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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended: June 30, 1998 Commission file number: 000-23291
DigiTEC 2000, Inc.
(Exact name of Registrant as specified in its charter)
Nevada 54-1287957
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
8 West 38th Street, Fifth Floor
New York, New York 10018
(Address of principal executive offices) (Zip Code)
(212) 944-8888
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12 (g) of the Act: Common Stock,
par value $.001 per share
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. ( )
The aggregate market value of the Registrant's Common Stock, par value $.001 per
share (the "Common Stock"), held by non-affiliates of the Registrant was
$14,167,812 on October 8, 1998, based on the closing sale price of the Common
Stock on the Over The Counter (Bulletin Board) market on that date.
The number of outstanding shares of the Registrant's Common Stock as of October
8, 1998 was 6,858,998.
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DOCUMENTS INCORPORATED BY REFERENCE
Sections of the Registrant's Definitive Proxy Statement (as defined in Part III
herein) for its Annual Meeting of Stockholders scheduled to be held on November
18, 1998.
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DIGITEC 2000, INC.
TABLE OF CONTENTS
PART I
Item 1 Business
Item 2 Properties
Item 3 Legal Proceedings
Item 4 Submission of Matters to a Vote of Security Holders
PART II
Item 5 Market for Registrant's Common Equity and Related Stockholder Matters
Item 6 Selected Financial Data
Item 7 Management's Discussion and Analysis of Financial Condition and
Results of Operations
Item 7A Quantitative and Qualitative Disclosures About Market Risk
Item 8 Consolidated Financial Statements and Supplementary Data
Item 9 Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
PART III
Item 10 Directors and Executive Officers of the Registrant
Item 11 Executive Compensation
Item 12 Security Ownership of Certain Beneficial Owners and Management
Item 13 Certain Relationships and Related Transactions
PART IV
Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor"
for forward-looking statements. Certain information included in this Annual
Report on Form 10-K for the year ended June 30, 1998 is forward-looking, such as
information relating to the plans of Digitec 2000, Inc. (the "Company") to
become a facilities-based carrier, the expected effects of this transition upon
the Company's margins and cash flow, the provision of Local Access Prepaid Phone
Cards, and competition in the marketplace for the Company's products. Such
forward-looking information involves important factors that could significantly
affect expected results in the future and potentially cause them to differ
materially from those expressed in any forward-looking statements made by, or on
behalf of, the Company. These factors include, but are not limited to,
uncertainties relating to general economic conditions, government regulatory and
taxation policies, pricing and availability of underlying telecommunications
services provided to the Company by its suppliers, technological developments
and changes in the competitive environment in which the Company operates. Each
such forward-looking statement is qualified by reference to the following
cautionary statements.
Changes in the factors set forth above or in other factors unknown to the
Company at this time may cause the Company's results to differ materially from
those discussed in the forward-looking statements. The factors described herein
are those that the Company believes are significant to the forward-looking
statements contained herein and reflect management's subjective judgment as of
the date hereof, which is subject to change. However, not all factors which may
affect such forward-looking statements have been set forth. The Company does not
undertake to update any forward-looking statement that may be made from time to
time by, or on behalf of, the Company.
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PART I
Item 1. Business
Overview
Digitec 2000, Inc. (the "Company") is engaged in the creation,
distribution, marketing and management of consumer prepaid utility telephone
cards ("Prepaid Phone Cards" or "Cards"). The Company commenced operations under
the present management in 1995 to capitalize upon opportunities in the Prepaid
Phone Card sector of the long distance telecommunications market. The Company's
Prepaid Phone Cards provide consumers with a competitive alternative to
traditional pre-subscribed long distance telecommunications services. The
Company's principal products are the F/X (R) series ("F/X (R)") and the TEC
DIRECT (R) series ("TEC DIRECT (R)") of Cards, which were introduced in May and
December 1996, respectively. The Company's Prepaid Phone Cards are marketed
through an extensive network of distributors, and the Company estimates that its
products are currently available in approximately 23,000 independent retail
locations. The Company's total revenues were $17,425,199, $26,027,909 and
$35,032,533 and its net losses were $129,275, $3,549,514 and $11,996,759 for the
fiscal years ended June 30, 1996, 1997 and 1998, respectively, after losses from
discontinued operations of $0, $1,069,261 and $813,178, respectively. The
Company sold approximately six million Cards, of which approximately five
million were its own proprietary branded Cards, and provided more than one
hundred million minutes of telecommunications services, during the fiscal year
ended June 30, 1998.
The Company believes it is among the leading independent providers (those
companies not owned or controlled by a regulated telephone common carrier) of
Prepaid Phone Cards in the United States. The Company markets its Prepaid Phone
Cards as a convenient and competitive alternative to credit cards and
conventional coin and collect long distance services. The Company's target
markets include ethnic communities with substantial international long distance
usage. For the year ended June 30, 1998, approximately 72% of the Company's
total minutes were derived from the sale of international long distance
telecommunications services. The Company believes that consumers typically use
F/X(R) and TEC DIRECT(R) Cards as their primary means of making long distance
calls due to (i) competitive rates, (ii) reliable service, (iii) convenience and
(iv) the inability of a portion of the Company's end users to attain the credit
necessary to have pre-subscribed or other types of postpaid long distance
service.
Brand awareness is important to commercial success in the intensely
competitive Prepaid Phone Card market. The Company has developed and promoted
its brand awareness by the design of its Cards as well as the high level of
service provided to the users of its Cards. The Company currently distributes
and markets its Prepaid Phone Cards through its own route distribution comprised
of 22 field representatives and four field sales managers servicing over 3,000
retail locations primarily in the New York/New Jersey metropolitan area (the
"Metro Area") and Arizona, and through approximately 250 distributors in 29
states, Puerto Rico and the U.S. Virgin Islands, reaching an estimated
additional 20,000 retail locations.
The F/X(R) and TEC DIRECT(R) Card users are provided with access to local,
domestic long distance and international telephone services through toll-free
calls directed to call processing platforms operated by Allied Communications
Holdings, LLC ("Allied"), Innovative Telecom Corporation ("Innovative") and
Premiere Communications, Inc. ("Premiere"). The customer can use Prepaid Phone
Cards at any touch tone telephone simply by dialing the toll-free number,
followed by a Personal Identification Number ("PIN") assigned to each Card and
the telephone number the customer wishes to reach. Prior to connection, the
caller is informed of the remaining dollar balance on the Card and the number of
minutes available for usage. Processed calls are switched by the platform
providers to long distance and local carriers for completion, and the Cards'
remaining balance is debited for the cost of the call.
Historically, the Company has purchased the majority of its Cards in bulk
at a discount below the face value of the Cards. It then resold them to either
independent distributors or to retail locations serviced by its field
representatives depending upon the locality of the distribution. The Company
received its gross margin on the difference between discounts given to customers
and the discounts received from its suppliers. During fiscal 1998, the Company
depended primarily upon Frontier Communications International, Inc. ("Frontier")
and Premiere to provide the Company with the bundled Prepaid Phone Cards that it
resold to its customers.
While the Company was able to negotiate fair and competitive rates from
its bundled product providers, the Company desired to lessen its dependence on
such providers and to obtain more competitive rates for its long distance
service through the use of facilities dedicated to the Company's use. The
Company began to implement the foregoing strategy to become a facilities-based
carrier on March 13, 1998, when it entered into a Services Agreement with
Innovative, pursuant to which Innovative agreed to provide processing services
for the Company's Prepaid Phone Cards utilizing its switching facilities and
platforms located at 60 Hudson Street, New York, NY (the "Hudson Street
Facility"). The Company subsequently has commenced facilities-based operations
on two dedicated platforms and is supplying services from these platforms on
five of its eight brands of Cards. At fiscal year end the Company was processing
a majority of its minutes through the Hudson Street Facility. On
facilities-based programs, the Company receives its gross margin on the
difference between its sales price to customers and the underlying cost to
provide the long distance service over its dedicated facilities plus the Cards'
production costs. The Company is currently negotiating contracts with local and
long distance carriers to provide origination, transport and termination
services for its Prepaid Phone Cards.
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The Company intends to continue to expand its dedicated telecommunications
facilities by acquiring points-of-presence ("POPs") in additional states.
Based on the Company's analysis, the Company's total cost per call using
dedicated facilities is significantly less than the cost under the bundled Card
product that historically represented the majority of the Company's business.
The transition to facilities-based operations is expected to have a positive
impact both on the Company's gross margins and its competitiveness in the
marketplace due to the additional pricing flexibility this creates. As the
Company commences facilities-based operations on each brand of Card, it receives
additional margin from one-minute rounding, monthly access fees and unused time,
subject to applicable state escheat laws. In addition, since payments to
suppliers for the underlying facilities usage follow the sale of the
facilities-based Cards, whereas the payments for the bundled Cards are made
prior to the sale and usage of the Cards, the transition to a facilities-based
carrier is expected to positively impact the Company's cash generated from
operations. There can be no assurances that the Company will be able to continue
to successfully implement this strategy. See "Growth Strategy--Facilities-Based
Carrier."
The multi-billion dollar U.S. long distance telecommunications industry is
dominated by the nation's three largest long distance providers, AT&T, MCI
Worldcom and Sprint, which together generated a significant majority of the
aggregate revenues of all U.S. long distance interexchange carriers. Other long
distance companies, some with national capabilities, accounted for the remainder
of the market. Based on published Federal Communications Commission ("FCC")
estimates, toll service revenues of U.S. long distance interexchange carriers
have grown from $38.8 billion in 1984 to $88.6 billion in 1997. The aggregate
market share of all interexchange carriers other than AT&T, MCI Worldcom and
Sprint has grown from 2.6% in 1984 to 26.5% in 1997. During the same period, the
market share of AT&T declined from approximately 90% to approximately 45%. The
Company believes that these changes in the telecommunications market have
created opportunities for the growth of niche market telecommunications
providers such as the Company.
The market for Prepaid Phone Cards has grown substantially, from an
estimated $25 million in 1992 to an estimated $1.5 billion in 1997, making it
one of the fastest growing segments of the telecommunications industry. Based on
industry reports by Salomon Smith Barney, the market is expected to grow to
approximately $5 billion by 2001. The Company has identified three distinct
divisions of the Prepaid Phone Card market. These three divisions are utility
card products, which are Prepaid Phone Cards sold in the retail market to
consumers and businesses, corporate/affinity Card products and promotional Card
products. The Company intends to continue to concentrate its efforts in the
utility Card market, and, as part of its growth strategy, is expanding into the
corporate/affinity market.
The Company's principal executive offices are located at 8 West 38th
Street, New York, New York, 10018, and its telephone number is (212) 944-8888.
Growth Strategy
The Company believes that it is well-positioned to capitalize on the
growth opportunities within the Prepaid Phone Card market as a result of: (i)
brand awareness of the Company's established Cards; (ii) the Company's position
as a significant conduit of telecommunications traffic to various international
destinations; (iii) the Company's distribution network through which the Company
can market, distribute and sell new and existing products; (iv) the Company's
experience in identifying and marketing to ethnic communities and other
consumers in the United States with significant long distance usage
requirements; and (v) the Company's ability to identify selective acquisitions
which may enable it to take advantage of anticipated consolidation in the
telecommunications industry.
The Company has identified the following strategies, in order to: (i)
reduce its costs of providing services as a percentage of sales, which will
allow the Company both to increase its gross margins and to increase its
competitiveness in the marketplace; (ii) improve its cash generated from
operations; and (iii) increase its existing revenue base by increasing its
market share in existing geographic markets and penetrating new geographic
markets:
Facilities-Based Carrier. The Company is in the process of a strategic
transition to provide the majority of its services as a facilities-based carrier
in order to migrate its traffic from the bundled arrangements under which it
historically has purchased the majority of its telecommunications services. By
obtaining use of dedicated facilities, the Company has significantly reduced its
dependence on any one supplier. In addition, based on the Company's analysis,
the Company's total cost per call using dedicated facilities is significantly
less than the cost under the bundled Card product that historically has
represented the majority of the Company's business. This is expected to have a
positive impact both on the Company's gross margins and its competitiveness in
the marketplace due to the additional pricing flexibility this creates. As the
Company commences facilities-based operations on each brand of Card, it receives
additional margin from one-minute rounding, monthly access fees and unused time,
subject to applicable state escheat laws. Also, since payments to suppliers for
the underlying facilities usage on facilities-based Cards follow the sale of the
Cards, whereas the payments for the bundled Cards were made prior to the sale
and usage of the Cards, the transition to a facilities-based carrier is expected
to positively impact the Company's cash generated from operations. The Company
will continue to purchase some Cards as a bundled product until the conversion
to a facilities-based carrier is complete.
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The Company began to implement the foregoing strategy to become a
facilities-based carrier on March 13, 1998, when it entered into a Services
Agreement with Innovative, expiring in June of 1999, pursuant to which
Innovative agreed to provide processing services for the Company's Prepaid Phone
Cards utilizing its switching facilities and platforms located at the Hudson
Street Facility. The agreement requires Innovative to activate PINs at the
direction of the Company, process calls initiated by the Company's Card holders
and received from local and long distance carriers, present those calls for
completion to designated local and long distance carriers, debit the Cards'
dollar balances and generate reports and other information. All transport and
carrier services must be provided by the Company. The Company purchases
transmission services on a per-minute basis and leases transmission capacity on
a fixed-cost basis from a variety of local and long distance carriers. The
Company is currently negotiating contracts with local and long distance carriers
to provide origination, transport and termination services for its Prepaid Phone
Cards and has begun to enter into termination agreements with foreign
telecommunications operators.
The Company intends to continue to expand its dedicated telecommunications
facilities by acquiring POPs in additional states and intends its facilities to
include: (i) switches, network POPs and debit card platforms in strategic
geographic regions in the United States; (ii) leased capacity to connect the
Company's proposed POPs; and (iii) direct termination agreements with
telecommunications operators in countries where the Company terminates a large
number of minutes. The Company's facilities strategy is to utilize the services
of other platform providers until the Company has developed substantial traffic
volume in a given geographic region. As the market is developed, the Company
expects to invest in platform facilities in that region, thus reducing the risks
associated with such capital investment and maximizing the efficiency of
expanding its facilities.
The Company has commenced facilities-based operations on two dedicated
platforms and is supplying services from these platforms on five of its eight
brands of Cards, including Mexico Direct, Brasil Direct, F/X Asia, F/X Quisqueya
and New York Direct. On facilities-based programs, the Company receives its
gross margin on the difference between its sales price to customers and the
underlying cost to provide the long distance service over its dedicated
facilities plus the Cards' production costs. While the Company's initial
experience in the transition to a facilities-based carrier has been successful,
there can be no assurance that the Company will be able to successfully continue
to implement this strategy or that it will be able to obtain and maintain
favorable rates and terms for the origination, transportation and termination of
its customers' long distance traffic.
Introduction of Local Access Cards. The Company intends to introduce Local
Access Cards ("LACs") in most of the markets that it currently services and in
many markets into which it expands. LACs provide the customer with a local
access (seven digit) number to call to access a debit card platform without the
need to dial an 800 number. This feature not only simplifies the use of the Card
for the customer, it further reduces the Company's cost of providing service by
eliminating the costs associated with the provision of an 800 number and the
non-billable charges for use of the 800 number. This cost reduction is expected
to further increase the Company's margins and its competitiveness in the
marketplace by providing increased pricing flexibility. The Company recently
introduced its first LAC, New York Direct, in the New York market during June,
1998, providing customers with long distance service to any U.S. destination at
5 cents per minute after a 25 cents connection charge per call. The initial
positive acceptance of the New York Direct Card in the marketplace has confirmed
the importance of LACs in the Company's overall strategy, and the Company is
proceeding with its plans to roll out similar Cards in other U.S. cities during
fiscal 1999.
Expansion of the Company's Retail Distribution Network. The Company's
Cards are currently sold in 29 states in the United States, Puerto Rico and the
U.S. Virgin Islands. The Company has a route distribution network servicing over
3,000 retail locations, primarily in the Metro Area and Arizona. In addition,
the Company currently distributes and markets its Prepaid Phone Cards to
approximately 20,000 retail locations through approximately 250 distributors. As
such, the Company's revenues are primarily generated though independent
distributors. The Company intends to increase its internal route distribution
network by expanding its coverage within the markets it currently serves and by
extending this network into new markets, including those markets where new LACs
are established. The Company will also evaluate the possibility of acquiring
existing or new distributors to internalize its distribution system and improve
margins in existing markets or to quickly gain a route distribution presence in
a new market. The Company has signed a letter of intent to acquire the customer
base of PhoneCard Wholesalers, Inc., consisting of more than 100 distributors in
the Metro Area, for a purchase price based upon monthly sales up to a maximum of
$750,000 in cash, assumption of certain liabilities and shares of the Company's
Common Stock with a market value of $1,000,000 based upon the closing market
price of the Common Stock on the closing date of the acquisition. For the year
ended June 30, 1998 PhoneCard Wholesalers, Inc. accounted for approximately 19%
of the Company's sales and at year end represented approximately 73% of the
Company's accounts receivable.
Introduction of New Prepaid Phone Cards and Services. The Company intends
to continue to identify niches of the international and domestic long distance
market in which to offer new Prepaid Phone Cards. The Company believes that it
will be able to capitalize on its brand awareness and effectively market these
products to new and existing customers. The Company believes that it will expand
the telecommunications services that it currently offers by the following:
College Enterprises, Inc. The Company has executed a letter
agreement with College Enterprises, Inc. ("CEI") pursuant to which it will
offer telecommunications services to certain universities and schools. At
the time of the agreement, CEI served approximately 200 colleges and
universities providing services such as meal plans, copy services and
educational material through the use of debit cards. The Company plans to
offer long distance telecommunications as one of the services available on
the debit cards distributed to CEI users. At the time of the agreement,
the CEI data base included approximately 800,000 students and faculty, and
CEI has advised the Company that it has grown to over 2,000,000 students
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and faculty since that time. The Company believes that most of the traffic
generated will be domestic long distance service. The Company is working
with CEI to develop an operational plan to selectively roll out the
provision of long distance telecommunications service to CEI debit card
users during the Company's 1999 fiscal year.
International Services. The Company currently targets consumers with
significant international long distance usage, such as immigrants and
members of ethnic communities in large metropolitan areas, by delivering
reliable international long distance services at competitive rates. The
Company believes that the international long distance market provides, and
will continue to provide, an attractive opportunity given its size and
expected growth rate. In addition, the Company intends to capitalize on
its brand awareness within certain ethnic communities in the United States
by offering international long distance services to consumers located in
selected countries to which its customers direct a substantial number of
calls, including the possible establishment of an International Division
to focus upon marketing the Company's Cards outside the United States.
Point of Sale. The Company has established a division to market new
brands of its Cards intended to be activated at Point of Sale ("POS" )
terminals. The Company believes that consumers are generally familiar with
these terminals because they are often used when making credit card
purchases. The Company's POS Cards contain a magnetic stripe and are
"swiped" through the terminal which reads the magnetic stripe on the back
of the Card and sends information to a processing platform. This
information is processed and retransmitted to the applicable
telecommunications platform, thus activating the Card for use by the
customer. The Company believes that this arrangement will increase the
quantity of distribution outlets available to the Company, enable the
Company to address a different demographic segment of the Prepaid Phone
Card market, result in increased consumer convenience, provide additional
security related to the distribution and sale of the Cards and further
increase the margins on the Cards. Merchants with existing terminals have
had them reprogrammed to activate the Company's Cards. Additionally, the
Company provides terminals to retail establishments without them.
Focus on Core Business. As part of the Company's continuing plan to
conserve assets and focus on its core business of marketing and distributing
Cards, on December 31, 1997, the Company decided to abandon the operations of
its cellular division. The operations of the cellular division ceased completely
by February 1, 1998. For the year ended June 30, 1998, the Company recorded a
loss from discontinued operations of the cellular division of $527,061, and a
loss on disposal of the cellular division of $114,524, which amount represented
a complete writeoff of the division's net assets. The Company does not
anticipate any additional charges to be recognized related to the operations or
disposal of the cellular division. In addition, in conjunction with the
Company's decision on June 30, 1997 to discontinue the operations of its
wholly-owned subsidiary, World Access, Inc. ("World Access"), for the year ended
June 30, 1998, the Company recorded an additional loss on disposal of this
subsidiary of $171,593, which amount represented a complete writeoff of the net
assets of World Access. The Company does not anticipate any additional charges
to be recognized related to the disposal of World Access. See "Notes to
Consolidated Financial Statements--Discontinued Operations of Cellular Division"
and "Notes to Consolidated Financial Statements--Related Party Transactions."
Strategic Corporate Development Activities. The Company continues to
evaluate potential mergers, acquisitions and joint ventures which would enhance
or expand its current operations and planned growth strategy. On September 22,
1998, the Company entered into a Letter of Intent with Convergence
Communications, Inc. ("CCI") pursuant to which the Company agreed to enter into
negotiations with respect to: (i) a possible combination of the Company and CCI;
(ii) an International Origination/Termination Agreement pursuant to which CCI
would provide for local origination and termination in certain foreign
countries; and (iii) the purchase by CCI of up to $1,000,000 of convertible
promissory notes issued by the Company accompanied by warrants to purchase
Common Stock of the Company. There can be no assurances that the Company and CCI
will reach agreement with respect to any of the business combination, the
International Origination/Termination Agreement or the sale of promissory notes.
Industry History
The Prepaid Phone Card business is a relatively recent development in the
telecommunications service industry. Prepaid local and long distance calling
cards began to develop in the United States during 1988-1989 using a technology
developed in Europe in the early 1980s that relied upon either an embedded
microchip or a magnetic strip on each card and a telephone set device with a
built in "reader" to access information contained on the cards. Although the
microchip and magnetic strip cards were introduced in the U.S. by several
telephone carriers, the results were disappointing and the product did not
attain sales volumes necessary for commercial success. The European technology
had developed primarily as a replacement for coin operated public pay
telephones. This technology worked reasonably well in areas where a monopoly
telephone service provider had the ability to set widespread standards for the
cards, readers and rates per minute of usage. However, in the U. S. with many
independent telephone providers, several versions of technologies soon developed
that were not compatible (i.e. a caller in the Metro Area purchasing one type of
card from one provider was not able to use that card with other types of
telephones installed by that provider or at certain public pay phones installed
by other providers). Other drawbacks included the significant cost of the reader
telephone sets, high maintenance costs associated with the remote reader
equipment and the inability to use the card with non-reader telephone sets.
By 1992, advances in computers and telephone switch technology allowed
several companies to introduce cards that could be used from any touch-tone
telephone in the U.S. This technology relies upon network based intelligence,
including the management
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of the debit card data bases. A card using this technology merely contains the
designated access number, the PIN that identifies the card to the network and
instructions for using the card. The card itself contains no technology such as
a chip or magnetic strip. There are no card readers or other forms of remote
special equipment required for use of the card. The card is more analogous to a
"debit account" in which a fixed amount of money is first deposited and the
account is then debited for services as they are used by the person with access
to the PIN number. When the prepaid account balance is depleted, it is
automatically closed by the remote debit card database computer of the prepaid
card provider. Thereafter, the card has no further value.
Company History
The Company was organized as a Nevada corporation in May 1987 under the
name Yacht Havens International Corp. ("Yacht Havens"). In July, 1995, the
Company changed its name from Yacht Havens International Corp. to Promo Tel,
Inc. ("Promo Tel-Nevada"). In August 1995, Promo Tel-Nevada merged with a
Delaware corporation, named Promo Tel, Inc. ("Promo Tel-Delaware"). The Company
exchanged 1,333,334 shares of previously unissued and unregistered common stock
for the outstanding common stock of Promo Tel-Delaware. Promo Tel-Delaware's
assets consisted of personnel, sales, marketing and distribution programs and
contacts for the development and sale of Prepaid Phone Cards. In October 1996,
the Company amended its Articles of Incorporation to change the name of the
Company to Digitec 2000, Inc.
During fiscal 1996, the Company introduced an array of Prepaid Phone
Cards. Although the Company had sales of approximately $17,425,000 for fiscal
1996, during the last quarter of fiscal 1996 and the first half of fiscal 1997,
the Company could not compete effectively in the marketplace due to price and
service issues. In October 1996, the Company and Frontier reached an agreement
whereby the Company would act as a distributor for Frontier's Prepaid Phone Card
and market Cards under the Company's brand names. As a result of this agreement
and a subsequent distributor agreement with Premiere, the customer service
issues were alleviated and the Company began to experience consistent sales
growth. The Company's sales for the fourth quarter of fiscal 1997 were
approximately $14,000,000 and its sales for the year ended June 30, 1997 reached
approximately $26,027,000.
On September 25 and 26 of 1997, the Company entered into two agreements
with Premiere providing for the Company to develop and market Cards with retail
values of up to $6 million and $75 million at discounts ranging from 23.5% to
41.75% off the retail value of the Cards. The first of these two agreements has
been satisfied. It is alleged that under the second agreement the failure of
the Company to sell a minimum value of Cards would result in the Company being
required to pay Premiere an amount equal to the retail value of the unsold
minimum number of Cards less the applicable discount that would have been
payable on such Cards. The agreement provided for the extension of certain
credit terms and expired on August 31, 1998. This agreement expanded the
relationship of the Company with Premiere, which previously had provided the
Company with Cards from time to time on a prepaid basis.
On or about October 13, 1997, the Company informed Premiere that Premiere
had mistakenly activated $5 and $10 denominated Cards as $20 Cards. Premiere,
however, continued to process excess minutes activated on the Cards and in
January 1998, informed the Company that it had processed approximately $4.5
million of retail value of traffic in error. In addition, during January 1998,
Premiere unilaterally suspended one of the Company's Card programs and repriced
the Cards under another of the Company's programs. Prior to the suspension and
repricing of the programs, the Company was selling approximately $4.75 million
retail value of Cards (approximately $3.2 million net to Premiere after the
Company's discounts) per month under the two programs that had been suspended or
repriced and, had sales continued at that level, management believes the Company
would have satisfied the alleged "take or pay" provisions of the agreement.
Following the suspension and repricing, the monthly sales rate declined to
approximately $1.5 million per month retail value, and continued at this lower
level for the remainder of the fiscal year. Accordingly, the Company believes it
was prevented by Premiere from fulfilling the alleged "take or pay" provisions
of the Agreement. Moreover, prior to August 31, 1998, the Company, without
conceding any obligation to do so, ordered the remaining Cards under the
agreement with Premiere, approximately $31 million net of discount, but Premiere
declined to provide same in response to the Company's order. Accordingly,
although it contests any "take or pay" or minimum obligation, the Company
believes it has satisfied any obligations it may have under the agreement with
Premiere and has claimed amounts against Premiere for damages suffered by the
Company for suspension/cancellation and repricing of programs. Although Premiere
may take the position that the alleged "take or pay" obligation was not
satisfied and that the Company owes Premiere the difference between the retail
value of the shortfall in Cards less the Company's discount of between 23.5% and
41.75%, the Company does not concede any "take or pay" or any minimum obligation
and believes that it has fulfilled its obligations to Premiere, and is entitled
to recovery against Premiere for damages. The Company is continuing to negotiate
with Premiere to resolve these matters. See "Notes to Consolidated Financial
Statements--Transactions with Premiere Communications, Inc." Although the
Company does not have any arrangements in place for the supply of
telecommunications services provided by Premiere, the Company is negotiating new
agreements on similar terms with other suppliers. There can be no assurance that
the negotiations with Premiere or other suppliers will be successful or that the
Company will be able to continue to market bundled Cards in its transition to a
facilities-based carrier.
On March 31, 1998, the Company entered into an agreement with Premiere
(the "Investment Agreement") in which Premiere received 61,050 shares of $.001
par value voting Series A Convertible Preferred Stock (the "Preferred Stock"),
valued by the Board of Directors at $6,105,093 which represented Premiere's
outstanding accounts receivable balance from the Company as of that date. The
$6,105,093 included approximately $4.6 million which was attributable to Cards
purchased in the normal course of business and a $1.5 million one-time
promotional expense for extra minutes processed by Premiere on Cards activated
under the existing program. The 4.6 million receivable included price
adjustments on one of the Company's programs, Cards returned by distributors to
the Company due to
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service problems not honored by Premiere and $1.4 million of excess minutes
which the Company charged its main distributor on March 31, 1998. During the
fourth quarter of fiscal 1998, the distributor informed the Company that no
monies were collected. Therefore, the Company reversed the sale of these minutes
and charged the $1.4 million as an additional promotional expense. The
Preferred Stock is convertible into Common Stock at any time at Premier's option
and the Company has the right to require Premiere to convert the Preferred Stock
after March 31, 1999. The Certificate of Designation for the Preferred Stock
provides for certain voting, liquidation, and registration rights and calculates
the conversion by multiplying 61,050, the number of shares of Preferred Stock
issued in connection with the Investment Agreement by $100, the Investment
Amount, as defined in the Certificate of Designation and then dividing by
$10.395, the Conversion Price, as defined in the Certificate of Designation,
resulting in a total of 587,302 shares of Common Stock to be issued under the
Investment Agreement, subject to adjustment in connection with certain
subsequent issues of securities. The Company may call the redemption of each
share of Preferred Stock at any time for $100 a share plus accrued dividends.
See "Notes to Consolidated Financial Statements--Transactions with Premiere
Communications, Inc."
Telecommunications Products and Services of the Company
The principal products of the Company are telephone network access
products commonly referred to as Prepaid Phone Cards, currently marketed under
eight brand names which include DigiTEC Direct, F/X Mexico, F/X Asia, F/X South
America, F/X Quisqueya, New York Direct, Mexico Direct and Brasil Direct, that
allow users to access domestic long distance, international long distance, and
local telephone services from any touch tone telephone set in the U.S. Each of
the brands targets a potential market segment by providing competitive rates to
specific geographic areas. The Company plans to introduce new Prepaid Phone
Cards as it identifies new market niches for its services.
Users purchase the Company's Cards in denominations of $5.00, $10.00 and
$20.00 at retail locations such as convenience stores, vending machines,
newsstands, delicatessens, gasoline stations, check cashing centers,
supermarkets, and drug stores. Each Card has printed on the back an access
number and a PIN that is unique to that Card. F/X(R) and DigiTEC Direct Cards
are currently available with instructions in English, Spanish and Chinese. When
the access number is entered, the user is connected to a debit or prepaid card
platform switch in the telephone network that provides interactive voice prompts
in the user selected language through the call process. After entering the PIN,
the user may dial one or more destination telephone numbers in the same manner
as a normal telephone call. The interactive voice prompts in the platform advise
the user of the minutes remaining available on that Card for the dialed
destination. The prepaid account balance associated with each Card is managed by
the platform which automatically deducts for usage. Upon use of all the value
stored in the Card's account, the debit card database computer automatically
instructs the debit platform to terminate the account associated with the Card.
Usage charges are based upon values in a "rate deck" stored in the computer
database connected to the platform. Different rates are set for domestic long
distance, international calls by country of destination and for local calls.
Facilities and Third Party Service
Currently the Company is dependent primarily upon the facilities of Allied,
Innovative and Premiere for the completion of the long distance traffic
generated by its Prepaid Phone Cards. See "Notes to Consolidated Financial
Statements - Concentration of Credit Risk." These facilities, and the Company's
facilities will, should the Company decide to construct them, include: (i)
switches, network POPs and debit card platforms in strategic geographic regions
in the United States; (ii) leased capacity to connect any third party provider's
network POPs and the Company's proposed network POPs; and (iii) direct
termination agreements with telecommunications operators in the countries where
the Company terminates a large number of minutes. The Company currently has a
Services Agreement with Innovative expiring in June of 1999 pursuant to which
Innovative has agreed to provide the Company with prepaid transaction services
utilizing its switching and platform facilities located at the Hudson Street
Facility. The agreement requires Innovative to activate PINs at the direction of
the Company, process calls initiated by the Company's Card holders and received
from local and long distance carriers, present those calls for completion to
designated local and long distance carriers, debit the Cards' dollar balances
and generate reports and other information. Since the Company began utilizing
the capacity of the Hudson Street Facility, it has transferred over a majority
of its platform traffic to that facility. All transport and carrier services
must be provided by the Company. The Company has negotiated for the provision
of, and will continue to negotiate for the provision of, those carrier services,
but there can be no assurance that the Company will be able to continue to
obtain and maintain favorable rates and terms for the origination,
transportation and termination of its customers' long distance traffic. In order
to reduce its reliance on key suppliers and their facilities, the Company is in
the process of establishing relationships with other carriers.
Marketing and Distribution
The Company distributes the F/X(R) and DigiTEC Direct Cards primarily
through independent distributors. Distributors purchase Cards from the Company
at a discount from the retail value of the Card. The amount of the discount
depends upon the
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Prepaid Phone Card and the volume of purchases by the distributor. Master
distributor agreements provide for limited exclusivity in defined metropolitan
areas, subject to the master distributor maintaining an agreed upon monthly
volume of Card purchases. A master distributor has the right to enter into local
distribution agreements with sub-distributors in his territory to which the
Company is not a party. Terms of the discount offered to the sub-distributor are
negotiated directly between the master distributor and the sub-distributor. A
master distributor is responsible for supplying the sub-distributor and may also
sell directly to retailers. The Company retains the right to supply national
accounts directly within the master distributor's territory as well as its own
direct retail accounts. A national account is generally defined as a large
retailer that operates in more than one state. As of September 25, 1998,
approximately 250 distributors purchased Prepaid Phone Cards directly from the
Company, reaching an estimated 20,000 retail locations.
