================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission file number: 000-23291
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)
Registrant's Telephone Number, Including Area Code: (212) 944-8888
Not Applicable
(Former Name, Former Address and Former Fiscal Year, if Changed
Since Last Report)
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 |_|
The number of outstanding shares of the registrant's common stock, par value
$.001 per share (the "Common Stock") as of November 13, 1998 was 6,858,998.
================================================================================
<PAGE>
DIGITEC 2000, INC.
INDEX TO FORM 10-Q
Page(s)
-------
PART I -- FINANCIAL INFORMATION
ITEM 1 -- Financial Statements
Consolidated Balance Sheets as of September 30, 1998 (unaudited)
and the Year Ended June 30, 1998........................................ 3
Consolidated Statements of Operations (Loss) for the Three Months Ended
September 30, 1998 and the Three Months Ended September 30, 1997
(unaudited) ............................................................ 4
Consolidated Statement of Stockholders' Deficit for the Three
Months Ended September 30, 1998 (unaudited) ............................ 5
Consolidated Statements of Cash Flows for the Three Months Ended
September 30, 1998 and the Three Months Ended September 30, 1997
(unaudited) ............................................................ 6
Notes to Consolidated Financial Statements (unaudited) ................. 7-14
ITEM 2 -- Management's Discussion and Analysis of Financial
Condition and Results of Operations .................................... 15-21
ITEM 3--Quantitative and Qualitative Disclosures About Market Risk ..... 21
PART II -- OTHER INFORMATION
ITEM 1 - Legal Proceedings ............................................. 22-23
ITEM 2 - Changes in Securities and Use of Proceeds ..................... 23
ITEM 6 - Exhibits and Reports on Form 8-K .............................. 23
Signatures ............................................................. 24
2
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Consolidated Balance Sheets
================================================================================
<TABLE>
<CAPTION>
September 30, 1998 June 30, 1998
(Unaudited)
- ------------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Current:
Cash $ 19,425 $ 108,722
Accounts receivable, net of allowance for bad debts
of $1,305,000 and $1,305,000, respectively
(Note 3(b)) 2,847,749 1,692,222
Inventory 454,496 393,586
Prepaid expenses and other 135,555 123,953
------------ ------------
Total current assets 3,457,225 2,318,483
Property and equipment, net of accumulated
depreciation of $77,259 and $64,877, respectively 149,902 160,040
Customer Lists, net of accumulated amortization of
$353,651 and $334,000, respectively 354,231 373,882
Carrier deposits and other 278,136 287,385
- ------------------------------------------------------------------------------------------
Total Assets 4,239,494 $ 3,139,790
==========================================================================================
Liabilities and Stockholders' Deficit
Current:
Accounts payable-Trade 2,650,838 1,379,896
Accounts payable and accrued expenses 126,923 464,620
Accounts payable to Premiere Communications, Inc. 597,132 597,132
Accrued legal 217,619 450,188
Accrued settlement expenses (Note 4) 169,307 204,126
Accrued research and development 325,000 325,000
Deferred revenue 1,808,229 955,117
Notes Payable - current (Note 8) 1,342,981 168,556
- ------------------------------------------------------------------------------------------
Total current liabilities 7,238,029 4,544,635
Deferred rent 89,545 89,545
- ------------------------------------------------------------------------------------------
Total Liabilities 7,327,574 4,634,180
- ------------------------------------------------------------------------------------------
Commitments and contingencies
Stockholders' Deficit
Series A Preferred Stock, Callable at $100 per share,
$.001 par value, 1,000,000 shares authorized;
61,050 and 61,050 shares issued and outstanding,
respectively 61 61
Common stock, $.001 par value, 100,000,000 shares
authorized; 6,858,998, and 6,814,248, issued and
outstanding, respectively 6,859 6,814
Additional paid-in capital 14,291,363 14,174,283
Accumulated deficit (17,386,363) (15,675,548)
- ------------------------------------------------------------------------------------------
Stockholders' Deficit (3,088,080) (1,494,390)
- ------------------------------------------------------------------------------------------
Total Liabilities and Stockholders' Deficit 4,239,494 $ 3,139,790
==========================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Consolidated Statements of Operations (Loss) (Unaudited)
================================================================================
Three Months Ended September 30, 1998 1997
- --------------------------------------------------------------------------------
Net sales $ 5,839,898 $ 13,322,142
Cost of sales 5,857,829 12,238,339
- --------------------------------------------------------------------------------
Gross profit (loss) (17,931) 1,083,803
Selling, general and administrative
expenses 1,692,884 765,927
- --------------------------------------------------------------------------------
Income (loss) from continuing
operations (1,710,815) 317,876
- --------------------------------------------------------------------------------
Discontinued operations:
Loss from operations of Cellular
Division (Note 6) -- (155,681)
Loss from operations of World
Access (Note 2) -- (105,554)
- --------------------------------------------------------------------------------
Loss from discontinued
Operations -- (261,235)
- --------------------------------------------------------------------------------
Net Income (loss) $ (1,710,815) $ 56,641
================================================================================
Net income (loss) per common share - basic
and diluted:
Income (loss) from continuing operations $ (.25) $ .06
Loss from discontinued operations -- (.05)
- --------------------------------------------------------------------------------
(.25) $ .01
================================================================================
Weighted average number of
common and common equivalent
shares outstanding used in basic and diluted 6,819,172 4,858,654
================================================================================
See accompanying notes to consolidated financial statements.
