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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, 2000 Commission file number: 000-23291
DigiTEC 2000, Inc.
(Exact name of Registrant as specified in its charter)
Nevada 54-1287957
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
8 West 38th Street, Fifth Floor
New York, New York 10018
(Address of principal executive offices) (Zip Code)
(212) 944-8888
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12 (g) of the Act: Common Stock,
par value $.001 per share
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. |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
$7,211,509 on October 10, 2000, 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
10, 2000 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 November
20, 2000.
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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, 2000 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. 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
General
The Company was organized as a Nevada corporation in May 1987 under the name
Yacht Havens International Corp, which was subsequently changed in July of 1995
to Promo Tel, Inc. ("Promo Tel-Nevada"). In August of 1995, Promo Tel-Nevada
merged with Promo Tel, Inc. ("Promo Tel-Delaware"), a Delaware corporation,
exchanging 1,333,334 shares of the Company's previously unissued and
unregistered common stock for all of the outstanding shares of common stock of
Promo Tel-Delaware. In October of 1996, the Company formally amended its
Articles of Incorporation to change the legal name of the Company to DigiTEC
2000, Inc.
The Company is engaged in the creation, distribution and marketing of consumer
prepaid telephone calling card products. The Company's prepaid cards provide
consumers with a competitive alternative to the traditional pre-subscribed
long-distance telecommunications services, credit/calling cards and conventional
coin and other operator assisted long-distance services.
The Company's principal products are the F/X (R) series ("F/X (R)") and the
DIRECT (R) series ("DIRECT (R)") prepaid phone cards. The Company's prepaid
products are marketed through an extensive network of distributors and are
currently available in approximately 20,000 independent retail locations
throughout the United States. The Company's net sales were $35,032,533,
$10,394,558 and $13,733,119 for the fiscal years ended June 30, 1998, 1999 and
2000, respectively.
The Company's target markets include ethnic communities with substantial
international long distance usage. The Company believes that consumers typically
use its prepaid products 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 through the design of its prepaid cards as well as the high level of
service provided to the users of its prepaid cards. The Company currently sells
its prepaid products in approximately 100 cities in twenty-nine U.S. states
through its wholly owned point-of-sale subsidiary, POS TEC Systems, LLC ("POS
TEC"), and through the Company's internal distribution network.
The Company purchases the majority of its prepaid cards in bulk at a discount
below the face value of the prepaid cards, which are subsequently resold 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 on the difference between discounts given to customers
and the discounts received from its suppliers. The Company's customers 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"), and the holder of
approximately 21% of the Company's Common Stock. The Company's customers can use
the Company's prepaid card 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. The platform
provider switches processed calls to the long distance and local carriers for
call completion, and the prepaid cards' remaining balance is debited for the
cost of the call.
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The Company initiated a strategy of becoming a facilities based carrier in April
of 1998. To accomplish this strategy, the Company migrated its brands to
dedicated platforms and entered into a Service Agreement with Innovative Telecom
Corporation ("Innovative"), substantially all of the operating assets of which
were subsequently acquired and reorganized as Enhanced Global Convergence
Services, Inc., pursuant to which Innovative agreed to provide processing
services for the Company utilizing its switching facilities and platforms
located at 60 Hudson Street, New York, NY (the "Hudson Street Facility").
However, the Company was unable to fund the necessary carrier deposits, prepay
for telecommunications services, and to secure sufficient network facilities to
provide competitive rates to its consumers. Significant returns of its
facilities-based cards and the loss of control over processed call minutes
further aggrevated the liquidity difficulties of the Company during this time
period.
Therefore in lieu of continuing the development of its operations as a
facilities-based carrier, in November of 1998 the Company initiated a strategy
of focusing on the sales, marketing and distribution of prepaid telephone
calling cards. In connection with the initiation of such strategy, TecNet began
to provide significant telecommunications services to the Company, as well as to
finance its current operations and to carry the unprocessed minutes on the
Company's remaining facilities-based calling cards. In February of 1999, the
Company began to receive semi-monthly operating cash advances from TecNet
through the issuance of 10% demand promissory notes. As of June 30, 2000, the
Company had an outstanding balance on such loans (including accrued interest)
from TecNet in the amount of $6,191,046 and TecNet provided approximately $10.6
million in telecommunications services for the year then ended. As of June 30,
2000, no formal written agreement exists between the Company and TecNet with
respect to the terms of repayment for such services.
Beginning in May of 1999, the Company terminated its facilities-based products
and TecNet became the primary provider of bundled prepaid calling cards to the
Company and the sole carrier for carrying the traffic and processing the minutes
related to the prepaid calling cards. As of June 30, 2000(and through the
issuance date of this report), the Company is totally dependent on TecNet to
provide financing and telecommunications support. There can be no assurance that
TecNet can or will continue to provide such services, to finance the current
operations or to provide the Company with bundled prepaid calling cards at
comparable rates in future periods.
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 prepaid 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. There can be no
assurance that the Company will be able to achieve its short-term goals, and for
the foreseeable future, the Company's dependence on TecNet to provide financing
will continue.
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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 points-of-presence ("POP's")
throughout the United States to process prepaid card traffic. In addition, the
Company is using the telecommunications POP's of TecNet to originate and
terminate traffic in Mexico. The Company is operating on three dedicated
platforms and is supplying services from these platforms to its current brands
of prepaid calling cards.
2. Introduction of Local Access Cards. The Company is introducing Local Access
Cards ("LAC's") in most of the markets that it currently services and into many
of the markets into which it is expanding its operations. The Company's overall
strategy is to introduce local access cards in major metropolitan areas in
alliance with top tier carriers, while continuing to provide both competitive
rates and a high quality product in current markets. LAC's 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 introduced its first LAC product, New York Direct, in the prior
fiscal year which was received positively by customers. In August of 1999, the
Company began offering its New Jersey Direct and LA Direct local access prepaid
phone cards, which allow customers in the New Jersey and Los Angeles markets the
ability to call anywhere in the continental United States for 3.9(cent) per
minute after a 49(cent) connection fee. The cards also provide customers with
competitive international rates for many African, Latin American, Asian,
Caribbean, and European countries. In addition, the Company launched its Dallas
Direct local access card subsequent to fiscal year-end and is anticipating
favorable market acceptance and revenue growth in the targeted market.
3. Expansion of the Company's Retail Distribution Network. The Company's prepaid
cards are currently sold in approximately 100 cities in twenty-nine U.S. states.
The Company intends to increase its 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 being established.
The Company will also evaluate the possibility of acquiring existing or new
distributors to internalize its distribution system and to improve margins in
existing markets or as a means of establishing a presence in new markets.
4. Introduction of New Products and Services. The Company intends to continue to
identify niches of the international and domestic long distance market in which
to offer new prepaid products. The Company believes that it will be able to
capitalize on its brand awareness and effectively market these products to new
and existing customers.
In response to overall competition, the Company began offering lower rates on
its DigiTEC Direct and F/X Mexico branded calling cards in June of 2000, as well
as on the local access branded cards, New York Direct, New Jersey Direct and
Dallas Direct. In addition, existing per-minute rates and access charges were
lowered on long distance calls to Brazil, China, Ecuador, Honduras, El Salvador,
Guatemala, Jamaica, Laos, Mexico, Peru, Philippines, Poland, and Puerto Rico.
The DigiTEC Direct card now offers customers the ability to call anywhere in the
continental United States for 2.9(cent) per minute with a 59(cent) connection
fee. Local access card rates were decreased to 1.9(cent) per minute with a
49(cent) connection fee. The Company believes that offering highly competitive
rates will significantly increase the overall number of prepaid minutes sold in
these key markets.
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 prepaid cards
outside the United States.
5
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6. Point of Sale. The Company through, POS TEC, acquired the assets of Total POS
Systems LLC in March of 1999, which included approximately 1,500 retail
locations. In August 1999, the Company commenced operations in an effort to
secure a market leadership position in the "point of sale" prepaid
telecommunications sector to market existing and future brands of its prepaid
cards. POS TEC utilizes point of sale technology that allows retailers the
ability to utilize traditional credit card processing terminals to activate
prepaid telecommunications products and other prepaid services directly on site.
The processing terminal equipment was co-developed with Lipman USA, currently
the third largest provider of credit card terminals in the United States. Point
of sale activation is emerging technology that will dominate the prepaid
industry with rapid penetration and wide spread acceptance, as it brings
dramatic improvements in the areas of inventory management, theft and fraud
prevention, revenue settlement and detailed sales reporting to distribution
channels.
The Company believes that retailers and their consumers are generally familiar
with the POS terminals because they are often used when making credit card
purchases. The Company's POS prepaid 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 prepaid cards,
reduce bad debt experience and improve cash flow and further increase the
margins on the prepaid cards. Merchants with existing terminals have them
reprogrammed to activate the Company's prepaid cards, and the Company provides
terminals to retail establishments without such devices who desire to sell the
Company's prepaid products.
There can be no assurance that the Company will be able to achieve its
short-term goals, and for the foreseeable future, the Company's dependence on
TecNet to provide financing will continue.
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 several
telephone carriers introduced the microchip and magnetic strip cards in the
U.S., 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 New York/New Jersey Metro Area (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 of the debit card databases. 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, the remote debit card database computer of the prepaid card provider
automatically closes it. Thereafter, the card has no further value.
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The market for prepaid phone cards has grown substantially, from an estimated
$25 million in 1992 to an estimated $2.5 billion in 2000, 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 2001. The
Company has identified three distinct divisions of the prepaid phone card
market. These three divisions are utility card products, which are 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.
Telecommunications Products and Services of the Company
The principal products of the Company are prepaid phone cards currently marketed
under three primary 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 products 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
The Company currently obtains its telecommunications services from TecNet
utilizing their switching and platform facilities located primarily at the
Hudson Street Facility. TecNet activates the PIN's at the direction of the
Company, processes calls initiated by the Company's card holders and received
from local and long distance carriers, presents those calls for completion to
designated local and long distance carriers, debits the cards' account balance
and generates reports and other information on behalf of the Company for
tracking revenues and usage. There can be no assurance that TecNet can or will
continue to provide such services in future periods.
Marketing and Distribution
The Company currently distributes its prepaid cards primarily through
independent distributors, field representatives and through POS TEC's
point-of-sale terminal network. Distributors purchase prepaid cards from the
Company at a discount from the retail value of the card. The amount of the
discount depends upon the 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.
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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 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.
Transactions with Premiere Communications, Inc.
On September 25 and 26 of 1997, the Company entered into two agreements with
Premiere Communications, Inc. ("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.
8
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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 $6,105,000 which represented the outstanding accounts
payable balance at March 31, 1998. The $6,105,000 consisted of approximately
$3,236,000 attributed to various charges and costs incurred in the normal course
of business and $2,869,000 of charges relating to excess minutes processed by
Premiere on cards previously 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 was 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 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 per share plus applicable accrued dividends, if any.