The Company also sells and distributes its Cards through its own route
distribution comprised of 22 field representatives and four field sales
managers, servicing over 3,000 retail locations primarily in the Metro Area and
Arizona. By building out its route distribution infrastructure, the Company is
able to attain higher gross margins since it eliminates the independent
distributor's discount on the sale. The Company intends to further expand its
route sales and distribution network as part of its plans for expansion. See
"Growth Strategy."
The Company has targeted heavily populated metropolitan areas, with an
emphasis on areas with significant ethnic community populations, in the
development and expansion of its distribution network. Many of the Company's
distributors are members of such ethnic communities, or otherwise have personal
or business relationships in such communities. In its expansion process the
Company intends to continue to focus on geographic and metropolitan areas with
significant ethnic community populations. The Company believes that the success
of its Prepaid Phone Cards has created significant brand loyalty and encourages
its distributors and retail locations to actively market the products. The
Company provides its distributors and retail locations with advertising and
explanatory materials, including posters presenting certain of the Company's
current rates and detailed rate sheets. The Company adjusts its pricing for
particular segments in order to target customer groups, respond to competitive
pressures and otherwise increase market share.
Customer Service
The Company believes that effective and convenient multilingual customer
service is essential to attracting and retaining customers. The Company's
customer service center handles customer inquiries, including those relating to
Prepaid Phone Card balances, Prepaid Phone Card availability, rates and
billings. As of September 30, 1998, the Company employed 18 full-time customer
service representatives ("CSRs"). Most CSRs are fluent in both English and
Spanish. Customer service is provided twenty-four hours per day, seven days per
week.
Prepaid Phone Card Production and Inventory Control
The Company controls its Prepaid Phone Card inventory by sequence numbers
and by physical count. Generally, Prepaid Phone Cards are received by, stored
at, and shipped from, the Company's headquarters. Physical inventory is counted
on a daily basis and reconciled against all incoming Card deliveries and
outgoing shipments. All PINs are inactive when the Prepaid Phone Cards arrive at
the Company's facility. Calls cannot be completed until PINs are activated by
the Company. PINs are activated upon shipment from the Company's facility to
distributors in order to minimize the number of cards with activated PINs in its
facility. Cards shipped to POS providers are shipped in an inactive state and
are only activated by "swiping" them through the POS terminal at the time of
sale to the end user, thus increasing the security associated with the transfer
and sale of the Cards.
PINs are created electronically with unique inventory and batch codes. The
Company currently relies on Allied, Innovative, Premiere and other suppliers to
provide software support to track Prepaid Phone Card information and deactivate
specified PINs in certain instances such as mistaken activation or theft.
Competition
The Prepaid Phone Card sector of the long distance market and the long
distance telecommunications market in general is highly competitive and is
affected by the constant introduction of new Cards and services by industry
participants. Competition in the Prepaid Phone Card sector of the long distance
telecommunications business is based upon pricing, customer service and
perceived reliability of the Prepaid Phone Cards. The Company's competitors
include some of the largest telecommunications providers and emerging carriers
in the Prepaid Phone Card market, which are substantially larger than the
Company and which have greater financial, technical, personnel and marketing
resources than the Company, as well as greater name recognition and larger
customer bases. The Company believes that additional competitors will be
attracted to the Prepaid Phone Card market, including Internet-based service
providers and other telecommunications companies. The ability of the Company to
compete effectively in the prepaid sector of the long distance market will
depend upon the Company's continued ability to provide reliable Cards at prices
competitive with, or lower than, those charged by its competitors.
The telecommunications industry is subject to a very high level of
technological change. Existing competitors are more than likely to continue to
develop new services that they offer to consumers. The ability of the Company to
compete effectively in the
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telecommunications industry will depend partly upon the Company's ability to
develop additional products and services which appeal to its intended end users.
Recent changes in the regulation of the telecommunications industry may
affect the Company's competitive position. The Telecommunications Act of 1996
(the "Telecommunications Act") effectively opens the long distance market to
competition from the Regional Bell Operating Companies ("RBOCs"). The entry of
these well-capitalized and well-known entities into the long distance market
likely will increase competition for long distance customers, including
customers who use Prepaid Phone Cards to make long distance calls. The
Telecommunications Act also grants the Federal Communications Commission ("FCC")
the authority to deregulate other aspects of the telecommunications industry,
which in the future may, if authorized by the FCC, facilitate the offering of
telecommunications services by regulated entities, including the RBOCs, in
competition with the Company. See "Government Regulation."
In addition, the Company may compete with other issuers of Cards which may
distribute Cards at or below the Company's cost. These issuers include companies
which have significantly larger capitalization and resources, which allow these
companies to achieve economies of scale and lower costs of funds employed or, in
the case of fraudulent practices, sell Cards without payment to
telecommunications carriers.
Government Regulation
Historically, the Company has been subject to minimal government
regulation. However, as the Company implements its plan to change the focus of
its business strategy from switchless reseller to facilities-based carrier, the
Company will become subject to extensive federal and state regulation. The
Telecommunications Act and the FCC regulations apply to interstate
telecommunications and international telecommunications that originate or
terminate in the United States. State regulatory authorities have jurisdiction
over telecommunications that originate and terminate within a state. See "Risk
Factors--Regulation."
Federal. The Telecommunications Act opened the local telecommunications
market to competition, and significantly opens the long distance market to local
exchange carriers, including the RBOCs, to provide inter-LATA (local access and
transport area) long distance telephone service. The Telecommunications Act also
grants the FCC the authority to deregulate other aspects of the
telecommunications industry and to implement certain policy objectives,
including access charge reform and establishment of the universal service fund.
The new legislation will likely result in increased competition in the industry,
including from the RBOCs, in the future. See "Competition."
As a non-dominant international carrier, the Company was required to
obtain Section 214 authority from the FCC. The Company has obtained an
authorization from the FCC to provide international long distance telephone
service. Since the Company became authorized under Section 214, it must also
comply with a variety of reporting requirements concerning international traffic
and revenues, active circuits, interlocking directors, foreign affiliates and
agreements it enters into with foreign carriers. No specific authorization is
required by the FCC to provide domestic interstate service. Both domestic
interstate and international non-dominant carriers must maintain current tariffs
for their service on file with the FCC which contain the current effective
rates, terms and conditions of telephone service. Although the tariffs of
non-dominant carriers, and the rates and charges they specify, are subject to
FCC review, they are presumed to be lawful. As an international non-dominant
carrier, the Company will be required to include detailed rate schedules in its
international tariffs. The Company has filed a domestic interstate tariff and
has prepared and will file an international tariff. On March 21, 1996, the FCC
initiated a rule making proceeding in which it proposed to eliminate the
requirement that non-dominant interstate carriers such as the Company maintain
tariffs on file with the FCC for domestic interstate services. The FCC's
proposed rules are pursuant to authority granted to the FCC in the
Telecommunications Act to "forbear" from regulating any telecommunications
service provider if the FCC determines that the public interest will be served.
The FCC subsequently adopted its proposal and eliminated the requirement that
interstate carriers file domestic tariffs. That decision has been appealed to
the Circuit Court and a stay has been issued pending a decision on the merits of
the appeal. It is unclear when the Court will rule on the appeal.
The Telecommunications Act requires long distance carriers to compensate
pay phone owners $.284 per call when a pay phone is used to originate a
telephone call through a toll-free number. The FCC's decision setting the $.284
compensation rate was remanded to the FCC by the U.S. Court of Appeals for a
more adequate justification. Consequently, the compensation rate may change.
The Company passes these charges directly to the end-users and transfers
collection to the long distance carriers to be submitted to the pay phone
owners.
On May 8, 1997, the FCC issued an order to implement the provisions of the
Telecommunications Act relating to the preservation and advancement of universal
telephone service (the "Universal Service Order"). The Universal Service Order
requires all telecommunications carriers providing interstate telecommunications
services to contribute to Universal Service support by contributing to a fund
(the "Universal Service Fund"). Universal Service contributions will be assessed
based on intrastate, interstate and international "end-user" gross
telecommunications revenues effective January 1, 1998. The contribution factors
proposed by the FCC for the fourth quarter of 1998 will require subject
telecommunications carriers to contribute as much as 3.93% of their end user
telecommunications revenues. The contribution factors are based on the ratio of
total projected quarterly expenses of the universal service support programs to
total end user telecommunications revenues and could, therefore, increase or
decrease in subsequent
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periods. The Company currently is determining whether the Universal Service
Order will be applicable to the Company. In addition, the Universal Service
Order is subject to petitions seeking reconsideration by the FCC and to certain
appeals. Until such petitions or appeals are decided, there can be no assurance
as to how the Universal Service Order will be implemented or enforced or what
effect the Universal Service Order generally will have on competition within the
telecommunications industry or specifically on the competitive position of the
Company.
Resale carriers are also subject to a variety of miscellaneous regulations
that, for instance, govern the documentation and verifications necessary to
change a consumer's long distance carrier, and limit the use of toll-free
numbers for pay-per-call services. Resale carriers such as the Company must also
pay certain fees annually, including Telecommunications Relay Services ("TRS"),
annual Federal Regulatory Fees and other fees and charges. On September 14,
1998, the Company requested the FCC to issue a six-month deferral of the
Company's payment of Federal Regulatory Fees for fiscal year 1998, currently
estimated to approximate $38,000. There is no assurance that this request will
be granted. Failure on the part of the Company to make Federal Regulatory Fee
payments could subject the Company to fines or other penalties, including the
revocation of its Section 214 authorization.
State. As the Company continues to establish its own dedicated facilities,
the intrastate long distance telecommunications operations provided will also be
subject to various state laws and regulations, including prior certification,
notification or registration requirements. The Company will be subject to
various levels of regulation in the states in which it provides telephone
service using its own dedicated facilities (which are generally subject to the
same rates as presubscribed long distance services by the states). The majority
of states will require that the Company apply for certification to provide
telecommunications services, or at least register, before commencing intrastate
service. In most of the states where certification or registration is required,
the Company is required to file and maintain detailed tariffs listing rates for
intrastate service. Many states also impose various reporting requirements
and/or require prior approval for transfers of control of certified carriers and
assignments of carrier assets, including customer bases, carrier stock offerings
and incurrence by carriers of significant debt obligations. Certificates of
authority can generally be conditioned, modified, canceled, terminated or
revoked by state regulatory authorities for failure to comply with state law and
the rules, regulations and policies of the state regulatory authorities. Fines
and other penalties, including revocation, may be imposed for such violations.
The Company has received authorization to do business in 20 states in the
United States and has applications on file for most of the remaining states as
well as Puerto Rico and the U.S. Virgin Islands. The Company is currently
authorized to provide intrastate telecommunications service in California, the
District of Columbia, Michigan, New Jersey and New York. The Company will make
additional filings and take other actions it believes are necessary to become
authorized to provide intrastate telecommunications services throughout the U.S.
See "Risk Factors--Regulation."
Other. The telecommunications industry has increasingly come under the
scrutiny of the Federal Trade Commission ("FTC") and state regulatory agencies
with respect to the promotion, marketing and advertising of effective rates,
terms and conditions of telecommunications services and products. The New York
regional office of the FTC and the New York Attorney General's Office ("NYATG")
are currently reviewing advertisements of products and services of other
telecommunications companies. While the Company believes that its advertising
has complied with federal and state regulations regarding advertising, there can
be no assurance that the FTC and the NYATG will not raise inquiries towards the
Company's advertising practices.
The Company is currently analyzing the effects of, and costs imposed by,
state escheat laws, the Universal Service Fee legislation and the requirement to
compensate pay phone owners under the Telecommunications Act.
Employees
As of September 30, 1998, the Company had 80 employees, consisting of 74
full-time employees, including three officers, and six part-time employees. None
of the Company's employees are members of a labor union or are covered by a
collective bargaining agreement. Management believes that the Company's
relationship with its employees is good.
Trademarks
The brand names F/X(R) and TEC DIRECT(R) are registered trademarks of the
Company, and trademark applications have been filed for all other brands of
Cards. As the Company develops new brands, it intends to file additional
trademark applications. There can be no assurance that the Company will receive
registration for any applied for trademarks or that any registered trademark
will provide the Company with any significant marketing or industry recognition,
protection, advantage or benefit.
Risk Factors
Dependence on Suppliers. The Company's ability to sell the Cards depends
upon whether it can continue to maintain a favorable relationship with its
suppliers of debit card platform, switching and terminating facilities and
bundled Prepaid Phone Cards. The Company currently obtains dedicated facilities
primarily from Allied, Innovative and Premiere, and obtains the bundled Cards
for three of its eight brands of Cards from Premiere. Currently the Company
processes a majority of its minutes through the Hudson Street Facility. Loss of
the use of this facility would have an adverse effect on the Company's
operations. The Company sells the Cards to either independent distributors or to
retail locations serviced by its field representatives, depending upon the
locality of the distribution. The Company receives its gross margin as follows:
(i) on facilities-based programs, on the difference between its sales price to
customers and the underlying cost to provide the long distance service over its
dedicated facilities plus the cost of production of the Cards; and (ii) on
bundled Card programs, on the difference between discounts given to customers
and the discounts received from its suppliers. During the year ended June 30,
1998,
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Premiere provided approximately 43% of the telecommunications services supplied
to the Company. The agreement under which these services were provided expired
on August 31, 1998. The Company is currently negotiating with Premiere regarding
a number of matters including, but not limited to, alleged obligations related
to the former agreement, the erroneous processing of extra minutes on Cards
activated by Premiere under the prior agreement, the unilateral suspension and
repricing of two of the Company's Card programs by Premiere and the potential
future provision of telecommunications services currently provided by Premiere.
The Company is negotiating new agreements on similar terms with other suppliers.
There can be no assurance that the negotiations with other suppliers will be
successful or that the Company will be able to continue to market bundled Cards
in its transition to a facilities-based carrier. See "Business--Company
History," "Notes to Consolidated Financial Statements - Concentrations of Credit
Risks--Concentration of Suppliers of Telecommunications Services" and "Notes to
Consolidated Financial Statements--Transactions with Premiere Communications,
Inc."
Dependence on Long Distance Telecommunications Providers. The Company's
ability to maintain and expand its business depends in part upon the ability of
its key suppliers to provide it with facilities and Prepaid Phone Cards at
favorable terms and rates. The transmission capacity of various long distance
telecommunications carriers to originate, transport and terminate the long
distance traffic of the Prepaid Phone Cards is currently used by the key
suppliers and will be used by the Company in implementing its strategy to become
a facilities-based carrier. Regulatory changes, competitive pressures and
changes in access charges may adversely affect the charges imposed upon the key
suppliers and the Company by other telecommunications providers. There is no
assurance that the key suppliers or the Company will be able to continue to
obtain origination, transport or termination services at favorable rates and
terms. Changes in terms and rates of the Prepaid Phone Cards could have an
adverse effect on the Company.
In addition to favorable rates and terms for its facilities, the key
suppliers and the Company also require the cooperation and efficiency of
incumbent local exchange carriers ("LECs"), competitive local exchange carriers
("CLECs") and foreign carriers to originate and terminate service for its
customers in a timely manner. Although the Company has not experienced
significant interruptions of service provided by these carriers in the past, no
assurance can be provided that the Company will not experience interruptions in
the future or that such interruptions will not have an adverse effect on the
Company. See "Facilities and Third Party Service."
Competition. The Prepaid Phone Card sector of the long distance
telecommunications market and the long distance telecommunications market in
general are highly competitive and are affected by the constant introduction of
new cards and services by industry participants. Competition is based upon
pricing, customer service and perceived reliability of the Prepaid Phone Cards.
The Company's competitors include some of the largest telecommunications
providers as well as emerging carriers in the Prepaid Phone Card market, which
are substantially larger than the Company and which have greater financial,
technical, personnel and marketing resources than the Company, as well as
greater name recognition and larger customer bases. The Company believes that
additional competitors will be attracted to the Prepaid Phone Card market
(including Internet-based service providers and other telecommunications
companies). The ability of the Company to compete effectively will depend upon
the Company's continued ability to provide highly reliable Cards at prices
competitive with, or lower than, those charged by its competitors. There can be
no assurance that competition from existing or new competitors or a decrease in
the rates charged for telecommunications services by the major long distance
carriers or other competitors will not have an adverse effect on the Company's
business.
The telecommunications industry is subject to a very high level of
technological change. Existing competitors are likely to continue to develop new
services that they offer to consumers. The ability of the Company to compete
effectively in the telecommunications industry will depend partly on the
Company's ability to develop additional products and services which appeal to
its intended end users.
Recent changes in the regulation of the telecommunications industry may
affect the Company's competitive position. The Telecommunications Act
effectively opens the long distance market to competition from the RBOCs. The
entry of these well-capitalized and well-known entities into the long distance
market will likely increase competition for long distance customers, including
customers who use Prepaid Phone Cards to make long distance calls. The
Telecommunications Act also grants the FCC the authority to deregulate other
aspects of the telecommunications industry, which in the future may, if
authorized by the FCC, facilitate the offering of telecommunications services by
regulated entities, including the RBOCs, in competition with the Company. See
"Competition" and "Government Regulation."
In addition, the Company may compete with other issuers of Cards which may
distribute Cards at or below the Company's cost. These issuers include companies
which have significantly larger capitalization and resources which allow these
companies to achieve economies of scale and/or lower costs of funds employed, or
in the case of fraudulent practices, sell Cards without payment to
telecommunications carriers.
Market Acceptance. The Prepaid Phone Card segment of the
telecommunications industry is an emerging business characterized by an
increasing and substantial number of new market entrants which have introduced
or are developing an array of new products and services. Each of these entrants
is seeking to market, advertise and position its products and services as the
preferred method for accessing long distance telephone services. In an emerging
industry, demand and market acceptance for newly introduced products and
services are subject to a high level of uncertainty. There can be no assurance
that substantial markets will
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continue to develop for Prepaid Phone Cards or that the Company will be able to
maintain or increase market acceptance for its existing products and services or
achieve significant market acceptance for its new products and services. See
"Growth Strategy," "Telecommunications Products and Services of the Company,"
and "Marketing and Distribution."
Ability to Manage Growth; Need to Hire Additional Employees. Although the
Company expects to continue to grow, there can be no assurance that the growth
experienced by the Company will continue or that the Company will be able to
achieve the growth contemplated by its business strategy. The expanding nature
of the Company's business strategy has placed, and is expected to continue to
place, significant demands on all aspects of the Company's business, including
its management, financial, technical and administrative personnel and systems.
The Company's future operating results will substantially depend upon the
ability of its executive officers to manage such anticipated growth and to
attract and retain additional highly qualified management, financial, technical
and administrative personnel. While all the Company's officers have executive
management experience managing start-up companies and in other entrepreneurial
activities, as of September 30, 1998, only one has had previous executive
management experience in a large public company. There can be no assurance that
the Company will successfully manage its expanding operations and continued
growth. Any difficulties in managing the Company's expanding operations and
continued growth or in attracting additional personnel could have an adverse
effect on the Company.
Financing Requirements. To date, the Company has funded its operations
through: (i) two offerings, which aggregated $1,000,000 of proceeds to the
Company; (ii) the exercise of certain warrants to purchase shares of the Common
Stock of the Company at $1.50 per share, which aggregated approximately
$3,400,000 of proceeds to the Company; (iii) sale of 61,050 shares of Preferred
Stock, which resulted in the elimination of an accounts payable balance to
Premiere totaling approximately $6,105,000; and (iv) sale of $1,200,000
principal amount of the Company's 10% Six-Month Notes (the "10% Notes") with
warrants to purchase shares of the Company's Common Stock at $2.375 per share,
all in offerings exempt from registration under the Securities Act of 1933, as
amended (the "Securities Act"). Due to operating losses and the Company's
expansion, the Company remains undercapitalized and to date has not been able to
finance its expansion as quickly as opportunities have arisen.
The Company will require both short-term financing for operations and
longer-term capital to fund its expected accelerated growth. To date the Company
has no existing bank lines of credit and has not established any sources for
such financing. During June 1998, the Company initiated discussions with several
entities regarding short-term financing related to accounts receivable to
provide funding for the immediate internal expansion of the business. As of
September 30, 1998, no such arrangement has been consummated. The Company
believes that such an arrangement can be consummated. However, there can be no
assurance that such funding will be available to the Company, or if available,
will be available in either a timely manner or upon terms and conditions which
are acceptable to the Company. The Company's ability to acquire additional
operations and facilities to further accelerate its growth will be dependent
upon its ability to raise longer-term capital or otherwise finance such
acquisitions. There can be no assurance that such financing will be available to
the Company, or if available, will be available in either a timely manner or
upon terms and conditions acceptable to the Company.
The Consolidated Financial Statements of the Company have been prepared on
the basis that it is a going concern, which contemplates the realization of
assets and the satisfaction of liabilities, except as otherwise disclosed, in
the normal course of business. However, because of the Company's recurring
losses from operations, such realization of assets and liquidation of
liabilities is subject to significant uncertainty. Further, the Company's
ability to continue as a going concern is highly dependent near term on its
ability to raise capital, reduce its costs of providing long distance service,
develop its collections tactics, develop market share and achieve profitable
operations thereon, and the ability to generate sufficient cash flow from
operations and financing sources to meet obligations.
Litigation. In June of 1996, the Company became a co-defendant in a legal
action in the Circuit Court for the First Judicial District of Hinds County in
Jackson, Mississippi in the case entitled Heritage Graphics, Inc. ("Heritage"),
et. al. v. Telephone Electronics Corporation ("TEC"), et. al., Civ. No.
251-96-000492. The named plaintiffs in the action are: Heritage Graphics, Inc.;
Thomas L. Gould, Jr.; Suzanne G. Gould; and Rainey Scott. The named defendants
in the action are: Telephone Electronics Corporation d/b/a TECLink; TECLink,
Inc.; the Company; Asynchronous Technologies, Inc.; Barbara Scott; Ronald D.
Anderson, Sr. d/b/a Anderson Engineering; Walter Frank; and Frank C. Magliato.
The second Amended Complaint filed in the action alleges a conspiracy on the
part of all of the defendants to destroy Heritage and to eliminate it as a
competitor in the Internet services provider market. The Company and others
allegedly duped Heritage into surrendering its trade secrets, its services, its
intellectual property, its expertise, etc. to the Company. The complaint's
lesser allegations are that (i) defendants conspired to slander the business
reputations of Heritage and Tom Gould; and (ii) TEC and the Company are jointly
and severally liable to it for $268,245 worth of production work and consulting
services provided over the September to December 1995 time period. The
plaintiffs seek damages of $500 million. The Company believes that plaintiffs'
claims are without merit. Further, the Company believes that its counterclaims
are sufficiently well grounded to offset any judgment entered against the
Company. The Company intends to vigorously contest this case. The case is set
for trial on September 7, 1999 in Jackson, Mississippi.
In June, 1998, the Company was served in an action entitled Michael
Bodian, as Chapter 11 Trustee of Communications Network Corp. ("Conetco"), a/k/a
Conetco v. Digitec 2000,Inc. f/k/a Promo Tel. Inc., Bankruptcy Case No.
96-B-53504 (PCB), Adv. Proc. No. 98-8621-A, pending in the United States
Bankruptcy Court, Southern District of New York, wherein the plaintiff alleges
that a preferential payment or fraudulent transfer in the amount of $150,800 was
made to the Company by Magic Communications, Inc. ("Magic"), an affiliate of
Conetco. Conetco, a reseller of long distance telecommunications services which
it purchased from WorldCom Network Services ("WorldCom"), sold prepaid telephone
debit cards through Magic which acted as its master sales agent. After WorldCom
terminated Conetco's access to its long distance network because of Conetco's
failure to pay its large outstanding balance, the debit cards became useless.
Conetco alleges that a "refund" of $150,800 in the form of a credit was given by
Magic to the Company as a result of cash refunds that the Company had given to
its customers on account of returned debit cards. An answer asserting numerous
defenses, including that the Company never received the "refund" in question,
has been filed on behalf of the
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Company, and a pre-trial conference is scheduled for October 15, 1998.
See "Legal Proceedings," below for additional litigation.
Limited Operating History; Net Losses. The Company has had only a limited
operating history. The Company reported losses from continuing operations and
net losses of $11,183,581 and $11,996,759, respectively for the year ended June
30, 1998, and $2,480,253 and $3,549,514, respectively, for the year ended June
30, 1997. There can be no assurance that the Company will be profitable in the
future. The Company's prospects must be considered in light of the risks,
expenses, problems and delays inherent in establishing a new business in a
rapidly changing industry. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations," "Consolidated Financial
Statements" and "Supplementary Financial Data".
Variability of Operating Results. The Company's operating results may vary
significantly in the future due to numerous factors, including (i) changes in
operating expenses; (ii) timing of the introduction of products and services;
(iii) market acceptance of new products and services; (iv) changes in
legislation and regulation which affect the competitive environment for the
Company's products and services; (v) other competitive conditions; and (vi)
general economic factors. The timing of receipt of cash by the Company may also
improve significantly in the future if the Company continues to successfully
establish its dedicated telecommunications facilities and ceases to provide
bundled Cards, as planned. The Company would no longer need to prepay for its
Cards, and the majority of its payments to the local and long distance carriers,
as well as the platform and switch providers, would not be payable until service
was actually rendered. See "Telecommunications Products and Services of the
Company," "Competition" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
Rapid Technological Change. The telecommunications service industry is
characterized by rapid technological change, new product and service
introduction, new sales channels and evolving industry standards. The Company's
success will depend, in significant part, upon its ability to make timely and
cost-effective additions to its technology and introduce new products and
services that meet customer demands. The Company expects new products and
services to be developed and introduced by other companies that compete with the
Company's products and services. The proliferation of new telecommunications
technology, including personal communication services and voice communication
over the Internet, may reduce demand for long distance services, including
Prepaid Phone Cards. There can be no assurance that the Company will be
successful in responding to these or other technological changes, evolving
industry standards or to new products and services offered by the Company's
current and future competitors. The inability of the Company to respond to new
products and services offered by competitors or to other changes could have a
material adverse effect on the Company. See "Telecommunications Products and
Services of the Company" and "Competition."
Dependence on Facilities and Third Party Services. Key suppliers'
facilities include, and the Company's facilities may include upon implementation
of its plan to become a facilities-based carrier: (i) switches, network POPs and
debit card platforms in strategic geographic regions in the United States; (ii)
leased capacity to connect third parties' network POPs and the Company's
proposed network POPs; and (iii) direct termination agreements with
telecommunications operators in the countries where key suppliers and the
Company terminate a large number of minutes. The Company is dependent on key
suppliers' and other telecommunications providers' facilities for efficient and
uninterrupted service to its customers. Currently the Company processes a
majority of its minutes through the Hudson Street Facility. The Company's
provision of reliable telecommunications service is dependent upon the ability
of key suppliers to protect the switches and other equipment and data at their
facilities against damage that may be caused by fire, power loss, technical
failures, unauthorized intrusion, natural disasters, sabotage and other similar
events. Although the Company believes that the key suppliers have taken
precautions, there can be no assurance that a fire, power loss, technical
failure, unauthorized intrusion, natural disaster, sabotage or other similar or
unforeseen event would not cause the failure of a switch, platform, or other
significant technical component, thereby resulting in an interruption in
telecommunications services and an adverse effect on the Company. In order to
mitigate its reliance on key suppliers and their facilities, the Company is in
the process of establishing relationships with additional carriers, as well as
expanding the operations of its own carrier division. See "Facilities and Third
Party Service."
Dependence on Key Personnel. The Company is dependent on its ability to
retain and motivate high quality personnel, especially its management and any
key technical personnel that may be needed in connection with the Company's
plans to establish its own dedicated facilities. The loss of services of any of
its executive officers or key employees could have a material adverse effect on
the business, operating results or financial condition of the Company. The
Company has employment agreements with all three of its executive officers, and
is currently evaluating the procurement of "key person" life insurance to cover
them. The Company's future success also depends on its continuing ability to
identify, attract and hire qualified personnel as it expands its business. There
can be no assurance that the Company will be able to attract and hire qualified
technical and managerial personnel in the future. The inability to attract and
retain the necessary personnel could have a material adverse effect upon the
Company's business, operating results or financial condition.
Market Listing; Volatility of Stock Price. The Company's Common Stock is
currently traded on the OTC Bulletin Board. To date, the Company's Common Stock
has been relatively illiquid and subject to wide price fluctuations. There can
be no assurance that an active public market for the Common Stock will develop
or be sustained. Further, the market price of the Company's Common Stock will
likely continue to be highly volatile based on actual or contemplated
fluctuations in quarterly results of operations, changes in earnings estimates
by securities analysts and announcements of new products or lines of business by
the Company or its competitors or other events or factors.
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Possible Depressive Effect of Future Sales of Common Stock; Registration
Rights. There are currently outstanding 6,858,998 shares of Common Stock. In
addition, as of September, 1998, the Company has outstanding the following
warrants, options and conversion rights to purchase or otherwise acquire
additional shares of Common Stock:
(i) warrants to purchase 600,000 shares of Common Stock at an exercise
price of $2.375 (the "$2.375 Warrants"), which were issued together
with the Company's $1,200,000 principal amount 10% Notes during
September, 1998,
(ii) warrants to purchase 1,333,334 shares of Common Stock at an exercise
price of $13.20 (the "$13.20 Warrants"), which were issued in
conjunction with the contribution of assets to the Company at the
time of its formation,
(iii) an option to purchase 145,000 shares of Common Stock at an exercise
price of $13.20 (the "$13.20 Option"), which was issued in
connection with the modification of debt terms on a note payable
related to the Company's acquisition of the customer base of Prime
Communications Inc. ("Prime") (See Notes to Financial
Statements--Note Payable),
(iv) options to purchase 1,048,610 shares of Common Stock at exercise
prices ranging from $8.1875 to $14.50 (the "Employee/Director
Options") per share issued to employees in connection with
employment agreements or performance awards and to directors for
their services as directors of the Company, and
(v) 61,050 shares of Preferred Stock issued by the Company to Premiere
on March 31, 1998, which shares are convertible into 587,302 shares
of Common Stock (the "Conversion Shares").
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
If all the foregoing were to be exercised or converted, there would be an
additional 3,714,246 shares outstanding, resulting in total shares outstanding
of 10,573,244 and the Company would receive approximately $31,800,000 in net
proceeds related to the exercise or conversion of these securities. Of the
underlying shares of Common Stock related to the foregoing, all have been
included in the Company's Registration Statement on Form S-1, dated April 20,
1998, as amended from time to time, with the exception of the $2.375 Warrants
and the Employee/Director Options. The 4,403,134 shares of Common Stock offered
by the Company's Prospectus, dated June 30, 1998, as supplemented by Prospectus
Supplement No. 1, dated August 14, 1998, including 2,337,498 shares of Common
Stock obtained upon exercise of warrants to purchase shares of Common Stock at
$1.50 per share, are freely tradeable without restriction under the Securities
Act. Subject to restrictions on transfer referred to below, all other
outstanding shares of Common Stock were issued by the Company in private
transactions, are treated as "restricted securities," as defined under the
Securities Act and in the future may be sold in compliance with Rule 144 under
the Securities Act or pursuant to a registration statement filed under the
Securities Act. The holders of the $2.375 Warrants currently have certain
"piggyback" registration rights at any time the Company undertakes to register
any transfer of its capital stock under the Securities Act for its own account
or for the account of a security holder. In addition, the Company has agreed,
subject to certain conditions, to effect a registration with respect to all
600,000 shares of Common Stock underlying the $2.375 Warrants. Rule 144
generally provides that a person holding restricted securities for a period of
one year may sell every three months in brokerage transactions or market-maker
transactions an amount equal to the greater of (i) one percent (1%) of the
Company's issued and outstanding Common Stock or (ii) the average weekly trading
volume of the Common Stock during the four calendar weeks prior to such sale.
Rule 144 also permits, under certain circumstances, the sale of shares without
any quantity limitation by a person who is not an affiliate of the company and
who has satisfied a two year holding period. The sale of substantial numbers of
such shares, whether pursuant to Rule 144 or pursuant to a registration
statement, may have a depressive effect on the market price of the Common Stock.
Dependence on and Concentration of Independent Distributors. The Company
distributes the most significant portion of its sales through independent
distributors. As a result, the Company's current success is still significantly
dependent upon its ability to recruit, maintain and motivate a network of
independent distributors. A significant element of the Company's growth strategy
is to increase its route sales and distribution of the Company's products and
services by expanding its presence in its current markets and by extending this
network into new markets either by internal growth, acquisition or both. There
can be no assurance that the Company will be able to continue to effectively
recruit, maintain and motivate independent distributors or prevent its
distributors from marketing other Prepaid Phone Cards.
PhoneCard Wholesalers, Inc. is currently an independent distributor of the
Company and accounted for approximately 19% of the Company's sales for fiscal
1998 and approximately 73% of the Company's accounts receivable at June 30,
1998. The Company has executed a letter of intent pursuant to which it intends
to acquire PhoneCard Wholesalers, Inc. However, there can be no assurance that
such acquisition will be completed in which event the Company's dependence on
this distributor could continue. See "Growth Strategy--Expansion of the
Company's Retail Distribution Network."
