FORM 10-KSB
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 (FEE REQUIRED) For the fiscal year ended June 30, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (NO FEE REQUIRED) For the transition period from
_____________ to _____________
Commission file number 000-21659
EDnet, INC.
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(Name of small business issuer in its charter)
Colorado 84-1273795
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
One Union Street, San Francisco, California 94111
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (415) 274-8800
Securities registered under Section 12(b) of the Exchange Act: None
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, par value $0.001
(Title of Class)
Check whether the Issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the Registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. Yes [ ] No
[X] (See "Disclosure Items Omitted")
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-
KSB or any amendment to this Form 10-KSB. [ ]
The Issuer's revenues for the twelve months ended June 30, 1997 were
$3,807,370
As of October 10, 1997, the aggregate market value of the Common Stock of
the Registrant based upon the closing bid prices of the Common Stock, as quoted
on the OTC Bulletin Board, held by non-affiliates of the Registrant was
approximately $3,212,357.
As of October 10, 1997, 7,858,465 shares of $0.001 par value Common stock,
of the Registrant were outstanding.
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DISCLOSURE ITEMS OMITTED
The financial statements included in Part II Item 7 (the "Consolidated Financial
Statements") are unaudited except for those portions attributable to FY 1996 and
June 30, 1996. This Annual Report on Form 10-KSB will be amended to include
audited financial statements, in accordance with the Securities Exchange Act of
1934, as soon as is practical.
PART I
ITEM 1 DESCRIPTION OF BUSINESS
Summary of Business
EDnet, Inc., a Colorado corporation (the "Company"), develops and markets
integrated systems for the delivery, storage and management of
professional-quality digital communications for media-based applications,
including audio and video production for the North American advertising and
entertainment industry. The Company has established a private wide-area network
through strategic alliances with long distance carriers, regional telephone
companies, satellite operators and independent fiber optic telecommunications
providers, which enables the exchange of high quality audio, compressed video
and multimedia data communications. The Company provides engineering services,
application-specific technical advice, audio, video and networking hardware and
software as part of its business. Additionally, the Company provides Internet
web site development and hosting to businesses conducting Internet commerce.
Industry Overview
The digital communications industry originated in the 1970's based on the
ability of digital technology to support new and advanced communication
capabilities. Digital data can be compressed, enabling data-dense applications
such as the instantaneous exchange of large amounts of data and high-quality
concurrent (or "real-time") interactive communication over any distance. The
Company's primary expertise is in systems integration using telecommunications
and Internet technology.
Business of the Company
Principal Markets. The Company sells its services to the advertising and
entertainment industry, including production and post-production companies,
advertisers, producers, directors and actors. The Company's networking
technology makes it possible for producers, directors and actors to interact in
real time, with less interruption of their schedules, despite being in separate
locations. The Company's management ("Management") believes that this is of
growing importance in the entertainment industry because while the production of
audio and video entertainment is inherently a creative process requiring the
collaboration of many parties, increasingly, the participants in this process
are in separate locations. Traditionally, this fact has accounted for frequent
travel and delay being a necessary element of the audio and video production
process. The Company's technology is designed to address this situation by
allowing the collaborative process to go forward despite physical separation.
The Company has established a "network" of recording studios; to join this
network a studio generally enters into an agreement with the Company to become
part of the network for a term of three years. Being part of the Company's
network allows a studio (which the Company refers to as an "affiliate studio")
to establish a link with, and therefore transmit audio and video information to,
any other affiliate studio. An affiliate studio may also participate in joint
promotional and advertising activities describing the Company's network of
affiliate studios, has access to certain technical support described below and a
software directory of affiliate studios. Affiliate studios also are charged
lower "link-up" rates than those charged to non-affiliate studios to connect to
studios with incompatible equipment. Currently, the network is composed of over
360 studios across North America, with major concentrations in California,
Seattle, St. Louis, Chicago, Minneapolis, Atlanta and on the East Coast from
Washington, D.C. to New York and Boston. By granting access to its network, the
Company earns one-time fees from customers for the sale and installation of its
equipment and ongoing fees for the use of the network.
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Audio and Video Network System Development Process. The Company has standardized
its process for developing audio and video network communications systems for
its customers. At the time that the Company contracts with a new audio or video
network customer, the Company's personnel obtain and determine technical
information and specifications regarding the customer's existing facility,
equipment and communications requirements. Based on those specifications, the
Company determines the configuration of the new system, selects the appropriate
equipment components, makes necessary modifications to the software and/or
hardware and performs final quality control procedures. The Company then
packages and ships the system to the customer. Installation of the system can
usually be performed by affiliated technicians with telephonic support from
Company engineers. Upon installation of the system, the Company's technical
personnel typically perform a routine series of system checks and diagnostics
from its headquarters facilities via the remote network connection to ensure
that the newly-installed equipment functions properly.
Technical Support. As part of a customer's monthly network connection fee, the
Company maintains a staff of technical support personnel to respond to customer
inquiries during business hours. For emergency support during non-business
hours, domestic customers can contact Company personnel through a toll-free 800
number, while a special direct-dial telephone number is available for
international customers. The Company generally can resolve the vast majority of
technical support issues directly through its network connection, which enables
Company personnel to perform remote diagnostics directly on a customer's
equipment. In the event that the Company is unable to diagnose and service a
hardware or software problem via the remote network connection, a customer can
ship equipment to the Company for on-site, or "bench," diagnostics and service.
Key Suppliers and Alliances. The Company functions as a systems integrator by
acquiring other companies' technologies and combining them into an effective
communications solution. The Company does not manufacture any of the components
used in its network, but rather purchases digital communications equipment
components directly from their manufacturers, including Dolby Labs, Telos,
Musicam USA, and APT, Inc. The Company performs installation services and
further equipment integration. Because the individual components used in the
Company's systems are available from more than one reliable source or
manufacturer, Management believes the risk of an adverse impact to the Company's
business from an interruption in supply from any single supplier is minimal. The
Company also maintains an ongoing inventory of all of the components of its
various communications products. Most of the Company's suppliers have offices
and/or distribution points near the Company's San Francisco headquarters. In the
event that the Company does not have sufficient inventory on-hand to fulfill a
system hardware order, the Company can usually order and receive additional
inventory with turnaround times of as little as twenty-four hours and generally
no more than four weeks.
Marketing. The Company markets its services through a combination of employing a
direct full-time sales staff and by appearing at industry trade shows.
Description of Current and Developing Products
Audio Media Networking Services. The Company develops integrated system
solutions (its "Audio Media Communications Service") which provide compression
and transmission of studio quality audio signals over fiber optic lines (i.e.,
telephone digital data lines) between separate studios. The audio data can also
be accompanied by time codes so that operators at the different studios can
synchronize the audio to film projectors or VCR machines in order to allow the
"real time" editing of movies and video. Upon installation of an audio media
communications system and the requisite sound equipment, a studio becomes an
"affiliate studio," equipped with a device to digitize, compress, send, receive
and decompress audio media (known as a "codec"). In addition, the studio becomes
a part of the Company's network of media production and post production studios.
Outside customers (non-affiliates) seeking to access media production facilities
or otherwise review or edit an audio clip with the assistance of a person in a
different location can do so through these affiliate studios. By using the
Company's Electronic Directory Software, someone in an affiliate studio can
determine whether that studio, or another affiliate studio, operates equipment
that is compatible with the needs of the customer. Once the appropriate
affiliate studio is chosen, the customer can schedule an appointment to use the
network. If nearby studios do not have compatible equipment, the Company's
personnel in San Francisco can digitally "bridge" the studios together. The
customer then pays a network access fee to the Company. The purchase price of
these audio media communications systems ranges from $5,250 to $18,000. The
Company pays local telephone service providers telephone connection installation
charges (depending
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upon bandwidth requirements, from $250 to $1,000) and monthly recurring
connection charges (from $50 to $1,200), most of which is reimbursed to the
Company by its customers. The primary market for the Audio Media Communications
Service are radio and television advertisers, motion picture and television
program production companies and music recording companies.
The Company has also developed a network application which is designed
especially for the music recording industry. The Company's "ZeroC" (for zero
compression) technology provides fiber-optic transmission of real-time,
uncompressed digital audio, using the true CD standard of 44.1 Khz sampling at
16 bits. The system relays, in real playback time, the audio bits of an AES/EBU
digital audio datastream with no re-sampling or rate adaption.
Video Media Networking Services. The Company is currently developing a video
communications service (its "Fast Forward Delivery System" or "FFD") which is
similar to its Audio Media Communications Service. Through the use of similar
equipment located at affiliate studios, the Company manages the transmission of
approval-quality video segments between studios. The Fast Forward Delivery
System transmits information on a 128 kilobit ("ISDN") data line, which has
dial-up capability, and operates on the same principle as the Audio Media
Communications Service except that the transmission does not happen in "real
time." However, using this technology, video media producers and their customers
can efficiently and effectively transmit edits, approvals, or modifications to
video and other types of media, including special effects media and graphic
media (including prints and logos). Management believes its system is similar to
e-mail for video and, compared to conventional methods of transmitting video,
i.e., mail or physical travel, can significantly increase the speed and
efficiency of the video editing process.
As with the Company's Audio Networking Services, outside customers
(non-affiliates) seeking to access media production facilities or otherwise
review or edit video with the assistance of a person in a different location can
do so by paying a fee to use an affiliate studio. The customer also pays a
network access fee to the Company. The purchase price of the Fast Forward
Delivery System ranges from $15,000 to $50,000. The Company pays local telephone
service providers telephone connection installation charges (depending upon
bandwidth requirements, from $250 to $1,000) and monthly recurring connection
charges (from $50 to $1,200), most of which is reimbursed to the Company by its
customers. The primary market for the Fast Forward Delivery System are
television advertisers, motion picture and television series production
companies and other corporate video users. During the past year, Fast Forward
Delivery Systems have been used in several television series projects in
Australia, Canada and Hollywood, California.
The FFD network can be significantly extended from EDnet's pending alliances
with companies which will provide EDnet with its own private wide area network
for its entertainment clients. EDnet assists in the engineering, selection and
provisioning of the video compression hardware and software needed on the
enterprise local area network (LAN) side of the network. EDnet and its alliance
partners will design sophisticated remote management capabilities into this
private network which will enable upgrading and support of the video affiliate
twenty-four hours a day, seven days a week from the Company's technical support
center in San Francisco. If a customer needs point to point connectivity to
start, EDnet can provide a network access connection which will allow an
affiliate to start small and add to the network as it expands. If a higher
volume wider bandwidth network connection is required, EDnet can provide it.
Internet Website Development and Hosting Services. The Company is also in the
Internet services marketplace. In June 1996, in order to increase its potential
to deliver high-quality audio and other media over the Internet, the Company
consummated a transaction whereby Internet Worldwide Business Solutions, a
California corporation, dba Internet Business Solutions ("IBS"), an Internet
services provider specializing in the development and hosting of web sites for
companies doing business on the Internet, merged with and into a subsidiary of
the Company. The Company thus improved its ability to integrate numerous
technologies to yield cost-effective media communications solutions. IBS
provides interactive web site development services, specializing in complex
database access and professional graphic appearance for its corporate customers.
Web site development services are sought by businesses that wish to pursue
on-line commerce on the Internet. Management believes that a key feature of the
Company's web site service is the Company's ability to provide interactive,
graphically appealing web pages, while many of the web sites developed by
competitors are static and plain. In addition to web site development, the
Company offers the following Internet related services: catalog-based search
engines for custom or existing databases; electronic forms for customer and
query
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information capture; specialized on-line ordering systems; and comprehensive
Internet networking, integration and consulting. Internet services for web site
development range from $5,000 to $75,000 depending on the content and complexity
of the web site. Web site host fees collected by the Company this year average
approximately $250 per month. The primary market for these services are large
and small corporate businesses.
Internet Audio. Vastly improved technology now provides the capability to
deliver CD quality audio via the Internet. Eager to provide it's professional
customers with services utilizing this technology, EDnet has entered into
marketing partnerships with Liquid Audiotm and Realtm Audio to sell, support and
host professional services using their encoding and compression technology.
EDnet creates "Virtual Studios" for these Internet Audio services. With this
technology, users will be able to search for and sample very high quality audio
clips, make selections and download the full length audio from an EDnet server
for replaying or further editing at a convenient time, even in an uncompressed
form, if necessary. Record companies, recording studios, producers and
distributors of radio and TV commercials, artists, producers, broadcasters,
Internet music shopping services, and many other Internet users can utilize
Virtual Studios for the transfer of audio for direction, approval, editing,
production, distribution, and webcasting - broadcasting over Internet
connections. Music and sound effects libraries can market to much larger
audiences, and musicians will have completely new opportunities for the direct
consumer distribution of new recordings via the world wide web. EDnet provides
all of the connectivity, encoding and decoding software, library and server
hosting and access, plus technical and marketing support.
Competition
Audio and Video Networking. Competition in the audio and video networking
business is based on the ability to provide systems compatibility and
proprietary off-the-shelf codecs. Due to the difficulty and expense of
developing and maintaining private digital networks, Management believes that
the number of competitors is, and will remain, small.
The Company's principal competitor in audio networking has been the 3D2 ("3D2")
division of Keystone Communications, Inc. Until March 31, 1995, 3D2 was the
exclusive North American distributor of apt-X codecs manufactured by Audio
Processing Technology ("APT"), which were in demand in the radio voice-over
market. In April 1995, the Company became one of APT's few distributors and
through aggressive marketing, within six months became APT's largest worldwide
distributor. Management believes that the Company was able to use its position
as a distributor of apt-X codecs to attract studios to its network because
studios grew increasingly confident in the Company's ability as a network
service provider as a result of its position as an apt-X codecs distributor.
Management estimates that, between July 1995 and June 1996, as a result of
distributing apt-X codecs, approximately 120 additional studios joined the
network.
The Company's primary video networking competitors are VYVX, a division of
Williams Co., and Sprint through its DRUMS products. These companies offer their
video networking services utilizing higher-bandwidth fiber connections, which,
because they do not have dial-up capability, require scheduling and are
considerably more expensive. Because the Fast Forward Delivery System has an
optional ISDN-based dial-up capability, it is generally less expensive than
sending video materials between studios by courier.
Patents & Trademarks
The Company does not own any patents and relies instead on a combination of
statutory and common law copyright, trademark and trade secret laws to protect
its rights in its proprietary technologies. The Company has registered "EDnet,"
"Entertainment Digital Network," and "ZeroC" as trademarks with the U.S. Patent
and Trademark Office.
Research and Development
During the fiscal years ended June 30, 1997 and June 30, 1996, the Company spent
approximately $1,017,000 and $42,000 respectively on research and development.
