U.S. 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 December 31, 1997
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____ to _____
COMMISSION FILE NUMBER 0-23503
INNOVACOM, INC.
(Exact name of registrant as specified in its charter)
NEVADA 367 88-0308568
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code) Identification No.)
3400 Garrett Drive, Santa Clara, California 95054; 408-727-2447
(Address and telephone number of principal executive offices)
Securities registered under Section 12(b) of the Exchange Act:
None
Securities registered under Section 12(g) of the Exchange Act:
TITLE OF EACH CLASS
Common Stock
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934, during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X . No .
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-B is not contained herein, and will not 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. [ ]
Revenues for the year ended December 31, 1997 were $149,000.
As of April 14, 1998, the aggregate market value of the voting common stock
held by non-affiliates was $36,222,518 based on the average bid and ask
price of $2.25 per share.
As of March 31, 1998, the number of shares of common stock outstanding was
20,561,897.
Documents incorporated by reference: None
Transitional Small Business Disclosure Format (check one): Yes . No X .
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WITH THE EXCEPTION OF HISTORICAL FACTS STATED HEREIN, THE FOLLOWING
DISCUSSION MAY CONTAIN FORWARD-LOOKING STATEMENTS REGARDING EVENTS AND
FINANCIAL TRENDS WHICH MAY AFFECT THE COMPANY'S FUTURE OPERATING RESULTS AND
FINANCIAL POSITION. SUCH STATEMENTS ARE SUBJECT TO RISKS AND UNCERTAINTIES
THAT COULD CAUSE THE COMPANY'S ACTUAL RESULTS AND FINANCIAL POSITION TO DIFFER
MATERIALLY FROM THOSE ANTICIPATED IN SUCH FORWARD-LOOKING STATEMENTS. FACTORS
THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY INCLUDE, IN ADDITION TO
OTHER FACTORS IDENTIFIED IN THIS REPORT, THE COMPANY'S OPERATING LOSSES, NEED
FOR ADDITIONAL CAPITAL, DEPENDENCE ON THE DEVELOPMENT OF ITS SINGLE CHIP
PRODUCT, ITS ABILITY TO DEVELOP NEW PRODUCTS, THE SECURITY INTEREST IN ALL OF
THE COMPANY'S ASSETS, AND DEPENDENCE ON KEY PERSONNEL, ALL OF WHICH FACTORS ARE
SET FORTH IN MORE DETAIL IN THE SECTIONS ENTITLED "CERTAIN CONSIDERATIONS" AND
"MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION" HEREIN. READERS OF
THIS REPORT ARE CAUTIONED NOT TO PUT UNDUE RELIANCE ON "FORWARD LOOKING"
STATEMENTS WHICH ARE, BY THEIR NATURE, UNCERTAIN AS RELIABLE INDICATORS OF
FUTURE PERFORMANCE. THE COMPANY DISCLAIMS ANY INTENT OR OBLIGATION TO PUBLICLY
UPDATE THESE "FORWARD LOOKING" STATEMENTS, WHETHER AS A RESULT OF NEW
INFORMATION, FUTURE EVENTS, OR OTHERWISE.
PART I.
ITEM 1. DESCRIPTION OF BUSINESS
BUSINESS
CORPORATE INFORMATION
The Company was originally incorporated in Florida in March of 1993 as a
research and development company and was essentially dormant until 1996. In
March of 1996, the Company began to emphasize the development of broadcast
quality encoded video utilizing the Motion Picture Experts Group ("MPEG")
second generation standard for video and audio compression ("MPEG-2") and
obtained a license from FutureTel, Inc to utilize portions of its development
of a video compression chip and related MPEG-2 technology, termed the "Gecko"
technology. From 1993 until 1995, Mr. Mark C. Koz, the Company's founder and
Chairman, was also a shareholder in and an officer and director of FutureTel
and assisted in the development of the Gecko technology. Mr. Koz terminated
his relationship as an officer, director and shareholder of FutureTel and, in
connection with his departure, FutureTel licensed the Gecko technology to the
Company in exchange for royalties, for a period of seven years and not to
exceed $3 million, based on sales of video compression chips utilizing or
derived from the Gecko technology. The Company has applied certain aspects of
the Gecko technology in its development of its single chip video encoder, the
DVImpact Chip.
In July 1996, the Company merged with Jettson Realty Development
Corporation, a Nevada corporation ("Jettson"). The merger took the form of a
share for share exchange, in which all of the shares of the Company were
exchanged for approximately 52% of Jettson. The merger was accounted for under
the reverse take-over method of accounting. Thereafter, the name of Jettson
was changed to "InnovaCom, Inc." The Company's Common Stock currently trades
on the OTC Bulletin Board under the symbol "MPEG." The merger between the
Company and Jettson is currently the subject of litigation. See "Legal
Proceedings."
In May 1997, the Company acquired Sierra Vista Entertainment, Inc., a
Nevada corporation ("Sierra Vista") in a share for share exchange by issuing
8,514,500 shares of its Common Stock to Sierra Vista shareholders. Sierra
Vista is a motion picture production company and as a result of the
acquisition, the Company gained access to approximately $3 million of working
capital and a credit facility of up to $5 million.
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The Company is developing digital video compression and processing
technology to provide broadcast quality video encoding and processing products
and systems utilizing the MPEG-2 standard. The Company's development includes
single chips, multiple chips, circuit boards, software, and complete digital
video compression and processing systems. The Company is currently developing
digital video compression and processing technology using existing third party
three chip compression hardware. The Company intends to replace this three
chip hardware with its own single chip video encoder, the DVImpact Chip, during
1998.
CERTAIN CONSIDERATIONS
In addition to the other information presented in the Annual Report, the
Company and its business are subject to certain factors as discussed as
follows.
LIMITED OPERATING HISTORY. Since its inception, the Company has generated
nominal revenues. Its primary activities to date have been the research and
development of MPEG-2 products for digital video compression and processing
technology. The Company's success is dependent upon the development and
marketing of its proposed products, as to which there can be no assurance.
Unanticipated problems, expenses and delays are frequently encountered in
developing new products. Other factors that may affect the development of
products and their sales include, but are not limited to, new or competing
products developed by competitors, the need to develop customer support
capabilities and market expertise, delays in product development, market
acceptance, and the success or failure of sales and marketing activities. The
Company has no experience in bringing products to market in any substantial
manner and the failure of the Company to meet any of the conditions discussed
above could have a materially adverse effect upon the Company's operations. No
assurances can be given that the Company can or will ever be profitable.
OPERATING LOSSES. Since its inception, the Company has incurred losses.
For the years ended December 31, 1997 and 1996, the Company incurred net losses
of $10,822,980 and $8,193,395 and had an accumulated deficit of $19,018,775
since inception. The Company expects to continue to incur losses and to
continue to accumulate a deficit for at least the first two quarters of 1998
and until the Company completely develops and markets its products and gains
significant market acceptance. No assurances can be given that the Company
will achieve profitability.
QUALIFIED OPINION. The report of the Company's independent accountants
contains an explanatory paragraph regarding the Company's ability to continue
as a going concern. Among the factors cited by the accountants as raising
substantial doubt as to the Company's ability to continue as a going concern
include the fact that the Company has no established source of operating
income and that it has recurring losses from operations.
NEED FOR ADDITIONAL CAPITAL AND DILUTION. Development of new products
require substantial capital. The Company's future capital requirements will
depend on many factors, including cash flow from operations, progress in
developing new products, competing technological and market developments, and
the Company's ability to successfully market its products. Because the Company
currently does not have significant revenues, and will not have revenues until
it begins to market its products, the Company will be required to raise
additional capital through equity or debt financings for its operations. Any
equity financings could result in dilution to the Company's then-existing
stockholders. Sources of debt financing will result in interest expense. If
the Company is unable to raise additional funds, the Company may be required to
reduce its operations.
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LITIGATION INVOLVING THE COMPANY The Company and its officers and
directors are involved in a number of legal proceedings. Such litigation
includes an action by the Company against former directors and officers of the
Company and alleged financial consultants to the Company for, among other
things, breach of fiduciary duty, fraud, breach of contract and RICO. Three
of these defendants have filed cross-complaints against the Company and its
officers and directors. Further, a former employee of the Company has filed an
action for breach of contract, and an alleged creditor of the Company has filed
an action for the repayment of monies. As a result of litigation, the Company
will have to spend a substantial amount of time and fees in prosecuting and
defending itself in these matters.
SECURITY INTEREST IN THE COMPANY'S ASSETS. The Company has entered into a
$5 million Credit Facility and Note which expires on June 30, 1998. As of
March 31, 1998, the amount of principal and interest outstanding under the
Credit Facility and Note was $4,181,422. The outstanding principal and
interest is secured by all of the assets of the Company. Therefore, in the
event the Company is unable to repay the Credit Facility, the holder will hold
a first-priority security interest in the Company's assets upon default. The
holder of the Note has indicated that it intends to convert the Note into
shares of Common Stock. However, no assurance can be given that the holder
will convert the Note. If the holder does not convert the Note, the Company
will be required to request the holder to extend the Note or seek some other
source to repay the Note. No assurances can be made that the Company will be
able to repay all amounts due under the Credit Facility and Note when required
or that a default will not occur prior to repayment.
COMPETITION. The digital video and audio industry is marked by numerous
small as well as large competitors. Some of the Company's competitors include
C-Cube Microsystems, Inc., IBM and LSI Logic, Inc. Additionally, the Company
competes in an industry segment in which numerous competitors have
substantially greater resources than the Company. The Company believes other
single chip encoder products may enter the market prior to the Company's
proposed single chip encoder. No assurances can be given that existing or
potential competitors of the Company will not develop products equal to or
better than those developed by the Company or that such products will not
receive greater market acceptance.
DEPENDENCE ON INDEPENDENT MANUFACTURERS/SUBCONTRACTORS AND SUPPLIERS OF
COMPONENTS. The Company does not maintain its own manufacturing or production
facilities, and does not intend to do so in the foreseeable future. The
Company anticipates that its products will be manufactured and its components
will be supplied by independent companies. Many of these independent companies
may also manufacture and supply products for the Company's existing and
potential competitors. The Company does not have any licensing or other supply
agreements with its manufacturers and suppliers. Therefore, the Company's
suppliers could terminate their relationship with the Company at any time. In
the event the Company were to have difficulties with its manufacturers and
suppliers, the Company could experience delays in supplying products to its
customers.
UNCERTAINTY OF MARKET ACCEPTANCE. To date, the Company has had minimal
sales of its products. The Company's success will depend upon acceptance of
its products by the technology industry, including independent third party
companies and the general public. Achieving such acceptance will require
significant marketing investment. No assurances can be given that the
technology industry will accept the Company's existing and proposed products
or, if accepted, the level of acceptance.
DEPENDENCE ON TECHNOLOGY INDUSTRIES AND TECHNOLOGICAL OBSOLESCENCE. The
digital video and audio industry is characterized by extensive research and
development and rapid technological changes, resulting in very short product
life cycles. Further, the video and audio industry is characterized by intense
competition among various technologies and their respective proponents.
Development of new or improved products, processes or technologies may render
the Company's products obsolete or less competitive. The Company will be
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required to devote substantial efforts and financial resources to enhance its
existing products and to develop new products. No assurances can be given that
competing products or new products or technology will not be developed
rendering the Company's products and technology obsolete.
DEPENDENCE ON MPEG-2 ACCEPTANCE AND CONTINUATION AS STANDARD. The Company
has focused much of its resources on the MPEG-2 technology and the success of
that standard will dramatically impact the Company's success. No assurances
can be given that the MPEG-2 standard will remain in favor in the industry.
Furthermore, should the standard be modified or replaced, no assurances can be
given that the Company's research and development work will successfully
transfer to an alternative standard.
RELIANCE ON OEM CUSTOMERS AND RETAIL DISTRIBUTORS. The Company's success
will depend to a significant extent upon its ability to develop a distribution
system with original equipment manufacturers ("OEMs") and retail distributors
to distribute and sell the Company's products in the marketplace. No
assurances can be given that the Company will be successful in obtaining and
retaining the OEM customers and retail distributors it requires to continue to
grow and expand its marketing and sales efforts.
PROTECTION OF INTELLECTUAL PROPERTY. The Company currently does not hold
any patents. The Company has a non-exclusive worldwide license from FutureTel
to manufacture, use, sell and otherwise deal with the Gecko video compression
technology. If the Company completes its acquisition of Intelligent
Instruments Corporation, it may become the holder of a patent for a proprietary
set-top box design and a pending patent for a proprietary server design. See
"Business - Intelligent Instruments Corporation." The Company currently holds
certain trademarks on the Company's name and the names of certain products.
No assurances can be given that another company will not attempt to
infringe upon any current or future licenses, patents, patent applications,
trademarks, or copyrights of the Company or its products and technology or that
the Company may not inadvertently infringe upon any current or future licenses,
patents, patent applications, trademarks, or copyrights of another company or
its products and technology. Such infringement could result in protracted and
costly litigation and sales losses. Further, no assurances can be given that
others will not independently develop products or technology that are
equivalent or superior to those of the Company or that such products will not
utilize the same or similar technology developed by the Company, whether
protected or unprotected by a license or patent.
CONCENTRATION OF STOCK OWNERSHIP. As of March 31, 1998, the present
directors, executive officers, and stockholders owning more than 5% of the
outstanding Common Stock and their respective affiliates will beneficially own
approximately 28.97% of the outstanding Common Stock of the Company. As a
result of their ownership, the directors, executive officers, and more than 5%
stockholders and their respective affiliates collectively will have substantial
control of all matters requiring stockholder approval, including the election
of directors and approval of significant corporate transactions. Such
concentration of ownership may also have the effect of delaying or preventing a
change in control of the Company.
POSSIBLE DILUTION FROM DEBENTURES, WARRANTS, AND A NOTE. As of March 31,
1998, there are Debentures, Warrants, Additional Warrants and a Note
outstanding to purchase up to an aggregate of 8,104,262 shares of Common Stock,
including up to 5,111,904 shares underlying the Debentures, 500,000 shares
underlying the Warrants, 250,000 shares underlying Additional Warrants and
2,242,358 shares underlying the Note. Depending on the current market price
per share of Common Stock, holders of the Debentures, Warrants, Additional
Warrants and Note may be able to purchase shares of Common Stock at a price
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less than the trading price of the Common Stock with a resulting dilution of
the interests to the other stockholders. Because of this potential dilutive
effect, the Debentures, Warrants, Additional Warrants and Note may have a
detrimental impact on the terms under which the Company may obtain financing
through a sale of its Common Stock in the future. Any evaluation of the
favorability of market conditions for a subsequent stock offering by the
Company must take into account any outstanding Warrants, Additional Warrants
and Note.
POSSIBLE VOLATILITY OF SECURITIES PRICES. The trading price of the
Company's Common Stock could be subject to wide fluctuations in response to
quarterly variations in operating results, announcements of technological
innovations or new products by the Company or its competitors, changes in
financial estimates by securities analysts, the operating and stock price
performance of other companies that investors may deem comparable to the
Company, and other events or factors. Moreover, in some future quarter the
Company's operating results may fall below the expectations of securities
analysts and investors. In such event, the market price of the Company's
Common Stock would likely be materially and adversely affected. In addition,
the stock market in general, and the market prices for high-tech related
companies in particular, have experienced extreme volatility that often has
been unrelated to the operating performance of such companies. These broad
market and industry fluctuations may adversely affect the trading price of the
Company's Common Stock, regardless of the Company's operating performance.
PENNY STOCK REGULATIONS. The Securities and Exchange Commission (the
"Commission") has adopted regulations which generally define "penny stock" to
be any equity security that has a market price (as defined) less than $5.00 per
share or an exercise price of less than $5.00 per share, subject to certain
exceptions. The Company's securities may be covered by the penny stock rules,
which impose additional sales practice requirements on broker-dealers who sell
to persons other than established customers and accredited investors
(generally, institutions with assets in excess of $5,000,000 or individuals
with net worth in excess of $1,000,000 or annual income exceeding $200,000 or
$300,000 jointly with their spouse). For transactions covered by this rule,
the broker-dealers must make a special suitability determination for the
purchase and receive the purchaser's written agreement of the transaction prior
to the sale. Consequently, the rule may affect the ability of broker-dealers
to sell the Company's securities and also affect the ability of purchasers to
sell their shares in the secondary market.