Regulation. The Company anticipates that it will be regulated at both the
federal and state level as it becomes a facilities-based carrier. The Company
will be regulated at the federal level by the FCC and will be required to
maintain both domestic and international tariffs for its services containing the
current effective rates, terms and conditions of service. The FCC has proposed,
however, to eliminate the tariffing requirement for domestic interstate
non-dominant carriers. Since the Company will be classified as a domestic
interstate non-dominant carrier, this proposal could eliminate the requirement
that the Company comply with domestic tariffing requirements. In addition, the
Company has received a Section 214 authorization from the FCC to provide
international long distance services. As a condition of its Section 214
authorization, the Company must comply with a variety of reporting and filing
requirements related to its traffic and revenues, its foreign affiliations and
its correspondent and/or termination relationships with the foreign carriers, if
any. The intrastate long distance telecommunications operations of the Company
will be subject to various state
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laws and regulations, including prior certification, notification or
registration requirements. The Company generally must obtain and maintain
certificates of public convenience and necessity from regulatory authorities in
most states in which it offers service. The Company is currently authorized to
provide intrastate telecommunications service in California, the District of
Columbia, Michigan, New Jersey and New York. In most jurisdictions, the Company
will be required to file and obtain prior regulatory approval of tariffs for
intrastate services. In addition, the Company will also be required to update or
amend the tariffs when rates are adjusted or new products are added to the long
distance services offered by the Company. The FCC and numerous state agencies
also impose prior approval requirements on "transfers of control," including pro
forma transfers of control and corporate reorganizations, and assignments of
regulatory authorizations.
While the Company expects to receive all such approvals that it submits
for and believes that it is or shall be otherwise in compliance with the
applicable federal and state regulations governing telecommunications service,
there can be no assurance that the FCC or the regulatory authorities in one or
more states will not raise material issues with regard to the Company's
compliance with applicable regulations, or that other regulatory matters will
not have an adverse effect on the Company's financial condition or results of
operations. In addition, changes in the federal and state regulations requiring
LECs to provide equal access for origination and termination of calls by long
distance subscribers (such as the Company's customers) or in the regulations
governing the fees to be charged for such access services, particularly changes
allowing variable pricing based upon volume, could have a material adverse
effect on the Company's results of operations. See "Business--Government
Regulation."
The Telecommunications Act requires long distance carriers, which the
Company has become with its establishment as a facilities-based carrier, to
compensate pay phones owners $.284 per call when a pay phone is used to
originate a telephone call through a toll-free number. The FCC's decision
setting the $.284 compensation rate was remanded to the FCC by the U.S. Court of
Appeals for a more adequate justification. Consequently, the compensation rate
may change. The Company passes these charges directly to the end-users and
transfers collection to the long distance carriers to be submitted to the pay
phone owners. See "Business--Government Regulation."
On May 8, 1997, the FCC issued an order to implement the provisions of the
Telecommunications Act relating to the Universal Service Order. The Universal
Service Order requires all telecommunications carriers providing interstate
telecommunications services to contribute to Universal Service support by
contributing to the Universal Service Fund. Universal Service contributions will
be assessed based on intrastate, interstate and international "end user" gross
telecommunications revenues effective January 1, 1998. The contribution factors
proposed by the FCC for the fourth quarter of 1998 will require subject
telecommunications carriers to contribute as much as 3.93% of their end user
telecommunications revenues. The contribution factors are based on the ratio of
total projected quarterly expenses of the Universal Service support programs to
total end user telecommunications revenues and could, therefore, increase or
decrease in subsequent periods. The Company currently is determining whether the
Universal Service Order will be applicable to the Company. In addition, the
Universal Service Order is subject to petitions seeking reconsideration by the
FCC and to certain appeals. Until such petitions or appeals are decided, there
can be no assurance as to how the Universal Service Order will be implemented or
enforced or what effect the Universal Service Order generally will have on
competition within the telecommunications industry or specifically on the
competitive position of the Company. If it is determined that the Company is
subject to the Universal Service Order, compliance with the Universal Service
Order could have a material adverse effect on the Company's results of
operations.
In addition, in recent years, the telecommunications industry has
increasingly come under the scrutiny of the FTC and state regulatory agencies
with respect to the promotion, marketing and advertising of effective rates,
terms and conditions of telecommunications services and products. The New York
regional office of the FTC and the NYATG are currently reviewing advertisements
of products and services of other telecommunications companies. While the
Company believes that its advertising has complied with federal and state
regulations regarding advertising, there can be no assurance that the FTC and
the NYATG will not raise inquiries towards the Company's advertising practices.
Taxes. The taxation of Prepaid Phone Cards is evolving and is not
specifically addressed by the laws of many of the states in which the Company
does or intends to do business. Certain states may enact regulation which
specifically provides for taxation of such Prepaid Phone Cards or may interpret
current laws in a manner resulting in additional tax liabilities.
In addition, The Taxpayer Relief Act (which became effective on November
1, 1997) provides for a three percent federal excise tax on Prepaid Phone Card
sales, based upon retail value, to be charged by telecommunications carriers to
any such party who is not a carrier. To date, the federal excise tax has been
built in as part of the Company's cost structure from its providers. The Company
is responsible for collecting the federal excise tax from its independent
distributors for its facilities-based operations. The Company believes that the
imposition of such taxes will not have a material adverse effect on the
Company's results of operations.
Fraud; Theft of Services; Uncollectible Accounts. From time to time,
callers may obtain services without rendering payment to the Company by
unlawfully utilizing the Company's access numbers and PINs. The Company attempts
to manage theft and fraud risks through its internal controls, monitoring and
blocking systems. The Company believes that its risk management
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practices are adequate, and to date the Company has not experienced material
losses due to such unauthorized use of access numbers and PINs. There can be no
assurance that the Company's risk management practices will be sufficient to
protect the Company in the future from unauthorized transactions or thefts of
services which could have an adverse effect on the Company's financial condition
and results of operations.
In addition, the Company sells its products to certain of its distributors
and retail accounts on credit terms, and the Company may introduce new services
for which customers may be billed after services are rendered. Although the
Company evaluates the risk of uncollectible accounts, it will implement
additional credit and collections procedures. There can be no assurance that the
Company's actual collection experience will not be worse than anticipated.
ITEM 2. PROPERTIES
The Company occupies leased premises of approximately 20,000 square feet
on two floors at 8 West 38th Street, New York, New York. The sublease with
Vanity Fair provides for 10,000 rentable square feet per floor, with a base
rental of $14.50 per square foot per annum or approximately $24,200 per month,
commencing July 1, 1997 and annual fixed increases of 2.5% in lieu of payment
for operating expenses, plus payments of amounts due under the settlement with
Vanity Fair. See "Legal Proceedings," below. The sublease expires on March 31,
2001. The Company's present use of the premises involves: 2,000 square feet for
reception and common areas; 1,400 square feet for executive offices; 1,000
square feet for conference rooms; 1,500 square feet for shipping and receiving;
and the remainder is for general office working areas.
The Company also maintains a sales and distribution office in Phoenix,
Arizona in leased premises containing 1,360 square feet. The lease is for a
two-year term which commenced in April 1997 and provides for an annual rent of
approximately $19,000 the first year and $20,000 the second year of the term.
World Access occupied leased premises in Suite 1510 at 125 South Congress
Street, Jackson, Mississippi. The offices contain 4,750 square feet. The lease
is for a five-year term commencing June 1, 1997 and ending May 31, 2002. The
monthly rental is $5,940 per month for the first three years, $6,237 per month
in the fourth year and $6,336 per month in the fifth year. As part of an
agreement with Meta3, Inc. ("Meta3"), in conjunction with the Company's
disposition of World Access, Meta3 has agreed to assume the obligations under
this lease. See "Notes to Consolidated Financial Statements--Related Party
Transactions."
ITEM 3. LEGAL PROCEEDINGS
In June of 1996, the Company became a co-defendant in a legal action in
the Circuit Court for the First Judicial District of Hinds County in Jackson,
Mississippi in the case entitled Heritage Graphics, Inc. ("Heritage"), et. al.
v. Telephone Electronics Corporation, et. al. Civ. No. 251-96-000492. The named
plaintiffs in the action are: Heritage Graphics, Inc.; Thomas L. Gould, Jr.;
Suzanne G. Gould; and Raine Scott. The named defendants in the action are:
Telephone Electronics Corporation d/b/a TECLink; TECLink, Inc.; the Company;
Asynchronous Technologies, Inc.; Barbara Scott; Ronald D. Anderson, Sr. d/b/a
Anderson Engineering; Walter Frank; and Frank C. Magliato. The second Amended
Complaint filed in the action alleges a conspiracy on the part of all of the
defendants to destroy Heritage and to eliminate it as a competitor in the
Internet services provider market. The Company and others allegedly duped
Heritage into surrendering its trade secrets, its services, its intellectual
property, its expertise, etc. to the Company. The complaint's lesser allegations
are that (i) defendants conspired to slander the business reputations of
Heritage and Tom Gould; and (ii) TEC and the Company are jointly and severally
liable to it for $268,245 worth of production work and consulting services
provided over the September to December 1995 time period. The plaintiffs seek
damages of $500 million. The Company believes that the plaintiffs' claims are
without merit. Further, the Company believes that its counterclaims are
sufficiently well grounded to offset any judgment entered against the Company.
The Company intends to vigorously contest this case. The case is set for trial
on September 7, 1999 in Jackson, Mississippi.
In October of 1997, the Company initiated a lawsuit against IDT
Corporation ("IDT"), CG Com, Inc. ("CG Com"), and Carlos Gomez in the Supreme
Court of the State of New York for the County of New York (Index No. 604920/97).
The Company initially sought and was granted a temporary restraining order which
enjoined CG Com and Carlos Gomez from distributing Prepaid Phone Cards of IDT, a
competitor of the Company, which the Company alleged was in violation of an
Independent Master Distributor Agreement (the "Distribution Agreement") with the
Company which provided for CG Com and Carlos Gomez to act as exclusive
distributors of the Company's Prepaid Phone Cards in the state of New York. The
Amended Complaint sought preliminary injunctive relief against both CG Com and
IDT, which was denied by the court. Subsequently, the Company discontinued the
action against Mr. Gomez and CG Com. The action seeks $50 million in damages for
tortious interference with the Distribution Agreement against IDT. The Amended
Complaint alleges, among other things that IDT entered into its distributorship
arrangement with CG Com and Mr. Gomez with full knowledge of the business
relationship between the Company and those parties. The case is now concluding
the discovery phase and a trial date of November 12, 1998 has been set.
During March 1998, Vanity Fair Intimates, Inc. ("Vanity Fair") commenced
an action entitled Vanity Fair Intimates, Inc. formerly known as Vanity Fair
Mills, Inc. v. Promo Tel, Inc. also known as and/or trading as Digitec 2000,
Inc., in the Civil Court of the City of New York for the County of New York, L&T
Index No. 066018-98 seeking eviction and judgment against the
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Company for a total of $472,799. The matter was settled in September, 1998 for
$208,916, to be paid in monthly installments of approximately $35,000 commencing
in September 1998 and continuing through and including the month of February,
1999.
In June, 1998, the Company was served in an action entitled Michael
Bodian, as Chapter 11 Trustee of Communications Network Corp. ("Conetco"), a/k/a
Conetco v. Digitec 2000,Inc. f/k/a Promo Tel. Inc., Bankruptcy Case No.
96-B-53504 (PCB), Adv. Proc. No. 98-8621-A, pending in the United States
Bankruptcy Court, Southern District of New York, wherein the plaintiff alleges
that a preferential payment or fraudulent transfer in the amount of $150,800 was
made to the Company by Magic Communications, Inc. ("Magic"), an affiliate of
Conetco. Conetco, a reseller of long distance telecommunications services which
it purchased from WorldCom Network Services ("WorldCom"), sold prepaid telephone
debit cards through Magic which acted as its master sales agent. After WorldCom
terminated Conetco's access to its long distance network because of Conetco's
failure to pay its large outstanding balance, the debit cards became useless.
Conetco alleges that a "refund" of $150,800 in the form of a credit was given by
Magic to the Company as a result of cash refunds that the Company had given to
its customers on account of returned debit cards. An answer asserting numerous
defenses, including that the Company never received the "refund" in question,
has been filed on behalf of the Company, and a pre-trial conference is scheduled
for October 15, 1998.
On June 9, 1998, the Company was served with a Summons and Motion for
Summary Judgment by Frontier in a case entitled Frontier Communications
International, Inc. v. Digitec 2000, Inc. in the Supreme Court of the State of
New York, County of Monroe 5390196 seeking judgment on a promissory note (the
"Frontier Note") issued by the Company for $893,061 in connection with
Frontier's termination of its Card division. The outstanding amount on the
Frontier Note at that time was approximately $558,000, which was reflected in
the accounts payable of the Company. On June 19, 1998, the Company paid
approximately $56,000 on the Frontier Note, reducing the balance to
approximately $502,000. On August 6, 1998, the Company negotiated a settlement
with Frontier for $200,000. The Company satisfied the settlement in September
1998, and as a result, a security interest held by Frontier against certain
assets of the Company was removed.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The following matters were submitted to, and voted upon by, the
stockholders of the Company in conjunction with the 1997 Annual Meeting of
Shareholders held on December 22, 1997 in New York, New York:
1. The election of three directors to serve until the next Annual
Meeting of Shareholders or until their successors shall be duly
elected and qualified;
2. A proposal to approve the adoption of the Company's Stock Incentive
Plan;
3. The ratification of the appointment of BDO Seidman, LLP ("BDO") as
the Company's independent certified public accountants for fiscal
1998; and
4. The transaction of such other business as may properly come before
the Annual Meeting or any adjournment thereof.
With respect to the election of directors, the Board designated three
nominees for election as directors to the Board to serve until the 1998 Annual
Meeting or until their successors are duly elected and qualified. The three
nominees consisted of Mr. Frank C. Magliato, the Company's Chief Executive
Officer and a director, Ms. Lori Ann Perri, a director, and Mr. Francis J.
Calcagno, a new nominee to the Board. The stockholders approved the election of
the three nominees to the Board by the affirmative vote of a majority of the
shares of Common Stock present, in person or by proxy, and entitled to vote at
the Annual Meeting. Each of the foregoing nominees received the following votes:
NAME FOR AGAINST ABSTAIN
------------------ --------- ------- -------
Mr. Frank C. Magliato 2,945,486 0 0
Ms. Lori Ann Perri 2,945,486 0 0
Mr. Francis J. Calcagno 2,945,486 0 0
With respect to the ratification of the Board's prior adoption of the
Company's Stock Incentive Plan, the Board recommended a vote in favor of the
adoption of the Stock Incentive Plan under which stock options, stock
appreciation rights or "restricted" or unrestricted stock awards, for up to
600,000 shares of the Company's Common Stock may be granted subject to the
approval of the Plan by the stockholders of the Company on or before April 24,
1998. Upon approval by the Company's stockholders, the Plan would be
administered by a committee of the Board of Directors, the members of which must
be non-employees of the Company and outside directors as defined by the Code.
The stockholders approved the proposal by the affirmative vote of a majority of
the shares of Common Stock present, in person or by proxy, at the Annual
Meeting. The proposal received the following votes:
FOR AGAINST ABSTAIN
--------- ------- -------
2,945,486 0 0
With respect to the appointment of independent auditors of the Company for
the 1998 fiscal year, the Board proposed that the stockholders approve the
appointment of the firm of BDO Seidman, LLP to serve as the independent auditors
of the Company for the 1998 fiscal year until the 1998 Annual Meeting. BDO
served as the Company's independent auditors for the 1997 fiscal year. The
stockholders approved the appointment by the affirmative vote of a majority of
the shares of Common Stock present, in person or by proxy, at the Annual
Meeting. The proposal received the following votes:
FOR AGAINST ABSTAIN
--------- ------- -------
2,945,486 0 0
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Since October 15, 1996, the Company's Common Stock has been quoted and
traded on the OTC Bulletin Board, under the trading symbol "DGTT." Prior to such
time, it so traded under the symbol "PROE."
The following table sets forth the high and low bid prices as reported on the
OTC Bulletin Board for the periods indicated.
-------------------------------------------------------------------
Period (1) High(1) Low(1)
-------------------------------------------------------------------
Year Ending June 30, 1997(2):
First Quarter $31.50 $18.00
Second Quarter 15.00 9.50
Third Quarter 13.00 9.88
Fourth Quarter 15.00 12.00
Year Ending June 30, 1998(2):
First Quarter $16.63 $13.00
Second Quarter 14.25 5.25
Third Quarter 9.25 4.88
Fourth Quarter 11.31 6.00
-------------------------------------------------------------------
(1) High and low bid prices prior to October 15, 1996 have been
retroactively adjusted to give effect to the Company's 1:6
reverse stock split of its Common Stock.
(2) For the years ended June 30, 1997 and 1998, the Company's
Common Stock was thinly traded. Further, over-the-counter
market quotations may not necessarily represent actual
transactions.
On October 8, 1998, the last sale price of the Common Stock on the OTC
Bulletin Board was $3.625 per share. As of September 30, 1998, there were 700
registered shareholders of the Common Stock. During the year ended June 30,
1998, the Company made the following sales of securities that were not
registered under the Securities Act:
(i) As of June 29, 1998, the Company issued an option to purchase
145,000 shares of Common Stock at an exercise price of $13.20 to
Prime.
(ii) On March 31, 1998, the Company issued 61,050 shares of Preferred
Stock to Premiere, which shares are convertible into 587,302 shares
of Common Stock.
In addition, during September 1998, the Company issued $1,200,000
principal amount of its 10% Notes with warrants to purchase 600,000 shares of
the Company's Common Stock at an exercise price of $2.375 per share. Nine
investors participated in this offering, including an officer/director and his
family and a director. The Preferred Stock and the 10% Notes with related
warrants were issued to meet working capital needs, and the option to Prime was
issued in connection with the restructuring of the payment terms of a note
payable to Prime issued in connection with the acquisition of Prime's customer
base. The sales of all the foregoing securities were exempt from registration
under the Securities Act pursuant to Regulation D.
The Company has never paid cash dividends on its Common Stock, and the
current policy of the Board of Directors is to retain any available earnings for
use in the operation and expansion of the Company's business. Therefore, no cash
dividends on the Common Stock will be paid in the foreseeable future. Any future
determination to pay cash dividends will be at the discretion of the Board of
Directors and will depend upon the Company's earnings, capital requirements,
cash flow, financial condition and any other factors deemed relevant by the
Board of Directors.
20
<PAGE>
- - --------------------------------------------------------------------------------
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data set forth below should be read in
conjunction with Item 7--Management's Discussion and Analysis of Financial
Condition and Results of Operations and the Consolidated Financial Statements of
the Company and related Notes thereto included elsewhere in this Report.
<TABLE>
<CAPTION>
Year Ended June 30,
--------------------------------------------
1998 1997 1996
--------------------------------------------
Consolidated Statements of Operations Data:
<S> <C> <C> <C>
Sales ................................. $ 35,032,533 $ 26,027,909 $ 17,425,199
Cost of sales ......................... 33,545,412 25,161,443 16,900,370
Gross profit .......................... 1,487,121 866,466 524,829
Selling, general and
administrative expenses ............... 12,394,471 2,040,749 654,104
Loss from operations .................. (10,907,349) (1,174,283) (129,275)
Other expenses, net ................... (276,232) (1,305,970) --
Loss from continuing operations ....... $(11,183,581) $ (2,480,253) (129,275)
Net Loss .............................. $(11,996,759) $ (3,549,514) (129,275)
Net Loss per share (basic and diluted):
From continuing operations ........ $ (1.99) $ (.55) (.05)
From discontinued operations ...... $ (.15) $ (.23) --
Net Loss per share ................ $ (2.14) $ (.78) (.05)
Weighted average common
shares outstanding .................... 5,618,994 4,579,075 2,599,532
<CAPTION>
AS OF JUNE 30,
--------------------------------------------
Balance Sheet Data: 1998 1997 1996
--------------------------------------------
<S> <C> <C> <C>
Working Capital (Deficit) ........... (2,226,152) (636,687) 1,216,279
Total Assets ........................ $ 3,139,790 3,526,723 6,056,462
Long Term Debt ...................... $ -- -- --
Stockholders' Equity (Deficit) ...... $ (1,494,390) (71,469) 3,126,946
</TABLE>
21
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the
Consolidated Financial Statements, including the notes thereto, and other
detailed information regarding the Company included elsewhere in this Form 10-K.
Certain statements set forth below regarding matters that are not historical
facts, such as statements concerning the expansion and growth of the Company,
future growth in the demand for Prepaid Phone Cards and the Company's plans to
expand its own dedicated facilities and distribution network, are
forward-looking statements within the meaning of Section 27A of the Securities
Act and Section 21E of the Exchange Act. Because such forward-looking statements
include risks and uncertainties, actual results may differ materially from those
expressed or implied by such forward-looking statements. Factors that could
cause actual results to differ materially include, but are not limited to, those
discussed under "Business--Risk Factors".
The Company commenced operations under present management in 1995 to
exploit the Prepaid Phone Card sector of the long distance telecommunications
market. The Company's Prepaid Phone Cards provide consumers with a competitive
alternative to traditional calling cards and presubscribed long distance
telecommunications services. The Company's total revenues were $35,032,533,
$26,027,909 and $17,425,199, and its net losses were $11,996,759, $3,549,514 and
$129,275, for the fiscal years ended June 30, 1998, 1997 and 1996, respectively,
after losses from discontinued operations of $813,178, $1,069,261 and $0,
respectively. The Company sold approximately six million Cards, of which
approximately five million were its own proprietary branded Cards, and provided
more than one hundred million minutes of telecommunications services, during the
fiscal year ended June 30, 1998.
The Company's target markets include ethnic communities with substantial
international long distance calling requirements. For the year ended June 30,
1998 approximately 72% of the Company's total minutes were derived from the sale
of international long distance telecommunications services. Retail rates in the
international long distance market have declined in recent years and, as
competition in this segment of the telecommunications industry continues to
intensify, the Company believes that this downward trend in rates is likely to
continue. Although there can be no assurance, the Company believes that any
reduction in rates will be offset in whole or in part by efficiencies
attributable to the planned expansion of the Company's services as well as by
lower transmission costs per minute resulting from the Company's increased
volume of minutes. See "Business--Risk Factors--Competition."
The Company's fiscal 1997 and 1998 sales have been derived primarily from
the resale of bundled Prepaid Phone Cards. The Company resold the Cards at a
discount off the retail value of the Cards to either independent distributors or
retail locations, depending on the locality of distribution. The Company's
fiscal 1997 and 1998 cost of sales consisted primarily of the purchase of the
Cards at a greater discount off the face value than the price at which the Cards
were resold by the Company. As a result, the Company received its gross margin
on the difference between discounts given to its customers and the discounts the
Company received from its long distance provider. Since the Cards were sold to
the Company as a bundled product, the supplier was liable to the end user for
the long distance time on the Cards. At the point of sale, the Company had no
further obligation with respect to the Cards sold and revenues were recognized
upon sale of the Cards.
During the last quarter of fiscal 1998 the Company became predominantly a
facilites-based carrier. Under these arrangements the Company negotiated and was
responsible to the long distance carriers and platform providers for the long
distance usage and related platform fee charges incurred in connection with
providing service to the end users. Since the Company was not liable for the
usage and platform fees on the underlying traffic until it was consumed by the
end user, the Company records all sales as deferred revenue until the time on
Cards sold is actually used by the consumer.
The Company believes that its ability to negotiate competitive rates with
its long distance providers, attract distributors and successfully market to
certain ethnic markets are the primary reasons for its sales increases in fiscal
1997 and 1998. In addition, the Company believes that its further growth is
dependent on its ability to (i) continue its planned transition to a
facilities-based carrier, (ii) introduce LACs in many of the markets in which it
currently distributes Cards or into which it expands, (iii) increase the retail
distribution of its products, (iv) introduce additional products and services,
(v) continue to attract consumers with significant international long distance
usage and (vi) capitalize upon economies of scale. See "Business--Growth
Strategy."
22
<PAGE>
Operations
Year Ended June 30, 1998 Compared to Year Ended June 30, 1997
Net Sales. Net Sales for the year ended June 30, 1998 increased by
$9,004,624 or 34.6% to $35,032,533 from $26,027,909 for the year ended June 30,
1997. The Company's sales increase in the first half of the 1998 fiscal year was
primarily due to the market acceptance of brands introduced by the Company
during the fourth quarter of fiscal 1997 and the first quarter of fiscal 1998.
These Cards offered competitive pricing and reliable service.
Despite the significant year-to-year sales increase of approximately 35%,
two events adversely impacted sales and earnings for fiscal 1998. Sales and
earnings for the first half of fiscal 1998 were adversely impacted by the
decline in sales to CG Com, which had exclusivity in the Metro Area for the
Company's primary brand under an Independent Master Distribution Agreement. CG
Com accounted for 52% and 42% of sales during the year ended June 30, 1997 and
the three months ended September 30, 1997, respectively. During October, 1997,
the Company initiated litigation against IDT Corporation and CG Com for tortious
interference with the contract seeking $50 million in damages. See "Legal
Proceedings." CG Com's percentage of sales declined substantially to 19% of
total sales for the year ending June 30, 1998. The Company does not anticipate
that sales will continue to be adversely affected since the Company has obtained
other distributors for this area and also delivers products through its
employees directly to the retail locations.
In addition, during the year ended June 30, 1998, Premiere provided
approximately 43% of the telecommunications services supplied to the Company.
During January, 1998, Premiere unilaterally suspended one of the Company's Card
programs and repriced the Cards under another of the Company's programs. Prior
to the suspension and repricing of the programs, the Company was selling
approximately $4.75 million retail value of Cards per month (approximately $3.2
million net revenue to the Company) under the two programs. Following the
suspension and repricing, which made the Company's products less competitive in
the marketplace, the monthly sales rate declined to approximately $1.5 million
per month retail value (approximately $1.0 million net revenue to the Company)
and continued at this lower level for the remainder of the year. See
"Business--Company History" and "Notes to Consolidated Financial Statements -
Transactions with Premiere Communications, Inc."
During the fourth quarter of fiscal 1998, the Company introduced its
facilities-based Cards and its first local access cards (LACs). These Cards
significantly lowered the Company's cost of providing long distance services to
its customers, thereby having a positive impact upon both the Company's gross
margins and its competitiveness in the marketplace due to the additional pricing
flexibility created by the lower costs. The Company anticipates that this
additional pricing flexibility will have a positive impact upon future sales
growth.
Cost of Sales. The Company's cost of sales for the year ended June 30,
1998 increased to $33,545,412 from $25,161,443 for the fiscal year ended June
30, 1997. The increase of $8,383,969 or 33.3% was primarily related to the
increase in revenues that the Company experienced for the fiscal year ended June
30, 1998. Although the Company anticipates that implementation of its
facilities-based programs and introduction of additional LACs will substantially
increase its gross margins in the future, this effect was not evident during the
year ended June 30, 1998 because the volume of sales on these programs was a
relatively small portion of total 1998 sales.
Gross Profit. Gross profit for the year ended June 30, 1998 was $1,487,121
or 4.2% as compared to a gross profit of $866,466 or 3.3% for the fiscal year
ended June 30, 1997. During the first quarter of fiscal 1998, the Company
obtained additional discounts from Frontier off the face value of Cards
distributed by it which increased the Company's gross margin for the quarter to
approximately 8% on sales of over $13,000,000. Gross profit margin was adversely
affected for the remainder of the year by the Company's transition of its name
brands under the Premiere agreement under which the Company was unable to
negotiate as competitive a discount. The transition to Premiere followed
notification by Frontier of their intention to terminate their Prepaid Phone
Card division.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the year ended June 30, 1998 increased by 507% from
$2,040,749 for the fiscal year ended June 30, 1997 to $12,394,471. This
substantial increase of $10,353,722 can be separated into two distinct
categories: (i) non-recurring charges and (ii) other expenses resulting from the
growth of the business. With respect to non-recurring charges, the Company
recorded the following during the year ended June 30, 1998:
(i) a one-time promotional expense of approximately $2,869,000, related
to the improper processing of additional minutes on the Company's $5
and $10 Cards, which were mistakenly processed by Premiere as $20
Cards. Of this amount, approximately $1,468,000 was charged to
operations as a one-time promotional charge during the quarter ended
March 31, 1998, and the remainder was charged during the fourth
quarter of fiscal 1998 when the distributor who received, and was
billed for, most of the Cards with the improperly processed minutes
advised the Company that no monies had been collected with respect
to the additional minutes processed and refused to pay for same. See
23
<PAGE>
"Business--Company History" and "Notes to Consolidated Financial
Statements--Transactions with Premiere Communications, Inc."
(ii) a charge of $1,248,000 for director compensation expense
related to the awarding of 300,000 options to directors during March
1998 for their services as directors of the Company.
(iii) a one-time charge of approximately $287,000 related to the $13.20
Option granted to Prime in conjunction with the modification of the
terms of a note payable to Prime. See "Notes to Consolidated
Financial Statements--Note Payable."
(iv) a one-time charge of approximately $234,000 due to the cancellation
of print jobs related to Frontier's termination of its Card division
and the ensuing disruption in the production and sale of the Cards.
The foregoing items, totaling approximately $4,638,000, represent 45% of the
total increase in selling, general and administrative expenses, which the
Company believes will not recur.
The remaining selling, general and administrative expense increases of
approximately $5,716,000 were primarily related to the growth of the business
over the prior year and the Company's initial implementation of its plan to
increase its infrastructure in anticipation of moving its existing brands to
facilities-based platform, switching and termination arrangements. For the year
ending June 30, 1998 the primary increases in selling, general and
administrative expenses as compared to the prior fiscal year ending June 30,
1997 were:
(i) salaries and employee-related costs increased by approximately
$1,318,000 to approximately $2,019,000 from $701,000 as the employee
base increased from 26 on June 30, 1997 to 70 on June 30, 1998. The
increase in employees was due to the build up of the Company's
internal route distribution network, expansion of customer service,
the establishment of a carrier services division to negotiate rates
for the Company as it introduces its facilities-based programs, and
the preparation for the introduction of other new services such as
LACs and POS. In addition, the Company added personnel in
anticipation of the Company's plans for future growth.
(ii) bad debt expense charges increased approximately $1,270,000 due to
the increase in accounts receivable aged over 90 days at the end of
the 1998 fiscal year. See "Notes to Consolidated Financial
Statements--Concentrations of Credit Risk." Although bad debt
expense is a normal cost of conducting business, the Company
believes that charges of this magnitude should not recur due to its
plans to implement more stringent credit and collection policies
during fiscal 1999.
(iii) the Company's professional fees also increased by approximately
$802,000 to $1,025,000 from approximately $223,000, primarily due to
the filing of a Registration Statement on Form S-1 and an amendment
thereto, preparation of a Prospectus related to the foregoing
Registration Statement, increased legal costs due to regulatory
filings and litigation expense, and increased expenses for
accounting and corporate consulting.
(iv) office expenses, utilities and telephone expenses increased an
aggregate of approximately $533,000 primarily due to the Company's
growth in employees and due to increased rental payments under the
lease for the Company's new distribution and administrative
headquarters which the Company began occupying April 1, 1997.
(v) field expenses, travel and entertainment expenses increased an
aggregate of approximately $240,000 due to increases in the internal
route distribution network and expenses related to the greater
number of employees.
(vi) advertising expense increased approximately $190,000 due to the
Company's introduction of new programs and services, and the
expansion of existing programs, and amortization expense increased
approximately $159,000, primarily due to amortization of customer
bases acquired during the year ended June 30, 1997.
(vii) shareholder relations and filing expenses increased approximately
$57,000 incurred in connection with complying with the reporting
regulations promulgated by the Securities and Exchange Commission
("SEC"). During fiscal 1997, the Company was exempt from complying
and, therefore, was not required to report to the SEC.
The Company anticipates that its recurring growth-related selling, general
and administrative expenses, which represented approximately $7.8 million (i.e.,
$12.4 million total less $4.6 million non-recurring) of the total selling,
general and administrative expenses incurred during the year ended June 30,
1998, will continue to increase, but at a substantially lesser rate, during
fiscal 1999, as it continues to add the necessary operational and administrative
infrastructure to support the anticipated growth of the Company. However, since
approximately 45% of the total 1998 selling, general and administrative expenses
are not expected to recur, the Company expects a significant reduction in
overall selling, general and administrative expenses during the 1999 fiscal
year.
Loss from Continuing Operations. The increase in loss from continuing
operations of $8,703,328 to $11,183,581 for the year ended June 30, 1998 as
compared to $2,480,253 for the year ended June 30, 1997 is primarily
attributable to the significant increase in selling, general and administrative
expenses, which was only partially offset by the increase in sales and much
smaller
24
<PAGE>
increase in gross profit.
Loss from Discontinued Operations. As of June 30, 1997, management
determined to discontinue the operations of World Access. The Company recognized
a net loss from the disposal of World Access of $171,593 for the fiscal year
ended June 30, 1998. The Company does not anticipate any additional charges to
be recognized related to World Access.
As of December 31, 1997, management, in connection with its plan to
conserve assets to expand its core business, determined to discontinue the
operations of its cellular operations division by terminating its operations.
The operations of the cellular division were completely discontinued by February
1, 1998. The Company recognized a net loss from the operations of the cellular
division of $527,061, and an additional net loss related to the disposal of this
division of $114,524, for the year ended June 30, 1998.