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 June 30, 2000, the Company employed approximately 22 full-time
customer service representatives, most of which are fluent in multiple
languages. 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 number and by
physical count. Generally, the cards are received, stored, 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
PIN's are inactive when the cards arrive at the Company's facility and the cards
are inoperable until the individual PIN numbers are activated. PIN's are
activated upon shipment from the Company's facility to distributors in order to
minimize the number of prepaid cards with activated PINs in its facility.
Prepaid cards shipped to POS providers are shipped in an inactive state and are
activated by "swiping" them through the POS terminal at the point of sale to the
end user, thus increasing the security associated with the transfer and sale of
the prepaid cards.
PIN's are created electronically with unique inventory and batch codes. The
Company currently relies on TecNet to provide software support to track prepaid
phone card information and deactivate specified PIN's in certain instances such
as nonpayment, mistaken activation or theft.
Competition
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 2000. 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 32% in 1999.
During the same period, the market share of AT&T declined from approximately 90%
to approximately 37%. 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.
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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 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.
Technology and Obsolescence
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 telecommunications industry will also depend upon the
Company's ability to develop additional products and services that appeal to its
intended end users.
Government Regulation
Historically, the Company has been subject to minimal government regulation. The
Telecommunications Act of 1996 (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.
Federal. The Telecommunications Act opened the long distance market to
competition from the Regional Bell Operating Companies ("RBOC's") and to local
exchange carriers 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.
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 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, active circuits, interlocking directors, its foreign
affiliations and its correspondent and/or termination relationships with the
foreign carriers, if any. 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.
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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 LEC's 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.
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.
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 periods. 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, 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, filing and remitting related excise taxes and
penalties.
State. Intrastate long distance telecommunications operations of the Company are
subject to various state 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 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 the 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.
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.
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The Company has received authorization to do business in approximately 20 states
in the United States. 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.
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.
Employees
As of June 30, 2000, the Company employed approximately 55 full-time employees,
three officers and two directors. None of the Company's employees are members of
a labor union or are covered by a collective bargaining agreement.
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 prepaid 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 Key Supplier/Telecommunications Provider and its Facilities. The
Company's ability to sell prepaid cards depends upon whether it can continue to
maintain its favorable relationship with its key supplier of prepaid products,
TecNet, in order to offer bundled prepaid calling cards at competitive rates in
future periods. For the fiscal year ended June 30, 2000, TecNet provided
substantially all of the Company's telecommunications services. The Company
believes that this relationship will increase overall revenues to both parties
by creating strong synergies within the prepaid telecommunications market, as
well as to further the Company's strategy of offering quality prepaid products
at competitive prices within existing and prospective markets.
Key supplier's facilities include (i) switches, network POP's and debit card
platforms in strategic geographic regions in the United States; (ii) leased
capacity to connect third parties' network POP's; 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 TecNet for efficient and uninterrupted service to its customers and
their willingness to continue to provide the Company with favorable
rate-per-minute terms in future periods. The Company's provision of reliable
telecommunications service is dependent upon the ability of its key supplier to
protect the switches and other equipment and data at its 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 its key supplier has 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.
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The Company's ability to maintain and expand its business depends in part upon
the ability of its key supplier, TecNet to provide it with facilities and at
favorable terms and competitive rates. Acceptance of the Company's prepaid 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 underlying prepaid cards. Regulatory changes,
competitive pressures and changes in access charges may adversely affect the
charges imposed upon its key supplier and the Company by other
telecommunications providers. There is no assurance that its key supplier or the
Company will be able to continue to obtain origination, transport or termination
services at favorable rates and terms. Changes in the underlying terms or rates
charged on the prepaid cards could have an adverse effect on the Company.
In addition to favorable rates and terms for its facilities, its key supplier
and the Company also require the cooperation and efficiency of incumbent local
exchange carriers ("LEC's"), competitive local exchange carriers ("CLEC's") 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 "Business--General," and "Notes to
Consolidated Financial Statements."
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 his employment with the Company 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.
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 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 competitor's products. The
initiation of POS activities though POS TEC will decrease dependence on such
distributors.
Competition. The prepaid phone card sector of the long distance
telecommunications market is highly competitive and is affected by the constant
introduction of new prepaid cards and services by industry participants. The
Company competes with other providers of prepaid calling cards and with
providers of telecommunications services in general. Competition is based upon
pricing, quality of transmission, customer service and perceived reliability of
the underlying prepaid products. 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 barriers to entry are not insurmountable in
the markets in which the Company currently competes, and the Company expects
such competition to intensify in future periods.
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The Company competes for customers in the telecommunications market primarily
based on price and, to a lesser extent, the type and quality of services
offered. Increased competition could force the Company to reduce its prices and
overall profit margins if its competitors are able to procure rates that are
comparable to or better than those the Company obtains, or are able to offer
other incentives to existing and potential customers. The ability of the Company
to compete effectively will depend largely upon the Company's continued ability
to provide highly reliable prepaid 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.
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 RBOC's. 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 RBOC's, in competition with the Company. See "Government
Regulation."
In addition, the Company must potentially compete with competitors which
fraudulently sell prepaid phone cards below cost without paying the
telecommunications carrier for the related services.
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 who 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 continue to develop for 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. Although the Company expects to grow, there can be no
assurance that the Company will be able to achieve the growth contemplated by
its overall 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. Additionally the Company's stability within
its existing markets is dependent up on its ability to generate sufficient
operating cash flows and financing sources to meet its obligations.
Financing Requirements. 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 alternate sources
for financing other than the present relationship whereby TecNet funds its
current operating short-falls. No formal written agreement exists between the
Company and TecNet with respect to the terms of repayment for such services. As
of June 30, 2000 (and through the issuance date of this report), the Company is
totally dependent on TecNet to provide consulting services, financing and
telecommunications support until it has achieved profitable operations. However,
there can be no assurance that TecNet can or will continue to provide such
services, to finance the current operations or to provide the Company with
bundled prepaid calling cards at comparable rates in future periods.
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Limited Operating History; Net Losses. The Company has had only a limited
operating history. The Company reported losses from continuing operations of
$11,183,581, $13,566,927 and $4,499,526 for the fiscal years ended June 30,
1998, 1999 and 2000, respectively. There can be no assurance that the Company
will achieve profitability 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 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 industry is subject to a very
high level of technological change. In addition, new product and service
introduction by existing and future competitors, the introduction of new sales
channels and evolving industry standards present additional challenges within
the telecommunications service industry. 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 the
underlying demand for prepaid phone cards. The ability of the Company to compete
effectively in the telecommunications industry in general, and in existing
markets, will be dependent on the Company's ability to develop additional
products and services that appeal to its intended end users. 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."
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.
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, 2000, the Company has the following outstanding 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, 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, which was issued in connection with the
modification of debt terms on a note payable related to the
Company's acquisition of the customer base of Prime Communications,
Inc.,
(iv) options to purchase 731,944 shares of Common Stock at exercise
prices ranging from $8.1875 to $14.50 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
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(v) 61,050 shares of Preferred Stock issued by the Company to Premiere
Communications, Inc. on March 31, 1998, which shares are convertible
into 731,462 shares of Common Stock.
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 $29,000,000 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 1933 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.
Taxes. The taxation of prepaid products 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 or may interpret current laws in a manner
resulting in additional tax liabilities.
The Company evaluates 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.
The Company analyzes 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.
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 PIN's. The Company attempts to manage theft and
fraud risks through its internal controls, monitoring and blocking systems. The
Company believes that its risk management practices are adequate, and to date
the Company has not experienced material losses due to such unauthorized use of
access numbers and PIN's. 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.
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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.
Regulation. The Company is subject to various federal and state regulations
which are subject to interpretation and change. There can be no assurance that
such regulations will not adversely affect the Company. See "Government
Regulation".
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.
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.
POS TEC occupies leased premises of approximately 2,600 square feet at 4570
Westgrove Air Plaza in Dallas, Texas, at a base rent of $18 per square foot per
year. The thirty month lease term commenced on December 1, 1999 and will expire
on May 31, 2002.
ITEM 3. LEGAL PROCEEDINGS
The Company and its Chief Executive Officer were named as defendants 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")
vs. Telephone Electronics Corporation. A settlement agreement was executed on
September 21, 2000. As a result of the agreement, the Company was not required
to contribute any funds towards the settlement award and all claims pending
against the Company and its Chief Executive Officer were duly discharged.
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, the parties executed a settlement
agreement pursuant to which the Company would pay nine monthly installments
commencing December, 1999 for a total of $887,000. The Company paid
approximately $621,000 to Qwest related to the settlement agreement for the year
ended June 30, 2000 and the balance owed of $266,521 is reflected in the accrued
settlement expenses on the consolidated balance sheet.
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 outstanding balance, the debit cards became inoperable. 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. Management believes such litigation will not
have a material adverse effect on the financial condition or the results of
operations of the Company.
17
<PAGE>
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.
On October 20, 1999, Union Telecard Alliance LLC ("Union") 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. In February of 2000, the Company filed
its answer along with a third-party complaint against IDT Corporation, the
majority owner of Union, for $2.5 million. The maximum exposure to the Company
appears to be approximately $725,000. Presently, the Company is exploring
settlement possibilities with both Union and IDT. The Company is not in a
position to express an opinion as to the probable outcome of this matter.
On June 28, 2000, Innovative commenced an arbitration proceeding before the
American Arbitration Association in Boston, Massachusetts asserting claims in
the amount of $604,979 related to unpaid fees and charges for services rendered
in connection with the platform and switching services performed on behalf of
the Company until approximately July of 1999. The Company has asserted
counterclaims against Innovative in the amount of $3,900,000 based on lost
profits and additional expenses incurred as the result of the poor quality of
Innovative's software and network switching services. The Company is presently
exploring settlement possibilities with Innovative and believes that any such
settlement, if realized, will not have a material adverse effect on the
financial condition or the results of operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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, 2000(1):
First Quarter $1.562 $1.375
Second Quarter 2.000 1.937
Third Quarter 1.500 1.250
Fourth Quarter 1.375 1.375
Year Ending June 30, 1999(1):
First Quarter $6.375 $1.530
Second Quarter 4.375 .810
Third Quarter 2.340 .875
Fourth Quarter 4.375 .875
-------------------------------------------------------------------
(1) For the years ended June 30, 2000 and 1999, the Company's Common Stock was
thinly traded. Further, over-the-counter market quotations may not necessarily
represent actual transactions.
On October 10, 2000, the closing sale price of the Common Stock on the OTC
Bulletin Board was $1.75 per share. As of October 10, 2000, there were 7,058,998
shares of DigiTEC 2000, Inc. Common Stock issued and outstanding, held by
approximately 651 shareholders of record.
