SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______ TO ______
Commission file number 1-10588
INTELLICALL(R), INC.
(Exact name of registrant as specified in its charter)
Delaware 75-1993841
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2155 Chenault, Suite 410, Carrollton, Texas 75006-5023
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (972) 416-0022
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $0.01 par value New York Stock Exchange
(Title of Class) (Name of each exchange on which registered)
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months, and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
[ X ]
The aggregate market value of the voting stock (which consists solely
of shares of Common Stock) held by non-affiliates of the registrant as of March
17, 1999, computed by reference to the closing sales price of the registrant's
Common Stock on the New York Stock Exchange on such date, was approximately
$24,458,530.
Number of shares of the registrant's Common Stock outstanding as of
March 17, 1999: 12,074,385.
Documents Incorporated By Reference:
The information required by Part III of this Form 10-K Annual Report
is incorporated by reference from the registrant's definitive proxy statement to
be filed not later than 120 days after the end of the 1998 fiscal year.
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PART I
ITEM 1. BUSINESS.
I. GENERAL
Intellicall(R), Inc. ("Intellicall" or the "Company") designs, manufactures and
sells public access telecommunications equipment, and provides billing services
and automated operator services ("Services"), principally to payphone owners and
telephone companies in the United States and in developing countries.
The Company's line of products consists of payphone products and accessories,
network equipment and software (the "Products"). In various configurations, the
Products permit their owners to provide traditional payphone services to users
of the Products and live or automated operator services for operator-assisted
calls. In addition, the Products may be used in international gateway
applications and to render prepaid or other long distance service to callers
using prepaid or other calling cards. The Company has historically sold most of
its Products to the U.S. private pay telephone industry. In recent years, a
portion of the Products has been sold in developing countries and in the United
States to regulated telephone companies.
The Company provides automated operator services to payphone users utilizing
patented microprocessor technology incorporated into the payphone. These
services enable callers to make collect, calling card and credit card calls from
the Company's payphones without requiring the assistance of live operators.
Prior to 1998, the Company provided live operator services, prepaid calling card
and other long distance services principally to independent payphone providers
("IPPs") either directly or through a then majority-owned subsidiary, ILD
Telecommunications, Inc. ("ILD"). ILD was formed by the Company in May 1996 to
conduct the long distance resale and live operator service businesses previously
owned by the Company. After its formation, ILD grew rapidly and diversified its
business, principally through acquisitions of related businesses which included
the prepaid calling card operations of the Company. As a consequence of ILD
issuing its stock to sellers of acquired businesses and of the Company's sales
of a portion of its ILD equity investment to third parties, the Company's
ownership interest in ILD's equity declined to less than 50% in the first
quarter of 1998. See Note 1 to the Financial Statements. Because of the change
in the Company's ownership of ILD, ILD's financial condition and results of its
operations have not been consolidated with those of the Company since December
31, 1997. Thus ILD's revenues and associated costs, and its individual assets
and liabilities, are not shown in the Company's 1998 financial statements. In
lieu thereof, the Company utilizes the equity
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method of accounting for its investment in ILD pursuant to which the Company
records its prorata share of ILD's net income and net assets as single line
items in its 1998 statement of income and balance sheet.
The Company is a Delaware corporation with its principal executive offices
located at 2155 Chenault, Suite 410, Carrollton, Texas 75006-5023. The Company's
telephone number at that address is (972) 416-0022.
Recent Developments. On January 27, 1999, the Company closed and commenced
funding under a Receivables Sale Agreement (the "RFC Agreement") with RFC
Capital Corporation ("RFC") pursuant to which RFC has agreed to purchase from
the Company certain telecommunication receivables generated by the Company in
the ordinary course of the Company's business. The RFC Agreement calls for RFC
to purchase eligible receivables from the Company from time to time upon
presentation thereof for a purchase price equal to the net value of such
receivables. Net value is designed to yield RFC an effective interest rate of
prime plus 2.75% plus allow RFC to retain a holdback of five percent of the face
amount of the receivables, net of collections, against future collection risk.
Under the RFC Agreement the Company performs certain servicing, administrative
and collection functions with respect to the receivables sold to RFC. Also,
pursuant to the terms of the RFC Agreement, the Company has granted to RFC a
security interest in and to the Company's receivables not sold to RFC and the
Company's customer base relating to the generation of such accounts receivable.
The initial term of the RFC Agreement is to December 21, 2000.
II. PRODUCTS.
Industry Background. Prior to its breakup in 1984, payphone service in the
United States was provided solely by AT&T. In 1984, the Federal Communications
Commission ("FCC") authorized competition in the operation of payphones subject
to state and federal regulation. Since 1984 an industry comprised of IPPs has
emerged to compete with payphone networks owned and operated by local exchange
carriers ("LECs"). The principal difference between payphone equipment utilized
by IPPs and LECs can be found in the location of the payphone system's
intelligence. Since IPP payphones lacked the intelligence provided to LEC phones
by the LEC central office, IPPs moved to incorporate system intelligence in the
payphone itself. As a result, call rating, answer detection, operator service
and equipment status reporting were among the features designed into IPP
payphones. The IPP payphones in turn utilized telephone lines which provide
little more than "dial-tone" from the LEC central office. The "smart phone",
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as it came to be called, was the product of choice of the IPP. The Company
originated, and has extensively developed, smart phone technology.
Domestic Payphones. The Company's principal payphone product (available in
multiple configurations) offered for sale in the United States is the ASTRATEL
2(R). This phone can be used to provide automated operator service and to
perform all functions customarily available in payphones. As opposed to needing
an external electric connection to operate, the ASTRATEL 2 utilizes electrical
current provided through the telephone line. Because of its unique design,
functionality of the ASTRATEL 2 is principally provided through software. Most
older payphones (including those manufactured by the Company) utilize a product
design which incorporates a far greater number of electronic components and
circuitry.
The "brain" of the ASTRATEL 2 payphone is an integrated circuit board located in
the payphone housing (the "Boardset"). From its inception, the ASTRATEL 2
Boardset was designed to sell at attractive prices and to easily fit most
payphone housings, including those sold by the Company's competitors. As a
result, the Boardset has accounted for an increasing percentage of the Company's
equipment sales since 1996. The Boardset is not manufactured by the Company, but
a number of companies exist that possess the ability to manufacture the Boardset
in accordance with the Company's specifications. The Boardset's software
intensity and flexibility provide the Company's customers with considerable
protection against obsolescence.
The Company's payphones operate by means of advanced microprocessor technology
located in the Boardset. When a call is initiated, the microprocessor
automatically performs a series of functions, including, in the case of coin
generated phone calls, determining the applicable rate for the call and whether
the call has been answered. The Company's payphones communicate with a caller by
voice messages digitally synthesized and stored in memory chips located in the
Boardset.
Among the most important features of an Intellicall payphone is the ability to
reliably and accurately detect whether a call has been answered. This answer
detection capability is not dependent upon an electronic signal from the LEC
central office. Accurate answer detection is critical to the successful
operation of a private payphone in order to ensure that all completed calls are
properly billed and that incomplete calls are not billed.
The ASTRATEL 2 possesses many programmable features that may be altered from a
remote location by means of the Company's proprietary software using a personal
computer. These programmable features include rate tables and various management
reporting capabilities that enable the owner to determine if and when a payphone
requires service or coin collection. In addition, a number of enhancements may
be added to the Company's payphones from a remote location. Management believes
the ASTRATEL 2 uses the highest speed modem in the
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payphone industry (14.4 Kps) to communicate with a remote location and that such
high-speed modem constitutes a current competitive advantage.
International Payphones. Since 1993, the Company has produced a line of
payphones targeted for sale outside the United States. These phones accommodate
a variety of payment systems including U.S. and international coinage, credit
cards and several types of prepayment cards, such as cards based on personal
identification numbers, magnetic stripe cards and integrated circuit cards.
Additionally, these telephones can be operated with auxiliary power sources,
including solar power or power supplied by telephone lines, and can be utilized
in wireless systems.
In 1997 and 1998, the Company modified the ASTRATEL 2 for sale in the Canadian
and Mexican markets and is working on further modifications to enhance sales
prospects in these and other countries. Because of its software reliance, the
ASTRATEL 2 can be economically modified to accommodate the different calling
patterns, coinage denominations, rating systems and languages of numerous
countries.
N-Genius System. The Company's N-GeniusTMSystem enables network operators in the
United States and abroad to provide enhanced, switched, public access services.
Public access services are of special importance to network operators in
developing countries where demand for publicly accessible telephone service is
high due to the expense of, and lengthy delays often involved in, obtaining
residential phone service.
Applications utilizing the N-Genius System permit network and payphone system
operators to offer prepaid calling services over wireline or cellular networks.
In addition, the N-Genius System can be used as a switched international gateway
that is transparent to the communications protocols which differ among
countries. The system can be used as well to enhance the public phone management
capability of network and payphone system operators. Among its other features,
the N-Genius System can provide automated credit card validation, calling card
validation or voice recognition validation, and protection against telephone
fraud. The Company is developing applications for the N-Genius, which allow
payphone system operators to incorporate the Internet to carry phone traffic.
Specifically, the Company has entered into a strategic alliance with Netspeak
Inc. to help facilitate the development and delivery of these applications.
Intelli*Star. The Intelli*Star(R) system is an automated operator product
licensed to owners of the Company's payphones. The Company's older UltraTel(R)
line of payphones required the addition of a separate integrated circuit board,
commonly called the I*Star board, to complete the system. This separate
integrated circuit board was attached to the payphone's operating circuitry.
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In the ASTRATEL line of payphones, Intelli*Star is activated by means of a
software enhancement and requires no additional circuit board. Intelli*Star is
available on every payphone offered for sale by the Company in the United
States.
Sales and Marketing. The Company's U.S. sales of Products are made through a
combination of distributors and a direct sales force consisting of five
employees. International sales are generally made through in-country agents and
distributors supported by sales, engineering and technical support personnel at
the Company's Carrollton, Texas office.
The markets for the Company's Products consist of public access
telecommunications providers, principally providers of payphone services.
Included in this grouping are the payphone operations of IPPs and LECs in the
United States. Service revenues of this market segment are estimated to range
from $2.5 billion to $3.0 billion annually. Annual sales of hardware and
software to this segment are estimated to exceed $250 million. The potential
size of international markets for the Company's Products is believed to
appreciably exceed the size of the U.S. market, since international markets in
which the Company sells its Products have far lower per- capita investments in
telephone products than in the U.S.
Receivables arising from domestic product sales are generally payable within 60
days and may be offset, on a customer-by-customer basis, against amounts the
Company may owe for Intelli*Star commissions to payphone owners. Discounts are
provided for prepayment or prompt payment. International Product sales are
generally made pursuant to confirmed letters of credit or payments prior to
shipment.
Manufacturing and Assembly. The Company's Products are principally assembled at
its manufacturing facility in McAllen, Texas. Boardsets are currently assembled
for the Company by an electronics manufacturer in McAllen, Texas. After Products
are assembled at the Company's manufacturing facility, they are thoroughly
tested before shipment to the purchaser. Once a payphone or Boardset is shipped
to a U.S. private payphone industry customer by the Company, the Company is not
responsible for ensuring that the Product is properly installed, maintained or
operated in accordance with applicable federal and state regulations. The
Company assists in the installation of N-Genius Systems with respect to certain
international customers and LECs.
The Company purchases certain components from single-source suppliers. The
Company believes that alternative sources are available and that an interruption
in supply would not have an enduring impact on its results of operations. As a
result of market factors, suppliers of certain components used in the Company's
equipment may occasionally place the Company on allocation
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for those parts. The Company continues working to secure alternate sources for
single-source components and components subject to allocation.
Warranty, Maintenance and Service. The Company repairs Intelli*Star boards
without charge when the boards are properly licensed and used in older UltraTel
payphones. The Company provides the original purchaser of products (not
including ASTRATEL electronic components) a limited 90-day or one-year warranty,
depending on the kind of equipment involved. The Company offers a two-year
limited warranty on ASTRATEL 2 electronic components. The Company's technical
support staff at its corporate offices currently provides support services over
the telephone to customers who have installation or operational questions. The
Company currently offers a maintenance agreement covering N-Genius Systems.
Other non-warranty service is provided on a per-repair basis. Warranty and
non-warranty product repairs are generally provided by the Company at its
manufacturing facility in McAllen, Texas.
The Company holds classes to train its customers in the proper installation,
operation and maintenance of the Company's products.
Competition. The Company competes directly with other payphone and switching
equipment manufacturers, and indirectly with providers of wireless portable
telephony, many of who are larger and better capitalized than the Company. The
Company's principal direct competitors in the U.S. private payphone market are
Elcotel, Inc. and Protel, Inc. (a subsidiary of Inductotherm Industries, Inc.).
Its indirect competitors include numerous service businesses providing cellular,
paging and personal communications services ("Wireless Telecommunications")
throughout the Company's markets. In certain instances, Wireless
Telecommunications compete successfully with telecommunications services offered
through payphones to callers away from home. However, for callers with limited
needs to make calls while away-from-home, payphones offer a convenient and
economical alternative to Wireless Telecommunications devices.
The Telecommunications Act of 1996 (the "1996 Act") requires, among other
things, that LECs end subsidies to their own payphone services and provide
services to IPPs on the same rates, terms and conditions as they are made
available to their own payphone service operations. Effective April 15, 1997,
local telephone companies reclassified their payphone service from regulated to
non-regulated status, substantially changing many of the rates and terms upon
which payphone lines are available. These changes were required by the 1996
Act's explicit prohibition against the local telephone companies discriminating
between their own payphone operations and those of IPPs. Local telephone
companies generally must receive service under the same tariffs available to
IPPs for payphones. The Company expects these changes to benefit its IPP
customers. By equalizing the basis for competition between LECs and IPPs, the
1996 Act may create additional opportunities for existing payphone providers, or
for new entrants, to compete
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with the LECs. The demand for payphones may also be affected by the
interconnection arrangements offered by the local telephone operating companies
to IPPs.
The 1996 Act contains provisions which, if not successfully challenged, would
permit Bell Operating Companies ("BOCs"), under certain circumstances, to
manufacture telecommunications equipment, including payphones and switched
network products. They may do so, however, only after the FCC finds that they
have completed actions necessary to open their local telecommunications markets
to competition. To date the FCC has made no such finding with respect to any of
the BOCs.
Numerous entities compete with the Company in the international public
communications markets, including many larger and better-capitalized companies
with experience in the marketing of products internationally. The Company has
adopted a strategy of focusing its marketing efforts on countries with a low
ratio of public communication lines to total population, where rapid growth in
sales of public communications equipment is projected. Many of the Company's
competitors have adopted a similar strategy. The market for international public
communications is highly competitive and subject to the risks of doing business
abroad. Consequently, there can be no assurances that the Company's efforts in
international markets will be successful.
Although the Company is encountering and expects to continue to encounter
intense competition, the Company believes that its products are competitive in
its markets based upon price, equipment capabilities and quality. Since the
telephone industry is subject to rapid technological change, the Company
believes that it will continue to be required to develop improved or additional
Products and to continue to reduce the cost of existing Products in order to
remain competitive. The Company's ability to develop additional Products will
depend generally in the foreseeable future on its ability to generate working
capital internally.
Regulations Affecting Telecommunications Equipment Manufacturers. The Company's
domestic payphones and call processing systems must comply with technical
requirements contained in Parts 15 and 68 of rules promulgated by the FCC in
order to operate and/or be connected to the public telephone network. The
Company has performed those tests necessary to assure compliance with these
technical and operational requirements and has obtained the proper registrations
and certifications from the FCC for all its products. The Company updates these
registrations and certifications periodically and the Company believes that such
registrations and certifications will be routinely granted.
On January 29, 1998, the FCC adopted a Report and Order in its long-standing
docket considering various proposals that would have required most interstate
long distance calls initiated by dialing "0" from pay telephones to be completed
using a long distance carrier associated with the automated pay telephone or
operator service provider to whom the private
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pay telephones are pre-subscribed ("Billed Party Preference"). The Commission's
order concluded that the Billed Party Preference proposal was cost prohibitive
for pay telephones and that the same measure of consumer protection could be
provided at far lower cost with price disclosure.
As an alternative to Billed Party Preference, the FCC adopted a rule that all
operator service providers, including owners of the Company's payphones using
Intelli*Star, must audibly disclose during the call-setup that rates are
available on request, but need not provide an exact rate quote unless the caller
specifically requests it. Although the Order gives operator service providers
until July 1, 1998 to comply with this new rule where it is technically feasible
to do so, the Company's payphones, including those sold after July 1, 1998, need
not be compliant with the rule until October 1, 1999. A few states have adopted
rules for intrastate 0+ calls that mirror those of the FCC. In two states
however, the rules adopted do not have the same compliance period. In
Massachusetts, Intellicall has requested clarification of the rule seeking an
extended compliance period to mirror the federal rule and petitions for
reconsideration of the rule are pending. In the state of Washington, rules
generally paralleling those of the FCC were adopted on December 28, 1998. These
rules however do not contain the specific waiver for store and forward payphones
included in the federal rule but the Washington Commission has stated that it
would consider waivers consistent with the federal rules. In Washington
Intellicall will file a waiver request seeking a compliance period mirroring the
federal rule unless the Washington Commission provides for a generally
applicable waiver not requiring individual filings. We can not predict what
action the Massachusetts and Washington Commissions will take with respect to
this issue.
The rule will require additional development by the Company to modify the
ASTRATEL 2 software to comply and will require the Company's payphone customers
using Intelli*Star to retrofit non-compliant payphones or cease using
Intelli*Star technology after October 1, 1999. The Company believes that any new
software required can be developed and incorporated into its ASTRATEL products
within the time frame established by the FCC and that the embedded base of
UltraTel payphones can be replaced with ASTRATEL technology in the same time
frame.
