-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, FgdWguckcbHKGkNFairnf/OV1ezQx+rJ1yYKQuAKXbS64t+79X/IdzmIN+N9MF9W n5y7RJPV51tVQ81NLc+V1g== 0001019056-99-000357.txt : 19990624 0001019056-99-000357.hdr.sgml : 19990624 ACCESSION NUMBER: 0001019056-99-000357 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19990228 FILED AS OF DATE: 19990528 FILER: COMPANY DATA: COMPANY CONFORMED NAME: C-PHONE CORP CENTRAL INDEX KEY: 0000835585 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE & TELEGRAPH APPARATUS [3661] IRS NUMBER: 061170506 STATE OF INCORPORATION: NY FISCAL YEAR END: 0228 FILING VALUES: FORM TYPE: 10KSB SEC ACT: SEC FILE NUMBER: 000-24426 FILM NUMBER: 99637634 BUSINESS ADDRESS: STREET 1: 6714 NETHERLANDS DRIVE CITY: WILMINGTON STATE: NC ZIP: 28405 BUSINESS PHONE: 9103956100 MAIL ADDRESS: STREET 1: 6714 NETHERLANDS DR CITY: WILMINGTON STATE: NC ZIP: 28405 FORMER COMPANY: FORMER CONFORMED NAME: TARGET TECHNOLOGIES INC DATE OF NAME CHANGE: 19940615 10KSB 1 FORM 10-KSB SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------- FORM 10-KSB (Mark One) [X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934: For the fiscal year ended February 28, 1999 ----------------- [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934: For the transition period from __________ to __________ Commission file number 0-24426 ------- C-PHONE CORPORATION ---------------------------------------------- (Name of small business issuer in its charter) New York 06-1170506 ------------------------------- ------------------- (State or other jurisdiction of (I.R.S. employer incorporation or organization) identification No.) 6714 Netherlands Drive, Wilmington, North Carolina 28405 -------------------------------------------------- ---------- (Address of principal executive offices) (Zip Code) Issuer's telephone number: (910) 395-6100 -------------- Securities registered under Section 12(b) of the Exchange Act: None Securities registered under Section 12(g) of the Exchange Act: Common Stock, $.01 par value ---------------------------- (Title of class) Check whether the issuer: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [x] State issuer's revenues for its most recent fiscal year: $1,621,196 State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was sold, or the average bid and asked price of such common equity, as of a specified date within the past 60 days: Approximately $14,138,912 based on the closing sales price ($2-1/16) on The Nasdaq National Market on May 25, 1999. State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: As of May 25, 1999 - 7,978,605 shares. Documents Incorporated by Reference: Portions of the issuer's definitive proxy statement to be mailed to shareholders in connection with the issuer's 1999 Annual Meeting are incorporated by reference into Part III of this Annual Report on Form 10-KSB. Transitional Small Business Disclosure Format(check one) Yes [ ] No [X] TABLE OF CONTENTS Item 1. Description of Business............................................2 Item 2. Description of Property...........................................12 Item 3. Legal Proceedings.................................................12 Item 4. Submission of Matters to a Vote of Security Holders...............13 Item 5. Market for Common Equity and Related Stockholder Matters..........13 Item 6. Management's Discussion and Analysis or Plan of Operations........14 Item 7. Financial Statements..............................................21 Item 8. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure..........................................21 Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act.................21 Item 10. Executive Compensation............................................21 Item 11. Security Ownership of Certain Beneficial Owners and Management....21 Item 12. Certain Relationships and Related Transactions....................21 Item 13. Exhibits and Reports on Form 8-K..................................21 Signatures..................................................................25 i PART I ITEM 1. DESCRIPTION OF BUSINESS GENERAL We are engaged primarily in the engineering, manufacturing and marketing of video conferencing systems. Our stand-alone video conferencing products are designed to operate over either a regular, analog phone line or ISDN, a type of digital phone line and are available in configurations for the U.S. market as well as most international markets. We presently distribute our products primarily to the business market and for special applications such as health care and security services. We sell our products primarily to resellers and system integrators. COMPANY HISTORY We were incorporated in New York in 1986 under the name Target Tuning, Inc., as a manufacturer of promotional radios. In 1990, we developed data/fax modems under the name "TWINCOM" and changed our name to Target Technologies, Inc. In early 1993, we shifted our primary focus to the development of video conferencing products and, in late 1993, we introduced C-Phone, our first PC-based video conferencing system, which operated over digital networks. During 1995, we phased out our modem product line. In August 1996, we changed our name to "C-Phone Corporation" in order to more closely identify us with our C-Phone product line and to eliminate confusion among investors. The market for PC-based systems did not grow as we and others expected and our efforts to generate sufficient revenues from such market to become profitable were not successful. Based upon our experience, we believe that the market for PC-based systems has become limited, due to the cost and complexity of these systems. Therefore, we began shifting our resources to our stand-alone video conferencing products during 1998. In 1997, we introduced C-Phone Home(TM), a stand-alone set-top "video phone," which operates over analog phone lines using a standard television set. C-Phone Home was aimed at the U.S. consumer market and sold through retailers and catalogs. However, the consumer market did not generally accept C-Phone Home or similar products offered by others. We believe that the limited amount of data that generally can be transmitted in a given amount of time over a analog phone line did not provide a product which was acceptable to consumers. In early 1998, we introduced the DS-324(TM), a stand-alone video conferencing system, which operates over either an analog or ISDN phone line. When used with an ISDN phone line, the DS-324 offers comparable picture quality to PC-based systems while being substantially easier to use and less expensive. We believe that our new stand-alone products have greater market potential, particularly in the business market and special applications, such as health care and security services. Therefore, we are no longer focusing on marketing video conferencing systems to the home consumer market. In 1998, we introduced C-Phone ITV, a self-contained set-top device that provides Internet access, without a PC, using a standard television and an analog phone line. To date, we have supplied only limited quantities of this product to certain of our business and institutional partners. We were unable to develop an appropriate retail marketing plan. In conjunction with our current plan to market our products to business users and special applications, we do not currently intend to market this product to the retail market. 2 INDUSTRY BACKGROUND Video conferencing was introduced in the late 1970s with video conferencing rooms located in office parks or office buildings. These rooms required expensive video conferencing equipment, trained operators, and special leased digital phone lines. These systems initially could only communicate with other compatible facilities and early video conferencing rooms cost between $200,000 and $400,000. Technological improvements and increased production volumes lowered the cost of room-based systems to between $50,000 and $90,000, with certain lower-cost, lesser-function systems selling below $20,000. Video conferencing rooms were first typically used by large corporations primarily for intra-company communications between distant locations. The adoption of an industry standard by most manufacturers after 1990 provided the ability for systems from different manufacturers to communicate with each other thereby making inter-company video conferencing easier. During the last several years, mobile video conferencing systems, known as "roll-about" systems, have become available at prices generally ranging from $15,000 to $30,000, which allow the video conferencing equipment to be moved between locations. In addition, desktop video conferencing systems using a personal computer have been developed with a system price, excluding the cost of the PC, of typically less than $5,000, with prices of certain available systems as low as $1,200 to $2,000. We believe that the overall operating costs and the complexity of use have limited the market for new PC-based video conferencing systems. In 1996, a new standard was adopted which incorporated technology that improved the quality of video transmission over phone lines. As a result, in 1997, a few companies, including us, introduced stand-alone "set-top" video phones which allow a user to make video calls, without the need for a PC, using a television set and an analog phone line. These systems were designed to appeal to non-commercial home users and small businesses, but did not receive widespread market acceptance in those markets. In addition, during such time, a number of companies introduced products primarily marketed to the home user, which, when connected to a PC, allow video phone calls to be made over the Internet. In the last several years, several companies, including us, have introduced stand-alone "set-top" video conferencing systems which use ISDN. These systems are generally easy to operate, relatively inexpensive and offer a degree of portability. Competitive systems typically cost between $4,000 and $10,000. Our systems typically cost between $2,200 and $4,800 depending on the features selected by the user. OUR PRODUCTS GENERAL Our stand-alone products generally consist of a "set-top" box, a hand-held remote and a power adapter. All of our products are designed to maximize the ease of use in both initial set-up and day-to-day operations. The set-top box, which weighs less than five pounds, connects to the television and includes a built-in color camera, built-in microphone, built-in modem and proprietary software. The remote control is used to operate and configure the system, with easy-to-use, on-screen instructions and text menus, as well as to dial, answer or end a call by pushing one or two buttons. Audio is provided by using the speakers in the television set and the built-in microphone. Other types of microphones such as tabletop or lapel can be used by plugging them into the set-top box auxiliary audio input jack. Most of our current products, in addition to operating over an analog phone line, also can operate over an ISDN phone line utilizing a separate terminal adaptor which can be purchased from us. We believe that we are the only ones currently marketing a product capable of using either an analog or ISDN phone line. SPECIAL FEATURES Certain of our products include an electronic pan/tilt/zoom feature for the built-in camera. We also have available an optional external, higher quality, pan, tilt and zoom camera with far end control. Other products have separate inputs for up to seven cameras which are designed primarily for use in security applications. Certain of our products support the telecommunications standard used by most of the existing systems, including PC-based systems, video conferencing rooms and stand-alone video 3 conferencing systems. We also have developed a feature which will allow a connection through the Internet when using an ISDN phone line and an Internet service provider which support a specific protocol. As only a limited number of Internet service providers support this protocol, we are in the process of expanding the capability of these products to use other current protocols supported by most Internet service providers. MARKETING AND SALES GENERAL We believe that a market for our stand-alone products exists for business videoconferencing and for special applications such as video surveillance, recruiting, distance learning and training, tele-maintenance and tele-health. Our current products are sold under several names including DS-324, DS- 324/Pro(TM), DS-324/AV(TM), Sentinel(TM), C-Station(TM) and C-Phone Home. Our products are primarily marketed to resellers by our sales staff working under four regional sales managers. In addition, we have established relationships with companies operating in 19 countries, including Turkey, South Africa, Slovenia, Spain, Japan, Mexico, Canada, and Korea for the foreign distribution of our products. Our international partners are responsible for establishing a local presence for our products, creating market awareness, handling local government import and certification requirements, arranging local technical support and distribution, demonstrating at trade shows, implementing local advertising and marketing programs, and translating the manual and related materials into the local language. SIGNIFICANT CUSTOMERS Historically, a significant portion of our sales have been to a limited number of customers. During Fiscal 1999, sales to Alternative Options, LLC and Fotron S.A. (TTTY) Ltd. accounted for 16.1% and 10.5%, respectively, of our total revenues while our ten largest customers accounted for 62.7% of our total revenues. During Fiscal 1998, we did not have any customers who accounted for 10% or more of our total revenues while our ten largest customers accounted for 39.7% of our total revenues. FOREIGN SALES During Fiscal 1999, our foreign revenue accounted for 50.1% of our total revenue and came from resellers primarily located in Turkey, South Africa, Slovenia, Spain, Japan, Mexico, Korea, Canada, France and Israel. Almost all of our foreign revenue was from sales of our stand-alone products. During Fiscal 1998, our foreign revenue accounted for 17.1% of our total revenue and came from resellers primarily located in South Africa, India, Malaysia, Mexico, Canada, Korea and Japan. Of our Fiscal 1998 foreign revenue, 55.6% was from sales of our stand-alone products and 44.4% was from sales of our PC-based products. We generally make our foreign sales on a prepaid basis or against letters of credit due to the difficulty in collecting foreign accounts receivable. Foreign sales are denominated in U.S. dollars and we do not incur any foreign currency risks. See "Factors That Could Effect Us - Our Results Of Operations May Suffer If Foreign Trade is Restricted" for further information. MANUFACTURING Our products are comprised primarily of components manufactured on a batch basis for us, subassemblies and parts manufactured to our specifications by third parties and certain other "off the shelf" electronic components purchased from third parties. Historically, a substantial portion of our manufacturing, as well as the final assembly, testing and packaging of our products have been performed at our facility in Wilmington, North Carolina. Given our change in focus to the business and special applications markets, we recently have decided to more heavily rely on contract manufacturers to manufacture and assemble most of our products. See "Factors That Could Effect Us - - Our Results Of 4 Operations Could Suffer If We Lost Any Of Our Contract Manufacturers" and "- Use Of Contract Manufacturers May Require Increased Inventory" for further information. SOURCES OF SUPPLY Our products contain a significant number of off-the-shelf semiconductor integrated circuit chips, most of which are available from a number of different manufacturers. However, we do rely on a single source of supply for certain components and specialized subassemblies, some of which are manufactured outside of the United States and only to customer order or are inventoried by the manufacturers in limited quantities. We believe that all these components could be obtained elsewhere if needed and that our products could be redesigned to use alternative components. Certain of our manufacturers, sub-assemblers and suppliers, including suppliers of components made outside the United States, may require us to make firm scheduling and delivery commitments and deliver secure financing arrangements, such as letters of credit, as a condition to fulfillment of their contractual obligations to us. We anticipate that, if we are successful in the commercialization of our products, so that larger quantities of our products can be sold, we will become even more dependent on a timely supply of purchased inventory, and will be required to devote significant capital to inventory. See "Factors That Could Effect Us - Our Results Of Operations Could Suffer If We Lost Any Of Our Sole Source Suppliers " and Item 6 - "Management's Discussion and Analysis or Plan of Operations - Liquidity and Capital Resources" for further information. RESEARCH AND DEVELOPMENT The technology underlying video conferencing products is subject to rapid change, including potential introduction of new products and technologies which could significantly and adversely impact our ability to sell our products. Our success will depend, in great part, on our ability to maintain an ongoing research, development and engineering program capable of responding quickly to technological advances and developing and introducing new features. In addition, even though the open architecture of our products allow components to be replaced as new technologies develop, development of technologies and products by competitors could render our products noncompetitive or obsolete. See "Factors That Could Effect Us - We Face Substantial Competition In The Video Conferencing Market And May Not Be Able to Successfully Compete" and "- Our Products May Be Rendered Obsolete By Rapid Introduction of Competitive Products And Technological Changes" for further information. COMPETITION To date, stand-alone video conferencing has received very limited market acceptance. As a result of technological advances and the adoption of standards for video telephony over phone lines, video conferencing systems have been developed by a number of companies. Existing competitors include PictureTel Corporation, Polycom, Inc., Tanberg, Inc. and VTEL Corporation. Potential competitors may include well-known established suppliers of consumer electronic products, such as Lucent Technologies, Inc., Philips Electronics N.V. and Sony Corp. In April 1999, 8x8, Inc.,a former competitor in the video conferencing market, announced that it was exiting the business of manufacturing video phones to focus on telephony products and technology based on Internet protocols. However, 8x8 also announced that it will continue to sell its video conferencing integrated chips to other manufacturers. We believe that the principal competitive factors in the stand-alone video conferencing product market are quality of video and audio, price, compatibility with standard communication protocols, ease of use, strength of distribution channels, ability to timely fulfill order requests, customer support, reliability and brand-name recognition. Our marketing efforts emphasize the ease of use and affordability of our products. See "Factors That Could Effect Us - We Face Substantial Competition In The Video Conferencing Market And May Not Be Able to Successfully Compete" and "Our Products May Be Rendered Obsolete By Rapid Introduction of Competitive Products And Technological Changes" for further information. 