18
<PAGE>
The Company did not pay any cash dividends on its Common Stock for the fiscal
years ended June 30, 2000 and 1999, respectively. The current dividend policy of
the Company's Board of Directors is to retain any available discretionary
earnings to fund current operations and to finance the overall expansion of the
Company's business and product offerings. Therefore, it is likely that the
Company will forego the payment of any cash dividends on the outstanding shares
of Common Stock in the foreseeable future. Any future revisions of the existing
dividend policy will be at the discretion of the Board of Directors and will be
contingent upon the Company's earnings, capital requirements, cash flows and
financial condition, as well as any other factors deemed relevant by the Board
of Directors.
Preferred Stock
The DigiTEC Series A Convertible Preferred Stock is convertible into shares of
the Company's common stock by multiplying the number of shares of Series A
Convertible Preferred Stock (61,050) issued in connection with the Premier
Investment Agreement by $100 (the Investment Amount as defined in the
Certificate of Designation) divided by $8.3463 (the Conversion Price as defined
in the Certificate of Designation) which results in a total of 731,462 shares of
common stock to be issued subject to certain subsequent securities issues.
Dividends will be paid or accrued, as and if declared by the Board of Directors.
The Company has not declared any dividends on such stock to date, and it is
unlikely that the Company will declare the payment of any such dividends in the
foreseeable future. The Certificate of Designation for the Series A Convertible
Preferred Stock provides for certain voting, liquidation and registration rights
for the holder. The Company may call the redemption of each share of Series A
Convertible Preferred Stock at any time for $100 per share plus applicable
accrued dividends, if any.
19
<PAGE>
--------------------------------------------------------------------------------
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following is a summary of selected financial data of the Company as of and
for the five years ended June 30, 2000. This data should be read in conjunctions
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Company's Consolidated Financial Statements and the notes
thereto appearing elsewhere in this document.
<TABLE>
<CAPTION>
For the Years Ended June 30,
----------------------------------------------------------------------------
2000 1999 1998 1997 1996
----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Consolidated Statements of Operations
Data:
Net Sales ............................. $ 13,733,119 $ 10,394,558 $ 35,032,533 $ 26,027,909 $ 17,425,199
Cost of sales ......................... 12,142,746 15,278,886 36,648,219 25,161,443 16,900,370
Gross profit (loss) ................... 1,590,373 (4,884,328) (1,615,686) 866,466 524,829
Selling, general and
administrative expenses ............... 6,019,015 6,242,157 9,232,477 2,035,045 654,104
Loss from operations .................. (4,428,642) (11,126,485) (10,848,163) (1,168,579) (129,275)
Other expenses, net ................... (70,884) (2,440,442) (335,418) (1,311,674) --
Loss from continuing operations ....... (4,499,526) (13,566,927) (11,183,581) (2,480,253) (129,275)
Net Loss .............................. (4,499,526) (13,566,927) (11,996,759) (3,549,514) (129,275)
Net Loss per share (basic and diluted):
From continuing operations ........ $ (.64) $ (1.96) $ (1.99) $ (.55) $ (.05)
From discontinued operations ...... $ -- $ -- $ (.15) $ (.23) $ --
Net Loss per share ................ $ (.64) $ (1.96) $ (2.14) $ (.78) $ (.05)
Weighted average common
shares outstanding .................... 7,058,998 6,913,495 5,618,994 4,579,075 2,599,532
</TABLE>
<TABLE>
<CAPTION>
AT JUNE 30,
------------------------------------------------------------------------
Balance Sheet Data: 2000 1999 1998 1997 1996
------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Working Capital (Deficit) ...... $(17,069,595) $(11,852,574) $(2,226,152) $ (636,687) $1,216,279
Total Assets ................... 3,572,460 1,696,739 3,139,790 3,526,723 6,056,462
Convertible Debt ............... 900,000 1,200,000 -- -- --
Stockholders' Equity (Deficit).. (16,703,563) (12,336,232) (1,494,390) (71,469) 3,126,946
</TABLE>
20
<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.
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
$13,733,119, $10,394,558 and $35,032,533, and its net losses were $4,499,526,
$13,566,927, and $11,996,759 for the fiscal years ended June 30, 2000, 1999 and
1998, respectively, after losses from discontinued operations of $0, $0 and
$813,178, 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. As a result, the Company was unable to market its new facilities-based
cards as quickly as originally planned and was forced to accept returns of
product from distributors. The liquidity problems of the Company were further
aggravated by the loss of control over processed call minutes and termination of
customers' calls on the Company's network, as well as the increased costs of
sales attributed to the repricing of the Company's cards by Premiere. In lieu of
continuing the development of its operations as a facilities-based carrier, in
November of 1998 the Company initiated a strategy of focusing on the sales,
marketing and distribution of prepaid telephone calling cards. In connection
with the initiation of such strategy, TecNet began to provide significant
telecommunications services to the Company, as well as to finance its current
operations and to carry the unprocessed minutes on the Company's remaining
facilities-based calling cards. In February of 1999, the Company began to
receive semi-monthly operating cash inflows from TecNet through the issuance of
10% demand promissory notes. However, no formal written agreement exists between
the Company and TecNet with respect to the terms of repayment for such services.
As of June 30, 2000 (and through the issuance date of this report), the Company
is totally dependent on TecNet to provide consulting services, financing and
telecommunications support until it has achieved profitable operations. However,
there can be no assurance that TecNet can or will continue to provide such
services, to finance the current operations or to provide the Company with
bundled prepaid calling cards at comparable rates in future periods.
21
<PAGE>
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 and significant arrearages on trade payables, 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.
Furthermore, the Company's ability to continue as a going concern is highly
dependent in the near term on both the willingness and ability of TecNet to
finance the Company's telecommunications products and services and working
capital short-falls, and the ability of the Company and TecNet 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 sources to meet obligations. The independent auditor's
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 TecNet to provide significant amounts of telecommunications
products and services and to provide material amounts of operating cash flows.
The Company believes that future growth is dependent on the continued receipt of
operational and financial support from TecNet, providing customers with a high
quality prepaid product at a competitive price, and the ability to terminate the
related minutes on TecNet's network facilities at favorable rates. In addition,
the Company expects to produce favorable operating results in the future by
increasing its existing retail distribution market, to introduce new products to
its target market which are cost competitive on a per minute basis and to
capitalize upon economies of scale within existing markets. There can be no
assurance that the Company will continue to receive the support of TecNet or be
able to achieve favorable operating results in future periods.
Operations
Year Ended June 30, 2000 Compared to Year Ended June 30, 1999
Net Sales:
Sales, net of discount and returns, increased approximately $3.3 million (32%)
to $13,733,119 for the twelve month period ended June 30, 2000 as compared to
$10,394,558 for the twelve month period ended June 30, 1999. The overall
increase is attributed to the Company's strategy of focusing on the sales,
marketing and distribution of prepaid telephone calling cards within its target
market and the termination of its unprofitable proprietary branded
facilities-based cards. By abandoning its prior strategy of becoming a
facilities-based carrier and through the infusion of operating capital by
TecNet, the Company has been able to increase overall sales by directly focusing
on the specific needs of its target market and utilizing its cash flows for the
development of existing and prospective markets instead of purchasing costly
network infrastructure. The Company's revenues are now based on both the dollar
value and the total number of cards sold, and the Company was able to
significantly increase the total number of prepaid cards sold during the twelve
month period ended June 30, 2000 through its master distributor networks. The
Company has been able to realize market growth by offering cost competitive
prepaid calling cards utilizing the favorable pricing obtained from TecNet on
bundled products.
Cost of Sales:
The Company's cost of sales decreased approximately $3.1 million (21%) to
$12,142,746 for the twelve month period ended June 30, 2000 as compared to
$15,278,886 for the twelve month period ended June 30, 1999. The overall
decrease is directly related to the Company's abandonment of its prior strategy
of becoming a facilities-based carrier. By focusing its efforts on reselling
bundled prepaid products obtained from TecNet (which are terminated on TecNet's
network), the Company was able to realize cost savings by not paying facilities-
based carrier charges, fixed cost circuit charges or private line charges to
route the customers' calls.
22
<PAGE>
Gross Profit:
The Company realized a gross profit of approximately $1.6 million for the twelve
month period ended June 30, 2000 as compared to a gross loss of approximately
$4.9 million for the twelve month period ended June 30, 1999. The gross profit
realized is directly related to the Company's use of bundled prepaid cards
purchased from TecNet which did not have the higher costs of facilities based
cards, as well as the cost savings from not having to pay fixed circuit costs
and private line charges on activated cards. In addition, the Company was able
to obtain more favorable short-term financing rates from TecNet in connection
with the purchase of the bundled prepaid cards, which helped to facilitate the
increase in overall net sales.
Selling, General and Administrative Expenses:
The Company's selling, general and administrative expenses decreased
approximately $223,000 (4%) to $6,019,015 for the twelve month period ended June
30, 2000 as compared to $6,242,157 for the twelve month period ended June 30,
1999. The overall decrease is related to the combined effect of several factors.
The Company realized cost savings from the consulting, financing and
telecommunications support services provided by TecNet on its behalf during the
fiscal year ended June 30, 2000. In addition, the Company realized reductions in
both depreciation and amortization expense from that of prior presented periods
due to fully amortized customer lists in the current period and sale/retirement
of facilities based network equipment. Finally, overall rent expense declined
from the prior period due to the fact that the Company sublet under utilized
office space to third parties.
Loss before other Income (Expenses):
The Company's realized loss before other income (expenses) of approximately $4.4
million for the twelve month period ended June 30, 2000 improved significantly
as compared to the loss before other income (expense) of approximately $11.1
million for the twelve month period ended June 30, 1999. The overall improvement
is directly related to the combination of factors noted above for net sales,
cost of sales and selling, general and administrative expenses.
Other Income (Expenses):
The Company's other income (expenses) decreased approximately $2.4 million (97%)
to $70,884 net expense for the twelve month period ended June 30, 2000 as
compared to $2,440,442 net expense for the twelve month period ended June 30,
1999. The overall decline is related to the amortization of debt issue costs and
the refinancing charge of $1.2 million attributed to the $2.375 Warrants in the
prior presented period, offset by current period interest expense related to
notes payable to TecNet.
Net Loss:
The Company's realized net loss of approximately $4.5 million for the twelve
month period ended June 30, 2000 improved significantly as compared to the net
loss of approximately $13.6 million for the twelve month period ended June 30,
1999. The overall improvement is directly related to the factors noted above for
gross profit and other income (expenses).
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--General".
23
<PAGE>
(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--General."
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.
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.
24
<PAGE>
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 $11,183,581 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 of 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.
Liquidity and Capital Resources
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 warrants to purchase shares of the Common Stock of the
Company at $1.50 per share (the "$1.50 Warrants"), which aggregated
approximately $3,400,000 of proceeds to the Company; (iii) sale of 61,050 shares
of the Company's Series A Preferred Stock, which resulted in the elimination of
an accounts payable balance to Premiere totaling approximately $6,105,000; (iv)
sale of $1,200,000 principal amount of the Company's Notes with the $2.375
Warrants (as subsequently exchanged, the "10% Notes"); (v) issuance of a
$100,000 10% promissory note to an officer/director family member; and (vi) the
infusion of approximately $14 million of operating capital through the issuance
of 10% demand promissory notes and the extension of trade credit by TecNet. All
of the above offerings were exempt from registration under the applicable
Securities Act.