Product Sales. In 1998, the Company's sales of Products amounted to $13.9
million, constituting 35% of its sales and revenues. Compared with 1997, sales
of Products decreased by $5.5 million or 28%.
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III. SERVICES.
Services Provided by the Company. In 1998, service revenues were generated from
the provision of automated operator services and billing and collection
services. The predominant portion of these revenues was generated by the
Company's own proprietary automated operator technology, Intelli*Star. The
Company's automated operator system is a combination of hardware and software
that performs, without human intervention, all of the functions necessary for
completing an operator assisted payphone call (i.e., collect, calling card, and
credit card calls) and a range of other payphone services and features. Each
system performs the functions previously performed by live operators. The
payphone provides callers with appropriate instructions in a digitized human
voice for entering billing information (i.e., a calling card number or a
terminating phone number for a collect call) and completes the calls. For
example, in the case of a collect call, a synthesized voice directs the caller
to speak his name into the pay-phone handset and the caller's response is
digitally recorded and played back when the call is answered at its destination.
The called party is instructed to press "1" on his telephone, or, if the system
is configured with voice recognition capability, to say "yes", if he wishes to
accept the call. The automated operator system records call and billing
information for later retrieval by the telephone owner, all without human
operator assistance. Calls requiring human operator assistance, such as
person-to-person calls, emergency calls and calls billed to a third party, are
routed to live operators selected by the payphone owner.
By performing most operator functions, Intelli*Star technology substantially
reduces the need for (i) an operator-assisted call to be routed first to a live
operator service and then routed to the final destination, a process known as
"backhauling," and (ii) centralized switching equipment. As a result, these
systems generally allow the owner of a payphone to provide operator services
more efficiently and profitably than a centralized operator service provider,
and at a lower cost to the consumer.
The Company provides billing and collection services to owners of payphones who
use the Company's automated operator technology, and, until May 1997, provided
such services to certain customers that generated call traffic from public
access communications systems utilized by correctional institutions. Billing and
collection is the process whereby owners receive payment for the non-coin calls
processed by their systems. The billing and collection process includes the
collection of phone call billing information, editing and formatting of that
data, and processing the data for billing through LECs. Call data is accumulated
by both the periodic receipt of computer disks and by electronic data
transmission.
The Company does not sell Intelli*Star technology, but licenses it instead to
payphone owners under long-term license agreements. Under its most common
Intelli*Star license agreement,
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Intellicall owns and has the exclusive right to process the stored call and
billing information generated by the Intelli*Star technology. By virtue of its
ownership, the Company typically retains the right under an Intelli*Star license
agreement to bill, collect and record related call revenues, subject to its
obligation to pay commissions to payphone owners. Set forth below are the
Company's principal service offerings:
The "Easy*Star"(R) Program. The Easy*Star program is the Company's primary
program for editing, billing, collecting and recording Intelli*Star
generated revenues, and determining the amount of commissions payable to
payphone owners related to their submitted call traffic. Pursuant to this
program, the Company edits, reformats and bills call traffic which is
typically submitted to the Company by payphone owners in machine-readable
form. The Company then computes the commission payable to each payphone
owner (based on the edited value of the processed call traffic) and
transmits the edited and reformatted call traffic media to billing agents,
who sort it for submission to, and billing by, LECs.
Not more than 15 days after the end of the month in which the Company
receives call traffic, the Company pays related commissions to payphone
owners. Commissions are based upon each customer's historical bad debt
experience and call traffic demographics. The Company generally assumes
responsibility for uncollectible call traffic, as well as the costs of
credit validation and billing. Approximately 60 days, on average, after
payment of commissions to the Company's payphone customers, the Company
receives payment from LECs for the related call traffic, less certain fees
and other amounts deducted by the LECs prior to remittance.
"Unbundled" Program. Under certain circumstances, the Company charges
reduced fees to owners of payphones or systems who contract directly with
third parties for credit validation, billing and collection services.
Generally under these unbundling arrangements, the Company receives and
records as revenue a processing fee for editing and reformatting call
traffic media, while the payphone owner receives call traffic proceeds and
is responsible for costs of validation, billing, collection and bad debts.
As of December 31, 1998, the Company's customers were operating approximately
37,500 payphones utilizing the Intelli*Star technology.
Sales and Marketing. The Company's automated operator services are sold to
customers who purchase its payphones with Intelli*Star technology.
Competition. In the provision of automated operator services, the Company
competes with a large number of operator service companies, many of which
have more technical support
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personnel and greater financial resources. AT&T, MCI/Worldcom and Sprint
dominate the operator services market and long distance industry in general. In
order to successfully compete with other providers of operator assisted long
distance calling services, the Company must pay competitive compensation to
payphone owners for submitted call traffic. In addition, only long distance
operator assisted calls which are billable to certain credit or LEC calling
cards may be originated through use of the Company's Intelli*Star technology. If
long distance payphone calls are billable to AT&T or other non-LEC proprietary
calling cards, or 800 numbers, the calls by-pass the Company's Intelli*Star
technology (a process termed "dial-around"), thereby depriving the Company of
the opportunity to capture, bill and collect the related long distance call.
In recent years, AT&T has intensified an aggressive marketing campaign designed
to capture market share from its major competitors and from the operator
services industry. The marketing campaign encourages callers to dial 1-800
COLLECT or 1-800 CALLATT or to use AT&T proprietary calling cards when making
long distance calls away from home. In addition, prepaid and other calling
cards, which the Company cannot bill, have become increasingly popular in the
public access communications marketplace in recent years. The expanded use of
proprietary and prepaid calling cards, and of other dial-around practices by
payphone callers, has had, and is expected to continue to have, a material
adverse effect on the Company's and its customers' revenues from automated
operator assisted calls.
Automated Operator Service Revenues. In 1998, the Company's revenues from
automated operator services and billing and collection services amounted to
$25.8 million, compared with $37.2 million in 1997 (exclusive of $60.5 million
of sales related to ILD, an unconsolidated subsidiary in 1998, and prepaid
calling card business, which was sold to ILD in January, 1998). Of this 1998
total, $25.3 million was derived from the Easy*Star and other bundled programs
and $423,000 was derived from unbundled services.
IV. OTHER BUSINESS FACTORS.
Research and Development. The Company's research and development programs are
focused on development of new products and product enhancements for payphone
systems operated by IPPs, regulated telephone companies and international
customers. The Company's focus in 1998 was on the development of (a) lower cost
payphone equipment, (b) additional application software to expand the utility of
N-Genius systems, and (c) modifications of ASTRATEL 2 payphones which expand
their functionality and the number of domestic and international markets which
they may successfully address.
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In 1999, the Company intends to further modify the ASTRATEL 2 for use in new
markets and applications, and continue development of the N-Genius to improve
and expand the switching platform product line.
The Company considers research and development to be important to the
continuation and enhancement of its competitive position. The Company's ability
to adequately fund future research and development costs will depend on its
ability to generate sufficient funds from operations or external sources.
Patents and Licenses. The Company holds 23 United States patents and has
numerous United States and foreign pending patent applications relating to the
Company's Intelli*Star and other technology. These patents cover the ability to
complete automated collect telephone calls, perform certain validity checks and
internally store and retrieve data files from telephones, as well as many other
features and structures of payphones. The Company considers its patents
important to its business.
Under an exclusive patent license agreement between Gateway Technologies, Inc.
("Gateway") and the Company, the Company and Gateway have agreed to share
revenues received from sub- licensing certain of Gateway's and the Company's
patents pertaining to call processing. The Company and Gateway have entered into
sublicensing arrangements with certain manufacturers and users of call
processing equipment. The patent license agreement with Gateway expires in 2002.
In 1992, the Company entered into an agreement with MessagePhone, Inc. ("MPI"),
pursuant to which the Company licenses MPI's automated voice messaging patents.
The license permits the Company to offer voice messaging services to its
Intelli*Star and call processing customers. The MPI agreement expires in 2008,
however, it is effective until the expiration of the MPI patents, including any
continuations of such patents.
The Company licenses certain Voice over Internet Protocol (VOIP) software from
Netspeak Corporation. The Company pays fees to Netspeak on products manufactured
by the Company which utilize the licensed technology.
Trademarks. The Company has registered in the United States its trademarks
"Intellicall," "ASTRATEL," "UltraTel"(R), "N-Genius", "World Connect"(R),
"Intelli*Star" and "Easy*Star". The Company considers its trademarks
important to its business.
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Regulation. Telecommunications services and equipment offered by the Company and
its customers are subject to varying degrees of regulation at both federal and
state levels. There can be no assurance that changes in such regulation, if
proposed and adopted, would not have an adverse impact on the operations of the
Company and its customers.
Federal. The FCC has enacted rules requiring that a verbal announcement
identifying the service provider must be given to users of pay telephones and
recipients of collect calls from pay telephones, and rate quotes must be
provided to them upon request. Other requirements include a prohibition on
blocking access to alternative telecommunications carriers via certain access
codes. The FCC has, in the past, declined to impose such requirements on
operator services offered in connection with pay telephones in confinement
facilities. However, in Docket 92-77, adopted January 29, 1998, the FCC required
operator service providers ("OSPs") to orally notify callers of their right to
obtain rate quotes prior to the imposition of any charges for interstate calls
made from confinement facilities. With certain expectations discussed above
relating to "Billed Party Preference," this requirement applies to all OSPs that
provide service at public phones and phones in inmate facilities beginning July
1, 1998.
The compensation program adopted by the FCC in its September and November 1996
orders implementing the 1996 Act, required telecommunications carriers carrying
access code calls (such as 10ATT or 1 800-CALL-ATT) and calls to toll-free
800/888 numbers to pay compensation to the pay phone owner when such calls
originate and are completed from pay telephones. The FCC also concluded that,
effective in October 1997, pay telephone owners will be permitted to set
whatever rates they select for local calls placed from their pay telephones. On
July 1, 1997, the U.S. Court of Appeals for the D.C. circuit upheld the FCC's
decision to deregulate the rate for local calls placed from pay phones, but
vacated and remanded the FCC's pay phone compensation program.
On October 9, 1997, the FCC adopted a revised compensation plan, which
established an interim rate of $0.284 per completed call after October 7, 1997.
It also adopted a permanent rate commencing October 7, 1999 of the local coin
rate minus 6.6 cents. The FCC's decision again was appealed to the U.S. Court of
Appeals for the D.C. Circuit which reversed and remanded the matter to the FCC.
On January 28, 1999, the FCC adopted a Third Report and Order in its proceeding
implementing the payphone compensation provisions of Section 276 of the 1996
Act. In response to the remand, this Order establishes a new default rate at
which payphone owners will be compensated for dial around and toll free calls
originating from their payphones. Under this new rate, IXCs will be required to
compensate payphone owners at 24 cents per completed call originating from
payphones. In addition, the FCC applied this new rate (which is lower than the
rate originally adopted by the FCC) retroactively to all compensation owed since
October 7, 1997. However,
-13-
<PAGE>
payphone owners will not be required to make any refunds at least until after
the FCC issues a future order dealing with an interim period of payphone
compensation. The Company cannot predict when such an order will be issued.
State. State regulatory commissions in all states have established rules and
regulations governing the provision of private payphone services. Such rules
typically require certification or registration; notice to end users of the
identity of the service provider in the form of postings and verbal
announcements; rate quotes on request; call routing restrictions; and maximum
rates. While not necessarily uniform, these rules and regulations generally
establish minimum technical and operational requirements to assure that public
interest considerations are addressed. Most states regulate rates for local and
intrastate toll calls placed from payphones. Initially established to regulate
only services paid for by coin, such regulations have been modified in a number
of states to include the provision of automated operator services and thus also
apply to payphone providers using Intelli*Star technology. Other states have
chosen to regulate the provision of automated operator services through rules
established for operator service providers rather than those established for
payphone owners. Effective October 1997, the FCC ordered states to eliminate any
barriers to competition in pay telephone services and pre-empted state
regulations limiting the rates charged for local coin calls.
Although many state regulatory commissions regulate the provision of inmate
telecommunications services by private providers through waivers of applicable
portions of their payphone rules, a growing number of states have adopted
separate regulations governing the provision of such services. In some
instances, states that do not otherwise permit private payphone owners to
compete with regulated telephone companies have authorized such competition with
respect to confinement facilities.
Employees. As of March 1, 1999, the Company had 138 employees, of which 105
were employed in operations and 33 were employed in executive and
administrative capacities. The Company believes its employee relations
are good.
Major Customers. The Company had one single customer who accounted for 14.6%, or
$5.8 million of the Company's revenues in 1998. No single customer accounted for
more than 10% of the Company's consolidated revenues during 1997. One single
customer accounted for 10.5%, or $9.7 million, of Intellicall's revenues in
1996.
Seasonality. The Company's revenues from domestic phone equipment sales are
affected by seasonal weather conditions throughout the United States, which tend
to reduce the number and duration of pay telephone calls made in the winter
months, and which similarly reduces the number of outdoor payphone
installations.
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<PAGE>
ITEM 2. PROPERTIES.
The Company leases approximately 32,000 square feet of space at 2155 Chenault,
Carrollton, Texas, where its principal executive, sales and product development
offices are located. The lease expires May 31, 2002. The Company leases
approximately 26,500 square feet of manufacturing space on a month-to-month
basis in McAllen, Texas. The Company considers that its properties are generally
in good condition, well-maintained and suitable to carry on the Company's
business.
ITEM 3. LEGAL PROCEEDINGS.
The Company is subject to various legal proceedings arising in the normal course
of its business. It is the opinion of the management of the Company that the
ultimate disposition of these proceedings will not have a material adverse
effect on the Company's financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
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<PAGE>
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.
Stock Prices
The Common Stock currently trades on the New York Stock Exchange ("NYSE")
under the symbol ICL. The following table sets forth, for each of the periods
indicated, the reported high and low sales price per share on the NYSE of the
Common Stock.
<TABLE>
<CAPTION>
Common Stock
------------
High Low
---- ---
<S> <C> <C>
1998
First Quarter............................................................. $ 5 7/16 $ 4 1/8
Second Quarter............................................................ 6 3/16 3 7/8
Third Quarter............................................................. 4 5/16 2
Fourth Quarter ........................................................... 2 7/16 1 3/8
1997
First Quarter............................................................. $ 6 5/8 $ 4 3/4
Second Quarter............................................................ 5 3/8 4 1/8
Third Quarter............................................................. 6 1/4 3 3/8
Fourth Quarter............................................................ 6 4 11/16
</TABLE>
On March 17, 1999, the Company had approximately 1,067 stockholders of
record.
Dividend Policy on Intellicall's Common Stock
The Company has never paid cash dividends on its Common Stock. The Company
currently intends to retain any future earnings for use in its business and
therefore does not expect to pay any cash dividends on Common Stock in the
foreseeable future. Any future determination to pay cash dividends will depend
upon the earnings and financial position of the Company and such other factors
as the Board of Directors of the Company may deem appropriate at that time.
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<PAGE>
ITEM 6. SELECTED FINANCIAL DATA.
The following selected financial information for each of the five years in
the period ended December 31, 1998, is derived from the Company's Financial
Statements. The information should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Financial Statements and the notes thereto included elsewhere in this Annual
Report on Form 10-K.
<TABLE>
<CAPTION>
Year Ended December 31,(1)
--------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(In thousands, except per share amounts)
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Revenues and Sales:
Service revenues........................................... $ 25,769 $ 97,673 $ 76,905 $ 54,558 $ 60,059
Equipment sales ........................................... 13,859 19,313 15,884 19,944 23,322
---------- ---------- ---------- ---------- ----------
39,628 116,986 92,789 74,502 83,381
Cost of Revenues and Sales:
Service revenues........................................... 24,948 87,830 68,078 45,318 49,692
Equipment sales ........................................... 11,600 21,929 17,690 21,454 27,221
---------- --------- --------- --------- ----------
36,548 109,759 85,768 66,772 76,913
Gross profit............................................... 3,080 7,227 7,021 7,730 6,468
Selling, general and administrative expenses............... (8,099) (13,947) (10,598) (9,436) (12,473)
Provision for doubtful accounts............................ (876) (1,006) (364) (820) (3,517)
Research and development expenses.......................... (1,587) (741) (608) (2,350) (2,965)
---------- --------- ---------- ---------- -----------
Operating loss............................................. (7,482) (8,467) (4,549) (4,876) (12,487)
Gain on sale of assets..................................... 7,389 -- 572 1,607 --
Other income............................................... 538 695 710 440 1,100
Interest expense........................................... (1,539) (2,660) (2,918) (3,310) (3,079)
Subsidiary Loss............................................ (762) -- -- -- --
Minority interest.......................................... -- (196) (113) -- --
---------- --------- --------- -------- ----------
Loss before income taxes................................... (1,856) (10,628) (6,298) (6,139) (14,466)
Income tax benefit......................................... -- -- 1,303 -- --
Income tax expense......................................... -- (277) -- -- --
---------- --------- --------- -------- ----------
Net loss................................................... $ (1,856) $ (10,905) $ (4,995) $ (6,139) $ (14,466)
Redeemable preferred stock dividend........................ -- (186) -- -- --
=========== ========== ========== ========== ==========
Net loss available to common shareholders.................. $ (1,856) $ (11,091) $ (4,995) $ (6,139) $ (14,466)
========== ========== ========== ========== ==========
Basic and diluted net loss per share....................... $ (.19) $ (1.20) $ (0.62) $ (.80) $ (1.91)
========== ========= ========= ========= ==========
Weighted average number of basic and
diluted shares outstanding................................ 9,927 9,268 8,024 7,672 7,571
Balance Sheet Data:
Total assets............................................... $ 22,404 $ 84,789 $ 45,254 $ 48,644 $ 58,799
Total long term obligations................................ $ 8,530 $ 23,008 $ 20,107 $ 10,796 $ 25,894
Redeemable preferred stock................................. $ -- $ 13,196 $ -- $ -- $ --
Convertible preferred stock................................ $ 1 $ 4 $ -- $ -- $ --
Stockholders' equity (2)................................... $ 6,046 $ 7,471 $ 12,669 $ 13,243 $ 19,322
<FN>
(1) Certain prior year amounts have been reclassified to conform to current
year presentation.
