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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB/A
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
FOR THE FISCAL YEAR ENDED MARCH 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
COMMISSION FILE NUMBER 0-8164
MSI HOLDINGS, INC.
(HEREIN REFERRED TO AS "REGISTRANT", "COMPANY", "MSHI", "WE", "US", AND "OUR")
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
UTAH 87-0280886
(STATE OF INCORPORATION OR ORGANIZATION) (IRS EMPLOYER I.D. NO.)
501 WALLER STREET AUSTIN, TEXAS 78702
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(ISSUER'S TELEPHONE NUMBER, INCLUDING AREA CODE) 512-476-6925
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 $.10
Check whether the Issuer (1) filed all reports required to be filed by section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such report(s), and (2) has been
subject to such filing requirements for the past 90 days.
(1) Yes [X] No [ ] (2) Yes [X] No [ ]
Check if disclosure of delinquent filers in response to Item 405 of Regulation
S-B is not contained in this form, and no disclosure will be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [ ]
State issuer's revenues for its most recent fiscal year: $3,550,722
State the aggregate market value of the voting stock held by non-affiliates
computed by reference to the price at which the stock was sold, or the average
bid and asked prices of such stock, as of a specified date within the past 60
days.
The Company does not have an active trading market and it is, therefore,
difficult, if not impossible, to determine the market value of the stock. Based
on the closing price for the Company's Common Stock at February 22, 2000 of
$20.25 per share, the market value of shares held by non-affiliates would be
approximately $492,475,606.
As of February 22, 2000 the Registrant had 35,995,254 shares of Common Stock
issued and outstanding.
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MSI Holdings, Inc.
Form 10-KSB
<TABLE>
<CAPTION>
Table of Contents
<S> <C>
Part I 3
Item 1. Description of Business 3
Item 2. Description of Property 18
Item 3. Legal Proceedings 18
Item 4. Submission of Matters to a Vote of Security
Holders 19
Part II. 19
Item 5. Market for the Registrant's Common Stock and
Related Stockholder Matters 19
Item 6. Management's Discussion and Analysis of
Financial Condition and Results of Operations 20
Item 7. Financial Statements 24
Item 8. Changes in and Disagreements With
Accountants on Accounting and Financial
Disclosure 24
Part III. 24
Item 9. Executive Officers and Directors 24
Item 10. Executive Compensation 27
Item 11. Security Ownership of Certain Beneficial
Owners and Management Principal Stockholders 28
Item 12. Certain Relationships and Related
Transactions 31
Item 13. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K 31
</TABLE>
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-KSB contains forward-looking statements
regarding the Company, its business, prospects and results of operations and
views with respect to future events and performance. These forward-looking
statements are subject to risks and uncertainties posed by many factors and
events that could cause the Company's actual business, prospects and results of
operations to differ materially from historical results or those that may be
anticipated by such forward-looking statements. Words used in this Report such
as "anticipate," "believe," "effect," "may," "will" and similar expressions are
intended to identify forward-looking statements but are not exclusive means of
identifying such statements. Factors that might cause such a difference include,
but are not limited to, those discussed herein as well as those discussed under
the captions "Risk Factors" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" as well as those discussed
elsewhere in the Report. Readers are cautioned not to place undue reliance on
these forward-looking statements, which speak only as of the date of this
Report. The Company undertakes no obligation to revise any forward-looking
statements in order to reflect events or circumstances that may subsequently
arise. In addition, the disclosures under the caption "Risk Factors" consist
principally of a brief discussion of risks that may affect future results and
are, in their entirety, forward-looking in nature. Readers are urged to
carefully review and consider the various disclosures made by the Company in
this Report, as well as the Company's annual, periodic and current reports filed
with the Commission, and those described from time to time in the Company's
press releases and other communications, which attempt to advise interested
parties of the risks and factors that may affect the Company's business.
OVERVIEW
Micro-Media Solutions, Inc. (MSI) is the operating subsidiary of MSI
Holdings, Inc. (MSHI). MSI was founded in 1993 in Austin, Texas to provide
computer hardware, software programming, system installation and support,
maintenance, and media duplication to customers in both the public and private
sectors. On June 23, 1997, the stockholders of MSI entered into an agreement and
plan of reorganization with Mountain States Resources Corporation (now known as
MSHI). MSHI acquired all of the issued and outstanding stock of MSI in exchange
for 9,310,000 shares of the Common Stock of MSHI.
During fiscal year 1999, MSI's revenues were derived entirely from the sale
of computer hardware, peripherals, network systems integration, service and
support. These products and services are not expected to comprise more than 20%
of revenue in fiscal year 2000. MSI previously maintained certification as a
Minority-Owned Business Enterprise (MBE) and status as a Historically
Underutilized Business (HUB)(Please refer to Our Decision Not to Seek
Re-certification for our Operating Subsidiary as a HUB). As such, MSI was
qualified by a number of city, state, and federal agencies to provide the
aforementioned services. MSI has recently shifted its business direction to
focus on opportunities in the Internet industry.
We provide high-speed Internet connectivity solutions and co-location and
web-hosting services to businesses seeking to maximize the performance of
critical Internet applications. Through our unique Direct Optical Co-location
Connection (DOCC) between our data center and the Internet backbone we provide
our customers with virtually unlimited bandwidth, up to the available capacity
of one of the largest fiber optic high-speed networks in the United States. This
capacity gives our customers the ability of "bursting" to a maximum of 10 Gbps
of bandwidth usage on demand. Our DOCC enables our customers to access the
Internet and provide Internet content without the cost, congestion and failure
rates associated with local access lines.
Several members of our executive management team were formerly employees of
GTE, which has been instrumental in the creation and continued development of
our strategic relationship with GTE. Due to the proximity of our facility to the
fiber backbone, GTE selected our facility for their Austin, Texas Internet
backbone point-of-presence (GTE POP). We subsequently expanded that relationship
to become a reseller of GTE products and services and established the first data
center to have a direct connection to a GTE Global Network Infrastructure POP.
Based on the success of this pilot project and our relationship with GTE, we are
in the process of selecting up to 15 GTE POP locations serving major
metropolitan areas for new data centers. We are currently in the process of
negotiating leases for the first three of these additional data centers. We are
also an authorized reseller of Southwestern Bell's and Covad Communications's
DSL services.
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Our strategic relationships allow us to provide a broad variety of
cost-effective product solutions, including:
o Internet Connectivity -- High-speed direct Internet connections and data
transport with a usage-based billing system where the customer only pays for
bandwidth actually consumed, rather than flat rate, fixed capacity billing
o Broadband Co-location and Web-Hosting Services -- Data center facilities for
hosting customer web sites on our servers, typically known as web-hosting,
and housing customer-owned servers, typically known as co-location services,
together with an array of managed services
o Digital Subscriber Lines (DSL) -- Capability for our customers to offer DSL
services to their end-users through agreements with Southwestern Bell and
Covad Communications
o Broadband Webcasting -- Production and webcasting services for live and
on-demand audio/video broadcasting over the Internet, and related services
o Private Label ISPs -- Internet services and connectivity branded with an
organization's logo and identity
o Private Portals -- Creation and maintenance of web sites and extranets aimed
at the transformation of existing communities of interest into on-line
virtual communities
In June 1999, we began providing Internet-related services from our data
center located in our approximately 40,000 square foot Austin, Texas facility.
Our data center was designed and built using GTE/BBN Professional Services
consultants and has been certified as meeting GTE/BBN's technology and service
quality standards for network architecture, security architecture and facilities
design. GTE/BBN is one of the originators of the ARPANET (the predecessor to the
Internet) and has built much of the United States government high-security
defense network. We provide customers with a secure, redundant environment that
includes backup HVAC, uninterruptible power supply, backup generators, 24-hour
security and 24-hour network monitoring and management.
As of September 28, 1999, we had 49 Internet solutions customers, including
ISPs, Internet-related businesses and businesses with outsourced applications.
INDUSTRY BACKGROUND
Increasing Demand for Internet Access and Internet-Related Outsourced
Services
The Internet has experienced rapid growth in the 1990's and has emerged
as a global medium for communications and commerce. Internet access and
Internet-related outsourced services have been two of the fastest growing
segments of the telecommunications services market. For example:
o International Data Corporation estimates that Internet users
worldwide will increase from approximately 142 million in 1998
to 502 million by 2003.
o Forrester Research estimates that by 2003 there will be over
26 million subscribers with broadband access to the Internet.
o International Data Corporation estimates that the revenue from
Web-hosting services in the United States was approximately
$770 million in 1998 and is expected to grow to approximately
$12 billion by 2002.
o International Data Corporation believes that the ASP market in
the United States will grow from $23.1 million in 1998 to over
$2.0 billion by 2003.
Accelerating Demand for Bandwidth
The increasing demand for bandwidth is being driven by a combination of
factors. First, the number of Internet users is growing rapidly. Second,
end-users are quickly adopting broadband access technologies that allow users to
access the Internet at speeds six to 30 times greater than 56.6 Kbs dial-up
access modems. Broadband access is driving the increasing demand for full motion
video/audio content and applications. The result is greater demand for broadband
access and related value added services
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needed to deliver multimedia content to a global marketplace. ISPs will have to
offer high-speed Internet access and content providers will need more bandwidth
in order to remain competitive. End-user adoption of recently introduced
broadband access technologies like DSL and cable modem reflects this demand.
The Need for Cost-Effective High-Speed Internet Access
End-user demand is growing for broadband Internet access. As a
consequence, ISPs are being required to offer their customers high-speed,
broadband technologies, like DSL and cable modems. ISPs must also connect their
customers to the Internet, typically by purchasing fixed bandwidth connections
through a local loop. Because the bandwidth is typically fixed, the ISP must
either purchase enough capacity to cover peak usage, which will remain mostly
unused at non-peak usage times, or fail to meet end-user requirements at peak
usage times. Both the infrastructure necessary to provide high-speed Internet
access from the ISP to its customers, and the infrastructure necessary to
maintain peak usage bandwidth from the ISP to the Internet, may be cost
prohibitive for many smaller ISPs. As an analogy, instead of the information
superhighway only needing more lanes to handle congestion, it now also needs to
have wider lanes for larger vehicles, and the ability to expand into overflow
lanes at peak travel times. In addition, many ISPs are required to connect to
the Internet over local loops where congestion and network failure account for a
large part of Internet delay. To remain competitive, smaller ISPs will need to
provide high-speed, reliable Internet access to their customers, while retaining
their branding but freed of the burden of making the capital expenditures and
using the other resources necessary to build and maintain the systems required
to provide access.
Demand for Web-Hosting and Co-Location
The Internet can provide an effective and efficient means for
businesses to increase their revenues, but the infrastructure required to use
the Internet effectively is becoming more complex and challenging to manage.
Ensuring the quality, reliability and availability of Internet operations
typically requires substantial investments in developing Internet operations and
applications and hardware expertise. However, such a significant investment can
often be an inefficient use of business resources. As a result, businesses are
seeking outsourcing arrangements that can increase performance, provide
continuous operation of their Web sites, reduce Internet operating expenses and
eliminate the need for expensive and dedicated information technology staff.
These businesses are also seeking service providers who can host their Web sites
in a secure location with a controlled environment and active around-the-clock
monitoring.
We categorize the market for outsourced Web hosting services into the
following segments:
o Co-location Hosting. Customers own their hardware, software
and network equipment, which is housed at the Web site hosting
company's facilities. The customers retain responsibility for
the installation, management, scalability and security of
their Web sites. However, co-location has been and remains an
attractive option for Web-centric companies with advanced
in-house Internet expertise that do not want the capital
expenses of maintaining a secure environment with high
bandwidth access.
o Dedicated Hosting. Customers are provided a complete Web site
hosting solution. Unlike co-location, the service provider
supplies the hardware, software, network equipment and support
necessary to run the Web site. As Web sites have become more
complex, even large and technically astute businesses have
found Internet technologies and solutions a challenge to
manage. For such companies, including many Fortune 2000
companies, dedicated Web site hosting has become a preferred
alternative.
o Shared Hosting. Customers share server hardware and bandwidth
with other customers. Shared hosting provides a price
competitive entry point for individuals and businesses
desiring a simple Web site.
o Application Hosting. Customers are provided the services of
dedicated Web site hosting along with the management of
Web-enabled business applications supporting such common
business processes as customer service, procurement, human
resource management and sales force automation. The service
provider implements and configures the business applications
to meet the specific needs of its customers. For large and
small businesses alike, application hosting offers numerous
benefits, including faster time-to-market, access to advanced
application skills and significantly lower costs of operation.
A variety of companies, such as ISPs and large systems integrators,
offer products and services that attempt to address enterprises' Internet
outsourcing needs. However, we believe the solutions offered by these companies
generally fail to address
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certain elements required to ensure that customers' mission-critical Internet
operations are reliable, scalable and responsive. ISPs have traditionally
focused on providing Internet access and many have not developed the technical
expertise and physical resources to support mission-critical Web sites. In
addition, many large systems integrators focus primarily on large enterprises
and traditional information technologies. These firms often lack the network and
Internet expertise required to provide mission-critical solutions. As a result,
we believe a significant opportunity exists for a highly-focused company to
provide a combination of complex Web site hosting, outsourced applications
management and professional consulting services that enable mid-size businesses
to implement reliable, high performance and cost effective Internet strategies.
MSI SOLUTION
We provide hosting, access and value added services, and we are
developing an ASP infrastructure platform, for companies looking to outsource
the increasingly complex infrastructure needed to utilize the Internet
effectively. We believe that we are positioned to become an industry leader in
high-bandwidth Internet infrastructure services for the next generation of
enriched content. We eliminate existing data transmission constraints by
enabling customers to connect Internet servers directly to the Internet
backbone, completely bypassing the local loop that other Web hosting and
co-location companies typically use. Since we are not constrained by local loop
connections and have access to virtually unlimited bandwidth, our customers can
deliver large amounts of high-bandwidth content as needed.
The benefits to our customers are:
o Bandwidth Burstability. Our customers can "burst" to high
levels of bandwidth usage on demand without having to add and
then remove additional local loop circuits, which typically
takes 45 to 60 days to obtain and results in significant
costs. This ability is critical for high-bandwidth
applications, such as Webcasting and full-motion audio/video.
o Response Time. Direct fiber-optic access to the Internet
backbone allows our customers to get to other Internet
providers' networks with fewer switches (hops) between
carriers and routers.
o Elimination of Local Loop. Through our unique DOCC
infrastructure, we provide all of our customers including ISPs
"one hop" connectivity to the Internet. This direct access to
a Tier-1 Internet backbone eliminates the need for data to
travel over local loops and its related cost, congestion, and
failure points.
o Usage-based Billing. Our customers are billed only for the
bandwidth actually consumed, rather than flat-rate
fixed-capacity billing.
o Scalability and Flexibility. Our services are designed to be
highly scalable and flexible in order to meet the needs of our
customers as their Internet operations expand. Our network is
designed to scale bandwidth quickly to meet our customers'
needs. We also provide flexibility for our customers by
supporting most leading Internet hardware and software systems
vendor platforms.
o Reliability. Our data center and infrastructure are certified
as meeting GTE/BBN technology and service quality standards
for network architecture, security architecture and facilities
design.
o High Performance and Enhanced Connectivity. We are able to
address the high bandwidth needs and rapid growth of our
customers' mission-critical operations by maintaining direct
peering interconnections, including peering relationships with
Tier-one network providers such as GTE. In order to provide
our customers with uncongested bandwidth during network
traffic spikes, we have access to the available capacity of
one of the largest fiber optic high-speed networks in the
United States.
o Sophisticated Network Management Services and Tools. By
leveraging the knowledge gained from supporting many
leading-edge Internet operations, we provide sophisticated
network management and monitoring services on a 24x7 basis. We
monitor all of our direct and indirect network connections for
latency and packet loss, allowing our network engineers to
reroute traffic to avoid congested points. We are able to
identify and resolve many potential problems before they
impact an Internet site's availability or performance.
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o Fault Tolerant Facilities. We have built fault tolerant
facilities designed to enable the uninterrupted operations
necessary for mission-critical Internet operations. Our
facility is equipped with an uninterruptible DC or AC power
supply and back-up generators for power redundancy,
multi-tiered fire suppression systems, seismically braced
racks, separate and redundant cooling zones and security
systems.
o Cost Effective Solution. Our customers benefit from leveraging
the significant capital, operating and labor investments that
we have made to support distributed, mission-critical Internet
operations. Most enterprises today do not have the
infrastructure that Internet operations require, including
data centers located adjacent to major Internet connection
points, 24x7 operations and specialized Internet technology
expertise. We believes that our solutions to optimize
enterprises' Internet operations are significantly more
cost-effective than most in-house solutions.
OUR STRATEGY
Our objective is to strengthen our position as a leading provider of
fast and reliable Internet infrastructure solutions targeted at bandwidth
intensive mid-market businesses seeking to maximize the performance of critical
Internet-based applications. Our strategy to achieve our objective is to:
o Invest in Infrastructure and Additional Data Centers. We
intend to continue to make significant investments to expand
and improve our infrastructure and capitalize on the trend by
corporate information technology departments to outsource
critical Internet operations. We have a strategic relationship
with GTE which allows us to select additional GTE POP sites in
which to build out data centers to provide our DOCC
infrastructure to area customers. Initially, our build out
will focus on large metropolitan areas in which GTE has an
existing POP and we have the opportunity for multi-homing
capabilities. Our next target markets are Atlanta, Dallas,
Denver, Philadelphia, Phoenix and Tampa. Through these
additional data centers, we intend to establish a national
presence to better serve our customers. In addition, we intend
to make significant additional investments in our Austin,
Texas data center, adding more server racks, infrastructure,
office and customer service areas.
o Create Multi-Homed Networks. Our connectivity strategy is
centered around redundancy, load-sharing and balance between
multiple networks. We anticipate that each DOCC data center
will be connected to two networks: the GTE GNI Internet
backbone and a second Internet provider. We intend to leverage
our relationship with GTE to take advantage of its peering
capabilities and to provide bi-directional exchange of
Tier-one traffic. The second connection will be used to route
traffic to non-Tier-one backbones that can only be accessed
through Network Access Points, Metropolitan Area Exchanges and
other public or semi-public peering points. Our goal is to
move traffic along the most efficient routes available.
o Become Outsourced Solution Provider to Other Internet Backbone
Providers. We will seek to establish relationships similar in
scope to GTE with other Internet backbone providers. These
relationships will enable us to position ourselves as the
preferred outsourced solution to these other providers to
address the needs of their mid-market customers. We believe
that there are other Internet backbone providers who would
like to offer broadband web-hosting services to the mid-market
but are not yet in the position to do so on a cost effective
basis. We believe that we can fill this demand by leveraging
our expertise in this market and provide a cost effective
outsourced solution to these other providers. o Establish
Brand Recognition. We believe that brand recognition will
continue to be important in our attracting customers. We
intend to leverage aggressively our GTE/BBN certification, our
DOCC infrastructure to the Internet backbone and our full
range of value-added solutions through an advertising campaign
using traditional media, press tours, trade shows, speaking
engagements and strategic co-marketing relationships. We
intend to focus on an "informed strategy" differentiating the
benefits and flexibility of a direct connection to the
Internet compared to the problems associated with local loop
access.
o Expand Customer Base. We intend to expand our base of
approximately 166 customers by increasing our sales and
marketing efforts. In each city where we operate a data
center, we intend to maintain a direct sales force. We will
extend frequent invitations to target customers to visit our
data centers and leverage the visual and technical impact of
our DOCC infrastructure.
o Make Strategic Alliances and Acquisitions. For many
businesses, co-location and Web-hosting are transparent parts
of packaged solutions. Companies that sell these packaged
applications benefit from a relationship with co-location
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and Web-hosting companies. We intend to form a number of
alliances to result in additional reseller or agent
relationships, including Web design firms, application
developers, Web-hosting companies, ISPs and consulting firms.
In addition, we may make strategic acquisitions of other
Internet service companies to increase our market presence,
expand our service offerings and facilities and obtain key
business relationships.
o Develop an ASP Infrastructure. We are developing an ASP
infrastructure platform to simplify and expedite the
deployment of applications over the Web. The components of
this platform include security, billing, database management
and a development environment.
o Provide Value-Added Services. In addition to establishing a
presence as a premier provider of Internet bandwidth,
co-location and Web-hosting services, we intend to
aggressively introduce and expand value-added service
offerings and build our customer support services. We have
developed various other value-added services which we believe
significantly enhances the availability and effectiveness of
our customers' Websites. Examples of some of these services
include e-commerce solutions such as security, network
management, cacheing and backup and recovery. We believe that
we can enhance our profitability and attract and retain
additional customers through these value-added service
offerings.
PRODUCTS AND SERVICES
We currently offer the following products and services:
Hosting Services
o Broadband Co-location. We offer co-location services for
customers who prefer to own and have physical access to their
servers but require the high performance, reliability and
security of our data center. Co-location customers are
typically larger enterprises employing more sophisticated
Internet hardware and software and possessing the expertise to
maintain their Web sites and related equipment. Our
co-location services include fault-tolerant physical
facilities and reliable, high-bandwidth Internet access
tailored to meet the outsourcing needs of our customers'
critical Internet operations. We support most leading Internet
hardware and software platforms. Our multi-vendor flexibility
enables us to offer our customers a broad range of technology
best suited for their needs. Customers have 24x7 physical and
remote access to the data center to administer, upgrade and
maintain their own equipment, or they may engage us to provide
systems administration and maintenance.
o Dedicated Web Server Hosting. We also offer dedicated
Web-hosting solutions for customers that require greater
server capacity than is offered by a shared Web-hosting
arrangement. Our dedicated Web-hosting solutions provide
customers with dedicated servers that we own and maintain
within our data center. This service is offered at various
price levels, depending on the required hardware and service.
o Shared Server Web-Hosting. We offer a variety of shared server
Web-hosting solutions that provide customers with servers that
we own and maintain within our data center and that are shared
with other customers. We offer shared server Web-hosting at
various price levels, depending on the customer's hardware and
service requirements.
Access
o Internet Connectivity. We offer high-speed direct Internet
connectivity and data transport and provide our customers
access to virtually unlimited bandwidth on-demand, up to the
available capacity of one of the largest fiber optic
high-speed networks in the United States. Our DOCC
infrastructure provides a direct Ethernet connection to a
Tier-1 Internet backbone through GTE's POP at speeds of 10 to
10,000 Mbps. We offer our customers a usage-based billing
system where they pay only for bandwidth actually consumed,
versus flat-rate, fixed-capacity billing. All of our Internet
access customers receive 24x7 customer and technical support.
o Digital Subscriber Lines (DSL). Through master reseller
agreements with Southwestern Bell and Covad Communications, we
offer our ISP customers the ability to offer DSL services to
their end-users at bandwidth options between 144 Kbps and 7
Mbps. DSL delivers high-speed Internet connections through
existing copper telephone lines. DSL is also more
cost-effective for many small and medium-sized businesses than
other common
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high-speed leased line services. Our DSL services have been
designed to enable our ISP customers to offer their end-users
high-speed Internet access, without the need to add additional
hardware or systems.
Value Added Services
o Broadband Webcasting. Broadband Internet access enables
end-users to receive audio and visual streams which approach
the quality of television and radio. While these end-users are
finding it easier to download these streams, content providers
are finding it more difficult to send them due to bandwidth
constraints. By providing access to large amounts of
bandwidth, we seek to become one of the leading providers of
streaming media services. Our services will be aimed at
content providers, offering completely integrated, in-house
services. These services include the three main components of
streaming media technology: production; encoding; and hosting
of live or pre-recorded media.
o Private Label ISPs. We offer Internet services and
connectivity branded with an organization's logo and identity.