4
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Consolidated Statement of Stockholders' Deficit (Unaudited)
<TABLE>
<CAPTION>
Three Months Ended September 30, 1998
- --------------------------------------------------------------------------------------------------------------------------------
Preferred Stock Common Stock Total
--------------- ----------------- Additional Accumulated stockholders'
Shares Amount Shares Amount paid-in capital deficit deficit
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, July 1, 1998 61,050 $ 61 6,814,248 $ 6,814 $ 14,174,283 $(15,675,548) $ (1,494,390)
For the three months ended
September 30, 1997:
Exercise of warrants (Note 7) 44,750 45 67,080 -- 67,125
Warrants accompanying
10% Notes (Note 8) 50,000 50,000
Net income -- -- -- (1,710,815) (1,710,815)
- --------------------------------------------------------------------------------------------------------------------------------
Balance, September 30, 1998 61,050 $ 61 6,858,998 $ 6,859 $ 14,291,363 $(17,386,363) $ (3,088,080)
================================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Consolidated Statements of Cash Flows (Unaudited)
================================================================================
Three Months Ended September 30, 1998 1997
- --------------------------------------------------------------------------------
Cash flows from operating activities:
Net income (loss) $(1,710,815) $ 56,641
Adjustments to reconcile net income (loss) to net
cash used in operating activities:
Provision for bad debts -- 15,000
Amortization 19,651 56,128
Depreciation 12,382 8,005
Discount on Notes Payable (Note 8) 50,000 --
Deferred income 853,112 --
(Increase) decrease in:
Accounts receivable (1,155,527) (108,558)
Inventory (60,910) (583,800)
Prepaid expenses and other assets (2,355) (15,620)
Increase (decrease) in:
Accounts payable and accrued expenses 665,857 447,654
- --------------------------------------------------------------------------------
Net cash used in operating activities of
continuing operations (1,328,605) (124,550)
Net cash used in operating activities
of discontinued operations -- (113,728)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Net cash used in operating activities (1,328,605) (238,278)
- --------------------------------------------------------------------------------
Cash flows from investing activities:
Capital expenditures (2,243) (40,167)
- --------------------------------------------------------------------------------
Net cash used in investing activities (2,243) (40,167)
- --------------------------------------------------------------------------------
Cash flows from financing activities:
Repayment of Note Payable (25,574) --
Proceeds from issuance of 10% Notes (Note 8) 1,200,000 --
Proceeds from exercise of warrants (Note 7) 67,125 31,875
- --------------------------------------------------------------------------------
Net cash provided by financing activities 1,241,551 31,875
- --------------------------------------------------------------------------------
Net decrease in cash (89,297) (246,570)
Cash, beginning of period 108,722 727,197
- --------------------------------------------------------------------------------
Cash, end of period 19,425 $ 480,627
================================================================================
See accompanying notes to consolidated financial statements.
6
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
1. Summary of Significant Accounting Policies
(a) Liquidity and Basis of Presentation
The accompanying Consolidated Financial Statements of DigiTEC 2000, Inc.
and Subsidiary (formerly Promo Tel, Inc.) (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 these 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 fiscal 1999, the Company issued $1.2 million of its 10%
six-month notes (the "Notes") with accompanying warrants. The majority of
the proceeds was used to make payments to providers of telecommunications
facilities or to satisfy existing financial obligations, and the Company
remains severely undercapitalized.
As the Company's facilities-based operations increase, management believes
that the operating cash flow will increase because the payments to
suppliers of telecommunications facilities generally are payable after the
usage of the prepaid telephone calling cards ("Cards") versus prepaid in
the case of bundled Cards. 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.
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 up to
$1,000,000 of convertible promissory notes and warrants to CCI. These
negotiations are ongoing, and as of November 20, 1998, no agreements have
been reached. There can be no assurance 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.