(2) The Company has never paid cash dividends on its Common Stock.
</FN>
</TABLE>
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<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.
Forward-Looking Statements - Cautionary Statements
This Form 10-K contains certain "forward-looking statements" within the meaning
of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"),
and Section 21E of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"). Specifically, all statements other than statements of
historical facts included in this report regarding the Company's financial
position, business strategy and plans and objectives of management of the
Company for future operations are forward-looking statements. These
forward-looking statements are based on the beliefs of the Company's management,
as well as assumptions made by and information currently available to the
Company's management. When used in this report, the words "anticipate,"
"believe," "estimate," "expect," "intend", and words or phrases of similar
import, as they relate to the Company or Company management, are intended to
identify forward-looking statements. Such statements (the "cautionary
statements") reflect the current view of the Company with respect to future
events and are subject to risks, uncertainties and assumptions related to
various factors including, without limitation, competitive factors, general
economic conditions, customer relations, relationships with vendors, the
interest rate environment, governmental regulation and supervision, seasonality,
product introductions and acceptance, technological change, changes in industry
practices and one-time events. Although the Company believes that expectations
are reasonable, it can give no assurance that such expectations will prove to be
correct. Based upon changing conditions, should any one or more of these risks
or uncertainties materialize, or should any underlying assumptions prove
incorrect, actual results may vary materially from those described herein as
anticipated, believed, estimated, expected or intended. All subsequent written
and oral forward-looking statements attributable to the Company or persons
acting on its behalf are expressly qualified in their entirety by the applicable
cautionary statements. The Company's future operating results are subject to a
number of risks and uncertainties. Those believed by management of the Company
to be the most troublesome if they were to occur are set forth below in Risk
Factors.
The following discussion of the financial condition and results of operations of
the Company for 1998, 1997 and 1996 should be read in conjunction with the
Financial Statements of the Company, the Notes thereto and information included
elsewhere in this report. References in the following discussion to annual
periods refer to the Company's years ended December 31 and references to
quarterly periods refer to the Company's fiscal quarters ended March 31, June
30, September 30, and December 31.
Results of Operations. The following table sets forth certain items in the
Company's Statements of Operations as a percentage of total revenues and sales
and as a percentage of related sales for the years indicated:
-18-
<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
<S> <C> <C> <C> <C> <C>
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
Revenues and Sales:
Service Revenues 65.0% 83.5% 82.9% 73.2% 72.0%
Equipment Sales 35.0% 16.5% 17.1% 26.8% 28.0%
----- ----- ----- ----- -----
Total 100.0% 100.0% 100.0% 100.0% 100.0%
====== ====== ====== ====== ======
Gross Profit Percentage:
Service Revenues 3.2% 10.1% 11.5% 16.9% 17.3%
======== ===== ===== ===== =====
Equipment Sales 16.3% (13.5)% (11.4)% (7.6)% (16.7)%
======= ======= ======= ====== =======
</TABLE>
1998 Compared to 1997. Effective January 1, 1998, the Company changed its method
of accounting for its investment in ILD Telecommunications, Inc. ("ILD") from
consolidation to the equity method, since its percentage ownership in ILD
declined from 53.7% at December 31, 1997 to 42.0% in 1998. Under the equity
method, an investment in common stock is generally shown in the balance sheet of
an investor as a single amount. Likewise, an investor's share of net earnings or
losses from its investment is ordinarily shown in its income statement as a
single amount. Prior- year comparative financial information has not been
restated to the equity method and is presented as previously reported. In
reviewing the financial statements and discussion contained in this Form 10-K,
the reader must be aware that much of the information is not directly comparable
as the operating results and balance sheet of ILD were consolidated with those
of the Company in 1997.
Service Revenues. Total service revenues declined in 1998, due primarily to
adoption of the equity method of accounting for the operating results of ILD
effective January 1, 1998. In 1997, ILD's service revenues (including prepaid
calling card revenues) amounted to $60.5 million. Exclusive of prepaid calling
card revenues and ILD revenues, 1998 service revenues declined by $11.4 million,
or 30.6%, from $37.2 million in 1997. Of the $11.4 million decline, $7.2 million
resulted from the discontinuation in June 1997 of Jail*Star, the Company's
marginally profitable inmate services program, and the discontinuation in August
1998 of call traffic submissions to the Company by a major customer. In 1997 and
1998, the major customer accounted for $2.4 million and $5.8 million,
respectively, of call traffic revenue (not including long distance and operator
service revenue of ILD). The remaining $7.6 million portion of the decline
results from the continuing decline in the volume of call traffic due to
dial-around partially offset by an increase in the number of phones utilizing
Intelli*Star technology. Dial-around is the increasingly prevalent practice by
payphone users of accessing operator service systems other than those used by
payphone owners.
Gross profit from 1998 service revenues decreased $9 million, or 91.7%, from
$9.8 million in 1997. The exclusion of gross profit for ILD and the prepaid
calling operations from the 1997 total accounts for $7.9 million, or 87.8%, of
the decline. The remaining portion results from changes in the mix of service
revenues from 1997 to 1998. In 1997, highly profitable unbundled service
revenues and
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<PAGE>
validation service revenues accounted for larger portions of overall service
revenues than in 1998, when the portions were negligible.
Equipment Sales. Equipment sales declined in 1998 by $5.5 million, or 28.2%,
from $19.3 million in 1997. Demand for the Company's payphones and related
equipment from independent payphone providers ("IPPs") continues to be markedly
weaker than in 1997 as evidenced by a $6.2 million decline in equipment sales to
IPPs from 1997 to 1998.
Delayed, sporadic and negligible payments to IPPs of dial-around compensation
appear to have diminished the incentives of IPPs to expand their routes. In lieu
of route expansion, many IPPs have chosen to rotate phones within their routes
from one location (where increased numbers of undercompensated dial-around calls
have rendered a location insufficiently profitable) to another (where a higher
rate of coin and lower rate of dial-around calls promise profitability). Until
the amount and timing of dial-around compensation payments become adequate and
reliable, management of the Company believes that sales to IPP's will continue
to be depressed.
Partially offsetting the weakness in the IPP market segment has been the
increased demand for N- Genius systems from international customers and,
commencing in the 1998 third quarter, demand from a regulated telephone company
for ASTRATEL 2 kits. Although international sales have been hampered by the
currency weakness of Pacific Rim and certain Latin American countries,
Intellicall's export sales continued to expand in 1998. The Company's equipment
sales in 1998 to the international and regulated telephone company segments
increased by $729,000 as compared to 1997.
The Company's gross profit on 1998 equipment sales was $2.3 million, or 16.3% of
equipment sales, compared to a $2.6 million negative gross profit in 1997. In
1997, the Company provided $5.9 million for inventory losses and the impairment
of certain capitalized software costs (the "1997 Loss Provision"), without which
gross profit from equipment sales would have been $3.3 million, or 17.0% of 1997
equipment sales. After excluding the effect of the 1997 Loss Provision from the
comparison, the change in gross margin from 17.0% in 1997 to 16.3% in 1998
resulted principally from the lower volume of equipment sales in 1998, offset by
a $933,000 reduction in 1998 of amortized software development costs, receipt in
1998 of a $518,000 order cancellation fee, reduced material costs and reduced
overhead costs and labor efficiency.
Selling, General and Administration. In 1997, ILD's and the prepaid business's
selling, general and administrative ("SG&A") expenses were $6.1 million.
Excluding ILD's and the prepaid business's SG&A expenses from the comparison of
annual expense levels, the Company's SG&A expenses increased by $300,000, or
3.8%, from $7,800,000 in 1997 to $8,100,000 in 1998. The increased expenses
resulted from increases in marketing, public relations and customer service
expenses, offset by a general reduction in payroll related expenses.
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<PAGE>
Provision for Doubtful Accounts. The provision for doubtful accounts declined
from $1,006,000 in 1997 to $876,000 in 1998. The $130,000 decline is a result of
the improved credit quality and lower level of the Company's sales.
Research and Development Expenses. Research and development expenses increased
$846,000 from 1997 to 1998 partially due to a $291,000 reduction in the amount
of software development costs capitalized in 1998, as compared to 1997, and an
increase in research and development expenditures.
Gain on Sale of Assets. During the first quarter of 1998, Intellicall reported
gains on sales of assets totaling $6.4 million resulting from the sale of the
Company's prepaid services operation to ILD and from a sale in March 1998 of a
portion of the Company's ownership interest in the common stock of ILD to an
unrelated third party.
During the second quarter of 1998, the Company reported a $493,000 gain from the
sale of a portion of the Company's ownership interest in ILD to an unrelated
third party.
In the fourth quarter of 1998, the Company recognized $500,000 of deferred gain
relating to the sale of the Company's prepaid services operation to ILD. (See
Note 1 to the Financial Statements).
1997 Compared to 1996. As noted above, during 1997 and 1996 the Company
consolidated the results of operations of ILD.
Service Revenues. Service revenues were $97.7 million in 1997, compared to $76.9
million in 1996. The table below provides a summary of service revenues by type
for each of the two years (in thousands).
1997 1996
---- ----
Call Traffic Revenue ....................... $37,223 $46,581
Long-distance Resale ....................... 6,927 5,068
Operator Services .......................... 47,108 21,609
Prepaid Calling Services.................... 6,415 3,647
------- -------
$97,673 $76,905
======= =======
During 1997, call traffic revenues declined $9.4 million (20.1%) compared with
the corresponding period in 1996. The decline principally resulted from the
discontinuation in June 1997 of the Company's Jail*Star inmate services program,
and the continuing effects of dial-around. The portion of the decline from 1996
in call traffic revenue attributable to the discontinuance of the Jail*Star
program was $5.6 million and a loss of 4,057 phones reporting under this
program. Partially offsetting this decline was an increase in the number of
phones reporting through other programs from 57,671 phones reporting in 1996 to
60,029 phones reporting in 1997. The remainder of the decline in call traffic
revenues is principally attributable to dial-around.
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<PAGE>
Gross profit derived from call traffic revenues was $1.9 million, or 5.2%, of
related sales in 1997 compared to $5.2 million, or 11.3%, of related sales in
1996. Primarily accounting for the decline in gross margin was an increase in
bad debt reserves on current and prior-year traffic. In addition, unbundled
revenues, which have a 100% margin, declined $238,000 from 1997 to 1996.
Long-distance resale and operator service revenues rose $27.4 million, or 103%,
in 1997 compared to 1996. The majority of the increase arose from acquisitions
by ILD of operator service and long-distance service businesses in 1997. The
remaining portion of operator service revenue growth was generated internally.
In line with the growth of revenues from the acquired businesses, and reflecting
economies of scale, gross profit from long-distance resale and operator service
revenues rose to $6.1 million, or 11.2%, in 1997 compared to $2.1 million,
or 8.0%, in 1996.
Compared with 1996, prepaid calling card revenues increased by $2.8 million, or
75.9% in 1997. The growth in revenues reflects the Company's increased sales of
prepaid calling cards through retail distribution channels. Gross profit from
prepaid calling card revenues increased from $1.1 million, or 31.5%, of
revenues in 1996 to $1.9 million, or 29.1%, in 1997. The growth in gross
profit dollars was principally a function of the growth in revenues.
Equipment Sales. The Company's equipment sales were $19.3 million and $15.9
million in 1997 and 1996, respectively. The following table summarizes equipment
sales by market (in thousands):
1997 1996
---- ----
Independent Payphone Providers................ $16,726 $11,529
International................................. 2,577 3,933
Regulated .................................... 10 422
------- -------
Total equipment sales ............ $19,313 $15,884
======= =======
Equipment sales in 1997 rose $3.4 million, or 21.6%, from 1996. The growth in
sales resulted from increased demand for ASTRATEL 2 payphones, kits and
accessories, and for network systems used to render prepaid calling card
services. In 1997 sales of ASTRATEL 2 phones and kits were $10.3 million
compared to $1.1 million in 1996. International and regulated sales in 1997
declined $1.8 million from 1996.
For both years being compared, the Company recorded negative gross margins on
equipment sales due to, in 1996, a $2.7 million provision for inventory losses,
and in 1997, a $5.9 million provision for inventory losses and for the
impairment in value of certain capitalized software development costs. In both
years, these provisions were recorded in recognition of the Company's limited
success in moving older generations of payphone and switch-based products at
prices above their inventory values.
-22-
<PAGE>
Without the $2.7 million and $5.9 million provisions for losses in 1996 and
1997, the Company's gross profit and gross margin in 1996 would have been
$900,000, or 5.6% of sales, and $3.3 million, or 17.0% of sales in 1997. The
year-to-year improvement in gross profit and gross margin on equipment sales is
attributable to the expanded volume of equipment sales and a favorable mix of
sales. Compared to 1996, the increase in sales of ASTRATEL 2 payphones and kits
created higher margins due to their much lower costs than previous generation
payphones and accessories.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $3.3 million higher in 1997 than in 1996 as a
result of ILD's acquisitions of operator service and long distance service
businesses. ILD's selling, general and administrative expenses rose from
$713,000 in 1996 to $4.3 million in 1997. Other changes affecting the yearly
comparison were reductions in sales, customer support and administrative costs
partially offset by increased marketing costs.
Provision for Doubtful Accounts. The provision for doubtful accounts increased
$642,000 in 1997 when compared to 1996. This increase reflects higher expected
levels of collection losses, principally on equipment receivables.
Research and Development Expenses. Although gross spending for research and
development declined by $727,000 from 1996 to 1997, the Company capitalized
$1.32 million of amounts spent in 1997 compared to $2.18 million in 1996.
Consequently, research and development expense showed little change from 1996 to
1997.
Income Tax Refund. In September 1996, the Company received a net federal income
tax refund in the amount of $1.3 million and approximately $259,000 of related
interest earned on the claim. The Company recorded the income tax benefit and
related interest income when the refund was received.
Liquidity and Capital Resources
In recent years, the Company has financed its net losses, capital expenditures
and capitalized research and development costs through a combination of asset
sales, reductions in working capital and external financing. In 1998, the
Company generated $5.6 million of cash from asset sales, proceeds of which were
used in part to reduce outstanding borrowings under the Company's previous line
of credit. Assets sold in 1998 included the Company's prepaid calling card
operations and a portion of its holdings in ILD.
Effective January 28, 1999, the Company entered into an arrangement with RFC
Capital Corporation ("RFC"), pursuant to which RFC purchased and agreed to make
future purchases of the Company's
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<PAGE>
eligible accounts receivable generated in the ordinary course of business at a
discount, with limited recourse to the Company (see Note 10 to the Financial
Statements). Proceeds from such purchases have been used by the Company to
retire all of its obligations to Finova Capital Corporation ("Finova"), and for
other working capital purposes. In terminating its relationship with Finova, and
entering into the arrangement with RFC, Intellicall has retained the right to
use all of its assets which are not otherwise sold to RFC, including its ILD
holdings, in secured lending arrangements, should it become desirable and
possible to do so.
The Company reported a net loss of $1.86 million in 1998. This loss included
non-cash charges of $4.0 million for depreciation and amortization, provisions
for doubtful accounts, inventory losses and the minority interest of losses
reported by the ILD subsidiary and depreciation and amortization of $2.0
million and interest charges of $1.5 million to the net loss results in
earnings before interest, taxes, depreciation and amortization (EBITDA)
of approximately $1.64 million. Net changes in operating assets and
liabilities during 1998 provided a use of cash of $624,000. Accounts
receivable declined $4.4 million for the period primarily resulting from
lower equipment and service sales, while accounts payable declined $4.2
million due to reduced inventory purchasing and more timely payment to vendors.
Cash flows from financing activities include a $1.3 million repayment on the
line of credit from Finova. In addition, $1.0 million in cash was invested in
software and product development. Capital expenditures were $478,000 for 1998,
which was a significant decline when compared to $2.0 million for 1997. Future
capital expenditures are expected to approach the levels experienced in 1998.
At March 31, 1999, the Company is required to retire the $1.0 million
convertible subordinated note due to T.J. Berthel Investments, L.P.. The Company
does not anticipate being able to make such payment from funds generated from
operations, and is in the process of negotiating with third party financing
sources to obtain sufficient capital to make such payment by the due date.
In and beyond 1999, the Company's ability to obtain further funds from external
sources will depend in part on its ability to generate operating profits, or to
substantially reduce its operating losses. Although management of the Company
believes that the Company's sales will grow in 1999 and that profitability will
expand in tandem with sales, there can be no assurance that the events necessary
for such sales growth will occur as or when expected, or that future sales
growth will be sufficiently large or profitable to permit the Company to finance
its activities without recourse to continuing sales of assets or external
funding sources. There can be no assurance that under such conditions, external
funds would be available or, if available, would not potentially dilute
shareholders' interests or returns.
