously was reflected in "accumulated other comprehensive loss" in
stockholders' equity, has been reclassified to the 2001 consolidated statement
of operations as impairment of available-for-sale securities.
Fixed Assets (of discontinued operations)
Fixed assets were stated at cost less accumulated depreciation and amortization.
The Company provided for depreciation and amortization using the straight-line
method over the following estimated useful lives:
Estimated
Assets Useful Lives
Computer and equipment 3 Years
Furniture and fixtures 5 Years
Leasehold improvements Term of lease
Income Taxes
The Company complies with SFAS No. 109, "Accounting for Income Taxes", which
requires an asset and liability approach to financial accounting and reporting
for income taxes. Deferred income tax assets and liabilities are computed for
differences between the financial statement and tax bases of assets and
liabilities that will result in future taxable or deductible amounts, based on
enacted tax laws and rates to the periods in which the differences are expected
to affect taxable income. Valuation allowances are established, when necessary,
to reduce deferred tax assets to the amount expected to be realized.
F-10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Summary of significant accounting policies (continued)
Net Loss Per Common Share
The Company complies with SFAS No. 128, "Earnings Per Share", which requires
dual presentation of basic and diluted earnings per share. Basic earnings (loss)
per share excluded dilution and is computed by dividing net income (loss)
available to common stockholders by the weighted average common shares
outstanding for the year. Diluted earnings per share reflects the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised or converted to common stock or resulted in the issuance of
common stock that then shared in the earnings of the entity. Since the effect of
outstanding options is antidilutive, they have been excluded from the Company's
computation of net loss per common share. Therefore, basic and diluted loss per
common share for the years ended December 31, 2001 and 2000 were the same.
Stock-Based Compensation
The Company follows SFAS No. 123 "Accounting for Stock-Based Compensation." The
provisions of SFAS No. 123 allow companies to either expense the estimated fair
value of stock options or to continue to follow the intrinsic value method set
forth in Accounting Principles Board ("APB") Opinion No. 25, "Accounting for
Stock Issued to Employees" but disclose the pro forma effect on net income
(loss) had the fair value of the options been expensed. The Company has elected
to continue to apply ABP Opinion No. 25 in accounting for its stock option
incentive plans.
New Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS Nos.
141 and 142, "Business Combinations" and "Goodwill and Other Intangibles." SFAS
No. 141 requires all business combinations initiated after June 30, 2001 to be
accounted for using the purchase method. Under SFAS No. 142, effective the first
quarter of the year ending December 31, 2002, goodwill will no longer be subject
to amortization over its estimated useful life; rather, goodwill will be subject
to at least an annual assessment for impairment applying a fair-value based
test. Additionally, an acquired intangible asset will be separately recognized
if the benefit of the intangible asset is obtained through contractual or other
legal rights, or if the intangible asset can be sold, transferred, licensed,
rented, or exchanged, regardless of the acquirer's intent to do so.
In August 2001, FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets". This statement established a single accounting
model, based upon the framework established in SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of, "
for long-lived assets to be disposed of by sale and to address significant
implementation issues.
The Company does not anticipate that these pronouncements will have a
significant impact on its consolidated financial position, results of operations
or cash flows.
3. Sale of assets and discontinued operations
Background
On August 29, 2001, the Company sold fixed and intangible assets essential to
its business operations to IIS including certain of the Company's customer
contracts, furniture, fixtures, equipment and intellectual property, for an
aggregate purchase price of $444,000, of which $419,000 was paid in cash and
$25,000 of capital lease obligations were assumed by IIS. IIS also assumed
certain deferred revenues and customer deposits.
Under the terms of the purchase agreement governing the transaction (the
"Purchase Agreement"), IIS assumed the Company's office lease obligations, took
up occupancy in the Company's premises and made offers of employment to
substantially all of the remaining employees of the Company, which offers have
been accepted.
