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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(Mark One)
[x] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934
For the fiscal year ended December 31, 1998
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 For the transition period from _______________to__________________
COMMISSION FILE NUMBER: 000-23329
C3, INC.
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(Exact name of Registrant as specified in its charter)
North Carolina 56-1928817
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(State or other jurisdiction of incorporation) (I.R.S. Employer Identification No.)
3800 Gateway Boulevard, Suite 310, Morrisville, N.C. 27560
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (919) 468-0399
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Securities registered pursuant to Section 12(b) of the Act:
None
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Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value per share
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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-K 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-K or any amendment to this
Form 10-K [X].
The aggregate market value of the voting stock held by non-affiliates of the
Registrant as of January 31, 1999 was $111,892,944. On January 31, 1999 there
were 6,993,309 outstanding shares of the Registrant's Common Stock.
DOCUMENT INCORPORATED BY REFERENCE
Certain portions of the Proxy Statement of the Registrant for the Annual Meeting
of Shareholders to be held on May 17, 1999 have been incorporated by reference
into Part III of this Annual Report on Form 10-K.
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FORWARD LOOKING STATEMENTS
This Form 10-K contains forward-looking statements within the meaning of Section
27A of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. These forward-looking statements represent the
Company's judgment on future events. Because the Company is in the early stages
of its key supplier's establishment of manufacturing processes and capacity and
of building the Company's own distribution channels and has not yet engaged in
significant revenue-producing activities, the Company is subject to risks and
uncertainties that could cause the Company's actual performance and results to
differ materially from those projected or discussed herein. These risks and
uncertainties are discussed in "Business Risks" in Item 1 below and in "Risk
Factors" in the Company's Prospectus dated November 14, 1997.
PART I
ITEM 1. BUSINESS
INTRODUCTION
The Company manufactures, markets and distributes lab-created moissanite
gemstones (hereinafter referred to as moissanite or moissanite gemstones) for
sale in the jewelry market. Moissanite, also known by its chemical name, silicon
carbide (SiC), is a rare, naturally occurring mineral found primarily in
meteorites. See "--Moissanite." Moissanite is being marketed as an exclusive new
gemstone with properties, including brilliance, fire, luster and hardness that
rival other fine gemstones like diamonds, rubies and emeralds. See
"--Distribution, Marketing and Sales".
From its inception in June 1995 through June 30, 1998, the Company was a
development stage enterprise that devoted its resources to funding research and
development of moissanite gemstones, market research, developing initial
consumer marketing themes and assembling a management team. The Company began
shipping moissanite to jewelry retailers in Atlanta and Miami/Ft. Lauderdale
during the second quarter of 1998, and, in July 1998, launched consumer-focused
advertising and promotion activities in those areas. During the second half of
1998 the Company expanded the number of authorized retail jewelers in the
southeastern states of North Carolina, South Carolina, Georgia and Florida. In
addition, the Company continued limited distribution and promotional activities
in domestic locations outside this region. The Company also entered into
exclusive distribution agreements with a number of international distributors.
See "--Distribution, Marketing and Sales".
The Company's moissanite gemstones are currently made from SiC crystals grown by
Cree Research, Inc. ("Cree"). Cree has an exclusive license to a patent related
to a process for growing large single crystals of SiC. To the Company's
knowledge, there are currently no producers of SiC other than Cree that could
readily supply lab-grown SiC crystals in qualities, sizes or volumes suitable
for use as gemstones. The Company has certain exclusive licenses and supply
rights with Cree for SiC materials to be used for gemstone applications. See
"--Products and Product Development" and "Business Risks." The Chief Executive
Officer of the Company and one of the founders of the Company are the brothers
of the Chief Executive Officer of Cree. As of August 7, 1998, based on the
shareholdings reported in Cree's Proxy statement dated October 1, 1998, Cree and
certain of its officers and directors own approximately five percent (5%) of the
Company's outstanding Common Stock.
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The Company believes that its sales volumes will increase as the yield of
salable gemstones from each crystal provided by Cree increases, larger diameter
crystals are produced, additional crystal growth capacity is added, and as the
market introduction of moissanite gemstones expands geographically. As
distribution of moissanite expands, the Company will incur increasing spending
levels as it continues to make investments in development efforts with Cree to
increase production volumes and yields, as it makes investments in receivables,
inventory and manufacturing equipment, and as it increases advertising,
marketing and personnel expenditures. The Company expects to continue operating
at a loss through at least part of 1999. Moreover, there can be no assurance
that the Company will ever achieve the expected sales increases or profitability
or that if profitability is achieved, that such profitability can be sustained.
See "Business Risks."
THE JEWELRY MARKET
In 1997, worldwide retail jewelry sales were estimated to be in excess of $90
billion and jewelry sales in the United States were estimated to be
approximately $35 billion. The volume of natural diamond, ruby, emerald and
sapphire imported into the U.S. for jewelry consumption exceeds 30 million
carats annually. In comparison, slightly more than 18,000 carats of moissanite
were shipped worldwide in 1998 demonstrating the exclusive nature of this
product.
DIAMOND JEWELRY. In 1997, worldwide retail diamond jewelry sales were estimated
to be in excess of $52 billion and diamond jewelry sales in the United States
were estimated to be $ 20.4 billion. In 1997, approximately 70 million pieces of
diamond jewelry were sold worldwide of which over 32 million were sold in the
United States. Over 80% of the diamond jewelry pieces sold domestically used
settings other than engagement rings (i.e., pendants, bracelets, etc.).
DISTRIBUTION CHANNELS. Traditionally, jewelry has been sold to consumers through
independent and chain jewelry stores and department stores. However, in the past
two decades, non-traditional distribution channels have emerged including
catalog showrooms, mass-market discounters, price clubs, mail order, TV shopping
channels and the internet. Moissanite currently is sold through single and
multiple location independent jewelry stores. Independent jewelry stores
comprise approximately 50% of the estimated 40,000 retail jewelry outlets in the
United States.
MOISSANITE
Moissanite is a rare, naturally occurring mineral which is found primarily in
meteorites. The naturally occurring moissanite that has been found has generally
been very small in size and dark green or black in color and is not a
commercially viable gemstone material. Therefore, only lab-grown SiC crystals
are expected to provide a meaningful source of moissanite for gemstones.
The Company believes that moissanite gemstones have unique features that compare
favorably to diamond and other fine gemstones and that make it attractive for
use as a gemstone which will result in market demand for the Company's products.
Because of its unique atomic structure, moissanite can be grown in a variety of
colors including blue, green or yellow. Additionally, although none have been
produced to date, the color red is theoretically possible to grow. To date, the
Company has focused its development, manufacturing and distribution efforts on
the colorless form of moissanite.
It is generally accepted that, in addition to carat size, the most important
characteristics of a gemstone are its beauty, durability and rarity. The beauty
of gemstones is determined by the stone's color, brilliance,
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"fire" and luster. The brilliance of a gemstone is measured by its refractive
index or the extent to which it reflects light. The "fire" of a gemstone, or the
breaking of light rays into the spectrum of colors, is measured by its
dispersion. Luster is the amount of light that is reflected back to the observer
from the surface of the gemstone. The durability of a gemstone is determined by
the gem's hardness, or resistance to scratching, and its toughness, or
resistance to chipping or cleaving. The gemstone's hardness also determines the
extent to which brilliance and "fire" can be highlighted by cutting with sharp,
highly polished facets. Rarity is the availability or perceived availability of
a gemstone.
Based on their physical properties, the Company believes that moissanite
gemstones compare favorably to diamond, ruby, emerald and other fine gemstones
for beauty and durability. The refractive index and dispersion of moissanite
gemstones are higher than other fine gemstones. The Company believes that the
hardness of moissanite gemstones is greater than all known gemstone materials
except diamond. As a result, the Company believes that moissanite gemstones,
like diamond, can be cut with sharp, highly polished facets that accentuate
their brilliance and "fire." The cutting specifications for moissanite gemstones
are designed to maximize the brilliance and fire inherent in the material.
Additionally, the Company evaluates the finished stones to exacting standards
with automated video-imaging equipment and specially trained quality control
personnel. In light of the very rare natural occurrence of moissanite and the
proprietary and technical limitations in producing gem quality moissanite, the
Company believes that moissanite is among the rarer gemstones.
The Company believes that other physical properties of moissanite gemstones
compare favorably to diamond and other fine gemstones and will aid in jewelers'
acceptance of its products. Moissanite gemstones, like diamond, can withstand
high temperatures which allows jewelers to make extensive repairs to the jewelry
setting without removing the stone and to use the same basic methods that are
used to repair diamond jewelry.
The following table compares the physical properties of moissanite gemstones
with other fine gemstone materials:
Gemstone Material Comparison (1)
Hardness Refractive Specific
Gemstone Material (Mohs Scale) (2) Toughness Index Dispersion Gravity
- ----------------- ---------------- --------- ----- ---------- -------
Diamond 10 Good* 2.42 .044 3.52
Lab Created Moissanite (3) 9.25-9.50 Excellent 2.65-2.69 .090-.104 3.14-3.22
Sapphire & Ruby 9 Excellent 1.76-1.78 .018 3.90-4.00
Emerald 7.5 Poor to Good 1.56-1.60 .014 2.69-2.75
* In cleavage directions, otherwise excellent.
1. Sources: Gemological Institute Of America, Gem Reference Guide For The GIA
Colored Stones, Gem Identification And Colored Stone Grading Courses
32-35, 65-82, 87-90 (1995); Cornelius S. Hurlburt, Jr. & Robert C.
Kammerling, Gemology 320-324 (2d Ed. 1991); Kirk-Othmer Encyclopedia Of
Chemical Technology 891-906 (4th Ed. 1994); Institution Of Electrical
Engineers, Properties Of Silicon Carbide (Gary L. Harris, Ed., 1995);
Robert Webster, Gems: Their Sources, Descriptions and Identification
889-940 (5th Ed. 1994); W. Von Muench, "Silicon Carbide" in
Landolt-Boemstein Numerical Data and Functional Relationships in Science
and Technology, New Series, Group III, Vol. 17C, pp. 403-416 and 585-592
(M. Schultz And H. Weiss, Eds., 1984); Kurt Nassau, Shane F. McClure,
Shane Elen & James E. Shigley, "Synthetic Moissanite: A New Diamond
Substitute" in Gems & Gemology, Winter 1997, 260-275.
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2. The Mohs Scale is approximately logarithmic and quantitative comparisons
of different gemstone materials cannot be made directly using the Mohs
Scale. Moissanite gemstones are approximately 1/2 to 1/3rd as hard as
diamond.
3. With the exception of the "Synthetic Moissanite: A New Diamond Substitute"
article, the physical properties of moissanite gemstones set forth in the
preceding table utilized materials from SiC crystals produced by parties
other than the Company or Cree. These crystals had various sizes, colors
and atomic structures that the Company believes made them unsuitable for
use as a gemstone. The Company has conducted tests on the hardness,
toughness and refractive index of samples of its gemstones, and the
results of these tests are consistent with the results reported in this
table. Because the Company, through development programs with Cree,
continues to work toward improved quality of SiC crystals, the specific
properties of the moissanite gemstones that will eventually be
commercialized are not now known. However, the Company believes that the
physical properties of its moissanite gemstones will fall within the
ranges of the moissanite shown in this table.
PRODUCTS AND PRODUCT DEVELOPMENT
MOISSANITE GEMSTONES. The Company currently sells primarily colorless moissanite
gemstones cut in the round brilliant shape in sizes ranging from 3 to 9mm
(approximately .09 to 2.3 carats) to authorized domestic retail jewelers and
exclusive international distributors. The Company also has available for sale to
its authorized retail customers a limited number of pieces of custom designed
jewelry featuring moissanite gemstones. The Company offers this jewelry as a
result of customer demand and to explore other means of distributing moissanite
gemstones. For the foreseeable future, the Company plans to continue to sell
loose round brilliant cut moissanite gemstones primarily in sizes of two carats
or less. Demand for larger size stones in the one to two carat range currently
exceeds supply. Over time, the Company intends to market a greater percentage of
larger carat gemstones depending on progress made by Cree in improving yields.
In 1999, the Company began distribution of a limited quantity of green
moissanite gemstones to evaluate the market potential of colored moissanite. In
addition, the Company may elect to offer, from time to time, additional cuts or
colors of moissanite gemstones.
AMENDED AND RESTATED EXCLUSIVE SUPPLY AGREEMENT WITH CREE. On June 6, 1997, the
Company and Cree entered into the Amended and Restated Exclusive Supply
Agreement (Exclusive Supply Agreement) whereby the Company has agreed to
purchase from Cree at least fifty percent (50%), by dollar volume, of the
Company's requirements for SiC crystals for the production of gemstones in each
calendar quarter during the term of the Agreement, and Cree is obligated to
supply this amount of crystals to the Company. Although the Company is obligated
to purchase only fifty percent (50%) of its requirements from Cree, the Company
does not believe there are currently any other alternative sources of supply for
SiC crystals suitable for gemstones. Therefore, at the present time, the Company
is dependent on Cree as its sole source of supply of lab-grown SiC crystals. The
price for SiC crystals is set at Cree's loaded manufacturing cost plus a margin,
which margin may increase if the price of crystals declines below a specified
amount. Through June 30, 1999 the Company has agreed to purchase all crystals
produced by existing crystal growers and the Company and Cree have agreed that
the price paid to Cree for SiC crystals will be based upon a sliding scale
depending on the quality of each crystal received. Under the Exclusive Supply
Agreement, Cree has agreed not to sell SiC crystals for gemstone applications to
anyone other than the Company.
Under the terms of the Exclusive Supply Agreement, when C3's orders for SiC
crystals exceeds the capacity of the existing crystal growth systems, Cree may,
at its sole discretion, elect to have the Company purchase the additional growth
systems that will be needed or to fund the cost of the systems on its own and
recoup its costs by incorporating the costs of the additional systems into the
cost of the SiC crystals purchased by the Company. If the Company funds the
costs of the crystal growth systems, Cree must supply the Company with one
hundred percent (100%) of the output from these systems,
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unless Cree gives notice of certain production time available in excess of the
Company's then-current demand and C3 does not demonstrate a need for the excess
production capacity, in which case Cree may sell SiC crystals produced by these
systems to any of its other customers for any use other than gemstone
applications. The title to these crystal growth systems passes to Cree once they
are fully depreciated by C3. If Cree elects to fund the cost of additional
growth systems on its own, there can be no assurance that Cree will supply the
Company with all of the output from these crystal growth systems or fill all of
the Company's orders, however it will be obligated to use the capacity to supply
the quantities that the Company is required to purchase from Cree. Additionally,
when new crystal growth systems are added, the Company must commit to purchase
all of the output of the new systems for at least six months. Any delay or
reduction in the availability of SiC crystals could delay or limit the Company's
ability to deliver and sell its gemstones, which would have a material adverse
effect on the Company. See "Business Risks - Reliance on Cree Research, Inc."
In May 1998 the Company ordered quantities of SiC crystals exceeding the
capacity of the existing crystal growth systems. Cree elected to have the
Company purchase $3.4 million of additional crystal growers. The first of these
crystal growers became operational in August 1998 with all the ordered growers
on-line by December 1998. The Company funded this purchase on a monthly basis as
the systems were manufactured.
The Exclusive Supply Agreement also restricts the Company from entering into
numerous types of arrangements with identified parties. See "--Distribution,
Marketing and Sales" and "Business Risks--Anti-Takeover and Certain Other
Provisions." The Exclusive Supply Agreement has an initial term through June
2005, which may be extended for an additional ten years by either party if the
Company orders in any 36-month period SiC crystals with an aggregate purchase
price in excess of $1.0 million. The Company has met this order threshold and
expects to extend the term of the Agreement.
AMENDED AND RESTATED DEVELOPMENT AGREEMENT WITH CREE. On July 1, 1998, the
Company entered into an Amended and Restated Development Agreement (Development
Agreement) with Cree, which is focused on increasing the yield of usable
material in each SiC crystal manufactured by Cree for use by C3 in the
production of moissanite gemstones. In June 1998 Cree demonstrated its ability
to meet the definition of a "repeatable process" for 2-inch diameter crystals
and began to produce 2-inch crystals using that process. The Development
Agreement establishes performance milestones, primarily focused on yield
improvement, for 1999 and contemplates that the Company and Cree will revise the
performance milestones annually to provide both parties with more flexibility to
pursue further color and yield improvements on both 2-inch and 3-inch diameter
crystals. The 4-year Development Agreement replaces the June 1997 Development
Agreement and the 1998 Supplemental Development Agreement between the parties
and requires the Company to fund the program at $2.88 million annually. Either
party may terminate the Agreement if Cree does not meet the annual performance
milestones or if the Company and Cree do not mutually agree on the performance
milestones for the ensuing year. The Company expensed $3.1 million, $1.7 million
and $0.2 million under development arrangements with Cree in 1998, 1997 and 1996
respectively.