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<PAGE>
Risk Factors Relating to Forward-Looking Statements
Regulatory Changes. As described in ITEM I., BUSINESS, the Company's sales and
revenues are affected by existing regulations and by changes in state and
federal regulations to which the Company's customers, equipment business and
service business are subject. The rate of change in proposed and promulgated
regulations affecting operator service businesses and payphone manufacturers has
accelerated since passage of the Telecommunications Act of 1996 in February of
that year. In addition, numerous parties affected by regulatory changes have
sought modifications or rescission of proposed or existing regulations, some of
which would adversely affect the Company if adopted. There can be no assurance
that proposed regulatory changes that might adversely affect the Company will
not be adopted, or that existing regulations that may benefit the Company's
operations if implemented will not be rescinded or delayed in their
implementation. Furthermore, many aspects of telecommunications legislation and
regulations have been litigated in various federal and state courts. Decisions
emanating from federal and state courts could have an adverse effect on the
Company.
Acceleration of Dial-around. The number of long distance calls which are
billable by the Company has declined since 1992 as a consequence of aggressive
marketing programs pursued by AT&T, Sprint and MCI which have made it possible
for payphone callers to route their calls in ways that preclude the Company from
billing them. Dial-around has become increasingly popular among payphone users
as 1-800 numbers have proliferated in response to the successful marketing of
prepaid and other proprietary calling card programs. Certain LECs have
introduced their own proprietary calling cards which may accelerate the
incidence of dial-around and further erode the Company's service revenues.
Volume and Profitability of Equipment Sales. The Company has developed products
which have found increasing customer acceptance in many of its markets. The
Company's long term financial welfare will depend on deeper and more profitable
penetration of existing and targeted markets. The Company's limited financial
resources may limit its ability to increase equipment sales. Funds available to
the Company from external sources may be insufficient to finance growth in
working capital, and internally generated funds may be insufficient to finance
desired capital spending or research and development spending.
The Company has historically suffered from low gross margins on equipment sales.
Although provisions for inventory losses have resulted in negative gross margins
until 1998, the Company's variable gross margins on phone and network equipment
products introduced since 1996 have markedly improved. Notwithstanding such
improvement, increased equipment sales volume is required in future periods to
cover a variety of costs. Such costs include but may not be limited to fixed
manufacturing overhead expenses and selling, general and administrative expenses
associated with the production and sale of the Company's products. There is no
guarantee that the required
-25-
<PAGE>
increase in sales will generate sufficient gross profit to finance the portion
of working capital growth not financed externally.
International Economic Conditions. As a manufacturer of payphone and network
switching equipment, the Company is a capital goods producer. As are most
capital goods producers, the Company is subject to changes in economic
conditions and in prospective returns available to its customers from the
purchase of its products. In the sale of the Company's products to customers in
developing countries, changes in currency values or the imposition of exchange
controls may lead to steep increases in the price of the Company's equipment or
leave customers unable to make payment for the equipment in U.S. dollars.
Year 2000 Discussion. The Company has undertaken a program (the "Y2K Program")
to ensure that its operations, computer systems and certain products are not
functionally impaired as a result of a failure to properly record in any
electronic medium the correct time and date on and after January 1, 2000. The
Y2K Program is a multi-year program which commenced in 1997.
Responsibilities for achieving Y2K compliance have been assigned to two groups
of employees: the Engineering Group and the Information Systems Group. The
Engineering Group is responsible for ensuring that the functionality of certain
of the Company's products is not impaired as a result of being Y2K
non-compliant. The Information Systems Group is responsible for assessing and
suitably modifying or replacing components of systems and networks used in the
Company's operations, including those used to process customer call records, so
as to ensure that the Company's business is not materially disrupted by an
instance of Y2K non-compliance over which the Company had control.
Engineering Group Y2K Program Status. The Company issues periodic status reports
on its Web Page concerning the products which will be certified for Y2K
operation. In general, products which are currently produced, supported or
widely deployed will be certified.
Conceptually, the certification process requires (a) the testing of selected
existing products in a simulated Y2K environment to determine whether
remediation is required (the "Test Phase"), (b) the development of remedial
software (the "Programming Phase"), and (c) final testing and product
certification (the "Final Test Phase"). Since the Test Phase requires the
development of test plans and scripts for a multitude of products and their
components, it is necessarily a lengthy one. The Table below summarizes, for
each phase, the estimated historical cost, the percentage of completion at
December 31, 1998, estimated total costs and targeted completion dates.
-26-
<PAGE>
<TABLE>
<CAPTION>
Phase
------------------------------------------------------------------------
Test Programming Final Test
---- ----------- ----------
<S> <C> <C> <C>
Estimated Cost to 12/31/98 $ 13,000 $ 37,000 $ 0
Percent Complete at 12/31/98 5% 20% 0%
Estimated Total Cost $118,000 $180,000 $ 73,000
Estimated Completion Date 4/99 6/99 8/99
</TABLE>
Until the Test Phase is complete, the timing and cost of remedial programming
can not be reliably estimated. Y2K product modifications are expected to be
completed principally by Company personnel.
There can be no assurance that tests and scripts devised by the Company will
detect all instances of Y2K non-compliance, or that the scope and cost of work
shown to be required upon completion of testing will be consistent with the
Company's current expectations, or that appropriate personnel will be available
when required to make and test the modifications, or that upgraded software will
be installed in customer equipment on a timely basis.
Information Systems Group ("ISG") Y2K Program Status. The ISG's areas of
responsibility include the evaluation and remediation (or replacement) of
information technology systems ("IT Systems") used by the Company, and of the
Y2K readiness of the Company's key vendors. Based upon its evaluation of the IT
system used to process customer-submitted call traffic data (the "CTD System"),
the ISG has concluded that the CTD System requires a major rewrite and upgrade
to be made Y2K compatible. The CTD System upgrade is expected to be undertaken
by existing Intellicall personnel with the use of outside consultants as needed,
to be completed by the end of the third quarter of 1999. The phases, estimated
historical and projected costs, estimated completion dates and percentages of
completion of the CTD System upgrade are set forth in the following table.
<TABLE>
<CAPTION>
Phase
---------------------------------------------------------
System Design Coding System Test
------------- ------ -----------
<S> <C> <C> <C>
Implementation
Estimated Cost to 12/31/98 $ 8,150 0 0
Percent Complete at 12/31/98 30% 0% 0%
Estimated Total Cost $25,000 $225,000 $25,000
Estimated Completion Date 4/99 7/99 9/99
</TABLE>
Until the system design phase is complete, estimates of work scope and projected
costs may be imprecise. There can be no assurance that the CTD System upgrade
will be completed on time or
-27-
<PAGE>
within budget, or that it will be sufficiently Y2K compatible to permit
processing of customer call traffic without material business disruption or
cost.
The ISG has completed its evaluation of IT Systems used by the Company in its
manufacturing, accounting, administration and human resources departments, and
on the basis of letters of assurance obtained and expected from third-party
vendors, has concluded that the Company's accounting, MRP and payroll systems
will be Y2K capable in 1999. Letters of assurance have been requested from other
key third-party vendors concerning other equipment and systems utilized by the
Company, including outside billing agents used in the collection of customer
call traffic accounts receivable. However, there can be no assurance that the
Company will receive responses from all of its vendors in a timely manner, or
that such responses will be accurate or complete. Moreover, the Company has not
conducted, and will be unable to conduct, an in-depth evaluation of third-party
providers in relation to their ability to adequately address Y2K issues.
The ISG has inventoried all personal computers, and related servers and software
used by the Company. The inventory is largely complete, on the basis of which,
the Company has tentatively adopted a plan to spend approximately $100,000 for
replacements and upgrades of the inventoried equipment and software to achieve
Y2K capability and otherwise improved performance. Management believes that the
necessary replacements and upgrades can be obtained from third parties on a
timely basis.
The success of Intellicall's business is dependent on and interconnected with
numerous third-party suppliers. The depth and complexity of interconnectivity
raises the probability that an unforeseen Y2K problem may arise, notwithstanding
the best efforts of the Company and its suppliers to avoid one. Consequently,
there can be no assurance that the Company's operations, financial condition or
prospects will not be materially impaired by a non-compliant Y2K event over
which it had no control.
Y2K Risk Assessment and Contingency Plans. Intellicall's business interruption
insurance excludes coverage of losses resulting from Y2K defects, and the
Company has been informed by its insurance agent that reasonable insurance
protection is unavailable. Most of the Company's software used in its
accounting, human resources, payroll and production functions is purchased from
reliable third-party vendors that have provided assurance of Y2K compatibility.
The planned modifications of product and most other software will be made by
company personnel in lieu of being outsourced. On a scale of difficulty, such
modifications are not expected to be more challenging than other software
modifications routinely made by Company personnel in the ordinary conduct of
their jobs.
The Company views the inability of the CTD call processing software to properly
edit decripted call records for uncollectible calls after 1999 as the most
probably Y2K worst case scenario. Notwithstanding the Company's effort to
rewrite the system by third quarter, 1999, The Company's contingency plan for
the Y2K problem relating to the CTD system includes decripting the customer's
-28-
<PAGE>
call records and submitting them to third party billing agents to collect
the call traffic revenue for the customer. This contingency plan essentially
moves customers using the Easy*Star program to an Unbundled program. This
plan currently includes the Company commission payments to Easy*Star customers
using historical bad debt and uncollectible call traffic experience, holding
back amounts typically identified and calculated by the CTD software.
The Company has no other contingency plan at the present time for Y2K problems
that might emerge, but will continue to develop other plans as problems
become evident. There can be no assurance, however, that any plan,
currently developed or yet to be developed, will be sufficiently timely or
effective to avoid a material disruption of Intellicall's or its
customer's operations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
See the Index to Financial Statements located on page F-1 for a listing
of the financial statements included as a part of this Annual Report on Form
10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
Not applicable.
-29-
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
ITEM 11. EXECUTIVE COMPENSATION.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by Items 10, 11, 12 and 13 of this Annual
Report on Form 10-K is omitted pursuant to General Instruction G(3) and will be
included in the Registrant's Definitive Proxy Statement to be filed with the
Commission not later than 120 days after the end of the fiscal year covered by
this Annual Report on Form 10-K.
-30-
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K.
(a) (1) Financial Statements.
The financial statements filed as a part of this
Annual Report on Form 10-K are listed in the "Index to
Financial Statements" on page F-1 hereof.
(2) Financial Statement Schedules.
The financial statement schedules filed as part of
this Annual Report on Form 10-K are listed in the "Index to
Financial Statements" on page F-1 hereof.
(3) Exhibits.
The following exhibits are filed as a part of this
Annual Report on Form 10-K.
(a)3.1 Certificate of Incorporation of the Company
and all amendments thereto through
December 31, 1992.
(c)3.2 Amendment to Certificate of Incorporation
raising the authorized common stock from
10,000,000 shares to 50,000,000 shares.
(f)3.3 Amendment to Certificate of Incorporation
lowering the authorized common stock from
50,000,000 shares to 20,000,000 shares.
(b)3.4 By-laws of the Company, as amended.
(a)4.1 Specimen certificate for Common Stock of
the Company.
(f)10.1 Intellicall, Inc. 1991 Stock Option Plan,
as amended.
(b)10.2 Form of Incentive Stock Option Agreement.
(b)10.3 Form of Nonqualified Stock Option
Agreement.
(b)10.4 Form of Director Stock Option Agreement.
(f)10.5 Form of 1995 Employee Stock Purchase Plan.
(b)10.6 ADREC Development and License Agreement,
dated as August 2, 1990, between VCS
Industries, Inc. d/b/a Voice Control
Systems and the Company.
(b)10.7 Amended and Restated Patent License
Agreement dated as of January 1, 1992,
between the Company and MessagePhone, Inc.
(d)10.8 Amended and Restated 10% Convertible
Subordinated Note Due 1999 dated August 11,
1994 with T.J. Berthel Investments, L.P.
-31-
<PAGE>
(c)10.9 Registration Rights Agreement dated
February 14, 1994, among between the
Company and T.J. Berthel Investments, L.P.
(e)10.10 Note and Warrant Purchase, Paying and
Conversion/Exercise Agency Agreement
entered into on December 22, 1995 between
Banca Del Gottardo and the Company.
(e)10.11 Form of 8% Convertible Subordinated Note
executed by the Company to Banca Del
Gottardo dated December 22, 1995.
(e)10.12 Form of Warrants issued with Notes.
(g) 10.13 Note and Warrant Purchase, Paying and
Conversion/Exercise Agency Agreement dated
November 22, 1996 and executed with Banca
del Gottardo.
(g) 10.14 Form of 8% Convertible Subordinated
Notes executed by the Company to Banca Del
Gottardo dated November 22, 1996 (included
within Exhibit 10.13).
(g) 10.15 Form of Warrants issued with Notes
(included within Exhibit 10.13). (h) 10.16
Receivable Sale Agreement executed with
RFC Capital Corporation.
++21.1 Subsidiaries of the Company.
++23.1 Consent of Independent Accountants.
++27.1 Financial Data Schedule.
++ Filed herewith.
(a) Incorporated by Reference from the Company's Form S-1 filed
August 28, 1987, file no. 33-15723.
(b) Incorporated by reference from the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 1991.
(c) Incorporated by reference from the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 1993.
(d) Incorporated by reference from the Company's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1994.
(e) Incorporated by reference from the Company's Current Report on Form
8-K (Date of Earliest Event Reported - December 28, 1995).
(f) Incorporated by reference from the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 1995.
(g) Incorporated by reference from the Company's Current Report on Form
8-K (Date of Earliest Event Reported - November 22, 1996).
(h) Incorporated by reference from the Company's Current Report on Form
8-K (Date of Earliest Event Reported - January 27, 1999).
-32-
<PAGE>
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the last fiscal
quarter of 1998.
The following undertaking set forth herein relates to the Company's
Registration Statement on Form S-8 (No. 33-60235), and on
Form S-8 (No. 33-64583):
"Insofar as indemnification for liabilities arising under the
Securities Act of 1933 may be permitted to directors, officers and controlling
persons of the registrant pursuant to the foregoing provisions, or otherwise,
the registrant has been advised that in the opinion of the Securities and
Exchange Commission such indemnification is against public policy as expressed
in the Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Act and will
be governed by the final adjudication of such issue."
-33-
<PAGE>
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.
March 25, 1999 INTELLICALL, INC.
/s/ John J. McDonald, Jr.
----------------------------
By: John J. McDonald, Jr.
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 the registrant and
in the capacities indicated, on March 25, 1999.
Name Office
---- ------
/s/ John J. McDonald, Jr.
- -----------------------------
John J. McDonald, Jr. President and Chief Executive Officer
(Principal Executive Officer)
/s/ R. Phillip Boyd
- -----------------------------
R. Phillip Boyd Vice President of Finance, Chief
(Principal Financial Financial Officer and Secretary
and Accounting Officer)
/s/ William O. Hunt
- -----------------------------
William O. Hunt Chairman of the Board
/s/ B. Michael Adler
- -----------------------------
B. Michael Adler Director
/s/ Thomas J. Berthel
- -----------------------------
Thomas J. Berthel Director
/s/ Lewis E. Brazelton III
- -----------------------------
Lewis E. Brazelton III Director
/s/ Arthur Chavoya
- -----------------------------
Arthur Chavoya Director
/s/ Richard B. Curran
- -----------------------------
Richard B. Curran Director
<PAGE>
INTELLICALL, INC.
INDEX TO FINANCIAL STATEMENTS
Report of Independent Accountants...........................................F-2
Financial Statements:
Balance Sheets ..........................................................F-3
Statements of Operations ................................................F-5
Statements of Stockholders' Equity ......................................F-6
Statements of Cash Flows ................................................F-7
Notes to Financial Statements............................................F-8
Financial Statement Schedules (Note A):
Valuation and Qualifying Accounts...................................F-38
Note A: All other schedules are omitted, since the required information is not
present or is not present in amounts sufficient to require submission of the
schedule, or because the information required is included in the financial
statements and notes thereto.
F-1
<PAGE>
Report of Independent Accountants
To the Board of Directors and Stockholders of Intellicall, Inc.
In our opinion, the financial statements listed in the accompanying index on
page F-1 present fairly, in all material respects, the financial position of
Intellicall, Inc. (the "Company") at December 31, 1998 and 1997, and the results
of its operations and its cash flows for each of the three years in the period
ended December 31, 1998, in conformity with generally accepted accounting
principles. 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 audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for the opinion expressed
above.
PricewaterhouseCoopers LLP
Dallas, Texas
February 23, 1999
F-2
<PAGE>
INTELLICALL, INC.
<TABLE>
<CAPTION>
BALANCE SHEETS
ASSETS
(in thousands)
December 31,
------------
1998 1997
---- ----
<S> <C> <C>
Current assets
Restricted cash .................................................. $ -- $ 2,488
Cash and cash equivalents ........................................ 16 66
Receivables............................................................ 11,267 34,881
Less allowance for doubtful accounts......................... 3,417 6,211
--------- ---------
7,850 28,670
Inventories, net.................................................. 5,177 5,002
Receivables from related party, net (See Note 1).................. 658 --
Other current assets.............................................. 197 1,908
--------- ---------
Total current assets......................................... 13,898 38,134
Fixed assets, net...................................................... 1,425 8,387
Capitalized software costs, net........................................ 2,481 2,968
Notes receivable, net.................................................. 1,074 1,125
Intangible assets, net................................................. 749 31,802
Investment in subsidiary............................................... 1,491 --
Other assets, net...................................................... 1,286 2,373
--------- ---------
$ 22,404 $ 84,789
======== ========
</TABLE>
See notes to financial statements.
F-3
<PAGE>
INTELLICALL, INC.
