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SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-KSB
(Mark One)
/X/ ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the fiscal year ended NOVEMBER 30, 1997
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/ / TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from _________ to _________
Commission File Number 0-20936
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DIVERSIFAX, INC.
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(Name of Small Business Issuer in Its Charter)
DELAWARE 13-3637458
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
4274 INDEPENDENCE COURT, SARASOTA, FLORIDA 34234-2109
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(Address of Principal Executive Offices) (Zip Code)
(941) 351-2720
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(Issuer's Telephone Number
Including Area Code)
Securities registered under Section 12(b) of the Exchange Act:
None
Securities registered under Section 12(g) of the Exchange Act:
COMMON STOCK, PAR VALUE $.001 PER SHARE
----------------------------------------------------
(Title of class)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
YES X NO
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Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. / /
The issuer's revenues for its most recent fiscal year: $5,552,743.
The aggregate market value of the voting stock held by non-affiliates of
the Issuer as of February 20, 1998 was $3,858,787.
There were 15,149,869 shares outstanding of the issuer's common stock, par
value $.001 per share, as of February 20, 1998.
Transitional Small Business Disclosure Format (check one):
YES NO X
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Documents incorporated by reference:
None
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
INTRODUCTION
DiversiFax, Inc. (the "Company") has been engaged, since November 1993, in
the business of owning and operating coin and debit card pay-per-copy photocopy
machines, microfilm reader-printers and accessory equipment. The Company
currently intends to pursue a strategy of expanding this business through
acquisitions.
In addition, since April 1995, the Company has been engaged in the
development and marketing of the Smart Switch-TM-, a computerized switching
device with an automated switching system. The Smart Switch permits the use of
any "off-the-shelf facsimile" ("Fax") machine as a public Fax machine and
facilitates billing of a public Fax message without the need for human
intervention or the incorporation of a high cost credit card reading device into
the Fax machine. The Company through January 1994 owned and operated self-
service, credit card activated, public access combination Fax machines, a
business different than its current Smart Switch business.
During the period from July through December 1993, the Company attempted to
redirect its marketing program with respect to its previous form of Fax business
which had yielded disappointing results. During January 1994, it became evident
that this redirected marketing program would not be successful. Management
believed that based on this and the continuation of disappointing revenues being
generated from the DiversiFax systems previously placed and being operated by
the Company, it would be in the best interest of the Company and the
stockholders of the Company to redirect the focus of the Company's business to
concentrate its efforts and resources on building and expanding the self-service
photocopying machine business. Accordingly, the Company terminated this
previous form of Fax business.
The Company, thereafter, sought an alternative and more advanced technology
for its Fax business. The Company negotiated for the purchase of the Smart
Switch from Faxit Corporation, as described in the second paragraph of this
Section (the "Faxit Acquisition Agreement").
Since October 1996, the Company, through a supply and distribution
agreement, has been engaged in the marketing and sale of scanner units capable
of screening microfilm, microfiche and microcard images and (1) printing the
scanned images onto a printer without the aid of a computer and/or (2)
transferring the images to CD Rom and maintaining the information on the users'
computers.
The Company was incorporated under the laws of the State of Delaware on
February 28, 1989. The Company's principal executive offices and operations
center are located at 4274 Independence Court, Sarasota, Florida 34234-2109,
telephone number (941) 351-2720.
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ACQUISITION AND MERGER OF IMSG SYSTEMS, INC. AND AFFILIATES. Prior to
November 1, 1993, the Company was only engaged in the self-service public Fax
machine business. As of November 1, 1993, the Company became the sole parent of
IMSG Systems, Inc. ("IMSG") and its affiliated companies, National Copy Corp.
("National"), Capital Copy Corp. ("Capital") and Advanced Business Systems, Inc.
("Advanced") (IMSG, National, Capital and Advanced collectively "IMSG and
Affiliates"), which have been operating their self-service pay-per-copy
photocopy and microfilm reader-printer business since 1969. The acquisition was
accomplished pursuant to four substantially similar merger agreements (the
"Merger Agreements"), which were deemed effective as of November 1, 1993, by and
among each of IMSG, National, Capital and Advanced and a separate acquisition
subsidiary formed by the Company for each merger.
Pursuant to the terms of the Merger Agreements, the Company issued an
aggregate of 662,000 shares of Convertible Voting Preferred Stock, Series A, par
value $.001 per share (the "Series A Preferred Stock"), of the Company to Dr.
Irwin A. Horowitz ("Dr. Horowitz"), the sole stockholder of IMSG and Affiliates,
in exchange for all of their outstanding securities. The Preferred Stock was
automatically converted into an aggregate of 6,620,000 shares of Common Stock of
the Company in November 1995.
As a result of the Mergers, the Company acquired the self-service
pay-per-copy photocopier and microfilm reader-printers and accessories and the
marketing capacity and customer base of IMSG and Affiliates, which comprises a
substantial portion of the Company's business since November 1, 1993.
Upon the consummation of the acquisition of IMSG and Affiliates, Dr.
Horowitz became the Chairman of the Board, Chief Executive Officer and President
of the Company. Prior to the Merger, from July 1993 to November 1, 1993, Dr.
Horowitz served as Chief Operating Officer of the Company.
ACQUISITION OF SMART SWITCH. On April 27, 1995, the Company, through
DiversiFax Acquisition Corp., a wholly owned subsidiary of the Company,
purchased from Faxit Corporation ("Faxit") the Smart Switch. Pursuant to the
Faxit Acquisition Agreement, the Company issued (a) shares of Series B
convertible Preferred Stock (which were automatically converted in November 1995
into 350,000 shares of Common Stock) to Faxit in exchange for Faxit's Smart
Switch and (b) shares of Series B convertible Preferred Stock (which were
automatically converted in November 1995 into 50,000 shares of Common Stock) to
the finder, Josephthal Lyon & Ross Incorporated.
OPERATIONS : COPIERS
GENERAL. Since November 1, 1993, the Company, through its wholly-owned
subsidiaries IMSG and Affiliates, has been engaged in the business of owning,
leasing, operating and servicing coin and debit card pay-per-copy photocopiers
and microfilm reader-printers (collectively the "Copiers"), cash dispensers,
laser printers and accessory equipment. IMSG and Affiliates have been in
business since 1969. The Company operates its Copiers in New York,
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Massachusetts, Pennsylvania, Illinois, Connecticut, Florida, Vermont, New
Hampshire, Wisconsin, North Carolina, South Carolina and Georgia, in various
sites including libraries, courthouses, colleges, drug stores, office supply
stores and similar high traffic outlets. The Company has over 2,500 Copiers and
accessories on site. Generally, the Company is responsible for the collection
of payments from each site and, at most locations, site operators share in the
revenues derived from the copy sales at their site. The Company has the ability
to service and repair its Copiers seven days a week. Users can pay per copy by
inserting coins in the Copier or by using a debit access card, which the user
may purchase at the site location.
PRODUCTS. The Company's Copiers consist of a photocopier or microfilm
reader-printer with an adaption which allows the user to operate the Copier and
pay for the copy by inserting coins or a debit access card. The users can
purchase debit access cards at the site location. If coins are used, the Copier
will return change in excess of the price of the copies. As copies are made
using the debit access card, the price of each copy is deducted from the
aggregate value of the debit access card.
SUPPORT SERVICES. The Company provides continuous preventative maintenance
to its Copiers and related equipment based on manufacturer specifications.
Frequency of service will vary depending upon usage of a given machine. Copiers
in high volume locations may require servicing as frequently as once a day. The
Company maintains service centers in Valley Stream (Long Island), New York;
Albany, New York; Des Plains, Illinois; Sarasota, Florida; Jacksonville,
Florida; Harrisburg, Pennsylvania; and Norwood, Massachusetts which it utilizes
to service regional accounts including repairing machines and storing supplies
and parts. The Company may also service machines on site. Service of the
Copiers is provided to its customers seven days a week by the Company's staff
which is supervised by the Company's trained managers. In addition, the Company
provides four hour emergency service repair, when needed. The cost to the
Company of providing service to its Copiers and related equipment is moderate,
as the Company employs its own service personnel, and amounts to approximately
$.04 per copy. Impact to the Company's revenues from down-time of Copiers due
to repair is negligible, as nearly all locations have multiple machines and the
Company's response time to service calls is generally prompt.
MARKETING AND DISTRIBUTION. At February 20, 1998, the Company employed a
sales staff of seven people (including two managers) and 61 service/sales
technicians, who work to increase the Company's customer base in regions where
it is currently operating, as well as to expand into new regions. To that end,
the salespersons will target potential high-traffic locations and ascertain
whether there is the need for the Company's Copiers and the potential that site
locations will be profitable for the Company. The salesperson will then
directly solicit the site locations for the placement for the Company's Copiers
and establish a commission structure with its site operators. The Company's
salespersons are compensated on either a salary basis, a commission only basis
or on a combination salary/commission basis. The site operator commission
structure varies with each customer, and will depend upon expected volume,
usage, competition and profit margin.
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SUPPLIES AND SUPPLIERS. The Company currently purchases both new and used
Copiers from a variety of sources, including acquiring Copiers from other
companies as it expands when it purchases assets from other companies. Since
machines are available from a variety or sources, the loss of any one supplier
will not adversely impact the Company.
The Company has primarily used Sharp photocopiers and Minolta microfilm
reader-printers. The Company buys these machines and supplies from brokers,
dealers and the manufacturers.
The Company did not experience any difficulties in obtaining equipment or
parts and supplies and does not anticipate that there will be any problems
obtaining any equipment, parts or supplies in the future.
EXPANSION STRATEGY. The Company presently intends to selectively expand
its Copier operations in certain targeted areas in the United States, both into
some regions where it has not previously operated, as well as expanding its
presence in the regions where it currently operates its business, subject to the
availability of requisite financing and the number of Copiers in the Company's
inventory. The Company may seek such additional financing through equity and/or
debt offerings, or through loans from Dr. Horowitz, its Chief Executive Officer,
for which there can be no assurance of obtaining. During the fiscal years ended
November 30, 1996 and November 30, 1997, Dr. Horowitz has made loans to the
Company to finance acquisitions and for working capital and has deferred certain
salary payments. At November 30, 1997, the Company owed Dr. Horowitz a balance
of $1,781,000. In addition, the Company may pay all or a portion of the
acquisition prices for such acquired businesses by means of issuing Common Stock
of the Company.
On January 27, 1994, the Company through its wholly-owned subsidiary, Coin
Copy, Inc. acquired the contract revenues and business of MDM Copying Services,
Coin-Op, Inc., which at the time had expanded the Company's position in the New
York Metropolitan area.
In June 1996, the Company, through its wholly-owned subsidiary JA-Hunt
Services, Inc., acquired the assets of a Pennsylvania-based company engaged in
the servicing of high end copier equipment and the retail sale of copier
supplies and office equipment.
In February 1998, the Company, through its wholly-owned subsidiary JA-Hunt
Services, Inc., acquired the assets of a Florida-based company engaged in the
retail sale and servicing of copier supplies and equipment. The annual revenues
of the business prior to acquisition were approximately $300,000 and the
purchase price was $80,000 ($40,000 in cash and $40,000 in stock) plus assumed
liabilities of approximately $45,000.
It is the Company's intent, subject to the availability of requisite
capital, to acquire a substantial number of companies in these and other fields
related to the Company's business.
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The Company's planned expansion requires an increase in the number of its
Copiers and accessories. Additionally, as the Company expands into new regions,
it will carefully consider whether new service centers should be established and
will engage additional service staff members and supervising technicians. The
Company intends to continue to focus on controlled growth in new and existing
domestic market areas, so that the Company will expand at a rate which will
absorb new business without disrupting operations, and optimize working capital.
There can be no assurance that the Company's expansion strategy will be
successful.
