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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, 1999 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 |_| No |X|
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. |X|
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
$5,398,329 on October 25, 1999, 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 25, 1999 was 7,058,998.
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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 December
9, 1999.
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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, 1999 is forward-looking, such as
information relating to the plans of Digitec 2000, Inc. (the "Company") to
become a sales, marketing and distribution company for providers of
telecommunications services in lieu of the Company's previously announced plans
to become a facilities-based carrier, the expected effects of this transition
and timing thereof upon the Company's margins and cash flow, 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 DIRECT
(R) series ("DIRECT (R)") of Cards, which were introduced in May and December of
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 20,000 independent retail locations.
The Company's total revenues were $26,027,909, $35,032,533 and $10,394,558 and
its net losses were $3,549,514, $11,996,759 and $13,566,927 for the fiscal years
ended June 30, 1997, 1998 and 1999, respectively, after losses from discontinued
operations of $1,069,261, $813,178 and $0, respectively.
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, 1999,
approximately 65% 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 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 (i) approximately 100 distributors
in 29 states, Puerto Rico, Mexico and the U.S. Virgin Islands, reaching an
estimated additional 17,000 retail locations, (ii) its wholly owned point of
sale subsidiary, POS TEC Systems, LLC ("PTS"), and (iii) the Company's own route
distribution department. The Company's route distribution department is
comprised of 17 field representatives and one field sales manager servicing over
3,000 retail locations primarily in the New York/New Jersey metropolitan area
(the "Metro Area").
The F/X(R) and DIRECT(R) Card users are provided with access to local,
domestic long distance and international telephone services through toll-free
and local access calls directed to call processing platforms operated by TecNet,
Inc. ("TecNet"), a wholly owned subsidiary of Telephone Electronics Corporation
("TEC"), the holder of approximately 21% of the Company's Common Stock.
Formerly, the Company used the platforms of 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 or local access 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.
As previously reported, the Company initiated a strategy of becoming a
facilities based carrier in April, 1998. To accomplish this strategy the Company
migrated its brands to dedicated platforms. However, because the Company was
unable to fund carrier deposits and prepay for telecommunications services, the
Company was unable to secure sufficient network facilities and competitive
rates, with the result that the Company was unable to market its new
facility-based Cards as quickly as planned and was forced to accept returns of
Cards due to the failure of the Cards to properly process calls. The liquidity
difficulties of the Company were further aggrevated by the returns of Cards and
loss of control of processed call minutes. Accordingly, in November, 1998, due
to network and liquidity problems, including those caused by the termination and
repricing of the Company's Cards by Premiere (See "Company History"), which
prevented the Company from implementing its strategy of becoming a
facilities-based carrier, the Company initiated its current strategy to become a
sales, marketing and distribution company for significant providers of
telecommunication services. In this connection, the Company has been advanced
both significant telecommunications services and funds by TecNet to finance its
operations during this transition period. The Company will continue to be
dependent upon TecNet until it fully implements its new strategy and has
profitable operations. TecNet is not obligated by any written agreement to
continue advancing telecommunication services or funds to the Company.
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.
The Company was able to negotiate fair and competitive rates from its
bundled product providers. However, last year 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, thereby becoming a facilities-based carrier and thereby increasing its cash
flow. The Company began to implement its 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 Innovative's switching
facilities and platforms located at 60 Hudson Street, New York, NY (the "Hudson
Street Facility"). When the Company was unsuccessful in implementing its
facilities-based carrier strategy, it continued to sell bundled cards in
connection with implementing its new strategy through the Hudson Street
Facility. Subsequent to the Services Agreement expiring, a wholly owned
subsidiary of TecNet acquired substantially all of the assets of Innovative and
the Company continues to process its bundled Cards primarily through the Hudson
Street Facility. At fiscal year-end of 1999 the Company was processing a
majority of its minutes through the Hudson Street Facility.
Due to continuing network and ensuing liquidity problems, the Company
determined in fiscal 1999 to implement a strategy of becoming a sales, marketing
and distribution company for facilities-based carriers. This strategy was
facilitated by TecNet's ability to allow the Company to implement its new
strategy without further disruption of services. In addition, the Company is in
negotiations with TecNet for (i) a long-term operating agreement pursuant to
which the Company's traffic can be originated and terminated through the network
facilities of TecNet, and (ii) arrangements to finance point of sale ("POS")
equipment and operations of a POS distribution network for sale of the Company's
Cards through PTS. There can be no assurances that these negotiations will be
successful or that TecNet will continue to handle traffic for the Company or
advance funds for working capital expenditures. As of June 30, 1999, the Company
has accrued $4,391,167 for telecommunication services and $547,028 for bundled
cards with TecNet and borrowed a total of $1,884,190 from TecNet pursuant to
demand promissory notes bearing interest at ten percent per annum.
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Based on the Company's analysis, the Company's total cost per call using
dedicated facilities would be less than the cost under the bundled Card product,
except that the Company must rely on third parties to accurately process and
monitor the minutes processed at a facility. The Company has determined that by
implementing its new strategy of selling bundled cards for TecNet, a significant
telecommunications service provider, it will provide the Company with additional
margin and more competitive products. There can be no assurances that the
Company will be able to successfully implement its strategy. See "Growth
Strategy".
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 over $100 billion in 1999. The
aggregate market share of all interexchange carriers other than AT&T, MCI
Worldcom and Sprint has grown from 2.6% in 1984 to approximately 40% in 1999.
During the same period, the market share of AT&T declined from approximately 90%
to approximately 40%. The Company believes that these trends 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 $2.5 billion in 1999, making it
one of the fastest growing segments of the telecommunications industry. Based on
industry reports, the market is expected to grow to approximately $5 billion by
2000. 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 intends to capitalize on the growth opportunities within the
Prepaid Phone Card market using: (i) TecNet's network facilities and economies
of scale; (ii) brand awareness of the Company's established Cards; (iii) the
Company's position as a significant conduit of telecommunications traffic to
various international destinations; (iv) the Company's distribution network
through which the Company can market, distribute and sell new and existing
products; and (v) the Company's experience in identifying and marketing to
ethnic communities and other consumers in the United States with significant
long distance usage requirements.
The Company has identified the following short-term goals: (i) reduce its
costs of providing services as a percentage of sales, which will allow the
Company both to begin to achieve 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.
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The Company has identified the following strategies in conjunction those goals:
1. Telecommunications Services. The Company is negotiating with TecNet to
upgrade TecNet's existing telecommunications POPs throughout the United States
to process Card traffic. In addition, the Company is using the
telecommunications POPs of TecNet to originate and terminate traffic in Mexico.
The Company is operating on three dedicated platforms and is supplying services
from these platforms on its three current brands of Cards, including F/X Mexico,
Digitec Direct and New York Direct.
2. Introduction of Local Access Cards. The Company is introducing 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 competitiveness in the marketplace by
providing increased pricing flexibility. The Company recently released its first
LAC, New York Direct, with services provided by TecNet in the New York market
during May, 1999, providing customers with long distance service to any U.S.
destination at 3.9 cents per minute after a 49 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 introduce similar Cards in other U.S.
cities during fiscal 2000.
3. Expansion of the Company's Retail Distribution Network. The Company's
Cards are currently sold in 29 states in the United States, Puerto Rico, Mexico
and the U.S. Virgin Islands. The Company has a route distribution network
servicing over 3,000 retail locations, primarily in the Metro Area. In addition,
the Company currently distributes and markets its Prepaid Phone Cards to
approximately 17,000 retail locations through approximately 100 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.
4. 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.
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5. 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 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.
6. Point of Sale. The Company through PTS acquired the assets of Total POS
Systems LLC, including approximately 1,500 locations in 1999 to market existing
and new brands of its Cards intended to be activated at POS terminals. The
Company believes that retailers and their 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 host server. This information is processed and retransmitted to
the applicable telecommunications platform, thus activating the Card for use by
the customer. Funds are electronically transferred from the merchant to the
Company after Card activation. 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, reduce bad debt experience
and improve cash flow and further increase the margins on the Cards. Merchants
with existing terminals have them reprogrammed to activate the Company's Cards.
Additionally, the Company provides terminals to retail establishments without
them.
7. 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, the Company decided to abandon the operations of its cellular division on
December 31, 1997. 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.
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 Promo
Tel, Inc. a Delaware corporation ("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 by Premiere 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.
Immediately following the suspension and repricing by Premiere, the monthly
sales rate declined to approximately $1.5 million per month retail value,
continued at this lower level for the remainder of the 1998 fiscal year, and
during fiscal 1999 fell to approximately $400,000 per month retail value.
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."
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 Preferred Stock (the "Preferred Stock"), valued by the
Board of Directors at $6,105,093 which represented the outstanding accounts
payable balance at March 31, 1998. The $6,105,093 consisted of $3,236,104
attributed to the normal course of business and $2,868,989 of charges for excess
minutes processed by Premiere on cards sold. During the third quarter of fiscal
1998, the Company incurred the charge of $1,468,112 and invoiced the remaining
$1,400,877 to the Company's main distributor. During the fourth quarter of 1998,
this distributor informed the Company that no monies had been collected on the
excess minutes and refused to pay the $1,400,877 invoice. Therefore, the Company
reversed the sale of these minutes during the fourth quarter. The $2,868,969
representing the total charges related to these excess minutes is included as a
separate component of cost of sales. The $2,868,969 consists of the $1,400,877
recorded in the fourth quarter as a reversal of a sale and the $1,468,112 which
was originally recorded as part of selling, general, and administrative expenses
and was reclassified to cost of sales in the fourth quarter. The Preferred Stock
is
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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 $8.3463, the
Conversion Price, as defined in the Certificate of Designation, resulting in a
total of 731,462 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
three brand names, including Digitec Direct, F/X Mexico and New York 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. New York Direct and Digitec Direct
Cards are currently available with instructions in English, Spanish and Russian.
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 of 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
Previously the Company was 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 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 obtains
its telecommunications services from TecNet utilizing the switching and platform
facilities located at the Hudson Street Facility. TecNet activates 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.
Marketing and Distribution
The Company distributes the New York Direct, Digitec Direct and F/X Mexico
Cards primarily through independent distributors, field representatives and
through PTS. 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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brand of the Card and the dollar volume of purchases made by the distributor.
Master distributor agreements provide for limited exclusivity in defined
metropolitan areas, subject to the master distributor maintaining an agreed upon
monthly dollar 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 30, 1999, approximately 100 distributors purchased Prepaid Phone
Cards directly from the Company, reaching an estimated 17,000 retail locations.
The Company also sells and distributes its Cards through its own route
distribution comprised of 17 field representatives and one field sales manager,
servicing over 3,000 retail locations in the Metro Area. By building out its
route distribution infrastructure, the Company is able to attain higher gross
margins since it eliminates the independent distributor's margin on the sale.
The Company intends to further expand its route sales and distribution network
as part of its plans for expansion, including 1,500 POS locations acquired by
PTS. 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 call
detail records. As of September 30, 1999, the Company employed 18 full-time
customer service representatives ("CSRs"). Most CSRs are fluent in both English
and Spanish or Russian. 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. The Company also maintains activated inventory for its
own route distribution.
PINs are created electronically with unique inventory and batch codes. The
Company currently relies on TecNet and other suppliers to provide software
support to track Prepaid Phone Card information and deactivate specified PINs in
certain instances such as nonpayment, 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 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 largely 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 also depend 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
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 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 below cost without payment to
telecommunications carriers.
Government Regulation
Historically, the Company has been subject to minimal government
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 opened 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 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.
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 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 operations.
State. Intrastate long distance telecommunications is 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 June 30, 1999, the Company had 44 full time employees including
three officers. 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), Digitec Direct(R), New York Direct(R) and F/X
Mexico(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 Prepaid Phone Cards, primarily TecNet. As of May, 1999 the Company
abandoned facilities-based operations and continues to utilize TecNet for
substantially all of its telecommunications services. 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: on the difference between
discounts given to customers and the discounts received from its suppliers.