The Company has commenced a complete review of its selling, general and
administrative expenses, targeting cost reductions and reduced cash needs
of approximately $500,000 during the 1999 fiscal year. During fiscal 1999,
the Company has reduced its workforce by a total of eight full-time
employees, two of whom were hired during fiscal 1999, and reduced the
working hours of certain other hourly-compensated personnel. The
anticipated annual reduction in the employee wages, salaries and benefits
component of selling, general and administrative expenses resulting from
the foregoing actions approximates $390,000, approximately $280,000 of
which is expected to be realized during the 1999 fiscal year. The Company
is continuing its review of other selling, general and administrative
expenses in an effort to reduce costs further and minimize cash needs.
There can be no assurance that further progress toward achievement of
these objectives will be made or that acceptable alternatives will be
found.
(b) Business
The Company is primarily engaged in the distribution, marketing and
management of 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.
7
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Notes to Consolidated Financial Statements (continued)
- --------------------------------------------------------------------------------
(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 $.001 Promo Tel-Nevada common stock for the outstanding shares of
Promo Tel-Delaware's outstanding common stock.
Since the Merger resulted in voting control by the stockholder of Promo
Tel-Delaware and Promo Tel-Delaware had the personnel and owned all the
assets to be utilized for its ongoing business, the Merger was treated as
a recapitalization of Promo Tel-Delaware and the sale of 59,042 shares of
previously issued Promo Tel-Nevada common stock for the net assets of
Promo Tel-Nevada ($-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. Accordingly, the Company had no results of operations for
fiscal years ended prior to June 30, 1996. 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(b)).
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.
(d) Principles of Consolidation
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 Note 2.)
The Consolidated Financial Statements and related notes thereto as of
September 30, 1998 and for the three months ended September 30, 1998 and
1997 are unaudited but, in the opinion of management, include all
adjustments necessary to present fairly the information set forth therein.
These adjustments consist solely of normal recurring accruals. The
Consolidated Balance Sheet for June 30, 1998 was derived from the audited
Consolidated Financial Statements included in the Company's Annual Report
on Form 10-K/A for the period ended June 30, 1998. These interim financial
statements should be read in conjunction with that report. The interim
results are not necessarily indicative of the results for any future
periods.
8
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Notes to Consolidated Financial Statements (continued)
- --------------------------------------------------------------------------------
(e) 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 income
(loss) per share amounts for all periods have been presented and the
amount for prior period has 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 reverse
stock split.
(f) Reclassifications
Certain amounts as previously reported have been reclassified to conform
to the fiscal 1999 presentation.
(g) Recent Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board ("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, 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. Accordingly, the Company has
adopted both the foregoing standards for the accompanying financial
statements for the quarter ended September 30, 1998. SFAS No. 130 divides
comprehensive income into net income and other comprehensive income, and
specifies that an enterprise that has no items of other comprehensive
income in any period presented is not required to report comprehensive
income. Accordingly, since the Company did not have any items of other
comprehensive income in any period presented, comprehensive income is not
separately reported. The adoption of SFAS No. 131 did 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.
9
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Notes to Consolidated Financial Statements (continued)
- --------------------------------------------------------------------------------
2. Related Party Transactions
(a) On January 20, 1996, the Company 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.
On October 1, 1997, the Company entered into an agreement (the
"Agreement") to sell the customer base, the 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 was to 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 disposal 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 the 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
10
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Notes to Consolidated Financial Statements (continued)
- --------------------------------------------------------------------------------
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, with related party
investments 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. See Note
8, "Issuance of 10% Six-Month Notes with Warrants."
3. Concentrations of Credit Risk
The Company experiences risk concentration due to geographic and customer
concentrations and a limited number of suppliers.
(a) Geographic Concentration of Sales
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 85% of the Company's total
sales for the quarter ended September 30, 1998. No other areas accounted
for more than 10% of the Company's sales.
(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, and sales to this master distributor declined significantly
thereafter. An additional customer, who replaced a significant portion of
the former master distributor's sales, 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. The primary
reason that this customer accounted for an apparently disproportionate
share of receivables at June 30, 1998 versus sales during fiscal 1998 was
the significant ramp-up of sales to this customer during the last four
months of fiscal 1998. During the period from March through June, 1998,
this customer accounted for over $5 million in sales and represented
approximately 72% of the Company's total sales during this four-month
period. The foregoing percentage of sales matched very closely to the 73%
of total accounts receivable due from this customer as of June 30, 1998.
This customer and one additional master distributor accounted for 34% and
25% respectively of the Company's sales for the quarter ended September
30, 1998 and represented 29% and 18% respectively of the Company's
accounts receivable as of September 30, 1998.