SIGNIFICANT CUSTOMERS. During the fiscal years ended November 30, 1997 and
November 30, 1996, revenue derived from one of the Company's Copier customers, a
large university located in the southeastern United States, amounted to
approximately 11.5% and 11.6%, respectively, of the Company's revenues. The
Company's contract with this university will expire in 1998 and such university
has requested bids for a new contract which was required by state law.
PATENTS AND TECHNOLOGY. The Company does not, in general, rely on patented
technology with respect to its Copier operations. The Company purchases and
operates Copiers which may contain patented technology. However, management
believes that the proprietary nature of this technology does not affect the
Company's operations. There can be no assurance however that patented
technology will not affect the Company in the future if the Company is unable to
obtain Copiers that have a patented feature which make them more desirable than
Copiers being used by the Company or that will be acquired by the Company in the
future.
COMPETITION. The Company markets its coin-operated Copier services to
users at site locations who need to copy documents, books and other materials
located at the sites where the Company's Copiers have been placed. Other
companies that offer similar coin-operated services include Continental Copy
Products Limited, Dual/Select Office Supplies, Inc. and Boston Copico. Each
of these competitors competes directly with the Company in a different and
limited geographic region. Continental Copy Products Limited principally
conducts operations in Connecticut and downstate New York (including New York
City); Dual Office Supplies principally conducts operations in Illinois and
Boston Copico principally conducts operations in Massachusetts, Connecticut,
downstate New York and southern Florida. Competition between companies is
generally based on price and quality of service offered.
SEASONALITY. The Company's Copier activities are subject to seasonal
fluctuations. Revenues from Copiers tend to be lower during the summer months
of June through September and in the last weeks of December and the first weeks
of January due to school and employee vacation patterns. Although the Company
has experienced working capital deficits and cash flow tends to be tight in
these periods of low revenue, the Company has not experienced severe cash flow
difficulties, due to the reasons discussed in this paragraph. Seasonally slow
periods are immediately preceded by periods of high volume of use, which
generate increased cash flows. In addition, because the Copier business is
conducted primarily in cash, there is no lead time between sales and
collections. Also, fluctuations are regular and predictable, thereby allowing
the Company to plan for such low revenue months. Over the past three fiscal
years, Dr. Horowitz, the Chief Executive Officer of the Company, has advanced
funds to the Company
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when needed so that it could meet its day to day cash obligations, although
there can be no assurance he will continue to do so in the future. Cash flow has
also been favorably affected in that many creditors have typically allowed the
Company to forbear during these slow months, although there can be no assurance
they will continue to do so in the future. Finally, the Company expects that
the addition of its microfiche scanner operations will offset to some extent the
seasonality of Copier operations, as scanner revenues are expected to be higher
during the summer months, during which period universities and public libraries,
the primary customers of scanners, receive a high proportion of their
municipality funding. See "Microfiche Scanner Operations."
OPERATIONS: FAX MACHINES (SMART SWITCH-TM-)
GENERAL - THE SMART SWITCH. The Company commenced its Smart Switch-TM-
operations in April 1995, upon the acquisition of the Smart Switch. The Smart
Switch is a computerized switching device, which has an automated switching
system, which permits the use of any "off the shelf" Fax machine as a public Fax
machine and facilitates billing of a public Fax message without the need for
human intervention or the incorporation of a high cost credit card reading
device into the Fax machine. When using a Fax machine equipped with a Smart
Switch, the user takes the phone off the hook and hears a voice prompt directing
the user to enter his or her credit card number and expiration date. Once
verified, the Smart Switch gives the caller a dial tone and allows a direct call
to be placed to the receiving Fax machine. If the Fax number dialed is busy,
the Smart Switch will give the caller a Fax tone and accept and store the Fax
for later retry, allowing the customer the ability to have the Fax sent to a
busy fax at such time as it becomes free, without any human intervention.
Because the Smart Switch is a computer based system and not equipment
based, the Smart Switch gives the Company the capacity to offer a variety of
Fax and voice services, such as Fax and voice mailbox systems and services
that allow users to send and receive faxes directly in a hotel room without
additional costly telephone lines, together with other services which allow
users to make copies and print from lap top computers, all in one unit.
These units are available to hotels, libraries and airport lounges, and
domestic and international Fax transmission services at competitive rates.
The Smart Switch permits hotels to offer in-room Fax machines for guests'
confidential use, as well as a port to plug into guests laptop computers,
enabling guests to print reports from fax machines and allowing copies to be
made on plain paper, thereby converting each room into a "Smart Suite". The
Smart Switch software has been upgraded by the Company following its
acquisition to permit billing of the user not only through the user's credit
card but also by billing to the user's hotel bill either by a transfer of the
billing information to the hotel's computer or by an electronic scanning of
calls to listen for a Fax tone.
SUPPORT SERVICES. The Company services the Smart Switch units in all
states where it currently services its Copiers and related equipment. In other
states, the Company will be using outside service companies for this purpose.
MARKETING AND DISTRIBUTION. The Smart Switch is marketed under the
direction of Paul
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Akel, the President of DiversiFax Information Services, Inc., the wholly-owned
subsidiary of the Company conducting Smart Switch operations.
Although certain limited trials of a version of the Smart Switch had been
conducted, no sales of the Smart Switch had been made prior to its acquisition
by the Company. The Company commenced marketing of the Smart Switch in April
1995 and has placed units under lease at hotels, airport lounges, libraries and
colleges, principally in the Northeast. The term of the agreements range from
one year to 39 months, and the hotel, lounge or other party is responsible to
pay the Company for the cost of the equipment as well as a per minute usage
charge. Generally, users of Fax machines (e.g., hotel guests) are charged by
the minute per usage, with the amounts collected by the Company, who remits a
portion to the relevant provider of the Fax machine (e.g., the hotel). In some
cases, the hotel collects for usage, and remits the required portion to the
Company.
The initial results from the Company's Fax machine operations have been
below expectations. A number of hotels, airport lounges, libraries and
colleges, as described above, have installed and are currently utilizing the
Smart Switch. Specifically, there are 52 units in hotels, five units in airport
lounges and five units in libraries and universities. Several hotels have
canceled or determined not to permanently install a significant number of such
machines, apparently primarily due to a competitor who has been providing
in-room fax machines to hotels free of charge. One hotel returned 87 machines
which the Company believes is related to a change in control of such hotel.
There can be no assurance that there will not be a material amount of additional
cancellations, or that significant new orders will develop so as to make the Fax
machine operations of the Company profitable. Smart Switch revenues to date
have been nominal. There can be no assurance that the Smart Switch will gain
broad market acceptance.
In November 1995, the Company entered into an agreement with AT&T to
jointly market the Company's in-room Fax services on an exclusive basis to AT&T
hotel accounts, and in November 1996, the Company entered into a co-marketing
agreement with Danka.
Although there are results of several market research studies and surveys
available to the Company which indicate that over 50% of all business travelers
expect hotels to offer fax and copier services, there has been no research
completed in connection with in-room fax services that gives management
sufficient information to estimate potential demand for its Smart Switch with
certainty. There can be no assurance that sufficient market penetration can be
achieved so that planned placement of any of the Company's equipment will be
absorbed by the market in the event such demand can be identified.
AGREEMENT WITH AT&T. In November 1995, the Company and AT&T entered into
an agreement providing for the joint marketing of the Smart Switch in hotels
utilizing AT&T's "0 Plus" service. The Agreement was for an initial term of one
year, absent termination based on breach, and has been renewed by agreement of
the parties for an additional two year term. Under the agreement, the Company
will (a) obtain, install and maintain all individual Fax units and the Facsimile
Central Systems at hotel units desiring the service and (b) partner exclusively
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with AT&T for hotels with AT&T "0 Plus" service. AT&T is required to (a)
provide a sales distribution channel for agreed upon territories, (b) provide
sales support, and (c) exclusively offer the Smart Switch in room Fax service
during the term of the agreement. The Company will be compensated directly by
the hotels and users (guests) of the Smart Switch. To date, minimal sales
have resulted from this agreement.
AGREEMENT WITH DANKA. In November 1996, the Company entered into a
co-marketing agreement with Danka to jointly market the Company's Smart
Switch Fax services. It is contemplated that Danka will provide hotels with
Fax machines incorporating Smart Switch functionality as part of Danka's
preferred vendor status offered to Hotel Franchise System, a hotel chain
association, whose members include, among others, Ramada Inn, Travelodge,
Days Inn, Howard Johnson and Super 8. Danka is a leading independent
supplier of office imaging equipment and related services. To date, no
revenues have been generated under this agreement.
SUPPLIES AND SUPPLIERS. The Company assembles the Smart Switch by
programming the Company's proprietary software into off-the-shelf computers and
leases the programmed computer together with off-the-shelf Fax machines and
telephones, dialers and components, all of which are manufactured by other
vendors. The Company purchases certain custom components and complete Fax
machines from single suppliers in order to obtain lower prices. In the past,
the Company has had satisfactory relationships with its suppliers and has not
experienced delays in the delivery of components or public-fax machines. The
Company generally does not maintain supply contracts with its suppliers and
purchases pursuant to purchase orders in the ordinary course of business. The
Company believes that there are a number of other suppliers for the components
that it uses. The Company did not experience any difficulties in obtaining
equipment or parts and supplies and, although there can be no assurance, does
not anticipate that there will be any problems obtaining any equipment, parts or
supplies in the future.
PATENTS AND TECHNOLOGY. The Company does not believe that the technology
upon which the Smart Switch systems are based is patentable. Other companies
may have been or may be involved in research and development which may lead to
patents relating to specific aspects of the Company's products and technologies,
and the Company has not engaged counsel to determine whether its products are in
general free from patent infringement. Unless protected by patents or
nondisclosure agreements, the Smart Switch may be susceptible to being analyzed
and reconstructed by an existing or potential competitor. The Company is not
aware of any claims that its products infringe upon the proprietary rights of
third parties. However, there can be no assurance that third parties will not
assert infringement claims against the Company in the future, and the cost of
responding to such assertions, regardless of their validity, could be
significant. In addition, such claims may be found to be valid and could result
in awards against the Company, which could have a material adverse effect on the
Company's business. As a result, the cost to the Company of protecting itself
against patent claims could be substantial. The market for the Company's
public-Fax products is characterized by rapidly changing technologies and
evolving industry standards. The Company's success will depend in large part
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on the Company having a technically competent staff and on its ability to
anticipate changes in technology and industry standards and, to the extent such
changes impact the Company's technology and products, to respond to market and
technological developments on a timely basis. There can be no assurance that
the Company will be able to keep pace with the technological demands of the
market place. Moreover, there can be no assurance that new products or
technologies will not render the Company's Smart Switch less competitive or
obsolete.
GOVERNMENT REGULATION. There are no known federal or state regulations
which regulate the public facsimile transmission business, other than the
regulations of the telephone industry, whose services the Company utilizes.
There can be no assurance that the Company's business will not be regulated in
the future nor that such regulations will not have an adverse effect upon the
Company's profitability.
CREDIT CARD REGULATIONS. The Company's Fax business is dependent on its
securing processing for its credit card transactions. Credit card companies
establish the rules and regulations for eligibility for processing and determine
which businesses may accept their cards, and upon what terms. While the
Company's facsimile machines are presently processed through all major credit
card companies, there can be no assurance that in the future some or all credit
card companies may not change the terms upon or circumstances under which their
credit cards will be accepted so as to adversely effect the business of the
Company.
COMPETITION. The public Fax business is in an early stage of development.
