**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-KSB**

 

**ý****  ANNUAL REPORT PURSUANT TOSECTION 13 OR 15(d)**

**OF THE SECURITIES EXCHANGE ACT OF1934**

 

**For thefiscal year ended December 31, 2001**

 

**OR**

 

**o ****TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE**

**SECURITIES EXCHANGE ACT OF 1934**

 

**For thetransition periodfrom             to             **

 

**CommissionFile Number: 1-11873**

 

**K2 DIGITAL, INC.**

(Exact name of registrantas specified in its charter)

 

| **Delaware**                                                      |   | **13-3886065**                           |
|-------------------------------------------------------------------|--------|------------------------------------------|
| (State or other jurisdiction  of incorporation or   organization) |   | (I.R.S. Employer  Identification Number) |
|                                                              |   |                                     |
| **30  Broad Street, New York, NY 10004**                          |
| (Address of principal  executive offices, including zip code)     |
|                                                              |
| Issuer’s telephone  number**: (212) 785-9402**               |

** **

**Securities registered pursuant to Section 12(b) of theExchange Act:**

 

None.

 

**Securities registered pursuant to Section 12(g) of theExchange Act:**

 

Common Stock

(Title of Class)

 

 

 

Check whether the issuer: (1) filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes ý  No  o

 

Check if there is no disclosure of delinquent filerspursuant to Item 405 of Regulation SB contained in this form, and no disclosurewill be contained, to the best of registrant’s knowledge, in definitive proxyor information statements incorporated by reference in Part III of this Form10-KSB or any amendment to this Form 10-KSB. ý

 

State issuer’s revenuesfor its most recent fiscal year:                $1,997,106

 

As of April 15, 2002, there were 4,982,699 shares (notincluding treasury shares) of the Company’s common stock outstanding.  Based on the closing sales price of theCompany’s common stock on April 10, 2002 of $0.05 per share, the approximateaggregate market value of the Company’s common stock held by non-affiliates was$249,135.

 

**DOCUMENTSINCORPORATED BY REFERENCE**

 

Certain exhibits are incorporated by reference to theCompany’s Registration Statement on Form SB-2 and the amendments thereto, aslisted in response to Item 13(a)(2).

 

Transitional Small Business Disclosure Format (checkone):

 

Yes   o               No ý

 

**EXPLANATORY NOTE**

 

**The financial statements included in this annual report onForm 10-KSB are unaudited and have not been reviewed in any manner by anyindependent public accountant.**  Historically, K2 Digital, Inc.’s (the “Company”) financialstatements have been audited by Arthur Andersen LLP (“Andersen”). On April 10,2002, the Board of Directors of the Company made a determination not to engageAndersen, as its independent public accountants and resolved to appointRothstein, Kass & Company, P.C. (“Rothstein”) as its independent publicaccountants to audit its financial statements for the fiscal year endedDecember 31, 2001.

 

On March 18, 2002, the Securities and ExchangeCommission issued a release adopting certain temporary and final rules intendedto assure a continuing and orderly flow of information to investors and theU.S. capital markets and to minimize any potential disruptions that mightotherwise occur as a result of the indictment of Andersen.

 

In the release, the Commission adopted rules pursuantto which the Commission will accept filings that include unaudited financialstatements from any Andersen client that is unable to obtain from Andersen (orelects not to have Andersen issue) a manually signed audit report and istherefore unable to provide timely audited financial statements.  The rules adopted by the Commission requirethat any Andersen client electing this alternative will generally be requiredto amend their filings within 60 days to include audited financial statements.

 

In accordance with these rules, the Company intends toamend this report on Form 10-KSB no later than May 31, 2002 in order to filethe audited financial statements of the Company for the fiscal year endedDecember 31, 2001, any required selected financial data, a discussion of anymaterial changes from the unaudited financial statements and any other sectionsof the Company’s annual report, including Management’s Discussion and Analysisof Financial Condition and Results of Operations, that should be amended toreflect any changes in the financial statements.

 

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The Business section and other parts of this reportcontain forward-looking statements that involve risks and uncertainties. TheCompany’s actual results may differ significantly from the results discussed inthe forward-looking statements. Factors that might cause such a differenceinclude, but are not limited to, those discussed in the section entitled“Management’s Discussion and Analysis of Financial Condition and Results ofOperations — Factors Affecting Operating Results and Market Price of Stock”commencing on page 7.

 

**PART I**

 

**ITEM 1.                  Description of Business**

 

**History**

 

K2 Digital, Inc. (the “Company” or “K2”) was foundedin 1993 as a general partnership and initially operated a traditional graphicdesign business. In August 1994, the Company shifted its principal business toWeb site design and creation. Thereafter, the Company incorporated as a Delaware corporation.  After the Company’s initial public offeringon July 26, 1996, the Company began to develop its business as a full-servicedigital professional services company. The Company has historically provided consulting and developmentservices including analysis, planning, systems design, creative andimplementation.  In November 2000, theCompany changed its name from K2 Design, Inc. to K2 Digital, Inc.  As discussed below, the Company effectivelyceased its operations in August 2001.

 

The Company’s offices are located at 30 Broad Street,New York, New York 10004 and its telephone number is (212) 785-9402.

 

**Discontinued Operations**

 

*Disposition of Assets*

 

On May 15, 2001, the Company entered into anon-binding letter of intent with SGI Graphics LLC, a Delaware limitedliability company (“SGI”) pursuant to which SGI expressed its interest inpurchasing shares of restricted common stock of the Company that would haverepresented fifty-one percent (51%) of the issued and outstanding capital stockof the Company on a fully diluted basis. Concurrently with the execution of the letter of intent, the Companyborrowed $250,000 from an affiliate of SGI, for working capital purposespursuant to a promissory note secured by a first priority security interest inall of the assets of the Company.  TheCompany and SGI were ultimately not able to agree on the definitive terms ofthe transaction and, in July 2001, the Company and SGI terminated negotiationsand the letter of intent.

 

On August 29, 2001, the Company sold certain of itsfixed and intangible assets to Integrated Information Systems, Inc., a Delawarecorporation (“IIS”), including certain of the Company’s customer contracts,furniture, fixtures, equipment and intellectual property, for an aggregatepurchase price of $444,000, of which $419,000 was paid in cash and $25,000 ofcapital lease obligations were assumed by IIS.

 

Under the terms of the purchase agreement governingthe transaction (the “Purchase Agreement”), IIS assumed the Company’s officelease obligations, took up occupancy in the Company’s premises and made offersof employment to substantially all of the remaining employees of the Company,which offers have been accepted.

 

In addition to the purchase price and as considerationof the Company’s release of certain employees from the non-competitionrestrictions contained in their agreements with the Company, the Companyreceived from IIS at closing a recruitment and placement fee of $75,000. Inaddition, the Purchase Agreement provided for the Company to receive from IISan additional placement fee of $7,500 per key employee and $2,500 per otheremployee that remained employed by IIS through December 31, 2001. Thisadditional contingent placement fee was to be paid by IIS in cash in fivemonthly installments beginning August 31, 2001, pro rated monthly for thenumber of employees retained.  As ofDecember 31, 2001, $31,000 of these contingent fees had been paid to theCompany and $36,500 due to the Company remained unpaid by IIS.

 

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Under the Purchase Agreement, the Company alsoreceived from IIS a cash fee of $50,000 in return for entering into certainnoncompetition provisions contained in the Purchase Agreement, which providethat the Company will not, for a period of five years, (i) engage in anybusiness of substantially the same character as the business engaged in by theCompany prior to the transaction, (ii) solicit for employment any employee ofIIS (including former employees of the Company), or (iii) solicit any client orcustomer of IIS (including any customer transferred to IIS under the PurchaseAgreement) to do business with the Company.

 

Accordingly, the aggregate cash considerationdelivered to the Company at closing was $544,000, of which approximately$258,000 was paid directly to K2 Holdings LLC, an affiliate of SGI, theCompany’s principal secured creditor, in order to release SGI’s securityinterest in the assets of the Company.

 

Subsequent to the sale of assets to IIS, the Companyeffectively ceased operations and has been in the process of liquidatingassets, collecting accounts receivable and paying creditors.  The Company does not have any ongoingbusiness operations or any remaining revenue sources beyond those few remainingreceivables not purchased by IIS and not yet collected by the Company.  Accordingly, the Company’s remaining operationswill be limited to either the sale of the Company or the winding up of theCompany’s remaining business and operations, subject, in either case, to theapproval of the stockholders of the Company. The proceeds from the sale of assets plus the additional payment duefrom IIS (collection of which is uncertain), together with assets not sold toIIS may not be sufficient to repay substantially all remaining liabilities ofthe Company.  The Company has entered intonegotiations with certain creditors to settle specific obligations for amountsless than reflected in the financial statements reported herein.  If these negotiations are unsuccessful,there will not be sufficient cash to repay all of the obligations of theCompany.

 

*Agreement and Plan of Merger*

 

The Board of Directors of the Company has determinedthat, subject to stockholder approval of certain actions as described below,the best course of action for the Company is to complete a business combinationwith a third party with an existing business. Accordingly, from September 2001 through January 15, 2002, the Companywas involved in structuring and negotiating the general terms and conditions ofa business combination transaction between the Company and First StepDistribution Network, Inc., a California corporation (“First Step”) pursuant towhich the Company plans to exchange newly issued shares of its common stock forall of the issued and outstanding securities of First Step.  On January 15, 2002, the Company enteredinto an Agreement and Plan of Merger (the “Merger Agreement”) by and amongFirst Step and its shareholders (the “First Step Shareholders”) and First StepAcquisition Corp., a Delaware corporation and wholly-owned subsidiary of theCompany (“Merger Sub”). Under the terms of the Merger Agreement, the Companyintends to acquire First Step by means of a triangular merger (the “Merger”),pursuant to which the Merger Sub will merge with and into First Step in a taxfree reorganization within the meaning of Section 368 of the Internal RevenueCode of 1986, as amended.

 

The First Step Shareholders will exchange theirrespective shares of common stock, par value $.0001 per share, of First Step(the “First Step Common Stock”) for shares of common stock, par value $.01 pershare of the Company’s common stock. Each share of First Step Common Stock willbe converted into the right to receive 16.609 shares of Company’s common stock.Pursuant to the Merger Agreement, the aggregate number of shares of theCompany’s common stock issuable to the First Step Shareholders by virtue of theMerger as of the date of the Merger Agreement will equal approximately ninetypercent (90%) of the Company’s issued and outstanding common stock on afully-diluted basis.

 

After the effective date of the Merger, the Merger Subwill cease its separate legal existence and First Step will continue as thesurviving corporation. As a condition to the Merger, the Company is required toimplement a 3 for 1 reverse split (the “Reverse Stock Split”) of the Company’scommon stock, thereby reducing its outstanding shares of common stock from4,982,699 shares to approximately 1,660,900 shares. In the Reverse Stock Split,fractional shares will be rounded up to the nearest whole share. Theimplementation of the Reverse Stock Split is subject to the approval of thestockholders of the Company. The Board of Directors of the Company has approvedthe Reverse Stock Split and intends to submit the Reverse Stock Split to thestockholders of the Company for their approval.