<TABLE>
<CAPTION>
BALANCE SHEETS (Continued)
LIABILITIES AND STOCKHOLDERS' EQUITY
(in thousands, except share information)
December 31,
1998 1997
---- ----
<S> <C> <C>
Current liabilities
Accounts payable.......................................... $2,085 $ 11,320
Accrued transmission, customer commissions and billing
charges............................................... 880 12,222
Deferred revenue.......................................... 84 1,262
Accrued liabilities....................................... 968 4,456
Capital lease obligation, current......................... -- 157
Current portion of long-term debt ........................ 3,811 4,928
--------- -------
Total current liabilities................................. 7,828 34,345
Long-term debt ................................................ 7,312 21,217
Capital lease obligation, long-term .......................... -- 843
Other liabilities.............................................. 250 948
Minority interest.............................................. -- 6,769
Deferred gain on sale of assets................................ 968 --
=== ========
Commitments and contingent liabilities (See Note 9)............ -- --
=========== ========
Total liabilities 16,358 64,122
======== ========
Redeemable preferred stock Series B-2, $100 par value;
zero and 111,960 shares issued and outstanding,
respectively.............................................. -- 11,196
Redeemable preferred stock Series B-3, $300 par value; zero
and 6,667 shares issued and outstanding,
respectively.............................................. -- 2,000
Stockholders' equity
Preferred stock, $.01 par value; 1,000,000 shares
authorized; 510 and 4,000 shares issued
and outstanding, respectively......................... 1 1
Common stock, $.01 par value; 20,000,000 shares
authorized; 11,738,001 and 9,471,944 shares issued,
respectively......................................... 117 95
Additional paid-in capital................................ 57,895 57,486
Less common stock in treasury, at cost;
24,908 shares........................................ (258) (258)
Accumulated deficit....................................... (51,709) (49,853)
-------- -------
Total stockholders' equity........................... 6,046 7,471
--------- -------
$ 22,404 $ 84,789
======== ========
</TABLE>
See notes to financial statements.
F-4
<PAGE>
INTELLICALL, INC.
<TABLE>
<CAPTION>
STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
For the Years Ended December 31,
--------------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Revenues and sales:
Service revenues............................................. $ 25,769 $ 97,673 $ 76,905
Equipment sales.............................................. 13,859 19,313 15,884
========= ========== =========
39,628 116,986 92,789
--------- --------- ---------
Cost of revenues and sales:
Service revenues............................................. 24,948 87,830 68,078
Equipment sales.............................................. 11,600 21,929 17,690
========= ========== =========
36,548 109,759 85,768
========= ========= =========
Gross profit..... 3,080 7,227 7,021
Selling, general and administrative expenses...................... (8,099) (13,947) (10,598)
Provision for doubtful accounts................................... (876) (1,006) (364)
Research and development expenses................................. (1,587) (741) (608)
--------- ----------- ----------
Operating loss... (7,482) (8,467) (4,549)
Gain on sale of assets............................................ 7,389 -- 572
Other income. 538 695 710
Interest expense.................................................. (1,539) (2,660) (2,918)
Equity in the loss of subsidiary.................................. (762) -- --
Minority interest................................................. -- (196) (113)
--------- ----------- -----------
Loss before income taxes.......................................... (1,856) (10,628) (6,298)
Income tax refund................................................. -- -- 1,303
Income tax expense................................................ -- (277) --
------------ ------------
Net loss.......................................................... $ (1,856) $ (10,905) $ (4,995)
Redeemable preferred stock dividend............................... -- (186) --
========= =========== ==========
Net loss available to common shareholders......................... $ (1,856) $ (11,091) $ (4,995)
========= ========= ==========
Basic and diluted net loss per share.............................. $ (0.19) $ (1.20) $ (0.62)
========= ========== ==========
Weighted average number of basic and diluted
shares outstanding........................................... 9,927 9,268 8,024
========= ========== ==========
</TABLE>
See notes to financial statements.
F-5
<PAGE>
INTELLICALL, INC.
<TABLE>
<CAPTION>
STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
Additional
Common Stock Preferred Stock Paid-in Treasury Stock Accumulated
------------ --------------- --------------
Shares Amount Shares Amount Capital Shares Cost Deficit Total
------ ------ ------ ------ ------- ------ ---- ------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balances at December 31, 1995 7,703 $ 77 -- $ -- $47,191 (25) $(258) $(33,767) $13,243
Exercise of stock options 31 -- -- -- 148 -- -- -- 148
Issuance of warrants -- -- -- -- 760 -- -- -- 760
Employee stock purchase 16 -- -- -- 48 -- -- -- 48
plan
Issuance of stock 100 2 -- -- 123 -- -- -- 125
Conversion of sub-ordinated 796 8 -- -- 3,332 -- -- -- 3,340
notes
Net loss -- -- -- -- -- -- -- (4,995) (4,995)
-------- -------- ------- --------- ------- ------- ----- ------ -------
Balances at December 31, 1996 8,646 87 -- -- 51,602 (25) (258) (38,762) 12,669
Exercise of stock options 65 1 -- -- 268 -- -- -- 269
Employee stock purchase 17 -- -- -- 74 -- -- -- 74
plan
Issuance of stock 430 4 -- -- 481 -- -- -- 485
Conversion of sub- ordinated 314 3 -- -- 1,237 -- -- -- 1,240
notes
Redeemable preferred -- -- -- -- -- -- -- (186) (186)
dividends declared
Issuance of preferred stock -- -- 4 1 3,824 -- -- -- 3,825
Net loss -- -- -- -- -- -- -- (10,905) (10,905)
-------- ------- ------ ------- ------- -------- ------ -------- -------
Balances at December 31, 1997 9,472 95 4 1 57,486 (25) (258) (49,853) 7,471
Exercise of stock options 47 -- -- -- 183 -- -- -- 183
Employee stock purchase 8 -- -- -- 30 -- -- -- 30
plan
Conversion of sub-ordinated 50 1 -- -- 200 -- -- -- 201
notes
Conversion of preferred 2,149 21 (3) -- (12) -- -- -- 9
stock
Issuance of stock 12 -- -- -- 8 -- -- -- 8
Net loss -- -- -- -- -- -- -- (1,856) (1,856)
-------- -------- ------ -------- ------- -------- ----- -------- -------
Balances at December 31, 1998 11,738 $ 117 1 $ 1 $57,895 (25) $(258) $(51,709) $ 6,046
====== ======== ======= ======== ======= ======== ===== ======== =======
</TABLE>
See notes to financial statements.
F-6
<PAGE>
INTELLICALL, INC.
<TABLE>
<CAPTION>
STATEMENTS OF CASH FLOWS (in thousands)
For the Years Ended December 31,
1998 1997 1996
==== ==== ====
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss........................................... $ (1,856) $ (10,905) $ (4,995)
Adjustments to reconcile net loss to net
cash provided by operating activities:
Gain on sale of investments..................... (7,389) -- --
Depreciation and amortization................... 2,002 5,973 3,810
Provision for doubtful accounts................. 876 1,393 364
Provision for inventory losses.................. 333 4,382 2,772
Equity in loss of an unconsolidated subsidiary.. 762 -- --
Minority interest in income of ILD.............. -- 196 113
Changes in operating assets and liabilities, net of prepaid sale:
Restricted cash............................. -- (2,473) 477
Cash of deconsolidated subsidiary........... (66) -- --
Receivables................................. 4,356 (7,830) 183
Inventories................................. (757) (1,451) 1,265
Receivables from related party, net......... 673 -- --
Other current assets........................ 233 (308) (1,242)
Notes receivable............................ 160 446 1,749
Accounts payable ........................... (4,187) 4,611 2,172
Transmission, customer commissions and .....
billing charges............................. (1,764) 7,261 1,223
Accrued liabilities......................... (153) 1,600 (557)
Deferred revenues........................... 938 (361) (1,070)
Other....................................... (57) (2,051) (1,344)
----------- -------------- -------------
Net cash provided by operating activities... (5,896) 483 4,920
=========== ============== =============
(CONTINUED ON NEXT PAGE)
<PAGE>
(CONTINUED FROM PREVIOUS PAGE)
Cash flows from investing activities:
Capital expenditures............................... (478) (2,082) (790)
Capitalized software............................... (1,031) (1,322) (2,175)
Cash received on sale of assets.................... 8,463 -- --
Capital lease obligation........................... -- 1,000 --
Acquisition of WorldCom assets..................... -- (10,021) --
Acquisition of Interlink assets.................... -- (10,521) --
------------- ------------- -------------
Net cash used in investing activities.. 6,954 (22,946) (2,965)
----------- ------------- -------------
Cash flows from financing activities:
Net proceeds from (repayments on) line of credit... (1,303) 9,517 (618)
Net borrowings (repayments) on notes payable....... (28) -- --
Proceeds from issuance of stock................... 223 4,653 321
Proceeds from issuance of stock in ILD............. -- 6,088 --
------------- ------------- -------------
Net cash provided by (used in) financing
activities............................ (1,108) 20,258 (297)
----------- ------------- -------------
Net (decrease) increase in cash and cash equivalents.... (50) (2,205) 1,658
Cash and cash equivalents at beginning of period........ 66 2,271 613
------------- ------------- -------------
Cash and cash equivalents at end of period.............. $ 16 $ 66 $ 2,271
============= =============== =============
Supplemental cash flow information:
Interest paid......................................... $ 1,141 $ 2,056 $ 2,387
=========== ============== =============
Supplemental non cash flow information:
Issuance of warrant................................... $ -- $ -- $ 760
============= ============== =============
Conversion of debt to equity.......................... $ 210 $ 1,320 $ 3,340
============= ============== =============
Stock issued to purchase WorldCom assets.............. $ -- $ 11,196 $ --
============= ============== =============
Stock issued to purchase Interlink assets............. $ $ 2,000 $ --
============= ============== =============
Redeemable preferred stock dividend declared ......... $ -- $ 186 $ --
============= ============== =============
</TABLE>
See notes to consolidated financial statements.
F-7
<PAGE>
INTELLICALL, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 1 - BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Business: Intellicall, Inc. (the "Company") provides automated
operator services for the independent pay telephone industry ("service
revenues"). The Company designs, engineers, manufactures and sells pay
telephones and retrofit kits, parts and intelligent network platforms
in the United States and internationally ("equipment sales").
Principles of Consolidation: In 1997 and 1996, the consolidated
financial statements include the accounts of the Company and its then majority
owned subsidiary (the "Subsidiary") formed on May 10, 1996. All significant
intercompany accounts and transactions were eliminated in consolidation.
Creation of ILD Telecommunications, Inc.: On May 10, 1996, the Company
entered into an agreement with certain investor groups to create ILD
Telecommunications, Inc. ("ILD"), a new long-distance re-sale and operator
services company. The Company transferred ownership in its wholly owned
subsidiary, Intellicall Operator Services, Inc. ("IOS"), to ILD in exchange for
cash in the amount of $2.0 million, a $1.0 million subordinated convertible
note, and preferred and common stock representing approximately 72.5% of the
voting stock of ILD. The other investor groups collectively purchased $2.0
million, or 27.5% of the voting stock of ILD, and $1.0 million of ILD's
subordinated convertible notes. ILD also issued a secured loan in the amount of
$2.0 million, at inception. The Company recorded a $572,000 gain from the
transaction.
In September 1997, ILD acquired the Operator Services Division of
WorldCom, Inc. ("WorldCom") (see Note 8). The assets acquired by ILD include the
operator services and long distance customer contracts, operator service
centers, switching facilities, billing and collection operations and inmate
operator services businesses. This acquisition by ILD lowered the Company's
ownership percentage to 59.26%.
In December 1997, ILD acquired all of the outstanding common stock of
Interlink Telecommunications, Inc. ("Interlink") (see Note 8), a switched
reseller of long distance services and provider of enhanced services including
operator services, prepaid debit cards and prepaid local service. This
acquisition by ILD lowered the Company's ownership percentage to 53.7%.
In March 1998, the Company sold to SMCO, LLP 18,348.62 shares of ILD
Telecommunications, Inc. common stock. SMCO is an unrelated third party, the
negotiations for the sale transaction were at arms length, and there were no
additional obligations or elements of financial consideration relating to the
sale transaction. The Company sold the shares for $325 each and recorded a gain
on the sale in the amount of $5.6 million. This transaction lowered the
Company's ownership percentage to 42.9% as of March 31, 1998. Accordingly, the
Company accounts for its investment in ILD under the equity method of accounting
retroactively to January 1, 1998.
On April 3, 1998 the Company sold 1,539 shares of its Series A
preferred stock in ILD Telecommunications, Inc. to SMCO Investments, LLC. This
transaction lowered the Company's ownership percentage to 42.0% as of April 3,
1998.
F-8
<PAGE>
INTELLICALL, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Use of Estimates: The preparation of financial statements in
conformity with generally accepted accounting principles requires the Company to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent liabilities at the date of the
financial statements and reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Revenue Recognition: Revenues from sales of telephones and related
products are recognized upon shipment to customers. Revenues relating to the
licensing of automated operator systems are recognized upon shipment of licensed
technology to licensees.
Call revenues from customer-licensed microautomated operator systems
are recognized based on the amounts charged to billed parties for calls
processed and billed by the Company. In 1997 and prior, ILD's call revenues were
recognized at the time the calls were placed. Revenues associated with
customer-owned call processing systems and customers utilizing licensed
microautomated operator systems who have agreed to submit call traffic to a
third party billing service for processing, instead of the Company, consist of
the fees charged to customers for use of the technology.
For 1997 and 1996, prepaid debit card revenue is deferred and
recognized as calling services are used. The prepaid calling card division was
sold in January 1998, therefore no debit card revenue was recorded in 1998.
Cash and Cash Equivalents: Cash and cash equivalents include
short-term liquid investments purchased with remaining maturities of three
months or less.
Restricted Cash: Restricted cash at December 31, 1997 represents
amounts received by ILD from local exchange carriers (LECs), arising from its
capacity as a billing agent, that were not yet remitted to its third party
billing and collection customers. As cash was received from the LEC, the amounts
would become a contractual obligation to ILD's billing and collection customers.
Related Party: Related party represents a $1 million note receivable
due from ILD, which is partially offset by receivables and payables between the
Company and ILD, which were incurred during the normal course of business.
Software Development Costs: The Company capitalizes costs related to
the development of certain software products. In accordance with Statement of
Financial Accounting Standards No. 86, "Accounting for the Costs of Computer
Software to be Sold, Leased, or Otherwise Marketed", capitalization of costs
begins when technological feasibility has been established and ends when the
product is available for general release to customers. Amortization is computed
on an individual product basis based on the product's estimated economic life
using the straight line method, not to exceed five years.
F-9
<PAGE>
INTELLICALL, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
The amounts of software development costs capitalized for the years
ended December 31, 1998, 1997 and 1996 were $1.03 million, $1.32 million and
$2.18 million, respectively. The Company recorded $575,000, $1.70 million and
$1.62 million of software amortization expense for the years ended December 31,
1998, 1997 and 1996, respectively. The Company also recognized an impairment in
value of certain capitalized software development costs of $1.6 million during
1997, which is included in amortization in the statement of operations for the
year ended 1997.
Receivables: Receivables (current and long-term) consist of amounts
owed by various telephone companies for processed call traffic and amounts owed
by customers relating to uncollected call traffic and equipment sales, leases
and license fees. Excluding the call traffic receivable amounts for ILD,
approximately 50% and 68% of receivables relate to call traffic due from various
telephone companies and customers as of December 31, 1998 and 1997,
respectively. The Company advances cash to a majority of its customers prior to
the time such cash is collected from end users, and generally bears the risk of
collection and bad debt. Such amounts previously advanced but uncollected
represent significant portions of the call traffic receivables. Equipment
receivables are subject to right of offset against payments due to customers
related to call revenues. The Company believes it has provided adequate reserves
for potential uncollectible accounts. Reserves for uncollectible accounts
include $269,000 for related party receivables.
Credit Concentrations: Certain financial instruments, consisting
primarily of accounts receivable, potentially subject the Company to
concentrations of credit risk. The Company's customers range from individuals
with small pay telephone routes to large corporations, and reflect a large
customer base with much geographic diversity. The Company believes it has
provided adequate reserves for potential uncollectible accounts.
Inventories: Inventories are stated at the lower of cost or market
with cost determined on a first-in, first-out method. Costs include acquisition
costs of purchased components, freight costs, labor and overhead.
The components of inventories, net of the related reserves, are (in thousands):
December 31,
------------
1998 1997
---- ----
Raw materials......................................... $ 3,629 $ 2,491
Work in process....................................... 428 378
Finished goods........................................ 1,120 2,133
------- -------
$ 5,177 $ 5,002
======= =======
F-10
<PAGE>
INTELLICALL, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Reserves in 1998, 1997 and 1996 were $2.0 million, $2.7 million and
$3.0 million, respectively. 1998 results of operations include a charge of
$132,000, representing the excess of cost over market for a product manufactured
for a related party, which was not sold. Inventories in 1997 were written down
to estimated net realizable value, and results of operations for 1997 include a
charge of $4.4 million which represents the excess of cost over market. In 1996,
the Company established $2.7 million of reserves for the excess of cost over the
estimated realizable value of slow moving and obsolete inventories.
Debt Issuance Costs: The Company defers costs incurred directly in
connection with the issuance of debt obligations and charges such costs to
interest expense on a straight-line basis over the terms of the respective debt
agreements.
Fixed Assets: Fixed assets are recorded at cost. Depreciation expense
is computed by the straight-line method over the estimated useful lives of the
related assets, where the useful lives range from three to five years.
Maintenance and repairs are expensed as incurred while replacements and
betterments are capitalized.
The components of fixed assets are (in thousands):
December 31,
------------
1998 1997
---- ----
Office equipment.... $ 3,351 $ 8,148
Switching and other network equipment................. -- 1,720
Tooling and other equipment........................... 5,010 5,342
------- -------
8,361 15,210
Less accumulated depreciation......................... (6,936) (6,823)
------- --------
1,425 $ 8,387
======= ========
Depreciation expense for the years ended December 31, 1998, 1997 and 1996 was
$704,000, $1,279,000 and $901,000, respectively.