The Company has no existing bank lines of credit and has not established any
sources for such financing.
The Company's major components of cash flow are as follows:
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
--------------------------------------
2000 1999 1998
-------- -------- --------
<S> <C> <C> <C>
Net cash used in operating activities ... $(2,632,388) $(2,902,901) $(3,430,032)
Net cash used in investing activities ... (50,637) (14,805) (87,181)
Net cash provided by financing activities 3,692,123 2,965,740 2,898,738
----------- ----------- -----------
Net increase (decrease) in cash ...... $ 1,009,098 $ 48,034 $ (618,475)
=========== =========== ===========
</TABLE>
The Company's net cash used in operating activities decreased approximately
$270,000 (9%) to $(2,632,388) for the fiscal year ended June 30, 2000 as
compared to $(2,902,901) for the fiscal year ended June 30, 1999. The overall
decrease in net cash used in operating activities from the fiscal year ended
June 30, 2000 is related to the combined effect of a decrease in the net loss of
approximately $9 million, a decrease in the cash flow effect of accounts
receivable of approximately $3.5 million, a decrease in the cash flow effect of
accounts payable and accrued expenses of approximately $4.6 million, an increase
in the cash flow effect of deferred revenue of approximately $1 million, and the
amortization of $2.3 million of debt issue costs in the prior period.
To date, capital expenditures have not been material. Cash used in investing
activities for both the fiscal years ended June 30, 2000 and 1999 related solely
to capital expenditures of approximately $51,000 for the fiscal year ended June
30, 2000 and approximately $15,000 for the fiscal year ended June 30, 1999.
25
<PAGE>
During the fiscal year ended June 30, 2000, cash provided from financing
activities related primarily to the issuance of approximately $4.2 million in
promissory notes to TecNet, the repayment of approximately $300,000 in principal
to the holders of the $1.2 million promissory notes, the payment of
approximately $121,000 to settle the outstanding obligations and claims with
Prime Communications, Inc., and the repayment of approximately $83,000 in
principal on an outstanding loan with a family member of an officer/director of
the Company. During the fiscal year ended June 30, 1999, cash provided from
financing activities related primarily to the proceeds of the Company's sales of
$1.2 million of 10% Notes, the sale of a $100,000 10% promissory note payable to
an immediate family member of an officer/director of the Company and $1.6
million received through the issuance of promissory notes to TecNet.
Since June 30, 1999, the Company has raised cash primarily through the issuance
of 10% demand promissory notes payable to TecNet. Since November of 1999, the
Company has been dependent on TecNet financing its shortfalls in cash flows and
current operations and the provisioning of telecommunication services by TecNet.
In addition, the Company has imposed a fifty-percent deferral of its two
executives' salaries and has subleased a portion of its corporate headquarters
to reduce the overall cash shortfalls. As the Company increases the sales of its
bundled prepaid products, its capital requirements are expected to progressively
decline. Although the Company has achieved significant improvements in cash
flows from operations, it does not expect to achieve positive cash flows from
operations until the end of fiscal year 2001.
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, 1998" 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.
26
<PAGE>
(viii) Other write-downs and write-offs associated with operating activities
aggregating $.5 million.
Cash used in investing activities in fiscal 1999 was solely related to capital
expenditures of $14,805, 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 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.
The $2,898,738 cash provided by financing activities in fiscal 1998 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.
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 $11,853,000.
The Company remains undercapitalized and to date has not been able to finance
its expansion as quickly as opportunities have arisen.
The Company expects capital requirements of approximately $2.0 million during
fiscal 2001, before it begins to generate positive cash flow during the latter
half of fiscal 2001. The foregoing amount includes further expansion of the
Company's prepaid products into additional cities and expanding the Company's
existing master distribution network. If cash needs prove to be greater than
contemplated, the Company will need to slow the expansion of its prepaid product
offerings to additional cities during fiscal year 2001. Also, the Company
expects to consider other financing opportunities during the 2001 fiscal year.
The Company believes that with the continued support of TecNet, internally
generated cash from operations in fiscal 2001 will be sufficient to fund its
operations throughout the 2001 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 2001 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.
For the year ended June 30, 2000, the Company experienced a substantial
operating loss of $4.4 million and used approximately $2.6 million of cash in
operating activities. The Company's cash position at June 30, 2000 approximated
$1.2 million and its working capital deficit approximated $17 million. The
Company remains undercapitalized and to date has not been able to finance its
expansion as quickly as opportunities have arisen.
Market Risk
The Company does not hold any derivatives or investments that are subject to
market risk. The carrying values of financial instruments, including cash and
notes payable at June 30, 2000 and 1999, approximate fair value as of those
dates because of the relatively short-term maturity of these instruments which
minimizes potential market risk associated with such instruments.
27
<PAGE>
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.
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," as amended by SFAS Nos. 137 and 138, which
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. The Company will adopt the
statement effective July 1, 2000 and believes that the adoption of the new
standard will not have a material adverse effect on the Company's consolidated
results of operations or financial position.
In December 1999, Staff Accounting Bulletin ("SAB") No. 101, "Revenue
Recognition in Financial Statements", was issued. SAB No. 101 summarizes the
Securities and Exchange Commission's staff views on applying accounting
principles generally accepted in the United States of America to revenue
recognition. The Company will implement SAB No. 101 prior to the fourth quarter
of fiscal year 2001. The Company believes that the adoption of SAB No. 101 will
not have a material impact on our revenue recognition.
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, which includes cash and notes payable, at June 30, 2000
and 1999, approximates fair value as of such dates, due to the short-term
maturity of such instruments and the fact that the underlying interest rates
approximate current market rates of interest.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements of the Company and the related Notes
thereto and the financial information required to be filed herewith are included
on pages F1 to F21 and Schedule S-1 of this Report on Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Effective June 30, 2000, BDO Seidman, LLP, New York, New York was replaced by
Deloitte & Touche LLP, New York, New York as the independent auditors to audit
the financial statements of the registrant. The decision to change accountants
was recommended and approved by the Board of Directors and Audit Committee of
the registrant.
The reports of BDO Seidman, LLP on the registrant's last two annual reports on
Form 10-K contained going concern language as follows:
"1998 Report:
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1(a) to the
financial statements, the Company has experienced significant losses from
continuing operations for the three years ending June 30, 1998, has a deficit in
working capital and equity at June 30, 1998 and may have significant contractual
obligations as discussed in Note 6. These matters raise substantial doubt about
its ability to continue as a going concern. Management's plan 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."
"1999 Report:
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%
28
<PAGE>
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."
The registrant believes that, for the registrant's fiscal years ended June 30,
1998 and June 30, 1999, and the subsequent interim period preceding the
replacement of BDO Seidman, LLP, the registrant and BDO Seidman, LLP did not
have any disagreement on any matter of accounting principles or practices,
financial statement disclosure or auditing scope or procedure, which
disagreement, if not resolved to the satisfaction of BDO Seidman, LLP would have
caused it to make reference in connection with its report on the registrant's
financial statements to the subject matter of the disagreement.
At the request of BDO Seidman, LLP, the registrant restated its 10-Qs for the
periods ending September 30, 1998, December 31, 1998 and March 31, 1999 to
reflect the interest charges related to the amortization of certain warrants to
purchase common stock related to certain debt refinancing with related parties
and to record unfiled federal excise taxes with related penalties and interest.
The June 30, 1998 10-K was amended to disclose reclassification of excess
minutes processed by Premier Communications, Inc., a stockholder of the
registrant.
BDO Seidman, LLP, has communicated to the management and audit committee of the
registrant during and after the fiscal 1999 and 1998 audits certain issues
related to the lack of management and internal controls of the registrant during
these periods.
The Audit Committee has reviewed these matters and the registrant has authorized
BDO Seidman, LLP to respond to inquiries of Deloitte & Touche LLP on all matters
of the registrant's financial reporting.
The registrant provided BDO Seidman, LLP with a copy of the foregoing
disclosures and requested that BDO Seidman, LLP furnish a letter addressed to
the Securities and Exchange Commission stating whether or not BDO Seidman, LLP
agrees with such disclosures. A copy of such letter has been filed as Exhibit 16
to Form 8-K by amendment on July 25, 2000.
PART III
The information called for by Item 10, Directors and Executive Officers of the
Registrant; Item 11, Executive Compensation; Item 12, Security Ownership of
Certain Beneficial Owners and Management; and Item 13, Certain Relationships and
Related Transactions, is hereby incorporated by reference to the corresponding
sections of the Registrant's definitive proxy statement (the "Definitive Proxy
Statement") for its Annual Meeting of Stockholders to be held on November 20,
2000.
29
<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)
-------
Reports of Independent Auditors ............................... F-2
Consolidated Balance Sheets as of June 30, 2000 and 1999....... F-4
Consolidated Statements of Loss for the years ended
June 30, 2000, 1999 and 1998 .................................. F-5
Consolidated Statements of Stockholders' Deficit
for the years ended June 30, 2000, 1999 and 1998 .............. F-6
Consolidated Statements of Cash Flows for the years ended
June 30, 2000, 1999 and 1998 .................................. F-7
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
(i) Current Report on Form 8-K filed July 10, 2000 reporting under Item 4,,JHV
Changes in Certifying Accountants.
(ii) Amendment to Current Report on Form 8-K filed July 25, 2000 reporting
under Item 4, Changes in Certifying Accountants.
(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 Quarterly 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 Ameridial, Inc. Acquisition Agreement (Incorporated by
reference herein to Exhibit 2 of the Company's Quarterly
Report on Form
<PAGE>
10-Q filed February 13, 1998)
10.14 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)
10.15 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)
10.16 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)
10.17 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)
10.18 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 Quarterly
Report on Form 10-Q filed May 21, 1999)
10.19 10% Promissory Note (Tec Net, Inc.) (Incorporated by reference
herein to Exhibit 10.1 of the Company's Quarterly Report on
Form 10-Q filed May 21, 1999)
10.20 10% Promissory Note (Incorporated by reference herein to
Exhibit 2 of the Company's Quarterly Report on Form 10-Q filed
February 23, 1999)
10.21 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)
16.1 Letter Regarding Changes in Certifying Accountants
(Incorporated by reference herein to Exhibit 16.1 of Amendment
#1 to the Company's Current Report on Form 8-K filed July 25,
2000)
27 Financial Data Schedule
F-1
<PAGE>
Report of Independent Auditors'
To the Board of Directors and Stockholders of
DigiTEC 2000, Inc.
New York, N.Y.