Total net losses from discontinued operations for the year ended June 30,
1998 aggregated $813,178 as compared to $1,069,261 in the prior fiscal year.
Net Loss. For the year ended June 30, 1998, the Company realized a total
net loss of $11,996,759 as compared to a net loss of $3,549,514 in the prior
year ending June 30, 1997. The increased loss is due to the substantial increase
in selling, general and administrative expenses in 1998 as compared to 1997, as
discussed above.
Year Ended June 30, 1997 Compared to Year Ended June 30, 1996
Net Sales. Sales for the year ended June 30, 1997 increased to $26,027,909
from $17,425,199 for the fiscal year ended June 30, 1996, representing an
increase of 49.4%. During the six months ended December 31, 1996, the Company
terminated its switchless unbundled Card and introduced its branded bundled
Cards which it purchased primarily from Frontier. With the Company offering a
more reliable Card at more competitive rates, the Company's revenues for the
third and fourth quarters of fiscal 1997 were approximately $7,000,000 and
$14,000,000 respectively, or about 80% of total 1997 revenues. CG COM, as
exclusive distributor in the Metro Area, accounted for approximately 52% of the
Company's sales during fiscal 1997.
Cost of Sales. The Company's cost of sales for the year ended June 30,
1997 increased to $25,161,443 from $16,900,370 for the fiscal year ended June
30, 1996. The increase of $8,261,073 or 48.9% was primarily related to the
increase in revenues that the Company experienced in the last half of fiscal
1997, together with offering more competitive rates.
Gross Profit. Gross profit for the year ended June 30, 1997 was $866,466
or 3.3% as compared to $524,829 or 3.0% or an increase of $341,637 or 65.1% as
compared to the prior fiscal year. The increase in gross profit is entirely
related to the Company's ability, in the last half of fiscal 1997, to offer
reliable Cards whose rates per minute were priced more competitively.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the year ended June 30, 1997 increased to $2,040,749
from $654,104 for the year ended June 30, 1996. This increase of $1,386,645 or
212.0% is primarily related to an increase in salaries and personnel-related
expenses of $463,683 as the Company's employees increased from 5 to 26 employees
by June 30, 1997. The Company's rent expense increased to $92,308 or 177%
primarily due to the Company recording a $71,000 non-cash charge for the
straight-lining of its rental payments under the lease for the new distribution
and administrative headquarters which the Company began occupying April 1, 1997.
Advertising, telephone, office expense, bad debt expense, bank charges, repairs
and maintenance, and travel and entertainment increased by $186,291, $54,898,
$54,702, $51,562, $42,418, $32,116 and $25,569, respectively, primarily related
to an increase in the Company's volume of business and greater number of
employees. The Company's professional fees also increased by $131,326 primarily
in connection with the Company's role in the Heritage litigation as well as
having increased needs for accounting and corporate consulting. See
"Business--Legal Proceedings." The Company also recorded amortization related to
its intangibles of $87,798 primarily due to the acquisition of customer bases
during fiscal 1997.
Other Expenses. During 1996, the Company participated in the establishment
of TecLink, Inc. ("TecLink") as a Mississippi-based Internet service provider by
selling TecLink certain Internet service provider assets, intellectual property,
computer hardware, software and office equipment (that it had previously
purchased from TEC and others) as well as an exclusive value added reseller
distribution contract for Direct PC satellite dishes from Hughes Corporation
("Hughes"). In exchange for these assets, the Company received $50,000 cash and
a 6% per annum note payable (the "Note") for $2,405,000 from TecLink due the
earlier of December 31, 1998 or upon the completion of TecLink's initial public
offering ("IPO"). The Note was collateralized by the assets of TecLink.
25
<PAGE>
TecLink and Hughes never reached an accord related to Hughes'
responsibilities under its agreement and TecLink experienced losses resulting
from not being able to proceed with its initial business plan. As a result of
this and other factors, TecLink's IPO was never consummated. Due to the
continuing losses, the Company entered into an agreement to acquire the net
assets of TecLink as partial satisfaction of the outstanding balance of the Note
from TecLink (then $2,105,000). The Company recorded a loss on the Note
satisfaction of $1,340,230. On June 1, 1997, the Company established World
Access as a wholly-owned subsidiary providing Internet access with the assets
reacquired from TecLink. As of June 30, 1997, management determined that it
needed to focus on its core business and would discontinue the operations of
World Access by selling its net assets. On October 1, 1997, the Company entered
into an agreement (the "Agreement") to sell the customer base, the equipment and
software which services the customer base and the Company's obligations under
its leases for its premises to Meta3, Inc. ("Meta3"), a Mississippi corporation
in a similar business. The assets sold had a book value of $988,347. The
Agreement calls for Meta3 to pay for the assets sold over a ten month period,
commencing November, 1997 (the "Purchase Period"), based on the number of
subscribers in the identified customer base, adjusted for its attrition rate for
the first five months of the Purchase Period. See "Notes to Consolidated
Financial Statements--Related Party Transactions."
Loss from Continuing Operations. The Company's switchless unbundled
product, which was terminated during the quarter ended September 30, 1996 and
was replaced by the offering of bundled products during the second half of
fiscal 1997, had not been a profitable, nor a reliable product. It is primarily
for this reason that the Company experienced a loss (before other expenses) of
$1,174,283 for the year ended June 30, 1997. The Company further experienced a
loss on the Note satisfaction (as described above) of $1,340,230. As a result,
the Company's loss from continuing operations was $2,480,253.
Loss from Discontinued Operations. As described above, management
resolved, as of June 30, 1997 that it would discontinue the operations of World
Access. As a result of the Agreement, the Company accrued a loss on disposal of
$893,347. World Access reported a net loss from operations of $175,914 for the
one month ended June 30, 1997. Therefore, the Company's total loss from
discontinued operations aggregated $1,069,261 for the year ended June 30, 1997.
Net Loss. Due to its market and customer service issues related to its
products during the first half of fiscal 1997 and losses related to TECLink and
World Access, the Company recorded a net loss of $3,549,514 for the year ended
June 30, 1997.
Year Ended June 30, 1996 Compared to Period May 18, 1995 (Inception) to June 30,
1995
While the Company began operations as of May 18, 1995, it was primarily a
shell entity until July, 1995, at which point the Company began to enter the
prepaid sector of the long distance telecommunications market.
Sales. Sales for the year ended June 30, 1996 were $17,425,199 as the
Company began to exploit relationships with contacts of certain employees of the
Company. Sales were primarily made to distributors who were selling the Cards in
credit-challenged residential areas within the Metro Area.
Cost of Sales. The Company's cost of sales for the year ended June 30,
1996 was $16,900,370 which is directly related to the Cards sold during that
year.
Gross Profit. Gross profit for the year ended June 30, 1996 was $524,829
or 3.0% of sales. In its efforts to gain market share, the Company was selling
the Cards with little markup over cost.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the year ended June 30, 1996 were $654,104. The
expenses were comprised primarily of salaries and personnel-related expenses of
$261,339 and organization expenses of $86,518 related to various corporate
filings in order to establish the Company. The Company also had rent of $51,801
for its then current premises for its distribution and administrative
headquarters.
Net Loss. As a result of the Company's initiation of sales efforts to
achieve market share, the Company recorded a loss of $129,275 for the year ended
June 30, 1996.
Liquidity and Capital Resources
The accompanying consolidated financial statements of the Company have
been prepared on the basis that it is a going concern, which contemplates the
realization of assets and the satisfaction of liabilities, except as otherwise
disclosed, in the normal course of business. However, because of the Company's
recurring losses from operations, such realization of assets and liquidation of
liabilities is subject to significant uncertainty. Further, the Company's
ability to continue as a going concern is highly dependent near term on its
ability to raise capital, reduce its costs of providing long distance service,
develop its collections tactics, develop market share and achieve profitable
operations thereon, and the ability to generate sufficient cash flow from
operations and financing sources to meet obligations. During the first quarter
of 1999, the Company addressed its working capital needs through the issuance of
$1.2 million 10% six month notes. As the facilities-based operations increase,
the operating cash flow will increase because the payments to suppliers are
payable after the usage of the Cards versus prepaid in the case of bundled
Cards. The Company has entered into a Letter of Intent with Convergence
Communications, Inc. ("CCI") pursuant to which the Company agreed to enter into
negotiations with respect to combining the two companies, an
Origination/Termination Agreement, and issuance of $1,000,000 convertible
promissory note from CCI. However, there can be no assurance that these
objectives will be met or that acceptable alternatives will be found.
The Company's major components of cash flow are as follows:
26
<PAGE>
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
--------------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Net cash used in operating activities ... $(3,422,762) $ (440,074) $ (89,880)
Net cash (used in) provided by investing
activities .............................. (87,181) 171,779 (461,003)
Net cash provided by financing activities 2,891,469 486,375 1,000,000
----------- ----------- -----------
Net increase (decrease) in cash ........ $ (618,474) $ 218,080 $ 449,117
=========== =========== ===========
</TABLE>
Net cash used in operating activities during the year ended June 30, 1998
was $3,422,762, an increase of $2,982,688 as compared to $440,074 for the year
ended June 30, 1997. The net cash used in operating activities during 1998 was
primarily comprised of uses of cash of approximately $14.3 million, primarily
offset by a number of items which reduced the cash needs by an aggregate of
approximately $10.9 million, as explained below.
The primary factors contributing to increases in the Company's cash used
in operating activities for the year ended June 30, 1998, and analysis of same,
follow:
(i) The Company's net loss was approximately $12.0 million. See
"Operations--Year Ended June 30, 1998 Compared to Year Ended June
30, 1997" for a full explanation of the net loss.
(ii) Receivables, prior to allowances for bad debt and writeoffs,
increased approximately $1.2 million. The increase was due to the
Company's extension of credit terms to customers, related in part to
Premiere's extension of credit terms to the Company.
(iii) Prepaid expenses and other assets increased approximately $0.4
million due to the Company's prepayments for facilities usage and
carrier deposits related to the establishment of the Company's
facilities-based programs.
(iv) Cash used in the operating activities of discontinued operations
totaled approximately $0.5 million. See "Notes to Consolidated
Financial Statements--Discontinued Operations of Cellular Division."
The foregoing cash uses in operating activities, aggregating approximately
$14.1 million, were partially offset by the following items which reduced the
cash needs by approximately $10.9 million, primarily accounting for the
increased cash used in operating activities of $3.4 million:
(i) Increases in accounts payable and accrued expenses associated with
the growth of the business and, to a lesser degree, the Company's
liquidity issues during the quarter ended June 30, 1998, aggregated
approximately $3.5 million.
(ii) Promotional expense increased by approximately $2.9 million due to a
one-time, non-cash charge related to the erroneous processing of
additional minutes on the Company's Cards by Premiere. The amount of
$2.9 million was included in accounts payable and subsequently
satisfied through the issuance of the Preferred Stock to Premiere.
See "Business--Company History" and "Notes to Consolidated Financial
Statements--Transactions with Premiere Communications, Inc."
(iii) Bad debt expense increased by approximately $1.3 million due to
charges to the reserve for doubtful accounts due to an increase in
receivables aged over 90 days.
(iv) Expenses related to option grants increased approximately $1.5
million, consisting of approximately $1.2 million related to options
granted to non-employee directors of the Company and approximately
$0.3 million related to options granted to Prime in conjunction with
the Prime debt restructuring. See "Notes to Consolidated Financial
Statements--Note Payable."
(v) Deferred revenues related to the introduction of four of the
Company's five facilities-based programs during the fiscal 1998
fourth quarter approximated $1.0 million.
(vi) Other writedowns and writeoffs associated with operating activities
aggregated approximately $0.5 million.
(vii) Other operating activities represented net sources of cash of
approximately $0.2 million.
The net cash used in operating activities of approximately $0.4 million
during fiscal 1997, was composed primarily of approximately $5.6 million of cash
uses, largely offset by approximately $5.1 million of operating cash sources.
The primary factors contributing to the increases in the Company's cash used in
operating activities for the year ended June 30, 1997, and analysis of same,
follow:
(i) The Company's net loss approximated $3.5 million. See
"Operations--Year Ended June 30, 1997 Compared to Year Ended June
30, 1996" for a full explanation of the net loss.
(ii) Accounts receivable increased by approximately $1.5 million,
primarily due to the higher sales of approximately $14,000,000 in
the fourth quarter of 1997, which resulted in an associated higher
level of receivables.
(iii) Deferred revenue decreased by approximately $0.6 million related to
the Company's termination of its initial switchless unbundled Card
program during the quarter ending September 30, 1996 due to service
issues.
The primary factors which mitigated the Company's need for cash during the
year ended June 30, 1997, and analysis of same, follow:
(i) Accounts payable and accrued expenses increased by approximately
$2.4 million due to the higher level of business activity during the
fourth quarter of fiscal 1997 when the sales level reached
approximately $14,000,000.
(ii) The Company incurred a one-time, non-cash charge of approximately
$1.3 million associated with the write-down of a note receivable
from Teclink. See "Notes to Consolidated Financial
Statements--Related Party Transactions."
(iii) Prepaid expenses decreased by approximately $0.5 million related to
the Company's termination of its switchless unbundled Card program
during the quarter ended September 30, 1996.
(iv) Cash provided by discontinued operations approximated $0.9 million
due to the disposal of World Access. See "Notes to Consolidated
Financial Statements--Related Party Transactions."
The foregoing net additions and reductions primarily account for the
approximately $0.4 million cash used in operating activities for the year ended
June 30, 1997.
During fiscal 1996, the Company's cash used in operating activities
approximated $0.1 million. This consisted of uses of cash for accounts
receivable of approximately $0.8 million, increases in prepaid expenses totaling
approximately $0.5 million related to the Company's switchless unbundled Card
program and a net loss approximating $0.1 million, substantially offset by
increases in accounts payable of approximately $0.8 million and deferred revenue
of $0.6 million.
Cash used in investing activities in 1998 was solely related to capital
expenditures of $87,181, which was not material. Cash provided by investing
activities of $171,779 during fiscal 1997 is primarily due to receipt of a
payment of $200,000 on the note from TecLink. Cash used in investing activities
of $461,003 during fiscal 1996 is primarily related to the purchase of
communications equipment valued at $533,625, which subsequently was sold as part
of the TecLink transaction, partially offset by the receipt of $150,000 in cash
related to payments on the note receivable from TecLink and sales of assets
during fiscal 1996. See "Notes to Consolidated Financial Statements--Related
Party Transactions."
The increase in cash provided by financing activities in fiscal 1998 of
$2,919,159 is primarily related to the exercise of certain $1.50 Warrants
pursuant to which 1,955,825 shares of the Company's Common Stock were purchased
at $1.50 per share yielding approximately $2,933,738 of proceeds to the Company.
The increase in cash provided by financing activities in fiscal 1997 of
$486,375 is solely due to the Company's receipt of net proceeds from the
exercise of certain $1.50 Warrants pursuant to which 324,250 shares of the
Company's Common Stock were purchased at $1.50 per share.
In April of 1996, the Company entered into an agreement enabling the
Company to issue the $1.50 Warrants and certain $13.20 Warrants to purchase an
aggregate of 4,203,124 shares of its Common Stock to four individuals and six
corporations in exchange for trade secrets, customer bases and other intangible
property. $1.50 Warrants and $13.20 Warrants to purchase 3,677,082 shares of the
Company's Common Stock were actually issued. The remaining $13.20 Warrants and
$1.50 Warrants to purchase 526,042 shares of Common Stock were held awaiting the
delivery of certain assets to the Company. Those assets were never received and
the Company never issued the warrants to the three parties. All $1.50 Warrants
and $13.20 Warrants have a term of five years commencing April 23, 1996 and are
callable by the Company, upon 30 days notice, at a call price of $.10 per
warrant to purchase one share. Of the 1,333,334 $13.20 Warrants issued, all
remain outstanding and are exercisable at a price of $13.20 per share. $1.50
Warrants to purchase 1,760,865 shares of the Company's Common Stock at $1.50 per
share were exercised in February and March, 1998. As of June 30, 1998, an
aggregate of 2,291,498 shares of Common Stock have been issued related to the
exercise of $1.50 Warrants. On August 20, 1998, the Company notified holders of
the 52,250 outstanding $1.50 Warrants of its intention to call them in 30 days.
As of September 20, 1998, 44,750 of the $1.50 Warrants were exercised, providing
$67,125 in net proceeds to the Company, and the remaining 7,500 $1.50 Warrants
were terminated.
For the year ended June 30, 1998, the Company experienced a substantial
operating loss before discontinued operations of approximately $11,200,000 and
used approximately $3,400,000 cash in operating activities. The Company's cash
position at June 30, 1998 approximated $100,000 and its working capital deficit
approximated $2,200,000. Due to operating losses and the Company's expansion,
the Company remains undercapitalized and to date has not been able to finance
its expansion as quickly as opportunities have arisen. Of the Company's
approximately $2.2 million working capital deficit, approximately $1.0 million
consists of deferred revenue which represents sales for which provision of the
underlying telecommunications service has not yet been redered or paid for by
the Company. This does not represent an immediate cash requirement. In addition,
as the Company's facilities-based Cards become more fully deployed, management
believes that the total deferred revenue balance, which is one component of the
negative net working capital balance, will increase to approximately $4.0
million during fiscal 1999, and will serve to mitigate the effect of negative
net working capital.
Since June 30, 1998, the Company has raised cash through the issuance of
$1,200,000 principal amount of its 10% Notes. The majority of this cash has been
used by the Company to make facility deposits and to prepay for facilities usage
related to further expansion of its facilities-based operations, and to address
existing obligations. As the Company increasingly sells more of its
facilities-based Cards, which significantly improve the Company's ability to
generate cash as compared to the sale of bundled Cards, its capital requirements
are expected to progressively decline on a monthly basis until the Company
begins to generate positive cash flow, which the Company believes will occur
during the third quarter of the 1999 fiscal year. There can be no assurance that
the Company's projections for positive cash generation commencing in the second
half of fiscal 1999 will be realized.
To date, capital expenditures have not been material.
The Company, during fiscal 1997, acquired the customer bases of certain of
its distributors through the release of their outstanding obligations to the
Company. In connection with one of these transactions, the Company issued a
$182,000 note payable with interest at 8% per annum. During June 1998 the terms
of this note were renegotiated. As of June 30, 1998, the Company had paid
$35,000 principal and $13,564 interest on the note. The remaining principal
balance of $147,000 is payable in monthly installments of $12,787 on the first
day of each month commencing August 1998 and continuing through July 1999,
inclusive. See "Notes to Consolidated Financial Statements--Note Payable."
The Company's ability to sell its Cards depends upon whether it can
continue to maintain a favorable relationship with its suppliers of debit card
platform, switching and terminating facilities. The Company currently obtains
dedicated facilities primarily from Allied, Innovative and Premiere. During the
year ended June 30, 1998, the Company obtained approximately 43% of its
telecommunications services from Premiere. These services were provided pursuant
to an agreement which expired on August 31, 1998. Among other things, this
agreement provided for the extension of certain credit terms by Premiere.
Although the Company does not have any arrangements in place to replace the
services provided by Premiere, the Company believes that it
27
<PAGE>
will be able to either have Premiere continue the services currently provided or
negotiate new agreements on similar terms with another supplier. There can be no
assurance that the negotiations with Premiere or other suppliers will be
successful. In addition, the Company is in negotiations with Premiere to resolve
claims arising out of the September 26, 1997 agreement with Premiere relating to
development and marketing of Card. In this context, it should be noted that the
Company is seeking damages suffered by it and disputing alleged "take or pay"
obligations. See "Business--Company History" and "Notes to Consolidated
Financial Statements--Transactions with Premiere Communications, Inc.
("Premiere")."
On March 31, 1998, the Company entered into the Investment Agreement in
which Premiere received 61,050 shares of Preferred Stock valued by the Board of
Directors at $6,105,093 which represented Premiere's outstanding accounts
receivable balance from the Company as of that date. The $6,105,093 included
approximately $4.6 million which was attributable to Cards purchased in the
normal course of business, including price adjustments on one of the Company's
programs, Cards returned by distributors to the Company due to service problems
not honored by Premiere and excess minutes processed by Premiere on Cards
activated under the Company's existing programs. In addition, in connection with
the closing of the transaction, Premiere charged the Company an additional $1.5
million for minutes improperly processed by Premiere. The Company wrote off
approximately $1.5 million as promotional expense and billed the distributor who
received most of the Cards which were processed for minutes in excess of their
face value. The distributor has informed the Company that no monies were
collected, and an additional $1.5 million has been written off as promotional
expense since the brands with the excess minutes are still offered by the
Company. The Preferred Stock is convertible into Common Stock at any time at
Premier's option and the Company has the right to require Premiere to convert
the Preferred Stock after March 31, 1999. The Certificate of Designation for the
Preferred Stock provides for certain voting, liquidation, and registration
rights and calculates the conversion by multiplying 61,050, the number of shares
of Preferred Stock issued in connection with the Investment Agreement, by $100,
the Investment Amount, as defined in the Certificate of Designation and then
dividing by $10.395, the Conversion Price, as defined in the Certificate of
Designation, resulting in a total of 587,302 shares of Common Stock to be issued
under the Investment Agreement, subject to adjustment for certain subsequent
securities issuances. The Company may call the redemption of each share of
Preferred Stock at any time for $100 a share plus accrued dividends. See
"Business--Company History" and "Notes to Consolidated Financial
Statements--Transactions with Premiere Communications, Inc."
Financing Requirements
To date, the Company has funded its operations through: (i) two offerings,
which aggregated $1,000,000 of proceeds to the Company; (ii) the exercise of
approximately 2,280,000 $1.50 Warrants to purchase shares of the Common Stock of
the Company at $1.50 per share, which aggregated approximately $3,400,000 of
proceeds to the Company; (iii) sale of 61,050 shares of Preferred Stock, which
resulted in the elimination of an accounts payable balance to Premiere totaling
approximately $6,105,000; and (iv) sale of $1,200,000 principal amount of the
Company's 10% Notes with warrants to purchase shares of the Company's Common
Stock at $2.375 per share, all in offerings exempt from registration under the
Securities Act.
The Consolidated Financial Statements of the Company have been prepared on
the basis that it is a going concern, which contemplates the realization of
assets and the satisfaction of liabilities, except as otherwise disclosed, in
the normal course of business. However, because of the Company's recurring
losses from operations, such realization of assets and liquidation of
liabilities is subject to significant uncertainty. Further, the Company's
ability to continue as a going concern is highly dependent near term on its
ability to raise capital, reduce its costs of providing long distance service,
develop its collections tactics, develop market share and achieve profitable
operations thereon, and the ability to generate sufficient cash flow from
operations and financing sources to meet obligations.
To date, the Company has no existing bank lines of credit and has not
established any sources for such financing. During June 1998, the Company
initiated discussions with several entities regarding short-term financing
related to accounts receivable to provide funding for the immediate internal
expansion of the business. As of September 30, 1998, no such arrangement has
been consummated. The Company believes that such an arrangement can be
consummated. However, there can be no assurance that such funding will be
available to the Company, or if available, will be available in either a timely
manner or upon terms and conditions which are acceptable to the Company.
For the year ended June 30, 1998, the Company experienced a substantial
operating loss before discontinued operations of approximately $11,200,000 and
used approximately $3,400,000 cash in operating activities. The Company's cash
position at June 30, 1998 approximated $100,000 and its working capital deficit
approximated $2,200,000. Due to operating losses and the Company's expansion,
the Company remains undercapitalized and to date has not been able to finance
its expansion as quickly as opportunities have arisen.
Since June 30, 1998, the Company has raised cash through the issuance of
$1,200,000 principal amount of its 10% Notes. The majority of this cash has been
used by the Company to make facility deposits and to prepay for facilities usage
related to further expansion of its facilities-based operations, and to address
existing obligations. As the Company increasingly sells more of its
facilities-based Cards, which significantly improve the Company's ability to
generate cash as compared to the sale of bundled Cards, its capital requirements
are expected to progressively decline on a monthly basis until the Company
begins to generate positive cash flow, which the Company believes will occur
during the third quarter of the 1999 fiscal year.
On September 22, 1998, the Company entered into a Letter of Intent with
CCI pursuant to which the Company agreed to enter into negotiations with respect
to: (i) a possible combination of the Company and CCI; (ii) an International
Origination/Termination Agreement pursuant to which CCI would provide for local
origination and termination in certain foreign countries; and (iii) the purchase
by CCI of up to $1,000,000 of convertible promissory notes issued by the Company
accompanied by warrants to purchase Common Stock of the Company. The Company is
currently negotiating International Origination/Termination Agreement and the
sale of the first $500,000 of the convertible notes with warrants and expects to
finalize this portion of the potential transaction during October, 1998. There
can be no assurances that the Company and CCI will reach agreement with respect
to the business combination, the International Origination/Termination Agreement
or the sale of promissory notes.
In addition, the Company is negotiating with a shareholder group for a
$1.25 million revolving line of credit, which it believes will be finalized
during November, 1998. There can be no assurance that this line of credit will
be available to the Company, or, if available, will be available in either a
timely manner or upon terms and conditions which are acceptable to the Company.
Management expects to realize additional cash flow improvement through a gradual
reduction in inventory of bundled Cards, which represent the majority of current
inventory. As the bundled Cards are phased out during the transition to full
facilities-based operations, the Company expects to realize approximately
$250,000 from this inventory reduction. In addition, the Company plans a
complete review of its selling, general and administrative expenses, which
management believes may provide further cost reductions and reduced cash needs
of approximately $500,000 during the remainder of the 1999 fiscal year.
With implementation of the above plans, the Company expects capital
requirements of appoximately $2.25 million during fiscal 1999, before it begins
to generate positive cash flow during the second half of fiscal 1999. The
foregoing amount includes further expansion of the Company's facilities-based
LACs into additional cities. The Company believes that any two of the potential
purchase by CCI of $1,000,000 of convertible promissory notes, the potential
revolving line of credit arrangement or the accounts receivable financing
referenced above should meet the above financing needs if addtional facilities
are made operable by the Company's sulliers in a timely manner to increase
facilities-based sales. If none of these financing arrangements should not
occur, or if cash needs prove to be greater than contemplated, the Company will
need to slow its expansion of its LAC offerings to additional cities during 1999
to fund its operating shortfall during the second quarter and early portion of
the third quarter of fiscal 1999 or until the Company becomes cash flow
positive. Also, the Company expects to consider other financing opportunities
during the 1999 fiscal year. The Company believes that its potential sources of
capital and internally generated cash from operations in the latter half of
fiscal 1999 will be sufficient to fund its operations throughout the 1999 fiscal
year. There can be no assurance that the foregoing external sources of financing
will be available to the Company, or that the Company's projections for positive
cash generation commencing in the second half of fiscal 1999 will be realized.
minimize its up-front cash requirements in order to extend its cash availability
through the end of fiscal 1999.
The Company's ability to acquire additional operations and facilities to
further accelerate its growth will be dependent upon its ability to raise
longer-term capital or otherwise finance such acquisitions. There can be no
assurance that such financing will be available to the Company, or if available,
will be available in either a timely manner or upon terms and conditions
acceptable to the Company.
28
<PAGE>
Market Risk
The Company does not hold any derivatives or investments that are subject
to market risk. The carrying values of financial instruments, including cash and
note payable at June 30, 1998 and 1997, approximate fair value as of those dates
because of the relatively short-term maturity of these instruments which
eliminates any potential market risk associated with such instruments.
Seasonality
The business of the Company does not experience significant seasonality.
Inflation
Management does not believe that inflation has had, or is expected to
have, any significant adverse impact on the Company's financial condition or
results of operations.
The Year 2000 Issue
Many existing computer programs use only two digits to identify a year in
their date fields. These programs were designed and developed without
considering the impact of the upcoming change in the century (the "Year 2000
Issue"). If not corrected, many computer applications could fail or create
erroneous results by or at the year 2000.
None of the Company's Card activations are date-dependent. All activations
and deactivations are based on payment and usage only, as a normal debit account
works. Further, the Company currently is not utilizing any integrated software
which will be impacted significantly by the Year 2000 Issue. As a result, the
Company does not anticipate significant expense in ensuring that the Company has
adequately provided for any corrections to its existing hardware or software.
Furthermore, the Company is currently evaluating an upgrade of its financial and
accounting software and has obtained documentation from vendors of such software
stating that the Year 2000 Issue has been addressed.
In addition, the Company is beginning the process of contacting its key
suppliers and other vendors to assure that they have addressed the Year 2000
issue as regards continuing provision of services to the Company.
Recent Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income," which established standards for reporting and display of
comprehensive income, its components and accumulated balances. Comprehensive
income is defined to
29
<PAGE>
include all changes in equity except those resulting from investments by, or
distributions to, owners. Among other disclosures, SFAS No.130 requires that all
items that are required to be recognized under current accounting standards as
components of comprehensive income be reported in a financial statement that is
displayed with the same prominence as other financial statements.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information," which supersedes SFAS No. 14, "Financial
Reporting for Segments of a Business Enterprise." SFAS No. 131 establishes
standards for the reporting of certain information about operating segments by
public companies in both annual and interim financial statements. SFAS No. 131
defines an operating segment as a component of an enterprise for which separate
financial information is available and whose operating results are reviewed
regularly by the chief operating decision maker to make decisions about
resources to be allocated to the segment and to assess its performance.
SFAS Nos. 130 and 131 are both effective for financial statements for
periods beginning after December 15, 1997 and both require comparative
information for earlier years to be restated. The adoption of SFAS No. 130 will
not have a material effect on the Company's financial position or results of
operations. The adoption of SFAS No. 131 will have no effect on the Company's
financial position or results of operations, and the Company continually
evaluates SFAS No. 131 in order to fully evaluate the impact, if any, the
adoption of the provisions of this Statement, will have on future financial
disclosures.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company believes that its financial instruments as described elsewhere
in this Form 10-K are not subject to material market risk. The Company's
financial instruments at June 30, 1998 and 1997 consist of Notes Payable of
$168,556 and $182,000 respectively. The carrying value of each of these
financial instruments approximates its market value due to the short maturity of
each of the instruments and due to the fact that the interest rates approximate
current market rates.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of the Company and related Notes
thereto and the financial information required to be filed herewith are included
on pages F-1 to F-28 and Schedule S-1 of this Report on Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
The information called for by Item 10, Directors and Executive Officers of
the Registrant; Item 11, Executive Compensation; Item 12, Security Ownership of
Certain Beneficial Owners and Management; and Item 13, Certain Relationships and
Related Transactions, is hereby incorporated by reference to the corresponding
sections of the Registrant's definitive proxy statement (the "Definitive Proxy
Statement") for its Annual Meeting of Stockholders to be held on November 18,
1998.
30
<PAGE>
Part IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 10-K
(a) Consolidated Financial Statements and Financial Schedules
(1) Consolidated Financial Statements
Page(s)
-------
Report of Independent Certified Public Accountants............. F-2
Consolidated Balance Sheets as of June 30, 1998 and 1997....... F-3
Consolidated Statements of Loss for the years ended
June 30, 1998, 1997 and 1996. ................................. F-4
Consolidated Statements of Stockholders' Equity (Deficit)
for the years ended June 30, 1998, 1997 and 1996............... F-5
Consolidated Statements of Cash Flows for the years ended
June 30, 1998, 1997 and 1996. ................................. F-6
Notes to Consolidated Financial Statements..................... F-8
(2) Financial Statement Schedule
Schedule II -- Valuation and Qualifying Accounts................ S-1
(b) Reports on Form 8-K
None
(c) Exhibits
4.4 Form of Note and Warrant Purchase Agreement, dated as of
September 1, 1998
10.23 Letter of Intent to acquire Phonecard Wholesalers, Inc. dated
February 16, 1998
10.24 Settlement Agreement with Frontier Communications, Inc., dated
August 7, 1998
10.25 Letter of Intent between Convergence Communications, Inc. and
DigiTEC 2000 Inc., dated September 22, 1998
27 Financial Data Schedule
- - --------
(1) To be filed by amendment.
F-1
<PAGE>
Report of Independent Certified Public Accountants
To the Board of Directors and Stockholders of
DigiTEC 2000, Inc. (formerly Promo Tel, Inc.)
New York, N.Y.
We have audited the accompanying consolidated balance sheets of DigiTEC 2000,
Inc. and subsidiary (formerly Promo Tel, Inc.) as of June 30, 1998 and 1997 and
the related consolidated statements of loss, stockholders' equity (deficit) and
cash flows for the years ended June 30, 1998, 1997 and 1996 and the financial
statement schedule of Digitec 2000, Inc. and subsidiary (the "Company") listed
in Item 14(a) of this Form 10-K. These financial statements and schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and schedule are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements and
schedule. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
presentation of the financial statements and schedule. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of DigiTEC 2000, Inc.
and subsidiary as of June 30, 1998 and 1997, and the consolidated results of
their operations and their cash flows for the years ended June 30, 1998, 1997
and 1996, in conformity with generally accepted accounting principles.
Also, in our opinion, the schedule presents fairly, in all material respects,
the information set forth therein.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1(a) to the
financial statements, the Company has experienced significant losses from
continuing operations for the three years ending June 30, 1998, has a deficit in
working capital and equity at June 30, 1998 and may have significant contractual
obligations as discussed in Note 6. These matters raise substantial doubt about
its ability to continue as a going concern. Management's plans in regard to
these matters are described in Note 1(a) to the financial statements. The
financial statements do not include any adjustments that might result from the
outcome of the uncertainties.