In addition, on October 20, 1998, Cree achieved the first milestone for 3-inch
diameter crystals under the Development Agreement by producing, in development,
a 3-inch crystal meeting mutually agreed upon yields of useable material. A
3-inch crystal can produce approximately twice as many moissanite gemstones as a
2-inch crystal with the same percentage yield of useable material. Future
activities under the development program will be focused on moving this initial
achievement to a repeatable process with continued efforts to maximize the
crystal quality.
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MOISSANITE/DIAMOND TEST INSTRUMENT. Gemstone test instruments most commonly used
by jewelry industry employees rely on thermal properties to distinguish diamond
from other gemstones or diamond simulants such as synthetic cubic zirconia.
Because the thermal properties of moissanite gemstones are relatively close to
those of diamond, such instruments have not, to date, been able to reliably
differentiate between diamond and moissanite gemstones. Although gemologists
trained in the physical properties of moissanite gemstones may find a number of
ways to distinguish moissanite from diamond, the Company believes that a
moissanite/diamond test instrument must be available to jewelers and pawnbrokers
to help prevent fraud.
The Company began shipping its moissanite/diamond test instrument, the Tester
Model 590, during the first quarter of 1998. This instrument, which
distinguishes moissanite gemstones from diamonds in the colors and clarities
most commonly sold by retail jewelers, is used in conjunction with existing
thermal test instruments. A number of other companies have introduced devices
that claim to distinguish moissanite gemstones from diamonds at retail prices
substantially lower than the Tester Model 590. There can be no assurance that a
significant market will develop for the Company's test instrument, that other
competing devices will not be introduced or that other readily available means
will not be developed which can effectively distinguish moissanite gemstones
from diamond.
MOISSANITE/DIAMOND TEST INSTRUMENT COMPONENT. Under a letter agreement
(Instrument Agreement) dated February 12, 1996, Cree is the sole supplier of a
component proprietary to Cree used in the Company's Tester Model 590. The
Instrument Agreement, which expires in 2016, obligates the Company to purchase
all of its requirements for that component from Cree and gives the Company the
exclusive right to purchase those components from Cree. The Company is also
obligated to pay Cree a royalty of two and one-half percent (2 1/2%) of net
sales of all test instruments incorporating the Cree component. Although to date
Cree has supplied a sufficient quantity of this component, if Cree were to fail
to deliver this component, as required, the Company would not be able to
manufacture additional test instruments.
INTELLECTUAL PROPERTY
INTELLECTUAL PROPERTY OF THE COMPANY. The Company has been issued U.S. product
and method patents for moissanite gemstones, which expire in 2015, under which
the Company has broad, exclusive rights to manufacture, use and sell moissanite
gemstones in the United States. The Company has applications pending in a number
of foreign jurisdictions for these same patents. In addition, the Company has
been issued a U.S. apparatus and method patent for the Tester Model 590, which
expires in 2016, that covers the physical structure and the testing techniques
so employed in the Tester Model 590. This patent gives the Company exclusive
rights to manufacture and sell the Tester Model 590 in the United States. The
Company also has patent applications pending related to certain methods of
producing moissanite gemstones and related technologies. Although the Company
intends to enforce its patent rights and vigorously prosecute all its patent
applications, there can be no assurance that such actions will be successful,
that any additional patents will be issued, that any issued patent will not be
challenged, invalidated or circumvented or that any issued patent will have any
competitive or commercial value.
The Company's success and ability to compete successfully is heavily dependent
upon its proprietary technology. In addition to its patents and pending patents,
the Company relies on trade secret laws and employee, consultant and customer
confidentiality agreements to protect certain aspects of its technology. There
can be no assurance that the Company will be able to protect its proprietary
technology from disclosure or that others will not develop technologies that are
similar or superior to its technology. See "Business Risks -- Dependence on
Intellectual Property."
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While the Company has not received any claims that its products or processes
infringe on the proprietary rights of third parties, there can be no assurance
that third parties will not assert such claims against the Company with respect
to its existing and future products. In the event of litigation to determine the
validity of any third party's claims, such litigation could result in
significant expense to the Company and divert the efforts of the Company's
technical and management personnel, whether or not such litigation is determined
in favor of the Company. In the event of an adverse result of any such
litigation, the Company could be required to expend significant resources to
develop non-infringing technology or to obtain licenses to, and pay royalties on
the use of, the technology which is the subject of the litigation. There can be
no assurance that the Company would be successful in such development or that
any such license would be available on commercially reasonable terms.
PROPRIETARY TECHNOLOGY OF CREE. Cree, the Company's current source for
development and supply of lab-grown SiC crystals, has developed or licensed
numerous proprietary processes for the growth of SiC crystals that it uses in
semiconductor, laser and other applications. The founders of the Company
recognized the potential use of SiC as a gemstone, and the Company has obtained
the exclusive right to purchase SiC crystals from Cree for gemstones and
gemological instrumentation. The Company believes that Cree is currently the
only producer of SiC crystals in sizes and qualities suitable for commercial
production of gemstones. In addition, Cree is the only producer of SiC known by
the Company to be developing colorless SiC crystals suitable for gemstone use at
the present time. Cree has significant proprietary rights related to its
processes for growing SiC crystals. Cree has an exclusive license on a patent
for a process of growing large single crystals of SiC. This patent expires in
years ranging from 2006 to 2011, depending on the country in which issued. In
addition, Cree has a patent for a process for growing colorless SiC and other
patents relating to certain aspects of its SiC crystal growth process. To
further protect its proprietary SiC crystal growth process, Cree internally
produces the crystal growth systems used to produce its SiC crystals. The
Company has a royalty-free, perpetual license for the use in gemstone
applications of the technology covered by Cree's patent for growing colorless
SiC.
At the present time, the Company's success and ability to compete is heavily
dependent upon Cree's ability to successfully complete the objectives of the
Development Agreement and on Cree's proprietary technology. See "Business
Risks--Dependence on Intellectual Property."
MANUFACTURING
The production of moissanite gemstones includes (i) growing SiC crystals, (ii)
cutting crystals into preforms that will yield gemstones of an approximate carat
weight and millimeter size, (iii) faceting preforms into gemstones, and (iv)
inspecting, sorting and grading faceted gemstones.
GROWTH OF SIC CRYSTALS. SiC crystals are grown for the Company by Cree in
accordance with the terms of the Exclusive Supply Agreement. Under the Exclusive
Supply Agreement, Cree is required to sell to the Company all of the crystals
grown in a specified number of crystal growth systems without charging the
Company for such crystal growth systems and all the crystals grown in the new
crystal growth systems acquired by the Company from Cree during 1998, unless
Cree gives notice of certain production time available in excess of the
Company's then-current demand and the Company does not demonstrate a need for
the excess production capacity, in which case Cree may sell SiC crystals
produced by these systems to any of its other customers for any use other than
gemstone applications. Upon its receipt of an order from the Company for a
quantity of crystals that will require the acquisition of additional crystal
growth systems, Cree may elect, in its sole discretion, to have the Company
purchase the additional growth systems that will be needed or to fund the costs
on its own and recoup its costs by incorporating the costs of the systems into
the cost of the SiC crystals purchased by the Company. See "--Products and
Product Development - Amended and Restated Exclusive Supply Agreement with
Cree."
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The Company routinely evaluates Cree's progress under the Development Agreement
and the yield of salable gemstones from SiC crystals being produced by Cree to
determine when to place additional orders with Cree that will require the
acquisition of crystal growth systems. The yield of salable gemstones from each
crystal is the most significant factor affecting the volume and cost of
gemstones available for sale and, therefore, is a key driver in the Company's
consideration of placing orders for additional crystals. Yield of salable
gemstones is dependent on the quality of the crystals. Improvements in crystal
quality increase the volume, or yield, of gemstones from a crystal and decrease
the cost of each gemstone produced. The yields of salable gemstones increased
during the first half of 1998 as C3 announced the repeatable process for
two-inch diameter crystals, and the Company expected yields to continue to
improve throughout the year. Yields from the highest quality crystals did
improve in the fourth quarter of 1998, however, on average, net yields remained
constant during the second half of the year. This effect resulted largely from
the Company cutting the highly demanded larger stones that require higher
quality crystals. Continued significant improvements in the quality of SiC
crystals and the resulting higher yield of salable gemstones of all sizes are
required for the Company to achieve its profitability goal. The Company intends
to order quantities of SiC crystals in amounts that would require the purchase
of additional growth systems as, on average, net yields of salable gemstones
improve. There can be no assurance that Cree will achieve the required yield
improvements or that, if achieved, the yield improvements will occur as rapidly
as demand increases. Additionally, once appropriate improvements in crystal
yield are achieved, the Company may be unable to rapidly increase its production
of moissanite gemstones to satisfy the demand as a result of the several months
that may elapse between the Company placing an order for crystals and the time
that additional growth systems needed could begin producing crystals.
See "Business Risks--Reliance on Cree Research, Inc."
PREFORMS. The Company divides all SiC crystals through slicing and dicing
processes into preforms in sizes suitable for faceting into predetermined
calibrated-size gemstones. The Company uses readily available automated and
computerized equipment utilized in the semiconductor industry along with
proprietary technology developed in-house to slice and dice crystals into
preforms. The Company believes that this equipment will enable it to maximize
the number of preforms obtained from each SiC crystal.
FACETING GEMSTONES. The faceting of preforms is a critical stage in obtaining
quality gemstones. The techniques and skills used in faceting moissanite
gemstones differ somewhat from those used in faceting diamonds and other
gemstones. The Company is, and expects to continue, outsourcing the faceting of
its moissanite gemstones, other than faceting for research and product
development purposes which it conducts internally. The Company currently has two
suppliers of volume faceting services which are located in Asia. To date the
Company has been satisfied with the capabilities and performance of these two
suppliers. The Company has identified three additional suppliers of faceting
services in Asia, has qualified their faceting skills on a sample basis and is
currently assessing these other vendors' production capabilities. There is,
however, no assurance that these vendors will be suitable for reliable supply
arrangements or that the Company will be able to enter into agreements with
these additional vendors or with other reliable, quality faceting providers on
terms acceptable to the Company. Even if these agreements can be reached, the
Company intends during some or all of 1999 to source faceting services primarily
from its two existing suppliers and will be dependent on their ability to
provide an adequate quantity of quality faceted moissanite gemstones. There is
no assurance that they will be able to expand and continue to produce the
Company's quality specifications for faceting and within the Company's quantity
and time requirements.
The Company has entered into a multi-year agreement with its primary supplier of
faceting services, John M. Bachman, Inc. (JMB). Pursuant to this agreement and
related amendments thereto, the Company has
9
advanced $180,000 to JMB to expand the production facilities of its affiliate
which facets the Company's moissanite gemstone preforms. These funds are being
repaid through reductions to the per piece cutting charges through approximately
December 31, 1999. The Company has a right of first refusal to acquire any
excess gemstone cutting capacity that occurs at JMB's affiliate and any equity
securities offered by JMB or its affiliate. The term of the Company's agreement
with JMB is through December 31, 2000; however, the Company has the right to
terminate the agreement at any time after January 1, 2000 upon 90 days written
notice. Under this agreement, JMB has agreed to grant, and to cause its
affiliates to grant, to the Company a perpetual, non-exclusive, royalty-free
license to use any inventions or proprietary information developed by or for JMB
or its affiliates that is useful in the faceting of moissanite gemstones.
INSPECTION, SORTING AND GRADING. Faceted moissanite gemstones are currently
returned to the Company for inspection, sorting and grading. During this stage,
specially trained personnel individually examine and grade each moissanite
gemstone against certain quality parameters. This phase of manufacturing is
relatively labor-intensive and requires skills not readily available in the
general work force. In the future, the Company may elect to outsource certain
portions of this stage of the manufacturing process to an independent third
party. Any third parties to which these processes are outsourced will be
required to adhere to the same rigorous quality control and monitoring standards
presently used at the Company. There can be no assurance that the Company will
be able to hire or retain sufficient numbers of appropriately skilled personnel
for this phase of manufacturing, find and enter into acceptable agreements with
third party vendors or that such vendors will be able to provide accurate
inspection, sorting and grading services on a timely basis.
MOISSANITE/DIAMOND TEST INSTRUMENT. The Company has contracted with an
unaffiliated third party for the assembly of its moissanite/diamond test
instrument from components produced by third parties. The Company believes that,
other than with respect to a component containing a proprietary semiconductor
chip that the Company obtains from Cree under the Instrument Agreement, the
components and assembly functions would be readily available from a wide variety
of other suppliers.
DISTRIBUTION, MARKETING AND SALES
The Company has entered into agreements with 139 independent retail jewelry
stores primarily in the initial launch area of the Southeastern United States.
The Company began shipping moissanite to its authorized retail jewelers in
Atlanta and Miami/Ft. Lauderdale during the second quarter of 1998, and, in July
1998, launched consumer-focused advertising and promotion activities in those
areas. During the second half of 1998 the Company expanded the number of
authorized retailers in the southeastern states of North Carolina, South
Carolina, Georgia and Florida. In addition, the Company continued limited
distribution and promotional activities in domestic locations outside this
region.
The Company has also entered into 17 international agreements for distribution
of moissanite gemstones in 23 countries and various areas in the Caribbean. The
international agreements require the purchase of an aggregate of approximately
$19 million of moissanite gemstones through the year 2000. Sales under these
agreements aggregated approximately $1.4 million during calendar 1998. All sales
to international customers are denominated in U.S. dollars and the Company
requires full payment before the merchandise is shipped.
The Company intends to continue to distribute moissanite gemstones in the U.S.
through independent retail jewelry stores. The Company has targeted the United
States because it believes that the United States represents a significant
portion of the worldwide jewelry market and will be relatively accepting of a
new gemstone that compares favorably to fine gemstones like diamond, ruby and
emerald. The
10
Company continues to interview certain independent retail jewelry stores in its
target markets and will seek to enter into agreements with retailers in these
areas during the remainder of 1999. The Company currently grants selected
retailers the right to be the exclusive retail store selling moissanite
gemstones in a limited geographic territory. The Company sells its products to
its authorized retail jewelers with terms requiring payment within 30 days. The
Company continues to evaluate the most appropriate structure for exclusive
retailing arrangements in the U.S. and may, in certain circumstances, enter into
other types of arrangements.
The Company believes that exclusive distribution agreements will provide
retailers with an opportunity to earn a profit margin that compares favorably to
other jewelry products and will allow the retailer to distinguish its product
line from other jewelers in the highly competitive retail jewelry market. The
Company also believes that the profit margins associated with its products will
create incentives for these retailers to maximize their sales and promotional
efforts, resulting in additional consumer demand for the Company's moissanite
gemstones. As the Company's supply of moissanite gemstones increases, the
Company plans to increase the number of markets in which its products are
available. The Company's sales staff divides its time between providing sales
support to its existing network of retailers and entering new target markets and
new arrangements.
The Company believes that marketing loose stones will allow its authorized
retail jewelers to individually select the most appropriate jewelry settings for
their individual market areas. The sale of round brilliant cut stones also
provides the jeweler with a wide range of uses for the stones in rings,
earrings, pendants and bracelets. When evaluating potential independent
retailers, the Company reviews, among other criteria, the design and the quality
of the materials and workmanship of the jewelry products offered by the
retailer. Consumer perception and acceptance of the Company's products will be
directly impacted by the quality, design and workmanship of the settings chosen
by the retailers, however, the Company will have no control over these
individual decisions.
The Company has positioned moissanite as a new gemstone, highlighting its beauty
and other unique physical properties, to consumers and the jewelry industry.
Market research indicates that this positioning will create the highest possible
image for the product and provide the Company with the greatest pricing and
marketing flexibility. Agreements with authorized retail jewelers and exclusive
international distributors require that they sell moissanite as a lab-created
product. In addition they agree to represent moissanite as a unique new gemstone
in a very favorable and positive manner.
Domestically, marketing and advertising activities to date have consisted of
"market launch" activities and cooperative advertising programs with the
Company's exclusive retailers. As the Company develops a significant base of
exclusive retailers in targeted areas, "market launches" are held. These market
launches consist of focused local advertising efforts including newspaper,
magazine and radio advertisements as well as direct mailings to the existing
customer bases of the Company's exclusive retailers. The advertising efforts are
supplemented by extensive public relations activities including in-store events
with on-site local radio promotions and product give-aways during local radio
shows. Additionally, the Company has contracted with the actress, Hunter Tylo,
to make personal appearances at certain market launches. Expansion of current
localized marketing and advertising activities on a nationwide basis will be
dependent on the Company having sufficient quantities of moissanite gemstones in
the qualities and sizes necessary to satisfy demand. Under its cooperative
advertising programs, the Company reimburses its exclusive retailers for a
portion of their moissanite specific advertising, up to predetermined spending
limits.