5 PATENTS AND OTHER INTELLECTUAL PROPERTY Although we have several United States patents, none are directly related to our current product line. The inventions which are the subject of these patents were created jointly by Daniel Flohr and certain of our other employees or consultants. In each case, all rights to these inventions have been assigned to us. We have issued to a third party a non-exclusive license for our utility patent for camera display configuration used in our previously marketed PC-based desktop video conferencing product. We seek to protect our intellectual property rights through a combination of trade secret, nondisclosure and other contractual arrangements, and patent, copyright and trademark laws. We generally enter into confidentiality agreements with our employees, consultants, sales representatives and certain potential customers and limit access to and distribution of our proprietary information. GOVERNMENT REGULATION Our products must comply with FCC requirements and specifications regulating electromagnetic radiation and the connection of terminal equipment to the public switched telephone network. Our products also must be in compliance with these regulations as a prerequisite to marketing them. We are required to comply with similar requirements of various foreign government agencies to sell our product in foreign countries. Our foreign distributors, as part of their distribution agreements, are responsible for ensuring compliance with, and obtaining any necessary permits from, foreign government agencies. See "Factors That Could Effect Us - New And Redesigned Products Require Compliance With Government Regulations, Which We May Not Be Able To Afford" for further information. EMPLOYEES As of May 25, 1999, we had 40 employees, three of whom were part-time. Of these employees, nine work in manufacturing and distribution, ten work in product development and engineering, ten work in sales and marketing, nine work in management and administrative and two work in customer support. In comparison, at May 25, 1998, we had 50 employees, 3 of whom were part-time. The decrease in the number of our employees primarily reflects our decision to outsource most of our manufacturing. We consider that our relationship with our employees is good. FACTORS THAT COULD EFFECT US OUR BUSINESS MAY NOT BECOME PROFITABLE. During each of our three fiscal years ended February 28, 1999, we incurred significant losses. We expect to continue to incur significant losses due to our expenditures for product development and the commercialization of our products. The following table summarizes our total revenues and net losses since March 1, 1996. Year Ended February 28, -------------------------------------------- 1999 1998 1997 ---------- ---------- ---------- Total revenues $1,621,196 $1,890,666 $2,042,878 Net loss $4,478,725 $5,974,828 $3,008,224 WE WILL REQUIRE SIGNIFICANT ADDITIONAL CAPITAL TO BECOME PROFITABLE, WHICH CAPITAL MAY NOT BE READILY AVAILABLE. In order to become profitable, we will need to sell significant quantities of our products. However, to sell significant quantities of our products, we will need to substantially increase the amount we spend on manufacturing, inventory and marketing and we will incur increased costs associated with the carrying of anticipated increased accounts receivable. This will require us to raise substantial additional capital. We are unable to assure you that additional capital will be available when needed or, if available, that the terms of any then available financing will be favorable or will be acceptable to us. 6 WE MAY NOT BE ABLE TO SUCCESSFULLY SELL OUR CURRENT PRODUCTS. To date, we have not sold a significant amount of our currently offered video conferencing products. In addition, we have no reliable data to assure us that there will be adequate market acceptance of these products. As a result, we cannot assure you that our currently offered products will gain sufficient market acceptance to generate significant revenues. OUR RESULTS OF OPERATIONS MAY SUFFER IF WE LOST ANY OF OUR KEY EMPLOYEES. As a small, technology driven company, we are heavily dependent upon the efforts and talents of a limited number of people. If any of our key employees left us, we believe that it would be difficult to replace them in a timely manner, if at all. If we were unable to quickly replace key employees, our operations would be significantly and adversely affected. OUR RESULTS OF OPERATIONS MAY SUFFER IF FOREIGN TRADE IS RESTRICTED. During the year ended February 28, 1999, approximately 50% of our total revenue was from foreign distributors. A reduction in the volume of foreign trade, material restrictions on foreign trade or fluctuations in foreign exchange rates could significantly reduce our foreign distributors' orders. We generally do not have written agreements with any of our foreign distributors which require minimum levels of purchases. Therefore, our foreign distributors could reduce or curtail their purchases at any time without financial penalty. OUR RESULTS OF OPERATIONS COULD SUFFER IF WE LOST ANY OF OUR SOLE SOURCE SUPPLIERS. We rely on sole sources of supply for some of our components and specialized subassemblies, some of which are manufactured outside of the United States and only to customer order or are inventoried by the manufacturer in limited quantities. If our sources of supply were to become unavailable, other sources of supply may not be available without significant delay or increased cost, and the use of alternative available components could require us to undertake costly re-engineering of portions of our products. OUR RESULTS OF OPERATIONS COULD SUFFER IF WE LOST ANY OF OUR CONTRACT MANUFACTURERS. We rely on contract manufacturers to manufacture or assemble a substantial amount of our products and their components and subassemblies. If any of our contract manufacturers were to become unavailable, we may not be able to arrange for substitute manufacturers in a timely manner or at the same cost. USE OF CONTRACT MANUFACTURERS MAY REQUIRE INCREASED INVENTORY. To be economical, we place our purchase orders with our contract manufacturers based on our forecasted demand for our products. Until we can accurately predict our product sales, we will need to commit for production volumes that may exceed current order rates, which may increase our inventory costs. WE FACE SUBSTANTIAL COMPETITION IN THE VIDEO CONFERENCING MARKET AND MAY NOT BE ABLE TO SUCCESSFULLY COMPETE. Many of our competitors are more established, benefit from greater market recognition and have significantly greater financial, technological, manufacturing and marketing resources than us. Potential competitors include well-known established suppliers of consumer electronic products. These potential competitors sell television and/or telephone products into which they may integrate video conferencing, thereby eliminating the need to purchase a separate video conferencing product. OUR PRODUCTS MAY BE RENDERED OBSOLETE BY RAPID INTRODUCTION OF COMPETITIVE PRODUCTS AND TECHNOLOGICAL CHANGES. We expect that the technology underlying video conferencing will continue to undergo rapid change as new products are introduced and different standards are developed. With our limited resources, we may not be able to timely and adequately respond to new product developments and technological advances by developing and introducing new products or features. As a result, technological developments and new products introduced by competitors could render our existing products and features noncompetitive or obsolete. OUR PRODUCTS MAY INFRINGE THIRD PARTY INTELLECTUAL PROPERTY RIGHTS. The technology applicable to our products is developing rapidly. A number of companies have filed applications for, or have been issued, patents relating to products or technology that are similar to some of the products or technology developed or used by us. Since we do not have the resources to maintain a staff whose primary function is 7 to investigate the level of protection afforded to third parties on devices and components which we use in our products, it is possible that a third party could successfully claim that our products infringe on their intellectual property rights. If this were to occur, we may be subject to substantial damages, we may not be able to obtain appropriate licenses at a cost we could afford and we may not have the ability to timely redesign our products. WE DO NOT HAVE THE FINANCIAL RESOURCES TO ENFORCE AND DEFEND ALL OF OUR INTELLECTUAL PROPERTY RIGHTS. The actions we take to protect our intellectual property may not be adequate to deter misappropriation of our proprietary information. We do not have adequate financial resources to finance the high cost required to enforce, through litigation, all of our intellectual property rights. In addition, litigation could result in a substantial diversion of managerial time and resources, which could be better and more fruitfully utilized on other activities. NEW AND REDESIGNED PRODUCTS REQUIRE COMPLIANCE WITH GOVERNMENT REGULATIONS, WHICH WE MAY NOT BE ABLE TO AFFORD. If we redesign or otherwise modify any of our products, or if current government regulations are revised, we may be required to have our products recertified by the FCC or otherwise brought into compliance to continue selling our products. We cannot assure you as to when, if ever, that our redesigned or modified products would continue to be in compliance with applicable governmental regulations. In addition, we must comply with similar requirements of various foreign government agencies to effect our foreign sales. While our foreign distributors, as part of their distribution agreements, are responsible for ensuring compliance with foreign government regulations, we cannot assure you that they will do so. If our foreign distributors fail to ensure compliance with these regulations, they may be unable to make sales in their respective countries, as we do not have the necessary resources to ensure governmental compliance outside of the Untied States. WE MAY BE UNABLE TO CONTINUE TO USE THE C-PHONE NAME. A proceeding brought by the former owner of the C-Phone trademark to cancel registration of our "C-Phone"(R) trademark is pending before the U. S. Patent and Trademark Office's Trial and Appeal Board. If we are not successful in this proceeding, we may need to change the identifying name on some of our products. We also would need to consider whether we should change our corporate name. In addition, we could be required to pay damages to the former owner of the mark, if it could show that we had infringed its common law rights. Any change in our use of the C-Phone name would result in a loss of good will and identification which we have been promoting since 1993, and could have a temporary adverse impact on our marketing plans. WE MAY NOT RECEIVE ALL OF THE PROCEEDS THAT WE ANTICIPATE FROM OUR AGREEMENT WITH SOVEREIGN PARTNERS. In September 1998, we entered into an agreement with Sovereign Partners pursuant to which Sovereign Partners has agreed to purchase up to $5,000,000 of our common stock, as we elect from time to time, over an 18-month period which began April 1, 1999. We have a registered 1,500,000 shares for sale to Sovereign Partners. If we determine to sell Sovereign Partners more than a total of 1,500,000 shares, we would need to file an additional registration statement with the SEC. In addition, if we determine to sell Sovereign Partners more than a total of 1,543,765 shares, we would require approval of our shareholders, which may not be obtainable. Since the price at which we will sell our shares to Sovereign Partners is at a 15% discount to the average market price of our common stock, if the average market price is less than approximately $3.92 per share at the time of sale, we will receive gross proceeds of less than $5,000,000. As of May 25, 1999, we had not sold any shares to Sovereign Partners. For additional information concerning our agreement with Sovereign Partners, see "Recent Equity Offerings" in Item 6. - "Management's Discussion and Analysis or Plan of Operations," SHAREHOLDERS MAY EXPERIENCE SIGNIFICANT DILUTION FROM OUR SALE OF SHARES TO SOVEREIGN PARTNERS. As the market price for our common stock decreases, the number of shares which may be sold to Sovereign Partners will increase. If we were to require Sovereign Partners to purchase our common stock at a time when our stock price is depressed, our current shareholders' interest in our company will be significantly reduced. The following table sets forth the number of shares that we would issue if we required Sovereign Partners to purchase the maximum amount of $5,000,000 permitted under our agreement with Sovereign Partners, based on a range of stock prices. The table also shows the percentage that these 8 shares would constitute, immediately after issuance, of the total number of shares which we currently have outstanding. The information in the table is based on 7,978,605 shares of common stock outstanding on May 25, 1999. The per share average market price of $2.49 was the average market price of our common stock on May 25, 1999. Per Share Average Per Share Price Payable Number of Percentage of Market Price by Sovereign Partners Shares Issuable Outstanding ------------ --------------------- ---------------- ----------- $5.00 $4.25 1,176,471 12.9% $4.00 $3.40 1,470,588 15.6% $3.92 $3.33 1,500,000 15.8% $3.00 $2.55 1,960,784 19.7% $2.49 $2.12 2,358,649 22.8% $2.00 $1.70 2,941,176 26.9% $1.00 $0.85 5,882,353 42.4% OUR PRIOR TRANSACTION WITH SOVEREIGN PARTNERS RESULTED IN SIGNIFICANT DILUTION TO SHAREHOLDERS. In December 1997, we completed a private placement of convertible preferred stock and warrants with Sovereign Partners and several other investors. The terms of the preferred stock allowed the investors to purchase our common stock at a 15% discount to the market price of our common stock at the time of conversion. All the preferred shares were converted into 1,987,622 shares of our common stock, or 37.2% of the common stock outstanding on the date we issued the preferred stock. We cannot assure you that our current agreement with Sovereign Partners also will not significantly reduce our existing shareholders' interest in our company. THE RESALE BY SOVEREIGN PARTNERS OF OUR SHARES MAY LOWER THE MARKET PRICE OF OUR COMMON STOCK. The resale by Sovereign Partners of the common stock that it purchases from us will increase the number of our publicly traded shares, which could lower the market price of our common stock. Moreover, the shares that we sell to Sovereign Partners will be available for immediate resale, and the mere prospect of this transaction also could lower the market price for our common stock. WE MAY NOT BE ABLE TO OBTAIN PAYMENT FROM SOVEREIGN PARTNERS. As discussed under "Recent Equity Offerings" in Item 6. - "Management's Discussion and Analysis or Plan of Operations," Sovereign Partners' obligation to purchase our shares is dependent upon various conditions being satisfied. If these conditions are not satisfied, we cannot require Sovereign Partners to purchase our shares. Since the obligation of Sovereign Partners to complete its purchase is not secured or guaranteed, if Sovereign Partners does not have available funds at the time that it is required to make a purchase or if Sovereign Partners otherwise refuses to honor its obligation to us, we may not be able to force it to do so. RESALE OF OUR SHARES HELD BY OUR DIRECTORS AND OFFICERS MAY LOWER THE MARKET PRICE OF OUR SHARES. As of May 25, 1999, we had a total of 7,978,605 shares of common stock outstanding, 1,123,375 of which were held by our directors and executive officers. These shares may only be resold in limited quantities and only within the limitations imposed by Rule 144 under the Securities Act. The mere prospect that these shares may be publicly resold could lower the market price for our common stock. OUR STOCK PRICE HAS BEEN HIGHLY VOLATILE. The market price for our common stock has been, and is likely to continue to be, highly volatile. Factors which could significantly affect the market price of our shares include: o actual or anticipated fluctuations in our operating results, 9 o changes in alliances or relationships with our customers, o new products or technical innovations by us or by our existing or potential competitors, o trading activity and strategies occurring in the marketplace with respect to our common stock, o general market conditions and other factors unrelated to us or outside of our control. POTENTIAL LOSS OF OUR NASDAQ NATIONAL MARKET LISTING COULD ADVERSELY AFFECT THE PRICE OF OUR SHARES. Our common stock is quoted on the Nasdaq National Market. If the bid price of our common stock were to fall below $1.00 per share, if we were to have less than $4,000,000 in net tangible assets or if the value of our common stock held by our shareholders (other than our officers and directors) were to be less than $5,000,000, our common stock could be delisted from the Nasdaq National Market. In addition, The Nasdaq Stock Market has recently issued an interpretive release regarding the issuance of securities that are convertible into common shares at a price lower than the market price of the common shares at the time of conversion. If Nasdaq considers that our agreement with Sovereign Partners involves this type of security, and that we have failed to comply with these rules, our common stock could be delisted from The Nasdaq Stock Market. Nasdaq also could delist our common stock if it determines that our agreement with Sovereign Partners raises public interest concerns. If our common stock is delisted from Nasdaq, any trading of our shares then would be conducted in the over-the-counter market. This would make it more difficult for an investor to dispose of, or to obtain accurate quotations for, our common stock. In addition, delisting would make it more difficult for us to raise funds through the sale of our securities. OUR OPERATIONS MAY BE AFFECTED BY YEAR 2000 ISSUES. Computer systems may experience problems handling dates beyond the year 1999 because many computer programs use only two digits to identify a year in a date field. We have completed our internal Year 2000 compliance program, but we have not yet received adequate assurances from all our critical third-party suppliers of their Year 2000 readiness. Year 2000 problems which interrupt the normal business operations of our customers also could significantly and adversely impact us. We have not yet developed a contingency plan for noncompliance by any of our key suppliers or customers. As a result, we cannot be certain that Year 2000 problems involving our suppliers or customers will not significantly and adversely affect us. WE DO NOT EXPECT TO PAY DIVIDENDS. We never have paid any dividends. For the foreseeable future, we expect that our earnings, if any, will be retained to finance the expansion and development of our business. Any payment of dividends is within the discretion of our Board of Directors and will depend, among other factors, on our earnings (if any), capital requirements, and operating and financial condition. SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS. We have made statements in this Annual Report on Form 10-K that are "forward-looking statements" within the meaning of the Securities Act and the Securities Exchange Act. Sometimes these statements contain words like "may," "believe," "expect," "continue," "intend," "anticipate" or other similar words. These statements could involve known and unknown risks, uncertainties and other factors that might significantly alter the actual results suggested by the statements. In other words, our performance might be quite different from what the forward-looking statements imply. The following factors, as well as those discussed above in this section, could cause our performance to differ from the implied results: o inability to obtain capital for continued development and commercialization of our products. o inability to generate market acceptance of our products. o failure to obtain new customers or retain existing customers. 10 o inability to manage our growth. o loss of our key employees. o changes in general economic and business conditions. o changes in industry trends. We have no obligation to release publicly the result of any revisions to any of our "forward-looking statements" to reflect events or circumstances that occur after the date of this Annual Report or to reflect the occurrence of other unanticipated events. ITEM 2. DESCRIPTION OF PROPERTY We conduct all of our operations from our 14,420 square foot Wilmington, North Carolina facility, which we use as follows: Function Percentage of Space -------- ------------------- Marketing and sales 11% Engineering 17% Administration 20% Production, inventory, shipping and 52% receiving Our facility was built in 1993 to our specifications. We lease our facility from our two principal executive officers, Daniel Flohr and Tina Jacobs, under a triple net lease pursuant to which we are responsible for all costs and expenses, including applicable taxes, relating to the facility. Our lease expires on April 30, 2002. The current annual rent is $75,360, subject to increase on May 1. 2000. We believe that the terms and conditions of our lease are no less favorable to us than those available from unaffiliated third parties. Mr. Flohr and Ms. Jacobs allow us to use approximately 9,000 square feet of a 1.4 acre adjacent parcel of land owned by them as a parking area for our employees and customers. In consideration for use of this parcel, we provide minimal maintenance of the parking area and pay approximately $345 per year of real estate taxes on this parcel. Our present facility is being fully utilized. If we need additional space, Mr. Flohr and Ms. Jacobs have offered to construct an additional building to our specifications on the adjacent parcel and to lease this building, when constructed, to us on terms similar to the lease for our current facility, including at a rental no greater than fair market value at the commencement of the lease term. See Note 10 of Notes to Financial Statements included in Item 7. - "Financial Statements." ITEM 3. LEGAL PROCEEDINGS In 1995, the U.S. Patent and Trademark Office registered the "C-Phone" trademark to us. In 1996, in order to more closely identify us with our products, all of which then used the C-Phone name, and in an attempt to eliminate confusion among investors, we changed our name to C-Phone Corporation. In August 1996, we were advised by the Patent and Trademark Office that the former owner of the registered C-Phone trademark had filed a petition to cancel our registration, alleging that there was a likelihood of confusion and that its failure to file a required affidavit was inadvertent. The former owner has continued to use the C-Phone name for marine telephone products, and may have certain "common law" rights to 11 continued use of the name and to prevent others from using the name. A proceeding concerning this matter is pending before the Patent and Trademark Office's Trademark Trial and Appeal Board, who will determine whether the conflicting use by us is so confusingly similar that a registration should not have been granted to us. If we are unable to satisfactorily resolve this matter with the former owner or we are not successful in the current Patent and Trademark Office proceeding, we may need to change the identifying name on some of our products. In addition, we may determine that it is appropriate to change our corporate name. We also may be subject to damages if it can be shown that we had infringed the former owner's common law rights. See "Factors That Could Effect Us - We May Be Unable To Continue To Use The C-Phone Name" in Item 1. - "Description of Business." In addition, we are involved in various legal proceedings which are incidental to the conduct of our business. We do not expect that any of these proceedings will have a significant adverse effect on our financial position or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of our securities holders during the fiscal quarter ended February 28, 1999. PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Our common stock is traded on the Nasdaq National Market under the symbol "CFON." The following table sets forth the high and low sales price for each quarterly period since March 1, 1997 for our common stock, as reported by The Nasdaq Stock Market, Inc.