 

Upon consummation of the transactions contemplated bythe Merger Agreement and the Reverse Stock Split, the Company’s currentstockholders will experience immediate and severe dilution and will own an

 

2

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aggregate of approximately 1,660,900 shares of Company’s common stock,or approximately 10% of the outstanding voting securities of the Company on afully diluted basis. The First Step Shareholders will own an aggregate of14,948,100 or approximately 90% of the outstanding voting securities of theCompany on a fully-diluted basis.

 

The Merger Agreement contains a provision fortermination of the Merger Agreement by either the Company or First Step if theMerger is not consummated by April 30, 2002. On April 8, 2002, the Company and First Step entered into a side letterunder which the Company agreed to waive its right to terminate the MergerAgreement until June 30, 2002; *provided* that First Step has deliveredto the Company a true and correct copy of First Step’s financial statements (asdescribed in the Merger Agreement) on or before May 8, 2002.

 

There can be no assurance that the Merger will in factbe consummated, or that the shares of the Company's common stock will have anyvalue following the Merger.

 

**Government Regulation**

 

Having effectively ceased operations in August 2001,the Company is not currently subject to direct regulation by any governmentagency, other than regulations applicable to businesses generally.  Web site developers such as the Company facepotential liability for the actions of clients and others using their services,including liability for infringement of intellectual property rights, rights ofpublicity, defamation, libel and criminal activity under the laws of the U.S.and foreign jurisdictions.  Anyimposition of liability from the Company’s prior operations could have amaterial adverse effect on the Company.

 

**Employees**

 

As a result of the transaction entered into with IISin August 2001 and the fact that the Company has effectively ceased operations,at December 31, 2001, the Company had only one full time employee, Gary Brown,the Company’s current President, Chief Operating Officer, Chief FinancialOfficer and Secretary.  Since August2001, Mr. Brown’s employment with the Company has been limited to structuringand negotiating the transactions contemplated by the Merger Agreement and theReverse Stock Split, as well as liquidating assets, collecting accountsreceivable and paying creditors.  SinceDecember 31, 2001, Mr. Brown has taken no salary.

 

**ITEM 2.                  Description of Property**

 

Under the terms of the Purchase Agreement, IIS nowoccupies the Company’s premises and has assumed the Company’s office leaseobligations.  Pursuant to an arrangementwith IIS and the landlord for its premises at 30 Broad Street, New York, NewYork, the Company continues to occupy a small office space in the premises nowoccupied by IIS.

 

**ITEM 3.                  Legal Proceedings**

 

The Company is not a party to any material pendinglegal proceedings as of the date hereof.

 

**ITEM 4.                  Submission of Matters to aVote of Security Holders**

 

The Company did not submit any matters to a vote ofits stockholders, through the solicitation of proxies or otherwise, during thefourth quarter of fiscal 2001.

 

3

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**PART II**

 

**ITEM 5.                  Market for Registrant’s CommonEquity and Related Stockholder Matters**

 

The Company’s common stock wasdelisted from the Nasdaq SmallCap Market (“NASDAQ”) effective August 15, 2001 and currently trades inthe over-the-counter market under the symbol “KTWO.OB.”  Prior to its delisting, the Company’scommon stock was traded on NASDAQ under the symbol “KTWO.” The following tablesets forth, for the periods indicated, the range of high and low price quotesof the Company’s common stock as reported by the over-the-counter bulletinboard (for periods subsequent to the delisting) and NASDAQ (for periods priorto the delisting) from the quarter ended March 31, 2000 through December 31,2001. These quotations reflect inter-dealer prices, without retail mark-up,mark-down or commission, and may not necessarily represent actual transactions.

 

| **Fiscal Quarter Ended** |   | **High** |   | **Low** |   |
|--------------------------|--------|----------|--------|---------|--------|
| March 31, 2000           |   | $        | 10.50  |    | $      | 5.13 |   |
| June 30, 2000            |   | $        | 6.94   |    | $      | 4.13 |   |
| September 30,  2000      |   | $        | 6.75   |    | $      | 3.06 |   |
| December 31, 2000        |   | $        | 4.25   |    | $      | 0.44 |   |
| March 31, 2001           |   | $        | 1.06   |    | $      | 0.28 |   |
| June 30, 2001            |   | $        | 0.46   |    | $      | 0.26 |   |
| September 30,  2001      |   | $        | 0.29   |    | $      | 0.02 |   |
| December 31,  2001       |   | $        | 0.05   |    | $      | 0.02 |   |

 

The approximate number of record holders of theCompany’s common stock at December 31, 2001 was 26, not including beneficialowners whose shares are held by banks, brokers and other nominees.

 

There were no repurchases by the Company of its commonstock on the open market or from any of its shareholders in fiscal year 2000 or2001. At December 31, 2001, the Company held a total of 417,417 shares oftreasury stock at a cost of  $819,296.

 

On December 11, 2000, the Company entered into acommon stock purchase agreement (the “Fusion Facility”) with Fusion CapitalFund II, LLC (“Fusion Capital”), a Chicago-based institutional investor.  On January 26, 2001, the Company issued toFusion Capital, as a commitment fee for the Fusion Facility, 380,485 shares ofcommon stock, as well as warrants to purchase 297,162 shares of common stock atan exercise price of $.01 per share, exercisable at any time over a five yearperiod. In May 2001, the Company issued 862,069 shares of common stock underthe Fusion Facility to an officer of the Company, in exchange for net proceedsof $250,000.  On August 14, 2001, FusionCapital exercised a warrant to purchase an additional 297,162 shares of theCompany’s common stock at an exercise price of $.01 per share. After applyingthe net exercise provisions of the warrant, based upon the closing sale priceof the Company’s common stock of $0.15 per share on August 13, 2001, FusionCapital received 277,351 shares of common stock upon exercise of the warrant.The shares of common stock and warrants issued to Fusion Capital were soldpursuant to the exemption from registration provided by Section 4 (2) of theSecurities Act of 1933, as amended, as an offering not involving any publicoffering. Because the common stock and warrants were issued to Fusion Capitalas a commitment fee under the Fusion Facility, no proceeds were received by theCompany upon issuance of such common stock and warrants.

 

The Company has not paid any dividends. The Companydoes not expect to pay cash dividends on its common stock in the foreseeablefuture.  Declaration of dividends in thefuture will remain within the discretion of the Company’s Board of Directors.

 

4

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**ITEM 6.                  Management’s Discussion andAnalysis of Financial Condition and Results of Operations**

 

The following presentation of management’s discussionand analysis of the Company’s financial condition and results of operationsshould be read in conjunction with the Company’s unaudited consolidatedfinancial statements, the accompanying notes thereto and other financialinformation appearing elsewhere in this report.  By amendment to this report, the Company intends to file auditedfinancial statements with the Commission no later than May 31, 2002 and thefollowing presentation of management’s discussion and analysis of the Company’sfinancial condition and results of operations will accordingly be amended. Thissection and other parts of this report contain forward-looking statements thatinvolve risks and uncertainties. The Company’s actual results may differsignificantly from the results discussed in the forward-looking statements.Factors that might cause such a difference include, but are not limited to,those discussed in the section entitled “Management’s Discussion and Analysisof Financial Condition and Results of Operations-Factors Affecting OperatingResults and Market Price of Stock” commencing on page 7.

 

**Overview**

 

Founded in 1993, the Company is a digital professionalservices company that, until August 2001,has historically provided consulting and development services, including analysis,planning, systems design, creative and implementation.  In August 2001, the Company effectivelyceased operations as described below.

 

**Results of Operations**

 

*Sale of Assets and DiscontinuedOperations*

 

On August 29, 2001, the Company sold certain fixed andintangible assets of the Company to IIS, including certain of the Company’scustomer contracts, furniture, fixtures, equipment and intellectual property,for an aggregate purchase price of $444,000, of which $419,000 was paid in cashand $25,000 of capital lease obligations were assumed by IIS.

 

Under the terms of the Purchase Agreement, IIS assumedthe Company’s office lease obligations, took up occupancy in the Company’spremises and made offers of employment to substantially all of the remaining employeesof the Company, which offers have been accepted.

 

In addition to the purchase price and as considerationof the Company’s release of certain employees from the non-competitionrestrictions contained in their agreements with the Company, the Companyreceived from IIS at closing a recruitment and placement fee of $75,000. Inaddition, the Purchase Agreement provided for the Company to receive from IISan additional placement fee of $7,500 per key employee and $2,500 per otheremployee that remained employed by IIS through December 31, 2001. Thisadditional contingent placement fee was to be paid by IIS in cash in fivemonthly installments beginning August 31, 2001, pro rated monthly for thenumber of employees retained. As of December 31, 2001, $31,000 of thesecontingent fees had been paid to the Company and $36,500 due to the Companyremains unpaid by IIS. Collection of the amounts due are uncertain.

 

Under the Purchase Agreement, the Company alsoreceived from IIS a cash fee of $50,000 in return for entering into certainnoncompetition provisions contained in the Purchase Agreement, which providethat the Company will not, for a period of five years, (i) engage in anybusiness of substantially the same character as the business engaged in by theCompany prior to the transaction, (ii) solicit for employment any employee ofIIS (including former employees of the Company), or (iii) solicit any client orcustomer of IIS (including any customer transferred to IIS under the Purchase  Agreement) to do business with the Company.

 

Accordingly, the aggregate cash considerationdelivered to the Company at closing was $544,000, of which approximately$258,000 was paid directly to K2 Holdings LLC, an affiliate of SGI, theCompany’s principal secured creditor, in order to release SGI’s securityinterest in the assets of the Company.

 

Subsequent to the sale of assets to IIS, the Companyeffectively ceased operations and has been in the process of liquidatingassets, collecting accounts receivable and paying creditors.  The Company does not have any ongoingbusiness operations or any remaining revenue sources beyond those few remainingreceivables not purchased by IIS and not yet collected by the Company.  Accordingly, the Company’s remainingoperations will be limited to either the sale of the Company or the winding upof the

 

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Company’s remaining business and operations, subject, in either case,to the approval of the stockholders of the Company. The proceeds from the saleof assets plus the additional payment due from IIS (collection of which isuncertain), together with assets not sold to IIS may not be sufficient to repaysubstantially all remaining liabilities of the Company.  The Company has entered into negotiationswith certain creditors to settle specific obligations for amounts less thanreflected in the financial statements reported herein.  If these negotiations are unsuccessful,there will not be sufficient cash to repay all of the obligations of theCompany.

 

*General*

* *

Revenues are recognized on a percentage-of-completionbasis. Provisions for any estimated losses on incomplete projects are made inthe period in which such losses are determinable. A portion of the Company’srevenues has been generated on a fixed fee or cap fee basis, as well as on anhourly bill rate basis.