Internationally, the Company works with its exclusive distributors to develop
appropriate advertising and
11
marketing campaigns for the local marketplace, building on the marketing themes
developed in the US. However, the exclusive distributors are responsible for all
advertising and marketing efforts and expenses in their territories.
The Company is selling its moissanite/diamond test instrument directly to
jewelers, gemologists and pawnbrokers through direct mailings, advertisements in
trade publications and at trade shows. In addition, the Company has retained
non-exclusive distributors to distribute the test instrument in some U.S.
markets and through exclusive distribution agreements in certain territories
internationally. The Company may enter into other distribution agreements, as it
deems appropriate.
The Exclusive Supply Agreement prohibits the Company, without Cree's consent,
from entering into an exclusive marketing or distribution agreement with DeBeers
or any party that Cree reasonably believes is affiliated with DeBeers; the
Central Selling Organization (the international cartel of diamond producers);
any party whose primary business is the development, manufacture, marketing or
sale of diamond gemstones; or any non-gemstone and non-jewelry industry
competitor of Cree. These provisions may limit the avenues of distribution
potentially available to the Company and could prevent the Company from entering
into certain potentially profitable transactions.
COMPETITION
MOISSANITE GEMSTONES. Competition in the marketplace for gemstones is intense.
Gemstone materials can be grouped into three types: (i) natural gemstone, which
is found in nature; (ii) synthetic gemstone, which has the same chemical
composition and characteristics of natural gemstone but is created in a lab; and
(iii) simulated or substitute material, which is similar in appearance to
natural gemstone but does not have the same chemical composition. The Company's
moissanite gemstones, which are positioned as a unique new gemstone, may compete
with fine gemstones such as ruby, sapphire, emerald and tanzanite as well as
with natural and treated diamonds and existing synthetic gemstones such as
synthetic cubic zirconia presently in commercial distribution. The Company may
also face competition from additional gemstones such as synthetic diamonds,
synthetic diamond films and other sources of synthetic moissanite not presently
available in qualities, sizes and volumes suitable for use as gemstones. Most of
the suppliers of diamonds and other fine gemstones, as well as the suppliers of
synthetic gemstones, have substantially greater financial, technical,
manufacturing and marketing resources and greater access to distribution
channels than the Company.
The worldwide market for large, uncut high-quality diamonds is significantly
consolidated through the Central Selling Organization, a cartel led by DeBeers.
The cartel has a major impact on the worldwide supply and pricing of these
diamonds at both the wholesale and retail levels. Although the Company believes
that its gemstones will appeal primarily to the consumer who would not otherwise
purchase comparable diamond jewelry, diamond producers may undertake additional
marketing or other activities designed to protect the diamond jewelry market
against sales erosion from consumer acceptance of moissanite gemstones.
The Company may also face competition from treated diamonds. Treated diamonds,
which are natural diamonds with imperfections or flaws that have been altered in
some manner to enhance their appearance, are presently available in the jewelry
industry and are generally less expensive than diamonds of similar size, cut and
color which have not been altered. Synthetic diamond in gemstones or film form
may also become available in the marketplace and compete with the Company's
gemstones. Synthetic diamonds are regularly produced for industrial
applications, but the Company believes that gemstone quality synthetic diamonds
presently cannot be produced at prices competitive with those currently offered
for the Company's colorless moissanite gemstones. The primary producers of these
12
synthetic diamonds are DeBeers, Sumitomo and GE. There are also a number of
Russian producers of synthetic diamonds for industrial uses. Synthetic diamond
films can be grown at commercially viable prices in thicknesses that can be
applied to other surfaces but these films adhere well to only a few minerals
such as diamond, silicon and SiC (moissanite). There could, however, be
technological advances that would enable competitively priced synthetic diamond
in gemstone or film form to be offered.
Although the Company believes that its products have a proprietary position, it
could face competition from other companies who develop competing SiC
technologies. Some of these technologies could be spawned by producers of SiC
used for other industrial applications. Manufacturers of industrial SiC products
include The Carborundum Corporation, for abrasive uses, and Cree, Siemens AG,
ABB and Northrup Grumman Corporation, for semiconductor uses. The Company
believes that Cree is presently the only supplier of SiC crystals in colors,
sizes and volumes suitable for gemstone applications and believes that the
patents owned or pending by Cree or the Company provide substantial
technological, legal and cost barriers to other companies' development of
colorless moissanite gemstones. It is possible, however, that these or other
producers of SiC could develop SiC crystals suitable for gemstone applications
and produce moissanite gemstones until the Company could obtain judicial
enforcement of its patent rights.
The Company's products may also face competition from synthetic cubic zirconia,
the principal existing diamond simulant and, to a lesser degree, other synthetic
gemstones. Two of the largest producers of synthetic cubic zirconia gemstones
are D. Swarovski & Co. and Golay Buchel. In addition, there are a significant
number of other producers of jewelry containing synthetic gemstones. Three of
the largest retailers of synthetic cubic zirconia jewelry in the United States
are QVC, Home Shopping Network and Wal-Mart. Some of the major retailers of
synthetic cubic zirconia, including QVC, have captive manufacturing divisions
that produce synthetic cubic zirconia jewelry. These producers and sellers may
see their markets being eroded by the introduction of the Company's moissanite
gemstones. The Company believes that price is the primary basis upon which these
products will compete with its moissanite gemstones.
The Company intends to compete primarily on the basis that the unique qualities
of its moissanite gemstones compare favorably to diamond, ruby, emerald and
other fine gemstones at a significant cost advantage, especially in the one
carat size and larger. Its ability to compete successfully is dependent on its
ability to: (i) achieve jeweler and consumer acceptance of its products; (ii)
obtain quantities of lab-grown SiC crystals in acceptable qualities and prices;
(iii) obtain reliable and high quality faceting services from third parties;
(iv) respond to market entries of other gemstone materials with technological or
cost improvements; and (v) meet consumer demand for its moissanite gemstones.
There can be no assurance that the Company will be able to obtain the materials
and services needed to deliver its products or to otherwise be able to compete
successfully in the marketplace.
MOISSANITE/DIAMOND TEST INSTRUMENT. The Company's proprietary, patented
moissanite/diamond test instrument, the Tester Model 590, faces competition from
other devices that distinguish moissanite gemstones from diamond. The Tester
Model 590, working in conjunction with existing thermal test instruments,
readily distinguishes loose moissanite gemstones and moissanite gemstones set in
jewelry from diamond in the colors and clarities most often sold by jewelers.
The Presidium Corporation has recently begun to market a test instrument that is
capable of distinguishing primarily loose moissanite gemstones from diamond. The
Ceres and Moissketeer Corporations have released electrical conductivity
measuring devices that they claim are capable of distinguishing moissanite from
diamond. Another company has introduced a reflectivity meter that is capable of
distinguishing primarily large loose moissanite gemstones from diamond, however,
while the Company does not plan to sell such moissanite
13
gemstones, a certain process can permanently change the retractive index of
moissanite such that moissanite would measure as a diamond on such reflectivity
meters. Other competitors may also introduce devices that compete with the
Company's Tester Model 590 or gemologists trained in the physical properties of
moissanite gemstones may develop less expensive methods of distinguishing
moissanite gemstones from diamond. There can be no assurance that a market for
moissanite/diamond test instruments will develop or that the Company will be
able to successfully compete in that market, if it develops.
GOVERNMENT REGULATION
The Company's products are subject to regulation by the Federal Trade Commission
(FTC). The FTC has issued regulations and guidelines governing the marketing of
synthetic gemstones and other gemstones that have physical properties similar to
diamond that require synthetic gemstones and other gemstones to be clearly
identified in any promotional or marketing materials. While the Company intends
to comply fully with all FTC regulations, there can be no assurance that the FTC
or a competitor will not challenge the Company's promotional or marketing
activities. Such a challenge could result in significant expense to the Company
and divert the efforts of the Company's management, whether or not such
challenge is resolved in favor of the Company. If the Company's actions were
found to be in violation of FTC regulations, the Company could be forced to
suspend marketing and sales of its products and could incur significant expenses
in developing new marketing strategies and materials that would not violate FTC
regulations. There can be no assurance that the Company would be successful in
developing new marketing strategies and materials that would comply with FTC
regulations or that such strategies, once developed, would allow the Company to
market its products profitably.
EMPLOYEES
At February 28, 1999, the Company had 49 employees. The Company believes that
its future prospects will depend, in part, on its ability to obtain additional
management, marketing, sales, manufacturing, scientific and technical personnel.
Competition for such personnel is intense, and the number of persons with
relevant experience is limited. None of the Company's employees is represented
by a labor union. The Company believes that its employee relations are good.
BACKLOG
At February 28, 1999, the Company had orders for moissanite gemstones and
jewelry which are anticipated to result in approximately $130,000 of revenue.
BUSINESS RISKS
In addition to the other information in this Form 10-K, readers should carefully
consider the following important factors that in some cases have affected, and
in the future could affect, the Company's actual performance and results and
could cause the Company's actual results of operations to differ materially from
those expressed in any of the forward-looking statements made by, or on behalf
of, the Company.
LIMITED RELEVANT OPERATING HISTORY
The Company, which was incorporated in June 1995, was in the development stage
through June 30, 1998. The Company is now in the early stages of commercializing
moissanite gemstones and building its distribution channels. The timing or
existence of any significant revenues is dependent on continued
14
improvements in the yield of gemstones in the qualities, sizes and volumes
desired from each SiC crystal and on market acceptance of moissanite gemstones.
The Company's business is also subject to the risks inherent in the rapid
increase in production levels. Likewise, the Company's products are subject to
the risks inherent in the development and marketing of new products, including
unforeseen design, manufacturing or other problems or failure to develop market
acceptance. Failure by the Company to continue to develop the ability to produce
its products in higher quantities and qualities would have a material adverse
effect on the Company's business, operating results and financial condition.
Accordingly, the Company's prospects must be considered in light of the risks,
expenses and difficulties frequently encountered by companies in their early
stage of development, particularly technology-based companies operating in the
early stages of manufacturing unproven products.
15
NEED FOR FURTHER PRODUCT DEVELOPMENT
Although the Company is selling initial production volumes of colorless
moissanite gemstones and Cree, the Company's current supplier of SiC crystals,
achieved a fully repeatable process in June 1998 for two-inch crystals, Cree has
not yet established a manufacturing process for producing lab-grown SiC crystals
in the qualities, sizes and volumes desired for the Company's products. If Cree
is unable to improve crystal yields and develop a manufacturing process for
growing SiC crystals in the desired qualities, sizes and volumes, the Company's
business, operating results and financial condition would be materially
adversely affected.
RELIANCE ON CREE RESEARCH, INC.
The Company is currently dependent on a single source, Cree, for development and
supply of SiC crystals. Cree has certain proprietary rights relating to its
process for growing large single crystals of SiC and its process for growing
colorless SiC crystals. Under the Company's Exclusive Supply Agreement with
Cree, the Company is obligated to buy from Cree, and Cree is obligated to sell
to the Company, fifty percent (50%), by dollar volume, of the Company's
requirements for SiC material for the production of gemstones in each calendar
quarter. Although the Company is only required to purchase fifty percent (50%)
of its SiC requirements from Cree, the Company does not currently believe that
any other SiC producer could readily supply crystals in the qualities, sizes and
volumes needed for the Company's products. Therefore, at the present time, the
Company is dependent on Cree as its sole source for its principal raw material.
The Company's effort to develop colorless SiC crystals in qualities, sizes and
volumes desired for use as gemstones is currently concentrated entirely with
Cree and is dependent on Cree's expertise in SiC technology which Cree uses in
connection with semiconductor, laser and other applications. A primary focus of
the development programs with Cree has been to improve the yield of salable
gemstones from each SiC crystal that the Company purchases from Cree. The yield
of salable gemstones from each crystal is the most significant factor affecting
the volume and cost of gemstones available for sale and is dependent on the
quality of the crystals. Improvements in crystal quality increase the volume, or
yield of gemstones from a crystal, and decrease the cost of each gemstone
produced. The yields of salable gemstones increased during the first half of
1998 as C3 announced the repeatable process for two-inch diameter crystals and
the Company expected yields to continue to improve throughout the year. Yields
from the highest quality crystals did improve in the fourth quarter of 1998,
however on average, net yields remained constant resulting largely from the
Company cutting the highly demanded larger stones that require higher quality
SiC crystals. To reach profitability the Company must receive increasingly
higher quality SiC crystals from Cree that yield more salable gemstones. The
Company intends to order quantities of SiC crystals that would require the
purchase of additional growth systems as, on average, net yields of salable
gemstones improve. Any delay in achieving higher quality crystals or any decline
in average crystal quality could limit the Company's ability to expand
distribution of its products and increase the cost of goods sold which would
have a material adverse effect on the Company's business, operating results and
financial condition. See "Business--Products and Product Development."
When the Company does elect to order quantities of crystals that would require
additional crystal growth systems, Cree may, under the Exclusive Supply
Agreement, elect to have the Company purchase the additional crystal growth
systems that will be needed, and Cree would be obligated to supply the Company
with one hundred percent (100%) of the output from systems funded by the
Company. If, however, Cree elects to fund the cost of these additional growth
systems on its own, then there can be no assurance that Cree will supply the
Company with all of the output from these crystal growth systems or fill all of
the Company's orders for SiC crystals. Any delay or reduction in the
availability of SiC
16
crystals could delay or limit the Company's ability to deliver and sell its
gemstones, which would have a material adverse effect on the Company's business,
operating results and financial condition.
The Company also obtains from Cree a component proprietary to Cree used in the
production of the Company's moissanite/diamond test instrument. See
"Business--Products and Product Development--Moissanite/Diamond Test
Instrument." If Cree were unable to deliver this component in the quantities and
at the times needed by the Company, the Company's ability to provide the market
with its test instrument would be adversely affected.
As a result of the Company's reliance on Cree, Cree's failure to complete the
desired development objectives under the Development Agreement and to supply the
Company with SiC crystals or components for its moissanite/diamond test
instrument would have a material adverse effect on the Company's business,
operating results and financial condition and could result in a curtailment,
suspension, cessation or significant change in the strategic direction of the
Company's business. See "Business--Products and Product Development."
UNDEVELOPED MARKETS; UNPROVEN ACCEPTANCE OF THE COMPANY'S PRODUCTS
The market for colorless moissanite gemstones among retail jewelers and
consumers is in the early stages of development as the Company shipped
approximately 18,000 carats in 1998. The Company believes that many retail
jewelers and most consumers are generally unaware of the existence and
attributes of these gemstones. As is the case with any new product, market
acceptance and demand are subject to a significant amount of uncertainty. The
Company's future financial performance will depend upon consumer acceptance of
the Company's gemstones as a unique product that rivals diamond, ruby, emerald
and other fine gemstones in brilliance, fire and luster, which may be impacted
by jewelers' acceptance of gemstones. The Company has conducted limited market
tests to predict retail jeweler and consumer reaction to its products. Although
retail jewelers typically purchase finished jewelry rather than loose gemstones,
the Company plans to market loose gemstones to retailers. The retailers will
then select the jewelry into which the stones will be set and will be
responsible for completing the setting. The quality, design and workmanship of
the jewelry settings selected by retail jewelers, which will not be within the
Company's control, could impact the consumer's perception and acceptance of the
Company's gemstones. Thus, the Company's future financial performance may be
impacted by (i) the willingness of retail jewelers to purchase loose stones and
undertake setting of the loose stones, (ii) the ability of retail jewelers to
select jewelry settings that encourage consumer acceptance of and demand for the
Company's gemstones (iii) the ability of retail jewelers to set loose gemstones
in jewelry with high quality workmanship and (iv) the ability of retail jewelers
to effectively market and sell moissanite jewelry.
The market for the Company's gemstones may develop at a slower pace than
expected as a result of lack of acceptance of gemstones by retail jewelers or by
consumers. If the market fails to develop or develops more slowly than expected,
or if the Company's products do not achieve significant market acceptance, the
Company's business, operating results and financial condition would be
materially adversely affected. See "Business--Products and Product Development"
and " Business--Distribution, Marketing and Sales."
LIMITED DISTRIBUTION CHANNELS
The Company began shipping moissanite to jewelry retailers in Atlanta and
Miami/Ft. Lauderdale during the second quarter of 1998 and expanded sales to
authorized domestic retail jewelers in other areas of the U.S. as well as
through exclusive international distributors during the second half of the year.
While the Company grants to selected retail jewelry stores the right to be the
exclusive retailer of moissanite
17
gemstones in a limited geographic territory, there can be no assurance that the
Company will be able to enter into additional exclusive agreements with retail
jewelers or other distributors on terms acceptable to the Company or that such
retail jewelers or other distributors will be successful in their efforts to
market the Company's gemstones to consumers. The inability of the Company to
enter into favorable arrangements with retail jewelers or other distributors or
to achieve its desired distribution of its moissanite gemstones or the inability
of the Company's distributors to successfully market moissanite gemstones to
consumers would have a material adverse effect on the Company's business,
operating results and financial condition. See "Business--Distribution,
Marketing and Sales."