During each of the last two fiscal years, the Company did not spend any funds on
material customer-sponsored research and development.
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Governmental Approvals and Regulation
The Company's networking services are currently not subject to regulation by any
government agency or regulatory body.
History and organization
Background. Prior to founding the Company, two of current Management were
employed by Skywalker Sound ("Skywalker"), the post production division of
LucasArts/Lucasfilm Ltd. ("LucasArts"). In 1991, while at Skywalker, they made a
breakthrough in the application of digital communications technology. They were
able to send four channels of compressed, professional-quality digital audio
over T-1 fiber-optic telephone lines (individual DSO's or channels over a single
line) from a Skywalker studio in Northern California to a Skywalker studio in
Southern California. The group thereafter sent the audio mix for the movie
Backdraft, then under production, between the two studios on a daily basis. The
result was that Backdraft was the first film in which the director reviewed
movie audio from a remote studio on the same day it was produced.
Based upon this success (and with the acknowledgment of LucasArts), the
Company's management organized Entertainment Digital Network ("EDN") as a Nevada
corporation on June 26, 1992, and set up a trial network of seven studios and
developed other proprietary technology to market T-1 digital communications to
the music, movie and television industries. On January 25, 1993, EDN was
re-incorporated in the State of California.
Effective August 27, 1993, EDN acquired the assets of Digital Patch Systems
("Digital Patch"), an unrelated networking service provider, for 235,000 shares
of EDN common stock and 140,000 shares of EDN preferred stock. At that time,
Digital Patch used MPEG-based audio-compression, switched 56 and ISDN data
lines, which the Company has since adopted as its primary technology. Management
believed that ISDN, which had become the standard in the telecommunications
industry in Europe, Japan and many parts of the Pacific Rim, would likewise
become the standard in the U.S. ISDN is, in fact, now common in most areas of
the world. EDN also obtained non-competition agreements from the two
shareholders of Digital Patch which prohibited these individuals from competing
with EDN for a period of five years in areas where Digital Patch had operated
before the transaction. Following this transaction, Bert Berdis, who owned 50%
of the outstanding shares of Digital Patch, became a Director of the Company
and served in such capacity until his resignation in March 1997.
Merger With AP Office Equipment. On or about September 20, 1995, EDN's
management determined that it was in EDN's best interests to effect a business
combination with a company whose shares were publicly-traded in order to access
the public capital markets. Toward this end, EDN, its seven largest shareholders
and AP Office Equipment, Inc. ("AP"), an unrelated company, entered into a Stock
Purchase Agreement pursuant to which such shareholders exchanged their EDN
common and preferred stock for 1,275,818 shares of AP common stock, par value
$.001 per share (the "Common Stock"). In addition, (a) outstanding non-qualified
options to purchase an aggregate of 263,420 shares of EDN common stock at an
exercise price of $.10 per share were converted into options to purchase an
aggregate of 230,479 shares of Common Stock at an exercise price of $.11 per
share, and (b) outstanding warrants to purchase an aggregate of 347,343 shares
of EDN common stock at $2.625 per share, which terminated as of October 31,
1996, were converted into warrants to purchase an aggregate of 303,908 shares of
Common Stock at an exercise price of $3.00 per share. The closing of these
transactions was contingent upon the successful completion by AP of a sale of
1,500,000 shares of Common Stock at a price of $0.665 per share.
By means of an Amendment of Articles of Incorporation which was filed with the
Colorado Secretary of State on September 29, 1995, AP changed its name to
"EDnet, Inc."
Finally, pursuant to a Stock Purchase Agreement executed by the Company
(formerly AP) and the remaining shareholders of EDN, dated as of October 18,
1995, such shareholders sold their EDN common stock to the Company in exchange
for 243,720 shares of Common Stock. The result was that EDN became, and remains,
a wholly-owned subsidiary of the Company.
IBS Transaction. Pursuant to an Agreement and Plan of Reorganization dated as of
June 24, 1996 (the "IBS Agreement"), the Company acquired all of the outstanding
shares of common stock of IBS, an unrelated Internet services provider, through
a merger of IBS into a subsidiary of the Company. As
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consideration for such merger, the Company delivered the following to the two
shareholders of IBS, Trevor Stout and Randall Schmitz: (i) two promissory notes
in the aggregate amount of $250,000 (the "First IBS Notes"); (ii) two promissory
notes in the aggregate amount of $250,000 (the "Second IBS Notes"); and (iii)
311,284 shares of Common Stock. The First IBS Notes were due sixty (60) days
after the closing of the IBS Agreement and were repaid by the Company in August
1996. The Second IBS Notes originally provided for interest of eight percent
(8%) and maturity on the earlier of one year from the closing under the IBS
Agreement or fifteen (15) days after the closing of a public offering by the
Company of its Common Stock. In addition, pursuant to an earn-out plan, Messrs.
Stout and Schmitz were originally entitled to receive up to an aggregate of
500,000 shares of Common Stock if IBS was to meet certain specified performance
goals during a period commencing on the effective date of the IBS Agreement and
ending 120 days after June 30, 1999 (the "Earnout"), and Messrs. Stout and
Schmitz entered into three-year employment agreements with the Company and IBS
(collectively, the "IBS Employment Agreements"). Finally, the Company granted to
three employees of IBS options to purchase an aggregate of 50,000 shares of
Common Stock under the NSO Plan (as defined below), at $1.25 per share, which
options vest over a three year period. The merger was accounted for as a
purchase. Upon the closing of the IBS Agreement, Mr. Stout was appointed a
director of the Company and served in such capacity until his resignation in
June, 1997.
Subsequently, the Company determined that the cost of supporting IBS in
researching, developing and marketing certain software related to the
development, operation and maintenance of world-wide web sites (the "IBS Website
Software") was, in Management's view, prohibitively expensive. Accordingly,
pursuant to an Amendment to the Agreement and Plan of Reorganization dated as of
January 31, 1997 and certain collateral documents: (i) IBS licensed the IBS
Website Software to a new entity, Breakthrough Software, Inc., a California
corporation ("Breakthrough"); (ii) the Company agreed to lend up to $250,000 to
Breakthrough to be used for specified purposes, as represented by an unsecured
promissory note made by Breakthrough in favor of the Company, payable 30 days
after demand after July 1, 1997 or upon the date that Breakthrough closes a
financing of not less than $1,000,000; (iii) Breakthrough issued to the Company
2,000,000 shares of convertible Series A Preferred Stock (the "Breakthrough
Series A Preferred Shares") representing (after conversion into Breakthrough
common stock) 40% of Breakthrough's outstanding common stock; (iv) Breakthrough
issued to Messrs. Stout and Schmitz common stock representing 60% of
Breakthrough's outstanding common stock; (v) the Company canceled the Second
Notes; (vi) the Company reduced the number of shares of Common Stock subject to
the Earnout from 500,000 to 125,000; (vii) the IBS Employment Agreements
terminated as of December 31, 1996; and (viii) Messrs. Stout and Schmitz entered
into consulting agreements with the Company to provide transition services to
IBS for a period of three months ending March, 1997.
The Breakthrough Series A Preferred Shares have a liquidation preference worth
$605,000, which represented Management's estimate of the value to date of the
Company's capital investment in the IBS Website Software. So long as 1,500,000
shares of Breakthrough Series A Preferred Shares remain outstanding, the holder
of the Breakthrough Series A Preferred Shares is entitled to elect one director
to the Breakthrough board of directors and the affirmative approval of the
Company is required to approve certain events, including but not limited to, any
increase or decrease in the authorized number of shares of Breakthrough common
or preferred stock, any amendment of Breakthrough's articles of incorporation or
bylaws which adversely affects the rights of the holders of Breakthrough Series
A Preferred Shares, any issuance of securities on a parity with or senior to the
Breakthrough Series A Preferred Shares and any issuance of any additional
securities to either Messrs. Stout and Schmitz or any trust or other entity
controlled by either of them. The rights, privileges and preferences of the
Breakthrough Series A Preferred Shares are contained in the Amended and Restated
Articles of Incorporation of Breakthrough, which were filed with the California
Secretary of State on January 31, 1997
ITEM 2 PROPERTY
Description of property
The Company and its EDN subsidiary operate from two offices located in San
Francisco and Los Angeles, California. The San Francisco office, located at One
Union Street, San Francisco, California, is a 5,000 square foot facility that
operates as administrative headquarters and provides the centralized
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network hub for electronically bridging affiliate studios, as well as overall
network management. The Company leases this facility pursuant to a Sublease
dated November 1, 1993 with Varitel Video, Inc. ("Varitel"), an unaffiliated
entity. This sublease provides for a term of five years commencing November 15,
1993 (with an option to extend for an additional five year term), with monthly
lease payments of zero during the first three months of the term, $5,653.39
during months four through 24 of the term and $5,992.59 during months 25 through
60 of the term (plus the Company's proportionate share of rent adjustments under
the master lease). In lieu of a security deposit, the Company has granted
Varitel a security interest in certain of the Company's equipment with an
aggregate purchase price of approximately $75,000. Varitel may terminate this
sublease upon 90 days prior written notice upon a change in the "principal
ownership" of the Company or in the event that the Company engages in a
"competing type of film or video service business like or similar to Varitel"
excluding, however, any "networking service application" which the Company
engages in connection with its audio, video and other multimedia networking
services. The Los Angeles office, located at 3000 Olympic Blvd., Suite 2121,
Santa Monica, California, is a 4,000 square foot facility that serves as a sales
and demonstration facility and provides access to many users of the Company's
services from the entertainment industry located in Southern California. The
Company leases this facility pursuant to an Office Lease dated June 16, 1993
with Lantana Center, a California limited partnership ("Lantana"), an
unaffiliated entity. This lease provides for a term of ten years commencing July
1, 1993, with monthly lease payments of $7,749.50 (subject to a cost-of-living
adjustment) and reimbursement to the Company of up to $61,015 incurred for the
installation of permanent tenant improvements. As discussed in "Part III - Item
12. Certain Relationships and Related Transactions - Short-Term Loans from
Officers, Directors and Shareholders; Guaranty of Lease" below, the Company's
obligations under this lease have been guaranteed by Mr. Kobayashi, the Chairman
of the Company.
The IBS subsidiary operates from an office located in Mountain View, California.
The Mountain View office, located at 2083 Landings Drive, Mountain View,
California, is a 2,000 square foot facility that operates as its administrative
and operations headquarters. IBS leases this facility pursuant to a Building
Lease dated August 28, 1995, as amended by a Modification No. 1 dated February
13, 1996, with Landmark Investments, Limited, an entity unaffiliated with either
IBS or the Company. This lease, as amended, provides for a term commencing
September 15, 1995 and ending March 3, 1997, with monthly lease payments from
September 15, 1995 through September 30, 1995 of $707.19, from October 1, 1995
through March 3, 1996 of $1,580.80 and from March 4, 1996 through March 3, 1997
of $4,348 (subject to a cost-of-living adjustment). The lease has since been
amended to include 2,174 square feet for a term expiring March 3, 2000 at a
current rate of $5,000.00 per month, increasing to $6,413.30 on March 4, 1998
and 3% annually thereafter.
ITEM 3 LEGAL PROCEEDINGS
The Company is not a party to any material pending legal proceedings other than
ordinary litigation which, in the opinion of the Management, is incidental to
the business of the Company.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No items were submitted to the shareholders for a vote during the fourth quarter
of fiscal 1997.
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PART II
ITEM 5 MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
Price range of common stock
The Company's common stock is traded on the OTC electronic bulletin board under
the symbol "DNET". The reported high and low bid information as quoted on the
OTC bulletin board for the period November 13, 1995 (inception of trading),
through June 30, 1997, is shown below. The high and low bid information as
quoted on the OTC bulletin board represents prices between brokers and dealers
and does not include retail markups, markdowns or commissions to the
broker-dealer.
High and Low Bid Price for Registrant's Common Stock
November 13, 1995 through June 30, 1997
Period High Low
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Quarter ended June 30, 1997 2.06 .50
Quarter ended March 31, 1997 2.19 1.06
Quarter ended December 31, 1996 3.44 1.00
Quarter ended September 30, 1996 3.75 3.00
Quarter ended June 30, 1996 7.13 4.63
Quarter ended March 31, 1996 5.88 2.00
Quarter ended December 31, 1995 3.69 2.00
The number of holders of record of the Company's common stock as of October 1,
1996, was approximately 611.
Dividends
The Company has never paid cash dividends on its common stock, and intends to
utilize current resources to expand its operations. Moreover, the Warrants
restrict the ability of the Company to pay dividends. Therefore, the Company
anticipates that cash dividends will not be paid on the Common Stock in the
foreseeable future.
Recent Sale of Unregistered Securities
Private Placement of Units. On or about June 26, 1996, the Company commenced a
private placement of up to $3,000,000 of Units (each Unit consisting of one
share of Common Stock and one Warrant), for a price per Unit equal to the lesser
of: (i) $3.00; or (ii) the average closing bid price of the Common Stock during
a consecutive thirty (30) day period immediately preceding the termination of
the offering minus thirty percent (30%) (the "Stock Purchase Price"). The
purchase price for each Warrant was one-tenth of one cent ($0.001) per Warrant.
Each Warrant is exercisable until July 31, 1999, provided, however, that in the
event that the average closing bid price of the Common Stock exceeds one hundred
sixty percent (160%) of the Stock Purchase Price for thirty (30) consecutive
trading days, then the Company may, within three business days following the end
of such thirty (30) day period, give notice of its intent to repurchase the
Warrants at a purchase price of one-tenth of one cent ($0.001) per Warrant, in
which case Holders will have (30) days following the date of the Company's
notice to exercise the Warrants. Each Warrant entitles the holder to purchase
one share of Common Stock at an exercise price equal to the lesser of: (i)
$4.75; or (ii) the average closing bid price of the Common Stock during a
consecutive thirty (30) day period immediately preceding the termination of the
offering (subject
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to adjustment in certain circumstances). Holders of Common Stock and Warrants
have been granted piggyback and Form S-3 registration rights for the Common
Stock (and the Common Stock underlying the Warrants).