During the quarter ended June 30, 1998, due to the increased amount of
receivables aged over 90 days and the related greater risk of asset
impairment, the Company recorded a bad debt reserve of $1,467,000, and
wrote off approximately $223,000 of accounts receivable against that
reserve. The bad debt reserve included approximately $487,000 related to
the foregoing customer which represented 73% of the Company's receivables
as of June 30, 1998. As this customer had previously exhibited a favorable
payment history and had an excellent relationship with the Company, the
Company believed that at least the unreserved portion of the amounts due
from this customer would be collected. Since June 30, 1998 the Company has
received approximately $2,787,000 in payments from this customer, which
amount paid
11
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Notes to Consolidated Financial Statements (continued)
- --------------------------------------------------------------------------------
off the entire receivable balance from the customer, with the remainder
applying to sales of approximately $1.7 million to this customer
subsequent to June 30, 1998.
The Company has initiated discussions with one of the top outside
collection agencies in the United States with respect to collecting
overdue accounts, and intends to retain that agency, or another such
agency of similar reputation, for that purpose. Costs for collection of
such accounts will be on a contingent basis billed to the Company as a
percentage of collected funds; therefore, the Company does not expect any
cash requirements associated with implementing this program and expects
that its liquidity position will improve as a result of its
implementation. Concurrently with the foregoing effort, the Company plans
to improve its documentation of processes and procedures by developing a
formal Credit and Collections Policy including, but not limited to,
customer credit file requirements, standard credit application processes
and procedures and standard procedures for the collection of past due
accounts. The Company believes that the combination of the foregoing
actions will result in reduced credit risk to the Company, improved
liquidity and enhanced ability to establish an asset-backed working
capital credit facility due to the increased quality of the receivables
portfolio. Since these planned actions are in an early stage of
implementation, it is not possible at this time to estimate the
anticipated effects, if any, on sales to current customers.
(c) Concentration of Suppliers of Telecommunications Services
Prior to June 30, 1998, the Company purchased its long distance services
primarily from three suppliers of bundled Cards, Frontier Communications,
Inc. ("Frontier"), Premiere Communications, Inc. ("Premiere") and ATI
Telecom, Inc. ("ATI"). For the year ended June 30, 1998, Frontier
accounted for approximately 35%, Premiere accounted for approximately 43%
and ATI accounted for approximately 14%, respectively, of those services.
During the quarter ended September 30, 1998, none of these suppliers
accounted for more than 10% of purchases of long distance services. During
the quarter ended September 30, 1998, Allied Communications Holdings
("Allied") became a key supplier of facilities-based services to the
Company, providing approximately 46% of total communications services
purchased by the Company. No other supplier accounted for more than 10% of
such purchases. As of September 30, 1998, the amounts of accounts payable
to Frontier, Premiere, ATI and Allied were approximately $105,000,
$597,000, $293,000 and $0, respectively.
4. Accrued Settlement
During March 1998, Vanity Fair Intimates, Inc. ("Vanity Fair") commenced
an action for breach of a sublease agreement, seeking, inter alia,
eviction and judgment against the 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. The Company
made the first payment due in September in accordance with the settlement
agreement. However, due to its liquidity problems, the Company failed to
make the payments due in October and November, 1998. Due to the Company's
failure to make the foregoing payments, Vanity Fair gave notice of its
intention to enter a Confession of Judgment for $369,774, less the amount
previously paid by the Company. The Company subsequently negotiated an
alternative payment plan with Vanity Fair, and to date is in compliance
with the revised payment terms.
12
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Notes to Consolidated Financial Statements (continued)
- --------------------------------------------------------------------------------
5. 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 as of June 30, 1998 was reflected in accounts payable of the
Company with a balance of approximately $502,000. During August, 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. This recovery is recognized in the financial statements for the
quarter ended September 30, 1998.
6. Discontinued Operations of Cellular Division
On December 31, 1997, management decided to abandon the operations of its
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 $155,681 for the three
months ended September 30, 1997 and $527,061 for the year ended June 30,
1998, the majority of which losses were incurred due to the write down of
cellular division assets. As of June 30, 1998, the assets of this division
had been completely written off, and the Company does not anticipate any
additional charges to be recognized related to disposal of its cellular
division. Sales for fiscal 1998 were immaterial.
7. 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. At the expiration of the notice period,
44,750 of the $1.50 Warrants had been exercised, yielding net proceeds of
$67,125 to the Company, and the remainder have been terminated.
8. Issuance of 10% Six-Month Notes with Warrants
During September, 1998, the Company issued the Notes with accompanying
$2.375 Warrants to purchase 600,000 shares of the Company's Common Stock
at an exercise price of $2.375 per share, 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, with related party investments totaling $600,000.
The issuance and sale of the Notes and $2.375 Warrants was exempt from
registration under the Securities Act pursuant to Regulation D.
The $2.375 Warrants are detachable from the Notes. The amounts
attributable to the debt and the purchase warrants were computed based
upon the relative values of the two securities at the time of issuance.