DEPENDENCE ON INTELLECTUAL PROPERTY
The Company has been issued U.S. product and method patents for moissanite
gemstones under which the Company has broad, exclusive rights to manufacture,
use and sell moissanite gemstones in the United States. The Company has
applications pending in a number of foreign jurisdictions for these same
patents. In addition, the Company has been issued a U.S. apparatus and method
patent for the Tester Model 590 that covers the physical structure and the
testing techniques so employed. This patent gives the Company exclusive rights
to manufacture and sell the Tester Model 590 in the United States. The Company
believes that these patents create substantial technological barriers to its
potential competitors. The Company also has applications pending related to
certain methods of producing moissanite gemstones and related technologies.
There can be no assurance that any other patents will be granted or that any
issued patent will have any commercial or competitive value.
At the present time, the Company is also dependent on Cree's technology for the
production of SiC crystals. Cree is exclusively licensed to use a patent
concerning a process for growing large single crystals of SiC, has certain
patents of its own relating to growth of large single crystals of SiC and has a
patent for a process for growing colorless SiC crystals.
There can be no assurance that any patents issued to or licensed by or to the
Company or Cree will provide any significant commercial protection to the
Company or Cree, that the Company or Cree will have sufficient resources to
prosecute its respective patents or that any patents will be upheld by a court
should the Company, Cree or Cree's licensor seek to enforce their respective
rights against an infringer. The existence of valid patents does not prevent
other companies from independently developing competing technologies. Existing
producers of SiC or others may refine existing processes for growing SiC
crystals or develop new technologies for growing large single crystals of SiC or
colorless SiC crystals in a manner that does not infringe patents owned or
licensed by or to the Company or Cree. In addition, existing producers of SiC,
existing producers of other synthetic or natural gemstones or other parties may
develop new technologies for producing moissanite gemstones in a manner that
does not infringe patents owned or licensed by or to the Company or Cree.
As a result of the foregoing factors, existing and potential competitors may be
able to develop products that are competitive with or superior to the Company's
products, and such competition could have a material adverse effect on the
Company's business, operating results and financial condition. See
"Business--Competition."
DEPENDENCE ON THIRD PARTIES
In addition to its current dependence on Cree and on third party distribution
channels, the Company's prospects depend upon its ability to identify, reach
agreements with and work successfully with other third parties. In particular,
the Company relies on third parties to facet its gemstones. Faceting moissanite
gemstones requires different techniques than faceting diamond and other
gemstones. There
18
can be no assurance that the Company can enter into additional contracts with
faceting vendors on terms satisfactory to the Company or that faceting vendors
will be able to provide faceting services in the quality and quantities required
by the Company. In addition, the Company relies on third parties to manufacture
components for and assemble its moissanite/diamond test instrument. There can be
no assurance that the Company will be successful in maintaining its
relationships with these component manufacturers and assemblers or that the
Company will be able to find suitable replacements if the Company is unable to
maintain such relationships. Failure by the Company to achieve any of the above
would have a material adverse effect on the Company's business, operating
results and financial condition. See "Business--Manufacturing."
COMPETITION
See "Business--Competition."
INTERNATIONAL OPERATIONS
The Company has entered into 17 international agreements for distribution of
moissanite gemstones in 23 countries and various areas in the Caribbean. The
Company intends to expand the number of international markets for its products.
In addition, it expects to continue to use certain companies based outside the
United States to facet its moissanite gemstone products. Due to the Company's
reliance on development of foreign markets and use of foreign vendors, the
Company is subject to the risks of conducting business outside of the United
States. These risks include unexpected changes in, or impositions of,
legislative or regulatory requirements, delays resulting from difficulty in
obtaining export licenses, tariffs and other trade barriers and restrictions and
the burdens of complying with a variety of foreign laws and other factors beyond
the Company's control. Additionally, while all foreign transactions are
denominated in U.S. dollars, foreign currency fluctuations could impact demand
for the Company's products or the ability of the Company's foreign suppliers to
continue to perform. The Company is also subject to general geopolitical risks
in connection with its international operations, such as political, social and
economic instability, potential hostilities and changes in diplomatic and trade
or business relationships. There can be no assurance that such factors will not
adversely affect the Company's operations in the future or require the Company
to modify its anticipated business practices.
GOVERNMENTAL REGULATION
The Company is subject to governmental regulations in the manufacture and sale
of moissanite gemstones and the moissanite/diamond test instrument. In
particular, the FTC has the power to restrict the offer and sale of products
that could deceive or have the tendency or effect of misleading or deceiving
purchasers or prospective purchasers with regard to the type, kind, quality,
character, origin or other characteristics of a diamond. The Company may be
under close scrutiny both by governmental agencies and by competitors in the
gemstone industry, any of which may challenge the Company's promotion and
marketing of its gemstone products. If the Company's production or marketing of
its lab-created gemstones is challenged by governmental agencies or competitors,
or if regulations are issued that restrict the ability of the Company to produce
and market its products, the Company's business, operating results and financial
condition could be materially adversely affected.
See "Business--Government Regulation."
IMITATION MOISSANITE
If market acceptance of the Company's products continues to grow, it is possible
that low-quality gemstones or synthetics could be marketed as moissanite. The
sale of low-quality products as moissanite
19
could damage the perception of moissanite as a unique gemstone that compares
favorably to other fine gemstones like diamond, ruby and emerald. This could
damage the Company's reputation among retail jewelers and consumers and result
in a loss of consumer confidence in the Company's products. The introduction of
low-quality imitation moissanite gemstones and the inability of the Company to
limit the adverse effects thereof could have a material adverse effect on the
Company's business, operating results and financial condition.
MANAGEMENT OF RAPID GROWTH
The Company has recently experienced a period of rapid and significant growth
and expects such growth to continue in the future with the commercialization of
moissanite gemstones. Periods of rapid growth place a significant strain on the
Company's resources. The Company's ability to manage its growth effectively will
require it to implement and improve operational and financial systems and to
expand, train and manage its employee base. The Company also will be required to
manage multiple relationships with various suppliers, customers and other third
parties. The Company's future operating results will also depend on its ability
to expand its sales and marketing, research and development and administrative
support organizations. The Company's executive officers have no significant
experience in managing rapidly growing businesses. If the Company is unable to
manage growth effectively, the Company's business, financial condition and
results of operations would be materially adversely affected.
DEPENDENCE UPON KEY PERSONNEL; NEED FOR ADDITIONAL PERSONNEL
The Company's success depends in part upon retaining the services of certain
executive officers and other key employees. The Company has entered into
employment agreements with the Company's Chief Executive Officer, Jeff N.
Hunter, President and Chief Operating Officer, Robert S. Thomas, Chief Financial
Officer, Mark W. Hahn, Director of Technology, Dr. Mark Kellam, and Director of
Manufacturing, Earl R. Hines. The Company does not maintain "key man" life
insurance policies on any of its executive officers or key employees. The loss
of the services of the Company's executive officers or other key employees could
have a material adverse effect on the Company's business, operating results and
financial condition.
Because of the Company's early stage of development, the Company is also
dependent on its ability to recruit, retain and motivate personnel with
technical, manufacturing and gemological skills. There are a limited number of
personnel with these qualifications and competition for such personnel is
intense. The inability of the Company to attract and retain additional qualified
personnel would materially adversely affect the Company's business, operating
results and financial condition.
OPERATING LOSSES
Since its inception the Company has incurred net losses aggregating
approximately $12.1 million. The Company expects to incur substantial additional
costs building the manfacturing capacity of its products and expanding its
efforts to market and distribute such products. The Company expects to incur
losses through at least some of 1999, and there can be no assurance that the
Company will ever achieve profitability or, if achieved, that such profitability
will be sustained. See "Selected Financial Data" and "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
POTENTIAL FOR FLUCTUATIONS IN QUARTERLY RESULTS
Because the Company has limited operating history, management has very little
data upon which to estimate operating revenues and expenses. The Company's
revenues will be affected by many factors,
20
including those discussed in "Business Risks." At the same time, the Company's
expenses will be growing to support anticipated rapid expansion. The Company
will likely experience substantial quarterly fluctuations in its operating
results. As a result, the Company believes that period-to-period comparisons of
its results of operations are not necessarily meaningful and should not be
relied upon as an indication of future performance. Moreover, it is likely that
in some future quarters the Company's operating results will be below the
expectations of public market analysts and investors. In such event, the price
of the Company's common stock would likely be materially adversely affected.
VOLATILITY OF STOCK PRICE
Since its initial public offering, the trading price of the Common Stock has
experienced significant volatility and substantial and sudden fluctuations. The
trading price of the Common Stock may continue to be subject to wide
fluctuations in response to quarterly variations in operating results, changes
in financial estimates by securities analysts, announcements of technological
innovations or new products by the Company or its competitors, or other events
or factors. In addition, the stock market has experienced extreme price and
volume fluctuations that have particularly affected the market prices for many
technology and small capitalization companies. These broad market fluctuations
may materially and adversely affect the market price of the Common Stock.
ANTI-TAKEOVER AND CERTAIN OTHER PROVISIONS
ARTICLES OF INCORPORATION AND BYLAWS
A number of provisions of the Company's articles of incorporation and bylaws
deal with matters of corporate governance and the rights of shareholders.
Certain of these provisions may be deemed to have an anti-takeover effect and
may delay or prevent takeover attempts not first approved by the Board of
Directors (including takeovers that certain shareholders may deem to be in their
best interests). These provisions also could delay or frustrate the removal of
incumbent directors or the assumption of control by shareholders. The Company
believes that these provisions are appropriate to protect the interests of the
Company and all of its shareholders.
EXCLUSIVE SUPPLY AGREEMENT
Under the terms of the Exclusive Supply Agreement, the Company is prohibited
from entering into an exclusive marketing or distribution agreement with DeBeers
or its affiliates or the Central Selling Organization (the international cartel
of diamond producers) or any party whose primary business is the development,
manufacture, marketing or sale of diamond gemstones or any non-gemstone and
non-jewelry industry competitor of Cree (collectively, the "Prohibited
Parties"). The agreement also prohibits the Company from entering into certain
merger, acquisition, sale of assets or similar transactions with a Prohibited
Party. These provisions of the Exclusive Supply Agreement could limit the price
that third parties might be willing to pay in the future for some or all of the
shares of the Company's Common Stock. In addition, this agreement could prevent
the Company from entering into certain potentially profitable transactions with
Prohibited Parties.
SHAREHOLDER RIGHTS PLAN
On February 21, 1999 the Company adopted a Shareholder Rights Plan under which
all shareholders of record as of March 8, 1999, will receive rights to purchase
shares of a new series of Preferred Stock.
21
The Rights Plan is designed to enable all C3 shareholders to realize the full
value of their investment and to provide for fair and equal treatment for all
shareholders in the event that an unsolicited attempt is made to acquire C3. The
adoption of the Rights Plan is intended as a means to guard against abusive
takeover tactics and is not in response to any particular proposal.
The rights will be distributed as a non-taxable dividend and will expire in ten
years. The rights will be exercisable only if a person or group acquires 20
percent or more of the C3 Common Stock or announces a tender offer for 20
percent or more of the Common Stock.
If a person or group acquires 20 percent or more of C3's Common Stock, all
shareholders except the purchaser will be entitled to acquire C3 Common Stock at
a 50 percent discount. The effect will be to discourage acquisitions of more
than 20 percent of C3 Common Stock without negotiations with the Board.
The rights will trade with C3's Common Stock, unless and until they are
separated upon the occurrence of certain future events. The rights distribution
is not taxable to the shareholders. C3's Board of Directors may redeem the
rights prior to the expiration of a specified period following the acquisition
of more than 20 percent of C3's Common Stock. Additional details regarding the
Rights Plan will be outlined in a summary to be mailed to all shareholders
following the Record Date.
ITEM 2. PROPERTIES
The Company leases approximately 12,700 square feet of mixed-use space (general
office, light manufacturing and laboratory) in the Research Triangle Park area
of North Carolina from an unaffiliated third party. This space houses the
Company's executive offices, sales offices and research and development
facilities. The Company believes that comparable mixed-use space could be
obtained from other parties on terms substantially the same as the Company's
current lease. This space is considered by management to be sufficient for the
Company's foreseeable needs over the next 12 months. From February 1997 through
January 1998, the Company leased approximately 3,000 square feet of mixed-use
space from a subsidiary of Cree. This space previously housed the Company's
offices and research and development facilities.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable.
EXECUTIVE OFFICERS OF THE REGISTRANT
NAME AGE POSITION WITH THE COMPANY
- ---- --- -------------------------
Jeff N. Hunter 42 Chief Executive Officer and
Chairman of the Board
Robert S. Thomas 51 President and Chief Operating Officer
Mark W. Hahn 36 Chief Financial Officer, Treasurer and
Secretary
Mark D. Kellam 42 Director of Technology
22
JEFF N. HUNTER, one of the founders of the Company, has served as the Company's
Chief Executive Officer and Chairman of the Board since June 1996, and as a
director since the Company's inception in June 1995. From June 1996 to June
1998, Mr. Hunter served as President of the Company and from June 1995 to June
1996 he served as Secretary and Treasurer of the Company. From July 1980 to May
1996, he was employed in various capacities with North Carolina State
University, most recently as Director of Business, Finance and Research
Administration for the College of Engineering. Mr. Hunter received his Master of
Science degree in management science from North Carolina State University.
ROBERT S. THOMAS has served as the President and Chief Operating Officer of the
Company since June 1998. From November 1996 to June 1998 Mr. Thomas served as a
consultant to the Company on various financing and sales related matters. From
October 1977 to November 1996 Mr. Thomas was employed with Morven Partners, one
of the nations largest processors and distributors of both raw and processed
edible nuts, and its predecessor companies in various capacities including
President and Chief Executive Officer. Mr. Thomas earned his Bachelor of Science
degree in Business Administration from West Virginia University.
MARK W. HAHN has served as the Chief Financial Officer of the Company since
October 1996 and as Treasurer and Secretary since August 1997. From January 1984
to October 1996, Mr. Hahn was employed with Ernst & Young LLP, most recently as
Senior Manager in the Entrepreneurial Services Group. He earned his Bachelor of
Business Administration degree with concentrations in accounting and finance
from the University of Wisconsin in Milwaukee and is a Certified Public
Accountant.
MARK D. KELLAM has served as Director of Technology for the Company since May
1998. From August 1995 to May 1998, Dr. Kellam was employed in various
capacities with the Microelectronics Center of North Carolina, most recently as
Director of Manufacturing and Quality Assurance. Dr. Kellam earned his Ph.D. in
Solid State Physics from the University of North Carolina at Chapel Hill.
23
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
The Company's Common Stock is traded on the NASDAQ National Market under the
symbol "CTHR." The following table presents, for the periods indicated, the high
and low sales prices of the Company's Common Stock, as reported by the NASDAQ
National Market. As of March 1, 1999, there were 258 shareholders of record of
the Common Stock.
Sales Price Per Share
1997 High Low
- ---- ---- ---
November 14, 1997 to December 31, 1997 $ 15.63 $ 11.00
1998
- ----
First Quarter $ 12.38 $ 8.50
Second Quarter 10.00 7.25
Third Quarter 9.75 4.75
Fourth Quarter 14.50 5.25
The Company has never paid dividends on its capital stock. The Company intends
to retain earnings, if any, for use in its business and does not anticipate
paying any cash dividends in the foreseeable future.
USE OF PROCEEDS
On November 14, 1997, the Securities and Exchange Commission declared the
Company's Registration Statement on Form S-1 (File No. 333-36809) to be
effective. The net proceeds of this offering were $41,072,982. As of December
31, 1998, the Company had approximately $25,525,000 of the remaining net
proceeds of the offering invested in money market accounts, debt instruments
having an original maturity of three months or less and other highly liquid
investments. Approximately $4,791,700 of the proceeds have been used in research
and development, of which $141,475 was paid to officers, directors or
shareholders owning more than ten percent (10%) of the Common Stock outstanding.
The Company has also used approximately $4,492,600 to fund sales, marketing and
administrative expenses, of which $294,000 was paid to officers, directors or
shareholders owning more than ten percent (10%) of the Common Stock outstanding.
The Company also expended approximately $2,386,400 to build inventory of its
products. In addition, the Company acquired $3,877,300 of production equipment,
including $3,375,000 of crystal growth systems from Cree, certain computerized
wafering and preform development equipment, and other equipment.
RECENT SALES OF UNREGISTERED SECURITIES
Not Applicable
24
ITEM 6. SELECTED FINANCIAL DATA
The following selected statement of operations data for the years ended December
31, 1998, 1997 and 1996, and the selected balance sheet data at December 31,
1998 and 1997 have been derived from, and are qualified by reference to, the
Company's financial statements included elsewhere in this report, which have
been audited by Deloitte & Touche LLP, independent auditors. The selected
statement of operations data for the period from inception through December 31,
1995 and the selected balance sheet data at December 31, 1996 and 1995 have been
derived from audited financial statements not included herein. The selected
financial data set forth below should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Financial Statements and Notes thereto included elsewhere in this report.