The Common Stock, the Warrants and the shares purchasable pursuant to the
Warrants were offered and sold only to "accredited investors" as defined in
Regulation D promulgated under the Securities Act of 1933, as amended (the
"Securities Act") in a private placement exempt from the registration
requirements of the Securities Act under Rule 506 promulgated under the
Securities Act. The Company has agreed to pay the following fees in connection
with sales of Units as more fully described in Part III Item 12 Certain
Relationships and Related Transactions - Investment Banking and Brokerage
Services - Morgan Fuller Capital Group L.L.C.: (i) to Morgan Fuller Capital
Group L.L.C. ("Morgan Fuller"), or any other broker selling Units, a brokerage
fee of eight percent (8%) of the value of Units sold; (ii) to Morgan Fuller a
fee of five percent (5%) of the value of Units sold by any other broker; and
(iii) to Morgan Fuller that number of Warrants equal to twenty percent (20%) of
the value of Units sold by Morgan Fuller divided by the market bid price of the
Common Stock on the day the Units are sold, at such price. This offering was
terminated on November 30, 1996 and as of such date the Company had itself sold
an aggregate of 297,143 of Units directly at $1.75 per share and warrants at
$2.50 each and had not paid any brokerage fees or issued any Warrants to Morgan
Fuller.
Private Placement of Note Participations. On or about July 3, 1996, the Company
delivered to Morgan Fuller $1,000,000 of Senior Secured Promissory Notes (the
"Senior Secured Notes"), made by the Company, as debtor, in favor of Morgan
Fuller, as lender. The Senior Secured Notes are secured by a broad lien on the
Company's assets and provide for interest at the rate of fourteen percent (14%)
per annum and were originally due on November 15, 1996, provided, however, that
if the principal and accrued interest was not repaid on such date, the loan
represented by the Senior Secured Notes would be converted into a term loan with
monthly principal payments of $100,000 commencing December 1, 1996 and interest
at eighteen percent (18%) per annum. Morgan Fuller offered participations
("Participations") in the Senior Secured Notes. Investors purchasing
Participations have also received that number of Warrants equal to one-sixth
(1/6) of the aggregate dollar amount of Participations purchased divided by the
exercise price (as discussed below), at exercise prices of $4.25 and $3.69. Each
Warrant is exercisable until July 31, 1999, provided, however, that in the event
that the average closing bid price of the Common Stock exceeds one hundred sixty
percent (160%) of the exercise price for thirty (30) consecutive trading days,
then the Company may, within three business days following the end of such
thirty (30) day period, give notice of its intent to repurchase the Warrants at
a purchase price of one-tenth of one cent ($0.001) per Warrant, in which case
Holders will have (30) days following the date of the Company's notice to
exercise the Warrants. Each Warrant entitles the holder to purchase one share of
Common Stock at an exercise price equal to the closing bid price of the Common
Stock on the date of the Note(s) in which the investor has purchased
Participations (subject to adjustment in certain circumstances). The purchase
price for each Warrant is one-tenth of one cent ($0.001) per Warrant. As of
March 31, 1997, Morgan Fuller had sold an aggregate of $1,000,000 of
Participations.
The Participations, the Warrants and the shares purchasable pursuant to the
Warrants have been offered and sold only to "accredited investors" as defined in
Regulation D promulgated under the Securities Act and the original execution and
delivery of the Senior Secured Notes and the offering of Participations was a
private placement of securities exempt from the registration requirements of the
Securities Act under Rule 506 promulgated under the Securities Act. For Morgan
Fuller's services in connection with the Senior Secured Notes and selling the
Participations, the Company has: (i) paid Morgan Fuller a loan fee of five
percent (5%) of the amount of the Senior Secured Notes; and (ii) granted Morgan
Fuller 39,255 Warrants to purchase Common Stock at an exercise price of $4.25,
and 45,205 Warrants at an exercise price of $3.69. Holders of Warrants have been
granted piggyback and Form S-3 registration rights for the Common Stock
underlying the Warrants. This offering has been terminated.
Pursuant to that Amendment No. 1 to Senior Secured Promissory Notes dated as of
November 15, 1996, the Company and Morgan Fuller extended the term of the Senior
Secured Notes to January 31, 1997. Pursuant to an engagement letter dated
November 19, 1996, in which Morgan Fuller agreed to use its best efforts to
obtain a 75 day extension of the Participations, the Participations were
extended to January 31, 1997. On January 31, 1997, the indebtedness represented
by the Senior Secured Notes converted into a term loan with monthly principal
payments beginning February 15, 1997. In connection with the extension of the
Participations, the Company has agreed to pay to Morgan Fuller a cash fee of
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one and one-half percent (1.5%) of the amount of the Senior Secured Notes and
granted Morgan Fuller or its nominees 55,970 three-year Warrants with an
exercise price of $2.68.
Pursuant to engagement letters dated May 20, June 25, June 28, June 28, November
19 and November 21, 1996, and as of June 30, 1997, the Company had: (i) granted
Morgan Fuller 250,000 Warrants at an exercise price of $6.37 per share for
general investment advisory services; and (ii) granted Morgan Fuller 39,255
Warrants at an exercise price of $4.25 and 45,205 Warrants at an exercise price
of $3.69 in connection with the sale of Participations. In connection with the
extension of the Participations, the Company granted Morgan Fuller 55,970
three-year Warrants with an exercise price of $2.68.
On February 15, 1997, the Company made a $100,000 principal payment on the
Senior Secured Notes to Morgan Fuller and subsequently made no further payments
through June 30, 1997. Pursuant to a Loan Modification Agreement effective June
30, 1997, accrued penalties and interest were forgiven, and the Notes were
converted to a term loan payable in 60 installments with accrued interest at 6%
commencing September 1, 1997. In connection with the Loan Modification Agreement
the Company agreed to re-price the Morgan Fuller warrants to $1.50 each. The
notes are collateralized by the Company's assets.
Private Placement of Common Stock. On December 31, 1996, the Company initiated a
private placement of up to $5,000,000 of Common Stock at $1.00 per share (the
"December 1996 Private Placement"). This Common Stock was offered and sold only
to "accredited investors" as defined in Regulation D promulgated under the
Securities Act and the offering of such Common Stock was a private placement of
securities exempt from the registration requirements of the Securities Act under
Rule 506 promulgated under the Securities Act. Holders of this Common Stock have
been granted piggyback and Form S-3 registration rights. The Company has agreed
to pay to brokers selling Common Stock in this offering a brokerage fee of eight
percent (8%) of the Common Stock sold. The offering was closed on April 30, 1997
at which time the Company had raised $265,000 in this private placement.
Private Placement of EDnet Series A Preferred Shares. On February 3, 1997, the
Company commenced a private placement of up to $1,750,000 of EDnet Series A
Preferred Shares at $1,000 per share to non-United States persons in an offering
exempt from the registration requirements of the Securities Act pursuant to
Regulation S promulgated under the Securities Act. The terms of the EDnet Series
A Preferred Shares are described below. The Series A Preferred Shares are
convertible into Common Stock at any time until the third anniversary of their
issuance at the lesser of 70% of: (i) the average of the closing bid price of
the Common Stock on the five trading days preceding conversion (the "Market
Price"); or (ii) the average of the closing bid prices for the Common Stock on
the five trading days preceding the closing (the "Closing Price"), but if the
Market Price or the Closing Price is less than $1.43 per share it shall be
deemed to be $1.43 per share (the "Floor"). The Series A Preferred Shares are
also subject to mandatory conversion on the third anniversary of their issuance
at the lesser of 70% of the Market Price or the Closing Price, subject to the
Floor. Upon conversion, the holders of Series A Preferred Shares will be paid a
6% cumulative dividend measured from the issuance date of the Series A Preferred
Shares through the conversion date, payable in Common Stock valued at the Market
Price. The Series A Preferred Shares have a liquidation preference of $1,000 per
share and all other stock of the Company are subordinate to such preference.
Holders of Series A Preferred Shares or the underlying conversion Common Stock
will be granted piggyback and Form S-3 registration rights for the underlying
Common Stock. As of April 30, 1997, the Company had raised $150,000 in this
private placement, at which time the offering was closed. The Company has also
paid NET Financial placement fees described in "Part III - Item 12. Certain
Relationships and Related Transactions - Investment Banking and Brokerage
Services - NET Financial International, Ltd.".
Onggara Option. As discussed further in "Part III - Item 12. Certain
Relationships and Related Transactions Investment Banking and Brokerage Services
- - Century Financial Partners, Inc.," EDN entered into a Consulting Agreement,
dated July 31, 1995, with Century Financial Partners, Inc. ("Century"). As
payment for Century's services, such consulting agreement provided that EDN
would grant to Mr. Irawan Onggara ("Mr. Onggara"), an investor in Century, and a
shareholder of the Company holding an aggregate of 100,000 shares of Common
Stock, an option to purchase 1,000,000 shares of the common stock of any
publicly traded entity into which EDN would merge, at $1.25 per share, which
option shares would be registered "immediately" by EDN with the SEC
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on Form S-8. Management does not believe that such a registration is legally
possible due to the fact that Mr. Onggara is not an employee of the Company.
Subsequent to June 30, 1997, the Company provided warrants for 1,000,000 shares
of the Company's Common Stock exercisable at $1.25 per share and expiring five
years from the date of issuance as part of a negotiated settlement of Mr.
Onggara's outstanding loan to the Company of $340,000 (see Part III - Item 12.
Certain Relationships and Related Transactions - Short-Term Loans from Officers,
Directors and Shareholders; Guarantee of Lease).
IBS Transaction. As discussed more fully in "Part I - Item 1. Description of
Business - History and Organization - IBS Transaction," pursuant to the IBS
Agreement, the Company acquired all of the outstanding shares of common stock of
IBS, an unrelated internet services provider, through a merger of IBS into a
subsidiary of the Company. As consideration for such merger, the Company
delivered to the two shareholders of IBS, Trevor Stout and Randall Schmitz,
among other things, 311,284 shares of Common Stock. In addition, pursuant to an
earn-out plan, Messrs. Stout and Schmitz were granted the Earnout, pursuant to
which they were entitled to receive up to an aggregate of 500,000 shares of
Common Stock if IBS was to meet certain specified performance goals during a
period commencing on the effective date of the IBS Agreement and ending 120 days
after June 30, 1999. The Company also granted to three employees of IBS options
to purchase an aggregate of 50,000 shares of Common Stock under the NSO Plan at
$1.25 per share, which options vest over a three year period. These sales of
securities were a private placement exempt from the registration requirements of
the Securities Act under Rule 506 promulgated under the Securities Act.
Subsequently, the Company entered into an Amendment to the Agreement and Plan of
Reorganization dated as of January 31, 1997 and certain collateral documents,
pursuant to which, among other things, the Company reduced the number of shares
of Common Stock subject to the Earnout from 500,000 to 125,000.
Liviakis Financial Communications, Inc. As discussed more fully in " Part III -
Item 12. Certain Relationships and Related Transactions - Investment Banking and
Brokerage Services - Liviakis Financial Communications, Inc., the Company is a
party to a Consulting Agreement, dated as of January 12, 1996, with Liviakis
Financial Communications, Inc. A California corporation, ("Liviakis") for public
relations consulting services. As payment for its services, Liviakis received
390,000 unregistered shares of Common Stock from the Company in a private
placement to an "accredited investor" as defined in Regulation D promulgated
under the Securities Act exempt from the registration requirements of the
Securities Act under Rule 506 promulgated under the Securities Act. At the end
of the term of the consulting agreement, Liviakis may demand that the Company
use its best efforts to register such shares with the SEC. Pursuant to an
additional Consulting Agreement effective as of January 12, 1997, between the
Company and Liviakis, Liviakis agreed to provide public relations consulting
services to the Company for a term of one year ending on January 2, 1998. As
payment for its services, Liviakis received 490,000 unregistered shares of
Common Stock from the Company in a private placement to an "accredited investor"
as defined in Regulation D promulgated under the Securities Act exempt from the
registration requirements of the Securities Act under Rule 506 promulgated under
the Securities Act. At the end of the term of the consulting agreement, Liviakis
shall have the same demand registration rights to register such shares with the
SEC as given to investors in the December 1996 Private Placement (as defined in
"Private Placement of Common Stock" above.
The Company has filed all required filings on Form D with respect to the
transactions discussed above.
Subsequent Events - Charles W. Clark Consulting Agreement. In conjunction with a
consulting agreement entered into on June 30, 1997 with Charles W. Clark ("Mr.
Clark") subsequent to June 30, 1997, the Company issued 400,000 shares of Common
Stock with an S-8 registration under the Securities Act of 1934 as compensation
for restructuring the Company's Senior Secured Notes and certain other
activities more fully described in Part III - Item 12 - Certain Relationships
and Related Transactions - Consulting Agreement With Charles W. Clark.
Subsequent Events - T Bar W Ranch Investments, Inc. Under a subsciption
agreement signed July 10, 1997, the Company received a commitment to purchase
3,750,000 shares of Common Stock at a price of $0.20 per share. Each share came
with a warrant to purchase an additional share of Common Stock at an exercise
price of $1.00 and an expiration date five years from the date of issuance.
As of October 10, 1997, the total amount invested by T Bar W Ranch Investments
is $147,596. The Company has experienced delays in obtaining the full amount of
the funding commitment described above, and is working with T Bar W Ranch
Investments to effect full funding. The Company is
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considering alternative courses of action should the full amount of T Bar W
Ranch Investment's commitment not be forthcoming.
ITEM 6 MANAGEMENT'S DISCUSSION AND ANALYSIS
The following discussion and analysis should be read in conjunction with the
financial statements and notes thereto appearing elsewhere in this report.
Overview
EDnet, Inc. develops and markets integrated systems for the delivery, storage
and management of professional-quality digital communications for media-based
applications, including audio and video production for the North American
entertainment industry. The Company has established a private wide-area network
through strategic alliances with long distance carriers, regional telephone
companies, satellite operators and independent fiber optic telecommunications
providers, which enables the exchange of high quality audio, compressed video
and multimedia data communications. The Company provides engineering services,
application-specific technical advice, audio, video and networking hardware and
software as part of its business. Additionally, the Company provides Internet
web site development and hosting to businesses conducting Internet commerce.
On June 24, 1996, the Company acquired Internet Worldwide Business Solutions
(IBS), an Internet service provider specializing in the development and hosing
of web sites. On December 31, 1996, the Company amended the terms of its
previously consummated acquisition of its wholly-owned subsidiary, IBS, by
dividing IBS into two separate corporations. IBS's Internet service business
continues to operate as IBS. IBS licensed to Breakthrough Software, Inc. (BSI)
certain software under development by IBS related to development, operation, and
maintenance of world-wide web sites. The Company retained ownership of 2,000,000
shares of BSI's convertible preferred stock, which represents, after conversion
into BSI non-voting common stock, 40% of BSI's outstanding common stock.
Liquidity And Capital Resources At June 30, 1997
At June 30, 1997, the Company's principal sources of liquidity included $197,734
of cash and investments and two unsecured $10,000 and $20,000 revolving lines of
credit, which expire in February 1999 and March, 1998.