/s/ BDO Seidman, LLP
BDO Seidman, LLP
New York, New York
October 9, 1998
F-2
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Consolidated Balance Sheets
================================================================================
<TABLE>
<CAPTION>
June 30, 1998 1997
- - -------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Current:
Cash $ 108,722 $ 727,197
Accounts receivable, net of allowance for bad
debts of $1,305,000 and $60,000 (Note 3) 1,692,222 1,868,227
Inventory 393,586 218,877
Prepaid expenses and other 123,953 11,814
- - -------------------------------------------------------------------------------------------------
Total current assets 2,318,483 2,826,115
Property and equipment, net of depreciation of
$64,877 and $14,202 (Note 4) 160,040 64,397
Customer lists, net of accumulated amortization of
$334,000 and $98,000 (Note 7) 373,882 606,920
Carrier deposits and other 287,385 29,291
- - -------------------------------------------------------------------------------------------------
$ 3,139,790 $ 3,526,723
=================================================================================================
Liabilities and Stockholders' Deficit
Current:
Accounts payable - trade $ 1,379,896 $ 2,410,756
Accounts payable and accrued expenses 464,620 551,698
Payable to Premiere Communications, Inc.
(Note 6) 597,132 123,923
Accrued legal 450,188 47,313
Accrued settlement expenses (Note 8) 204,126 --
Accrued research and development (Note 2(j)) 325,000 --
Deferred revenue 955,117 --
Note payable - current (Note 7) 168,556 117,610
Net liabilities of discontinued operations
(Notes 5(b) and 15) -- 211,502
- - -------------------------------------------------------------------------------------------------
Total current liabilities 4,544,635 3,462,802
Note payable (Note 7) -- 64,390
Deferred rent (Note 2(k)) 89,545 71,000
- - -------------------------------------------------------------------------------------------------
Total liabilities 4,634,180 3,598,192
- - -------------------------------------------------------------------------------------------------
Commitments and contingencies (Notes 6 and 9)
Stockholders' deficit
Series A Callable at $100 per share, Convertible
Preferred Stock, $.001 par value, 1,000,000
shares authorized; 61,050 and -0-, shares issued
and outstanding, respectively 61 --
Common Stock, $.001 par value, 100,000,000
shares authorized; 6,814,248 and 4,858,418
shares issued and outstanding, respectively 6,814 4,858
Additional paid-in capital 14,174,283 3,602,462
Accumulated deficit (15,675,548) (3,678,789)
- - -------------------------------------------------------------------------------------------------
Total stockholders' deficit (Notes 10 and 11) (1,494,390) (71,469)
- - -------------------------------------------------------------------------------------------------
$ 3,139,790 $ 3,526,723
=================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Consolidated Statements of Loss
================================================================================
<TABLE>
<CAPTION>
Year ended June 30,
------------------------------------------------
1998 1997 1996
- - -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net sales (Note 3) $ 35,032,533 $ 26,027,909 $ 17,425,199
Cost of sales (Note 3) 33,545,412 25,161,443 16,900,370
- - -------------------------------------------------------------------------------------------------------
Gross profit 1,487,121 866,466 524,829
Selling, general and administrative
expenses (Note 3, 6, 10(b)) 12,394,471 2,040,749 654,104
- - -------------------------------------------------------------------------------------------------------
Loss before other income (expenses) (10,907,350) (1,174,283) (129,275)
- - -------------------------------------------------------------------------------------------------------
Other income (expenses):
Other income 10,869 34,260 --
Loss on modification of debt terms (Note 7) (287,100) -- --
Loss on note satisfaction (Note 5(b)) -- (1,340,230) --
- - -------------------------------------------------------------------------------------------------------
Other expenses (276,231) (1,305,970) --
- - -------------------------------------------------------------------------------------------------------
Loss from continuing operations (11,183,581) (2,480,253) (129,275)
- - -------------------------------------------------------------------------------------------------------
Discontinued operations (Notes 5(b) and 15):
Loss from operations of Cellular Division (527,061) -- --
Loss from operations of World Access -- (175,914) --
Loss on disposal of Cellular Division (114,524) -- --
Loss on disposal of World Access (171,593) (893,347) --
- - -------------------------------------------------------------------------------------------------------
Loss from discontinued operations (813,178) (1,069,261) --
- - -------------------------------------------------------------------------------------------------------
Net loss $(11,996,759) $ (3,549,514) $ (129,275)
=======================================================================================================
Net loss per common share-basic and diluted
(Note 11):
Loss from continuing operations $ (1.99) $ (.55) $ (.05)
Loss from discontinued operations (.15) (.23) --
- - -------------------------------------------------------------------------------------------------------
$ (2.14) $ (.78) $ (.05)
=======================================================================================================
Weighted average number of common and common
equivalent shares outstanding used in basic and
diluted 5,618,994 4,579,075 2,599,532
=======================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Consolidated Statements of Stockholders' Equity (Deficit)
================================================================================
<TABLE>
<CAPTION>
Preferred stock Common stock Additional
------------------ --------------------- paid-in Accumulated
Shares Amount Shares Amount capital deficit
- - ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance, June 30, 1995 -- $ -- 1,333,334 $ 1,334 $ (1,334) $ --
Sale of common stock relating to merger
with Promo Tel-Nevada (Note 1(b)) -- -- 59,042 59 (59) --
Issuance of stock subscriptions -- -- 833,333 833 499,167 --
Issuance of common stock relating to
debt conversion (Note 5(a)) -- -- 833,333 833 499,167 --
Issuance of options to purchase common
stock in exchange for customer lists and
other tangible property (Note 5(b)) -- -- -- -- 584,143 --
Issuance of common stock relating to asset
purchase (Note 3(a)) -- -- 1,605,385 1,605 1,670,473 --
Payment of stock subscriptions receivable -- -- -- -- -- --
Net loss -- -- -- -- -- (129,275)
- - ------------------------------------------------------------------------------------------------------------------------------
Balance, June 30, 1996 -- -- 4,664,427 4,664 3,251,557 (129,275)
Acquisition of treasury stock (Note 3(a)) -- -- -- -- -- --
Retirement of treasury stock -- -- (130,259) (131) (135,145) --
Exercise of warrants -- -- 324,250 325 486,050 --
Net loss -- -- -- -- -- (3,549,514)
- - ------------------------------------------------------------------------------------------------------------------------------
Balance, June 30, 1997 -- -- 4,858,418 4,858 3,602,462 (3,678,789)
Exercise of warrants -- -- 1,955,825 1,956 2,931,782 --
Issuance of options to directors in lieu
of compensation (Note 10) -- -- -- -- 1,248,000 --
Adjustment: Fractional shares -- -- 5 -- -- --
Issuance of preferred stock to satisfy
trade payable (Note 6) 61,050 61 -- -- 6,104,939 --
Issuance of option related to debt
modification -- -- -- -- 287,100 --
Net loss -- -- -- -- -- (11,996,759)
- - ------------------------------------------------------------------------------------------------------------------------------
Balance, June 30, 1998 61,050 $ 61 6,814,248 $ 6,814 $ 14,174,283 $(15,675,548)
==============================================================================================================================
<CAPTION>
Stock sub- Treasury stock Total
scriptions ----------------------- stockholders'
receivable Shares Amount equity (deficit)
- - --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance, June 30, 1995 $ -- -- $ -- $ --
Sale of common stock relating to merger
with Promo Tel-Nevada (Note 1(b)) -- -- -- --
Issuance of stock subscriptions (440,000) -- -- 60,000
Issuance of common stock relating to
debt conversion (Note 5(a)) -- -- -- 500,000
Issuance of options to purchase common
stock in exchange for customer lists and
other tangible property (Note 5(b)) -- -- -- 584,143
Issuance of common stock relating to asset
purchase (Note 3(a)) -- -- -- 1,672,078
Payment of stock subscriptions receivable 440,000 -- -- 440,000
Net loss -- -- -- (129,275)
- - --------------------------------------------------------------------------------------------------------------
Balance, June 30, 1996 -- -- -- 3,126,946
Acquisition of treasury stock (Note 3(a)) -- 130,259 (135,276) (135,276)
Retirement of treasury stock -- (130,259) 135,276 --
Exercise of warrants -- -- -- 486,375
Net loss -- -- -- (3,549,514)
- - --------------------------------------------------------------------------------------------------------------
Balance, June 30, 1997 -- -- -- (71,469)
Exercise of warrants -- -- -- 2,933,738
Issuance of options to directors in lieu
of compensation (Note 10) -- -- -- 1,248,000
Adjustment: Fractional shares
Issuance of preferred stock to satisfy
trade payable (Note 6) -- -- -- 6,105,000
Issuance of option related to debt
modification -- -- -- 287,100
Net loss -- -- -- (11,996,759)
- - --------------------------------------------------------------------------------------------------------------
Balance, June 30, 1998 $ -- -- $ -- (1,494,390)
==============================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Consolidated Statements of Cash Flows
================================================================================
<TABLE>
<CAPTION>
Year ended June 30,
--------------------------------------------
1998 1997 1996
- - ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $(11,996,759) $ (3,549,514) $ (129,275)
Adjustments to reconcile net loss to net cash used in
operating activities:
Provision for bad debts 1,467,656 196,752 86,752
Provision for bad debts - Cellular Division 52,463 -- --
Write-off of accounts receivable (222,656) (130,000) (33,504)
Write-down of inventory 206,281 (33,000) --
Depreciation 50,675 11,657 2,545
Amortization 236,256 87,798 9,946
Promotional expense 2,868,989 -- --
Deferred revenue 955,117 (567,136) 567,136
Deferred rent 18,545 71,000 --
Directors' compensation 1,248,000 -- --
Loss on modification of debt 287,100 -- --
Loss on disposal of World Access 171,593 893,347 --
Write-down of Cellular Division 114,524 -- --
Loss on write-down of note receivable -- 1,340,230 --
(Increase) decrease in:
Accounts receivable (1,161,958) (1,539,648) (752,100)
Inventory (381,433) (146,948) (71,929)
Prepaid expenses and other (104,727) 470,047 (530,726)
Carrier deposits and other (258,093) -- --
Increase (decrease) in:
Accounts payable - trade (1,030,860) 1,735,432 675,325
Accounts payable and accrued expenses (87,078) 486,322 65,376
Payable to Premiere Communications, Inc. 3,709,220 123,923 --
Accrued legal 402,875 26,739 20,574
Accrued settlement 204,126 -- --
Accrued research and development 325,000 -- --
- - ------------------------------------------------------------------------------------------------------------
Net cash used in operating activities of
continuing operations (2,925,144) (522,999) (89,880)
Net cash provided by (used in) operating activities of
discontinued operations (497,619) 82,925 --
- - ------------------------------------------------------------------------------------------------------------
Net cash used in operating activities (3,422,763) (440,074) (89,880)
- - ------------------------------------------------------------------------------------------------------------
============================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Consolidated Statements of Cash Flows (continued)
================================================================================
<TABLE>
<CAPTION>
Year ended June 30,
---------------------------------------------
1998 1997 1996
- - ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from investing activities:
Capital expenditures $ (87,181) $ (69,439) $ (9,160)
Proceeds from repayment of related party loans -- 41,218 --
Payment received on note receivable -- 200,000 100,000
Purchase of communications equipment -- -- (533,625)
Proceeds from sale of assets -- -- 50,000
Issuance of related party loans -- -- (68,218)
- - ------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing
activities (87,181) 171,779 (461,003)
- - ------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Repayment of Prime Communications loan (35,000) -- --
Principal payments on note payable (7,269) -- --
Proceeds from exercise of warrants 2,933,738 486,375 --
Proceeds from stock subscriptions -- -- 500,000
Proceeds from issuance of convertible debt -- -- 500,000
- - ------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 2,891,469 486,375 1,000,000
- - ------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash (618,475) 218,080 449,117
Cash (including restricted cash of $367,363 at June 30,
1996), beginning of period 727,197 509,117 60,000
- - ------------------------------------------------------------------------------------------------------------
Cash (including restricted cash of $367,363 at June 30,
1996), end of period $ 108,722 $ 727,197 $ 509,117
============================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
F-7
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Notes to Consolidated Financial Statements
================================================================================
1. The Company (a) Liquidity and Basis of Presentation
The accompanying consolidated financial
statements of the Company have been
prepared on the basis that it is a going
concern, which contemplates the
realization of assets and the satisfaction
of liabilities, except as otherwise
disclosed, in the normal course of
business. However, because of the
Company's recurring losses from
operations, such realization of assets and
liquidation of liabilities is subject to
significant uncertainty. The financial
statements do not include any adjustments
that might result from the outcome of
uncertainties. Further, the Company's
ability to continue as a going concern is
highly dependent near term on its ability
to raise capital, reduce its costs of
providing long distance service, develop
its collections tactics, develop market
share and achieve profitable operations
thereon, and the ability to generate
sufficient cash flow from operations and
financing sources to meet obligations.
During the first quarter of 1999, the
Company addressed its working capital
needs through the issuance of $1.2 million
10% six month notes. As the
facilities-based operations increase, the
Company believes that the operating cash
flow will increase because the payments to
suppliers are payable after the usage of
the Cards versus prepaid in the case of
bundled Cards. In addition, the Company
has entered into a Letter of Intent with
Convergence Communications, Inc. ("CCI")
pursuant to which the Company agreed to
enter into negotiations with respect to
combining the two companies, an
Origination/Termination Agreement, and/or
issuance of $1,000,000 convertible
promissory note from CCI. The Company is
continuing to negotiate new agreements
with suppliers with more competitive
pricing. There can be no assurance that
the negotiations with other suppliers will
be successful or that the Company will be
able to continue to market bundled cards
in its transition to a facilities-based
carrier. Operationally, the Company plans
a complete review of its selling, general
and administrative expenses, which
management believes may provide cost
reductions and reduced cash needs of
approximately $500,000 during the
remainder of the 1999 fiscal year. In
addition, the Company expects to realize
approximately $250,000 in cash generation
through a gradual reduction in bundled
Card inventory, which represents the
majority of its current inventory, as the
bundled Cards are phased out during the
transition to facilities-based operations.
However, there can be no assurance that
these objectives will be met or that
acceptable alternatives will be found.
(b) Business
DigiTEC 2000, Inc. and Subsidiary
(formerly Promo Tel, Inc., the "Company")
is primarily engaged in the distribution,
marketing and management of prepaid
telephone calling cards ("Cards"). It
currently markets its telephone calling
card products principally throughout the
New York tri-state metropolitan area. On
October 18, 1996, the Company changed its
name to DigiTEC 2000, Inc.
(c) Organization
On July 11, 1995, Promo Tel, Inc., a
Delaware corporation ("Promo
Tel-Delaware"), merged (the "Merger") into
Promo Tel, Inc., a Nevada corporation
("Promo Tel-Nevada"). Immediately prior to
the Merger, Promo Tel-Nevada changed its
name from Yacht Havens International Corp.
("Yacht Havens"). The surviving
corporation remained Promo Tel, Inc.
Pursuant to the terms of the Merger, Promo
Tel-Nevada, which had 59,042 shares of its
common stock previously outstanding,
exchanged with the sole stockholder of
Promo Tel-Delaware an aggregate of
1,333,334 shares of previously unissued
$.001 Promo Tel-Nevada common stock for
the outstanding shares of Promo
Tel-Delaware's outstanding common stock.
F-8
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Notes to Consolidated Financial Statements
(continued)
================================================================================
Since the Merger resulted in voting
control by the stockholder of Promo
Tel-Delaware and Promo Tel-Delaware had
the personnel and owned all the assets to
be utilized for its ongoing business, the
Merger was treated as a recapitalization
of Promo Tel-Delaware and the sale of
59,042 shares of previously issued Promo
Tel-Nevada common stock for the net assets
of Promo Tel-Nevada ($-0-).
Promo Tel-Delaware is the continuing
entity for financial reporting purposes,
and the financial statements prior to July
11, 1995 represent its financial position
and results of operations. The assets,
liabilities and results of operations of
Promo Tel-Nevada are included as of July
11, 1995. The Company was formed on May
18, 1995 and commenced operations in July
1995. Although Promo Tel-Delaware is
deemed to be the acquiring corporation for
financial accounting and reporting
purposes, the legal status of Promo
Tel-Nevada as the surviving corporation
has not changed. Promo Tel-Nevada had
amended its Articles of Incorporation to
change its name from Promo Tel, Inc. to
the Company's current name (Note 1(a)).
In September 1996, the Board of Directors
of the Company approved a reverse stock
split of the Company's common stock. Each
stockholder of record on October 18, 1996
received one share of new common stock for
each six shares of common stock held. The
equity accounts of the Company and all
disclosures have been retroactively
adjusted to reflect the recapitalization
and the one-for-six reverse stock split.
2. Summary of Significant (a) Principles of Consolidation
Accounting Policies
The consolidated financial statements
include the accounts of the Company and,
from June 1, 1997, through October 1997,
its wholly-owned subsidiary, World Access
Solutions, Inc. ("World Access"). All
significant intercompany balances and
transactions have been eliminated. (See
Notes 5 and 12.)
(b) Use of Estimates
In preparing the consolidated financial
statements in conformity with generally
accepted accounting principles, management
is required to make estimates and
assumptions that affect the reported
amounts of assets and liabilities at the
date of the consolidated financial
statements and revenues and expenses
during the reported period. Actual results
could differ from those estimates.
(c) Revenue Recognition
F-9
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Notes to Consolidated Financial Statements
(continued)
================================================================================
Sales of bundled Cards from third-party
providers for which the Company acts
solely as a distributor are recorded at
the sale price of the Card and are
recognized upon delivery. The related cost
of the Cards is simultaneously charged to
the cost of sales.
Revenue from the sale of proprietary,
branded, facilities-based prepaid phone
Cards and the related costs of providing
long distance services are recognized as
the telephone calls are completed by end
users. A monthly access fee of $.25 per
Cards is recognized at the beginning of
each month commencing thirty days after
the first use of the Card. Unused calling
time is recognized into income on the
expiration date of the Card, twelve months
after activation, subject to applicable
state escheat laws. Amounts collected
prior to the recording of revenue are
classified as Deferred Revenue.
(d) Allowance for Bad Debts
The Company maintains an allowance for bad
debts to provide for estimated future
losses due to lack of collectibility of
customers' accounts. These allowances are
based on a detailed analysis of
delinquencies, an assessment of overall
risks, mamagement's evaluation of probable
losses, historical performance, and the
credit grade of certain customers.
Specific accounts are written off when the
probability of loss has been established
in amounts determined to cover such losses
after considering the customer's financial
condition. (See Note 3(b))
(e) Cash and Cash Equivalents
The Company considers cash and cash
equivalents as those highly liquid
investment purchased with original
maturity of three months or less. The risk
associated with cash and cash equivalents
in banks is considered low as management
utilizes financial institutions with a
credit quality of at least AA.
(f) Inventory
F-10
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Notes to Consolidated Financial Statements
(continued)
================================================================================
Inventory, consisting primarily of
telephone calling cards, is stated at the
lower of cost or market. Cost is
determined by the first-in, first-out
(FIFO) method.
(g) Property and Equipment
Property and equipment are stated at cost.
Depreciation and amortization are
calculated using the straight-line method
over the estimated useful lives of the
assets ranging from 3 to 5 years.
(h) Customer Lists
Customer lists were purchased from third
parties during 1997 and 1996. These costs
are amortized on a straight-line basis
over the estimated useful lives of the
customer bases acquired, which approximate
three years. The Company periodically
evaluates the recoverability of these
intangibles based on several factors,
including management's intention with
respect to the acquired assets and the
estimated future non-discounted cash flows
expected to be generated by such assets.
To date, the Company has not recorded any
impairment of its intangibles.
(i) Carrier Deposits
Carrier deposits represent deposits
required by the facilities providers to
secure usage of telecommunications
facilities. Carrier deposits are included
in other assets for financial statement
purposes.
(j) Research and Development
Research and development costs consist of
costs to develop customized programs for
the Company's Prepaid Phone Card products
and services. These costs are recorded as
period expenses when incurred and included
in selling, general and administrative
expenses. For the year ended June 30,
1998, the amount of $325,000 represents
the Company's portion of the development
costs incurred pursuant to the agreement
with College Enterprises, Inc. ("CEI"),
which offers telecommunications services
to certain universities and schools. The
Company intends to offer long distance
telecommunications service to CEI debit
card users during fiscal 1999. Amounts
incurred by the Company during fiscal 1997
and 1996 were deemed immaterial.
(k) Deferred Rent
The Company accounts for rent on a
straight-line basis over the term of the
leases. The effect of such adjustment for
the years ended June 30, 1998 and 1997 was
approximately $18,545 and $71,000
respectively. No adjustment was necessary
for fiscal 1996.
(l) Advertising Costs
All advertising costs are expensed as
incurred and included in selling, general
and administrative expenses.
F-11
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Notes to Consolidated Financial Statements
(continued)
================================================================================
(m) Deferred Income Taxes
Deferred tax assets and liabilities are
recognized for the future tax consequences
attributable to temporary differences
between the financial statement carrying
amounts of existing assets and liabilities
and their respective tax bases and any
operating loss or tax credit
carryforwards. Deferred tax assets and
liabilities are measured using enacted tax
rates expected to apply to taxable income
in the years in which those temporary
differences are expected to be recovered
or settled. The effect on deferred tax
assets and liabilities of a change in tax
rates is recognized in income in the
period that includes the enactment date of
such change. Adequate reserves against
deferred tax assets which may not be
utilized have been provided.
(n) Earnings Per Share
The Company adopted the provisions of
Statement of Financial Accounting
Standards ("SFAS") No. 128 "Earnings per
Share" for the fiscal year ended June 30,
1998. The adoption of this standard did
not have a material impact on the
Company's income (loss) per share
computation. The computation of income
(loss) per common share is based on the
weighted average number of common shares
and common stock equivalents (convertible
preferred shares, stock options and
warrants), assumed to be outstanding
during the year. The dilutive earnings
(loss) per share have not been presented
since the effect of the options and
warrants to purchase common stock and the
convertible preferred stock were
anti-dilutive. Net loss per share amounts
for all periods have been presented and
the amounts of prior periods have been
restated to comply with provisions of SFAS
128. The weighted average shares have been
retroactively adjusted to reflect the
exchange of the 1,333,334 shares and the
one-for-six reserve stock split.
(o) Fair Value of Financial Instruments
The carrying values of financial
instruments, including cash and
note payable at June 30, 1998 and 1997,
approximate fair value as of those dates
because of the relatively short-term
maturity of these instruments and because
their interest rates approximate current
market rates.
(p) Reclassifications
Certain amounts as previously reported
have been reclassified to conform to the
1998 presentation.
F-12
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Notes to Consolidated Financial Statements
(continued)
================================================================================
(q) Recent Accounting Pronouncements
In June 1997, the FASB issued SFAS No.
130, "Reporting Comprehensive Income",
which established standards for reporting
and display of comprehensive income, its
components and accumulated balances.
Comprehensive income is defined to include
all changes in equity except those
resulting from investments by, or
distributions to, owners. Among other
disclosures, SFAS No. 130 requires that
all items that are required to be
recognized under current accounting
standards as components of comprehensive
income be reported in a financial
statement that is displayed with the same
prominence as other financial statements.
In June 1997, the FASB issued SFAS No.
131, "Disclosures about Segments of an
Enterprise and Related Information", which
supersedes SFAS No. 14, "Financial
Reporting for Segments of a Business
Enterprise." SFAS No. 131 establishes
standards for the reporting of certain
information about operating segments by
public companies in both annual and
interim financial statements. SFAS No. 131
defines an operating segment as a
component of an enterprise for which
separate financial information is
available and whose operating results are
reviewed regularly by the chief operating
decision maker to make decisions about
resources to be allocated to the segment
and to assess its performance.
SFAS Nos. 130 and 131 are both effective
for financial statements for years
beginning after December 15, 1997 and both
require comparative information for
earlier years to be restated. The adoption
of SFAS No. 130 will not have a material
effect on the Company's financial position
or results of operations. The adoption of
SFAS No. 131 will not have a material
effect on the Company's financial position
or results of operations. The Company
continually evaluates SFAS No. 131 in
order to fully evaluate the impact, if
any, the adoption of the provisions of
this Statement, will have on future
financial disclosures.
3. Concentrations of The Company experiences risk concentration
Credit Risk due to geographic and customer concentrations
and a limited number of suppliers.
(a) Geographic Concentration of Sales
F-13
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Notes to Consolidated Financial Statements
(continued)
================================================================================
The Company currently distributes and
markets its Cards primarily in the New
York/New Jersey metropolitan area (the
"Metro Area"). The Company sells Cards in
29 states, Puerto Rico and the U.S. Virgin
Islands. The Metro Area sales accounted
for approximately 63% and 79% of the
Company's total sales for the years ending
June 30, 1998 and 1997, respectively, and
had outstanding receivables equating to
____ and _____ at June 30, 1998 and 1997,
respectively. No other areas accounted for
more than 10% of the Company's sales or
outstanding accounts receivable.
(b) Concentration of Customer Accounts
For the years ended June 30, 1998 and
1997, one master distributor accounted for
approximately 0% and 48% of the Company's
accounts receivable and 19% and 52% of the
Company's sales, respectively. During
September 1997, the Company amended its
agreement with the master distributor by
terminating the exclusivity clause of the
distribution agreement. An additional
customer accounted for approximately 73%
of the Company's accounts receivable as of
June 30, 1998, and approximately 19% of
the Company's sales for the year ended
June 30, 1998. At June 30, 1996,
approximately 60% of trade receivables and
approximately 57% of sales for the year
ended June 30, 1996 was accounted for by
the master distributor who had certain
exclusive distribution rights in the Metro
Area with respect to one of the Company's
programs. No other customer accounted for
more than 10% of revenue or outstanding
accounts receivable.
During the quarter ended June 30, 1998,
the Company reserved by recording a
provision for bad debts of $1,467,000 and
wrote off approximately $223,000 of
accounts receivable against its accounts
receivable reserve. During the first three
quarters of fiscal 1998, management
believed that accounts receivable would be
collected. However, by year end,
management decided that due to the
increased amount of receivables aged over
90 days, that the risk of asset impairment
had increased and, accordingly, that both
a write-off of selected accounts and an
increased reserve for bad debt was
necessary.
F-14
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Notes to Consolidated Financial Statements
(continued)
================================================================================
(c) Concentration of Suppliers of
Telecommunications Services
The Company has purchased its long
distance services from three suppliers of
bundled Cards, Frontier Communications,
Inc. ("Frontier"), Premiere
Communications, Inc. ("Premiere") and ATI
Telecom, Inc. ("ATI"). For the years ended
June 30, 1998 and 1997, respectively,
Frontier accounted for approximately 35%
and 48%, Premiere accounted for
approximately 43% and 30%, and ATI
accounted for approximately 14% and 0%,
respectively, of those services. As of
June 30, 1998, the amounts of accounts
payable to Frontier, Premiere and ATI were
approximately $502,000, $597,000 and
$363,000, respectively.
4. Property and Equipment Major classes of property and equipment are:
Estimated
June 30, useful
------------------- lives
1998 1997 (in years)
-------------------------------------------------------------------------
Computer equipment $182,222 $ 72,195 3
Furniture, fixtures and office
equipment 21,284 5,404 5
Vehicles 21,411 -- 5
-------------------------------------------------------------------------
Property and equipment 223,917 78,599
Less: Accumulated depreciation 64,877 14,202
-------------------------------------------------------------------------
Property and equipment, net $160,040 $ 64,397
=========================================================================
Depreciation expense for the years ended June
30, 1998, 1997 and 1996 was approximately
$50,700, $11,700 and $2,500, respectively.
F-15
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Notes to Consolidated Financial Statements
(continued)
================================================================================
5. Related Party (a) On January 20, 1996, the Company
Transactions purchased certain Internet service
provider assets consisting primarily of
computer hardware, software and office
equipment from Telephone Electronics
Corporation ("TEC") in exchange for
1,605,385 shares of the Company's
restricted common stock valued at
approximately $1.7 million based on the
estimated fair values of the assets
received. TEC is a communications company
headquartered in Jackson, Mississippi that
provides local and long distance telephone
exchange services and provides other
telecommunications services nationally.
Subsequent to the purchase date, the
purchase agreement was amended to reflect
certain assets which were not delivered by
TEC, resulting in a receivable from TEC of
$135,276 at June 30, 1996. In November
1996, TEC returned 130,259 of the
Company's shares to the Company. TEC's
current ownership interest at June 30,
1998 was approximately 22%.
(b) The Company helped establish TecLink,
Inc. ("TecLink") as a Mississippi-based
Internet service provider by selling to
TecLink certain Internet service provider
assets, intellectual property, computer
hardware, software and office equipment
(that it had previously purchased from TEC
and others) as well as a value added
reseller contract (the "Contract") from
Hughes Corporation ("Hughes"). The Company
received in the sale $50,000 cash and a 6%
per annum promissory note of $2,405,000
due the earlier of December 31, 1998 or
upon the completion of TecLink's initial
public offering. In accordance with the
terms of the promissory note,
collateralized by the assets of TecLink,
the $250,000 became due upon the
completion of a private placement of
TecLink's common stock. TecLink's
management believed that Hughes never met
their responsibility under the contract,
as such, TecLink was never able to fully
implement its business plan. As a result
of this and other factors, TecLink's
initial public offering was never
consummated and TecLink continued to
experience losses. Due to the continuing
losses, the Company entered into an
agreement to acquire the net assets as
partial satisfaction of its outstanding
balance of its note receivable from
TecLink ($2,105,000). As a result, the
Company recorded a loss of $1,340,230. The
Company established World Access as a
wholly-owned subsidiary providing Internet
access with the net assets re-acquired
from TecLink.
As of June 30, 1997, management determined
that it needed to focus on its core
business and would discontinue the
operations of World Access by selling its
net assets.
F-16
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Notes to Consolidated Financial Statements
(continued)
================================================================================
On October 1, 1997, the Company entered
into an agreement (the "Agreement") to
sell the customer base, the related
hardware related to servicing the customer
base and its obligations under World
Access' leases for its premises and
telephone equipment to Meta3, Inc.
("Meta3"), a Mississippi corporation in a
similar line of business. The Agreement
calls for Meta3 to pay for the subscribers
at $10 per month per customer for ten
months. The amount to be paid will be
adjusted by the identified customer base's
net attrition rate for the first five
months of the purchase period. As a result
of the Agreement and the Company's plan to
dispose of the remaining assets and
liabilities, the Company recorded a loss
on disposal of $893,347 for the year ended
June 30, 1997. At June 30, 1997, $175,000
was accrued for the estimated remaining
expenses related to the of World Access.
For the year ended June 30, 1998, the
Company recorded an actual loss of
$171,593 on the disposal, which represents
a complete write-off of all net assets of
World Access.
(c) During September, 1998, the Company
issued $1,200,000 of 10% Six-month Notes
(the "Notes") and warrants to purchase
600,000 shares of the Company's Common
Stock at an exercise price of $2.375 per
share (the "$2.375 Warrants"), subject to
certain adjustments. The $2.375 Warrants
are exercisable for five years from the
date of issuance. The exercise price under
the $2.375 Warrants are set at the closing
price of the Common Stock on September 4,
1998. Nine investors participated in this
offering, including an officer/director
and his family, and a director, totaling
$600,000. The issuance and sale of the
Notes and $2.375 Warrants are exempt from
registration under the Securities Act of
1933, as amended ("the "Securities Act")
pursuant to Regulation D.
6. Transactions with On September 25 and 26 of 1997, the Company
Premiere entered into two agreements with Premiere
Communications, Inc. providing for the Company to purchase $6
million and $75 million of Cards at discounts
ranging from 23.5% to 41.75% off the retail
value of the cards by August 31, 1998. Under
the first of the two agreements with Premiere,
the Company entered into a $6,000,000, 15% per
annum notes payable that was satisfied with
purchases by December 31, 1997. In order to
fulfill its obligation under the second
agreement, the Company issued a purchase order
for approximately $31 million of Cards on
August 28, 1998. As of October 9, 1998,
Premiere has not filled this purchase order.
Although failure of the Company to purchase
the minimum value would result in the Company
being required to pay Premiere an amount equal
to the retail value of the unsold minimum
number of Cards less the applicable discount,
the Company believes it has satisfied its
commitments. The Company is currently
contesting certain provisions of the agreement
with Premiere and is seeking damages arising
thereunder. Accordingly, notwithstanding the
foregoing description, the Company reserves
all rights against Premiere.
The Company believes that it is not subject to
any remaining obligation under the agreement
because Management believes Premiere has
breached its contract suspending one of the
Company's card programs and repricing the
Cards under another of the Company's programs.
The Company is continuing to negotiate with
Premiere to resolve various operating and
contractual matters. Although the Company does
not have any arrangements in place for the
supply of telecommunications services provided
by Premiere, the Company is negotiating new
agreements with other suppliers. There can be
no assurance that the negotiations with other
suppliers will be successful or that the
Company will be able to continue to market
bundled Cards in its transition to a
facilities-based carrier.