During the fiscal year ended June 30, 1999,
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Premiere provided minimal service as opposed to 48% of the telecommunications
services supplied to the Company in the fiscal year ended June 30, 1998. The
agreement under which services were provided by Premiere expired on August 31,
1998. The Company continues to negotiate 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 and the unilateral suspension and repricing
of two of the Company's Card programs by Premiere. The Company currently
receives substantially all of its telecommunications services from TecNet. 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, primarily TecNet to provide it with facilities and Prepaid
Phone Cards at favorable terms and competitive rates. Acceptance of the
Company's Cards is dependent upon the transmission capacity of various long
distance and local telecommunications carriers to originate, transport and
terminate the long distance traffic of the Prepaid Phone Cards. 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,
other than service provided by Premiere, 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, quality of transmission, 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 largely 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 below cost without payment to
telecommunications carriers.
Market Acceptance. In an emerging industry, demand and market acceptance
for newly introduced products and services are subject to a high level of
uncertainty. 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. 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 grow, there can be no assurance that the Company will be able
to achieve the growth contemplated by its business strategy. The Company's new
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. 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; (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 $1.10 per share; (v) subsequent
exchange of the 10% Notes and attached warrants for two-year 10% Notes (the
"Convertible Debt") convertible at $1.10 per share of Common Stock with attached
warrants to purchase 1,800,000 shares of Common Stock at $1.10 per share (the
"$1.10 Warrants"); (vi) issuance of a $100,000 10% promissory note to an
officer/director family member; and (vii) the issuance of demand promissory
notes bearing interest at ten percent interest to TecNet totaling $1,884,190 in
principal amount through June 30, 1999 increasing to $2,019,000 through October
25, 1999. All of the offerings were exempt from registration under the
Securities Act of 1933, as amended (the "Securities Act"). In addition, the
Company has financed a substantial portion of the telecommunications services
used by it in fiscal 1999 with TecNet. At June 30, 1999, amounts due TecNet for
such services total $4,391,167 for telecommunications services and $547,028 for
bundled cards. Due to operating losses 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 growth. To date the Company has no existing bank
lines of credit and has not established any sources for such financing, except
to the extent TecNet continues to fund certain operating expenses and continues
to provide telecommunication services. 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
October 25, 1999, 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 or that TecNet will continue to provide such
financing. 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, significant arrearages on trade payables, significantly
reduced sales revenues and aggregate gross loss on its products, such
realization of assets and satisfaction of liabilities is subject to significant
uncertainties. The Consolidated 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 the willingness and ability of TecNet to finance the Company's
telecommunications products and services and working capital shortfalls and
TecNet's and the Company's ability to provide reliable and competitive Cards.
Additionally the Company's stability is dependent up on its ability to raise
capital, develop market share, achieve profitable operations, and to generate
sufficient cash flow from operations and financing sources to meet obligations.
The independent auditors' opinion on the Company's consolidated financial
statements includes a going concern paragraph based on the significant losses
from operations, significant deficits in working capital and net worth and the
Company's economic dependence on its 21% stockholder to provide significant
telecommunications products and services and funding for operating cash flows.
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 and 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 5, 2000 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. The Company intends to
vigorously contest this case. 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 November 2,
1999.
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. However,
due to its liquidity problems, the Company failed to make the payment due in
October and November 1998 and Vanity Fair gave notice of its intention to enter
a Confession of Judgment against the Company for $369,774, less amounts
previously paid. The Company subsequently negotiated an alternative payment plan
with Vanity Fair, and to date is in compliance with the revised payment terms.
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.
The Company was served on March 30, 1999 in an action by Qwest
Communications Corporation ("Qwest") entitled Qwest Communications Corporation v
Digitec 2000, Inc., in the United States District Court for the Southern
District of New York, seeking payment for approximately $1.37 million of
telecommuncation services provided to the Company by Qwest. In May, 1999 the
parties executed a settlement agreement pursuant to which the Company would pay
in nine monthly installments commencing December, 1999 a total of $887,000 and
TecNet, Inc would satisfy the remaining $490,000.
On March 10, 1999, the Company was served with a Motion for Summary
Judgement by Prime Communications (NY) Inc. ("Prime") in a case entitled Prime
Communications (NY), Inc v Digitec 2000, Inc. in the Supreme Court of the State
of New York, County of Suffolk seeking judgement on a promissory note issued by
the Company for $147,000, which note was issued in connection with the
acquisition of certain assets from Prime. The outstanding amount on the note is
approximately $121,425. The Company has countermoved against Prime alleging
failure of Prime to deliver the contemplated consideration and seeks damages
against Prime. Judgement on the motion was rendered in favor of the Company and
Prime has sought a rehearing and commenced a pleniary action. The Company and
Prime are currently negotiating a settlement of the matter.
On March 18, 1999 the Company was served with a complaint by the
Weeks-Lerman Group, LLC ("Weeks-Lerman") in a case entitled Weeks-Lerman Group
LLC v Digitec 2000 Inc., in the Supreme Court of the State of New York for the
County of Kings. Weeks-Lerman alleges that it provided the Company with work,
labor and services and/or sold and delivered goods to the Company in the amount
of $75,988.31. Weeks-Lerman seeks that amount together with interest from June
23, 1998, costs and disbursements. Presently, the Company is exploring
settlement possibilities with Weeks-Lerman. The Company is not in a position to
express an opinion as to the probable outcome of this matter.
On October 20, 1999, Union Telecard Alliance LLC filed a suit entitled
Union Telecard Alliance LLC v Digitec 2000, Inc., TecNet Inc. in Supreme Court
of the State of New York, New York County against the Company to recover
$462,000 for Cards sold to the Company. The Company has not had sufficient time
to review the complaint and accordingly is not in a position to express an
opinion as to the probable outcome of this matter.
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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 net losses from continuing operations of $13,566,927 for the year
ended June 30, 1999. 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
product pricing; (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. 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 Key Suppliers and their Facilities. Key suppliers'
facilities, such as TecNet, include (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, including primarily TecNet for efficient and
uninterrupted service to its customers and their willingness to continue to
provide the Company with favorable terms. 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 all appropriate and
reasonable 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. See
"Facilities and Third Party Service."
As previously reported, the Company initiated a strategy of becoming a
facilities based carrier in April, 1998. To accomplish this strategy the Company
migrated its brands to dedicated slat forces. However, because the Company was
unable to fund carrier deposits and prepay for telecommunications services, the
Company was unable to secure sufficient network facilities and competitive
rates, with the result that the Company was unable to market its new
facility-based Cards as quickly as planned and was forced to accept returns of
Cards due to the failure of the Cards to properly process calls, the liquidity
difficulties of the Company were further aggrevated by the returns of Cards and
loss of control of proceeds call minutes. Accordingly, in November, 1998, the
Company, due to network and liquidity problems caused by Premiere's termination
and repricing of the Company's Cards (see "Company History"), which prevented
the Company from implementing its strategy of becoming a facilities-base
carrier, initiated its current strategy to become a sales, marketing and
distribution company for significant providers of telecommunication services. In
this connection, the Company has been advanced significant telecommunications
services by TecNet and TecNet has advanced significant funds to the Company to
finance its operations during this restructuring period. The Company will
continue to be dependent upon TecNet until it fully implements its new strategy
and returns to profitable operations. TecNet is not obligated by any written
agreement to continue advancing telecommunication services or funds to the
Company.
Dependence on Key Personnel. The Company is dependent on its ability to
retain and motivate high quality personnel, especially its management and any
sales personnel that are needed in connection with the Company's plans to become
a sales, marketing and distribution company. In December, 1998, the Company's
Chief Financial Officer terminated employment and to date the Company has been
unable to fill the position. 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 two of its executive officers. 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 7,058,998 shares of Common Stock. In
addition, as of June 30, 1999, the Company has outstanding the following
warrants, options and conversion rights to purchase or otherwise acquire
additional shares of Common Stock:
(i) $1.10 Warrants to purchase 1,800,000 shares of Common Stock at an
exercise price of $1.10, which were issued in connection with the
exchange of the Company's 10% Notes and accompanying warrants during
May, 1999, for the Convertible Debt which is convertible into
approximately 1,090,909 shares of Common Stock.
(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
(See Notes to Financial Statements--Note Payable),
(iv) options to purchase 731,944 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 731,462 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 5,832,649 shares outstanding, resulting in total shares outstanding
of 12,891,647 and the Company would receive approximately $27,250,000 in net
proceeds related to the exercise or conversion of these securities. Of the
underlying shares of Common Stock related to the foregoing, 2,209,796 have been
included in the Company's Registration Statement on Form S-1, dated April 20,
1998, as amended from time to time (the "Registration Statement"). The
Employee/Director Options, the shares issuable pursuant to the Convertible Debt,
the $1.10 Warrants were not included. Due to liquidity problems of the Company,
the Registration Statement is not currently effective. However, the Company
intends to reactivate the Registration Statement to cover the shares not sold
pursuant to Rule 144 since the effective date thereof. The shares of Common
Stock to be offered by the Company's Prospectus will be 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 promulgated under the Securities Act or pursuant to a registration
statement filed under the Securities Act. The holders of the $1.10 Warrants and
shares obtained on the conversions of the Convertible Debt 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 1,800,000 shares of Common Stock underlying the $1.10 Warrants and shares of
Common Stock issuable upon conversion of the Convertible Debt. Rule 144
generally provides that a person holding "restricted securities", as defined
under the Securities Act, 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. The Company is largely 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. The initiation of POS activities though PTS will decrease
dependence on such distributors.
Regulation. The Company is regulated at the federal level by the FCC and
is 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
are 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, Massachusetts, 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 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 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 3% 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 operations.
The Company is currently evaluating various tax and other regulatory
assessments to determine their applicability to the Company's operations. As
these operations expand, the Company may become subject to additional tariffs
and the federal and state regulatory charges. During the fourth quarter of
fiscal 1999, the Company accrued approximately $462,000 in expenses relating to
various taxes, penalties and interest related to unfiled tax returns.
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 has implemented
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.
PTS occupies premises of 875 square feet at 17250 North Dallas Parkway,
Dallas, Texas on a month to month basis at $12.00 per square foot per year. PTS
is currently negotiating a lease for a new expanded facility at 17130 North
Dallas Parkway, Dallas, Texas for a three year term covering approximately 4250
square feet at a monthly rental of approximately $6,200.
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 5, 2000 in Jackson, Mississippi.
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
17
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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. However, due to its liquidity problems, the Company failed to make the
payment due in October and November 1998 and Vanity Fair gave notice of its
intention to enter a Confession of Judgment against the Company for $369,774,
less amounts previously paid. 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. a/k/a Conetco
("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. The Company believes that the
plaintiffs' claims are without merit. The company intends to vigorously
contest this case. 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 November 2, 1999.
The Company was served on March 30, 1999 in an action by Qwest
Communications Corporation ("Qwest") entitled Qwest Communications Corporation v
Digitec 2000, Inc., in the United States District Court for the Southern
District of New York, seeking payment for approximately $1.37 million of
telecommuncation services provided to the Company by Qwest. The parties have
executed settlement agreements pursuant to which the Company would pay in nine
monthly installments, commencing December, 1999, a total of $887,000 and TecNet
would satisfy the remaining $490,000.
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.
On March 10, 1999, the Company was served with a Motion for Summary
Judgement by Prime Communications (NY) Inc. ("Prime") in a case entitled Prime
Communications (NY), Inc v Digitec 2000, Inc. in the Supreme Court of the State
of New York, County of Nassau seeking judgement on a promissory note issued by
the Company for $147,000, which note was issued in connection with the
acquisition of certain assets from Prime. The outstanding amount on the note is
approximately $121,425. The Company has countermoved against Prime alleging
failure of Prime to deliver the contemplated consideration and seeks damages
against Prime. Judgement on the motion was rendered in favor of the Company and
Prime has sought a rehearing and commenced a pleniary action. The Company and
Prime are currently negotiating a settlement of the matter.
On March 18, 1999 the Company was served with a complaint by the
Weeks-Lerman Group, LLC ("Weeks-Lerman") in a case entitled Weeks-Lerman Group
LLC v Digitec 2000 Inc., in the Supreme Court of the State of New York for the
County of Kings. Weeks-Lerman alleges that it provided the Company with work,
labor and services and/or sold and delivered goods to the Company in the amount
of $75,988.31. Weeks-Lerman seeks that amount together with interest from June
23, 1998, costs and disbursements. Presently, the Company is exploring
settlement possibilities with Weeks-Lerman. The Company is not in a position to
express an opinion as to the probable outcome of this matter.