We have audited the accompanying consolidated balance sheet of DigiTEC 2000,
Inc. and subsidiary (the "Company") as of June 30, 2000, and the related
consolidated statements of loss, stockholders' deficit, and cash flows for the
year then ended. Our audit also included the financial statement schedule for
the year ended June 30, 2000 listed in the index at Item 14(a)(2). These
consolidated financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements and financial statement
schedule based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company as of June 30, 2000,
and the results of its operations and its cash flows for the year then ended in
conformity with accounting principles generally accepted in the United States of
America. Also, in our opinion, such financial statement schedule, when
considered in relation to the basic consolidated financial statements taken as a
whole, presents fairly in all material respects the information set forth
therein.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1(d) to
the consolidated financial statements, the Company's recurring losses from
operations and stockholders' capital deficiency raise substantial doubt about
its ability to continue as a going concern. In addition, the Company has become
economically dependent upon a 21 percent stockholder to fund operating cash
flows and to provide significant telecommunications products and services.
Management's plans concerning these matters are also described in Note 1(d). The
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
/s/ Deloitte & Touche LLP
New York, New York
September 28, 2000
F-2
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
Digitec 2000, Inc.
New York, New York
We have audited the accompanying consolidated balance sheet of DigiTEC 2000 Inc.
and Subsidiary as of June 30, 1999, and the related consolidated statements of
operations, stockholders' deficit and cash flows for each of the years ended
June 30, 1999 and 1998 and the financial statement schedule II listed in Item 14
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 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 the consolidated results of their operations
and their cash flows for each of the years ended June 30, 1999 and 1998 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(d) to the
financial statements, the Company has significant deficiencies in working
capital and net worth at June 30, 1999 and experienced significant losses from
continuing operations for each of the years ended June 30, 1999 and 1998. 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(d) 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
New York, New York
October 25, 1999
F-3
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
Consolidated Balance Sheets
================================================================================
<TABLE>
<CAPTION>
June 30,
2000 1999
--------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Current:
Cash and cash equivalents $ 1,165,854 $ 156,756
Due from TecNet, Inc. -- 260,000
Accounts receivable, net of allowance for bad
debts of $1,817,657 and $847,000 1,598,164 604,586
Inventory 423,288 58,818
Prepaid expenses and other 13,116 133,887
--------------------------------------------------------------------------------------------------
Total Current Assets 3,200,422 1,214,047
Property and equipment, net of accumulated
depreciation of $171,290 and $113,124 123,370 141,778
Customer lists, net of accumulated amortization
of $118,675 and $583,611 166,145 261,559
Other assets 82,523 79,355
--------------------------------------------------------------------------------------------------
Total Assets $ 3,572,460 $ 1,696,739
==================================================================================================
Liabilities and Stockholders' Deficit
Current:
Notes and accounts payable to TecNet, Inc. $ 14,430,310 6,849,385
Accounts payable - Trade 1,600,389 2,133,887
Accrued taxes and penalties 1,307,141 462,000
Accounts payable and accrued expenses 437,744 699,524
Payable to Premiere Communications, Inc. 583,152 583,152
Accrued legal 727,760 825,615
Accrued settlement expenses 266,521 991,633
Notes payable 17,000 221,425
Convertible Debt 900,000 300,000
--------------------------------------------------------------------------------------------------
Total Current Liabilities 20,270,017 13,066,621
Deferred rent 6,006 66,350
Convertible debt -- 900,000
--------------------------------------------------------------------------------------------------
Total Liabilities 20,276,023 14,032,971
--------------------------------------------------------------------------------------------------
Commitments and Contingencies (NOTE 6)
--------------------------------------------------------------------------------------------------
Stockholders' Deficit
Series A Convertible Preferred Stock, $.001 par value, 1,000,000
shares authorized; 61,050 shares issued and outstanding 61 61
Common Stock, $.001 par value, 100,000,000 shares
authorized; 7,058,998 shares issued and outstanding 7,059 7,059
Additional paid-in capital 17,031,318 16,899,123
Accumulated deficit (33,742,001) (29,242,475)
--------------------------------------------------------------------------------------------------
Total Stockholders' Deficit (16,703,563) (12,336,232)
--------------------------------------------------------------------------------------------------
Total Liabilities and Stockholders' Deficit $ 3,572,460 $ 1,696,739
==================================================================================================
</TABLE>
See accompanying notes to Consolidated Financial Statements.
F-4
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
Consolidated Statements of Loss
================================================================================
<TABLE>
<CAPTION>
For the Years ended June 30,
--------------------------------------------
2000 1999 1998
--------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net sales $ 13,733,119 $ 10,394,558 $ 35,032,533
Cost of sales 12,142,746 15,278,886 36,648,219
--------------------------------------------------------------------------------------------------
Gross profit (loss) 1,590,373 (4,884,328) (1,615,686)
Selling, general and administrative
expenses 6,019,015 6,242,157 9,232,477
--------------------------------------------------------------------------------------------------
Loss before other income (expenses) (4,428,642) (11,126,485) (10,848,163)
--------------------------------------------------------------------------------------------------
Other income (expenses):
Interest expense (519,291) (1,245,272) (59,187)
Refinancing of debt -- (1,200,000) --
Loss on modification of debt terms -- -- (287,100)
Other income (expenses) 448,407 4,830 10,869
--------------------------------------------------------------------------------------------------
Other expenses (70,884) (2,440,442) (335,418)
--------------------------------------------------------------------------------------------------
Loss from continuing operations (4,499,526) (13,566,927) (11,183,581)
--------------------------------------------------------------------------------------------------
Discontinued operations:
Loss from operations of Cellular Division -- -- (527,061)
Loss on disposal of Cellular Division -- -- (114,524)
Loss on disposal of World Access -- -- (171,593)
--------------------------------------------------------------------------------------------------
Loss from discontinued operations -- -- (813,178)
--------------------------------------------------------------------------------------------------
Net loss $ (4,499,526) $(13,566,927) $(11,996,759)
==================================================================================================
Net loss per common share-basic and diluted:
Loss from continuing operations $ (.64) $ (1.96) $ (1.99)
Loss from discontinued operations -- -- (.15)
--------------------------------------------------------------------------------------------------
$ (.64) $ (1.96) $ (2.14)
==================================================================================================
Weighted average number of common and common
equivalent shares outstanding used in basic and
diluted computations 7,058,998 6,913,495 5,618,994
==================================================================================================
</TABLE>
See accompanying notes to Consolidated Financial Statements.
F-5
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
Consolidated Statements of Stockholder's Deficit
================================================================================
<TABLE>
<CAPTION>
For the Three Years Ended June 30, 2000
Preferred stock Common stock Additional Total
--------------- ------------------ paid-in Accumulated stockholders'
Shares Amount Shares Amount capital deficit deficit
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance, June 30, 1997 -- -- 4,858,418 $ 4,858 $ 3,602,462 $ (3,678,789) $ (71,469)
Exercise of warrants -- -- 1,955,825 1,956 2,931,782 -- 2,933,738
Issuance of options to directors in lieu
of compensation -- -- -- -- 1,248,000 -- 1,248,000
Adjustment: Fractional shares -- -- 5 -- -- -- --
Issuance of preferred stock to satisfy
trade payables 61,050 61 -- -- 6,104,939 -- 6,105,000
Issuance of options related to debt
modification -- -- -- -- 287,100 -- 287,100
Net loss -- -- -- -- -- (11,996,759) $(11,996,759)
-----------------------------------------------------------------------------------------------------------------------------------
Balance, June 30, 1998 61,050 $ 61 6,814,248 $ 6,814 $ 14,174,283 $(15,675,548) $ (1,494,390)
Exercise of warrants -- -- 44,750 45 67,080 -- 67,125
Issuance of Warrants accompanying 10%
six-month notes 1,120,000 -- 1,120,000
Issuance of common stock relating to
asset purchase 200,000 200 299,800 -- 300,000
Issuance of warrants accompanying
convertible debt 1,200,000 -- 1,200,000
Contributed capital 37,960 -- 37,960
Net loss -- (13,566,927) $(13,566,927)
-----------------------------------------------------------------------------------------------------------------------------------
Balance, June 30, 1999 61,050 $ 61 7,058,998 $ 7,059 $ 16,899,123 $(29,242,475) $(12,336,232)
Contributed capital -- -- -- -- 132,195 -- 132,195
Net loss -- (4,499,526) (4,499,526)
-----------------------------------------------------------------------------------------------------------------------------------
Balance, June 30, 2000 61,050 $ 61 7,058,998 $ 7,059 $ 17,031,318 $(33,742,001) $(16,703,563)
===================================================================================================================================
</TABLE>
See accompanying notes to Consolidated Financial Statements.
F-6
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
Consolidated Statements of Cash Flows
================================================================================
<TABLE>
<CAPTION>
For the Years ended June 30,
-----------------------------------------------
2000 1999 1998
------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $ (4,499,526) $(13,566,927) $(11,996,759)
Adjustments to reconcile net loss to net cash used in
operating activities:
Provision for losses on customer receivables 1,025,000 356,059 1,467,656
Provision for losses on customer receivables - Cellular -- -- 52,463
Write-off of accounts receivable (54,343) (814,059) (222,656)
Write-down of inventory -- -- 206,281
Depreciation 61,610 48,247 50,675
Amortization of customer lists 95,414 250,054 236,256
Impairment of customer lists -- 147,089 --
Promotional expense -- -- 2,868,989
Deferred revenue -- (955,117) 955,117
Deferred rent (60,344) (23,195) 18,545
Amortization of debt issue cost -- 1,120,000 --
Services provided by shareholder 132,195 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
Write-down of Cellular Division -- -- 114,524
(Increase) decrease in:
Accounts receivable (1,964,235) 1,545,636 (1,161,958)
Inventory (364,470) 334,768 (381,433)
Prepaid expenses and other 385,038 198,096 (362,820)
Increase (decrease) in:
Accounts payable and accrued expenses 2,611,273 7,218,488 3,516,014
------------------------------------------------------------------------------------------------------------------
Net cash used in operating activities of
continuing operations (2,632,388) (2,902,901) (2,932,413)
Net cash used in operating activities of
discontinued operations -- -- (497,619)
------------------------------------------------------------------------------------------------------------------
Net cash used in operating activities (2,632,388) (2,902,901) (3,430,032)
------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Capital expenditures (50,637) (14,805) (87,181)
------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (50,637) (14,805) (87,181)
------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Proceeds from issuance of TecNet notes 4,196,548 1,624,190 --
Proceeds from issuance of promissory notes -- 1,300,000 --
Repayment of notes payable and convertible debt (504,425) (25,575) (35,000)
Proceeds from exercise of warrants -- 67,125 2,933,738
------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 3,692,123 2,965,740 2,898,738
------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash
and cash equivalents 1,009,098 48,034 (618,475)
Cash and cash equivalents beginning of year 156,756 108,722 727,197
------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents end of year $ 1,165,854 $ 156,756 $ 108,722
==================================================================================================================
</TABLE>
See accompanying notes to Consolidated Financial Statements.