DEPENDENCE ON KEY PERSONNEL. The Company's performance is substantially
dependent on the performance of its executive officers and key personnel and on
its ability to retain and motivate such personnel. The loss of any of the
Company's key personnel, particularly the Company's founder Mark C. Koz, could
have a material adverse effect on the Company's business, financial condition
and operating results. The Company's success will also depend upon its ability
to hire and retain additional qualified personnel. No assurance can be given
that the Company will be able to hire or retain such qualified personnel.
DIGITAL VIDEO INDUSTRY OVERVIEW
In the past, video images were transmitted and stored using almost
exclusively analog formats. Digital video technology, including the Company's
technology, has been developed more recently and provides several benefits over
analog. For example, unlike analog, digital video can be compressed, providing
significant storage and transmission efficiencies. Further, digital video can
generally be duplicated and transmitted without significant loss of quality.
The Moving Picture Experts Group ("MPEG") was formed in 1988 to develop a
worldwide industry standard for digital compression of video. In 1991, the
MPEG committee adopted the first technical standard of digital video
compression for full video motion for personal computers, which is known as
"MPEG-1."
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The MPEG committee determined that a higher quality digital video standard
was needed for broadcast quality video. The MPEG committee eventually adopted
the second generation standard of MPEG for video and audio compression ("MPEG-
2"). The MPEG-2 video compression standard defines the standard applicable to
broadcast quality video which may permit effective storage and transmission of
digital video.
THE COMPANY'S PRODUCTS AND TECHNOLOGY
Currently, the Company is utilizing existing third party three chip
compression hardware in development of its digital video compression and
processing technology. The Company intends to replace this three chip hardware
with its own single chip video encoder, which has been termed "DVImpact," along
with the Company's development of a circuit board and software for providing
MPEG-2 video encoding.
The DVImpact Chip and related video compression hardware and software,
which is the subject of patent application docket numbers 2056 and 2057, has
applied certain aspects of the Gecko technology which was licensed from Future
Tel in 1996.
Under the License Agreement, the Company has the rights to use, duplicate,
distribute, modify and enhance the technology for the development, manufacture
and distribution of its products and to sublicense the technology to others for
the enhancement, development, manufacture and distribution of its products.
The Company also holds trademarks on the Company's name and the names of
certain products under development.
The Company develops core technologies and methodologies for digital video
compression and processing technology applications. The Company's adherence to
MPEG-2 non-proprietary "open standards" is anticipated to help facilitate
customers' flexibility in developing solutions based on the Company's products
under development. The Company believes adherence to the open standards may,
therefore, help customers' products meet time-to-market requirements. The
following are products currently under development by the Company.
DVIMPACT SINGLE CHIP MPEG-2 ENCODER is currently under development and is
designed to provide real time encoding of a digital video input and to generate
a compressed data stream that management believes will be smaller and of better
quality than that of competing solutions. With minor modifications, the same
chip is designed to act as a high quality MPEG-1 encoder for applications
compliant with MPEG-1 standards. The Company anticipates using the DVImpact in
its own board and systems level products as well as selling the chip on a
merchant basis into appropriate applications. Management believes that the
DVImpact will address needs in a variety of different markets and that
customers will perceive advantages in the DVImpact over competing solutions
both included in the Company's other products and as a stand alone merchant
product.
In connection with the development of the DVImpact single chip MPEG-2
encoder, the Company entered into an agreement with a Company to manufacture
the Company's chip. The agreement calls for payment of $225,000 for design and
manufacture of the chip. As of December 31, 1997, the Company made a $90,000
non-refundable deposit to TriTech Microelectronics, Inc. for the start of
design work. The remaining amounts are due upon shipment of prototypes.
DV-2110 MPEG-2 ENCODER BOARD, currently under development, is designed to
act as the system interface, i/o manager, and host for the DVImpact chip, or
other MPEG-2 encoder chips. The Company intends to use the DV-2110 imbedded in
the Company's systems products, and to sell the board as a stand alone
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component, or packaged with certain Company-developed software as an OEM
product to customers in markets that the Company does not currently service
with its own system level products. The board is intended to be compatible
with personal computers running Windows 95 and NT operating systems, and to
operate with a variety of video compression hardware. Its modular design and
flexible architecture are designed to allow it to function in a wide range of
digital audio and video applications in many different hardware and software
environments.
TRANSPEG<trademark> AND MAVNET<trademark> SYSTEMS-LEVEL PRODUCTS are
currently in advanced stages of development and are designed for professional
broadcast markets. This includes: A line of interchangeable digital multi-
channel transmissions products that incorporate compressed video and transmit
on multiple digital video broadcast standards; a digital broadcast
player/recorder that incorporates MPEG-2 video compression; and MPEG-2
instrumentation cluster for vector scope and waveform monitoring; and MPEG-2
multi-channel encoding system; and a corporate DVD authoring system utilizing
MPEG-2 video compression. These products are intended to provide digital video
processing technology to customers who are facing the conversion from analog to
digital broadcast technology while maintaining the look and feel of the
interface that the users have known on their analog tools. One potential
application is a system designed specifically for broadcasters for use in
producing, downloading, editing and delivering digitally compressed broadcast
quality video. However, the Company believes that a complete MPEG-2 digital
video compression system could also be utilized by end-users in producing a
variety of other video and audio programs.
SALES AND MARKETING
The Company intends to market its systems and products through its own
sales force and through the use of independent sales representatives.
Currently, the Company is emphasizing the sale of its system based solutions to
the video broadcast industry through direct sales calls from the Company's
sales force and by attendance at national and international trade shows.
Because the Company's systems and products have been in the development stage,
the Company has not achieved significant revenue from sales and does not
anticipate significant sales revenue until its products become available in
commercial quantities.
MARKET FOR THE COMPANY'S PRODUCTS
The markets for the Company's systems and products using its digital video
compression technology can be divided into three broad markets: video
applications in communications, especially the broadcast market; video
applications in computers and computer networks; and video applications in
consumer electronics. The Company intends to market its products in all three
broad markets, but will initially emphasize video applications in
communications targeting the analog to digital conversion of television
broadcast technology.
VIDEO APPLICATIONS IN COMMUNICATIONS
Digital video compression is currently used in several new applications in
the communications market, including the conversion from analog to digital
television, increase transponder capacity on satellite DBS networks, and wired
and wireless cable networks.
The Company intends to initially emphasize the marketing of its systems
solutions to the analog television broadcast station which desires to convert
to the transmission of digital television in accordance with the mandates of
the Federal Communications Commission. Most analog television stations must
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convert to digital transmission within the next six years. The Company is in
the final stages of development of a full product line targeting the video
compression needs of television broadcast stations converting from analog to
digital transmissions.
The first full-scale digital video transmission systems to achieve full
deployment were a series of DBS networks (Direct Broadcast Satellite
television). Through the use of digital video compression technology on high-
power Ku-band satellites, DBS networks typically provide 100 or more channels
to large geographical areas. The Company intends to target this market once
its DVImpact Chip is commercially available through the development of video
and audio compression and multiplexing systems which are intended to have the
capability of increasing the number of video channels available to networks
over existing satellite transponders.
The wireless cable or MMDS networks involve a local "line-of-sight"
broadcast network which broadcasts video over much shorter distances from a
stationary ground-based antenna directly to small receiving antennas placed at
each subscriber's home. Wireless cable or MMDS systems are typically deployed
in areas where there may not be an existing wired cable system or as an
alternative to existing wired cable systems in high-density urban centers. The
Company intends to target this market once its DVImpact Chip is commercially
available through the development of video and audio compression and
multiplexing systems which are intended to have the capability of increasing
the number of video channels available to wireless networks using the same
amount of radio spectrum.
Wired cable networks, which include such varied architectures as switched
digital video, fiber to the curb (FTTC), HFC and twisted pair schemes such as
ADSL and HDSL, are currently in the early stages of deployment by
telecommunications suppliers and digital cable providers. Switched digital
networks can provide a much higher level of interactivity compared to either
DBS or MMDS including the potential for full two-way video communication.
However, the significant investment in new infrastructure, presents a major
barrier to market penetration as the cost of this infrastructure is likely to
be passed onto the consumer. However, the Company intends to target this
market once its DVImpact Chip is commercially available through the development
of video and audio compression and multiplexing systems which are intended to
have the capability of increasing the number of video channels available to
wired cable networks using the same amount of bandwidth available over the
cable system.
VIDEO APPLICATIONS IN COMPUTERS AND COMPUTER NETWORKS
Manufacturers and consumers of computer technology are increasingly
embracing digital video applications for use in educational, entertainment
communication and training applications. Furthermore, computers are emerging as
the technical platform of choice for video editing and video encoding through
the integration of dedicated video-specific hardware. The Company intends to
target this market as its system level solutions and DVImpact Chip become
commercially available. Hardware systems involving DVD-ROMs may incorporate
some of the Company's video encoding technology on an OEM basis. Computers are
commonly used as video post-production systems though the addition of
appropriate capture and encoding hardware and application software enabling the
system to provide digital editing and/or content encoding. The Company's
technology, especially its digital authoring software technology, would have
applications in this market as well. Finally, the Company intends to market its
products and systems for use over local area networks and wide area networks
providing a cost effective solution for live video streams over network
applications.
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VIDEO APPLICATIONS IN CONSUMER ELECTRONICS
One emerging growth market for the Company's technology is in consumer
electronics. Through the use of MPEG-2 compression, video can be stored,
reproduced and distributed on the same media currently in use for other types
of digital data, such as 5-inch (12 cm) CDs that are commonly used for digital
audio. Emerging applications for digital video capture, playback and
distribution at the consumer level are being advanced by the rapid adoption of
new consumer-oriented media formats such as VideoCD Players, DVD Players,
Recordable DVD and Consumer Digital Video Cameras. The Company intends to
target the consumer market once its DVImpact Chip is commercially available
through the development of video and audio compression and multiplexing systems
with specific applications in the consumer electronics market.
COMPETITION
The Company faces competition from numerous companies, some of which are
more established, have greater market recognition, and have greater financial,
production and marketing resources than the Company. The Company's products
compete on the basis of certain factors, including first to market product
capabilities, product performance, price, support of industry standard, ease of
use and customer support as well as user productivity.
The market for the Company's products is intensely competitive, subject to
rapid change and significantly affected by new product introductions and other
market activities of industry participants. The Company faces direct and
indirect competition from a broad range of competitors who offer a variety of
products and solutions to the Company's current and potential customers. The
Company's principal competition comes from: (i) companies offering competing
systems; and (ii) companies offering competing technologies capable of
addressing certain components of the Company's technology. Many of the
Company's competitors have longer operating histories, including greater
experience in the market, significantly greater financial, technical and other
resources than the Company, greater name recognition and a larger installed
base of customers.
C-Cube Microsystems ("C-Cube") is a direct competitor to the Company and
is similarly focused on video encoded compression. C-Cube has grown very
rapidly through the sales of its MPEG products, primarily in the MPEG-1 market,
and has significantly greater resources than the Company. However, C-Cube
generally sells components rather than the complete hardware and software
digital video compression and processing systems the Company hopes to develop
for its customers.
IBM was expected to compete with a single-chip MPEG-2 encoder and decoder,
but has not done so yet. The Company and many other market participants
presently buy a 3-chip MPEG-2 chipset from IBM for their own current board
products. IBM is expected to release its own single chip encoder in the
future.
Other major potential competitors include companies such as Phillips and
SGS-Thomson, as well as large, integrated Japanese and Korean consumer
electronics companies, such as Sony, Hyundai, Toshiba, NEC and Samsung, which
have their own semiconductor design and manufacturing capacity. In high-level
MPEG-2 decoders as well as MPEG-1 encoders, LSI Logic has substantial market
share. In many of these cases, the Company hopes to be able to work jointly
with these companies to enhance quality encoding and decoding in the mass
markets.
Among the Company's smaller competitors is FutureTel, which primarily
serves the video authoring marketplace with boards and software toolkits for
encoding video sequences for television broadcast studios. Minerva is a
venture-funded, fast-growing system reseller using C-Cube and other chip
sources. Another market participant, 3DO, started shipping MPEG-2
11
encoder/decoders for the Apple MacIntosh in 1996, based on IBM's chipset, and
may decide to compete in the personal computer market. Several other companies
develop specialized professional video production boards.
The Company's competitors can be expected to continue to improve the
design and performance of their products and to introduce new products with
more competitive prices and performance features. Maintaining the
technological and other advantages of the Company's products over its
competitors' products will require a continued high level of investment by the
Company in both research and development and operations. No assurances can be
given that the Company will be able to continue to make such investments and
receive the necessary capital or that the Company will be able to achieve the
technological advances necessary to achieve competitive advantages.
RESEARCH AND DEVELOPMENT
For the past two years, substantially all of the Company's time has been
devoted toward the research and development of digital video compression and
processing products and systems. Internal research is supplemented through the
utilization of consultants who specialize in various areas. Product
development is largely performed at the Company's headquarters in California by
approximately 20 engineers who are supported and assisted by five to ten
engineer consultants and by one technician. The Company's total expenditures
for research and development were approximately $4,388,000 and $2,711,000 for
the years ended December 31, 1997 and 1996, respectively.
FUTURETEL LICENSE AGREEMENT
The Company has entered into an agreement with FutureTel whereby FutureTel
has licensed to the Company certain proprietary technology related to digital
video compression. The license agreement was entered into on March 7, 1996 and
was exclusive for a period of one year and became non-exclusive thereafter.
Under the license agreement, FutureTel granted the Company the right to
develop, manufacture and distribute products using the licensed technology and
derivative works. Under the terms of the license agreement, the Company will
also have the right to sublicense the technology.
FutureTel's proprietary technology is currently subject to patents and in
the event FutureTel decides not to continue to protect its patents, the Company
has the right to enforce and protect the patents which are subject to the
license.
For its right to use the technology, the Company shall pay to FutureTel a
percentage of gross revenues related from the sale of products using the
technology by sublicenses or by the Company equal to 20% during year 1; 15%
during year 2; 8% during year 3; 5% during year 4; 3% during year 5; 1% during
year 6 and 1% during year 7. Thereafter, the Company will not be responsible
for any further payments. Further, the royalty payments are subject to
maximum cumulative amount not to exceed $3 million.
SIERRA VISTA ENTERTAINMENT, INC. Sierra Vista Entertainment, Inc.("Sierra
Vista") was incorporated under the laws of Nevada on April 3, 1996, for
purposes of engaging in the production of television or theatrical feature
films. Sierra Vista intends to produce feature motion pictures with a
production budget of between $1 million and $5 million per film.
The Company and Sierra Vista entered into a Plan and Agreement of
Reorganization ("Reorganization") in which the Company acquired 100% of Sierra
Vista's issued and outstanding common stock in exchange for 8,514,500 shares of
Common Stock of the Company. Upon consummation of the Reorganization, Sierra
Vista became a wholly-owned subsidiary of the Company. As a condition of the
12
closing of the Reorganization, certain shareholders of Sierra Vista who held,
in the aggregate, approximately 5.5 million shares of Sierra Vista voting
common stock entered into a voting agreement with Mr. Koz who then owned
approximately 4.9 million shares of Common Stock of the Company. Pursuant to
the voting agreement the parties agreed to nominate six directors of the
Company, three of which to be nominated by Mr. Koz and three of which to be
nominated by Sierra Vista shareholders. Currently, Mr. Koz and one other
shareholder are subject to the voting agreement. Further as a condition of the
closing to the Reorganization, Sierra Vista was required to raise $3 million,
which was used by the Company for working capital upon consummation of the
Reorganization. Sierra Vista also arranged for a $5 million Credit Facility
which has been used by the Company for working capital.
Sierra Vista employs three full-time employees and is currently seeking
financing to produce one motion picture. However, Sierra Vista is dependent on
the Company for its working capital and has been limited in its production
activities due to the financial constraints of the Company. As the Company
continues to expend resources on the development of its systems and products,
management anticipates re-evaluating the propriety of continuing Sierra Vista's
production activities. No assurance can be given that the Company will
continue Sierra Vista's production activities in the future.
CHINA JOINT VENTURE
The Company entered into a joint venture agreement with CRI, a Chinese
corporation located in Beijing ("CRI"), in September 1997. The joint venture
intends to establish an exhibition facility in China to display United States
technology and products and to provide a forum for various companies and
individuals to develop potential business relationships and projects. The
Company and CRI are currently completing the necessary documentation for
operation of the joint venture in China. Pursuant to the terms of the
agreement, the Company will contribute $200,000 to the joint venture and CRI
will contribute $100,000. The joint venture will divide any profits in amounts
in proportion to their investment. As of March 31, 1998, the Company has not
contributed any funds to the joint venture. In connection with entering into
the joint venture with CRI, the Board of Directors approved the issuance of
100,000 shares of Common Stock to NATV Marketing, a salary of $60,000 per year
and the opportunity to receive up to 50% of the Company's joint venture
interest provided that the joint venture achieves certain objectives,
including, but not limited to, full subscription of all rental facilities at
the trading pavilion.