On October 20, 1999, Union Telecard Alliance LLC filed suit entitled Union
Telecard Alliance LLC v Digitec 2000, Inc., TecNet Inc. in Supreme Court of the
State of New York, New York County against the Company to recover $462,000 for
Cards sold to the Company. The Company has not had sufficient time to review the
complaint and accordingly is not in a position to express an opinion as to the
probable outcome of this matter.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
19
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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 asked and low bid prices as reported on
the OTC Bulletin Board for the periods indicated.
-------------------------------------------------------------------
Period High Low
-------------------------------------------------------------------
Year Ending June 30, 1998(1):
First Quarter $17.25 $13.00
Second Quarter 14.75 5.50
Third Quarter 9.375 5.00
Fourth Quarter 11.50 6.00
Year Ending June 30, 1999(1):
First Quarter $6.375 $ 1.53
Second Quarter 4.375 .81
Third Quarter 2.34 .875
Fourth Quarter 4.375 .875
-------------------------------------------------------------------
(1) For the years ended June 30, 1998 and 1999, the Company's
Common Stock was thinly traded. Further, over-the-counter
market quotations may not necessarily represent actual
transactions.
On October 25, 1999, the last sale price of the Common Stock on the OTC
Bulletin Board was $1.31 per share. As of September 15, 1999, there were 700
registered shareholders of the Common Stock. During the fiscal year ended June
30, 1999, the Company made the following sales of securities that were not
registered under the Securities Act:
(i) 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, his family and a former director. The 10% Notes
with related warrants were issued to meet working capital needs.
(ii) On March 4, 1999, the Company issued 200,000 shares of Common Stock
to acquire the assets, properties and business of Total Pos
Solutions, LLC, a Texas limited liability company.
(iii) In May, 1999, the Company exchanged the 10% Notes and accompanying
warrants for the Convertible Debt and the $1.10 Warrants.
(iv) In October, 1998, the Company borrowed $100,000 from a member of an
officer/director family which borrowing bears interest at 10% per
annum.
(v) Between February, 1999 and September 30, 1999, the Company borrowed
a total $1,884,190 from TecNet pursuant to 10% demand promissory
notes.
The sales of all the foregoing securities and the exchange of the 10%
Notes 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,
-------------------------------------------------------------------------
1999 1998 1997 1996 1995
-------------------------------------------------------------------------
Consolidated Statements of Operations Data:
<S> <C> <C> <C> <C> <C>
Sales ................................. $ 10,394,558 $ 35,032,533 $ 26,027,909 $ 17,425,199 --
Cost of sales ......................... 15,278,886 36,648,219 25,161,443 16,900,370 --
Gross profit (loss) ................... (4,884,328) (1,615,686) 866,466 524,829 --
Selling, general and
administrative expenses ............... 6,242,157 9,232,477 2,035,045 654,104 --
Loss from operations .................. (11,126,485) (10,848,163) (1,168,579) (129,275) --
Other expenses, net ................... (2,440,442) (335,418) (1,311,674) -- --
Loss from continuing operations ....... (13,566,927) $(11,183,581) $ (2,480,253) (129,275) --
Net Loss .............................. (13,566,927) $(11,996,759) $ (3,549,514) (129,275) --
Net Loss per share (basic and diluted):
From continuing operations ........ $ (1.96) $ (1.99) $ (.55) (.05) --
From discontinued operations ...... $ -- $ (.15) $ (.23) -- --
Net Loss per share ................ $ (1.96) $ (2.14) $ (.78) (.05) --
Weighted average common
shares outstanding .................... 6,913,495 5,618,994 4,579,075 2,599,532 --
<CAPTION>
AS OF JUNE 30,
-------------------------------------------------------------------------
Balance Sheet Data: 1999 1998 1997 1996 1995
-------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Working Capital (Deficit) ........... $(11,552,574) (2,226,152) (636,687) 1,216,279 --
Total Assets ........................ $ 1,696,739 $ 3,139,790 3,526,723 6,056,462 60,000
Convertible Debt.................... $ 1,200,000 $ -- -- -- --
Stockholders' Equity (Deficit) ...... $(12,336,232) $ (1,494,390) (71,469) 3,126,946 60,000
</TABLE>
21
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
General
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
become a sales, marketing and distribution company, 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
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 calling cards and
presubscribed long distance telecommunications services. The Company's total
revenues were $10,394,558 $35,032,533 and $26,027,909, and its net losses were
$13,566,927, $11,996,759 and $3,549,514 for the fiscal years ended June 30,
1999, 1998 and 1997, respectively, after losses from discontinued operations of
$0, $813,178 and $1,069,261, respectively.
The Company's target markets include ethnic communities with substantial
international long distance calling requirements. 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."
As previously reported, the Company initiated a strategy of becoming a
facilities based carrier in April, 1998. To accomplish this strategy the Company
migrated its brands to dedicated platforms. However, because the Company was
unable to fund carrier deposits and prepay for telecommunications services, the
Company was unable to secure sufficient network facilities and competitive
rates, with the result that the Company was unable to market its new
facility-based Cards as quickly as planned and was forced to accept returns of
Cards due to the failure of the Cards to properly process calls. The liquidity
difficulties of the Company were further aggrevated by the returns of Cards and
loss of control of proceeds call minutes. Accordingly, in November, 1998, due to
network and liquidity problems, including those caused by the termination and
repricing of the Company's Cards by Premiere (see "Company History"), which
prevented the Company from implementing its strategy of becoming a
facilities-based carrier, the Company initiated its current strategy to become a
sales, marketing and distribution company for significant providers of
telecommunication services. In this connection, the Company has been advanced
both significant telecommunications services and funds by TecNet to finance its
operations during this transition period. The Company will continue to be
dependent upon TecNet until it fully implements its new strategy and has
profitable operations. TecNet is not obligated by any written agreement to
continue advancing telecommunications services or funds 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, significant arrearages on trade payables, significantly
reduced sales revenues and aggregate gross loss on its products, such
realization of assets and satisfaction of liabilities is subject to significant
uncertainties. The Consolidated 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 willingness and ability of TecNet to finance the Company's
telecommunications products and services and working capital shortfalls and
TecNet's and the Company's ability to provide reliable and competitive Cards.
Additionally, the Company's stability is dependent up on its ability to raise
capital, develop market share, achieve profitable operations and to generate
sufficient cash flow from operations and financing sources to meet obligations.
The independent auditors' opinion on the Company's Consolidated Financial
Statements includes a going concern paragraph based on the significant losses
from operations, significant deficits in working capital and net worth and the
Company's economic dependence on its 21% stockholder to provide significant
telecommunications products and services and funding for operating cash flows.
The Company believes that its further growth is dependent on continued
financial support from TecNet and on its ability to continue to receive from
TecNet facilities, competitive rates and quality service that allow the Company
to (i) introduce LACs in many of the markets in which it currently distributes
Cards or into which it expands, (ii) increase the retail distribution of its
products, (iii) introduce additional products and services, (iv) continue to
attract consumers with significant international long distance usage and (v)
capitalize upon economies of scale. See "Business--Growth Strategy."
Recent monthly operations have achieved reductions in working capital
short-falls and the Company believes that increased sales in the third quarter
of fiscal 2000 will result in positive cash flow. The Company will continue to
be dependent during this period on TecNet's providing financing to the Company.
22
<PAGE>
Operations
Year Ended June 30, 1999 Compared to Year Ended June 30, 1998
Net Sales. Net Sales for the fiscal year ended June 30, 1999 decreased by
$24,637,975 to $10,394,558 or 70.3% from $35,032,533 for the year ended June 30,
1998. The decrease in sales was due primarily to:
(i) Following the suspension and repricing by Premiere, the monthly sales rate
declined to approximately $1.5 million per month retail value for bundled
cards (approximately $1.0 million net revenue to the Company), continued
at this lower level for the remainder of the year and during fiscal 1999,
fell to approximately $400,000 per month in retail value. See
"Business--Company History" and "Notes to Consolidated Financial
Statements - Transactions with Premiere Communications, Inc."
(ii) The Company's inability to market its new facilities-based Cards as
rapidly as planned due to network and ensuing 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.
(iii) Between February and June, 1999, the Company was unable to obtain
telecommunications services and accordingly could not activate and sell
new facilities-based Cards. During this period, the Company, in order to
maintain its customer base, sold other third party branded Cards.
Cost of Sales. The Company's cost of sales for the year ended June 30,
1999 decreased to $15,278,886 from $36,648,219 for the fiscal year ended June
30, 1998. The decrease of $21,369,333 or 58.3% was due to primarily the decrease
in the revenues that the Company experienced during fiscal 1999 as compared to
fiscal 1998. During the period the Company attempted to become a facilities-
based carrier, cost of sales exceeded net sales due to the Company not being
able to route its traffic on least cost providers due to its inability to prepay
carriers as a result of its limited capital. During the period the Company
relied on third parties to monitor processing of calls and as a result the
Company incurred significant returns of Cards due to the inability of the
Company to confirm the usage of such Cards. In addition, in November, 1998 the
Company began to purchase the international termination portion of its services
from TecNet, which at that point did not have favorable international rates.
Accordingly, the cost of sales of a major portion of the year's revenues
exceeded revenues. In fiscal 1998, the Company incurred a $2.8 million charge
to cost of sales for Cards activated by Premiere in error. The Company did not
incur any similar charges in fiscal 1999. However, the Company accrued
approximately $.3 million in federal excise tax payments in cost of sales in
fiscal 1999. See "Business--Company History" and "Notes to Consolidated
Financial Statements--Transactions with Premiere Communications, Inc."
Gross Profit (Loss). Gross loss for the fiscal year ended June 30, 1999
was $4,884,328 as compared to a gross loss of $1,615,686 for the fiscal year
ended June 30, 1998. This gross loss was primarily related to the lower volume
of sales during the period coupled with the Company's liquidity problems
preventing it from obtaining the least cost routing for telecommunications
services. The Company's gross losses during fiscal 1999, were attributable to
the Company's inability to purchase telecommunications services on a least cost
basis due to the Company's liquidity problems which precluded prepayment for
services.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the year ended June 30, 1999 decreased by 32.4% from
$9,232,477 for the fiscal year ended June 30, 1998 to $6,242,157. The decrease
in selling general and administrative expenses was due primarily to:
(i) Decrease in bad debt expense of $1.1 million due to the decrease in
accounts receivable aged over 90 days at the end of fiscal 1999.
(ii) Decrease in directors compensation expense of $1.2 million.
(iii) Decrease of $.3 million in research and development charges.
(iv) Decrease in advertising and promotional expenses of $1.8 million due
to the reduced sales of the Company's proprietary brand Cards.
These decreases were partially offset by an increase of salaries and employee
related costs of approximately $.4 million during the first two quarters of
fiscal 1999 in connection with implementation of its facilities based strategy.
The Company reduced its employee count and its Chief Financial Officer resigned
in the second half of fiscal 1999. In addition, the Company incurred
approximately $.1 million for impairment of customer lists.
23
<PAGE>
The additional selling, general and administrative expense decrease of
approximately $1.2 million related primarily to bad debt expense charges
decreasing approximately $1,111,000 due to the decrease in accounts receivable
aged over 90 days at the end of the 1999 fiscal year. See "Notes to Consolidated
Financial Statements--Concentrations of Credit Risk."
Loss from Continuing Operations and Net Loss. The increase in loss from
continuing operations to $13,566,927 for the year ended June 30, 1999 as
compared to $11,996,759 for the year ended June 30, 1998 is primarily
attributable to the significant decrease in sales and gross profit due to the
impact of returned Cards and its inability to route on least-cost providers
which was only partially offset by the decrease in selling, general and
administrative expense. In addition, during fiscal 1999 the Company incurred
non-cash charges approximately $2.4 million directly related to the issuance of
the Convertible Debt and the $1.10 Warrants. The Company incurred no losses from
discontinued 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 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. CG Com's percentage of sales declined
substantially to 19% of total sales for the year ending June 30, 1998.
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 lower levels thereafter. See "Business--Company History" and
"Notes to Consolidated Financial Statements Transactions with Premiere
Communications, Inc."
During the fourth quarter of fiscal year 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.
Cost of Sales. The Company's cost of sales for the year ended June 30,
1998 increased to $36,648,219 from $25,161,443 for the fiscal year ended June
30, 1997. The increase of $11,486,776 or 45.7% was primarily related to the
increase in revenues that the Company experienced for the fiscal year ended June
30, 1998. Although the Company anticipated that implementation of its
facilities-based programs and introduction of additional LACs would
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 loss for the year ended June 30, 1998 was $1,615,686
as compared to a gross profit of $866,466 for the fiscal year ended June 30,
1997. During the first quarter of fiscal year 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 to 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 353% from
$2,040,749 for the fiscal year ended June 30, 1997 to $9,232,477. This
substantial increase of $7,197,432 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 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.