The decrease in cash equivalents of $155,808 for fiscal year 1997 was
principally due to $508,718 of purchase of property and equipment, $254,928 of
repayment on notes payable and capital leases, and $1,337,563 of cash used in
operating activities, which was not fully offset by gross cash generated from
financing activities of $1,945,401.
The net cash used in operating activities for fiscal year 1997 of $1,372,562,
was primarily due to research and development expense incurred for the
development of the software product licensed to BSI at December 31, 1996 (see
Part I - Item 1. History and Organization - IBS Transaction). Development costs
were also incurred for the Internet audio products and FFD products (see Part I
- - Item 1. Description of Current and Developing Products).
Net cash used in investing activities of $508,718 for fiscal year 1997 related
primarily to expenditures for purchase of furniture, fixture and equipment.
Financing activities provided a net amount of $1,690,473 for fiscal year 1997,
primarily due to $1,071,489 of proceeds from senior notes, issuance of common
and preferred stock under Reg D and Reg S, less $235,534 of repayment of notes
payable and $19,394 of payment on capital leases.
At June 30, 1997, the Company's accumulated deficit was $6,709,227 and its
working capital deficit was $1,965,496. The Company has not been able to
generate any operating profit since inception, and is attempting to raise
additional funds as described in Part II - Item 7 - Consolidated Financial
Statements - Notes 1 and 13. However, if the Company is unable to raise
additional funds, it may not have the financial resouces to continue as a going
concern and may be forced to seek protection from its creditors under Chapter 11
of the bankruptcy code. The financial statements do not contain any adjustments
that may be needed if the Company is unable to continue as a going concern.
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Results Of Operations: June 30, 1997 Compared to June 30, 1996
The following table sets forth for the periods indicated the percentage of net
sales represented by certain line items from the Company's consolidated
statements of income:
Year Ended June 30,
--------------------
1997 1996
----- -----
Revenues 100.0% 100.0%
Cost of sales 59.8% 83.9%
----- -----
Gross profit 40.2% 16.1%
Operating expenses:
Research and development 26.7% 0.0%
Sales and marketing 24.9% 39.3%
General and administrative 96.8% 21.0%
----- -----
Total operating expenses 148.4% 60.2%
----- -----
Loss from operations -108.2% -44.1%
----- -----
Interest expenses -3.8% -1.4%
----- -----
Income before income taxes -112.0% -45.5%
Provision for income taxes 0.1% 0.1%
----- -----
Net Loss -112.0% -45.4%
===== =====
Net Sales for 1997 increased 50% to $3,807,370 as compared to $2,536,258 in
1996. Increases in revenue are attributed to increases in network access and
usage fees associated with a larger installed base and the addition of web
development and hosting revenues associated with the acquisition of IBS. The
equipment component of revenue declined in the period ended June 30, 1997 due to
unavailability of inventory for shipment due to vendor credit restrictions, and
comparison to unusually high equipment sales in the comparable period of the
prior year which resulted from equipment promotions.
Gross Profit increased to $1,530,251 or 40.2% of sales, in the period ended June
30, 1997 compared to $409,517, or 16.1% of sales in the period ended June 30,
1996. Increases in gross profit as a percentage of sales are attributed to
growth in usage revenues, which carry a higher profit margin, and the addition
of web development and hosting revenues, which carry a high profit margin.
Operating expenses (including Research & Development, Sales & Marketing, and
General & Administrative) increased to $5,650,349 in 1997 compared to $1,527,998
in 1996. The Company incurred $1,017,000 of research and development expense
during fiscal year 1997. Operating expenses for 1997 also included $2,534,000 of
additional non-recurring and corporate costs which represent amortization of
goodwill, non-recurring legal and accounting costs associated with the BSI
transaction, the filing of a Form 10-SB registration statement with the SEC, the
Company's initial three-year audit, amortization of the Company's investor
relations consulting agreement, and costs associated with being a public company
that were not incurred in the prior fiscal year. With these items excluded,
operating expenses were $2,099,349 for 1997, representing a 37% increase over
$1,527,998 in the comparable period of the prior year. This increase is
consistent with the necessary addition of infrastructure associated with the
Company's increase in sales.
Other expenses increased to $146,185 in the period ended June 30, 1997 compared
to $34,322 in the last fiscal year. The increase in other expenses was due to
increases in interest expense and amortization of
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debt issuance costs and note discounts associated with the Senior Secured Notes
(see Notes 5 and 9 of the Consolidated Financial Statements).
For fiscal year 1997, the Company incurred a net loss of $4,269,549 or ($0.86)
per share based on a weighted average of 4,967,539 shares outstanding, compared
with a net loss of $1,154,403, or ($0.36) per share based on a weighted average
of 3,181,350 shares outstanding in the prior year.
ITEM 7 FINANCIAL STATEMENTS
The 1997 Consolidated Financial Statements are unaudited except for those
portions attributable to FY 1996 and June 30, 1996. This Annual Report on Form
10-KSB will be amended to include audited financial statements, in accordance
with the Securities Exchange Act of 1934, as soon as is practical
The following financial statements are attached to this report and filed as part
thereof;
1) Table of Contents
2) Consolidated Balance Sheet, June 30, 1997;
3) Consolidated Statements of Operations for the years ended June 30, 1997,
and 1996;
4) Consolidated Statements of Stockholders Equity (Deficit) for the years
ended June 30, 1997, and 1996;
5) Consolidated Statements of Cash Flows for the years ended June 30, 1997,
and 1996; and
6) Notes to Consolidated Financial Statements.
ITEM 8 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There have been no changes in or disagreements with the Company's accountants
regarding accounting and financial disclosure.
PART III
ITEM 9 DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
The following sets forth the names, ages and current positions with the Company
held by Directors, Executive Officers and Significant Employees, together with
the year such positions were assumed. Tom Kobayashi, the Chairman and Chief
Executive Officer, and David Gustafson, President and Chief Operating Officer,
are brothers-in law. Other than as described in the preceding sentence, there is
no immediate family relationship between or among any of the Directors,
Executive Officers or Significant Employees and the Company is not aware of any
arrangement or understanding between any Director or Executive Officer and any
other person pursuant to which he was elected to his current position.
Tom Kobayashi, age 68, has served as the Chairman of the Board of Directors and
a Director of the Company since 1992 and as Chief Executive Officer from 1992 to
present. From 1986 to 1993, he was Vice President and General Manager of
Skywalker Sound division of LucasArts. During his tenure at Skywalker, the
sending of digital audio over fiber optic telephone lines was developed and the
idea for an entertainment digital network was formulated. In 1992, with George
Lucas's approval, Mr. Kobayashi utilized the technology first developed at
Skywalker to found EDN. Previously, he was with Glen Glenn Sound, a major sound
recording studio in Hollywood. He began with Glen Glenn in 1964 as Vice
President of Finance, later served as Vice President of Business Affairs and
Executive Vice President and in 1983 was appointed President and Chief Operating
Officer. Mr. Kobayashi is a member of the American Engineering Society, the
Society of Motion Picture and Television Engineers, the Society of Professional
Audio Recording Studios (of which he has been a member of the Board of Governors
for over seven years), the Academy of Motion Picture Arts and Sciences and the
Academy of Television Arts
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and Sciences. Mr. Kobayashi earned a Bachelor of Science degree at the
University of Southern California.
David Gustafson, age 50, has served as the President and Chief Operating Officer
of the Company from March 1996 to present, and as Vice President, Marketing and
Sales, from July 1992 to March 1996. He has served as a Director of the Company
since 1992. Previously, he was President and Chief Operating Officer of SLT,
Inc., a private New York-based apparel manufacturer; Corporate Vice President
and Director of Wacoal America, Inc., a $35 million division of the $1 billion
Wacoal Corp., a multi-national consumer products company based in Kyoto, Japan,
where his responsibilities included Merchandising and Design, Sales, Marketing
and Advertising; Vice President of Marketing and Merchandising for the Olga
Company; Management Information Systems Consultant with Deloitte, Haskins &
Sells in Los Angeles; and a computer Systems Engineer and Manager at EDS Corp.,
working in New York, Miami and Dallas. Mr. Gustafson received his Bachelor's
degree from Westmont College in Santa Barbara, California and further training
in Marketing and Executive Management from the graduate business schools at both
the University of California, Los Angeles and the University of Southern
California.
Thomas Scott, age 53, has served as the Vice President-Chief Technology Officer
of the Company since 1992. From 1985 to 1992, he was Chief Engineer for
Skywalker Sound, the post production division of LucasArts/Lucasfilm Ltd.
Previously, he was Chief Engineer of The Record Plant and eventually worked in
film sound on the picture Apocalypse Now. Mr. Scott has been involved with
motion pictures since then, being employed at American Zoetrope, Dolby
Laboratories and LucasArts as Director of Engineering. During this period Mr.
Scott received two Oscar Academy Awards for Best Sound on the films The Right
Stuff and Amadeus. His last LucasArts project was the supervision of the
EditDroid and SoundDroid--revolutionary computer-based picture and sound editing
equipment. Previously, he was Chief Engineer and Director of Remote Operations
at Wally Heider Recording, one of the first independent recording studios, and
an engineer with the Peace Corps in Venezuela. Mr. Scott is active in numerous
professional organizations and standards committees, including the American
Engineering Society, Society of Motion Picture and Television Engineers, the
Society of Professional Audio Recording Studios, the National Academy of
Recording Arts and Sciences and the Academy of Motion Picture Arts and Sciences.
Mr. Scott earned his Bachelor of Science degree from the Massachusetts Institute
of Technology.
Alan K. Geddes, age 47, has served as Vice President Finance and Chief Financial
Officer of the Company since July, 1996. From 1986 to 1996, he was the Chief
Financial Officer of IMAR Corporation and Oncogenetics, Inc., both emerging
companies in medical technology, in addition to founding his own company,
California Pacific Leasing, Inc. Previously, he served in corporate management
at Bio-Rad Laboratories, as Corporate Controller at Fiberplastics, Inc., was a
Financial Analyst with Litton Industries and a Plant Controller with Abbott
Laboratories. Mr. Geddes has a Masters in Business Administration in Finance
from Utah State University.
Mark L. Wallin, age 27, has served as the President of IBS since February 1,
1997. Previously, he served as the Technical Director of Web Services from June
1996 to February 1, 1997. From 1992 to 1996, he was a Project Manager, Technical
Team Leader and Application Integrator for IBM. He graduated from Stanford
University in 1993 with a degree in Computer Systems Engineering.
Robert J. Wussler, age 59, has served as a Director of the Company since 1995.
From 1994 to the present, he has been the President and Chief Executive Officer
of Affiliate Enterprises, Inc., the company formed by ABC Television affiliates
to pursue new business opportunities, including emerging technology
applications. From 1990 to 1993, he was President and Chief Executive Officer of
COMSAT Video Enterprises, where he managed the acquisition of the NBA Denver
Nuggets. Previously, from 1980 to 1990, he was Senior Vice President of Turner
Broadcasting, where he oversaw the launch of CNN, Headline News and TNT, in
addition to serving as President of SuperStation TBS, and from 1974 to 1978, he
was the President of the CBS Television Network and CBS Sports.
Avi A. Fogel, age 42, has served as a Director of the Company since 1995. In
1996 Mr. Fogel founded CommHome Systems Corporation, where he serves as Chief
Executive Officer. From 1995 to December, 1996, he had been the Vice President
of Global Marketing for Digital Equipment Corporation in the Network Division.
From 1987 to 1995, he served in various roles at Lannet Data Communications,
first as Sales and Marketing Manager, then as President and Chief Executive
Officer of
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Lannet North America and finally as Executive Vice President - Global Marketing
and Business Development, where he guided the development of international and
North American sales and marketing organizations, and established customer and
partnership relationships with Wellfleet Communications, AT&T, Mitel, Data
General, Fore Systems, Swiss Bank Corp., Sprint and General Motors. Mr. Fogel
initiated a $330 million acquisition of Lannet Data Communications by Madge
Networks.
Charles Clark, age 42, has served as a Director of the Company since July 1997.
Currently he is senior partner of Private Client Group, formed in 1991, which
works in concert with consulting groups assisting companies in corporate finance
and corporate reorganizations. From 1991 to 1995, he worked for Dean Witter as
an account executive. From 1980 to 1990, he worked as agency-based journalist in
Paris and New York, and as a free-lance producer of television documentaries and
news related pieces on social issues.
The directors named above have been elected for one-year terms. On January 29,
1997, the Board of Directors removed Christopher Desmond for failure to attend
to his duties as a director. The following directors resigned as of the noted
dates; Bert Berdis on March 18, 1997, Trevor Stout on June 12, 1997, John C.
Kraft on June 19, 1997, Phil Ramone on June 26, 1997 and Charles E. Erickson,
(who served for 60 days) on June 7, 1997.
Employment contracts
<TABLE>
The Company maintains employment contracts with key management and employees as
listed below. All referenced contracts contain identical non-competition
provisions:
<CAPTION>
Name, Title Date of Agreement Expiration Date
- ----------- ----------------- ---------------
<S> <C> <C>
Tom Kobayashi, Chairman and CEO September 1, 1995 December 31, 2000
David Gustafson, President & COO September 1, 1995 December 31, 2000
Alan Geddes, Vice President & CFO July 3, 1996 June 30, 1998
Mark Wallin, President COO (IBS) February 28, 1997 January 31, 2000
Jeff Dobkins, VP Sales (IBS) February 28, 1997 January 31, 2000
Thomas A. Scott, VP Engineering July 7, 1997 December 31, 2000
</TABLE>
Each contract provides that for the designated period following the date of the
employment agreement, the employee will not, directly or indirectly, within any
county, city or part thereof and other areas in the United States of America
(collectively, the "Locations"), so long as the Company continues to be engaged
in the same or similar business or activity (the "Business") in such Location:
(i) own, manage, operate, control, or be connected in any manner with the
ownership, management, operation or control of any person or entity that engages
in the same or similar type of Business as the Business or engages in a business
competitive with the Business (a "Competitive Business"), which includes but is
not limited to, acting as a director, officer, agent, employee, consultant,
partner or stockholder of a Competitive Business; (ii) engage in any activity
which is the same as, similar to or in competition with the Business; (iii)
interfere with, disrupt or attempt to disrupt the business relationship,
contractual, employment or otherwise, between the Company and any customer or
prospective customer, supplier, lessee or employee of the Company, including
without limitation the customers and suppliers of the Business prior to the date
of the employment agreement; (iv) solicit employment for or of employees of the
Company or induce any employee to leave the employ of the Company; (v) lend or
allow his name or reputation to be used by or in connection with any Competitive
Business; or (vi) otherwise allow his skill, knowledge or experience to be used
in or by any Competitive Business. Each employment agreement provides that the
employee may invest in up to 5% of the shares of any public corporation without
violating the non-competition provisions, and that such non-competition
provisions will survive the termination of the employment agreement, other than
where (a) the employee exercises his right to terminate the employment agreement
upon a sale or transfer of substantially all of the assets of the Company, or a
change in control of the Company, (b) when the Company exercises its right to
terminate the employment agreement upon 30 days written notice, or (c) the
Company breaches the employment agreement and fails to cure such breach within
thirty (30) days of receipt of written notice thereof. A court applying
California law may decline to enforce (or may partially enforce) these
non-competition provisions.