F-11
K2 DIGITAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. Sale of assets and discontinued operations (continued)
In addition to the purchase price and as consideration of the Company's release
of certain employees from the non-competition restrictions contained in their
agreements with the Company, the Company received from IIS at closing a
recruitment and placement fee of $75,000. In addition, the Purchase Agreement
provided for the Company to receive from IIS and additional placement fee of
$7,500 per key employee and $2,500 per other employee that remained employed by
IIS through December 31, 2001. This additional contingent placement fee was to
be paid by IIS in cash in five monthly installments beginning August 31, 2001,
pro rated monthly for the number of employees retained. As of December 31, 2001,
$31,000 of these contingent fees had been paid to the Company and $36,500 due to
the Company remained unpaid by IIS.
Under the Purchase Agreement, the Company also received from IIS a cash fee of
$50,000 in return for entering into certain non-competition provisions contained
in the Purchase Agreement, which provide that the Company will not, for a period
of five year (i) engage in any business of substantially the same character as
the business engaged in by the Company prior to the transaction, (ii) solicit
for employment any employee of IIS (including former employees of the Company),
or (iii) solicit any client or customer of IIS (including any customer
transferred to IIS under the Purchase Agreement) to do business with the
Company.
The aggregate cash consideration delivered to the Company at closing was
$544,000, of which approximately $258,000 was paid directly to K2 Holdings LLC,
an affiliate of SGI Graphics, LLC (collectively, "SGI") the Company's principal
secured creditor, in order to release SGI's security interest in the assets of
the Company.
Discontinued operations presentation and restatement
The operating results relating to the discontinued operations have been
segregated from continuing operations and reported as a separate line item on
the consolidated statements of operations. The Company has restated its
consolidated financial statements for the year ended December 31, 2000 to
conform to the 2001 presentation.
The following table provides certain information related to the discontinued
operations for the years ended December 31, 2001 and 2000:
2001 2000
Revenues $ 1,999,407 $ 5,162,213
-----------------------------
Direct salaries and costs 1,978,970 3,344,791
Selling, general and administrative
expenses 3,234,248 3,090,885
Depreciation and amortization 210,610 332,281
Other income (50,183) (130,550)
-----------------------------
5,373,645 6,637,407
-----------------------------
$(3,374,238) $(1,475,194)
=============================
F-12
K2 DIGITAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
4. Commitments and contingencies
The Company had a two-year employment contract with an executive officer, which
expired March 31, 2002. The contract provided for an annual salary of $225,000
and a discretionary bonus in the form of stock options based upon individual and
Company performance. Such agreement also provided for 100,000 shares of
restricted Common Stock, which vest over two years, 50% on April 14, 2001 and
50% on April 14, 2002. The value of the stock at the grant date was $5.00 per
share. As a result of this transaction, the Company incurred $500,000 of
deferred compensation costs, which are being amortized over the two-year vesting
period. The Company amortized $249,996 and $177,649 of deferred compensation in
2001 and 2000. Although this agreement is effective through March 31, 2002, the
officer has elected to take a reduced salary in the 4th quarter of 2001 and not
to be paid in cash under this agreement in 2002, due to the financial condition
of the Company. However, the officer may be compensated for the shortfall
through additional stock options in the future.
Although management believes that it has adequately provided for all of its
known liabilities at December 31, 2001, the Company may be exposed to potential
contingencies related to its business activities that have been discontinued.
5. Income taxes
The benefit for income taxes on the net loss for the years ended December 31,
2001 and 2000 differs from the amount computed by applying the Federal statutory
rate due to the following:
2001 2000
-------------- --------------
Statutory Federal income tax rate (34.0)% (34.0)%
State and local taxes, net (5.1) (5.1)
Valuation allowance and other 39.1 39.1
--------------------------------
Effective income tax rate - % - %
=================================
As of December 31, 2001, the Company had net operating loss carryforwards of
approximately $6.9 million for federal and state income tax purposes, which are
available to reduce future taxable income and will expire through 2021 if not
utilized. In addition, the impairment charge related to the investment in
available-for-sale securities of approximately $1.4 million is not deductible
until the securities are sold. The future tax benefits associated with the net
operating loss carryforwards and impairment charge were the primary components
of an estimated $3.4 million deferred tax asset at December 31, 2001. A
valuation allowance has been established for the entire amount of the deferred
tax asset since its realization is considered unlikely. Further, a change in the
ownership of a majority of the fair market value of the Company's common stock
(such as the change in ownership that would occur in the contemplated
transaction with First Step - see Note 8) could delay or limit the utilization
of net operating loss carryforwards.