INTELLIGENT INSTRUMENTS CORPORATION
The Company's Board of Directors has approved the acquisition of Intelligent
Instruments for 2 million shares of Common Stock of the Company, subject to
review of tax and accounting consideration and subject to completion of
negotiations and final documentation. Intelligent Instruments holds the patent
for a proprietary set-top box design and has applied for a patent for a
proprietary server design, both of which may potentially be compatible with the
digital video compression and processing technology being developed by the
Company. Intelligent Instruments is a company wholly-owned by Mark C. Koz, the
Company's President and Chief Executive Officer.
TECHNICAL SYSTEMS ASSOCIATES, INC.
The Company entered into an interim agreement to acquire Technical Systems
Associates, Inc. ("TSA"), an antenna company located in Orlando, Florida, in
March of 1997. After conducting a due diligence review of TSA, the Company
determined that the acquisition would not likely meet its current business
objectives. In October 1997, the Company entered into an agreement for a
release from the interim agreement. Under this agreement, the Company paid
TSA an aggregate of $300,000, of which approximately $180,000 had
previously been paid, and agreed to provide a certain amount of contingent
debt financing in exchange for an option to be
13
held by the Company to acquire TSA and for the release. In January 1998, the
Company fully terminated the relationship and paid TSA approximately
$58,000 for a discharge of any financing or other obligations under the previous
agreements.
EMPLOYEES
As of March 31, 1998, the Company had approximately 45 full-time
employees.
ITEM 2. DESCRIPTION OF PROPERTY.
The Company is currently renting approximately 22,000 square feet of space
in Santa Clara, California, which includes offices and research space. The
Company has entered into a five (5) year lease agreement effective January
1998, with an option to extend for an additional three (3) year term, for the
leasing of new offices of approximately 18,000 square feet. The monthly base
rent is $28,800 for 1998, increasing by $900 per month for each year
thereafter, plus operating expenses for the common areas of the entire complex
equal to the Company's pro-rata square footage of the complex (approximately
47% of the building, 27% of the project). Approximately 4,000 square feet is
also being rented pursuant to a sublease agreement which expires on June 30,
1998, and a monthly payment of $9,000.
The offices are used primarily for engineering, software development and
administrative purposes. The Company does not maintain its own manufacturing
or production facilities.
Sierra Vista entered into a three (3) year lease agreement effective
October 1, 1997. The lease is for approximately 2,800 square fee of office
space in Beverly Hills, California. The monthly base rent is $5,882 for the
first eighteen months and $6,162 thereafter.
Sierra Vista is also currently leasing a single family residence of
approximately 2,500 square fee in Beverly Hills, California. The monthly rent
is currently approximately $7,000 per month, increasing to $7,300 in October
1998.
Sierra Vista's offices are used primarily for its film and video
production business.
ITEM 3. LEGAL PROCEEDINGS.
JETTSON REALTY DEVELOPMENT CORPORATION. On November 10, 1997, InnovaCom
filed suit against Michael D. Haynes, David S. Jett, Manhattan West, Inc.,
Marketing Direct Concepts, Inc., Checkers Foundation, Atlas Stock Transfer
Corporation, Arun Pande, Edwin Reedholm, and others in the Superior Court of
the County of San Francisco (Case Number 990965). The complaint alleges that
in connection with the reverse merger of Jettson Realty Development Corporation
("Jettson") and InnovaCom, a Florida corporation, the Company issued shares of
Common Stock to Michael D. Haynes and David S. Jett and entities controlled
by them based upon fraudulent misrepresentations. Further, the Company is
alleging that Manhattan West and Marketing Direct Concepts and Checkers
Foundation, an entity alleged to be controlled by Messrs. Haynes and Jett, were
issued fees, Common Stock, and options to acquire shares of Common Stock based
upon misrepresentations, including that they could raise capital to assist the
Company in its business. The Company has received monies in connection with a
stock purchase agreement between the Company and Checkers Foundation, but will
not issue the shares of Common Stock until this litigation involving Checkers
Foundation has been resolved. The Company is also alleging that Atlas Stock
Transfer, the Company's former transfer agent, breached its contract in
issuing shares of Common Stock in these transactions. In addition, the Company
is alleging that Mr. Pande, a former director and officer of InnovaCom,
violated his fiduciary duty by receiving shares of InnovaCom Common Stock
14
based upon misrepresentations and inadequate or no consideration, and made
inappropriate and unauthorized expenditures on behalf of the Company for his
personal benefit, and that Mr. Reedholm, a former director of the Company,
received shares of Common Stock of the Company without the payment of adequate
consideration. The Company is also alleging RICO (Racketeer Influenced
Corrupted Organizations Act) against all defendants. The Company is seeking
damages in excess of $26 million plus punitive damages.
In response to InnovaCom's lawsuit, certain defendants have filed cross-
claims against the Company. Mr. Pande filed a counterclaim against the
Company, and its directors, officers and attorneys for breach of contract,
fraud, negligent misrepresentation and other claims. Mr. Pande is alleging
that the Company breached his employment contract, failed to recognized Mr.
Pande's ownership in Innovacom, failed to acknowledged Mr. Pande's stock
options, and failed to reimburse Mr. Pande for expenses made on behalf of the
Company. Mr. Pande is requesting damages of $11 million plus punitive damages.
The Company is disputing each of Mr. Pande's claims. In addition, Marketing
Direct Concepts has filed a counter-claim against the Company and Manhattan
West for damages for breach of a financial consultant contract requesting
damages of approximately $1 million. Manhattan West has also filed a counter-
claim against the Company alleging breach of its consulting contract with
InnovaCom. Further, Atlas Stock Transfer has filed a claim against the Company
and all other defendants seeking indemnity.
A number of defendants have defaulted, including Michael Haynes, David
Jett and Checkers Foundation. InnovaCom will be seeking an entry of judgment
against the defaulting defendants including that the Common Stock that they own
may be canceled. The Jettson litigation is in its initial stage and limited
discovery has been conducted.
In February 1998, the Staff of the Division of Enforcement of the
Securities and Exchange Commission advised the Company that they are performing
an informal inquiry surrounding the circumstances of the reverse acquisition
involving Jettson and subsequent litigation and has requested certain documents
related to these transactions. The Company has complied with the Staff's
request.
JAPAN TOBACCO, MASATO HATA, FUTURETEL, ET. AL. On July 25, 1996, Mark C. Koz,
Intelligent Instruments Corporation and the Company filed suit against Japan
Tobacco, Masato Hata, FutureTel, et al., in the Santa Clara County Superior
Court (Case No. CV 759582). The Company and the other plaintiffs are claiming
fraud by the defendants in the formation of a business venture involving the
development and marketing of multimedia technology. On or about September 5,
1996, FutureTel filed a cross-complaint against the Company alleging breach of
contract by the Company for failure to pay FutureTel for salaries, payroll
taxes and insurance for certain personnel, rental equipment expenses incurred
by FutureTel, and legal fees all representing, in the aggregate,
approximately $120,000. The parties recently agreed to settle their dispute.
Under the settlement agreement, each party dropped their claims against each
other, the Company paid FutureTel $100,000, and the Company and FutureTel
amended the Company's license to manufacture, use, distribute, sell and
otherwise deal with the video compression technology from FutureTel to make it
irrevocable. At the time of litigation, neither Mr. Koz nor Intelligent
Instruments Corporation were associated with FutureTel.
MATURI. On October 7, 1996, InnovaCom filed a complaint for declaratory
relief in Santa Clara County Superior Court (Case No. CV 761218) against
Gregory V. Maturi, a former employee. The complaint seeks clarification
that Mr. Maturi is not entitled to any further payments or benefits under
his employment agreement with the Company, and that certain payments
amounting to approximately $150,000 made by InnovaCom to Mr. Maturi should
be returned to the Company. On October 18, 1996, Mr. Maturi filed a cross-
complaint against the Company for breach of contract, fraud and deceit, and
15
breach of the implied covenant of good faith and fair dealing, seeking
damages in excess of $5 million. The parties have conducted limited
discovery. No trial date has yet been set.
DECORAH COMPANY. On June 9, 1997, the Decorah Company and Edwin Reedholm, a
former director of the Company, filed a complaint against Digital Hollywood,
the Company and Mark C. Koz in the Circuit Court of Cook County, Illinois
County Department, Law Division, Case No. 97L06866. Plaintiffs are alleging
breach of contract in the amount of $7,225 lent to the Company. In addition,
Decorah Company is alleging that it has lent funds to Digital Hollywood which
has yet to be repaid and is seeking damages of approximately $900,000.
Further, Decorah Company is seeking damages against Mr. Koz because he
guaranteed the repayment of the monies by Digital Hollywood to Decorah Company
secured by a portion of Mr. Koz's Common Stock in the Company. Discovery has
yet to begin in this proceeding. In addition, the Company has recently filed
suit against Mr. Reedholm for breach of fiduciary duty in the Jettson Realty
litigation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock began trading on the OTC Bulletin Board under
the symbol "MPEG" on July 15, 1996. The following quotations reflect inter-
dealer prices, without retail mark-up, mark-down or commission and may not
represent actual transactions. The high and low prices of the Company's Common
Stock on a quarterly basis for the past two fiscal years are as follows:
<TABLE>
<CAPTION>
QUARTER HIGH LOW
<S> <C> <C>
September 30, 1996 $8.13 $1.25
December 31, 1996 $9.25 $4.25
March 31, 1997 $6.19 $1.63
June 30, 1997 $5.06 $2.44
September 30, 1997 $4.38 $2.38
December 31, 1997 $3.63 $2.38
</TABLE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The following sections discuss the Company's financial condition and
results of operations based upon the Company's consolidated financial
statements which have been prepared in accordance with generally accepted
accounting principles. The following sections also contain forward-looking
statements that involve risks and uncertainties. The Company's actual results
may differ materially from the results discussed in the forward-looking
statements. Factors that might cause such a difference include, but are not
limited to, those discussed in "Certain Considerations" section and elsewhere
in this Annual Report.
GENERAL
The Company is a development stage company with a principal focus in
digital video compression and processing technology compliant with MPEG-2
standards. The Company is currently developing chips, boards and systems for
16
targeted potential customers. In 1997, the Company merged with Sierra Vista, a
Nevada corporation in the development stages of production and distribution of
feature length films.
The Company plans to make the transition from development stage to full
production and sale of products in 1998. The Company's single-chip MPEG-2
encoder, the DV2100 MPEG-2 encoder board, and numerous system level products
are at advanced stages of development and are expected to begin significant
volume shipment in the near future. Management anticipates that the Company
will become profitable in 1998, but that continuing operating losses early in
1998 combined with the requirements of increased inventories and accounts
receivable will require additional funding in 1998. No assurances can be given
that the Company will become profitable or such additional funding will be
available or, if available, that it will be on terms favorable to the Company.
Product development in 1998 is planned to continue in areas complimentary
to the Company's pending product sales. These product development efforts are
expected to include updated versions of previously released products with
enhanced feature sets and functionality, products that will compliment other
existing products, and products that will broaden product lines to address
additional market niches. Management anticipates significant increases in the
staffing in its research and development efforts and in production, marketing,
sales and administration.
Management of Sierra Vista does not anticipate significant revenues during
the remainder of the fiscal year. No significant increases in permanent
employees and no significant purchases of equipment are anticipated. Sierra
Vista's operations are dependent on receiving adequate working capital from
InnovaCom.
The Company does not believe that inflation will have an impact on its
results of operations and does not believe that its business is seasonal.
RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with
the Company's consolidated financial statements and the notes thereto and other
financial information included elsewhere in this Annual Report.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO DECEMBER 31, 1996
REVENUES
Revenues for the year ended December 31, 1997 were $149,000 as compared to
zero for the year ended December 31, 1996. The revenues in 1997 were from
shipments of developer systems to five customers who purchased the systems to
begin development of their own software in anticipation of the Company's
commercial release of its board encoding products. The Company's products were
at an earlier stage of development in 1996, and accordingly there was no
revenue.
GROSS MARGINS
Gross margins were approximately $96,000, or 64% of revenues, for the year
ended December 31, 1997, as compared to zero for the year ended December 31,
1996. The gross margin percentage in 1997 is not necessarily representative of
the margins that the Company expects on its products when commercial shipments
to customers begin sometime in the future.
17
RESEARCH AND DEVELOPMENT
Research and development expense in the year ended December 31, 1997
totaled approximately $4,388,000. This was an increase of approximately
$1,677,000, or 62%, from the research and development expense for the year
ended December 31, 1996. The change results principally from an increase in
the number of employees in the research and development group and an increase
in the period that these people were working (activity in the first half of
1996 was low because the Company did not receive significant funding until July
of 1996), which increased payroll by approximately $1,394,000 and required the
Company to recognize approximately $732,000 in compensation expense in
connection with the issuance of stock options or common stock to employees in
accordance with Accounting Principles Board Opinion 25. This increase was
partially offset by a reduction of approximately $775,000 in the amount of
purchased research and development expenses in 1997 relative to 1996.
PRODUCTION EXPENSES
Production expenses of approximately $36,000 were related to Sierra Vista.
InnovaCom had no similar expenses during 1996.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative expenses were approximately $5,285,000
for the year ended December 31, 1997, which was a decrease of approximately
$156,000, or 3%, from approximately $5,441,000 during the same period in 1996.
The total in 1996 included approximately $3,396,000 in expense recognized in
conjunction with the issuance of Common Stock and stock options at prices below
fair market value to various consultants. This expense was approximately
$647,000 in 1997. Currently, some of the Common Stock options granted to
consultants are subject to litigation. Excluding the $3,396,000 in 1996 and
$647,000 in 1997, selling, general and administrative expense would have been
approximately $2,593,000 higher in 1997 than in 1996, an increase of 127%.
This increase is related to an increase in the number of employees and an
increase in the period of time they were present in 1997 relative to 1996,
$484,000 in expenses related to Sierra Vista which was present in 1997 but not
in 1996, and increases in legal and auditing of approximately $559,000 and
travel expenses of approximately $172,000.
INTEREST INCOME
Interest income increased from approximately $2,000 in 1996 to
approximately $10,000 in 1997. This increase reflects the return from the
temporary investment of surplus cash.
INTEREST EXPENSE
Interest expense substantially increased from approximately $11,000 during
the year ended December 31, 1996 to approximately $1,214,000 for the year ended
December 31, 1997. This increase resulted primarily from the credit facility
created in 1997 against which the Company had drawn approximately $3,982,000 of
principal as of December 31, 1997. The outstanding balance of the credit
facility may be converted into Common Stock of the Company at a discount to the
market price of a share of Common Stock. Accordingly, the value of this
discount, approximately $1,021,000 at December 31, 1997, is recorded as
interest expense.
18
INCOME TAX EXPENSE
Income tax expense for the year ended December 31, 1997 was approximately
$3,000 as compared to approximately $1,000 for the same period in 1996. This
increase was related to the merger with Sierra Vista which increased the
minimum franchise tax payable to the State of California.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 1997, the Company had negative working capital of
$1,454,500. At this time, the Company has no substantial revenues, and does
not anticipate any substantial revenues until the Company is able to complete
and sell its products. Historically, the Company has raised funds through
equity and debt financings to fund its operations and provide working capital
to it and its subsidiaries. It is anticipated that the Company will continue
to finance its operations and those operations of its subsidiaries through
equity and debt financings.
The Company will require additional working capital to fund its operations
and the operations of its subsidiaries. The Company intends to fund its
requirements through the issuance of debt obligations and, to a lesser extent.
the issuance of Common Stock The Company is currently in discussions with
institutional investors to finance the Company through the issuance of
convertible debentures. No assurance can be given that these discussions and
negotiations will lead to the financing of the Company. In the event that the
Company is unable to obtain adequate financing, there will be a material
adverse effect on the Company's ability to meet its business objectives.
Net cash used in operating activities totaled approximately $7,106,000
during fiscal 1997 and $1,970,000 during fiscal 1996. Net cash used during
fiscal 1997 and 1996 primarily related to the Company's losses of approximately
$10,823,000 and $8,193,000, respectively. The net loss during 1997 was offset
by non-cash items relating to interest expense from the discount resulting
from the beneficial conversion feature of the credit facility compensation
expense recognized upon the issuance of Common Stock and stock options,
and the acquisition of technology for Common Stock expensed. The net loss
during fiscal 1996 was offset by compensation expense related to the
issuance of Common Stock and stock options for compensation and the
acquisition of technology for Common Stock expensed.