 

*Revenues*

 

Net revenue represents gross revenue minus media passthrough costs and reimbursable expenses. Net revenue for the year endedDecember 31, 2001 was $1,997,106 which was realized during the first sevenmonths of  2001 prior to the sale ofassets to IIS and termination of the Company’s operations effective August2001.  The Company had net revenues of$5,162,000 for the full year ended December 31, 2000.

 

*Selected Quarterly Operating Results(Unaudited)*

 

The following table presents unaudited quarterlyfinancial information for the period from January 1, 2000 to June 30, 2001. Theinformation has been derived from the Company’s unaudited consolidatedfinancial statements appearing elsewhere in this report. TheCompany intends to amend this report on Form 10-KSB no later than May 31, 2002in order to file the audited financial statements of the Company for the fiscalyear ended December 31, 2001, any required selected financial data, adiscussion of any material changes from the unaudited financial statements andany other sections of the Company’s annual report, including Management’sDiscussion and Analysis of Financial Condition and Results of Operations, thatshould be amended to reflect any changes in the financial statements. Theseresults are not indicative of results for any future period.

 
|                                                                                    |   | **2000**   |      | **2001**   |   |
|-----------------------------------------------------------------------------------------|--------|------------|-----------|------------|--------|
|                                                                                    |   | **31-Mar** |      | **30-Jun** |   | **30-Sep** |   | **31-Dec** |   | **31-Mar** |   | **30-Jun** |   |
| Net Revenues                                                                            |   | $          | 1,488,848 |       | $      | 648,336 |   | $ | 1,115,029 |   | $ | 1,909,999 |   | $ | 865,925 |   | $ | 962,852 |   |
|                                                                                    |   |       |      |       |   |   |   |   |   |   |   |   |   |
| Direct salaries  and costs                                                              |   | 885,078    |      | 768,011    |   | 869,090 |   | 822,611 |   | 1,005,192 |   | 763,940 |   |
| Selling, general  and administrative expenses                                           |   | 857,100    |      | 768,458    |   | 894,699 |   | 1,020,977 |   | 1,075,964 |   | 1,007,755 |   |
| Write-off of deferred  issuance costs                                                   |   | —     |      | —     |   | — |   | — |   | 584,452 |   | 503,367 |   |
| Assets  Impairment                                                                      |   | —     |      | —     |   | — |   | — |   | — |   | 222,748 |   |
| Depreciation and  Amortization                                                          |   | 79,417     |      | 86,075     |   | 82,277 |   | 84,512 |   | 90,466 |   | 93,904 |   |
| Loss from  operations before interest , Other Income (Expenses), net & income taxes |   | (332,747   | )         | (974,208   | )      | (731,037 | ) | (18,101 | ) | (1,890,149 | ) | (1,628,862 | ) |
|                                                                                    |   |       |      |       |   |   |   |   |   |   |   |   |   |
| Interest and  Other Income (Expenses), net                                              |   | 41,634     |      | 39,504     |   | 54,298 |   | (2,641 | ) | 12,470 |   | 7,430 |   |
| Provision  (Benefit) for income taxes                                                   |   | 4,120      |      | 6,750      |   | 20,498 |   | (29,123 | ) | — |   | (25,827 | ) |
| Net Income  (Loss)                                                                      |   | $          | (295,233  | )          | $      | (941,454 | ) | $ | (697,237 | ) | $ | 8,381 |   | $ | (1,877,679 | ) | $ | (1,595,605 | ) |

 

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**Continuing Operations, Liquidity andCapital Resources**

 

Subsequent to the sale of assets to IIS, the Companyeffectively ceased operations and has been in the process of liquidatingassets, collecting accounts receivable and paying creditors.  The Company does not have any ongoingbusiness operations or revenue sources beyond those assets not purchased byIIS.  Accordingly, the Company’sremaining operations will be limited to either the sale of the Company or thewinding up of the Company’s remaining business and operations, subject, ineither case, to the approval of the stockholders of the Company.  The proceeds from the sale of assets plusthe additional contingent payments from IIS, together with assets not sold toIIS may not be sufficient to repay substantially all of the liabilities of theCompany.  The Company has entered intonegotiations with certain creditors to settle specific obligations for amountsless than reflected in the financial statements reported herein.  If these negotiations are unsuccessful,there will not be sufficient cash to repay all of the obligations of theCompany.

 

The Board of Directors of the Company has determinedthat, subject to stockholder approval, the best course of action for theCompany is to complete a business combination with a third party with anexisting business. On January 15, 2002, the Company entered into the MergerAgreement described above.  Under theterms of the Merger Agreement, the Company intends to acquire First Step bymeans of a triangular merger, pursuant to which a subsidiary of the Companywill merge with and into First Step in a tax free reorganization within themeaning of Section 368 of the Internal Revenue Code of 1986, as amended.

 

As a condition to the Merger, the Company is requiredto implement the Reverse Stock Split described above.  The implementation of the Reverse Stock Split is subject to theapproval of the stockholders of the Company. The Board of Directors of theCompany has approved the Reverse Stock Split and will submit the Reverse StockSplit to the stockholders of the Company for their approval.

 

In the event that the transactions contemplated by theMerger Agreement are not consummated for any reason, the Company’s remainingassets will not be sufficient to meet its ongoing liabilities and the Company’sremaining operations will be wound up subject to the approval of thestockholders of the Company.* *Theanticipated closing date for the Merger has been postponed due to delays inFirst Step’s ability to secure the financing for the transaction that isrequired pursuant to the terms and conditions of the Merger Agreement, as wellas delays in the preparation and finalization of the requisite financial andother information about First Step that will be included in the Company’s proxystatement being prepared in connection with the solicitation of stockholderapproval for the Reverse Stock Split. The Company has been informed byrepresentatives of First Step that First Step has made significant progress insecuring the necessary financing and financial statements and that First Stepexpects to be able to consummate the Merger during the second quarter of 2002,subject to the requisite stockholder approval.

 

The Company’s cash balance of $5,380 at December 31,2001, decreased by $730,226 or 99% compared to the $735,606 cash balance atDecember 31, 2000. This decrease is primarily due to the fact that the Companyeffectively ceased its operations as of August 1, 2001.

 

**Factors Affecting Operating Resultsand Market Price of Stock**

 

*The Company has effectivelydiscontinued its operations.*

* *

In August 2001, the Companysold certain fixed and intangible assets essential to its business operationsand entered into a purchase agreement containing provisions restricting theCompany’s ability to continue to engage in the business engaged in by the Companyprior to the transaction.  Accordingly,the Company’s remaining operations have been limited to liquidating assets,collecting accounts receivable, paying creditors, and negotiating andstructuring the transactions contemplated by the Merger Agreement or thewinding up of the Company’s remaining business and operations, subject, ineither case, to the approval of the stockholders of the Company.

 

*Thetransactions contemplated by the Merger Agreement may never be consummated.*

* *

In the event that the transactions contemplated by theMerger Agreement are not consummated for any reason, the Company’s remainingassets will not be sufficient to meet its ongoing liabilities and the Company’sremaining operations will be wound up subject to the approval of the stockholdersof the Company. The anticipated

 

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closing date for the Merger has been postponed due to delays in FirstStep’s ability to secure the financing for the transaction that is requiredpursuant to the terms and conditions of the Merger Agreement, as well as delaysin the preparation and finalization of the requisite financial and otherinformation about First Step that will be included in the Company’s proxystatement being prepared in connection with the solicitation of stockholderapproval for the Reverse Stock Split. The Company has been informed byrepresentatives of First Step that First Step has made significant progress insecuring the necessary financing and financial statements and that First Stepexpects to be able to consummate the Merger during the second quarter of 2002,subject to the requisite stockholder approval. Although First Step has assured the Company that First Step remainscommitted to the consummation of the transaction, the transaction is subject tothe satisfaction of a number of conditions and there can be no assurance thatthe transaction will be consummated.

 

*The financial statements included inthis report are unaudited.*

 

The financial statements included in this annual reporton Form 10-KSB are unaudited and have not been reviewed in any manner by anyindependent public accountant. Historically, the Company’s financial statements have been audited byArthur Andersen LLP (“Andersen”). On April 10, 2002, the Board of Directors ofthe Company made a determination not to engage Andersen, as its independentpublic accountants and resolved to appoint Rothstein, Kass & Company, P.C.(“Rothstein”) as its independent public accountants to audit its financialstatements for the fiscal year ended December 31, 2001. Rothstein also servesas the independent auditors for First Step.

* *

In accordance with rules recently adopted by theSecurities and Exchange Commission, the Company intends to amend this report onForm 10-KSB no later than May 31, 2002 in order to file the audited financialstatements of the Company for the fiscal year ended December 31, 2001, anyrequired selected financial data, a discussion of any material changes from theunaudited financial statements and any other sections of the Company’s annualreport, including Management’s Discussion and Analysis of Financial Conditionand Results of Operations, that should be amended to reflect any changes in thefinancial statements. When complete, the audited financial statements of theCompany may contain material differences from the unaudited financialstatements included in this report*.*

 

*The Company’s stock has beendelisted  from the Nasdaq SmallCapMarket*

* *

The Company’s common stock was delisted from theNasdaq SmallCap Market effective August 15, 2001 and currently trades in theover-the-counter market.  On March 13,2001, the Staff of the Nasdaq Stock Market notified the Company that it hadfailed to demonstrate a closing bid price of at least $1.00 per share for 30consecutive trading days and was in violation of Nasdaq Marketplace Rule4310(c)(4).  In accordance withapplicable Nasdaq Marketplace rules, the Company was provided a 90-day graceperiod, through June 11, 2001, during which to regain compliance.  On June 20, 2001, the Company requested ahearing, which effectively stayed the delisting.  However, after submission of materials in support of theCompany’s position to the Panel, the Panel decided to delist the Company’scommon stock from the Nasdaq SmallCap Market as of the open of business onAugust 15, 2001. The delisting of the Company’s common stock from The NasdaqSmallCap Market is likely to materially and adversely decrease the alreadylimited liquidity and market price of the common stock, and may increase bothvolatility and the “spread” between bid and asked prices of the common stock.

 

**ITEM 7.                  Financial Statements andSupplementary Data**

 

See Item 13(a)(1) in Part IV.

 

**The financial statements included in this annual report onForm 10-KSB are unaudited and have not been reviewed in any manner by anyindependent public accountant.** As described above, in accordance with newly established rules ofthe Securities and Exchange Commission, the Company intends to amend thisreport on Form 10-KSB no later than May 31, 2002 in order to file the auditedfinancial statements of the Company for the fiscal year ended December 31,2001, any required selected financial data, a discussion of any materialchanges from the unaudited financial statements and any other sections of theCompany’s annual report, including Management’s Discussion and Analysis ofFinancial Condition and Results of Operations, that should be amended toreflect any changes in the financial statements.

 

8

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**ITEM8.**                                                     **Changes in and Disagreements on Accounting andFinancial Disclosure**

 

As discussed above, on April 10, 2002, the Board ofDirectors of the Company made a determination not to engage Andersen, as itsindependent public accountants and resolved to appoint Rothstein, as itsindependent public accountants to audit its financial statements for the fiscalyear ended December 31, 2001.