The Company does not know of any other company which offers a computer software
switching device which can convert any "off-the-shelf" Fax machine into a public
Fax. The Company's principal competitors must physically reconfigure each fax
machine they install using a procedure that can only be used on a particular
model of fax machine in which they usually specialize (the same procedure cannot
be used on different models). AlphaNet, the Company's largest competitor, is
able to reconfigure a particular model fax machine and has placed these
reconfigured machines at a large number of locations. Other competitors,
Teledex and Action Fax, offer products which do not currently offer the various
features of the Company's Smart Switch, such as the range of useable fax
machines, customized billing by floor or room and voice mail. In general,
AlphaNet competes in all of the Company's markets, while Teledex and Action Fax
offer competition only in limited markets. Competition between companies is
generally based on price and quality of service offered. It should be noted,
however, that if the public Fax business generates substantial profits and
appears to be capable of significant growth, other companies with greater
resources than the Company's may enter the business and present intense
competition. The Company believes that if this were to occur, it could expect
to encounter significant competition in two general areas: (i) other companies
organized to provide public facsimile transmission services and/or equipment,
and (ii) assisted facsimile transmission services. In addition, it should be
noted that facsimile transmission also competes with alternative methods of
document delivery, principally overnight small package express services such as
Federal Express and United Parcel Service, as well as the United States Post
Office Express Mail Service. In all of the foregoing areas, virtually all
competitors can be expected to be considerably better established and larger
than the Company in total assets and resources.
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SEASONALITY. Based on the limited information available to the Company
regarding the public Fax industry, it appears to the Company that the Smart
Switch business is subject to seasonal fluctuations. Revenues from the Smart
Switch tend to be lower during the summer months due to the vacation patterns of
business travelers. These fluctuations appear to be regular and predictable,
thereby allowing the Company to plan for such low revenue months. Over the past
three fiscal years, Dr. Horowitz, the Chief Executive Officer of the Company,
has advanced funds to the Company when needed so that it could meet its day to
day cash obligations, although there can be no assurance he will continue to do
so in the future Finally, many creditors have typically allowed the Company to
forbear during these slow months, although there can be no assurance they will
continue to do so in the future.
MICROFICHE SCANNER OPERATIONS
In October 1996, and as amended, the Company entered into a Supply and
Distribution Agreement with ScreenScan Systems, Inc. ("ScreenScan"), pursuant
to which the Company has acted as the exclusive distributor of ScreenScan's
100C/200C Centronics interface scanners in North and South America. Pursuant
to the agreement, as amended, the Company has agreed to purchase a minimum of
$1,080,000 of scanner units during the period from October 1997 to March 31,
1998, which units are in addition to the units purchased by the Company prior
to October 1997. The Company is currently marketing the scanners to
university libraries, public libraries, insurance companies and banks
throughout the United States. The scanner units are capable of scanning
microfilm, microfiche and microcard images and (1) printing the scanned
images onto a printer without the aid of a computer and/or (2) transferring
the images to CD Rom and maintaining the information on the user's computers.
These machines can be card and coin operated for public use, thereby
creating a revenue source for libraries. The Company offers service
contracts to its customers with respect to this product. The first scanner
system sold by the Company was in November 1996 and sales during the fiscal
year ended November 30, 1997 were approximately $968,000.
The scanner units are marketed by the Company through five salespersons
exclusively marketing this device as well as other salespersons at the Company.
The Company also advertises the product in magazines and displays it at library
shows throughout the country. Marketing efforts are also undertaken by
ScreenScan.
Competition with respect to the scanning device includes a laser scanning
machine produced by Canon Corporation, which the Company believes is of lesser
quality and more expensive. There can be no assurance that additional
competition, including from companies with greater resources than that of the
Company, will not occur in the future.
The Company anticipates that sales of microfiche scanner units will be
higher during the summer months. During this season, universities and public
libraries receive a high proportion of their municipal funding, which will
provide them with the funds to consummate scanner purchases.
12
<PAGE>
EMPLOYEES
At February 20, 1998, the Company had 81 full time employees, including one
executive officer, four managers, 61 service technicians, eight clerical and
administrative employees and seven sales persons (of which two are managers),
none of whom are subject to a collective bargaining agreement.
ITEM 2. DESCRIPTION OF PROPERTY
The executive offices of the Company are currently maintained at 4274
Independence Court, Sarasota, Florida 34234-2109. These facilities are
comprised of executive offices, warehouse space and repair facilities covering
approximately 5,000 square feet. The Company presently has a three year lease
with respect to its office facility at $3,103 per month.
The Company also maintains service centers in Norwood, Massachusetts;
Albany, New York; Valley Stream, New York; Des Plains, Illinois; Harrisburg,
Pennsylvania; and Jacksonville, Florida. The Company utilizes these service
centers to service regional accounts including repairing machines and storing
supplies and parts. The Norwood, Massachusetts service center is leased for a
monthly rent of $650. The Albany, New York service center is leased for a
monthly rent of $1,219. The Valley Stream, New York service center is leased
for a monthly rent of $2,145. The Des Plains, Illinois service center is leased
for a monthly rent of $950. The Harrisburg, Pennsylvania service center is
leased for a monthly rent of $1,417. The Jacksonville, Florida service center
is leased for a monthly rent of $1,385.
All space currently utilized by the Company is dedicated to administrative,
marketing, data processing, equipment assembly storage, service, maintenance and
clerical functions. The Company believes that its facilities are adequate for
its present operations. Additionally, the Company believes its facilities are
adequately covered by insurance.
Machines are on site locations throughout New York, Massachusetts,
Pennsylvania, Illinois, Connecticut, Florida, Vermont, New Hampshire, Wisconsin,
North Carolina, South Carolina and Georgia.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material legal proceedings, except as
follows:
On October 26, 1995, the Company instituted an action in Supreme Court,
State of New York, Nassau County, entitled IMSG SYSTEMS, INC. V. KEVIN T.
GALLAGHER AND LGG CORP. D/B/A BOSTON COPICO. The Company brought the action to
enforce a restrictive covenant against Kevin Gallagher, a former employee of the
Company. LGG Corp. counterclaimed for $1,750,000 based upon an alleged unfair
or trade practice in seeking to prevent it from hiring Mr. Gallagher. The Court
denied the Company's motion for a permanent injunction. Discovery proceedings
are still pending.
On October 30, 1995, an action was brought against the Company in Supreme
Court, State
13
<PAGE>
of New York, New York County, entitled DIVERSIFIED INVESTORS CORP. V.
DIVERSIFAX, INC. AND JUDD ROTHMAN. The suit was brought seeking payment owed to
plaintiff pursuant to prior non-interest bearing loans totalling $228,670 made
to the Company by various creditors, two of whom have assigned their rights
under the loans to Diversified Investors Corp. The Company acknowledged the
amount due, but had not paid because the creditors had not indicated how the
amount was to be allocated (due to a dispute between the creditors). Based upon
the agreement describing the debt, the Company believed that the amount was
payable in Common Stock of the Company. The plaintiff sought cash in lieu of
stock. The Company and the plaintiff each appealed to the Appellate Division.
The Appellate Division has determined that payment of the debt should be made in
cash. The Company filed a motion for leave to appeal to the Court of Appeals,
which motion was denied. The judgment was satisfied by the Company in
October, 1997.
On March 28, 1997, an action was commenced against the Company in the
Supreme Court of Nassau County, entitled THE COUNTY OF NASSAU V. IMSG SYSTEMS,
INC., in which the County of Nassau is seeking an accounting at the end of a
contract with IMSG. The Company believes that all appropriate payments were
made to the County and that the County was overpaid. Discovery is now in
process.
On May 8, 1997, an action was brought against the Company in United States
District Court, District of Nevada, entitled MARKETING DIRECT CONCEPTS, INC. V.
DIVERSIFAX, INC. AND IRWIN HOROWITZ. Marketing Direct Concepts, Inc. alleges
that it performed marketing and public relation services on behalf of the
Company pursuant to an oral agreement with the Company, and is seeking $214,000
for fees and out-of-pocket expenses in connection therewith. The Company
disputes the existence of an oral agreement and the amount of claimed services
performed, including whether or not any services were performed at all.
The Company believes that the outcome of the above actions will not have a
material adverse effect on the Company's financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On September 8, 1997, the Company held its Annual Meeting of Stockholders.
At such meeting stockholders elected the following persons as directors: Irwin
A. Horowitz, Eugene Bilotti and Kenneth Ross Wolfe. In addition, the following
matters were approved:
a) ratification and approval of Company's 1996 Stock Option Plan:
For: 7,939,978
Against: 596,814
Abstain: 81,950
Not voted: 4,107,882
14
<PAGE>
b) approval of amendment to Company's Certificate of Incorporation to
increase number of authorized shares:
For: 12,136,667
Against: 549,637
Abstain: 40,320
c) ratification of Hoberman, Miller, Goldstein & Lesser, P.C., as
independent auditors:
For: 12,591,263
Against: 101,430
Abstain: 33,931
15
<PAGE>
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Common Stock is traded on the over-the-counter market with quotations
reported on the National Association of Securities Dealers Automatic Quotation
System (NASDAQ), Small Cap Market, under the symbol "DFAX," and all
corresponding prices represent high and low bid prices for the Common Stock on
NASDAQ for the periods indicated.
PRICE RANGE
HIGH LOW
YEAR ENDED NOVEMBER 30, 1997
1st Quarter 3 1/16 1 3/4
2nd Quarter 3 1 3/4
3rd Quarter 2 15/16 3/4
4th Quarter 7/8 3/8
YEAR ENDED NOVEMBER 30, 1996
1st Quarter 9 3/16 7
2nd Quarter 8 1/16 4 5/8
3rd Quarter 5 7/8 2 15/16
4th Quarter 4 11/16 1 3/4
The quotations reflect inter-dealer prices, without retail mark-up,
mark-down or commission, and may not represent actual transactions.
As of March 10, 1998, there were approximately 166 holders of record of the
Common Stock, including record holders which may hold such stock for beneficial
owners and which have not been polled to determine the extent of beneficial
ownership.
The Company has never paid cash dividends on its Common Stock. Holders of
Common Stock are entitled to receive such dividends as may be declared and paid
from time to time by the Board of Directors out of funds legally available
therefor. The Company intends to retain any earnings for the operation and
expansion of its business and does not anticipate paying cash dividends in the
foreseeable future. Any future determination as to the payment of cash dividends
will depend upon future earnings, results of operations, capital requirements,
the Company's financial condition and such other factors as
16
<PAGE>
the Board of Directors may consider.
Holders of Series D Preferred Stock are entitled to a 6% cumulative
dividend, payable in cash or in Common Stock, or any combination thereof, as
determined by the Company. The Series D Preferred Stock was issued to
"accredited investors" in reliance under the exemption provided by Rule 506
under Regulation D promulgated under the Securities Act of 1933, as amended, and
the terms of such securities are described in Item 6 hereof.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE FISCAL YEAR ENDED NOVEMBER 30, 1997 COMPARED TO THE FISCAL YEAR ENDED
NOVEMBER 30, 1996.
Sales increased approximately $461,000 or 9.0% for the fiscal year ended
November 30, 1997 compared to fiscal 1996. This increase is the result of sales
of microfiche scanner units of approximately $968,000 under a recently formed
dealership arrangement with ScreenScan Systems, offset in part by a decrease in
coin-operated Copier revenues. This decrease in Copier revenues was the result
of the loss of a contract with a library system in the City of New York, which
provided sales of approximately $319,000 during fiscal 1996, the loss of a
municipal agency in Long Island, New York, which provided sales of approximately
$173,000 during fiscal 1996, and the loss of certain other of the Company's
customers and the continued elimination of non-profitable accounts. In
addition, during the fourth quarter of fiscal 1997, the Company's contract with
a university in the southeast, which provided sales of approximately $245,104
in fiscal 1997, was not renewed. There are two primary reasons for the loss of
customers by the Company. The majority of the Company's customers are
maintained pursuant to contractual agreements, generally ranging from three to
five years. Over the past few years, the Company's business has become
increasingly more competitive. Accordingly, when contracts come up for renewal,
the Company may be out bid by its competitors. Secondly, the Company has
continued a critical review of its customer base, initiated during fiscal 1996,
and has determined not to renew customer contracts where the costs of
maintaining such customers exceeded the benefits. This often occurs when the
required commission structure is excessive or the customer's demands for
equipment are not reasonable. The Company believes sales from its microfiche
scanner units will continue to expand and revenues from the acquisition of
companies involved in more traditional sales and servicing of Copiers will
expand. Revenues derived from the Company's Smart Switch continue to be
minimal.