Net cash flows provided from financing activities totaled approximately
$9,217,000 during fiscal 1997 as compared to approximately $2,269,000 during
1996. During fiscal 1997, the Company received approximately $2,917,000 in
connection with the acquisition of Sierra Vista Entertainment, approximately
$665,000 from the sale of Common Stock to an investor, $4,609,000 upon the
issuance of debentures and $3,982,000 drawn down from the credit facility.
This cash received was offset by the acquisition of property and equipment of
approximately $768,000. During fiscal 1996, the Company received $2,224,000
from the sale of its Common Stock, offset by an advance to a related party of
approximately $94,000 and the acquisition of property and equipment of
approximately $205,000.
As of December 31, 1997, the Company's debts consisted of advances against
a $5,000,000 credit facility granted by a shareholder with a principal balance
of approximately $3,982,000 and accrued interest of approximately $101,000.
This note matures on June 30, 1998, bears interest at 10% per annum and is
secured by a first-priority security interest in essentially all of the
Company's assets. The principal and interest on this credit facility can be
converted at the lender's option into Common Stock of the Company at a 20%
discount to the market price of the stock at the date that individual advances
were made to the Company under this credit facility.
19
In addition, as of December 31, 1997, the Company issued $5 million in
the aggregate of convertible debentures receiving approximately $4,609,000 in
net proceeds. The convertible debentures bear interest at 7% and are due
December 22, 2002. The debentures are convertible into Common Stock in
increments of one-third; one-third may be convertible upon the earlier of the
effective date of a registration statement or after the 120th day after the
original issue date; one-third after the 120{th} day of the original issue
date but prior to the 150{th} day from the original issue date; and one-third
after the 150{th} day from the original issue date. In connection with the
private placement, the Company issued warrants to purchase 250,000 shares of
Common Stock at $2.43 per share.
In July 1997, the Company retained the services of an investment advisor
to assist in the raising of up to $15 million in a private placement. In
connection with these services, the Company granted options to purchase 400,000
shares of Common Stock at $2.50 per share. 200,000 of the options were
exercisable upon grant, the remaining will be exercisable upon the completion
of a $15 million private placement. In March 1998, the Company terminated the
relationship with the advisor.
IMPACT OF THE YEAR 2000 ISSUE. The Year 2000 Issue is the result of
computer programs being written using two digits rather than four to define the
applicable year. Any of the Company's, or its suppliers' and customers'
computer programs that have date-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in system
failures or miscalculations causing disruptions of operations including, among
other things, a temporary inability to process transactions, send invoices, or
engage in similar normal business activities.
The majority of the Company's operations are based on PC application and
the Company believes that its software is year 2000 compliant. The Company
has not yet identified any year 2000 problem but will continue to monitor the
issues. No assurances can be given that the year 2000 problem will not occur
with respect to the Company's computer systems.
Neither the Company nor its subsidiary have initiated formal
communications with significant suppliers and large customers to determine the
extent to which those third parties' failure to remedy their own Year 2000
Issues would materially effect the Company and its subsidiaries. The Company
has not received any indication from its suppliers and large customers that the
Year 2000 Issue may materially effect their ability to conduct business and the
Company has no current plans to formally undertake such an assessment.
ITEM 7. FINANCIAL STATEMENTS.
The financial statements for the Company are attached beginning on page F-
1.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Subsequent to the reverse merger between InnovaCom, Inc., a Florida
corporation, and Jettson, on June 4, 1997, the Company's Board of Directors
approved to retain Hein + Associates LLP as the Company's independent
accountants and Michael Hoffer, Jettson's former accountant, was not retained.
During the relationship between Jettson and Michael Hoffer, there were no
disagreements regarding any matters with respect to accounting principles or
practices, financial statement disclosure, or audit scope or procedure, which
disagreements, if not resolved to the satisfaction of the former accountant,
would have caused Michael Hoffer to make reference to the subject matter of the
disagreement in connection with its report. Michael Hoffer's report for
Jettson's financial position as of December 31, 1995, July 9, 1996 and July 31,
1996 and the results of its operations and cash flows for the periods July 10,
1996, to July 31, 1996, January 1, 1996, to July 9, 1996, for the year ended
December 31, 1995 and from October 3, 1990 (inception) to July 31, 1996 are
not a part of the financial statements of the Company included in this Annual
Report. Such report did not contain an adverse opinion or disclaimer of
20
opinion or qualification of modifications as to uncertainty, audit scope or
accounting principles under generally accepted auditing standards. However,
such report includes comments by the former accountant that cast substantial
doubt on Jettson's ability to continue as a going concern. Prior to retaining
Hein + Associates LLP, the Company had not consulted with Hein + Associates LLP
regarding accounting principles.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.
EXECUTIVE OFFICERS AND DIRECTORS
The directors and executive officers of the Company are as follows:
<TABLE>
<CAPTION>
Held Position
NAME AGE POSITION SINCE
<S> <C> <C> <C>
Mark C. Koz 43 President, Chief Executive 1993
Officer, Director
F. James Anderson 49 Secretary, Executive Director, May 1997
Corporate Strategy and Finance,
Director
Rand E. Shrader 43 Chief Operating Officer May 1997
Stanton Creasey 44 Chief Financial Officer April 1997
Simone Anderson 34 President, Sierra Vista May 1997
Tony Low 44 Director October 1996
Robert Sibthorpe 48 Director May 1997
John Champlin, M.D. 42 Director October 1997
</TABLE>
The following sets forth the principal occupations during the past five
years of the directors and executive officers of the Company and it
subsidiaries.
MARK KOZ (AGE 43) has been Chairman, Chief Executive Officer and
President of the Company since March 3, 1993. Mr. Koz was also Chief Executive
Officer, Chief Technical Officer and a Director of FutureTel from 1993 to 1995,
and has been Chief Executive Officer of Intelligent Instruments Corporation
since 1993. Mr. Koz has five years of technical education at Florida
Technological University (University of Central Florida). In addition, he is a
voting member of the Moving Picture Experts Group, the international
standards-setting body for MPEG.
F. JAMES ANDERSON (AGE 49) has been Secretary, Executive Director,
Corporate Strategy and Finance, and Director of the Company since May 1997.
Mr. Anderson is also and has been a director of Sierra Vista since January
1997. Prior to forming Sierra Vista in January 1997, Mr. Anderson was engaged
in reviewing and pursuing business opportunities. From January 1993 to the
present, Mr. Anderson served as Director General of the Moscow Country Club, a
21
Russian-American joint venture formed to develop a country club in Moscow,
Russia, and from February 1992 to May 1995 Mr. Anderson was President and
Chairman of the Board of the Moscow Country Club, Inc.("MCCI" ) which owned
50% of that joint venture. From December 1991 to April 1993 Mr Anderson was
CEO and Director of Brush Creek Mining and Development, Co., Inc., a Nevada
corporation, which was engaged in exploration and development of precious
mineral properties in the US and other countries. Mr. Anderson is the spouse
of Simone Anderson.
As previously discussed, Mr. Anderson was an executive officer and
Chairman of the Board of MCCI which entered into joint venture with an agency
of the Russian Government ("Russian Partner"). MCCI believes that the Russian
Partner illegally seized the assets of the joint venture which is currently the
subject of an arbitration proceeding in accordance with the terms of the joint
venture agreement. As a result of the Russian Partner's seizure of the joint
venture's assets, MCCI was unable to pay its obligations when they became due
and, as a result, certain creditors of MCCI filed an involuntary bankruptcy
action against MCCI (Case No. 95-22770-C-7 and 95-24391-C-11 United States
Bankruptcy Court Eastern District of California). The Bankruptcy Court has
approved a plan of reorganization for MCCI allowing all creditors to be repaid
from the potential judgment proceeds in the arbitration proceeding.
RAND E. SHRADER (AGE 43) has been Chief Operating Officer since May 1997.
Prior to joining the Company, Mr. Shrader was employed with ITT Automotive (now
part of ITT Industries) for 12 years. Mr. Shrader was Quality Manager at one
of Dayton-Walther's (now part of Lucas-Varity) plants for 6 years before
joining ITT.
STANTON RICHARD CREASEY (AGE 44) has been Chief Financial Officer since
April 1997. From March 1996 through April 1997, Mr. Creasey was an
independent consultant and from September 1994 through March 1996, he was at
Purus Inc. Mr. Creasey was Chief Financial Officer and President of Sixty-
Eight Thousand, Inc. from September 1989 through March 1994, and left that
company in April 1994. In June 1994, Sixty-Eight Thousand, Inc., a company
which made Macintosh compatible workstations, filed for bankruptcy protection
in San Jose, California (Case No.: 94-54123). Mr. Creasey is a CPA with 19
years of experience in finance, first with Arthur Andersen & Co., and then with
a number of high technology manufacturing companies, including National
Semiconductor Corporation. He has served as chief financial officer of several
Silicon Valley start-up companies during the past ten years.
SIMONE ANDERSON (AGE 34) was a Director of the Company from May 1997 to
March 1998, and has been the Marketing Director and President of Sierra Vista
since January 1997. She has been a director and officer of MCCI from February
1992 until May 1995 and was previously a director and chief financial officer
of Brush Creek Mining and Development Co., Inc. from April 1989 to February
1993. Prior to forming Sierra Vista, Ms. Anderson, along with her husband, F.
James Anderson, was engaged in the review and pursuit of new business
opportunities. As discussed above, certain creditors of MCCI filed an
involuntary bankruptcy action against MCCI. MCCI is still currently in
bankruptcy.
TONY LOW (AGE 44) has been a Director of the Company since October 1996.
Since July 1997, Mr. Low has been Chief Operating Officer of Darwin Digital, a
newly formed Saatchi & Saatchi Vision Company involved in interactive
advertising and media buying. Prior to that, from January 1996 through June
1997, Mr. Low was director of business affairs at the Los Angeles based
Saatchi Entertainment Group, a division of Saatchi & Saatchi, the multinational
advertising agency. From June 1993 through January 1996 he was President of
Tercer Mundo, Inc., a company marketing sound recordings, and from October 1983
through June 1993 he was Partner and Business Manager of Oberman, Tivoli,
Miller and Low, an accounting company specializing in the entertainment
industry.
22
ROBERT ALAN SIBTHORPE (AGE 49) has been a Director of the Company since
May 1997. Mr. Sibthorpe has been owner of Mag South Research, Inc., a
geological and financial consulting firm since October 1996. From June 1986
through April 1996 Mr. Sibthorpe was with Yorkton Securities, Inc. involved
in investment banking Mr. Sibthorpe has an MBA in Finance and a Bachelor of
Science in Earth Sciences both from the University of Toronto.
JOHN JOSEPH CHAMPLIN, M.D. (AGE 42) has been a Director of the Company
since October 1997. He has been owner and president of the Med Center Medical
Clinic in Carmichael, California, since 1993. Prior to founding Med Center
Medical Clinic, he was a medical director of Madison Center from 1988 to 1993.
He is also associate clinical professor, family practice, at the University of
California at Davis since 1986. Mr. Champlin earned his M.D. at the University
of Florida.
COMMITTEES OF THE BOARD.
The Board has an Audit Committee and a Compensation Committee. The Audit
Committee consists of Messrs. Low and Sibthorpe, and the Compensation Committee
consists of Messrs. Koz and Sibthorpe.
The primary functions of the Audit Committee are to review the scope and
results of audits by the Company's independent auditors, the Company's internal
accounting controls, the non-audit services performed by the independent
accountants, and the cost of accounting services.
The Compensation Committee administers the Company's 1996 Incentive and
Nonstatutory Stock Option Plan and approves compensation, remuneration, and
incentive arrangements for officers and employees of the Company.
The board has also established a litigation committee consisting of Mr.
Anderson, who serves as chairman, and Messrs. Low and Sibthorpe.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Based on the Company's information, none of the directors, officers and
beneficial owners of more than 10% of any class of equity securities have filed
their initial report on Form 3. The Company has informed such persons of their
obligations who intend to file the reports as soon as practicable.
23
ITEM 10. EXECUTIVE COMPENSATION
EXECUTIVE COMPENSATION.
The following table sets forth the Compensation of the Company's President
and Chief Executive Officer and the Executive Director, Corporate Strategy and
Finance during 1997. No other officer received annual compensation in
excess of $100,000 during 1997.
<TABLE>
<CAPTION>
SUMMARY
COMPENSATION TABLE
<S> <C> <C> <C> <C> <C> <C>
Long Term Compensation
Annual Compensation Awards Payouts
Other Securities
Annual Restricted Underlying
Compensa- Stock Options LTIP All Other
tion Award(s) (#) Payouts Compensa-
Name and Principal Year Salary ($) ($) ($) tion
Position
Mark C. Koz 1997 $241,500 $10,500{(1)} $0 300,000{(2)} $0 $0
President and CEO 1996 $120,000 $0 $0 2,000,000{(2)} $0 $0
F. James Anderson 1997 $112,500 $37,500{(3)} 300,000{(4)}
Executive
Director,
Corporate Strategy
and Finance
</TABLE>
(1) Represents a car allowance of $1,500 per month.
(2) Represents incentive stock options to acquire 192,770 shares of Common
Stock at $2.85 per share and non-qualified stock option to acquire 107,230
shares of Common Stock at $2.59 per share. Also includes options to acquire
2,000,000 shares of Common Stock at $3.00 per share.
(3) Represents a $3,500 per month housing allowance and a $1,500 per month car
allowance.
(4) Represents options to acquire 300,000 shares of Common Stock at $2.59.
On May 15, 1997, the Company and Mr. Koz entered into a five year
employment contract. Under the terms of Mr. Koz's employment contract, Mr. Koz
shall receive a salary of $240,000 per annum subject to a 7% cost of living
increase and other increases as determined by the Board of Directors. In
addition, pursuant to Mr. Koz's employment contract, in the event that Mr. Koz
is terminated in connection with a change in control, Mr. Koz shall be entitled
to receive a lump sum payment equal to three times his then annual salary.
Finally, pursuant to his contract, Mr. Koz shall be indemnified by the Company
for serving as an officer and director.
On May 15, 1997, the Company and Mr. Anderson entered into a five year
employment contract. Under the terms of Mr. Anderson's employment contract,
Mr. Anderson shall serve as Director of Strategic Planning and President of the
Company's Entertainment Division and his salary shall be $180,000 per annum
subject to a 7% cost of living increase and increases as determined by the
Board of Directors. In addition, pursuant to Mr. Anderson's employment
contract, in the event that Mr. Anderson is terminated in connection with a
change in control, Mr. Anderson shall be entitled to receive a lump sum payment
equal to three times his then annual salary. Finally, pursuant to his
contract, Mr. Anderson shall be indemnified by the Company for serving as
Director of Strategic Planning and President of The Company's Entertainment
Division.
24
FUTURE PRESIDENT AND CHIEF EXECUTIVE OFFICER
On March 23, 1998, the Company hired Thomas E. Burke as President and
Chief Executive Officer of the Company and as a member of the Board of the
Directors of the Company to commence May 1, 1998. As discussed below, Mr.
Burke's employment is subject to certain conditions. For the past 17 years,
Mr. Burke has been employed by TRW, most currently as Director of Strategic
Requirements which is responsible for identifying and evaluating major trends
and issues that can affect TRW's Space and Electronics Group. Prior to being
Director of Strategic Requirements, Mr. Burke was with TRW's automotive group
where he was vice president of advanced products and systems for the Automotive
Electronic Group. From 1981 to 1991 Mr. Burke held positions with TRW's Space
and Technology and the Electronic Systems Groups in Los Angeles. Mr. Burke
received a doctorate in chemistry form the California Institute of Technology
and his bachelor's degree in chemistry for the University of Minnesota.
Pursuant to his employment contract, Mr. Burke shall receive a salary of
$250,000 per year, a signing bonus equal to $200,000 net of taxes, a car
allowance equal to $1,000 per month net of taxes, a housing allowance equal to
$7,500 per month net of taxes, a life insurance policy equal to $1,500,000,
and other benefits granted to employees of the Company. Mr. Burke's employment
is for a term of five years and, upon each anniversary date, shall be
automatically extended by an additional one year term unless either party gives
prior notice not to extend. Mr. Burke shall be eligible to receive an annual
bonus of up to two times Mr. Burke's annual salary based on achieving certain
targets as mutually agreed upon by Mr. Burke and the Board of Directors. Mr.