Intangible Assets: Intangible assets consist primarily of the cost in
excess of net assets of acquired businesses. These assets are amortized using
the straight-line method over 20 to 25 years. Additionally in 1997, intangible
assets included $2.9 million for a covenant not to compete and a consulting
agreement from Interlink amortized over five years and certain contracts
acquired from the WorldCom transaction valued at $2.5 million amortized over six
years (see Note 8). In March 1995, Statement of Financial Accounting Standards
No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of" ("FAS 121") was issued. Effective January 1, 1996, the
Company adopted FAS 121 which requires that long-lived assets (primarily
goodwill) held and used by an entity, or to be disposed of, be reviewed for
impairment whenever events or changes in circumstances indicate that the net
book value of the asset may not be recoverable. An impairment loss will be
recognized if the sum of the expected future cash flows (undiscounted and before
interest) from the use of the asset is less than the net book value of the
asset. The amount of the
F-11
<PAGE>
INTELLICALL, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
impairment loss will generally be measured as the difference between the net
book value of the asset and the estimated fair value of the related asset. Based
on its most recent analysis, the Company believes that no impairment of long
lived assets existed at December 31, 1998 and 1997.
Accrued Transmission, Customer Commissions and Billing Charges: The
customer commissions consist of monies owed to customers (payphone owners) for
calls processed and billed. Payments are made within 15-90 days based on the
customer agreement. Billing charges consist of monies owed to billing agents for
fees charged to process call traffic. Additionally, for 1997, Accrued
Transmission consists of transmission costs incurred to originate and terminate
a call over ILD's owned or leased transmission facilities. This category
generally includes costs of local access circuits and transmission facilities,
as well as switched costs for calls carried on another provider's network.
Capital Lease Obligation: In 1997, assets recorded under capital
leases, primarily consisting of switching equipment, are recorded at the lower
of the present value of future minimum lease payments or the fair value of the
asset. Total assets recorded under capital leases in 1998 and 1997 were $0 and
$1,000,000, respectively. No amortization of the capital lease asset was
recorded in 1997 due to the asset being placed in service at the end of
December.
Income Taxes: Income taxes are accounted for using the asset and
liability method pursuant to Statement of Financial Accounting Standards No.
109, "Accounting for Income Taxes" ("FAS 109"). Deferred taxes are recognized
for the tax consequences of temporary basis differences by applying enacted
statutory tax rates applicable to future years to differences between the
financial statement carrying amounts and the tax bases of existing assets and
liabilities. The effect on deferred taxes for a change in tax rates is
recognized in income in the period that includes the enactment date. In
addition, FAS 109 requires the recognition of future tax benefits to the extent
that realization of such benefits is more likely than not. A valuation allowance
is provided for a portion or all of the deferred tax assets when there is
sufficient uncertainty regarding the Company's ability to recognize the benefits
of the assets in future years.
Net Loss per Share: The Company has adopted Statement of Financial
Accounting Standards No. 128, "Earnings per Share" ("FAS 128"). FAS 128
simplifies the standards for computing earnings per share ("EPS") previously
found in Accounting Principles Board No. 15, "Earnings per Share" ("APB 15"),
and makes them comparable to international EPS standards by replacing the
presentation of primary EPS with a presentation of basic EPS. The provisions and
disclosure requirements for FAS 128 were required to be adopted for interim and
annual periods ending after December 15, 1997, with restatement of EPS for prior
periods required. Accordingly, EPS data for all periods presented has been
restated to reflect the computation of EPS in accordance with provisions of FAS
128.
F-12
<PAGE>
INTELLICALL, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Disclosures about Reporting Comprehensive Income: In June 1997,
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" ("FAS 130") was issued. FAS 130 establishes standards for reporting and
display of comprehensive income and its components (revenues, expenses, gains,
and losses) in a full set of general-purpose financial statements. It requires
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. FAS 130 is
effective for fiscal years beginning after December 15, 1997. The Company has
adopted this Statement for the year ending December 31, 1998. There were no
items of comprehensive income for the years ended December 31, 1998, 1997 and
1996.
Disclosures about Segments of an Enterprise and Related Information:
In June 1997, Statement of Financial Accounting Standards No. 131, "Disclosure
About Segments of an Enterprise and Related Information" ("FAS 131") was issued.
FAS 131 establishes standards for the way that public business enterprises
report information about operating segments in annual financial statements and
requires that those enterprises report selected information about operating
segments in interim financial reports issued to shareholders. FAS 131 is
effective for financial statements for periods beginning after December 15,
1997. The Company has adopted FAS 131 for the year ended December 31, 1998.
(See Note 7.)
Accounting for Derivative Instruments: In June 1998, Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("FAS 133"), which is effective for fiscal
years beginning after June 15, 1999. Earlier application for certain
provisions of this standard is permitted. FAS 133 establishes accounting and
reporting standards for derivative instruments. The Statement requires that an
entity recognize all derivatives as either assets or liabilities in the
financial statements and measure those instruments at fair value, and it defines
the accounting for changes in the fair value of the derivatives depending on the
intended use of the derivative. FAS 133 is not expected to have a material
impact on the Company's results of operations, financial position or cash flows.
Accounting for Computer Software Developed or Obtained for Internal
Use: In March 1998, the American Institute of Certified Public Accountants (the
"AICPA") issued Statement of Position 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use" ("SOP 98-1").
SOP 98-1 provides guidance on accounting for the costs of computer software
developed or obtained for internal use. This pronouncement identifies the
characteristics of internal use software and provides guidance on new cost
recognition principles. SOP 98-1 is effective for fiscal years beginning
after December 15, 1998. SOP 98-1 is not expected to have a material
impact on the Company's results of operations, financial position or
cash flows.
Disclosures about Fair Value of Financial Instruments: The following
methods and assumptions were used to estimate the fair value of each class of
financial instruments for which it is practicable to estimate that value:
Restricted Cash and Cash equivalents. The carrying amount
approximates fair value because of the
F-13
<PAGE>
INTELLICALL, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
short maturity of those instruments.
Long-term debt. Based on the borrowing rates and terms of secured and
subordinated loans which the Company believes are currently available, the fair
value of long-term debt is $7.3 million ($21.2 million in 1997).
Short-term debt. Based on the borrowing rates and terms of secured and
subordinated loans which the Company believes are currently available, the fair
value of short-term debt is $3.8 million ($4.9 million in 1997).
Major Customers: The Company had one single customer who accounted for
14.6%, or $5.8 million of the Company's revenues in 1998. No single customer
accounted for more than 10% of the Company's revenues during 1997. One single
customer accounted for 10.5%, or $9.7 million, of the Company's revenues during
1996.
F-14
<PAGE>
INTELLICALL, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 2 - LONG-TERM DEBT AND LINE OF CREDIT
The Company's debt consisted of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
1998 1997
----------- -----------
<S> <C> <C>
Intellicall, Inc.
8% Convertible subordinated notes, due 2000 $ 2,630 $ 2,840
8% Convertible subordinated notes, due 2001 5,000 5,000
Convertible subordinated note, due 1999 1,000 1,000
Asset-based note collateralized by certain assets, due 1999 2,811 4,114
Installment note, due 1998 -- 28
--------- ---------
11,441 12,982
Less unamortized debt discount (318) (450)
--------- ---------
11,123 12,532
--------- ---------
ILD Telecommunications, Inc.
Senior secured debt, due 2001 -- 2,000
Revolving credit facility, due 2001 -- 1,957
Term loan facility, due 2001 -- 5,000
Promissory note payable, due 1998 -- 2,700
Promissory note payable, due 1999 -- 1,000
Convertible subordinated notes, due 2001 -- 1,000
--------- ---------
-- 13,657
Less unamortized debt discount -- (44)
--------- ---------
-- 13,613
--------- ---------
Total debt 11,123 26,145
Less: Current portion of long-term debt (3,811) (4,928)
--------- ---------
Total long-term debt $ 7,312 $ 21,217
========= =========
</TABLE>
On February 15, 1994 the Company issued a $1.0 million, 10.0%,
convertible, subordinated note to T.J. Berthel Investments, L.P., whose
ownership also controls 5.5% of the Company's outstanding common stock. Interest
is payable quarterly and commenced March 31, 1994. The entire principal amount
matures on March 31, 1999. The note may be converted by the holder into 160,000
shares of the Company's Common Stock at any time.
On December 29, 1995 the Company completed the sale of $7.5 million of
8.0% convertible subordinated notes, due December 31, 2000, to Banca Del
Gottardo in Lugano, Switzerland with the proceeds used to repay the previous
lender and for working capital purposes. The notes were issued with warrants to
purchase 300,000 shares of the Company's Common Stock at $4.20 per share. As a
result of activating certain anti-dilution provisions, the warrants entitle the
holder to purchase 412,637 shares of Common Stock, exercisable at $3.05 per
share. The notes are convertible into 1,785,714 shares of the Company's Common
F-15
<PAGE>
INTELLICALL, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Stock at a price of $4.20 per share. As of December 31, 1998, $4.87 million of
the Banca Del Gottardo Notes were converted to 1,159,517 shares of the Company's
Common Stock. Interest is payable semi-annually and commenced June 30, 1996.
On May 10, 1996 a majority-owned subsidiary of the Company during 1997,
ILD Telecommunications, Inc. ("ILD") completed the sale of $1.0 million of 10.0%
convertible subordinated notes, due May 10, 2001, to Triad-ILD Partners, L.P.
and Morris Telecommunications, LLC in the amounts of $666,666.67 and
$333,333.33, respectively. The notes can be converted at the rate of one (1)
share of common stock of ILD for each $90.00 of principal then due the holder.
Interest is paid quarterly.
On May 10, 1996 ILD issued Secured Promissory Notes in the aggregate
principal amount of $2.0 million with warrants to purchase an aggregate of 7,239
shares of ILD common stock at a price of $0.01 per share. Sirrom Capital
Corporation purchased a note in the original amount of $1.5 million with a
warrant to purchase 5,429 shares of common stock and Reedy River Ventures
Limited Partnership purchased a note in the original amount of $500,000 with a
warrant to purchase 1,810 shares of common stock at a price of $0.01 per share.
The notes are payable on May 10, 2001 and bear interest at 13.5% annually.
Interest is paid quarterly.
On November 22, 1996 the Company completed the sale of $5.0 million of
8.0% convertible subordinated notes, due November 22, 2001, to Banca Del
Gottardo in Lugano, Switzerland with the proceeds used to repay a portion of the
previous lender's debt and for working capital purposes. The notes were issued
with warrants to purchase 200,000 shares of the Company's Common Stock at $5.00
per share. As a result of activating certain anti-dilution provisions, the
warrants entitle the holder to purchase 251,234 shares of Common Stock,
exercisable at $3.98 per share. The notes are convertible into one million
shares of the Company's Common Stock at a price of $5.00 per share. Interest is
payable semi-annually beginning May 1997.
On November 22, 1996 the Company entered into a Loan and Security
Agreement (the "Loan Agreement") with Finova Capital Corporation ("Finova")
pursuant to which Finova agreed to loan the Company up to $12,000,000 (the
"Loan") based on an available borrowing base. The borrowing base consists
primarily of call traffic and trade equipment receivables, and inventory,
subject to eligibility requirements determined by Finova. Amounts loaned subject
to the borrowing base are determined by percentages established in the Loan
Agreement, but are within the discretion of Finova. Such percentages are subject
to change based on experience and Finova's expectations regarding future
collectibility of receivables and usage of inventory.
The Loan is evidenced by a Secured Revolving Credit Note (the "Note")
payable to the order of Finova. Borrowings under the Loan bear interest at the
rate of prime plus 1.75%. The interest rate may be decreased prospectively by up
to 0.5% based on future profitability of the Company. The Company used the
proceeds from the Finova Loan and Gottardo Notes (net of placement fees of
$509,406) to repay the remaining balance of its Series A Notes due to Nomura
Holding America, Inc., Intellicall's previous lender, in the amount of $12.7
million. Also the Loan has an unused line fee equal to one quarter of one
percent (0.25%) per annum of the unused portion of the Total Facility and a
facility fee equal to one-half of one percent (0.50%) per annum
F-16
<PAGE>
INTELLICALL, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
of the amount of the Total Facility payable on the first anniversary of the
Agreement and one each subsequent anniversary thereof. Interest is paid monthly.
The initial term of the Loan Agreement is three years at which time,
unless extended, all amounts then outstanding must be repaid. The Loan Agreement
contains prepayment penalties in the event it is terminated prior to expiration
of its initial term. The Loan is secured by first and prior liens and security
interests encumbering substantially all of the assets of the Company, including
inventory, equipment, accounts receivable, general intangibles, trademarks and
tradenames. The Loan Agreement contains various restrictions (including a
prohibition against the payment of dividends, limitations on capital
expenditures, and restrictions on investments) and financial ratio maintenance
requirements (including minimum working capital and net worth requirements). In
January 1999 the Company retired all of its obligations to Finova (See Note 10).
On August 29, 1997 ILD entered into a Loan and Security Agreement with
Nationsbank, N.A. ("Nations") pursuant to which Nations agreed to loan ILD up to
$20,000,000 (the "Revolving Credit Loan") based on an available borrowing base
comprised primarily of ILD's receivables, inventory, contract rights, general
intangibles, equipment, and deposit accounts. Borrowing under the revolving
credit loan bears interest at the current rate which is calculated (a) in the
case of Prime Rate Advances and LIBOR Advances made prior to December 30, 1998,
as the sum of the Prime Rate plus .50% per annum and LIBOR plus 2.75% per annum,
respectively, (b) in the case of Prime Rate Advances and LIBOR Advances made on
or after December 31, 1998, as the sum of the Prime Rate plus an amount
dependent on the calculation of Senior Funded Debt/EBITDA (as defined) and is
payable monthly. ILD borrowed $1,221,000 on the Revolving Credit Loan to pay for
assets acquired from WorldCom (see Note 8). The Revolving Credit Loan has an
unused line fee of one-quarter of one percent (0.25%) per annum of the
difference between $20,000,000 and the average daily outstanding balances of the
revolving credit loans during the period for which the unused line fee is due.
ILD further paid a closing fee of $300,000 to Nations and an annual
administrative fee of $25,000. The Revolving Credit Loan's initial term ends
February 13, 2001.
On August 29, 1997 Nations also agreed to loan ILD $5.0 million in a
term loan due February 13, 2001 with an interest rate of 11.5% per annum or
prime plus 2.5% per annum payable quarterly beginning March 31, 1998 (the "Term
Loan"). The Term Loan requires a mandatory reduction in the amount of $500,000
payable on or before March 31, 1998. The principal balance is due and payable in
(i) eight (8) consecutive quarterly installments in an amount equal to $300,000
each, commencing on the last day of the first (1st) fiscal quarter of 1998 and
continuing on the last day of each and every fiscal quarter thereafter through
and including the last fiscal quarter in 1999, (ii) four (4) consecutive
quarterly installments in an amount equal to $420,000 each, commencing on the
last day of the first (1st) fiscal quarter of 2000 through and including the
last fiscal quarter of 2000, and (iii) one (1) final installment in an amount
equal to $420,000 on the earlier to occur of (A) the Termination Date or (B) the
last day of the first (1st) fiscal quarter of 2001. Any portion of the Term Loan
repaid may not be reborrowed.
F-17
<PAGE>
INTELLICALL, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
The Nations loan agreement contains various restrictions (including a
prohibition against the payment of dividends, limitations on capital
expenditures, and restrictions on investments) and financial ratio maintenance
requirements (including fixed charge coverage and net worth requirements).
On December 15, 1997 ILD entered into two promissory notes in
consideration for partial payment in the acquisition of the Interlink common
stock. The first promissory note in the amount of $2,700,000 is due $1,800,000
on December 31, 1997 and $900,000 on March 31, 1998 bearing no interest and the
second promissory note in the amount of $1,000,000 is due $250,000 on a
quarterly basis commencing September 30, 1998 with interest at 9% per annum also
paid quarterly.
Aggregate maturities of long-term debt in the next three years are
$3,811,000, $2,630,000 and $5,000,000.
NOTE 3 - STOCKHOLDERS' EQUITY
Accounting for Stock-based Compensation: In October 1995, Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-based
Compensation" ("FAS 123"), was issued. The statement requires the fair value of
stock options and other stock-based compensation issued to employees to either
be included as compensation expense in the income statements of companies or the
proforma effect on net income and earnings per share of such compensation
expense to be disclosed in the footnotes to the Company's financial statements
beginning in 1996. The Company has elected to adopt FAS 123 on a disclosure
basis only. Had compensation cost for the Company's stock option plans been
determined based on the fair market value at the grant dates for awards under
those plans consistent with the method provided by FAS 123, the Company's net
loss and net loss per share would have been reflected by the following proforma
amounts for the years ended December 31, 1998, 1997 and 1996:
<TABLE>
<CAPTION>
Year Ended December 31,
1998 1997 1996
---- ---- ----
<S> <C> <C> <C> <C>
Net loss
available to
common As reported $ 1,856,000 $11,091,000 $4,995,000
shareholders Proforma $ 2,509,000 $12,179,000 $5,877,000
Basic and
diluted net As reported $ 0.19 $ 1.20 $ 0.62
loss per share Proforma $ 0.26 $ 1.31 $ 0.74
</TABLE>
The fair value of each grant is estimated on the date of grant using the
Black-Scholes Option pricing model
F-18
<PAGE>
INTELLICALL, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
with the following weighted-average assumptions used for grants during the years
ended December 31, 1998, 1997 and 1996:
Year Ended December 31,
1998 1997 1996
---- ---- ----
Dividend yield -- -- --
Expected volatility 46.85% 66.95% 65.49%
Risk free interest rate 5.59% 5.96% 6.55%
Option term 10 years 9 years 9 years
F-19
<PAGE>
INTELLICALL, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
The weighted average fair value for all options granted in 1998, 1997 and 1996
was $2.86, $3.53 and $4.06 respectively.