Through our DiaLinx reseller agreement with GTE, we provide
customers the ability to create and deploy a private label ISP
hosted or co-located at our data center. We can provide
e-mail, Web space and news group services, user authentication
and registration, user credit card billing, Internet access
kits, including bulk CD-ROM replication, and the ability for
users to choose from over 600 nationwide local dial-in
numbers. All of these services are branded with the private
label ISP's custom "look and feel," including logos, graphics
and text. Each private label ISP end-user can be allocated one
e-mail mailbox, plus 5 MB of personal Web page storage space,
with additional mailboxes and Web space available.
o Private Portals. We create and maintain Web sites and
extranets aimed at the transformation of existing communities
of interest into on-line virtual communities. Companies or
organizations with established communities of interest use
high-speed Internet access to provide enriched content to
their customers or users. We host private portals on a fully
redundant and secure environment for transactions or other
non-public or sensitive information. We provide our private
portal customers with hosting and co-location services for
their servers, on-demand high-bandwidth Internet access, Web
site and extranet design, transaction and database
architecture and remote user dial-up accessibility. In
addition to our typical hosting and Internet access service
fees, we believe that private portals will allow us to begin
generating advertising revenue from advertisers targeting a
specific private portal community.
o Systems Monitoring. We provide all of our Web-hosting
customers with 24x7 network and systems administration,
maintenance and security monitoring. We also offer our
Web-hosting customers the ability to control and update their
sites remotely, monitor Web site performance, track the number
of site visits, review account billing information and
evaluate the overall effectiveness of their Web sites. In
addition, all host Web servers will have regular back-up
procedures to protect customer files.
o Other Value Added Solutions. We have developed various other
value-added services which we believe significantly enhances
the availability and effectiveness of our customers' Websites.
Examples of some of these services include security, network,
database and operating system management, caching and backup
and recovery. In addition, we are developing an ASP
infrastructure to simplify and expedite the deployment of ASP
applications over the Internet. These services enable our
customers the ability to focus on their core competencies
rather than their Internet infrastructure. In addition these
services enable our customers the ability to seamlessly
integrate the various components of an Internet solution.
SALES AND MARKETING
Our sales and marketing objective is to position ourselves on a
national basis as a premium provider of broadband infrastructure services. We
differentiate ourselves by offering complete infrastructure solutions. Using a
consultative approach, our sales team works with our customers to understand
their critical business issues. Our sales and marketing efforts focus on
bandwidth intensive companies, ISPs and ASPs. As of December 31, 1999, we
employed 17 people in sales and marketing.
Direct Sales Force
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We primarily market our services through a direct sales force. As of
December 31, 1999, we had a sales force of 14 persons selling into our Austin,
Texas data center. Our core sales strategy is to work with leading application
developers, network equipment providers and Web-design firms to offer complete
e-business solutions.
Our target markets include businesses with significant Internet
applications, ASPs and ISPs. We are our retail customers' solutions provider of
choice due to our ability to provide end-to-end outsourced infrastructure
services, thus allowing them to focus on their Website content. Our wholesale
customers choose us because of our ability to provide direct Tier-1 access to
the Internet using our DOCC infrastructure. By extending frequent invitations to
target customers to visit our data centers, we intend to leverage the visual and
technical impact of our DOCC infrastructure.
We intend to build our sales force aggressively in each region in which
we operate data centers. Our direct sales professionals will be supported by a
telesales group that generates leads. The telesales group will also be used to
offer basic Web-hosting solutions. As we expand our strategic partnerships and
capabilities, the sales force will be structured along financial, medical,
entertainment, education and retail markets.
Indirect Channels
We leverage the effectiveness of our retail sales force by developing
close working relationships with application developers, web design firms,
venture capital firms, the Big Five accounting firms, leading technology law
firms and hardware vendors. We intend to deploy relationship executives in each
of our markets to focus on building these partnerships. We expect that indirect
channel relationships will range from simple sales lead exchanges to full
reseller relationships. We are currently a Cisco Powered Network partner and a
Hewlett Packard Covision partner, which provide us substantial marketing
assistance.
Marketing
Our marketing program is intended to build national and local MSI brand
awareness. We intend to aggressively leverage our GTE/BBN Certification, our
DOCC infrastructure to the Internet backbone and our full range of value-added
solutions through an advertising campaign using traditional media, press tours,
trade shows, speaking engagements and strategic co-marketing relationships. Our
marketing strategy will focus on differentiating the benefits and flexibility of
a direct connection to the Internet compared to the problems associated with
local-loop access to the Internet. Through speaking engagements, networking
events, and partnerships, we intend to establish ourselves as a leader within
each community in which we operate. We also intend to establish a program to
evaluate the efficiency of our marketing efforts through sales force automation
software, telemarketing, reader responses and Web responses.
CUSTOMERS
Our customers can be classified in four categories:
o Web-centric Companies. Internet-related businesses depend on
their Web site or Internet access for a significant portion of
their revenues. We offer these businesses a GTE/BBN-certified
facility specifically designed to provide a high level of
broadband quality, reliability and access. Our web-centric
customers include iBooks.com, inc., Global Ticket Exchange,
LLC, eBlox, Inc., and SpecIT Corp.
o Non-Web-centric Companies. We provide a cost effective and
efficient Internet infrastructure outsourced solution. Our
customers benefit from leveraging off of the significant
capital, operating and labor investments that we have made to
support distributed, mission-critical Internet operations. Our
non-Web-centric customers include Catapult, Teledynamics, Aim
Technologies and Esoterix.
o Internet Service Providers. ISPs provide end-users with access
to the Internet. We provide ISPs virtually unlimited Internet
bandwidth and bill only for the bandwidth actually consumed.
Our ISP customers include Outernet Connection Strategies,
Inc., Real Time Communications, Inc., Database City,
SVIWeb.com and Business Network Services, Inc.
o Application Service Providers. ASPs deploy applications over
the Internet and typically use a subscription or timeshare
billing model. ASPs typically struggle with infrastructure
issues such as billing, security, database management, latency
and application communication issues. We combine our hosting
infrastructure with value-
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added tools to help ASPs solve these business issues. Our ASP
customers include Ventix, Core Metrics and iAutoparts.com.
STRATEGIC RELATIONSHIPS
We plan to take advantage of the following strategic relationships:
o GTE GNI (Global Network Infrastructure). In Austin, GTE has
placed its OC-192 POP in our building. By locating its POP
within our facility, GTE provides us a direct connection to a
Tier-1 Internet backbone.
o GTECC (GTE Communications Corp.). GTECC is the subsidiary of
GTE that sells bundled services to the general public. These
services include premise equipment (PBX), long distance,
wireless, help desk, and dedicated access to the Internet but
do not include co-location. Our services are complementary to
GTECC's services and, therefore, GTECC and we maintain a
customer lead exchange program.
o GTE/BBN Technologies. GTE/BBN Technologies has over 30 years
of experience at building reliable, fault-tolerant data
centers. We use GTE/BBN Technologies to provide consulting and
design services in the construction and operation of our
facilities. GTE/BBN is one of the originators of the ARPANET
(the predecessor to the Internet) and has built much of the
United States government's high security defense network.
Utilizing the GTE/BBN design, our Austin, Texas data center
has been operational without any outages of more than two
minutes.
o Covad Communications and Southwestern Bell. Through Covad
Communication's and Southwestern Bell's DSL service, we are
able to provide customers with end-to-end connectivity. Covad
Communications has agreements with local exchange carriers
across the United States which enables it to provide DSL
circuits to homes and businesses. Our agreements with Covad
Communications and Southwestern Bell allow us to provide
access to the Internet through these circuits. The agreements
designate us as a master reseller under which we sell the
service through local Internet service providers.
o Cisco and Hewlett Packard. We are a Cisco Powered Network and
a HP Covision partner. These strategic partner designations
provide us with significant technical and marketing
assistance, preferred pricing, vendor financing and access to
potential customers.
DATA CENTER INFRASTRUCTURE
We operate a highly secure, fault-tolerant data center, and are
developing additional data centers, designed for the 24x7 hosting of Web sites
and Web-based applications. We anticipate that each of our data centers will
have a targeted minimum of 10,000 square feet. Our data centers will combine the
predictability and control of traditional mainframe-based data centers with the
network access and capacity required for today's bandwidth intensive
Internet-based computing. Our data centers will be designed to allow customers
to deploy new and strategic applications rapidly without substantially
increasing cost or incurring risk of service failure.
The physical infrastructure and security controls of our data centers
have been designed to satisfy rigorous requirements for secure data storage and
processing. Specifically, our data center offers the following major benefits to
our customers:
o Direct access to a high-performance POP. Our DOCC
infrastructure provides a direct Ethernet connection to a
Tier-1 Internet backbone through GTE's POP at speeds of 10 to
10,000 Mbps. Our DOCC infrastructure connects our customers
directly to the OC-192 (10Gbps) backbone. By having our
facilities located next to a GTE POP, our clients bypass the
local loop infrastructure, increasing efficiency, reducing
cost and failure rates.
o State-of-the-art physical security. We have implemented state
of the art physical security through tightly controlled
security zones requiring card key entry. Surveillance cameras
record movement through the data centers and security guards
provide real-time visibility. Access to our data centers is
further restricted to our employees and customer-authorized
personnel.
o Redundant networking equipment, utilities and environmental
control. Our network has been designed to provide redundancy,
security, reliability and disaster recovery. Our Austin data
center has been GTE/BBN certified for technology and service
quality standards, including network architecture, security
architecture and facilities design.
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In addition, the network has been certified by Cisco as a
Cisco-Powered Network, which gives us quick access to the
latest Cisco hardware and technical resources. We use computer
controlled environmental systems to maximize cooling, humidity
control and energy efficiency. We use an INERGEN Clean Agent
Fire Extinguishing System. We use redundant uninterruptible
power supply systems and redundant generators, to ensure the
power system is capable of maintaining power to the data
center in the event of component failure.
o Multi-home Network. Through our relationship with GTEI and our
unique DOCC infrastructure, we can leverage private network
peering points without having to build a costly network. Our
strategy of dividing traffic between GTE and a second Internet
provider in each market is designed to give us a highly
reliable solution. We expect to be able to access private
network peering points without relying on local telephone
loops and while maintaining a second access point for
redundancy and reliability.
NETWORK OPERATIONS CONTROL CENTER
Our Network Operations Control Center ("NOCC") performs operations
support for our network and infrastructure components on a 24x7 basis. The NOCC
is equipped with sophisticated Internet traffic management and reporting systems
that provide diagnostic tools allowing for the optimum bi-directional delivery
of data. Each client network device is monitored using the latest, most
sophisticated technologies. The NOCC serves three primary functions:
o Monitoring and routing MSI's traffic to and from the Internet.
Our NOCC continuously monitors and manages our DOCC
infrastructure. Most importantly, the NOCC takes advantage of
our fast and efficient routing platform which places traffic
on either GTE's OC-192 fiber Tier-one network or onto a second
Internet provider. From our Austin, Texas NOCC or other NOCCs,
we will monitor our DOCC infrastructures throughout the United
States. The monitoring is accomplished utilizing proven
methodologies and systems that ensure our customers' content
is being routed and delivered over the Internet from source to
destination in the fastest, most efficient path possible.
o Monitoring client equipment and Web sites. Our 24x7 monitoring
of customer Web sites allows our engineering staff to take
immediate action to isolate malfunctions in our customer's
equipment and provide swift problem resolution. Issues are
typically identified and resolved prior to content delivery
being impacted or the customer noticing the problem. We
provide our clients with 24 hour access to their systems data
via a Web-access interface. In addition, we provide our
customers with a single point of contact for support-related
issues and complete 24 hour access to engineering assistance.
We believe that our Internet-related skill set combined with
our approach to providing superior customer service in a
timely and methodical manner creates a significant advantage
over our competitors.
o Value-Added Monitoring. On a custom basis, we monitor Web site
thresholds and other processes. For example, a customer doing
a Webcast of a live event may want to monitor sound quality
and streaming video delivery. Some customers may ask us to
monitor thresholds of how many users are accessing their Web
site or how many transactions are occurring. In this manner,
the NOCC acts a revenue center while helping customers
outsource what would normally be internal monitoring.
COMPETITION
We are not aware of any company that currently duplicates our business
model in full. While many companies will provide strong competition in any one
component of our spectrum of offerings, few companies offer our solutions. Our
individual product offerings face competition from a variety of organizations:
o Broadband Co-location and Web-hosting. Our unmanaged
co-location and advanced managed Web-hosting services compete
with companies such as Metromedia Fiber/AboveNet
Communications, Inc. and Exodus Communications, Inc., as well
as internal information services departments. Unlike us, their
connectivity and bandwidth capabilities are limited by a
reliance on either local loop or SONET ring connections to the
Internet.
o Broadband Webcasting. Our broadband Webcasting service
competes with organizations like Broadcast.com. Unlike us,
they do not have a direct Tier-one connection to the Internet,
which constrains their bandwidth. In addition, their Web site
formats act as an aggregation point, meaning all content is
accessed from the same site, which limits the content
providers from branding an individual Web site.
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o Internet connectivity. Our connectivity services face
competition primarily from ISPs. We intend to license ISPs to
resell broadband access via DSL based on strategic alliances
with Southwestern Bell, Covad Communications and other
providers. We believe we can provide a competitive advantage
in speed, bandwidth, credibility and reliability.
RISK FACTORS
In addition to the other information in this report, you should
carefully consider the following factors in evaluating us and our business. The
discussions in this report and in our reports filed with the SEC contain
forward-looking statements that involve risks and uncertainties. Our actual
results may differ significantly from the results discussed in the
forward-looking statements. Factors that could cause or contribute to a
difference in our actual results are discussed below. Additionally, further
discussion of these risk factors and other risks may be found in the
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business" sections of this report.
RISKS RELATED TO OUR BUSINESS
WE ARE OPERATING UNDER AN UNPROVEN BUSINESS MODEL. DEMAND FOR OUR
PRODUCTS MAY FAIL TO MATERIALIZE AT THE ANTICIPATED LEVELS, ADVERSELY
AFFECTING OUR PERFORMANCE.
Our business model generates revenues by providing customers with
bandwidth and related services, which are relatively new products to the
marketplace. Our success depends on our products achieving wide acceptance in
the market at competitive prices. Our forecasts for future demand and operations
are based on the successful development of a market for our products and
services. Given the relative novelty of our products and services, there is
limited data available on which to base a reliable forecast. There is no
assurance that we will be successful in developing the market for our products
and services. We deliver our products and services through:
o Internet connectivity - High speed direct Internet connections
and data transport with a usage-based billing system;
o Broadband co-location and web-hosting - data center facilities
for hosting customer web sites on our servers and housing
customer owned servers;
o Broadband webcasting - production and webcasting services for
audio-video broadcasting over the Internet;
o Private label Internet service providers - Internet services
and connectivity branded with an organization's logo;
o Digital subscriber lines - Digital subscriber lines services
for our Internet service provider customers to offer their
end-users; and
o Private portals - Web sites and extranets for online virtual
communities.
THERE IS LIMITED INFORMATION ON WHICH TO EVALUATE OUR OPERATIONS WHICH
WILL NECESSARILY AFFECT YOUR ABILITY TO ACCURATELY APPRAISE OUR
PERFORMANCE.
Since March 1999, we have changed the focus of our business from
providing hardware and systems integration services to providing a suite of
high-speed Internet access, data transport and networking services, co-location
services and web site hosting services. Because of our limited operating history
in providing our current product mix, there is limited operating and financial
data about our business for you to use in evaluating us or our performance.
WE HAVE INCURRED NET LOSSES SINCE OUR INCEPTION AND ANTICIPATE
CONTINUING LOSSES.
To date, we have had limited revenues and have not shown a profit in
our operations. As of December 31, 1999, our accumulated deficit was
approximately $32.2 million. Approximately $19.8 million of the deficit relates
to losses from operations, while the remaining $12.4 million relates to losses
incurred due to discounts recorded on issuances and conversions of common and
preferred stock. We cannot predict when, or if, profitability might be achieved
or if we will be able to sustain it. If we are unable to obtain profitability or
sustain it, we may have to discontinue operations.
IF WE ARE UNABLE TO MANAGE COMPLICATIONS THAT ARISE DURING THE BUILD
OUT OF ADDITIONAL DATA CENTERS, WE MAY NOT SUCCEED IN OUR EXPANSION
PLANS.
We are planning to build out up to 15 new data centers across a wide
range of geographic regions. The build out of data centers, each of which takes
approximately 30 to 90 days to complete, is a key element of our business
strategy. Any delay in the
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build out of new data centers would significantly harm our plans to expand our
business. Many of the risks associated with significant expansion projects are
beyond our control and any of which could delay the build out of additional data
centers. These risks include:
o obtaining sites;
o cost estimation errors or overruns;
o equipment and material delays or shortages; and
o the inability to obtain necessary permits on a timely basis,
if at all.
WE MAY BE UNABLE TO EFFECTIVELY INTEGRATE ADDITIONAL DATA CENTERS INTO
OUR EXISTING NETWORK, WHICH COULD DISRUPT OUR SERVICE.
New data centers, if completed, will result in substantial new
operating expenses. Moreover, our operations will be significantly harmed if we
do not institute adequate financial and managerial controls, reporting systems
and procedures with which to operate multiple facilities in geographically
dispersed locations. The following expenses are representative of the new
operating expenses we anticipate incurring in connection with developing new
data centers:
o hiring, training, retaining and managing new employees;
o purchasing new equipment and implementing new systems; and
o leasing additional real estate.
WE HAVE HAD RECENT CHANGES IN MANAGEMENT AND CAN NOT ACCURATELY PREDICT
CURRENT MANAGEMENT'S EFFECTIVENESS.
Several member of our calendar year 1999 management team are no longer
with us. We have a new management team that has not had the opportunity to work
together in the past. There is no assurance the new management team will be able
to successfully lead us into profitability. The following table identifies the
new members of our management team and those who are no longer with us.
ARRIVALS
<TABLE>
<CAPTION>
NAME POSITION
- ---- --------
<S> <C>
Robert Gibbs president and chief executive officer
Robert Frank executive vice president
Patricia Hrabina vice president of human resources
Douglas W. Banister chief financial officer and vice president
of finance
Robert Hersch vice president of corporate finance
Cliff Luckey chief technology officer and vice president
of technology & solutions
</TABLE>
DEPARTURES
<TABLE>
<CAPTION>
NAME FORMER POSITION
- ---- ---------------
<S> <C>
Jose Chavez president and chief executive officer
Mitchell Kettrick vice president - technology and secretary
Jaime Munoz vice president of operations
Roger M. Lane chief operating officer
David Hill chief financial officer
</TABLE>
WE WILL BE UNABLE TO EFFECTIVELY COMPETE IF WE ARE UNABLE TO ATTRACT
AND RETAIN KEY PERSONNEL.
Our future success depends on our continuing ability to identify, hire,
train and retain highly qualified technical, sales, marketing and customer
service personnel. The industry in which we compete has a high level of employee
mobility and aggressive recruiting of skilled personnel. In particular, we face
intense competition for qualified personnel, particularly in software
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development, network engineering and product management. If we are unable to
attract and retain qualified personnel our ability to compete will be
compromised. There can be no assurances that we will be successful in our
recruiting or retention efforts.
WE MAY BE SUBJECT TO INFRINGEMENT CLAIMS THAT COULD MATERIALLY
ADVERSELY AFFECT US.
Our management personnel were previously employees of and may have had
contracts with other telecommunications companies. In many cases, these
individuals are conducting activities for us in areas similar to those in which
they were involved before joining us. As a result, we or our employees could be
subject to allegations of violation of trade secrets, breach of contract or
unfair competition. If such claims materialize, they may distract our management
and employees from their duties and requires reallocation of our resources.
Moreover, an unfavorable ruling may hinder our ability to obtain a license or
similar agreement to use technology we need to conduct our business. Defending
against and the exposure to liability under these claims could reduce revenues,
increase expenses and adversely affect our ability to compete.
OUR OPERATIONS DEPEND ON OUR ABILITY TO MAINTAIN FAVORABLE
RELATIONSHIPS WITH THIRD PARTY SUPPLIERS. WE CAN NOT ASSURE THE
CONTINUITY OF THOSE RELATIONSHIPS.
We have entered into several alliance and contractual agreements with
certain third parties to utilize their infrastructures and networks to deliver
our products and services to our customers. Moreover, we are dependent on the
continued availability of these infrastructures and networks for our growth and
development. If we are unable to maintain or replace the relationships with
these third parties, we will be unable to provide the current level of services
to our customers. Our failure to consistently provide current levels of service
could result in a reduction of our client base and sales volume.
SYSTEM FAILURES COULD DISRUPT OUR SERVICES AND CAUSE US TO LOSE
CUSTOMERS.
Our target market is particularly sensitive to service failures. If
service failures occur, they could result in reductions in, or terminations of,
services supplied to our customers, which could have a material adverse effect
on our operations and financial results. Our system is vulnerable to damage from
human error, power loss, facility failures, fire, earthquake, floods,
telecommunications failure, break-ins, sabotage, and vandalism. Moreover, we do
not presently have a disaster recovery plan, carry any business interruption
insurance or have any secondary off-site systems. Although we have not
previously experience any system failures, we have implemented security measures
that meet the standards adopted by BBN, the GTE division credited with
pioneering the Internet. However, our network and computer systems could still
be vulnerable to computer viruses, intrusions, or breaches of security that
might result in service interruptions. These risks are aggravated by the fact
that substantially all of our communications and computer hardware is located
within a single facility in Austin, Texas.
RISKS RELATED TO OUR INDUSTRY
OUR BUSINESS IS DEPENDENT ON THE CONTINUED GROWTH OF THE INTERNET,
WHICH MAY FACE RESISTANCE FROM THE MARKETPLACE.
Demand for our services could be reduced if the market for
business-related Internet solutions fails to further develop. Critical issues
concerning the commercial use of the Internet remain unresolved and may hinder
the growth of Internet use, especially in the business sector -- our target
market. If demand for our services fails to materialize at the anticipated
levels, our revenues will also fail to reach expectations.
Despite growing interest in the varied commercial uses of the Internet,
many businesses have been deterred from purchasing Internet connectivity
services for a number of reasons, including:
o inconsistent or unreliable quality of service;
o lack of availability of cost-effective, high-speed options;
o inability to integrate business applications on the Internet;
and
o the need to deal with multiple and frequently incompatible
vendors.
THE MARKET FOR OUR PRODUCTS AND SERVICES IS HIGHLY COMPETITIVE, AND WE
MAY NOT BE ABLE TO COMPETE EFFECTIVELY.
The market for Internet access, data transport, networking services,
web-hosting and related services is rapidly evolving, intensely competitive and
has relatively low barriers to entry. Many of our competitors and potential
competitors have longer operating histories, greater name recognition and
substantially greater financial, technical and marketing resources. Moreover,
our
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competitors may be able to negotiate contracts with suppliers on more favorable
terms than we can. Some of these competitors may also provide products with some
performance advantages over our products. Given the fierce competition which we
operate and our comparatively limited resources, we may not be able to compete
effectively.
OUR SERVICES ARE SUBJECT TO UNCERTAIN GOVERNMENT REGULATION. CHANGES IN
LAWS OR REGULATIONS COULD RESTRICT THE WAY WE OPERATE OUR BUSINESS.
We operate in an environment of unstable and evolving regulations. Our
services are not currently directly regulated by any federal or state agency.
However, many of the facilities and services we need to provide Internet
connectivity are subject to regulation at the federal, state and local levels.
Changes in applicable laws or regulations could impact our operations, and
impact our costs, service requirements and the scope of competition. Incumbent
local carriers, like Bell Atlantic and Southwestern Bell, are likely to pursue
litigation in courts, institute administrative proceedings with the FCC and
state telecommunications regulators and lobby the U.S. Congress in an effort to
affect the applicable laws and regulations in a manner that would be more
favorable to them and that may be against our interests. Additionally, we may
choose to expend significant resources to participate in regulatory proceedings
at the federal or state level without achieving favorable results. The expenses
associated with participating in and complying with an evolving regulatory
framework may increase our operating expenses beyond expectations.