Accordingly, the value of the $2.375 Warrants was calculated as the
difference between the Net Present Value ("NPV") of the known series of
13
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
(formerly Promo Tel, Inc.)
Notes to Consolidated Financial Statements (continued)
- --------------------------------------------------------------------------------
cash flows associated with the Notes using the 10% interest rate of the
Notes and the NPV of the same series of cash flows using a market-based
rate of 19%. The latter rate was determined based upon several quotations
to the Company by non-affiliated potential lenders during arms-length
negotiations of potential financing arrangements. The value of the $2.375
Warrants so calculated was approximately $50,000, which was recorded as
additional paid-in-capital. The related $50,000 discount on notes payable
is being amortized commencing September 15, 1998 over the six-month life
of the Notes, resulting in a monthly charge against net income of
approximately $8,333, during the first six months of fiscal 1999.
9. Letter of Intent with Convergence Communications, Inc.
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 of minutes provided by the Company; 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.
These negotiations are ongoing, and as of November 20, 1998, no agreements
have been reached. There can be no assurance 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.
14
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINACIAL 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 DigiTEC 2000, Inc. (the "Company") included elsewhere in
this Form 10-Q and in conjunction with the corresponding discussion and analysis
included in the Company's Annual Report on Form 10-K/A (the "10-K/A") for the
year ended June 30, 1998. The information set forth in this Form 10-Q includes
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended (the "Securities Act") and Section 21E of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"). The words "estimated,"
"intends," "believes," "plans," "planning," "expects," and "if" are intended to
identify forward-looking statements. Although management believes that the
assumptions made and expectations reflected in the forward-looking statements
are reasonable, because such forward-looking statements include risks and
uncertainties, it must be recognized that there is no assurance that the
underlying assumptions will, in fact, prove to be correct, or that actual future
results will not differ materially from the Company's expectations, either
expressed or implied by such forward-looking statements.
The Company commenced operations under present management in 1995 to capitalize
upon opportunities in the prepaid phone card sector of the long distance
telecommunications market. The Company's prepaid telephone calling cards
("Cards") provide consumers with a competitive alternative to traditional
calling cards and pre-subscribed 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. During the quarter ended September 30, 1998, the Company sold
approximately 1.1 million Cards, of which approximately 0.8 million were its own
proprietary branded Cards, and provided approximately seventeen million minutes
of telecommunications services.
The Company's target markets include ethnic communities with substantial
international long distance calling requirements. For the year ended June 30,
1998 and the quarter ended September 30, 1998 approximately 72% and 75%
respectively 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.
The Company's fiscal 1997 and 1998 sales were derived primarily from the resale
of bundled 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
15
<PAGE>
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
facilities-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. During the quarter ended September
30, 1998, approximately 78% of the Cards sold by the Company were
facilities-based Cards.
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) finance its operations (ii) continue its planned
transition to a facilities-based carrier, (iii) introduce Local Access Cards
("LACs") in many of the markets in which it currently distributes Cards or into
which it expands, (iv) increase the retail distribution of its products, (v)
introduce additional products and services, (vi) continue to attract consumers
with significant international long distance usage and (vii) capitalize upon
economies of scale.
Operations
Three Months Ended September 30, 1998 Compared to Three Months Ended September
30, 1997
Net Sales. Net Sales for the three months ended September 30, 1998 decreased by
approximately $7,482,000 or 56% from $13,322,000 during the three months ended
September 30, 1997 to $5,840,000 for the three months ended September 30, 1998.
Two master distributors accounted for approximately 34% and 25% respectively of
sales during the three months ended September 30, 1998. The decrease in sales is
due primarily to:
1. The Company terminating, during the quarter ended December 31, 1997,
the exclusivity clause in an agreement with a key master distributor
who accounted for sales of approximately $5.6 million during the
quarter ended September 30, 1997, and the failure to fully replace
the sales accounted for by the distributor.
2. The Company's inability to market its new facilities-based Cards as
rapidly as planned, due to liquidity issues which precluded the
Company from securing facilities as quickly as planned. This lack of
facilities forced the curtailment of sales activities on certain
Cards, since additional sales would have degraded the service
available to all customers due to the lack of adequate facilities to
complete the calls. This issue has continued into the second quarter
of fiscal 1999, and the Company's sales for the first half of the
second quarter of fiscal 1999 have been adversely affected. See
"Liquidity and Capital Resources."
In addition to the foregoing, due to the introduction of its branded,
facilities-based Cards during the fourth quarter of fiscal 1998, the Company
began phasing out the sale of its bundled products, which were no longer
competitively priced and which required greater capital resources to market than
the facilities-based Cards.