Stock Option Plans: The Company maintains a Nonqualified Stock
Option ("NSO") Plan, an Incentive Stock Option ("ISO") Plan (as amended) and a
Directors' Stock Option ("DSO") Plan (adopted in 1991). The number of shares
which may be granted under the NSO, ISO Plans, and DSO Plans may not exceed
600,000, 1,995,000, and 350,000, respectively. ISO's and NSO's are exercisable
at such times and in such installments as the Organization and Compensation
Committee of the Board of Directors (the "Committee") shall determine at the
time of grant. In the case of ISO's and DSO's, the option price of the shares
cannot be less than the fair market value of the underlying common stock at the
date of the grant. In the case of NSO's, the option price is determined by the
Committee and cannot be less than 85% of the fair market value of the underlying
common stock. Options expire at such time as the Committee shall determine at
the time of grant, but in the case of ISO's and DSO's no later than ten years
from the grant date. Options vest as follows: 50% on December 31 of the year of
grant and 25% on December 31 of the following two years. All options granted
under all plans in 1998, 1997 and 1996 were issued at fair market value.
NSO PLAN
Stock option activity under the NSO Plan was:
<TABLE>
<CAPTION>
Weighted Average
Options Option Price
------- ------------
<S> <C> <C>
Outstanding at December 31, 1995............... 600,000 $4.61
Activity....................................... -- --
-------
Outstanding at December 31, 1996............... 600,000 $4.61
Activity....................................... -- --
-------
Outstanding at December 31, 1997............... 600,000 $4.61
Activity....................................... -- --
-------
Outstanding at December 31, 1998............... 600,000 $4.61
=======
</TABLE>
At December 31, 1998, 1997 and 1996, there were no shares available to be
granted under the NSO plan.
F-20
<PAGE>
INTELLICALL, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
ISO PLAN
Stock option activity under the ISO Plan was:
<TABLE>
<CAPTION>
Weighted Average
Options Option Price
------- ------------
<S> <C> <C>
Outstanding at December 31, 1995............... 1,173,320 $5.63
Granted........................................ 142,000 $4.57
Exercised...................................... (32,200) $4.61
Canceled...................................... (141,505) $7.85
---------
Outstanding at December 31, 1996............... 1,141,615 $5.24
Granted........................................ 239,880 $4.62
Exercised...................................... (63,925) $4.21
Canceled....................................... (120,065) $5.28
--------
Outstanding at December 31, 1997............... 1,197,505 $5.17
Granted........................................ 207,500 $4.27
Exercised...................................... (46,715) $3.96
Canceled....................................... (129,085) $5.49
---------
Outstanding at December 31, 1998............... 1,229,205 $5.03
=========
</TABLE>
At December 31, 1998, 1997 and 1996, there were 392,455, 870 and 120,685
shares, respectively, available for grant under the ISO Plan.
DSO PLAN
Stock option activity under the DSO Plan was:
<TABLE>
<CAPTION>
Weighted Average
Options Option Price
<S> <C> <C>
Outstanding at December 31, 1995............... 140,000 $6.65
Granted........................................ 60,000 $3.50
---------
Outstanding at December 31, 1996.............. 200,000 $5.70
Canceled...................................... 30,000) $6.04
---------
Outstanding at December 31, 1997.............. 170,000 $5.64
Granted....................................... 30,000 $4.56
---------
Outstanding at December 31, 1998.............. 200,000 $5.48
=========
</TABLE>
F-21
<PAGE>
INTELLICALL, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
There were 100,000, 130,000 and 100,000 shares available for grant at December
31, 1998, 1997 and 1996, under the DSO Plan.
OTHER DIRECTORS' OPTIONS
The Company issued to certain members of the Board of Directors options prior
to the establishment of the DSO Plan.
Stock option activity pursuant to these options was:
<TABLE>
<CAPTION>
Weighted Average
Options Option Price
------- ------------
<S> <C> <C>
Outstanding at December 31, 1995.............. 60,000 $11.08
Activity...................................... -- --
---------
Outstanding at December 31, 1996.............. 60,000 $11.08
Activity...................................... -- --
---------
Outstanding at December 31, 1997.............. 60,000 $11.08
Canceled...................................... (15,000) $ 7.56
---------
Outstanding at December 31, 1998............... 45,000 $12.25
=========
</TABLE>
F-22
<PAGE>
INTELLICALL, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
The following tables summarize information about the fixed-price stock options
outstanding at December 31, 1998:
<TABLE>
NSO PLAN
Options Outstanding Options Exercisable
------------------------------------------------------------------- --------------------------------------------
Weighted-Average Weighted- Weighted-
Range of Outstanding Remaining Average Exercisable at Average
Exercise Prices at 12/31/98 Contractual Life Exercise Price 12/31/98 Exercise Price
--------------- ----------- ---------------- -------------- -------- --------------
<S> <C> <C> <C> <C> <C> <C>
$3.625 430,000 4.0 years $3.63 430,000 $3.63
6.625 100,000 2.9 years 6.63 100,000 6.63
7.750 70,000 1.7 years 7.75 70,000 7.75
-------- --------
$3.625 - 7.750 600,000 3.6 years $4.61 600,000 $4.61
========= ========
</TABLE>
<TABLE>
<CAPTION>
ISO PLAN
Options Outstanding Options Exercisable
------------------------------------------------------------------- --------------------------------------------
Weighted-Average Weighted- Weighted-
Range of Outstanding Remaining Average Exercisable Average
Exercise Prices at 12/31/98 Contractual Life Exercise Price at 12/31/98 Exercise Price
--------------- ------------ ---------------- -------------- ----------- --------------
<S> <C> <C> <C> <C> <C> <C>
$1.688 25,000 10.0 years $1.69 12,500 $1.69
3.375 - 4.50 621,825 5.9 years 3.91 589,200 3.90
4.625 - 5.625 330,880 8.2 years 4.99 224,630 5.11
5.813 - 8.00 176,500 3.4 years 7.27 170,250 7.32
10.375 75,000 5.3 years 10.38 75,000 10.38
---------- --------
$1.688 - 10.375 1,229,205 6.2 years $5.03 1,071,580 $5.12
========= =========
</TABLE>
F-23
<PAGE>
INTELLICALL, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
DSO PLAN & OTHER DIRECTORS OPTIONS
Options Outstanding Options Exercisable
------------------------------------------------------------------- -------------------------------------------
Weighted-Average Weighted- Weighted-
Range of Outstanding Remaining Average Exercisable at Average
Exercise Prices at 12/31/98 Contractual Life Exercise Price 12/31/98 Exercise Price
--------------- ----------- ---------------- -------------- -------- --------------
<S> <C> <C> <C> <C> <C> <C>
$3.50 60,000 7.2 years $3.50 60,000 $3.50
4.56 30,000 9.2 years 4.56 20,000 4.56
5.75 20,000 3.1 years 5.75 20,000 5.75
6.25 40,000 4.2 years 6.25 40,000 6.25
6.63 30,000 3.1 years 6.63 30,000 6.63
9.25 20,000 5.2 years 9.25 20,000 9.25
11.00 20,000 0.2 years 11.00 20,000 11.00
13.25 25,000 1.2 years 13.25 25,000 13.25
------ -------
$3.50 - 13.25 245,000 4.7 years $6.72 235,000 $6.81
======= =======
</TABLE>
Stock Option Plans for ILD Telecommunications, Inc.: ILD
Telecommunications, Inc. maintains a Non-qualified Stock Option ("NSO") Plan and
an Incentive Stock Option ("ISO") Plan. The number of shares which may be
granted under the NSO and ISO Plans may not exceed 49,500 shares to directors,
officers, and employees. Options under the Plan have a five year life. Options
granted in 1996 vested immediately. Options granted in 1997 vest ratably over a
three year period. ILD was not consolidated with the Company in 1998, therefore
option activity for 1998 is not included in the following schedules.
<TABLE>
<CAPTION>
NSO PLAN
Stock option activity under the NSO Plan was:
Weighted Average
Options Option Price
------- ------------
<S> <C> <C>
Outstanding at May 10, 1996.......................................... -- --
Granted.............................................................. 2,325 $24.20
--------
Outstanding at December 31, 1996..................................... 2,325 $24.20
Granted.............................................................. 2,500 $175.00
Exercised............................................................ (775) $24.20
-------
Outstanding at December 31, 1997..................................... 4,050 $117.28
========
</TABLE>
F-24
<PAGE>
INTELLICALL, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
ISO PLAN
Stock option activity under the ISO Plan was:
Weighted Average
Options Option Price
------- ------------
<S> <C> <C>
Outstanding at May 10, 1996........................................ -- --
Granted............................................................ 19,350 $24.20
------
Outstanding at December 31, 1996................................... 19,350 $24.20
Granted............................................................ 23,650 $126.90
------
Outstanding at December 31, 1997.................................... 43,000 $80.68
======
</TABLE>
At December 31, 1997 and 1996 there were 11,675 and 5,825 shares available to
be granted.
EMPLOYEE STOCK PURCHASE PLAN FOR INTELLICALL
On November 16, 1995 the Company adopted the Intellicall Employee
Stock Purchase Plan (the "ESPP"). After the offering period ending December 31,
1998, there remain authorized and available for sale to employees an aggregate
of 257,069 shares of the Company's common stock. The maximum number of shares
subject to each option under the ESPP is determined on the date of grant and
equals the sum of the payroll deductions authorized by each participating
employee (up to 10.0% of regular pay) divided by 85.0% of the lower of the fair
market value of a share of common stock on either the first or last trading day
of each offering period. Each offering period is approximately six months in
duration and commences on the first trading day on or after January 1 and
terminates on the last trading day ending the following June 30, or commences on
the first trading day on or after July 1 and terminates on the last trading day
ending the following December 31. Under the ESPP, 9,927 shares were issued at
$3.08 for the offering period ended June 30, 1996; 8,998 shares at $4.675 for
the offering period ended December 31, 1996; 8,190 shares at $3.936 for the
offering period ended June 30, 1997; 4,911 shares at $3.825 for the offering
period ended December 31, 1997; 3,335 shares at $3.347 for the offering period
ended June 30, 1998; and 1,603 shares at $1.859 for the offering period ended
December 31, 1998.
Common Stock: At December 31, 1998, there were 3,793,934 shares of
common stock reserved for options and warrants.
Preferred Stock: On July 21, 1997 (the "Closing Date") the Company
entered into a Securities Purchase Agreement (the "Purchase Agreement") with
four institutional investors (the "Investors") pursuant to which the Investors
purchased $4,000,000 of the Company's Series A Convertible preferred stock (the
"preferred stock"). The Company utilized the net proceeds from the sale of the
preferred stock (approximately $3,800,000) to pay down indebtedness to Finova.
F-25
<PAGE>
INTELLICALL, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Commencing 90 days after the Closing Date, the preferred stock, plus
all accrued stock dividend premiums at 7% annually, is convertible into common
stock of the Company at the option of each Investor at a conversion price equal
to the lower of $5.05 per share (the "Fixed Conversion Price") or eighty percent
(80%) of the average fifteen day trading price preceding the date of conversion
(the "Variable Conversion Price"). However, in the event any Investor acquires
common stock upon conversion of the preferred stock and the conversion price is
based on the Variable Conversion Price, such Investor must pay a fee to the
Company as follows:
(a) in the event the issuance of such common stock occurs from 91 to
180 days after the Closing Date, the fee payable to the Company is 25% times the
Variable Conversion Price times the number of such shares of common stock; and
(b) in the event the issuance of such common stock occurs from 181 to
365 days after Closing Date, the fee payable to the Company is 6.25% times the
Variable Conversion Price times the number of such shares of common stock.
Any shares of preferred stock outstanding two years after the Closing
Date will automatically convert into common stock.
The Investors may require the Company to redeem certain shares of
preferred stock (i) in the event the number of shares of common stock issuable
upon conversion (based on the conversion price in existence from time to time)
multiplied by 1.25 would exceed the maximum number of shares of common stock
which the Company can issue without shareholder approval pursuant to applicable
New York Stock Exchange Guidelines, unless shareholder approval is so obtained
within 120 days of such occurrence, (ii) in the event the Company fails to
reserve an adequate number of shares of common stock as contemplated by the
designation of preferred stock creating the preferred stock (the "Designation"),
unless such failure is cured by board of directors and/or shareholder approvals
as required, (iii) in the event the Company fails to honor a conversion notice
and (iv) in other events as more fully set forth in the Designation. Any
redemptions, however, are limited to the Company's borrowing availability under
its loan agreement with Finova, as further described below.
The Designation grants to the Company the option, under certain
circumstances, to redeem for cash any shares of preferred stock submitted for
conversion if the Variable Conversion Price is less than $4.00 per share and
funds are available under the Company's loan agreement with Finova.
As of December 31, 1998, $3.5 million of the Company's Series A
convertible preferred stock had been converted for 2.1 million shares of common
stock. The Company filed a registration statement on the common stock underlying
the conversion of the preferred stock on September 5, 1997.
F-26
<PAGE>
INTELLICALL, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In conjunction with the issuance of the preferred stock, the Company
entered into a Second Amendment to the Loan and Security Agreement with Finova
(the "Second Amendment"). The Second Amendment modified one financial covenant
and allowed the Company to redeem the preferred stock as contemplated in the
Designation if (i) following and giving effect to such redemption the Company
shall have excess borrowing availability under its borrowing base of not less
than $500,000, and shall have paid in full or made provision for payment in full
of all of Company's accounts payable in excess of $500,000 which are outstanding
beyond their due date and are not contested in good faith by the Company and all
bank overdrafts and (ii) at the time of such redemption no event of Monetary
Default, as defined in the loan agreement with Finova, and no event which, with
notice or passage of time or both, would constitute an event of Monetary Default
under the loan agreement with Finova has occurred and is continuing, or would
result from such redemption.
Series B-2 Redeemable Preferred Stock was issued by ILD upon ILD's
acquisition of WorldCom assets (see Note 8). Each share of the Series B-2
Redeemable Preferred Stock has a stated value of $100 and entitles the holder to
receive an annual cumulative dividend of $8.50 payable semi-annually. Subject to
certain restrictions in loan agreements, each holder has the right, commencing
on the fifth anniversary date after issuance, to require ILD to purchase the
holder's shares at the stated value of $100 per share, making such Series B-2
stock mandatorily redeemable. ILD, at its discretion, has the right to purchase
the holder's shares at the stated value of $100 per share for all shares not
previously purchased. Series B-2 Redeemable Preferred Stock is nonvoting, but
has preference over ILD's Common Stock and Series A Convertible Preferred Stock.
Series B-3 Redeemable Preferred Stock was issued by ILD upon ILD's
acquisition of Interlink (see Note 8). Each share of the Series B-3 Redeemable
Preferred Stock has a stated value of $300 and entitles the holder to receive an
annual cumulative dividend of $18.00 payable quarterly. Subject to certain
restrictions in loan agreements, each holder has the right, commencing on the
fifth anniversary date after issuance, to require ILD to purchase the holder's
shares at the stated value of $300 per share, making such Series B-3 stock
mandatorily redeemable. ILD, at its discretion, has the right to purchase the
holder's shares at the stated value of $300 per share for all shares not
previously purchased. Series B-3 Redeemable Preferred Stock is nonvoting, but
has preference over ILD's Common Stock and Series A Convertible Preferred Stock.
Common Stock Purchase Warrants: In connection with the December 29,
1995 subordinated debt issuance discussed in Note 2, and a result of activating
certain anti-dilution provisions, Banca Del Gottardo holds warrants entitling
the holder to purchase 412,637 shares of common stock, exercisable at $3.05 per
share. These warrants vested immediately and expire upon the date of maturity of
the underlying debt.
In connection with the issuance of the subordinated debt and as a
result of activating certain anti-dilution provisions, a third party holds an
additional Warrant to purchase 304,766 shares of common stock exercisable at
$2.76 per share. These warrants vested immediately and expire upon the date of
maturity of the underlying debt.
F-27
<PAGE>
INTELLICALL, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In November 1996, the Company issued additional subordinated debt to
Banca Del Gottardo as discussed in Note 2, and as a result of activating certain
anti-dilution provisions, Banca Del Gottardo holds warrants entitling the holder
to purchase 251,234 shares of common stock at $3.98 per share. In addition, a
third party holds an additional warrant to purchase 203,637 shares at $3.68.
These warrants vested immediately and expire upon the date of maturity of the
underlying debt.
F-28
<PAGE>
INTELLICALL, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 4 - INCOME TAXES
Differences between the expected income tax benefit calculated
using the statutory federal income tax rate and the actual income tax
provision are (in thousands):
<TABLE>
<CAPTION>
Year Ended December 31
----------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Expected income tax benefit at the statutory rate............ $(631) $(3,759) $(1,731)
Amortization of cost in excess of net assets
of acquired businesses........................ 31 31 31
Other:
Refund of federal income taxes................... -- -- (622)
Minority interest................................ -- 277 (101)
Other............................................ (1) 6 --
Operating loss not benefited..................... 601 3,722 2,423
------- ------------ ---------
Income tax provision................................ $ -- $ 277 $ --
========== ============ ===========
</TABLE>
The tax effect of temporary differences that give rise to a
significant portion of deferred tax assets and deferred tax liabilities
consisted primarily of timing differences in the recognition of license fee
revenues and related costs, provisions for doubtful accounts in excess of
write-offs, warranty costs, inventory reserves, gain or loss on sale of assets,
software development and operator services costs, and excess tax depreciation.