DIGITAL SUBSCRIBER LINE SERVICES ARE NEW AND EVOLVING AND WE CANNOT
PREDICT WHETHER THEY WILL BE ACCEPTED BY BUSINESSES AT PROFITABLE
PRICES.
The market for high-speed Internet access, data transport and
networking services using copper telephone lines is in the early stages of
development. If the market for our digital subscriber line services fails to
develop, grows more slowly than anticipated or becomes saturated with
competitors, our operations and future revenue stream could be materially
adversely affected. We cannot accurately predict the rate at which this market
will grow, if at all, or whether new or increased competition will result in
market saturation. Any of these factors could result in a reduction of demand
for our products and a corresponding reduction in anticipated revenues.
INTERNET SECURITY CONCERNS COULD HINDER THE DEVELOPMENT ELECTRONIC
COMMERCE AND THE DEMAND FOR OUR PRODUCTS AND SERVICES.
A significant barrier to commerce and communications over the Internet
has been the need for the secure transmission of confidential information.
Security breaches or the inadvertent transmission of computer viruses could
expose us to a risk of loss or litigation and possible liability. We may incur
significant costs to protect against the threat of security breaches or to
alleviate problems caused by breaches. A party who is able to penetrate our
network security could misuse our users' personal information and our users
might sue us or bring claims against us. We strive to protect ourselves and our
customers from such intrusions and from exposure to liability from a security
breach. However, these actions could occur in the future. To date we have not
experienced any security breaches nor are we aware of any attempts to penetrate
our network security. If any well-publicized compromise of security occurs,
Internet usage and the demand for our services could decline.
RISK FACTORS RELATING TO OUR STOCK
SOME SHAREHOLDERS HAVE SUBSTANTIAL CONTROL OVER US.
As of January 31, 2000, our current directors and executive officers
owned approximately 2.4% of the outstanding shares of our common stock. Also as
of January 31, 2000, Entrepreneurial Investors, Ltd. owned approximately 19.8%
of the outstanding shares of our common stock.
These persons and entities may continue to exert significant influence
over our business and affairs. Accordingly, these shareholders will possess
substantial control over our operations. This control may allow them to amend
corporate filings, elect all of our board of directors, other than the director
to be designated by some of our preferred shareholders, and substantially
control all matters requiring approval by our shareholders, including approval
of significant corporate transactions. Such shareholders will also have the
ability to delay or prevent a change in our control and to discourage a
potential acquirer for us or our securities.
Additionally, Messrs. Chavez, Kettrick and Munoz, who were terminated
by us on April 20, 1999, hold an aggregate of 4,057,750 shares or 15.2% of the
outstanding shares of our common stock as of January 31, 2000. These persons
have recently settled litigation with us and may oppose management.
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OUR ARTICLES OF INCORPORATION AND BYLAWS CONTAIN PROVISIONS THAT COULD
DELAY OR PREVENT A CHANGE IN CONTROL AND THEREFORE COULD HURT OUR
SHAREHOLDERS.
Provisions of our articles of incorporation and bylaws could make it
more difficult for a third party to acquire control of MSI Holdings, Inc., even
if a change in control would be beneficial to shareholders. Our articles of
incorporation allow our board of directors to issue, without shareholder
approval, preferred stock with terms set by the board of directors. The
preferred stock could be issued quickly with terms that delay or prevent the
change in control of MSI Holdings, Inc. or make removal of management more
difficult. Also, the issuance of preferred stock may cause the market price of
our common stock to decrease.
STOCKHOLDERS HAVE LIMITED LIQUIDITY IN OUR STOCK BECAUSE WE HAVE A
LIMITED MARKET FOR OUR COMMON STOCK AND OUR STOCK PRICE IS VOLATILE.
Trading on the Over-The-Counter Bulletin is sporadic and highly
volatile. The market prices of Internet-related stocks, such as ourselves, tend
to be more volatile than the market as a whole. The market price of our common
stock has fluctuated in the past and may continue to be volatile in the future.
There can be no assurance that an active trading market will develop or be
maintained. Failure to develop or maintain an active trading market could
negatively affect the price of our securities, as well as affect our
stockholders' ability to sell their shares.
THE SHARES ELIGIBLE FOR PUBLIC SALE AFTER THIS OFFERING COULD ADVERSELY
AFFECT OUR STOCK PRICE.
Sales in the public market of substantial amounts of common stock or
the perception that such sales may occur could materially and adversely affect
the market price of our common stock or our ability to raise capital through an
offering of equity securities. As an increasing number of shares become eligible
for sale, the related transactions may place downward sell pressures on our
market price. The adverse affect on the market price of our common stock may
occur even if the results of our operations are positive. As of January 31,
2000, we had 26,628,587 shares of common stock outstanding. The following table
illustrates the shares of common stock eligible for future sale if all
outstanding warrants and options were exercised.
<TABLE>
<CAPTION>
Fully Diluted %
------------- -----
<S> <C> <C>
Total Shares 32,154,016 100.0
Eligible for Future Sale 17,557,095 54.6
Subject to Rule 144 Restrictions 14,596,921 45.4
</TABLE>
PRINCIPAL SUPPLIERS
The Company purchases its products for resale and use in its service
products from a select group of suppliers. While we rely on relatively few
suppliers, the products are available from numerous sources throughout the
country.
GOVERNMENT REGULATIONS
We provide Internet services, in part, through transmissions over public
telephone lines. These transmissions are governed by regulatory policies
establishing charges and terms for communications. As an ISP, we are not subject
to direct regulation by the FCC or any other agency, other than regulations
applicable to business generally.
The FCC recently reaffirmed that ISPs should be classified as
unregulated "information service providers" rather than regulated
"telecommunications providers" under the terms of the 1996 Telecommunications
Act. Thus, we are not subject to regulations applicable to telephone companies
and similar carriers merely because, to some extent, we provide our serves via
telecommunications networks. We also are not required to contribute to the
universal service fund, which subsidizes phone service for rural and low income
consumers and supports Internet access among schools and libraries. This FCC
action also may discourage states from regulating ISPs as telecommunications
carriers or imposing similar subsidy obligations.
Nevertheless, Internet-related regulatory policies are continuing to
develop. It is possible that we could be exposed to regulation in the future.
For example, the FCC has stated its intention to consider whether to regulate
voice and fax telephony services provided over the Internet as
"telecommunications" even though Internet service itself would not be regulated.
The FCC is also
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considering whether such Internet-based telephone services should be subject to
the universal service support obligations discussed above or should pay carrier
access charges on the same basis as traditional telecommunications companies.
Access charges are assessed by local telephone companies to long distance
companies for the use of the local telephone network to originate and terminate
long distance calls, generally on a per-minute basis. We currently do not offer
telephony and so are not directly affected by these developments. However,
should we offer telephony in the future, we may be affected by these issues.
Additionally, we cannot predict whether consideration of these issues will cause
the FCC to reconsider its current policy of not regulating ISPs.
The FCC also proposed rules that could make it more difficult for ISPs
to access DSL and other high-speed data technology services provided by local
telephone carriers. If the FCC ultimately adopted this proposal or similar
proposals, our access to DSL and other high-speed data technology could be
curtailed. Such curtailment could have a material adverse effect on us.
Due to the increasing popularity and use of the Internet, it is
possible that additional laws and regulations may be adopted with respect to the
Internet, covering issues such as content, privacy, pricing, encryption
standards, consumer protection, e-commerce, taxation, copyright infringement and
other intellectual property issues. We cannot predict the impact, if any, that
any future regulatory changes or development may have on us. Changes in the
regulatory environment relating to the Internet industry, including regulatory
changes that directly or indirectly affect telecommunication costs or increase
the likelihood or scope of competition from regional telephone companies or
others, could have a material adverse affect on us.
EMPLOYEES
At September 28, 1999, MSI had a total of 60 employees, of which 59 were
full-time employees. None of MSI's employees are subject to a collective
bargaining agreement, and the Company believes its relations with its employees
are good.
ITEM 2. DESCRIPTION OF PROPERTY
Our three facilities in Austin, Texas consist of approximately 40,000 square
feet, 20,000 square feet and 12,000 square feet, respectively, of leased office
and warehouse space with the leases expiring on July 31, 2008, August 31, 2005,
and October 31, 2004, respectively. The first two leases contain an option for
renewal for an additional ten years, while the last lease contains an option for
renewal for an additional five years. The largest of the facilities is designed
for co-location, production, system integration services and depot repair. The
20,000 square foot facility is currently a warehouse which we are trying to
sublease. The 12,000 square foot facility is being designed for new corporate
offices.
The Company has executed five additional leases to construct new data
centers in Atlanta, Dallas, Denver, Phoenix, and Tampa. Phase I of the data
center construction in Dallas and Tampa is scheduled for completion by March 31,
2000. Additional phases will be completed in Dallas and Tampa as needed. Phase I
construction of data centers in Atlanta, Denver, and Phoenix is being scheduled
at this time. The Phase II expansion of the Austin data center is also scheduled
for completion by March 31, 2000.
MSI has obtained a trademark of the Direct Optical Co-location Connection.
This mark is used to describe the advantage that MSI is able to provide to its
customers through the GTE POP.
ITEM 3. LEGAL PROCEEDINGS
We have settled lawsuits related to our relationship with a former
consultant, Kenneth O'Neal (O'Neal) and a firm which he controls, Argus
Management, Inc. (Argus). On December 18, 1997 Argus filed a lawsuit in Kerr
County, Texas, 216th Judicial District, to collect on two promissory notes in
the aggregate principal amount of $200,000. We vigorously defended this lawsuit
and filed a related suit against O'Neal and Argus in Travis County, Texas on
February 6, 1998, alleging fraud, usury in connection with the promissory notes,
and seeking an order from the Court demanding that Argus transfer 293,185 shares
of our common stock, held by Argus, to various stockholders who have previously
purchased such shares (the Argus Related Shares). The agreed upon settlement
provides that Argus return 200,250 shares of our common stock to us, that we
tender $250,000 to Argus and that we issue the balance of 92,935 shares of
common stock as restricted shares. The parties have agreed to cancel the two
promissory notes from us to Argus and release all other claims among the
parties.
On July 28, 1999, the Company was sued by its former President and its
former Chief Technology Officer seeking more than $50,000, excluding cost and
attorneys' fees. A settlement has been reached during mediation on September 20,
1999. Formal settlement documents have been executed by the parties in the
lawsuit. The terms of the settlement are confidential, but were not material.
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<PAGE> 19
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders of MSHI during the
quarter ended March 31, 1999.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
The Company's Common Stock is traded on the NASD OTC Bulletin Board under
the symbol "MSIA." The table below shows the high and low bid prices of the
Common Stock for the periods indicated.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED MARCH 31, 1998 HIGH LOW
-------------------------------- -------- -------
<S> <C> <C>
First Quarter $ 2.00 $ 1.00
Second Quarter 2.25 0.50
Third Quarter 3.50 0.50
Fourth Quarter 2.63 0.75
FISCAL YEAR ENDED MARCH 31, 1999
-------------------------------- -------- -------
<S> <C> <C>
First Quarter 9.03 2.38
Second Quarter 12.88 4.06
Third Quarter 7.75 6.06
Fourth Quarter 10.50 3.25
</TABLE>
HOLDERS
As of December 31, 1999 there were approximately 5,358 stockholders of record of
the Common Stock.
DIVIDEND POLICY
The Company has never declared or paid any cash dividends on its Common
Stock, and the Company currently intends to retain any future earnings to fund
the development of its business and therefore does not anticipate paying any
cash dividends on its Common Stock in the foreseeable future. Future declaration
and payment of dividends on its Common Stock, if any, will be determined in
light of the then-current conditions, including the Company's earnings,
operations, capital requirements, financial conditions, restrictions in
financing agreements, and other factors deemed relevant by the Board of
Directors. However, the Company is obligated to pay cumulative dividends on a
quarterly basis with respect to all Series B, C, D and E Preferred shares
outstanding.
Preferred Stock dividends were paid with the issuance of Common Stock,
valued at the previous thirty day average closing bid price per share of Common
Stock as follows:
<TABLE>
<CAPTION>
SHARES AMOUNT
-------- --------
<S> <C> <C>
Year ended March 31, 1999 72,016 $ 363,904
Year ended March 31, 1998 23,742 58,668
</TABLE>
RECENT SALES OF UNREGISTERED SECURITIES
Presented below is certain information concerning all sales of securities by
the Company that were not registered under the Securities Act of 1933, as
amended (the "Securities Act") and that have not been previously reported in our
Annual Reports on Form 10-KSB and 10KSB/A and our Quarterly Reports on Form
10-QSB and 10-QSB/A.
During the quarter ended March 31, 1999, the Company received gross proceeds
of $2,105,040 for 70,168 additional shares of Series E Preferred Stock at a
purchase price of $30.00 per share. The Company paid cash of $220,995 and issued
4,190 shares of Series E Preferred Stock as payment of commission fees of the
private placement. Also, options to purchase 36,084 shares of Common Stock at
$4.50 per share were issued as part of the agreement. The stock options have a
fair market value of $136,784. At March 31, 1999, an additional $600,000 of
gross proceeds (representing 20,000shares of Series E Preferred) was subscribed
from stockholders and was recorded as Preferred Stock Subscribed in the
financial statements. Expenses for placement agent fees of $73,200 had not been
paid as of March 31, 1999.
19
<PAGE> 20
During the quarter ended March 31, 1999, 94,340 and 65,000 shares of Series
C Preferred and Series D Preferred, respectively, were converted for an
aggregate of 1,593,400 shares of the Company's Common Stock.
During the quarter ended March 31, 1999, 32,242 shares of common stock were
issued as preferred stock dividends and were recorded as a reduction of retained
earnings in the amount of $100,342.
During the quarter ended March 31, 1999, 15,000 shares of common stock
valued at $69,000 were issued as compensation in connection with a consulting
agreement.
During the quarter ended March 31, 1999, 200,250 shares of common stock were
re-purchased by the Company in connection with the settlement of a lawsuit as
discussed in Part 1, Item 3 of this 10-KSB/A.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis of our financial condition and results
of operations should be read in conjunction with our financial statements, the
notes to our financial statements and the other financial information contained
elsewhere in this document. In addition to the historical information, this
Management Discussion and Analysis of Financial Condition and Results of
Operations and other parts of this document contain forward-looking information
that involve risks and uncertainties. Our actual results could differ materially
from those anticipated by the forward-looking information as a result of certain
factors, including those set forth under "Risk Factors" and elsewhere in this
document.
OVERVIEW
We provide high-speed Internet connectivity solutions - direct access to the
Internet backbone and virtually unlimited bandwidth on demand with pricing based
on usage - and co-location/web-hosting services to businesses with critical
Internet applications and Internet service providers (ISPs). We currently
deliver our services from our Austin, Texas data center that is directly
connected to the Internet backbone. We intend to expand our operations to
multiple data centers. We have been providing these services since June 1999.
MSI was formed in 1969 as Mountain States Resources Corporation, a Utah
corporation that engaged in the exploration and production of mineral resources.
However, in 1993, MSI ceased operations and became a development stage company.
In June 1997, MSI acquired all of the outstanding securities of Micro-Media
Solutions, Inc., a Texas corporation formed in 1993, in exchange for 9,310,000
shares of MSI's common stock. Micro-Media Solutions was founded to provide
computer hardware, software programming, system installation and support,
maintenance and media duplication to the public and private sectors. Since the
acquisition of Micro-Media Solutions, MSI's revenue has been derived from the
sale of hardware and software and the performance of technical services,
including the installation and maintenance of computer networks.
We made our decision to change our business focus to capitalize on the
opportunities existing in the Internet access market. In July 1998, we entered
into a renewable ten year sublease with GTE under which we agreed to lease a
portion of our Austin, Texas facilities to GTE for installation of GTE's POP
equipment. On May 29, 1998, we entered into a three year subscription to GTE's
Internet Advantage version 5.1 Connection Service (upgraded to GTE's Internet
Advantage version 6.0 on September 29, 1998) granting us access to GTE's POP. We
have also subscribed to GTE's DiaLinx Services, allowing for the resale of
Internet access by us to end-users.
To capitalize on the opportunities existing in the Internet access market
and our physical proximity to the GTE point-of-presence (GTE POP), we have
focused our resources on providing bandwidth and Internet-related services.
Additionally, since March 1999, we have changed our management team and board of
directors to include individuals with Internet services expertise. During the
fiscal year ended March 31, 1999, our revenues were derived entirely from the
sale of computer hardware and peripherals, and network system integration,
service and support. These products and services are not expected to constitute
more than 20% of our revenues for the fiscal year ending March 31, 2000.
Throughout the last half of fiscal year 1999, in conjunction with GTE/BBN
Professional Services consultants, we designed and implemented our Direct
Optical Co-location Connection (DOCC). Our DOCC accelerates end-to-end Internet
connectivity, increasing the user's proximity to the Internet's content through
direct connection via the GTE POP. The DOCC allows direct access to virtually
unlimited bandwidth on demand and eliminates the need for costly local loop
circuits. Our DOCC was operational on a commercial
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<PAGE> 21
basis in July 1999 and was officially unveiled on August 25, 1999.
Since our DOCC has become operational, we derive our revenues primarily from
direct Internet access, web-hosting, co-location, and DSL services, as well as
other value-added services. The largest component of our revenues is derived
from providing our customers with direct high-speed Internet access. Our
Internet access, co-location and web-hosting customers typically sign one to
two-year contracts that provide for a minimum bandwidth usage. We also derive
revenues from web site hosting and co-location services based upon a customer's
bandwidth requirements. We provide DSL connectivity to ISPs who wish to offer
this service to their subscribers. We receive a portion of the monthly DSL fee
charged to the subscriber by the ISP. Other value-added services are charged on
a fixed price or time-and-materials basis.
Based on our relationship with GTE, we are in the process of selecting up to
fifteen GTE POP locations serving metropolitan areas for data centers with
DOCCs. In addition, we are expanding our Austin, Texas data center and moving
our corporate headquarters from the data center to another facility.
The building of data centers requires substantial financial resources.
Expenditures related to a data center commence well before the data center is
opened and it may take an extended period of time for us to approach break-even
capacity utilization at each site. As a result, we expect that individual data
centers will experience losses for an excess of one year from the time they are
opened. We expect to make investments in expanding our business rapidly into new
geographic regions, which, while potentially increasing our revenues in the
long-term, will lead to significant losses for the foreseeable future.
We intend to invest in new data centers and other sites, product
development, sales and marketing programs, and therefore believe that we will
continue to experience net losses on a quarterly and annual basis for the
foreseeable future.
RESULTS OF OPERATIONS
Year Ended March 31, 1999, Compared with the Year Ended March 31, 1998:
Comparison Table
<TABLE>
<CAPTION>
HARDWARE SERVICE,
SOFTWARE SUPPORT
AND NETWORKS AND
PERIPHERALS LAN/WAN INTEGRATION TOTAL
----------- ----------- ----------- -------------
YEAR ENDED MARCH 31, 1999
<S> <C> <C> <C> <C>
Revenues $ 1,479,984 $ 1,597,279 $ 473,459 $ 3,550,722
Cost of goods sold 1,522,365 1,883,417 849,679 4,255,461
Gross profit (loss)($) (42,381) (286,138) (376,220) (704,739)
Gross profit (loss)(%) (2.9)% (17.9)% (79.5)% (19.8)%
YEAR ENDED MARCH 31, 1998
Revenues $ 1,350,869 $ 685,711 $ 704,241 $ 2,740,821
Cost of goods sold 1,406,612 1,185,572 1,027,617 3,619,801
Gross profit (loss)($) (55,743) (499,861) (323,376) (878,980)
Gross profit (loss)(%) (4.1)% (72.9)% (45.9)% (32.1)%
INCREASE/(DECREASE)
Revenues $ 129,115 $ 911,568 $ (230,782) $ 809,901
Cost of goods sold 115,753 697,845 (177,938) 635,660
Gross profit (loss) ($) 13,362 213,723 (52,844) 174,241
Gross profit (loss) (%) 1.2% 55.0% (33.6)% 12.3%
</TABLE>
Total revenues for the year ended March 31, 1999, increased $809,901, or
29.5%, over the total revenues for the prior year. This
21
<PAGE> 22
increase is a combination of increases in hardware, software and peripherals
revenues and increases in network LAN/WAN revenues and a decrease in service,
support and integration revenues. The nominal increase of $129,115 in hardware,
software and peripherals revenues reflects normal fluctuations in sales. The
increase of $911,568 in network LAN/WAN revenues relates to significant school
district network installation projects that were in place during each period.
During the year ended March 31, 1998, we were performing a cabling and LAN/WAN
installation for the Hereford Independent School District, which started in
April 1997. During the year ended March 31, 1999, we began the installation of a
network system under a contract with San Felipe Del Rio Consolidated Independent
School District. This contract was executed in July 1998 with installation
beginning in August 1998. The $230,782 decrease in service, support and
integration revenues relates to a reduction in the scope of work on two
contracts. Revenues on contracts for the installation and maintenance of
interactive terminals decreased approximately $271,000 from the prior year.
Total cost of goods sold for the year ended March 31, 1999, increased
$635,660, or 17.6%, over the cost of goods sold for the prior year. The total
cost of goods sold consists of an increase of $115,753 and $697,845 in the cost
of goods sold associated with hardware, software and peripherals and LAN/WAN,
respectively, and a decrease of $177,938 in cost of goods sold associated with
service, support and integration.
The total gross loss for the year ended March 31, 1999, improved to a gross
loss of 19.8%, compared to the total gross loss of 32.1% for the year ended
March 31, 1998. The gross loss for hardware, software and peripherals for the
year ended March 31, 1999, was 2.9%, compared to a loss of 4.1% for the year
ended March 31, 1998. Overall profits are low because of market pressures to
lower prices on hardware, software and peripherals from our competitors and
customers, including the result of the competitive bidding process required for
sales to public entities. The gross loss for network LAN/WAN was 17.9% for the
year ended March 31, 1999, compared to a gross loss of 72.9% for the year ended
March 31, 1998. The improvement of 55.0% is due to extraordinary events
experienced in cost of goods sold for 1998, including a cost overrun of
approximately $500,000 on a large cabling project for a Texas school district.
The project was a fixed fee contract, and we absorbed the cost overrun. Problems
experienced with the substantial cost overrun situation have been addressed with
better controls, new project management and improved accounting procedures.
Management does not anticipate significant cost overruns in the future. During
the quarter ended September 30, 1998, we received a contract of approximately
$700,000 with San Felipe Del Rio Consolidated Independent School District (Del
Rio) for network LAN/WAN installation. The profit on this contract was depressed
due to the competitive bidding process. Subsequent to September 30, 1998, we
received numerous purchase orders from Del Rio to perform services beyond the
scope of the original contract that allowed the opportunity for increased
overall profits. Total sales attributable to Del Rio for the year ended March
31, 1999 exceeded $1.2 million. The gross loss for service, support and
integration was 79.5% for the year ended March 31, 1999, compared to a loss of
45.9% for the year ended March 31, 1998. The gross loss increased for fiscal
year 1999 due to the significant reduction in revenues without a corresponding
reduction in fixed costs.
Selling, general and administrative expenses, excluding interest expense,
for the year ended March 31, 1999, were $6,213,233, or 175.0% of revenues. The
selling, general and administrative expenses, excluding interest expense, for
the year ended March 31, 1999, represents an increase of $3,473,841, over the
year ended March 31, 1998. $1,155,295 of the increase is attributable to the
increase in staff and stock compensation expense for options granted to certain
employees of the Company. Staff additions include technical, sales, accounting
and project management. These increases were needed as we prepared to offer
broadband Internet services at our Austin, Texas data center. The increase in
professional fees of $2,063,522 is largely attributable to fees for technical
consulting related to the design and implementation of the broadband Internet
services described above and fees incurred while obtaining GTE/BBN
certification. Occupancy expense increased approximately $101,889 due to
facility expansion.