 

During the two most recent fiscal years, and throughApril 10, 2002, there were no disagreements with Andersen on any matter ofaccounting principles or practices, financial statement disclosure, or auditingscope or procedure, which disagreements, if not resolved to Andersen’ssatisfaction, would have caused Andersen to make reference to the subjectmatter of the disagreement in connection with its reports.

 

Andersen added an explanatory paragraph to their auditopinion issued in connection with the Company’s financial statements for thefiscal year ended December 31, 2000 which states that the Company’s lossessince inception and dependence on outside financing raise substantial doubtabout its ability to continue as a going concern.  The Company’s financial statements for the fiscal year endedDecember 31, 2000 did not include any adjustments that might result from theoutcome of that uncertainty.  With theexception of the foregoing, the audit reports of Andersen on the consolidatedfinancial statements of the Company as of and for each of the two fiscal yearsended December 31, 2000 did not contain any adverse opinion or disclaimer ofopinion, nor were they qualified or modified as to uncertainty, audit scope oraccounting principles.

 

None of the reportable events described under Item304(a)(1)(iv) of Regulation S-B occurred within the two most recent fiscalyears and through April 10, 2002.

 

The Company provided Andersen with a copy of the abovedisclosures. A letter dated April 10, 2002, from Andersen stating its agreementwith our statements is listed under Item 13(a)(2) in Part IV as Exhibit 16.1and is incorporated herein by reference to the Company’s Form 8-K filed withthe Securities and Exchange Commission on April 16, 2002.

 

During the two most recent fiscal years ended December31, 2001, and the subsequent interim period through April 10, 2002, the Companydid not consult with Rothstein regarding any of the matters or events set forthin Item 304(a)(2)(i) and (ii) of Regulation S-B.

 

9

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**PART III**

 

**ITEM9**.                                                     **Directors, Executive Officers, Promoters and ControlPersons; Compliance with Section 16(a) of the Exchange Act**

 

**Directorsof the Company**

 

Since December 31, 2000, three directors have tenderedtheir resignations from the Company’s Board of Directors.  P. Scott Munro resigned effective June 2001,Lynn Fantom resigned effective November 6, 2001 and Dr. Steven N. Goldsteinresigned effective March 31, 2002.  Setforth below are the current directors of the Company.

 

Matthew G. de Ganon, age 39, has been a director sincehe joined the Company in July 1995.  Mr.de Ganon resigned from his position as an executive officer of the Companyeffective August 1, 2001.  From thattime until April 2002, Mr. de Ganon was employed by Integrated InformationSystems, Inc., which purchased certain assets of the Company in August2001.  He was President of the Companyfrom June 1996 to November 1998 and was also the Chief Operating Officer of theCompany from July 1995 to November 1997. For the two years prior to joining the Company, Mr. de Ganon operated abusiness that created CD-ROM products and offered consulting services regardingthe use of electronic delivery to publishers of newsletters anddirectories.  Mr. de Ganon is co-authorof the essay, “Overcoming Future Shock on the Superhighway: Suggestions forProviders and Technocrats,” published and presented in the 1994 National OnlineConference Proceedings.  From August1992 to July 1993, Mr. de Ganon was the Vice President of New Media of SuperiorComputer Systems, Inc., a software developer. Mr. de Ganon’s work focused on UNIX-based 4GL accounting softwarecustomization for corporate clients. From May 1991 to July 1992, Mr. de Ganon was involved in castingadministration for the Motion Picture Group of Universal Studios, Inc. He was afranchised theatrical agent with the Stone Manners Agency in Los Angeles,California from August 1987 to May 1991.

 

Douglas E. Cleek, age 39, who co-founded the Companyin 1993, has been a director of the Company since it was reorganized as acorporation in January 1995. From January 1995 until August 2001, Mr. Cleekserved as the Company’s Executive Vice President—Chief Creative Officer.  From 1993 until 1995, Mr. Cleek was ageneral partner of the Company. For more than five years prior to that, Mr.Cleek was an art director for William Allen & Co. and its successor, A.J.Bart & Sons, specializing in graphic promotional materials for thehospitality industry.

 

Gary W. Brown, age 49, has been a director of theCompany since February 2000 and joined the Company in April 2000 as ExecutiveVice President and Chief Operating Officer. Since August 31, 2001, Mr. Brownhas served as President, Secretary, Chief Financial Officer and Chief OperatingOfficer of the Company.  Since November14, 2001, Mr. Brown has served as Vice President and Managing Director of theRisk Management Division of Canadian Imperial Bank of Commerce (CIBC WorldMarkets).  Prior to that, Mr. Brown wasemployed from July 1980 through June 1999 in various management roles with UBSAG, the successor organization to Union Bank of Switzerland, including the roleof New York Branch Manager. There he served as Division Head for StructuredFinance, one of UBS’s six operating divisions in the Americas prior to themerger of UBS with Swiss Bank Corporation in 1998. Post-merger, Mr. Brown wasdesignated Chief Credit Officer-Americas for UBS’s investment banking division,Warburg, Dillon Read, where he was responsible for capital commitments of thefirm. Mr. Brown held various business development and risk management positionsthroughout his 19-year career at UBS. He also served as President of the NewYork Chapter of Robert Morris Associates, the trade association for thefinancial services risk management industry, and as an ex-officio member of theRMA National Board. Since 1991, he has served on the Board of Directors ofSefar Americas, a subsidiary of Sefar AG, a manufacturer of Swiss syntheticfabrics. Prior to joining UBS in 1980, Mr. Brown was employed from June 1976through June 1980 with The Chase Manhattan Bank, having served in various businessdevelopment functions. Mr. Brown received a Bachelor of Science degree inBusiness Administration from Oral Roberts University in May 1976.

 

David R. Sklaver, age 50, has been a director of theCompany since 1999. Since October 2001, Mr. Sklaver has been President andChief Executive Officer of UPOC, Inc., a marketing company.  From June 1997 to October 2001, Mr. Sklaverwas a General Partner and Chief Executive Officer of Artustry Partnership, astrategic and creative marketing company, of which he was a founder.  Since October 1995, Mr. Sklaver has alsoserved as President of Phase 2, Inc. From 1993 to 1995, Mr. Sklaver served as President of Wells Rich GreeneDDB, an advertising agency handling Fortune 500 clients. Prior to beingpromoted to President, Mr. Sklaver served as

 

10

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Executive Vice President, Director of Client Services of Wells RichGreene from 1989 to 1993. From 1986 to 1988, Mr. Sklaver was Executive VicePresident, Account Group Head, at advertising agency BBD Needham, New York.From 1984 to 1985, Mr. Sklaver was Managing Director of DDB’s Sydney office.From 1978 to 1984, he served in Account Management at DDB New York. Prior to1978, Mr. Sklaver held positions at Foote, Cone & Belding Advertising andStandard Brands, both advertising agencies.

 

**FilingRequirements**

 

The Company believes that all filing requirementsunder Section 16(a) of the Securities Act of 1934, as amended, applicable toits officers, directors and greater than 10% beneficial owners were compliedwith during the fiscal year ended December 31, 2001.

 

**ITEM 10**.                                            **ExecutiveCompensation**

 

**DirectorFees**

 

Directors who are employees of the Company receive noadditional compensation for their service as directors. Directors not soemployed are entitled to receive $25,000 in compensation annually and areentitled to be reimbursed for expenses incurred in connection with meetingattendance. In addition, each of the Company’s non-employee Directors aregranted options to acquire 5,000 shares of the Company’s common stock upontheir election or reelection to the Board.

 

**AdvisorFees**

 

All nonemployees serving as members of the Company’sBoard of Advisors receive options to purchase up to 5,000 shares of theCompany’s common stock upon their election to the Board of Advisors. There aretwo members of the Board of Advisors.

 

11

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**ExecutiveCompensation**

 

The following table sets forth, for the last threecompleted fiscal years, the total annual compensation paid or accrued by theCompany for services in all capacities for the Chief Executive Officer, andthose other executive officers (the “Named Executives”) who served in executivecapacities during fiscal 2001 and had aggregate compensation in excess of$100,000.  Except for Mr. Brown, each ofthe Named Executives has resigned his or her position as an officer of theCompany, effective August 2001.

 
|                                                                                                      |   | **Annual  Compensation(1)** |   | **Long Term Compensation** |   |
|-----------------------------------------------------------------------------------------------------------|--------|-----------------------------|--------|----------------------------|--------|
| **Name and Principal Position**                                                                           |   | **Year**                    |   | **Salary ($)**             |   | **Bonus ($)** |   | **Restricted Stock  Awards** |   | **Option  Awards** |   |
| Lynn Fantom, Chief Executive Officer and  President (2)                                              |   | 2001  2000  1999            |   | 144,173  250,000  250,000  |   | —  —  — |   | —  —  — |   | 200,000  —  — |   |
|                                                                                                      |   |                        |   |                       |   |   |   |   |   |   |   |
| Matthew G. de Ganon, Executive Officer and  Chairman of the Board (2)                                |   | 2001  2000  1999            |   | 164,231  228,392  175,613  |   | —  —  25,000 |   | —  —  — |   | —  —  — |   |
|                                                                                                      |   |                        |   |                       |   |   |   |   |   |   |   |
| Douglas E. Cleek, Executive Vice President—  Chief Creative Officer (2)                         |   | 2001  2000  1999            |   | 115,837  182,423  166,794  |   | —  —  25,000 |   | —  —  — |   | —  —  — |   |
|                                                                                                      |   |                        |   |                       |   |   |   |   |   |   |   |
| Gary W. Brown, President, Chief Operating   Officer, Secretary and Chief  Financial Officer (3) |   | 2001  2000                  |   | 192,539  151,442           | (4)    | —  — |   | —  100,000 | (5) | 100,000  268,000 |   |

 

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(1)           The value of perquisites and otherpersonal benefits does not exceed 10% of the officer’s salary.

(2)           Resigned as an officer of the Companyeffective August 1, 2001.

(3)           Joined the Company in April 2000 andremains as an officer and director.

(4)           Mr. Brown accepted compensation lessthan provided for in his employment agreement during 2001, and has received nosalary since December 31, 2001.

(5)           50,000 shares vested on April 14,2001 and the remaining 50,000 shares vested on April 14, 2002.  Based on the closing price of the Company’scommon stock on April 14, 2000 of $5.00 per share, the fair market value of therestricted stock awards on the date of grant was $500,000.

 

**Employment Contracts for ExecutiveOfficers**

 

Matthew G. de Ganon, Lynn Fantom and Douglas E. Cleekresigned from their positions as officers of the Company effective August 1,2001.  In connection with theirresignations, Mr. de Gannon and Mr. Cleek executed releases, releasing theCompany from any further liability under their employment agreements with the Company.

 

The employment contract between the Company and LynnFantom, as Chief Executive Officer and President of the Company, terminated onDecember 31, 2000 and a new employment contract between the Company and Ms.Fantom as Chief Executive Office and President of the Company was entered intoon February 13, 2001 and was scheduled to terminate on December 31, 2002.  Ms. Fantom resigned from her position asChief Executive Officer and President of the Company effective August 1, 2001.  Pursuant to her employment contract, Ms.Fantom is subject to a non-compete restriction for twelve months after thetermination of her employment.