C3, INC.
Period from
Inception
Year Ended December 31 (June 28, 1995)
-------------------------------------------- to December 31,
1998 1997 1996 1995
------------- ----------- ---------- ------------
STATEMENTS OF OPERATIONS DATA
Net sales $ 4,026,309 $ -- $ -- $ --
Cost of goods sold 2,913,208 -- -- --
----------- ----------- ---------- -----------
Gross profit 1,113,101 -- -- --
Operating expenses:
Marketing and sales 2,989,737 535,329 47,019 10,313
General and administrative (1) 2,671,445 2,744,898 134,715 10,822
Research and development 4,001,740 2,111,062 236,047 6,052
----------- ----------- ---------- -----------
Total operating expenses 9,662,922 5,391,289 417,781 27,187
----------- ----------- ---------- -----------
Operating loss 8,549,821 5,391,289 417,781 27,187
Interest income, net (1,816,333) (471,130) (35,173) --
----------- ----------- ---------- -----------
Net loss $ 6,733,488 $ 4,920,159 $ 382,608 $ 27,187
=========== =========== ========== ===========
Basic and diluted net loss per share $ 0.97 $ 1.73 $ 0.19 $ .02
=========== =========== ========== ===========
Shares used in computing basic and
diluted net loss per share (2) 6,954,600 2,845,773 2,036,813 1,704,000
=========== =========== ========== ===========
December 31
----------------------------------------------------------
1998 1997 1996 1995
----------- ----------- ---------- -----------
BALANCE SHEET DATA
Cash and equivalents $ 32,004,045 $ 43,980,385 $ 1,167,458 $ 9,109
Working capital 33,887,496 43,687,405 1,161,603 8,355
Total assets 40,168,323 44,873,089 1,226,134 32,913
Shareholders' equity 37,996,332 44,046,281 1,213,279 22,813
1. Compensation expense related to the issuance of stock options for 1998 and
1997 was $527,811 and $1,632,804 respectively. In addition for the year
ended December 31, 1997, general and administrative expense includes $66,000
of compensation expense related to the January 2, 1997 issuance of Common
Stock to Cree pursuant to a stock option. See Note 6 of Notes to Financial
Statements.
2. The calculation of shares for all periods reflects a 2.13-for-1 common stock
split effected in September 1997. The calculation also gives effect to the
automatic conversion of the Series A Preferred Stock and Series B
25
Preferred Stock into 2.13 shares of Common Stock for each share of Preferred
Stock effective upon completion of the Company's initial public offering.
See Notes 2, 4 and 5 of Notes to Financial Statements.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
OVERVIEW
From its inception in June 1995 through June 30, 1998, the Company was a
development stage enterprise that devoted its resources to funding research and
development of colorless moissanite gemstones, market research, developing
initial consumer marketing themes and assembling a management team. The
Company's principal business is the manufacture, marketing and distribution of
moissanite gemstones. Moissanite is being marketed as an exclusive new gemstone
with properties, including brilliance, fire and hardness that rival other fine
gemstones like diamond, sapphire, ruby and emerald.
The Company began shipping moissanite to authorized retail jewelers in Atlanta
and Miami/Ft. Lauderdale during the second quarter of 1998, and, in July 1998,
launched consumer-focused advertising and promotion activities in those areas.
During the third and fourth quarters of 1998 the Company expanded the number of
authorized retail jewelers primarily located in the southeastern states of North
Carolina, South Carolina, Georgia and Florida and increased the number of
exclusive international distributors. Marketing and promotion activities were
focused primarily in these southeastern states. Domestically, during 1999, the
Company will focus on the market introduction of moissanite in other areas of
the United States. International efforts during the first half of 1999 will be
focused primarily on managing existing relationships with the last half of 1999
being focused on efforts to expand the international distribution of moissanite.
The Company believes that its sales volumes will increase as the yield of
salable gemstones from each crystal provided by Cree increases, additional
crystal growth capacity is added, and as the market introduction of moissanite
gemstones expands geographically. As distribution of moissanite expands, the
Company will incur increasing spending levels as it continues to make
investments in development efforts with Cree to increase production volumes and
yields, as it makes investments in receivables, inventory and manufacturing
equipment, and as it increases advertising, marketing and personnel
expenditures. The Company expects to continue operating at a loss through at
least part of 1999. Moreover, there can be no assurance that the Company will
ever achieve the expected sales increases or profitability or that if
profitability is achieved, that such profitability can be sustained. See
"Business Risks--Limited Relevant Operating History."
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1998 COMPARED WITH YEAR ENDED DECEMBER 31, 1997.
Net sales for the year ended December 31, 1998, were $4,026,309. The Company
generated net sales of approximately $3,174,000 from moissanite and
approximately $741,000 from the Company's proprietary test instrument. In
addition, during the first six months of 1998 prior to emerging from the
development stage, the Company generated net sales of approximately $324,000 for
gemstones, which have been netted against research and development expenses on
the operating statement because many of the gemstones were associated with the
Company's research and development program. There were no sales for the year
ended December 31, 1997.
26
Gross profit was $1,113,101 or 28% of net sales for the year ended December 31,
1998. During 1998, gross margins on sales of the Company's test instrument were
higher than the gross margins on sales of moissanite. The Company will seek to
increase gross margins for moissanite gemstones as the Company realizes improved
yields from each SiC crystal produced by Cree. Gross margins for test
instruments will likely decrease over time as the Company enters into additional
volume distribution agreements and if it experiences pricing pressures on its
testers from competitive test instruments.
Marketing and sales expenses increased by $2,454,408 from $535,329 for the year
ended December 31, 1997 to $2,989,737 for the year ended December 31, 1998. The
increase was primarily due to development and execution of consumer-focused
advertising and marketing expenses associated with the initial launch of
moissanite, increased market research and compensation and travel expenses
associated with the expansion of the Company's sales staff.
General and administrative expenses decreased by $73,453 from $2,744,898 for the
year ended December 31, 1997 to $2,671,445 for the year ended December 31, 1998.
The decrease resulted primarily from an approximate $1,200,000 decrease in
compensation expense related to the issuance of stock options. Stock option
compensation expense aggregated approximately $530,000 in 1998 compared to
approximately $1,700,000 in 1997. This decrease was partially offset by an
increase of approximately $1,100,000 resulting from compensation and other
expenses related to additional staff, occupancy expenses, investor relations and
legal expenses associated with business expansion and additional SEC compliance
obligations incurred as a public company.
Research and development expenses increased by $1,890,678 from $2,111,062 for
the year ended December 31, 1997 to $4,001,740 for the year ended December 31,
1998. Approximately $1,390,000 of the increase was attributable to development
expenses incurred under the Company's June 1997 Development Agreement, January
1998 Supplemental Development Agreement and July 1998 Amended and Restated
Development Agreement with Cree Research, Inc. The July 1998 agreement replaces
the two previous development agreements between C3 and Cree and provides both
parties increased flexibility to pursue further color and yield improvements on
both 2-inch and 3-inch diameter crystals. In addition, a portion of the increase
resulted from net production costs for moissanite gemstones during the first
half of 1998 while the Company was in the development stage. The remaining
increase was due to increased expenditures for the Company's internal
development of prototype gemstone pre-forming and faceting operations and
compensation expense for Company research and development staff.
Net interest income increased by $1,345,203 from $471,130 for the year ended
December 31, 1997 to $1,816,333 for the year ended December 31, 1998. This
increase resulted from higher interest income earned on higher cash balances due
primarily to the investment of proceeds from the Company's initial public
offering in November 1997.
YEAR ENDED DECEMBER 31, 1997 COMPARED WITH YEAR ENDED DECEMBER 31, 1996.
Marketing and sales expenses increased by $488,310 from $47,019 for the year
ended December 31, 1996 to $535,329 for the year ended December 31, 1997. The
increase was due to the compensation expense of additional sales staff hired
since the prior period, increased market research expenditures and the
development of preliminary advertising and marketing materials. Prior to May 1,
1996, the Company had no paid employees.
General and administrative expenses increased by $2,610,183 from $134,715 for
the year ended December 31, 1996 to $2,744,898 for the year ended December 31,
1997. Of this increase, approximately $1,600,000 represented compensation
expense related to the issuance of stock options to
27
employees and directors of the Company and an additional $66,000 represented
compensation expense related to the exercise of Cree's option to acquire 24,601
shares Common Stock on January 2, 1997. The balance of the increase was
primarily attributable to the compensation expense of additional staff hired
since the prior period and occupancy expenses. The Company had no paid employees
before May 1, 1996. Prior to February 4, 1997, the Company conducted its
operations from the home of two of its founders and did not incur any lease or
rent expenses during that time.
Research and development expenses increased by $1,875,015 from $236,047 for the
year ended December 31, 1996 to $2,111,062 for the year ended December 31, 1997.
The increase was attributable to expanded colorless SiC crystal development
efforts at Cree, internal development of prototype gemstone pre-forming and
faceting operations, qualifying of vendors for production and development of
production-quality prototypes of the moissanite/diamond test instrument.
Net interest income increased by $435,957 from $35,173 for the year ended
December 31, 1996 to $471,130 for the year ended December 31, 1997. The increase
generally reflected interest earned on cash and cash equivalents, consisting
primarily of U.S. Treasury Bills and U.S. Treasury money market funds acquired
by investing the proceeds from the Company's initial public offering of Common
Stock in November 1997 and its Series B Preferred Stock offering in January,
February and March 1997.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations since inception primarily through the
net proceeds of its initial public offering of Common Stock in November 1997
and, prior to such offering, through private equity sales. Net proceeds from the
Company's initial public offering were $41,072,982. In 1998 the Company used
$8,158,400 to fund operations and $3,973,668 to fund capital expenditures and
patent expenses. At December 31, 1998, the Company had $32,004,045 of cash and
cash equivalents and $33,887,496 of working capital.
In addition to the use of all of the crystal growth systems that Cree is
required to provide at its expense under the Exclusive Supply Agreement, during
1998 the Company ordered a quantity of crystals that required additional crystal
growth systems to be added. As permitted under the Exclusive Supply Agreement,
Cree elected to have C3 purchase those systems. During 1998 the Company paid
approximately $3.4 million to Cree for these systems which were placed in
operation at various dates from August through December. The Company is
obligated to purchase all of the output of these growth systems through June 30,
1999. The Company routinely evaluates Cree's progress under the Development
Agreement and the size and quality of SiC crystals being produced by Cree in
assessing its plans for larger orders which will require the acquisition of
additional crystal growth systems. Under the terms of the Exclusive Supply
Agreement, Cree has the option, in its sole discretion, of building the growth
systems at its own cost or requiring the Company to purchase the growth systems
from Cree. The Company intends to order quantities of SiC crystals in amounts
that would require the purchase of additional growth systems as, on average, net
yields of salable gemstones improve. See "Business--Manufacturing--Growth of SiC
Crystals". The Company plans to engage in increasingly substantial marketing
activities to support the expanding distribution of moissanite gemstones. Such
activities may include advertising campaigns, cooperative advertising with
retail jewelers and distributors, point-of-purchase displays, educational
materials and individualized jeweler training.
The 4-year Development Agreement between the Company and Cree requires the
Company to fund a development program at Cree for $2.88 million annually through
June 30, 2002. Either party may terminate the agreement if Cree does not meet
the annual performance milestone or if the Company and Cree do not mutually
agree on the performance milestones for the ensuing year. See "Business-Products
28
and Product Development-Amended and Restated Development Agreement with Cree."
The Company has no committed external sources of capital. Based on its current
operating plan, the Company anticipates that its existing capital resources will
be adequate to satisfy its capital requirements for at least the remainder of
1999. There may be circumstances, however, particularly a delay in obtaining
improvements in the yield of salable gemstones from each SiC crystal or lower
than anticipated sales, that might accelerate the use of the Company's existing
capital resources. In those circumstances, the Company may be required to raise
substantial additional funds in the future, through public or private sources or
other relationships. No assurance can be given that additional financing will be
available, or if available, that it will be available on terms acceptable to the
Company.
NET OPERATING LOSS CARRYFORWARD
As of December 31, 1998 the Company had a net operating loss ("NOL")
carryforward of approximately $9,500,000, which expires between 2010 and 2013.
In accordance with Section 382 of the Internal Revenue Code of 1986, as amended,
a change in equity ownership of greater than 50% of the Company within a
three-year period results in an annual limitation on the Company's ability to
utilize its NOL carryforwards that were created during tax periods prior to the
change in ownership. As a result of various equity offerings and certain
shareholder transactions, the utilization of the Company's NOL carryforwards has
become limited, however, the Company does not believe this limitation will have
a material effect on the Company's ability to utilize the NOL carryforward.
YEAR 2000 COMPLIANCE
Many currently installed computer systems and software products are coded to
accept only two digit entries in the date code field. These date code fields
will need to accept entries to distinguish 21st century dates from 20th century
dates. The inability to recognize or properly treat dates subsequent to December
31, 1999 may cause a company's systems and applications to process critical
financial and operational information incorrectly. The Company has undertaken a
program to address the Year 2000 issue with respect to the following: (i) the
Company's information technology and operating systems; and (ii) certain systems
of the Company's major suppliers, including Cree (insofar as such systems relate
to the Company's business activities with such parties).
As part of its evolution to an operating company, the Company has selected and
is in the process of implementing an enterprise-wide information technology
system to support the long-term information needs of the Company. The Company
has received written confirmation from the software vendor that the information
technology system selected by the Company is fully Year 2000 compliant. The
Company anticipates that the implementation of this system and testing of the
Year 2000 compliance of the system will be completed by mid 1999 and that the
Year 2000 issue will not pose significant operational problems for its computer
systems. The Company is in the process of reviewing its non-information
technology systems for Year 2000 compliance and expects this review to be
complete by mid 1999. The Company believes the Year 2000 exposure with respect
to those systems is not material.
The Company has also initiated communications with its significant suppliers and
vendors, including Cree. The Company is coordinating efforts with these parties
to minimize the extent to which the Company's business will be vulnerable to
their failure to remediate their own Year 2000 issues. The Company has received
confirmation from its significant suppliers and vendors that they have developed
plans to address the Year 2000 compliance issues of their systems prior to
December 31, 1999.
29
The crystal growth systems which Cree uses to produce silicon carbide crystals
for the Company are dependent upon microprocessors. Cree has confirmed to the
Company that it has evaluated the crystal growth systems and determined that
they are fully Year 2000 compliant. Cree is also evaluating and remediating its
other business systems which rely on microprocessors. According to Cree's Form
S-3 dated February 8, 1999, Cree expects to have completed all Year 2000
compliance efforts by April 1999. To the extent that they are not remediated,
Year 2000 issues could cause delays in the receipt of silicon carbide crystals
which would, in turn, delay deliveries of moissanite gemstones to the Company's
customers. Any significant delay in the Company's receipt of SiC crystals or
resulting delay in delivery of moissanite gemstones would have a material
adverse effect on the Company's business, operating results and financial
condition.
There can be no assurance that the systems of third parties on which the
Company's business relies will be modified on a timely basis. Additionally, to
the extent that the general economy slows down as a result of Year 2000
compliance issues, the Company's operations could be affected. The Company's
business, financial condition or results of operations could be materially
adversely affected by the failure of its systems or those operated by other
parties to operate properly beyond December 31, 1999. To the extent possible,
the Company will be developing and executing contingency plans designed to allow
continued operation in the event of failure of the Company's or third parties'
systems.
NEWLY ISSUED ACCOUNTING PRONOUNCEMENTS
In 1998 the Company adopted Statement of Financial Accounting Standards No. 130
Comprehensive Income. This Statement establishes standards for reporting and
display of comprehensive income and its components (revenues, expenses, gains
and losses) in a full set of general-purpose financial statements.
Reclassification of financial statements for earlier periods is required. There
was no impact from adoption of this Statement on the financial statements of the
Company since it has no items of other comprehensive income in any period
presented.
In 1998 the Company adopted Statement of Financial Accounting Standards No. 131
Disclosures about Segments of an Enterprise and Related Information. This
Statement establishes standards for reporting and disclosing selected
information regarding operating segments, products and services, geographic
areas, and major customers. The application of this standard did not have a
material impact on the financial statements of the Company since all activities
are within a single business segment and no significant disclosures were
required.