Interest expense for the year ended March 31, 1999, was $539,230, which is
15.2% of revenues. Interest expense increased as a result of a discount charged
to interest relating to senior convertible debt issued for cash. Interest
expense for the year ended March 31, 1998, was $294,198, which is 10.7% of
revenues.
OUR DECISION NOT TO SEEK RECERTIFICATION FOR OUR OPERATING SUBSIDIARY AS A HUB
Until the end of 1996, our operating subsidiary emphasized the sale of
electronics equipment with a concentration in contracts that relied on our
operating subsidiary's status as a "Historically Underutilized Business" (HUB).
However, in 1997, we decided to change our direction to concentrate on
communications technology services. As a HUB, we received favorable treatment by
certain governmental entities in their granting of contracts. We generated
revenues of approximately $483,000, $414,000 and $919,000 during fiscal years
1999, 1998 and 1997, respectively, from HUB related contracts, or 13.6%, 15.1%
and 19.7% of our gross revenues, respectively. We have decided not to seek
re-certification of our operating subsidiary's HUB status.
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<PAGE> 23
LIQUIDITY AND CAPITAL RESOURCES
The Company has a critical need for additional working capital to meet
obligations under lease agreements with GTE relating to the GTE POP located in
our primary facility in Austin, Texas. Management believes that its relationship
with GTE has the potential to substantially increase revenue if sufficient
working capital is obtained.
As of March 31, 1999, MSI had working capital deficit of $1,749,936. This
was a decrease of $1,557,856 from the working capital deficit of $192,080 on
March 31, 1998. Accounts payable and accrued expenses increased as a result of
consulting agreements and professional fees associated with a stock offering. In
addition, accounts receivable increased $424,379 for the year ended March 31,
1999.
We used $4,902,172 and $2,904,365 in our operating activities for the years
ended March 31, 1999, and 1998. This was mainly the result of losses of
$7,457,202 and $3,912,570 for the years ended March 31, 1999, and 1998. We
provided $505,156 and used $1,168,853 in investing activities for the years
ended March 31, 1999, and 1998. These expenditures primarily related to the data
center build out. Our financing activities for the years ended March 31, 1999,
and 1998, provided $4,379,701 and $4,080,892, respectively, from the private
placement of our securities.
Subsequent to March 31, 1999 the following significant transactions have
impacted our Liquidity and Capital Resources:
o We paid our loans with Compass Bank, N.A. in full and eliminated the
borrowing under our fully secured line of credit.
o We received net proceeds of $526,800 from the Private Placement of
20,000 shares of Series E, 6% Cumulative Convertible Non-Voting
Preferred Stock, Stated value $30.00 per share.
o The Company was approved for an initial $1,200,000 in lease financing
with Cisco Systems Capital Corporation. In January 2000 the Company was
approved for an additional $8,000,000 in lease financing. This
financing will be used to purchase equipment for the data center
expansion plans of the Company.
o Through December 31, 1999, the Company issued 1,598,011 shares of
Common Stock in a private placement resulting in net proceeds of
$4,859,175.
o We have borrowed through February 2000, an additional $4,286,500 in
bridge loans from 40 accredited investors.
o Through February 2000, the Company issued 2,771,650 shares of common
stock and received proceeds of $3,990,865 from the exercise of
2,771,650 common stock warrants.
o During February 2000, the Company concluded another private placement
of its common stock. The Company raised approximately $52,000,000 in
net proceeds and issued 9,166,667 shares of Common Stock in the
offering
As of February 22, 2000, we had cash on hand of approximately $53.5 million
and total current assets of $54.3 million. We had debt and lease obligations of
approximately $4.2 million with our total liabilities aggregating $6.2 million.
The Company intends to use its cash on hand to build out additional data
centers, implement a sales and marketing campaign, hire additional sales and
marketing personnel, repay indebtedness and for general corporate purposes. We
believe that our projected revenues and our present liquidity and capital
resources will be sufficient to finance our current and anticipated operations
until March 31, 2001. Management is consulting with investment bankers
concerning the Company's additional financing alternatives.
YEAR 2000 ISSUES
Many computer programs have been written using two digits rather than four
digits to define the applicable year. This poses a problem at the end of the
century because these computer programs would not properly recognize a year that
begins with "20" instead of "19." This, in turn, could result in major systems
failures or miscalculations, and is generally referred to as the year 2000
issue. We are in the process of completing a year 2000 plan to identify and
address year 2000 issues.
We recently completed a study of our computer systems to identify year 2000
issues with our network infrastructure and internal software. In addition,
GTE/BBN Professional Services consultants have informed us of year 2000 issues
that we must address to maintain our GTE/BBN certification. GTE's consultants
will continue to provide assistance to ensure our year 2000 readiness. We
believe we have identified our network and internal systems that require
modification, upgrade or replacement. Such modifications, upgrades or
replacements have been completed. In-house personnel were primarily responsible
for completing these tasks and the costs were not significant. While we expect
that our network infrastructure and internal software will not experience any
year 2000 related failures, we cannot assure you that we will not experience
such failures or that we will not discover additional year 2000 compliance
issues in the future.
We also rely on software and hardware supplied by numerous vendors. We have
obtained assurances from many of our vendors of
23
<PAGE> 24
their products' year 2000 compliance. However, because in most cases we do not
independently verify the year 2000 compliance of vendors' products, we cannot
assure you that the vendors' assurances are accurate. Because our operations are
substantially reliant on our connections to the Internet backbone through GTE's
POP and Southwestern Bell's and Covad's communications infrastructure, any
disruption of their services would likely have an impact on our operations. In
addition, we may face year 2000 related risks from our customers' hardware or
software that we host in our facilities. Although we assist our customers and
vendors to remedy their year 2000 issues, we cannot assure you that our
customers will achieve year 2000 compliance. The failure of our customers or
vendors to ensure that their hardware and software is year 2000 compliant could
disrupt our operations.
While there can be no assurance that we will not be adversely affected by
year 2000 related problems, we believe that our internal systems will be year
2000 compliant. To date we have expended immaterial resources to address the
year 2000 issue and we expect future expenditures to be immaterial to our
operations and financial position. However, the failure of our vendors' or
customers' systems, or systemic failures such as power outages, may adversely
affect our operations and financial position.
INFLATION
Management does not believe that inflation will have a material impact on
the Company's pricing of goods or services since the Company, generally, has the
ability to adjust prices for its technical services to meet the current market
conditions.
ITEM 7. FINANCIAL STATEMENTS
The information for this Item is included beginning on Page F-1 of this
Annual Report on Form 10-KSB.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On August 4, 1999, the Company's auditors, Brown Graham & Company, PC.
Georgetown, Texas, were dismissed as independent accountants to the Company.
The former accountants' reports for the fiscal years ended March 31, 1998
and March 31, 1999 did not contain an adverse opinion or a disclaimer of
opinion, but such reports were modified to include an explanatory paragraph as
to uncertainty concerning the Company's ability to continue as a going concern.
During the Company's two most recent fiscal years audited by Brown, Graham &
Company, PC and subsequent interim periods preceding the dismissal of Brown,
Graham & Company, PC, the Company had no disagreements with Brown, Graham &
Company, PC, on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedure.
The Company engaged Ernst & Young LLP as its independent auditors on August
4, 1999.
PART III
ITEM 9. EXECUTIVE OFFICERS AND DIRECTORS
As of February 22, 2000, MSHI's current executive officers and directors,
their ages, titles and tenure are:
<TABLE>
<CAPTION>
PERIOD FROM
NAME AGE POSITION WHICH SERVED
- ----------------------- --- --------------------------------------- ---------------
<S> <C> <C> <C>
Robert J. Gibbs 44 President, Chief Executive Officer, and June 14, 1999
Director
Dr. Robert Frank 48 Executive Vice President and Chief August 9, 1999
Operating Officer
Douglas W. Banister 37 Vice President and Chief Financial August 9, 1999
Officer
Glenn Birk 30 Vice President of Sales February 22, 1999
Cliff Luckey 40 Chief Technology Officer and Vice August 9, 1999
President of Technology and Solutions
Gary Fortin 37 Vice President of Marketing August 9, 1999
Robert Hersch 32 Vice President of Corporate Finance August 9, 1999
Patricia V. Hrabina 50 Vice President of Human Resources August 9, 1999
Shawn Wiora 34 Vice President of Strategic Alliances November 1, 1999
Mark R. Slosson 45 Vice President of Wholesale Markets January 17, 2000
Christopher Brickler 28 Director October 9, 1999
Blandina Cardenas (1) 43 Director February 16, 1998
</TABLE>
24
<PAGE> 25
<TABLE>
<S> <C> <C> <C>
Ernesto M. Chavarria (1) 43 Director February 16, 1998
Daniel Dornier (1) 36 Director July 21, 1998
Steve Metzger (2) 47 Director August 26, 1999
Humbert Powell, III (2) 61 Director August 9, 1999
Dr. Davinder Sethi (2) 52 Director August 9, 1999
</TABLE>
(1) Member of the audit committee.
(2) Member of the compensation committee
The Company has no knowledge of any arrangement or understanding in
existence between any executive officer named above and any other person
pursuant to which any such executive officer was or is to be elected to such
office or offices. All officers of the Company serve at the pleasure of the
Board of Directors. All Officers of the Company will hold office until the next
annual meeting of the Stockholders of the Company.
BIOGRAPHICAL INFORMATION
ROBERT J. GIBBS joined the Company in June 1999 as President and Chief
Executive Officer. From 1997 to 1999, Mr. Gibbs founded and served as a
consultant with Sigma Solutions Group, which provides executive management
services for high tech startup companies. From 1990 to 1997, Mr. Gibbs served as
President, Executive Vice President and Chief Financial Officer of Uniden
America Corporation, a wireless products and services company. He received a
Bachelor of Science in Finance from the University of Colorado and received a
Master of Business Administration from Southern Methodist University.
DR. ROBERT FRANK, Executive Vice President and Chief Operating Officer,
joined the Company in August 1999. From 1993 to 1998, Dr. Frank founded and
managed CORSEARCH, Inc., a trademark research firm. He serves as a member of the
Board of Governors for the Brand Names Education Foundation and a member of the
University of Missouri Development Council. He received his Doctorate from the
University of Missouri-Columbia.
DOUGLAS W. BANISTER, Vice President of Finance and Chief Financial Officer,
joined the Company in August 1999. From 1990 to 1999, Mr. Banister served as
Accounting Manager, Vice President and Chief Financial Officer of Uniden America
Corporation. From 1987 to 1990, Mr. Banister served as Controller for D.R.
Horton Custom Homes, a national home builder. From 1983 to 1987, he served as a
Senior Auditor with Ernst & Young, L.L.P. in its audit department. He received a
Bachelor of Business Administration in Accounting from Texas Wesleyan
University. He has been a Certified Public Accountant since 1986.
GLENN BIRK joined the Company in February 1999 as Vice President of Sales.
From 1997 to 1999, Mr. Birk served as an Account Executive with GTE/BBN. From
1996 to 1997, he served as an Account Executive with Lawson Software. From 1994
to 1996, he served as an Account Executive with AT&T Corp. From 1990 to 1994, he
served as an Account Executive with NCR Comten. He received a Bachelor of
Business Administration in Marketing from the University of Texas at Austin.
CLIFF LUCKEY, Vice President of Technology and Solutions and Chief
Technology Officer, joined the Company in August 1999. From 1996 to 1999, Mr.
Luckey served as Director of GTE's Enterprise Management Center, which provided
applications resolution support, network management and network design. From
1995 to 1996, Mr. Luckey was a Staff Manager managing engineers for Motorola.
Mr. Luckey received his technological training as a Hawk Missile Engineer from
the United States Army Air Defense School.
GARY FORTIN, Vice President of Marketing, joined the Company in September
1998. In 1998, he was an Account Executive with GTE Communications Corporation.
In 1997, he was a Digital Network Account Executive with AT&T Corp. For the
previous ten years, Mr. Fortin was a principal in Team Alpha Marketing and
Photografique Productions. Mr. Fortin received a Bachelor of Arts degree in
Marketing from the University of Maryland.
ROBERT HERSCH, Vice President of Corporate Finance, joined the Company in
August 1999. From 1996 to 1999, he was an independent consultant in the areas of
corporate finance, investor relations, and mergers and acquisitions. From 1994
to 1996, he was Chief Accounting Officer, Executive Vice President, and a
Director of American Bingo & Gaming Corp.
PATRICIA V. HRABINA, Vice President of Human Resources, joined the Company
in July 1999. From 1998 to 1999, Ms. Hrabina was an independent consultant. From
1997 to 1998, Ms. Hrabina was the Vice President of Human Resources for AMBAC
Connect, Inc. From 1988 to 1997, Ms. Hrabina was the Vice President of Human
Resources of Prime II Management, Inc. She received a Bachelor of Business
Administration degree from the University of St. Thomas in Houston, Texas.
25
<PAGE> 26
SHAWN WIORA joined us as our Vice President - Strategic Alliances in
November 1999. From November 1998 until November 1999, he directed strategic
planning for GTE's SuperPages.com, the online Yellow Pages for GTE, AOL,
Lycros.com and the GO! Network. He also directed merger integration efforts with
Bell Atlantic's BigYellow.com Prior to his employment with SuperPages.com, he
was employed for nine years with GTE, most recently as a program manager for
business development and strategic IP initiatives. He received a Bachelor of
Business Administration from the University of Texas and a Masters of Science in
Telecommunications System Management from Southern Methodist University.
MARK R. SLOSSON joined as our Vice President of Wholesale Markets in
February 2000. From 1970 to 2000, he served in various positions with GTE
Network Services, including National Sales Manager and General Manager -
National Accounts. He received a Bachelor of Science degree in Business
Administration from the University of Bedlands.
CHRISTOPHER BRICKLER has been a director of the Company since October 1999.
From December 1998 to October 1999, he served as Vice President - Marketing of
BT Global Business Markets, a communications services provider based in London.
Previously, he was employed for five years with GTE, most recently in the
development of GTE's Internet technology. He received a Bachelor of Business
Administration degree from the University of Texas.
BLANDINA CARDENAS has been a Director of the Company since November 1997.
Since 1995, Dr. Cardenas has been an Associate Professor of Education Leadership
at the University of Texas at San Antonio. From 1992 to 1995, she was a
Professor at Southwest Texas State University. She received a Doctorate in
Educational Leadership from the University of Massachusetts at Amherst and a
Bachelor in Journalism from the University of Texas at Austin.
ERNESTO M. CHAVARRIA has been a director of the Company since November 1997.
Mr. Chavarria has been with ITBR, Inc., an international consulting company,
since 1978 and has served as its President since 1990.
DANIEL DORNIER has been a director of the Company since July 1998. Since
1995, Mr. Dornier has been the president of Dornier Capital Advisers, an
investment-portfolio management company. From 1993 and 1995, Mr. Dornier was a
private investment manager for various companies owned by the Dornier family.
From 1991 to 1993, he was an investment banker at SBC Warburg, Dillon, Reed. He
received a Master of Business Administration from the City University of
Bellevue, Washington (the Zurich, Switzerland campus). He received a Bachelor of
Business Administration degree from the University of Nuertingen, Germany.
STEPHEN J. METZGER has been a director of the Company since August 1999.
From 1998 to 1999, he was the chief executive officer of Waller Creek
Communications, an Austin, Texas based competitive local exchange carrier. From
1994 to present, Mr. Metzger founded and manages Manchester International
Incorporated, a company which provides interim management, strategy, business
development, specialized training and investment consulting to
telecommunications carriers, computer companies and network equipment providers.
From 1991 to 1993, Mr. Metzger was president and chief executive officer of
NetCommand, a consulting firm specializing in the development of internet
services, EDI and electronic commerce strategy, products and organizations for
global corporations, international carriers and value added networks.
HUMBERT POWELL has been a director of the Company since August 1999. Since
1997, he has been a Managing Director of Sanders Morris Mundy, a NASD-member
investment banking firm. From 1995 to 1997, Mr. Powell was Vice Chairman and
Director of Marleau, Lemire, Securities, Inc. and Chairman of the Board of
Marleau, Lemire USA. From 1988 through February 1995, Mr. Powell served as a
Senior Managing Director in the Corporate Finance Department of Bear Stearns &
Co. Mr. Powell currently serves as a director for Bikers Dream Inc., Evolve,
Lawman Corp., Millennium Vue Inc. and Osicom Technologies Inc., and as a trustee
of Salem-Teikyo University. Mr. Powell received degrees in Business and
Economics from the University of Florida and Salem University.
DR. DAVINDER SETHI has been a Director of the Company since August 1999.
Since 1996, he has been an independent advisor and investor in the fields of
information technologies and finance. From 1990 to 1996, he served as Director
and Senior Advisor to Barclays de Zoete Wedd. Dr. Sethi currently serves as a
director of Pamet Systems, Inc., where he also serves on the Audit and
Compensation Committees. Dr. Sethi received a Doctorate and a Master degree in
Operations Research, Economics and Statistics from the University of California
at Berkeley and is a graduate of the Executive Management Program from
Pennsylvania State University.
26
<PAGE> 27
RECENT CHANGES
As of January 29, 1999, David W. Hill and Tom M. Upton, the former Chief
Financial Officer and Vice-President of Sales, respectively, resigned to pursue
other interests. On April 20, 1999, Jose Chavez, Mitchell Kettrick and Jaime
Munoz, the President and CEO, Secretary and Vice-President of Operations,
respectively, were terminated.
In June 1999, we hired Robert Gibbs, our President and Chief Executive
Officer, and in August 1999, we hired Douglas W. Banister, our Chief Financial
Officer and Vice President of Finance. In July 1999, Roger M. Lane, our previous
Chief Operating Officer was terminated, and we hired Patricia Hrabina, our Vice
President of Human Resources. In August 1999, we hired Cliff Luckey, our Chief
Technology Officer and Vice President of Technology and Solutions, Robert Frank,
our Chief Operating Officer and Executive Vice President, and Robert Hersch, our
Vice President of Corporate Finance. This new management team has not had the
opportunity to work together in the past and there is no assurance they will be
able to successfully lead the company into profitability.
BOARD COMMITTEES
We maintain (i) a Compensation Committee, consisting of three board members,
one of which is to be designated by the previous holders of our preferred stock
and (ii) an Audit Committee consisting of three board members one of which is to
be designated by the previous holders of our preferred stock. The audit
committee assists our board of directors in exercising its fiduciary
responsibilities for oversight of audit and related matters, including corporate
accounting, reporting and control practices. It is responsible for recommending
to the board of directors the independent auditors for the following year. The
audit committee meets periodically with management, financial personnel and the
independent auditors to review internal accounting controls and auditing and
financial reporting matters. The members of the audit committee are Ms. Cardenas
and Messrs. Chavarria and Dornier. The compensation committee is responsible for
review and making recommendations to the board of directors on all matters
relating to compensation and benefits provided to executive management. The
members of the compensation committee are Messrs. Metzger, Powell and Sethi. The
compensation committee has the authority to administer our 1998 stock option
plan.
INDEMNIFICATION OF OFFICERS AND DIRECTORS
As permitted by the Utah Business Corporation Act, as amended, the Company
has included in its Revised Articles of Incorporation a provision that the
Company may indemnify its officers, directors, employees and agents under
certain circumstances, including those circumstances in which indemnification
would otherwise be discretionary, and the Company is required to advance
expenses to its officers and directors as incurred in connection with proceeding
against them for which they may be indemnified.
ITEM 10. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE.
The following table sets forth compensation for the Chief Executive Officer
("CEO"), and the two most highly compensated other executive officers whose
salary and bonus for fiscal 1999 was $100,000 or greater. Only the former CEO
and two other former executive officers of MSHI received salaries and bonuses in
excess of $100,000 in fiscal 1999. Consequently, only the former CEO and two
other former executive officers appear in the following table.
EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM COMPENSATION
ANNUAL COMPENSATION AWARDS PAYOUTS
---------------------------------------------- ------------------------- -----------------
(a) (b) (c) (d) (e) (f) (g) (h) (i)
SECURITIES
RESTRICTED UNDERLYING
NAME AND OTHER ANNUAL STOCK OPTION/ LTIP ALL OTHER
PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION AWARD(S) SAR'S(#) PAYOUTS COMPENSATION
----------------------- ---- -------- -------- ------------ ----------- ----------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
JOSE G. CHAVEZ 1999 $ 95,000 $ 0 $ 7,800 $ 0 $ 0 $ 0 $ 0
(former Pres./CEO) 1998 105,500 0 0 0 62,500 0 0
1997 50,500 34,000 0 0 0 0 0
MITCHELL KETTRICK 1999 $ 68,000 $ 0 $ 0 $ 0 $ 0 $ 0 $ 0
(former V.P./ Sec.) 1998 75,000 0 0 0 31,250 0 0
1997 5,200 0 0 0 0 0 0
DAVID W. HILL 1999 $ 47,000 $ 0 $ 0 $ 0 $100,313 $ 0 $ 0
(former CFO)
</TABLE>
27
<PAGE> 28
COMPENSATION OF DIRECTORS
Each director who is not an employee of the Company ("Outside Director") is
paid $1,000 for each meeting of the Board of Directors they attend.
Additionally, they are reimbursed for expenses incurred in attending meetings of
the Board of Directors and related committees.
EMPLOYMENT CONTRACTS
In June 1999 the Company entered into an employment agreement with Robert
Gibbs, President and Chief Executive Officer. Mr. Gibbs's agreement provides for
a two-year term with a two-year extension and a base salary of $150,000 for the
first year and $240,000 during the second year, and each subsequent term if
extended. In addition, Mr. Gibbs's agreement provides for an option to purchase
up to 1,362,950 shares of common stock at $5.56 per share as follows: (i) an
option to purchase 272,590 shares of common stock vested immediately upon grant
on June 30, 1999, (ii) an option to purchase 272,590 shares of common stock to
vest 91 days after the grant date, (iii) an option to purchase 545,180 shares of
common stock to vest on the first anniversary of the grant date and (iv) an
option to purchase 272,590 shares of common stock to vest on the second
anniversary of the grant date. Mr. Gibbs's agreement also provides for a bonus
of up to $170,000 in the first year. Mr. Gibbs' agreement also provides for a
discretionary bonus to be decided by the Board of Directors of up to $50,000
during the first year. Additional bonus opportunities are available in the
second year. Upon termination of Mr. Gibbs's employment for death, disability or
without cause, Mr. Gibbs is entitled to payments over a two year period equal to
$240,000. Mr. Gibbs's agreement also provides for a $800 monthly transportation
allowance. Mr. Gibbs's agreement is terminable by either party at any time.
As of March 24, 1999, the Company entered into an employment agreement with
Roger M. Lane, Chief Operating Officer (the "Lane Agreement"). The Lane
Agreement provides for an annual base salary of $120,000 and reimbursement of
ordinary, necessary and documented business expenses. In addition, the Lane
Agreement provides for a stock option to purchase up to 450,000 shares of Common
Stock vesting as follows: (i) options to purchase 100,000 shares of Common Stock
will vest at six months after the grant date of March 24, 1999; (ii) options to
purchase an additional 110,000 shares of Common Stock will vest on the first
anniversary of the grant date; and (iii) options to purchase 120,000 shares of
Common Stock will vest on each of the second and third anniversary of the grant
date. The Lane Agreement is terminable by either party. In July 1999, Mr. Lane
was terminated.
On June 15, 1997, the Company entered into employment agreements with Jose
Chavez, President and Chief Executive Officer (the "Chavez Agreement"), and
Mitchell Kettrick, Secretary and Vice President (the "Kettrick Agreement").
Messrs. Chavez and Kettrick had agreed to renegotiate the option terms of the
Chavez and Kettrick Agreements. The renegotiations were expected to be, but were
not, concluded by January 1999. On April 20, 1999, the Company terminated
Messrs. Chavez and Kettrick.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
PRINCIPAL STOCKHOLDERS
The following table sets forth as of February 22, 2000, the number and
percentage of outstanding shares of common stock beneficially owned by:
o each person who beneficially owns more than five percent of the
outstanding shares of our common stock;
o each of our executive officers;
o each of our directors; and
o all of our officers and directors as a group.