(ii) 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."
(iii) 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 $1,769,000, represent 25% 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 a
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
<PAGE>
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 anticipated 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, would continue to increase, but at a substantially lesser rate, during
fiscal 1999, as the Company 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 expected 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 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, primarily due to the writedown of assets, 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 year 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 $2,035,045
from $654,104 for the year ended June 30, 1996. This increase of $1,380,941 or
211.0% 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 year 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 "TecLink 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 TecLink Note was collateralized by the assets of
TecLink.
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
TecLink Note from TecLink (then $2,105,000). The Company recorded a loss on the
TecLink 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 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 called 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
$1,168,579 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 with Meta3, 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.
24
<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, significant arrearages on trade payables, significantly
reduced sales revenues and aggregate gross loss on its products, such
realization of assets and satisfaction of liabilities is subject to significant
uncertainty. Further, the Company's ability to continue as a going concern is
highly dependent in the near term on the ability of TecNet to finance the
Company's telecommunications products and services and working capital
short-falls and TecNet's and the Company's ability to provide reliable and
competitive Cards. Additionally, the Company's stability is dependent up on its
ability to raise capital, develop market share, achieve profitable operations,
and generate sufficient cash flow from operations and financing sources to meet
obligations.
During the first quarter of fiscal 1999, the Company addressed its working
capital needs through the issuance of $1.2 million 10% six-month notes. As of
May, 1999, these notes and accompanying warrants were exchanged for the
Convertible Debt plus the $1.10 Warrants to purchase 1,800,000 shares of Common
Stock at $1.10 per share. As the Company achieves its new strategy of becoming a
sales, marketing and distribution company, it anticipates additional cash flow
from increased sales and a return to profitability. The Company is continuing to
negotiate agreements with suppliers, primarily TecNet. There can be no assurance
that the negotiations with these entities will be successful or that the Company
will be able to continue to market bundled cards. Operationally, the Company has
reduced substantially its selling, general and administrative expenses. However,
there can be no assurance that these objectives will be met or that acceptable
alternatives will be found.
As previously reported, the Company originally intended to migrate its
traffic to its own facilities, thereby becoming a facilities-based carrier and
thereby increasing its cash flow. The Company, due to network and ensuing
problems, was unable to generate or finance sufficient capital to fully
implement its facilities-based operations strategy. Accordingly, in connection
with its strategy to become a sales, marketing and distribution company, the
Company continues to receive (i) working capital from TecNet to enable the
Company to meet its current operating expenditures, (ii) origination and
termination services through the network facilities of TecNet, and (iii)
financing of the equipment and operations of a POS distribution network for the
Company's Cards from TecNet. There can be no assurances that TecNet will
continue to handle traffic for the Company or that TecNet will continue to
advance funds for working capital expenditures. Moreover, the Company has
accrued significant carrier charges with TecNet and third party providers which
it must satisfy. The Company has borrowed a total of $1,884,190 through
September 30, 1999 and $2,771,190 through October 25, 1999 from TecNet pursuant
to demand promissory notes bearing interest at 10% per annum and has accrued
amounts due to TecNet for telecommunications services of $4,938,195 at September
30, 1999 and $7,057,195 at October 25, 1999.
As a result of the Company's review of its selling, general and
administrative expenses, it has achieved reductions in cash needs of
approximately $2.5 million. During fiscal year 1999, the Company has reduced its
workforce by a total of 30 full-time employees, and reduced the working hours of
certain other hourly-compensated personnel. In addition, the Company has (i)
deferred payment of half of the salaries of its two senior executives and (ii)
consolidated its executive offices and sublet a significant portion of the space
originally occupied by the Company.
The Company's major components of cash flow are as follows:
26
<PAGE>
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
--------------------------------------
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Net cash used in operating activities ... $(2,902,901) $(3,430,032) $ (440,074)
Net cash (used in) provided by investing
activities .............................. (14,805) (87,181) 171,779
Net cash provided by financing activities 2,965,740 2,898,738 486,375
----------- ----------- -----------
Net increase (decrease) in cash ........ $ 48,033 $ (618,474) $ 218,080
=========== =========== ===========
</TABLE>
Net cash used in operating activities during the year ended June 30, 1999
was $2,902,901, a decrease of $527,131 as compared to $3,430,032 for the year
ended June 30, 1998. The net cash used in operating activities during 1999 was
primarily comprised of uses of cash of approximately $15.4 million, primarily
offset by a number of items which reduced the cash needs by an aggregate of
approximately $12.4 million, as explained below.
The primary factors contributing to decreases in the Company's cash used
in operating activities for the year ended June 30, 1999, and analysis of same,
follow:
(i) The Company's net loss was approximately $13.6 million. See
"Operations--Year Ended June 30, 1999 Compared to Year Ended June
30, 1999" for a full explanation of the net loss.
(ii) Write off of accounts receivable of approximately $.8 million.
(iii) Decrease in deferred revenue of approximately $1.0 million due to
the Company terminating its facilities-based program.
The foregoing cash uses in operating activities, aggregating approximately
$15.4 million, were partially offset by the following items which reduced the
cash needs by approximately $12.4 million, primarily accounting for the
decreased cash used in operating activities of $3.0 million:
(i) Increases in accounts payable and accrued expenses, including
amounts payable to TecNet for telecommunications services,
aggregating approximately $7.2 million.
(ii) Bad debt expense decreased by approximately $1.1 million and
amounted to approximately $.4 million.
(iii) Amortization of debt issue costs of $1.1 million associated with
the issuance of $2.375 Warrants which accompanied the Notes.
(iv) Loss on modification of debt of $1.2 million associated with the
issuance of the $1.10 Warrants which accompanied the Convertible
Debt.
(v) Receivables prior to allowances for bad debt or write-off,
decreased approximately $1.5 million, due to the Company's lack of
sales.
(vi) Decreases in inventory of $.3 million.
(vii) Decreases in carrier deposits and other assets of $.2 million due
to the Company terminating its facilities based Card program.
(viii) Other write-downs and write-offs associated with operating
activities aggregating $.5 million.
Net cash used in operating activities during the year ended June 30, 1998
was $3,430,032, an increase of $2,989,958 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 year 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 year 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 approimately $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 approximateted $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 fiscal 1999 was solely related to
capital expenditures of $14,508, which was not material as compared to capital
expenditures of $87,181 in fiscal 1998.
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 TecLink Note. 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."
Cash provided by financing activities in fiscal 1999 of $2,965,740 is
primarily related to the issuance of promissory notes to TecNet of $1,624,190
and issuance of the Convertible Debt and the $100,000 promissory note issued to
a family member of an officer/director. The Company also received net proceeds
from the exercise of certain $1.50 Warrants pursuant to which 44,750 shares of
Common Stock were purchased at $1.50 a share. These receipts were offset by
payments to Prime pursuant to its note in the amount of $25,575.00.
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 (the
"$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, 1999, the Company experienced a substantial
operating loss before discontinued operations of $13,566,927 and used $2,902,901
cash in operating activities. The Company's cash position at June 30, 1999
approximated $157,000 and its working capital deficit approximated $11,553,000.
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 and subsequent exchange thereof for
the Convertible Debt. As the Company increasingly sells more of its Cards, which
significantly improve the Company's ability to generate cash, 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 second half of the 2000 fiscal year. There can be no assurance
that the Company's projections for positive cash generation commencing in the
second half of fiscal 2000 will be realized.
To date, capital expenditures have not been material.
The Company's ability to continue to sell its Cards depends upon whether
it can continue to maintain a favorable relationship with its suppliers of debit
cards and platform, switching and terminating facilities, primarily TecNet and
TecNet's continuing willingness to finance operating cash flow. The Company
currently obtains dedicated facilities primarily from TecNet. During the year
ended June 30, 1999, the Company obtained approximately 70% of its
telecommunications services from TecNet and borrowed approximately $1.9 million
pursuant to demand promissory notes.
27
<PAGE>
There can be no assurance that the negotiations with TecNet 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 Cards. 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."
On March 31, 1998, the Company entered into the Investment Agreement in
which Premiere received 61,050 shares of $.001 par value voting series A
Preferred Stock (the "Preferred Stock"), valued by the Board of Directors at
$6,105,093 which represented the outstanding accounts payable balance at March
31, 1998. The $6,105,093 consisted of $3,236,104 attributed to the normal course
of business and $2,868,989 of charges for excess minutes processed by Premiere
on cards sold. During the third quarter of fiscal 1998, the Company incurred the
charge of $1,468,112 and invoiced the remaining $1,400,877 to the Company's main
distributor. During the fourth quarter of 1998, this distributor informed the
Company that no monies had been collected on the excess minutes and refused to
pay the $1,400,877 invoice. Therefore, the Company reversed the sale of these
minutes during the fourth quarter. The $2,868,969 representing the total charges
related to these excess minutes is included as a separate component of cost of
sales. The $2,868,969 consists of the $1,400,877 recorded in the fourth quarter
as a reversal of a sale and the $1,468,112 which was originally recorded as part
of selling, general, and administrative expenses and reclassed to cost of sales
in the fourth quarter. 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 $8.3463, the Conversion Price, as defined in
the Certificate of Designation, resulting in a total of 731,462 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; (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; (v) issuance of a $100,000 10% promissory note to an
officer/director family member; (vi) exchange of such notes and warrants, and
(vii) the sale of $1,884,190 in demand promissory notes to TecNet ($2,771,190
through October 25, 1999) 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, significant arrearages on trade payables significantly
reduced sales revenues and aggregate gross loss on its products, such
realization of assets and satisfaction of liabilities is subject to significant
uncertainty. The Consolidated 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 the willingness and ability of TecNet to finance the Company's
telecommunications products and services and working capital shortfalls and
TecNet's and the Company's ability to provide reliable and competative Cards.
Additionally the Company's stability is dependent up on its ability to raise
capital, develop market share, achieve profitable operations, and generate
sufficient cash flow from operations and financing sources to meet obligations.
The independent auditors' opinion on the Company's Consolidated Financial
Statements includes a going concern paragraph based on the significant losses
from operations, significant deficits in working capital and net worth and the
Company's economic dependence on its 21% stockholder to provide significant
telecommunications products and services and funding for operating cash flows.
To date, the Company has no existing bank lines of credit and has not
established any sources for such financing. The Company is dependent upon TecNet
and its affiliates to finance telecommunciations services and operations
requirements. The parties are negotiating long-term arrangements. As of
October 25, 1999, no written agreement 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, 1999, the Company experienced a substantial
operating loss before discontinued operations of approximately $13.6 million and
used approximately $2.9 million of cash in operating activities. The Company's
cash position at June 30, 1999 approximated $150,000 and its working capital
deficit approximated $11.6 million. 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, which were subsequently exchanged
for the Convertible Debt. The majority of this cash was previously used by the
Company to make facility deposits and to prepay for facilities usage and to
address existing obligations. Since November, 1998, the Company has been
dependent upon TecNet financing its short-fall in cash flow to finance
operations and the provision of telecommunications services by TecNet. In
addition, the Company has imposed a fifty percent deferral of its two
executive's salaries and subleased a portion of it headquarters to reduce the
short fall in cash requirements. As the Company increasingly sells more of its
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 second half of the 2000 fiscal year.
The Company expects capital requirements of appoximately $2.0 million
during fiscal 2000, before it begins to generate positive cash flow during the
second half of fiscal 2000. The foregoing amount includes further expansion of
the Company's LACs into additional cities and expanding the Company's
distribution network. 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 2000 to fund its operating shortfall during the second half of
fiscal 1999 or until the Company becomes cash flow positive. Also, the Company
expects to consider other financing opportunities during the 2000 fiscal year.
The Company believes that with the continued support of TecNet, internally
generated cash from operations in the latter half of fiscal 2000 will be
sufficient to fund its operations throughout the 2000 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 implement its new strategy to become a sales,
marketing and distribution company and to generate sufficient cash flow to begin
to address its obligations to TecNet and other suppliers will be dependent upon
continued financing by TecNet of cash flow needs and continued financing of
telecommunications services by TecNet. In addition, the Company will need to
raise long-term capital. There can be no assurance that such financing will
continue to be available to the Company from TecNet or that long-term financing
will be obtained, 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, 1999 and 1998, 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 on or after January 1, 2000.