Compliance with section 16(a) of the exchange act
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<PAGE>
Under the Securities Laws of the United States, the Company's Directors, its
Executive (and certain other) Officers, and any persons holding more than ten
percent (10%) of the Company's Common Stock are required to report their
ownership of the Company's Common Stock and any changes in that ownership to the
Securities and Exchange Commission and the NASDAQ stock market. Specific due
dates for these reports have been established and the Company is required to
disclose in this report any failure to file by these dates during the preceding
fiscal year. All of these filing requirements were satisfied by its Officers and
Directors and ten percent (10%) holders, except the following: subsequent to the
end of the fiscal year, Charles Clark, a Director, and John Wampler, a 10%
holder by definition of Section 16, failed to file with the Commission, on a
timely basis, an Initial Statement of Beneficial Ownership of Securities on Form
3. Additionally, Mr. Clark may have failed to file on a timely basis subsequent
Statements of Changes in Beneficial Ownership on Form 4. In making these
statements, the Company has relied on the representation of its Directors and
Officers or copies of the reports that they have filed with the Commission.
ITEM 10 EXECUTIVE COMPENSATION
The following table sets forth information concerning all annual compensation
paid to the Company's Chief Executive Officer and each of the four highest paid
persons other than the Chief Executive Officer who were officers or directors of
the Company for the fiscal year ended June 30, 1997:
Capacities in
Name of individual which remunera- Aggregate
or identity of group tion was received remuneration
Tom Kobayashi Chairman and Chief $132,000(1)
Executive Officer and
Director
David Gustafson President and Chief $139,000(2)
Operating Officer and
Director
Jeffrey Dobkins Vice President of Sales $100,000(3)
(IBS)
Alan Geddes Vice President Finance and $ 94,000(4)
Chief Financial Officer
Tom Scott Vice President and $ 91,000(5)
Chief Technical Officer
Total of above $556,000
- -----------
(1) Mr. Kobayashi has an Employment Agreement with the Company which provides
for a five-year term expiring December 31, 2000, with a base salary of
$10,416 per month from September 1, 1995 to February 28, 1996, with an
increase to "market rate" at March 1, 1996 and every year thereafter. FY
1997 compensation includes $8,400 of deferred payroll.
(2) Mr. Gustafson has an Employment Agreement with the Company which provides
for a five-year term expiring December 31, 2000, with a base salary of
$10,416 per month from September 1, 1995 to February 28, 1996, with an
increase to "market rate" at March 1, 1996 and every year thereafter. FY
1997 compensation includes $8,400 of deferred payroll.
(3) Mr. Dobkins has an Employment Agreement with the Company which provides for
a three-year term expiring January 31, 2000, with a base salary of $5,833
per month plus commissions.
(4) Mr. Geddes has an Employment Agreement with the Company which provides for
a two-year term expiring June 30, 1998, with a base salary of $8,333 per
month beginning July 1, 1996, increasing to $9,167 per month on January 1,
1997, and $10,416 per month on July 1, 1997. FY 1997 compensation includes
$9,800 of deferred payroll.
18
<PAGE>
(5) Mr. Scott has an Employment Agreement with the Company which provides for a
three-and-one-half-year term expiring December 31, 2000, with a base salary
of $7,500 per month. FY 1997 compensation includes $7,100 of deferred
payroll.
Directors of the Company do not receive any compensation for their services as
directors other than reimbursement by the Company of reasonable out-of-pocket
travel expenses incurred in connection with attending director meetings in
person.
Stock options
The Company maintains a nonstatutory stock option plan entitled The 1995-1996
Nonstatutory Stock Option Plan (the "NSO Plan"). The NSO Plan is administered by
a committee appointed by the board of directors, consisting of two members. The
NSO Plan reserves a total of 565,000 shares of Common Stock for option grants to
key employees and consultants (including directors) of the Company and its
subsidiaries and provides that the option price may be equal to or less than the
fair market value of the Common Stock on the grant date, provided, however, in
the event that the option price is less than 85% of the then current market
value of the Common Stock, the Board of Directors must approve such option
grant. In addition, the NSO Plan provides that no option period exceed five (5)
years after the grant date. As of June 30, 1997, options to purchase 459,550
shares of Common Stock had been issued under the NSO Plan. The NSO Plan was
approved by the Board of Directors on November 10, 1995. In addition, in
connection with the merger with AP, non-qualified options to purchase an
aggregate of 263,420 shares of EDN common stock at an exercise price of $.10 per
share issued under EDN's 1993 Flexible Stock Incentive Plan (the "EDN Option
Plan") were converted into options to purchase an aggregate of 230,479 shares of
Common Stock at an exercise price of $.11 per share, which options are fully
vested. Other than as discussed herein, the Company does not have any pension,
profit-sharing, stock bonus, or other benefit plans. In addition, the Company
makes available certain non-monetary benefits to its executive officers with a
view to acquiring and retaining qualified personnel and facilitating job
performance. The Company considers such benefits to be ordinary and incidental
business costs and expenses.
The following table sets forth certain information concerning the granting of
stock options during the last completed fiscal year to each of the named
executive officers:
Number of % of Total
Securities Options
Underlying Granted to
Options Employees Exercise
Name Granted (#) in Fiscal Year Price Expiration Date
- ---- ----------- -------------- ----- ---------------
Tom Kobayashi 72,413 23.4% $1.25 12/31/02
David Gustafson 72,412 23.4% $1.25 12/31/02
Alan Geddes 50,000 16.1% $1.25 6/30/02
Mark Wallin 50,000 16.1% $1.25 6/30/02
Jeffrey Dobkins 40,000 12.9% $1.25 6/30/02
------- ----
Total 284,825
-------
There were no options exercised during the fiscal year.
ITEM 11 SECURITY OWNERSHIP OF MANAGEMENT AND PRINCIPAL STOCKHOLDERS
The following table sets forth information, as of October 10, 1997, regarding
shares of Common Stock (a) held of record and (b) that the named owner has the
right to acquire within sixty days from options, warrants, rights, conversion
privilege or similar obligations by: (i) officers or directors of the Company;
(ii) all officers and directors as a group; and (iii) each shareholder who owns
more than 5% of any class of the Company's securities, including those shares
subject to outstanding options and warrants. Unless
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<PAGE>
expressly indicated otherwise, each shareholder exercises sole voting and
investment power with respect to the shares owned.
Amount Owned or
Title Name and Address Right to Acquire Percent
of Class of Owner Within 60 Days of Class (1)
Common Tom Kobayashi 461,614(2) 5.87%
One Union Street
San Francisco, CA 94111
Common David Gustafson 237,821(3) 3.03%
One Union Street
San Francisco, CA 94111
Common Tom Scott 172,802(4) 2.20%
One Union Street
San Francisco, CA 94111
Common Alan Geddes 33,300(5) 0.42%
One Union Street
San Francisco, CA 94111
Common Robert Wussler 50,000(6) 0.64%
One Union Street
San Francisco, CA 94111
Common Avi Fogel 50,000(6) 0.64%
One Union Street
San Francisco, CA 94111
Common Charles Clark 400,000 5.09%
One Union Street
San Francisco, CA 94111
Common Liviakis Financial 1,405,537 17.89%
Communications, Inc.
2118 "P" Street, Suite C
Sacramento, CA 95816
Common T Bar W Ranch Investments 1,476,000(7) 18.78%
101 E Brand
Mineola, TX 75773
Common All officers and
directors as a group (3) 1,405,537 17.89%
Series A Corner Bank Ltd. 150(8) 100.00%
Preferred via Canova 16
P.O. Box 2835-6901
Lugano, Switzerland
- -----------
(1) Based upon 7,858,465 shares of Common Stock and 150 shares of Series A
Preferred Stock issued and outstanding on October 10, 1997.
(2) Includes right to acquire 36,566 shares within 60 days from options.
(3) Includes right to acquire 102,060 shares within 60 days from options.
(4) Includes right to acquire 7,917 shares within 60 days from options.
(5) Includes right to acquire 33,300 shares within 60 days from options.
(6) Includes right to acquire 50,000 shares within 60 days from options.
(7) Includes right to acquire 738,000 shares within 60 days from warrants.
20
<PAGE>
(8) Includes right to acquire 150,000 shares within 60 days upon conversion.
ITEM 12 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Investment Banking and Brokerage Services
All of the agreements described below were negotiated with unrelated third
parties on an arms-length basis.
Century Financial Partners, Inc. Pursuant to a Consulting Agreement, dated July
31, 1995, between EDN and Century, EDN hired Century to advise EDN with respect
to a merger of EDN with an entity whose securities were publicly traded. Such
consulting agreement granted Century the exclusive right to represent EDN, on a
best efforts basis, to prospective investors for financing and general corporate
advisory services for a period of three years, and a right of first refusal to
provide investment banking services for a period of three years. Century advised
the Company with respect to the transaction with AP (see "Part I - Item 1.
Description of Business - History and Organization - Merger with AP Office
Equipment"). Century has verbally consented to the Company's agreements with
Morgan Fuller and others (described below). As payment for Century's services,
the Century consulting agreement provided that EDN would grant to Mr. Onggara,
an investor in Century, and a shareholder of the Company holding an aggregate of
100,000 shares of Common Stock, an option to purchase 1,000,000 shares of the
common stock of any publicly traded entity into which EDN would merge, at $1.25
per share, which option shares would be registered "immediately" by EDN with the
SEC on Form S-8. Management does not believe that such a registration is legally
possible due to the fact that Mr. Onggara is not an employee of the Company.
Subsequent to June 30, 1997, the Company provided warrants for 1,000,000 shares
of the Company's common stock at $1.25 per share as part of a negotiated
settlement of Mr. Onggara's outstanding loan to the Company of $340,000 (see
Short-Term Loans from Officers, Directors and Shareholders; Guarantee of Lease
below). When Mr. Onggara has received this stock issue and the warrants, and
assuming the exercise of those warrants (though the warrants are divisible and
transferable), he may become a shareholder holding more than ten percent of the
outstanding Common Stock.
Liviakis Financial Communications, Inc. Pursuant to a Consulting Agreement,
dated as of January 12, 1996, between the Company and Liviakis, Liviakis agreed
to provide public relations consulting services to the Company for a term of one
year ending on January 11, 1997. As payment for its services, Liviakis received
390,000 unregistered shares of Common Stock from the Company. At the end of the
term of the consulting agreement, Liviakis may demand that the Company use its
best efforts to register such shares with the Securities and Exchange Commission
(the "SEC"). Pursuant to an additional Consulting Agreement effective as of
January 12, 1997, between the Company and Liviakis, Liviakis agreed to provide
consulting services to the Company for a term of one year ending on January 2,
1998. As payment for its services, Liviakis received 490,000 unregistered shares
of Common Stock from the Company. At the end of the term of the consulting
agreement, Liviakis shall have the same demand registration rights to register
such shares with the SEC as given to investors in the December 1996 Private
Placement as defined in Part II - Item 5. Market For The Registrant's Common
Stock And Related Stockholder Matters - Recent Sales of Unregistered Securities.
Private Placement of Common Stock.
Subsequent to June 30, 1997 Liviakis resigned as EDnet's investor public
relations consultant.
Morgan Fuller Capital Group L.L.C. Pursuant to engagement letters dated May 20,
June 25, June 28, June 28, November 19 and November 21, 1996, the Company
retained Morgan Fuller to provide investment banking services to, and raise
capital for, the Company. As discussed more fully in "Part II - Item 5. Market
For The Registrant's Common Stock And Related Stockholder Matters - Recent Sales
of Unregistered Securities", as of October 10, 1997, the Company had: (i)
granted Morgan Fuller 250,000 Warrants at an exercise price of $6.37 per share
for general investment advisory services; (ii) delivered the Senior Secured
Notes (as defined) payable to Morgan Fuller in the aggregate principal amount of
$1,000,000; (iii) paid Morgan Fuller a loan fee of five percent (5%) of the
amount of the Senior Secured Notes; and (iv) granted Morgan Fuller 39,255
21
<PAGE>
warrants to purchase Common Stock ("Warrants") at an exercise price of $4.25 and
45,205 Warrants at an exercise price of $3.69 in connection with the sale of
Participations (as defined). The June 28, 1996 engagement letter provides that
in the event that the Company fails to proceed with a subsequent Regulation S
financing, the Company is obligated to pay to Morgan Fuller a cash fee of
$140,000 and $200,000 in aggregate amount of Warrants at an exercise price equal
to the lesser of: (i) $3.00; or (ii) sixty percent (60%) of the average closing
bid price of the Common Stock during a consecutive ten (10) day period
immediately preceding the issuance date of the Warrants. Because the Company has
engaged another broker in connection with such an offering (see "NET Financial
International, Ltd." below), the Company has had oral discussions with Morgan
Fuller regarding Morgan Fuller's waiver of this provision. In connection with
the extension of the Participations, the Company agreed to pay to Morgan Fuller
a cash fee of one and one-half percent (1.5%) of the amount of the Senior
Secured Notes and granted Morgan Fuller 55,970 three-year Warrants with an
exercise price of $2.68. In connection with a Loan Modification Agreement
effective June 30, 1997 (see "Part II Item 5 Market for the Registrant's Common
Stock and Related Stockholder Matters Recent Sale of Unregistered Securities -
Private Placement of Note Participations") the Company amended its agreement
with Morgan Fuller and agreed to re-price the Morgan Fuller warrants to $1.50.
LBC Capital Resources, Inc. Pursuant to an engagement letter dated October 17,
1996 (the "LBC Letter Agreement") between the Company and LBC Capital Resources,
Inc. ("LBC"), the Company retained LBC to solicit a broad range of transactions
on behalf of the Company, including equity and debt financings and to provide
advice with respect to potential merger and acquisition transactions. LBC would
be paid fees only upon the successful closing of any such transaction. Such fees
would be comprised of (i) a cash fee in the amount of six percent (6%) of the
gross amount of such transaction (to be paid as such proceeds are received by
the Company) and (ii) warrants as described in the next sentence. Upon the
completion of one or more transactions, for each $1,000,000 of such transaction
amount, after transactions aggregating at least $1,000,000 have been closed, LBC
would be entitled to purchase from the Company for $2,500 a seven year warrant
to purchase one hundred twenty thousand (120,000) shares of Common Stock, at an
exercise price per share equal to one hundred twenty-five percent (125%) of the
average closing price for the five (5) trading days preceding the execution of
the LBC Letter Agreement. The term of the LBC Letter Agreement is sixty (60)
days and thereafter, will remain in effect until terminated by either party upon
ten (10) days written notice. Upon execution of the LBC Letter Agreement, the
Company also paid to LBC a $2,500 non-accountable expense allowance.