28
<PAGE> 29
<TABLE>
<CAPTION>
Name and Address of Number of Shares Percentage of Shares
Beneficial Owner Beneficially Owned (1)(2) Beneficially Owned
- ---------------- ------------------ ------------------
<S> <C> <C>
Entrepreneurial Investors, Ltd. (3) 5,366,121 14.8%
P.O. Box 40643
Freeport, G.B., Bahamas
Jose G. Chavez (4) 3,191,900 8.9%
8021 Bottle Brush
Austin, Texas 78750
Andrew Ramirez 2,873,750 8.0%
40 North IH 35, TH-6
Austin, Texas 78701
Douglas W. Banister (5) 25,000 *
Glenn Birk (6) 86,500 *
Christopher Brickler (7) 70,000 *
Blandina Cardenas 5,000 *
Ernesto M. Chavarria 75,000 *
Daniel Dornier 340,000 *
Gary Fortin (8) 27,200 *
Robert Frank (5) 30,000 *
Robert J. Gibbs (9) 545,180 1.5%
Robert Hersch (10) 210,000 *
Patricia Hrabina (5) 30,000 *
Cliff Luckey (5) 25,000 *
Stephen J. Metzger (11) 115,000 *
Humbert B. Powell, III (5) 25,000 *
Davinder Sethi (5) 25,000 *
Shawn Wiora -- --
Mark Slossen -- --
All directors and officers as a group
(12) 1,633,880 4.5%
</TABLE>
* Denotes less than 1% ownership.
(1) The rules of the SEC provide that, for the purposes hereof, a person is
considered the "beneficial owner" of shares with respect to which the
person, directly or indirectly, has or shares the voting or investment
power, irrespective of his economic interest in the shares. Unless
otherwise noted, each person identified possesses sole voting and
investment power over the shares listed, subject to community property
laws.
(2) Calculations are based on 35,795,254 outstanding shares of common stock as
of February 22, 2000. Shares of common stock subject to options that are
exercisable within 60 days of February 22, 2000 are deemed beneficially
owned by the person holding
29
<PAGE> 30
such options for the purposes of calculating the percentage of ownership of
such person but are not treated as outstanding for the purpose of computing
the percentage of any other person.
(3) Includes 500,000 shares of common stock issuable upon the exercise of
warrants to purchase common stock.
(4) Includes 100,000 shares of common stock issuable upon the exercise of stock
options.
(5) Includes 25,000 shares of common stock issuable upon the exercise of stock
options.
(6) Includes 80,000 shares of common stock issuable upon the exercise of stock
options.
(7) Includes 55,000 shares of common stock issuable upon the exercise of stock
options and warrants to purchase common stock.
(8) Includes 25,000 shares of common stock issuable upon the exercise of stock
options.
(9) Includes 545,180 shares of common stock issuable upon the exercise of stock
options.
(10) Includes 150,000 shares of common stock owned by MMH Investments, Inc., of
which Mr. Hersch is the principal owner. Also includes 50,000 shares of
common stock issuable upon the exercise of options. See "Related Party
Transactions" and "Management - Executive Compensation" in the Memorandum.
(11) Includes 85,000 shares of common stock issuable upon the exercise of stock
options and warrants to purchase common stock.
(12) Includes information in the notes above.
30
<PAGE> 31
Rule 13d-3 under the Securities Exchange Act of 1934, involving the
determination of beneficial owners of securities, includes as beneficial owners
of securities, among others, any person who directly or indirectly, through any
contract, arrangement, understanding, relationship or otherwise has, or shares,
voting power and/or investment power with respect to such securities; and, any
person who has the right to acquire beneficial ownership of such security within
sixty days through means, including, by notice of any option, warrant or
conversion of a security. Any securities not outstanding which are subject to
such options, warrants or conversion privileges shall be deemed to be
outstanding securities of the class owned by such person, but shall not be
deemed to be outstanding for the purpose of computing the percentage of the
class by any other person.
There are no contractual arrangements or pledges of the Company's
securities, known to the Company, which may at a subsequent date result in a
change of control of the Company.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On December 1, 1997, the Company entered into a consulting agreement with an
entity whose President is the Chairman of the Board of the Company. The terms of
the consulting agreement include the following:
o $10,000 fee per month plus reasonable business expenses,
o 75,000 shares of Common Stock (issued on January 13, 1998),
o an option to purchase 75,000 shares of Common Stock,
o and various fees and commissions for acquisitions or sales secured by the
entity.
During the year ended March 31, 1999 the Company recognized expenses
totaling $132,356 related to this consulting agreement.
During the year ended March 31, 1999, the Company incurred a business
obligation with Dr. Davinder Sethi, a director, and MMH Investments, Inc., a
company that is principally owned and controlled by Robert Hersch, our vice
president of corporate finance. The consulting firm also has a financial
arrangement with another Director of the Company. The consulting firm claimed
compensation of 250,000 shares of the Company's common stock for services
allegedly performed. The Company disputed the validity of the claim. On December
20, 1999, this claim was settled. The Company issued 150,000 shares of common
stock to MMH Investments, Inc., and agreed to immediately register the shares
for resale on Form S-3.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibit Index
Exhibit
Number Description
------- -----------
27.1 Financial Data Schedule
b. Reports on Form 8-K
1. Form 8-K filed with the Commission on March 3, 1999 with reference to the
receipt of GTE/BBN certification for MSI's network and facility.
2. Form 8-K filed with the Commission on August 10, 1999 with reference to
changes in registrants certifying accountants.
3. Form 8-K filed with the Commission on January 10, 2000 with reference to
the announcement of a proposed private placement of common stock.
4. Form 8-K filed with the Commission on February 17, 2000 with reference to
the announcement of the consummation of a private placement of common
stock.
31
<PAGE> 32
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized.
MSI HOLDINGS, INC.
Date: February ___, 2000 BY: /s/ Robert Gibbs
Robert Gibbs, President and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of this Registrant and
in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ Stephen J. Metzger Director February ___, 2000
------------------------------
Stephen J. Metzger
/s/ Davinder Sethi Director February ___, 2000
------------------------------
Davinder Sethi
Director February ___, 2000
------------------------------
Ernesto Chavarria
/s/ Blandina Cardenas Director February ___, 2000
------------------------------
Blandina Cardenas
/s/ Daniel Dornier Director February ___, 2000
------------------------------
Daniel Dornier
/s/ Humbert Powell, III Director February ___, 2000
------------------------------
Humbert Powell, III
/s/ Robert Gibbs President and Chief February ___, 2000
------------------------------ Executive Officer
Robert Gibbs
/s/ Douglas W. Banister Chief Financial Officer February ___, 2000
------------------------------
Douglas W. Banister
</TABLE>
32
<PAGE> 33
MSI HOLDINGS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Ernst & Young LLP F-2
Consolidated Balance Sheet as of March 31, 1999 (restated) F-3
Consolidated Statement of Operations for the year ended
March 31, 1999 (restated) F-4
Consolidated Statement of Stockholders' Equity (Deficit)
for the year ended March 31, 1999 (restated) F-5
Consolidated Statement of Cash Flows for the year ended
March 31, 1999 (restated) F-6
Notes to Consolidated Financial Statements (restated) F-7
Report of Brown, Graham & Company, P.C. F-18
Consolidated Balance Sheet as of March 31, 1998 (restated) F-19
Consolidated Statement of Operations for the year ended
March 31, 1998 (restated) F-20
Consolidated Statement of Changes in Stockholders' Equity
(Deficit) for the year ended March 31, 1998 (restated) F-21
Consolidated Statement of Cash Flows for the year ended
March 31, 1998 (restated) F-22
Notes to Consolidated Financial Statements (restated) F-24
</TABLE>
F-1
<PAGE> 34
REPORT OF INDEPENDENT AUDITORS
The Board of Directors MSI Holdings, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheet (as restated) of
MSI Holdings, Inc. and its subsidiaries as of March 31, 1999 and the related
consolidated statement of operations (as restated), stockholders' equity
(deficit) (as restated) and cash flows (as restated) for the year ended March
31, 1999. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States. 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.
Since the date of completion of our audit of the accompanying financial
statements and initial issuance of our report thereon dated September 28, 1999,
which report contained an explanatory paragraph regarding the Company's ability
to continue as a going concern, the Company, as discussed in Note 15, has
completed an issuance of its common stock resulting in net proceeds of
approximately $52 million. Therefore, the conditions that raised substantial
doubt about whether the Company will continue as a going concern no longer
exist.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of MSI Holdings,
Inc. and its subsidiaries at March 31, 1999 and the consolidated results of
their operations and their cash flows for the year ended March 31, 1999, in
conformity with accounting principles generally accepted in the United States.
As more fully described in Note 16, the March 31, 1999 financial statements
have been restated to correct certain errors in the application of generally
accepted accounting principles.
/s/ ERNST & YOUNG LLP
September 28, 1999,
except for Notes 1, 13 and 15, as to which the date is
February 29, 2000
F-2
<PAGE> 35
MSI HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET (RESTATED)
MARCH 31, 1999
ASSETS
<TABLE>
<S> <C>
Current assets:
Cash......................................................... $ 8,471
Accounts receivable - trade.................................. 575,230
Other receivables - advances................................. 79,699
Other current assets......................................... 57,516
------------
Total current assets................................. 720,916
Property, plant and equipment, net............................. 2,155,340
------------
Total assets......................................... $ 2,876,256
============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable - trade..................................... $ 1,773,211
Other accrued expenses....................................... 143,485
Bank line of credit.......................................... 200,000
Current maturities of notes payable.......................... 235,420
Current portion of obligations under capital leases.......... 118,736
------------
Total current liabilities............................ 2,470,852
Long-term liabilities:
Notes payable................................................ 53,505
Obligations under capital leases............................. 680,928
Deferred rent................................................ 192,284
------------
Total long-term liabilities.......................... 926,717
Commitments and contingencies.................................. --
------------
Total liabilities.................................... 3,397,569
Stockholders' equity (deficit):
Preferred stock; 10,000,000 shares authorized:
Convertible preferred stock series B; $5.30 stated
value; 490,000 shares authorized and 400,000 shares
issued and outstanding................................... 2,120,000
Convertible preferred stock series D; $10.60 stated
value; 279,657 shares authorized and 196,340 shares
issued and outstanding................................... 2,081,204
Convertible preferred stock series E; $30.00 stated
value; 157,500 shares authorized and 146,252 shares
issued and outstanding................................... 4,387,560
Convertible preferred stock series E subscribed (20,000
shares).................................................. (600,000)
Common stock at $.10 par value; 50,000,000 authorized
and 14,618,352 (excluding 200,250 shares held in
treasury) shares issued and outstanding.................. 1,461,835
Additional paid-in capital................................ 11,982,324
Accumulated deficit....................................... (21,954,236)
------------
Total stockholders' equity (deficit)................. (521,313)
------------
Total liabilities and stockholders' equity
(deficit)............................................ $ 2,876,256
============
</TABLE>
See accompanying notes.
F-3
<PAGE> 36
MSI HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS (RESTATED)
YEAR ENDED MARCH 31, 1999
<TABLE>
<S> <C>
Revenues:
Hardware, software and peripherals .................... $ 1,479,984
Networks, LAN/WAN ..................................... 1,597,279
Service, support and integration ...................... 473,459
------------
3,550,722
------------
Cost of goods sold:
Hardware, software and peripherals .................... 1,522,365
Networks, LAN/WAN ..................................... 1,883,417
Service, support and integration ...................... 849,679
------------
4,255,461
------------
Gross margin ............................................ (704,739)
Selling, general and administrative expenses:
Salaries and benefits ................................. 2,454,298
Professional fees and consultants ..................... 2,424,597
Advertising ........................................... 152,920
Occupancy ............................................. 494,389
Depreciation and amortization ......................... 294,997
Vehicle expense ....................................... 106,593
Other expense ......................................... 285,439
------------
6,213,233
------------
Operating loss .......................................... (6,917,972)
Interest expense, net ................................... 539,230
------------
Net loss ................................................ $ (7,457,202)
============
Preferred stock dividends and discounts ................. (8,947,337)
------------
Net loss to common stockholders ......................... $(16,404,539)
============
Basic and diluted net loss per share .................... $ (1.30)
============
Basic and diluted weighted average shares outstanding ... 12,622,673
============
</TABLE>
See accompanying notes.
F-4
<PAGE> 37
MSI HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT) (RESTATED)
<TABLE>
<CAPTION>
PREFERRED STOCK
SERIES B SERIES C SERIES D SERIES E
------------------------ ------------------------ ------------------------ ------------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
----------- ----------- ----------- ------------ ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balances at April 1,
1998....................... 490,000 $ 2,597,000 99,057 $ 1,050,004 -- $ -- -- $ --
Preferred stock issuance... -- -- -- -- 279,657 2,964,364 146,252 4,387,560
Issuance of Common Stock... -- -- -- -- -- -- -- --
Common Stock issued as
Preferred stock
Dividend.................. -- -- -- -- -- -- -- --
Conversion of Class A
Warrants.................. -- -- -- -- -- -- -- --
Preferred stock conversion
To common................. (90,000) (477,000) (99,057) (1,050,004) (83,317) (883,160) -- --
Preferred stock beneficial
Conversion discount on
Series B and C
Offerings................. -- -- -- -- -- -- -- --
Discount on convertible
Debt...................... -- -- -- -- -- -- -- --
Common stock and stock
Options issued for
Compensation.............. -- -- -- -- -- -- -- --
Warrants issued for
Purchase of equipment..... -- -- -- -- -- -- -- --
Treasury stock............. -- -- -- -- -- -- -- --
Net loss................... -- -- -- -- -- -- -- --
------- ----------- ------- ----------- ------- ----------- ------- ----------
Balance at March 31,
1999....................... 400,000 $ 2,120,000 -- $ -- 196,340 $ 2,081,204 146,252 $4,387,560
======= =========== ======= =========== ======= =========== ======= ==========
</TABLE>
<TABLE>
<CAPTION>
PREFERRED STOCK
----------------------------
SUBSCRIBED COMMON STOCK ADDITIONAL
---------------------------- ---------------------------- PAID-IN ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT
------------- ------------- ------------- ------------- ------------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Balances at April 1,
1998....................... -- $ -- 11,506,846 $1,150,685 $ 698,057 $(5,549,697)
Preferred stock issuance... (20,000) (600,000) -- -- 5,648,161 (6,751,924)
Issuance of Common Stock... -- -- 50,000 5,000 48,000 --
Common Stock issued as
Preferred stock
dividend.................. -- -- 72,016 7,201 356,703 (363,904)
Conversion of Class A
warrants.................. -- -- 420,000 42,000 291,900 --
Preferred stock conversion
to common................. -- -- 2,723,740 272,374 2,137,790 --
Preferred stock beneficial
conversion discount on
Series B and C
offerings................. -- -- -- -- 1,831,509 (1,831,509)
Discount on convertible
debt...................... -- -- -- -- 371,000 --
Common stock and stock
options issued for
compensation.............. -- -- 46,000 4,600 579,783 --
Warrants issued for
purchase of equipment..... -- -- -- -- 81,300 --
Treasury stock............. -- -- (200,250) (20,025) (61,879) --
Net loss................... -- -- -- -- -- (7,457,202)
------ --------- --------- ---------- ----------- -----------
Balance at March 31,
1999...................... (20,000) $(600,000) 14,618,352 $1,461,835 $11,982,324 $(21,954,236)
======= ========= ========== ========== =========== ============
<CAPTION>
TOTAL
--------------
<S> <C>
Balances at April 1,
1998....................... $ (53,951)
Preferred stock issuance... 5,648,161
Issuance of Common Stock... 53,000
Common Stock issued as
Preferred stock
dividend.................. --
Conversion of Class A
warrants.................. 333,900
Preferred stock conversion
to common................. --
Preferred stock beneficial
conversion discount on
Series B and C
offerings................. --
Discount on convertible
debt...................... 371,000
Common stock and stock
options issued for
compensation.............. 584,383
Warrants issued for
purchase of equipment..... 81,300
Treasury stock............. (81,904)
Net loss................... (7,457,202)
----------
Balance at March 31,
1999...................... $ (521,313)
==========
</TABLE>
See accompanying notes.
F-5
<PAGE> 38
MSI HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS (RESTATED)
YEAR ENDED MARCH 31, 1999
<TABLE>
<S> <C>
Cash flows from operating activities:
Net loss ........................................... $(7,457,202)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization expense .......... 294,997
Amortization of deferred rent .................. 46,664
Amortization of debt discount .................. 371,923
Common stock and options issued for compensation 584,383
Write-down of inventory ........................ 232,000
Gain on disposal of property ................... (652)
Changes in operating assets and liabilities:
Accounts receivable - trade .................... (424,379)
Inventory ...................................... 53,023
Other receivables - advances ................... 7,262
Other current assets ........................... (57,516)
Accounts payable - trade ....................... 1,473,176
Other accrued expenses ......................... (25,851)
-----------
Net cash used in operating activities ..... (4,902,172)
-----------
Cash flows from investing activities:
Purchase of property, plant and equipment ........ (844,844)
Change in short term investment .................. 1,350,000
-----------
Net cash provided by investing activities . 505,156
-----------
Cash flows from financing activities:
Net draws on bank line of credit ................. (1,028,966)
Payments on notes payable ........................ (429,864)
Payments on obligations under capital leases ..... (114,626)
Proceeds -- private placement of preferred stock . 5,648,161
Proceeds -- issuance of common stock ............. 53,000
Proceeds -- exercise of warrants ................. 333,900
Repurchase of common stock ....................... (81,904)
-----------
Net cash provided by financing activities . 4,379,701
-----------
Net decrease in cash ............................... (17,315)
Cash at the beginning of the fiscal year ........... 25,786
-----------
Cash at end of the fiscal year ..................... $ 8,471
===========
Supplemental disclosure:
Cash paid during the year for:
Interest ....................................... $ 196,990
===========
Supplemental schedule of non-cash investing and
financing activities:
Preferred stock issued for:
Placement agent fees ........................... $ 338,680
Stock options or warrants issued for:
Purchase of equipment with long-term leases .... 81,300
Common stock issued for:
Employee compensation .......................... 152,906
Preferred stock dividends ...................... 363,904
Discount on preferred stock issued ............... 8,583,433
Purchase of equipment with long-term leases ...... 804,010
</TABLE>
See accompanying notes.
F-6
<PAGE> 39
MSI HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (RESTATED)
YEAR ENDED MARCH 31, 1999
1. BUSINESS
MSI Holdings, Inc. and Subsidiaries or (the "Company") is an Austin, Texas
based technology corporation initially formed to provide technology services to
governmental and commercial entities, primarily in Texas. The Company is a
business solutions technology integrator, offering infrastructure design and
implementation services. In addition, the Company performs computer networking
services including system integration and local wide-area networking. The
Company provides these services to customers at sites throughout Texas. In 1999,
the Company began construction of an Internet co-location facility in Austin,
Texas, and intends to deliver broadband Internet connectivity, co-location and
advanced web-hosting solutions to clients with business-critical applications.
Prior to the year-ended March 31, 1999, the Company was certified by the
State of Texas as a Historically Underutilized Business (HUB). The Company has
decided not to seek re-certification of it's HUB status.
Going Concern
The Company has incurred historical net losses; and for the year ended March
31, 1999, the Company had a net loss of $7,457,202. In addition, during fiscal
year 1999 the Company had a negative operating cash flow of $4,902,172, and at
year end the Company had a working capital deficit of $1,749,936 and a
stockholders' deficit of $521,313. Furthermore, at March 31, 1999 the Company
was in violation of certain debt covenants concerning liquidity ratios and
reporting requirements. The Company has been able to obtain financing to support
its operations to date. The Company is actively pursuing various sources of
permanent financing and/or equity capital. The Company believes that its
relationships with certain strategic companies has the potential to
substantially increase revenue if sufficient working capital is obtained.
However, there is no guarantee that additional financing will be available to
fund its operations through the end of fiscal year 2000. The consolidated
financial statements do not include any adjustments to reflect the possible
future effects on the recoverability and classification of assets or the amounts
and classification of liabilities that may result from the outcome of this
uncertainty.
The Company has subsequently raised cash in excess of $52 million (see Note
15). The Company believes that its projected revenues and its present liquidity
and capital resources will be sufficient to finance its current and anticipated
operations until March 31, 2001. Management is consulting with investment
bankers concerning the Company's additional financing alternatives.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates, and such
differences could be material to the financial statements.
Principles of Consolidation
The consolidated financial statements for the year ended March 31, 1999,
include the accounts and transactions of the Company and its wholly-owned
subsidiaries, Micro-Media Solutions, Inc. and Tele-Vista, Inc., (incorporated in
August 1998 and had not yet commenced operations by March 31, 1999). All
significant intercompany accounts and transactions have been eliminated in the
accompanying consolidated financial statements.
Cash Equivalents
Cash and cash equivalents consist primarily of cash deposits and funds
invested in short-term interest-bearing accounts. The Company considers all
highly liquid investments purchased with initial maturities of three months or
less to be cash equivalents.
F-7
<PAGE> 40
Other Assets
As of March 31, 1999, other assets primarily consisted of stores inventory
held for use. During the current year, the Company reclassified all inventory
held for resale to other assets, and wrote down the balance to its net
realizable value, resulting in a $232,000 charge.
Property, Plant and Equipment
Property, plant and equipment, including items acquired under capital lease
arrangements, are recorded at cost. Depreciation is provided on the
straight-line method over the estimated useful lives of the related assets,
typically five years. Amortization of leasehold improvements is provided using
the straight-line basis over the shorter of the term of the related lease, or
the useful life of the leasehold improvements, typically twelve years.
The following table details the Company's property, plant and equipment at
March 31, 1999:
<TABLE>
<S> <C>
Building ........................................... $ 176,175
Equipment, furniture and fixtures .................. 1,637,276
Vehicles ........................................... 316,277
Leasehold improvements ............................. 662,268
-----------
2,791,996
Less -- Accumulated depreciation and amortization... (636,656)
-----------
Property, plant and equipment, net ................. $ 2,155,340
===========
</TABLE>
Impairment of Long-lived Assets
Long-lived assets consist primarily of buildings and other capital assets.
The carrying value of these assets is regularly reviewed to verify they are
properly valued. If the facts and circumstances suggest that the value has been
impaired, the carrying value of the assets will be reduced appropriately.
Revenue and Cost Recognition
Hardware and peripheral sales consist of computers and related electronic
equipment. Software sales represent the resale of prepackaged software and
operating systems from Microsoft and other vendors to the end user. Revenue is
recognized when persuasive evidence of an arrangement exists, delivery has
occurred, the customer fee is fixed and collection is probable. Substantially
all hardware, software and peripherals sales are made without the right of
return. Product returns are minimal and are recorded as a reduction of sales
upon receipt of the product.
Revenue from fixed price contracts is recognized on the percentage-of-
completion method. Management considers total costs incurred to be the best
available measure of progress on contracts.
Contract costs include all direct costs and those indirect costs related to
contract performance. Changes in job performance, job conditions, and estimated
profitability and final contract settlements may result in revisions to costs
and revenue and are recognized in the period in which the revisions are
determined. Losses on uncompleted contracts are recognized in the period in
which the losses are determined. As of March 31, 1999 there were no contracts in
progress.
Advertising Costs
The Company expenses advertising costs as incurred. These expenses were
approximately $152,920 for the year ended March 31, 1999.
Income Taxes
The Company accounts for income taxes under the liability method in
accordance with Statement of Financial Accounting Standards (SFAS) No. 109,
Accounting for Income Taxes. Under the liability method, deferred tax assets and
liabilities are determined based on differences between financial reporting and
tax bases of assets and liabilities, and are measured using the enacted tax
rates and laws that will be in effect when the differences are expected to
reverse. Valuation allowances are established when necessary to reduce deferred
tax assets to the amounts expected to be realized.