During the last two fiscal quarters of 1999, the Company surveyed its
internal hardware and software to determine operational performance in
connection with the Year 2000 Issue. The survey has resulted in a determination
that the Company's internal systems will operate properly on and after January
1, 2000. In this connection a number of upgrades supplied by manufacturers have
been installed. In addition, the Company's newly installed accounting system
(Solomon) has been confirmed by the manufacturer as Year 2000 Issue compliant.
In addition, the Company has contacted its key supplier, TecNet, and other
vendors to assure that they have addressed the Year 2000 Issue as regards
continuing provision of services to the Company and received assurances that the
Year 2000 Issue has been addressed.
The Company is dependent on TecNet to provide a Year 2000 Issue compliant
product and service. Management has received assurance that TecNet has addressed
the issues and implemented a viable Year 2000 Issue contingency plan for all of
the products and services utilized by the Company.
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.
As all of the Company's telecommunication services are provided
bundled by TecNet, the Company and TecNet have reviewed the potential issues
raised by the Year 2000 Issue for the multiple carriers used by TecNet and have
developed alternate routing plans to maintain uninterupted service in the event
one or more carriers experiences difficulties on or after January 1, 2000.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") no. 133, "Accounting for Derivative
Instruments and Hedging Activities", requires companies to recognize all
derivatives contracts as either assets or liabilities in the balance sheet and
to measure them at fair value. Historically, the Company has not entered into
derivatives contracts either to hedge existing risks or for speculative
purposes. Accordingly, the Company does not expect adoption of the new standard
on January 1, 2000 to affect its financial statements.
29
<PAGE>
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 carrying values
of financial instruments, including cash and notes payable at June 30, 1999 and
1998, respectively approximates fair 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 December 9,
1999.
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, 1999 and 1998....... F-3
Consolidated Statements of Loss for the years ended
June 30, 1999, 1998 and 1997 .................................. F-4
Consolidated Statements of Stockholders' Equity (Deficit)
for the years ended June 30, 1999, 1998 and 1997 .............. F-5
Consolidated Statements of Cash Flows for the years ended
June 30, 1999, 1998 and 1997 .................................. 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
Exhibit No. DESCRIPTION
----------- -----------
2.1 Articles of Merger and Agreement and Plan of Merger
(Incorporated by reference herein to Exhibit 99.1 of the
Company's Form 10 filed with the Commission on October 30, 1997
Registration Statement File No. 000-23291)
2.2 Agreement and Plan of Reorganization and Amendments
(Incorporated by reference herein to Exhibit 99.5 of the
Company's Form 10 filed with the Commission on October 30, 1997
Registration Statement File No. 000-23291)
3.1 Restated Articles of Incorporation (Incorporated by reference
herein to Exhibit 3(i) of the Company's Form 10 filed with the
Commission on October 30, 1997 Registration Statement File No.
000-23291)
3.2 Amended and Restated ByLaws (Incorporated by reference herein to
Exhibit (3)(ii) of the Company's Form 10 filed with the
Commission on October 30, 1997 Registration Statement File No.
000-23291)
4.1 Certificate of Designations of Series A. Preferred Stock
(Incorporated by reference herein to Exhibit 4.1 of the
Company's Quarterly Report on Form 10-Q filed on May 15, 1998)
4.2 Forms of Option Agreement (Incorporated by reference herein to
Exhibit 4.2 of the Company's Form S-1/A filed with the
Commission on June 30, 1998 Registration Statement File No.
333-50563)
4.3 Forms of Warrant Agreement (Incorporated by reference herein to
Exhibit 4.3 of the Company's Form S-1/A filed with the
Commission on June 30, 1998 Registration Statement File No.
333-50563)
4.4 Form of Note and Warrant Purchase Agreement (Incorporated by
reference herein to Exhibit 4.4 of the Company's Annual Report
on Form 10-K/A filed January 13, 1999)
4.5 Note and Warrant Exchange Letter (Incorporated by reference
herein to Exhibit 10.2 of the Company's Quaterly Report on Form
10-Q filed May 21, 1999)
10.1 Services Agreement by and between Innovative Telecom Corporation
and DigiTEC 2000, Inc. (Incorporated by reference herein to
Exhibit 10.1 of the Company's Form S-1/A filed with the
Commission on June 30, 1998 Registration Statement File No.
333-50563)
10.2 Promissory Note (Incorporated by reference herein to Exhibit
10.2 of the Company's Form S-1/A filed with the Commission on
June 30, 1998 Registration Statement File No. 333-50563)
10.3 Sublease agreement between Vanity Fair Intimates, Inc. and Promo
Tel, Inc. (Incorporated by reference herein to Exhibit 99.2 of
the Company's Form 10 filed with the Commission on October 30,
1997 Registration Statement File No. 000-23291)
10.4 TECLink Promissory Note and Agreement (Incorporated by reference
herein to Exhibit 99.3 of the Company's Form 10 filed with the
Commission on October 30, 1997 Registration Statement File No.
000-23291)
10.5 Asset Purchase Agreement by and between World Access Solutions,
Inc. and Meta3, Inc. (Incorporated by reference herein to
Exhibit 99.4 of the Company's Form 10 filed with the Commission
on October 30, 1997 Registration Statement File No. 000-23291)
10.6 Telephone Electronics Corporation Agreement and Amendments
(Incorporated by reference herein to Exhibit 99.6 of the
Company's Form 10 filed with the Commission on October 30, 1997
Registration Statement File No. 000-23291)
10.7 TECLink Note Satisfaction Agreement (Incorporated by reference
herein to Exhibit 99.7 of the Company's Form 10 filed with the
Commission on October 30, 1997 Registration Statement File No.
000-23291)
10.8 Premiere Communications Agreement (Incorporated by reference
herein to Exhibit 99.8 of the Company's Form 10 filed with the
Commission on October 30, 1997 Registration Statement File No.
000-23291)
10.9 CG Com, Inc. Independent Master Distributor Agreement
(Incorporated by reference herein to Exhibit 99.9 of the
Company's Form 10 filed with the Commission on October 30, 1997
Registration Statement File No. 000-23291)
10.10 Frank C. Magliato Employment Agreement (Incorporated by
reference herein to Exhibit 99.10 of the Company's Form 10 filed
with the Commission on October 30, 1997 Registration Statement
File No. 000-23291)
10.11 Diego E. Roca Employment Agreement (Incorporated by reference
herein to Exhibit 99.11 of the Company's Form 10 filed with the
Commission on October 30, 1997 Registration Statement File No.
000-23291)
10.12 DigiTEC 2000, Inc. Stock Incentive Plan (Incorporated by
reference herein to Exhibit 99.13 of the Company's Form 10 filed
with the Commission on October 30, 1997 Registration Statement
File No. 000-23291)
10.13 Larry S. Diamond Employment Agreement (Incorporated by reference
herein to Exhibit 99.14 of the Company's Form 10 filed with the
Commission on October 30, 1997 Registration Statement File No.
000-23291)
10.14 Frontier Communications International, Inc. Prepaid Telephone
Services Distributor Agreement (Incorporated by reference herein
to Exhibit 99.15 of the Company's Form 10 filed with the
Commission on October 30, 1997 Registration Statement File No.
000-23291)
10.15 Ameridial, Inc. Acquisition Agreement (Incorporated by reference
herein to Exhibit 2 of the Company's Quarterly Report on Form
10-Q filed February 13, 1998)
10.16 Investment Agreement by and between Premiere Communications Inc.
and DigiTEC 2000, Inc. dated March 31, 1998 (Incorporated by
reference herein to Exhibit 10.1 of the Company's Quarterly
Report on Form 10-Q filed on May 15, 1998)
10.17 Investor Agreement by and between Frank Magliato and Prime
Communications, Inc. (Incorporated by reference herein to
Exhibit 10.19 of the Company's Form S-1/A filed with the
Commission on June 30, 1998 Registration Statement File No.
333-50563)
10.18 Letter of Agreement by and between Digitec 2000, Inc. and
College Enterprise Inc. (Incorporated by reference herein to
Exhibit 10.20 of the Company's Form S-1/A filed with the
Commission on June 30, 1998 Registration Statement File No.
333-50563)
10.19 Warranty Bill of Sale and Assignment and Related Agreement by
and between DigiTEC 2000, Inc. and Prime Communications, Inc.
(Incorporated by reference herein to Exhibit 10.21 of the
Company's Form S-1/A filed with the Commission on June 30, 1998
Registration Statement File No. 333-50563)
10.20 Letter Agreement between DigiTEC 2000, Inc. and certain
stockholders of Ameridial, Inc. (Incorporated by reference
herein to Exhibit 10.22 of the Company's Form S-1/A filed with
the Commission on June 30, 1998 Registration Statement File No.
333-50563)
10.21 Asset Purchase Agreement among DigiTEC 2000, Inc., Pos Tec
Systems, LLC and Total Pos Solutions, LLC (Incorporated by
reference herein to Exhibit 2.1 of the Company's Quaterly Report
on Form 10-Q filed May 21, 1999)
10.22 10% Promissory Note (Tec Net, Inc.) (Incorporated by reference
herein to Exhibit 10.1 of the Company's Quaterly Report on Form
10-Q filed May 21, 1999)
10.23 10% Promissory Note (Incorporated by reference herein to Exhibit
2 of the Company's Quaterly Report on Form 10-Q filed February
23, 1999)
10.24 Letter of Intent to acquire Phonecard Wholesalers, Inc.
(Incorporated by reference herein to Exhibit 10.23 of the
Company's Annual Report on Form 10-K/A filed January 13, 1999)
10.25 Settlement Agreement with Frontier Communications, Inc.
(Incorporated by reference herein to Exhibit 10.24 of the
Company's Annual Report on Form 10-K/A filed January 13, 1999)
27 Financial Data Schedule
F-1
<PAGE>
Report of Independent Certified Public Accountants
To the Board of Directors and Stockholders of
DigiTEC 2000, Inc.
New York, N.Y.
We have audited the accompanying consolidated balance sheets of DigiTEC 2000,
Inc. and subsidiary as of June 30, 1999 and 1998 and the related consolidated
statements of loss, stockholders' equity (deficit) and cash flows for the years
ended June 30, 1999, 1998 and 1997 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, 1999 and 1998, and the results of their operations
and their cash flows for the years ended June 30, 1999, 1998 and 1997, 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 significant deficiencies in working
capital and net worth at June 30, 1999 and 1998 and experienced significant
losses from continuing operations for the three years ended June 30, 1999, 1998,
and 1997. In addition, it has become economically dependent upon a 21%
stockholder to fund operating cash flows and to provide significant
telecommunications products and services. These matters raise substantial doubt
about the Company's 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 25, 1999
F-2
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
Consolidated Balance Sheets
================================================================================
<TABLE>
<CAPTION>
June 30, 1999 1998
- ------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Current:
Cash and cash equivalents $ 156,756 $ 108,722
Due from TecNet, Inc. (Note 5(e)) 260,000 --
Accounts receivable, net of allowance for bad
debts of $847,000 and $1,305,000 (Note 3) 604,586 1,692,222
Inventory 58,818 393,586
Prepaid expenses and other 133,887 123,953
- ------------------------------------------------------------------------------------------------
Total current assets 1,214,047 2,318,483
Property and equipment, net of depreciation of
$113,124 and $64,877 (Note 4) 141,778 160,040
Customer lists, net of accumulated amortization of
$583,611 and $334,000 (Notes 2(h) and 7) 261,559 373,882
Other assets 79,355 287,385
- ------------------------------------------------------------------------------------------------
$ 1,696,739 $ 3,139,790
================================================================================================
Liabilities and Stockholders' Deficit
Current:
Payable to TecNet, Inc. (Notes 3 and 5(e)) $ 6,849,385 --
Accounts payable - trade (Notes 3 and 8(b)) 2,133,887 $ 1,379,896
Accounts payable and accrued expenses (Notes 3,
5(g), 8(c) and 8(d)) 1,161,524 486,176
Payable to Premiere Communications, Inc.