Burke shall also receive options to acquire during a ten year term up to
1,000,000 shares of Common Stock of the Company at an exercise price equal to
$1.75 per share. The options shall vest in one-third increments with one
increment vesting immediately and the remaining two increments on each
anniversary date thereafter. In the event of a change of control, all the
options shall vest immediately.
Mr. Burke's employment contract may be terminated for cause by the Company
or for good reason by Mr. Burke. In general, the term "for cause" includes the
conviction of a felony, consistent willful failure to substantially perform
stated duties, a willful act of fraud, or a willful act of misconduct. In
general, the term good reason includes assignment of duties inconsistent with
Mr. Burke's position, failure to comply with or breach of Mr. Burke's
employment agreement, relocation of principal place of employment, failure to
extend the employment term, or an occurrence of a change of control. In the
event of termination without cause or for good reason, the Company shall pay
Mr. Burke an amount equal to his salary due for the remaining term of his
contract and any bonuses due, such an amount not to exceed $1,000,000 unless
the Company has earnings before deduction of any interest, taxes, depreciation,
amortization in excess of $2,000,000. In addition, all unvested options shall
immediately vest. In the event Mr. Burke's employment contract is terminated
for cause or without good reason, Mr. Burke shall be entitled to all accrued
but unpaid amounts and unvested options shall be forfeited.
Mr. Burke's obligations under the employment contract are contingent on
the Company obtaining financing in an amount of not less than $5,000,000 on or
before April 15, 1998. The failure of the Company to secure such financing or
the occurrence of any material adverse changes in the business affairs and
financial prospects of the Company, prior to May 1, 1998, could result in
termination of the employment contract by Mr. Burke. Further, the Company must
secure its performance under the employment contract for a period of two years
by the issuance of a letter of credit in the aggregate amount of $1,000,000 for
the benefit of Mr. Burke.
DIRECTOR COMPENSATION.
Directors do not receive cash compensation for serving as such. However,
during the year ended December 31, 1997, Messrs. Sibthorpe, Low and Champlin
each received options to acquire 200,000 shares of Common Stock at $2.59 which
represented the closing price of the Company's Common Stock at the date of
25
grant. The options are for a period of five years and vest in one-third
increments beginning on November 18, 1998.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
PRINCIPAL STOCKHOLDERS
The following table sets forth, as of March 31, 1998, certain information
with respect to the beneficial ownership of the Company's Common Stock by (i)
each stockholder known by the Company to be the beneficial owner of more than
5% of the Company's Common Stock, (ii) each officer and director of the
Company, and (iii) directors and executive officers of the Company and its
subsidiary as a group.
As of March 31, 1998, there were 20,561,897 shares of Common Stock
outstanding.
COMMON STOCK
Percentage
Number of Beneficially
NAME AND ADDRESS SHARES{(1)} OWNED
Mark C. Koz 5,463,000{(2)} 26.55%
InnovaCom, Inc.
3400 Garrett Drive
Santa Clara, CA 95054
507784 BC Ltd. 5,463,000{(3)} 26.55%
10th Fl., Four Bentall Centre
P.O. Box 49333
1055 Dunsmuir Street
Vancouver BC V7X 1L4
Canada
Rand E. Shrader 402,000{(4)} 1.9%
InnovaCom, Inc.
3400 Garrett Drive
Santa Clara, CA 95054
Stanton Creasey 200,000{(5)} *
InnovaCom, Inc.
3400 Garrett Drive
Santa Clara, CA 95054
John Champlin, MD 100,000{(6)} *
4373 Meadow Circle
Rescue, CA 95672
James Anderson -0- -0-
InnovaCom, Inc.
3400 Garrett Drive
Santa Clara, CA 95054
26
Simone Anderson -0- -0-
Sierra Vista Entertainment
9350 Wilshire Blvd., Suite 100
Beverly Hills, CA 90212
Robert Sibthorpe -0- -0-
6311 E. Naumann Dr.
Paradise Valley, AZ 85253
Tony Low -0- -0-
The Saatchi Entertainment Group
37 26th Avenue
Venice, CA 90291
All officers and directors as a group 6,165,000{(7)} 28.97%
(7 persons)
*Less than one percent
(1) Except as otherwise indicated, the Company believes that the beneficial
owners of Common Stock listed above, based on information furnished by
such owners, have sole investment and voting power with respect to such
shares, subject to community property laws where applicable. Beneficial
ownership is determined in accordance with the rules of the Securities
and Exchange Commission and generally includes voting or investment power
with respect to securities. Shares of Common Stock subject to options or
warrants currently exercisable, or exercisable within 60 days, are deemed
outstanding for purposes of computing the percentage ownership of the
person holding such options or warrants, but are not deemed outstanding
for purposes of computing the percentage ownership of any other person.
(2) Includes 1,000,000 shares of Common Stock owned by 507784 BC Ltd. and
4,463,000 shares beneficially owned by Mark C. Koz, all of which are
subject to a Voting Agreement by and between 507784 BC Ltd. and Mark C.
Koz, wherein Mr. Koz has the right to nominate three (3) members of the
six (6) member board of directors of the Company and 507784 BC Ltd, a
former Sierra Vista shareholder, has the right to nominate the remaining
three (3) members of the six (6) member board of directors of the
Company, and all the shares subject to the voting agreement shall vote in
favor of the six (6) nominees. The voting agreement is for a period of
five years ending on February 27, 2002. The voting agreement may be
extended for an additional five years. The owners of 507784 BC Ltd. are
unaffiliated with either the Company or Mr. Koz. Also includes options
to purchase 15,000 shares of Common Stock at $0.50 per share expiring
August 7, 2001, held by Mr. Koz's wife.
(3) Includes 1,000,000 shares of Common Stock owned by 507784 BC Ltd. and
4,478,000 shares beneficially owned by Mark C. Koz, all of which are
subject to a Voting Agreement by and between 507784 BC Ltd. and Mark C.
Koz, wherein Mr. Koz has the right to nominate three (3) members of the
six (6) member board of directors of the Company and 507784 BC Ltd, a
former Sierra Vista shareholder, has the right to nominate the remaining
three (3) members of the six (6) member board of directors of the
Company, and all the shares subject to the voting agreement shall vote in
favor of the six (6) nominees.
(4) Includes options to purchase 400,000 shares of the Company's Common Stock
at $2.75 per share, expiring May 27, 2002.
(5) Includes options to purchase 200,000 shares of the Company's Common Stock
at $1.75 per share, exercisable within sixty days.
27
(6) Includes options to purchase 100,000 shares of the Company's Common Stock
at $3.375 per share, exercisable within sixty days.
(7) Includes 715,000 options to acquire shares of Common Stock and 1,000,000
share subject to a voting agreement discussed in footnotes (2) through
(6).
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
MICRO TECHNOLOGY CREDIT FACILITY. In July 1997, a promissory note (the
"Note") was issued to Micro Technology in connection with a credit facility
agreement (the "Credit Facility"). The Credit Facility and Note provide for an
aggregate amount not to exceed $5 million. The Credit Facility terminates and
the Note is due on June 30, 1998 and bears interest at the lower of 10% or the
maximum rate allowed by law (Federal Reserve Bank of San Francisco's rate plus
5%) The Company has the right to prepay the Note. The principal and interest
on the Note may be converted, at the option of the holder, into shares of
Common Stock in an amount equal to 80% of the trading price of a share of
Common Stock on the date an advance of funds was made pursuant to the Credit
Facility. Advances made under the Credit Facility are secured by all of the
assets of the Company including, but not limited to, receivables, goods,
equipment, inventory, contract rights and other property interests.
As of March 31, 1998, the aggregate amount of principal and accrued
interest outstanding on the Credit Facility was $4,181,421 million with an
average conversion price of $2.40 per share. Through the merger with Sierra
Vista, Micro Technology received 2,500,000 shares of Common Stock which, at the
time, represented approximately a 14% interest in the Company. Prior to their
investment in Sierra Vista, the owners of Micro Technology were unaffiliated
with Sierra Vista and the Company.
ACQUISITION OF INTELLIGENT INSTRUMENTS CORPORATION. The Board of
Directors has agreed to acquire Intelligent Instruments Corporation, an
intellectual property holding company owned by Mark Koz, in exchange for two
million shares of the Company's Common Stock. Intelligent Instruments
Corporation holds the patent for a proprietary set-top box design and has
applied for a patent for a proprietary server design, both of which complement
and enhance the technology being developed by the Company. The acquisition of
the intellectual property of Intelligent Instruments Corporation is subject to
both parties analyzing structure, tax and accounting issues and entering into a
definitive agreement. During the negotiations, Mr. Anderson represented the
Company.
FUTURETEL. The Company has a license ("FutureTel License Agreement") from
FutureTel to manufacture, use, distribute, sell and otherwise deal with the
video compression technology which is the subject of docket numbers 2056 and
2057 for patent applications. Under the FutureTel License Agreement, the
Company has the rights to use, duplicate, distribute, modify and enhance the
technology for the development, manufacture and distribution of its products
and to sublicense the technology to others for the enhancement, development,
manufacture and distribution of its products. The term of the license from
FutureTel to the Company is in perpetuity.
From 1993 to 1996, Mr. Mark C. Koz was a substantial shareholder of and
Chief Executive Officer and Chairman of the Board of FutureTel. In connection
with his departure from FutureTel, Mr. Koz exchanged his interest in FutureTel
for the remaining interest held by a third party in Intelligent Instruments
Corporation. In addition, FutureTel granted the Company rights under the
FutureTel License Agreement. The Company, with Mark C. Koz and Intelligent
Instruments Corporation, filed a lawsuit against FutureTel and others claiming
fraud by the defendants in the formation of a business venture involving the
development and marketing of multimedia technology. This litigation was
settled by the Company paying FutureTel $100,000 and the parties amending the
FutureTel License Agreement to make it irrevocable.
28
SETTLEMENT AGREEMENT WITH MARK KOZ. The Company has entered into a
Settlement Agreement with Mark C. Koz which was adopted by the Company's
Litigation Committee of the Board of Directors. The Settlement Agreement
concerns the lawsuit recently filed by the Company regarding Jettson Realty
Development Corporation and concerns transactions and contracts, including
stock options and consulting agreements, entered into by the Company while Mr.
Koz was an officer and director of the Company. The parties enter into this
settlement in light of their desire to resolve any issues and in light of the
Company's dependence on Mr. Koz for future technology. Under the terms of the
Settlement Agreement, Mr. Koz has agreed to return to the Company for
cancellation 500,000 shares of Common Stock in exchange for a mutual release.
See "Legal Proceedings" for a discussion regarding the Jettson Realty
litigation.
DIGITAL HOLLYWOOD, INC. Beginning in March 1996, the Company made
advances to Digital Hollywood, Inc. in the aggregate amount of approximately
$139,000. Digital Hollywood is a corporation owned by Mr. Mark C. Koz, the
Company's president, and was formed to make and distribute a musical video
recorded on a digital video disk ("DVD") utilizing MPEG-2 compliant compression
technology. Digital Hollywood was unable to sell its video and because all of
Digital Hollywood's assets were secured by another lender, the Company wrote-
off its advances. Digital Hollywood, Mark Koz, the Company and Decorah Company
are currently in litigation.
With respect to each transaction between the Company and an affiliate of
the Company, the Company believes that such transactions were on terms at least
as favorable to the Company as they would have been had they been consummated
with unrelated third parties under similar circumstances.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
3.1 Certificate of Incorporation, as amended, of the Company (originally
filed as exhibit 2.1){(1)}
3.2 Amended and Restated Bylaws of the Company (originally filed as
exhibit 2.2){(1)}
10.1 Plan and Agreement of Reorganization, dated February 27, 1997, as
amended April 1, 1997 and May 14, 1997, between the Company and
Sierra Vista (originally filed as exhibit 6.1){(1)}
10.2 License Agreement, dated as of March 7, 1996, between the Company
and FutureTel (originally filed as exhibit 6.2){(1)}
10.3 Employment Agreement with Mark C. Koz, dated as of May 15, 1997
(originally filed as exhibit 6.3){(1)}
10.4 Employment Agreement with F. James Anderson, dated as of May 15,
1997 (originally filed as exhibit 6.4){(1)}
10.5 Escrow Agreement and Instructions between the Company, Sierra Vista
and Bartel Eng Linn & Schroder, dated as of February 27, 1997
(originally filed as exhibit 6.5){(1)}
10.6 Lease between Cooperage-Rose Properties II and the Company
(originally filed as exhibit 6.6){(1)}
10.7 Credit Facility Agreement between the Company and Micro Technology
S.A., dated as of July 1, 1997 (originally filed as exhibit
6.7){(1)}
10.8 Security Agreement between the Company and Micro Technology S.A.,
dated as of July 1, 1997 (originally filed as exhibit 6.8){(1)}
10.9 Convertible Debenture Purchase Agreement, dated as of December 22,
1997, with JNC (originally filed as exhibit 6.9){(2)}
10.10 7% Convertible Debentures, due December 22, 2002, payable to JNC
(originally filed as exhibit 6.10){(2)}
29
10.11 Registration Rights Agreement, dated as of December 22, 1997, with
JNC (originally filed as exhibit 6.11){(2)}
10.12 Escrow Agreement, dated December 22, 1997, between the Company, JNC
and Robinson Silverman Pearce Aronsohn & Berman LP (originally filed
as exhibit 6.12){(2)}
10.13 Warrants dated December 22, 1997, to purchase up to 500,000 shares
of Common Stock held by JNC (originally filed as exhibit 6.13){(2)}
10.14 Warrants dated December 22, 1997, to purchase up to 250,000 shares
of Common Stock held by Cardinal (originally filed as exhibit
6.14){(2)}
10.15 Addendum to Credit Facility, dated December 18, 1997, with Micro
Technology S.A. (originally filed as exhibit 6.15){(2)}
10.16 Settlement Agreement between the Company and Mark Koz (originally
filed as exhibit 6.16){(3)}
10.17 Joint Venture contract between the Company and CRI, dated September
13, 1997 {(3)}
10.18 Accord and satisfaction and Release Agreement between the Company
and Technical Systems Associates, Inc., dated January 16, 1998 {(3)}
10.19 Employment Agreement with Thomas E. Burke, dated March 23, 1998
{(3)}
10.20 1996 Incentive and Nonstatutory Stock Option Plan (originally filed
as exhibit 3.1){(1)}
10.21 Voting Agreement of InnovaCom, Inc., dated February 27, 1997, and
amended as of April 1, 1997, May 14, 1997, June 10, 1997, and
December 1, 1997, between Mark Koz and 507784 BC Ltd. (originally
filed as exhibit 5.1){(1)}
16.1 Letter regarding change in certifying accountant{(3)}
21.1 Subsidiary of the small business issuer{(3)}
27.1 Financial Data Schedule
(1) Previously filed with the Company's Form 10-SB on December 12, 1997
(2) Previously filed with the Company's Registration Statement on Form
SB-2 filed on February 9, 1998.
(3) Previously filed with the Company's Pe-Effective Amendment No. 1 to
Registration Statement on form SB-2 filed o April 15, 1998.
(b) Reports on Form 8-K.
None
30
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
causes this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
InnovaCom, Inc.
MARK C. KOZ
By: Mark C. Koz, President
In accordance with the requirements of 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.
March 31, 1998 MARK C. KOZ
Mark C. Koz, President and Chairman of the
Board of Directors (Principal Executive
Officer)
March 31, 1998 STANTON R. CREASEY
Stanton R. Creasey, Chief Financial Officer
(Principal Financial and Accounting Officer)
March 31, 1998 TONY LOW
Tony Low, Director
March 31, 1998 F. JAMES ANDERSON
F. James Anderson, Director
March 31, 1998 ROBERT SIBTHORPE
Robert Sibthorpe, Director
March 31, 1998 JOHN CHAMPLIN
John Champlin, Director
F-1
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
INDEPENDENT AUDITOR'S REPORT F-2
CONSOLIDATED BALANCE SHEET - December 31, 1997 F-3
CONSOLIDATED STATEMENTS OF OPERATIONS - For the
Years Ended December 31, 1997 and 1996, and For the
Period from March 3, 1993 (inception) to December 31, 1997 F-4
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT) -
For the Period from March 3, 1993 (inception) to December 31, 1997 F-5
CONSOLIDATED STATEMENTS OF CASH FLOWS - For the Years Ended
December 31, 1997 and 1996, and For the Period from March 3, 1993
(inception) to December 31, 1997 F-9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-11
F-2
INDEPENDENT AUDITOR'S REPORT
The Stockholders and Board of Directors
InnovaCom, Inc. and Subsidiaries (a Development Stage Enterprise)
Santa Clara, California
We have audited the accompanying consolidated balance sheet of InnovaCom, Inc.
and subsidiaries (a Development Stage Enterprise) as of December 31, 1997, and
the related consolidated statements of operations, stockholders' equity
(deficit), and cash flows for the years ended December 31, 1997 and 1996, and
for the period from March 3, 1993 (inception) to December 31, 1997. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of InnovaCom, Inc. and
subsidiaries (a Development Stage Enterprise) as of December 31, 1997, and the
results of their operations and their cash flows for the years ended December
31, 1997 and 1996, and for the period from March 3, 1993 (inception) to
December 31, 1997 in conformity with generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 3 to
the financial statements, the Company has suffered recurring losses from
operations, and as of December 31, 1997 has negative working capital of
$1,454,500, and has a stockholders deficit of $2,900,434, that raise
substantial doubt about the Company's ability to continue as a going concern.