F-8
<PAGE> 41
Stock-Based Compensation
The Company has elected to apply the disclosure-only provisions of SFAS No.
123, Accounting for Stock-Based Compensation. Accordingly, the Company accounts
for stock-based compensation using the intrinsic value method prescribed in
Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to
Employees, and related interpretations. Compensation cost for stock options is
measured as the excess, if any, of the fair value of the Company's Common Stock
at the date of grant over the stock option exercise price. The Financial
Accounting Standards Board (FASB) has proposed certain amendments to APB No. 25
which would require, among other things, (a) variable plan accounting for stock
options which have been repriced, and (b) that stock options granted to outside
directors would be treated similar to those granted to an outside contractor.
Concentration of Credit Risk
Financial instruments which potentially subject the Company to concentration
of credit risk consist principally of cash and trade accounts receivable. Many
of the Company's customers are in the computer and telecommunications
industries. The Company performs ongoing credit evaluations on its customers and
generally does not require collateral from its customers. Historically, the
Company has not experienced significant losses related to receivables from
individual customers or groups of customers in any particular industry or
geographic area. Two customers accounted for 35% and 12%, respectively, of the
Company's total revenues for the year ended March 31, 1999.
Net Loss Per Share
Basic net loss per share is computed by dividing net loss available to
Common Stockholders by the weighted average number of common shares outstanding
during the period. Diluted net loss per share has not been presented as the
effect of the assumed exercise of stock options, warrants and contingently
issued shares is antidilutive.
Comprehensive Income
In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income,
which establishes requirements for disclosure of comprehensive income and was
adopted by the Company during the year ended March 31, 1998. Comprehensive
income generally represents all changes in stockholders' equity except those
resulting from contributions by stockholders. There was no impact to the Company
as a result of the adoption of SFAS No. 130, as there were no differences
between net loss and comprehensive loss available to Common Stockholders for the
year ended March 31, 1999.
Business Segments
The adoption of SFAS No. 131, Disclosures about Segments of an Enterprise
and Related Information, did not have a significant effect on the disclosure of
segment information as the Company continued to manage its business activities
as a single segment.
3. BANK LINE OF CREDIT
The Company had a line of credit with a commercial bank of $1,600,000 with
an outstanding balance of $200,000 at March 31, 1999. The line matured April 30,
1999, was secured by accounts receivable, and was payable in monthly
installments of interest only at 7.25%. Interest was paid through March 31,
1999. The line of credit was paid-in-full subsequent to March 31, 1999 and was
not renewed.
F-9
<PAGE> 42
4. NOTES PAYABLE
Notes payable consisted of the following amounts, which approximate fair
value at March 31, 1999:
<TABLE>
<S> <C>
Austin Community Development Corporation, $100,000 equipment
loan dated June 20, 1996, secured by equipment and accounts
receivable. Interest rate is at 12%, with monthly principal
and interest payments of $2,224........................... $66,972
Austin Community Development Corporation, $100,000 working
capital loan dated June 14, 1995, secured by equipment
and accounts receivable. Interest rate is at 9%, with 48
monthly principal installments of $2,489.................. 35,417
Neighborhood Commercial Management Program, $75,000 loan
from City of Austin dated June 8, 1995, secured by second
lien on equipment and accounts receivable. Interest rate
is at 3%, with 60 monthly installments of principal and
interest of $1,347. This note was in default at March 31,
1999, due to covenant violations.......................... 31,833
Neighborhood Commercial Management Program,
$250,000 loan from City of Austin dated August
12, 1996, secured by second lien on equipment
and accounts receivable. Interest rate is at 3%, with
60 monthly installments of principal and interest of
$4,492. This note was in default at March 31, 1999,
due to covenant violations................................ 154,703
--------
288,925
Less current portion........................................ (235,420)
--------
$ 53,505
========
</TABLE>
Following are maturities of long-term debt for each of the next five years:
<TABLE>
<CAPTION>
YEAR ENDING MARCH 31
--------------------
<S> <C>
2000................. $235,420
2001................. 28,469
2002................. 25,036
--------
Total...... $288,925
========
</TABLE>
Certain former officers of the Company have personally guaranteed all notes.
5. OBLIGATIONS UNDER CAPITAL LEASES
The Company leases transportation, communication and electronic equipment
under capital leases expiring in various years through March 2004. The assets
and liabilities under capital leases are recorded at the lower of the present
value of the minimum lease payments or the fair value of the assets. The assets
are depreciated over the shorter of their related lease terms or estimated
productive lives. Depreciation of assets under capital leases is included in
depreciation expense.
Following is a summary of property held under capital leases as of March 31,
1999:
<TABLE>
<S> <C>
Vehicles................... $ 310,228
Communication Equipment.... 56,014
Electronic Equipment....... 707,831
</TABLE>
F-10
<PAGE> 43
Minimum future lease payments under capital leases as of March 31, 1999, for
the next five years and in the aggregate are:
<TABLE>
<S> <C>
2000 .......................................... $ 349,044
2001 .......................................... 378,405
2002 .......................................... 288,701
2003 .......................................... 288,701
2004 .......................................... 246,267
-----------
Total minimum lease payments .................. 1,551,116
Less amount representing interest ............. (751,452)
-----------
799,664
Less current portion .......................... (118,736)
-----------
Long-term obligations under capital leases .... $ 680,928
===========
</TABLE>
The Company issued warrants for and in consideration of a capital lease
obtained during the year ended March 31, 1999. The warrants granted the right to
purchase 30,000 shares of Common Stock, at an exercise price of $4.00 per share,
and were treated as a discount to the capital lease obligation. The discount was
valued at $81,300 and has an effective interest rate of 37%. It is being
amortized over the life of the lease, or 5 years. At March 31, 1999, the
amortization of the discount totaled $923. See Note 11 for discussion of
warrants issued.
6. FEDERAL INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary difference
between the carrying amounts of assets and liabilities for financial statement
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred taxes are as follows:
<TABLE>
<CAPTION>
MARCH 31, 1999
--------------
<S> <C>
Deferred tax liability:
Depreciable assets ................ $ (50,000)
Deferred tax assets:
Net operating loss carryforwards... 3,778,000
Nonqualified stock options ........ 139,000
-----------
Deferred tax asset ................. 3,917,000
Valuation allowance ............... (3,867,000)
Net deferred tax asset ............ 50,000
-----------
Net deferred taxes ................ $ --
===========
</TABLE>
The valuation allowance increased by approximately $2,409,000 during the
year ended March 31, 1999 primarily because the Company generated additional net
operating losses during the year which are not expected to be utilized.
As of March 31, 1999, the Company had federal net operating loss
carryforwards of approximately $11,112,000 which will expire beginning in 2011,
if not utilized. Utilization of the net operating losses may be subject to a
substantial limitation due to the "change in ownership" provisions of the
Internal Revenue Code of 1986. The annual limitation may result in the
expiration of net operating losses before utilization.
The Company's expense (benefit) for income taxes attributable to continuing
operations differs from the expected tax benefit amount by applying the
statutory federal income tax rate of 34% to income before taxes as a result of
the following:
<TABLE>
<CAPTION>
MARCH 31, 1999
------------------------------
TAX AMOUNT TAX RATE
------------------------------
<S> <C> <C>
Federal statutory rate ......... $(2,535,000) 34%
Permanent differences .......... 126,000 (1.7)%
Valuation allowance ............ 2,409,000 (32.3)%
----------- ------
Total expense (benefit) .... $ -- 0%
=========== ======
</TABLE>
7. RELATED PARTY TRANSACTIONS
On December 1, 1997, the Company entered into a consulting agreement with an
entity whose President is the Chairman of the Board of the Company. The terms of
the consulting agreement include the following:
- $10,000 fee per month plus reasonable business expenses,
- 75,000 shares of Common Stock (issued on January 13, 1998),
- an option to purchase 75,000 shares of Common Stock,
- and various fees and commissions for acquisitions or sales secured by the
entity.
During the year ended March 31, 1999 the Company recognized expenses
totaling $132,356 related to this consulting agreement.
See also Note 13.
F-11
<PAGE> 44
8. COMMITMENTS
The Company leases its principal general offices and warehouse facilities.
The leases expire at August 31, 2005 and July 31, 2008, each with a 10 year
renewable option. Future minimum lease payments (excluding property taxes) are
as follows:
<TABLE>
<CAPTION>
YEAR ENDING MARCH 31
- --------------------
<S> <C>
2000............................................. $ 231,248
2001............................................. 242,563
2002............................................. 266,365
2003............................................. 281,789
2004............................................. 297,458
Thereafter....................................... 1,065,249
----------
Total.................................. $2,384,672
==========
</TABLE>
The total rental expense for the year ended March 31, 1999 was $227,463.
9. COMMON STOCK
As of March 31, 1999, the Company had reserved shares of common stock for
future issuance as follows:
<TABLE>
<S> <C>
Stock options........................... 1,500,000
Common stock warrants................... 2,550,000
Convertible preferred stock............. 7,625,920
----------
11,675,920
</TABLE>
There are no restrictions on the payment of dividends.
10. CONVERTIBLE PREFERRED STOCK
The Company has 10,000,000 authorized shares of preferred stock. In October
1997, the Company completed a Private Placement Agreement, (the "Agreement")
with a group of accredited investors. The Agreement provided for three "Phases"
of financing.
All of the Convertible preferred stock agreements entered into by the
Company contained restrictions limiting the conversion of the preferred stock in
order to maintain the Company's status as a Historically Underutilized Business
(HUB).
Phase I of the Agreement was funded in November 1997. The Company received
$2,120,000 in exchange for 400,000 shares of Series B Preferred Stock. An
additional 20,000 shares of Series B Preferred were issued as placement agent
fees. Those shares along with 70,000 shares of Series B Preferred were converted
to 900,000 shares of Common Stock during the year ended March 31, 1999.
At the time of issuance, the Series B Preferred Stock was convertible to
Common Stock at an amount that was "in-the-money". The beneficial conversion
feature was limited to the proceeds of the offering. Although the preferred
stock was convertible immediately at the option of the holder, the conversion
was limited in accordance with a restrictive covenant in the agreement in order
to preserve the Company's HUB status. As a result, $961,540 in discount was
deferred and recognized in fiscal 1999 when the Company elected not to renew its
HUB status.
In fiscal 1998, the Company issued convertible debt at a discount. The
discount was limited to the proceeds of $371,000. The discount was deferred to
1999, again due to the preservation of the Company's HUB status. In 1999, the
Company recognized the discount as interest expense.
Phase II of the Agreement was funded in February 1998. The Company received
$1,000,004 in exchange for 94,340 shares of Series C Preferred Stock (Series C
Preferred). During the year ended March 31, 1999 all 99,057 shares of Series C
Preferred were converted to 990,570 shares of the Registrant's Common Stock.
At the time of issuance, the Series C Preferred Stock was convertible to
Common Stock at an amount that was "in-the-money". This beneficial conversion
feature was limited to the proceeds of the offering. Although the preferred
stock was convertible immediately at the option of the holder, the conversion
was limited in order to preserve the Company's HUB status. As a result, the
recognition of the $870,004 discount was deferred until the Company elected not
to renew its HUB status, making the preferred stock eligible for conversion
during fiscal 1999.
F-12
<PAGE> 45
Phase III of the Agreement was funded in May through July 1998. The Company
received $2,823,204 in exchange for 266,340 shares of Series D Preferred Stock.
The Company paid $349,284 in cash and issued 13,317 shares of Series D Preferred
Stock for placement agent fees. Also, options to purchase 255,850 shares of
Common Stock at $1.59 per share were issued as a part of the agreement. The
stock options had a fair value of $1,061,723. During the year ended March 31,
1999 the 13,317 shares of Series D Preferred issued as placement agent fees were
converted to 133,170 shares of the Registrant's Common Stock. Also during the
year ended March 31, 1999, 70,000 shares of Series D Preferred were converted to
700,000 shares of the Registrant's Common Stock.
At the time of issuance the Series D Preferred Stock was convertible to
Common Stock at an amount that was "in-the-money". This beneficial conversion
feature was limited to the proceeds of the offering and was accounted for as an
increase to additional paid in capital and an in-substance dividend to the
related preferred stockholders. The beneficial conversion feature resulted in
the recognition of a discount of $2,964,364, which is composed of the gross
proceeds of the offering and the stated value of the Series D Preferred Stock
issued for placement agent fees.
During the year ended March 31, 1999, the Company received $53,000 for 5,000
shares of Series D Preferred Stock at $10.60 per share. Due to the Series D
being oversubscribed, the Company issued 50,000 shares of Common Stock subject
to Rule 144 restrictions.
During fiscal 1999, the Company concluded the private placement of 119,668
shares of the Series E Preferred Stock at $30 per share. The Company paid
approximately $415,800 in cash and issued 6,584 shares of the Series E Preferred
Stock for placement agent fees. Also, options to purchase 90,584 shares of
Common Stock at $4.50 per share were issued as part of the agreement. The
options were valued at $434,994. The Series E Preferred offering raised proceeds
of $3,590,040 as of March 31, 1999. At March 31, 1999, an additional $600,000 of
gross proceeds (representing 20,000 shares of Series E Preferred) was subscribed
from stockholders and was recorded as Preferred Stock Subscribed in the
accompanying financial statements. Expenses for placement agent fees of $73,200
had not been paid as of March 31, 1999.
At the time of issuance the Series E Series stock was convertible to Common
Stock at an amount that was "in-the-money". This beneficial conversion feature
was limited to the proceeds of the offering and was accounted for as an increase
to additional paid in capital and an in-substance dividend to the related
preferred stockholders. The beneficial conversion feature resulted in the
recognition of a discount of $3,787,560, which is composed of the gross proceeds
of the offering and the stated value of the Series E Preferred Stock issued for
placement agent fees.
The Company's convertible preferred stock had the following characteristics:
<TABLE>
<CAPTION>
DIVIDEND LIQUIDATION CONVERSION VOTING
DESCRIPTION FEATURES PREFERENCE FEATURES RIGHTS
---------------- ----------- ----------------------- ----------------------- --------
<S> <C> <C> <C> <C>
Series B 5% Stated value ($5.30/share) One for ten, subject to None
cumulative plus accrued but unpaid adjustment as defined,
plus dividends six warrants
to purchase six shares of
common for $1.50/share
Series C 6% Stated value ($10.60/share) One for ten, subject to None
cumulative plus accrued but unpaid adjustment as defined
dividends
Series D 6% Stated value ($10.60/share) One for ten, subject to None
Cumulative plus accrued but unpaid adjustment as defined
dividends
Series E 6% Stated value ($30.00/share) One for ten, subject to None
cumulative plus accrued but unpaid adjustment as defined
dividends
</TABLE>
All preferred stock dividends have been paid through the issuance of common
stock.
11. STOCK OPTIONS AND WARRANTS
The Company has granted stock options to employees, outside consultants, and
placement agents. Each stock option granted can be exercised for one share of
Common Stock. Options are generally awarded at the discretion of the Board of
Directors, expire after 1.5 to 10 years, and vest over periods ranging from
immediately to 3 years.
On July 18, 1998, the Board of Directors adopted the 1998 Stock Option Plan
(the Plan). The Plan authorizes 1,500,000 shares of Common Stock for future
issuance. The Plan provides for options to be issued at not less than the fair
market value of the Common Stock on the date of grant, and for a term of not
more than 10 years.
F-13
<PAGE> 46
A summary of the status of the Company's stock options as of March 31, 1999,
is presented below:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
EXERCISE
OPTIONS PRICE
---------- ----------
<S> <C> <C>
Options outstanding at beginning of period........................ 622,170 $ 1.72
Options granted................................................... 1,427,934 4.50
Options exercised................................................. -- --
Options forfeited................................................. (275,500) 7.03
--------- ------
Options outstanding at end of period.............................. 1,774,604 $ 3.13
========= ======
Options exercisable at end of period.............................. 1,186,094
=========
</TABLE>
The weighted-average grant-date fair value of options granted during the
year is as follows:
<TABLE>
<S> <C>
Exercise price less than fair value of stock on date of grant....................... $ 5.08
Exercise price equal to fair value of stock on date of grant....................... 4.33
Exercise price greater than fair value of stock on date of grant.................... 3.26
</TABLE>
The following table summarizes outstanding stock options as of March 31,
1999:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE WEIGHTED
OPTIONS REMAINING WEIGHTED OPTIONS AVERAGE
RANGE OF OUTSTANDING AT CONTRACTUAL AVERAGE EXERCISABLE AT EXERCISE
EXERCISE PRICE MARCH 31, 1999 LIFE IN YEARS EXERCISE PRICE MARCH 31, 1999 PRICE
------------------- ------------------- ----------------- ------------------ ------------------- ---------
<S> <C> <C> <C> <C> <C>
$ 1.50 to $ 2.25...... 880,850 4.0 $ 1.58 814,340 $ 1.58
3.75 to 4.88........ 712,754 4.4 3.97 262,754 4.34
6.81 to 8.63........ 180,000 6.1 7.37 109,000 7.22
10.25 to 11.50....... 1,000 4.4 10.25 -- --
--------- ---------
1.50 to 11.50....... 1,774,604 4.4 3.13 1,186,094 2.71
========= =========
</TABLE>
Stock options granted to employees were recorded as compensation expense in
the amount of $177,965 to the extent the exercise price was less than the market
price of the stock on the grant date, in accordance with APB No. 25.
Stock options to non-employees as included above have been accounted for at
the fair value of the options at the grant date as determined using the
Black-Scholes option-pricing model. Options to consultants were recorded as
professional fees in the amount of $232,300, and options granted for placement
agent fees were valued at $1,496,667 for the year ended March 31, 1999.
The pro forma compensation expense as defined by SFAS No. 123 for stock
options granted to employees included in the pro forma information below is
determined based on the fair value of the options at the grant date using the
Black-Scholes option-pricing model and the following assumptions: risk-free
interest rates of 5.66% to 6.34%; no dividend yield; volatility of 0.985; and
expected option lives of 2 to 5.25 years.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. Pro forma net
loss and net loss per share information is as follows:
<TABLE>
<S> <C>
Net loss to common stockholders:
As reported............................... $(16,404,539)
============
Pro forma................................. (17,052,217)
============
Basic and diluted net loss per share:
As reported............................... $ (1.30)
============
Pro forma................................. (1.35)
============
</TABLE>
In addition, the Company has 2,550,000 warrants outstanding and exercisable
as of March 31, 1999. As indicated in Note 5, 30,000 warrants were issued during
the current year in connection with capital leases with an exercise price of
$4.00 per share. Of these warrants, 28,000 were exercised in July 1999, and
2,000 expired on July 18, 1999. The remaining 2,520,000 warrants outstanding
were issued during the year ended March 31, 1998 in connection with the Series B
Preferred Stock Private Placement Agreement and have an exercise price of $1.50
and expire on January 31, 2000.
During the year ended March 31, 1999, 420,000 warrants also previously
issued in connection with the Series B Preferred Stock Private Placement were
exercised for shares of Common Stock at $0.795 per share, totaling $333,900 in
proceeds.
F-14
<PAGE> 47
12. NET LOSS PER SHARE
No potentially dilutive securities were included in the basic and diluted
loss per share calculation as they would have been anti-dilutive. The following
table summarizes additional common shares that would, if converted, dilute
earnings. The number of common shares for each item is based on the number of
potentially dilutive securities outstanding as of the end of the year. The
figures presented for the convertible Preferred Stock assume that each preferred
share was converted into 10 common shares.
<TABLE>
<CAPTION>
MARCH 31, 1999
--------------
<S> <C>
Series B convertible Preferred Stock................. 4,000,000
Series D convertible Preferred Stock................. 1,963,400
Series E convertible Preferred Stock................. 1,262,520
Stock options........................................ 1,774,604
Warrants............................................. 2,550,000
----------
11,550,524
==========
</TABLE>
13. CONTINGENCIES
As of March 31, 1999, the Company has agreed to settle its lawsuits related
to the Company's relationship with a former consultant, Kenneth O'Neal
("O'Neal") and a firm which he controls, Argus Management, Inc. ("Argus"). On
December 18, 1997 Argus filed a lawsuit in Kerr County, Texas, 216th Judicial
District, to collect on two promissory notes in the aggregate principal amount
of $200,000. The Company vigorously defended this lawsuit and filed a related
suit against O'Neal and Argus in Travis County, Texas on February 6, 1998,
alleging fraud, usury in connection with the promissory notes, and seeking an
order from the Court demanding that Argus transfer 293,185 shares of Common
Stock of the Company, held by Argus, to various stockholders who have previously
purchased such shares (the "Argus Related Shares"). The agreed upon settlement
provides that Argus return 200,250 shares of the Company's Common Stock to the
Company, that the Company tender $250,000 to Argus and that the Company issue
the balance of 92,935 shares of Common Stock as restricted shares. The parties
have agreed to cancel the two promissory notes from the Company to Argus and
write-off an accounts receivable from Argus in the amount of $65,000 and release
all other claims among the parties.
During the year ended March 31, 1999, the Company incurred a business
obligation with Dr. Davinder Sethi, a director, and MMH Investments, Inc., a
company that is principally owned and controlled by Robert Hersch, the Company's
vice president of corporate finance. The consulting firm also has a financial
arrangement with another Director of the Company. The consulting firm claimed
compensation of 250,000 shares of the Company's common stock for services
allegedly performed. The Company disputed the validity of the claim. On December
20, 1999, this claim was settled. The Company issued 150,000 shares of common
stock to MMH Investments, Inc., and agreed to immediately register the shares
for resale on Form S-3.
14. SIGNIFICANT FOURTH QUARTER ADJUSTMENTS (UNAUDITED)
The following significant adjustments were made during the fourth quarter of
the year ended March 31, 1999:
<TABLE>
<CAPTION>
DESCRIPTION AMOUNT
-------------------------- ----------
<S> <C>
Inventory charge.......................... $ (232,000)
Consulting agreement...................... (550,000)
----------
Net decrease in income.................... $ (782,000)
==========
Per share decrease in income.............. $ (0.06)
==========
</TABLE>
15. SUBSEQUENT EVENTS
EMPLOYMENT CONTRACTS:
In June 1999, the Company entered into an employment agreement with its
President and Chief Executive Officer which calls for an established base annual
salary and a stock option to purchase 1,362,950 shares of Common Stock with a
vesting period over two years. This agreement is terminable by either party at
any time. In connection with this agreement, the Company also loaned $100,000 at
an interest rate of 8% with principal and interest due on July 16, 2000.
CONTINGENCIES AND LEGAL:
On July 28, 1999, the Company was sued by its former President and its
former Chief Technology Officer seeking more than $50,000, excluding cost and
attorneys' fees. A settlement was reached during mediation on September 20,
1999. Formal settlement documents have been executed by the parties in the
lawsuit. The terms of the settlement are confidential, but were not material.
F-15
<PAGE> 48
On November 19, 1999, the Company received a letter from Ernesto Chavarria,
a director, demanding payment of approximately $63,000 of past due board of
directors' fees and the issuance of options to acquire 45,000 shares of common
stock. The Company believes that it owes Mr. Chavarria his annual grant of
options to acquire 25,000 shares of common stock and his $1,000 per meeting
board fees for recent meetings, representing an aggregate of $9,000 as of
December 31, 1999. The Company believes that it does not owe Mr. Chavarria any
other amounts.
EQUITY:
Through June 30, 1999, the Company received gross proceeds of $600,000 from
the Private Placement of 20,000 shares of Series E, 6% Cumulative Convertible
Non-Voting Preferred Stock, Stated value $30.00 per share. The Company paid
$73,200 in cash for payment of commission fees of the Private Placement. Each
share of Preferred E stock is initially convertible into ten shares of the
Company's Common Stock.