Fiscal 1998 High Low ----------- ---- --- 1st Fiscal Quarter (ended May 31, 1997) $ 11.500 $ 5.875 2nd Fiscal Quarter (ended August 31, 1997) $ 10.000 $ 5.000 3rd Fiscal Quarter (ended November 30, 1997) $ 10.500 $ 5.000 4th Fiscal Quarter (ended February 28, 1998) $ 8.750 $ 3.813 Fiscal 1999 ----------- 1st Fiscal Quarter (ended May 31, 1998) $ 15.500 $ 2.625 2nd Fiscal Quarter (ended August 31, 1998) $ 6.688 $ 2.063 3rd Fiscal Quarter (ended November 30, 1998) $ 4.344 $ 2.000 4th Fiscal Quarter (ended February 28, 1999) $ 5.375 $ 2.531
On May 25, 1999, the closing sale price of our common stock was $2-1/16. As of May 25, 1999, we had 332 holders of record of our common stock, including broker-nominees who held an aggregate of 6,702,613 shares of our common stock as nominees for an undisclosed number of beneficial holders. We estimate that we have in excess of 2,000 beneficial holders of our common stock. See "Recent Equity Offerings" in Item 6 - "Management's Discussion and Analysis or Plan of Operations" for information concerning our issuances of securities during Fiscal 1998 and Fiscal 1999. See 12 "Factors That Could Effect Us - We Do Not Expect To Pay Dividends" in Item 1. - "Description of Business" for information concerning our dividend policy. ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS OVERVIEW We are engaged primarily in the engineering, manufacturing and marketing of video conferencing systems. Our stand-alone video conferencing products are designed to operate over either analog or ISDN phone lines and are available in configurations for the U.S. market as well as most international markets. We presently distribute our products primarily to the business market and for special applications such as health care and security services. We sell our products primarily to resellers and system integrators. We have incurred significant losses during our each of three fiscal years ended February 28, 1999. Until market acceptance of our products is established, which we cannot assure you will occur, we expect to continue to incur significant losses due to our current and anticipated level of expenditures. RECENT EQUITY OFFERINGS MARCH 1997 PRIVATE PLACEMENT. In March 1997, we completed a private placement in which we issued, either immediately or upon subsequent exercise of related rights, an aggregate of 970,530 shares of our common stock. We received net proceeds of approximately $4,370,000, after payment of fees and expenses of approximately $632,000. In connection with this private placement, we issued to an affiliate of the placement agent warrants to purchase 150,000 shares of our common stock at an exercise price of $9.60 per share, which warrants expired without being exercised. DECEMBER 1997 PRIVATE PLACEMENT. In December 1997, we completed a private placement in which we issued an aggregate of (a) 4,500 shares of Series A Convertible Preferred Stock, (b) Class A Warrants to purchase 315,000 shares of our common stock, and (c) Class B Warrants to purchase 135,000 shares of our common stock. We received net proceeds of approximately $4,110,000, after payment of fees and expenses of approximately $390,000. In connection with this transaction, we paid a finder's fee of $295,000 and issued to an affiliate of the finder a warrant, upon the same terms as the Class A Warrants, to acquire an aggregate of 185,000 shares of our common stock. All of the issued Series A Preferred Stock has been converted into a total of 1,987,622 shares of our common stock. The Class B Warrants have an exercise price of $9.10 per share, subject to adjustment under certain circumstances, including upon the issuance of shares of our common stock, or securities convertible or exchangeable into shares of our common stock, at less than 80% of the then market price. These warrants expire on December 19, 2000 and are not redeemable. As of May 25, 1999, Class B Warrants to purchase 60,000 shares of our common stock had been exercised and we had received aggregate proceeds of $546,000. The Class A Warrants expired on December 19, 1998. Prior to this date, Class A Warrants to purchase 325,000 shares of our common stock were exercised at $8.05 per share, including the warrant issued to the finder. We received aggregate proceeds of $2,616,250 from the exercise of these warrants. The remaining Class A Warrants expired unexercised. See "Factors That Could Effect Us - Shareholders May Experience Significant Dilution From Our Sale Of Shares To Sovereign Partners" in Item 1. "Description of Business." 1994 WARRANT EXERCISES. In connection with our 1994 initial public offering, we had issued, to the representative of the underwriters, warrants expiring August 19, 1999 to purchase 200,000 shares of our common stock at an exercise price of $8.40 per share payable in cash or by delivering back to us warrants 13 having an equivalent value. On May 13, 1998, we reduced the exercise price of these warrants to $6.00 per share, in consideration for (a) requiring payment of the exercise price for these warrants to be made in cash, rather than upon surrender of warrants, and (b) changing the expiration date thereof to May 21, 1998. On May 13, 1998, the closing sales price of our common stock was $9.75. All of these warrants were exercised and we received aggregate proceeds of $1,200,000. AGREEMENT WITH SOVEREIGN PARTNERS. On September 18, 1998, we entered into the private equity credit agreement with Sovereign Partners, L.P. Pursuant to the agreement, Sovereign Partners has agreed to purchase our common stock during the 18-month period that began on April 1, 1999. From time to time during the term of the agreement, but no more frequently than once every 30 days, we can require Sovereign Partners to purchase between $500,000 and $1,000,000 of our common stock until all these purchases total $5,000,000. The purchase price for each share will equal 85% of the average closing bid price of our common stock during the five trading days immediately preceding the day we notify Sovereign Partners of a purchase obligation. As of May 25, 1999, we had not sold Sovereign Partners any shares of our common stock under the agreement. Sovereign Partners' obligation to purchase shares of our common stock is subject to certain conditions, including: o The average closing bid price of our common stock being at least $1.00 per share for the 20 trading days preceding the date of our notice of purchase to Sovereign Partners. o Our common stock continuing to be traded on The Nasdaq Stock Market. o The total number of shares of common stock that we may sell to Sovereign Partners under the agreement cannot exceed 1,543,765 shares, unless we first obtain shareholder approval as required by the rules of The Nasdaq Stock Market, Inc. We do not presently intend to sell Sovereign Partners more than 1,500,000 shares. o The number of shares of common stock we may sell to Sovereign Partners on any draw date, when aggregated with all other shares then owned by Sovereign Partners, cannot exceed 9.9% of our total common stock then outstanding. o A current prospectus must then to be available to permit Sovereign Partners to publicly resell the shares of common stock that it acquires from us under the agreement. We may terminate the agreement without any further obligation to Sovereign Partners at any time after we have sold it at least $1,000,000 of common stock. If we terminate the agreement prior to this time, we must pay Sovereign Partners a penalty of up to $150,000, depending upon the amount of the shortfall. Sovereign Partners has agreed not to engage in any short sales of our common stock, except that it may engage in short sales after it receives a purchase notice from us, but only for the number of shares of common stock covered by our purchase notice. Under a related registration rights agreement, we have agreed to maintain effectiveness of a registration statement for the resale by Sovereign Partners of the shares it purchases from us under the agreement. If we fail to maintain effectiveness of the registration statement, Sovereign Partners may require us to pay a penalty equal to 1% of the purchase price of the shares of common stock then held by Sovereign Partners for each 30-day period that the registration statement is not effective. In connection with the agreement, we issued to Cardinal Capital Management, Inc., as finder, a two-year warrant to purchase 100,000 shares of our common stock at an exercise price of $8.00 per share. If the closing sales price of our common stock exceeds $10.00 for five consecutive trading days, we may give Cardinal Capital notice of our intention to redeem the warrant. If Cardinal Capital does not exercise the warrant prior to the redemption date specified in our redemption notice, we may redeem the warrant for $1,000. The shares of our common stock issuable to Cardinal Capital upon exercise of this warrant have 14 not been registered for sale under the Securities Act although we may register these shares in the future. We also paid Cardinal Capital a cash fee of $30,000 and have agreed to pay Cardinal Capital an additional cash fee equal to 6% of the dollar amount of any sales of common stock to Sovereign Partners under the agreement, with our initial $30,000 payment to be credited against this fee. RESULTS OF OPERATIONS FISCAL YEAR ENDED FEBRUARY 28, 1999 AS COMPARED TO FISCAL YEAR ENDED FEBRUARY 28, 1998 REVENUES. Net sales decreased 13% to $1,590,748 in Fiscal 1999 from $1,818,663 in Fiscal 1998, reflecting the discontinuance of our PC-based products during the first quarter of Fiscal 1999 and the shift in marketing emphasis for our stand-alone products from the consumer market to the business market and special applications. Sales of stand-alone products represented 94% of net sales during Fiscal 1999, as compared to 45% of net sales during Fiscal 1998. During Fiscal 1999, we had other revenue of $30,448 compared to $72,003 during Fiscal 1998. As a result of the foregoing, our total revenues decreased 14% to $1,621,196 in Fiscal 1999 from $1,890,666 in Fiscal 1998. COST OF REVENUE. Cost of revenue consists of cost of goods sold and cost of other revenue. Cost of goods sold includes labor, materials and other manufacturing costs, such as salaries, supplies, leasing costs, depreciation related to production operations and the write-down of inventories to net realizable value. Cost of other revenue consists primarily of the allocation of salaries and benefits of personnel and the cost of outside services directly related to this revenue. Cost of goods sold decreased 21% to $2,541,145, or 160% of net sales, in Fiscal 1999 from $3,209,875, or 176% of net sales, in Fiscal 1998. The decrease in cost of goods sold was primarily the result of a decrease in stand-alone unit costs and the decrease in sales. However, the decrease in cost of goods sold was offset in part by a $608,657 provision for inventory obsolescence, of which $142,691 relates to discontinued PC-based product inventory not sold during Fiscal 1999 and $465,966 relates to stand-alone product inventory, primarily the result of product changes as we shifted from the consumer market to the business and special applications markets. During Fiscal 1998, cost of goods sold included a $475,824 provision for inventory obsolescence which was primarily related to PC-based product inventory. In addition, the low production volume of our stand-alone units did not allow us to cover all fixed manufacturing costs. Cost of other revenue was $9,750 in Fiscal 1999, or 32% of related revenue, as compared to cost of other revenue of $22,506, or 31% of related revenue, in Fiscal 1998. GROSS LOSS. Our gross loss was $929,699 in Fiscal 1999, as compared to a gross loss of $1,341,715 in Fiscal 1998, a decrease of 31%. The gross loss in Fiscal 1999 was primarily the result of the low sales volume, the provision for inventory obsolescence and the high cost of goods sold, which is discussed above. SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative expenses decreased 21% to $3,000,128, or 185% of revenues, in Fiscal 1999 from $3,816,806, or 202% of revenues, in Fiscal 1998. The primary reason for the decrease was a 44% decrease in selling and marketing expenses to $1,085,908 in Fiscal 1999 from $1,943,345 in Fiscal 1998. This decrease was the result of several factors including advertising and display material expenses related to the launch of our home consumer product in early Fiscal 1998 and the shift in marketing emphasis for our standalone products from home consumer use to business and special applications during Fiscal 1999. This shift reduced our expenses related to salaries, travel expenses and outside consulting services. We expect that selling and marketing expenses will increase in Fiscal 2000 from the Fiscal 1999 level as we increase our internal sales staff to further expose our stand-alone products to the business and special applications markets. Therefore, we expect that we will continue to incur substantial selling, general and administrative expenses during Fiscal 2000. RESEARCH, DEVELOPMENT AND ENGINEERING. Research, development and engineering expenses decreased 16% to $814,366, or 50% of revenues, in Fiscal 1999 from $973,210, or 51% of revenues, in Fiscal 1998. The decrease was primarily the result of the completion of the initial development of our current stand-alone products during our Fiscal 1998. All of these costs were charged to operations as 15 incurred and were funded by our cash reserves. We expect to continue to invest significant resources during the foreseeable future in new product development and engineering as well as for enhancements to our existing products. OPERATING LOSS. As a result of the factors discussed above, our operating loss decreased 23% to $4,744,193 in Fiscal 1999 from $6,131,731 in Fiscal 1998. INTEREST. Interest income increased 69% to $265,468 in Fiscal 1999 from $157,350 in Fiscal 1998 as a result of interest earned on the higher average balance of cash and cash equivalents we had during Fiscal 1999 due to the receipt of proceeds from our December 1997 private placement and from the exercise in May 1998 of previously issued warrants and options. FISCAL YEAR ENDED FEBRUARY 28, 1998 AS COMPARED TO FISCAL YEAR ENDED FEBRUARY 28, 1997 REVENUES. Net sales decreased 4% to $1,818,663 in Fiscal 1998 from $1,890,213 in Fiscal 1997, reflecting an industry-wide slowdown in the rate of acceptance of PC-based desktop video conferencing. This decrease in net sales was partially offset by an increase in net sales of stand-alone products. Sales of stand-alone products represented 45% of net sales in Fiscal 1998 while we had no sales from that product line in Fiscal 1997. During Fiscal 1998, we had other revenue of $72,003 as compared to $152,665 in Fiscal 1997. This decrease was a result of decreased revenue from software development. As a result of the foregoing, our total revenues decreased 7% to $1,890,666 in Fiscal 1998 from $2,042,878 in Fiscal 1997. COST OF REVENUE. Cost of goods sold increased 97% to $3,209,875, or 176% of net sales, in Fiscal 1998 from $1,629,287, or 86% of net sales, in Fiscal 1997. The increase in cost of goods sold and the increase in the ratio of cost of goods sold to net sales reflected the low production volume of our stand-alone units, which did not allow us to cover all fixed manufacturing costs. In addition, during Fiscal 1998, we wrote-down our stand-alone product inventory to its then current net realizable value based upon the historical percentage of sales of stand-alone video conferencing products below manufactured cost when sold in conjunction with telecommunications services offered by with us. Cost of goods sold also included a $475,824 provision for inventory obsolescence related to our PC-based desktop video conferencing equipment as a result of the slowdown in the rate of acceptance of this product line and our decision to redeploy most of our available resources to other products. Cost of other revenue was $22,506 in Fiscal 1998, or 31% of related revenue, as compared to cost of revenue of $81,079, or 53% of related revenue, in Fiscal 1997. GROSS PROFIT (LOSS). Our gross loss was $1,341,715 in Fiscal 1998, as compared to a gross profit of $332,512, or 16% of revenues, in Fiscal 1997. The gross loss in Fiscal 1998 was primarily the result of the high cost of goods sold due to low volume production, our marketing strategy for our stand-alone products and the provision for inventory obsolescence for our PC-based inventory. SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative expenses increased 56% to $3,816,806, or 202% of revenues, in Fiscal 1998 from $2,454,337, or 120% of revenues, in Fiscal 1997. The primary reason for the increase was an 73% increase in selling and marketing expenses to approximately $1,943,000 in Fiscal 1998 from approximately $1,125,000 in Fiscal 1997, substantially all of which increase was directly related to the marketing launch of C-Phone Home. Other increases in expenses directly related to our this product were increased personnel costs resulting from additional customer support and administrative personnel and an increased reserve for bad debt expenses based upon our historical experience with the retail industry. In addition, other increases in administrative expenses were increased legal and accounting expenses, primarily as a result of the complexities related to the addition of our stand-alone product line, the reallocation of duties of certain personnel from research, development and engineering, and increased investor relations and other shareholder expenses resulting from a significant increase in the number of holders of our common stock. 16 RESEARCH, DEVELOPMENT AND ENGINEERING. Research, development and engineering expenses decreased 4% to $973,210, or 51% of revenues, in Fiscal 1998 from $1,016,293, or 50% of revenues, in Fiscal 1997. The decrease was primarily the result of a decrease in personnel costs resulting from a partial change in duties of certain personnel to selling, general and administrative, partially offset by development and engineering expenses related to the development of enhancements to our stand-alone products. All of these costs were charged to operations as incurred and were funded by our cash reserves. OPERATING LOSS. As a result of the factors discussed above, our operating loss increased 95% to $6,131,731 in Fiscal 1998 from $3,138,118 in Fiscal 1997. INTEREST. Interest income increased 19% to $157,350 in Fiscal 1998 from $132,405 in Fiscal 1997 as a result of interest earned on the higher average balance of cash and cash equivalents we had during Fiscal 1998 due to the receipt of proceeds from the March Placement and the December Placement. LIQUIDITY AND CAPITAL RESOURCES We have financed our recent operations primarily from the proceeds of private placements of our securities and from the exercise of previously issued warrants and options. For additional information, see "Recent Equity Offerings." At February 28, 1999, we had working capital of $5,305,512, as compared to $5,170,505 at February 28, 1998, an increase of $135,007. Our cash and cash equivalents were $4,602,752 at February 28, 1999, as compared to $4,200,231 at February 28, 1998. Our invested funds consisted primarily of overnight repurchase agreements for discount notes issued by the United States Treasury or United States government agencies. During Fiscal 1999, our operating activities used $4,155,784 of net cash, primarily to fund operating activities, our investing activities used $84,877 of net cash for equipment purchases, and our financing activities provided $4,643,182 of net cash from the exercise of previously issued warrants and options. We lease our facility and own our manufacturing equipment free from any liens or other encumbrances. As of February 28, 1999, we had no material commitments for capital expenditures. Due to the planned expansion of our marketing efforts aimed at the business and special applications markets, we expect to expend additional resources for selling and marketing expenses. We also expect to continue to expend significant resources for product development and engineering for enhancements, improvements and new products to keep our product line up to date. We believe that our current working capital, together with anticipated funds from our operations and available proceeds from our agreement with Sovereign Partners, will be sufficient to meet our projected operating needs and capital expenditures at least through the end of the first quarter of Fiscal 2001. If our stand-alone products gain significant market acceptance, we expect to make very substantial expenditures for inventory build-up, marketing and carrying of accounts receivable. This would require us to obtain even more working capital. See "Factors That Could Effect Us - We Will Require Significant Additional Capital To Become Profitable, Which Capital May Not Be Readily Available" in Item 1. - "Description of Business." We anticipate that these additional funds should be available through one or more possible sources, including o the sale of our common stock pursuant to our agreement with Sovereign Partners; o a private placement of our common stock, preferred stock or debt securities; o the exercise of our outstanding warrants, if the market price of our common stock were to exceed the exercise price of these warrants; and o a public offering of our common stock. 