 

Gary W. Brown joined the Company as Executive VicePresident and Chief Operating Officer on April 14, 2000 and is currently theCompany’s President, Chief Financial Officer, Chief Operating Officer andSecretary.  Mr. Brown signed anemployment contract with the Company that expired on March 31, 2002.  The employment contract provided for an annualsalary of $225,000 and a discretionary annual bonus in the form of stock optionsup to a maximum of 100,000 shares of the Company’s common stock per year.  Upon joining the Company, Mr. Brown alsoreceived 100,000 shares of restricted stock and options to purchase up to263,000 shares of the Company’s common stock, all of which had vested as ofApril 14, 2002.   In the event of achange of control of the Company, all of Mr. Brown’s unvested stock optionswere to immediately vest pursuant to his

 

12

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employment contract and if, within 180 days after a change of control,Mr. Brown is dismissed from the Company for any reason other than “Cause” or ifMr. Brown were to resign from the Company for “Good Reason” (as each term isdefined in his employment contract), Mr. Brown was to be entitled to a paymentequal to the greater of $225,000 or his base salary for the remainder of hisemployment term.  Pursuant to hisemployment contract, Mr. Brown is also subject to a non-compete restriction fortwelve months after the termination of his employment.

 

**Option Grants in Fiscal 2001**

 

The following table sets forth individual grants ofstock options made under the Company’s 1996 Stock Incentive Plan (the “1996Plan”) and the 1997 Stock Incentive Plan (the “1997 Plan”) during the fiscalyear ended December 31, 2001 for the Chief Executive Officer of the Company andeach of the Named Executives.

 
| **Name**            |   | **Number of  Securities  Underlying Options  Granted** |   | **Percent of Total  Options Granted to  Employees in Fiscal  Year(1)** |   | **Exercise or Base  Price ($/Sh)** |   | **Expiration Date** |            |
|---------------------|--------|--------------------------------------------------------|--------|------------------------------------------------------------------------|--------|------------------------------------|--------|---------------------|-----------------|
| Lynn Fantom         |   | 200,000(2)(3)                                          |   | 67%                                                                    |   | $                                  | 0.75   |                | January 2, 2011 |   |
|                |   |                                                   |   |                                                                   |   |                               |   |                |            |
| Matthew G. de Ganon |   | —                                                 |   | —                                                                 |   | —                             |   | —              |            |
|                |   |                                                   |   |                                                                   |   |                               |   |                |            |
| Douglas E. Cleek    |   | —                                                 |   | —                                                                 |   | —                             |   | —              |            |
|                |   |                                                   |   |                                                                   |   |                               |   |                |            |
| Gary W. Brown       |   | 100,000(2)                                             |   | 33%                                                                    |   | $                                  | 0.75   |                | January 2, 2011 |   |

 

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(1)           Calculated as a percentage of totaloptions granted to all employees under both the 1996 Plan and the 1997 Plan.

 

(2)           Such options were granted under the1997 Plan.

 

(3)           All unvested options granted to Ms.Fantom were cancelled upon her resignation from the Board of Directorseffective November 6, 2001.

 

No stock options were granted under the 1996 Plan and300,000 stock options were granted under the 1997 Plan to all executiveofficers and directors as a group during the fiscal year ended December 31,2001.  Such options are exercisable atprices per share (reflecting the fair market value on the dates of grant) of$0.75 under the 1997 Plan.  None of suchoptions were exercised during fiscal 2001.

 

13

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**Option Exercises and Year-End OptionValue Table**

 

The table set forth below shows the value ofunexercised options under the 1996 Plan and the 1997 Plan held on December 31,2001 by Ms. Fantom and each of the Named Executives.

 
| **Name**            |   | **Shares  Acquired  on  Exercise** |   | **Value Realized** |   | **Number of Securities  Underlying Unexercised  Options at December 31, 2001** |   | **Value of  Unexercised In-the-Money  Options held on December 31,  2001 ($)(1)** |   |
|---------------------|--------|------------------------------------|--------|--------------------|--------|--------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------|--------|
| **Exercisable**     |   | **Unexercisable**                  |   | **Exercisable**    |   | **Unexercisable**                                                              |   |
| Lynn Fantom         |   | —                             |   | —             |   | 400,000(2)                                                                     |   | —                                                                            |   | — |   | — |   |   |
|                |   |                               |   |               |   |                                                                           |   |                                                                              |   |   |   |   |   |   |
| Matthew G. de Ganon |   | —                             |   | —             |   | 6,250(3)                                                                       |   | —                                                                            |   | — |   | — |   |   |
|                |   |                               |   |               |   |                                                                           |   |                                                                              |   |   |   |   |   |   |
| Douglas E. Cleek    |   | —                             |   | —             |   | 6,250(3)                                                                       |   | —                                                                            |   | — |   | — |   |   |
|                |   |                               |   |               |   |                                                                           |   |                                                                              |   |   |   |   |   |   |
| Gary W. Brown       |   | —                             |   | —             |   | 268,000(4)                                                                     |   | 100,000(2)                                                                        |   | — |   | — |   |   |
|                     |        |                                    |        |                    |        |                                                                                |        |                                                                                   |        |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)   Based on the closing price of the Company’s commonstock on December 31, 2001, the last day in fiscal 2001 on which the marketswere open for business, which was $0.03.

 

(2)   Represents grants made under the 1997 Plan.

 

(3)   Represents grants made under the 1996 Plan.

 

(4)   Represents 246,000 options granted under the1997 Plan and 22,000 options granted under the 1996 Plan.

 

14

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**ITEM 11.**                                              **Security Ownership of Certain Beneficial Ownersand Management and Related Stockholder Matters**

 

**BeneficialOwnership**

 

The following table sets forth information, as ofApril 15, 2002 as to the beneficial ownership of common stock (includingshares which may be acquired within 60 days pursuant to stock options) of eachdirector of the Company, the Chief Executive Officer of the Company, alldirectors and executive officers as a group and persons known by the Company tobeneficially own 5% or more of the common stock.  Except as set forth below, each of the listed persons has solevoting and investment power with respect to the shares beneficially owned bysuch person.  Except as otherwiseindicated, the address of each person included in the table is c/o the Company,30 Broad Street, 15th Floor, New York, New York 10004.

 
| **Name of Owner**                                                 |   | **Shares of Common Stock  Beneficially Owned** |   | **Percent of Class (1)** |   |
|-------------------------------------------------------------------|--------|------------------------------------------------|--------|--------------------------|--------|
| Matthew G. de Ganon                                               |   | 936,993(2)                                     |   | 18.8                     |   |
|                                                              |   |                                           |   |                     |   |
| Douglas E. Cleek                                                  |   | 430,531(2)(3)                                  |   | 8.6                      |   |
|                                                              |   |                                           |   |                     |   |
| Lynn Fantom                                                       |   | 405,000(4)                                     |   | 8.1                      |   |
|                                                              |   |                                           |   |                     |   |
| Gary W. Brown                                                     |   | 1,348,069(5)                                   |   | 27.1                     |   |
|                                                              |   |                                           |   |                     |   |
| Steven N. Goldstein                                               |   | 15,000(6)                                      |   | *                        |   |
|                                                              |   |                                           |   |                     |   |
| David Sklaver                                                     |   | 15,000(6)                                      |   | *                        |   |
|                                                              |   |                                           |   |                     |   |
| All Directors and Executive  Officers as a group (6 persons) |   | 2,720,062(7)                                   |   | 54.6                     |   |

 

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*Less than one percent.

 

(1)           Does not give effectto: (i) shares held in treasury and (ii) options held by persons other than thepersons named above.

 

(2)                                  Messrs.de Ganon and Cleek resigned from their positions as officers of the Companyeffective August 1, 2001. Pursuant to a 10-year voting agreement entered intoby Messrs. de Ganon, Cleek, David Centner (a former Chief Operating Officer andDirector of the Company) and Bradley Szollose (a former Secretary and Directorof the Company), effective July 26, 1996 (the “Voting Agreement”), the votingcontrol over 498,158 shares held by Messrs. Cleek, Centner and Szollose and6,250 shares underlying presently exercisable stock options held by Mr. Cleekare vested in Mr. de Ganon.  Such sharessubject to the Voting Agreement must be voted in favor of the election of Mr.de Ganon.  In addition, the VotingAgreement grants each party thereto a right of first refusal as to the sale ofthe others’ common stock. Messrs. de Ganon, Cleek, Centner and Szollose eachdisclaim beneficial ownership of those shares with respect to which they arenot record owners.  Mr. de Ganon’sholdings also include 6,250 shares underlying presently exercisable stockoptions held by him.

 

(3)           Includes 6,250shares underlying presently exercisable stock options.

 

(4)                                  Ms.Fantom resigned from her position as an officer of the Company effective August1, 2001 and resigned as a director of the Company effective November 6, 2001.Includes 400,000 shares underlying presently exercisable stock options. Ms.Fantom disclaims beneficial ownership of all such shares underlying unexercisedoptions.

 

15

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(5)                                  Includes:(i) 136,500 shares underlying presently exercisable stock options; (ii) 131,500shares underlying options which vested on April 14, 2002, 50,000 sharesunderlying options which vested on January 2, 2002 and 50,000 shares underlyingunvested stock options which will vest on January 2, 2003 and upon theoccurrence of certain change of control transactions; and (iii) 50,000 sharesof restricted common stock which vested on April 14, 2002.  Mr. Brown disclaims beneficial ownership ofall shares underlying unexercised and/or unvested options.

 

(6)           Includes 15,000shares underlying presently exercisable stock options.

 

(7)                                  Includes760,500 shares underlying presently exercisable stock options and 50,000 sharesunderlying unvested stock options, all of which vest upon the occurrence ofcertain change of control transactions. Note that 430,531 of the 2,720,062 shares are subject to the VotingAgreement described above and are therefore listed as beneficially owned byboth Mr. de Ganon and Mr. Cleek.  Theseshares are counted only once for purposes of the aggregate number of shares ofcommon stock beneficially owned by all directors and executive officers as agroup.

 

**ITEM12.**                                              **Certain Relationships and Related Transactions**

 

**Certain Related Transactions**

 

On May 15, 2001, Mr. Brown acquired 862,069 shares ofcommon stock of the Company for an aggregate purchase price of $250,000.  Mr. Brown purchased the shares through theFusion Facility described above. Mr. Brown acquired the shares for personalinvestment purposes and to further demonstrate to a potential investor in theCompany his confidence in the Company and the alignment of his interests, as anofficer and director of the Company, with the interests of the stockholders ofthe Company.