Subsequent to June 30, 1997, the Company terminated this agreement by giving LBC
ten days written notice.
NET Financial International, Ltd. On January 31, 1997, the Company entered into
a Consulting Agreement with NET Financial International, Ltd. ("NET Financial"),
pursuant to which NET Financial agreed to act as placement agent for the sale of
up to $5,000,000 of EDnet Series A Convertible Preferred Stock (the "EDnet
Series A Preferred Shares") to non-United States persons in one or more
offerings exempt from the registration requirements of the Securities Act
pursuant to Regulation S promulgated under the Securities Act in two phases,
with the first phase commenced on February 3, 1997. For a description of this
offering, see "Part II - Item 5. Recent Sales of Unregistered Securities -
Private Placement of EDnet Series A Preferred Shares" below. The Company agreed
to pay NET Financial fees equal to 10% of the total capital raised in the
financing as well as issuing to it a warrant (with registration rights)
exercisable for two years allowing the purchase of shares of Common Stock with a
value on the date of the closing equal to 6% of the capital raised in the
financing, at an exercise price equal to the closing bid price of the Common
Stock on the date of the closing of the financing. The NET Financial consulting
agreement has a term of three months and thereafter is terminable by either
party upon ten days prior written notice. In addition, in the event that the
Company seeks additional financing during the twelve month period after the
execution of the NET Financial consulting agreement, the Company must give NET
Financial the right of first refusal to obtain such additional financing, upon
the compensation terms described above.
Subsequent to June 30, 1997, the Company terminated this agreement by giving NET
Financial ten days written notice.
Consulting Agreement with Charles W. Clark. On June 30, 1997, the Company
entered into a consulting agreement with Mr. Clark, pursuant to which Mr. Clark
agreed to serve the Company in advising and assisting in the structuring of debt
and liabilities, joint venture, acquisitions or merger
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<PAGE>
partners, business development and developing long term financial plans. The
Company has agreed to pay Mr. Clark for re-structuring and re-organizing the
Company's senior notes and debts on the Company's balance sheet four hundred
thousand (400,000) shares of Common Stock. These shares were issued to Mr. Clark
and registered with the Securities and Exchange Commission under Form S-8
registration on July 25, 1997. The term of the Agreement is for five (5) years
and can be terminated by either party with a thirty (30) day written notice
under certain conditions.
Short-Term Loans from Officers, Directors and Shareholders; Guaranty of Lease
Several of the officers and directors of the Company have made short term loans
to the Company pursuant to promissory notes each providing for maturity ninety
days after the date thereof and simple interest of 6% on unpaid principal. Such
promissory notes are overdue. Mr. Kobayashi made loans in the aggregate amount
of $36,000, as evidenced by promissory notes dated from June 11, 1993 to
February 10, 1994. As of June 30, 1997, 1997, unpaid principal (excluding
interest) of $24,000 was due on Mr. Kobayashi's notes. Mr. Scott, the Vice
President and Chief Technical Officer of the Company, made loans in the
aggregate amount of $43,050, as evidenced by promissory notes dated from August
6, 1993 to June 12, 1995. As of June 30, 1997, unpaid principal (excluding
interest) of $16,550 was due on Mr. Scott's notes. Each of these individuals has
agreed not to declare a default under these notes for an indefinite period and
to accept repayment by the Company at a future date.
Mr. Onggara has made three loans to the Company in the aggregate amount of
$425,000, pursuant to: (a) a promissory note in the principal amount of $250,000
dated February 8, 1996 with a maturity date of August 8, 1996; (b) a promissory
note in the principal amount of $100,000 dated April 18, 1996 with a maturity
date of October 18, 1996; and (c) a promissory note in the principal amount of
$75,000 dated May 20, 1996 with a maturity date of November 20, 1996. All such
promissory notes provide for interest of 7% on unpaid principal and are secured
by a subordinate security interest in the accounts receivable, chattel paper,
accounts and certain other assets of the Company. In August 1996, the Company
made aggregate principal payments of $120,000 to Mr. Onggara on the first note.
Mr. Onggara has verbally agreed to extend the maturity date of such notes for an
indefinite period and to accept repayment by the Company at a future date, and
readvanced $35,000 to the Company under the first note. As of June 30, 1997,
unpaid principal (excluding interest) of $340,000 was due on Mr. Onggara's
loans.
Subsequent to June 30, 1997, an agreement was reached with Mr. Onggara whereby
the $340,000 loan plus accrued interest of $35,000 was converted to shares of
the Company's Common Stock at $.375 per share, resulting in 1,000,000 shares.
EDnet addressed an unresolved commitment of options by issuing 1,000,000
warrants priced at $1.25 each (see Part II - Item 5. Market for the Registrant's
Common Stock and Related Stockholder Matters - Recent Sale of Unregistered
Securities - Onggara Option). The warrants are convertible over 3 years and are
transferable and divisible.
Mr. Kobayashi executed a Guaranty of Lease in favor of Lantana pursuant to which
Mr. Kobayashi personally guaranteed EDN's obligations under its lease for the
Company's Los Angeles office premises. Mr. Kobayashi's guaranty is limited to
$48,225 for so long as he remains the chief executive officer, and maintains
voting control, of the Company. Because Mr. Kobayashi does not currently have
voting control of the Company, his guarantee is therefore unlimited. Mr.
Kobayashi has had verbal discussions with Lantana regarding amending the
Guaranty of Lease to eliminate the voting control condition.
ITEM 13 EXHIBITS AND REPORTS ON FORM 8-K
Exhibit No. Type of Exhibit
- ----------- ---------------
(2) (a) Articles of Incorporation, as amended. PREVIOUSLY FILED.
(b) Bylaws, as amended. PREVIOUSLY FILED.
(c) Certificate of Designation, filed with the Colorado Secretary of
State on February 2, 1997. PREVIOUSLY FILED.
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(3) (a) Security Agreement dated as of July 5, 1996, made by the
Company, in favor of Morgan Fuller Capital Group L.L.C.
PREVIOUSLY FILED.
(b) Amendment No. 1 to Security Agreement dated as of August 1,
1996. PREVIOUSLY FILED.
(c) Form of Senior Secured Promissory Note in favor of Morgan
Fuller Capital Group L.L.C., executed on the following dates
for the following amounts:
1. dated July 5, 1996, in the amount of $500,000;
2. dated July 22, 1996, in the amount of $200,000; and
3. dated July 22, 1996, in the amount of $300,000.
PREVIOUSLY FILED.
(d) Amendment No. 1 to Senior Secured Promissory Notes, dated as
of November 15, 1996, executed by the Company and Fuller
Capital Group L.L.C. PREVIOUSLY FILED.
(e) Promissory Note dated February 8, 1996 in favor of Irawan
Onggara, in the principal amount of $250,000. PREVIOUSLY
FILED.
(f) Promissory Note dated April 18, 1996 in favor of Irawan
Onggara, in the principal amount of $100,000. PREVIOUSLY
FILED.
(g) Promissory Note dated May 20, 1996 in favor of Irawan Onggara,
in the principal amount of $75,000. PREVIOUSLY FILED.
(h) Form of Promissory Note dated June 24, 1996 in the principal
amount of $125,000, payable to each of Randall Schmitz and
Trevor Stout. PREVIOUSLY FILED.
(i) Breakthrough Software, Inc. Convertible Promissory Note dated
January 31, 1997 in the principal amount not to exceed
$250,000 payable to the Company. PREVIOUSLY FILED.
6 Material Contracts
(a) Agreement and Plan of Reorganization by and among EDnet, Inc.,
EDN Sub, Inc. and Internet Worldwide Business Solutions, dated
as of June 24, 1996. PREVIOUSLY FILED.
(b) Stock Purchase Agreement, dated September 22, 1995, between AP
Office Equipment, Inc., Entertainment Digital Network, Inc.
and certain shareholders of Entertainment Digital Network,
Inc. PREVIOUSLY FILED.
(c) Stock Purchase Agreement, dated October 18, 1995, between
EDnet, Inc. and certain shareholders of Entertainment Digital
Network, Inc. PREVIOUSLY FILED.
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(d) Employment Agreement between the Company and Tom Kobayashi
dated September 1, 1995. PREVIOUSLY FILED.
(e) Employment Agreement between the Company and David Gustafson
dated September 1, 1995. PREVIOUSLY FILED.
(f) EDnet, Inc. Incentive Stock Option Plan. PREVIOUSLY FILED.
(g) EDnet, Inc. 1995-1996 Nonstatutory Stock Option Plan.
PREVIOUSLY FILED.
(h) Entertainment Digital Network 1993 Flexible Stock Incentive
Plan. PREVIOUSLY FILED.
(i) Form of Entertainment Digital Network Nonqualified Stock
Option Agreement. PREVIOUSLY FILED.
(j) Form of Entertainment Digital Network Stock Purchase Warrant.
PREVIOUSLY FILED.
(k) Form of EDnet, Inc. Warrant. PREVIOUSLY FILED.
(l) Consulting Agreement, dated as of January 12, 1996, between
the Company and Liviakis Financial Communications, Inc.
PREVIOUSLY FILED.
(m) Consulting Agreement, effective as of January 12, 1997 between
the Company and Liviakis Financial Communications, Inc.
PREVIOUSLY FILED.
(n) Financial Advisory Agreement, dated as of July 31, 1995,
between EDN and Century Financial Partners, Inc. PREVIOUSLY
FILED.
(o) Engagement letter dated May 20, 1996 between the Company and
Morgan Fuller Capital Group L.L.C. PREVIOUSLY FILED.
(p) Engagement letter dated June 25, 1996 between the Company and
Morgan Fuller Capital Group L.L.C. PREVIOUSLY FILED.
(q) Engagement letter dated June 28, 1996 between the Company and
Morgan Fuller Capital Group L.L.C. PREVIOUSLY FILED.
(r) Engagement letter dated June 28, 1996 between the Company and
Morgan Fuller Capital Group L.L.C. PREVIOUSLY FILED.
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(s) Engagement letter dated October 17, 1996 between the Company
and LBC Capital Resources, Inc. PREVIOUSLY FILED.
(t) Form of Subscription, Representation and Securities Transfer
Restriction Agreement between the Company and investors in
Units. PREVIOUSLY FILED.
(u) Engagement letter dated November 19, 1996 between the Company
and Morgan Fuller Capital Group L.L.C. PREVIOUSLY FILED.
(v) Engagement letter dated November 21, 1996 between the Company
and Morgan Fuller Capital Group L.L.C. PREVIOUSLY FILED.
(w) Consulting Agreement dated January 31, 1997 between the
Company and Net Financial International, Ltd. PREVIOUSLY
FILED.
(x) Form of Subscription, Representation and Securities Transfer
Restriction Agreement between Morgan Fuller Capital Group
L.L.C. and investors in Participations. PREVIOUSLY FILED.
(y) Form of Subscription, Representation and Securities Transfer
Restriction Agreement between the Company and investors in
Common Stock. PREVIOUSLY FILED.
(z) Form of Subscription, Representation and Securities Transfer
Restriction Agreement between the Company and investors in
EDnet Series A Preferred Shares. PREVIOUSLY FILED.
(aa) Amendment No. 1 to the Agreement and Plan of Reorganization by
and among EDnet, Inc., EDN Sub, Inc. and Internet Worldwide
Business Solutions, dated as of September 13, 1996. PREVIOUSLY
FILED.
(ab) Amendment No. 2 to the Agreement and Plan of Reorganization by
and among EDnet, Inc., EDN Sub, Inc. and Internet Worldwide
Business Solutions, dated as of January 31, 1997. PREVIOUSLY
FILED.
(ac) Breakthrough Software, Inc. Stock Purchase Agreement by and
among Breakthrough Software, Inc. and EDnet, Inc., dated as of
January 31, 1997. PREVIOUSLY FILED.
(ad) Technology License Agreement by and among Internet Worldwide
Business Solutions and Breakthrough Software, Inc., dated as
of January 31, 1997. PREVIOUSLY FILED.
(ae) Form of Consulting Agreement by and among EDnet, Inc. and each
of Randall Schmitz and Trevor Stout, dated as of January 31,
1997. PREVIOUSLY FILED.
(27) Financial Data Schedule. FILED HEREWITH.
26
<PAGE>
SIGNATURES
In accordance with the requirements of Section 13 of 15(d) of the
Securities Exchange Act of 1934, the registrant has caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
EDnet, INC.
(Registrant)
Date: October 15, 1997 By: /s/Tom Kobayashi
-----------------------
Tom Kobayashi,
Chairman
Chief Executive Officer
In accordance with the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Date: October 15, 1997 By: /s/Tom Kobayashi
-----------------------
Tom Kobayashi,
Chairman
Chief Executive Officer
Date: October 15, 1997 By: /s/David Gustafson
-----------------------
David Gustafson,
President
Chief Operating Officer
27
<PAGE>
EDNET, INC.
------------------
CONSOLIDATED FINANCIAL STATEMENTS
as of June 30, 1997 and for the
years ended June 30, 1996 and 1997
<PAGE>
EDNET, INC.
------------------
CONTENTS
Page
----
Consolidated Balance Sheet 3
Consolidated Statements of Operations 4
Consolidated Statements of Stockholders' Equity 5
Consolidated Statements of Cash Flows 6
Notes to Consolidated Financial Statements 7-19
2
<PAGE>
<TABLE>
EDnet, Inc.