17 At February 28, 1999, we estimate that we had available net operating loss carryforwards of approximately $19,189,000 for Federal purposes and approximately $19,448,000 for state purposes, which may be used to reduce future taxable income, if any. The Federal carryforwards expire in 2009 through 2014. The state carryforwards expire in 2002 through 2014. We do not believe that inflation has had a significant impact on our sales or operating results, during the past three years. IMPACT OF YEAR 2000 ISSUE Computer systems may experience problems handling dates beyond the year 1999 because many computer programs use only two digits to identify a year in a date field. We have addressed this issue in several parts - our products, our application software for our internal operations and third-party suppliers. PRODUCTS - As our products do not include date/time mechanisms in their operating software, our products are Year 2000 compliant. However, some of our earlier PC-based products use Windows(R) for Workgroups as their operating system and there may exist Year 2000 issues with the specific user installed LAN interface employed by any certain customer which issues are beyond the scope of our involvement and responsibilities. APPLICATION SOFTWARE - During Fiscal 1998, for operational purposes, we made the decision to upgrade our internal financial and operational software system. This upgrade was completed in June 1998 and the system is now Year 2000 compliant. At December 31, 1998, in accordance with our plan, we had completed the identification of other internal computer-based systems we use which may require upgrading to insure operational continuity beyond December 31, 1999. We completed the upgrading and testing of all necessary applications (except for our internal voice mail system) by February 28, 1999. We plan to complete any upgrading and testing of our internal voice mail system by June 30, 1999. THIRD-PARTY SUPPLIERS - We are assessing the possible effects on our operations of Year 2000 compliance related to key suppliers and subcontractors. Our reliance on suppliers and subcontractors means that the failure to address Year 2000 compliance issues by these parties could have a material impact on our business. We have identified critical third-party suppliers and have requested information as to their plans and progress in addressing the Year 2000 problem. Our plan to complete the evaluation of our third-party suppliers by December 31, 1998 has been delayed due to the lack of appropriate responses from many of these suppliers. We submitted follow up requests for information from these suppliers and are presently assessing the additional responses. Additional contacts will be made during the month of May 1999. Alternative sourcing and contingency plans for our non-compliant or non-responding suppliers will be developed by August 31, 1999. COSTS - The total cost associated with the Year 2000 issue is not expected to be material to our financial position. Our current estimated out-of-pocket cost is not expected to exceed $50,000, of which less than $10,000 has been expended through May 25, 1999. As the upgrade of our application software was done for operational purposes, the cost of this upgrade has not been included in our estimates. RISKS - Due to the uncertainty of the Year 2000 readiness of our third-party suppliers, we are unable to determine at this time whether the consequences of Year 2000 failures will have a material impact on our results of operations, liquidity or financial condition. In addition, although our business is not dependent on any single or small number of customers, Year 2000 problems which significantly interrupt the normal business operations of a significant number of our customers could have a material adverse impact on us. We have not yet developed a contingency plan in the event of noncompliance by any of our key suppliers or customers. 18 NEW ACCOUNTING PRONOUNCEMENTS Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income", which establishes standards for the reporting and displaying of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general purpose financial statements, became effective for us in Fiscal 1999. SFAS No. 130 requires the disclosure of an amount that represents total comprehensive income and the components of comprehensive income in a financial statement. We had no items of other comprehensive income or loss during Fiscal 1999, Fiscal 1998 or Fiscal 1997. Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information", which establishes standards for determining an entity's operating segments and the type and level of financial information to be disclosed in both annual and interim financial statements, became effective for us in Fiscal 1999. SFAS No. 131 also establishes standards for related disclosures about products and services, geographic areas and major customers. The adoption of SFAS No. 131 did not have a material impact on our financial statements for Fiscal 1999, Fiscal 1998 or Fiscal 1997, as we operate in only one segment. Statement of Financial Accounting Standards No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits," revises employers' disclosures about pension and other postretirement benefit plans. As we do not presently have a pension or other postretirement benefit plan, SFAS No. 132 is not applicable to our financial statements. Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities," which requires all derivatives to be recorded on the balance sheet at fair value and establishes new accounting rules for hedging instruments, became effective for us in Fiscal 1999. As we do not presently hold these instruments, the adoption of SFAS No. 133 is not applicable to our financial statements ITEM 7. FINANCIAL STATEMENTS Table of Contents Page - ----------------- ---- Report of Independent Accountants F-1 Balance Sheets as of February 28, 1999 and 1998 F-2 Statements of Operations for the years ended February 28, 1999, 1998 and 1997 F-3 Statements of Shareholders' Equity for the years ended February 28, 1999, 1998 and 1997 F-4 Statements of Cash Flows for the years ended February 28, 1999, 1998 and 1997 F-5 Notes to Financial Statements F-6 19 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of C-Phone Corporation: In our opinion, the accompanying balance sheets and the related statements of operations, shareholders' equity and cash flows present fairly, in all material respects, the financial position of C-Phone Corporation (the "Company") at February 28, 1999 and 1998, and the results of its operations and its cash flows for each of the three years in the period ended February 28, 1999, in conformity with generally accepted accounting principles. 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 of these statements in accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PricewaterhouseCoopers LLP Raleigh, North Carolina April 15, 1999 F-1 C-PHONE CORPORATION BALANCE SHEETS FEBRUARY 28, 1999 AND 1998
ASSETS 1999 1998 ------------ ------------ Current assets: Cash and cash equivalents $ 4,602,752 $ 4,200,231 Accounts receivable, net of allowance for doubtful accounts of $181,347 and $173,227 at February 28, 1999 and 1998, respectively 105,717 346,684 Inventories 1,177,522 1,641,528 Prepaid expenses and other current assets 118,893 73,728 ------------ ------------ Total current assets 6,004,884 6,262,171 Property and equipment, net 112,607 164,174 Other assets 136,503 42,686 ------------ ------------ Total assets $ 6,253,994 $ 6,469,031 ============ ============ LIABILITIES, PREFERRED STOCK AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 306,302 $ 796,019 Accrued expenses 393,070 295,647 ------------ ------------ Total current liabilities 699,372 1,091,666 Commitments and Contingencies (Notes 10 and 12) Series A Convertible Preferred Stock, $1,000 stated amount; 5,000 shares designated; 0 and 4,500 shares issued and outstanding at February 28, 1999 and 1998, respectively (Note 6) -- 4,543,767 Shareholders' equity: Common stock, $.01 par value; 20,000,000 shares authorized at February 28, 1999 and 1998, respectively; 7,978,605 and 5,348,234 shares issued and outstanding at February 28, 1999 and 1998, respectively 79,786 53,482 Paid-in capital - common stock 28,601,398 18,038,006 Paid-in capital - preferred stock -- 1,318,350 Accumulated deficit (23,126,562) (18,576,240) ------------ ------------ Total shareholders' equity 5,554,622 833,598 ------------ ------------ Total liabilities, preferred stock and shareholders' equity $ 6,253,994 $ 6,469,031 ============ ============ The accompanying notes are an integral part of the financial statements.
F-2 C-PHONE CORPORATION STATEMENTS OF OPERATIONS FOR THE YEARS ENDED FEBRUARY 28, 1999, 1998 AND 1997
1999 1998 1997 ----------- ----------- ----------- Net sales $ 1,590,748 $ 1,818,663 $ 1,890,213 Other revenue 30,448 72,003 152,665 ----------- ----------- ----------- Total revenue 1,621,196 1,890,666 2,042,878 ----------- ----------- ----------- Cost of goods sold 2,541,145 3,209,875 1,629,287 Cost of other revenue 9,750 22,506 81,079 ----------- ----------- ----------- Total cost of revenue 2,550,895 3,232,381 1,710,366 ----------- ----------- ----------- Gross profit (loss) (929,699) (1,341,715) 332,512 ----------- ----------- ----------- Operating expenses: Selling, general and administrative 3,000,128 3,816,806 2,454,337 Research, development and engineering 814,366 973,210 1,016,293 ----------- ----------- ----------- Total operating expenses 3,814,494 4,790,016 3,470,630 ----------- ----------- ----------- Operating loss (4,744,193) (6,131,731) (3,138,118) Interest expense -- (447) (2,511) Interest income 265,468 157,350 132,405 ----------- ----------- ----------- Net loss $(4,478,725) $(5,974,828) $(3,008,224) =========== =========== =========== Per-share data: Basic and diluted net loss per common share $ (0.63) $ (1.49) $ (0.69) =========== =========== =========== Weighted average number of common shares outstanding 7,183,078 5,202,608 4,347,968 =========== =========== =========== The accompanying notes are an integral part of the financial statements.
F-3
C-PHONE CORPORATION STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED FEBRUARY 28, 1999, 1998 AND 1997 Common Stock Paid-In Capital Total -------------------------- Paid-In Capital Preferred Accumulated Shareholders' Shares Amount Common Stock Stock Deficit Equity ----------- ------------ --------------- --------------- --------------- ---------------- Balance, February 28, 1996 4,347,293 $ 43,473 $ 13,495,376 $ -- $ (7,840,613) $ 5,698,236 Exercise of employee stock options 8,100 81 25,232 25,313 Expense of stock options granted to consultant 9,600 9,600 Net loss (3,008,224) (3,008,224) ----------- ------------ --------------- -------------- --------------- ---------------- Balance, February 28, 1997 4,355,393 43,554 13,530,208 (10,848,837) 2,724,925 Exercise of employee stock options 17,571 176 59,412 59,588 Expense of stock options granted to consultant 74,400 74,400 Stock issued to consultant 4,740 47 14,173 14,220 Issuance of common stock in March 1997 private placement 833,667 8,336 4,361,182 4,369,518 Issuance of common stock pursuant to contingent value rights issued in March 1997 private placement 136,863 1,369 (1,369) -- Issuance of preferred stock in December 1997 private placement (390,458) (390,458) To reflect beneficial conversion feature of preferred stock 1,708,808 (1,708,808) -- Accretion of preferred stock (43,767) (43,767) Net loss (5,974,828) (5,974,828) ----------- ------------ --------------- -------------- --------------- ---------------- Balance, February 28, 1998 5,348,234 53,482 18,038,006 1,318,350 (18,576,240) 833,598 Exercise of stock options 57,749 578 304,359 304,937 Expense of stock options granted to consultant 12,800 12,800 Common stock issued upon exercise of warrants 585,000 5,850 4,332,395 4,338,245 Accretion of preferred stock (71,597) (71,597) Common stock issued upon conversion of preferred stock 1,987,622 19,876 5,913,838 (1,318,350) 4,615,364 Net loss (4,478,725) (4,478,725) ----------- ------------ --------------- -------------- --------------- ---------------- Balance, February 28, 1999 7,978,605 $ 79,786 $ 28,601,398 $ -- $ (23,126,562) $ 5,554,622 =========== ============ =============== ============== =============== ================ The accompanying notes are an integral part of the financial statements.
F-4
C-PHONE CORPORATION STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED FEBRUARY 28, 1999, 1998 AND 1997 1999 1998 1997 ----------- ----------- ----------- Cash flows from operating activities: Net loss $(4,478,725) $(5,974,828) $(3,008,224) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 136,444 131,231 134,202 Provision for inventory write-down and obsolescence 608,657 696,248 84,740 Bad debt expense 165,760 178,773 90,831 Compensation expense of stock options 12,800 74,400 9,600 Compensation expense of stock issued to consultant -- 14,220 -- Changes in operating assets and liabilities: Accounts receivable 75,207 (103,415) (114,869) Inventories (144,651) (995,845) (365,175) Prepaid expenses and other current assets (45,165) 8,338 41,849 Other assets (93,817) 111,560 (86,926) Accounts payable (489,717) 208,142 298,515 Accrued expenses 97,423 (30,291) 102,940 ----------- ----------- ----------- Net cash used in operating activities (4,155,784) (5,681,467) (2,812,517) ----------- ----------- ----------- Cash flows from investing activities: Equipment purchases (84,877) (43,492) (77,867) Purchases of short-term investments -- -- (1,647,371) Maturities of short-term investments -- -- 4,073,774 ----------- ----------- ----------- Net cash (used in) provided by investing activities (84,877) (43,492) 2,348,536 ----------- ----------- ----------- Cash flows from financing activities: Proceeds from exercise of stock options 304,937 59,588 25,313 Proceeds from private placement of common stock, net -- 4,369,518 -- Proceeds from private placement of preferred stock, net -- 4,109,542 -- Proceeds from exercise of warrants, net 4,338,245 -- -- Payment of capital lease obligations -- (11,507) (16,103) ----------- ----------- ----------- Net cash provided by financing activities 4,643,182 8,527,141 9,210 ----------- ----------- ----------- Net increase (decrease) in cash and cash equivalents 402,521 2,802,182 (454,771) Cash and cash equivalents, beginning of year 4,200,231 1,398,049 1,852,820 ----------- ----------- ----------- Cash and cash equivalents, end of year $ 4,602,752 $ 4,200,231 $ 1,398,049 =========== =========== =========== The accompanying notes are an integral part of the financial statements.
F-5 C-PHONE CORPORATION NOTES TO FINANCIAL STATEMENTS -------------------- 1. NATURE OF BUSINESS C-Phone Corporation (the "Company") was incorporated in the State of New York on March 28, 1986. The Company engineers, manufactures and markets video conferencing systems. The Company's stand-alone video conferencing system line consists of several models, some of which operate over either analog or digital phone lines and some of which operate only over analog phone lines. The Company's products are marketed primarily to business and special applications markets in the United States and internationally. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS The financial statements are prepared in conformity with generally accepted accounting principles which requires management to make estimates and assumptions that affect the amounts reported in the accompanying financial statements and notes. Actual results could differ from those estimates. CASH AND CASH EQUIVALENTS Cash and cash equivalents includes all cash balances and highly liquid investments with a maturity of three months or less at the date of purchase. CONCENTRATION OF CREDIT RISK Financial instruments which potentially subject the Company to concentrations of credit risk consist of trade receivables and cash deposits. Significant customers and concentrations of credit risk are discussed in Note 11. As discussed in Note 3, the Company maintains its cash in bank deposit accounts which, at times, may exceed federally insured limits. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying value of the Company's financial instruments, which consist of cash and cash equivalents at February 28, 1999, 1998 and 1997, approximates the fair value because of the short maturities of these investments. INVENTORIES Inventories are stated at the lower of cost (first-in, first-out "FIFO " basis) or market. Inventories are presented net of valuation allowances necessary to reduce inventories to their net realizable value. PROPERTY AND EQUIPMENT Property and equipment is stated at cost and is depreciated, including equipment under capital leases, by the double-declining-balance method over the estimated useful life of the assets, which range from three to seven years. Leasehold improvements are amortized over the remaining term of the lease or the useful life, if shorter. Major tooling costs are capitalized and amortized over the expected life of the tooling or the expected life of the related product, whichever is less. Expenditures for minor tooling, maintenance and repairs are charged to expense as incurred. F-6 C-PHONE CORPORATION NOTES TO FINANCIAL STATEMENTS -------------------- 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Significant expenditures for betterments and renewals are capitalized. The cost and related accumulated depreciation of property and equipment are removed from the accounts upon retirement or other disposition, and any gain or loss is reflected in operations. The Company assesses the impairment of its long-lived assets, including property, plant and equipment, whenever economic events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. Long-lived assets are considered to be impaired when the sum of the expected future operating cash flows, undiscounted and without interest charges, is less than the carrying values of the related assets. INCOME TAXES The Company provides for income taxes in accordance with Statement of Financial Accounting Standards No. 109 ("SFAS No. 109"), "Accounting for Income Taxes". SFAS No. 109 requires that all deferred tax asset and liability balances be determined by application to temporary differences of the tax rate expected to be in effect when taxes will become payable or receivable. Temporary differences are differences between the tax basis of assets and liabilities and their reported amounts in the financial statements that will result in taxable or deductible amounts in future years. The Company's temporary differences consist primarily of net operating losses, depreciation, allowance for doubtful accounts receivable and inventory valuation reserves. REVENUE RECOGNITION Product revenues are recognized when the product is shipped, collection of the purchase price is probable and the Company has no significant further obligation to the customer. Costs of remaining insignificant Company obligations, if any, are accrued as costs of revenue at the time of revenue recognition. WARRANTY The Company generally provides a one-year warranty on its products. Estimated warranty expenses are accrued and charged to cost of goods sold when the related revenues are recognized. RESEARCH AND DEVELOPMENT COSTS Research and development expenditures are charged to expense as incurred. PREFERRED STOCK In December 1997, the Company issued 4,500 shares (the "Preferred Shares" ) of the Company's Series A Convertible Preferred Stock (the "Preferred Stock"), with an initial stated value of $1,000 per share (which increased at the rate of 5% per annum) (such amount, as increased from time to time, the "Stated Value"). Each Preferred Share was convertible, from time to time, at the option of the holder, into such number of shares of Common Stock as was determined by dividing the Stated Value by the lesser of (x) $7.3575, and (y) 85% of the average of the closing bid price during such three consecutive trading day period selected by the holder during the 25-day trading period preceding the date of conversion. During the fiscal year ended February 28, 1999, all of the Preferred Shares were converted into 1,987,622 shares of Common Stock. See Note 6. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) In its November 7,1997 Current Issues and Rulemaking Projects, the Securities and Exchange Commission (the "SEC") addressed the issue of a "beneficial conversion feature", where securities may be convertible into common stock at the lower of a conversion rate fixed at the date of issue or a fixed discount to the common stock's market price at the date of conversion. The beneficial conversion feature of the Preferred F-7 C-PHONE CORPORATION NOTES TO FINANCIAL STATEMENTS -------------------- Stock is recognized and measured by allocating a portion of the proceeds equal to the intrinsic value of the feature to additional paid-in-capital. The beneficial conversion feature of $1,708,808 was calculated at the date of issue as the difference between the conversion price and the fair value of the Common Stock. This amount is recognized as a return to the preferred shareholders over the minimum period in which the shareholders can realize the return. As there are no time restraints on the conversion, the full amount of the feature was amortized on the date of issuance. SEC regulations require that all issues of mandatorily redeemable stock be excluded from the shareholders' equity section of the balance sheet and be presented separately. One of the characteristics of a mandatorily redeemable stock is that it contains conditions for redemption which are not solely within the control of the issuer. The Preferred Stock was subject to redemption at the option of the holder if (a) the Company failed to maintain an effective registration statement with respect to the shares of Common Stock issuable upon exercise of the Preferred Shares, (b) the Preferred Shares ceased to be convertible due to the a limitation imposed by the rules of the Nasdaq Stock Market came into effect and the Company did not obtain shareholder approval to waive such limitation within 75 days after requested by the holders, or (c) the Company failed to maintain listing of the Common Stock on the Nasdaq National Market or other principal securities exchange. Since there was the possibility that the occurrence of an event outside the control of the Company could have caused redemption, the Preferred Stock was classified separately from shareholders' equity on the balance sheet. See Note 6. NET LOSS PER SHARE The Company calculates earnings per share in accordance with Statement of Financial Accounting Standards No. 128 ("SFAS No. 128"), "Earnings Per Share." SFAS No. 128 requires the presentation on the face of the income statement of "basic" earnings per share and "diluted" earnings per share. Basic earnings per share is computed by dividing the net income (loss) available to common shareholders by the weighted average number of outstanding common shares. The calculation of diluted earnings per share is similar to the calculation of basic earnings per share, except that the denominator includes dilutive common stock equivalents such as stock options and warrants. Common stock options and warrants are not included for the years ended February 28, 1999 ("Fiscal 1999"), February 28, 1998 ("Fiscal 1998") and February 28, 1997 ('Fiscal 1997'), as they would be anti-dilutive. The accretion of the 5% annual increase in stated value of the Preferred Stock in the amount of $71,597 for Fiscal 1999 increased the net loss attributable to common shareholders from $4,478,725 to $4,550,322, thereby increasing the net loss per share for Fiscal 1999 from $0.62 to $0.63. The amortization of the beneficial conversion feature and the accretion of the 5% annual increase in stated value of the Preferred Stock in the total amount of $1,752,575 for Fiscal 1998 increased the net loss attributable to common shareholders from $5,974,828 to $7,727,403 thereby increasing the net loss per share for Fiscal 1998 from $1.15 to $1.49. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) ACCOUNTING FOR STOCK OPTIONS The Company has adopted SFAS No. 123, "Accounting for Stock Based Compensation". As permitted by SFAS No. 123, the Company has chosen to continue to apply APB Opinion No. 25, "Accounting for Stock Issued to Employees" and related Interpretations. Accordingly, no compensation cost has been recognized for options granted under the C-Phone Corporation Amended and Restated 1994 Stock Option Plan (the "Stock Option Plan") except for $12,800 for Fiscal 1999, $74,400 for Fiscal 1998 and $9,600 for Fiscal 1997 related to the fair value of services rendered in exchange for options granted to consultants. However, the Company has disclosed in Note 7 the pro forma impact on net loss had compensation cost been determined based on the fair value of the options at the grant date. F-8 C-PHONE CORPORATION NOTES TO FINANCIAL STATEMENTS -------------------- COMPREHENSIVE INCOME Statement of Financial Accounting Standards No. 130 ("SFAS No. 130"), "Reporting Comprehensive Income", which establishes standards for the reporting and displaying of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general purpose financial statements, became effective for the Company in Fiscal 1999. SFAS No. 130 requires the disclosure of an amount that represents total comprehensive income and the components of comprehensive income in a financial statement. The Company had no items of other comprehensive income or loss during Fiscal 1999, Fiscal 1998 or Fiscal 1997. SEGMENT INFORMATION Statement of Financial Accounting Standards No. 131 ("SFAS No. 131"), "Disclosures about Segments of an Enterprise and Related Information", which establishes standards for determining an entity's operating segments and the type and level of financial information to be disclosed in both annual and interim financial statements, became effective for the Company in Fiscal 1999. SFAS No. 131 also establishes standards for related disclosures about products and services, geographic areas and major customers. The adoption of SFAS No. 131 did not have a material impact on the Company's financial statements for Fiscal 1999, Fiscal 1998 or Fiscal 1997, as the Company operates in only one segment RECLASSIFICATION Certain prior year amounts have been reclassified to conform to the Fiscal 1999 presentation. 3. CASH AND CASH EQUIVALENTS The Company places a portion of its cash and cash equivalents with various financial institutions. At times, such cash and cash equivalents may be in excess of the FDIC insurance limits. At February 28, 1999 and 1998, the Company's cash equivalents consisted primarily of overnight repurchase agreements for discount notes issued by the United States Treasury or United States government agencies. The aggregate fair value of these investments approximated the amortized cost at February 28, 1999 and 1998. 4. INVENTORIES Inventories consist of the following at February 28, 1999 and 1998: 1999 1998 -------------- ------------- Raw materials $ 382,789 $ 881,095 Work in process 282,771 486,335 Finished goods 511,962 274,098 -------------- ------------- $ 1,177,522 $ 1,641,528 ============== ============= The Company wrote down obsolete inventory in the amount of $276,520 in Fiscal 1999 and $475,824 in Fiscal 1998. Other inventory reserves were $621,736, $391,164 and and $170,740 at February 28, 1999, 1998 and 1997, respectively. 5. PROPERTY AND EQUIPMENT Property and equipment consist of the following at February 28, 1999 and 1998: 1999 1998 -------------- ------------- Machinery and equipment $ 819,656 $ 997,210 Furniture and fixtures 32,992 50,940 Leasehold improvements 101,782 82,032 -------------- ------------- 954,430 1,130,182 Less accumulated depreciation and amortization 841,823 966,008 -------------- ------------- $ 112,607 $ 164,174 ============== ============= F-9 C-PHONE CORPORATION NOTES TO FINANCIAL STATEMENTS -------------------- 6. SHAREHOLDERS' EQUITY (a) In connection with the Company's initial public offering in August 1994, the Company granted to the managing underwriter warrants (the "1994 Warrants") to purchase 200,000 shares of Common Stock at $8.40 per share. The 1994 Warrants were exercisable at any time until expiration on August 18, 1999. On May 13, 1998, the Company reduced the exercise price of the 1994 Warrants to $6.00 per share in consideration for (i) requiring payment of the exercise price for the 1994 Warrants to be made in cash (rather than upon surrender of 1994 Warrants) and (ii) changing the expiration date thereof from August 18, 1999 to May 21, 1998. On May 13, 1998, the closing sales price of the Common Stock was $9.75. The holders of the 1994 Warrants exercised all of the 1994 Warrants by May 15, 1998 and the Company received aggregate proceeds of $1,200,000 therefrom. (b) During Fiscal 1997, in conjunction with a one-year consulting agreement, the Company granted to a consultant a five-year option to purchase 25,000 shares of Common Stock at a price of $3.375 per share (the market price of the Common Stock on the date of grant). The agreement was extended during Fiscal 1998 for another year and the Company granted the consultant another five-year option to purchase 24,000 shares at a price of $5.95 per share. The agreement was terminated in May 1998 and options to purchase 10,000 shares of Common Stock under the option granted in Fiscal 1998 were forfeited pursuant to the terms of the option. The options were granted in partial payment for services to be rendered by the consultant under the agreement, which services the Company valued at $12,800 for Fiscal 1999, $38,400 for Fiscal 1998 and $9,600 for Fiscal 1997. 6. SHAREHOLDERS' EQUITY (Continued) Also during Fiscal 1998, the Company granted to another consultant a five-year option to purchase 18,000 shares of Common Stock at $7.8125 per share (the market price of the Common Stock on the date of grant). The relationship with this other consultant was terminated prior to the end of its six-months term and the right to exercise one-third of the option was forfeited pursuant to the terms of the option. The option was granted in partial payment for services to be rendered by the consultant, which services the Company valued at $36,000 for Fiscal 1998. All of these amounts were expensed and, as a result, paid-in capital was increased by such amounts. (c) During the week of March 31, 1997, the Company completed a private placement (the "March Placement"), through a placement agent, pursuant to which the Company issued an aggregate of 833,667 shares (the "Original Shares") of Common Stock to the participants (the "Investors") in the March Placement and received net proceeds of approximately $4,370,000 (after payment of fees and expenses of approximately $632,000). Accompanying each of the Original Shares was the right, under certain circumstances, to receive additional shares of Common Stock in accordance with the terms of a "contingent value right" (the "Rights"). The Rights, which expired June 25, 1998, were automatically exercised at the time, and from time to time, as the Original Shares were first publicly sold through a broker-dealer. The terms of the Rights provided that, upon the first such sale of any Original Shares at a price of less than $8.00 per share, the seller of the Original Shares would automatically receive, for each such Original Share sold, and without the payment of any additional consideration, such additional number of shares of Common Stock as equaled (i) $8.00 divided by the Adjusted Price, minus (ii) one; where the Adjusted Price equals the greater of (x) the average closing bid price per share of Common Stock on The Nasdaq National Market for the ten trading days immediately preceding the date of sale of the Original Shares, and (y) $2.00. All the Original Shares have been publicly resold and, pursuant to the terms of the Rights, 136,863 additional shares were issued as a result thereof. In connection with the March Placement, the Company issued to an affiliate of the placement agent warrants to acquire an aggregate of 150,000 shares of Common Stock at an exercise price of $9.60 per share, which warrants expired without being exercised. F-10 C-PHONE CORPORATION NOTES TO FINANCIAL STATEMENTS -------------------- (d) On December 19, 1997, the Company completed a private placement (the "December Placement") pursuant to which the Company issued an aggregate of (i) 4,500 shares (the "Preferred Shares" ) of the Company's Series A Convertible Preferred Stock (the "Preferred Stock"), par value $.01 per share, with an initial stated value of $1,000 per share (which increased at the rate of 5% per annum) (such amount, as increased from time to time, the "Stated Value"), (ii) warrants (the "Class A Warrants") to acquire up to 315,000 shares of Common Stock, and (iii) warrants (the "Class B Warrants") to acquire up to 135,000 shares of Common Stock. The Company received net proceeds of approximately $4,110,000 (after payment of fees (including finders fees) and related expenses of approximately $390,000). Each Preferred Share was convertible, from time to time, at the option of the holder, into such number of shares of Common Stock as was determined by dividing the Stated Value by the lesser of (x) $7.3575, and (y) 85% of the average of the closing bid price during such three consecutive trading day period selected by the holder during the 25-day trading period preceding the date of conversion. Any outstanding Preferred Shares on December 19, 1999 automatically would have been converted into Common Stock at the conversion price then in effect. The Preferred Shares were subject to redemption at the option of the holder if, among other things, (i) the Company failed to maintain an effective registration statement with respect to the shares of Common Stock issuable upon exercise of the Preferred Shares for more than 30 consecutive days or more than 60 days in any 12-month period, or (ii) the Company failed to maintain the listing of the Common Stock on the Nasdaq National Market or another principal securities exchange or automated quotation system. 6. SHAREHOLDERS' EQUITY (Continued) If any of the foregoing events had occurred and the holders of the Preferred Shares had elected to exercise their redemption rights, the Company would have been required to redeem the remaining outstanding Preferred Shares at an amount equal to the greater of (x) 118% of the Stated Value of the Preferred Shares and (y) the market value of the Common Stock into which the Preferred Shares would have been converted on the date of redemption. In connection with the December Placement, the Company paid a finder's fee of $295,000 and issued to an affiliate of the finder warrants (upon the same terms as the Class A Warrants) to acquire an aggregate of 185,000 shares of Common Stock. All of the issued Preferred Shares were converted into a total of 1,987,622 shares of Common Stock. See Note 2. The Class A Warrants expired on December 19, 1998, had an exercise price of $8.05 per share and were redeemable at the option of the Company at a price of $.01 per warrant if the closing price of the Common Stock had been greater than 130% of the exercise price of the Class A Warrants for 10 consecutive trading days. Prior to expiration, Class A Warrants to purchase 325,000 shares of Common Stock were exercised and the Company received aggregate proceeds of $2,616,250. The remaining Class A Warrants expired unexercised. The Class B Warrants expire on December 19, 2000, have an exercise price of $9.10 per share and are not redeemable. As of April 15, 1999, Class B Warrants to purchase 60,000 shares of Common Stock had been exercised and the Company received aggregate proceeds of $546,000. (e) On September 18, 1998, the Company entered into a Private Equity Credit Agreement (the "Equity Credit Agreement") with Sovereign Partners, L.P. ("Sovereign Partners"). Pursuant to the Equity Credit Agreement, Sovereign Partners has agreed to purchase up to $5 million of the Common Stock during the 18-month period commencing April 1, 1999. From time to time during the term of the Equity Credit Agreement, but no more frequently than once every 30 days, the Company can require F-11 C-PHONE CORPORATION NOTES TO FINANCIAL STATEMENTS -------------------- Sovereign Partners to purchase between $500,000 and $1 million of the Common Stock. The purchase price for each share of Common Stock to be paid by Sovereign Partners will equal 85% of the average closing bid price of the Common Stock during the five trading days immediately preceding the day that the Company notifies Sovereign Partners of a purchase obligation. Sovereign Partners' obligation to purchase the Common Stock is subject to certain conditions, including: (i) the continued effectiveness of the registration statement under the Securities Act of 1933 covering the resale by Sovereign Partners of the Common Stock acquired under the Equity Credit Agreement, (ii) the average closing bid price of the Common Stock being at least $1.00 per share for the 20 trading days preceding the date of delivery to Sovereign Partners of the Company's notice of purchase; (iii) the continued trading of the Common Stock on The Nasdaq Stock Market and (iv) the number of shares to be sold to Sovereign Partners, when aggregated with all other shares of Common Stock then owned by Sovereign Partners Stock, not being more than 9.9% of the total Common Stock then outstanding. The Company may terminate the Equity Credit Agreement without any further obligation to Sovereign Partners at any time after the Company has sold it at least $1 million of the Common Stock. If the Company terminates the Equity Credit Agreement prior to such time, it must pay Sovereign Partners a penalty of up to $150,000. 6. SHAREHOLDERS' EQUITY (Continued) Sovereign Partners has agreed not to engage in any short sales of the Common Stock, except that it may engage in short sales after it receives a purchase notice from the Company, but only for the number of shares of Common Stock covered by the Company's purchase notice. Under a related registration rights agreement, the Company has agreed to file and maintain effectiveness of a registration statement under the Securities Act of 1933 for the resale by Sovereign Partners of the shares of Common Stock it purchases under the Equity Credit Agreement. If the Company fails to maintain effectiveness of the registration statement, Sovereign Partners may require the Company to pay a penalty equal to 1% of the purchase price of the Common Stock then held by it for each 30-day period that the registration statement is not effective. In connection with the Agreement, the Company issued to Cardinal Capital Management, Inc. ("CCM"), as finder, a two-year warrant (the "Warrant") to purchase 100,000 shares of Common Stock at an exercise price of $8.00 per share. If the closing sales price of the Common Stock exceeds $10.00 for five consecutive trading days, the Company may give CCM a notice of intention to redeem the Warrant. If CCM does not exercise the Warrant prior to the redemption date specified in the redemption notice, the Company may redeem the Warrant for $1,000. The shares of Common Stock issuable upon exercise of the Warrant have not been registered for sale under the Securities Act of 1933. The Company also paid CCM a cash fee of $30,000 and has agreed to pay CCM an additional cash fee equal to 6% of the dollar amount of any sales of Common Stock to Sovereign Partners under the Equity Credit Agreement, with the initial $30,000 payment to be credited against such fee. 7. STOCK OPTION PLAN The Stock Option Plan provides for the grant of options to officers, directors, employees and consultants. Options may be either incentive stock options or non-qualified stock options, except that only employees may be granted incentive stock options. Options generally vest over a period of three years. The maximum term of an option is ten years. The Stock Option Plan will terminate in August 2004, though options granted prior to termination may expire after that date. The Stock Option Plan was amended by the Board of Directors on December 2, 1998, to increase the maximum number of shares of Common Stock with respect to which options may be granted under the Stock Option Plan from 500,000 to 875,000. This amendment is subject to approval by shareholders at the next annual meeting of shareholders. F-12 C-PHONE CORPORATION NOTES TO FINANCIAL STATEMENTS -------------------- Had compensation cost for the Stock Option Plan been determined based on the fair value at the grant dates for awards under the Stock Option Plan, excluding the grants to consultants discussed in Note 6, consistent with the method of SFAS No. 123 (see Note 2), the Company's net loss and net loss per share would have increased to the pro forma amounts indicated below:
Fiscal 1999 Fiscal 1998 Fiscal 1997 ------------------- ------------------ ------------------ As Pro As Pro As Pro Reported Forma Reported Forma Reported Forma -------- --------- -------- ------ -------- ------ Net loss (in thousands) $ 4,479 $ 4,787 $5,975 $6,247 $3,008 $3,108 Net loss per share $ 0.63 $ 0.68 $ 1.49 $ 1.54 $ 0.69 $ 0.71
7. STOCK OPTION PLAN (Continued) The fair value of each option grant is estimated on the date of grant using the Black Scholes option-pricing method with the following weighted average assumptions used for grants. 1999 1998 1997 ---- ---- ----- Dividend yield 0% 0% 0% Expected volatility 83.5% 81.4% 138.8% Risk-free interest rate 4.93% 6.25% 6.25% Expected lives, in years 5 5 5 The weighted average fair value of options granted during Fiscal 1999, Fiscal 1998 and Fiscal 1997 was $2.03, $4.16 and $2.85 per share, respectively. A summary of the status of the Stock Option Plan at February 28, 1999, 1998 and 1997 and the changes during the years then ended is presented below:
1999 1998 1997 --------------------- ---------------------- --------------------- Weighted Weighted Weighted Shares Average Shares Average Shares Average Underlying Exercise Underlying Exercise Underlying Exercise Options Price Options Price Options Price ---------- -------- ---------- --------- ---------- -------- Outstanding at beginning of year 337,727 $6.07 275,200 $4.66 116,500 $7.34 Granted 167,150 $2.92 134,650 $8.11 189,150 $3.18 Exercised (57,749) $5.21 (17,571) $3.39 (8,100) $3.13 Forfeited (39,851) $6.89 (54,552) $4.86 (22,350) $6.39 ---------- ---------- ---------- Outstanding at end of year 407,277 $4.67 337,727 $6.07 275,200 $4.66 ========== ========== ========== Exercisable at end of year 203,844 $5.81 188,401 $5.47 85,967 $6.01 ========== ========== ==========
The following table summarizes information about stock options under the Stock Option Plan at February 28, 1999:
Options Outstanding Options Exercisable ---------------------------------------------------- ----------------------------------- Weighted Average Remaining Weighted Weighted Range of Number Contractual Average Number Average Exercise Price Outstanding Life Exercise Price Exercisable Exercise Price - ------------------- ----------------- ------------------ -------------- ----------------- --------------- $2.68 - $3.38 227,867 4.10 $ 2.95 70,443 $ 3.16 $4.38 - $4.50 13,500 7.20 $ 4.44 -- -- $5.95 - $6.91 32,517 4.65 $ 6.30 27,183 $ 6.19 $7.00 - $7.50 92,810 1.66 $ 7.29 92,476 $ 7.29 $8.38 35,583 3.71 $ 8.38 12,076 $ 8.38 $10.38 5,000 3.19 $10.38 1,666 $10.38 407,277 203,844 ================= ============