 

16

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**PART IV**

** **

**ITEM13.**                                              **Exhibit List and Reports on Form 8-K**

 
| (a)    | Documents filed as part of this report: |
|--------|-----------------------------------------|
|   |                                    |
|   | 1.                                      | Financial Statements | Page |
|   |                                    |   |   |
|   |                                    | Consolidated Balance Sheet - December 31, 2001  (unaudited) | F-1 |
|   |                                    |   |   |
|   |                                    | Consolidated Statements of Operations  - For the years ended December 31, 2001 and 2000 (unaudited). | F-2 |
|   |                                    |   |   |
|   |                                    | Consolidated Statements of  Cash Flows - For the years ended December 31, 2001 and 2000 (unaudited) | F-3 |
|   |                                    |   |   |
|   |                                    | Notes to unaudited Consolidated  Financial Statements. | F-4 |
|   |                                    |   |   |
|   | 2.                                      | Exhibits |   |
|   |                                    |   |   |
|   |                                    | 3.1 | Certificate of Incorporation of the Company* |
|   |                                    |   |   |
|   |                                    | 3.1(a) | Amendment to Certificate of Incorporation of the  Company* |
|   |                                    |   |   |
|   |                                    | 3.1(b) | Amendment to Certificate of Incorporation of the  Company (incorporated by reference from the Registrant’s Form 10-KSB for its  fiscal year ended 12/31/00). |
|   |                                    |   |   |
|   |                                    | 3.2 | By-laws of the Company* |
|   |                                    |   |   |
|   |                                    | 3.2(b) | Amendment to By-laws of the Company* |
|   |                                    |   |   |
|   |                                    | 4.1 | Common Stock Certificate* |
|   |                                    |   |   |
|   |                                    | 4.2 | Warrant Certificate* |
|   |                                    |   |   |
|   |                                    | 4.4 | Warrant Agreement by and between Continental Stock  Transfer & Trust Company and the Company* |
|   |                                    |   |   |
|   |                                    | 4.5 | Voting Agreement among Messrs. Centner, de Ganon,  Cleek and Szollose* |
|   |                                    |   |   |
|   |                                    | 10.1 | 1996 Stock Incentive Plan and Rules Relating  thereto* |
|   |                                    |   |   |
|   |                                    | 10.2 | 1997 Stock Option Plan (incorporated by reference  from the Registrant’s Form 10-KSB for its fiscal year ended 12/31/96). |
|   |                                    |   |   |
|   |                                    | 10.3 | Amendment to 1997 Stock Option Plan (incorporated by  reference from the Registrant’s Form 10-KSB for its fiscal year ended  12/31/00). |
|   |                                    |   |   |
|   |                                    | 10.4 | Consulting Agreement with Harvey Berlent* |
|   |                                    |   |   |
|   |                                    | 10.5 | Employment Agreement with Matthew G. de Ganon* |
|   |                                    |   |   |
|   |                                    | 10.6 | Extension of Employment Agreement with Matthew G. de  Ganon dated November 2, 1998 (incorporated by reference from the Registrant’s  Form 10-KSB for its fiscal year ended 12/31/98). |
|   |                                    |   |   |
|   |                                    | 10.7 | Amendment to Employment Agreement of Matthew G. de  Ganon dated April 14, 2000 (incorporated by reference from the Registrant’s  Form 10-QSB for the quarterly period ended 03/31/00). |
|   |                                    |   |   |
|   |                                    | 10.8 | Employment Agreement with Douglas E. Cleek* |
|   |                                    |   |   |
|   |                                    | 10.9 | Extension of Employment Agreement with Douglas E.  Cleek dated January 15, 1999 (incorporated by reference from the Registrant’s  Form 10-KSB for its fiscal year ended 12/31/98). |
|   |                                    |   |   |
|   |                                    | 10.10 | Employment Agreement with Gary W. Brown dated April  14, 2000 (incorporated by reference from the Registrant’s Form 10-QSB for the  quarterly period ended 03/31/00). |
|   |                                    |   |   |
|   |                                    | 10.11 | Restricted Stock Agreement of Gary W. Brown  (incorporated by reference from the Registrant’s Form 10-QSB for the  quarterly period ended 03/31/00). |
|   |                                    |   |   |
|   |                                    | 10.12 | Employment Agreement with Lynn Fantom dated  February 13, 2001 (incorporated by  reference from the Registrant’s Form 10-KSB for its fiscal year ended  12/31/00). |
|   |                                    |   |   |
|   |                                    | 10.13 | Agreement of Lease dated as of April 18, 1997,  between 30 Broad Associates, L.P., as landlord, and the Company, as tenant,  relating to 30 Broad Street, New York, New York (incorporated by reference  from the Registrant’s Form 10-KSB for its fiscal year ended 12/31/00). |
|   |                                    |   |   |
|   |                                    | 10.14 | Amendment to Lease dated as of April 1, 1998,  between 30 Broad Associates, L.P., as landlord, and the Company, as tenant,  relating to 30 Broad Street, New York, New York (incorporated by reference  from the Registrant’s Form 10-KSB for its fiscal year ended 12/31/00). |
|   |                                    |   |   |
|   |                                    | 10.15 | Second Amendment to Lease dated as of July 10, 2000,  between ASC-CSFB 30 Broad, LLC, as landlord, and the Company, as tenant,  relating to 30 Broad Street, New York, New York (incorporated by reference  from the Registrant’s Form 10-QSB for the quarterly period ended 06/30/00). |
|   |                                    |   |   |
|   |                                    | 10.16 | Common Stock Purchase Agreement dated as of December  11, 2000 between the Company and Fusion Capital Fund II, LLC (incorporated by  reference from the Registrant’s Current Report on Form 8-K filed 12/11/00). |
|   |                                    |   |   |
|   |                                    | 10.17 | Form of Registration Rights Agreement between the  Company and Fusion Capital Fund II, LLC (incorporated by reference from the  Registrant’s Current Report on Form 8-K filed 12/11/00). |
|   |                                    |   |   |
|   |                                    | 10.18 | Master Transaction Agreement, dated as of August 20,  2001, between the Company and Integrated Information Systems, Inc.  (incorporated by reference from the Registrant’s Current Report on Form 8-K  filed 8/30/01). |
|   |                                    |   |   |
|   |                                    | 10.19 | Agreement and Plan of Merger, dated as of January  15, 2002, by and among First Step Distribution Network, Inc. and its  shareholders, First Step Acquisition Corp. and the Company (incorporated by  reference from the Registrant’s Current Report on Form 8-K filed 01/17/02). |
|   |                                    |   |   |
|   |                                    | 10.20 | Side Letter dated April 8, 2002, by and between the  Company and First Step Distribution Network, Inc. |
|   |                                    |   |   |
|   |                                    | 16.1 | Letter from Arthur Andersen LLP regarding change in  certifying accountant (incorporated by reference from the Registrant’s  Current Report on Form 8-K filed 04/16/02). |
|   |                                    |   |   |
|   |                                    | 21.1 | Subsidiary List* |   |
|        |                                         |  |  |  |  |  |

 

----

*       Incorporated by reference from theCompany’s Registration Statement on Form SB-2, No. 333-4319.

 

(b)           The Company did not file any reportson Form 8-K during the last quarter of the period covered by this report.

 

17

----

 

**SIGNATURES**

 

In accordance with Section 13 or 15(d) of the ExchangeAct, the registrant caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
|                         | **K2 DIGITAL, INC.**     |
|------------------------------|--------------------------|
| Dated:  April  16, 2002 |                     |
|                         | By:                      |   | /s/  Gary W.  Brown |   |
|                         | Gary W. Brown, President |
|                              |                          |  |  |  |

 

**POWER OFATTORNEY**

 

Each of the undersigned hereby appoints Gary W. Brownas his attorney-in-fact to sign his or her name, in any and all capacities, toany amendments to this Form 10-KSB and any other documents filed in connectiontherewith to be filed with the Securities and Exchange Commission.

 

In accordance with the Exchange Act, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated. 

 
| **Signature**                  |                                                       | **Title**                                           |           | **Date** |   |
|--------------------------------|------------------------------------------------------------|-----------------------------------------------------|----------------|----------|--------|
|                           |                                                       |                                                |
|  /s/ Matthew  G. de Ganon |                                                       | Chairman of the Board                               | April 16, 2002 |
|  Matthew G.  de Ganon     |                                                       |                                                |
|                           |                                                       |                                                |
|  /s/ Gary W.  Brown       |                                                       | Chief Operating Officer, Secretary, Chief Financial | April 16, 2002 |
|  Gary W.  Brown           | Officer (Principal Financial and Accounting  Officer), and |                                                |
|                           | Director                                                   |                                                |
|                           |                                                       |                                                |
|  /s/ Douglas  E. Cleek    |                                                       | Director                                            | April 16, 2002 |
|  Douglas E.  Cleek        |                                                       |                                                |
|                           |                                                       |                                                |
|  /s/ David R.  Sklaver    |                                                       | Director                                            | April 16, 2002 |
|  David R.  Sklaver        |                                                       |                                                |
|                                |                                                            |                                                     |                |          |        |  |

 

18

----

 

**K2DIGITAL, INC.**

**ANDSUBSIDIARY**

 

**INDEX TOCONSOLIDATED FINANCIAL STATEMENTS**

 
|                                                                                                | Page   |
|-----------------------------------------------------------------------------------------------------|--------|
|                                                                                                |   |
| Consolidated Financial Statements of K2 Digital,  Inc. and Subsidiary                               |   |
|                                                                                                |   |
| Consolidated Balance Sheet - December 31,  2001(unaudited)                                          | F-1    |
|                                                                                                |   |
| Consolidated Statements of  Operations - For the years ended December 31, 2001 and 2000 (unaudited) | F-2    |
|                                                                                                |   |
| Consolidated Statements of  Cash Flows - For the years ended December 31, 2001 and 2000 (unaudited) | F-3    |
|                                                                                                |   |
| Notes to unaudited  Consolidated Financial Statements                                               | F-4    |

 

----

 

**K2 DIGITAL, INC. AND SUBSIDIARY**

**CONSOLIDATEDBALANCE SHEET**

 
|                                                                    |   | **DECEMBER 31, 2001** |    |
|-------------------------------------------------------------------------|--------|-----------------------|---------|
|                                                                    |   | **(UNAUDITED)**       |    |
| ASSETS                                                                  |   |                  |    |
| CURRENT ASSETS:                                                         |   |                  |    |
|                                                                    |   |                  |    |
| Cash and cash  equivalents                                              |   | $                     | 5,380   |   |
| Accounts  receivable, net of allowance for doubtful accounts of $50,000 |   | 123,913               |    |
| Prepaid expenses  and other current assets                              |   | 36,500                |    |
| Investment in  securities available for sale                            |   | 25,300                |    |
| Total assets                                                            |   | $                     | 191,093 |   |
|                                                                    |   |                  |    |
| LIABILITIES & STOCKHOLDERS’ EQUITY                             |   |                  |    |
|                                                                    |   |                  |    |
| CURRENT  LIABILITIES:                                                   |   |                  |    |
| Accounts payable                                                        |   | 205,727               |    |
| Accrued  compensation and payroll taxes                                 |   | 5,691                 |    |
| Accrued expenses                                                        |   | 18,471                |    |
| Other Current  Liabilities                                              |   | 62,099                |    |
| Total  liabilities                                                      |   | 291,988               |    |
|                                                                    |   |                  |    |
| STOCKHOLDERS’  EQUITY:                                             |   |                  |    |
| Preferred Stock,  $0.01 par value, 1,000,000 shares authorized;         |   |                  |    |
| 0 shares issued  and outstanding                                        |   | —                |    |
| Common Stock,  $0.01 par value, 25,000,000 shares authorized;           |   |                  |    |
| 5,400,116 shares  issued and 4,982,699 shares outstanding               |   | 54,001                |    |
| Treasury stock,  417,417 shares at cost                                 |   | (819,296              | )       |
| Additional  paid-in capital                                             |   | 8,285,410             |    |
| Accumulated  other comprehensive loss                                   |   | (84,700               | )       |
| Deferred  compensation                                                  |   | (72,355               | )       |
| Accumulated  deficit                                                    |   | (7,463,955            | )       |
| Total  stockholders’ equity                                        |   | (100,895              | )       |
| Total  liabilities & stockholders’ equity                      |   | $                     | 191,093 |   |

 

The accompanying notes are an integral part of theseunaudited Consolidated Financial Statements.