Management's plans with regard to these matters are also described in Note 3.
The financial statements do not include any adjustments relating to the
recoverability and classification of reported asset amounts or the amounts and
classification of liabilities that might result from the outcome of this
uncertainty.
HEIN + ASSOCIATES LLP
Certified Public Accountants
Orange, California
February 6, 1998, except for the last paragraph of Note 14, which is as of
March 23, 1998
F-3
INNOVACOM, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
CONSOLIDATED BALANCE SHEET
DECEMBER 31,
1997
ASSETS
CURRENT ASSETS:
Cash $ 4,148,434
Cash - restricted 8,480
Prepaid and other expenses 176,627
-------------
Total current assets 4,333,541
PROPERTY AND EQUIPMENT, net 772,457
FILM RIGHTS AND FILM COST INVENTORY 277,500
DEBT ISSUANCE COSTS, net of accumulated
amortization of $3,295 664,815
ACQUISITION COSTS 68,364
DEPOSITS 89,879
-----------
TOTAL ASSETS $ 6,206,556
===========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Notes payable - related parties $ 4,091,174
Accounts payable 691,247
Accrued liabilities 1,005,620
-----------
Total current liabilities 5,788,041
LONG-TERM DEBT, less unamortized discount of
$1,681,051 3,318,949
----------
Total liabilities 9,106,990
----------
COMMITMENTS AND CONTINGENCIES (Notes 3 and 9) -
STOCKHOLDERS' EQUITY (DEFICIT):
Common stock, $.001 par value, 50,000,000 shares
authorized, 21,061,897 shares issued and 20,561,897
outstanding 20,562
Warrants 968,578
Additional paid-in capital 15,129,201
Deficit accumulated during development stage (19,018,775)
-------------
Total stockholders' (deficit) (2,900,434)
-------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) $ 6,206,556
=============
SEE ACCOMPANYING NOTES TO THESE CONSOLIDATED FINANCIAL STATEMENTS.
F-4
INNOVACOM, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
MARCH 3, 1993
<S> <C> <C> <C>
FOR THE YEARS ENDED (INCEPTION) TO
December 31, DECEMBER 31,
1997 1996 1997
REVENUES $ 149,000 $ - $ 149,000
------------ ------------ ------------
COSTS AND EXPENSES:
Costs of goods sold 52,538 - 52,538
Research and development 4,388,180 2,711,028 7,099,208
Production expenses 36,235 - 36,235
Selling, general and administrative 5,285,493 5,441,088 10,726,581
------------ ----------- ------------
Total costs and expenses 9,762,446 8,152,116 17,914,562
------------ ------------ ------------
OPERATING LOSS (9,613,446) (8,152,116) (17,765,562)
------------ ------------ -------------
OTHER INCOME (EXPENSE):
Interest income 10,462 1,622 12,084
Interest expense (1,214,237) (10,611) (1,224,848)
Loss on disposal of
property and equipment (2,559) - (2,559)
Other income (expense) - (31,490) (31,490)
----------- ----------- ------------
(1,206,334) (40,479) (1,246,813)
----------- ----------- ------------
LOSS BEFORE INCOME TAX EXPENSE (10,819,780) (8,192,595) (19,012,375)
INCOME TAX EXPENSE 3,200 800 6,400
----------- ----------- ------------
NET LOSS $(10,822,980) $ (8,193,395) $(19,018,775)
------------ ----------- ------------
BASIC AND DILUTED NET LOSS PER SHARE $ (.60) $ (.98)
============ ===========
WEIGHTED AVERAGE NUMBER OF SHARES
OUTSTANDING 17,895,305 8,361,597
============ =========
</TABLE>
SEE ACCOMPANYING NOTES TO THESE CONSOLIDATED FINANCIAL STATEMENTS.
F-5
INNOVACOM, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(DEFICIT)
<TABLE>
<CAPTION>
DEFICIT
<S> <C> <C> <C> <C> <C> <C>
ACCUMULATED TOTAL
ADDITIONAL DURING STOCKHOLDERS'
COMMON STOCK PAID-IN DEVELOPMENT EQUITY
SHARES AMOUNT Warrants CAPITAL STAGE (Deficit)
COMMON STOCK, issued to
form company at
$0.0017 per share
(March 1993) 5,100,000 $ 5,100 $ - $ 3,400 $ - $ 8,500
Net loss - - - - (800) (800)
--------- ----------- ---------- ------------ ---------- -----------
BALANCES, December 31,
1993 5,100,000 5,100 - 3,400 (800) 7,700
Net loss - - - - (800) (800)
--------- ----------- ----------- ------------- ---------- -----------
BALANCES, December 31,
1994 5,100,000 5,100 - 3,400 (1,600) 6,900
Net loss - - - - (800) (800)
--------- ---------- ----------- ------------- ---------- -----------
BALANCES, December 31,
1995 5,100,000 5,100 - 3,400 (2,400) 6,100
Issuance of common stock
at $0.50 per share to
directors for services
performed (March 1996) 900,000 900 - 449,100 - 450,000
Acquisition of Jettson
Realty Development
Inc. at $0.30 per
share (June 1996) 561,069 561 - 168,184 - 168,745
Sale of common stock,
net of expenses at
$0.16 per share
(July 1996) 4,620,015 4,620 - 715,380 - 720,000
Issuance of common
stock at $0.50 per
share to employees
for services performed
(July 1996) 500,000 500 - 249,500 - 250,000
F-6
Issuance of common
stock at $1.36 per
share for consulting
services performed
(July 1996) 250,000 250 - 388,960 - 389,210
Sale of common stock
at $5.00 per share,
net of expenses
(October 1996) 280,000 280 - 1,399,720 - 1,400,000
Compensation
recognized upon
issuance of stock
options - - - 2,493,873 - 2,493,873
Contribution of
Product License - - - 1,275,000 - 1,275,000
Net loss - - - - (8,193,395) (8,193,395)
----------- -------- -------- ----------- -------------- -------------
BALANCES, December 31,
(1996) 12,211,084 12,211 - 7,143,117 (8,195,795) (1,040,467)
Issuance of common
stock in exchange
for technology at
$5.00 per share
(January 1997) 100,000 100 - 499,900 - 500,000
Sale of common
stock, net of
expenses at $2.90
per share
(February 1997) 229,310 229 - 664,771 - 665,000
Acquisition of
Sierra Vista
net of expenses
at $0.37 per share
(May 1997) 8,514,500 8,515 - 3,158,283 - 3,166,798
F-7
Issuance of common
stock at $2.43 per
share for legal
services rendered
(June 1997) 7,003 7 - 16,976 - 16,983
F-8
Shares returned per
settlement agreement
at par value (500,000) (500) - 500 - -
Warrants issued with
sale of convertible
debentures
(December 1997) - - 968,578 - - 968,578
Allocation of proceeds
from notes payable and
long-term liabilities
due to beneficial
conversion features - - - 2,086,988 - 2,086,988
Compensation recognized
upon issuance of stock
options - - - 1,558,666 - 1,558,666
Net loss - - - - (10,822,980) (10,822,980)
---------- ---------- ---------- ----------- ------------ ------------
BALANCES, December 31,
1997 20,561,897 $ 20,562 $ 968,578 $15,129,201 $(19,018,775) $(2,900,434)
========== =========== ========== ============ ============= ============
</TABLE>
SEE ACCOMPANYING NOTES TO THESE CONSOLIDATED FINANCIAL STATEMENTS.
F-9
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
MARCH 3, 1993
<S> <C> <C> <C>
FOR THE YEARS ENDED (INCEPTION) TO
DECEMBER 31, DECEMBER 31,
1997 1996 1997
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (10,822,980) $ (8,193,395) $ (19,018,775)
--------------- --------------- ---------------
Adjustments to reconcile net
loss to net cash used in
operating activities:
Depreciation and amortization 173,656 21,175 194,831
Loss on disposal of property and
equipment 2,559 - 2,559
Interest related to beneficial
conversion features of notes
payable and long-term liabilities 1,101,107 - 1,101,107
Compensation recognized upon 3,648,083
issuance of stock or stock options 1,575,649 3,648,083 5,223,732
Contribution of product license - 1,275,000 1,275,000
Write down of purchased incomplete
research and development 500,000 - 500,000
Write-off of related party
receivable 45,532 94,062 139,594
Changes in operating assets and
liabilities:
Cash-restricted 1,026 (9,507) (8,481)
Prepaid and other expenses (173,427) 5,300 (176,627)
Film rights and film cost inventory (27,500) - (27,500)
Deposits (70,581) (19,298) (89,879)
Accounts payable 296,961 394,286 691,247
Accrued liabilities 291,680 814,100 1,108,180
------------ ------------ -------------
Net adjustments 3,716,662 6,223,201 9,933,763
------------ ------------ -------------
Net cash used in operating (7,106,318) (1,970,194) (9,085,012)
------------ ------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash received in acquisition of
Sierra Vista Entertainment 2,916,798 - 2,916,798
Cost incurred for organization of
joint venture (68,364) - (68,364)
Advance to related party (45,532) (94,062) (139,594)
Purchases of property and
equipment (768,181) (205,166) (973,347)
Proceeds from sale of assets 3,500 - 3,500
------------- ----------- --------------
Net cash provided by (used in)
inveseting activities 2,038,221 (299,228) 1,738,993
------------- ----------- --------------
F-10
CASH FLOWS FROM FINANCING ACTIVITIES:
Bank overdraft (38,574) 38,574 -
Proceeds from sale of common stock 665,000 2,224,170 2,897,670
Proceeds from notes payable 3,981,512 106,478 4,087,990
Net proceeds from sale of debenture
with detachable warrants 4,608,593 - 4,608,593
Principal payments on notes payable - (99,800) (99,800)
---------- ---------- --------------
Net cash provided by financing
activities 9,216,531 2,269,422 11,494,453
---------- ---------- ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 4,148,434 - 4,148,434
CASH AND CASH EQUIVALENTS,
beginning of period - - -
------------- ---------- -------------
CASH AND CASH EQUIVALENTS,
end of period $ 4,148,434 $ - $ 4,148,434
============= =========== =============
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash payments for:
Interest $ - $ 9,079 $ 9,079
============= =========== ============
Income taxes $ 4,800 $ - $ 4,800
============= =========== =============
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Net assets acquired, net of cash,
through acquisition of Sierra
Vista Entertainment $ 250,000 $ - $ 250,000
============= =========== =============
Return of 500,000 shares of
common stock per settlement
agreement $ 500 $ - $ 500
============= =========== =============
Acquisition of technology
for stock $ 500,000 $ - $ 500,000
============= =========== =============
</TABLE>
SEE ACCOMPANYING NOTES TO THESE CONSOLIDATED FINANCIAL STATEMENTS.
F-11
INNOVACOM, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS:
InnovaCom, Inc. ("the Company") was formed to develop, manufacture
and/or supply Very Large Scale Integrated Circuits ("VLSI") and other
related products for the specific application of broadcast quality
encoded video using the Second Generation Standard of the Motion
Picture Experts Group standard for video and audio compression ("MPEG-
2"). The Company employs VLSI to create an MPEG-2 digital video
encoding system on a chip.
The Company was formed pursuant to a business reorganization effective
July 10, 1996 between Jettson Realty Development, Inc. ("JRD"), a
Nevada corporation formed in 1990 and InnovaCom Corp. (InnovaCom
Florida), a Florida corporation formed in 1993. Under the
reorganization, JRD issued 6,000,000 previously unissued restricted
common shares in exchange for all of the issued and outstanding common
stock of InnovaCom Florida. JRD's board of directors then changed the
name of JRD to InnovaCom, Inc. and InnovaCom Florida became its wholly
owned subsidiary. Prior to the reorganization, JRD had no operations.
This transaction was accounted for as a reverse acquisition of JRD by
InnovaCom Florida.
On May 14, 1997, the Company acquired 100% of the issued and
outstanding shares of Sierra Vista Entertainment, Inc., a Nevada
Corporation ("Sierra Vista"), solely in exchange for common stock of
the Company. Sierra Vista was originally incorporated under the name
of Simone Anderson Productions under the laws of the state of Nevada
on April 3, 1996. Simone Anderson Productions changed its name to
Sierra Vista Entertainment, Inc. on February 21, 1997. Sierra Vista
was formed to produce, acquire, and distribute low-budget feature
films. The Company agreed to acquire all of the issued and
outstanding shares of common stock of Sierra Vista for 8,514,500
previously unissued shares of common stock of the Company. The
agreement between the Company and Sierra Vista obligates the Company
to use its best efforts to register the shares issued in the
acquisition with the SEC. The agreement calls for the Board of
Directors to consist of six members; three to be nominated by the
Company and three to be nominated by Sierra Vista, and the nominations
approved by all shareholders. The transaction was accounted for as a
purchase. Management believes that this transaction is a capital
transaction in substance rather than a business combination.
Therefore, no goodwill has been recorded. Sierra Vista had no
material activity prior to the merger, therefore, the statements
presented for the year ended December 31, 1997 resemble those that
would be shown in a proforma.
2. SIGNIFICANT ACCOUNTING POLICIES:
PRINCIPLES OF CONSOLIDATION - The consolidated financial statements
include the accounts of the Company and its wholly owned subsidiaries.
All significant intercompany accounts and transactions have been
eliminated in consolidation.
STATEMENT OF CASH FLOWS - For purposes of the statements of cash
flows, the Company considers all highly liquid debt instruments
purchased with an original maturity of three months or less to be cash
equivalents.
F-12
INNOVACOM, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
PROPERTY AND EQUIPMENT - Property and equipment are stated at cost.
Depreciation is calculated using the straight-line method over the
estimated useful lives (3 years) of the respective assets. The cost
of normal maintenance and repairs is charged to operations as
incurred. Material expenditures which increase the life of an asset
are capitalized and depreciated over the estimated remaining useful
life of the asset. The cost of fixed assets sold, or otherwise
disposed of, and the related accumulated depreciation or amortization
are removed from the accounts, and any gains or losses are reflected
in current operations.
FILM RIGHTS AND FILM COST INVENTORY - Film rights are stated at the
fair market value of the stock issued upon contribution to the
Company, which has become the cost of the assets, and consists of
screen plays, foreign films, and other materials related to the film
industry. Such amounts will be amortized to expense over their
estimated useful lives. In compliance with Financial Accounting
Standards Board (FASB) Statement Number 53 "Financial Reporting by
Producers and Distributors of Motion Picture Films," the Company has
capitalized production costs as film cost inventory. Such amounts
will be amortized using the individual - film - forecast - computation
method. Currently the Company has only incurred costs related to
story rights and scenarios.
DEBT ISSUANCE COSTS - Debt issue costs represent the offering costs
associated with the sale of the debentures (See Note 7) and are being
amortized using the interest method over the life of the debentures.
ACQUISITION COSTS - Acquisition costs represent the cost incurred to
date for the organization of the joint venture. (See Note 9) Such
costs will be considered additional purchase price if the joint
venture is ultimately formed, or otherwise charged to expense.
RESEARCH AND DEVELOPMENT COSTS - Research and Development costs are
charged to operations in the period incurred.
INCOME TAXES - The Company accounts for income taxes under the
liability method, which requires recognition of deferred tax assets
and liabilities for the expected future tax consequences of events
that have been included in the financial statements or tax returns.
Under this method, deferred tax assets and liabilities are determined
based on the difference between the financial statements and tax basis
of assets and liabilities using enacted tax rates in effect for the
year in which the differences are expected to reverse.
ACCOUNTING ESTIMATES - The preparation of financial statements in
conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the amounts
reported in the financial statements and the accompanying notes. The
actual results could differ from those estimates.
The Company's financial statements are based upon a number of
significant estimates, including the estimated useful lives selected
for property and equipment, amortization of film cost inventory and
other assets, and the adequacy of valuation allowances. Due to the
uncertainties inherent in the estimation process, it is at least
reasonably possible that these estimates will be further revised in
the near term and such revisions could be material.