F-13 C-PHONE CORPORATION NOTES TO FINANCIAL STATEMENTS -------------------- 8. RELATED PARTY TRANSACTIONS The Company leases its office, manufacturing and warehouse space from two of its executive officers who also are directors of the Company. See Note 10. 9. OBLIGATIONS UNDER CAPITAL LEASES The Company leased certain manufacturing equipment during Fiscal 1997. The lease provided for monthly payments of $1,506 and for the Company to purchase the equipment for a nominal cost at the end of the lease. The lease term ended during Fiscal 1997 and the Company purchased the equipment which was fully depreciated at that time. 10. COMMITMENTS The Company leases office, manufacturing and warehouse space, totaling approximately 14,420 square feet, from two of its executive officers who also are directors of the Company. The lease currently expires on April 30, 2002 with monthly rental payments of $6,280; subject to increase on May 1, 2000. Under the lease, the Company is required to pay all real estate taxes and maintenance costs, and maintain property and liability insurance on the leased property. The future minimum aggregate lease payments under this operating lease are as follows at February 28, 1999: Fiscal year ending February 28, ------------------------------- 2000 $ 75,360 2001 75,360 2002 75,360 2003 12,560 ------------- $ 238,640 ============= Rent expense was $75,360, $75,360 and $72,800 in Fiscal 1999, Fiscal 1998 and Fiscal 1997, respectively. 11. SIGNIFICANT CUSTOMERS AND CONCENTRATION OF CREDIT RISK The Company monitors the granting of credit to all its customers and, generally, no collateral is required. In each of Fiscal 1999 and Fiscal 1997, there were net revenues from two major customers that exceeded 10% of total net revenues. For Fiscal 1998, the Company did not have any revenues from any single customer that exceeded 10% of total net revenues. Net revenues from these major customers were as follows: 1999 1998 1997 ----------- ----------- ----------- Customer A $ 261,328 $ 1,100 $ -- Customer B 170,658 71,991 -- Customer C -- -- 291,710 Customer D -- -- 211,224 ----------- ----------- ----------- $ 431,986 $ 73,091 $ 502,934 =========== =========== =========== F-14 C-PHONE CORPORATION NOTES TO FINANCIAL STATEMENTS -------------------- 11. SIGNIFICANT CUSTOMERS AND CONCENTRATION OF CREDIT RISK (Continued) Accounts receivable from these customers were as follows at February 28, 1999 and 1998: 1999 1998 ---------- --------- Customer A $ 3,860 $ -- Customer B 4,208 -- ---------- --------- $ 8,068 $ -- ========== ========= The Company had net revenues from customers located outside of the United States of $812,203, $314,000 and $308,000 during Fiscal 1999, Fiscal 1998 and Fiscal 1997, respectively. All of the Company's foreign sales are denominated in U.S. dollars and generally are made either on a prepaid basis or against letters of credit. 12. CONTINGENCIES An action by the former owner of the "C-Phone" trademark" seeking to cancel the Company's registration of the "C-Phone" trademark is pending before the U.S. Patent and Trademark Office's Trial and Appeals Board. If the Company is unable to satisfactorily resolve this matter with the former owner or it is not successful in the current Patent and Trademark Office proceeding, it may need to change the identifying name on some of its products. In addition, the Company may determine that it is appropriate to change its corporate name. The Company also may be subject to damages, if it can be shown that it had infringed the former owner's common law rights. The Company also is involved in various legal proceedings which are incidental to the conduct of its business. Although the final resolution of these matters cannot be determined, it is management's opinion that the final outcome of these matters will not have a material adverse effect on the Company's financial position or results of operations. 13. INCOME TAXES The significant components of the deferred tax were as follows at February 28, 1999 and 1998:
1999 1998 ------------- ------------ Net operating loss carryforwards $ 7,518,939 $ 5,926,262 Alternative minimum tax credit carryforwards 5,924 5,924 Allowance for doubtful accounts 83,927 164,782 Research and development tax credit 201,211 135,529 Inventory reserve 602,593 404,663 Fixed assets 67,732 37,734 Other 31,708 45,735 ------------- ------------ Deferred tax assets 8,512,034 6,720,629 Valuation allowance (8,512,034) (6,720,629) ------------- ------------ Net deferred tax assets $ -- $ -- ============= ============
F-15 C-PHONE CORPORATION NOTES TO FINANCIAL STATEMENTS -------------------- 13. INCOME TAXES (Continued) The Company provides a valuation allowance for deferred tax assets that are not expected to be realized. Due to the recent net losses incurred by the Company, a valuation allowance has been established for all deferred tax assets. Reconciliation of differences between the statutory U.S. Federal income tax rate and the Company's effective tax rate are as follows: 1999 1998 1997 -------- -------- --------- Federal statutory income tax rate (34)% (34)% (34)% State income taxes, net of federal benefit (5) (5) (5) Valuation allowance increase 39 39 39 -------- -------- --------- 0% 0% 0% ======== ======== ========= The Company's net operating loss carryforwards for Federal tax purposes as of February 28, 1999 are estimated to be $19,189,000 and expire in 2009 through 2014. The Federal net operating loss carryforward may be subject to limitation under the rules regarding changes in stock ownership as determined under the Internal Revenue Code. The Company's net operating loss carryforwards for state tax purposes as of February 28, 1999 are estimated to be $19,448,000 and expire in 2002 through 2014. F-16 ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE PricewaterhouseCoopers LLP, independent accountants, is, and for more than our last two fiscal years has been, our independent auditors. Since the beginning of this two fiscal year period, (a) PricewaterhouseCoopers LLP has not expressed reliance, in its audit report, on the audit services of any other accounting firm, and (b) there have been no reported disagreements between PricewaterhouseCoopers LLP and us on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure. PART III ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT The information required by this Item 9 is incorporated by reference from our definitive proxy statement which we will file with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act on or before June 29, 1999. ITEM 10. EXECUTIVE COMPENSATION. The information required by this Item 10 is incorporated by reference from our definitive proxy statement which we will file with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act on or before June 29, 1999. ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information required by this Item 11 is incorporated by reference from our definitive proxy statement which we will file with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act on or before June 29, 1999. ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item 9 is incorporated by reference from our definitive proxy statement which we will file with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act on or before June 29, 1999. ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits. 3. Articles of incorporation and by-laws. 3(i)(a) Restated Certificate of Incorporation, as filed with the Secretary of State of the State of New York on February 24, 1994(1) (b) Certificate of Amendment to Certificate of Incorporation, as filed with the Secretary of State of the State of New York on August 9, 1996(2) (c) Certificate of Amendment to Certificate of Incorporation, as filed with the Secretary of State of the State of New York on August 12, 1997(3) (d) Certificate of Amendment to Certificate of Incorporation, as filed with the Secretary of State of the State of New York on December 18, 1997(4) 21 3(ii) By-laws, as currently in effect(1) 4. Instruments defining the rights of security holders, including indentures. 4.1 Form of certificate representing shares of the Common Stock(5) 4.2 Form of Class A Warrant, dated December 19, 1997, of C-Phone Corporation(4) 4.3 Form of Class B Warrant, dated December 19, 1997, of C-Phone Corporation(4) 4.4 Common Stock Purchase Warrant, dated as of September 18, 1998, of C-Phone Corporation issued to Cardinal Capital Management, Inc.(6) 9. Voting trust agreement and amendments - None. 10. Material contracts. 10.1 (a) Lease, dated May 1, 1993, between C-Phone Corporation and Daniel Flohr and Tina Jacobs(1) (b) Addendum, dated as of May 1, 1996, to Indenture of Lease, between C-Phone Corporation and Daniel Flohr and Tina Jacobs(7) (c) Addendum, dated as of May 1, 1999, to Indenture of Lease, between C-Phone Corporation and Daniel Flohr and Tina Jacobs 10.2 (a) Employment Agreement, dated as of March 1, 1994, between C-Phone Corporation and Daniel Flohr, as amended(8) (b) Amendment No. 2 to Employment Agreement, dated as of March 1, 1996, between C-Phone Corporation and Daniel Flohr(7) 10.3 (a) Employment Agreement, dated as of March 1, 1994, between C-Phone Corporation and Tina Jacobs, as amended(8) (b) Amendment No. 2 to Employment Agreement, dated as of March 1, 1996, between C-Phone Corporation and Tina Jacobs(7) 10.4 Employment Agreement, dated as of September 15, 1998, between C-Phone Corporation and James Jarvis 10.5 Employment Agreement, dated as of December 3, 1998, between C-Phone Corporation and Stuart Ross 10.6 C-Phone Corporation Amended and Restated 1994 Stock Option Plan and form of Option Agreement(7) 10.7 (a) Form of Securities Purchase Agreement, dated as of December 17, 1997, between C-Phone Corporation and each purchaser party thereto(4) (b) Form of Registration Rights Agreement, dated December 19, 1997, between C-Phone Corporation and each purchaser party thereto(4) 22 10.8 (a) Private Equity Credit Agreement, dated as of September 18, 1998, between C-Phone Corporation and Sovereign Partners, L.P.(6) (b) Registration Rights Agreement, dated as of September 18, 1998, between C-Phone Corporation and Sovereign Partners, L.P.(6) 11. Statement re computation of per share earnings - Not required since this computation can be clearly determined from the material contained in this report on Form 10-KSB. 13. Annual report to security holders for the last fiscal year, Form 10-Q or 10-QSB or quarterly report to security holders, if incorporated by reference in the filing - Not applicable. 16. Letter on change in certifying accountant - Not applicable. 18. Letter on change in accounting principles - Not applicable. 21. Subsidiaries of the small business issuer - None. 22. Published report regarding matters submitted to vote of security holders - Not applicable. 23. Consent of experts and counsel 23.1 Consent of PricewaterhouseCoopers LLP 24. Power of attorney - Not applicable. 27. Financial Data Schedule 28. Information from reports furnished to state regulatory authorities - Not applicable. 99. Additional Exhibits - Not applicable. - -------------------- (1) Incorporated by reference to an Exhibit filed as part of our Registration Statement on Form S-1 (the "S-1 Registration Statement") (Registration No. 33-80280), filed on June 14, 1994. (2) Incorporated by reference to an Exhibit filed as part of our Quarterly Report on Form 10-QSB for the fiscal quarter ended August 30, 1996. (3) Incorporated by reference to an Exhibit filed as part of our Quarterly Report on Form 10-QSB for the fiscal quarter ended August 30, 1997. (4) Incorporated by reference to an Exhibit filed as part of our Current Report on Form 8-K, dated December 31, 1997. (5) Incorporated by reference to an Exhibit filed as part of Amendment No. 2 to our Registration Statement on Form S-1 (Registration No. 33-80280), filed on August 11, 1994. (6) Incorporated by reference to an Exhibit filed as part of our Current Report on Form 8-K, dated September 24, 1998. (7) Incorporated by reference to an Exhibit filed as part of our Annual Report on Form 10-KSB for the fiscal year ended February 29, 1996. 23 (8) Incorporated by reference to an Exhibit filed as part of Amendment No. 1 to our Registration Statement on Form S-1 (Registration No. 33-80280), filed on July 21, 1994. (b) Reports on Form 8-K. We did not file a Current Report on Form 8-K during the quarter ended February 28, 1999. 24 SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Dated: May 26, 1999 C-PHONE CORPORATION By: /s/ DANIEL P. FLOHR ---------------------------------------------------- Daniel P. Flohr, President and Chief Executive Officer In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated: Dated: May 26, 1999 /s/ DANIEL P. FLOHR ---------------------------------------------------- Daniel P. Flohr President, Chief Executive Officer and Director (Principal Executive Officer) May 26, 1999 /s/ TINA L. JACOBS ---------------------------------------------------- Tina L. Jacobs Director May 26, 1999 /s/ SEYMOUR L. GARTENBERG ---------------------------------------------------- Seymour L. Gartenberg Director May 26, 1999 /s/ E. HENRY MIZE ---------------------------------------------------- E. Henry Mize Director May 26, 1999 /s/ DONALD S. MCCOY ---------------------------------------------------- Donald S. McCoy Director May 26, 1999 /s/ STUART E. ROSS ---------------------------------------------------- Stuart E. Ross Director May 26, 1999 /s/ PAUL H. ALBRITTON ---------------------------------------------------- Paul H. Albritton Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) 25 EXHIBIT INDEX 10.1(c) Addendum, dated as of May 1, 1999, to Indenture of Lease, between C-Phone Corporation and Daniel Flohr and Tina Jacobs 10.9 Employment Agreement, dated as of September 15, 1998, between C-Phone Corporation and James Jarvis 10.10 Employment Agreement, dated as of December 3, 1998, between C-Phone Corporation and Stuart Ross 23.1 Consent of PricewaterhouseCoopers LLP 27 Financial Data Schedule 26 EX-10.1(C) 2 EXHIBIT 10.1(C) Exhibit 10.1(c) ADDENDUM TO INDENTURE OF LEASE THIS ADDENDUM TO INDENTURE OF LEASE is made as of the 1st day of May, 1999, between DANIEL FLOHR and TINA JACOBS (collectively "Landlord") and C-PHONE CORPORATION (formerly Target Technologies, Inc.) ("Tenant"). RECITALS A. Landlord and Tenant entered into an Indenture of Lease as of May 1, 1993, pertaining to certain real estate and improvements thereon located at 6714 Netherlands Drive, Wilmington, North Carolina ("Lease"). B. The Lease was extended for an additional three years ("First Renewal Term") in accordance with the terms of the Lease by written addendum executed by Landlord and Tenant and effective as of May 1, 1996. B. The First Renewal Term of the Lease was for three years ending April 30, 1999 with the right of Tenant to renew for an additional three year period subject to certain provisions contained in the Lease. C. Tenant desires to exercise its Second Renewal Option as defined in the Lease and Landlord and Tenant have agreed to new terms for the net rent. D. Capitalized terms used herein but not otherwise defined herein shall have the meanings assigned to such terms in the Lease. AGREEMENTS 1. Landlord hereby waives the written notice of exercise by Tenant of the Second Renewal Option as set forth in Section 23.02 of the Lease. 2. Landlord and Tenant agree that the annual net rent for the Second Renewal Term shall be the same as for the First Renewal Term in the amount of $75,360.00 payable in monthly payments of $6,280.00; provided, however, Landlord shall have the option to adjust the Net Rent effective May 1, 2000, to the Fair Market Rent for the balance of the Second Renewal Term. For the purposes of determining the Fair Market Rent, the terms and provisions of Section 23.04(b) of the Lease shall apply with the exception that Landlord shall give Tenant a Rent Notice setting forth Landlord's Determination of the Fair Market Rent no later than January 31, 2000. 3. All other terms and conditions of the Lease shall remain unmodified and in full force and effect. IN WITNESS WHEREOF, Landlord and Tenant have duly executed this instrument as of the day and year first above written. LANDLORD: TENANT: /s/ DANIEL P. FLOHR C-Phone Corporation - ------------------- Daniel Flohr By: /s/ PAUL ALBRITTOM ------------------------------------ /s/ TINA JACOBS Paul Albritton, Vice President & - ------------------- Chief Financial Officer Tina Jacobs EX-10.9 3 EXHIBIT 10.9 Exhibit 10.9 EMPLOYMENT AGREEMENT AGREEMENT, dated as of September 15, 1998, between C-PHONE CORPORATION, a New York corporation having its executive office at 6714 Netherlands Drive, Wilmington, North Carolina 28405 (the "Company"), and JAMES A. JARVIS residing at 121 Bayview Avenue, Belvedere, California 94920 (the "Employee"). The Company desires to employ the Employee on the terms and conditions set forth herein, and the Employee desires to accept such employment. In consideration of the undertakings set forth in this Agreement, and intending to be legally bound, the parties agree as follows: 1. General Agreement for Services. The Company employs the Employee and the Employee accepts employment, upon the terms and conditions of this Agreement. 2. Term of Employment. This Agreement and the employment of Employee by the Company shall commence on September 18, 1998 and shall continue until terminated by either party as provided in Section 6. 3. Duties. (a) The Employee shall devote all his attention and energies to the business of the Company and its affiliates, if any, on a full-time basis, and shall not, during the term of this Agreement, be engaged in any other business activity, whether or not such business activity is pursued for gain, profit or other pecuniary advantage; but this shall not be construed as preventing the Employee from investing the Employee's assets in such manner as will not require the Employee to expend any time or effort in regard thereto or to perform any services in connection therewith. The Company understands and accepts that Employee is involved with and will be required to address family business matters from time to time, including family real estate and agricultural interests. Such business matters are specifically excepted from this section, provided, however, that the involvement in these matters do not interfere or negatively impact the ability of Employee to fulfill his obligations and duties to the Company. (b) The Employee shall serve the Company and its affiliates faithfully, diligently and in good faith. (c) The Employee shall perform such services as may be required of the Employee by the Company and its affiliates, under and subject to the instructions, directions and control of the Board of Directors and the senior executives of the Company, including without limitation the Company's president, chief executive officer and chief operating officer. The Employee shall serve initially as the Vice President of Sales & Marketing of the Company. The Employee's primary responsibility shall be to perform those duties reasonably required of, and related to, the Employee's position and such other duties as may be assigned to the Employee from time to time which are not inconsistent with those customarily assigned to senior employees of the Company. If the Employee is elected as a director of the Company or is promoted to a more senior position within the Company, during the term of this Agreement, the Employee shall serve in such capacities without further remuneration, except as otherwise agreed upon by the Employer and Employee. (d) At all times during the term of this Agreement, the Employee shall adhere to all rules and regulations that have been or that hereafter may be established by the Company for the conduct of its employees. (e) The Employee shall be based at the Company's principal executive office. Travel and temporary work assignments at other locations may be required, but shall be of a kind and frequency common for the Employee's position or shall result from periodic assignment to tasks appropriate for the Employee. (f) The Employee affirms that the Employee, to the best of his knowledge, is in good health, with no chronic or recurring illness, and is insurable at normal rates. If requested by the Company, the Employee shall cooperate in applying for and obtaining, at the Company's expense, key-man insurance for the benefit of the Company. 4. Compensation. As and for full and complete compensation to the Employee for the services the Employee agrees to render pursuant hereto, the Company agrees to pay to the Employee and the Employee agrees to accept the following: (a) The Company shall pay the Employee during the term of this Agreement a salary at the annual rate of $150,000 (the "Base Salary") payable in equal bi-weekly installments, or as otherwise may be the practice of the Company in making salary payments. (b) The Employee shall be granted stock options to purchase shares of the Company's stock under the Company's 1994 Stock Option Plan as set forth on Schedule A - Employee Stock Options (which schedule is hereby made a part of this Agreement). (c) The Employee shall be entitled to receive cash bonus in such amounts and based upon such criteria as shall be determined in good faith by the Compensation Committee of the Board of Directors of the Company in consultation with the Employee. Said criteria shall be determined and set forth as soon as possible and in any event no later than 120 days from Employee's commencement of employment. (d) In consideration for the Employee's relocation to the Wilmington area, the Employee shall receive a non-accountable relocation expense payment as set forth on Schedule B - Relocation Package (which schedule is hereby made a part of this Agreement). -2- (e) The Company, in its sole and absolute discretion, at any time and from time to time, may increase the Base Salary to be paid to the Employee, either permanently or for a limited period, or pay to the Employee such additional bonus compensation as the Company may determine in its sole discretion. (f) All compensation paid to the Employee shall be subject to withholding and deductions to the extent required by applicable law. (g) The Employee shall be eligible to participate in and to be covered by each life insurance, accident insurance, health insurance and hospitalization, or other plan or benefit, if any, effective generally (and not only with respect to a specific individual or individuals) with respect to employees of the Company, if the Employee shall be eligible under the terms of such plan, without restriction or limitation by reason of this Agreement. Nothing contained herein, however, shall be construed to require the Company to establish any plans not in existence on the date hereof, to continue any plans in existence on the date hereof, or to prevent the Company from modifying and/or terminating any of the plans in existence on the date hereof, and no such act or omission shall be deemed to affect this Agreement or any of the provisions contained herein. (h) The Employee shall be entitled to a vacation of two weeks with full compensation for each full year of this Agreement. The Employee also shall be entitled to all paid holidays given by the Company to its senior employees. Vacation days not taken shall not accumulate and shall not be available to the Employee in subsequent years of this Agreement, unless the Employee is restricted from taking any planned vacation at the written request of the Company or as otherwise agreed upon from time to time. Vacations shall be coordinated with the president, chief executive officer or chief operating officer of the Company, shall be scheduled by the Employee with due regard to the Employee's activities and responsibilities for the Company and shall not be for a continuous period of more than two weeks. (i) The Employee shall be entitled to reimbursement for all reasonable out-of-pocket expenses incurred in performing the Employee's services hereunder, within the limits of authority which may be established by the Company from time to time, provided that the Employee properly accounts for such expenses in accordance with the Company policy. 