F-7
<PAGE>
DigiTEC 2000, Inc. and Subsidiary
Notes to Consolidated Financial Statements
June 30, 2000
1. The Company and Significant Accounting Policies:
(a) Description of Business and Organization
The Company was organized as a Nevada corporation in May 1987 under the name
Yacht Havens International Corp, which was subsequently changed in July of 1995
to Promo Tel, Inc. ("Promo Tel-Nevada"). In August of 1995, Promo Tel-Nevada
merged with Promo Tel, Inc. ("Promo Tel-Delaware"), a Delaware corporation,
exchanging 1,333,334 shares of the Company's previously unissued and
unregistered common stock for all of the outstanding shares of common stock of
Promo Tel-Delaware. In October of 1996, the Company formally amended its
Articles of Incorporation to change the legal name of the Company to DigiTEC
2000, Inc.
The Company is engaged in the creation, distribution and marketing of consumer
prepaid telephone calling cards. The Company's prepaid cards provide consumers
with a competitive alternative to the traditional pre-subscribed long-distance
telecommunications services, credit/calling cards and conventional coin and
other operator assisted long-distance services.
(b) Business Combinations
On March 4, 1999, the Company (through its subsidiary POS TEC Systems, LLC)
acquired the assets, property and business of TOTAL POS SOLUTIONS, LLC, in
exchange for 200,000 shares of the Company's common stock. The shares of common
stock were valued at $1.50 per share based on the market price on the Closing
Date ("February 24, 1999") of the Asset Purchase Agreement. The acquisition was
recorded utilizing the purchase method of accounting and the Company valued the
underlying customer lists obtained under the transaction at approximately
$285,000 to be amortized over a period of thirty-six months. The operating
results of the acquired entity have been included within the Company's
consolidated financial statements since March 4, 1999.
(c) Principles of Consolidation
The accompanying consolidated financial statements, which include the accounts
of DigiTEC 2000, Inc. (the "Company") for the entire period presented and those
of its wholly owned subsidiary, POS TEC Systems, LLC ("POS TEC") from the date
of acquisition have been prepared in accordance with accounting principles
generally accepted in the United States of America and with the instructions to
Form 10-K and Article 4 of Regulation S-X. All significant intercompany
transactions and balances have been eliminated in consolidation.
(d) Basis of Presentation
The accompanying consolidated financial statements have been prepared on the
basis that the Company is a going concern, which contemplates the realization of
assets and the satisfaction of liabilities in the normal course of business.
However, because of the Company's recurring losses from operations, accumulated
deficit, negative working capital and significant arrearages on trade payables,
such realization of assets and the satisfaction of the related liabilities are
subject to significant uncertainty. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty. Furthermore,
the Company's ability to continue as a going concern is highly dependent in the
near term on both the willingness and ability of TecNet, Inc. ("TecNet") to
finance the Company's telecommunications products and services and working
capital short-falls, and the ability of the Company and TecNet to provide
reliable and competitive prepaid telephone cards. TecNet is a wholly owned
subsidiary of Telephone Electronics Corporation ("TEC") and is a holder of
approximately 21% of the Company's outstanding common stock. Additionally, the
Company's overall stability is highly dependent upon its ability to raise
working capital, to increase market share while developing existing markets and
improving overall customer retention, to achieve profitable operations and to
generate sufficient cash flows from operating and financing activities to meet
its obligations as they become due.
F-8
<PAGE>
In lieu of continuing the development of its operations as a facilities-based
carrier, in November of 1998 the Company initiated a strategy of focusing on the
sales, marketing and distribution of prepaid telephone calling cards. In
connection with the initiation of such strategy, TecNet began to provide
significant telecommunications services to the Company, as well as to finance
its current operations and to carry the unprocessed minutes on the Company's
remaining facilities-based calling cards. In February of 1999, the Company began
to receive semi-monthly operating cash inflows from TecNet through the issuance
of 10% demand promissory notes. As of June 30, 2000, the Company had an
outstanding balance on such loans (including accrued interest) from TecNet in
the amount of $6,191,046 and TecNet provided approximately $10.6 million in
telecommunications services for the year then ended. As of June 30, 2000, no
formal written agreement exists between the Company and TecNet with respect to
the terms of repayment for such services.
Beginning in May of 1999, the Company terminated its facilities-based products
and TecNet became the primary service provider for bundled prepaid calling cards
sold by the Company and the sole carrier for carrying the traffic and processing
the minutes related to the prepaid calling cards. As of June 30, 2000 (and
through the issuance date of this report), the Company is totally dependent on
TecNet to provide financing and telecommunications support. However, there can
be no assurance that TecNet can or will continue to provide such services, to
finance the current operations or to provide the Company with bundled prepaid
calling cards at comparable rates in future periods.
(e) Nature of Operations
DigiTEC 2000, Inc. and its wholly owned subsidiary (the "Company") are primarily
engaged in the distribution, marketing and sales of prepaid telephone calling
cards. It currently markets its prepaid products throughout the New York/New
Jersey metropolitan area (the "Metro Area"). The Company also sells its prepaid
telephone cards in approximately 100 cities in twenty-nine U.S. states.
(f) Revenue Recognition
Sales of bundled prepaid calling cards from third-party providers for which the
Company acts solely as a distributor are recorded at the sales price of the card
and are recognized as revenue upon delivery to the Company's customers. The
related costs are simultaneously charged to the cost of sales accounts upon such
delivery.
The revenue from the sale of proprietary, branded, facilities-based prepaid
cards, along with the related costs of providing long distance services are
recognized as the telephone calls are initiated and completed by the end user.
Weekly and access fees per card are recognized at the beginning of each month
commencing thirty days after the first use of the underlying card. Any amounts
collected prior to the recording of revenue by the Company are classified as
Deferred Revenue. As of April 30, 1999, the Company no longer provided
facilities-based prepaid calling cards to its customers.
Revenue from Point of Sale ("POS") sales by the Company's subsidiary POS TEC,
are recognized upon the initial activation by the retailer upon the sale of the
underlying prepaid calling card to the end user. The related costs are
simultaneously charged to the respective cost of sales accounts upon the
activation of the card.
F-9
<PAGE>
(g) Allowance for Bad Debt
The Company maintains an allowance for bad debts to adequately provide for
estimated future losses due to the overall lack of collectibility of customers'
accounts. The recorded allowances are based on the Company's detailed analysis
of delinquencies, assessments of overall risk related to the entity's
operations, evaluations of probably future losses and historical performance and
the credit worthiness of certain key customers. Specific customer accounts are
written off when the probability of a future loss has been established based on
a careful consideration of the customer's financial condition, and after all
other attempts at collection have failed.
(h) 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.
(i) Cash and Cash Equivalents
The Company considers all demand deposits, time deposits and certificates of
deposit purchased with an original maturity of three months or less to be cash
equivalents.
(j) Customer Lists
During 1998 and 1999, customer lists were purchased from third parties and
amortized on a straight-line basis over the estimated useful lives of the
customer bases acquired, which approximates three years. The Company
periodically evaluates the recoverability of these intangible assets based on
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 recorded a charge to current
operations of approximately $147,089 to reflect the write-down of the carrying
value of these intangibles based on such assessments. Additionally, during the
second quarter of fiscal year 2000, the Company wrote off $560,350 of fully
amortized customer lists.
Amortization expense related to the customer lists was approximately $95,000,
$250,000 and $236,000 for the fiscal years ended June 30, 2000, 1999 and 1998,
respectively.
(k) Deferred Rent
The Company accounts for rent on a straight-line basis over the term of the
leases. The difference between cash rental payments and straight-line rent
expense for the years ended June 30, 2000, 1999 and 1998 was approximately
$60,000, $23,000 and $19,000, respectively.
(l) Advertising Costs
Costs incurred for producing and communicating advertising are expensed as
incurred.
(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.
F-10
<PAGE>
(n) Earnings (Loss) Per Share
The Company presents earnings per share ("EPS") in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share." SFAS No.
128 requires the dual presentation of basic EPS and diluted EPS on the face of
the statements of operations. Basic earnings per share is computed by dividing
net loss by the weighted average number of common shares outstanding, and
diluted earnings per share is based on net loss divided by the weighted average
number of common shares outstanding together with all dilutive potential common
shares outstanding. Since the Company incurred losses for all of the periods
presented, the dilutive net loss per share has not been presented due to the
fact that the conversion of options, warrants and preferred stock to Weighted
Average Common Shares would be anti-dilutive. Therefore there is no difference
between basic and diluted earnings per share.
(o) Fair Value of Financial Instruments
The carrying value of financial instruments, which includes cash and cash
equivalents and notes payable, at June 30, 2000 and June 30, 1999, approximates
fair value as of such dates, due to the relatively short-term maturity of such
instruments and the fact that the underlying interest rates approximate current
market rates of interest.
(p) Reclassifications
Certain consolidated financial statement amounts as previously reported have
been reclassified for consistent presentation.
(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," as amended by SFAS Nos. 137 and 138, which
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 derivative contracts either to
hedge existing risks or for speculative purposes. The Company will adopt this
statement effective July 1, 2000 and believes that the adoption of the new
standard will not have a material adverse effect on the Company's consolidated
results of operations or financial position.
In December 1999, Staff Accounting Bulletin ("SAB") No. 101, "Revenue
Recognition in Financial Statements", was issued. SAB No. 101 summarizes the
Securities and Exchange Commission's staff views on applying accounting
principles generally accepted in the United States of America to revenue
recognition. The Company will implement SAB No. 101 prior to the fourth quarter
of fiscal year 2001. The Company believes that the adoption of SAB No. 101 will
not have a material impact on our revenue recognition.
(r) Disclosures Regarding Risk Concentrations
Financial instruments, which potentially subject the Company to credit risk,
consist primarily of balances in excess of FDIC coverage and trade receivables.
Cash balances on deposit are placed with high credit quality financial
institutions. Although cash balances on deposit may from time to time exceed the
FDIC limits of coverage, the Company limits the amount of exposure in any one
financial institution and believes that no significant concentration of credit
risk exists with respect to its cash deposits as of the date of the presented
condensed consolidated balance sheet.
Trade receivables subject the Company to the potential for credit risk and
business concentration risk. The Company extends credit to customers generally
on an unsecured basis in the normal course of business, and performs ongoing
evaluations of its customers' financial condition to help reduce overall credit
risk. Allowances are maintained for potential credit losses and such losses have
historically been within management's overall expectations. Although sales
within the New York/New Jersey Metro Area (the "Metro Area") accounted for more
that 90% of the Company's total sales, for the year ended June 30, 2000, the
Company believes that the credit risks are moderated because of the geographical
dispersion of its target market, the cost competitiveness of its prepaid product
in relation to other suppliers, its utilization of a master distribution and
vendor route sales network and the realized (and forecasted) growth in new
markets within the United States and Mexico.