During the three months ended September 30, 1998, the Company's agreement with
Premiere Communications, Inc. ("Premiere") expired. Premiere previously has been
a significant supplier of bundled Cards and telecommunications services to the
Company. Since the expiration of the agreement with Premiere, the Company has
negotiated arrangements with other telecommunications service providers for the
supply of the Company's telecommunications needs. Accordingly, the Company does
not believe that its future sales will be materially affected by the expiration
of this agreement.
16
<PAGE>
Cost of Sales. The Company's cost of sales for the three months ended September
30, 1998 decreased to approximately $5,858,000 from $12,238,000 for the three
months ended September 30, 1997. The decrease of $6,380,000 or 52% was primarily
related to the decrease in revenues that the Company experienced in the three
months ended September 30, 1998 as compared to the first quarter in the prior
year. Cost of sales exceeded net sales due to the Company not being able to
route its traffic on its least cost providers due to its inability to prepay the
carriers as a result of its limited capital resources, thereby increasing the
cost of goods sold significantly over budgeted amounts.
Gross Profit. For the three months ended September 30, 1998, the Company
experienced a gross loss of approximately $18,000 as compared to a gross profit
of approximately $1,084,000 for the three months ended September 30, 1997. The
decrease of $1,102,000 or 102% was primarily related to the lower volume of
sales during the current period and the higher cost of sales due to the higher
facilities costs, as discussed above. In addition, the transition of the
Company's brands from bundled Cards to facilities-based Cards was accompanied by
introductory pricing, thereby further reducing the gross profit on those sales.
During the three months ended September 30, 1998, the Company phased out its
bundled products since they were no longer competitively priced and since the
Company's agreement with Premiere, a major supplier of such Cards, had expired.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the three months ended September 30, 1998 increased
to approximately $1,693,000 from $766,000 for the three months ended September
30, 1997. This increase of $927,000 or 121% is primarily related to:
1. Increases in salaries, wages and personnel-related expenses of
approximately $401,000, as the Company's employee base increased
from 41 full-time employees on September 30, 1997 to 80, including
six part-time employees, by September 30, 1998. The increase in
employees was related to an expansion of the Company's internal
route distribution network and expanded customer service.
2. Increases in rent, telephone, general office and non-wage-related
customer service expenses of approximately $199,000, which were
related to the larger workforce.
3. Increases in professional fees of approximately $106,000, primarily
due to increased corporate consulting fees and legal expenses
related to litigation, regulatory filings and financing.
The remaining $221,000 of the increase in selling, general and administrative
expenses was caused by immaterial increases in several accounts.
Loss from Continuing Operations. The Company incurred a loss from continuing
operations of approximately $1,711,000 for the three months ended September 30,
1998, as compared to income from continuing operations of approximately $318,000
for the three months ended September 30, 1997. This loss is primarily due to the
combination of lower gross margin resulting from the decreased sales and higher
facilities costs, coupled with higher selling, general and administrative
expenses incurred during the quarter ended September 30, 1998.
Loss from Discontinued Operations. The Company incurred no losses from
discontinued operations for the three months ended September 30, 1998 as
compared to a loss from discontinued operations of $155,681 related to the
discontinued operations of the cellular division for the period ended September
30, 1997.
Net Loss. For the quarter ended September 30, 1998, the Company realized a total
net loss of $1,710,815, as compared to net income of $56,641 for the quarter
ended September 30, 1997. The loss in the quarter ended September 30, 1998 is
due to the lower gross margin on decreased sales coupled with the substantial
increase in selling, general and administrative expenses as discussed above.
17
<PAGE>
Liquidity and Capital Resources
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. The financial statements do not include any
adjustments that might result from the outcome of these 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.
As the Company's facilities-based operations increase, management believes that
the operating cash flow will increase because the payments to suppliers of
telecommunications facilities generally are payable after the usage of the Cards
versus prepaid in the case of bundled Cards. 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.
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 warrants to purchase shares of the Common Stock of the
Company at $1.50 per share (the "$1.50 Warrants"), which aggregated
approximately $3,400,000 of proceeds to the Company; (iii) sale of 61,050 shares
of the Company's Series A 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 Notes with the $2.375
Warrants, all in offerings exempt from registration under the Securities Act.
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 November 20, 1998, no such arrangement has been consummated. The
Company believes that such an arrangement can be consummated, but also believes
that the potential terms of such an arrangement will be more favorable following
the implementation of the additional credit and collection activities discussed
in Note 3(b) to the Consolidated Financial Statements. 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.