Cost of sales represented 68.2% of sales for the fiscal year 1997 compared
to 82.2% of sales for the fiscal year 1996. This decrease was primarily the
result of the higher gross margins realized on the sale of microfiche scanner
units than on the Company's Copier revenues, along with management's continued
efforts to cut costs, the renegotiation of commission rates with many of the
Company's larger customers and the elimination of non-profitable accounts.
Depreciation and amortization decreased approximately $252,000 for the year
ended November 30, 1997 compared to the year ended November 30, 1996 as a result
of certain of the Company's Copiers becoming fully depreciated during fiscal
1996 and a decrease in the write off of intangible assets from prior years.
17
<PAGE>
Selling, general and administrative expenses increased to approximately
$2,667,000 or 48% of sales for the year ended November 30, 1997 from
approximately $1,942,000 or 38.1% of sales for the year ended November 30, 1996.
This increase is primarily attributable to the amortization of Common Stock
issuances under a marketing agreement (approximately $206,000), various
litigation settlements (approximately $150,000), costs incurred in connection
with attempted and unsuccessful acquisitions and expenses incurred in connection
with the marketing, promotion and development of the newly acquired ScreenScan
dealership.
Interest expense increased approximately $170,000 for the year ended
November 30, 1997 compared to the year ended November 30, 1996 as a result of
interest incurred on recently acquired capital lease obligations and the
recognition of approximately $137,000 in interest expense in connection with
the issuance of options and warrants to purchase Common Stock in fiscal 1997.
As a result of the continued operating losses, the Company further
evaluated the realizability of the deferred tax asset and determined an
increase in the valuation allowance in the amount of $640,000 was required,
resulting in a net deferred tax asset of $180,000 which is equal to the
existing deferred tax liabilities at November 30, 1997.
The above factors resulted in a net loss of approximately $1,896,000 for
the year ended November 30, 1997 compared to a net loss of approximately
$2,171,000 for the year ended November 30, 1996.
The Company's Copier activities are subject to seasonal fluctuations.
Revenues from Copiers tend to be lower during the summer months of June through
September and in the last weeks of December and the first weeks of January due
to school and employee vacation patterns. However, the Company expects that the
addition of its microfiche scanner operations will offset to some extent the
seasonality of Copier operations, as scanner revenues are expected to be higher
during the summer months, during which period universities and public libraries,
the primary customers of scanners, receive a high proportion of their
municipality funding.
THE FISCAL YEAR ENDED NOVEMBER 30, 1996 COMPARED TO THE FISCAL YEAR ENDED
NOVEMBER 30, 1995.
Sales, substantially all of which were derived from Copier operations,
declined approximately $599,000 or 10.5% for the fiscal year ended November 30,
1996 compared to fiscal 1995. This decline was the result of the loss of
certain of the Company's customers and the elimination of non-profitable
accounts, offset in part by the additions of a university and a major library
system to the Company's customer base in March and July of 1995, respectively.
There are two primary reasons for the loss of customers by the Company. The
majority of the Company's customers are maintained pursuant to contractual
agreements, generally ranging from three to five years. Recently, the Company's
business has become increasingly more competitive. Accordingly, when contracts
come up for renewal, the Company may be out bid by its competitors. Secondly,
during fiscal 1996, the Company commenced a critical review of its customer base
and has determined not to renew customer contracts where the costs of
maintaining such customers exceeded the benefits. This often occurs when the
required commission structure is excessive or the customer's demands for
equipment are not reasonable based on the revenue generated by the customer. In
March 1996, the Company was not successful in its bid for the renewal of its
contract with a library system in the
18
<PAGE>
City of New York, which provided approximately 12.3% of the Company's sales for
the fiscal year ended November 30, 1995. The Company continued to collect
revenue from this library system through July 1996, when the last of the
Company's copiers were removed. Revenue derived from the Company's Smart Switch
were minimal.
Cost of sales represented 82.2% of sales for the fiscal year 1996 compared
to 78.3% of sales for the fiscal year 1995. The increase is primarily
attributed to an increase in the cost of toner and other supplies, and
additional technical support needed for new equipment purchased. In addition,
the Company continued its program to refurbish its Copiers and reader printers
which commenced in the second half of fiscal 1995. Management believes that for
certain segments of its customer base refurbishment represents a less costly
alternative to the purchase of new equipment. In addition, the Company's
current commission structure as a percentage of revenue was higher in fiscal
1996 than in previous years as a result of increased competition and the loss of
a major library system, which received a flat rate commission irrespective of
the amount of revenue generated.
As a result of the unfavorable determination with the State of Connecticut,
the Company continues to provide a provision, included in cost of sales, for any
other sales tax assessments by any other states that may arise. For the fiscal
year ended November 30, 1996, the Company accrued an additional $200,000.
Depreciation and amortization increased approximately $496,000 for the year
ended November 30, 1996 compared to the year ended November 30, 1995 as a result
of depreciation on recently acquired Copiers and accessories, depreciation of
the Company's Smart Switch software and the write off of certain intangible
assets obtained in connection with a prior acquisition.
Selling, general and administrative expenses decreased to approximately
$1,942,000 or 38.1% of sales for the year ended November 30, 1996 from
approximately $2,396,000 or 42.1% of sales for the year ended November 30, 1995.
This decrease is primarily attributable to a reduction in the Chief Executive
Officer's salary of approximately $125,000, a reduction in professional and
consulting fees and the fruition of previously established cost cutting
measures.
Interest expense decreased approximately $124,000 for the year ended
November 30, 1996, compared to the year ended November 30, 1995, as a result of
the Company's paying off all outstanding bank indebtedness in December 1995.
During the year ended November 30, 1995, the Company determined to
write-off the unamortized portion of the fair market value of common shares
issued, in the amount of approximately $1,615,000, to an individual for services
that were to be performed over a seven year period, due to the individual's
failure to perform his obligations pursuant to the agreement.
As a result of the continued operating losses, the Company further
evaluated the realizability of the deferred tax asset and determined an increase
in the valuation allowance in the amount of $630,000 was required, resulting in
a net deferred tax asset of $210,000 which is equal to the existing deferred tax
liabilities at November 30, 1996.
The above factors resulted in a net loss of approximately $2,171,000 for
the year ended November 30, 1996 compared to a net loss of approximately
$3,219,000 for the year ended
19
<PAGE>
November 30, 1995.
LIQUIDITY AND CAPITAL RESOURCES
At November 30, 1997, the Company had cash of $805,000 as compared to
$198,00 at November 30, 1996. Working capital at November 30, 1997 was
$1,015,000 as compared to a working capital deficiency of $615,000 at
November 30, 1996.
The Company's primary need for funds is to finance working capital, capital
expenditures and the further development of the Company's Smart Switch business
and ScreenScan dealership and the acquisition of new businesses and the further
growth of acquisitions to broaden and diversify its revenue source making it
less seasonal.
Net cash used in operating activities of approximately $1,216,000 during
the fiscal year ended November 30, 1997 resulted from the net loss of
approximately $1,896,000 offset by non-cash items including depreciation and
amortizations, ($794,000), a decrease in the deferred tax benefit ($30,000),
and interest and other expenses related to the issuance of stock options
(171,000). In addition, net cash used in operating activities included
increases in accounts receivable ($166,000) and inventories ($151,000) and a
decrease in accounts payable and accrued expenses ($148,000), offset by a
decrease in prepaid expenses and other ($96,000). Net cash used to settle
litigation amounted to approximately $58,000.
Net cash used in investing activities in the amount of approximately
$12,000 during the fiscal year ended November 30, 1997 resulted from the
acquisition of Copiers and accessories.
In addition, during the year ended November 30, 1997, the Company incurred
capital lease obligations in the amount of approximately $273,000 in connection
with the acquisition of microfiche scanner units.
Net cash provided by financing activities amounted to approximately
$1,835,000 during the fiscal year ended November 30, 1997 primarily as a result
of the proceeds from the sale of Common and Preferred Stock of $52,000 and
$1,325,000 respectively, stockholders' loans of $795,000, offset by the
repayment of affiliate loans and capital lease obligations of $325,000. The
proceeds from stockholders' loans represent loans from Dr. Irwin A. Horowitz,
the Chairman of the Board, Chief Executive Officer and President of the Company
and Gregg Horowitz (Dr. Horowitz's son). For the fiscal year ended
November 30, 1997, Dr. Horowitz loaned a net aggregate amount of approximately
$616,000 and Gregg Horowitz loaned $178,700. At November 30, 1997, the amount
of the loans payable by the Company to Dr. Irwin Horowitz and Gregg Horowitz
were $1,781,000 and $178,700, respectively.
The above resulted in a net increase in cash of approximately $607,000 for
the year ended November 30, 1997.
In June 1997, the Company completed a private placement of 1,500 shares of
Series D Convertible Preferred Stock of the Company (the "Preferred Stock") at a
price of $1,000 per share, for which it received gross proceeds of $1,500,000.
After expenses of the sale of approximately $175,000, the Company received net
proceeds of approximately $1,325,000. Each share of the Series D Preferred
Stock is convertible into such number of shares of Common Stock of the
20
<PAGE>
Company as is determined by dividing $1,000 by the lesser of (A) 80% of the
average bid price of the Common Stock for the five trading days immediately
preceding the date of notice of conversion and (B) (i) $2.25 for the first one
third of the shares of Series D Preferred stock converted by a holder; or (ii)
$2.50 for the next one-third of the shares of Series D Preferred stock converted
by a holder; or (iii) $2.75 for the balance of the shares of Series D Preferred
Stock converted by a holder. In no event can the conversion price be less than
$.60. The Series D Preferred Stock, unless sooner converted, automatically
converts into shares of Common Stock on June 5, 2000. In addition, holders of
the Series D Preferred stock are entitled to receive a six percent cumulative
dividend on each share of Series D Preferred Stock for the period that such
share is outstanding. If on the conversion date, the closing price per share of
the Common Stock is $1.00 or less, then the Company can, at its option and in
lieu of conversion, redeem any or all of the Series D Preferred stock for an
amount equal to the sum of (i) $1,200 for each share of Series D Preferred Stock
redeemed, plus (ii) all accrued but unpaid dividends, if any, on each share of
Series D Preferred stock which was to be converted.
Through November 30, 1997, 679 shares of the Series D Preferred Stock have
been converted to approximately 1,072,000 shares of Common Stock.
In May 1997, in consideration for interest free loans aggregating
approximately $555,000 (which amount includes reduced salary payments) made by
Dr. Horowitz from December 1, 1996 though May 2, 1997, which loans do not become
due upon demand until December 1, 1997, the Company granted to Dr. Horowitz
three year warrants to purchase 350,000 shares of Common Stock, at an exercise
price of $1.9375 per share, all of which warrants are immediately exercisable.
In September 1997, in consideration of Dr. Horowitz having made an additional
one year interest-free loan to the Company in the amount of $500,000, the
Company granted Dr. Horowitz a three year warrant to purchase 1,100,000 shares
of Common Stock at an exercise price of $.84375 per share. The warrant is
immediately exercisable.
In September 1997, Gregg Horowitz, loaned the Company an aggregate of
$178,700 in the form of two promissory notes, payable on or before September 19,
1998. The notes are non-interest bearing, provided however, that if the Company
failed to make payment on or before the due dates, interest will accrue from the
dates of origination, at an annual rate of 8%. In consideration for the loans,
the Company granted Gregg Horowitz a three year warrant to purchase 331,540
shares of Common Stock at an exercise price of $.78125 per share, and a three
year warrant to purchase 61,600 shares of Common Stock at an exercise price of
$.8125 per share. The warrants are immediately exercisable.