F-11
<PAGE>
During fiscal years ended June 30, 2000 and 1999, respectivley, the Company had
the following significant customers which accounted for the following
percentages of overall operating revenues and trade receivables:
<TABLE>
<CAPTION>
Operating Revenues Trade Receivables
$ Amount Percentage $ Amount Percentage
<S> <C> <C> <C> <C>
2000
Telecard Marketing Group, Inc. $5,736,112 42% $ 618,015 39%
Central Jersey Telecard Company, Inc. 428,838 3% 378,838 24%
Touch Tell Communications 648,648 5% 161,221 10%
1999
Phonecard Wholesalers $1,872,861 18% $ 223,073 39%
Telecard Marketing Group, Inc. 1,988,528 19% 235,101 39%
</TABLE>
No other customer accounted for more than 10% of sales or outstanding accounts
receivable.
(s) Property and Equipment
Depreciation is calculated on the underlying assets using the straight-line
method over their estimated useful lives as follows:
Furniture and fixtures - 5 Years
Computer equipment - 3 Years
Computer software - 2 Years
Vehicles - 5 Years
Depreciation expense for the years ended June 30, 2000, 1999 and 1998 was
approximately $62,000, $48,000 and $51,000, respectively.
The Company evaluates the recoverability of property and equipment, as well as
other long-lived assets, when events and circumstances indicate that such assets
may be impaired. The Company determines impairment by comparing the undiscounted
future cash flows estimated to be generated by these assets to their respective
carrying values. In the event that impairment exists, a loss is recognized based
on the amount by which the carrying value exceeds the fair value of the asset.
If quoted market prices for an asset are not available, the fair market value is
determined primarily using the anticipated cash flows discounted at a rate
commensurate with the risk involved. Losses on property and equipment, as well
as other long-lived assets, to be disposed of are determined in a similar
manner, except that their fair market value are reduced for the costs of
disposal.
Maintenance and repairs are expensed as incurred. The costs and related reserves
of assets sold or retired are removed from the accounts, and any resulting gains
or losses are reflected in the results of operations.
(t) Inventory
Inventory consists primarily of unactivated prepaid cards and is stated at the
lower of cost or market. Cost is determined by the first-in, first-out (FIFO)
methodology.
(u) Segment Disclosures
The Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise
and Related Information" in the prior fiscal year. SFAS 131 established
standards for the way that public business enterprises report financial
information on operating business segments. As the Company has only one
reportable business segment, prepaid telecommunications services, the adoption
and implementation of the disclosure and reporting requirements did not
significantly affect the presentation of the results of operation or financial
position of the Company.
F-12
<PAGE>
(v) Stock Based Compensation
The Company accounts for stock options issued to employees using the intrinsic
value methodology prescribed in Accounting Principles Board ("APB") Opinion No.
25, "Accounting for Stock Issued to Employees," and related Interpretations in
accounting for their stock option plans. Compensation expense for stock options
issued to employees is measured as the excess of the quoted market price of the
Company's stock at the date of grant over the amount an employee must pay to
acquire the underlying shares of stock.
SFAS No. 123, "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 methodology prescribed by SFAS 123. These
disclosures are presented within Note 7.
2. Related Party Transactions:
During September of 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"),
exercisable for a period of five years from the date of original issuance. The
exercise price of the underlying warrants was calculated as the closing price of
the Company's common stock on September 4, 1998, subject to certain adjustments.
Nine investors participated in the offering, and officers/directors of the
Company and immediate family members of such parties purchased $600,000 of the
total offering. The issuance and sale of the Notes and the $2.375 Warrants were
exempt from registration under the Securities Act of 1933 (the "Securities
Act"), as amended by Regulation D. The $1,120,000 fair value of the $2.375
Warrants was recorded as debt issue costs and amortized to interest expense over
a six-month period beginning September 20, 1998. Amortization expense was
$1,120,000 for the fiscal year ended June 30, 1999.
On May 15, 1999, the Company exchanged the Notes for 10% two-year promissory
notes convertible into shares of the Company's common stock (the "Convertible
Debt") at $1.10 per share. Furthermore, the Convertible Debt provided for
quarterly payments of interest only during the first twelve months of issuance
and quarterly payments of both interest and principal commencing in the second
year. The $2.375 Warrants were concurrently exchanged for new warrants which
provided for the purchase of up to 1,800,000 shares of the Company's common
stock (the "$1.10 Warrants"), calculated as the market price of the common stock
as of the maturity date of the Notes. The exchanges of the notes and the
warrants were exempt from registration under the Securities Act pursuant to
Section 4 thereof. As the market price of the Company's 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 the full amount of its
gross proceeds. No fair value was allocated to the debt issue costs associated
with such warrants. During the fiscal year ended June 30, 2000, the Company paid
$300,000 in scheduled principal payments on the Convertible Debt, and the
outstanding principal balance of $900,000 at June 30, 2000 is scheduled to be
paid during the first three quarters of fiscal year 2001.
In October of 1998, the Company borrowed $100,000 from an immediate family
member of an officer/director of the Company. (See Note 5).
In November 1998 the Company reached a verbal agreement with TecNet to carry the
remaining unprocessed minutes on the Company's facilities-based debit cards. In
February of 1999, the Company began funding its operating shortfalls through the
issuance of demand promissory notes to TecNet bearing an annual interest rate of
approximately 10%. Subsequently, in the fourth quarter of 1999, the Company
reached a verbal agreement with TecNet whereby TecNet would become the primary
provider of bundled prepaid calling card services to the Company and the sole
carrier for carrying the traffic and processing the minutes related to the
prepaid calling cards. TecNet provided approximately $10.6 million in
telecommunications services for the fiscal year ended June 30, 2000. In
addition, TecNet provided approximately $133,000 and $38,000 of consulting
services to the Company during fiscal year 2000 and 1999, respectively, which
has been accounted for as a capital contribution.
F-13
<PAGE>
The following presents the detail of the payable to TecNet at June 30, 2000 and
1999:
June 30,
---------------------------
2000 1999
---------------------------
Demand notes payable $ 5,818,963 $1,884,190
Payable for bundled phone cards 3,848,097 574,028
Payable for telecommunication services 4,391,167 4,391,167
Accrued interest 372,083 --
=========== ===========
$14,430,310 $6,849,385
=========== ===========
3. Property, Plant and Equipment:
The major classes of property and equipment are as follows:
June 30,
---------------------
2000 1999
-------------------------------------------------------
Computer equipment $228,276 $204,771
Furniture and fixtures 42,973 28,720
Computer software 2,000 --
Vehicles 21,411 21,411
-------------------------------------------------------
Property and equipment 294,660 254,902
Less: Accumulated depreciation 171,290 113,124
-------------------------------------------------------
Property and equipment, net $123,370 $141,778
=======================================================
4. Preferred Stock:
On March 31, 1998, the Company entered into an Investment Agreement with
Premiere Communications, Inc. ("Premiere")in which Premiere received 61,050
shares of $.001 par value voting Series A Preferred Stock in full satisfaction
of the outstanding accounts payable balance at March 31, 1998. The $6,105,000
consisted of approximately $3,236,000 attributed to various charges and costs
incurred in the normal course of business with Premiere and approximately
$2,869,000 of charges relating to excess minutes processed by Premiere on cards
previously sold. (See Note 7).
5. Notes Payable:
Notes payable of the Company are summarized as follows:
June 30,
--------------------
2000 1999
-------- --------
Promissory note payable to a family member
of an officer/director, fixed interest at 10%,
maturing fiscal year 2001 $ 17,000 $100,000
Note payable to Prime Communications, Inc. for
acquisition of customer base in fiscal year 1997 -- 121,425
--------------------
$ 17,000 $221,425
====================
F-14
<PAGE>
6. Commitments and Contingencies:
(a) Leases
The Company leases office space under two separate noncancellable operating
lease agreements which expire on March 31, 2001 and May 31, 2002, respectively.
Rent expense for the years ended June 30, 2000, 1999 and 1998 was approximately
$348,000, $299,000 and $261,000, respectively. Future minimum rentals required
as of June 30, 2000 under all noncancellable operating leases are:
Fiscal year ended June 30,
2001 $ 255,000
2002 31,000
---------
$ 286,000
=========
(b) Contingencies
The Company and its Chief Executive Officer were named as defendants 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")
vs. Telephone Electronics Corporation. A settlement agreement was executed on
September 21, 2000. As a result of the agreement, the Company was not required
to contribute any funds towards the settlement award and all claims pending
against the Company and its Chief Executive Officer were duly discharged.
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, the parties executed a settlement
agreement pursuant to which the Company would pay nine monthly installments
commencing December, 1999 for a total of $887,000. The Company paid
approximately $621,000 to Qwest related to the settlement agreement for the year
ended June 30, 2000 and the balance owed of $266,521 is reflected in the accrued
settlement expenses on the consolidated balance sheet.
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 outstanding balance, the debit cards became inoperable. 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. Management believes such litigation will not
have a material adverse effect on the financial condition or the results of
operations of the Company.
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.
F-15
<PAGE>
On October 20, 1999, Union Telecard Alliance LLC ("Union") 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. In February of 2000, the Company filed
its answer along with a third-party complaint against IDT Corporation, the
majority owner of Union, for $2.5 million. The maximum exposure to the Company
appears to be approximately $725,000. Presently, the Company is exploring
settlement possibilities with both Union and IDT. The Company is not in a
position to express an opinion as to the probable outcome of this matter.
The $583,152 payable to Premiere, as reflected within the Consolidated Financial
Statements, relates to billings by Premiere for the purchase of prepaid phone
cards which are currently being disputed by the Company. Management believes
that it has a meritorious position with respect to such matters due to breach of
contract and repricing issues surrounding the terms of the original purchase
agreement. The Company is not in a position to express an opinion as to the
probable outcome of this matter. Therefore, due to the overall uncertainty
surrounding the accrual, the liability remains unchanged from the prior
presented period.
On June 28, 2000, Innovative Telecom Corporation ("Innovative") commenced an
arbitration proceeding before the American Arbitration Association in Boston,
Massachusetts asserting claims in the amount of $604,979 related to unpaid fees
and charges for services rendered in connection with the platform and switching
services performed on behalf of the Company until approximately July of 1999.
The Company has asserted counterclaims against Innovative in the amount of
$3,900,000 based on lost profits and additional expenses incurred as the result
of the poor quality of Innovative's software and network switching services. The
Company is presently exploring settlement possibilities with Innovative and
believes that any such settlement, if realized, will not have a material adverse
effect on the financial condition or the results of operations of the Company.
(c) Employment Agreements
Effective January 1999, the Company's two executive officers agreed to a 50%
deferral of their base salaries under their respective employment agreements
until such time as the Company was able to generate positive cash flows from
operations. Approximately $240,000 and $120,000 of deferred compensation was
accrued during the fiscal year ended June 30, 2000 and 1999, respectively, and
is included within accrued expenses.