On March 31, 1998, the Company entered into an
agreement with Premiere (the "Investment
Agreement") in which Premiere received 61,050
shares of $.001 par value voting Series A
Convertible Preferred Stock (the "Preferred
Stock"), valued by the Board of Directors at
$6,105,093 which represented the balance of
the amounts payable to Premiere at March 31,
1998. The $6,105,093 included $3,236,104
attributed to the normal course of business, a
$1,400,877 charge for excess minutes processed
by Premiere which was invoiced to the
Company's main distributor, and $1,468,112 for
a one-time promotional expense for additional
excess minutes processed by Premiere. The
$1,400,877 was charged against cost of goods
sold during the third quarter of 1998.
F-17
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Notes to Consolidated Financial Statements
(continued)
================================================================================
7. Note Payable As part of an acquisition agreement dated May
1, 1997 with Prime Communications, Inc.
("Prime") to acquire Prime's customer base,
the Company entered into an unsecured 8% per
annum note payable for $182,000 and forgave
approximately $204,000 of trade receivables.
The note was payable monthly from November 1,
1997 to October 1, 1998. On June 29, 1998, the
parties renegotiated the terms of the note, as
the Company did not comply with the original
payment provisions. The revised terms provided
for a principal payment of $35,000 on June 30,
1998 with the remaining balance of $147,000
payable in monthly installments of $12,787
commencing on August 1, 1998 and maturing on
July 1, 1999. In conjunction with this
renegotiation, the Company issued an option to
Prime to purchase 145,000 shares of Common
Stock at the negotiated exercise price of
$13.20 per share (the "$13.20 Option") with a
contractual life of approximately 9.5 years.
This issuance was charged as a $287,100 debt
modification charge based on the fair value of
the $13.20 Option on the date of grant.
Management calculated the fair value of the
$13.20 Option at the grant date using the
Black-Scholes option pricing model. Key
assumptions used to apply this pricing model
include: no dividends paid for all years, a
volatility factor of 46.5%, a risk-free
interest rate of 4.9% and an expected life of
6.9 years. As of June 30, 1998, the Company
had paid $35,000 principal and $13,564
interest on the note. As of September 30,
1998, the Company has remained current on its
obligations under the note.
8. Accrued Settlement During March 1998, Vanity Fair Intimates, Inc.
("Vanity Fair") commenced an action for breach
of a sublease agreement, seeking, inter alia,
judgment against the Company for a total of
$472,799. The matter was settled on September
1, 1998 for a total sum of $208,916, which is
payable monthly through February 1999. (See
Note 9(a))
9. Commitments and (a) Leases
Contingencies
The Company leases its office space under
a noncancellable operating sublease
agreement which expires on March 31, 2001.
Rent expense for the years ended June 30,
1998, 1997 and 1996 was approximately
$261,000, $144,000, and $52,000,
respectively. Future minimum rentals
required as of June 30, 1998 under all
noncancellable operating leases (exclusive
of renewals and inclusive of the
settlement with Vanity Fair (See Note 8))
are:
F-18
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Notes to Consolidated Financial Statements
(continued)
================================================================================
Fiscal year ended June 30,
------------------------------------------
1999 $ 534,000
2000 317,000
2001 240,000
------------------------------------------
$1,091,000
==========================================
(b) Litigation
The Company and its Chief Executive
Officer have been named as defendants in a
legal action in Mississippi in the case
entitled, Heritage Graphics, Inc.
("Heritage") vs. Telephone Electronics
Corporation. The compliant alleges, among
other things, that the defendants breached
a contractual agreement and conspired to
have Heritage go out of business. The
compliant seeks damages of $500,000,000.
The case is in discovery. Management
believes such litigation will not have a
material adverse effect on the financial
condition or operations of the Company,
and is defending the suit vigorously and
asserting appropriate counterclaims. The
case is set for trial on September 7,
1999.
In June 1998, the Company was served by a
former distributor who alleges that a
preferential payment or fraudulent
transfer in the amount of $150,800 was
made to the Company by Magic
Communications, Inc. ("Magic"), an
affiliate of Conetco. Conetco, a reseller
of long distance telecommunications
services which it purchased from WorldCom
Network Services ("WorldCom"), sold
prepaid telephone debit cards through
Magic which acted as its master sales
agent. After WorldCom terminated Conetco's
access to its long distance network
because of Conetco's failure to pay its
large outstanding balance, the debit cards
became useless. Conetco alleges that a
"refund" of $150,800 in the form of a
credit was given by Magic to the Company
as a result of cash refunds that the
Company had given to its customers on
account of returned debit cards. An answer
asserting number defenses, including that
the Company never received the "refund" in
question, has been filed on behalf of the
Company, and a pre-trial conference is
scheduled for October 15, 1998. Management
believes such litigation will not have a
material adverse effect on the financial
condition or operations of the Company,
and is defending the suit vigorously.
(c) Employment Agreements
As of June 30, 1998, the Company has
employment agreements with three of its
officers and an additional employee. The
aggregate minimum payments under the
agreements are as follows:
F-19
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Notes to Consolidated Financial Statements
(continued)
================================================================================
Year ending June 30,
------------------------------------------
1999 $ 807,500
2000 882,500
------------------------------------------
$1,690,000
==========================================
(d) Provider Commitments
Pursuant to its Service Agreement with
Innovative Telecom Corporation
("Innovative"), a provider of
facilities-based platform services, the
Company is required to purchase a minimum
of 5 million minutes per month, valued at
approximately $50,000 per month, beginning
October 1998 through June 1999.
(e) Regulatory Requirements
The Company is currently evaluating
various tax and other regulatory
assessments to determine their
applicability to the Company's
facilities-based operations. As these
operations expand, the Company may become
subject to additional tariffs and other
regulatory federal and state charges.
F-20
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Notes to Consolidated Financial Statements
(continued)
================================================================================
10. Stockholders' Equity (a) Series A Convertible Preferred Stock
The 61,050 shares of $.001 par value
voting Series A Convertible Preferred
Stock was received on March 31, 1998 in
lieu of outstanding trade payables (See
Note 6). The Series A Preferred Stock is
convertible into common stock at any time
at Premiere's option and the Company has
the right to require Premiere to convert
the Series A Preferred Stock after March
31, 1999. The Certificate of Designation
(the "Certificate of Designation") for the
Series A Preferred Stock provides for
certain voting, liquidation and
registration rights and calculates the
conversion by multiplying 61,050, the
number of shares of Series A Preferred
Stock issued in connection with the
Investment Agreement by $100, the
Investment Amount as defined in the
Certificate of Designation and then
dividing by $10.395, the Conversion Price
as defined in the Certificate of
Designation, resulting in a total of
587,302 shares of common stock to be
issued under the Investment Agreement
subject to adjustment for certain
subsequent securities issues. The Company
may call the redemption of each share of
Series A Preferred Stock at any time for
$100 a share plus accrued dividends, if
any.
(b) Stock Options and Warrants
In April, 1997, the Company's Board of
Directors adopted the Company's Stock
Incentive Plan (the "Plan") which provides
for the granting of up to 600,000 shares
of the Company's common stock ("Common
Stock"), subject to the approval of the
Plan by the stockholders of the Company on
or before April 24, 1998. The Plan has
reserved authorized, but unissued, shares
of Common Stock for issuance of both
Qualified Stock Options and Non-Qualified
Stock Options to employees and directors
of the Company. A primary purpose of the
Plan is to attract and motivate able
persons to join and remain with the
Company by providing a means whereby
employees and directors of the Company can
acquire and maintain Common Stock
ownership, thereby strengthening their
commitment to the welfare of the Company
and promoting a common identity of
interest between stockholders and these
employees and directors.
As of June 30, 1996, there were no
outstanding options. On April 25, 1997,
the Company granted a stock option to one
of its officers, as part of his employment
agreement, to purchase 187,500 shares of
Common Stock at $14.50 per share, the
market price on the date of grant. The
option is exercisable at the date of grant
and expires ten years from the date of
grant. At June 30, 1997, this was the only
outstanding option to purchase Common
Stock of the Company. The foregoing option
was not issued under the terms of the
Plan, since the Plan was not approved by
stockholders until the 1997 Annual Meeting
of Stockholders held in December, 1997.
The Company applies the Accounting
Principles Board ("APB") Opinion 25,
"Accounting for Stock Issued to
Employees", and related Interpretations in
accounting for their stock option plans.
Under APB Opinion 25, no compensation cost
is recognized if the exercise price of the
Company's employee stock options equals
the market price of the underlying stock
on the date of the grant.
SFAS No. 123 of the FASB, "Accounting for
Stock Based Compensation", which became
effective for transactions entered into
after December 15, 1995, requires the
Company to provide pro forma information
regarding net income and earnings per
share as if compensation cost for the
Company's stock option plans had been
determined in accordance with the fair
value method prescribed by SFAS No. 123.
F-21
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Notes to Consolidated Financial Statements
(continued)
================================================================================
During the year ended June 30, 1998, the
Company granted to officers and directors
of the Company additional options to
purchase 861,110 shares of the Company's
Common Stock, and an option to purchase
145,000 shares of the Company's Common
Stock to Prime Communications, Inc.
("Prime") in conjunction with the
acquisition of Prime's customer base. The
options granted to Prime were immediately
exercisable at the date of grant at the
negotiated price of $13.20 per share and
expire ten years from the date of grant.
The 861,110 employee and director options
were granted at the market price of the
Common Stock on the date of grant, and
exercisable at prices ranging from $8.19
to $13.00 per share and vest and become
exercisable as follows: (i) 461,110 are
exercisable at the date of grant; (ii)
50,000 vest and become exercisable over a
one-year period commencing on the date of
grant; and (iii) 350,000 vest and become
exercisable over a two-year period
commencing on the date of grant. Of the
employee and director options, 800,000
expire 10 years from the date of grant and
61,110 have terms ranging from
approximately 6 months to approximately 3
years. The options granted to directors as
compensation for services provided were
charged against net income at their fair
value of $1,248,000 on the date of grant.
Of the total employee and director
options, 550,000 were issued pursuant to
the Plan, leaving a total of 50,000 shares
reserved for issuance pursuant to the Plan
as of June 30, 1998. On such date, a total
of 1,193,610 options to purchase shares of
the Company's Common Stock were
outstanding, with a weighted average
remaining exercise life of approximately
9.2 years. Of such amount, 856,110 are
exercisable on such date at a weighted
average exercise price of $10.94.
At June 30, 1998, the Company had option
agreements with two of its officers, one
additional employee, four non-employee
directors and two former employees. The
following table contains summary
information on stock options for the three
year period ended June 30, 1998.
<TABLE>
<CAPTION>
Exercise Weighted average
Option shares price exercise price
------------------------ --------------- -------------------------
Granted Exercisable Range per share All options Exercisable
- - ------------------------------------------------------------ -------------------------------------------
<S> <C> <C> <C> <C> <C>
Outstanding June 30, 1996 -- -- $ -- $ -- $ --
Granted 1997 Fiscal Year 187,500 187,500 $ 14.50 $ 14.50 $ 14.50
- - -----------------------------------------------------------------------------------------------------------
Outstanding June 30, 1997 187,500 187,500 $ 14.50 $ 14.50 $ 14.50
Granted 1998 Fiscal Year 1,006,110 668,610 $8.19-13.20 $ 9.97 $ 9.94
- - -----------------------------------------------------------------------------------------------------------
Outstanding June 30, 1998 1,193,610 856,110 $8.19-14.50 $ 10.68 $ 10.94
===========================================================================================================
</TABLE>
F-22
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Notes to Consolidated Financial Statements
(continued)
================================================================================
SFAS No. 123 requires the Company to
provide pro forma information regarding
net income and earnings per share as if
compensation cost for the Company's stock
options had been determined in accordance
with the fair value-based method
prescribed in SFAS No. 123. The Company
estimates the fair value of each stock
option at the grant date by using the
Black-Scholes option-pricing model with
the following weighted average assumptions
used for grants in fiscal 1998 and 1997,
respectively: no dividends paid for all
years; expected volatility of 46.5% and
30%; weighted average risk-free interest
rate of 4.9% and 5.9%; and an expected
life of 2 years and 1 year, respectively.
Under the accounting provisions of SFAS
No. 123, the Company's net loss and net
loss per share from continuing operations
for the years ending June 30, 1998 and
1997, respectively, would have been
increased to the pro forma amounts
indicated below.
Year ended June 30, 1998
- - ----------------------------------------------------------------------------
Net loss from continuing operations:
As reported $ 11,183,581
Pro forma $ 12,872,577
Net loss per share from continuing operations:
As reported $ 1.99
Pro forma $ 2.29
============================================================================
Year ended June 30, 1997
- - ----------------------------------------------------------------------------
Net loss from continuing operations:
As reported $ 2,480,253
Pro forma $ 2,590,662
Net loss per share from continuing operations:
As reported $ (.55)
Pro forma $ (.57)
============================================================================
The weighted average fair value of the
options granted during the years ended
June 30, 1998 and 1997 was $3.01 and $.59,
respectively.
F-23
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Notes to Consolidated Financial Statements
(continued)
================================================================================
In April 1996, the Company entered into an
agreement which enabled the Company to issue
warrants to purchase 4,203,124 shares of
Common Stock to various individuals and
corporations in exchange for trade secrets,
customer bases, software and other intangible
property. Warrants to purchase 3,677,082
shares of the Company's Common Stock were
actually issued. The remaining warrants to
purchase 526,042 shares of Common Stock were
held awaiting certain parties to deliver their
promised assets to the Company. Those assets
were never received and the Company did not
issue the remaining warrants. The warrants
issued have a term of five years from date of
grant and are immediately exercisable. The
Company may call the warrants at a price of
$.10 per share of common stock. The following
table contains information on warrants for the
three-year period ended June 30, 1998:
Weighted
average
Warrant Exercise price exercise
shares range per share price
- - --------------------------------------------------------------------------------
Outstanding and exercisable,
June 30, 1995 -- $ -- $ --
Granted 3,677,082 $1.50-13.20 $ 5.74
- - --------------------------------------------------------------------------------
Outstanding and exercisable,
June 30, 1996 3,677,082 $1.50-13.20 $ 5.74
Exercised (324,250) $ 1.50 $ 1.50
- - --------------------------------------------------------------------------------
Outstanding and exercisable,
June 30, 1997 3,352,832 $1.50-13.20 $ 6.15
Exercised (1,955,825) $ 1.50 $ 1.50
- - --------------------------------------------------------------------------------
Outstanding and exercisable,
June 30, 1998 1,397,007 $1.50-13.20 $ 12.67
================================================================================
The weighted average remaining contractual
life of the outstanding and exercisable
warrants as of June 30, 1998 is 2.8 years.
11. Net Loss Per Share The following table set forth the computation
of basic and diluted net loss per common share
from continuing operations:
Year ended June 30, 1998 1997 1996
- - --------------------------------------------------------------------------------
Numerator:
Net loss from continuing
operations available to
common shareholders $(11,183,581) $ (2,480,253) $ (129,275)
- - --------------------------------------------------------------------------------
Denominator:
Denominator for basic
earnings per
share - weighted
average common shares
outstanding 5,618,994 4,579,075 2,599,532
Effect of dilutive
securities: -- -- --
Denominator for diluted loss
per share - adjusted
weighted average common
shares and assumed
conversions $ 5,618,994 $ 4,579,075 $ 2,599,532
================================================================================
Basic loss per common share
from continuing operations $ (1.99) $ (.55) $ (.05)
================================================================================
Diluted loss per common share
from continuing operations $ (1.99) $ (.55) $ (.05)
================================================================================
F-24
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Notes to Consolidated Financial Statements
(continued)
================================================================================
12. Acquisition of Ameridial On October 31, 1997, the Company entered into
an agreement for the acquisition of all of the
outstanding shares of Ameridial, in exchange
for 52,632 shares of the Company's Common
Stock. Ameridial was established to negotiate
and resell rates between international long
distance carriers. The shares were valued
based on the closing market price on October
31, 1997 of $9.50 per share. The acquisition
was recorded under purchase accounting with
the entire value of the transaction being
attributed to goodwill to be amortized over 15
years. Operating results for Ameridial were
immaterial to the Company and, accordingly,
pro forma results have not been provided. On
June 4, 1998, the acquisition of Ameridial was
rescinded, and all consideration paid or due
from the parties was returned.
13. Deferred Income Taxes The tax effects of temporary differences that
give rise to deferred tax assets are as
follows:
June 30, 1998 1997 1996
- - ----------------------------------------------------------------------------
Net operating loss
carryforwards $ 6,106,000 $ 876,000 $ --
Loss on World Access -- 313,000 --
Deferred rent 42,000 25,000 --
Allowance for bad debts 613,000 21,000 18,000
Deferred revenue 449,000
Customer lists 125,000 30,000 --
Other 16,000 13,000 1,000
- - ----------------------------------------------------------------------------
Total deferred
tax assets 7,351,000 1,278,000 19,000
Less: Valuation
allowance (7,351,000) (1,278,000) (19,000)
- - ----------------------------------------------------------------------------
Net deferred
tax assets $ -- $ -- $ --
============================================================================
The ultimate realization of the deferred tax
assets is dependent on the generation of
future taxable income during the period in
which the temporary differences become
deductible. Based on the Company's historical
earnings, management has established a
valuation allowance equal to the tax effects
of the Company's deferred tax assets at June
30, 1998 and 1997.
The Company's net operating loss carryforwards
of approximately $13,000,000 are available to
offset future Federal taxable income, if any,
through 2013 and may be subject to various
limitations.
F-25
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Notes to Consolidated Financial Statements
(continued)
================================================================================
14. Supplemental Cash Flow Cash paid for interest during the years ending
Information June 30, 1998, 1997, and 1996 was
approximately $14,000, $5,000, and $-0-,
respectively. Additional supplemental
disclosures of cash flow information are as
follows:
Year ended June 30, 1998 1997 1996
- - --------------------------------------------------------------------------------
Non-cash investing and financing
activities:
Preferred stock issued
for satisfaction of
accounts payable $6,105,000 $ -- $ --
Return of Common Stock 500,000 135,276 --
Computer equipment
received in lieu of
cash for trade
receivables 40,500 -- --
Write-off of
receivables for
acquisition of
customer lists -- 363,521 --
Note received from sale
of assets -- -- 2,405,000
Common Stock issued for
assets purchased -- -- 1,672,078
Common Stock issued for
conversion of debt -- -- 500,000
Common Stock issued in
exchanges for all
outstanding shares of
Ameridial 500,000 -- --
Transfer of Hughes'
communications
equipment and related
payable -- 1,601,105 --
Communications
equipment and related
payable obtained from
Hughes -- -- 1,601,105
Acquisition of the net
assets of TecLink in
satisfaction of note
receivable -- 764,770 --
================================================================================
F-26
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Notes to Consolidated Financial Statements
(continued)
================================================================================
15. Discontinued Operations On December 31, 1997, management adopted a
of Cellular Division formal plan to abandon the operations of
its conventional cellular division as a
result of the Company's continuing plan to
conserve assets to focus on and expand its
core business. The operations of the
cellular division ceased completely by
February 1, 1998. The Company recorded a
loss from discontinued operations of
$527,061 for the nine months ended March
31, 1998. The net assets of the cellular
division at March 31, 1998 totaled $28,622
and consisted of accounts receivable,
inventory and other liabilities. At March
31, 1998, $75,000 was recorded for the
estimated additional losses related to the
disposal of the cellular division during
subsequent periods. During the quarter
ended June 30, 1998, the Company recorded
an actual loss on disposal of the cellular
division of $103,622, which amount
represented a complete write-off of the
net assets of the cellular division. The
Company does not anticipate any additional
charges to be recognized related to the
operations or disposal of its cellular
division. Sales for fiscal 1998 were
immaterial and the majority of the
$527,061 loss from discontinued operations
was incurred from the write down of the
related assets.
16. Subsequent Events (a) Settlement of Promissory Note with
Frontier
In June, 1998, the Company was served with
a Summons and Motion for Summary Judgment
by Frontier seeking judgment on a
promissory note (the "Frontier Note")
issued by the Company for $893,061 in
connection with Frontier's termination of
its Card division. The outstanding amount
on the Frontier Note is reflected in
accounts payable of the Company with a
balance of approximately $502,000.
Subsequent to year end, the Company
negotiated a settlement with Frontier for
$200,000. The Company satisfied the
settlement in September, 1998 and as a
result, a security interest held by
Frontier against certain assets of the
Company was removed. This recovery will be
recognized during the first quarter of
fiscal 1999.
(b) Redemption of $1.50 Warrants
On August 20, 1998, the Company notified
the holders of the 52,250 outstanding
warrants to purchase shares of the
Company's Common Stock at $1.50 per share
(the "$1.50 Warrants") of its election to
redeem all unexercised portions of the
$1.50 Warrants at $.10 per share thirty
days following the date of the notice.
Upon the expiration of the notice period,
the $1.50 Warrants terminated with respect
to any then unexercised portion and only
the right of the $1.50 Warrant holder to
receive payment of the redemption price
survived. As of September 20, 1998, 44,750
of the $1.50 Warrants have been exercised,
yielding net proceeds of $67,125 to the
Company, and the remainder have been
terminated.
(c) Issuance of 10% Six-Month Notes with
Warrants
F-27
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Notes to Consolidated Financial Statements
(concluded)
================================================================================
During September, 1998, the Company issued
$1,200,000 10% six-month notes (the "10%
Notes") with warrants to purchase 600,000
shares of the Company's Common Stock at an
exercise price of $2.375 per share (the
"$2.375 Warrants"), subject to certain
adjustments. The $2.375 Warrants are
exercisable for five years from the date
of issuance. The exercise price under the
$2.375 Warrants was set at the closing
price of the Common Stock on September 4,
1998. Nine investors participated in this
offering, including an officer/director
and his family, and a director, totaling
$600,000. The issuance and sale of the 10%
Notes and $2.375 Warrants was exempt from
registration under the Securities Act
pursuant to Regulation D.
(d) Letter of Intent with Convergence
Communications, Inc.
On September 22, 1998, the Company entered
into a Letter of Intent with Convergence
Communications, Inc. ("CCI") pursuant to
which the Company agreed to enter into
negotiations with respect to: (i) a
possible combination of the Company and
CCI; (ii) an International
Origination/Termination Agreement pursuant
to which CCI would provide for local
origination and termination in certain
South American countries of minutes
provided by the Company; and (iii) the
purchase by CCI of up to $1,000,000 of
convertible, based upon the average bid
price on the date of the issuance of the
note, promissory notes issued by the
Company accompanied by warrants to
purchase Common Stock of the Company.
There can be no assurances that the
Company and CCI will reach agreement with
respect to any of the business
combination, the International
Origination/Termination Agreement or the
sale of promissory notes.
F-28
<PAGE>
DigiTEC 2000, Inc.
(formerly Promo Tel, Inc.)
and Subsidiary
Schedule II - Valuation and Qualifying Accounts
================================================================================
<TABLE>
<CAPTION>
Year ended June 30, 1998
- - ------------------------------------------------------------------------------------------------------
Balance at Charged to Balance at
beginning costs and Other end of
of period expenses charges Deductions period
- - ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Reserves and allowances
deducted from asset
accounts:
Allowance for bad debts $60,000 $1,467,656 $ -- $ 222,656 $1,305,000
======================================================================================================
Year ended June 30, 1997
- - ------------------------------------------------------------------------------------------------------
Reserves and allowances
deducted from asset
accounts:
Allowance for bad debts $26,000 $ 34,000 $ -- $ -- $ 60,000
======================================================================================================
Year ended June 30, 1996
- - ------------------------------------------------------------------------------------------------------
Reserves and allowances
deducted from asset
accounts:
Allowance for bad debts $ -- $ 26,000 $ -- $ -- $ 26,000
======================================================================================================
</TABLE>
S-1
<PAGE>
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, in New York, New York on
October 12, 1998.
DIGITEC 2000, INC.
/s/ Frank C. Magliato
------------------------------------------
Frank C. Magliato
President, Chief Executive Officer and
Chairman of the Board of Directors
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant in
the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Frank C. Magliato President and Chief October 13, 1998
- - -------------------------- Executive Officer
Frank C. Magliato and Chairman of the
Board of Directors
/s/ Charles N. Garber Chief Financial Officer October 13, 1998
- - --------------------------
Charles N. Garber
/s/ Diego E. Roca Senior Vice President and October 13, 1998
- - -------------------------- Chief Operating Officer,
Diego E. Roca Secretary and Treasurer
/s/ Francis J. Calcagno Director October 13, 1998
- - --------------------------
Francis J. Calcagno
Director October __, 1998
- - --------------------------
Amy L. Newmark
/s/ Lori Ann Perri Director October 13, 1998
- - --------------------------
Lori Ann Perri
/s/ Scott W. Steffey Director October 13, 1998
- - --------------------------
Scott W. Steffey
Exhibit 4.4
Form of Note and Warrant Purchase Agreement
DIGITEC 2000, INC.
8 West 38th Street
New York, New York 10018
NOTE AND WARRANT PURCHASE AGREEMENT
Re:
$2,000,000 10% Six Month Notes
and
Warrants to Purchase Common Stock
As of September 1, 1998
To the Purchaser named in Schedule I
hereto which is a signatory of this Agreement
Gentlemen:
The undersigned, Digitec 2000, Inc., a Nevada corporation (the "Company"),
hereby agrees with you as follows:
SECTION 1. PURCHASE AND SALES OF NOTES.
1.1. Issue of Notes.
The Company has authorized the issue and sale of its 10% Six Month Notes
in the aggregate principal amount of up to $2,000,000 (the "Notes"), to be dated
the date of issue, to bear interest at the rate of 10% per annum prior to
maturity, which accrued interest shall be payable ninety (90) days after
issuance and at maturity, until the principal amount thereof shall be due and
payable, to bear interest on overdue principal (including any overdue required
or optional prepayment of principal) and premium, if any, and (to the extent
legally enforceable) on any overdue installment of interest at the rate of 18%,
with the unpaid principal thereof to mature on the one hundred eightieth (180th)
day after issuance, and to be substantially in the form attached hereto as
Exhibit A.
<PAGE>
Interest on the Notes shall be computed on the basis of a 360-day year of
twelve 30-day months. The principal of the Notes and interest and any premium
thereon shall be payable in accordance with the terms set forth in the Notes,
subject to Section 4.1 of this Agreement. The Notes are not subject to
prepayment or redemption at the option of the Company prior to their expressed
maturity dates, except on the terms and conditions and in the amounts and with
the premium, if any, set forth in Section 4.1 of this Agreement. The terms
"Notes" and "Warrants" as used herein shall include all 10% Six Month Notes and
the Warrants, as hereinafter defined, of the Company delivered pursuant to this
Agreement and the separate Note and Warrant Purchase Agreements, in
substantially similar form, with the other purchasers named in Schedule I
thereto, true and correct copies of which separate agreements will be delivered
to you upon written request. You and such other purchasers are hereinafter
sometimes referred to as the "Purchasers" or "Holder".
1.2. The Closings.
Subject to the terms and conditions hereof and on the basis of the
representations and warranties hereinafter set forth, the Company agrees to
issue and sell to you, and you agree to purchase from the Company, the Note or
Notes at a price of 100% of the principal amount thereof, together with the
number of Warrants, as hereinafter defined, set forth opposite your name in
Schedule I.
Delivery of the respective Notes and Warrants to the Purchasers will be
made at the offices of Patterson, Belknap, Webb & Tyler LLP, 1133 Avenue of the
Americas, New York, New York 10036 at 10:00 a.m., New York time, on such date
not later than September 15, 1998 as may be mutually agreed to by the Company
and the Purchasers against payment therefor in Federal Reserve funds current and
immediately available in New York, New York to an account designated by the
Company. Your commitment to purchase a Note or Notes shall expire on September
15, 1998. One or more Notes will be delivered to you registered in your name or
in the name of such nominee as may be specified in Schedule I hereto. The date
agreed upon for delivery of Notes and Warrants to the Purchasers shall be
referred to as a "Closing Date", and in each instance the consummation of the
purchase of Notes and Warrants by any Purchaser of Notes and Warrants pursuant
hereto shall be referred to as a "Closing".
Concurrently with the execution and delivery of this Agreement or promptly
thereafter, but not later than September 11, 1998, the Company is entering into
a similar agreement with each of the other Purchasers. Your obligations and
those of the other Purchasers shall be several and not joint and you shall not
be liable or responsible for the acts or defaults of any other Purchaser.
1.3. Warrants to Purchase Common Stock
In consideration of, and as an inducement to, your purchase of the Notes,
the Company also agrees to deliver to you on the Closing Date warrants (such
warrants together with the warrants delivered to the other Purchasers being
referred to collectively as the "Warrants") substantially in the form attached
hereto as Exhibit B to purchase 50,000 shares of the Common Stock, $.001 par
value per share, of the Company ("Common Stock") at a price per share equal to
$2.375 (the "Exercise Price") for each $100,000 principal value of Notes
purchased, appropriately apportioned for smaller principal amounts, and
indicated on Schedule 1 pursuant to this Agreement. The number of shares
-2-
<PAGE>
which may be purchased upon the exercise of the Warrants and the price per share
are subject to adjustment in the manner and on the terms and conditions set
forth herein.
-3-
<PAGE>
1.4. Purchase for Investment.
(a) You represent to the Company that you are purchasing the Notes and the
Warrants for your own account, for investment and with no present intention of
distributing or reselling the Notes, the Warrants, the shares of Common Stock
purchasable thereunder or any interest therein, but without prejudice, however,
to your right at all times to sell or otherwise dispose of all or any part of
the Notes, the Warrants or the shares of Common Stock purchasable thereunder
under a registration statement filed under the Securities Act of 1933, as
amended (the "Act"), or in a transaction exempt from the registration
requirements of such Act and, in the event the facts so warrant, evidenced by an
opinion of counsel reasonably satisfactory to the Company.
(b) You further represent to the Company that you are (i) an "accredited
investor," as that term is defined in Regulation D under the Act and (ii) you
have such knowledge, skill, sophistication and experience in business and
financial matters, based on actual participation, that you are capable of
evaluating the merits and risks of an investment in the Notes, Warrants and the
securities purchasable upon exercise of the Warrants and the suitability thereof
as an investment.
(c) It is understood and agreed that the Notes and Warrants will bear the
legends set forth thereon in Exhibits A and B.
1.5. Failure to Deliver.
If at the Closing of the sale of the Notes to you the Company fails to
tender to you the Notes and the Warrants to be purchased by you or if the
conditions specified in Section 3 have not been fulfilled, you may thereupon
elect to be relieved of all further obligations under this Agreement. Nothing in
this Section shall operate to relieve the Company from any of its obligations
hereunder or to waive any of your rights against the Company.
1.6. Expenses.
Whether or not the Notes and the Warrants are sold, the Company will pay
all expenses relating to this Agreement, including but not limited to:
(a) the cost of reproducing this Agreement, the Warrants, the
Warrant Agreement and the Notes;
(b) the fees and disbursements of your special counsel;
(c) your out-of-pocket expenses;
(d) the cost of delivering to your home office, insured to your
satisfaction, the Notes and the Warrants purchased by you at the closing;
(e) all expenses relating to any amendments, waivers or consents
pursuant to the provisions hereof, including, without limitation, any
amendment, waiver or consent resulting from any work-out, restructuring or
similar proceeding relating to the performance by the
-4-
<PAGE>
Company of its obligations under this Agreement, the Warrant Agreement,
the Warrants and the Notes.
The obligations of the Company under this Section 1.6 shall survive the
payment or prepayment of the Notes and the termination of this Agreement and the
exercise or expiration of the Warrants.
SECTION 2. WARRANTIES AND REPRESENTATIONS.
A. The Company warrants and represents to you as of the date of this
Agreement that:
2.1 Corporate Organization and Authority of the Company and Subsidiaries.
The Company
(a) is a corporation duly organized, validly existing and in good
standing under the laws of its jurisdiction of incorporation;
(b) has all requisite power and authority, has taken all necessary
corporate actions, and has all necessary licenses and permits, to execute,
deliver and perform this Agreement, the Notes and the Warrants and own and
operate its properties and to carry on its business as now conducted and
as presently proposed to be conducted, except as would not have a material
adverse effect on the Company, and, upon execution and delivery by the
Company, this Agreement, the Notes and the Warrants will constitute legal,
valid and binding agreements or instruments of the Company and the
obligations of the Company thereunder will be enforceable in accordance
with their respective terms.
(c) is duly licensed or qualified and is authorized to do business
and is in good standing as a foreign corporation in each jurisdiction
where the character of its properties or the nature of its activities
makes such licensing or qualification necessary, except as would not have
a material adverse effect on the Company and its subsidiaries taken as a
whole.
(d) The execution, delivery and performance of this Agreement, the
Notes and the Warrants, and the consummation of the transactions
contemplated thereby, do not and will not conflict with or result in a
breach of any material term or provision of, or constitute a default
under, or result in the maturing of any indebtedness pursuant to, any
indenture, mortgage, deed of trust, note or loan agreement, or other
material agreement or instrument to which the Company is a party and by
which the Company or any of its properties is bound. The execution,
delivery and performance by the Company of this Agreement, the Notes and
the Warrants and the consummation of the transactions contemplated thereby
do not and will not result in a violation of any judgment, order, decree,
determination or award of any court or governmental authority now in
effect and applicable to the Company or to any of its properties.
(e) Except for those which have been obtained by the Company, no
consent, approval, authorization or order of any court or governmental
agency is or was required (a)
-5-
<PAGE>
for the execution and delivery by it of this Agreement, the Notes and the
Warrants, (b) for the consummation by it of the transactions contemplated
hereby or (c) for the performance by it of its obligations hereunder.