F-13
K2 DIGITAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
6. Stock option plan
The Company has two stock plans, the 1996 Stock Option Plan (the "1996 Plan"),
and the 1997 Stock Incentive Plan (the "1997 Plan", and together with the 1996
Plan, the "Plans"). Pursuant to the Plans, designated employees, including
officers and directors of the Company and certain outside consultants, will be
entitled to receive nonqualified stock options and qualified stock incentive
compensation of up to 225,000 and 500,000 options under the 1996 Plan and 1997
Plan respectively. The number of options available under the 1997 Plan were
increased by an additional 400,000 and 800,000 options in 1999 and 2000,
respectively, to a total of 1,700,000 options. In January 2001, the Board of
Directors and stockholders approved an amendment to the 1997 Plan to increase
the aggregate number of shares reserved for future issuance of the Company's
common stock under the 1997 Plan from 1,700,000 shares to 3,000,000 shares. As
of December 31, 2001, there were 1,135,500 shares of common stock available for
grant under the Plans. The 1996 Plan expires on January 1, 2006 and the 1997
Plan expires on June 12, 2007. Under the terms of the Plans, the minimum
exercise price of options granted cannot be less than 100% of the fair market
value of the common stock of the Company on the option grant date. Options
granted under the Plan generally expire ten years after the option grant date.
For incentive stock options granted to such persons who would be deemed to have
in excess of a 10% ownership interest in the Company, the option price shall not
be less that 110% of such fair market value for all options granted, and the
options expire five years after the option grant date.
A summary of the Plans at December 31, 2001, and 2000 is presented in the table
below:
Weighted Average
Shares Exercise Price
----------------------------------
Outstanding at January 1, 2000 642,700 $ 1.87
Granted 1,040,500 $ 3.70
Exercised (29,129) $ 2.09
Forfeited (58,821) $ 4.68
-----------------------------
Outstanding at December 31, 2000 1,595,250 $ 2.96
Granted 175,000 $ 0.73
Forfeited (815,000) $ 2.93
-----------------------------
Outstanding at December 31, 2001 955,250 $ 2.55
=============================
Shares exercisable at December 31, 2001 701,250
=======
F-14
K2 DIGITAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
6. Stock option plan (continued)
The Company accounts for the Plans under APB Opinion No. 25, "Accounting for
Stock Issued to Employees" under which no compensation cost is recognized for
stock options granted to employees with an exercise price at or above the
prevailing market price on the date of the grant. Had compensation cost for the
Plans been determined consistent with the fair value approach required by SFAS
No. 123, the Company's net loss and basic and diluted net loss per common share
for the years ended December 31, 2001 and 2000 would have been the following pro
forma amounts:
2001 2000
Net loss:
As reported $(5,139,334) $(1,925,543)
===============================
Pro forma $(5,742,188) $(2,445,078)
===============================
Net loss per common
share, basic and diluted:
As reported $ (1.16) $ (0.57)
===============================
Proforma $ (1.29) $ (0.67)
The fair value of each option granted is estimated on the date of the grant
using the Black-Scholes option pricing model with following assumptions:
risk-free interest rates of 4.5% and 6.0% in 2001 and 2000, respectively; no
expected dividend yields for options granted; expected lives of 4 years in 2001
and 2000 and expected stock price volatility of 124% and 127% in 2001 and 2000,
respectively. The weighted average fair value of options granted during 2001 and
2000 was $0.63 and $2.00, respectively.