In June 1998, Statement of Financial Accounting Standards No. 133 ("FAS 133"),
Accounting for Derivative Instruments and Hedging Activities, was issued. This
statement establishes standards for valuing and reporting at fair value all
derivative instruments as either assets or liabilities. FAS 133 is effective for
all fiscal quarters of all fiscal years beginning after June 15, 1999. The
Company has not evaluated the impact of the adoption of this Statement on the
financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company believes that its exposure to market risk for changes in interest
rates is not significant because the Company's investments are limited to highly
liquid instruments with maturities of three months or less. At December 31, 1998
the Company has approximately $31.6 million of short-term investments classified
as cash and equivalents. All of the Company's transactions with international
customers and suppliers are denominated in US dollars.
30
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Financial Statements
Page
----
Independent Auditors' Report 31
Statements of Operations for the years ended December 31, 1998, 1997 and 1996 32
Balance Sheets as of December 31, 1998 and 1997 33
Statements of Shareholders' Equity for the years ended December 31, 1998, 1997 and 1996 34
Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996 35
Notes to Financial Statements 36
Financial Statement Schedule
Schedule II - Valuation and Qualifying Accounts 45
All other schedules are omitted due to the absence of the conditions under which
they are required or because the required information is included within the
financial statements or the notes thereto included in Item 8.
31
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of C3, Inc.
Research Triangle Park, North Carolina
We have audited the accompanying balance sheets of C3, Inc. (the "Company") as
of December 31, 1998 and 1997, and the related statements of operations,
shareholders' equity, and cash flows for each of the three years in the period
ended December 31, 1998. Our audits also included the financial statement
schedule listed in the Index at Item 8. These financial statements and financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on the financial statements and
financial statement schedule 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, such financial statements present fairly, in all material
respects, the financial position of the Company at December 31, 1998 and 1997,
and the results of its operations and its cash flows for each of the three years
in the period ended December 31, 1998 in conformity with generally accepted
accounting principles. Also, in our opinion, such financial statement schedule,
when considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
As discussed in Note 2 to the financial statements, the Company changed its
method of computing earnings per share effective January 1, 1997 in accordance
with Statement of Financial Accounting Standards No. 128.
DELOITTE & TOUCHE LLP
Raleigh, North Carolina
February 18, 1999
32
C3, INC.
STATEMENTS OF OPERATIONS
Year Ended December 31
------------------------------------------------
1998 1997 1996
------------- ------------- --------------
Net sales $ 4,026,309 $ ---- $ ----
Cost of goods sold 2,913,208 ---- ----
------------- ------------- --------------
Gross profit 1,113,101 ---- ----
Operating expenses:
Marketing and sales 2,989,737 535,329 47,019
General and administrative 2,671,445 2,744,898 134,715
Research and development 4,001,740 2,111,062 236,047
------------- ------------- --------------
Total operating expenses 9,662,922 5,391,289 417,781
------------- ------------- --------------
Operating loss 8,549,821 5,391,289 417,781
Interest income, net (1,816,333) (471,130) (35,173)
------------- ------------- --------------
Net loss $ 6,733,488 $ 4,920,159 $ 382,608
============= ============= ==============
Basic and diluted net loss per
share (Note 2) $ 0.97 $ 1.73 $ 0.19
============= ============= ==============
Weighted-average common shares,
basic and diluted (Note 2) 6,954,600 2,845,773 2,036,813
============= ============= ==============
SEE NOTES TO FINANCIAL STATEMENTS.
33
C3, INC.
BALANCE SHEETS
December 31
-----------------------------
1998 1997
------------ -------------
ASSETS
Current Assets:
Cash and equivalents $ 32,004,045 $ 43,980,385
Accounts receivables, net of allowance for doubtful
accounts of $77,000 at December 31, 1998 546,921 4,298
Interest receivable 121,276 177,654
Inventory, net (Note 2) 3,092,448 278,602
Prepaid expenses and other assets 294,797 73,274
------------ -------------
Total current assets 36,059,487 44,514,213
Equipment, net (Note 3) 3,832,019 214,990
Patent and license rights, net (Note 3) 276,817 143,886
------------ -------------
$ 40,168,323 $ 44,873,089
============ =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable:
Cree Research, Inc. (Note 8) $ 1,679,600 $ 567,110
Other 250,157 237,186
Accrued expenses and other liabilities 223,248 --
Deferred revenue 18,986 22,512
------------ -------------
Total current liabilities 2,171,991 826,808
Commitments (Note 8)
Shareholders' Equity (Notes 4, 5, and 6):
Common stock, no par value; 50 million shares authorized;
6,993,309 and 6,938,476 shares issued and outstanding
at December 31, 1998 and 1997, respectively 48,149,406 47,743,431
Additional paid-in capital--stock options 1,910,368 1,632,804
Accumulated deficit (12,063,442) (5,329,954)
------------ -------------
Total shareholders' equity 37,996,332 44,046,281
------------ -------------
$ 40,168,323 $ 44,873,089
============ =============
SEE NOTES TO FINANCIAL STATEMENTS.
34
C3, INC.
STATEMENTS OF SHAREHOLDERS' EQUITY
1996 Series A 1997 Series B
Preferred Stock Preferred Stock Common Stock Additional
---------------- ---------------- ---------------- Paid-in
Number Number Number Capital Total
Of Of Of Stock Accumulated Shareholders'
Shares Amount Shares Amount Shares Amount Options Deficit Equity
------ ------ ------ ------ ------ ------ ------- ----------- -----------
Balance at
December 31, 1995 ---- $ ---- ---- $ ---- 1,704,000 $ 50,000 $ ---- $ (27,187) $ 22,813
Issuance of common
stock, net of
offering costs of
$20,197 ---- ---- ---- ---- 532,500 979,803 ---- ---- 979,803
Issuance of 1996
Series A
preferred
stock, net of
offering costs
of $10,479 105,000 593,271 ---- ---- ---- ---- ---- ---- 593,271
Net loss ---- ---- ---- ---- ---- ---- ---- (382,608) (382,608)
- ------------------- -------- ---------- -------- ---------- --------- --------- --------- ------------ -----------
Balance at
December 31, 1996 105,000 593,271 ---- ---- 2,236,500 1,029,803 ---- (409,795) 1,213,279
Exercise of stock
option ---- ---- ---- ---- 24,601 66,000 ---- ---- 66,000
Issuance of 1997
Series B
preferred
stock, net of
offering costs
of $34,999 ---- ---- 682,500 4,981,375 ---- ---- ---- ---- 4,981,375
Compensation
expense related
to stock options ---- ---- ---- ---- ---- ---- 1,632,804 ---- 1,632,804
Proceeds from
IPO, net of
offering costs
of $3,927,018 ---- ---- ---- ---- 3,000,000 41,072,982 ---- ---- 41,072,982
Conversion of
preferred stock
to common stock (105,000) (593,271) (682,500) (4,981,375) 1,677,375 5,574,646 ---- ---- ----
Net loss ---- ---- ---- ---- ---- ---- ---- (4,920,159) (4,920,159)
- ------------------- -------- ---------- -------- ---------- --------- --------- --------- ------------ -----------
Balance at
December 31, 1997 ---- ---- ---- ---- 6,938,476 47,743,431 1,632,804 (5,329,954) 44,046,281
Exercise of stock
options ---- ---- ---- ---- 54,833 405,975 (250,247) ---- 155,728
Compensation
expense related
to stock options ---- ---- ---- ---- ---- ---- 527,811 ---- 527,811
Net loss ---- ---- ---- ---- ---- ---- ---- (6,733,488) (6,733,488)
=================== ======== ========== ======== ========== ========= ========= ========= ============ =============
Balance at
December 31,
1998 ---- $ ---- ---- $ ---- 6,993,309 $48,149,406 $1,910,368 $(12,063,442) $37,996,332
=================== ======== ========== ======== ========== ========= =========== ========== =========== ==============
SEE NOTES TO FINANCIAL STATEMENTS.
35
C3, INC.
STATEMENTS OF CASH FLOWS
Year Ended December 31
----------------------------------------------------
1998 1997 1996
--------------- --------------- ----------------
OPERATING ACTIVITIES
Net loss $ (6,733,488) $ (4,920,159) $ (382,608)
Adjustments:
Depreciation and amortization 223,708 26,154 3,618
Compensation expense related
to exercise and issuance of 527,811 1,698,804 ----
stock options
Changes in assets and
liabilities:
Accounts receivable (542,623) (4,298) ----
Interest receivable 56,378 (177,654) ----
Inventory (2,813,846) (278,602) ----
Prepaid expenses and
other assets (221,523) (66,274) 2,346
Accounts payable 1,125,461 791,441 12,855
Accrued expenses and
other liabilities 223,248 ---- ----
Deferred revenue (3,526) 22,512 ----
--------------- --------------- ----------------
Net cash used in operating
activities (8,158,400) (2,908,076) (363,789)
INVESTING ACTIVITIES
Purchases of equipment (3,827,322) (221,177) (10,331)
Patent costs (146,346) (112,177) (30,505)
--------------- --------------- ----------------
Net cash used in investing
activities (3,973,668) (333,354) (40,836)
FINANCING ACTIVITIES
Proceeds from notes payable ---- ---- 53,000
Repayment of notes payable ---- ---- (63,100)
Stock options exercised 155,728 ---- ----
Proceeds from common stock
offerings, net of costs ---- 41,072,982 979,803
Proceeds from preferred stock
offerings, net of costs ---- 4,981,375 593,271
--------------- --------------- ----------------
Net cash provided by financing
activities 155,728 46,054,357 1,562,974
--------------- --------------- ----------------
Net change in cash and equivalents (11,976,340) 42,812,927 1,158,349
Cash and equivalents at beginning
of year 43,980,385 1,167,458 9,109
--------------- --------------- ----------------
Cash and equivalents at end of year $ 32,004,045 $ 43,980,385 $ 1,167,458
=============== =============== ================
SEE NOTES TO FINANCIAL STATEMENTS.
36
C3, INC.
NOTES TO FINANCIAL STATEMENTS--YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1. ORGANIZATION AND BASIS OF PRESENTATION
C3, Inc. ("C3" or the "Company"), was incorporated in North Carolina on June 28,
1995, and manufactures, markets and distributes lab-created moissanite gemstones
(hereinafter referred to as moissanite or moissanite gemstones) for sale in the
jewelry market. Moissanite, also known by its chemical name, silicon carbide
(SiC), is a rare, naturally occurring mineral found primarily in meteorites.
Moissanite is being marketed as an exclusive new gemstone with properties,
including brilliance, fire, luster and hardness that rival other fine gemstones
like diamonds, rubies and emeralds. In addition to moissanite gemstones, the
Company has developed and began selling, in 1998, a test instrument which
distinguishes colorless moissanite gemstones from diamond.
From its inception in June 1995 through June 30, 1998, the Company was a
development stage enterprise that devoted its resources to funding research and
development of moissanite gemstones, market research, developing initial
consumer marketing themes and assembling a management team and did not, through
June 30, 1998, generate significant revenues from its planned principal
operations. The Company began shipping moissanite during the second quarter of
1998, and, in July 1998, launched consumer-focused advertising and promotion
activities in the introductory areas. During the second half of 1998 the Company
expanded the number of authorized retail jewelers in the southeastern states of
North Carolina, South Carolina, Georgia and Florida. In addition, the Company
continued limited distribution and promotional activities in domestic locations
outside this region. The Company also entered into exclusive distribution
agreements with a number of international distributors.
The ability of the Company to successfully develop, manufacture and market its
proprietary products is dependent upon many factors, and during the period
required to develop and market these products, the Company may require
additional funds which may not be available to it. Accordingly, there can be no
assurance of the Company's future success.
All the Company's activities are within a single business segment.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH AND EQUIVALENTS
The Company considers all money market accounts, debt instruments purchased with
an original maturity of three months or less, and other highly liquid
investments to be cash equivalents.
INVENTORY
Inventory is stated at the lower of cost or market, and is determined on a
first-in, first-out basis. At December 31, 1998 finished goods includes
$1,018,465 of test instruments, net of a $132,000 reserve for excess inventory.
Inventories consist of the following:
December 31
---------------------------------
1998 1997
--------------- ---------------
Raw materials $ 140,411 $ 14,108
Work in process 819,953 167,294
Finished goods 2,132,084 97,200
--------------- ---------------
$ 3,092,448 $ 278,602
=============== ===============
37
EQUIPMENT
Equipment is recorded at cost and depreciated on the straight-line method based
on estimated useful lives of three to 12 years. Leasehold improvements are
amortized on the straight-line method over the life of the related lease.
PATENTS AND LICENSE RIGHTS
The Company capitalizes costs associated with obtaining patents issued or
pending for inventions and license rights related to the manufacture of
moissanite gemstones and moissanite gemstone test instruments. Such costs are
amortized over 17 years.
ACCOUNTING FOR LONG-LIVED ASSETS
The Company accounts for long-lived assets in accordance with Statement of
Financial Accounting Standards No. 121 ("FAS 121"), Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of. The
Company evaluates the recoverability of its long-lived assets for financial
impairment whenever events or changes in circumstances indicate that the
carrying value of such assets may not be fully recoverable. Based on these
evaluations, there were no adjustments to the carrying value of long-lived
assets in 1998 or 1997.
CONCENTRATIONS OF CREDIT RISK
Financial instruments which potentially subject the Company to concentrations of
credit risk are primarily cash equivalents and trade receivables. The Company
places its cash equivalents with high quality financial institutions and invests
in low risk securities including U.S. Treasury bills and money market funds,
government agency notes and commercial paper.
Trade receivables are generated from a broad and diverse group of customers,
primarily independent retail jewelry stores. The Company extends credit to its
customers based upon an evaluation of the customer's financial condition and
credit history and generally does not require collateral. No customer has
accounted for 10% or more of the Company's revenue.
INCOME TAXES
From the date of inception (June 28, 1995) to December 31, 1995, the Company was
treated as a C Corporation for federal and state income tax purposes. Effective
January 1, 1996, the Company elected to change its tax status from a C
Corporation to an S Corporation. On September 4, 1996, in connection with the
closing of the 1996 Series A preferred stock offering, the Company's number of
shareholders exceeded the maximum 35 shareholder limitation for S Corporations
and, as a result, the Company's S Corporation status was automatically
terminated. Losses of the Company for the period January 1, 1996 through
September 4, 1996 (totaling $259,533) are included in the personal income tax
returns of the common shareholders as of that date. The tax effect of losses for
the years ended December 31, 1998 and 1997, the period September 5, 1996 to
December 31, 1996 and the seven-month period ending December 31, 1995 are
recorded under the provisions of Statement of Financial Accounting Standards No.
109 ("FAS 109"), Accounting for Income Taxes. Pro forma income tax benefit is
not presented to reflect the impact of losses incurred by the Company during its
S Corporation tax status since a valuation allowance would have been provided
for any net operating losses incurred. Accordingly, no pro forma tax benefit
would be recognized.
RESEARCH AND DEVELOPMENT
All research and development costs are expensed when incurred.
STOCK COMPENSATION
38
The Company's stock option plans are accounted for in accordance with Accounting
Principles Board Opinion No. 25 ("APB 25"), Accounting for Stock Issued to
Employees. In January 1996, the Company adopted the disclosure requirements of
Statement of Financial Accounting Standards No. 123 ("FAS 123"), Accounting for
Stock Based Compensation.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
NET LOSS PER SHARE
In 1997, the Company adopted Statement of Financial Accounting Standards No. 128
("FAS 128"), Earnings Per Share. FAS 128 requires the presentation of both basic
and diluted earnings per share, regardless of materiality unless per share
amounts are equal. Basic loss per share computations are based on the
weighted-average common shares outstanding. Diluted loss per share computations
include the dilutive effect, if any, of stock options and warrants using the
treasury stock method.
Warrants to purchase 300,000 shares of common stock at $18 per share, options
outstanding at December 31, 1998 to purchase 1,215,774 shares of common stock
(exercise prices ranging from $1.88 - $15.00), and retroactive conversion of the
Series A and Series B preferred stock into common shares as of the date of
issuance were excluded from the computation of diluted loss per share because
either the options' exercise price was greater than the average market price of
the common shares or the effect of inclusion of such amounts would be
anti-dilutive to loss per share.
NEWLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1998, Statement of Financial Accounting Standards No. 133 ("FAS 133"),
Accounting for Derivative Instruments and Hedging Activities, was issued. This
statement establishes standards for valuing and reporting at fair value all
derivative instruments as either assets or liabilities. FAS 133 is effective for
all fiscal quarters of all fiscal years beginning after June 15, 1999. The
Company has not evaluated the impact of the adoption of this Statement on the
financial statements.
RECLASSIFICATION
Certain 1997 and 1996 amounts have been reclassified to conform with the 1998
presentation.
3. EQUIPMENT AND PATENT AND LICENSE RIGHTS
Equipment balances are summarized as follows:
December 31
----------------------------
1998 1997
------------- -----------
Machinery and equipment $ 3,614,984 $ 173,438
Computer equipment 310,054 ----
Furniture and fixtures 55,209 ----
Leasehold improvements 44,345 15,496
Construction in progress 39,440 47,776
------------- -----------
Total 4,064,032 236,710
Accumulated depreciation and amortization (232,013) (21,720)
------------- -----------
Total equipment, net $ 3,832,019 $ 214,990
============= ===========
Depreciation expense for 1998, 1997 and 1996 was $210,293, $20,268 and $1,810,
respectively.