5. Confidentiality; Non-Competition. (a) The Employee shall treat as confidential any proprietary, confidential or non-public information relating to the business or interests of the Company or any affiliate of the Company, including, without limitation, business plans or technical projects of the Company or any affiliate, and any research datum or result, invention, customer list, process or other work product developed by or for the Company or any affiliate, whether on the premises of the Company or elsewhere ("Confidential Information"). The Employee shall not disclose, utilize or make accessible in any manner or in any form any Confidential Information other than in connection with performing the services -3- required of the Employee under this Agreement, without the prior consent of the Company. Notwithstanding the foregoing, the provisions of this Section 5(a) shall not apply to any Confidential Information which is, or at some later date becomes, publicly known under circumstances not involving a breach of any confidentiality agreement with the Company or which is required to be disclosed pursuant to order or requirement of a court, administrative agency or other governmental body, provided that the Company has been given appropriate notice of such proceeding and an opportunity to contest such disclosure. (b) All business and technical records, information relating to the business of the Company and its affiliates, papers, documents, correspondence, or studies containing information relating to the Company and its affiliates, in all cases irrespective of the manner in which such information is kept or stored ("business records"), made or kept by the Employee or under the Employee's possession or control shall be and remain the property of the Company, and shall be surrendered to the Company upon the termination of the Employee's employment. Upon such termination, the Employee shall not take with him, publish, or disclose, or otherwise use, without the consent of the president or chief executive officer of the Company, any business records. (c) The Employee agrees that, during the period of the Employee's employment with the Company or any affiliate thereof and for a period of two years following the date upon which such employment shall terminate, the Employee shall not, in any capacity, compete or attempt to compete with the business of the Company; and the Employee acknowledges that a portion of the payments being made to the Employee hereunder are being made, in part, as consideration for such noncompetition agreement. The Employee represents and agrees that, in the event of the termination of the Employee's employment with the Company or any affiliate thereof, the Employee's experiences and capabilities are such that the Employee can obtain employment in a non-competing business, and that the enforcement of a remedy by way of injunction will not prevent the Employee from earning a livelihood. The Employee further represents and agrees that the covenants contained in this Section 5(c) are necessary for the protection of the Company's legitimate business interests and are reasonable in scope and content. (d) The provisions of this Section 5 on the part of the Employee shall be construed as an agreement independent of any other provision contained in this Agreement and shall be enforceable in both law and equity, including by temporary or permanent restraining order, notwithstanding the existence of any claim or cause of action of the Employee against the Company or any affiliate of the Company, whether predicated on this Section 5 or otherwise. (e) The Employee agrees that all processes, technologies and inventions, including new contributions, improvements, ideas or discoveries, whether patentable or not, conceived, developed, invented or made by or under the supervision of the Employee (collectively, "Inventions" ) during the period of the Employee's employment by the Company, shall belong to the Company, provided that the Inventions grow out of the Employee's work with the Company or are related in any manner to any business (commercial or experimental) of the Company. The Employee agrees that the Employee shall promptly (i) disclose all Inventions to the Company, (ii) assign to the Company, without additional compensation, all patents and other rights to all Inventions for the United -4- States and all foreign countries, (iii) sign all papers necessary to carry out the above, and (iv) give testimony (but without expense to the Employee) in support of the Employee's inventorship. In the event that any Invention is described in a patent application or is disclosed to third parties by the Employee, directly or indirectly, within one year after leaving the employ of the Company, it is to be presumed that the Invention was conceived or made during the period of the Employee's employment by the Company. The Employee agrees that the Company shall be entitled to shop rights with respect to any Invention conceived or made by the Employee during the period of the Employee's employment by the Company that is not related in any manner to any business (commercial or experimental) of the Company but which was conceived or made on the Company's time or with the use of the Company's facilities or materials. Attached as an exhibit to this Agreement is a complete list of the Inventions, patented or unpatented (including a brief description thereof), if any, which the Employee conceived or made prior to the Employee's employment by the Company, and which the Employee desires to exclude from this Agreement. There is no other contract to assign Inventions that is now in existence between the Employee and any other person, firm or corporation, unless indicated on the exhibit, if any, attached to this Agreement, and unless a copy of any such other contract is attached to such exhibit. 6. Termination. (a) General. The Employee reaffirms that he is considered to be employed by the Company "at will", which means that the Employee has the right to terminate his employment with the Company whenever the Employee so chooses, for any reason or for no reason; and that the Company has reserved to itself the same right to terminate the Employee; provided, however, that the Employee shall give the Company at least 30 days' prior notice of his intention to terminate his employment; and provided further, that the Company upon receipt of such notice of termination may elect to change the effective date of such termination to such earlier date as it shall, in its sole discretion, determine (which change in the effective date shall not be deemed to be a termination of Employee's employment by the Company). -5- (b) Termination Without Good Cause. (i) Irrespective of the provisions set out in section 6 (a) above In the event that the Company terminates the Employee without good cause, the Company shall then make the following payments to the Employee, in addition to any termination payments then required to be made by applicable law to an employee who was employed on an "at will" basis: (A) (1) If the Employee is terminated on or before November 13, 1998, the Company shall pay the Employee the sum of $5,000, (2) if the Employee is terminated on or after November 14, 1998 and on or before January 12, 1999, the Company shall pay the Employee the sum of $10,000, (3) if the Employee is terminated on or after January 13, 1999 and on or before March 13, 1999, the Company shall pay the Employee the sum of $15,000, and (4) if the Employee is terminated on or after March 14, 1999, the Company shall pay the Employee the sum of $25,000. (B) If the Employee is terminated within 60 days following a change in control of the Company (as such term is used in Section 6.3 of the Company's 1994 Stock Option Plan, as currently in effect), the Company shall pay the Employee, in lieu of and not in addition to any payment required by clause (A) above, the sum of $25,000. (ii) The Employee agrees that good cause for the Employee's termination shall include (A) the Employee's (1) willful refusal to accept duties and responsibilities which are lawfully assigned by the Board of Directors or the president, chief executive officer or chief operating officer of the Company, which assignments are consistent with the Employee's status with the Company, or (2) willful refusal, failure or physical inability to perform all or a material part of the Employee's assigned duties or responsibilities, which refusal, failure or physical inability, whether under subclause (1) or subclause (2) of this clause (A), is not remedied promptly, but in no event later than, five days after notice thereof is provided to the Employee, (B) the Employee's commission of an act of fraud, misappropriation or dishonesty (including a meaningful falsification of information (such as with respect to the Employee's prior experience or ability, among other things) given to the Company by Employee in connection with the Employee's hire) to the Company or any of its affiliates or falsification of a written document delivered to the Company or any of its affiliates or on the Company's or such affiliate's behalf, (C) the Employee's commission of a crime with respect to which, in the reasonable judgment of the Company, the Employee is likely to be incarcerated or as a result of which the Company, in its reasonable judgment, determines it would be inappropriate for the Employee to continue as an employee of the Company, and (D) notice by the Employee of his intention to breach any of the terms or conditions of this Agreement. 7. Indemnity of Employee for Good Faith Acts and Omissions. The Company agrees to indemnify, defend and hold the Employee harmless of and from any liability, loss, expense, claim, cost, or other damage whatsoever arising out of or in connection with any act or omission of the Employee, taken or omitted in good faith in any capacity in which the Employee is acting for, or at the request of, the Company, to the extent permitted by applicable law. The Company presently maintains a Director and Officers Liability Policy covering corporate officers. Employee shall be entitled to review a copy of any such policy or policies which are in place from time to time. -6- 8. Miscellaneous Provisions. (a) Entire Agreement. This Agreement sets forth the entire agreement and understanding between the parties with respect to the employment of the Employee by the Company and supersedes all prior agreements, arrangements and understandings between the parties with respect thereto. (b) Modification. This Agreement may be amended, modified, superseded, canceled, renewed or extended, and the terms or covenants hereof may be waived, only by an instrument executed by the party to be charged, or in the case of a waiver, by the party waiving compliance. (c) Waiver. The failure of either party at any time or times to require performance of any provision of this Agreement in no manner shall affect the right at a later time to enforce the same. No waiver by either party of a breach of any term or covenant contained in this Agreement, whether by conduct or otherwise, in any one or more instances, shall be deemed to be or construed as a further or continuing waiver of any such breach, or a waiver of any other term or covenant contained in this Agreement. (d) Notices. All notices, demands, consents, waivers and other communications ("Communications") given under this Agreement shall be in writing and shall be given (and shall be deemed to have been duly given) upon the earlier of actual receipt, one business day after being sent by telegram or telecopier or three business days after being sent by registered or certified mail to the parties at the addresses set forth above or to such other address as either party may hereafter specify by notice to the other party. Simultaneously with sending a Communication to the Company, a copy of the Communication shall be sent to Warshaw Burstein Cohen Schlesinger & Kuh, LLP, 555 Fifth Avenue, New York, New York 10017, Attention: Arthur A. Katz, Esq. Irrespective of the foregoing, notice of change of address shall be effective only upon receipt. (e) Governing Law. This Agreement and any supplemental agreements hereto shall be construed in accordance with and governed by the laws of the State of North Carolina applicable to contracts made and to be performed wholly within such state and the courts of said state, including the federal courts therein, shall have sole and exclusive jurisdiction of the parties and of the subject matter of their respective agreements. Venue for any legal action shall be in New Hanover County, North Carolina and in any legal action between the parties, service of process may be accomplished by certified mail. (f) Attorneys' Fees and Disbursements. In the event that either party takes legal action to enforce any of the provisions of this Agreement, the prevailing party shall be entitled to recover all reasonable expenses incurred in connection therewith. -7- (g) Assignability. This Agreement, and the Employee's rights and obligations hereunder, may not be assigned by the Employee. The Company may assign its rights, together with its obligations hereunder, to a successor by merger or to a purchaser of substantially all of its assets, and such rights and obligations shall inure to, and be binding upon, any such successor. (h) Binding Effect. This Agreement shall be binding upon and inure to the benefit of the parties and their respective legal representatives, heirs, successors and permitted assigns. (i) Invalidity. The invalidity of any part of this Agreement is not intended to render invalid the remainder of this Agreement. If any provision of this Agreement is so broad as to be unenforceable, such provision is intended to be interpreted to be only so broad as is enforceable. IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement as of the day and year first written above. C-PHONE CORPORATION By: /s/ DANIEL P.FLOHR ------------------------------- Daniel Flohr, President and Chief Executive Officer EMPLOYEE /s/ JAMES A. JARVIS ------------------------------- James A. Jarvis -8- SCHEDULE A Employee Stock Options 1. Options under the Company's 1994 Stock Option Plan (the "Plan") to acquire 50,000 Shares shall be granted as of the date of this Agreement with the option price equal to the Fair Market Value of the Shares on such date (as determined in accordance with the Plan) and expiring five years from the date of grant, which shall be exercisable in accordance with the terms of the Plan as follows: Nonqualified Stock Option to purchase 12,500 Shares, which shall vest 90 days from date of grant; Incentive Stock Option to purchase 12,500 Shares, which shall vest one year from date of grant; Incentive Stock Option to purchase 12,500 Shares, which shall vest two years from date of grant; and Incentive Stock Option to purchase 12,500 Shares, which shall vest three years from date of grant. 2. Options under the Plan to acquire an additional 50,000 Shares shall be granted as of the date of this Agreement with the option price equal to the Fair Market Value of the Shares on such date and expiring five years from the date of grant, which shall be exercisable in accordance with the terms of the Plan as follows: Nonqualified Stock Option to purchase 25,000 Shares, which shall vest on May 31, 2000 if the Company has met the performance goals approved in good faith by the Compensation Committee of the Board of Directors for the fiscal year ending February 29, 2000; and Nonqualified Stock Option to purchase 25,000 Shares, which shall vest on May 31, 2001 if the Company has met the performance goals approved in good faith by the Compensation Committee of the Board of Directors for the fiscal year ending February 28, 2001. 3. In the event that the Employee voluntarily terminates his employment, any Options that have vested and are exercisable on the effective date of his termination will remain exercisable until the expiration of 90 days from such date of termination (but in no event after the expiration date of such Options). In the event that the Company terminates the Employee for good cause, any Options that are -9- exercisable will immediately terminate; and if any of such Options were exercised but the underlying Shares were not yet delivered, such exercises will be rescinded. In the event that the Company terminates the employment of the Employee other than for good cause, any Options that have vested and are exercisable on the effective date of the Employee's termination will remain exercisable until the expiration of such number of days as the Employee was immediately prior thereto continuously employed by the Company but in no event less than 90 days nor more that one year from such date of termination. 4. Any Options intended to be Incentive Stock Options must satisfy Section 422(b) of the Internal Revenue Code of 1986. In the event that any of the provisions thereof are not satisfied, the effected Options shall be deemed to be Nonqualified Stock Options. 5. All capitalized terms used in this Schedule A and not otherwise defined herein shall have the meaning given them in the Plan, as currently in effect. -10- SCHEDULE B Relocation Package Housing Allowance: The Company shall provide the Employee with living accommodations for the Employee and his family or otherwise reimburse the Employee for his cost therefor up to a maximum of $2,000 per month until such time (not to exceed a period of six months) as the Employee has obtained a permanent residence. Moving Expenses: The Company shall advance the Employee the sum of $6,250 against a non-accountable expense allowance in connection with the expenses of moving Employee and his family permanently to the Wilmington, North Carolina area. The actual amount of relocation expense, whether non-accountable or documented, shall be agreed upon and approved in advance by Employer. In the event that the Employee voluntarily terminates his employment prior to his permanent relocation to the Wilmington, North Carolina area, the Employee shall reimburse the Company for the full amount of the advance; which the Company is permitted to deduct from any sums due and owing the employee. If Employer terminates Employee without cause prior to permanent relocation to the Wilmington, North Carolina area, Employer shall reimburse the Employee for reasonable expenses incurred for the return to California of Employee and his family. -11- EX-10.10 4 EXHIBIT 10.10 Exhibit 10.10 EMPLOYMENT AGREEMENT AGREEMENT, dated as of December 3, 1998, between C-PHONE CORPORATION, a New York corporation having its executive office at 6714 Netherlands Drive, Wilmington, North Carolina 28405 (the "Company"), and STUART E. ROSS residing at 6311 Marywood Drive, Wilmington, North Carolina 28409 (the "Employee"). Prior to the date hereof, the Company has been employing the Employee. The Company desires to continue to employ the Employee on the terms and conditions set forth herein, and the Employee desires to accept such employment. In consideration of the undertakings set forth in this Agreement, and intending to be legally bound, the parties agree as follows: 1. General Agreement for Services. The Company employs the Employee and the Employee accepts employment, upon the terms and conditions of this Agreement. 2. Term of Employment. This Agreement and the employment of Employee by the Company under this Agreement shall commence on January 1, 1999. Subject to any provisions of this Agreement governing extension or early termination of this Agreement, the term of employment under this Agreement shall be for two years (the "Initial Term"). After the Initial Term, this Agreement shall continue for successive terms of one year unless terminated be either party giving notice of its or his intention not to renew this Agreement at least 120 days prior to the end of the Initial Term or the renewal term then in effect. 