2.2. SEC Reports and Filings; Financial Statements.
(a) The Forms 10-K and 10-Q for the periods ending June 30, 1997 and
September 30 and December 31, 1997 and March 31, 1998, together with the
Registration Statement on Form S-1 with respect to the Company's Common Stock
filed with the Securities and Exchange Commission on April 20, 1998 as amended
and declared effective on June 30, 1998 and as subsequently "stickered" are
accurate and complete as of the date of filing ("SEC Documents"). The
consolidated balance sheets of the Company and its subsidiaries as of June 30,
1997, and the related consolidated statements of operations, stockholders'
equity and cash flows of the Company and its subsidiaries for the fiscal years
ended on such date, such annual statement accompanied by a report thereon
containing an opinion without qualifications except as therein noted, by BDO
Seidman & Co., was prepared in accordance with generally accepted accounting
principles consistently applied, except for accounting changes noted in such
reports, and present fairly the financial position of the Company and its
subsidiaries as of such dates and the results of their operations for such
periods. The unaudited consolidated balance sheets of the Company and its
subsidiaries as of September 30, 1997 and December 31, 1997 and March 31, 1998
and statements of operations, stockholders' equity and cash flows of the Company
and its subsidiaries for the quarterly periods ended on said dates, copies of
which have been furnished to you, have been prepared in accordance with
generally accepted accounting principles consistently applied and present fairly
the financial position of the Company and its subsidiaries as of such dates and
the results of their operations for such periods.
(b) Since March 31, 1997, except as set forth in the aforesaid
quarterly financial statements and Exhibit C, there has been no change in the
properties, business, prospects, profits or condition (financial or otherwise)
of the Company and its subsidiaries except changes in the ordinary course of
business, none of which individually or in the aggregate have been materially
adverse to the properties, business, profits or financial condition of the
Company and its subsidiaries.
2.3. Full Disclosure.
Neither this Agreement, nor the SEC Documents, nor any written statement
furnished by the Company or its agents to you in connection with the negotiation
of the sale of the Notes and the Warrants, contains any untrue statement of a
material fact known to the Company or any of its subsidiaries or omits a
material fact known to the Company or any of its subsidiaries necessary to make
the statements contained therein or herein not misleading. There is no fact
known to the Company or any of its subsidiaries (or which, after due inquiry,
should have been known) which the Company has not disclosed to you in writing
(other than general economic conditions and conditions prevailing in the
industry in general) which materially affects adversely, nor, so far as the
Company can foresee, could materially affect adversely, the properties,
business, prospects, profits or condition (financial or otherwise) of the
Company and its subsidiaries taken as a whole or the ability of the Company to
perform its obligations contained in this Agreement, the Warrants, the Warrant
Agreement or the Notes.
-6-
<PAGE>
2.4. Pending Litigation.
Except as set forth in the SEC Documents and on Exhibit C, there are no
actions, suits, investigations, arbitrations or other proceedings pending or, to
the best knowledge of the Company or any of its subsidiaries, threatened against
or affecting the Company or any subsidiary in any court or before any
governmental authority or arbitration board or tribunal which, if adversely
determined, would materially and adversely affect the properties, business,
profits or condition (financial or otherwise) of the Company and its
subsidiaries or the ability of the Company to perform its obligations contained
in this Agreement, the Warrants, the Warrant Agreement or the Notes. Neither the
Company nor any subsidiary is in default with respect to any order of any court,
governmental authority or arbitration board or tribunal, which default could
have a material adverse effect on the condition (financial or otherwise) of the
Company and its subsidiaries taken as a whole.
2.5. Private Offering.
The Company has not offered nor will it offer the Notes or Warrants or any
similar security nor has it solicited nor will it solicit an offer to acquire
the Notes or Warrants or any similar security from or has otherwise approached
or negotiated or will approach or negotiate in respect of the Notes or the
Warrants or any similar security with any person other than the Purchasers and
not more than 50 other institutional investors, each of whom was offered a
portion of the Notes and the Warrants at private sale for investment. For
purposes of the preceding sentence, "similar security" shall mean any security,
the offer or sale of which would be "integrated" with the offer and sale of the
Notes and Warrants under applicable securities laws and regulations.
SECTION 3. CLOSING CONDITIONS.
Your obligation to purchase and pay for the Notes and the Warrants to be
delivered to you on the Closing Date on which you will purchase Notes and
Warrants pursuant to Section 1.2 shall be subject to the following conditions
precedent:
3.1. Warranties and Representations True as of the Closing.
The warranties and representations contained in Section 2 shall be true in
all material respects on the Closing Date with the same effect as though made on
and as of that date.
3.2. Compliance with this Agreement.
The Company shall have performed and complied with all agreements and
conditions contained herein which are required to be performed or complied with
by the Company on or before the Closing Date.
3.3. Officers' Certificate.
You shall have received a certificate dated the Closing Date and signed by
the President or any Vice President, certifying that the conditions specified in
Sections 3.1 and 3.2 have been fulfilled and setting forth the names, addresses
and amounts of Notes purchased by all Purchasers.
-7-
<PAGE>
SECTION 4. PREPAYMENTS.
4.1. Company's Option to Prepay.
The Company may at any time in accordance with the other terms of this
Agreement prepay the Notes in whole or in part (provided that any partial
prepayment shall be a prepayment of at least $1,000 principal amount) by paying
to the registered holders of the Notes in immediately available funds in
accordance with the terms of the Notes the principal amount to be prepaid plus
all interest owing on the principal amount so prepaid (accrued to the time of
actual payment)..
SECTION 5. COMPANY BUSINESS COVENANTS.
From and after the Closing Date and continuing so long as any amount
remains unpaid on any Note:
5.1. Maintenance of Properties and Corporate Existence.
(a) The Company will, and will cause each of its subsidiaries to do or
cause to be done, all things necessary to preserve and keep in full force, and
effect the existence of the Company and each of its subsidiaries and the rights
and franchises of the Company and each of its subsidiaries which are material to
the proper conduct of the business of the Company and its subsidiaries.
(b) The Company shall (i) reserve at all times a sufficient number of
shares of Common Stock to permit the exercise of the Warrants and (ii) take no
action to limit or prevent the exercise of the Warrants.
5.2. Financial Reports.
The Company will provide the following reports to each registered holder
of Notes:
(a) as soon as practicable and in any event within 50 days after the
end of each quarterly period (other than the last quarterly period) in
each fiscal year, consolidated statements of operations, stockholders'
equity and cash flows of the Company and its subsidiaries for the period
from the beginning of the current fiscal year to the end of such quarterly
period, and a consolidated balance sheet of the Company and its
subsidiaries as at the end of such quarterly period, setting forth in each
case in comparative form figures for the corresponding period in the
preceding fiscal year, all in reasonable detail and certified by an
authorized financial officer of the Company, subject to changes resulting
from year end adjustments;
(b) as soon as practicable and in any event within 95 days after the
end of each fiscal year, consolidating and consolidated statements of
operations, stockholders' equity and cash flows of the Company and its
subsidiaries for such year, and the consolidating and consolidated balance
sheet of the Company and its subsidiaries as at the end of such year,
setting forth in each case in comparative form corresponding consolidated
figures from the preceding annual audit, all in reasonable and, as to the
consolidated statements, certified to
-8-
<PAGE>
the Company by its independent public accountants (and accompanied by a
certificate of such accountants stating (i) that they have reviewed this
Agreement, (ii) whether, in making their audit, such accountants have
become aware of any condition, circumstance or event which then
constitutes an Event of Default and (iii) if any such condition,
circumstance or event is known to them, specifying the nature and period
of existence thereof).
5.3. Payment of Notes, Registers and Maintenance of Office.
(a) The Company will punctually pay or cause to be paid the principal,
premium, if any, and interest to become due in respect of the Notes according to
the terms thereof. The Company will maintain an office which shall at all times
be in the State of New York where notices, presentations, demands and service of
process in respect of this Agreement, the Notes or the Warrants may be made upon
it. The register of the Notes and Warrants shall be maintained thereat by the
Company. Such office shall be maintained at 8 West 38th Street, New York, New
York 10018, until such time as the Company shall notify the registered holders
of the Notes and the Warrants of any change of location of such office.
(b) The Company irrevocably and unconditionally submits to the
jurisdiction of the courts of the State of New York in respect to all matters
arising under this Agreement, the Notes and the Warrants and hereby waives any
objection to the laying of venue or convenience of the forum in any suit, action
or proceeding in such courts.
SECTION 6. ANTI-DILUTION PROVISIONS; REGISTRATION RIGHTS
6.1. Anti-Dilution Provisions.
The Exercise Price shall be subject to adjustment from time to time as
provided in Sections 6.1 through 6.12. Upon each adjustment of the Exercise
Price, each holder of a Warrant (a "Holder") shall thereafter be entitled to
purchase, at the Exercise Price resulting from such adjustment, the largest
number of Warrant Shares obtained by multiplying the Exercise Price in effect
immediately prior to such adjustment by the number of Warrant Shares purchasable
hereunder immediately prior to such adjustment and dividing the product thereof
by the Exercise Price resulting from such adjustment. For purposes of this
Agreement, the term "Capital Stock", as used herein, means the Common Stock and
any additional class of stock of the Company having no preference as to
dividends or distributions on liquidation which may be authorized in the future
by an amendment to the Company's charter. In addition, as used hereinafter, the
following terms have the following meanings:
"Additional Shares of Capital Stock" shall mean all shares (including
treasury shares) of Capital Stock issued or sold (or, pursuant to Sections 6.4
or 6.5 hereof deemed to be issued) by the Company after the date hereof, whether
or not subsequently reacquired or retired by the Company, other than shares of
Common Stock issued upon the exercise of the Warrants.
"Convertible Securities" shall mean any evidences of indebtedness, shares
of stock, or securities directly or indirectly convertible into or exchangeable
for Additional Shares of Capital Stock.
-9-
<PAGE>
"Market Price" shall mean, on any date specified herein, (A) if any class
of Capital Stock is listed or admitted to trading on any national securities
exchange, the highest price obtained by taking the arithmetic mean over a period
of 20 consecutive Trading Days ending the second Trading Day prior to such date
of the average, on each such Trading Day, of the high and low sale prices of
shares of each such class of Capital Stock or if no such sale takes place on
such date, the average of the highest closing bid and lowest closing asked
prices thereof on such date, in each case as officially reported on all national
securities exchanges on which each such class of Capital Stock is then listed or
admitted to trading, or (B) if no shares of any class of Capital Stock are then
listed or admitted to trading on any national securities exchange or if such
exchange is not the principal trading market for such Capital Stock, the last
sale price of any class of Capital Stock on such date in the over-the-counter
market as reported by NASDAQ if such Capital Stock is quoted on the NASDAQ
National Market or NASDAQ SmallCap Market or the National Association of
Securities Dealers, Inc., if quoted on the OTC Bulletin Board, or, if no such
shares of any class of Capital Stock are then quoted in such markets, the
average of the highest bid and lowest asked prices as published by the National
Quotation Bureau, Inc. or any similar successor organization. If no shares of
any class of Capital Stock are then listed or admitted to trading on any
national securities exchange and if no last sale price or closing bid and asked
prices thereof are then so reported, quoted or published in the over-the-counter
market, "Market Price" shall mean the higher of (x) the book value per share of
Capital Stock (assuming for the purposes of this calculation the economic
equivalence of all shares of all classes of Capital Stock) as determined on a
fully diluted basis in accordance with generally accepted accounting principles
by a firm of independent certified public accountants of recognized standing
selected by the Board of Directors of the Company, as of the last day of any
month ending within 60 days preceding the date as of which the determination is
to be made or (y) the fair value per share of Capital Stock (assuming for the
purposes of this calculation the economic equivalence of all shares of all
classes of Capital Stock), as determined on a fully diluted basis in good faith
by an independent investment banking firm (as selected by the Board of Directors
of the Company), as of a date which is 15 days preceding the date as of which
the determination is to be made.
"Options" shall mean rights, options, or warrants to subscribe for,
purchase, or otherwise acquire either Additional Shares of Capital Stock or
Convertible Securities.
"Other Securities" shall mean any stock (other than Capital Stock) and any
other securities of the Company or any other person (corporate or otherwise)
which the Holders at any time shall be entitled to receive, or shall have
received, upon the exercise or partial exercise of the Warrants, in lieu of or
in addition to Common Stock, or which at any time shall be issuable or shall
have been issued in exchange for or in replacement of Common Stock or Other
Securities pursuant to Section 6.10 hereof or otherwise.
"Warrant Shares" shall mean the shares of Capital Stock or Other
Securities issued or issuable upon exercise of a Warrant.
6.2. Issuance of Additional Shares of Capital Stock.
In case the Company at a time or from time to time after the date hereof,
shall issue or sell Additional Shares of Capital Stock without consideration or
for a consideration per share less than the greater of the Exercise Price or the
Market Price in effect, in each case, on the date of and
-10-
<PAGE>
immediately prior to such issue or sale, then, and in each such case, subject to
Section 6.9 hereof, the Exercise Price shall be reduced, concurrently with such
issue or sale, to a price (calculated to the nearest .1 of a cent) determined by
multiplying such Exercise Price by a fraction:
(a) the numerator of which shall be (i) the number of shares of
Capital Stock outstanding immediately prior to such issue or sale plus (ii) the
number of shares of Capital Stock which the aggregate consideration received by
the Company for the total number of such Additional Shares of Capital Stock so
issued or sold would purchase at the greater of such Market Price or such
Exercise Price, and
(b) the denominator of which shall be the number of shares of
Capital Stock outstanding immediately after such issue or sale;
provided that, for the purposes of this Section 6.2, (x) immediately after any
Additional Shares of Capital Stock are deemed to have been issued pursuant to
Section 6.4 or 6.5 hereof, such Additional Shares shall be deemed to be
outstanding, and (y) treasury Shares shall not be deemed to be outstanding.
6.3. Extraordinary Dividends and Distributions.
In case the Company, at any time or from time to time after the date
hereof shall declare, order, pay, or make a dividend or other distribution
(including, without limitation, any distribution of other or additional stock or
other securities or property or Options by way of dividend or spin-off,
reclassification, recapitalization, or similar corporate rearrangement) on the
Capital Stock, other than (a) a dividend payable in Additional Shares of Capital
Stock or Convertible Securities or in Options for Capital Stock or (b) a
dividend payable in cash or other property, declared out of retained earnings of
the Company, then, and in each such case, subject to Section 6.9 hereof, the
Exercise Price in effect immediately prior to the close of business on the
record date fixed for the determination of holders of any class of securities
entitled to receive such dividend or distribution shall be reduced, effective as
of the close of business on such record date, to a price (calculated to the
nearest .1 of a cent) determined by multiplying such Exercise Price by a
fraction
(a) the numerator of which shall be the Market Price in effect on
such record date or, if any class of Capital Stock trades with respect to said
dividend or other distribution on an ex-dividend basis, the date prior to the
commencement of ex-dividend trading, less the value of such dividend or
distribution (as determined in good faith by the Board of Directors of the
Company) applicable to one share of Capital Stock, and
(b) the denominator of which shall be such Market Price.
6.4. Treatment of Options and Convertible Securities.
In case the Company, at any time to time after the date hereof, shall
issue, sell, grant, or assume, or shall fix a record date for the determination
of holders of any class of securities entitled to receive any Options or
Convertible Securities, then, and in each such case, the maximum number of
Additional Shares of Capital Stock (as set forth in the instrument relating
thereto, without regard
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<PAGE>
to any provisions contained therein for a subsequent adjustment of such number)
issuable upon the exercise of such Options or, in the case of Convertible
Securities and Options therefor, the conversion or exchange of such Convertible
Securities, shall be deemed to be Additional Shares of Capital Stock issued as
of the time of such issue, sale, grant, or assumption or, in case such a record
date shall have been fixed, as of the close of business on such record date,
provided that such Additional Shares of Capital Stock shall not be deemed to
have been issued unless the consideration per share (determined pursuant to
Section 6.06 hereof) of such shares would be less than the greater of the
Exercise Price or the Market Price in effect, in each case, on the date of and
immediately prior to such issue, sale, grant, or assumption or immediately prior
to the close of business on such record date or, if the Capital Stock trades
with respect to said Options or Convertible Securities on an ex-dividend basis,
on the date prior to the commencement of ex-dividend trading, as the case may
be, and provided, further, that in any such case in which Additional Shares of
Capital Stock are deemed to be issued,
(a) no further adjustment of the Exercise Price shall be made upon
the subsequent issue or sale of Additional Shares of Capital Stock or
Convertible Securities upon the exercise of such Options or the conversion or
exchange of such Convertible Securities;
(b) if such Options or Convertible Securities by their terms
provide, with the passage of time or otherwise, for any change in the
consideration payable to the Company, or change in the number of Additional
Shares of Capital Stock issuable, upon the exercise, conversion, or exchange
thereof (by change of rate or otherwise), the Exercise Price computed upon the
original issue, sale, grant, or assumption thereof (or upon the occurrence of
the record date with respect thereto), and any subsequent adjustments based
thereon, shall, upon any such change becoming effective, be recomputed to
reflect such change insofar as it affects such Options, or the rights of
conversion or exchange under such Convertible Securities, which are outstanding
at such time;
(c) upon the expiration of any such Options or of the rights of
conversion or exchange under any such Convertible Securities which shall not
have been exercised (or upon purchase by the Company and cancellation or
retirement of any such Options which shall not have been exercised or of any
such Convertible Securities the rights of conversion or exchange under which
shall not have been exercised), the Exercise Price computed upon the original
issue, sale, grant, or assumption thereof (or upon the occurrence of the record
date with respect thereto), and any subsequent adjustments based thereon, shall,
upon such expiration (or such cancellation or retirement, as the case may be),
be recomputed as if:
(i) in the case of Options for Capital Stock or of Convertible
Securities, the only Additional Shares of Capital Stock issued or sold (or
deemed issued or sold) were the Additional Shares of Capital Stock, if any,
actually issued or sold upon the exercise of such Options or the conversion or
exchange of such Convertible Securities and the consideration received therefor
were (A) an amount equal to (1) the consideration actually received by the
Company for the issue, sale, grant, or assumption of all such Options, whether
or not exercised, plus (2) the consideration actually received by the Company
upon such exercise, minus (3) the consideration paid by the Company for any
purchase of such Options which were not exercised, or (B) an amount equal to (1)
the consideration actually received by the Company for the issue, sale, grant,
or assumption of all such Convertible Securities which were a converted or
exchanged, plus (2) the additional consideration, if any, actually received by
the Company upon such conversion or exchange, minus
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(3) the excess, if any, of the consideration paid by the Company for any
purchase of such Convertible Securities, the rights of conversion or exchange
under which were not exercised over an amount that would be equal to the fair
value (as determined in good faith by the Board of Directors of the Company) of
the Convertible Securities so Purchased if such Convertible Securities were not
convertible into or exchangeable for Additional Shares of Capital Stock, and
(ii) in the. case of Options for Convertible Securities, only
the Convertible Securities, if any, actually issued or sold upon the exercise of
such Options were issued at the time of the issue, sale, grant, or assumption of
such Options, and the consideration received by the Company for the Additional
Shares of Capital Stock deemed to have then been issued were an amount equal to
(A) the consideration actually received by the Company for the issue, sale,
grant, or assumption of all such Options, whether or not exercised, plus (B) the
consideration deemed to have been received by the Company (pursuant to Section
6.6 hereof) upon the issue or sale of the Convertible Securities with respect to
which such Options were actually exercised, minus (C) the consideration paid by
the Company for any purchase of such Options which were not exercised; and
(d) no readjustment pursuant to subdivision (b) or (c) above shall
have the effect of increasing the Exercise Price then in effect, unless such
adjustment is in respect of the expiration of Options consisting of rights
issued to shareholders of the Company to purchase Capital Stock or Convertible
Securities, which rights expire not more than 60 days after the issue thereof,
in which event such readjustment may have the effect of increasing the Exercise
Price by an amount not in excess of the amount of the adjustment thereof
originally made in respect of the issue of such rights.
6.5. Treatment of Stock Dividends, Stock Splits, Etc.
In case the Company, at any time or from time to time after the date
hereof, shall declare or pay any dividend or other distribution on the Capital
Stock payable in Capital Stock, or shall effect a subdivision of the outstanding
shares of Capital Stock into a greater number of shares of Capital Stock (by
reclassification or otherwise than by payment of a dividend in Capital Stock),
then, and in each such case, Additional Shares of Capital Stock shall be deemed
to have been issued (a) in the case of any such dividend, immediately after the
close of business on the record date for the determination of holders of any
class of securities entitled to receive such dividend, or (b) in the case of any
such subdivision, at the close of business on the day immediately prior to the
day upon which such corporate action becomes effective.
6.6. Computation of Consideration.
For the purposes of Sections 6.1 through 6.12:
(a) The consideration for the issue or sale of any Additional Shares
of Capital Stock or for the issue, sale, grant, or assumption of any Options or
Convertible Securities, irrespective of the accounting treatment of such
consideration,
(i) insofar as it consists of cash, shall be computed as the
amount of cash received by the Company, and insofar as it consists of securities
or other property, shall be computed as of the date immediately preceding such
issue, sale, grant, or assumption as the fair value (as
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<PAGE>
determined in good faith by the Board of Directors of the Company) of such
consideration (or, if such consideration is received for the issue or sale of
Additional Shares of Capital Stock and the Market Price thereof is less than the
fair value, as so determined, of such consideration, then such consideration
shall be computed as the Market Price of such Additional Shares of Capital
Stock), in each case without deducting any expenses paid or incurred by the
Company, any commissions or compensation paid or concessions or discounts
allowed to underwriters, dealers, or others performing similar services, and any
accrued interest or dividends in connection with such issue or sale, and
(ii) in case Additional Shares of Capital Stock are issued or
sold or Options or Convertible Securities are issued, sold, granted, or assumed
together with other stock or securities or other assets of the Company for a
consideration which covers both, shall be the proportion of such consideration
so receive computed as provided in subdivision (i) above, allocable to such
Additional Shares of Capital Stock or Options or Convertible Securities as the
case may be, all as determined in good faith by the Board of Directors of the
Company.
(b) All Additional Shares of Capital Stock, Options, or Convertible
Securities issued in payment of any dividend or other distribution on any class
of stock of the Company and all Additional Shares of Capital Stock issued to
effect a subdivision of the outstanding shares of Capital Stock into a greater
number of shares of Capital Stock (by reclassification or otherwise than by
payment of a dividend in Capital Stock) shall be deemed to have been issued
without consideration.
(c) Additional Shares of Capital Stock deemed to have been issued
for consideration pursuant to Section 6.4 hereof, relating to Options and
Convertible Securities, shall be deemed to have been issued for a consideration
per share determined by dividing
(i) the total amount, if any, received and receivable by the
Company as consideration for the issue, sale, grant, or assumption of the
Options or Convertible Securities in question, plus the minimum aggregate amount
of additional consideration (as set forth in the instruments relating thereto,
without regard to any provision contained therein for a subsequent adjustment of
such consideration) payable to the Company upon the exercise in full of such
Options or the conversion or exchange of such Convertible Securities or, in the
case of Options for Convertible Securities, the exercise of such Options for
Convertible Securities and the conversion or exchange of such Convertible
Securities, in each case comprising such consideration as provided in the
foregoing subdivision (a),
by
(ii) the maximum number of shares of Capital Stock (as set
forth in the instruments relating thereto, without regard to any occasion
contained therein for a subsequent adjustment of such number) issuable upon the
exercise of such Options or the conversion or exchange of such Convertible
Securities.
(d) In case the Company shall issue any Additional Shares of Capital
Stock, Options, or Convertible Securities in connection with the acquisition by
the Company of the stock or assets of any other Corporation or the merger of any
other corporation into the Company under circumstances where on the date of
issue of such Additional Shares of Capital Stock, Options, or
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Convertible Securities the consideration per share received for such Additional
Shares of Capital Stock or deemed to have been received for the Additional
Shares of Capital Stock deemed to be issued pursuant to Section 6.4 hereof is
less than the Market Price per share of the Capital Stock in effect immediately
prior to such issue, but on the date the number of Additional Shares of Capital
Stock or the amount and the exercise price or conversion price of such Options
or Convertible Securities to be so issued were set forth in a binding agreement
between the Company and the other party or parties to such transaction, the
consideration received for such Additional Shares of Capital Stock or deemed to
have been received for the Additional Shares of Capital Stock deemed to be
issued pursuant to Section 6.4 hereof would not have been less than the Market
Price of the Capital Stock then in effect, such Additional Shares of Capital
Stock shall not be deemed to have been issued for less than the Market Price of
the Capital Stock if such terms so set forth in such binding agreement are not
changed prior to the date of issue.
6.7. Adjustments for Combinations, Etc.
In case the outstanding shares of Capital Stock shall be combined or
consolidated, by reclassification or otherwise, into a lesser number of shares
of Capital Stock, the Exercise Price in effect immediately prior to such
combination or consolidation shall, concurrently with the effectiveness of such
combination or consolidation, be proportionately increased.
6.8. Dilution in Case of Other Securities.
In case any Other Securities shall be issued or sold or shall become
subject to issue or sale upon the conversion or exchange of any securities of
the Company or to subscription, purchase, or other acquisition pursuant to any
options issued or granted by the Company for a consideration such as to dilute,
on a basis to which the standards established in the other provisions of
Sections 6.1 through 6.12 are applicable, the exercise rights of the Holders,
then, and in each such case, the computations, adjustments, and readjustments
provided for in Sections 6.1 through 6.12 with respect to the Exercise Price
shall be made as nearly as possible in the manner so provided and applied to
determine the amount of Other Securities from time to time receivable upon the
exercise of the Warrants, so as to protect the Holders against the effect of
such dilution.
6.9. Minimum Adjustment of Exercise Price.
If the amount of any adjustment of the Exercise Price required Pursuant to
Sections 6.1 through 6.12 would be less than two percent (2%) of the Exercise
Price in effect at the time such adjustment is otherwise so required to be made,
such amount shall be carried forward and adjustment with respect thereto made at
the time of and together with any subsequent adjustment which, together with
such amount and any other amount or amounts so carried forward, shall aggregate
at least two percent (2%) of such Exercise Price; provided that, upon the
exercise of the Warrants, all adjustments carried forward and not theretofore
made up to and including the date of such exercise shall, with respect to the
portion of the Warrants then exercised, be made to the nearest .1 of a cent.
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<PAGE>
6.10. Certain Issues Excepted.
Anything herein to the contrary notwithstanding, the Company shall not be
required to make any adjustment of the Exercise Price in the case of (a) the
issuance of the Warrants, (b) the issuance of shares of Common Stock issuable
upon exercise of the Warrants, (c) the granting, after the date hereof of stock
options, warrants, phantom stock, restricted shares, performance shares or stock
appreciation rights with respect to Capital Stock by the Company to employees of
the Company or any of its subsidiaries pursuant to any stock compensation plan
approved by the shareholders of the Company, (d) the issuance of shares of
Common Stock upon the exercise of the stock options referred to in clause (c)
above, and (e) the issuance of shares of Common Stock pursuant to those
outstanding securities of the Company as of the date of this Agreement.
6.11. Changes in Capital Stock.
In case at any time the Company shall be a party to any transaction
(including, without limitation, a merger, consolidation, sale of all or
substantially all the Company's assets, liquidation, or recapitalization of the
Capital Stock) in which the previously outstanding Capital Stock shall be
changed into or exchanged for different securities of the Company or common
stock or other securities of another corporation or interests in a noncorporate
entity or other property (including cash) or any combination of any of the
foregoing (each such transaction being herein called the "Transaction", the date
of consummation of the Transaction being herein called the "Consummation Date,"
the Company (in the case of a recapitalization of the Capital Stock or any other
such transaction in which the Company retains substantially all of its assets
and survives as a corporation) or such other corporation or entity (in each
other case) being herein called the "Acquiring Company", and the common stock
(or equivalent equity interests) of the Acquiring Company being herein called
the "Acquirer's Common Stock"), then, as a condition of the consummation of the
Transaction, lawful and adequate provisions shall be made so that the Holders,
upon the exercise thereof at any time on or after the Consummation Date, shall
be entitled to receive, and the Warrants shall thereafter represent the right to
receive, upon payment of the then effective Exercise Price, in lieu of the
Common Stock issuable upon such exercise prior to the Consummation Date, shares
of the Acquirer's Common Stock.
6.12. Notice of Adjustment.
Upon the occurrence of any event requiring an adjustment of the Exercise
Price, then and in each such case the Company shall promptly deliver to the
Holders an officer's certificate stating the Exercise Price resulting from such
adjustment and the increase or decrease, if any, in the number of shares of
Common Stock issuable upon exercise of the Warrants, setting forth in reasonable
detail the method of calculation and the facts upon which such calculation is
based. Within 90 days after each fiscal year in which any such adjustment shall
have occurred, or within 30 days after any request therefor by a Holder stating
that such Holder contemplates exercise of the Warrants, the Company will obtain
and deliver to the Holders the opinion of its regular independent auditors or
another firm of independent certified public accountants of recognized national
standing selected by the Company's Board of Directors, which opinion shall
confirm adjustments to the Exercise Price.
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<PAGE>
6.13. Registration Rights.
(a) If the Company at any time proposes to register any transfer of
its Capital Stock under the Securities Act for its own account or for the
account of a security holder (other than a registration relating to employee
benefit plans, the acquisition of another company or business, or an exchange
offer solely for already outstanding securities of the Company), the Company
will each such time give prompt written notice to all holders of outstanding
Warrant Shares (herein collectively called the "Prospective Sellers") of its
intention to do so. Upon the written notification by any Prospective Seller of
an intention to register a transfer of Warrant Shares under this Section 6.13
(stating the intended method of transfer of such Warrant Shares by such
Prospective Seller and the number of Warrant Shares to be transferred), given
within thirty (30) days after receipt of any such notice from the Company, the
Company will cause such intended transfer of all Warrant Shares of which any
such Prospective Sellers shall have given such notice to be registered under the
Securities Act. The Company shall have the right to reduce or eliminate Warrant
Shares of a Prospective Seller to be included pursuant to exercise of its
incidental rights under this Section 6.13 in an underwritten offering, by the
Company if, in the good faith opinion of the managing underwriter, supported by
written reasons therefor, the inclusion of such shares would raise a substantial
doubt as to whether the proposed offering could be successfully consummated, and
if all directors or officers of the Company who had sought to have any of their
shares included in such registration shall have withdrawn all such shares from
registration; provided, however, that any reduction of Warrant Shares of a
Prospective Seller to be included in an incidental registration pursuant to the
above shall be made on a basis no less favorable to such Prospective Seller than
a pro rata reduction of all securities requested to be registered on an
incidental basis by all sellers of securities in such registration. The Company
shall undertake to include in such a registration all of the Warrant Shares
requested by the Prospective Sellers to be included in such registration that
are not eliminated from such registration by the underwriters. In the case of an
underwritten public offering by the Company, each Prospective Seller
participating in such incidental registration shall, if requested by the
managing underwriter, agree not to transfer any securities of the Company held
by such Prospective Seller for a period of up to thirty (30) days following the
effective date of the registration statement relating to such offering or such
longer period as may be reasonably requested by such underwriter, but in no
event to exceed ninety (90) days, and the Company hereby covenants that it will
take whatever actions (including amendment of its registration statement) shall
be reasonably necessary to enable such Prospective Seller to register a transfer
of any such securities at such time.
(b) (i) Following the Company becoming eligible to register
securities with the Securities and Exchange Commission on Form S-3, the Company
shall effect a registration on Form S-3 (or similar short form) with respect to
all of the Warrant Shares whether or not registrations have been previously
requested; provided if the Company has not filed a registration on Form S-3 (or
similar short form) with respect to all of the Warrant Shares within six months
of the Closing of the sale of the last of the Notes, the Company shall file a
registration statement with respect to all of the Warrant Shares on Form S-1
prior to the expiration of such six month period and the Company shall use its
best efforts to have such registration statement declared effective promptly;
provided, further, if the Company determines in good faith that such filing
would interfere with a material financing or acquisition and so notifies the
holders of Warrant Shares, the Company shall have the right to delay for a
period not to exceed ninety days the registration of Warrant Shares contemplated
hereunder. (ii) With respect to any registration under Section 6.13, the Company
shall bear all expenses and pay all fees in connection with such registration,
including the preparation, filing and amendment of the registration statement
and the printing of a prospectus and any supplement thereto in such reasonable
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<PAGE>
quantities as requested by a Prospective Seller. The Company shall keep such
registration effective and the prospectus current until all of the Warrant
Shares registered thereunder have been sold.
(c) The Prospective Sellers shall not have the right to participate
in a registration under Section 6.13 if the Prospective Sellers receive a
written opinion of counsel for the Company, in substance and authorship
acceptable to the Prospective Sellers, together with a confirming opinion of
counsel selected by such Prospective Sellers, which opinion shall be paid for by
the Company, that such Prospective Sellers may make such transfer of all of
their Warrant Shares (if applicable) in a public sale which will be in
compliance with all applicable securities laws concerning transfer of
non-registered securities. If Prospective Sellers participate in a registration
under this Section 6.13, the Company and such Prospective Sellers shall provide
to the other the usual indemnifications.
SECTION 7. EVENTS OF DEFAULT.