CONSOLIDATED BALANCE SHEETS
As of June 30, 1997 and June 30, 1996
<CAPTION>
ASSETS
6/30/97 6/30/96
( Unaudited )
-----------------------------------
<S> <C> <C>
CURRENT ASSETS
Cash $ 31,067 $ 186,875
Accounts Receivable, net 445,121 478,076
Inventories 202,913 147,409
Other Current Assets 193,949 49,298
-----------------------------------
TOTAL CURRENT ASSETS 873,050 861,658
PROPERTY AND EQUIPMENT, NET 556,533 488,943
GOODWILL, NET (0) 1,088,568
OTHER ASSETS 5,478 79,342
-----------------------------------
TOTAL ASSETS $ 1,435,061 $ 2,518,511
===================================
LIABILTIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES
Accounts payable $ 1,648,167 $ 659,709
Accrued expenses 466,455 390,002
Deferred revenue 69,193 69,623
Line of credit 34,628 16,638
Notes payable 592,286 990,991
Current portion of capital lease obligations 27,817 24,493
-----------------------------------
TOTAL CURRENT LIABILITIES 2,838,546 2,151,456
LONG TERM LIABILITIES 770,904 43,622
-----------------------------------
TOTAL LIABILITIES 3,609,450 2,195,078
STOCKHOLDERS' EQUITY (DEFICIT)
Common stock; par value $.001 per share
Authorized 50,000,000 shares, 5,720,465 and
4,468,322 shares issued and outstanding as of
June 30, 1997 and June 30,1996 respectively 5,720 4,468
Preferred Stock; par value $1,000 per share
Authorized 1,750 shares, 150 shares issued and
outstanding as of June 30, 1997 117,541 --
Common stock warrants --
Capital paid in excess of par value of common stock 4,411,577 2,758,644
Accumulated Deficit (6,709,227) (2,439,679)
-----------------------------------
TOTAL STOCKHOLDERS' EQUITY (DEFICIT) (2,174,389) 323,433
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) $ 1,435,061 $ 2,518,511
===================================
<FN>
The accompanying notes are an integral part of these consolidated financial statements.
</FN>
</TABLE>
3
<PAGE>
EDnet, Inc.
CONSOLIDATED STATEMENTS OF INCOME
For the Twelve Months ended June 30, 1997 & 1996
1997 1996
--------------------------
Revenues:
Equipment sales and installation $ 1,010,179 $ 1,713,622
Site development and services 869,946 --
Access, Usage, and Hosting fees 1,799,346 637,262
Other fees 127,899 185,374
--------------------------
3,807,370 2,536,258
Cost of sales 2,277,119 2,126,741
--------------------------
Gross Profit 1,530,251 409,517
Research & Development 1,017,233 --
Sales and Marketing expenses 948,548 995,917
General and Administrative expenses 3,684,568 532,081
--------------------------
5,650,349 1,527,998
Loss from operations (4,120,098) (1,118,481)
--------------------------
Other income (expense):
Interest income (expense) (145,332) (34,322)
Gain (loss) on sales of fixed assets (853) --
--------------------------
Total other income (expense), net (146,185) (34,322)
--------------------------
Loss before provision for income taxes (4,266,283) (1,152,803)
Income taxes 3,266 1,600
--------------------------
Net Loss $(4,269,549) $(1,154,403)
==========================
Net Loss Per Common Share $ (0.86) $ (0.36)
==========================
Weighted Average Number
of Shares Outstanding 4,967,539 3,181,350
==========================
The accompanying notes are an integral part of these consolidated financial
statements.
4
<PAGE>
<TABLE>
EDnet, Inc.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
for the years ended June 30, 1997 and 1996
<CAPTION>
Common Stock Preferred Stock
----------- ----------- ----------- -----------
Shares Amount Shares Amount
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Beginning balance, July 1, 1996 4,468,322 $ 4,468
Share issued under Reg D Offering 562,143 562
Shares issued under IBS earnout agreement 125,000 125
Shares issued pursuant to consulting agreement 500,000 500
Shares issued under conversion of Viscorp Notes 65,000 65
Shares issued under Reg S Offering 150 117,54
Net loss
-------------------------------------------------------
Ending balance, June 30, 1997 5,720,465 $ 5,720 150 $ 117,541
=======================================================
</TABLE>
<TABLE>
<CAPTION>
Additional
Paid-In Accumulated
Capital Deficit Total
----------- ----------- -----------
<S> <C> <C> <C>
Beginning balance, July 1, 1996 $ 2,758,644 $(2,439,679) $ 323,433
Share issued under Reg D Offering 755,812 $ 756,374
Shares issued under IBS earnout agreement 195,188 195,313
Shares issued pursuant to consulting agreement 652,000 652,500
Shares issued under conversion of Viscorp Notes 49,935 50,000
Shares issued under Reg S Offering 117,541
Net loss (4,269,549) (4,269,549)
-----------------------------------------
Ending balance, June 30, 1997 $ 4,411,578 $(6,709,228) $(2,174,389)
=========================================
<FN>
The accompanying notes are an integral part of these consolidated financial statements.
</FN>
</TABLE>
5
<PAGE>
<TABLE>
EDnet, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the Twelve Months ended June 30, 1997 and 1996
<CAPTION>
6/30/97 6/30/96
( Unaudited )
----------------------------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(4,269,549) $(1,154,403)
Adjustments to reconcile net loss to
cash used in operating activities:
Depreciation and amortization 1,308,342 136,823
Increase (decrease) in Provision
for doubtful accounts (2,061) 6,142
Noncash compensation expenses 485,833 465,377
Decrease (increase) in other current assets 95,880 (72,844)
Decrease (increase) in accounts receivable 35,016 (163,237)
Increase in inventory (55,504) (147,409)
Increase in accounts payable
and accrued expenses 1,064,910 77,793
Decrease in deferred revenue (430) (161,078)
----------------------------------
Net cash used in operating activities (1,337,563) (1,012,836)
----------------------------------
Cash flows from investing activities:
Purchase of property and Equipment (508,718) (81,638)
Cash from the acquisition of IBS, net of cash paid -- 113,814
----------------------------------
Net cash used in investing activities (508,718) 32,176
----------------------------------
Cash flows from financing activities:
Repayment on borrowings (235,534) (277,825)
Proceeds from borrowings 1,071,489 400,001
Repayments on capital leases (19,394) (8,577)
Issuance of shares under Reg D 756,374 997,500
Issuance of shares under Reg S 117,538 --
----------------------------------
Net cash provided by financing activities 1,690,473 1,111,099
----------------------------------
Net increase (decrease) in cash (155,808) 130,439
==================================
Cash at beginning of period 186,875 56,436
----------------------------------
Cash at end of period $ 31,067 $ 186,875
==================================
Supplemental disclosure of cash flow information:
Cash paid during the year for interest 73,432 24,050
Cash paid during the year for taxes 3,266 800
<FN>
The accompanying notes are an integral part of these consolidated financial statements.
</FN>
</TABLE>
6
<PAGE>
EDNET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-----------
1. The Company:
Summary of Business:
EDnet, Inc. (the Company), a Colorado corporation, and its subsidiaries
develop and market integrated systems for the delivery, storage, and
management of professional-quality digital communications for media-based
applications, including audio and video production for the North American
entertainment industry. The Company, through strategic alliances with long-
distance carriers, regional telephone companies, satellite operators, and
independent fiber optic telecommunications providers, has established a
worldwide network that enables the exchange of high quality audio, video,
multimedia, and data communications. The Company provides engineering
services and application-specific technical advice, audio, video, and
networking hardware and software as part of its business. Additionally,
through one of its wholly owned subsidiaries, the Company provides Internet
web site development and hosting service to businesses conducting Internet
commerce.
Organization:
The Company's principal subsidiary, Entertainment Digital Network (EDN),
was originally incorporated in the state of Nevada in June 1992. In January
1993, EDN was reincorporated in the state of California. During September
and October of 1995, EDN's stockholders exchanged 100% of their shares of
common stock for 1,519,538 shares of common stock of AP Office Equipment
(APO), a public company with no operations and no significant assets or
liabilities. At the time of the exchange, APO, a Colorado corporation that
was incorporated in May 1994, had 747,500 shares of common stock
outstanding. Concurrently, APO sold 1,500,000 shares of common stock to a
group of investors for $.665 per share. APO then changed its name to EDnet,
Inc. EDN became a subsidiary of the Company as a result of this
transaction. For accounting purposes, this transaction has been treated as
a recapitalization of EDN, recognizing the issuance of shares of common
stock for the net assets of the Company. The historical financial
statements prior to this transaction are those of EDN.
Acquisition of Internet Worldwide Business Solutions:
On June 24, 1996, the Company acquired all the outstanding shares of common
stock of Internet Worldwide Business Solutions (IBS) in a business
combination accounted for as a purchase. IBS is primarily an Internet
service provider specializing in the development and hosting of web sites.
The results of operations of IBS are included in the accompanying financial
statements since the date of acquisition. The purchase price of $1,162,568
included 311,284 shares of the Company's common stock, notes payable in the
aggregate amount of $500,000 (Note 5) and $40,000 of acquisition related
costs. The purchase
7
<PAGE>
EDNET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-----------
price exceeded the $74,000 estimated fair value of the net tangible assets
of IBS by $1,088,568, which was initially reflected as goodwill on the
balance sheet and amortized using the straight-line method over a five-year
period (see "Goodwill" below).
In addition, the Company entered into a performance based stock bonus plan
to issue up to an aggregate of 500,000 shares of its common stock to the
two former owners of IBS, who became employees of the Company. The plan set
certain threshold levels for revenue and profit goals to be realized in
order for the stock to be issued. This agreement represented an earn-out
plan and the fair market value of any additional shares issued would be
added to goodwill when and if the goals were met.
In conjunction with the acquisition, under the terms of its non statutory
stock option plan, options to purchase an aggregate of 50,000 shares of
common stock of the Company were granted to certain IBS employees at $1.25
per share.
Had the acquisition occurred on October 1, 1995 (the commencement of
operations for IBS), the pro forma statement of operations for the Company
for the year ended June 30, 1996 would have been as follows:
Pro Forma
As Stated Adjustments Pro Forma
----------- ----------- -----------
Revenues $ 2,536,258 $ 480,030 $ 3,016,288
Cost of sales 2,126 258,716 2,385,457
----------- ----------- -----------
Gross profit 409,517 221,314 630,831
Sales and marketing 995 64,679 1,060,596
General and administrative 532,081 271,083 803,164
----------- ----------- -----------
(Loss) income from operations (1,118,481) (1,144,488) (1,232,929)
Other expenses, net 34,322 832 35,154
(Loss) income before income taxes (1,152,803) (1,152,800) (1,268,083)
Income taxes 1,600 10,335 11,935
----------- ----------- -----------
Net (loss) income $(1,154,403) $(1,256,155) $(1,280,018)
=========== =========== ===========
Net (loss) per share $ (0.36) $ (0.37)
=========== ===========
8
<PAGE>
EDNET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-----------
On December 31, 1996, the Company amended the terms of its previously
consummated acquisition of IBS, by dividing IBS into two separate
corporations. IBS's Internet service business continues to operate as IBS.
IBS licensed to Breakthrough Software, Inc. (BSI) certain software
developed by IBS related to development, operation, and maintenance of
world-wide web sites, and the Company agreed to lend BSI up to $250,000
(represented by an unsecured note) to be used for specified purposes. The
Company retained ownership of 2,000,000 shares of BSI's convertible
preferred stock, which represents, after conversion into BSI non-voting
common stock, 40% of BSI's outstanding common stock. This investment is
accounted for using the cost method of accounting. Also as a part of the
amendment, remaining acquisition notes payable from the Company to the
founders of IBS in the amount of $250,000 were canceled, and the remaining
term of the earn-out stock bonus plan to the founders was canceled. The
Company amended its employment contracts with the founders of IBS to
terminate on December 31, 1996, and the Company entered into consulting
agreements with the IBS founders to provide transition services to IBS for
a period of three months commencing December 31, 1996.
Going Concern:
The Company and its subsidiaries have not been able to generate any
operating profit since inception. Through June 30, 1997, the Company and
its subsidiaries have aggregated losses of $6,709,227 and current
liabilities exceed current assets by $1,965,496. Subsequent to year end,
the Company obtained commitment for additional funding as described in Note
13, but has experienced delays in obtaining the full amount of the funding
commitment therein described. Should the Company be unable to raise these
or other funds, it may not have the financial resources to continue as a
going concern and may be forced to seek protection from its creditors under
Chapter 11 of the bankruptcy code. The financial statements do not contain
any adjustments that may be needed if the Company is unable to continue as
a going concern.
2. Summary of Significant Accounting Policies:
Consolidation:
The consolidated financial statements include the accounts of the Company's
wholly owned subsidiaries EDN and IBS. Material inter-company transactions
and balances have been eliminated.
Revenue Recognition:
A significant component of revenues relate to the sale of equipment which
is recognized when the equipment is installed. Installation fees are
recognized when the installation has been completed and usage fees are
recognized over the period the equipment is used based
9
<PAGE>
EDNET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-----------
on the relative usage level. Deferred revenues represent billings in excess
of revenue recognized.
Allowance for Doubtful Accounts:
Bad debts are provided on the allowance method based on historical
experience and management's evaluation of outstanding accounts receivable.
Inventories:
Inventories are valued at the lower of cost or market with cost being
determined on the first- in, first-out basis.
Property and Equipment and Leasehold Improvements:
Property and equipment are carried at cost and are depreciated on the
straight-line basis over their estimated useful lives, which range from
five to seven years. The costs of leasehold improvements are amortized over
the lesser of the length of the related leases or the estimated useful
lives of the assets. Expenditures for improvement or expansion of property
and equipment are capitalized. Repairs and maintenance are charged to
expense as incurred. When the assets are sold or retired, their cost and
related accumulated depreciation are removed from the accounts with the
resulting gain or loss reflected in the statement of operations.
Goodwill:
The Company evaluates the recovery of its goodwill and other intangible
assets by comparing the aggregate estimated cash flows generated by those
assets with their carrying value. In June, 1997, the Company recognized
that there had been significant changes in technology and business
conditions in the Internet website development and hosting business.
Considering these changes and the amendment to the acquisition of IBS
discussed above, the Company determined that the carrying value of the
goodwill related to the IBS acquisition exceeded the aggregate realizable
cash flow amount, and, in accordance with SFAS 121 (see below), the Company
eliminated the carrying cost of goodwill related to the IBS acquisition.
Income Taxes:
The Company accounts for income taxes using the liability method. Deferred
income tax assets and liabilities are computed annually for differences
between the financial reporting and tax bases of assets and liabilities
that will result in taxable or deductible amounts in the future based on
enacted tax laws and rates applicable to the periods in which the
differences are expected to affect taxable income. Valuation allowances are
established when necessary to reduce deferred tax assets to the amount
expected to be realized.
10
<PAGE>
EDNET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-----------
Loss Per Share:
Loss per share has been calculated using the weighted average number of
shares outstanding for the period, which were 3,181,350 for 1996 and
4,967,539 for 1997. Common stock equivalents (stock options, preferred
stock and warrants) have been excluded from the calculation because they
are anti-dilutive.
Use of Estimates:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect certain reported amounts and disclosures.
Accordingly, actual results could differ from those estimates.