At December 31, 1998 the Company has net operating loss carryforwards
of $47.8 million for federal income tax reporting purposes. Such carryforwards,
which may provide future tax benefits, do not expire before 2007. Additionally,
in conjunction with the Alternative Minimum Tax ("AMT") rules, the Company has
available a minimum tax credit carryforward for tax purposes of $126,541. Such
credit may be carried forward indefinitely as a credit against regular tax
liability.
The Company received no income tax refunds in 1998 or 1997. The
Company received a net tax refund of $1.3 million in 1996. The Company received
the refund as a result of a ten-year carryback claim under Section 172(f) of the
Internal Revenue Code. The refund was associated with a claim of $4,534,487 of
Net Operating Loss. The Company also used $448,459 of its Alternative Minimum
Tax ("AMT") credit, the result of being subject to AMT in the fiscal year ended
June 30, 1989.
F-29
<PAGE>
INTELLICALL, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Significant components of the Company's deferred tax assets and
deferred tax liabilities under FAS 109 are (in thousands):
<TABLE>
<CAPTION>
December 31,
1998 1997
---- ----
<S> <C> <C>
Deferred tax assets:
Investment in subsidiary................................. $ 824 -
Other reserves and accruals............................... 974 $2,302
Net operating loss carryforwards.......................... 16,238 14,756
Unused alternative minimum tax credits.................... 127 127
Deferred revenue.......................................... 86 147
-------- --------
Total gross deferred tax assets............................... 18,249 17,332
======== ========
Deferred tax liabilities:
Bad debt reserves......................................... (183) (370)
Depreciation and amortization............................. (584) (478)
--------- ---------
Total gross deferred tax liabilities........................... (767) (848)
--------- ---------
Less valuation allowance....................................... (17,482) (16,484)
-------- --------
Net deferred tax assets........................................ $ -- $ --
========== ==========
</TABLE>
The valuation allowance on deferred tax assets reflects the Company's
uncertainty regarding realization of such assets due to recent operating loss
trends.
NOTE 5 - BASIC AND DILUTED NET LOSS PER SHARE
Basic and diluted net loss per share has been computed in accordance
with FAS 128 and is based on the weighted average number of common shares
outstanding during 1998, 1997 and 1996. The weighted average common shares
outstanding were 9,927,000, 9,268,000 and 8,024,000 for the years ended December
31, 1998, 1997 and 1996, respectively.
Diluted net loss per share gives effect to all dilutive potential
common shares that were outstanding during the period. The Company had a net
loss for each of the three years ended December 31, 1998; therefore, none of the
Series A preferred shares, convertible into common stock as described in Note 3,
or the options or warrants outstanding in Note 3 or the shares of common stock
to be issued upon conversion of debt to equity at each of the period ends were
included in the diluted net loss per share calculation for the years ended
December 31, 1998, 1997, and 1996, as they were anti-dilutive. The denominator
(the number of shares) and the numerator (net loss) is the same for the basic
and diluted EPS computations for all periods presented.
F-30
<PAGE>
INTELLICALL, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 6 - COMMITMENTS
The Company leases its office space, manufacturing facility, and
certain office equipment under operating leases.
Future minimum rental commitments under noncancelable operating leases
are (in thousands):
1999................................................... $ 446
2000................................................... 429
2001................................................... 365
2002................................................... 155
2003................................................... --
------
$1,395
======
Total operating lease expense was $610,000, $1,011,000 and $840,000
for the years ended December 31, 1998, 1997 and 1996, respectively.
F-31
<PAGE>
INTELLICALL, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 7 - BUSINESS SEGMENTS
The Company has two reportable segments, services and equipment. The
services segment provides billing and collection services to owners of payphones
who use the Company's automated operator technology. The equipment segment
manufactures and sells payphones, switches and related software.
The accounting policies of the segments are the same as those
described in Note 1, Business and Significant Accounting Policies. The Company
evaluates segment performance based on revenues, gross profit and net income
before taxes and interest.
Financial information that is provided to the chief operating decision
maker includes revenues, gross profit and net income. Note that there are no
intersegment revenues. The Company's primary measure of profit, net income, is
that by which it formulates decisions and communicates to investors and
analysts. Gross profit data is provided for additional information. Financial
information internally reported for the years ended December 31, 1998, 1997 and
1996 is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998
SERVICES EQUIPMENT SUBTOTAL CORPORATE(3) TOTAL
-------- --------- -------- ------------ -----
<S> <C> <C> <C> <C> <C>
REVENUES(1) 25,769 13,859 39,628 39,628
65.0% 35.0% 100.0%
GROSS PROFIT 821 2,259 3,080 -- 3,080
26.7% 73.3% 100.0%
NET INCOME (LOSS)(2) 215 (7,697) (7,482) 5,626 (1,856)
2.8% 100.0% N/A
<FN>
(1) Equipment revenues include international sales of $2,798.
(2) Percentage is determined based on the greater of the absolute amount of
all segments reporting a profit or all segments reporting a loss. The
absolute amount of all segments reporting a profit is $215, while the
absolute value of all segments reporting a loss is $7,697. Accordingly,
the percentages are calculated based on a denominator of $7,697.
(3) Note that "corporate" is not a segment. As a consequence, percentage
amounts are not calculated for "Corporate".
</FN>
</TABLE>
F-32
<PAGE>
INTELLICALL, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
SERVICES EQUIPMENT SUBTOTAL CORPORATE(4) TOTAL
-------- --------- -------- ------------ -----
<S> <C> <C> <C> <C> <C>
REVENUES(1) 97,673 19,313 116,986 116,986
83.5% 16.5% 100.0%
GROSS PROFIT(2) 9,843 (2,616) 7,227 -- 7,227
100.0% 26.6% N/A
NET INCOME (LOSS)(3) 8,941 (17,408) (8,467) (2,438) (10,905)
51.4% 100.0% N/A
<FN>
(1) Equipment revenues include international sales of $2,575.
(2) Percentage is determined based on the greater of the absolute amount of
all segments reporting a positive gross profit or all segments reporting a
negative gross profit. The absolute amount of all segments reporting a
positive gross profit is $9,843, while the absolute value of all segments
reporting a negative gross profit is $2,616. Accordingly, the percentages
are
calculated based on a denominator of $9,843.
(3) Percentage is determined based on the greater of the absolute amount of all
segments reporting a profit or all segments reporting a loss. The absolute
amount of all segments reporting a profit is $8,941, while the absolute
value of all segments reporting a loss is $17,408. Accordingly, the
percentages are calculated based on a denominator of $17,408.
(4) Note that "corporate" is not a segment. As a consequence, percentage amounts
are not calculated for "Corporate".
</FN>
</TABLE>
F-33
<PAGE>
INTELLICALL, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996
SERVICES EQUIPMENT SUBTOTAL CORPORATE(4) TOTAL
-------- --------- -------- ------------ -----
<S> <C> <C> <C> <C> <C>
REVENUES(1) 76,905 15,884 92,789 92,789
82.9% 17.1% 100.0%
GROSS PROFIT(2) 8,827 (1,806) 7,021 -- 7,021
100.0% 20.5% N/A
NET INCOME (LOSS)(3) 8,163 (12,712) (4,549) (446) (4,995)
64.2% 100.0% N/A
<FN>
(1) Equipment revenues include international sales of $3,934.
(2) Percentage is determined based on the greater of the absolute amount of all
segments reporting a positive growth profit or all segments reporting a
negative gross profit. The absolute amount of all segments reporting a
positive gross profit is $8,827, while the absolute value of all segments
reporting a negative gross profit is $1,806. Accordingly, the percentages
are calculated based on a denominator of $8,827.
(3) Percentage is determined based on the greater of the absolute amount of all
segments reporting a profit or all segments reporting a loss. The absolute
amount of all segments reporting a profit is $8,163, while the absolute
value of all segments reporting a loss is $12,712. Accordingly, the
percentages are calculated based on a denominator of $12,712.
(4) Note that "corporate" is not a segment. As a consequence, percentage amounts
are not calculated for "Corporate".
</FN>
</TABLE>
F-34
<PAGE>
INTELLICALL, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 8 - ACQUISITIONS MADE BY ILD TELECOMMUNICATIONS
On September 2, 1997 the Company announced that its majority owned
subsidiary, ILD Telecommunications, Inc. (ILD), purchased the operator services
business and related assets from WorldCom, Inc. ("WorldCom"). The assets
acquired by ILD include the operator services and related long distance customer
contracts, operator service centers in San Antonio, Texas, Las Vegas, Nevada and
Boca Raton, Florida and switching facilities in Dallas, Texas and Los Angeles,
California as well as WorldCom's billing and collection operations and inmate
operator services businesses. ILD also entered into a long-term operator
services agreement with WorldCom to handle the international and domestic
operator services requirements of WorldCom. In addition, ILD entered into a
network services contract with WorldCom.
The acquisition was accounted for under the purchase method as
prescribed by Accounting Principles Board No. 16 "Business Combinations". The
results of operations of the acquired business are included in the consolidated
financial statements from the date of acquisition through December 31, 1997. The
purchase price was $21.4 million net of $1.2 million of liabilities assumed. ILD
paid $550,000 in cash, issued 111,960 shares of redeemable preferred stock at
$100 per share, issued 34,403.67 shares of its common stock valued at
$3,750,000, and entered into loan agreements with Nationsbank in the amount of
$6.2 million (including $325,000 of debt costs - see Note 2).
Approximately $15.5 million was assigned to the excess of purchase
price over the fair value of net assets of the business acquired. The asset is
amortized using the straight-line method over 25 years. Also, $2.5 million was
assigned to contracts acquired and are being amortized over 6 years.
The following unaudited proforma consolidated results of operations
for the years ended December 31, 1997 and 1996 are presented as if the WorldCom
acquisition had been made at the beginning of each period presented. The
unaudited proforma information is not necessarily indicative of either the
results of operations that would have occurred had the purchase been made during
the periods presented or the expected future results of the combined operations.
The Company's financial statements have not been consolidated with those of
ILD's for the year ended December 31, 1998, therefore information for 1998 has
not been included in the following table.
Year ended December 31,
(in thousand, except per share)
1997 1996
---------- ----------
Net sales $168,862 $186,288
Net loss available to common shareholders (11,027) (5,826)
Basic and diluted net loss per common share (1.19) (.73)
F-35
<PAGE>
INTELLICALL, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
On December 15, 1997 ILD also acquired all of the outstanding common
stock of Interlink Telecommunications, Inc. ("Interlink"), a switched reseller
of long distance services and provider of enhanced services including operator
services, prepaid calling cards and prepaid local service. Interlink is located
in Atlanta, Georgia and principally serves the southeastern United States.
The acquisition was accounted for as a purchase whereby the excess
purchase price over net assets acquired was recorded based upon the fair values
of assets acquired and liabilities assumed. The results of operations of the
acquired business were included in the consolidated financial statements from
the date of acquisition through December 31, 1997. The purchase price was $11.4
million. ILD accomplished the acquisition of the Interlink common stock through
issuance of the following consideration; (i) $2,000,000 in cash; (ii) $2,700,000
in the form of a promissory note; (iii) $1,000,000 in the form of a promissory
note; (iv) 16,117 shares of ILD's common stock valued at $175 per share; (v)
6,667 shares of ILD's Series B-3 Redeemable Preferred Stock valued at $300 per
share which is mandatorily redeemable; and (vi) $850,000, payable $425,000 on
June 1, 1998 and $425,000 on June 1, 1999, for a five year consulting agreement.
Approximately $10.6 million has been assigned to the excess of
purchase price over the fair value of net assets of the business acquired. The
asset is amortized using the straight-line method over 25 years. Also $2.0
million was assigned to the non-compete agreement and is being amortized over 5
years.
On January 1, 1998 the Company sold its prepaid services operation to
ILD Telecommunications, Inc. in exchange for (i) $2,000,000 in cash, (ii)
forgiveness of the Company's promissory note in the original principal amount of
$2,000,000 which had previously been executed and delivered to ILD to purchase
18,348.62 shares of ILD common stock valued at $109 a share, and (iii) a
$1,000,000 promissory note due at the earlier of the date of ILD's public
offering or December 31, 1998. The cash proceeds were used to further reduce the
Company's indebtedness to Finova. The Company recorded a $835,000 gain on the
sale of the prepaid services operation with the balance recorded as deferred
gain on sale of assets to an unconsolidated investee. As of December 31, 1998,
the Company had $968,000 of deferred gain.
As stated in Note 1, the Company's ownership interest declined below
50% as of January 1, 1998, therefore the Company has not consolidated its
financial position and results of operations, with those of ILD.
NOTE 9 - LITIGATION AND CONTINGENCIES
In April 1997, U.S. Long Distance, Inc. ("USLDI") filed a Second
Amended Complaint against the Company, the ("Lawsuit"). The complaint sought
actual damages of $4.0 million, exemplary damages, attorney's fees and interest
for the Company's alleged tortious interference of USLDI's existing and
prospective contractual relationships with PhoneTel Technologies, Inc.
("PhoneTel"). The Second Amended Complaint alleged the Company and its then
subsidiary, Intellicall Operator Services, Inc., interfered with USLDI's
existing contractual relationship with PhoneTel, another defendant, when
PhoneTel executed an operator services
F-36
<PAGE>
INTELLICALL, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
agreement with the Company and its subsidiary. On July 24, 1998, The Company,
Intellicall Operator Services and ILD settled the Lawsuit with USLDI through the
collective payment of $225,000 (of which approximately $112,500 was paid by the
Company) and execution of a mutual release of all claims.
NOTE 10 - SUBSEQUENT EVENT
On January 27, 1999, the Company closed and commenced funding under a
Receivables Sale Agreement (the "RFC Agreement") with RFC Capital Corporation
("RFC") pursuant to which RFC has agreed to purchase from the Company certain
telecommunication receivables generated by the Company in the ordinary course of
the Company's business. The RFC Agreement calls for RFC to purchase eligible
receivables from the Company from time to time upon presentation thereof for a
purchase price equal to the net value of such receivables. Net value is designed
to yield RFC an effective interest rate of prime plus 2.75% plus allow RFC to
retain a holdback of five percent of the face amount of the receivables, net of
collections, against future collection risk.
Under the RFC Agreement the Company performs certain servicing,
administrative and collection functions with respect to the receivables sold to
RFC. Also, pursuant to the terms of the RFC Agreement, the Company has granted
to RFC a security interest in and to the Company's receivables not sold to RFC
and the Company's customer base relating to the generation of such accounts
receivable.
The initial term of the RFC Agreement is to December 21, 2000.
F-37
<PAGE>
<TABLE>
<CAPTION>
INTELLICALL, INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
Additions
------------------------------------
Balance at
Beginning Charged to Costs Charged to Other Deductions- Balance at End
Description of Period and Expenses Accounts - Describe Describe of Period
- ---------------------------------------------- --------- --------------- ------------------- ----------- --------------
<S> <C> <C> <C> <C> <C>
Year Ended December 31, 1998:
Allowance for doubtful
accounts........................ $ 4,422 $ 4,688(c) $ -- $ (5,693)(a) $ 3,417
============ ============ ================ =========== ============
Year Ended December 31, 1997:
Allowance for doubtful
accounts........................ $ 3,610 $ 9,331 $ -- $ (6,407) $ 6 ,534
Allowance for doubtful accounts -
notes receivable................ $ 1,762 $ -- $ -- $ (1,762) $ --
========= ============ ================ ============ ===========
Year Ended December 31, 1996:
Allowance for doubtful
accounts........................ $ 3,674 $ 3,793 $ -- $ (3,857)(a)(b) $ 3,610
============= ============ ================ =========== ===========
Allowance for doubtful accounts -
notes receivable................ $ 2,718 $ -- $ -- $ (956)(a) $ 1,762
============ ============ ================ =========== ===========
<FN>
(a) Write-off of uncollectible accounts.
(b) Includes $912,000 reserved directly against another asset.
(c) Includes $94,000 reserved from a related party receivable.
</FN>
</TABLE>
F-38
EXHIBIT 21.1
SUBSIDIARIES OF THE COMPANY
None.
We hereby consent to the incorporation by reference in the Prospectus
constituting part of the Registration Statement on Form S-3 of our report dated
March 22, 1999 appearing on page F-2 of Intellicall Inc.'s Annual Report on Form
10-K for the year ended December 31, 1997. We also consent to the incorporation
by reference in the Registration Statements on Form S-8 (Nos. 33-60235 and
33-64853) of such report. We also consent to the reference to us under the
handling "Experts" in the Prospectus constituting part of the Registration
Statement on Form S-3.
PRICEWATERHOUSECOOPERS LLP
Dallas, Texas
March 23, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<CIK> 0000818674
<NAME> Intellicall, Inc.
<MULTIPLIER> 1,000
<CURRENCY> U.S. Dollars
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<EXCHANGE-RATE> 1
<CASH> 16
<SECURITIES> 0
<RECEIVABLES> 11,267
<ALLOWANCES> (3,417)
<INVENTORY> 5,177
<CURRENT-ASSETS> 13,898
<PP&E> 8,360
<DEPRECIATION> (6,935)
<TOTAL-ASSETS> 22,404
<CURRENT-LIABILITIES> 7,828
<BONDS> 0
0
1
<COMMON> 117
<OTHER-SE> 5,995
<TOTAL-LIABILITY-AND-EQUITY> 22,404
<SALES> 13,859
<TOTAL-REVENUES> 39,628
<CGS> 11,600
<TOTAL-COSTS> 36,548
<OTHER-EXPENSES> 10,562
<LOSS-PROVISION> (7,482)
<INTEREST-EXPENSE> (1,539)
<INCOME-PRETAX> (1,856)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,856)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,856)
<EPS-PRIMARY> (.19)
<EPS-DILUTED> 0
</TABLE>