39
Patent and license rights balances are summarized as follows:
December 31
----------------------------
1998 1997
------------- -----------
Patent and license rights $ 298,182 $ 151,836
Accumulated amortization (21,365) (7,950)
------------- -----------
Patent and license rights, net $ 276,817 $ 143,886
============= ===========
4. COMMON STOCK
On April 2, 1996 the Company declared an eight-for-one common stock split. On
September 25, 1997, the Company effected a 2.13-for-1 stock split of its common
stock. The effect of these stock splits are reflected as if they had occurred at
the beginning of the earliest period presented.
In May 1996, the Company issued 532,500 shares of common stock with net proceeds
of approximately $979,800 (net of offering costs of $20,197).
On November 14, 1997, the Company completed an initial public offering of
3,000,000 shares of its Common Stock with net proceeds of $41,072,982 (net of
offering costs of $3,927,018).
5. PREFERRED STOCK
The Company has authorized 10 million shares of preferred stock, no par value.
The preferred stock may be issued from time to time in one or more series.
1996 Series A Preferred Stock--The Board designated 105,000 shares of its
preferred stock as 1996 Series A preferred stock. In September 1996, the Company
issued 105,000 shares of Series A preferred stock with net proceeds of
approximately $593,000 (net of offering costs of $10,479). All of the 1996
Series A preferred stock was converted to common stock concurrent with the
initial public offering at a ratio of 2.13 common shares for each share of
preferred stock.
1997 Series B Preferred Stock--The Company designated 682,500 shares of its
preferred stock as 1997 Series B preferred stock. Effective March 7, 1997, the
Company completed the offering of 682,500 shares of its 1997 Series B preferred
stock with net proceeds of approximately $5 million. All of the 1997 Series B
preferred stock was converted to common stock concurrent with the initial public
offering at a ratio of 2.13 common shares for each share of preferred stock.
6. STOCK OPTION PLANS
In 1996, the Company adopted the 1996 Stock Option Plan of C3, Inc. ("1996
Option Plan") under which options to acquire 777,450 common shares, reduced by
the number of options granted outside the 1996 Option Plan, may be granted to
key employees, directors and independent consultants. Under the 1996 Option
Plan, both incentive and non-qualified options may be granted under terms and
conditions
40
established by the compensation committee of the board of directors. The
exercise price for incentive options will be the fair market value of the
related common stock on the date the option is granted. Options granted under
the 1996 Option Plan generally vest equally over a three-year period and have
terms of 10 years. The company currently has no plans to award additional
options under the 1996 Option Plan.
In September 1997, the Company adopted the 1997 Omnibus Stock Plan of C3, Inc.
(the "1997 Omnibus Plan"). The 1997 Omnibus Plan authorizes the Company to grant
stock options, stock appreciation rights and restricted awards (collectively,
"awards") to selected employees, independent contractors and directors of the
Company and related corporations in order to promote a closer identification of
their interests with those of the Company and its shareholders. The maximum
number of shares of Common Stock for which awards may be granted under the 1997
Omnibus Plan may be increased from time to time to a number of shares equal to
(i) 20% of the shares of common stock outstanding as of that time less (ii) the
number of shares of common stock subject to outstanding options under the 1996
Option Plan. The number of shares reserved for issuance under the 1997 Omnibus
Plan may also be adjusted upon certain events affecting the Company's
capitalization. Options granted under the 1997 Omnibus Plan generally vest over
three to five-year periods and have terms of 10 years. The Board of Directors
has reserved 677,979 shares for the 1997 Omnibus Plan.
The following is a summary of activity for the Company's two stock option plans:
1996 Option Plan 1997 Omnibus Plan
---------------------- ----------------------
Weighted Weighted
Number Average Number Average
Of Exercise of Exercise
Shares Price Shares Price
--------- --------- --------- ---------
1996
Granted and outstanding at end of year 200,220 $ 2.37 ---- $ ----
1997
Granted 461,571 4.64 477,000 14.61
--------- --------- --------- ---------
Outstanding at end of year 661,791 3.95 477,000 14.61
1998
Granted ---- ---- 195,000 8.94
Exercised 93,379 4.97 ---- ----
Canceled 13,547 3.66 48,366 14.67
--------- --------- --------- ---------
Outstanding at end of year 554,865 $ 3.78 623,634 $12.83
========= ========= ========= =========
During 1996, the Company granted options to acquire 37,275 shares of common
stock to certain consultants. These options are immediately exercisable, have a
term of five years, and an exercise price of $1.88 per share.
During 1995, the Company issued Cree Research, Inc. ("Cree"), a related company,
an option to acquire one percent (1%) of the outstanding shares of common stock
on the date of exercise at an exercise price of $500 at any time through July 1,
1997. However, the Company retained the right to waive the $500 option fee and
issue the stock at any time during the option period. The Company issued 24,601
shares of common stock to Cree pursuant to this right on January 2, 1997. The
Company recorded compensation expense of approximately $66,000 in 1997 related
to this transaction.
41
The following summarizes information about stock options outstanding at December
31, 1998:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- --------------------------------------------------------------------- -------------------------
Weighted-
Average Weighted- Weighted-
Outstanding Remaining Average Exercisable Average
Range of as of Contractual Exercise as of Exercise
Exercise Price 12/31/1998 Life Price 12/31/1998 Price
- ----------------------- ----------- ----------- ------------- ----------- ----------
$1.5001- $3.0000 224,715 7.6 $2.3100 187,085 $2.3319
$3.0001- $4.5000 89,034 8.3 $3.4500 71,994 $3.4500
$4.5001- $6.0000 278,391 8.5 $4.8100 262,061 $4.8100
$6.0001- $7.5000 10,500 9.8 $7.5000 0 $0.0000
$7.5001- $9.0000 141,900 9.6 $8.6211 15,000 $8.1250
$9.0001- $10.5000 18,000 7.7 $9.8100 0 $0.0000
$10.5001-$12.0000 21,234 8.9 $10.8100 16,038 $10.8100
$13.5001-$15.0000 432,000 8.9 $14.5632 104,767 $14.3996
----------- ----------- ------------- ----------- ----------
1,215,774 8.6 $8.3608 656,945 $5.7067
In accordance with APB 25, the Company recorded compensation expense of
approximately $530,000 and $1,633,000 during 1998 and 1997, respectively,
relating to stock options granted with exercise prices less than market value or
granted to consultants. Had compensation expense for stock options been
determined consistent with FAS 123, (which was effective as of January 1, 1996),
rather than APB 25, the Company's net loss and loss per share for the years
ended December 31, 1998, 1997 and 1996 would have been increased to the pro
forma amounts indicated below:
1998 1997 1996
------------------ ----------------- ---------------
Net loss, as reported $ 6,733,488 $ 4,920,159 $ 382,608
Pro forma net loss $ 7,525,000 $ 5,561,000 $ 404,000
Basic and diluted net loss per share:
As reported $ 0.97 $ 1.73 $ 0.19
Pro forma $ 1.08 $ 1.95 $ 0.20
The fair value of each option grant is estimated on the grant date. Options
granted during 1996 and 1997 were valued using the minimum value method and 1998
grants were valued using a Black-Scholes option pricing model. The valuations
for the years ended December 31, 1998, 1997 and 1996 were based on the following
assumptions:
1998 1997 1996
------------ ------------- ------------
Weighted-average grant date fair value $ 7.46 $ 10.28 $ 4.88
Weighted-average expected lives (in years) 9.98 3.04 1.80
Risk-free interest rate 5.13% 5.50% 6.00%
Dividend yield 0% 0% 0%
Volatility factor .782 0% 0%
In connection with the Company's initial public offering on November 14, 1997,
the Company granted the underwriters options to purchase 450,000 shares of
common stock at $15 per share solely to cover over-allotments in the sale of
common stock in the offering. The options had an exercise term of 45 days and
expired as of December 31, 1997. Also in connection with the offering, the
Company issued
42
warrants to the underwriter to purchase 300,000 shares of common stock at a
price of $18 per share. The warrants are exercisable for a period of four years
beginning November 14, 1998.
7. INCOME TAXES
The Company accounts for income taxes under the liability method in accordance
with FAS 109. Under the liability method, deferred income taxes are recognized
for the tax consequences of "temporary differences" by applying enacted
statutory tax rates applicable to future years to differences between the
financial statement carrying amounts and the tax bases of existing assets and
liabilities.
Significant components of the Company's deferred tax assets and liabilities are
as follows:
December 31
------------------------------------
1998 1997
------------- ---------------
Federal and state loss carryforwards $ 3,716,000 $ 1,319,000
Benefit of research tax credits 234,000 ----
Reserves and accruals 131,000 ----
Depreciation (168,000) (9,000)
------------- ---------------
Total deferred tax assets 3,913,000 1,310,000
Less valuation allowance (3,913,000) (1,310,000)
------------- ---------------
Net deferred tax assets $ ----- $ ----
============= ===============
A reconciliation between expected income taxes, computed at the statutory
federal income tax rate applied to pretax accounting income, and the income
taxes included in the statements of operations for the years ended December 31,
1998, 1997 and 1996 follows:
1998 1997 1996
------------ ------------ ------------
Anticipated income tax
benefit at the statutory federal rate $(2,290,000) $(1,673,400) $ (40,600)
State income tax benefit,
net of federal tax effect (344,000) (252,000) (6,300)
Research tax credits (142,000) ---- ----
Compensation expense--stock options 164,000 640,000 ----
Other 9,000 33,000 ----
Increase in valuation allowance 2,603,000 1,252,400 46,900
---------- ----------- ----------
Income tax (benefit) expense $ ---- $ ---- $ ----
========== =========== ==========
At December 31, 1998, the Company has operating and economic loss carryforwards
of approximately $9,500,000 expiring through 2013, which can be offset against
future federal and state taxable income. In accordance with Section 382 of the
Internal Revenue Code of 1986, as amended, a change in equity ownership of
greater than 50% of the Company within a three-year period results in an annual
limitation on the Company's ability to utilize its NOL carryforwards that were
created during tax periods prior to the change in ownership. As a result of
various equity offerings and certain shareholder transactions, the utilization
of the Company's NOL carryforwards has become limited, however, the Company does
not believe this limitation will have a material effect on the Company's ability
to utilize the NOL carryforward.
43
8. COMMITMENTS
OPERATING LEASE
In August 1997, the Company entered into an agreement to lease approximately
12,700 square feet of mixed use space from an unaffiliated third party at a base
cost of approximately $9,800 per month, plus contingent rentals based on the
Company's proportionate share of the lessor's operating costs, as defined in the
lease agreement. The lease expires August 31, 2004. The Company may cancel the
lease effective as of the last day of the 38th month by delivering to the lessor
written notice nine months prior to the cancellation date and by paying a
cancellation fee of $66,300. The lease provides for escalations of the base rent
throughout the lease term, up to $11,706 at November 1, 2003. The future minimum
lease payments, including the $66,300 cancellation fee, are as follows: $122,400
in 1999, $170,925 in 2000, totaling $293,325.
Rental expense incurred for operating leases and leases whose terms are less
than one year in duration for 1998 and 1997 was approximately $153,000 and
$69,000, respectively. There was no rental expense prior to 1997.
PURCHASE COMMITMENT
On June 6, 1997, the Company entered into an Amended and Restated Exclusive
Supply Agreement ("Supply Agreement") and a Development Agreement with Cree, a
related company. The Supply Agreement has an initial term of ten years which may
be extended for an additional ten years by either party if the Company orders in
any 36-month period SiC crystals with an aggregate purchase price in excess of
$1 million. The Company has met this order threshold and expects to extend the
term of the Supply Agreement. In connection with the Supply Agreement, the
Company has committed to purchase a minimum of fifty percent (50%) (by dollar
volume) of its requirements for SiC crystals from Cree. If the Company's orders
require Cree to expand beyond specified production levels, the Company must
commit to purchase certain minimum quantities. Through June 30, 1999 the Company
has agreed to purchase all crystals produced by existing crystal growers and the
Company and Cree have agreed that the price paid to Cree for SiC crystals will
be based on a sliding scale depending on the quality of each crystal received.
The Company is totally dependent on Cree to supply SiC crystals for its
production process. If the Company is unable to obtain SiC crystals from Cree,
its operations would be adversely affected.
The July 1, 1998 Development Agreement, which replaces the June 1997 Development
Agreement and the 1998 Supplemental Development Agreement, provides for a
four-year development effort by Cree to increase the yield of usable material in
each SiC crystal manufactured by Cree for use by C3 in the production of
moissanite gemstones. The Company is obligated to pay Cree approximately $2.88
million annually through June 30, 2002 under this agreement, however, either
party may terminate the agreement if Cree does not meet the annual performance
milestones or if the Company and Cree do not mutually agree on the performance
milestones for the ensuing year.
During 1998, 1997, and 1996, the Company made purchases from Cree of
approximately $7,568,500, $2,022,700 and $189,600, respectively, for SiC
materials and research and development costs.
44
SCHEDULE II
C3, INC.
VALUATION AND QUALIFYING ACCOUNTS
Additions Collections
Balance at Charged to of Accounts Balance at
Year ended Beginning Costs and Previously Deductions End of
December 31 of Period Expenses Written Off Write Offs Period
- ----------------- ------------ ------------ -------------- ------------- ------------
Allowance for
Doubtful
Accounts
1998 $ ---- $ 77,607 $ ---- $ 607 $ 77,000
Reserve for
Excess Inventory
1998 $ ---- $ 132,000 $ ---- $ ---- $ 132,000
45
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
ITEM 11. EXECUTIVE COMPENSATION
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information called for in items 10 through 13 is incorporated by reference
from the Company's definitive proxy statement relating to its annual meeting of
shareholders, which will be filed with the Securities and Exchange Commission
within 120 days after the end of fiscal 1998.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) and (2) Financial statements and financial statement schedule--the
financial statements, financial statements schedule, and report of independent
accountants are filed as part of this report (see Index to Financial Statements
at Part II Item 8 on page 30 of this Form 10-K).
(a) (3) The following exhibits have been or are being filed herewith and are
numbered in accordance with Item 601 of Regulation S-K:
Exhibit
Number Description
- ------ -----------
3.1 Amended and Restated Articles of Incorporation of C3, Inc. which is
hereby incorporated by reference to Exhibit 3.1 to the Registration
Statement on Form S-1 of C3, Inc. (File No. 333-36809).
3.2 Articles of Amendment of C3, Inc., as filed with the Secretary of State
of North Carolina on February 23, 1999.
3.3 Amended and Restated Bylaws of C3, Inc. which is hereby incorporated by
reference to Exhibit 3.2 to the Registration Statement on Form S-1 of
C3, Inc. (File No. 333- 36809).
4.1 Specimen Certificate of Common Stock.
46
4.2 Form of Representative's Warrant which is hereby incorporated by
reference to Exhibit 4.2 to the Registration Statement on Form S-1 of
C3, Inc. (File No. 333- 36809).
4.3 Rights Agreement dated as of February 22, 1999 between C3, Inc. and
First Union National Bank as Rights Agent which includes the Form of
Rights Certificate as Exhibit A.
10.1 Consulting Agreement, dated May 1, 1997, between Kurt Nassau and C3,
Inc. which is hereby incorporated by reference to Exhibit 10.1 to the
Registration Statement on Form S-1 of C3, Inc. (File No. 333-36809).+
10.2 Letter Agreement, dated May 17, 1997, between Kurt Nassau and C3, Inc.
which is hereby incorporated by reference to Exhibit 10.2 to the
Registration Statement on Form S-1 of C3, Inc. (File No. 333-36809).+
10.3 Letter Agreement, dated February 17, 1997, between Howard Rubin and C3,
Inc. which is hereby incorporated by reference to Exhibit 10.3 to the
Registration Statement on Form S-1 of C3, Inc. (File No. 333-36809).+
10.4 Independent Contractor Agreement, dated May 1, 1997, between Paula K.
Berardinelli and C3, Inc. which is hereby incorporated by reference to
Exhibit 10.4 to the Registration Statement on Form S-1 of C3, Inc.
(File No. 333-36809).+
10.5 Independent Contractor Agreement, dated September 3, 1997, between C.
Eric Hunter and C3, Inc. which is hereby incorporated by reference to
Exhibit 10.5 to the Registration Statement on Form S-1 of C3, Inc.
(File No. 333-36809).
10.6 Independent Contractor Agreement dated July 10, 1997 between Ollin B.
Sykes and C3, Inc. which is hereby incorporated by reference to Exhibit
10.6 to the Registration Statement on Form S-1 of C3, Inc. (File No.