At the time of issuance the Series E Preferred Stock was convertible to
Common Stock at an amount that was "in-the-money". This beneficial conversion
feature was limited to the proceeds of the offering and was accounted for as an
increase to additional paid in capital and an in-substance dividend to the
related preferred stockholders. The beneficial conversion feature resulted in
the recognition of a discount of $600,000 in the quarter ended June 30, 1999,
which is equivalent to the gross proceeds of the offering.
Through the nine months ended December 31, 1999, 16,654 shares of common
stock were issued as preferred stock dividends and were recorded as an increase
in retained deficit in the amount of $81,339.
Through February 2000 all outstanding shares of preferred stock were
converted into common stock. 400,000 shares of Series B, 196,340 shares of
Series D, and 146,252 shares of Series E Preferred Stock were collectively
converted to 7,425,920 shares of Common Stock.
During the nine months ended December 31, 1999, the Company issued 1,598,011
shares of Common Stock in a private placement resulting in net proceeds of
$4,859,175.
During February 2000, the Company concluded a private placement of its
common stock. The Company raised $55 million in gross proceeds and issued
9,167,667 shares of common stock in the offering. The Company intends to use the
net proceeds of the offering to build out additional data centers, implement a
sales and marketing campaign, hire additional sales and marketing personnel,
repay indebtedness and for general corporate purposes.
Through February 2000, the Company issued 2,771,650 shares of common stock
and received proceeds of $3,990,865 from the exercise of 2,771,650 common stock
warrants.
On February 1, 2000, the Company entered into an agreement with Equity
Services, LTD, ("ESL") the placement agent for our prior private placements of
equity securities, and ESL's affiliate, Entrepreneurial Investors, Ltd. ("EIL").
The agreement became effective upon the completion of our private placement
during February 2000. Pursuant to the agreement, EIL and ESL facilitated the
conversion of all of the Company's outstanding preferred stock into shares of
common stock, and the Company issued to EIL a warrant to purchase 500,000 shares
of common stock at an exercise price of $12 per share. The issuance of the
warrants to EIL resulted in an expense to the Company of approximately $2.4
million in February 2000, as an arrangement fee to EIL for services.
During the nine months ended December 31, 1999, 183,000 shares of common
stock were issued for compensation and were recorded as professional fees in the
amount of $1,051,610.
NOTE AND LEASE PAYABLES:
In October 1999, the Company was approved for an initial $1,200,000 in lease
financing with Cisco Systems Capital Corporation. In January 2000 the Company
was approved for an additional $8,000,000 in lease financing through Cisco
Systems Capital Corporation. This financing will be used to purchase equipment
for the data center expansion plans of the Company.
Through January 2000, the Company received a total of $2,286,500 in bridge
loans from thirty-nine accredited individuals. These promissory notes bear
interest of 8.25% per annum and mature in March, April and May of 2000 or upon
consummation of a public offering by our Company, whichever is sooner. In
connection with these loans, warrants were issued to purchase an aggregate of
228,650 shares of our common stock with an exercise price of $0.10 per share.
The Company paid $228,670 in cash for debt issuance costs.
F-16
<PAGE> 49
During January 2000, the Company received $2,000,000 in a secured bridge
loan from TSG Financial Limited Partnership. The promissory note bears interest
at prime (8.25% at December 31, 1999) and matures on June 30, 2000 or upon the
consummation of the $55 million equity financing disclosed above. The
outstanding principal and interest under the note is convertible at TSG's option
into the securities issued in such financing at the lowest sale price for such
securities. In connection with this loan, stock warrants were issued to purchase
an aggregate of 200,000 shares of our common stock with an exercise price of
$0.10 per share.
SERVICE, SUPPORT & INTEGRATION:
In October 1999, the Company was notified by its Service, Support, and
Integration ("SSI") customers that as of October 31, 1999, the contracts for SSI
would not be renewed. The cancellation of these contracts affected fifteen
employees of the Company. This change did not have a material adverse effect on
the Company's results of operations or financial condition as the Company's
revenues now are primarily from Broadband Internet Services.
ADDITIONAL FACILITIES:
The Company has executed five additional leases to construct new data
centers in Atlanta, Dallas, Denver, Phoenix, and Tampa. Phase I of the data
center construction in Dallas and Tampa is scheduled for completion by March 31,
2000. Additional phases will be completed in Dallas and Tampa as needed. Phase I
construction of data centers in Atlanta, Denver, and Phoenix is being scheduled
at this time. The Phase II expansion of the Austin data center is also scheduled
for completion by March 31, 2000.
CONNECTIVITY AGREEMENTS:
During the quarter ended December 31, 1999, the Company signed 3-year
agreements with GTE Internetworking for their Internet Advantage connectivity
service for the cities of Atlanta, Austin, Chicago, Dallas, Denver, Los Angeles,
Philadelphia, Phoenix, Reno, San Francisco and Tampa. This will provide the
Company with direct connections to the GTE POP in each of the above cities when
the Company completes its construction of new data centers within those cities.
LOCATION CHANGE OF CORPORATE OFFICE:
The Company relocated its corporate headquarters to 1121 East 7th Street,
Austin, Texas 78702 on February 7, 2000.
STOCK OPTION PLANS:
On August 9, 1999, the stockholders approved an amendment to the 1998 Stock
Option Plan to increase the number of common shares reserved for future issuance
from 1,500,000 to 4,500,000 shares.
On August 9, 1999, the stockholders approved the Non-Employee Directors
Stock Option Plan. The Plan provides for the grant of nonqualified options, as
defined by the Internal Revenue Code, to directors
NOTE 16: RESTATEMENT OF FINANCIAL STATEMENTS
The Company has restated the accompanying financial statements for the
year-ended March 31, 1999 to (i) effect for the limitation of dividend
recognition by $10,551,000 related to the beneficial conversion features on the
convertible preferred stock issuances (previously, the Company did not limit the
recognition of a discount and the related dividend to the proceeds raised in the
issuance), (ii) record additional consulting fees of $269,000 incurred during
the year but not previously recognized, (iii) record additional stock
compensation expense of $225,000 not previously recognized for options issued
during the year, (iv) record amortization of interest expense of $371,000
related to prior year debt discounts, and (v) record various other items
resulting in additional expense of $119,000. The following table shows the
restated results of operations for the period compared to previously reported
results:
<TABLE>
<CAPTION>
PREVIOUSLY
AS RESTATED REPORTED
----------- -------------
<S> <C> <C>
Net loss $ (7,457,202) $(6,472,943)
Preferred stock dividends and discounts (8,947,337) (19,498,451)
Net loss to common stockholders (16,404,539) (25,971,394)
Basic and diluted net loss per share (1.30) (2.06)
</TABLE>
F-17
<PAGE> 50
BROWN, GRAHAM & CO., P.C.
CERTIFIED PUBLIC ACCOUNTANTS
GEORGETOWN, TEXAS
To the Board of Directors of Micro-Media Solutions, Inc.,
INDEPENDENT AUDITOR'S REPORT
We have audited the accompanying consolidated balance sheet of
Micro-Media Solutions, Inc. and Subsidiary (the "Company") as of March 31, 1998
and the related consolidated statements of operations, stockholders' equity and
cash flows for the year then ended. These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated financial statements based on our audit.
We conducted our audit 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 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 the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Micro-Media
Solutions, Inc. and Subsidiary as of March 31, 1998, and the results of their
operations and cash flows for the year then ended in conformity with generally
accepted accounting principles.
The accompanying financial statements have been prepared assuming that
the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, and the Company has suffered losses from
operations for the years ended March 31, 1998 and current liabilities exceed
current assets by $192,080 at March 31, 1998, which raise substantial doubt
about its ability to continue as a going concern. The financial statements do
not include any adjustments relating to the recoverability and classification of
recorded assets, or the amounts and classification of liabilities that might be
necessary in the event the Company cannot continue in existence.
As more fully described in Note 14, subsequent to the issuance of the
Company's March 31, 1998, financial statements and our report thereon dated June
9, 1998, we became aware that those financial statements did not reflect certain
adjustments as described in Note 14. In our original report we expressed an
unqualified opinion on the March 31, 1998, financial statements as described in
paragraph three above, and our opinion on the revised statements, as expressed
herein, remains unqualified.
/s/ Brown, Graham & Company, P.C.
Georgetown, Texas
June 9, 1998, except as the fifth paragraph above and Note 14, which are as of
September 24, 1999
F-18
<PAGE> 51
MICRO-MEDIA SOLUTIONS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET (RESTATED)
MARCH 31, 1998
ASSETS
<TABLE>
<S> <C>
Current assets:
Cash and cash equivalents $ 25,786
Accounts receivable - Trade 150,851
Inventory 285,023
Short-term Investment, restricted (Note 4) 1,350,000
Other receivables - Advances (Note 2) 86,961
-----------
Total current assets 1,898,621
-----------
Property, plant and equipment, net (Notes 3, 5 & 6) 800,831
-----------
Total assets $ 2,699,452
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable - trade $ 300,035
Other accrued expenses 169,336
Bank line of credit (Note 4) 1,228,966
Current maturities of long-term debt (Note 5) 151,267
Current portion of obligations under
capital leases (Note 6) 41,097
Other notes payable (Note 13) 200,000
-----------
Total current liabilities 2,090,701
-----------
Long-term liabilities:
Notes payable (Note 5) 367,522
Obligations under capital leases (Note 6) 149,560
Deferred Rent 145,620
-----------
Total long-term Notes 662,702
-----------
Commitments and contingencies (Notes 9 & 13)
Total liabilities 2,753,403
-----------
Stockholders' equity (Note 10)
Preferred stock Series B; $5.30 stated value;
490,000 shares authorized, issued & outstanding 2,597,000
Preferred stock Series C; $10.60 stated value;
99,057 shares authorized, issued & outstanding 1,050,004
Common stock at $.10 par value; 50,000,000
authorized, 11,506,846 shares issued & outstanding 1,150,685
Additional paid-in capital 698,057
Accumulated deficit (5,549,697)
-----------
Total stockholders' equity (53,951)
-----------
Total liabilities and stockholders' equity $ 2,699,452
===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-19
<PAGE> 52
MICRO-MEDIA SOLUTIONS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS (RESTATED)
FOR THE YEAR ENDED MARCH 31, 1998
<TABLE>
<S> <C>
Revenues:
Hardware, software and peripherals $ 1,350,869
Service, support and integration 704,241
Networks, LAN/WAN 685,711
------------
Total revenues 2,740,821
------------
Cost of goods sold:
Hardware, software and peripherals 1,406,612
Service, support and integration 1,027,617
Networks, LAN/WAN 1,185,572
------------
Total cost of goods sold 3,619,801
------------
Gross margin (deficit) (878,980)
------------
Selling, general and administrative expenses:
Salaries and benefits 1,299,003
Professional fees and consultants 361,075
Advertising and marketing 55,561
Occupancy 392,500
Depreciation 178,892
Vehicle expense 106,131
Other expense 272,978
Interest expense 294,198
Provision for uncollectible accounts 73,252
------------
Total selling, general and administrative expenses 3,033,590
------------
Net loss (3,912,570)
Plus: Preferred stock dividends (1,503,128)
------------
Net loss available to common stockholders $ (5,415,698)
============
Basic and diluted net loss per share $ (.49)
============
Basic and diluted weighted average shares outstanding 10,998,874
============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-20
<PAGE> 53
MICRO-MEDIA SOLUTIONS, INC, AND SUBSIDIARY
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (RESTATED)
FOR THE YEAR ENDED MARCH 31, 1998
<TABLE>
<CAPTION>
Series B Series C Common Stock
----------------------- ---------------------- --------------------------
Shares Amount Shares Amount Shares Amount
------- ----------- ------ ----------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balance March 31, 1997 0 0 0 0 10,764,733 1,076,473
Common stock issued:
Interest 0 0 0 0 10,286 1,029
Compensation 0 0 0 0 414,900 41,490
Preferred stock dividend 0 0 0 0 23,742 2,374
Preferred stock issued:
Private Placement 420,000 2,226,000 99,057 1,050,004 0 0
Senior Debt 70,000 371,000 0 0 0 0
Preferred stock dividend
discount 0 0 0 0 0 0
Stock option for:
Compensation 0 0 0 0 0 0
Placement agents 0 0 0 0 0 0
Cash received for
uncertificated stock 0 0 0 0 293,185 29,319
Common stock-uncertificated
issued for note receivable 0 0 0 0 0 0
Note receivable offset against
common stock subscribed 0 0 0 0 0 0
Net loss 0 0 0 0 0 0
------- ----------- ------ ----------- ---------- -----------
Balance March 31, 1998 490,000 $ 2,597,000 99,057 $ 1,050,004 11,506,846 $ 1,150,685
======= =========== ====== =========== ========== ===========
</TABLE>
<TABLE>
<CAPTION>
Common Stock
------------------------- Additional
Subscribed (Discount on) Accum-
------------------------- Paid - In ulated
Shares Amount Capital Deficit Total
-------- ----------- ------------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Balance March 31, 1997 0 0 (1,046,058) (133,999) (103,584)
Common stock issued:
Interest 0 0 4,114 0 5,143
Compensation 0 0 250,367 0 291,857
Preferred stock dividend 0 0 56,294 (58,668) 0
Preferred stock issued:
Private Placement 0 0 0 (975,641) 2,300,363
Senior Debt 0 0 0 0 371,000
Preferred stock and Senior Debt dividend
discount 0 0 856,460 ( 856,460) 0
Stock option for:
Compensation 0 0 93,750 0 93,750
Placement agents 0 0 0 387,641 387,641
Cash received for
uncertificated stock 0 0 483,130 0 512,449
Common stock-uncertificated
issued for note receivable 543,000 407,250 0 0 407,250
Note receivable offset against
common stock subscribed (543,000) (407,250) 0 0 (407,250)
Net loss 0 0 0 (3,912,570) (3,912,570)
-------- ----------- ----------- ----------- -----------
Balance March 31, 1998 0 $ 0 $ 698,057 $(5,549,697) $ ( 53,951)
======== =========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-21
<PAGE> 54
MICRO-MEDIA SOLUTIONS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (RESTATED)
FOR THE YEAR ENDED MARCH 31, 1998
<TABLE>
<S> <C>
Cash flows from operating activities:
Net loss $ (3,912,570)
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation expense 178,892
Stock issued for compensation and placement agent fees 291,857
Stock options issued for compensation 93,750
Stock issued for interest 5,143
Change in trade receivables 832,062
Change in inventory (19,569)
Change in accounts payable (577,325)
Change in deferred rent 145,620
Change in accrued expenses 57,775
------------
Net cash used by operating activities (2,904,365)
------------
Cash flows from investment activities:
Purchase of property & equipment (195,685)
Purchase of short term investment (1,350,000)
Additional notes receivables (142,265)
Proceeds from notes receivables 477,645
Proceeds from other receivables 162,793
Additional other receivables (121,341)
------------
Net cash used by investing activities (1,168,853)
------------
Cash flows from financing activities:
Proceeds from line of credit (net) 504,076
Proceeds from other notes payable 200,000
Payments on long-term debt (162,153)
Payments on capital lease obligations (32,485)
Proceeds from private placement of preferred stock 2,688,004
Proceeds from issuance of common stock 512,450
Proceeds from senior convertible debt 371,000
------------
Net cash provided by financing activities 4,080,892
------------
Net increase in cash 7,674
Cash as beginning of period 18,112
------------
Cash at end of period $ 25,786
============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-22
<PAGE> 55
MICRO-MEDIA SOLUTIONS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOW (RESTATED) - CONTINUED
FOR THE YEAR ENDED MARCH 31, 1998
<TABLE>
<S> <C>
Supplemental disclosure:
Cash paid during the year for:
Interest $ 232,578
============
Supplemental schedule of non-cash investing and
financing activities:
Preferred stock issued for placement agent fees $ 156,000
Stock options:
Placement agent fees 387,641
Compensation 93,750
Common stock issued for:
Compensation 291,857
Interest on debt 5,143
Preferred stock dividends 58,668
Common stock subscribed for note receivable 407,250
Debt converted to preferred stock 371,000
Inventory received for other notes receivable 84,394
Discount on preferred stock issued for dividend 856,460
============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-23
<PAGE> 56
MICRO-MEDIA SOLUTIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (RESTATED)
FOR THE YEAR ENDED MARCH 31, 1998
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS AND ORGANIZATION:
Micro-Media Solutions, Inc. (formerly Mountain States Resources Corporation,
("MSRC")), was organized under the laws of the State of Utah on April 15, 1969.
MSRC began operations in April 15, 1969, as a mining, mineral extraction and oil
and gas exploration company. MSRC discontinued its operations in 1993 and became
a development stage company as described in the Statement of Financial
Accounting Standards No.7, "Accounting and Reporting by Development Stage
Enterprises". On June 23, 1997, MSRC entered into an agreement and plan of
reorganization with the shareholders of Micro-Media Solutions, Inc. (a Texas
Corporation), ("MSI-Texas"), in which MSRC acquired 100% of the common stock of
MSI-Texas. As part of the reorganization, MSRC changed its name to Micro-Media
Solutions, Inc., (a Utah Corporation), ("MSI") (the "Company"). The transaction
was accounted for as a recapitalization.
MSI-Texas is an Austin, Texas, based technology corporation formed to provide
computer hardware, software programming, system support, maintenance, media
duplication, and kitting to the public and private sectors. In addition,
MSI-Texas is certified by the State of Texas as a Historically Underutilized
Business (HUB).
MSI-Texas is a business solutions technology integrator with infrastructure
design and implementation services. In addition, MSI-Texas' computer networking
services includes system integration and local and wide-area networks.
GOING CONCERN:
As shown in the accompanying consolidated financial statements, the Company has
incurred a net loss in the current year of $3,912,570. As of March 31, 1998, the
Company's current liabilities exceeded its current assets by $192,080 and owes
accounts payable with dates due in excess of thirty (30) days in the approximate
amount of $170,000. These factors create a substantial doubt about the Company's
ability to continue as a going concern. The ability of the Company to continue
as a going concern is dependent on the Company's obtaining additional financing
to fund the expenses related to operations and capital improvements.
Subsequent to March 31, 1998, the Company received $2 million in phase III of a
private placement agreement, (see Note 10), which have been used to retire debt,
decrease past due accounts payable and for operating expenses. In addition, the
Company is continuing discussions with private investment groups for a private
placement of a newly created series of preferred stock with net proceeds to the
Company of approximately $2.6 million, and plans a public offering in the year
ending March 31, 1999. Management has identified and closed substantial
contracts during the year ended March 31, 1999, and believes it can produce the
level of revenue necessary to return the Company to a positive earnings trend.
The financial statements do not include any adjustments that might be necessary
if the Company is unable to continue as a going concern.
PRINCIPLES OF CONSOLIDATION:
The consolidated financial statements for the years ended March 31, 1998 include
the accounts and transactions of MSI and MSI-Texas. All significant
inter-company accounts and transactions have been eliminated in the accompanying
consolidated financial statements. MSI, however, did not have any material asset
or liability accounts or account balances. With the exception of MSI's equity
accounts and a deficit retained earnings of $5.7 million, the significant
account balances belong to MSI-Texas.
CASH AND CASH EQUIVALENTS:
Cash equivalents consist primarily of funds invested in short-term
interest-bearing accounts. The Company considers all highly liquid investments
purchased with initial maturities of three months or less to be cash
equivalents.
F-24
<PAGE> 57
MICRO-MEDIA SOLUTIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (RESTATED)
FOR THE YEAR ENDED MARCH 31, 1998
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
ACCOUNTS RECEIVABLE:
The Company follows the allowance method of expensing accounts receivable when
considered uncollectible. As of March 31, 1998, management believes all accounts
are collectible; and therefore, no allowance has been recorded.
INVENTORY:
Inventory is valued at lower of cost, using the FIFO method
(first-in/first-out), or market. Inventory consists principally of hardware and
software needed for maintaining and building network technology for customers.
PROPERTY, PLANT, AND EQUIPMENT:
Property and equipment are stated at cost. For financial statement purposes,
depreciation is computed using the straight-line method over the estimated
useful lives of the related assets. Amortization of leasehold improvements is
computed using the straight-line method over the shorter of the term of the
related lease or the useful life of the leasehold improvements. Accelerated
depreciation methods are used for tax purposes. Depreciation and amortization
are calculated over the following useful lives stated in years:
<TABLE>
<CAPTION>
Useful Lives
------------
<S> <C>
Vehicles 5
Furniture and fixtures 5
Equipment 5
Leasehold improvements 20
</TABLE>
REVENUE AND COST RECOGNITION:
Revenue from sales of hardware, software and peripherals is recognized upon
shipment to the customer. Most hardware, software and peripherals sales are made
without the right of return. Product returns which are minimal are recorded as a
reduction of sales upon receipt of the product. Service, support and integration
sales are recognized upon completion of the service and is not subject to
warranty.
Revenue from fixed priced contracts is recognized on the
percentage-of-completion method of accounting, measured by the cost-to-cost
method. This method is used because management considers total costs incurred to
be the best available measure of progress on contracts.
Contract costs include all direct costs and those indirect costs related to
contract performance. Changes in job performance, job conditions, and estimated
profitability and final contract settlements may result in revisions to costs
and revenue and are recognized in the period in which the revisions are
determined.
The asset, "Costs and Estimated Earnings in Excess of Billings on Uncompleted
Contracts", represents revenue earned in excess of amounts billed. The liability
"Billings in Excess of Costs and Estimated Earnings on Uncompleted Contracts"
represents billings in excess of amounts earned.
Revenue and contract costs from fixed priced contracts are included in the
various categories of revenue and cost of goods sold. As of March 31, 1998,
there were no contracts in progress.
F-25
<PAGE> 58
MICRO-MEDIA SOLUTIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (RESTATED)
FOR THE YEAR ENDED MARCH 31, 1998
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
FEDERAL INCOME TAX:
The Company uses the liability method of accounting for income taxes as
prescribed by the Financial Accounting Standard Board Statement No. 109.
Deferred tax liabilities and assets are determined based on differences between
the financial statement and tax basis of assets and liabilities using enacted
tax rates expected to be in effect for the year in which the differences are
expected to reverse. The net change in deferred tax assets and liabilities is
reflected in the statement of operations.
NEW ACCOUNTING PRONOUNCEMENTS:
The Company accounts for stock options and warrants issued to employees in
accordance with APB 25, "Accounting for Stock Issued to Employees". The Company
follows FASB Statement 123, "Accounting for Stock- Based Compensation" ("SFAS
No. 123") for financial statement disclosure purposes and issuance of options
and warrants to non-employees for services rendered.
In accordance with SFAS 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed Of", management reviews long-lived
assets and intangible assets for impairment whenever events or changes in
circumstances indicate the carrying amount of an asset may not be fully
recoverable. As part of this assessment, management prepares an analysis of the
undiscounted cash flows for each product that has significant long-lived or
intangible asset values associated with it. This analysis for the asset values
as of March 31, 1998, indicated there was no impairment to the carrying value of
these assets.
SFAS No. 130, "Reporting Comprehensive Income", effective for fiscal years
beginning after December 15, 1997, establishes standards for reporting and
display of comprehensive income and its components in a full set of general
purpose financial statements. This statement requires that all items that are
required to be recognized under accounting standards as components of
comprehensive income be reported in a financial statement that is displayed with
the same prominence as other financial statements. The Company has addressed the
requirements of SFAS No. 130 and no material impact on the financial statements
is expected.
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information", effective for fiscal years beginning after December 15, 1997,
establishes standards for reporting information about operating segments in
annual financial statements and interim financial reports issued to
shareholders. Generally, certain financial information is required to be
reported on the basis that is used internally for evaluating performance or an
allocation of resources to operating segments. The Company has not yet
determined to what extent the standard will impact its financial statements.