F-13
INNOVACOM, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
IMPAIRMENT OF LONG-LIVED ASSETS - In the event that facts and
circumstances indicate that the cost of long-lived assets may be
impaired, an evaluation of recoverability would be performed. If an
evaluation is required, the estimated future undiscounted cash flows
associated with the asset would be compared to the asset's carrying
amount to determine if a write-down to market value or discounted cash
flow value is required.
STOCK-BASED COMPENSATION - The Company has elected to follow
Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" (APB25) and related interpretations in accounting
for its employee stock options. In accordance with FASB123 entitled
"Accounting for Stock-Based Compensation", the Company will disclose
the impact of adopting the fair value accounting of employee stock
options. Transactions in equity instruments with non-employees for
goods or services have been accounted for using the fair value method
prescribed by FASB123.
CONCENTRATIONS OF CREDIT RISK - Credit Risk represents the accounting
loss that would be recognized at the reporting date if counterparties
failed completely to perform as contracted. Concentrations of credit
risk (whether on or off balance sheet) that arise from financial
instruments exist for groups of customers or groups of counterparties
when they have similar economic characteristics that would cause their
ability to meet contractual obligations to be similarly effected by
changes in economic or other conditions. In accordance with FASB105
entitled "Disclosure of Information about Financial Instruments with
Off-Balance-Sheet Risk and Financial Instruments with Concentrations
of Credit Risk," the credit risk amounts shown in Note 10 do not take
into account the value of any collateral or security.
FAIR VALUE OF FINANCIAL INSTRUMENTS - The estimated fair values for
financial instruments, under FASB107 entitled "DISCLOSURES ABOUT FAIR
VALUE OF FINANCIAL INSTRUMENTS", are determined at discrete points in
time based on relevant market information. These estimates involve
uncertainties and cannot be determined with precision. The estimated
fair values of the Company's financial instruments, which includes all
cash, accounts payable, long-term debt, and other debt, approximates
the carrying value in the consolidated financial statements at
December 31, 1997.
EARNINGS PER SHARE - In February 1997, the FASB issued Statement of
Financial Accounting Standards No. 128, "Earnings per Share"
(FASB128). FASB128 provides for the calculation of "basic" and
"diluted" earnings per share versus primary and fully diluted earnings
per share. Basic earnings per share excludes dilution and is computed
by dividing income available to common stockholders by the weighted
average number of shares of common stock outstanding for the period.
Diluted earnings per share reflects the potential dilution that could
occur if securities or other contracts to issue common stock were
exercised or converted into common stock or resulted in the issuance
of common stock that then shared in the earnings of the entity. The
Company has implemented this statement for the current year and has
appropriately reflected the adoption in the statement of operations.
The results of operations and financial position were unaffected by
this implementation.
IMPACT OF RECENTLY ISSUED STANDARDS - The FASB recently issued
Statement of Financial Accounting Standards 130 "Reporting
Comprehensive Income" (FASB130) and Statement of Financial Accounting
Standards 131 "Disclosures About Segments of an Enterprise and Related
Information" (FASB131). FASB130 establishes standards for reporting
F-14
INNOVACOM, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
and display of comprehensive income, its components and accumulated
balances. Comprehensive income is defined to include all changes in
equity except those resulting from investments by owners and
distributions to owners. Among other disclosures, FASB130 requires
that all components of comprehensive income shall be classified based
on their nature and shall be reported in the financial statements in
the period in which they are recognized. A total amount for
comprehensive income shall be displayed in the financial statements
where the components of other comprehensive income are reported.
FASB131 supersedes Statement of Financial Accounting Standards 14
"Financial Reporting for Segments of a Business Enterprise." FASB131
establishes standards on the way that public companies report
financial information about operating segments in annual financial
statements and requires reporting of selected information about
operating segments in interim financial statements issued to the
public. It also establishes standards for disclosures regarding
products and services, geographic areas and major customers. FASB131
defines operating segments as components of a company about which
separate financial information is available that is evaluated
regularly by the chief operating decision maker in deciding how to
allocate resources and in assessing performance.
FASB130 and FASB131 are effective for financial statement for period
beginning after December 15, 1997 and require comparative information
for earlier years to be restated. Because of the recent issuance of
these standards, management has been unable to fully evaluate the
impact, if any, the standards may have on the future financial
statement disclosures. Results of operations and financial position,
however, will be unaffected by implementation of these standards.
3. BASIS OF PRESENTATION:
The financial statements have been prepared on a going concern basis,
which contemplates, among other things, the realization of assets and
the satisfaction of liabilities in the normal course of business.
However, there is substantial doubt about the Company's ability to
continue as a going concern because of the magnitude of its loss of
$10,822,980 for the year ended December 31, 1997, and its negative
working capital of $1,454,500 and its stockholder's deficit of
$2,900,434 as of December 31, 1997. The Company's continued existence
is dependent upon its ability to raise substantial capital, to
generate revenues and to significantly improve operations.
Management has taken several actions in response to these conditions.
In May 1997, the Company acquired Sierra Vista in exchange for shares
of its common stock (See Note 1). As a condition of completing the
transaction, Sierra Vista raised approximately $3,000,000 in a private
placement of its common stock, of which in excess of $2,000,000 was
allocated for the Company's operations. In June 1997, the Company
obtained a $5,000,000 convertible debt facility from a shareholder
(See Note 6). In December 1997, the Company sold $5,000,000 of 7%
convertible debentures through a private placement
(See Note 7). Management believes that these actions will allow the
Company to continue as a going concern.
Accordingly, the financial statements do not include any adjustments
relating to the recoverability and classification of recorded asset
amounts or the amount and classification of liabilities or any other
adjustment that might be necessary should the Company be unable to
continue as a going concern.
F-15
INNOVACOM, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. PROPERTY AND EQUIPMENT:
Property and equipment consists of the following:
DECEMBER 31,
1997
----
Computer and equipment $ 897,079
Office equipment and furniture 69,233
---------
966,213
Accumulated depreciation 193,855
---------
$ 772,457
=========
5. ACCRUED LIABILITIES:
Accrued liabilities consists of the following:
DECEMBER 31,
1997
----
Accrued payroll and benefits $ 377,841
Accrued consulting 216,402
Other 411,378
-----------
$ 1,005,621
===========
6. NOTES PAYABLE - RELATED PARTIES:
Note payable - shareholder bearing
interest at 10%, secured by all assets
of the Company. $ 4,083,247
Note payable - related party in the
original amount of $50,000 bearing
interest at 18%, collateralized by
certain stock of the Company, due on 7,927
demand (See Note 9)
-----------
$ 4,091,174
===========
F-16
INNOVACOM, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note payable - shareholder is related to a revolving convertible debt
facility with a shareholder that calls for maximum outstanding principal
balance not to exceed $5,000,000, bearing interest at 10%. The balance
includes all borrowing and accrued interest outstanding. The debt is
convertible into common stock at 80% of the market price for a share of
common stock at the time a draw is funded. The Company has recorded
interest expense and additional paid-in capital totaling $1,020,812 equal to
the intrinsic value of the beneficial conversion feature of the debt. The
principal and any unpaid interest are due June 1998.
7. LONG-TERM DEBT:
In December 1997, the Company issued $5,000,000 of 7% convertible
debentures, with two detachable warrants due December 2002. The net
proceeds from the issuance totaled $4,608,593 and are being used for
operations.
The sales price of the debenture was allocated between the debt securities
and the detachable warrants based on their relative fair values. In
addition to the $391,407 of offering costs paid, a third warrant was issued
as a finders fee. The third warrant entitles the holder to purchase 250,000
shares of the Company's common stock at a price of $2.43 per share and
expires December 2002. The total offering costs have been allocated
proportionately between the debentures and detachable warrants.
Each of the two warrants attached to the debt securities entitle the holder
to purchase up to 250,000 shares of the Company's common stock. The
exercise price of warrant one is $3.00 per share and for warrant two is
$4.00 per share. Both warrants expire December 2002.
The debentures are convertible into shares of common stock as follows:
1) 33% of the aggregate principal amount upon the earlier of (a)
effective date of registration of the shares or (b) the 120th day
after the Original Issue Date;
2) 33% of the aggregate principal amount at any time prior to the
150th day after the Original Issue Date; and
3) The balance any time after the 150th day after the Original Issue
Date and prior to the closing on the maturity date.
The conversion price to be used to determine the number of shares of common
stock into which the debentures can be converted is the lesser of (1) $3.47
per share or (2) the applicable percentage multiplied by the average market
price calculated on the conversion date. The applicable percentages are as
follows:
1) 85% of the average market price for any conversion prior to 120th
day after the Original Issue Date;
F-17
INNOVACOM, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2) 82.5% of the average market price for any conversion on or after
the 120th day and prior to 150th day after the Original Issue Date;
and
3) 80% of the average market price for any conversion after the 150th
day after the Original Issue Date.
The Company must maintain a minimum trading volume of its common stock and
must register the shares of common stock issuable upon conversion of the
debentures, payment of interest thereon and exercise of the warrants.
Interest is payable quarterly and may be paid with cash or registered shares
of common stock. Accrued interest in the amount of $8,069 is included in
accrued liabilities at December 31, 1997.
The outstanding balance of the debentures of $3,318,949 as of December 31,
1997 has been reduced from the face amount due to allocation of the relative
fair value of the detachable warrants and the beneficial conversion feature.
The discount totalled $1,758,051 and is being amortized using the interest
method. Amortization of the discount totalled $77,000 for the year ending
December 31, 1997 and is included in interest expense. The amount related to
the warrants ($691,875) is being amortized over the life of the debenture of
5 years. The discount related to the beneficial conversion feature
($1,066,176) is being amortized over the conversion period.
8. STOCKHOLDERS' EQUITY:
In March 1996, the Company granted 900,000 shares of common stock to two
directors for services performed in 1996. The Company has recognized
$450,000 in compensation expense related to their services for the year
ended December 31, 1996. The shares were valued by the Board of Directors,
and the 900,000 shares of common stock are the subject of current
litigation. (See Note 9)
In March 1996, a company controlled by the Company's president contributed a
license to the Company. The Company recorded the license at the cost
recorded by the contributing company of $1,275,000. (See Note 9,
Commitments and Contingencies, Product License.)
In July 1996, the Company issued 500,000 shares of common stock to certain
officers and directors of JRD for services rendered. The Company has
recognized $250,000 in compensation expense related to these services for
the year ended December 31, 1996. The shares were valued by the Board of
Directors, and the 500,000 shares of common stock are the subject of current
litigation (See Note 9).
In October, 1996, the Company adopted the 1996 Incentive and Nonstatutory
Stock Option Plan (the 1996 Plan) covering 1,500,000 shares. In 1997 this
was increased to 3,000,000 shares pending shareholder approval. Under the
plan, the Company can grant to key employees, directors, and consultants
either incentive, non-statutory, or performance based stock options. The
price of the options granted pursuant to the plan shall not be less than
100% of the fair market value of the shares on the date of grant. The board
of directors will decide the vesting period of the options, if any, and no
option will be exercisable after ten years from the date granted. Prices
F-18
INNOVACOM, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for incentive options granted to employees who own 10% or more of the
Company's stock are at least 110% of market value at date of grant.
During 1996, the Company issued 380,000 shares of common stock and options
to purchase 1,099,500 shares of common stock to consultants for services
rendered. The options were granted with exercise prices ranging from $0.001
to $3.00 per share, vesting throughout 1999 and expire from one to five
years after the date of grant. The majority of these options were granted as
a form of compensation to the consultants, and the exercise price was
determined by the then Board of Directors. Of the options granted, 369,500
were granted under the 1996 Plan and 700,000 were granted for services
rendered in connection with a private placement of the Company's common
stock. Certain of these options are the subject of litigation (See Note 9).
The Company has recognized $2,292,406 in compensation expense related to
these services for the options and $389,210 for the stock for the year ended
December 31, 1996. The 369,500 options granted under the Plan were forfeited
during 1997.
In October 1996, the Company granted non-plan options to purchase 3,500,000
shares of common stock to three individuals who are officers, directors and
shareholders of the Company. The options were granted with an exercise
price of $3.00 per share and expire in October 2001. The options vest as
follows: 1,166,666 vest if fiscal 1997 revenues exceeds $5,000,000,
1,166,667 vest if fiscal 1998 revenue exceeds $25,000,000 and 1,166,667 vest
if fiscal 1999 revenue exceeds $50,000,000. The 1,166,666 options related
to 1997 expired due to lack of performance. These options are the subject of
litigation. (See Note 9)
In January 1997, the Company purchased the rights to certain proprietary
technology from a third party in exchange for 100,000 shares of the
Company's common stock. This technology was valued at $500,000 or $5.00 per
share which was the current market value of the Company's common stock. At
December 31, 1997, the $500,000 of the technology cost is included in
research and development costs.
During 1997 and 1996, the Company granted options under the 1996 plan to
purchase 1,278,640 shares of common stock to employees who were hired in
1997 and 1996. The options were granted with exercise prices ranging from
$0.50 to $3.75 per share, expire in 2002 and vest over three years from the
date of hire. The Company has recognized $509,354 and $201,467 in
compensation expense related to services provided for the years ending
December 31, 1997 and 1996, respectively. During 1997, 171,050 of these
options were forfeited.
In April 1997, the Company granted options to purchase 100,000 shares of
common stock for $3.375 per share for a term of three years in exchange for
consulting services. Compensation expense in the amount of $272,480 was
recognized during the year ended December 31, 1997 for services provided.
In May 1997, the Company granted options to purchase 1,000,000 shares of
common stock under the 1996 Plan to an officer. The options were granted
with exercise prices ranging from $2.75 to $4.75 per share. 200,000 options
vested upon grant, the remainder vest upon attainment of certain performance
criteria.
F-19
INNOVACOM, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In July 1997, the Company granted 122,160 options to purchase common stock
for prices ranging from $0.50 to $3.00 per share for consulting services
rendered. Consulting expense in the amount of $374,295 was recorded for the
year ending December 31, 1997.
In July 1997, the Company retained the services of an investment advisor to
assist in raising up to $15,000,000 in a private placement. In connection
with these services, the Company granted options to purchase 400,000 shares
of common stock under the Plan at $2.50 per share. 200,000 of the options
were exercisable upon grant, the remainder will be exercisable upon the
successful completion of a $15,000,000 private placement.
In October 1997, the Company granted options to purchase 261,233 shares of
common stock to employees under the 1996 Plan. The options were granted with
an exercise price equal to market, $3.0625 per share. The options expire in
2002 and vest over three years or upon attainment of certain performance
criteria. As of December 31, 1997, 65,500 of these options were forfeited.
In November 1997, the Company granted options to purchase 105,000 shares of
common stock to employees under the 1996 Plan. The options were granted
with an exercise price equal to market, $2.5938 per share. The options
expire in 2002 and vest over three years or upon a specific date.
In November 1997, the Company granted non-plan options to purchase 1,500,000
shares of common stock to directors of the Company. The options were
granted with an exercise price equal to market, $2.5938 per share, and
expire in 2002. The options vest evenly over three years.
In December 1997, the president of the Company returned 500,000 shares of
common stock originally issued at par value. The stock was returned to
settle any potential claims the Company may hold against him relating to the
November 10, 1997 legal action described in Note 9. The return of these
shares was recorded based on their original issue cost.
F-20
INNOVACOM, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table sets forth activity for all options granted under the
Plan:
AVERAGE
EXERCISE PRICE
Number PER SHARE
------ ---------------
OUTSTANDING, from
inception - $ -
---------- ----------------
through December 31,1995
Granted 369,500 1.62
Forfeited - -
Exercised - -
---------- ---------------
BALANCE, December 31, 1996 369,500 1.62
Granted 3,044,873 2.60
Forfeited (606,050) 1.84
Exercised - -
---------- ---------------
BALANCE, December 31, 1997 2,808,323 $ 2.63
========== ===============
Presented below is a comparison of the weighted average exercise price and
market price of the Company's common stock on the grant date for all options
granted under the 1996 Plan during the year ended December 31, 1997.