During the quarters ended September 30, 1998 and 1997, the Company's major
components of cash flow were as follows:
QUARTER ENDED SEPTEMBER 30,
----------------------------
1998 1997
----------- -----------
Net cash used in operating activities .......... $(1,328,605) $ (238,278)
Net cash used in investing activities .......... (2,243) (40,167)
Net cash provided by financing activities ...... 1,241,551 31,875
----------- -----------
Net decrease in cash ........................... $ (89,297) $ (246,570)
=========== ===========
Net cash used by operating activities during the quarter ended September 30,
1998 was $1,328,605 as compared to $238,278 for the quarter ended September 30,
1997. The increase of approximately $1,090,000 was caused by a net loss of
$1,711,000 for the quarter ended September 30, 1998 as compared to net income of
$57,000 for the quarter ended September 30, 1997 and an increase in accounts
receivable of $1,156,000 for the quarter ended September 30, 1998 as compared to
an increase of $109,000 for the quarter ended September 30, 1997. The primary
factor which partially offset the foregoing increased uses
18
<PAGE>
of cash was the increase in deferred income of $853,000 in the quarter ended
September 30, 1998 related to the sale of facilities-based Cards during the
quarter, which non-cash charge was not incurred in the corresponding quarter of
the prior year, since bundled Cards were sold at that time. In addition,
accounts payable increased by $666,000 during the quarter ended September 30,
1998 as compared to $448,000 in the quarter ended September 30, 1997. During the
quarter ended September 30, 1998 the Company experienced a much smaller increase
in inventory, $61,000, as compared to $584,000 in the corresponding prior year
period.
To date, capital expenditures have not been material. Cash used in investing
activities for both the quarters ended September 30, 1998 and 1997 related
solely to capital expenditures of approximately $2,000 for the quarter ended
September 30, 1998 and $40,000 for the quarter ended September 30, 1997.
Cash provided from financing activities of $1,242,000 during the quarter ended
September 30, 1998 consisted of $1,200,000 net proceeds from the Company's sale
of the Notes and $67,000 proceeds from the exercise of certain $1.50 Warrants
less payments of approximately $25,000 related to the Prime Communications, Inc.
note payable. During the quarter ended September 30, 1997, cash provided from
financing activities of $32,000 related solely to the proceeds from the exercise
of certain $1.50 Warrants.
For the quarter ended September 30, 1998, the Company experienced a substantial
operating loss of $1,711,000 and used $1,329,000 cash in operating activities.
The Company's cash position at September 30, 1998 approximated $19,000 and its
working capital deficit approximated $3,781,000. Of the Company's working
capital deficit, approximately $1,808,000 consists of deferred revenue, which
represents sales for which provision of the underlying telecommunications
service has not yet been rendered or paid for by the Company. This does not
represent an immediate cash requirement. However, due to operating losses and
the Company's expansion, the Company remains severely undercapitalized and to
date has not been able to finance its expansion as quickly as opportunities have
arisen. During the quarter ended September 30, 1998 and into the first portion
of the second quarter of fiscal 1999, the Company has experienced substantial
difficulty in making timely payments to its vendors and satisfying other
financial obligations, including payments to its landlord, employees and the
providers of its telecommunications facilities, professional services and other
general corporate services. Because of the lack of liquidity and the difficulty
in making payments to the providers of certain telecommunications facilities,
the Company has not been able to add the requisite facilities as rapidly as
planned, and the Company's sales of Cards has been adversely affected.
During September, 1998, the Company raised cash through the issuance of
$1,200,000 principal amount of the Notes. The majority of this cash was 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. These
negotiations are ongoing, and to date no agreement has been reached with CCI.
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 by
year-end. 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.
19
<PAGE>
The Company has commenced a complete review of its selling, general and
administrative expenses, targeting cost reductions and reduced cash needs of
approximately $500,000 during the 1999 fiscal year. During fiscal 1999, the
Company has reduced its workforce by a total of eight full-time employees, two
of whom were hired during fiscal 1999, and reduced the working hours of certain
other hourly-compensated personnel. The anticipated annual reduction in the
employee wages, salaries and benefits component of selling, general and
administrative expenses resulting from the foregoing actions approximates
$390,000, approximately $280,000 of which is expected to be realized during the
1999 fiscal year. The Company is continuing its review of other selling, general
and administrative expenses in an effort to cut costs further and minimize cash
needs. There can be no assurance that further progress toward achievement of
these objectives will be made or that acceptable alternatives will be found.