 

F-1

----

 

**K2 DIGITAL, INC. AND SUBSIDIARY**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

 
|                                                                                 |   | **Year Ended  December 31,  2001** |     | **Year Ended December 31,  2000** |       |
|--------------------------------------------------------------------------------------|--------|------------------------------------|----------|-----------------------------------|------------|
|                                                                                 |   | **(unaudited)**                    |     | **(unaudited)**                   |       |
| General and administrative  expenses                                                 |   | $                                  |     | 570,459                           |       |   | $ | 450,349 |   |   |
|                                                                                 |   |                               |     |                              |       |   |   |
| Loss from continuing  operations before impairment of investment in  securities |   | $                                  | (570,459 | )                                 |       | $ | (450,349 | ) |   |
|                                                                                 |   |                               |     |                              |       |   |   |
| Impairment of securities                                                             |   | 1,328,047                          |     |                              | —     |   |   |
|                                                                                 |   |                               |     |                              |       |   |   |
| Loss from continuing operations                                                      |   | 1,898,506                          |     |                              | $          | (450,349 | ) |   |
|                                                                                 |   |                               |     |                              |       |   |   |
| Loss from discontinued operations after income taxes                                 |   | (3,467,281                         | )        |                              | (1,521,094 | ) |   |
|                                                                                 |   |                               |     |                              |       |   |   |
| Gain on disposal of discontinued operations                                          |   | 442,108                            |     |                              | —     |   |   |
|                                                                                 |   |                               |     |                              |       |   |   |
| Net Loss                                                                             |   | $                                  |     | (4,923,679                        | )          |   | $ | (1,971,443 | ) |   |
|                                                                                 |   |                               |     |                              |       |   |   |
| Net Loss per share – Basic and Diluted                                          |   |                               |     |                              |       |   |   |
|                                                                                 |   |                               |     |                              |       |   |   |
| Loss from continuing operations                                                      |   | $                                  |     | (0.43                             | )          |   | $ | (0.14 | ) |   |
|                                                                                 |   |                               |     |                              |       |   |   |
| Loss from discontinued operations                                                    |   | $                                  |     | (0.78                             | )          |   | $ | (0.45 | ) |   |
|                                                                                 |   |                               |     |                              |       |   |   |
| Gain on disposal of discontinued operations                                          |   | $                                  |     | 0.10                              |       |   | — |   |   |
|                                                                                 |   |                               |     |                              |       |   |   |
| Net Loss                                                                             |   | $                                  |     | (1.11                             | )          |   | $ | (0.59 | ) |   |
|                                                                                 |   |                               |     |                              |       |   |   |
| Weighted average common  shares outstanding – basic and diluted                 |   | 4,440,836                          |     |                              | 3,371,579  |   |   |

 

The accompanying notes arean integral part of these unaudited Consolidated Financial Statements.

 

F-2

----

 

**K2DIGITAL, INC AND SUBSIDIARY**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000**

 
|                                                                               |   | **2001**        |       | **2000**   |   |
|------------------------------------------------------------------------------------|--------|-----------------|------------|------------|--------|
| **(unaudited)**                                                                    |   | **(unaudited)** |       |
| CASH FROM  OPERATING ACTIVITIES:                                                   |   |            |       |       |   |
| Net Loss                                                                           |   | $               | (4,923,679 | )          | $      | (1,925,543 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities — |   |            |       |       |   |
| Impairment of  investment in securities                                            |   | 1,321,447       |       | —     |   |
| Non-cash  compensation expense                                                     |   | 249,996         |       | 325,359    |   |
| Write-off of  deferred issuance and transaction costs                              |   | 757,861         |       | —     |   |
| Assets  impairment                                                                 |   | 223,998         |       | —     |   |
| Gain on disposal  of discontinued operations                                       |   | (442,108        | )          | —     |   |
| Depreciation                                                                       |   | 210,640         |       | 332,281    |   |
| Changes in —                                                                  |   |            |       |       |   |
| Accounts  Receivable, net                                                          |   | 1,546,235       |       | (744,584   | )      |
| Prepaid expenses  and other current assets                                         |   | (30,675         | )          | (73,073    | )      |
| Unbilled revenue                                                                   |   | 482,773         |       | 189,817    |   |
| Other assets                                                                       |   | 3,797           |       | 2,882      |   |
| Accounts payable                                                                   |   | (572,134        | )          | 300,714    |   |
| Accrued  compensation and payroll taxes                                            |   | (188,955        | )          | 80,724     |   |
| Other accrued  expenses and current liabilities                                    |   | (486,557        | )          | (7,844     | )      |
| Deferred revenue  and customer advances                                            |   | (102,251        | )          | 238,358    |   |
| Deferred rent                                                                      |   | 121,926         |       | 107,950    |   |
| Restricted cash                                                                    |   | 250,000         |       | (99,289    | )      |
|                                                                               |   |            |       |       |   |
| Net cash used in  operating activities                                             |   | $               | (1,577,686 | )          | $      | (1,272,248 | ) |
|                                                                               |   |            |       |       |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                             |   |            |       |       |   |
| Net proceeds  from disposal of discontinued operations                             |   | 528,500         |       | —     |   |
| Gross proceeds  from sale of investment securities                                 |   | 94,127          |       | —     |   |
| Purchase of  equipment                                                             |   | (8,074          | )          | (298,899   | )      |
| Software  development costs                                                        |   | —          |       | (274,567   | )      |
| Advances for  proposed transaction                                                 |   | —          |       | (254,494   | )      |
| Investments in  available for sale securities                                      |   | —          |       | (100,000   | )      |
|                                                                               |   |            |       |       |   |
| Net cash (used  in) provided by investing activities                               |   | $               | 614,553    |       | $      | (927,960 | ) |
|                                                                               |   |            |       |       |   |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                             |   |            |       |       |   |
| Principal  payments on capital lease obligations                                   |   | (17,093         | )          | (28,712    | )      |
| Equity issuance                                                                    |   | 250,000         |       | —     |   |
| Options  exercised for cash                                                        |   | —          |       | 27,609     |   |
|                                                                               |   |            |       |       |   |
| Net cash (used  in) provided by financing activities                               |   | $               | 232,907    |       | $      | (1,103 | ) |
|                                                                               |   |            |       |       |   |
| Net decrease in  cash and cash equivalents                                         |   | (730,226        | )          | (2,201,311 | )      |
| CASH AND CASH  EQUIVALENTS, beginning of period                                    |   | 735,606         |       | 2,936,917  |   |
| CASH AND CASH  EQUIVALENTS, END of period                                          |   | $               | 5,380      |       | $      | 735,606 |   |

 

The accompanying notesare an integral part of these unaudited Consolidated Financial Statements.

 

F-3

----

 

**K2DIGITAL, INC. AND SUBSIDIARY**

**NOTESTO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

**(UNAUDITED)**

 

**1.             ORGANIZATION AND BUSINESS**

 

K2 Digital, Inc., a Delaware corporation (“K2” or the “Company”), is astrategic digital services company, that has historically provided consultingand development services including analysis, planning, systems design, creativeand implementation.

 

On August 29, 2001, theCompany completed the closing under an agreement (the “Purchase Agreement”)with Integrated Information Systems, Inc., a Delaware corporation (“IIS”)pursuant to which, among other things, IIS purchased certain fixed andintangible assets of the Company, including most of the Company’s customercontracts, furniture, fixtures, equipment and intellectual property, for anaggregate purchase price of $444,000, of which $419,000 was paid in cash and$25,000 of which was paid through the assumption by IIS of capital leaseobligations of the Company. IIS also assumed certain deferred revenues andcustomer deposits.

 

Under the terms of thePurchase Agreement, IIS now occupies the Company’s premises and has assumed theCompany’s office lease obligations. As part of the same transaction, IIS hasalso made offers of employment to substantially all of the remaining employeesof the Company, all of which offers have been accepted.

 

In addition to the purchaseprice and as consideration of the Company’s release of certain employees fromthe non-competition restrictions contained in their agreements with theCompany, the Company received from IIS at closing a recruitment and placementfee of $75,000. In addition, the Purchase Agreement provided for the Company toreceive from IIS an additional placement fee of $7,500 per key employee and$2,500 per other employee that remained employed by IIS through December 31,2001. This additional contingent placement fee was to be paid by IIS in cash infive monthly installments beginning August 31, 2001, pro rated monthly for thenumber of employees retained.  $31,000of these contingent fees had been paid to the Company as of December 31,2001.  $36,500 due to the Companyremains unpaid by IIS.  Collection ofthis amount is uncertain.

 

Under the PurchaseAgreement, the Company also received from IIS a cash fee of $50,000 in returnfor entering into certain non-competition provisions contained in the PurchaseAgreement, which provide that the Company will not, for a period of five years,(i) engage in any business of substantially the same character as the businessengaged in by the Company prior to the transaction, (ii) solicit for employmentany employee of IIS (including former employees of the Company), or (iii)solicit any client or customer of IIS (including any customer transferred toIIS under the Purchase Agreement) to do business with the Company.

 

The aggregate cashconsideration delivered to the Company at closing was $544,000, of whichapproximately $258,000 was paid directly to K2 Holdings LLC, an affiliate ofSGI Graphics, LLC (collectively, “SGI”), the Company’s principal securedcreditor, in order to release SGI’s security interest in the assets of the Company.

 

Accordingly, theoperating results relating to the discontinued operations have been segregatedfrom continuing operations and reported as a separate line item on theconsolidated statements of operations. The Company has restated itsconsolidated financial statements for prior periods to conform to the currentyear presentation. Gain on disposal of discontinued operations includes actualgain from the disposal of the discontinued operations.