In February 1998, the Company's Board of Directors voted to lower the
exercise price of all outstanding options and warrants held by Dr. Horowitz,
and other employees of the company (except for Dr. Horowitz's incentive stock
options which were lowered to $.4125 per share) to $.375 per share, the then
current market value of the Common Stock, in consideration of his agreement
to extend the due date of all of his loans to the Company to February 19,
1999.
In February 1998, the Company, through its wholly-owned subsidiary JA-Hunt
Services, Inc., acquired the assets of a Florida-based company engaged in the
retail sale and servicing of copier supplies and equipment for a purchase price
of $80,000 ($40,000 cash and $40,000 of Common Stock) plus assumed liabilities.
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Management continues to believe the expected cash flow from operations, the
expected growth of newly acquired companies, its ScreenScan dealership, and the
willingness and ability of the Company's Chief Executive officer to fund any
operating deficit will allow the Company to continue operations over the next 12
months. However, no assurance can be given that these factors will materialize.
ITEM 7. FINANCIAL STATEMENTS
The response to this Item is submitted as a separate section to this report
on pages F-1 through F-24.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ACCOUNTING ON FINANCIAL
DISCLOSURE
None
22
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PART III
Directors and Executive Officers
The current directors and executive officers of the Company are as follows:
NAME AGE POSITION
Dr. Irwin A. Horowitz 61 Chairman of the Board,
Chief Executive Officer
and President
Richard R. Confessore 55 Chief Financial Officer
Judd Rothman 55 Director
Kenneth Ross Wolfe 52 Secretary and Director
Irwin A. Horowitz has been the Chairman of the Board, Chief Executive
Officer and President of the Company since November 1, 1993. From July through
October 1993, he served as Chief Operating Officer of the Company. For more
than the past five years, Dr. Horowitz has been Chairman of the Board and
President of IMSG Systems, Inc. and certain affiliated companies ("IMSG and
Affiliates"), which were acquired by the Company effective November 1, 1993.
Dr. Horowitz is a director of Dynamics Imaging, Inc., a private company which is
primarily engaged in the development of advanced medical technologies.
Richard R. Confessore was appointed Chief Financial Officer of the Company
in February 1998. From 1996 to 1998, Mr. Confessore was employed at Arthur
Andersen Technology Solutions as a software test designer and executer. During
1995 and 1996, Mr. Confessore served as Chief Financial Officer of Just Like
Home, Inc., a publicly-held developer and operator of assisted living
facilities. From 1993 to 1995, he served as Chief Executive Officer and Chief
Financial Officer of Salvatori Opthalmics, Inc., a publicly-held manufacturer
and distributor of contact lenses. Mr. Confessore, a CPA, graduated from the
University of Miami.
Judd Rothman has been a director of the Company since February 5, 1998.
Mr. Rothman is one of the Company's original founders and the former Treasurer
and Chief Financial Officer from 1989 to 1993. Since 1994, Mr. Rothman has been
President of ProTect Business Management Corp., a management consulting firm.
Since 1992, Mr. Rothman has also been President of Rothman & Rothman P.C.,
Certified Public Accountants. Mr. Rothman received a BS degree from the
University of Louisville.
Kenneth Ross Wolfe has been a director of the Company since November 1,
1993 and was Secretary of the Company from November 1994 to January 1996, and
has served as Secretary of the Company from May 1996 to present. Mr. Wolfe is
an attorney who has maintained a private law practice since 1976 and, since
January 1, 1998, has been the senior partner of Wolfe, Romano &
23
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Joyce, LLP. From 1969 to 1976, he was a prosecuting attorney in New York,
including two years as a Special Assistant Attorney General in the Office of
The Special State Prosecutor, investigating corruption in the criminal justice
system. Mr. Wolfe received his JD degree from Brooklyn Law School in 1969,
where he served as a member of the law review. He is admitted to practice in
New York, as well as various Federal Courts, including the United States Supreme
Court.
No family relationship exists between any director or executive officer and
any other director or executive officer.
COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934
The Company's officers, directors and beneficial owners of more than 10% of
any class of its equity securities registered pursuant to Section 12 of the
Securities Exchange Act of 1934 ("Reporting Persons") are required under that
Act to file reports of ownership and changes in beneficial ownership of the
Company's equity securities with the Securities and Exchange Commission. Copies
of those reports must also be furnished to the Company. Based solely on a
review of the copies of reports furnished to the Company pursuant to that Act,
the Company believes that during fiscal year ended November 30, 1997 all filing
requirements applicable to Reporting Persons were complied with, except with
respect to Mr. Eugene Bilotti, a former director, for whom there was one late
filing (a sale of Common Stock).
ITEM 10. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table sets forth information with respect to the compensation
of each of the named executive officers for services provided in all capacities
to the Company and its subsidiaries in the fiscal years ended November 30, 1997,
1996 and 1995. No other executive officer or former executive officer received
more than $100,000 in compensation in the fiscal year ended November 30, 1997.
For the purposes of this table, warrants are deemed to be equivalent of stock
options.
<TABLE>
<CAPTION>
ANNUAL COMPENSATION LONG TERM
COMPENSATION
NAME AND PRINCIPAL YEAR SALARY ($) BONUS ($) OTHER ($)(1) SECURITIES UNDERLYING
POSITION OPTIONS (#)
- ---------------------- ---- ---------- --------- ------------ ---------------------
<S> <C> <C> <C> <C> <C>
Dr. Irwin A. Horowitz 1997 125,000(2) -- 88,724 2,485,577
Chairman of the
Board, Chief Executive
Officer and President
1996 126,142 -- 67,200 1,277,520
1995 201,923 -- 65,155 --
</TABLE>
24
<PAGE>
(1) Represents the fair market value of benefits and perquisites afforded by
the Company to Dr. Horowitz.
(2) Includes accruals of $91,896 for amounts that were deferred.
OPTION GRANTS IN FISCAL 1997
(INDIVIDUAL GRANTS)
The following table sets forth certain information of the named executive
officer with respect to grants of options (for the purposes of this table,
warrants are deemed to be equivalent to stock options) to purchase Common Stock
of the Company made during the fiscal year ended November 30, 1997.
NO. OF % OF TOTAL
SECURITIES OPTIONS
UNDERLYING GRANTED TO EXERCISE PRICE EXPIRATION
OPTIONS EMPLOYEES ($/SH)(1) DATE
NAME GRANTED (#) IN YEAR
Irwin A. Horowitz 38,270 1.4 2.613 12/16/01
711,730 25.2 2.375 12/16/01
350,000 12.9 1.9375 5/5/02
1,100,000 38.9 .84375 9/3/00
285,577 10.1 .6875 10/27/00
(1) The exercise price of all of these options and warrants was lowered to
$.375 on February 19, 1998, in consideration of the interest free extension
of Dr. Horowitz' loans to the Company.
AGGREGATED OPTION EXERCISES DURING FISCAL 1997 AND YEAR END OPTION VALUES
The following table provides information related to options exercised by
the named executive officer during fiscal 1997 and the number and value of
options held at November 30, 1997. The Company does not have any outstanding
stock appreciation rights (for the purposes of this table, warrants are deemed
to be equivalent to stock options).
25
<PAGE>
<TABLE>
<CAPTION>
NAME SHARES VALUE NUMBER OF UNEXERCISED VALUE OF UNEXERCISED IN-
ACQUIRED ON REALIZED OPTIONS AT YEAR END(#) THE-MONEY OPTIONS AT YEAR
EXERCISE(#) ($) EXERCISABLE UNEXERCISABLE END ($)
EXERCISABLE UNEXERCISABLE
----------- -------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Irwin A. Horowitz -- -- -- -- 0 0
</TABLE>
EMPLOYMENT AGREEMENT
During fiscal 1997, Dr. Horowitz divided his business time primarily
between New York (the location of the Company's then principal office and
significant customers) and Florida (where the Company also has significant
business). On October 29, 1996, the Company entered into a renewable one year
Employment Agreement with Dr. Horowitz, pursuant to which the Company agreed to
pay Dr. Horowitz a salary of $125,000, together with an annual incentive bonus
equal to a percentage of the Company's pre-tax profits. Such incentive bonus
ranges from 6% to 18% of the Company's pre-tax profits, based on the level of
such pre-tax profits. In addition, upon execution of the agreement, Dr.
Horowitz received options to purchase 750,000 shares of Common Stock, which
options vest as to 150,000 shares on the date of grant and upon each of the next
four anniversary dates thereof. The Company further agreed to grant Dr.
Horowitz options to purchase an additional 100,000 shares of Common Stock, in
consideration of Dr. Horowitz' prior guaranty of the Company's payments under a
certain bank loan agreement. The Company paid or reimburses Dr. Horowitz for
the travel expense between New York and Florida, the rental of an apartment in
New York and the rental of cars in both locations. During fiscal 1997, 1996 and
1995, these expenses aggregated $88,724, $67,200, and, $65,155 respectively.
The Employment Agreement was not renewed in October 1997.
COMPENSATION OF DIRECTORS
The directors of the Company are not currently compensated, nor were they
during the last fiscal year, for their services as such, except that in
September 1995, the Company adopted the Directors' Plan, pursuant to which all
current non-employee directors and non-employees who became directors of the
Company received an option to purchase 100,000 shares of the Common Stock at the
market value thereof at the time of grant. Said options vest at the rate of
20,000 per year (the first 20,000 vested upon grant) and terminate 90 days after
the director ceases to serve as a director. Pursuant to the Directors' Plan, in
September 1995, options to purchase 100,000 shares of Common Stock at an
exercise price of $4.125 per share were granted to Mr. Wolfe. In October 1996,
the Company amended the Directors' Plan so that no further options could be
granted thereunder. Pursuant to the Stock Option Plan, which allows the Company
to grant options to directors of the Company, in December 1996 Mr. Wolfe
received additional options to purchase 100,000 shares of Common Stock at an
exercise price of $2.375 per share. In connection with such grant, Mr. Wolfe
agreed to cancel the unvested portion (for 60,000 shares) of his original
options. In February 1998, the exercise price of all options held by Mr. Wolfe
was reduced to $.375 per share. In February, 1998, Mr. Rothman received options
to purchase 100,000 shares of Common Stock at an exercise price of $.375 per
share.
26
<PAGE>
INDEMNIFICATION OF DIRECTORS
The Company's Certificate of Incorporation eliminates the liability of a
director of the Company for monetary damages for breach of duty as a director,
subject to certain exceptions. In addition, the Certificate of Incorporation
provides for the Company to indemnify, under certain conditions, directors,
officers, employees and agents of the Company against all expenses, liabilities
and losses reasonably incurred by such persons in connection therewith. The
foregoing provisions may reduce the likelihood of derivative litigation against
directors and may discourage or deter stockholders or management from suing
directors for breaches of their duty of care, even though such an action, if
successful, might otherwise benefit the Company and its stockholders.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
PRINCIPAL STOCKHOLDERS
The following table sets forth, based upon information obtained from the
persons named below, certain information regarding beneficial ownership of the
Common Stock as of February 20, 1998 and as adjusted to reflect the sale of all
of the Common Stock offered hereby by (i) each stockholder known by the Company
to be the beneficial owner of 5% or more of the outstanding shares of Common
Stock, (ii) each director of the Company, (iii) each person named in the Summary
Compensation Table above and (iv) all of the Company's current officers and
directors as a group.