(Note 6) 583,152 597,132
Accrued legal 825,615 450,188
Accrued settlement expenses (Note 8(b)) 991,633 204,126
Accrued research and development (Note 2(j)) -- 325,000
Deferred revenue -- 955,117
Notes payable - (Notes 5(f), 7 and 8(b)) 221,425 147,000
- ------------------------------------------------------------------------------------------------
Total current liabilities 12,766,621 4,544,635
Deferred rent (Note 2(k)) 66,350 89,545
Convertible debt (See Note 5(d)) 1,200,000 --
- ------------------------------------------------------------------------------------------------
Total liabilities 14,032,971 4,634,180
- ------------------------------------------------------------------------------------------------
Commitments and contingencies (Notes 6 and 8)
Stockholders' deficit
Series A Callable at $100 per share, Convertible
Preferred Stock, $.001 par value, 1,000,000
shares authorized; 61,050 shares issued
and outstanding, respectively 61 61
Common Stock, $.001 par value, 100,000,000
shares authorized; 7,058,998 and 6,814,248
shares issued and outstanding, respectively 7,059 6,814
Additional paid-in capital 16,899,123 14,174,283
Accumulated deficit (29,242,475) (15,675,548)
- ------------------------------------------------------------------------------------------------
Total stockholders' deficit (Notes 9 and 10) (12,336,232) (1,494,390)
- ------------------------------------------------------------------------------------------------
$ 1,696,739 $ 3,139,790
================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
Consolidated Statements of Loss
================================================================================
<TABLE>
<CAPTION>
Year ended June 30,
------------------------------------------------
1999 1998 1997
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net sales (Note 3) $ 10,394,558 $ 35,032,533 $ 26,027,909
Cost of sales (Notes 3 and 6) 15,278,886 36,648,219 25,161,443
- -------------------------------------------------------------------------------------------------------
Gross profit (loss) (4,884,328) (1,615,686) 866,466
Selling, general and administrative
expenses (Notes 2(h), 3, 6, 9(b)) 6,242,157 9,232,477 2,035,045
- -------------------------------------------------------------------------------------------------------
Loss before other income (expenses) (11,126,485) (10,848,163) (1,168,579)
- -------------------------------------------------------------------------------------------------------
Other income (expenses):
Interest expense (Notes 5(c) and 9(b)) (1,245,272) (59,187) (5,704)
Refinancing of debt (Note 5(d) and 9(b)) (1,200,000) -- --
Loss on modification of debt terms
(Note 7) (287,100) --
Other income 4,830 10,869 34,260
Loss on note satisfaction (Note 5(b)) -- -- (1,340,230)
- -------------------------------------------------------------------------------------------------------
Other expenses (2,440,442) (335,418) (1,311,674)
- -------------------------------------------------------------------------------------------------------
Loss from continuing operations (13,566,927) (11,183,581) (2,480,253)
- -------------------------------------------------------------------------------------------------------
Discontinued operations (Notes 5(b) and 14):
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 $(13,566,927) $(11,996,759) $ (3,549,514)
=======================================================================================================
Net loss per common share-basic and diluted
(Note 10):
Loss from continuing operations $ (1.96) $ (1.99) $ (.55)
Loss from discontinued operations -- (.15) (.23)
- -------------------------------------------------------------------------------------------------------
$ (1.96) $ (2.14) $ (.78)
=======================================================================================================
Weighted average number of common and common
equivalent shares outstanding used in basic and
diluted 6,913,495 5,618,994 4,579,075
=======================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
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, 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 9) -- -- -- -- 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)
Exercise of warrants -- -- 44,750 45 67,080 --
Issuance of Warrants accompanying 10%
six-month notes (Note 5(c)) 1,120,000
Issuance of common stock relating to asset
purchase (Note 11(b)) 200,000 200 299,800 --
Issuance of warrants accompanying
convertible debt (Note 5(d)) 1,200,000
Contributed capital (Note 5(e)) 37,960
Net loss (13,566,927)
- ------------------------------------------------------------------------------------------------------------------------------
Balance, June 30, 1999 61,050 $ 61 7,058,998 $ 7,059 $ 16,899,123 $(29,242,475)
==============================================================================================================================
<CAPTION>
Treasury stock Total
----------------------- stockholders'
Shares Amount equity (deficit)
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C>
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 9) -- -- 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)
Exercise of warrants 67,125
Issuance of Warrants accompanying 10%
six-month notes (Note 5(c)) 1,120,000
Issuance of common stock relating to asset
purchase (Note 11(b)) 300,000
Issuance of warrants accompanying
convertible debt (Note 5(d)) 1,200,000
Contributed capital (Note 5(e)) 37,960
Net loss $(13,566,927)
- --------------------------------------------------------------------------------------------
Balance, June 30, 1999 $(12,336,232)
============================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
Consolidated Statements of Cash Flows (See Note 13)
================================================================================
<TABLE>
<CAPTION>
Year ended June 30,
--------------------------------------------
1999 1998 1997
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $(13,566,927) $(11,996,759) $ (3,549,514)
Adjustments to reconcile net loss to net cash used in
operating activities:
Provision for bad debts (Note 3(c)) 356,059 1,467,656 196,752
Provision for bad debts - Cellular Division -- 52,463 --
Write-off of accounts receivable (Note 3(c)) (814,059) (222,656) (130,000)
Write-down of inventory -- 206,281 (33,000)
Depreciation 48,247 50,675 11,657
Amortization of customer lists 250,054 236,256 87,798
Impairment of customer lists 147,089 -- --
Promotional expense -- 2,868,989 --
Deferred revenue (955,117) 955,117 (567,136)
Deferred rent (23,195) 18,545 71,000
Amortization of debt issue cost (Note 5(c)) 1,120,000 -- --
Services provided by shareholder (Note 5(e)) 37,960 -- --
Directors' compensation -- 1,248,000 --
Refinancing of debt 1,200,000 -- --
Loss on modification of debt terms -- 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 1,545,636 (1,161,958) (1,539,648)
Inventory 334,768 (381,433) (146,948)
Prepaid expenses and other (9,934) (104,727) 470,047
Carrier deposits and other 208,030 (258,093) --
Increase (decrease) in:
Payable to TecNet Inc. 4,965,195 -- --
Accounts payable - trade 753,991 (1,030,860) 1,735,432
Accounts payable and accrued expenses 675,348 (94,347) 486,322
Payable to Premiere Communications, Inc. (13,980) 3,709,220 123,923
Accrued legal 375,427 402,875 26,739
Accrued settlement 787,507 204,126 --
Accrued research and development (325,000) 325,000 --
- ------------------------------------------------------------------------------------------------------------
Net cash used in operating activities of
continuing operations (2,902,901) (2,932,413) (522,999)
Net cash provided by (used in) operating activities of
discontinued operations -- (497,619) 82,925
- ------------------------------------------------------------------------------------------------------------
Net cash used in operating activities (2,902,901) (3,430,032) (440,074)
- ------------------------------------------------------------------------------------------------------------
============================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
Consolidated Statements of Cash Flows (continued)
================================================================================
<TABLE>
<CAPTION>
Year ended June 30,
---------------------------------------------
1999 1998 1997
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from investing activities:
Capital expenditures $ (14,805) $ (87,181) $ (69,439)
Proceeds from repayment of related party loans -- -- 41,218
Payment received on note receivable -- -- 200,000
- ------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing
activities (14,805) (87,181) 171,779
- ------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Proceeds from issuance of TecNet notes 1,624,190 -- --
Proceeds from issuance of promissory notes 1,300,000 -- --
Repayment of Prime Communications loan (25,575) (35,000) --
Proceeds from exercise of warrants 67,125 2,933,738 486,375
- ------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 2,965,740 2,898,738 486,375
- ------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash 48,034 (618,475) 218,080
Cash and cash equivalents beginning of period 108,722 727,197 509,117
- ------------------------------------------------------------------------------------------------------------
Cash and cash equivalents end of period $ 156,756 $ 108,722 $ 727,197
============================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
F-7
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
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, significant arrearages on
trade payables, significantly reduced
sales revenues, and aggregate gross loss
on its products, such realization of
assets and satisfaction 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 the willingness and ability of
TecNet, Inc. ("TecNet"), a wholly owned
subsidiary of Telephone Electronic
Corporation ("TEC"), a holder of
approximately 21% of the Company's Common
Stock, to finance the Company's
telecommunications products and services
and working capital short-falls and
TecNet's and the Company's ability to
provide reliable and competitive prepaid
telephone cards. Additionally, the
Company's stability is dependent upon its
ability to raise capital, develop market
share, achieve profitable operations, and
to generate sufficient cash flow from
operations and financing to meet
obligations.
In November, 1998, the Company, due to
network and ensuing liquidity problems,
initiated a strategy of focusing on sales,
marketing and distribution in lieu
developing as a facilities-based carrier.
In connection with the Company's
initiation of this new strategy, TecNet
began to provide significant
telecommunications services, to finance
operations and carry the unprocessed
minutes on the Company's remaining
facilities based Cards, as hereinafter
defined. Total telecommunications services
provided by TecNet amounted to
approximately $4.4 million during the
period November 1998 through April 1999.
No written agreement with respect to the
terms of payment for those services has
been made to date. In February, 1999, the
Company began to receive funds for
operating cash flows on a semi-monthly
basis from TecNet through the issuance of
demand promissory notes. These funds were
used to finance the Company's operations.
As of June 30, 1999, the Company had
borrowed $1,884,000, and as of October 25,
1999 the Company has borrowed an
additional $887,000, in the form of demand
promissory notes from TecNet. Beginning
May, 1999, the Company terminated its
facilities based products and TecNet
became the primary supplier of bundled
cards to the Company. There can be no
assurance that the Company will be able to
continue to finance its operations and
continue to obtain bundled cards at
comparable rates through TecNet. Currently
however, the Company continues to be
dependent on TecNet providing financing
and telelcommunications support to the
Company.
(b) Business
DigiTEC 2000, Inc. and subsidiary (the
"Company") is primarily engaged in the
distribution, marketing and sales of
prepaid telephone calling cards ("Cards").
It currently markets its telephone calling
card products principally throughout the
New York tri-state metropolitan area.
F-8
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
Notes to Consolidated Financial Statements
(continued)
================================================================================
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") and from
March 4, 1999 through June 30, 1999, its
wholly owned subsidiary, POS TEC Systems,
LLC ("POS TEC"). 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 periods. Actual
results could differ from those estimates.
(c) Revenue Recognition
F-9
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
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. As of
April 30, 1999, the Company no longer
provided facilities-based Cards.
Revenue from Point of Sale ("POS") sales,
in particular, sales by the Company's
subsidiary POS TEC, are recognized upon
activation of Cards. Activation occurs
when the end-user purchases a card from a
retailer. Related costs of the Cards is
simultaneously charged to the cost of
sales.
(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, management'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(c))
(e) Cash and Cash Equivalents
The Company considers cash and cash
equivalents as those highly liquid
investments purchased with original
maturities 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
Notes to Consolidated Financial Statements
(continued)
================================================================================
Inventory, consisting primarily of
unactivated Cards and 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 1999, 1998 and 1997. 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. During the fourth quarter of
fiscal 1999, management adjusted their
valuations of several customer lists.
Based on managements evaluations, the
Company recorded approximately $147,000 as
an impairment of these 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. As of April 30, 1999, the
Company no longer provided
facilities-based cards and all carrier
deposits were offset against outstanding
carrier trade payables.
(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 is no longer selling cards to CEI
and does not anticipate further activity,
with CEI.
(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, 1999, 1998 and
1997 was approximately $23,000 and $19,000
and $71,000, respectively.
(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
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) Loss Per Share
The computation of loss per common share
is based on the weighted average number of
common shares and common stock equivalents
(convertible debt, convertible preferred
shares, stock options and warrants),
assumed to be outstanding during the year.
The dilutive losses 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.
(o) Fair Value of Financial Instruments
The carrying values of financial
instruments, including cash and
notes payable at June 30, 1999 and 1998,
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
1999 presentation.
F-12
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
Notes to Consolidated Financial Statements
(continued)
================================================================================
(q) Recent Accounting Pronouncements
In June 1998, the Financial Accounting
Standards Board issued Statement of
Financial Accounting Standards ("SFAS")
no. 133, "Accounting for Derivative
Instruments and Hedging Activities",
requires companies to recognize all
derivatives contracts as either assets or
liabilities in the balance sheet and to
measure them at fair value. Historically,
the Company has not entered into
derivatives contracts either to hedge
existing risks or for speculative
purposes. Accordingly, the Comapny does
not expect adoption of the new standard on
January 1, 2000 to affect its financial
statements.