7.1. Events of Default.
An "Event of Default" shall exist if any of the following occurs:
(a) The Company fails to make any payment of principal or premium on
any Note on or before the date such payment is due;
(b) The Company fails to make any payment of interest on any Note
when the same shall have become due and such default shall continue for a
period of three calendar days;
(c) The Company breaches any of its covenants hereunder;
(d) A custodian, receiver, liquidator or trustee of the Company, or
any of its subsidiaries which holds a substantial part of the properties
of the Company and its subsidiaries (taken as a whole), or of any
substantial part of the properties of the Company and its subsidiaries
(taken as a whole), is appointed by court order and such order remains in
effect for more than 60 days; or the Company, or any of its subsidiaries
which holds a substantial part of the properties of the Company and its
subsidiaries (taken as a whole), is adjudicated bankrupt or insolvent; or
any substantial part of the properties of the Company and its subsidiaries
(taken as a whole), is sequestered by court order and such order remains
in effect for more than 60 days; or petition is filed against the Company
or any of its subsidiaries which holds a substantial part of the
properties under any bankruptcy, reorganization, arrangement insolvency,
readjustment of debt, dissolution or liquidation law of any jurisdiction,
whether now or hereafter in effect, and is not dismissed or stayed within
60 days after such filing; or
(e) The Company, or any of its subsidiaries, files a petition in
voluntary bankruptcy or seeking relief under any provision of any
bankruptcy, reorganization, arrangement, insolvency, readjustment of debt,
dissolution or liquidation law or regulation, whether now or hereafter in
effect, or consents to the filing of any petition against it under such
law.
7.2 Default Remedies.
(a) When any Event of Default described in paragraph (a) or (b) of Section
7.1 has occurred and is continuing, any holder of any Note which has not
received the required payment, may, and when any Event of Default described in
paragraph (c) through (e), inclusive, has occurred and is continuing, the
holders of at least $350,000 in principal amount of the Notes may, exercise any
right, power or remedy permitted to holders of the Notes by law, and shall have,
in particular, without limiting the generality of the foregoing, the right to
declare the entire principal and all interest
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<PAGE>
accrued on all the Notes then outstanding to be, and such Notes shall thereupon
become, forthwith due and payable, without any presentment demand, protest or
other notice of any kind, all of which are hereby expressly waived.
SECTION 8. INTERPRETATION OF THIS AGREEMENT.
8.1. Governing Law.
This Agreement, the Notes, the Warrants and the other documents
contemplated hereby shall be deemed to be contracts made under and shall be
construed in accordance with and governed by the laws of the State of New York
(without reference to the conflicts of laws principles thereof) and the laws of
the United States of America.
8.2. Notices; Payments.
(a) All notices and other communications under this Agreement or under the
Notes shall be given or made by telex or in writing and telecopied or mailed by
certified mail, return receipt requested, postage prepaid, air courier, or
delivered personally to the intended recipient,
(1) if to you, at your address and in the manner provided for
notices in Schedule I to this Agreement, marked for attention as there
indicated, or at such other address as you may have furnished the Company
in writing;
(2) if to the Company, at its address shown at the beginning of this
Agreement, marked for the attention of the President, or at such other
address as it may have furnished in writing to you and all other
registered holders of the Notes at the time outstanding; or
(3) if to any other holder of a Note, at its address set forth in
the Register maintained by the Company.
(b) All such notices and other communications shall be deemed to have been
duly given when transmitted by telex or telecopy, subject to telephone
confirmation of receipt, or when personally delivered or, in the case of a
mailed notice, three days after being duly deposited in the mails, in each case
given or addressed as aforesaid.
(c) All payments of principal, interest and premium due on any Note or any
other amount due under this Agreement shall be made in strict compliance with
the payment instructions contained in Schedule I with respect to the Purchaser
which is party to this Agreement, or such substitute written instructions as
such Purchaser or another registered holder of such Note may provide the Company
in accordance with this Section 8.2.
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<PAGE>
8.3. Counterparts.
This Agreement may be executed in any number of counterparts, each
executed counterpart constituting an original but all together only one
Agreement.
8.4. Headings and Table of Contents.
The headings of the sections of this Agreement are inserted for purposes
of convenience only and shall not be construed to affect the meaning or
construction of any of the provisions hereof.
The execution by you shall constitute a contract between us for the uses
and purposes hereinabove set forth.
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<PAGE>
Dated as of the day and year first above written.
IN WITNESS WHEREOF, the parties have executed and delivered this Note and
Warrant Purchase Agreement as of the date first above written.
DIGITEC 2000, INC.
By:
----------------------------------
Its
----------------------------
-----------------------------------
By:
----------------------------------
Its
----------------------------
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SCHEDULE I
Name and Addresses Principal Shares Initially
of Purchaser; Amount of Notes Purchasable
Payment Instructions to be Purchased Under Warrants
- - -------------------- --------------- --------------
<PAGE>
EXHIBIT A
DIGITEC 2000, INC.
10% SIX MONTH NOTE
DUE MARCH __, 1998
No.__________ ______, 1998
DIGITEC 2000, INC., a Nevada corporation (the 'Company'), for value
received, hereby promises to pay to
------------------
Or Registered Holders
The Principal Amount of
-------------------
DOLLARS ($________)
and to pay, interest (computed on the basis of a 360-day year of twelve 30-day
months) on the principal amount from time to time remaining unpaid hereon at the
rate of Ten Percent (10%) per annum from the date hereof until maturity, payable
ninety days after issuance and at maturity. The entire then outstanding
principal amount and the unpaid interest shall be payable on March ___, 1999.
Payments of principal, premium, if any, and interest shall be made in such
coin or currency of the United States of America as at the time of payment is
legal tender for the payment of public and private debts by wire transfer in
immediately available funds over the Federal Wire Transfer System to the
registered holder hereof at the written instruction of the registered holder
hereof or, at the option of the registered holder hereof, in such manner and at
such other place in the United States of America as the registered holder hereof
shall have designated to the Company in writing. If any amount of principal,
premium, if any, or interest on or in respect of this Note becomes due and
payable on any date which is not a Business Day, such amount shall be payable on
the next Business Day. "Business Day' means any day other than a Saturday,
Sunday, statutory holiday or other day on which banks in New York, New York are
required by law to close or are customer closed.
The Company's obligations under this Note are unconditional and not
subject to deduction, diminution, abatement, counter-claim, defense or set-off
for any reason whatsoever. The Company's obligations hereunder shall not be
subordinate to any other indebtedness of the Company.
This Note is one of the 10% Six Month Notes of the Company in the
aggregate principal amount of up to $2,000,000.00 issued under and pursuant to
the terms and provisions of separate and several Note and Warrant Purchase
Agreements, each dated as of September 1, 1998 (the "Purchase
<PAGE>
Agreements"), entered into by the Company with the purchasers named therein; and
this Note and the holder hereof are entitled equally and ratably with the
holders of all other Notes outstanding under the Purchase Agreements to all the
benefits provided for thereby or referred to therein, to which Purchase
Agreements reference is hereby made for the statement thereof. Said Purchase
Agreements also provide for the issuance of Warrants of the Company to purchase
its common stock.
This Note is registered on the books of the Company and is transferable
only by surrender thereof at the office of the Company in New York, New York,
duly endorsed or accompanied by a written instrument of transfer duly executed
by the registered holder of this Note or its attorney duly authorized in
writing. Payment of or on account of principal, premium, if any, and interest on
this Note shall be made only to or upon the order in writing of the registered
holder.
This Note and the other Notes under the Purchase Agreements are not
subject to prepayment or redemption at the option of the Company prior to its or
their expressed maturity date except on the terms and conditions and in the
amount and with premium, if any, provided for herein and in the Purchase
Agreements. The Company agree to make required prepayments on account of said
Notes in accordance with the provisions of this Note and the Purchase
Agreements.
THIS NOTE, THE NOTE AND WARRANT PURCHASE AGREEMENTS AND THE OTHER
DOCUMENTS CONTEMPLATED THEREBY, INCLUDING BUT NOT LIMITED TO, THE WARRANTS,
SHALL BE DEEMED TO BE CONTRACTS MADE UNDER AND SHALL BE CONSTRUED IN ACCORDANCE
WITH AND GOVERNED BY THE LAWS OF THE STATE OF NEW YORK (WITHOUT REFERENCE TO THE
CONFLICTS OF LAWS PRINCIPLES THEREOF) AND THE LAWS OF THE UNITED STATES OF
AMERICA.
DIGITEC 2000, INC.
By:
----------------------------------
Its
----------------------------
THIS NOTE IS SUBJECT TO THE TERMS AND PROVISIONS OF A NOTE AND WARRANT PURCHASE
AGREEMENT, DATED AS OF SEPTEMBER 1, 1998, BETWEEN DIGITEC 2000, INC. (THE
"COMPANY") AND THE PURCHASER NAMED THEREIN (AS SUCH AGREEMENT MAY BE
SUPPLEMENTED, MODIFIED, AMENDED, OR RESTATED FROM TIME TO TIME, THE
"AGREEMENT"). COPIES OF THE AGREEMENT ARE AVAILABLE AT THE OFFICES OF THE
COMPANY.
THIS NOTE HAS NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 OR UNDER ANY
STATE SECURITIES OR BLUE SKY LAWS. THIS NOTE MAY NOT BE OFFERED, SOLD, ASSIGNED,
PLEDGED, TRANSFERRED, OR OTHERWISE DISPOSED OF IN THE ABSENCE OF REGISTRATION
UNDER SAID ACT AND UNDER APPLICABLE STATE SECURITIES OR BLUE SKY LAWS OR
EXEMPTIONS FROM SUCH REGISTRATION, AS EVIDENCED BY AN OPINION OF COUNSEL
REASONABLY SATISFACTORY TO THE COMPANY.
<PAGE>
EXHIBIT B
THESE WARRANTS AND THE SECURITIES ISSUABLE UPON EXERCISE HEREOF ARE SUBJECT TO
THE TERMS AND PROVISIONS OF NOTE AND WARRANT PURCHASE AGREEMENTS, DATED AS OF
SEPTEMBER 1, 1998, BETWEEN DIGITEC 2000, INC. (THE "COMPANY") AND THE PURCHASERS
NAMED THEREIN (AS SUCH AGREEMENT MAY BE SUPPLEMENTED, MODIFIED, AMENDED, OR
RESTATED FROM TIME TO TIME, THE "AGREEMENT"). COPIES OF THE AGREEMENT ARE
AVAILABLE AT THE OFFICES OF THE COMPANY.
THESE WARRANTS AND ANY SHARES ISSUABLE UPON THE EXERCISE OF THESE WARRANTS HAVE
NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 OR UNDER ANY STATE
SECURITIES OR BLUE SKY LAWS. NEITHER THE WARRANTS NOR ANY OF SUCH SHARES MAY BE
OFFERED, SOLD, ASSIGNED, PLEDGED, TRANSFERRED, OR OTHERWISE DISPOSED OF IN THE
ABSENCE OF REGISTRATION UNDER SAID ACT AND UNDER APPLICABLE STATE SECURITIES OR
BLUE SKY LAWS OR EXEMPTIONS FROM SUCH REGISTRATION, AS EVIDENCED BY AN OPINION
OF COUNSEL AS PROVIDED FOR IN THE AGREEMENT.
WARRANT CERTIFICATE
Certificate Number Certificate for
W-
- - ------------------ --------------------------
Warrants
This Certificate is Transferable
in New York, New York
DIGITEC 2000, INC.
Incorporated under the Laws of the State of Nevada
THIS CERTIFIES THAT, ______________________________________ for
value received, the registered holder hereof or registered assigns (the
"Holder"), is entitled to purchase from Digitec 2000, Inc., a Nevada corporation
(the "Company"), at any time after the date hereof and until 5:00 P.M., Eastern
Standard Time, September __, 2003 at the purchase price of $_____ per share (the
"Exercise Price"), as adjusted pursuant to Article 6 of the Note and Warrant
<PAGE>
Purchase Agreements, dated as of September 1, 1998, among the Company and the
Purchasers named therein (the "Purchase Agreements"), the number of shares of
Common Stock, $.001 par value per share, of the Company (the "Common Stock")
which is equal to the number of Warrants set forth above. The number of shares
purchasable upon exercise of this Warrant and the Exercise Price per share shall
be subject to adjustment from time to time as set forth in the Purchase
Agreements. This Warrant shall not be redeemable by the Company and the Company
shall take no action prior to September __, 2003 to terminate this Warrant. This
Warrant is issued under and in accordance with the Purchase Agreement and is
subject to the terms of the Purchase Agreement, to all of which terms every
holder of this Warrant Certificate consents by acceptance hereof.
A copy of the Purchase Agreement may be obtained for inspection by
the Holder hereof upon written request to the Company.
This Warrant may be exercised in whole or in part by presentation of
this Warrant with the Election to Exercise at the end hereof duly executed and
simultaneous payment of the Exercise Price (subject to adjustment) at the office
of the Company in New York, New York. Payment of such price shall be made at the
option of the Holder hereof in cash, by check or by surrender of Notes.
Upon any partial exercise of this Warrant, there shall be issued to
the Holder hereof a new Warrant Certificate in respect of the shares of Common
Stock as to which this Warrant shall not have been exercised. No fractional
shares will be issued upon the exercise of this Warrant, but the Company shall
pay the cash value (as determined pursuant to the Purchase Agreements) of any
fraction of a share of Common Stock upon the exercise of one or more Warrants.
This Warrant Certificate may be exchanged either separately or in
combination with other Warrant Certificates for new Warrant Certificates
representing the same aggregate number of Warrants as are evidenced by the
Warrant Certificate or Warrant Certificates exchanged. This Warrant Certificate
is transferable at the office of the Company in New York, New York in the manner
and subject to the limitation set forth in the Purchase Agreements.
This Warrant does not entitle any Holder hereof to any of the rights
of a stockholder of the Company.
Dated: _____________________, 199_.
DIGITEC 2000, INC.
By: By:
-------------------------- ---------------------------
Secretary President
Notice of the call will be given as
provided in the Warrant Purchase Agreement
<PAGE>
ELECTION TO EXERCISE
The undersigned hereby irrevocably elects to exercise the right of
purchase represented by the within Warrant for, and to purchase thereunder,
shares of Common Stock, as provided for therein.
Please issue a certificate or certificates for such shares of Common
Stock in the name of, and pay any cash for any fractional share to:
Name: __________________________________________
Signature: ____________________________________
Taxpayer Identification Number: ______________________________________
Address: ______________________________________
______________________________________
Note: The above signature should correspond
exactly with the name on the face of this
Warrant Certificate or with the name of
assignee appearing in assignment form
below.
Signature Guaranteed
AND, if said number of shares shall not be all the shares purchasable under the
within Warrant, a new Warrant Certificate is to be issued in the name of said
undersigned for the balance remaining of the shares purchasable thereunder less
any fraction of a share paid in cash and delivered to the address stated above.
<PAGE>
ASSIGNMENT
For value received, the undersigned hereby sells, assigns and
transfers unto ________________________________________________________
(Taxpayer Identification Number: ________________________________) the within
Warrant, together with all right, title and interest therein, and does hereby
irrevocably constitute and appoint ___________________________________ attorney,
to transfer said Warrant on the books of the within-named Company with full
power of substitution in the premises.
Dated: ________________, 19__
------------------------------
Note: The above signature should correspond
exactly with the name on the face of
this Warrant Certificate.
Signature Guaranteed
- - --------------------------
<PAGE>
EXHIBIT C
1. On August 6, 1998, the Company settled the litigation with Frontier
Communications, Inc. initiated on June 9, 1998, subject to payment of $150,000
by the Company on or before September 7, 1998 and $50,000 two weeks following
such initial payment by the Company.
2. The Company and Premiere Communications, Inc. ("Premiere") are
negotiating a release from the Independent Distribution Agreement, dated as of
September 26, 1997, pursuant to an agreement with Premiere which provides for
the Company to pay certain outstanding amounts currently payable to Premiere of
approximately $600,000 in conjunction with new carrier and network services
agreements. There are no assurances that these negotiations will be completed or
that agreements satisfactory to the Company will be signed.
3. The Company currently owes Vanity Fair Inc., the current sublessor of
the Company's offices in New York, approximately $175,000 which is in arrears.
Part of the proceeds of the current financing will be used to bring the Company
current.
Exhibit 10.23
Letter of Intent to acquire Phonecard Wholesalers, Inc.
February 16, 1998
Lizette Rodriguez, President
Phonecard Wholesalers, Inc.
1103 Cassel Hill Avenue
Bronx, N.Y. 10461
Re: Letter of Intent for Corporate Affiliation Between DIGITEC 2000, Inc.
("DIGITEC 2000") and Phonecard Wholesalers, Inc. ("Phonecard
Wholesalers")
Reference is made to the negotiations and discussions between the
management and representatives of Phonecard Wholesalers and DIGITEC 2000
("Parties") regarding a corporate affiliation between the Parties in which
DIGITEC 2000 would acquire ownership of certain net assets of Phonecard
Wholesalers, as agreed to by the parties, in exchange for the purchase price as
described below ("Acquisition"). This letter, if accepted and approved by
Phonecard Wholesalers as provided below, will constitute a Letter of Intent and
Understanding pursuant to which the Parties will use their best efforts and due
diligence to prepare and enter into a "Definitive Agreement" for the
Acquisition.
Subject to such changes and additional terms and conditions as to
which the Parties may mutually agree, the Definitive Agreement will provide for:
(1) Purchaser: The purchaser will be either DIGITEC 2000 or a
corporation newly formed by DIGITEC 2000.
(2) At completion of the Acquisition, DIGITEC 2000 will hold
ownership of certain net assets of Phonecard Wholesalers, as agreed to by the
parties.
(3) Accounting FOR the Transaction: The Company intends to account
for this transaction under purchase accounting as promulgated under Generally
Accepted Accounting Standards due to the structure as a net asset purchase.
(4) Purchase Price: The purchase price, subject to the evaluation of
due diligence procedures will be as follows:
(a) The purchase price will equal the monthly average of net
sales for the first three full calendar months subsequent to
the closing date of the Definitive Agreement ("Purchase
Price").
<PAGE>
(b) DIGITEC 2000 agrees to offset its existing receivable with
Phonecard Wholesalers as of the closing date of the Definitive
Agreement as a down payment against the Purchase Price.
(c) DIGITEC 2000 agrees to accept and be responsible for
accounts payable of Phonecard Wholesalers, as outstanding on
the closing date of the Definitive Agreement, not to exceed
$750,000, to be offset against the Purchase Price.
(d) DIGITEC 2000 will issue DIGITEC 2000, Inc. $0.001 par
value Common Stock with an aggregate market value of
$1,000,000 based upon the per share closing price of the
Common Stock as defined by the NASDAQ Bulletin Board as of the
closing date of the Definitive Agreement. The Common Stock
delivered by DIGITEC 2000 and acquired by the shareholders of
Phonecard Wholesalers shall be "restricted securities" as that
term is defined under the Securities Act of 1933, as amended
("33 Act") and pursuant to the exemption from the registration
requirements of Section 5 of the 33 Act provided by Section
4(2) thereof in a transaction not involving a public offering.
(e) DIGITEC 2000 will issue a note payable with interest at
1% above Chase Bank's Prime Rate, per annum, as of the closing
date of the Definitive Agreement in monthly installments for
24 months for any remaining Purchase Price after the terms in
Section 4(a) through 4(d) have been fulfilled.
(5) The Definitive Agreement will contain the customary and usual
provisions with respect to representations and warranties of the Parties as
reasonably requested by the respective counsel;
(6) Confidentiality: The Parties shall use their best efforts to
maintain at all times as confidential information the fact that you, or we, have
executed this letter, the terms of this letter and the existence and content of
any negotiations between us except that both parties may inform advisors,
counsel, employees as considered necessary to consummate the transaction and
make appropriate disclosures if required by appropriate laws.
(7) Expenses: Purchaser and Seller shall bear their own costs and
expenses.
(8) Negotiations: The Parties agree to negotiate to determine if the
Acquisition will be appropriate for the parties; provided, however, that either
party may terminate negotiations at any time for any reason.
(9) Due Diligence: The Parties agree that the above Letter of Intent
is subject to due diligence procedures by both parties and that both parties
agree to dispense information which is considered crucial to the evaluation of
the Acquisition. This includes, but is not limited
2
<PAGE>
to, reasonable access to its premises and to all its books and records and will
furnish such financial data, operating data and other financial information as
the other party may reasonably request.
If the foregoing accurately sets forth our agreement with respect to
this matter, please execute and return a copy of this letter to me, whereupon
this letter shall be considered to consummate a Letter of Intent among the
Parties.
Sincerely,
/s/ Frank C. Magliato
------------------------
Frank C. Magliato
Chief Executive Officer
DIGITEC 2000, Inc.
A Nevada Corporation
AGREED AND ACCEPTED:
/s/ Lizette Rodriguez
- - ------------------------
Lizette Rodriguez, President
Phonecard Wholesalers, Inc.,
A New York Corporation
Dated: Monday, February 16, 1998
3
Exhibit 10.24
Settlement Agreement with Frontier Communications, Inc.
August 17, 1998
Kenneth A. Payment, Esq.
Harter, Secrest & Emery
700 Midtown Tower
Rochester, New York 14604
Re: Frontier Communications International, Inc. v. Digitec 2000, Inc.
Dear Ken:
As per the terms of the settlement agreement that we reached on
August 6, 1998, Digitec will pay Frontier $150,000.00 via wire transfer, on or
before the close of business on September 7, 1998. Digitec will pay Frontier the
remaining $50,000.00 via wire transfer, on or before the close of business on
September 22, 1998. The transfer of funds should be made to the account of
Frontier Communications International, Inc., at Marine Midland Bank, Rochester,
New York. The pertinent transfer information is as follows:
Credit account number: 590 838 814
ABA routing number: 021 001 088
In response to your letter dated August 6, 1998, regarding the
release of the UCC-1's currently filed by Frontier against Digitec, please
prepare and forward to me the necessary documentation for our review and
execution.
I have enclosed the following for signature by your client:
Affidavit of Confession of Judgment, Release, and Stipulation Discontinuing
Action. Please have them executed and return them to me at your earliest
convenience. We will hold these documents in escrow pending receipt of the
September 22, 1998 payment. As soon as Frontier executes the Release, I will
forward it to you.
Very truly yours,
/s/ Michael D. Norris
---------------------
Michael D. Norris
MDN/atb
Enclosures
cc: Terrance P. O'Grady, Esq.
Exhibit 10.25
Letter of Intent between Convergence Communications, Inc. and DigiTEC 2000, Inc.
September 22, 1998
Frank Magliato VIA FACSIMILE: 212-782-1555
Digitec 2000, Inc.
8 West 38th Street, 5th Floor
New York, NY 10018
Letter of Intent
Dear Sirs:
The purpose of this letter ("Letter of Intent") is to set forth the
general terms under which Convergence Communications, Inc. ("CCI") will enter
into a series of agreements with Digitec 2000, Inc. ("Digitec"). Based on our
discussions, I believe we have agreed as follows:
1. International Origination/Termination Agreement. On and subject to the
further terms of this Letter of Intent, CCI and Digitec will enter into an
Agreement pursuant to which all international long distance minutes, either
originated or terminated by or through Digitec will be first offered to CCI for
local origination and/or termination in any country where CCI operates provided
that CCI provides origination and/or termination at the prevailing market
pricing subject to the parties' good faith negotiations. The initial commitment
level will be 1 million minutes per month after a 90 day ramp up to the Republic
of Guatemala. Additional countries will be added by CCI as soon as possible.
Digitec will provide a list of actual and projected usage by country for each
country CCI offers origination and/or termination. The International
Origination/Termination Agreement will have an initial term of 3 years with
extension periods.
2. Purchase of Promissory Notes. On and subject to the terms and
conditions of definitive agreements to be executed between and among the
parties, CCI will purchase from Digitec, and Digitec will sell to CCI, two
promissory notes, each in the original principal amount of $500,000 (the
"Promissory Notes"). The first Promissory Note will be purchased by CCI at the
Initial Closing, as defined in paragraph 7 below. The second Promissory Note
will be purchased by CCI, assuming it is not in default on its obligations under
the first Promissory Note, upon the execution by CCI and Digitec of the
definitive agreements for the transactions described in paragraph 3 below. The
principal amounts of each of the Promissory Notes will be payable in twelve
equal monthly installments, together with interest on all unpaid portions
thereof at the rate of 10% per annum (except in the event of a default
thereunder, in which case the interest rate will be 12% per annum from the date
of default until all amounts due under the Promissory Notes are paid in full.).
At the sole election of CCI at any time during the period when any amounts
remain unpaid
<PAGE>
under the Promissory Notes, all or any portion of those unpaid amounts
(including interest and charges and fees, if any) will be payable through the
conversion of those amounts into common shares of Digitec (the "Conversion
Right"). If CCI elects to exercise the Conversion Right, the number of Digitec
common shares CCI will be entitled to receive in the conversion will be equal to
the aggregate amounts elected by CCI to be so converted, divided by an amount
equal to the average bid price for Digitec's common shares on the principal
market on which they trade during the 5 day period immediately preceding the
closing of CCI's purchase of the Promissory Notes (hereinafter, the "5 Day
Average Price"). In connection with CCI's purchase of the Promissory Notes, CCI
will also acquire, for a nominal price, warrants to acquire common shares of
Digitec. The number of shares subject to the warrants, the terms of their
exercise and their exercise price will be determined by good faith negotiations
between the parties.
3. Corporate Combination Transaction. CCI and Digitec will negotiate,
diligently and in good faith, the terms of an agreement pursuant to which (i)
CCI will acquire 100% of Digitec's outstanding capital stock (or its assets, at
CCI's election) solely in exchange for shares of CCI common stock, or (ii)
Digitec will acquire 100% of CCI's outstanding capital stock (or its assets, at
Digitec's election) solely in exchange for shares of Digitec common stock.
4. Assistance in Protel Negotiations. Digitec will use its diligent and
good faith efforts to assist CCI in its negotiations with Protel, Inc.,
("Protel") regarding an agreement pursuant to which CCI and Protel will form a
joint venture entity for the purpose of utilizing Protel's wireless and
fiber-optic network to provide last-mile connectivity for data, voice and video
telecommunication services. CCI's capital contribution to the joint venture
would consist of certain management services and the capital necessary to fund
the joint venture's business operations in compliance with a business plan to be
determined mutually by Protel and CCI, and Protel's capital contribution would
be its wireless networks rights and a usage right for its fiber-optic cable
systems.
5. Conditions to Purchase of Promissory Notes. CCI's obligation to
purchase the Promissory Notes will be subject to the satisfaction of the
following conditions:
(a) The execution of the Minute Termination Agreement.
(b) The conclusion of the limited due diligence review by CCI
referred to in paragraph 6 below and the results of such due diligence review
being satisfactory to CCI in its sole discretion.
(c) The receipt by CCI of opinion of counsel to Digitec relating to
the matters set forth in this Letter of Intent.
(d) No suit or action pending or being threatened which would
prevent the consummation of any of the transactions contemplated by this Letter
of Intent.
(e) The parties having performed and complied with all of their
covenants in all material respects through the Closing.
2
<PAGE>
(f) Digitec making standard representations, warranties and
covenants regarding its business, operations and financial condition in the
definitive agreements for the purchase of the Promissory Notes and the Minute
Termination Agreement, and those representations, warranties and covenants being
true and correct as of the date of the execution and closing of those documents.
6. Due Diligence Review. The parties acknowledge and agree that it will be
a condition to the parties' obligations under this Letter of Intent that either
party be able to conduct a review and audit of the other party in connection
with the consummation of the transactions described in this Letter of Intent.
The parties currently anticipate that, although CCI's purchase of the Promissory
Notes and the execution of the Minute Termination Agreement will require only a
limited review and audit of Digitec's business operations and financial
conditions, the consummation of the transactions described in paragraphs 3 will
require a more extensive review and audit of Digitec. In order to facilitate
these reviews and audits, each party will provide to the other party with
reasonable access, following reasonable notice, to its books of account,
financial and corporate records, contracts, leases, licenses, permits, tax
returns, properties and other assets, permit the other party to make copies of
such records and other documents as each party may reasonably requests,
cooperate with each party in conducting those examinations, and cause its
officers, employees, accountants, counsel and other advisors to furnish such
additional market, financial and operating data and other information as the
other party may from time to time reasonably request in order to carry out the
due diligence review and audit. Each party will bear its own costs relating to
the due diligence review and audit. Promptly after the execution of this Letter
of Intent, CCI and Digitec will execute standard confidentiality and
non-disclosure agreements to protect the confidentiality of any information
disclosed to either party during or as a result of the due diligence process.
7. Timetable.
(a) Within 7 business days of the execution of this Letter of
Intent, CCI will deliver to Digitec an initial draft of the documents for the
purchase of the first Promissory Note and the Minute Termination Agreement. It
is the intention of CCI and Digitec to work diligently and in good faith to
effect a closing of the transactions described in those agreements (the "Initial
Closing") within 15 business days of the execution of this Letter of Intent.
(b) Within 30 business days of the date of the Initial Closing, CCI
will deliver an initial draft of the documents for the transaction described in
paragraph 3. It is the intention of CCI arc Digitec to work diligently and in
good faith to effect the closing of that transaction within 60 business days of
the Initial Closing.
8. Conduct of Business Pending the Closing. Between the date of the
execution of this Letter of Intent and the Initial Closing, Each party will
conduct its business and operations in substantially the same manner in which it
operated them prior to entering into this Letter of Intent. During such period,
Digitec will also give CCI prompt written notice of any
3
<PAGE>
material developments in its business or operations.
9. Notices. All notices and other communications required or permitted
under this Letter of Intent must be in writing and will be deemed given if
delivered personally or by facsimile (with confirmation), or mailed by
registered mail or by overnight courier to the parties at the following
addresses, or such address for a party as it shall hereafter specify in writing:
(a) If to CCI, to Mr. Lance D'Ambrosio, Chairman and Chief Executive
Officer, at 102 West 500 South, Suite 320, Salt Lake City, Utah, 84101, USA,
facsimile number 801-532-6060.
(b) If to Digitec, to Frank Magliato at 8 West 38th Street, 5th
Floor, New York, New York 10018, USA, facsimile number 212-782-1555.
10. No Assignment. No party to this Letter of Intent may assign its rights
or obligations under it to any other party or individual without the prior
written approval of the other parties.
11. Agency Clause. Nothing in this Letter of Intent will be construed as
creating a joint venture or legal partnership between CCI and Digitec, or as
authorizing any party to act as an agent or representative of any other party to
this Letter of Intent.
12. Termination. The parties' agreements to cooperate in the specific
areas set forth in this Letter of Intent will terminate upon the earliest to
occur if (i) the execution of the definitive agreements anticipated by this
Letter of Intent, (ii) the parties' mutual agreement in writing to terminate
this Letter of Intent, or (iii) the expiration of 90 business days from the date
of this Letter of Intent unless extended by the parties by written amendment.
13. Press Releases. No party to this Letter of Intent will make any news
release, public announcement, advertisement or publicity concerning this Letter
of Intent without the prior written approval of the other parties; provided,
however, that this provision shall not be interpreted so as to prevent the
disclosure of information to any governmental agency or other authority which is
necessary to carry out the intent of this Letter of Intent or a party's
obligations under law, rule or regulation.
14. Entire Agreement. This Letter of Intent constitutes the entire
understanding of the Parties to cooperate with respect to the areas specifically
set forth in it. No modification of this Letter of Intent will be operative
unless it is in writing and signed by the authorized representatives of the
parties.
15. Governing Law. This Letter of Intent shall be governed by the laws of
the State of Nevada.
* * * * * *
4
<PAGE>
If this Letter of Intent correctly sets forth your understanding of
our discussions, please executed it in the appropriate space below and return a
copy of the executed agreement to CCI for its files.
Sincerely,
CONVERGENCE COMMUNICATIONS, INC.
By: /s/ Lance D'Ambrosio
----------------------------
Its: CEO
ACCEPTED AND AGREED:
DIGITEC 2000, INC.
By: /s/ Frank C. Magliato
-------------------------
Its: CEO
5
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from Consolidated
Financial Statements for year ended 6/30/98 of Digitec 2000, Inc. and is
qualified in its entirety by reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-START> JUL-01-1997
<PERIOD-END> JUN-30-1998
<CASH> 108,722
<SECURITIES> 0
<RECEIVABLES> 2,997,222
<ALLOWANCES> 1,305,000
<INVENTORY> 393,586
<CURRENT-ASSETS> 2,318,483
<PP&E> 224,917
<DEPRECIATION> 64,877
<TOTAL-ASSETS> 3,139,790
<CURRENT-LIABILITIES> 4,544,635
<BONDS> 0
0
61
<COMMON> 6,814
<OTHER-SE> (1,501,265)
<TOTAL-LIABILITY-AND-EQUITY> 3,139,790
<SALES> 35,032,533
<TOTAL-REVENUES> 35,032,533
<CGS> 33,545,412
<TOTAL-COSTS> 33,545,412
<OTHER-EXPENSES> 276,231
<LOSS-PROVISION> 1,467,285
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (11,183,581)
<INCOME-TAX> 0
<INCOME-CONTINUING> (11,183,581)
<DISCONTINUED> (813,178)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (11,996,759)
<EPS-PRIMARY> (2.14)
<EPS-DILUTED> (2.14)
</TABLE>