BENEFICIAL OWNERSHIP OF COMMON STOCK
NAME AND ADDRESS OF NUMBER OF SHARES PERCENTAGE OF CLASS
BENEFICIAL HOLDER BENEFICIALLY OWNED(1)
Dr. Irwin A. Horowitz 9,623,097(2) 52.1
111 Ocean Place
Sarasota, Florida 24242
Kenneth Ross Wolfe 100,000(3) *
532 Broad Hollow Road
Melville, New York 11747
Judd Rothman 39,785(4) *
31 Oak Street
Patchogue, New York
All officers and directors as a
group (4 persons) 9,762,882(5) 52.5
________
27
<PAGE>
* less than 1%.
(1) Unless otherwise indicated below, all shares are owned beneficially and of
record.
(2) Includes 1,150,000 shares of Common Stock underlying options exercisable
within 60 days and 2,163,097 shares underlying warrants exercisable within
60 days.
(3) Includes 100,000 shares of Common Stock underlying options exercisable
within 60 days.
(4) Includes 20,000 shares of Common Stock underlying options exercisable
within 60 days.
(5) Includes an aggregate of 1,270,000 shares underlying options exercisable
within 60 days and aggregate of 2,163,097 shares underlying warrants
exercisable within 60 days.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Mr. Kenneth Ross Wolfe, a director of the Company, provides legal services
to the Company. Mr. Wolfe has received approximately $89,000 in legal fees in
fiscal year 1997 and $33,000 in fiscal year 1996.
From June 1994 to November 1995, Dr. Irwin A. Horowitz, the Chairman of the
Board, Chief Executive Officer and President of the Company, guaranteed the
Company's payments under certain bank loan agreements. Such loans were in the
aggregate principal amount of $1,185,000, and as of December 1995, were paid in
full, at which time the total balance was $1,007,459. In consideration for such
guaranty, in August 1996, Dr. Horowitz received options to purchase 100,000
shares of Common Stock at an exercise price of $3.25 per share. Such exercise
price was lowered to $.375 in February 1998.
During the fiscal year ended November 30, 1996, Dr. Horowitz loaned the
Company funds to cover its working capital needs and to finance acquisitions on
a number of occasions, in the net aggregate principal amount of $887,000. In
consideration thereof, and for Dr. Horowitz's agreement that such loans would
not bear interest, on August 16, 1996, the Company delivered to Dr. Horowitz a
promissory note in the amount of $668,000 (the principal balance on that date),
payable on demand after June 1, 1997, and five year warrants to purchase 427,520
shares of Common Stock at an exercise price of $3.125 per share. On December
17, 1996, Dr. Horowitz agreed to extend to December 2, 1997 the due date of the
loans made on or before November 30, 1996, as well as all subsequent loans, in
the net aggregate principal amount of $887,000. In consideration thereof and
for Dr. Horowitz's agreement that such loans would be interest free, the Company
agreed that the per share exercise price of the warrants granted in August 1996
as well as of the options granted to him in October 1996 pursuant to his
Employment Agreement with the Company, would be reduced to $2.375 per share, the
then current fair market value of the Common Stock. In addition, the Company
granted to Dr. Horowitz additional incentive and non-incentive options, to
purchase an aggregate of 750,000
28
<PAGE>
shares of Common Stock, of which the incentive options (for 38,270 shares) are
exercisable at $2.613 per share and the non-incentive options (for 711,730
shares) are exercisable at $2.375 per share. On May 6, 1997, in consideration
for additional interest-free loans aggregating approximately $555,000 (which
amount includes reduced salary payments) made by Dr. Horowitz from December 1,
1996 through May 2, 1997, which loans shall not become due upon demand until
December 1, 1997, the Company granted to Dr. Horowitz additional three-year
warrants to purchase 350,000 shares of Common Stock, at an exercise price of
$1.9375 per share, all of which warrants are immediately exercisable. On
September 4, 1997, as compensation to Dr. Horowitz for having made a one year
interest-free loan to the Company in the amount of $500,000, the Company issued
to Dr. Horowitz a three year warrant to purchase 1,100,000 shares of Common
Stock at an exercise price of $.84375 per share. On October 28, 1997, as
compensation to Dr. Horowitz for having deferred salary payments totalling
$129,808, the Company issued to Dr. Horowitz a three year warrant to purchase
285,577 shares of Common Stock at an exercise price of $.6875 per share.
On February 19, 1998, the exercise price of all of the options and warrants
held by Dr. Horowitz was lowered to $.375 per share (except for incentive stock
options, which were lowered to $.4125 per share), the then current market price
of the Common Stock in consideration of his agreement to extend the due date of
all of his loans to the Company to February 19, 1999.
29
<PAGE>
ITEM 13. EXHIBITS, LIST AND REPORT ON FORM 8-K
(a) Exhibits. The Exhibits are filed as part of, or incorporated by
reference into this report.
<TABLE>
<CAPTION>
Exhibit # Document Sequentially Numbered Page
Where Located
<S> <C> <C>
2. (a) Plan of reorganization and Agreement --
of Merger by and among the Company,
Diversified Acquisition Corp. 1 and
IMSG Systems, Inc.*
(b) Plan of Reorganization and Agreement --
of Merger by and among the Company,
Diversified Acquisition Corp. 2 and
National Copy Corp.*
(c) Plan of Reorganization and Agreement --
of Merger by and among the Company,
Diversified Acquisition Corp. 3 and
Advanced Business Systems, Inc.*
(d) Plan of Reorganization and Agreement --
of Merger by and among the Company,
Diversified Acquisition Corp. 4 and
Capital Copy, Inc.*
3. (a) Restated Certificate of Incorporation* --
(b) Amendment to Restated Certificate of Incorporation* --
(c) By-laws* --
</TABLE>
30
<PAGE>
<TABLE>
<S> <C> <C>
10. (a) Agreement of Acquisition by and Among --
DiversiFax, Inc., a Delaware Corporation,
Faxit Corporation, a Delaware Corporation,
Faxit Corporation, a New Jersey Corporation,
Mario DiNatale, and DiversiFax Acquisition
Corp., a New York corporation*
(b) Letter Agreement, dated December 18, 1996, --
between DiversiFax, Inc. and Irwin A. Horowitz
regarding loans made to the Company*
(c) Employment Agreement between DiversiFax, Inc. --
and Dr. Irwin A. Horowitz dated October 29, 1996*
(d) Stock Purchase Agreement with Copier Machine --
Professionals, Inc., dated November 1, 1996*
(e) Letter Agreement dated November 21, 1996 between --
DiversiFax Information Service, Inc. and Danka
Business Systems, plc*
(f) Agreement dated as of October 1, 1996 between --
ScreenScan Systems, Inc. and DiversiFax, Inc.*
21. Subsidiaries of the Company* --
23. Independent Auditor's Consent --
27. Financial Data Schedule.
</TABLE>
- --------------------
*Incorporated by reference.
31
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
DIVERSIFAX, INC.
/s/ Irwin A. Horowitz
------------------------------
Date: March 13, 1998 Dr. Irwin A. Horowitz
Chairman of the Board, Chief
Executive Officer and President
(principal executive officer)
/s/ Richard R. Confessore
------------------------------
Richard R. Confessore
Chief Financial Officer
(principal financial and
accounting officer)
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
Signature Title Date
/s/ Irwin A. Horowitz Director March 13, 1998
- --------------------------
Irwin A. Horowitz
/s/ Kenneth Ross Wolfe Director March 13, 1998
- --------------------------
Kenneth Ross Wolfe
/s/ Judd Rothman Director March 13, 1998
- --------------------------
Judd Rothman
32
<PAGE>
DIVERSIFAX, INC. AND SUBSIDIARIES
FINANCIAL STATEMENTS
YEARS ENDED
NOVEMBER 30, 1997 AND 1996
<PAGE>
DIVERSIFAX, INC. AND SUBSIDIARIES
CONTENTS
- --------------------------------------------------------------------------------
Report of Independent Certified Public Accountants.......................F-2
Consolidated Balance Sheet...............................................F-3
Consolidated Statements of Operations....................................F-4
Consolidated Statements of Stockholders' Equity..........................F-5
Consolidated Statements of Cash Flows....................................F-6
Notes to Consolidated Financial Statements...............................F-7
F-1
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
DiversiFax, Inc.
Valley Stream, New York
We have audited the consolidated balance sheet of DiversiFax, Inc. and
Subsidiaries as of November 30, 1997, and the related consolidated statements of
operations, stockholders' equity and cash flows for the years ended November 30,
1997 and 1996. 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 in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of DiversiFax, Inc.
and Subsidiaries as of November 30, 1997 and the consolidated results of their
operations and their cash flows for the years ended November 30, 1997 and 1996,
in conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As shown in the financial statements,
the Company incurred a net loss of $1,895,885 for the year ended November 30,
1997 and has incurred substantial net losses for each of the past several years.
These factors, and others discussed in Note 1, raise substantial doubt about the
Company's ability to continue as a going concern. The financial statements do
not include any adjustments relating to the recoverability and classification of
recorded assets, or the amounts and classification of liabilities that might be
necessary in the event the Company cannot continue in existence.
HOBERMAN, MILLER, GOLDSTEIN & LESSER, P.C.
New York, New York
February 20, 1998
F-2
<PAGE>
DIVERSIFAX, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
NOVEMBER 30, 1997
- -----------------------------------------------------------------------------------------------------------------------
A S S E T S
CURRENT ASSETS
<S> <C>
Cash (Notes 13 and 15) $ 804,931
Accounts receivable 273,566
Inventories 583,202
Prepaid expenses and other 366,129
- -----------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 2,027,828
Equipment and vehicles, less accumulated depreciation (Note 3) 3,274,851
Intangible assets (net of accumulated amortization of $9,000) (Notes 2 and 11) 21,000
Deferred tax benefit (Note 9) 180,000
Other assets 53,235
- -----------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $5,556,914
- -----------------------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Current portion of obligations under capital leases (Note 4) $ 41,937
Accounts payable and accrued expenses 791,757
Loan payable, stockholder (Note 6) 178,877
- -----------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 1,012,571
- -----------------------------------------------------------------------------------------------------------------------
Loans payable, officer/stockholder (Note 5) 1,781,308
Obligations under capital leases (Note 4) 205,301
- -----------------------------------------------------------------------------------------------------------------------
1,986,609
- -----------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 2,999,180
- -----------------------------------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES (Notes 4 and 13)
STOCKHOLDERS' EQUITY (Notes 5, 6, 7, 8, 10 and 13)
Convertible preferred stock, Series C, $.001 par value,
authorized 10,000 shares
Convertible preferred stock, Series D, $.001 par value,
authorized 1,500 shares, issued and outstanding 821 shares 1
Common stock, $.001 par value, authorized 40,000,000
shares, issued 15,299,215 shares 15,299
Additional paid in capital 11,651,195
Deficit ( 8,879,261)
- -----------------------------------------------------------------------------------------------------------------------
2,787,234
Less: Treasury stock, at cost ( 229,500)
- -----------------------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 2,557,734
- -----------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $5,556,914
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements.
F-3
<PAGE>
DIVERSIFAX, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE YEARS ENDED NOVEMBER 30, 1 9 9 7 1 9 9 6
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
SALES $5,552,743 $5,091,917
- -----------------------------------------------------------------------------------------------------------------------
COST AND EXPENSES
Cost of sales, exclusive of depreciation 3,789,979 4,186,631
Depreciation and amortization 751,553 1,003,245
Selling, general and administrative 2,700,936 1,942,240
Interest expense (income) 170,299 ( 7,309)
- -----------------------------------------------------------------------------------------------------------------------
7,412,767 7,124,807
- -----------------------------------------------------------------------------------------------------------------------
LOSS BEFORE INCOME TAXES ( 1,860,024) ( 2,032,890)
INCOME TAXES (Note 9) 35,861 137,977
- -----------------------------------------------------------------------------------------------------------------------
NET LOSS ($1,895,885) ($2,170,867)
- -----------------------------------------------------------------------------------------------------------------------
Weighted average common shares outstanding (Note 2) 14,394,457 14,011,980
Loss per share of common stock ($.13) ($.15)
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements.