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
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, Mexico and the
U.S. Virgin Islands. The Metro Area sales
accounted for approximately 82%, 63% and
79% of the Company's total sales for the
years ending June 30, 1999, 1998 and 1997,
respectively. No other areas accounted for
more than 10% of the Company's sales.
(b) Concentration of Customer Accounts
The Company utilizes master distributors
to distribute its prepaid cards. The
master distributors and their respective
percentages of sales and accounts
receivables are:
Distributor Sales Accounts receivables
1999 1998 1997 1999 1998
Phonecard Wholesalers 18% 19% 2% 39% 73%
CG Com 0% 19% 52% 0% 0%
TMG 19% 3% 0% 39% 4%
No other customer accounted for more than
10% of sales or outstanding accounts
reveivable.
(c) Allowance for Bad Debts
During the quarter ended June 30, 1999
and 1998, the Company recorded bad debt
expenses of approximately $356,000 and
$1,468,000, respectively. During the
fourth quarter of fiscal 1999 and 1998,
the Company, wrote off approximately
$814,000 and $223,000 of accounts
receivable against its reserves,
respectively. During the first three
quarters of fiscal 1999 and 1998,
management, based on prior experience,
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 and certain customers whose
balance exceed one year 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
Notes to Consolidated Financial Statements
(continued)
================================================================================
(d) Concentration of Suppliers of
Telecommunications Services
The Company purchases telecommunications services from six main suppliers. The
suppliers and their respective percentages of cost of sales and accounts payable
are:
- --------------------------------------------------------------------------------
Vendor Cost of Sales Accounts Payable
1999 1998 1997 1999 1998
- --------------------------------------------------------------------------------
TecNet 34% 0% 0% 53% 0%
Allied Communications Holdings 20% 0% 0% 0% 0%
Qwest Communications, Inc. 11% 1% 0% 9% 6%
ATI Telecom, Inc. 5% 14% 0% 2% 14%
Premiere Communications, Inc. 3% 43% 30% 6% 23%
Frontier Communications, Inc. 0% 35% 48% 2% 19%
- --------------------------------------------------------------------------------
No other vendor accounted for more than 10% of cost of sales or outstanding
accounts payable.
4. Property and Equipment Major classes of property and equipment are:
Estimated
June 30, useful
------------------- lives
1999 1998 (in years)
-------------------------------------------------------------------------
Computer equipment 204,771 $182,222 3
Furniture, fixtures and office
equipment 28,720 21,284 5
Vehicles 21,411 21,411 5
-------------------------------------------------------------------------
Property and equipment 254,902 223,917
Less: Accumulated depreciation 113,124 64,877
-------------------------------------------------------------------------
Property and equipment, net $141,778 $160,040
=========================================================================
Depreciation expense for the years ended June
30, 1999, 1998 and 1997 was approximately
$48,000, $51,000 and $12,000, respectively.
F-15
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
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 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,
1999 was approximately 21%.
(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,
$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
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. 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 were
exercisable for five years from the date
of issuance. The exercise price under the
$2.375 Warrants were 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. The fair value
of the $2.375 Warrants was recorded as
debt issue costs and amortized over the
six-month period ending March, 1999 with a
$1,120,000 interest charge.
(d) On May 15, 1999 the Company exchanged the
Notes for 10% Two-Year promissory notes
convertible into shares of common stock at
$1.10 a share (the "Convertible Debt")
which provided for quarterly interest only
payments for the first year and quarterly
principal payments with interest in the
second year. The $2.375 Warrants were
concurrently exchanged for new warrants
providing for the purchase of up to
1,800,000 shares of Common Stock at $1.10
(the "$1.10 Warrants"). The exchange of
the Notes and $2.375 Warrants was exempt
from registration under the Securities Act
pursuant to Section 4 thereof. The
exercise price of the Convertible Debt and
$1.10 Warrants was based on the market
value of the common stock as of the
maturity date of the Notes. As the market
price of the common stock was $4.3125 on
May 15, 1999, the Company recorded a
refinancing charge of $1,200,000 to
reflect the intrinsic value of the
Convertible Debt up to its gross proceeds.
No fair value was allocated to the debt
issue costs associated with the warrants.
To date the Company has remained current
with the terms and interest payments of
the Convetible Debt.
(e) In November 1998, as part of its
transition to becoming a sales, marketing
and distribution company, the Company
reached a verbal agreement with TecNet to
carry the remaining unprocessed minutes on
the Company's facilities-based debit
cards. In February 1999 the Company began
funding its operating short fall through
the sale of demand promissory notes to
TecNet. The demand promissory notes bear
interest at the rate of 10% per annum. The
Company has no commitment from TecNet for
continued financing. Subsequently, in the
fourth quarter of fiscal 1999 the Company
reached a verbal agreement with TecNet to
sell their bundled cards, resulting in
approximately $701,000 of revenue and
approximately $138,000 of gross margin and
payable at the point of sale. Also during
the fourth quarter of fiscal 1999, the
Company was provided a consultant through
TecNet. Total services rendered amounted
to approximately $38,000 which was
accounted for as a capital contribution.
The following presents the detail of the
payble to TecNet at June 30, 1999:
Demand notes payable $1,884,190
Payable for bundled phone cards 574,028
Payable for telecommunication
services 4,391,167
=========
$6,849,385
=========
Included in demand notes payable as of
June 30, 1999 is a note in the amount of
$260,000 which was not funded until July
2, 1999.
(f) In October, 1998, the Company borrowed an
additional $100,000 from a member of
officer/director's family. (See Note 7(b))
(g) In May 1999, the Board of Directors
declared directors fee of $30,000 which is
included in accrued expenses at June 30,
1999.
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 note payable that was satisfied with
purchases by December 31, 1997. 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. As of October 1998, the
Company ceased utilizing Premiere as a
supplier and has not utilized them in any
capacity since that time.
The Company believes that it is not subject to
any remaining obligation under the second
agreement because Management believes Premiere
has breached its contract by suspending one of
the Company's card programs and repricing the
Cards under another of the Company's programs.
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 is continuing to
negotiate with Premiere to resolve various
contractual matters.
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
Preferred Stock (the "Preferred Stock"),
valued by the Board of Directors at $6,105,093
which represented the outstanding accounts
payable balance at March 31, 1998. The
$6,105,093 consisted of $3,236,104 attributed
to the normal course of business and
$2,868,989 of charges for excess minutes
processed by Premiere on cards sold. During
the third quarter of fiscal 1998, the Company
incurred the charge of $1,468,112 and invoiced
the remaining $1,400,877 to the Company's main
distributor. During the fourth quarter of
1998, this distributor informed the Company
that no monies had been collected on the
excess minutes and refused to pay the
$1,400,877 invoice. Therefore, the Company
reversed the sale of these minutes during the
fourth quarter. The $2,868,969 representing
the total charges related to these excess
minutes is included in cost of sales. The
$2,868,969 consists of the $1,400,877 recorded
in the fourth quarter as a reversal of a sale
and the $1,468,112 which was originally
recorded as part of selling, general, and
administrative expenses and reclassed to cost
of sales in the fourth quarter.
F-17
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
Notes to Consolidated Financial Statements
(continued)
================================================================================
7. Notes Payable (a) 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 customer list purchased from Prime was
written down as of June 30, 1999. 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, 1999, the Company
had paid $25,575 of the note, leaving a
balance of $121,425. The Company ceased
payment on the note and litigation is
currently pending (See Note 8(b)).
(b) In October, 1998, the Company borrowed an
additional $100,000 from a member of an
officer/director's family. This borrowing
bears interest at the rate of 10% (See Note
5(f)).
8. 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,
1999, 1998 and 1997 was approximately
$299,000, $261,000 and $144,000,
respectively. Future minimum rentals
required as of June 30, 1999 under all
noncancellable operating leases (exclusive
of renewals and inclusive of the
settlement with Vanity Fair) are:
F-18
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
Notes to Consolidated Financial Statements
(continued)
================================================================================
Fiscal year ended June 30,
------------------------------------------
2000 $ 321,000
2001 244,000
2002 4,000
------------------------------------------
$ 569,000
==========================================
(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 scheduled for trial on September
5, 2000.
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 the 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. This recovery of
$358,000 was recorded as a reduction in
costs of sales during 1999.
The Company was served on March 30, 1999
in an action by Qwest Communications
Corporation ("Qwest") entitled Qwest
Communications Corporation v Digitec 2000,
Inc., in the United States District Court
for the Southern District of New York,
seeking payment for approximately $1.37
million of telecommunication services
provided to the Company by Qwest. In May
1999, they executed a settlement agreement
pursuant to which the Company would pay in
nine monthly installments commencing
December, 1999 a total of $887,000 and
TecNet would satisfy the remaining
$490,000. The $887,000 is reflected in
accrued settlement expenses as of June 30,
1999. The amount of the settlement was the
same as the original amount of the cost of
sales as TecNet charged the Company for
the amount it assumed.
In June, 1998, the Company was served in
an action entitled Michael Bodian, as
Chapter 11 Trustee of Communications
Network Corp. a/k/a Conetco ("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.
On March 10, 1999, the Company was served
with a Motion for Summary Judgement by
Prime Communications (NY) Inc. ("Prime")
in a case entitled Prime Communications
(NY), Inc v Digitec 2000, Inc. in the
Supreme Court of the State of New York,
County of Nassau seeking judgement on a
promissory note issued by the Company for
$147,000, which note was issued in
connection with the acquisition of certain
assets from Prime. The outstanding amount
on the note is approximately $121,425. The
Company has countermoved against Prime
alleging failure of Prime to deliver the
contemplated consideration and seeks
damages against Prime. Judgement on the
motion was rendered in favor of the
Company and Prime has sought a rehearing
and commenced a pleniary action. The
Company and Prime are currently
negotiating a settlement of the matter.
On March 18, 1999, in the Supreme Court of
the State of New York for the County of
Kings, the Weeks-Lerman Group, LLC
("Weeks-Lerman") brought suit against the
Company alleging that it provided the
Company with work, labor and services
and/or sold and delivered goods to the
Company in the amount of approximately
$76,000. Weeks-Lerman seeks that amount
together with interest from June 23, 1998,
costs and disbursements. Presently, the
Company is exploring settlement
possibilities with Weeks-Lerman. The
Company is not in a position to express an
opinion as to the probable outcome of this
matter.
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. However, due to its
liquidity problems, the Company failed to
make the payment due in October and
November 1998 and Vanity Fair gave notice
of its intention to enter a Confession of
Judgment against the Company for $369,774,
less amounts previously paid. The Company
subsequently negotiated an alternative
payment plan with Vanity Fair, and to date
is in compliance with the revised payment
terms.
On October 20, 1999, Union Telecard
Alliance LLC filed suit entitled Union
Telecard Alliance LLC v Digitec 2000,
Inc., TecNet Inc. in Supreme Court of the
State of New York, New York County against
the Company to recover $462,000 for Cards
sold to the Company. The Company has not
had sufficient time to review the
complaint and accordingly is not in a
position to express an opinion as to the
probable outcome of this matter.
(c) Employment Agreements
As of June 30, 1999, the Company has
employment agreements remaining with two
of its officers. The aggregate remaining
minimum payments under the agreements are
$475,000 for fiscal 2000.
F-19
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
Notes to Consolidated Financial Statements
(continued)
================================================================================
Effective January, 1999, the Company's two
executive officers agreed to a 50%
deferral of their respective base salaries
until the Company returns to positive cash
flows from operations. The $120,000 of
deferred compensation was accrued during
the fourth quarter of fiscal 1999 and is
included in accrued expenses.
(d) Regulatory Requirements
The Company is currently evaluating
various tax and other regulatory
assessments to determine their
applicability to the Company's operations.
As these operations expand, the Company
may become subject to additional tariffs
and the federal and state regulatory
charges. During the fourth quarter of
fiscal 1999 the Company accrued
approximately $462,000 relating to various
taxes, penalties and interest related to
unfiled tax returns.
F-20
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
Notes to Consolidated Financial Statements
(continued)
================================================================================
9. 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 $8.3463, the Conversion Price
as defined in the Certificate of
Designation, resulting in a total of
731,462 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 Common Stock, subject to the approval
of the Plan by the stockholders of the
Company on or before April 24, 1998. The
Plan was approved by stockholders of the
Company and subsequently amended to
increase the number of shares of Common
Stock covered by the Plan to 1,600,000.