USE OF ESTIMATES AND CERTAIN CONCENTRATIONS:
Management of the Company has made a number of estimates and assumptions
relating to the valuation and reporting of assets and liabilities and the
disclosure of contingent assets and liabilities to prepare these consolidated
financial statements in conformity with generally accepted accounting
principles. Although actual results could differ from those estimates,
management believes its estimates are reasonable. Certain components,
subassemblies and software included in the Company's computer systems are
obtained from sole suppliers or a limited number of suppliers. The Company
relies, to a certain extent, upon the ability of its suppliers' to enhance
existing products in a timely and cost-effective manner, to develop new products
to meet changing customer needs and to respond to emerging standards and other
technological developments in the computer industry. The Company's reliance on a
limited number of suppliers involves several risks, including the possibility of
shortages and/or increases in costs of components and subassemblies, and the
risk of reduced control over delivery schedules.
F-26
<PAGE> 59
MICRO-MEDIA SOLUTIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (RESTATED)
FOR THE YEAR ENDED MARCH 31, 1998
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
FINANCIAL INSTRUMENTS:
Cash equivalents include highly liquid short-term investments with original
maturities of three months or less, readily convertible to known amounts of
cash. The amounts reported as cash equivalents, receivables, other assets,
accounts payable and accrued expenses and debt are considered by the Company to
be reasonable approximations of their fair values, based on market information
available to management as of March 31, 1998. The use of different market
assumptions and estimation methodologies could have a material effect on the
estimated fair value amounts. The reported fair values do not take into
consideration potential taxes or other expenses that would be incurred in an
actual settlement. Financial instruments that potentially subject the Company to
concentration of credit risk consist principally of cash and cash equivalents
and trade accounts receivable. A concentration of credit risk may exist with
respect to trade receivables, as many of the Company's customers are in the
computer and telecommunications industries. The Company has a large number of
customers on which it performs ongoing credit evaluations and generally does not
require collateral from its customers. Historically, the Company has not
experienced significant losses related to receivables from individual customers
or groups of customers in any particular industry or geographic area.
NOTE 2 - OTHER RECEIVABLES
Other receivables include employee advances for travel and lodging for out of
town projects in the amount of $21,961. Also included in other receivables is
$65,000 of cost paid by the Company to the third parties in satisfaction of
obligations of Argus Management, Inc., (see Note 13).
NOTE 3 - PROPERTY, PLANT AND EQUIPMENT
A summary of the Company's investment in property, plant and equipment at March
31, 1998, is as follows (see Notes 5 and 6):
<TABLE>
<S> <C>
Equipment, Furniture and Fixtures $ 613,184
Transportation Equipment 253,204
Leasehold Improvements 307,790
----------
1,174,178
Less Accumulated Depreciation 373,347
----------
Net Property, Plant and Equipment $ 800,831
==========
</TABLE>
Depreciation charged against income for the year ended March 31, 1998 was
$178,892.
NOTE 4 - BANK LINE OF CREDIT
The Company was in default on a secured line of credit agreement with Bank One
Texas, N.A. providing for borrowings of up to $725,000 based on the amount of
the Company's eligible receivables. As of March 31, 1998, the Company owed
$208,966 plus accrued interest at 18% in the amount of $19,219 secured by
accounts receivable. This amount was paid in full in April 1998 and was not
renewed. Under the agreement, the Company was subject to covenants including
certain financial ratios.
The Company has a secured line of credit agreement with Compass Bank for
$1,350,000 secured by two certificates of deposit aggregating $1,350,000 held in
the Company's name by Compass Bank and payable in monthly installments of
interest only. The balance as of March 31, 1998, was $1,020,000 plus accrued
interest at 8% per annum in the amount of $4,893. Subsequent to March 31, 1998,
the outstanding balance of the line of credit was reduced to $750,000 using
subsequent funding (see note 10) and matures February 5, 1999. The subsequent
F-27
<PAGE> 60
reduction in the loans did not release the restriction on the certificates of
deposit. There are no additional loan covenants associated with this line of
credit.
MICRO-MEDIA SOLUTIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (RESTATED)
FOR THE YEAR ENDED MARCH 31, 1998
NOTE 5 - NOTES PAYABLE
Long-term notes payable consist of the following amounts at March 31, 1998:
<TABLE>
<S> <C>
Austin Community Development Corporation, $100,000 equipment loan dated May 29,
1996, secured by equipment and accounts receivable. Loan requires interest
payments at 9% for the first six months, principal and interest payments
thereafter of $2,224 beginning in February 1997. Loan will mature over a 60
month period ending January 2002 $ 81,327
Austin Community Development Corporation, $100,000 working capital loan dated
June 14, 1995, secured by equipment and accounts receivable. Loan is due in 48
monthly principal installments of $2,083 along with interest of 9% beginning in
July 1996. Loan will mature in June 2000. 56,497
Neighborhood Commercial Management Program, $75,000 loan from City of Austin
dated June 8, 1995, secured by second lien on equipment and accounts receivable.
Loan is due in 60 monthly installments of principal and interest of $1,347 43,104
beginning January 1996. Interest rate of 0% until December 1995, thereafter 3%
rate to maturity. Loan will mature over a 60 month period ending December 2000.
Neighborhood Commercial Management Program, $250,000 loan from City of Austin
dated August 12, 1996, secured by second lien on equipment and accounts
receivable. Loan is due in 60 monthly installments of principal and interest of
$4,492 beginning January 1997. Interest rate of 0% until December 1996,
thereafter 3% rate to maturity. Loan will mature over a 60 month period ending
December 2001. 191,194
Bank One Texas, N.A., $200,000 loan dated June 26, 1996, secured by a first lien
On equipment and leasehold improvements. Loan is due in 60 monthly principal 146,667
installments of $3,333 along with interest equal to the Bank One Texas, N.A. ----------
base rate plus 2%. Subsequent to March 31, 1998, loan was paid in full. 518,789
$ 151,267
----------
$ 367,522
==========
</TABLE>
Following are maturities of long-term debt for each of the next five years:
<TABLE>
<CAPTION>
Year ended March 31,
--------------------
<S> <C>
1999 $ 151,267
2000 153,067
2001 134,348
2002 80,107
----------
Total $ 518,789
==========
</TABLE>
The officers of the Company have personally guaranteed all notes.
F-28
<PAGE> 61
MICRO-MEDIA SOLUTIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (RESTATED)
FOR THE YEAR ENDED MARCH 31, 1998
NOTE 6 - OBLIGATIONS UNDER CAPITAL LEASES
The Company is lessee of transportation and telephone equipment under capital
leases expiring in various years through September 2001. The asset and
liabilities under capital leases are recorded at the lower of the present value
of the minimum lease payments or the fair value of the assets. The assets are
depreciated over the lower of their related lease terms or their estimated
productive lives. Depreciation of assets under capital leases is included in
depreciation expense (see Note 3).
<TABLE>
<S> <C>
Following is a summary of property held under capital leases:
Transportation Equipment $ 218,055
Communication Equipment 56,014
</TABLE>
Minimum future lease payments under capital leases as of March 31, 1998, for
each of the next five years and in the aggregate are:
<TABLE>
<CAPTION>
Year ended March 31,
<S> <C>
1999 $ 68,077
2000 60,343
2001 74,985
----------
Total minimum lease payments 203,405
Less: Amount representing interest (12,748)
----------
190,657
Less: Current portion (41,097)
----------
$ 149,560
==========
</TABLE>
NOTE 7 - FEDERAL INCOME TAXES
A reconciliation of income tax at the statutory rate to the Company's effective
rate is as follows:
<TABLE>
<S> <C>
Computed at the expected statutory rate $ (1,330,000)
Non-deductible items 40,000
Valuation allowance 1,290,000
------------
$ --
============
Deferred tax assets are as follows:
Deferred tax asset $ 1,334,000
Valuation allowance (1,334,000)
------------
$ --
============
</TABLE>
The Company has available at March 31, 1998, $3,924,000 of unused operating loss
carryforwards that may be applied against future taxable income and that expire
in various years through 2013.
NOTE 8 - RELATED PARTY TRANSACTIONS
The Company had notes receivable from certain related parties at March 31, 1997,
in the amount of $419,774. These related parties are owned and controlled by
majority stockholders of the Company. During the year ended March 31, 1998, the
Company loaned an additional $142,265 to these related entities and received
payments in the amount of $562,039. At March 31, 1998, the Company did not have
any notes receivables or payables to related parties. The Company did not have
sales or purchases with the related parties for the years ended March 31, 1998.
F-29
<PAGE> 62
MICRO-MEDIA SOLUTIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (RESTATED)
FOR THE YEAR ENDED MARCH 31, 1998
NOTE 9 - COMMITMENTS
The Company leases its principal general offices and warehouse facilities. The
leases expire at August 31, 2005 and July 31, 2008, each with a 10 year
renewable option. Future minimum lease payments (excluding property taxes) are
as follows:
<TABLE>
<CAPTION>
Year ended March 31,
--------------------
<S> <C>
1999 $ 186,107
2000 231,248
2001 242,563
2002 266,365
2003 281,789
2004 297,458
Thereafter 1,065,249
-----------
$ 2,570,779
===========
</TABLE>
The total rental obligation under the above contract for the year ended March
31, 1998, was $109,980.
NOTE 10 - STOCKHOLDERS' EQUITY
In October 1997, the Company completed a Private Placement Agreement, (the
"Agreement") with a group of accredited investors. The Agreement provides for
three "Phases" of financing.
Phase I of the Agreement was funded in November 1997. The Company received
$2,120,000 in exchange for 400,000 shares of series B preferred stock (5%
cumulative, convertible, non-voting, stated value $5.30) ,(the "Series B
Stock"). Each share of preferred stock is initially convertible into 10 shares
of the Company's common stock subject to adjustment and six warrants, (the
"Warrants") for the purchase of six shares of common stock at $1.50 per share.
The Company paid $302,000 and issued 20,000 shares of series B preferred stock
for placement agent fees in Phase I. Also options to purchase 400,000 shares of
common stock at $1.50 per share were issued as a part of the Agreement. The
common stock had a fair value of $0.92 per share at the grant date resulting in
$367,350 in placement agent fees.
At the time of issuance the Series B Stock was convertible to common stock at an
amount that was "in-the-money". This beneficial conversion feature was limited
to net proceeds of $1,818,000. Due to the limitation on the number of shares of
stock that can be issued to retain the HUB status, $856,460 has been recorded as
dividends and as an increase in additional paid-in capital in the accompanying
financial statements. The unrecognized portion of the discount in the amount of
$961,540 will be recorded if and when the preferred stock is converted or the
HUB status changes.
Phase II of the Agreement was funded in February 1998. The Company received
$1,000,004 in exchange for 94,340 shares of series C preferred stock (6%
cumulative, convertible, non-voting, stated value, $10.60), (the "Series C
Stock). Each share of preferred stock is initially convertible into 10 shares of
the Company's common stock, subject to adjustment. The Company paid $130,000 and
issued 4,717 shares of series C preferred stock for placement agent fees. Also
options to purchase 47,170 shares of common stock at $4.00 per share were issued
as a part of the Agreement. The common stock had a fair value of $0.43 per share
at the grant date resulting in $20,291 in placement agent fees.
F-30
<PAGE> 63
MICRO-MEDIA SOLUTIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (RESTATED)
FOR THE YEAR ENDED MARCH 31, 1998
NOTE 10 - STOCKHOLDERS' EQUITY - CONTINUED
At the time of issuance the Series C Stock was convertible to common stock at an
amount that was "in-the-money". This beneficial conversion feature was limited
to net proceeds of $870,000. Due to the limitation on the number of shares of
stock that can be issued to retain the HUB status, the unrecognized discount in
the amount of $870,000 will be recorded if and when the preferred stock is
converted or the HUB status changes.
Phase III of the Agreement was partially funded in April and May 1998 with the
completion of the funding planned in July 1998. The Company has received
$2,000,000 in the partial funding of Phase III.
Senior convertible debt in the amount of $371,000 was issued for cash in
November 1997. This debt was converted to 70,000 shares of series B preferred
stock (5% cumulative, convertible, non-voting, stated value, $5.30), in February
1998. Accrued interest in the amount of $5,143 was paid with the issuance of
10,286 shares of common stock.
At the time of issuance the Senior convertible debt was convertible to common
stock at an amount that was "in-the-money". This beneficial conversion feature
was limited to net proceeds of $371,000. Due to the limitation on the number of
shares of stock that can be issued to retain the HUB status, interest expense in
the amount of $371,000 will be recorded if and when the preferred stock is
converted or the HUB status changes.
Preferred stock dividends were accrued and paid through March 31, 1998, in the
amount of $58,668 by the issuance of 23,742 shares of common stock.
NOTE 11 - STOCK OPTIONS AND WARRANTS
A summary of the status of the Company's stock options as of March 31, 1998, is
presented below:
<TABLE>
<S> <C>
Options outstanding at March 31, 1997 --
Options granted 622,710
Options exercised
Options canceled
Less: options not exercisable at year end 222,710
----------
Options outstanding and exercisable at March 31
400,000
==========
Weighted Average Exercise Price per Share $ 1.50
==========
</TABLE>
The following table summarizes the information about the stock options as of
March 31, 1998:
<TABLE>
<CAPTION>
Weighted Weighted Weighted
Number Average Average Number Average
Range of Outstand- Remaining Exercise Exercisable Exercise
Exercise ing at Contractual Price At Price
Price March 31 Life (Total Shares) March 31 (Exer. Shares)
- -------- --------- ----------- -------------- ----------- --------------
<S> <C> <C> <C> <C> <C>
$ 1.50 50,000(1) 5 years $ 1.50 -- $ 1.50
2.25 25,000(1) 2 years 2.25 -- 2.25
1.50 100,000(1) 5 years 1.50 -- 1.50
1.50 400,000(2) 5 years 1.50 400,000 1.50
4.50 47,170(2) 6 years 4.00 -- 4.00
1.50
------ --------- ------- ------ ------- ------
$ 4.00 622,170 5 years $ 1.72 400,000 $ 1.50
====== ========= ======= ====== ======= ======
</TABLE>
(1) Options issued to employees for past services.
F-31
<PAGE> 64
(2) Options granted for placement agent fees (Note 10)
MICRO-MEDIA SOLUTIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (RESTATED)
FOR THE YEAR ENDED MARCH 31, 1998
NOTE 11 - STOCK OPTIONS & WARRANTS - CONTINUED
Stock options to employees have been recorded as compensation as
applied under APB No. 25 in the amount of $93,750.
SFAS No. 123 requires the Company to provide pro forma information
regarding net income (loss) applicable to common stockholders and
income (loss) per share as if compensation cost for the Company's stock
options granted to employees had been determined in accordance with the
fair value based method prescribed in that Statement.
The Company estimated 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 as follows:
<TABLE>
<S> <C>
Dividend yield 0%
Expected volatility 16.46%
Risk-free interest rate 8.54%
Expected lives 5 Years
</TABLE>
The weighted fair value of options granted for compensation during the
year ended March 31, 1998, was $1.08.
Under the accounting provisions of SFAS No 123, the Company's net loss
applicable to common stockholders and loss pro forma amounts are
indicated as follows:
<TABLE>
<CAPTION>
Net (loss) applicable to common stockholders:
<S> <C>
As reported $(5,415,698)
Pro forma $(5,509,948)
</TABLE>
<TABLE>
<CAPTION>
Net (loss) per share:
<S> <C>
As reported $ (.49)
Pro forma $ (.50)
</TABLE>
At March 31, 1998, the Company had warrants outstanding to acquire
2,940,000 shares of common stock. All of the warrants were eligible to
be exercised at year end. The following table summarizes the
information about the warrants as of March 31, 1998:
<TABLE>
<CAPTION>
Number Outstanding
Exercise Price at March 31 Expiration Date
<S> <C> <C>
$1.50 120,000 1/31/2000
$1.50 2,400,000 1/31/2000
$0.795 300,000 1/31/2000
$0.795 120,000 1/31/2000
--------------
2,940,000
==============
</TABLE>
In addition, all of the warrant contracts prohibit exercise of the
warrants if the HUB status of the Company is compromised upon such
exercise.
F-32
<PAGE> 65
MICRO-MEDIA SOLUTIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (RESTATED)
FOR THE YEAR ENDED MARCH 31, 1998
NOTE 12 - EARNINGS PER SHARE
The following data details the amounts used in computing earnings per
share (EPS) and the effect on income and the weighted average number of
shares of dilutive potential common stock.
<TABLE>
<CAPTION>
1998
-----------
<S> <C>
Loss from continuing operations (3,912,570)
Less: Preferred dividends (1,503,128)
-----------
Loss available to common shareholders used in basic EPS
(5,415,698)
===========
Weighted average number of common shares used in basic EPS 10,998,874
Effect of dilutive securities:
Stock options --
Warrants --
-----------
Weighted number of common shares and dilutive potential common stock
used in diluted EPS 10,998,874
===========
</TABLE>
Options on 622,170 shares of common stock and warrants on 2,940,000
shares of common stock were not included in computing diluted EPS for
the year ended March 31, 1998, because their effects were antidilutive.
NOTE 13 - CONTINGENCY
On December 18, 1997, Argus Management, Inc. filed Plaintiff's Original
Petition in the 216th District Court of Kerr County, Texas. Argus
claims the Company and Mr. Jose G. Chavez, as joint obligors, defaulted
on their obligation to Argus pursuant to two promissory notes for
$100,000 each, both dated June 2, 1997. Argus is seeking a judgment for
$200,000, together with interest on the notes at the rate of 20% per
annum from June 2, 1997, through the date the notes are satisfied. As
of March 31, 1998, $65,000 had been disbursed to third parties in
satisfaction of obligations of Argus Management, Inc. The $65,000 has
been recorded in other receivables in the accompanying financial
statements.
On February 6, 1998, the Company filed Plaintiff's Original Petition in
the above-referenced case. The Company asserts breach of contract,
fraud, defamation, usury, and civil conspiracy claims against Argus
Management, Inc. The Company strongly disagrees with Argus' contentions
and denies liability to Argus under the notes and plans to oppose
vigorously Argus' claims and recover the amounts disbursed to third
parties.
A lawsuit was filed by Manpower, Inc. to preserve its claims for
certain delinquent obligations that were reduced to approximately
$38,000 which is included in accounts payable at March 31, 1998. The
full amount of the principal and interest was paid on April 29, 1998,
and a Notice of Dismissal was filed on May 8, 1998.
On January 22, 1998, the Company filed a lawsuit against Bits Technical
Corporation for damages attributable to a breach of commitment. This
matter is still pending. On August 17, 1998, Bits Technical Corporation
("BTC") filed a counterclaim against the Company in connection with the
above case. In the counterclaim, BTC asserts the Company fraudulently
induced BTC to promise to loan money to the company. In particular, BTC
claims the Company promised certain contracts and business
opportunities to BTC that the Company was unwilling or unable to
deliver.
Bank One, Texas, NA filed a lawsuit against the Company for the
collection of approximately $355,633 of principal plus interest of
$29,289 as well as attorney fees and court costs of $10,000. The bank
was paid in full in April 1998. The bank then executed a Notice of
Nonsuit to dismiss with prejudice the lawsuit on April 29, 1998.
F-33
<PAGE> 66
MICRO-MEDIA SOLUTIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (RESTATED)
FOR THE YEAR ENDED MARCH 31, 1998
NOTE 13 - CONTINGENCY - CONTINUED
On November 20, 1996, MCA Communications, Inc. ("MCA") filed a lawsuit
against the Company in County Court at Law No. 2 in Harris County,
Texas. MCA claims the Company owes $12,485.40 for certain goods and
services that MCA claims to have provided to MSI in connection with
various projects for the Texas Department of Health. MCA also seeks
interest, costs, and attorneys' fees. On January 6, 1997, the Company
filed its answer and denied the above-referenced claim in its entirety.
NOTE 14 - SUBSEQUENT CHANGE
Subsequent to issuing the March 31, 1998, audited financial statements
and accompanying auditor's report dated June 9, 1998, additional
adjustments to the financial statements were recorded for undocumented
obligations of the Company's common stock. An adjustment has been made
to record the Company's obligation to issue 362,400 shares of common
stock for compensation in the amount of $256,295, to the Company's
employees, consultants and stockholder's prior to March 31, 1998. Also
an adjustment was made to record 543,000 shares of common stock
subscribed in the amount of $407,250 for a note receivable. The note
receivable has been offset against the common stock subscribed in the
accompanying financial statements.
Additionally, 293,185 shares of uncertificated common stock has been
reported for the cash recorded and reported as of March 31, 1998, in
the amount of $512,450. An adjustment has been made to increase common
stock and decrease additional paid in capital in the amount of $29,319.
Also, an adjustment has been made to correct stock options issued for
placement agent fees recorded under SFAS No. 123. A decrease of
$153,547 to additional paid-in capital as an offset against preferred
stock proceeds with a corresponding increase in additional paid-in
capital of $153,545 has been recorded for the year ended March 31,
1998.
The following adjustments have been included in the restated financial
statements and accompanying audit report dated October 9, 1998:
<TABLE>
<CAPTION>
Balance as Balance after
CONSOLIDATED BALANCE SHEET ADJUSTMENTS: Previously Reported Adjustments Adjustments
------------------- ------------- -------------
<S> <C> <C> <C>
Other accrued expenses $ 153,240 $ 16,096 $ 169,336
Common stock 1,085,126 65,559 1,150,685
Additional paid-in capita 2,491,459 174,640 2,666,099
Accumulated deficit (7,115,822) (256,297) (7,372,119)
CONSOLIDATED STATEMENT OF OPERATION ADJUSTMENT:
Selling, General and Administrative expenses
3,190,842 256,295 3,447,137
Net loss (3,510,653) (256,297) (3,766,950)
Preferred stock dividend 3,471,170 -- 3,471,170
Net loss available to common stockholders
(6,981,823) (256,297) (7,238,120)
Basic and diluted loss per share (0.65) (0.01) (0.66)
============ ============ ============
Basic and diluted shares outstanding $ 10,785,717 $ 213,157 $ 10,998,874
============ =========== ============
</TABLE>
F-34
<PAGE> 67
MICRO-MEDIA SOLUTIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (RESTATED)
FOR THE YEAR ENDED MARCH 31, 1998
NOTE 14 - SUBSEQUENT CHANGE - CONTINUED
Subsequent to issuing the March 31, 1998, audited financial statements
and accompanying auditor's report dated June 9, 1998 as restated on
October 9, 1998, additional adjustments to the financial statements
have been recorded. An adjustment has been made to record deferred rent
in accordance with SFAS No. 23. An increase in current liabilities with
a corresponding increase in rent expense in the amount of $145,620 has
been recorded for the year ended March 31, 1998. Also, subsequent to
issuing the restated financial statements, EITF 98-5 was issued
limiting the beneficial conversion feature for instruments issued after
May 20, 1999 to the net proceeds. A decrease in discount recognized in
the amount of $1,499,780 has been recorded. The financial statements
are being restated as recommended by the SEC staff as discussed in Note
10. Other amounts have been reclassified to agree to the current year
presentation.
The following adjustments have been included in the restated financial
statements:
<TABLE>
<CAPTION>
Balance as Balance after
CONSOLIDATED BALANCE SHEET ADJUSTMENTS: Previously Reported Adjustments Adjustments
------------------- ------------- -------------
<S> <C> <C> <C>
Deferred rent $ -- $ 145,620 $ 145,620
Additional paid-in capital 2,666,099 (1,968,042) 698,057
Accumulated deficit (7,372,119) 1,822,422 (5,549,697)
CONSOLIDATED STATEMENT OF OPERATION ADJUSTMENT:
Cost of goods sold 3,060,634 559,167 3,619,801
Selling, General and Administrative expenses
3,447,137 (413,547) 3,033,590
Net loss (3,766,950) (145,620) (3,912,570)
Preferred stock dividend 3,471,170 (1,968,042) 1,503,128
Net loss available to common stockholders (7,238,120) 1,822,422 (5,415,698)
Basic and diluted loss per share (0.66) 0.17 (0.49)
========== =========== ===========
Basic and diluted shares outstanding $10,998,874 $ -- $10,998,874
=========== =========== ===========
</TABLE>
On October 14, 1998, the Company changed its name to MSI Holdings, Inc.
F-35