F-4
<PAGE>
DIVERSIFAX, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
YEARS ENDED NOVEMBER 30, 1997 AND 1996
PREFERRED ADDITIONAL
STOCK COMMON PAID IN
SERIES D STOCK CAPITAL DEFICIT
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
BALANCE, DECEMBER 1, 1995 $13,350 $ 8,198,006 ($4,800,914)
Exercise of common stock warrants 688 1,547,616
Sale of common stock 7 12,497
Capital contribution 7,500
Cost incurred in connection with
registration of common stock ( 48,000)
Amortization of unearned compensation
Net loss for the year ( 2,170,867)
- ---------------------------------------------------------------------------------------------
BALANCE, NOVEMBER 30, 1996 14,045 9,717,619 ( 6,971,781)
Sale of common stock 24 51,976
Issuance of common stock for services 118 217,070
Issuance of common stock in connection
with the settlement of litigation 40 69,960
Issuance of preferred stock $1 1,324,523
Conversion of preferred stock to
Common stock 1,072 ( 1,072)
Write off of subscription receivable ( 247,500)
Dividends paid ( 11,595)
Issuance of stock options 518,619
Net loss for the year ( 1,895,885)
- ---------------------------------------------------------------------------------------------
BALANCE, NOVEMBER 30, 1997 $1 $15,299 $11,651,195 ($8,879,261)
<CAPTION>
TOTAL
UNEARNED TREASURY SUBSCRIPTION STOCKHOLDERS'
COMPENSATION STOCK RECEIVABLE EQUITY
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
BALANCE, DECEMBER 1, 1995 ($74,147) ($229,500) ($247,500) $2,859,295
Exercise of common stock warrants 1,548,304
Sale of common stock 12,504
Capital contribution 7,500
Cost incurred in connection with
registration of common stock ( 48,000)
Amortization of unearned compensation 74,147 74,147
Net loss for the year ( 2,170,867)
- ---------------------------------------------------------------------------------------------
BALANCE, NOVEMBER 30, 1996 ( 229,500) ( 247,500) 2,282,883
Sale of common stock 52,000
Issuance of common stock for services 217,188
Issuance of common stock in connection
with the settlement of litigation 70,000
Issuance of preferred stock 1,324,524
Conversion of preferred stock to
Common stock
Write off of subscription receivable 247,500
Dividends paid ( 11,595)
Issuance of stock options 518,619
Net loss for the year ( 1,895,885)
- ---------------------------------------------------------------------------------------------
BALANCE, NOVEMBER 30, 1997 ($229,500) $2,557,734
</TABLE>
See Notes to Consolidated Financial Statements.
F-5
<PAGE>
DIVERSIFAX, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------
FOR THE YEARS ENDED NOVEMBER 30, 1 9 9 7 1 9 9 6
- -----------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
<S> <C> <C>
Net loss ($1,895,885) ($2,170,867)
ADJUSTMENTS TO RECONCILE NET LOSS TO
NET CASH USED IN OPERATING ACTIVITIES
Depreciation and amortization 793,553 1,021,245
Litigation settlement 58,129
Amortization of unearned compensation 74,147
Deferred tax debit 30,000 130,000
Interest expense related to issuance of stock options 137,424
Other expenses related to issuance of stock options 34,000
CHANGES IN OPERATING ASSETS AND LIABILITIES
Accounts receivable ( 165,509) ( 54,145)
Inventories ( 150,506) ( 176,299)
Prepaid expenses and other 95,867 ( 11,472)
Accounts payable and accrued expenses ( 147,924) ( 471,078)
Other assets ( 5,235) 10,327
- -----------------------------------------------------------------------------------------------------------------------
NET CASH USED IN OPERATING ACTIVITIES ( 1,216,086) ( 1,648,142)
- -----------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Purchases of equipment and vehicles ( 12,141) ( 725,132)
Assets acquired through acquisitions ( 180,000)
- -----------------------------------------------------------------------------------------------------------------------
NET CASH USED IN INVESTING ACTIVITIES ( 12,141) ( 905,132)
- -----------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Proceeds from exercise of common stock warrants 1,548,304
Repayment of long term debt and conversion to
capital lease obligations ( 146,238)
Dividends paid ( 11,595)
Proceeds from sale of preferred stock 1,324,524
Proceeds from sale of common stock 52,000 12,500
Proceeds from stockholder's loan 178,877
Proceeds from officer/stockholder's loan, net 616,495 886,785
Repayment of capital lease obligations ( 25,212) ( 810,880)
Proceeds from (repayment of) affiliate loan ( 300,000) 300,000
Proceeds from capital contribution 7,500
Cost incurred in connection with registration of common stock ( 48,000)
- -----------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 1,835,089 1,749,971
- -----------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash 606,862 ( 803,303)
Cash, beginning of year 198,069 1,001,372
- -----------------------------------------------------------------------------------------------------------------------
CASH, END OF YEAR $ 804,931 $ 198,069
- -----------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
CASH PAID DURING THE YEAR FOR:
Interest $32,875
Income taxes $5,861 $7,977
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements.
F-6
<PAGE>
DIVERSIFAX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF
BUSINESS Effective November 1, 1993, DiversiFax, Inc. (the "Company")
acquired all of the outstanding common stock of IMSG Systems,
Inc. ("IMSG") and its affiliated companies, National Copy
Corp. ("National"), Capital Copy Corp. ("Capital") and
Advanced Business Systems, Inc. ("Advanced") (IMSG, National,
Capital and Advanced collectively "IMSG and Affiliates") in
exchange for the issuance of 662,000 shares of Series A,
convertible preferred stock. The preferred stock was
automatically converted into an aggregate of 6,620,000 shares
of common stock of the Company in November, 1995.
IMSG and Affiliates, formerly headquartered in Valley Stream,
New York, owns, supplies and maintains self-service coin and
card reader operated photocopy machines in colleges,
universities, libraries, courthouses, government agencies,
pharmacies and other retail establishments throughout the
eastern United States. In November, 1997, the Company
relocated its executive offices to Sarasota, Florida.
Generally, the Company is responsible for the collection of
the payments and most locations share in the revenue from the
photocopy machines.
On April 27, 1995, the Company's wholly owned subsidiary,
DiversiFax Information Services, Inc. ("DAC"), purchased from
Faxit Corporation ("Faxit") the Smart Switch, a computerized
switching device used in the public facsimile business.
On October 1, 1996, the Company entered into a supply and
distribution agreement with ScreenScan Systems, Inc.
("ScreenScan"), pursuant to which the Company will act as the
exclusive distributor of ScreenScan's 100c Centronics
interface scanners in North and South America until March 31,
1998. (See Note 13). ScreenScan develops and manufactures
devices capable of scanning microfilm images and printing the
scanned images onto a printer without the aid of a computer.
GOING CONCERN The accompanying financial statements have been prepared in
conformity with generally accepted accounting principles,
which contemplates continuation of the Company as a going
concern. However, the Company has sustained substantial
operating losses in recent years. In addition, the Company
has used substantial amounts of working capital in its
operations.
F-7
<PAGE>
DIVERSIFAX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- ------------------------------------------------------------------------------
1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)
GOING CONCERN
(Continued) In view of these matters, continuation of the Company as a
going concern is dependent upon the ability of the Company to
return its present operations to profitability, the future
success of the Company's Smart Switch and ScreenScan
operations, the expected growth from its recent acquisitions
and the willingness and ability of the Company's chief
executive officer and others to fund any operating deficits.
Management believes that actions presently being taken to
revise the Company's operations and the willingness and
ability of the Company's chief executive officer to fund any
operating deficits provide the opportunity for the Company to
continue as a going concern.
PRINCIPLES OF
CONSOLIDATION The consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiaries. All
significant intercompany accounts and transactions have been
eliminated.
CASH
EQUIVALENTS Cash equivalents include all temporary cash investments with
original maturities of three months or less.
INVENTORIES Inventories, consisting principally of supplies and parts,
and scanner units, are stated at the lower of cost or market.
Cost is determined using the first-in, first-out method.
EQUIPMENT AND
VEHICLES Equipment and vehicles are recorded at cost. Depreciation is
generally recorded using the straight-line method over the
estimated useful lives of the related assets as follows:
Photocopy machines and accessories 10 years
Office and computer equipment 5 years
Furniture and fixtures 5-7 years
Vehicles 5 years
F-8
<PAGE>
DIVERSIFAX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)
AMORTIZATION The cost of the trademark acquired and covenant not to
compete are being amortized by the straight-line method over
the five year terms of the respective agreements. Goodwill
and the customer lists acquired are being amortized by the
straight-line method over five years. Management and the
Board of Directors evaluate the intangible assets on a
continuing basis at each balance sheet date. During the years
ended November 30, 1997 and 1996, management determined that
certain intangible assets were impaired. See Note 11, for
details regarding the write down of such assets.
INCOME TAXES The Company accounts for income taxes in accordance with
Statement of Financial Accounting Standards No. 109
"Accounting For Income Taxes" ("SFAS 109"), which requires
recognition of deferred tax assets and liabilities for the
expected future tax consequences of events that have been
included in the financial statements or tax returns. Under
this method, deferred tax assets and liabilities are
determined based on the differences between the financial
statement and tax bases of assets and liabilities using
enacted tax rates in effect for the year in which the
differences are expected to reverse.
LOSS PER SHARE Loss per share has been computed using the weighted average
number of common and common equivalent shares outstanding
during each period presented. Common equivalent shares for
outstanding options and warrants were not included in the
weighted average shares outstanding because the effect would
be antidilutive.
REVENUE
RECOGNITION Revenue from the Company's self-service coin and card reader
operated photocopy machines is principally recognized at the
time payment is received.
Revenue from the Smart Switch is recognized at the time of
facsimile transmission. Revenue from the Smart Switch was not
material during the years ended November 30, 1997 and 1996.
Revenue from the Company's scanner units is recognized when
the product is shipped.
F-9
<PAGE>
DIVERSIFAX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)
RECENTLY ISSUED
ACCOUNTING
STANDARDS The Company has adopted Statement of Financial Accounting
Standards No. 123, "Accounting for Stock Based Compensation"
("SFAS 123"). As permitted by SFAS 123, the Company measures
compensation cost in accordance with Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to
Employees." Therefore, the adoption of SFAS 123 was not
material to the Company's financial condition or results of
operations, however, the proforma impact on earnings per
share has been disclosed in the Notes to Consolidated
Financial Statements as required by SFAS 123.
USE OF
ESTIMATES The preparation of financial statements in conformity with
generally accepted accounting principles requires management
to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could
differ from those estimates.
2. ACQUISITIONS During the year ended November 30, 1996, the Company through
its newly formed, wholly-owned subsidiary, J.A. Hunt Service,
Inc., acquired three businesses engaged in the servicing of
reproduction equipment and the providing of supplies, for the
aggregate cost of $180,000. The acquisitions have been
accounted for as purchases. The cost of the acquisitions have
been allocated on the basis of the estimated fair value of
the assets acquired.
In October, 1996, management determined to withdraw from one
of the acquisitions as a result of misrepresentations made by
the seller. The Company is presently pursuing legal remedies
to recover the acquisition cost of $20,000.
During the year ended November 30, 1997 management determined
to withdraw from a second acquisition as a result of
misrepresentations made by the seller. Accordingly, the
intangible assets acquired in connection with these two
acquisitions have been written off.
F-10
<PAGE>
DIVERSIFAX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
2. ACQUISITIONS
(Continued) Pro forma information reflecting results of operations as
though these companies had been owned for all required
periods has not been presented because the acquisitions did
not meet the materiality parameters as required in accordance
with Regulation S-B.