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.
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", 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
Notes to Consolidated Financial Statements
(continued)
================================================================================
No options were granted to employees
during the year ended June 30, 1999 and a
total of 316,666 options were forfeited or
expired in connection with resignations of
various officers from the Company. At June
30, 1999, there are 487,500 outstanding
options held by an officer and two
directors. On June 30, 1999, a total of
876,944 options to purchase shares of the
Company's Common Stock were outstanding,
with a weighted average remaining exercise
life of approximately 8.09 years. Of such
amount, 776,944 are exercisable on such
date at a weighted average exercise price
of $11.36.
At June 30, 1999, the Company had option
agreements with one of its officers and
two non-employee directors. The following
table contains summary information on
stock options grants for the three year
period ended June 30, 1999.
<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
Granted 1998 Fiscal Year 1,006,110 806,110 $8.19-13.20 $ 9.97 $ 9.94
Forfeited or expired
1999 Fiscal Year (316,666) (216,666) $8.19-9.50 -- --
- -----------------------------------------------------------------------------------------------------------
Outstanding June 30, 1999 876,944 776,944 $8.19-14.50 $ 13.04 $ 11.36
===========================================================================================================
</TABLE>
F-22
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
Notes to Consolidated Financial Statements
(continued)
================================================================================
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. No options were granted for
the fiscal year ended June 30, 1999
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, 1999
- ----------------------------------------------------------------------------
Net loss from continuing operations:
As reported ($ 13,566,927)
Pro forma ($ 14,120,927)
Net loss per share from continuing operations:
As reported ($1.96)
Pro forma ($2.04)
============================================================================
Year ended June 30, 1998
- ----------------------------------------------------------------------------
Net loss from continuing operations:
As reported ($ 11,183,581)
Pro forma ($ 12,872,577)
Net loss per share from continuing operations:
As reported $ (1.99)
Pro forma $ (2.25)
============================================================================
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
Notes to Consolidated Financial Statements
(continued)
================================================================================
On August 20, 1998, the Company notified
holders of 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. 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.
In September, 1998, the Company issued the
Notes accompanied by the $2.375 Warrants,
subject to certain adjustments. The $2.375
Warrants were exercisable for five years from
the date of issuance. The exercise price under
the $2.375 Warrants were set at the closing
price of the Common Stock on September 4,
1998. (See Note 5(c))
The Company estimates the fair value of each
stock warrant at the grant date by using the
Black-Scholes pricing model with the following
weighted average assumptions; no dividends
paid for all years; expected volatility of
46.5%; weighted average risk-free interest
rate of 4.92% and an expected life of 5 years.
In the fourth quarter of fiscal 1999,
management reviewed their original valuation
of the net present value of cash flows for
these warrants using the Black Scholes pricing
model. Based upon the Black Scholes model the
detachable warrants had a fair value of
$1,120,000 on the date of grant. In the fourth
quarter of fiscal 1999, the Company recorded
an additonal $1,070,000 debt issue costs at
the date of grant and amortized fully over the
six month term ending March 1999.
The Company was unable to repay the Notes and
their related interest on the maturity date of
March 1999. On May 15, 1999, this debt was
exchanged for the Convertible Debt. (See Note
5(d))
On May 15, 1999 the Company exchanged the
Notes for 10% Two-Year promissory notes
convertible into shares of common stock at
$1.10 a share (the "Convertible Debt") which
provided for quarterly interest only payments
for the first year and quarterly principal
payments with interest in the second year. The
$2.375 Warrants were concurrently exchanged
for new warrants providing for the purchase of
up to 1,800,000 shares of Common Stock at
$1.10 (the "$1.10 Warrants"). The exchange of
the Notes and $2.375 Warrants was exempt from
registration under the Securities Act pursuant
to Section 4 thereof. The exercise price of
the Convertible Debt and $1.10 Warrants was
based on the market value of the common stock
as of the maturity date of the Notes. As the
market price of the common stock was $4.3125
on May 15, 1999, the Company recorded a
refinancing charge of $1,200,000 to reflect
the intrinsic value of the Convertible Debt up
to its gross proceeds. No fair value was
allocated to the debt issue costs associated
with the warrants. To date the Company has
remained current with the terms and interest
payments of the Convertible Debt.
The Company estimates the fair value of each
stock warrant at the date of grant by using
the Black Scholes pricing model with the
following weighted average assumptions: no
dividends paid for all years; expected
volatility of 46.1%; weighted average risk
free interest rate of 5.33% and an expected
life of approximately 4 years. As the
intrinsic value of the Convertible Debt
exceeded the gross proceeds of the new debt, a
refinancing charge of $1,200,000 was charged
as of May 15, 1999. No fair value was
allocated to debt issue costs paid in the form
of the $1.10 Warrants.
The following table contains information on
warrants for the three-year period ended June
30, 1999:
Weighted
average
Warrant Exercise price exercise
shares range per share price
- --------------------------------------------------------------------------------
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
Exercised (44,750) $ 1.50 $ 1.50
Expired (18,923) $ 1.50 $ 1.50
Granted 600,000 $ 2.375 $ 2.375
Exchanged (600,000) $ 2.375 $ 2.375
Granted 1,800,000 $ 1.10 $ 1.10
- --------------------------------------------------------------------------------
Outstanding and exercisable,
June 30, 1999 3,133,334 $1.10-13.20 $ 6.04
================================================================================
The weighted average remaining contractual
life of the outstanding and exercisable
warrants as of June 30, 1999 is 3.57 years.
The Convertible Debt is convertible at $1.10
principal amount per share into 1,090,909
shares of Common Stock. The Preferred Stock
held by Premiere is currently convertible into
731,462 shares of Common Stock.
10. 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, 1999 1998 1997
- ------------------------------------------------------------------------------
Numerator:
Net loss from continuing
operations available to
common shareholders $(13,566,927) $(11,183,581) $ (2,480,253)
- ------------------------------------------------------------------------------
Denominator:
Denominator for basic
earnings per
share - weighted
average common shares
outstanding 6,913,495 5,618,994 4,579,075
Effect of dilutive
securities: -- -- --
Denominator for diluted loss
per share - adjusted
weighted average common
shares and assumed
conversions $ 6,913,495 $ 5,618,994 $ 4,579,075
==============================================================================
Basic loss per common share
from continuing operations $ (1.96) $ (1.99) $ (.55)
==============================================================================
Diluted loss per common share
from continuing operations $ (1.96) $ (1.99) $ (.55)
==============================================================================
F-24
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
Notes to Consolidated Financial Statements
(continued)
================================================================================
11. Acquisitions On March 4, 1999, the Company, through POS
TEC, acquired the assets, property and
business of TOTAL POS SOLUTIONS, LLC in return
for 200,000 shares of Common Stock. The shares
were valued at $1.50. per share based on the
market price on February 24, 1999 the
date of the Asset Purchase Agreement. The
acquisition was recorded under purchase
accounting with the customer list acquired
valued by management at approximately
$285,000, to be amortized over 3 years in
addition to other miscellaneous assets.
Operating results for the acquired company are
included in the Company's financial statements
since March 4, 1999.
12. Deferred Income Taxes The tax effects of temporary differences that
give rise to deferred tax assets are as
follows:
June 30, 1999 1998 1997
- -----------------------------------------------------------------------------
Net operating loss
carryforwards $11,246,000 $ 6,106,000 $ 876,000
Loss on World Access -- -- 313,000
Deferred rent 31,000 42,000 25,000
Allowance for bad debts 399,000 613,000 21,000
Deferred revenue -- 449,000
Customer lists 287,000 125,000 30,000
Accrued Taxes 147,000 -- --
Officer's and Director's
Compensation 71,000 -- --
Other 8,000 16,000 13,000
- -----------------------------------------------------------------------------
Total deferred
tax assets 12,189,000 7,351,000 1,278,000
Less: Valuation
allowance (12,189,000) (7,351,000) (1,278,000)
- -----------------------------------------------------------------------------
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
results of operations, management has
established a valuation allowance equal to the
tax effects of the Company's deferred tax
assets at June 30, 1999 and 1998
The Company's net operating loss carryforwards
of approximately $23,860,000 are available to
offset future Federal taxable income, if any,
through 2019 and may be subject to various
limitations.
F-25
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
Notes to Consolidated Financial Statements
(continued)
================================================================================
13. Supplemental Cash Flow Cash paid for interest during the years ending
Information June 30, 1999, 1998 and 1997, was
approximately $67,000, $14,000 and $5,000,
respectively. Additional supplemental
disclosures of cash flow information are as
follows:
Year ended June 30, 1999 1998 1997
- --------------------------------------------------------------------------------
Non-cash investing and financing
activities:
Common Stock issued for assets
of Total POS Solutions, LLC $ 300,000 $ -- $ --
Note payable to TecNet
via cash in transit 260,000 -- --
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 --
Common Stock issued in
exchanges for all
outstanding shares of
Ameridial -- 500,000 --
Write-off of
receivables for
acquisition of
customer lists -- -- 363,521
Transfer of Hughes'
communications
equipment and related
payable -- -- 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
Notes to Consolidated Financial Statements
(continued)
================================================================================
14. 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.
15. Subsequent Events (a) Subsequent to June 30, 1999, the Company
borrowed an additional $887,000 from TecNet
pursuant to demand promissory notes bearing
10% interest per annum. The Company has used
an additional $2,019,000 in telecommunications
services financed by TecNet since June 30,
1999. TecNet continues as of the date of this
report to finance telecommunication services
and cash flow needs of the Company. There is
no written agreement pursuant to which these
funds and services are provided by TecNet
other than demand promissory notes issued by
the Company upon advances of funds by TecNet.
There can be no assurances that such financing
will be continued by TecNet.
(b) On October 1999, the Company entered into a
promissory note in principal amount $887,174,
bearing interest at 6% per annum, with Qwest
relating to the settlement agreement, dated
May 1999.
F-27
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
Notes to Consolidated Financial Statements
(concluded)
================================================================================
F-28
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
Schedule II - Valuation and Qualifying Accounts
================================================================================
<TABLE>
<CAPTION>
Year ended June 30, 1999
- ------------------------------------------------------------------------------------------------------
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 $1,305,000 $ 356,059 $ -- $814,059 $ 847,000
======================================================================================================
Year ended June 30, 1998
- ------------------------------------------------------------------------------------------------------
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 $ 196,752 $ -- $ 162,752 $ 60,000
======================================================================================================
</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 on Form 10-K to be
signed on its behalf by the undersigned, thereunto duly authorized, in New York,
New York on November 5, 1999.
DIGITEC 2000, INC.
/s/ Frank C. Magliato
------------------------------------------
Frank C. Magliato
President, Chief Executive Officer,
Chairman of the Board of Directors and
Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report on Form 10-K 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 November 5, 1999.
- -------------------------- Executive Officer,
Frank C. Magliato Chairman of the
Board of Directors and
Chief Financial Officer
/s/ Diego E. Roca Senior Vice President, November 5, 1999.
- -------------------------- Chief Accounting Officer,
Diego E. Roca Secretary and Treasurer
/s/ Francis J. Calcagno Director November 5, 1999.
- --------------------------
Francis J. Calcagno
/s/ Lori Ann Perri Director November 5, 1999.
- --------------------------
Lori Ann Perri
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from Consolidated
Financial Statements for year ended 6/30/99 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-30-1999
<PERIOD-START> JUL-01-1998
<PERIOD-END> JUN-30-1999
<CASH> 156,756
<SECURITIES> 0
<RECEIVABLES> 604,586
<ALLOWANCES> 0
<INVENTORY> 58,818
<CURRENT-ASSETS> 1,214,047
<PP&E> 141,778
<DEPRECIATION> 0
<TOTAL-ASSETS> 1,696,739
<CURRENT-LIABILITIES> 12,766,621
<BONDS> 0
0
61
<COMMON> 7,059
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 1,696,739
<SALES> 10,394,558
<TOTAL-REVENUES> 10,394,558
<CGS> 15,278,886
<TOTAL-COSTS> 21,521,043
<OTHER-EXPENSES> 2,450,102
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (13,566,927)
<INCOME-TAX> 0
<INCOME-CONTINUING> (13,566,927)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (13,566,927)
<EPS-BASIC> (1.96)
<EPS-DILUTED> (1.96)
</TABLE>