 

F-4

----

 

**2.   BASIS OF PRESENTATION**

 

**Thefinancial statements included in this annual report on Form 10-KSB areunaudited and have not been reviewed in any manner by any independent publicaccountant.**In accordance with newly established rules of theSecurities and Exchange Commission, the Company intends to amend this report onForm 10-KSB no later than May 31, 2002 in order to file the audited financialstatements of the Company for the fiscal year ended December 31, 2001, anyrequired selected financial data, a discussion of any material changes from theunaudited financial statements and any other sections of the Company’s annualreport, including Management’s Discussion and Analysis of Financial Conditionand Results of Operations, that should be amended to reflect any changes in thefinancial statements.

 

The accompanying unaudited condensed consolidated financial statementshave been prepared by the Company and reflect all adjustments, consisting onlyof normal recurring adjustments, which are, in the opinion of management,necessary for a fair presentation of the financial position as of December 31,2001 and the financial results for the years ended December 31, 2001 and 2000,in accordance with generally accepted accounting principles for interimfinancial statements and pursuant to Form 10-KSB and Regulation S-B.

 

The preparation of financial statements in conformity with generallyaccepted accounting principles requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities andrevenues and expenses during the reporting periods. Actual results may differfrom those estimates.

 

**3.   GOING CONCERN**

 

The Company has incurred negative cash flows from operations andsustained net losses. Furthermore, in August 2001, the Company sold certainfixed and intangible assets essential to its business operations and enteredinto a purchase agreement containing provisions restricting the Company’sability to continue to engage in the business engaged in by the Company priorto the transaction. Accordingly, the Company’s remaining operations will belimited to either the sale of the Company or the winding up of the Company’sremaining business and operations, subject, in either case, to the approval ofthe stockholders of the Company. The Company’s former independent publicaccountants added an explanatory paragraph to their audit opinion issued inconnection with the 2000 financial statements which stated that the Company’slosses since inception and dependence on outside financing raise substantialdoubt about its ability to continue as a going concern. The attached unauditedconsolidated financial statements do not include any adjustments that mightresult from the outcome of this uncertainty.

 

F-5

----

 

**4.   NET INCOME (LOSS) PER SHARE OF COMMON STOCK**

 

SFAS 128, “Earnings per Share,” establishes standards for computing andpresenting earnings per share (“EPS”). The standard requires the presentationof basic EPS and diluted EPS. Basic EPS is calculated by dividing incomeavailable to common stockholders by the weighted average number of shares ofcommon stock outstanding during the period. Diluted EPS is calculated bydividing income available to common stockholders by the weighted average numberof shares of common stock outstanding adjusted to reflect potentially dilutivesecurities.

 

In accordance with SFAS 128, the following table reconciles net lossand share amounts used to calculate basic and diluted loss per share:

 
|                                                                |   | **Year Ended  December 31,  2001** |       | **Year Ended  December 31,  2000** |   |
|---------------------------------------------------------------------|--------|------------------------------------|------------|------------------------------------|--------|
|                                                                |   | **(unaudited)**                    |       | **(unaudited)**                    |   |
|                                                                |   |                               |       |                               |   |
| Net Loss                                                            |   | $                                  | (4,923,679 | )                                  | $      | (1,971,443 | ) |
|                                                                |   |                               |       |                               |   |
| **Net Loss per share – Basic and  Diluted**                    |   |                               |       |                               |   |
|                                                                |   |                               |       |                               |   |
| Loss from continuing operations                                     |   | $                                  | (0.43      | )                                  | $      | (0.14 | ) |
|                                                                |   |                               |       |                               |   |
| Loss from discontinued operations                                   |   | $                                  | (0.78      | )                                  | $      | (0.45 | ) |
|                                                                |   |                               |       |                               |   |
| Gain on disposal of discontinued operations                         |   | $                                  | 0.10       |                               | — |   |
|                                                                |   |                               |       |                               |   |
| Net Loss                                                            |   | $                                  | (1.11      | )                                  | $      | (0.59 | ) |
|                                                                |   |                               |       |                               |   |
| Weighted average common shares outstanding – basic and diluted |   | 4,440,836                          |       | 3,371,579                          |   |
|                                                                     |        |                                    |            |                                    |        |  |  |  |  |

 

**5.   INVESTMENT IN SECURITIES**

 

As of December 31, 2001, the Company held 110,000 shares of commonstock of 24/7 Media Inc. These shares have been classified as “investments insecurities available for sale” as a result of the Company’s ability and intentto sell such shares in the near future. In accordance with SFAS No. 115, theshares are stated at fair market value on the Company’s December 31, 2001consolidated balance sheet. Management believes that the decline of $1,328,047in value of such investment is permanent. Accordingly, such amount, whichpreviously was reflected in “other comprehensive loss” in the stockholders’equity, is recorded in the statement of operations as impairment of investmentsecurities. Any remaining unrealized holding loss is reflected as “othercomprehensive loss” in the stockholders’ equity section of the balance sheet.

 

The following disclosures are presented in accordance with SFAS No.115:

 
| Equity Securities:             |   |   |    |
|--------------------------------|--------|--------|---------|
| Aggregate fair  market value   |   | $      | 25,300  |   |
| Gross unrealized  holding loss |   | $      | (84,700 | ) |

 

The Company did not sell any shares of capital stock of 24/7 Media Inc.during the fiscal year ended December 31, 2001.

 

F-6

----

 

**6.   FUSION CAPITAL AGREEMENT**

 

On December 11, 2000, the Company entered into a common stock purchaseagreement (the “Fusion Facility”) with Fusion Capital Fund II, LLC (“FusionCapital”). In May 2001, the Company issued 862,069 shares of common stock underthe Fusion Facility in exchange for net proceeds of $250,000. On August 14,2001, Fusion Capital exercised a warrant to purchase an additional 297,162shares of the Company’s common stock at an exercise price of $.01 per share.After applying the net exercise provisions of the warrant, based upon theclosing sale price of the Company’s common stock on the Nasdaq SmallCap Marketof $.15 per share on August 13, 2001, Fusion Capital received 277,351 shares ofcommon stock upon exercise of the warrant.

 

As a result of the sale of assets of the Company consummated in August2001, the Company is currently in default under the Fusion Facility. Inaddition, due to the Company’s current financial circumstances, the Companydoes not anticipate that, even if the current defaults are cured, it will beable to make any further issuances under the Fusion Facility.

 

**7.   RECENT ACCOUNTING PRONOUNCEMENTS**

 

In July 2001, the Financial Accounting Standards Board issuedStatements of Financial Accounting Standards No. 141, Business Combinations(“FAS 141”) and No. 142, Goodwill and Other Intangible Assets (“FAS 142”). FAS141 requires all business combinations initiated after June 30, 2001 to beaccounted for using the purchase method. Under FAS 142, goodwill and intangibleassets with indefinite lives are no longer amortized but are reviewed annually(or more frequently if impairment indicators arise) for impairment. Separableintangible assets that are not deemed to have indefinite lives will continue tobe amortized over their useful lives (but with no maximum life). Theamortization provisions of FAS 142 apply to goodwill and intangible assetsacquired after June 30, 2001. With respect to goodwill and intangible assetsacquired prior to July 1, 2001, the Company is required to adopt FAS 142effective January 1, 2002. The Company believes that the provisions of FAS 141and FAS 142 will not have a material effect on its results of operations andfinancial position.

 

**8.   NASDAQ DELISTING**

 

The Company’s common stock was delisted from the Nasdaq SmallCap Marketeffective August 15, 2001 and currently trades in the over-the-counter market.On March 13, 2001, the Staff of the Nasdaq Stock Market notified the Companythat it had failed to demonstrate a closing bid price of at least $1.00 pershare for 30 consecutive trading days and was in violation of NasdaqMarketplace Rule 4310(c)(4). In accordance with applicable Nasdaq Marketplacerules, the Company was provided a 90-day grace period, through June 11, 2001,during which to regain compliance. On June 20, 2001, the Company requested ahearing, which effectively stayed the delisting. However, after submission ofmaterials in support of the Company’s position to the Panel, the Panel decidedto delist the Company’s common stock from the Nasdaq SmallCap Market as of theopen of business on August 15, 2001.

 

**9.   RECENT EVENTS**

 

The Board of Directors of the Company has determined that, subject tostockholder approval, the best course of action for the Company is to completea business combination with a third party with an existing business.  On January 15, 2002, the Company enteredinto an Agreement and Plan of Merger with First Step Distribution Network, Inc.and its shareholders.  Under the termsof the agreement, the Company intends to acquire First Step by means of atriangular merger, pursuant to which a subsidiary of the Company will mergewith and into First Step.  If thetransaction contemplated by the agreement is consummated, it is anticipatedthat the shareholders of First Step will thereby acquire substantially themajority of the issued and outstanding voting common stock in the survivingentity.  Certain aspects of thetransaction are subject to the prior approval of the stockholders of theCompany. There can be no assurance that the proposed transaction, or any otherbusiness combination, will be completed.

 

F-7

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**Exhibit 10.20**

 

April 8, 2002

 

First Step Distribution Network, Inc.

2325 Mount Olympus Drive

Los Angeles, CA 90046

Telephone: (310) 994-2813

Attention: Robert Millet/John McCracken

 

Re:                Agreement and Plan of Mergerdated as of January 15, 2002

 

Gentlemen:

 

Reference is made to the Agreement and Plan of Mergerdated as of January 15, 2002 by and among K2 Digital, Inc. (the “Parent”),First Step Acquisition Corp. (“Merger Sub”), First Step Distribution Network,Inc. (the “Company”) and the shareholders of the Company (the “MergerAgreement”).  Capitalized terms used,but not defined in this letter agreement have the meanings ascribed thereto in theMerger Agreement.

 

As you know, Section 6.1(b) of the Merger Agreementprovides that the Merger Agreement “may be terminated at any time prior to theEffective Time of the Merger, whether before or after approval of thetransactions contemplated hereby by the stockholders of the Parent ....  by either the Company or the Parent if theMerger shall not have been consummated by April 30, 2002.” Notwithstanding theforegoing, the Parent hereby waives its right to terminate the Merger Agreementpursuant to Section 6.1(b) of the Merger Agreement until June 30, 2002; *provided*that the Company has delivered to the Parent a true and correct copy of theCompany Financials described in Section 2.5 of the Merger Agreement on orbefore May 8, 2002.

 

In consideration of the Parent’s waiver of its rightsas aforesaid, the Company hereby agrees to advance to the Parent or itsdesignee, the sum of $10,000 to be used as a retainer by counsel to the Parentagainst which such counsel will bill its fees and expenses in connection withthe preparation of the Parent’s annual report of Form 10-KSB for the fiscalyear ended December 31, 2001.
|   |   |   | K2 DIGITAL, INC. |                     |   |
|--------|--------|--------|------------------|--------------------------|--------|
|   |   |   | By:              | /s/ Gary Brown           |   |
|   |   |   |             | Gary Brown               |   |   |
|   |   |   |             | Chief Operating  Officer |   |   |
|        |        |        |                  |                          |        |  |  |

 

Approved and Agreed:

FIRST STEP DISTRIBUTION NETWORK, INC.

 
| By:                  | /s/ Robert Millet |   |   |
|----------------------|-------------------|--------|--------|
|                 |              |
| Date: April 10, 2002 |              |

 

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