Recent Accounting Pronouncements:
In March 1995, the Statement of Financial Accounting Standards No. 121,
Accounting for the Impairment of Long-Lived assets and for Long-Lived
Assets to Be Disposed Of, (SFAS 121) was issued and is effective for the
Company's 1997 fiscal year. SFAS 121 establishes accounting standards for
the impairment of long-lived assets, certain identifiable intangibles, and
goodwill related to those assets to be held and used for long-lived assets
and certain identifiable intangibles to be disposed. The Company adopted
this standard during fiscal year 1996 with no impact on the financial
statements. During fiscal year 1997, the Company made the adjustments noted
above under "Goodwill." The Company's policy related to evaluating
long-lived assets is included in the goodwill policy disclosures above.
During October 1995, the Financial Accounting Standards Board issued
Statement No. 123 (SFAS No. 123), Accounting for Stock-Based Compensation,
which establishes a fair value based method of accounting for stock-based
compensation plans. Because the current price of the Company's common stock
is significantly below the issuance price and exercise price for the
majority of stock options issued by the Company, the fair value impact that
the Company's options would have on the financial statements is not
material.
3. Accounts Receivable and Allowance for Doubtful Accounts:
Accounts receivable at June 30, 1997 comprise the following:
Current trade $379,529
Rebillable charges 97,467
---------
476,996
Less allowance for doubtful accounts (31,875)
---------
Total $445,121
=========
11
<PAGE>
EDNET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-----------
Allowances are made as a percentage of sales adjusted annually based upon
review of the individual accounts receivable. Accounts are written off when
deemed to be worthless. Total bad debt expense was $6,461 and $272,556 for
the years ended June 30, 1996 and 1997, respectively. The June 30, 1997
amount includes 100% provision for a note receivable from Breakthrough
Software Inc., in the amount of $250,000.
4. Property and Equipment:
Property and equipment are summarized by major category as follows as of
June 30, 1997:
Network and related equipment $ 962,609
Furniture and fixtures 137,737
Computer software 7,954
Leasehold improvements 26,184
-----------
1,134,484
Depreciation and amortization (577,951)
-----------
Net property and equipment $ 556,533
===========
Depreciation and amortization included in the statements of operations
amounted to $136,823 and $187,817 for the years ended June 30, 1996 and
1997, respectively. The Company leases some equipment to customers under
terms which are accounted for as operating leases. Under the operating
method, rental revenue from leases are recognized ratably over the life of
the lease and the related equipment is depreciated over its estimated
useful life.
<TABLE>
5. Notes Payable:
<CAPTION>
Notes payable consist of the following as of June 30, 1997:
<S> <C>
Senior collateralized promissory notes (Notes) payable to Morgan Fuller
Capital Group L.L.C., with original amounts of $500,000, $200,000 and
$300,000 and interest payable quarterly at 14% beginning September 30,
1996. The original due date of the Notes was extended from November 15,
12
<PAGE>
EDNET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-----------
1996 to February 15, 1997, when the Notes converted into a term loan with
principal in the amount of $100,000 and interest at 18% payable monthly.
The Company repaid principal of $100,000 and accrued interest on February
15, 1997, but failed to make the March 15, 1997 payment. Effective June 30,
1997, accrued penalties and interest were forgiven, and the Notes were
converted to a term loan payable in 60 installments with accrued interest
at 6% commencing September 1, 1997 (see Note 13). The notes are
collateralized by the Company's assets. 900,000
Notes payable to Mr. Irawan Onggara, a shareholder and financial advisor,
with original amounts of $250,000, $100,000, $75,000 and $20,000 at 7%
interest, collateralized by assets of the Company subordinated to the
senior notes and equipment covered by individual capital leases, due August
8, 1996, October 18, 1996, and November 20, 1996, respectively. The Company
has repaid $90,000 and offset accounts payable in the amount of $15,000 to
Mr. Onggara. The Company had obtained verbal agreement to extend the due
dates of the notes, and, subsequent to June 30, 1997, entered into an
agreement with Mr. Onggara to convert the notes to equity (see Note 13).
340,000
Notes payable to an officer, interest at 6% per annum, uncollateralized. 24,000
Notes payable to an officer, interest at 6% per annum, uncollateralized 16,500
Note payable to a director, interest at 6% per annum, uncollateralized. 15,000
---------
$1,295,500
=========
</TABLE>
The notes payable to officers and director are overdue as of October 21,
1996. Each of these individuals has agreed not to declare a default under
these notes for an indefinite period and to accept repayment by the Company
at a future date.
The carrying value of these financial instruments approximates fair value
due to the relatively short maturity.
6. Line of Credit:
The Company has a $10,000 line of credit with a financial institution, of
which $9,628 was outstanding as of June 30, 1997. The line of credit bears
interest at the institution's monthly periodic rate plus 1.2708% (15.25% as
of June 30, 1997) and is payable monthly. The line of credit expires on
February 28, 1999.
13
<PAGE>
EDNET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-----------
The Company's wholly owned subsidiary, IBS, has a $25,000 line of credit
with a financial institution, of which $25,000 was outstanding as of June
30, 1996. The line of credit bears interest at the institutions reference
rate plus 5.06% (12.56% as of June 30, 1997) and is payable monthly. The
line of credit expires on March 8, 1998.
7. Income Taxes:
The provision for income taxes consists of federal income taxes and
California franchise taxes payable and includes the following:
Currently payable $0.00
Deferred --
--------
Total provision for income taxes $0.00
========
A reconciliation of the expected and reported provision for income taxes
follows:
For the Years Ended June 30,
----------------------------
1996 1997
----- -----
Benefit expected based on federal statutory rate 34.0% 34.0%
State taxes, net of federal benefit 6.1 6.1
Nondeductible expenses 0.2 0.1
Valuation allowance, net (40.2) (40.2)
----- -----
Net income tax provision 0.1% 0.0%
===== =====
The tax effects of significant temporary differences representing deferred
tax assets and liabilities are as follows:
Net operating loss carryforwards $ 4,269,549
Property and equipment 15,000
Other, net 4,000
Valuation allowance (4,288,549)
-----------
Net deferred tax asset --
===========
Due to the uncertainty of realization, a valuation allowance has been
provided to eliminate the net deferred tax assets. The increase in the
valuation allowance was $3,409,549 in fiscal 1997. The Company has Federal
and California loss carryforwards totaling approximately $6.6 million and
$3.3 million expiring through 2012 and 2002, respectively,
14
<PAGE>
EDNET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-----------
that may be offset against future income taxes. The utilization of these
net operating loss carryforwards are limited due to a change of ownership
as defined in the Internal Revenue Code (see Note 1) in November 1995.
8. Lease Commitments:
As of June 30, 1997, the Company leases office space and certain equipment
under various noncancelable capital and operating leases. Future minimum
lease payments required under the noncancelable leases are as follows:
Operating Capital
Year Ending June 30, Leases Leases
--------------------- -------- -------
1998 164,905 35,347
1999 119,961 13,824
2000 92,994 10,961
2001 92,994 --
Thereafter 185,988 --
-------- -------
Total minimum lease payments 856,960 60,132
======== =======
Less amount representing interest 8,743
-------
Present value of net minimum lease payments 51,389
Less current portion 29,268
-------
Long-term portion $22,121
=======
As of June 30, 1997, the Company has equipment purchased under
noncancelable capital leases with a cost of $76,990 and accumulated
amortization of $35,719. Total rental expense for all operating leases for
the years ended June 30, 1997 and 1996 amounted to $230,417 and $121,584,
respectively. The Company's obligations under its lease for its Los Angeles
office premises are guaranteed by its Chairman and Chief Executive Officer.
9. Options and Warrants:
Options to Key Employees and Directors:
On September 19, 1995, EDN granted a total of 263,420 non-qualified options
to certain employees and directors to purchase shares in EDN at $.10 per
share. As a result of the recapitalization discussed in Note 1, the EDN
options were converted into options to purchase the Company's stock at a
conversion of .87495 per share for each EDN share. As
15
<PAGE>
EDNET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-----------
a result, at June 30, 1996, there were 230,479 options outstanding at a
price of $.11 per share. These options expire on September 29, 2000. There
were no options exercised during the period.
Nonstatutory Stock Option Plan:
On November 10, 1995, the Company adopted a nonstatutory stock option plan
whereby 565,000 shares of the Company's common stock was reserved for
issuance. Under the terms of the plan, the price shall be determined by the
Company's Compensation Committee (CC); the period of option shall not
exceed five years from the date of grant; and the option must be paid in
cash when exercised unless a payment plan is authorized by the CC.
As of June 30, 1997, 459,550 options had been granted with an exercise
price of $1.25 per share.
Investment Banking Warrants:
In May 1996, the Company entered into an investment banking relationship
with Morgan Fuller Capital Group (Morgan). Under the terms of the
agreement, Morgan was to provide the Company with financial advisory
services as well as arrange for equity and debt funding. As part of
Morgan's compensation, they received 250,000 warrants to purchase shares of
the Company's common stock at a price of $6.37 per share to be exercised
prior to May 1999. In connection with the placement of senior secured
promissory notes and selling of participations, Morgan and nominees
received 58,824 warrants at a price of $4.25 per share to be exercised
prior to July 4, 1999 and 67,806 warrants at a price of $3.687 per share to
be exercised prior to August 8, 1999 and September 10, 1999, respectively,
for debt placement services. In connection with the extension of the due
date of the Notes from November 15, 1996 to February 15, 1997, Morgan and
nominees received 55,970 warrants at a price of $2.68 per share to be
exercised prior to November 14, 1999. The full cost of all warrants issued
in connection with the Morgan agreement has been expensed in the fiscal
year ending June 30, 1997.
Subsequent to June 30, 1997, additional warrants were issued and the Morgan
Fuller warrants were re-priced as described in Note 13.
Pursuant to a Consulting Agreement dated July 31, 1995, between EDN and
Century Financial Partners, Inc. (CFP), the Company was obligated to grant
an option to purchase 1,000,000 shares of common stock at $1.25 per share.
In connection with the conversion of notes payable to Irawan Onggara to
equity that occurred subsequent to June 30, 1997, the Company addressed
this unresolved commitment by issuing warrants described in Note 13.
16
<PAGE>
EDNET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-----------
A recap of the options and warrants outstanding as of June 30, 1997 is as
follows:
Quantity
Price Reserved Outstanding
----- -------- -----------
Employee EDN options converted $0.11 230,479 230,479
Nonstatutory options $1.25 565,000 459,550
--------- ---------
Total options 795,479 690,029
========= =========
Morgan warrants $6.37 250,000 250,000
Morgan warrants $4.25 58,824 58,824
Morgan warrants $3.69 67,806 67,806
Morgan warrants $2.68 55,970 55,970
--------- ---------
Total warrants 432,600 432,600
========= =========
10. Employment Contracts:
The Company has entered into employment contracts with key management and
employees whereby each will receive stated minimum annual salary adjusted
at the discretion of the Compensation Committee of the Board of Directors,
and stock options as described in Note 9. Some of the contracts provide for
a minimum annual salary increase The expiration date of these agreements
ranges from June 30, 1998 to December 31, 2000.
11. Concentration of Credit Risk:
The Company and its subsidiaries maintain cash in bank deposit accounts at
accredited financial institutions. The balances in these accounts may, at
times, exceed federally insured limits.
12. Supplemental Disclosures of Noncash Investing and Financing Activities:
The following noncash activity occurred during the referenced periods as
follows:
17
<PAGE>
EDNET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-----------
The Company entered into capital leases for office and computer equipment
in the amount of $66,408 and $41,271, for the years ended June 30, 1996 and
1997, respectively.
During fiscal year 1996, the Company issued 395,228 shares of its common
stock to officers and employees of the Company in lieu of payroll.
The Company issued 390,000 of its shares of common stock in consideration
for consulting services performed during fiscal year 1996. At the time of
issuance these shares were valued at $414,375.
The Company issued 490,000 of its shares of common stock in consideration
for consulting services performed during fiscal year 1997. At the time of
issuance these shares were valued at $643,125.
In conjunction with the acquisition of IBS during fiscal year 1996 (Note
1), the Company issued notes payable totaling $500,000 and 311,284 shares
of common stock valued at $622,257. $250,000 of the notes payable were
canceled in the subsequent amendment to the acquisition agreement.
In conjunction with the earnout provision of the IBS acquisition (Note 1),
during fiscal year 1997 the Company issued 125,000 shares of common stock.
In conjunction with the conversion to equity of a $50,000 short-term loan
from Visual Information Service Corp., an Illinois corporation, the Company
issued 65,000 shares of Common Stock valued at $50,000.
13. Subsequent Events:
Issuance of Stock Under a Consulting Agreement
In conjunction with a consulting agreement entered into on June 30, 1997
with Charles Clark the Company issued 400,000 shares of Common Stock with
an S-8 registration under the Securities Act of 1934.
Investment by T Bar W Ranch Investments
Under a subscription agreement signed July 10, 1997, the Company received a
commitment to purchase 3,750,000 shares of Common Stock at a price of $0.20
per share. Each share would be issued with a warrant to purchase an
additional share of Common Stock at an exercise price of $1.00 and an
expiration date five years from the date of issuance.
As of October 10, 1997, the total amount invested by T Bar W Ranch
Investments was $147,596. The Company has experienced delays in obtaining
the full amount of the funding commitment described above, and is working
with T Bar W Ranch Investments to effect full funding. The Company is
considering alternative courses of action should the full amount of T Bar W
Ranch Investment's commitment not be forthcoming.
18
<PAGE>
EDNET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-----------
Restructuring of Onggara Notes
Subsequent to June 30, 1997, an agreement was reached whereby the Company's
note payable to Mr. Onggara in the amount of $340,000 plus accrued interest
of $35,000 was converted to shares of the Company's Common Stock at $.375
per share, resulting in an issuance of 1,000,000 shares. The Company
addressed an unresolved commitment of options to Mr. Onggara by issuing
1,000,000 warrants priced at $1.25 each. The warrants are convertible over
3 years and are transferable and divisible.
Restructuring of Senior Notes
Subsequent to June 30, 1997 the Company reached an agreement with Morgan
Fuller to convert the Notes to a term loan payable in 60 installments with
accrued interest at 6% commencing September 1, 1997. In conjunction with
the restructuring, Morgan Fuller agreed to forgive accrued penalties and
interest and the Company agreed to re-price all warrants previously issued
to Morgan Fuller to an exercise price of $1.50.
19
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<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> JUN-30-1997
<PERIOD-START> JUL-01-1996
<PERIOD-END> JUN-30-1997
<CASH> 31,067
<SECURITIES> 0
<RECEIVABLES> 445,121
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<CURRENT-ASSETS> 199,427
<PP&E> 556,533
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117,541
0
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<TOTAL-REVENUES> 3,807,370
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