(d) Regulatory Requirements
The Company is currently evaluating various tax and other regulatory assessments
to determine their overall applicability to its current operations. As the
Company's operations continue to expand, the Company may become subject to
additional tariffs and both state and federal regulatory charges. In connection
with a verbal agreement with TecNet whereby the Company is responsible for
filing and remitting excise taxes, the Company accrued approximately $845,000
and $462,000 for excise taxes payable and the related penalties to such unfiled
returns for the fiscal years ended June 30, 2000 and 1999, respectively.
7. Stockholders' Equity:
(a) Series A Convertible Preferred Stock
The 61,050 shares of $.001 par value voting Series A Convertible Preferred Stock
was issued on March 31, 1998 to Premiere in lieu of payment of the outstanding
trade payable balance owed by the Company. The Series A Preferred Stock is
convertible into common stock of the Company at any time by Premiere and the
Company has the right to require Premiere to convert such Preferred Stock after
March 31, 1999. The Certificate of Designation for the Series A Convertible
Preferred Stock provides for certain voting, liquidation and registration rights
for the holder. The conversion of such stock is calculated by multiplying the
number of shares of Series A Convertible Preferred Stock (61,050) issued in
connection with the Premier Investment Agreement by $100 (the Investment Amount
as defined in the Certificate of Designation) divided by $8.3463 (the Conversion
Price as defined in the Certificate of Designation) which results in a total of
731,462 shares of common stock to be issued subject to certain subsequent
securities issues. The Company may call the redemption of each share of Series A
Convertible Preferred Stock at any time for $100 per share plus applicable
accrued dividends, if any.
F-16
<PAGE>
(b) Stock Options and Warrants
In 1998, the Company's stockholders approved the Company's stock incentive plan
which provides for the granting of up to 1,600,000 shares of Common Stock. 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 summary of stock option activity under the Company's stock option plan is as
follows:
Weighted Average
Shares Exercise Price
--------- ----------------
Outstanding at June 30, 1997: 187,500 $ 14.50
Granted 1,006,110 10.03
Exercised -- --
Canceled -- --
Forfeited -- --
--------- -----------
Outstanding at June 30, 1998: 1,193,610 11.54
Granted -- --
Exercised -- --
Canceled -- --
Forfeited (316,666) 8.47
--------- -----------
Outstanding at June 30, 1999: 876,944 11.54
Granted -- --
Exercised -- --
Canceled -- --
Forfeited -- --
--------- -----------
Outstanding at June 30, 2000: 876,944 $ 11.54
================================================================================
The following table summarizes the status of stock options outstanding and
exerciseable at June 30, 2000:
Stock Options Outstanding
-------------------------
Total Number Weighted-Average Total Number
Of Options Remaining of Options
Outstanding Contractual Life Exerciseable
------------------------------------------------
Exercise Price
--------------
$ 8.19 200,000 7.68 200,000
$ 8.25 100,000 7.91 100,000
$12.25 200,000 7.26 200,000
$13.00 44,444 1.10 44,444
$13.20 145,000 7.01 145,000
$14.50 187,500 6.77 187,500
------- -------
876,944 876,944
======= =======
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. The weighted average fair value of the options granted
during the years ended June 30, 1998 and 1997 was $3.01 and $.59, respectively.
F-17
<PAGE>
Under the accounting provisions of SFAS No. 123, the Company's net loss and net
loss per share from continuing operations for the years ending June 30, 2000,
1999 and 1998, respectively, would have been increased to the pro forma amounts
indicated below:
Year ended June 30, 2000
--------------------------------------------------------------------------------
Net loss from continuing operations:
As reported ($ 4,499,526)
Pro forma ($ 4,499,526)
Net loss per share from continuing operations:
As reported ($0.64)
Pro forma ($0.64)
================================================================================
Year ended June 30, 1999
--------------------------------------------------------------------------------
Net loss from continuing operations:
As reported ($ 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)
================================================================================
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 was set at the closing price of the Common Stock on September 4, 1998.
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 which was 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.
F-18
<PAGE>
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.
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 against operations as of May 15, 1999.
The following table contains information on warrants for the three-year period
ended June 30, 2000:
Weighted
average
Warrant Exercise price exercise
shares range per share price
--------------------------------------------------------------------------------
Outstanding and exerciseable,
June 30, 1997 3,352,832 $ 1.50 - 13.200 $ 6.150
Exercised (1,955,825) $ 1.500 $ 1.500
--------------------------------------------------------------------------------
Outstanding and exercisable,
June 30, 1998 1,397,007 $ 1.50 - 13.200 $ 12.670
Exercised (44,750) $ 1.500 $ 1.500
Expired (18,923) $ 1.500 $ 1.500
Granted 600,000 $ 2.375 $ 2.375
Exchanged (600,000) $ 2.375 $ 2.375
Granted 1,800,000 $ 1.100 $ 1.100
--------------------------------------------------------------------------------
Outstanding and exercisable, 3,133,334 $ 1.10 - 13.200 $ 6.250
June 30, 1999
Exercised -- $ -- $ --
Expired -- $ -- $ --
Granted -- $ -- $ --
Exchanged -- $ -- $ --
--------------------------------------------------------------------------------
Outstanding and exercisable,
June 30, 2000 3,133,334 $ 1.10 - 13.200 $ 6.250
================================================================================
The weighted average remaining contractual life of the outstanding and
exercisable warrants as of June 30, 2000 is 2.51 years.
F-19
<PAGE>
8. 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, 2000 1999 1998
--------------------------------------------------------------------------------
Numerator:
Net loss from continuing
operations available to
common shareholders $ (4,449,526) $(13,566,927) $(11,183,581)
--------------------------------------------------------------------------------
Denominator:
Denominator for basic and
diluted earnings (loss) per
share - weighted average
common shares outstanding 7,058,998 6,913,495 5,618,994
================================================================================
Basic and diluted loss per common
share - continuing operations $ (0.64) $ (1.96) $ (1.99)
================================================================================
9. Deferred Income Taxes:
Deferred income taxes reflect the net tax effects, at an effective tax rate of
approximately 47%, of temporary differences between the carrying amounts of
assets and liabilities for financial reporting purposes, the amounts used for
income tax purposes and the impact of available net operating loss
carryforwards.
The tax effects of significant components of the Company's deferred tax assets
consists of the following:
June 30, 2000 1999
----------------------------------------------------------
Net operating loss
carryforwards $ 12,340,000 $ 11,246,000
Deferred rent 3,000 31,000
Allowance for bad debts 854,000 399,000
Customer lists 263,000 287,000
Accrued taxes 500,000 147,000
Officers' and Directors'
Compensation 169,000 71,000
Other 5,000 8,000
----------------------------------------------------------
Total deferred tax assets 14,134,000 12,189,000
Less: Valuation allowance (14,134,000) (12,189,000)
----------------------------------------------------------
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 for the portion of
the deferred tax assets for which it is more likely than not that the benefit
will not be realized.
As of June 30, 2000, the Company has net operating loss carryforwards of
approximately $26,300,000 for tax purposes which are available to offset future
Federal taxable income, if any, and expires in various years through 2020.
There may be some limitations on the use of the net operating loss carryforwards
under Internal Revenue Code Section 382 ownership change rules.
F-20
<PAGE>
10. Supplemental Cash Flow Information:
Cash paid for interest during the years ending June 30, 2000, 1999 and 1998, was
approximately $209,000, $67,000 and $14,000, respectively. Additional
supplemental disclosures of cash flow information are as follows:
<TABLE>
<CAPTION>
Year ended June 30, 2000 1999 1998
--------------------------------------------------------------------------------------
<S> <C> <C> <C>
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
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
======================================================================================
</TABLE>
11. Unaudited Quarterly Financial Data: Quarter Ended
<TABLE>
<CAPTION>
Quarter Ended
September 30, December 31,
1999 1998 1999 1998
===========================================================
<S> <C> <C> <C> <C>
Net sales $ 2,887,504 $ 5,839,898 $ 3,331,102 $ 2,808,448
Gross profit (loss) 715,524 (193,128) 445,530 (663,106)
Net income (loss) (666,119) (2,156,110) (1,464,305) (3,137,007)
Net income (loss) per share (0.09) (0.32) (0.21) (0.46)
<CAPTION>
Quarter Ended
March 31, June 30,
2000 1999 2000 1999
===========================================================
<S> <C> <C> <C> <C>
Net sales $ 3,314,592 $ 1,443,787 $ 4,199,921 $ 302,425
Gross profit (loss) 152,215 (2,717,122) 277,104 (1,310,972)
Net income (loss) (1,359,608) (4,787,477) (1,009,494) (3,486,333)
Net income (loss) per share (0.19) (0.69) (0.15) (0.49)
</TABLE>
12. Subsequent Events:
TecNet continues to provide consulting services, financing and
telecommunications support. Subsequent to June 30, 2000, the Company borrowed an
additional $1,356,000 from TecNet pursuant to 10% demand promissory notes
bearing an annual rate of interest of ten percent. As there is no formalized
agreement between the parties, there can be no assurance that TecNet will
continue to provide such services, to finance the current operations or to
provide the Company with bundled prepaid calling cards at comparable rates in
future periods.
On September 7, 2000, the Company elected to cease its route sales department.
This measure is expected to allow the Company to concentrate its efforts on
developing brand awareness and loyalty of its prepaid products within existing
and target markets, to capitalize upon economies of scale within existing
markets and to increase overall net sales by expanding its master distribution
network.
F-21
<PAGE>
DigiTEC 2000, Inc.
and Subsidiary
Schedule II - Valuation and Qualifying Accounts
================================================================================
<TABLE>
<CAPTION>
Year ended June 30, 2000
------------------------------------------------------------------------------------------------------------
Balance at Charged to Balance at
beginning costs and Other end of
of period expenses charges Deductions(1) period
===========================================================================================================
<S> <C> <C> <C> <C> <C>
Reserves and allowances
deducted from asset
accounts:
Allowance for bad debts $ 847,000 $1,025,000 $ -- $ 54,343 $1,817,657
===========================================================================================================
Year ended June 30, 1999
------------------------------------------------------------------------------------------------------------
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
===========================================================================================================
</TABLE>
(1) Amount represents write-offs of customer accounts receivable against the
allowance for bad debt reserve account.
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 October 13, 2000.
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 October 13, 2000
------------------------ Executive Officer,
Frank C. Magliato Chairman of the
Board of Directors and
Chief Financial Officer
/s/ Diego E. Roca Senior Vice President, October 13, 2000
------------------------ Chief Accounting Officer,
Diego E. Roca Secretary and Treasurer
/s/ Francis J. Calcagno Director October 13, 2000
------------------------
Francis J. Calcagno
/s/ Lori Ann Perri Director October 13, 2000
------------------------
Lori Ann Perri