The Company has initiated discussions with one of the top outside collection
agencies in the United States with respect to collecting overdue accounts, and
intends to retain that agency, or another such agency of similar reputation, for
that purpose. Costs for collection of such accounts will be on a contingent
basis billed to the Company as a percentage of collected funds; therefore, the
Company does not expect any cash requirements associated with implementing this
program and expects that its liquidity position will improve as a result of its
implementation. Concurrently with the foregoing effort, the Company plans to
improve its documentation of processes and procedures by developing a formal
Credit and Collections Policy including, but not limited to, customer credit
file requirements, standard credit application processes and procedures and
standard procedures for the collection of past due accounts. The Company
believes that the combination of the foregoing actions will result in reduced
credit risk to the Company, improved liquidity and enhanced ability to establish
an asset-backed working capital credit facility due to the increased quality of
the receivables portfolio. Since these planned actions are in an early stage of
implementation, it is not possible at this time to estimate the anticipated
effects, if any, on sales to current customers.
A shareholder of the Company recently has begun to originate and terminate
domestic and international telecommunications traffic for the Company, thereby
reducing the short-term capital requirements of the Company. The Company is in
the process of negotiating a long-term operating agreement with the shareholder.
However, there can be no assurances that the parties will reach an agreement or
that the shareholder will continue to originate and terminate telecommunications
traffic for the Company.
With implementation of the above plans, the Company expects capital requirements
of approximately $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 additional facilities are made operable
by the Company's suppliers in a timely manner to increase facilities-based
sales. If only one of these financing arrangements occurs, or if cash needs
prove to be greater than contemplated, the Company will need to slow or
eliminate 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.
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.
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,
20
<PAGE>
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 ("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, 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. Accordingly, the Company has adopted both the
foregoing standards for the accompanying financial statements for the quarter
ended September 30, 1998. SFAS No. 130 divides comprehensive income into net
income and other comprehensive income, and specifies that an enterprise that has
no items of other comprehensive income in any period presented is not required
to report comprehensive income. Accordingly, since the Company did not have any
items of other comprehensive income in any period presented, comprehensive
income is not separately reported. The adoption of SFAS No. 131 did 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT 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
notes payable at September 30, 1998 and June 30, 1998, respectively, 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.
21
<PAGE>
PART 2--OTHER INFORMATION
Item 1. 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 discovery phase of the
case was concluded and a trial date of November 12, 1998 was set. Based upon
settlement negotiations between the parties, the trial had not commenced as of
November 20, 1998.
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 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. The Company made
the first payment due in September in accordance with the settlement agreement.
However, due to its liquidity problems, the Company failed to make the payments
due in October and November, 1998. Due to the Company's failure to make the
foregoing payments, Vanity Fair gave notice of its intention to enter a
Confession of Judgment for $369,774, less the amount previously paid by the
Company. The Company subsequently negotiated an alternative payment plan with
Vanity Fair, and to date is in compliance with the revised payment terms.
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
22
<PAGE>
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.
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.
Item 2. Changes in Securities and Use of Proceeds
During September, 1998, the Company issued the Notes with accompanying $2.375
Warrants to purchase 600,000 shares of the Company's Common Stock at an exercise
price of $2.375 per share, 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, with related party investments
totaling $600,000. The majority of the net proceeds of $1,200,000 from the
offering was 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. The issuance and sale of the 10% Notes and
$2.375 Warrants was exempt from registration under the Securities Act pursuant
to Regulation D.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 27-Financial Data
(b) Reports on Form 8-K
None
23
<PAGE>
Pursuant to the requirements 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.
Date: November 23, 1998 DigiTEC 2000, Inc.
(Registrant)
By: /s/ Frank C. Magliato
------------------------------------
Frank C. Magliato
Chief Executive Officer, President and
Director
November 23, 1998 By: /s/ Charles N. Garber
------------------------------------
Charles N. Garber
Vice President and Chief Financial
Officer
November 23, 1998 By: /s/ Diego E. Roca
------------------------------------
Diego E. Roca
Senior Vice President and Chief
Operating Officer, Treasurer and
Secretary
24
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from Consolidated
Financial Statements for the quarter ended 9/30/98 for DigiTEC 2000, Inc. and is
qualified in its entirety by reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JUL-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 19,425
<SECURITIES> 0
<RECEIVABLES> 4,152,749
<ALLOWANCES> 1,305,000
<INVENTORY> 454,496
<CURRENT-ASSETS> 3,457,225
<PP&E> 227,161
<DEPRECIATION> 77,259
<TOTAL-ASSETS> 4,239,494
<CURRENT-LIABILITIES> 7,238,029
<BONDS> 0
0
61
<COMMON> 6,859
<OTHER-SE> (3,095,000)
<TOTAL-LIABILITY-AND-EQUITY> 4,239,494
<SALES> 5,839,898
<TOTAL-REVENUES> 5,839,898
<CGS> 5,857,829
<TOTAL-COSTS> 5,857,829
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 6,715
<INCOME-PRETAX> (1,710,815)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,710,815)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,710,815)
<EPS-PRIMARY> (.25)
<EPS-DILUTED> (.25)
</TABLE>