333-36809).+
10.7 Employment Agreement, dated June 1, 1997, between Jeff N. Hunter and
C3, Inc. which is hereby incorporated by reference to Exhibit 10.7 to
the Registration Statement on Form S-1 of C3, Inc. (File No.
333-36809).+
10.8 Employment Agreement, dated July 30, 1997, between Mark W. Hahn and C3,
Inc. which is hereby incorporated by reference to Exhibit 10.8 to the
Registration Statement on Form S-1 of C3, Inc. (File No. 333-36809).+
10.9 Employment Agreement, dated September 15, 1997, between Martin J. DeRoy
and C3, Inc. which is hereby incorporated by reference to Exhibit 10.9
to the Registration Statement on Form S-1 of C3, Inc. (File No.
333-36809).+
10.10 Employment Agreement, dated March 1, 1997, between Thomas G. Coleman
and C3, Inc. which is hereby incorporated by reference to Exhibit 10.10
to the Registration Statement on Form S-1 of C3, Inc. (File No.
333-36809).+
10.11 Amended and Restated Exclusive Supply Agreement, dated June 6, 1997,
between Cree Research, Inc. and C3, Inc. which is hereby incorporated
by reference to Exhibit 10.11 to the Registration Statement on Form S-1
of C3, Inc. (File No. 333-36809).*
47
10.12 Development Agreement, dated as of June 6, 1997, between Cree Research,
Inc. and C3, Inc. which is hereby incorporated by reference to Exhibit
10.12 to the Registration Statement on Form S-1 of C3, Inc. (File No.
333-36809).*
10.13 Letter Agreement, dated July 14, 1997, between Cree Research, Inc. and
C3, Inc. which is hereby incorporated by reference to Exhibit 10.13 to
the Registration Statement on Form S-1 of C3, Inc. (File No.
333-36809).*
10.14 Letter Agreement, dated January 31, 1996, between Cree Research, Inc.
and C3, Inc. which is hereby incorporated by reference to Exhibit 10.14
to the Registration Statement on Form S-1 of C3, Inc. (File No.
333-36809).*
10.15 1996 Stock Option Plan of C3, Inc. (as amended October 27, 1997) which
is hereby incorporated by reference to Exhibit 10.15 to the
Registration Statement on Form S-1 of C3, Inc. (File No. 333-36809).+
10.16 1997 Omnibus Stock Plan of C3, Inc. which is hereby incorporated by
reference to Exhibit 10.16 to the Registration Statement on Form S-1 of
C3, Inc. (File No. 333- 36809).
10.17 Restricted Stock Agreement, dated June 30, 1995, between Jeff N. Hunter
and Paula K. Berardinelli and C3, Inc. which is hereby incorporated by
reference to Exhibit 10.17 to the Registration Statement on Form S-1 of
C3, Inc. (File No. 333-36809).+
10.18 Shareholders Agreement, dated March 18, 1997, between General Electric
Pension Trust, C. Eric Hunter and C3, Inc. which is hereby incorporated
by reference to Exhibit 10.18 to the Registration Statement on Form S-1
of C3, Inc. (File No. 333-36809).
10.19 Registrations Rights Agreement, dated March 18, 1997, between General
Electric Pension Trust and C3, Inc. which is hereby incorporated by
reference to Exhibit 10.19 to the Registration Statement on Form S-1 of
C3, Inc. (File No. 333-36809).
10.20 Agreement, dated September 24, 1997, between John M. Bachman, Inc. and
C3, Inc. which is hereby incorporated by reference to Exhibit 10.20 to
the Registration Statement on Form S-1 of C3, Inc. (File No.
333-36809).*
10.21 Agreement, dated September 12, 1997, between QMD, Inc. and C3, Inc.
which is hereby incorporated by reference to Exhibit 10.21 to the
Registration Statement on Form S-1 of C3, Inc. (File No. 333-36809).*
10.22 1997 Declaration of Amendment to 1997 Omnibus Stock Plan of C3, Inc.
which is hereby incorporated by reference to Exhibit 99.3 to the
Registration Statement on Form S-8 of C3, Inc. (File No. 333-43613).+
10.23 Supplemental Development Agreement, dated January 8, 1998, between Cree
Research, Inc. and C3, Inc. which is hereby incorporated by reference
to Exhibit 10.23 to the Annual Report on Form 10-K of C3, Inc. for the
fiscal year ended December 31, 1997.*
10.24 Letter Agreement, dated January 8, 1998, between Cree Research, Inc.
and C3, Inc. which is hereby incorporated by reference to Exhibit 10.24
to the Annual Report on From 10-K of C3, Inc. for the Fiscal year ended
December 31, 1997.*
48
10.25 Amended and Restated Development Agreement, dated July 1, 1998 between
Cree Research, Inc. and C3, Inc. which is hereby incorporated by
reference to Exhibit 10.25 to the Quarterly Report on Form 10-Q of C3,
Inc. for the quarter ended June 30, 1998.*
10.26 Letter Agreement dated, July 14, 1998, between Cree Research, Inc. and
C3, Inc. which is hereby incorporated by reference to Exhibit 10.26 to
the Quarterly Report on Form 10-Q of C3, Inc. for the quarter ended
June 30, 1998.*
10.27 Employment Agreement, dated April 6, 1998, between Mark Kellam and C3,
Inc. which is hereby incorporated by reference to Exhibit 10.27 to the
Quarterly Report on Form 10-Q of C3, Inc. for the quarter ended
September 30, 1998.+
10.28 First Amendment to Agreement, dated March 23, 1998 between John M.
Bachman, Inc. and C3, Inc. which is hereby incorporated by reference to
Exhibit 10.28 to the Quarterly Report on Form 10-Q of C3, Inc. for the
quarter ended September 30, 1998.*
10.29 Second Amendment to Agreement, dated September 28, 1998 between John M.
Bachman, Inc. and C3, Inc. which is hereby incorporated by reference to
Exhibit 10.29 to the Quarterly Report on Form 10-Q of C3, Inc. for the
quarter ended September 30, 1998.*
10.30 1998 Declaration of Amendment to 1996 Stock Option Plan of C3, Inc.+
10.31 1998 Declaration of Amendment to 1997 Omnibus Stock Plan of C3, Inc.+
10.32 Employment Agreement, dated March 1, 1999, between Robert Thomas and
C3, Inc.+
23.1 Consent of Deloitte & Touche LLP
27.1 Financial Data Schedule - Fiscal year ended December 31, 1998.
* The registrant has requested that certain portions of this exhibit be given
confidential treatment.
+ Denotes a management contract or compensatory plan or arrangement.
49
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
C3, Inc.
By: /s/ Robert S. Thomas Date: 3/16/99
____________________________ _____________
Robert S. Thomas, President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
By: /s/ Jeff N. Hunter Date: 3/16/99
____________________________ _____________
Jeff N. Hunter
Chairman of the Board and Director
(Principal executive officer)
By: /s/ Mark W. Hahn Date: 3/16/99
____________________________ _____________
Mark W. Hahn
Chief Financial Officer
(Principal financial and accounting officer)
By: /s/ Richard Hartigan, Jr. Date: 3/18/99
____________________________ _____________
Richard Hartigan, Jr.
Director
By: /s/ Barbara Kotlikoff Date: 3/16/99
____________________________ _____________
Barbara Kotlikoff
Director
By: /s/ Kurt Leutzinger Date: 3/16/99
____________________________ _____________
Kurt Leutzinger
Director
By: /s/ Joel N. Levy Date: 3/17/99
____________________________ _____________
Joel N. Levy
Director
By: /s/ Kurt Nassau Date: 3/16/99
____________________________ _____________
Kurt Nassau
Director
By: /s/ Howard Rubin Date: 3/16/99
____________________________ _____________
Howard Rubin
Director
By: /s/ Frederick A. Russ Date: 3/17/99
____________________________ _____________
Frederick A. Russ
Director
By: /s/ Ollin B. Sykes Date: 3/16/99
____________________________ _____________
Ollin B. Sykes
Director
50
EXHIBIT INDEX
TO
ANNUAL REPORT ON FORM 10-K
OF
C3, INC.
Exhibit
Number Description
- ------ -----------
3.1 Amended and Restated Articles of Incorporation of C3, Inc. which is
hereby incorporated by reference to Exhibit 3.1 to the Registration
Statement on Form S-1 of C3, Inc. (File No. 333-36809).
3.2 Articles of Amendment of C3, Inc., as filed with the Secretary of State
of North Carolina on February 23, 1999.
3.3 Amended and Restated Bylaws of C3, Inc. which is hereby incorporated by
reference to Exhibit 3.2 to the Registration Statement on Form S-1 of
C3, Inc. (File No. 333- 36809).
4.1 Specimen Certificate of Common Stock.
4.2 Form of Representative's Warrant which is hereby incorporated by
reference to Exhibit 4.2 to the Registration Statement on Form S-1 of
C3, Inc. (File No. 333- 36809).
4.3 Rights Agreement dated as of February 22, 1999 between C3, Inc. and
First Union National Bank as Rights Agent which includes the Form of
Rights Certificate as Exhibit A.
10.1 Consulting Agreement, dated May 1, 1997, between Kurt Nassau and C3,
Inc. which is hereby incorporated by reference to Exhibit 10.1 to the
Registration Statement on Form S-1 of C3, Inc. (File No. 333-36809).+
10.2 Letter Agreement, dated May 17, 1997, between Kurt Nassau and C3, Inc.
which is hereby incorporated by reference to Exhibit 10.2 to the
Registration Statement on Form S-1 of C3, Inc. (File No. 333-36809).+
10.3 Letter Agreement, dated February 17, 1997, between Howard Rubin and C3,
Inc. which is hereby incorporated by reference to Exhibit 10.3 to the
Registration Statement on Form S-1 of C3, Inc. (File No. 333-36809).+
10.4 Independent Contractor Agreement, dated May 1, 1997, between Paula K.
Berardinelli and C3, Inc. which is hereby incorporated by reference to
Exhibit 10.4 to the Registration Statement on Form S-1 of C3, Inc.
(File No. 333-36809).+
10.5 Independent Contractor Agreement, dated September 3, 1997, between C.
Eric Hunter and C3, Inc. which is hereby incorporated by reference to
Exhibit 10.5 to the Registration Statement on Form S-1 of C3, Inc.
(File No. 333-36809).
51
10.6 Independent Contractor Agreement dated July 10, 1997 between Ollin B.
Sykes and C3, Inc. which is hereby incorporated by reference to Exhibit
10.6 to the Registration Statement on Form S-1 of C3, Inc. (File No.
333-36809).+
10.7 Employment Agreement, dated June 1, 1997, between Jeff N. Hunter and
C3, Inc. which is hereby incorporated by reference to Exhibit 10.7 to
the Registration Statement on Form S-1 of C3, Inc. (File No.
333-36809).+
10.8 Employment Agreement, dated July 30, 1997, between Mark W. Hahn and C3,
Inc. which is hereby incorporated by reference to Exhibit 10.8 to the
Registration Statement on Form S-1 of C3, Inc. (File No. 333-36809).+
10.9 Employment Agreement, dated September 15, 1997, between Martin J. DeRoy
and C3, Inc. which is hereby incorporated by reference to Exhibit 10.9
to the Registration Statement on Form S-1 of C3, Inc. (File No.
333-36809).+
10.10 Employment Agreement, dated March 1, 1997, between Thomas G. Coleman
and C3, Inc. which is hereby incorporated by reference to Exhibit 10.10
to the Registration Statement on Form S-1 of C3, Inc. (File No.
333-36809).+
10.11 Amended and Restated Exclusive Supply Agreement, dated June 6, 1997,
between Cree Research, Inc. and C3, Inc. which is hereby incorporated
by reference to Exhibit 10.11 to the Registration Statement on Form S-1
of C3, Inc. (File No. 333-36809).*
10.12 Development Agreement, dated as of June 6, 1997, between Cree Research,
Inc. and C3, Inc. which is hereby incorporated by reference to Exhibit
10.12 to the Registration Statement on Form S-1 of C3, Inc. (File No.
333-36809).*
10.13 Letter Agreement, dated July 14, 1997, between Cree Research, Inc. and
C3, Inc. which is hereby incorporated by reference to Exhibit 10.13 to
the Registration Statement on Form S-1 of C3, Inc. (File No.
333-36809).*
10.14 Letter Agreement, dated January 31, 1996, between Cree Research, Inc.
and C3, Inc. which is hereby incorporated by reference to Exhibit 10.14
to the Registration Statement on Form S-1 of C3, Inc. (File No.
333-36809).*
10.15 1996 Stock Option Plan of C3, Inc. (as amended October 27, 1997) which
is hereby incorporated by reference to Exhibit 10.15 to the
Registration Statement on Form S-1 of C3, Inc. (File No. 333-36809).+
10.16 1997 Omnibus Stock Plan of C3, Inc. which is hereby incorporated by
reference to Exhibit 10.16 to the Registration Statement on Form S-1 of
C3, Inc. (File No. 333- 36809).
10.17 Restricted Stock Agreement, dated June 30, 1995, between Jeff N. Hunter
and Paula K. Berardinelli and C3, Inc. which is hereby incorporated by
reference to Exhibit 10.17 to the Registration Statement on Form S-1 of
C3, Inc. (File No. 333-36809).+
10.18 Shareholders Agreement, dated March 18, 1997, between General Electric
Pension Trust, C. Eric Hunter and C3, Inc. which is hereby incorporated
by reference to Exhibit 10.18 to the Registration Statement on Form S-1
of C3, Inc. (File No. 333-36809).
52
10.19 Registrations Rights Agreement, dated March 18, 1997, between General
Electric Pension Trust and C3, Inc. which is hereby incorporated by
reference to Exhibit 10.19 to the Registration Statement on Form S-1 of
C3, Inc. (File No. 333-36809).
10.20 Agreement, dated September 24, 1997, between John M. Bachman, Inc. and
C3, Inc. which is hereby incorporated by reference to Exhibit 10.20 to
the Registration Statement on Form S-1 of C3, Inc. (File No.
333-36809).*
10.21 Agreement, dated September 12, 1997, between QMD, Inc. and C3, Inc.
which is hereby incorporated by reference to Exhibit 10.21 to the
Registration Statement on Form S-1 of C3, Inc. (File No. 333-36809).*
10.22 1997 Declaration of Amendment to 1997 Omnibus Stock Plan of C3, Inc.
which is hereby incorporated by reference to Exhibit 99.3 to the
Registration Statement on Form S-8 of C3, Inc. (File No. 333-43613).+
10.23 Supplemental Development Agreement, dated January 8, 1998, between Cree
Research, Inc. and C3, Inc. which is hereby incorporated by reference
to Exhibit 10.23 to the Annual Report on From 10-K of C3, Inc. for the
Fiscal year ended December 31, 1997.*
10.24 Letter Agreement, dated January 8, 1998, between Cree Research, Inc.
and C3, Inc. which is hereby incorporated by reference to Exhibit 10.24
to the Annual Report on From 10-K of C3, Inc. for the Fiscal year ended
December 31, 1997.*
10.25 Amended and Restated Development Agreement, dated July 1, 1998 between
Cree Research, Inc. and C3, Inc. which is hereby incorporated by
reference to Exhibit 10.25 to the Quarterly Report on Form 10-Q of C3,
Inc. for the quarter ended June 30, 1998.*
10.26 Letter Agreement dated, July 14, 1998, between Cree Research, Inc. and
C3, Inc. which is hereby incorporated by reference to Exhibit 10.26 to
the Quarterly Report on Form 10-Q of C3, Inc. for the quarter ended
June 30, 1998.*
10.27 Employment Agreement, dated April 6, 1998, between Mark Kellam and C3,
Inc. which is hereby incorporated by reference to Exhibit 10.27 to the
Quarterly Report on Form 10-Q of C3, Inc. for the quarter ended
September 30, 1998.+
10.28 First Amendment to Agreement, dated March 23, 1998 between John M.
Bachman, Inc. and C3, Inc. which is hereby incorporated by reference to
Exhibit 10.28 to the Quarterly Report on Form 10Q of C3, Inc. for the
quarter ended September 30, 1998.*
10.29 Second Amendment to Agreement, dated September 28, 1998 between John M.
Bachman, Inc. and C3, Inc. which is hereby incorporated by reference to
Exhibit 10.29 to the Quarterly Report on Form 10-Q of C3, Inc. for the
quarter ended September 30, 1998.*
10.30 1998 Declaration of Amendment to 1996 Stock Option Plan of C3, Inc.+
10.31 1998 Declaration of Amendment to 1997 Omnibus Stock Plan of C3, Inc.+
10.32 Employment Agreement, dated March 1, 1999, between Robert Thomas and
C3, Inc.+
53
23.1 Consent of Deloitte & Touche LLP
27.1 Financial Data Schedule - Fiscal year ended December 31, 1998.
* The registrant has requested that certain portions of this exhibit be given
confidential treatment.
+ Denotes a management contract or compensatory plan or arrangement.