7. Fusion capital agreement
In December 2000, the Company entered into a common stock purchase agreement
(the "Fusion Facility") with Fusion Capital Fund II, LLC ("Fusion Capital")
pursuant to which Fusion Capital would purchase up to $12 million of the
Company's common stock in two tranches. Each $6 million tranche is to be
purchased over a period of up to twenty-four months, subject to a six-month
extension or earlier termination at the Company's discretion. The selling price
of the shares will be equal to the lesser of (1) $15.00 or (2) a price based
upon the future market price of the common stock without any fixed discount to
the market price. After all of the shares of the Company's common stock
purchasable under the first tranche of the common stock purchase agreement have
been purchased by Fusion Capital, the Company has the right to deliver to Fusion
Capital an irrevocable written notice stating that it elects to commence the
second tranche. The obligation of Fusion Capital to commence the second tranche
is subject only to customary conditions, all of which are outside the control of
Fusion Capital. In early 2001, the Company issued to Fusion Capital as a
commitment fee for the Fusion Facility, an aggregate of 677,647 shares of common
stock, 297,162 of these shares were issued in the form of warrants to purchase
shares of common stock at an exercise price of $.01 per share, exercisable at
any time over a five year period. The aggregate commitment fee (or deferred
issuance cost) of approximately $718,000, including warrants valued at
approximately $314,000 using a Black-Scholes option pricing model, was initially
recorded as a "contra account" in the stockholders' equity and was to be applied
over the course of the capital raising activity under the Fusion Facility.
F-15
K2 DIGITAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
7. Fusion capital agreement (continued)
In May 2001, the Company issued 862,069 shares of common stock under the Fusion
Facility to an officer of the Company in exchange for net proceeds of $250,000.
On August 14, 2001, Fusion Capital exercised warrants to purchase an additional
297,162 shares of the Company's common stock at an exercise price of $.01 per
share. After applying the net exercise provisions of the warrant, based upon the
closing sale price of the Company's common stock on the Nasdaq SmallCap Market
of $.15 per share on August 13, 2001, Fusion Capital received 277,351 shares of
common stock upon exercise of the warrant.
As a result of the sale of assets of the Company consummated in August 2001, the
Company is currently in default under the agreement. In addition, due to the
Company's current financial circumstances, the Company does not anticipate that,
even if the current defaults are cured, it will be able to make any further
issuances under the Fusion Facility. Accordingly, deferred issuance costs were
written-off fully during the year ended December 31, 2001.
8. Subsequent events
In January 2002, the Company entered into an agreement for a proposed merger
with First Step on a date to be decided. Pursuant to the merger agreement, the
Company intends to acquire First Step by means of a triangular merger, pursuant
to which a subsidiary of the Company will merge with and into First Step. If the
transaction contemplated by the agreement is consummated, it is anticipated that
the shareholders of First Step will thereby acquire substantially the majority
of the issued and outstanding voting common stock of the Company. The proposed
transaction is subject to various conditions including, but not limited to, a 3
for 1 reverse stock split of the Company's common stock and approval of the
Company's shareholders.
In its capital raising efforts, First Step has granted equity interests and
options in the Company (if the transactions with First Step is consummated)
pursuant to (i) a convertible debt agreement whereby $100,000 of First Step
notes would be convertible into common stock of the Company at a conversion rate
of the lesser of (a) $0.0375 per share or (b) 80% of the lowest bid price of the
Company during the 20 trading days prior to such conversion, subject to
limitations; (ii) a subscription agreement whereby the subscribers would receive
50,000 shares of the Company's common stock and (iii) another First Step debt
agreement resulting in the issuance of 30,000 shares of common stock of the
Company.
F-16
K2 DIGITAL, INC. AND SUBSIDIARY
SCHEDULE II
K2 DIGITAL, INC. AND SUBSIDIARY
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000
Allowance for doubtful accounts, January 1, 2000 $100,000
Less: Charge-off of uncollectible accounts (11,751)
Add: Provision to increase allowance for doubtful accounts 11,751
--------
Allowance for doubtful accounts, December 31, 2000 100,000
Less: Charge-off of uncollectible accounts (50,000)
Add: Provision to increase allowance for doubtful accounts 21,650
--------
Allowance for doubtful accounts, December 31, 2001 $ 71,650
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F-17