3. Duties. (a) The Employee shall devote all his attention and energies to the business of the Company and its affiliates, if any, on a full-time basis, and shall not, during the term of this Agreement, be engaged in any other business activity, whether or not such business activity is pursued for gain, profit or other pecuniary advantage; but this shall not be construed as preventing the Employee from (i) investing the Employee's assets in such manner as will not require the Employee to expend a material amount of time or effort in regard thereto or otherwise, in any way, impair his ability to fully meet his obligations hereunder, (ii) providing technical services which are a continuation of already incurred obligations of New Potato Technologies, Inc., if the rendering of such services will not, in any way, impair the Employee's ability to fully meet his obligations hereunder, or (iii) engaging in any other activity which does not compete with the business of the Company or a proposed business of the Company, if engaging in such activity does not require the Employee to expend a material amount of time or effort in regard thereto, does not, in any way, impair his ability to fully meet his obligations hereunder, and such action by the Employee has been approved by the Board of Directors of the Company (or the Compensation Committee thereof), which approval shall be reasonably given so long as such action fulfills the foregoing criteria, as determined by the Board (or Committee) in good faith. -1- (b) The Employee shall serve the Company and its affiliates faithfully, diligently and in good faith. (c) The Employee currently serves as Vice President and Director of Engineering and shall perform such services as may be required of the Employee by the Company and its affiliates, under and subject to the instructions, directions and control of the Board of Directors and the senior executives of the Company, including without limitation the Company's president, chief executive officer and chief operating officer. The Employee's primary responsibility shall be to perform those duties reasonably required of, and related to, the Employee's position and such other duties as may be assigned to the Employee from time to time which are not inconsistent with those customarily assigned to senior employees of the Company. The Employee agrees that if he is promoted to a more senior position within the Company, during the term of this Agreement, the Employee shall serve in such position without further remuneration, except as otherwise agreed upon by the Company and Employee. The Employee has been elected as a director of the Company, and may continue to act as such during the term of this Agreement. The Employee's resignation as a director shall not be deemed a breach of this Agreement by the Employee; likewise, the failure of the Company to reelect or appoint the Employee as a director shall not be deemed a breach of this Agreement by the Company. (d) At all times during the term of this Agreement, the Employee shall adhere to all rules and regulations that have been or that hereafter may be established by the Company for the conduct of its employees. (e) The Employee shall be based at the Company's principal executive office. Travel and temporary work assignments at other locations may be required, but shall be of a kind and frequency common for the Employee's position or shall result from periodic assignment to tasks appropriate for the Employee. 4. Compensation. As and for full and complete compensation to the Employee for the services the Employee agrees to render pursuant hereto, the Company agrees to pay to the Employee and the Employee agrees to accept the following: (a) The Company shall pay the Employee during the term of this Agreement a salary at the annual rate of $120,000 (the "Base Salary") payable in equal bi-weekly installments, or as otherwise may be the practice of the Company in making salary payments. (b) The Company, in its sole and absolute discretion, at any time and from time to time, may increase the compensation to be paid to the Employee, either permanently of for a limited time, or pay to Employee such bonus compensation as the Company may determine in its sole discretion. -2- (C) All compensation paid to the Employee shall be subject to withholding and deductions to the extent required by applicable law. (D) The Employee shall be eligible to participate in and to be covered by each life insurance, accident insurance, health insurance and hospitalization, or other plan or benefit, if any, effective generally (and not only with respect to a specific individual or individuals) with respect to employees of the Company, if the Employee shall be eligible under the terms of such plan, without restriction or limitation by reason of this Agreement. Nothing contained herein, however, shall be construed to require the Company to establish any plans not in existence on the date hereof, to continue any plans in existence on the date hereof, or to prevent the Company from modifying and/or terminating any of the plans in existence on the date hereof, and no such act or omission shall be deemed to affect this Agreement or any of the provisions contained herein. (E) The Employee shall be entitled to a vacation of two weeks with full compensation for each full year of this Agreement. The Employee also shall be entitled to all paid holidays given by the Company to its senior employees. Vacation days not taken shall not accumulate and shall not be available to the Employee in subsequent years of this Agreement, unless the Employee is restricted from taking any planned vacation at the written request of the Company or as otherwise agreed upon from time to time. Vacations shall be coordinated with the president, chief executive officer or chief operating officer of the Company, shall be scheduled by the Employee with due regard to the Employee's activities and responsibilities for the Company and shall not be for a continuous period of more than two weeks. (F) The Employee shall be entitled to reimbursement for all reasonable out-of-pocket expenses incurred in performing the Employee's services hereunder, within the limits of authority which may be established by the Company from time to time, provided that the Employee properly accounts for such expenses in accordance with the Company policy. 5. Confidentiality; Non-Competition. (a) The Employee shall treat as confidential any proprietary, confidential or non-public information relating to the business or interests of the Company or any affiliate of the Company, including, without limitation, business plans or technical projects of the Company or any affiliate, and any research datum or result, invention, customer list, process or other work product developed by or for the Company or any affiliate, whether on the premises of the Company or elsewhere ("Confidential Information"). The Employee shall not disclose, utilize or make accessible in any manner or in any form any Confidential Information other than in connection with performing the services required of the Employee under this Agreement, without the prior consent of the Company. Notwithstanding the foregoing, the provisions of this Section 5(a) shall not apply to any Confidential Information which is, or at some later date becomes, publicly known under circumstances not involving a breach of any confidentiality agreement with the Company or which is required to be disclosed pursuant to order or requirement of a court, administrative agency or other governmental body, provided that the Company has been given appropriate notice of such proceeding and an opportunity to contest such disclosure. -3- (b) All business and technical records, information relating to the business of the Company and its affiliates, papers, documents, correspondence, or studies containing information relating to the Company and its affiliates, in all cases irrespective of the manner in which such information is kept or stored ("business records"), made or kept by the Employee or under the Employee's possession or control shall be and remain the property of the Company, and shall be surrendered to the Company upon the termination of the Employee's employment. Upon such termination, the Employee shall not take with him, publish, or disclose, or otherwise use, without the consent of the president or chief executive officer of the Company, any business records. (c) The Employee agrees that, during the period of the Employee's employment with the Company or any affiliate thereof and for a period of ONE year following the date upon which such employment shall terminate, the Employee shall not, in any capacity, compete or attempt to compete with any business of the Company which existed at any time during the Employee's employment with the Company, or which was being developed by the Company; and the Employee acknowledges that a portion of the payments being made to the Employee hereunder are being made, in part, as consideration for such non-competition agreement. The Employee represents and agrees that, in the event of the termination of the Employee's employment with the Company or any affiliate thereof, the Employee's experiences and capabilities are such that the Employee should be able to obtain suitable employment, and that the enforcement of a remedy by way of injunction will not prevent the Employee from earning a livelihood. The Employee further acknowledges that the covenants contained in this Section 5(c) are necessary for the protection of the Company's legitimate business interests and are reasonable in scope and content. (d) The provisions of this Section 5 on the part of the Employee shall be construed as an agreement independent of any other provision contained in this Agreement and shall be enforceable in both law and equity, including by temporary or permanent restraining order, notwithstanding the existence of any claim or cause of action of the Employee against the Company or any affiliate of the Company, whether predicated on this Section 5 or otherwise. (e) The Employee agrees that all processes, technologies and inventions, including new contributions, improvements, ideas or discoveries, whether patentable or not, conceived, developed, invented or made by or under the supervision of the Employee (collectively, "Inventions" ) during the period of the Employee's employment by the Company, shall belong to the Company, provided that the Inventions grow out of the Employee's work with the Company or are related in any manner to any business (commercial or experimental) of the Company. The Employee agrees that the Employee shall promptly (i) disclose all Inventions to the Company, (ii) assign to the Company, without additional compensation, all patents and other rights to all Inventions for the United States and all foreign countries, (iii) sign all papers necessary to carry out the above, and (iv) give testimony (but without expense to the Employee) in support of the Employee's inventorship. In the event that any Invention which grew out of the Employee's work with the Company, or is related in any manner to any business or prospective business of the Company, is described in a patent -4- application or is disclosed to third parties by the Employee, directly or indirectly, within one year after leaving the employ of the Company, it is to be presumed (which presumption the Employee shall have the right to rebut) that the Invention was conceived or made during the period of the Employee's employment by the Company. The Employee agrees that the Company shall be entitled to shop rights with respect to any Invention conceived or made by the Employee during the period of the Employee's employment by the Company that is not related in any manner to any business (commercial or experimental) of the Company but which was conceived or made on the Company's time or with the use of the Company's facilities or materials. Attached as an exhibit to this Agreement is a complete list of the Inventions, patented or unpatented (including a brief description thereof), if any, which the Employee conceived or made prior to the Employee's employment by the Company, and which the Employee desires to exclude from this Agreement. There is no other contract to assign Inventions that is now in existence between the Employee and any other person, firm or corporation, unless indicated on the exhibit, if any, attached to this Agreement, and unless a copy of any such other contract is attached to such exhibit. 6. Termination. (a) Death. In the event that the Employee shall die during the term of this Agreement, then, notwithstanding any other provisions hereof, the Employee's employment herewith shall terminate forthwith. In addition to any unpaid compensation then accrued, the Employee's Estate shall be entitled to receive the proceeds of any life insurance on the Employee's life if and to the extent then maintained by the Company for the Employee's specific benefit. (b) Disability. If the Employee shall become incapacitated during the term of this Agreement to such an extent that he shall be unable to perform his duties hereunder, and such incapacity shall continue for at least six consecutive weeks or for at least 60 days in any twelve month period, the Company may, at or at any time thereafter, and during the continuance of such incapacity, give notice to the Employee of the termination of his employment hereunder on a date stated in such notice, and, in such event, the Employee's employment hereunder shall terminate on such date: provided, however, that such termination shall not affect any disability payments otherwise due hereunder to the Employee. Irrespective of the foregoing, the Employee also may be terminated by the Company at such time as the Employee becomes unable to perform any duties hereunder by reason of disability, as defined in the Employer's disability insurance coverage, if any, if he is then entitled to disability payments under such coverage at a rate at least equal to two-thirds of his then Base Salary. (c) For Cause. If, during the term of this Agreement, the employment of the Employee by the Company shall terminate by reason of the Employee's voluntary action, or by the Company for "Cause", then the Company's obligations for payment or delivery of salary, incentive bonus, if any, and other entitlements under this Agreement with respect to any future period shall thereupon terminate. Written notice of termination for Cause shall be given by the Company to the Employee and shall be effective upon receipt. For purposes of this Agreement, Cause means (i) the Employee's (A) willful refusal to accept duties and responsibilities which are lawfully assigned by the Board of -5- Directors or the president, chief executive officer or chief operating officer of the Company, which assignments are consistent with the Employee's status with the Company, or (B) willful refusal or failure to perform all or a material part of the Employee's assigned duties or responsibilities, which refusal or failure in either case under clause (A) or (B) is not remedied promptly, but in no event later than, fifteen days after notice thereof is provided to the Employee, (ii) the Employee's commission of an act of fraud, misappropriation or dishonesty to the Company or any of its affiliates or falsification of a written document delivered to the Company or any of its affiliates or on the Company's or such affiliate's behalf, (iii) the Employee's commission of a crime with respect to which, in the reasonable judgment of the Company, the Employee is likely to be incarcerated or as a result of which the Company, in its reasonable judgment, determines it would be inappropriate for the Employee to continue as an employee of the Company, and (iv) notice by the Employee of his intention to breach any of the terms or conditions of this Agreement. (b) Without Cause. If, during the term of this Agreement, the employment of the Employee shall be terminated by the Company without Cause, then the Company shall continue to pay the Employee his then base salary for SIX months, on the normal salary dates. The Employee shall have no duty to attempt to mitigate such obligation of the Company, and any compensation earned by the Employee during such period may be retained by the Employee for his own account. In the event of such termination, all other obligations of the Company to the Employee under this Agreement arising and accruing after the state of the Employee's termination shall terminate, except as otherwise specifically provided to the contrary under this Agreement or by applicable law. The Employee shall have the right to elect to terminate this Agreement, and treat such termination as non-voluntary by him and a termination without Cause by the Company, if the Employee does not receive from the Company any compensation or other payment due him (pursuant to this Agreement) within ten days after such compensation or other payment is due; provided, however, that the Company does not remedy such action within fifteen days after notice thereof by the Employee to the Company. 7. Indemnity of Employee for Good Faith Acts and Omissions. The Company agrees to indemnify, defend and hold the Employee harmless of and from any liability, loss, expense, claim, cost, or other damage whatsoever arising out of or in connection with any act or omission of the Employee, taken or omitted in good faith in any capacity in which the Employee is acting for, or at the request of, the Company, to the extent permitted by applicable law. The Company presently maintains a Director and Officers Liability Policy covering corporate officers. Employee shall be entitled to review a copy of any such policy or policies which are in place from time to time. 8. Miscellaneous Provisions. (a) Entire Agreement. This Agreement sets forth the entire agreement and understanding between the parties with respect to the employment of the Employee by the Company and supersedes all prior agreements, arrangements and understandings between the parties with respect thereto. -6- (b) Modification. This Agreement may be amended, modified, superseded, canceled, renewed or extended, and the terms or covenants hereof may be waived, only by an instrument executed by the party to be charged, or in the case of a waiver, by the party waiving compliance. (c) Waiver. The failure of either party at any time or times to require performance of any provision of this Agreement in no manner shall affect the right at a later time to enforce the same. No waiver by either party of a breach of any term or covenant contained in this Agreement, whether by conduct or otherwise, in any one or more instances, shall be deemed to be or construed as a further or continuing waiver of any such breach, or a waiver of any other term or covenant contained in this Agreement. (d) Notices. All notices, demands, consents, waivers and other communications ("Communications") given under this Agreement shall be in writing and shall be given (and shall be deemed to have been duly given) upon the earlier of actual receipt, one business day after being sent by telegram or telecopier or three business days after being sent by registered or certified mail to the parties at the addresses set forth above or to such other address as either party may hereafter specify by notice to the other party. Simultaneously with sending a Communication to the Company, a copy of the Communication shall be sent to Warshaw Burstein Cohen Schlesinger & Kuh, LLP, 555 Fifth Avenue, New York, New York 10017, Attention: Arthur A. Katz, Esq. Irrespective of the foregoing, notice of change of address shall be effective only upon receipt. (e) Governing Law. This Agreement and any supplemental agreements hereto shall be construed in accordance with and governed by the laws of the State of North Carolina applicable to contracts made and to be performed wholly within such state and the courts of said state, including the federal courts therein, shall have sole and exclusive jurisdiction of the parties and of the subject matter of their respective agreements. Venue for any legal action shall be in New Hanover County, North Carolina and in any legal action between the parties, service of process may be accomplished by certified mail. (f) Attorneys' Fees and Disbursements. In the event that either party takes legal action to enforce any of the provisions of this Agreement, the prevailing party shall be entitled to recover all reasonable expenses incurred in connection therewith. (g) Assignability. This Agreement, and the Employee's rights and obligations hereunder, may not be assigned by the Employee. The Company may assign its rights, together with its obligations hereunder, to a successor by merger or to a purchaser of substantially all of its assets, and such rights and obligations shall inure to, and be binding upon, any such successor. (h) Binding Effect. This Agreement shall be binding upon and inure to the benefit of the parties and their respective legal representatives, heirs, successors and permitted assigns. (i) Invalidity. The invalidity of any part of this Agreement is not intended to render invalid the remainder of this Agreement. If any provision of this Agreement is so broad as to be unenforceable, such provision is intended to be interpreted to be only so broad as is enforceable. -7- IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement as of the day and year first written above. C-PHONE CORPORATION By: /s/ DANIEL FLOHR ------------------------------- Daniel Flohr, President and Chief Executive Officer EMPLOYEE /s/ STUART E ROSS ------------------------------- Stuart E. Ross -8- EX-23.1 5 EXHIBIT 23.1 EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANT We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 33-95306) and Form S-3 (No. 333-46309) of C-Phone Corporation of our report dated April 15, 1999, relating to the financial statements, which appears in this Form 10-KSB. RALEIGH, NORTH CAROLINA MAY 27, 1999 EX-27 6 FDS
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE REGISTRANT'S BALANCE SHEET AS OF FEBRUARY 28, 1999 AND THE STATEMENTS OF OPERATION AND STATEMENTS OF CASH FLOW FOR THE YEAR THEN ENDED AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO THESE FINANCIAL STATEMENTS. 0000835585 C-Phone Corporation 1 USD YEAR FEB-28-1999 MAR-01-1998 FEB-28-1999 1 4,602,752 0 287,064 (181,347) 1,177,522 6,004,885 954,430 (841,823) 6,253,994 699,372 0 0 0 79,786 5,474,836 6,253,994 1,590,748 1,621,196 2,541,145 2,550,895 0 (165,760) 0 (4,478,725) 0 (4,478,725) 0 0 0 (4,478,725) (0.63) (0.63)
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