1997
NUMBER EXERCISE MARKET
of Shares Price Price
Market price equal to
exercise price 1,064,533 $ 3.00 $ 3.00
Market price greater than
exercise price 940,340 $ 1.37 $ 3.39
Exercise price greater than
market price 1,040,000 $ 3.29 $ 2.53
F-21
INNOVACOM, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At December 31, 1997 options to purchase 958,557 shares were exercisable at
prices ranging from $0.50 to $3.375 per share. The remaining 1,849,766
options outstanding become exercisable as follows:
WEIGHTED
NUMBER OF AVERAGE
YEAR ENDING DECEMBER 31, SHARES EXERCISE PRICE
1998 1,337,647 $ 3.04
1999 340,666 1.44
2000 171,453 2.99
--------- ------
1,849,766 $ 2.74
========= ======
If not previously exercised, all options outstanding will expire during the
year ended December 31, 2002.
The following is a summary of all of the activity for non-plan options:
WEIGHTED
NUMBER OF AVERAGE PRICE
Shares Per Share
OUTSTANDING, from inception
through December 31, 1995 - $ -
Vested options granted to
consultants 730,000 2.90
Performance options
granted to officers 3,500,000 3.00
Vested options exercised by
consultants (30,000) 0.50
---------- ----------
BALANCE, December 31, 1996 4,200,000 3.00
Vested options granted to
consultants 217,500 2.89
Options granted to consultants 4,660 .50
Options granted to directors 1,500,000 2.59
Expired/cancelled options (1,171,667) 3.00
----------- -----------
BALANCE, December 31, 1997 4,750,493 $ 2.86
=========== ===========
F-22
INNOVACOM, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Presented below is a comparison of the weighted average exercise price and
market price of the Company's common stock on the grant date for all non-
plan options granted during the year ended December 31, 1997:
1997
NUMBER EXERCISE MARKET
of Shares Price Price
Market price equal to
exercise price 1,602,500 $ 2.64 $ 2.64
Market price greater than
exercise price 119,660 $ 2.43 $ 4.19
Exercise price greater than
market price - $ - $ -
At December 31, 1997 options to purchase 914,220 shares were exercisable at
prices ranging from $0.50 to $3.37 per share. The remaining 3,836,273
options outstanding become exercisable as follows:
WEIGHTED
YEAR ENDING NUMBER OF AVERAGE
DECEMBER 31, Shares Exercise Price
1998 1,668,888 $ 2.87
1999 1,667,387 2.88
2000 499,998 2.59
--------- ---------
3,836,273 $ 2.84
========= =========
If not previously exercised, all options will expire during the year ended
December 31, 2002.
As stated in Note 2, the Company has not adopted the fair value accounting
prescribed by FASB123 for employees. Had compensation cost for stock options
issued to employees been determined based on the fair value at grant date
for awards in 1997 and 1996 consistent with the provisions of FASB123, the
Company's net loss and net loss per share would have been adjusted to the
proforma amounts indicated below:
1997 1996
Net loss $ (12,352,083) $ (8,229,908)
============== =============
Net loss per common share $ (.69) $ (.98)
============== =============
The fair value of each option is estimated on the date of grant using the
present value of the exercise price and is pro-rated based on the percent of
time from the grant date to the end of the vesting period. The weighted-
F-23
INNOVACOM, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
average fair value of the options on the grant date for 1997 and 1996 was
$2.10 and $3.22 per share, respectively. The following assumptions were
used for grants in 1997 and 1996: risk-free interest rates of 6.22% and
6.17%, respectively; expected lives of three years; dividend yield of 0%;
and expected volatility of 144.0% and 164.7%, respectively.
9. COMMITMENTS AND CONTINGENCIES:
In June 1997, the Company entered into an agreement with a foundry company in
anticipation of manufacturing the Company's single chip MPEG-2 encoder. The
agreement calls for payment of $225,000 for design and manufacture of the
chip. As of December 31, 1997, the Company made a $90,000 non-refundable
deposit to this entity for the start of design work. The remaining amounts
are due upon shipment of the prototypes.
In July 1997, the board of directors approved the Company entering into an
agreement to obtain a 66% interest in a joint venture with China
International Radio Development. As part of this agreement, the Company
will have to fund up to $200,000 of expenses. The purpose of the joint
venture is to develop an exhibition center in China to display new high-tech
products. In connection with obtaining the joint venture interest, the
Company will be issuing 100,000 shares of common stock to a third party as a
finder's fee upon close of the agreement. As of December 31, 1997, the
Company had not made this investment.
In July 1997, the Company entered into an interim agreement to acquire all
of the issued and outstanding shares of Technical Systems Associates ("TSA")
in exchange for 100,000 shares of common stock. In October 1997, the
Company rescinded the interim agreement and entered into an Option to
Purchase and Mutual Release Agreement. Under the new agreement, the Company
had the option to purchase TSA under the terms of the interim agreement
through November 30, 1997 in exchange for $300,000. In addition, the
Company agreed to provide up to $150,000 in debt financing if TSA obtained a
certain purchase order. The debt financing was never provided. In January
1998, the Company entered into an Accord and Satisfaction and Release
Agreement which stated that the Company would make a final payment in the
amount of $58,000 to TSA for full release from any prior agreements entered
into. This amount is included in accrued liabilities at December 31, 1997.
LEASES
The Company leases office space in California and certain office equipment
under long-term operating leases. The Company's leases include the cost of
real property taxes and maintenance expenses. Insurance and utilities are
the Company's responsibility. Future minimum lease payments for all non-
cancelable operating leases are as follows:
F-24
INNOVACOM, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDING DECEMBER 31, AMOUNT
1998 $ 549,387
1999 490,615
2000 401,685
2001 349,306
2002 348,688
-----------
$ 2,139,681
===========
Rent expense was $193,214 for 1997.
EMPLOYMENT AGREEMENT
In connection with the acquisition of Sierra Vista Entertainment, Inc. (See
Note 1), the Company entered into five year employment agreements with its
president and the president of Sierra Vista which provide for minimum annual
salaries totaling $420,000 and other incentives, as well as severance
payments equal to one year's salary for termination without cause, and three
years salary for termination without cause in connection with a change in
control.
LITIGATION
On October 7, 1996, the Company filed a complaint for declaratory relief
against a former employee. The lawsuit states that the person breached a
written employment agreement between the two parties. In response to the
action, the employee filed a similar cross-complaint, which was subsequently
amended after an unsuccessful mediation process. The amended cross
complaint seeks damages in excess of $5,000,000 and 2% of the Company's
stock outstanding as of April 1996. Management intends to pursue and defend
this lawsuit vigorously and believes, based on current information, that no
material adverse impact will arise as a result of the litigation.
On December 27, 1996, the Company issued a purchase order to Compass Design
Automation (Compass) in the amount of $1,021,300 for software tools. On
March 18, 1997, the Company canceled this purchase order because it believes
Compass reneged on certain commitments. In July 1997, Compass made a demand
for payment. Company management has had discussions with Compass to resolve
this issue, however, no agreement has been reached. Management believes,
based on current information, that any settlement would not have a material
adverse impact on the Company.
On June 18, 1997, the Decorah Company and Edwin Reedholm, a shareholder and
former director and officer, commenced a lawsuit seeking to recover in
excess of $900,000 on a promissory note given to the plaintiffs by Digital
Hollywood, Inc., a company controlled by the Company's president. The
Company's president allegedly guaranteed the note through the pledging of
approximately six million shares of the Company's stock. In addition to the
original note amount, the Decorah Company and Edwin Reedholm seek to recover
the pledged shares as well as a $7,225 balance on a promissory note
F-25
INNOVACOM, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
including interest and $69,746 in accrued wages and other expenses, both of
which are accrued as of December 31, 1997. Management believes, based on
current information, that this lawsuit will have no additional material
adverse impact on the Company.
Future Tel, Inc., filed claims amounting to $123,000 against the Company for
recovery of unpaid lease payments and wages under an alleged reimbursement
agreement. The parties have reached an agreement whereby the Company will
pay $100,000. The Company has accrued this amount as of December 31, 1997.
On November 10, 1997 the Company filed a suit against former officers and
directors of the Company for breach of fiduciary duty and third parties who
were involved in the initial merger between the Company and Jettson Realty
Development as well as private placements of the Jettson Realty Development
stock. The suit claims fraud, breach of fiduciary duty and negligence
surrounding the acquisition. As part of this lawsuit, a director of the
Company has filed a counterclaim asserting approximately $11,000,000 in
damages. In addition, the suit also seeks to remove restrictive legends on
the stock currently owned. The Company has accrued $75,000 for unpaid wages
as of December 31, 1997. Management believes that this lawsuit will not have
any material adverse impact on the Company. The litigation is in its initial
stages and no discovery has commenced. Management intends to pursue this
lawsuit vigorously and believes, based on current information, that no
material adverse impact will arise as a result of the litigation. The
Company has entered into a settlement agreement with the Company's president
related to this suit whereby the Company's president agreed to return
500,000 shares of common stock. (See Note 8)
On December 10, 1997, certain employees filed suit against the Company for
compensation and waiting time penalties. The parties have reached an
agreement whereby the Company will pay $34,370. The Company has accrued
this amount at December 31, 1997.
A former consultant has asserted claims against the Company for unpaid
compensation of approximately $30,000 and stock option rights involving
169,500 shares. Settlement discussions are now underway. The unpaid
compensation has been accrued as of December 31, 1997. Management believes,
based on current information, that this lawsuit will not have any additional
material adverse impact on the Company.
PRODUCT LICENSE
In March 1996, a company controlled by the Company's president contributed a
license to the Company. The Company recorded the license at the cost
recorded by the contributing company of $1,275,000. The license grants the
Company rights to use and grant sublicenses to use proprietary technology to
develop the MPEG-2 video encoding systems on a chip. In accordance with
Statement of Financial Accounting Standards 2, the cost of intangibles that
are acquired from others for a particular research and development project
and that have no alternative future use are research and development costs
at the time the costs are incurred. As stated in Note 2, research and
development costs are charged to operations in the period incurred.
Consequently, the cost of acquiring the license was charged to research and
development expense during 1996.
F-26
INNOVACOM, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company is committed under the license to pay royalties to a third party
for a percentage of gross revenue on sublicenses and for a percentage of the
Foundry price for silicon in connection with sales to end users as follows:
12- MONTH PERIOD
Ending March 26, Percentage
1998 15%
1999 8%
2000 5%
2001 3%
2002 1%
2003 1%
The maximum amount of royalties to be paid under the license shall not
exceed $3,000,000. No royalties have been earned or paid through December
31, 1997.
10. SIGNIFICANT CONCENTRATIONS OF CREDIT RISK:
As of December 31,1997, the Company maintained cash in banks that was
approximately $3,648,000 in excess of the federally insured limited.
11. RELATED PARTY TRANSACTION:
During 1997 and 1996, the Company made advances to a company controlled by
the Company's president totaling $45,532 and $94,062, respectively.
Management does not believe that the advances made are realizable and, as a
result, has written off the receivable as of December 31, 1997, and 1996.
In October 1997, the Company agreed to acquire certain patents from a
company controlled by the Company's president in exchange for 2,000,000
shares of common stock. As of February 6, 1998, the exchange had not taken
place.
F-27
INNOVACOM, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. INCOME TAXES:
Income tax expense is comprised of the following:
MARCH 3, 1993
FOR THE YEAR ENDED (INCEPTION) TO
DECEMBER 31, DECEMBER 31,
1997 1996 1997
Current
Federal $ - $ - $ -
State 3,200 800 6,400
---------- ---------- ---------
3,200 800 6,400
---------- ---------- ---------
Deferred
Federal - - -
State - - -
---------- ---------- -------
Income tax expense $ 3,200 $ 800 $ 6,400
========== ========== =======
Deferred income tax assets (liabilities) are comprised of the following
at December 31, 1997:
Current deferred income tax assets
(liabilities):
Accounts receivable allowance $ 13,767
Accrued vacation 42,648
Accrued wages 102,813
Stock based compensation 1,626,689
Accrued settlement 74,002
Other 2,193
-------------
1,862,112
Valuation allowance (1,862,112)
-------------
Net current deferred tax asset $ -
=============
Long-term deferred tax assets (liabilities):
Depreciation/amortization $ 217,720
Net operating loss carryforward 4,801,223
Research and development credit 521,364
-------------
5,540,307
Valuation allowance (5,540,307)
-------------
Net long-term deferred tax asset $ -
=============
F-28
INNOVACOM, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Total income tax expense differed from the amounts computed by applying the
U.S. federal statutory tax rates to pre-tax income as follows:
MARCH 3, 1993
FOR THE YEARS ENDED (INCEPTION) TO
DECEMBER 31, DECEMBER 31,
1997 1996 1997
Total expense (benefit) computed
by applying the U.S. statutory rate (34.0%) (34.0%) (34.0%)
statutory rate
Nondeductible license costs - 5.3 2.3
Effect of valuation allowance 34.0 28.7 31.7
------ ------ ------
- % - % - %
====== ====== =======
As of December 31, 1997, the Company has available net operating loss
carryforwards for income taxes of $11,052,533 for federal purposes and
$11,218,948 for California purposes which begin to expire in the year 2011 and
2001, respectively. The benefit of the net operating loss to offset future
taxable income may be subject to limitation as a result of changes in stock
ownership as prescribed in Internal Revenue Code Section 382.
13. BUSINESS SEGMENTS:
The Company's operations have been classified into two business segments:
technology and motion picture. The technology segment includes the
development, manufacture, and/or supply of MPEG-2 video encoding systems and
other related products. The motion picture segment includes the production,
acquisition and distribution of feature films.
F-29
INNOVACOM, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Summarized financial information by segment for the year ended December 31,
1997 is as follows:
<TABLE>
<CAPTION>
ADJUSTMENTS
AND
TECHNOLOGY MOTION PICTURE ELIMINATIONS CONSOLIDATED
<S> <C> <C> <C> <C>
Revenues $ 149,000 $ - $ - $ 149,000
Interest income 6,080 4,382 - 10,462
Interest expense (1,214,237) - - (1,214,237)
Loss before income
tax expense (10,304,250) (515,530) - (10,819,780)
Depreciation and
amortization 169,259 4,397 - 173,656
Capital expenditures 715,151 53,030 - 768,181
Identifiable assets 7,393,890 2,685,089 (3,872,423) 6,206,556
</TABLE>
During 1997, the Company acquired the motion picture segment, therefore,
there are no segments to report for the year ended December 31, 1996.
14. SUBSEQUENT EVENTS:
In January 1998, the Company established the InnovaCom, Inc. 401(K) Profit
Sharing Plan (the Plan) covering substantially all of its employees and the
employees of its subsidiaries. Management determines, at its discretion,
the amount of any matching or other contributions to the Plan.
In February 1998, the Company granted 142,500 options to employees under the
1996 Plan. The options were granted at market of $2.50 per share, and vest
over 3 years at 30% for the first year, 30% for the second year, and 40% in
the third year.
In February 1998, the Company established a Gecko Chip Release Bonus whereby
if a prototype of the Gecko chip is functioning by April 30, 1998, the
design team will be eligible for a cash payment of $60,000 plus 100,000
options, with the distribution to be determined by the design team manager.
In February 1998, the Company established a bonus pool for the design team
working on the Gecko chip. The team members employed on January 1, 1998
would be eligible for 2% of the 1998 revenue generated by the Gecko chip and
1% of the 1999 revenue generated by the Gecko chip. The 1999 bonus shall not
exceed $600,000. Eligibility will be determined based on employment status.
On March 23, 1998, the Company hired a new individual to become President,
Chief Executive Officer and a member of the Board of Directors of the
Company effective May 1, 1998. The Company has entered into an employment
agreement with this individual which provides for a signing bonus of
$200,000 and an annual salary of $250,000 and other incentives including
options to purchase up to 1,000,000 shares of the Company's common stock for
$1.75 per share and severance payments up to $1,000,000 for termination
without cause. The options expire in ten years. One third of the options
vest immediately, one third vest in one year and the remainder vest in two
years. The initial term of the employment agreement is five years. The
employment agreement is contingent on the Company's obtaining $5,000,000 in
financing on or before April 15, 1998, and securing its performance under
the agreement by the issuance of a $1,000,000 letter of credit.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-KSB
FILED BY INNOVACOM, INC. AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 4,156,914
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 4,333,541
<PP&E> 966,213
<DEPRECIATION> 193,855
<TOTAL-ASSETS> 6,206,556
<CURRENT-LIABILITIES> 5,788,041
<BONDS> 0
<PREFERRED-MANDATORY> 0
<PREFERRED> 0
<COMMON> 20,562
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 6,206,556
<SALES> 0
<TOTAL-REVENUES> 0
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 9,762,446
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,214,237
<INCOME-PRETAX> (10,819,780)
<INCOME-TAX> 3,200
<INCOME-CONTINUING> (10,822,980)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (10,822,980)
<EPS-PRIMARY> (.60)
<EPS-DILUTED> (.60)
</TABLE>