3. EQUIPMENT AND
VEHICLES Equipment and vehicles consist of the following:
<TABLE>
<CAPTION>
<S> <C>
Photocopy machines and accessories $6,377,579
Furniture and fixtures and computer equipment 105,238
Software 400,000
Vehicles 117,582
Property held under capital leases 272,450
--------------------------------------------------------------------------
7,272,849
LESS: ACCUMULATED DEPRECIATION 3,997,998
--------------------------------------------------------------------------
$3,274,851
--------------------------------------------------------------------------
</TABLE>
4. OBLIGATIONS
UNDER CAPITAL
LEASES During the year ended November 30, 1997 the Company financed
the acquisition of scanner units by entering into various
capital lease agreements.
Minimum future lease payments under capital leases as of
November 30, 1997, for each of the next five years and in the
aggregate are:
<TABLE>
<CAPTION>
YEAR ENDING NOVEMBER 30, AMOUNT
--------------------------------------------------------------------------
<S> <C>
1998 $ 82,733
1999 82,733
2000 82,733
2001 82,733
2002 25,528
--------------------------------------------------------------------------
Total minimum lease payments 356,460
Less: Amount representing interest 109,222
--------------------------------------------------------------------------
Present value of net minimum lease payments 247,238
Less: Current portion ( 41,937)
--------------------------------------------------------------------------
LONG TERM OBLIGATION AT NOVEMBER 30, 1997 $205,301
--------------------------------------------------------------------------
</TABLE>
F-11
<PAGE>
DIVERSIFAX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
5. LOANS PAYABLE,
OFFICER
/STOCKHOLDER From time to time, Dr Irwin A. Horowitz, the Chairman of the
Board, Chief Executive Officer and President of the Company,
loans the Company funds to cover its working capital needs
and to finance acquisitions. In consideration thereof, and
for Dr. Horowitz's agreement that such loans would not bear
interest, on August 16, 1996, the Company delivered to Dr.
Horowitz a promissory note in the amount of $668,000 (the
principal balance on that date), payable on demand after June
1, 1997, and five year warrants to purchase 427,520 shares of
common stock at an exercise price of $3.125 per share. On
December 17, 1996, Dr. Horowitz agreed to extend to December
2, 1997 the due date of the loans made on or before August
16, 1996, as well as all subsequent loans, in the aggregate
principal amount of $1,034,013. In consideration thereof, and
for Dr. Horowitz's agreement that such loans would be
interest-free, the Company agreed that the per share exercise
price of the warrants granted to him in August 1996, as well
as of options to purchase 750,000 shares of common stock
granted to him in October 1996 pursuant to his employment
agreement with the Company, would be reduced to $2.375 per
share, the then current fair market value of the common
stock. In addition, the Company granted to Dr. Horowitz
additional incentive and non-incentive options, to purchase
an aggregate of 750,000 shares of common stock, of which the
incentive options (for 38,270 shares) are exercisable at
$2.613 per share and the non-incentive options (for 711,730
shares) are exercisable at $2.375 per share.
On May 6, 1997, in consideration for the additional
interest-free loans made by Dr. Horowitz, the Company granted
to Dr. Horowitz additional warrants to purchase 350,000
shares of common stock at an exercise price of $1.935 per
share, all of which warrants are immediately exercisable.
In September, 1997, Dr. Horowitz made a one year
interest-free loan to the Company in the amount of $500,000.
In consideration for the loan, the Company granted Dr.
Horowitz a three year warrant to purchase 1,100,000 shares of
common stock at an exercise price of $.84375 per share. The
warrant is immediately exercisable.
On October 28, 1997, as compensation to Dr. Horowitz for
having deferred salary payments totalling approximately
$130,000, the Company issued to Dr. Horowitz a three year
warrant to purchase 285,577 shares of common stock at an
exercise price of $.6875 per share.
The loans payable, officer/shareholder, were $1,034,013 at
November 30, 1996 and the average loan balance during the
year ended November 30, 1997 was approximately $1,335,000
computed on a quarterly basis.
F-12
<PAGE>
DIVERSIFAX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
5. LOANS PAYABLE,
OFFICER
/STOCKHOLDER
(Continued) The options granted to Dr. Horowitz in connection with his
loans to the Company were valued by an investment banking
firm. The value of the options was approximately $406,000 and
is being amortized to expense over the terms of the loans.
On February 19, 1998, the exercise price of all of the
options and warrants held by Dr. Horowitz was lowered to
$.375 per share (except for incentive stock options, which
were lowered to $.4125 per share), the then current market
price of the common stock in consideration of his agreement
to extend the due date of all of his loans to the Company to
February 19, 1999.
6. LOANS PAYABLE,
STOCKHOLDER In September, 1997, Dr. Horowitz's son, a stockholder, loaned
the Company an aggregate of $178,700 in the form of two
promissory notes, payable on or before September 19, 1998.
The notes are non-interest bearing, provided however, that if
the Company fails to make payment on or before the due dates,
interest will accrue, from the due dates, at an annual rate
of 8%. In consideration for the loans, the Company granted
Dr. Horowitz's son a three year warrant to purchase 331,540
shares of the Company's common stock at an exercise price of
$.78125 per share, and a three year warrant to purchase
61,600 shares of the Company's common stock at an exercise
price of $.8125 per share. The warrants are immediately
exercisable.
The option granted to Dr. Horowitz's son in connection with
his loans to the Company were valued by an investment banking
firm. The value of the options was approximately $79,000 and
is being amortized to expense over the terms of the loans.
In November, 1996, a stockholder loaned the Company an
aggregate of $300,000 pursuant to a non-interest bearing
promissory note due and payable within three months. In lieu
of interest the Company granted the stockholder three year
warrants to purchase 30,000 shares of common stock at an
exercise price of $3.00 per share. Had the Company failed to
repay the loan on or before the due date, the Company would
have granted the stockholder three year warrants to purchase
10,000 shares of common stock at an exercise price of $3.00
per share each month for as long as the loan remained
outstanding. The loan was guaranteed by Dr. Irwin A.
Horowitz, the Chairman of the Board, Chief Executive Officer
and President of the Company. The loan was repaid in full
during the year ended November 30, 1997.
F-13
<PAGE>
- -------------------------------------------------------------------------------
DIVERSIFAX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. STOCKHOLDERS'
EQUITY In November 1992, the Company completed its initial public
offering (1,000,000 units) which included 1,000,000 shares of
common stock and 1,000,000 warrants to purchase an additional
500,000 shares of common stock. The warrants were exercisable
until November, 1995 (subsequently extended through December,
1995), at an exercise price of $7.50 per share. The Company
had the right to redeem the warrants at any time during the
exercise period at a price of $.05 per warrant. Net proceeds
from the offering were $4,127,848 after deducting
underwriting commissions of $500,000, the underwriter's
non-accountable expense allowance of $150,000 and direct
offering costs of $222,152.
In addition, the Company had agreed to sell to the
underwriter or its designees, for $100, four year unit
purchase warrants to purchase from the Company an aggregate
of 100,000 units at an exercise price of $6 per unit.
By their original terms, two warrants were exercisable to
purchase one share of common stock for $7.50. As a result of
the acquisition of IMSG and affiliates, the dilutive effect
of the conversion of all 662,000 shares of preferred stock
into 6,620,000 shares of common stock, and the issuance of
other shares by the Company, the exercise price was adjusted
to $2.25 per share (or $4.545 per 2.02 shares) and the number
of shares purchasable upon the exercise of two warrants was
increased to 2.02 shares.
In November, 1995, the Company received approximately
$827,000 in connection with the exercise of the underwriter's
warrants resulting in the issuance of 200,998 shares of
common stock.
Also, in November, 1995, the Company received approximately
$720,000 in connection with the exercise of the warrants
issued in the initial public offering, resulting in the
issuance of 320,119 shares of common stock.
In December, 1995, an additional $1,548,000 was received by
the Company in connection with the exercise of the remaining
outstanding warrants, resulting in the issuance of 688,130
shares of common stock.
F-14
<PAGE>
DIVERSIFAX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
7. STOCKHOLDERS'
EQUITY
(Continued) In October, 1996, the Company commenced another private
placement offering of up to 1,000,000 units, each consisting
of one share of common stock and one three year warrant to
purchase one share of common stock. Each warrant is
exercisable, subject to adjustment, at a price per share
equal to $2.00 above the per unit purchase price. The
purchase price of each unit is equal to the closing bid price
of the common stock as reported by NASDAQ on the date of
receipt by the Company of each respective subscription. As of
November 30, 1996, 4,878 units were sold for a total purchase
price of $12,500. During the year ended November 30, 1997,
the Company sold an additional 23,806 units for a total
purchase price of $52,000.
During the year ended November 30, 1997, the Company
completed a private placement offering of 1,500 shares of the
Company's series D convertible preferred stock, pursuant to
Rule 506, for which the Company received net proceeds of
approximately $1,325,000. Each share of the series D
preferred stock is convertible into such number of shares of
common stock as is determined by dividing $1,000 by the
lesser of (A) 80% of the average bid price of the common
stock for the five trading days immediately preceding the
date of notice of conversion and (B) (i) $2.25 for the first
one-third of the shares of series D preferred stock converted
by a holder; or (ii) $2.50 for the next one-third of the
shares of series D preferred stock converted by a holder; or
(iii) $2.75 for the balance of the shares of series D
preferred stock converted by a holder. In no event can the
conversion price be less than $.60. The series D preferred
stock unless sooner converted, automatically converts to
shares of common stock on June 5, 2000.
In addition, holders of the series D preferred stock are
entitled to receive a six percent cumulative dividend on each
share of series D preferred stock for the period that such
share is outstanding. If on the proposed conversion date, the
closing price per share of the common stock is $1.00 or less,
then the Company can, at its option and in lieu of
conversion, redeem any or all of the series D preferred stock
for an amount equal to the sum of (1) $1,200 for each share
of series D preferred stock redeemed, plus (ii) all accrued
but unpaid dividends, if any, on each share of series D
preferred stock redeemed. If the Company chooses to redeem
some, but not all of the series D preferred stock, then the
Company shall redeem a pro-rata amount from each holder of
the series D preferred stock which was to be converted.
F-15
<PAGE>
DIVERSIFAX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
7. STOCKHOLDERS'
EQUITY
(Continued) Through November 30, 1997, 679 shares of the series D
preferred stock have been converted into 1,072,816 shares of
common stock.
In May 1997, the Board of Directors voted to eliminate from
the Company's charter the designations relating to the Series
A Preferred Stock and the Series B Preferred Stock.
In September, 1997, the Company's shareholders voted to amend
the Company's certificate of incorporation to increase the
aggregate number of shares of all classes of capital stock
which the Company will have the authority to issue to
41,000,000 of which 40,000,000 shares shall be common stock,
par value $.001 per share, and 1,000,000 shares shall be open
stock, par value $.001 per share. Shares of open stock may be
issued from time to time in one or more classes or one or
more series within any class thereof, in any manner permitted
by law, as determined from time to time by the Board of
Directors.
8. STOCK OPTIONS
AND WARRANTS In September, 1995, the Board of Directors of the Company
approved a stock option plan ("the 1995 Plan") subject to
stockholder approval to grant 500,000 shares of the Company's
common stock to key employees upon exercise of options
designated as "incentive stock options" under Section 422 of
the Internal Revenue Code. The 1995 Plan is administered by
the Board of Directors. Options granted pursuant to the 1995
Plan are non-transferable by the optionees during their
lifetime, expire if not exercised within five years from the
date of the grant and, under certain circumstances set forth
in the 1995 Plan, may be exercised within three months
following termination of employment, or up to one year after
death or total disability. Incentive stock options are
granted to key employees as determined by the Board of
Directors at not less than the fair market value of the
shares underlying the option on the date the option is
granted. The amount of aggregate fair market value of common
stock (determined at the time of the grant of the option) for
which an employee may be granted incentive stock options
under the 1995 Plan in any calendar year shall not exceed
$100,000, plus certain unused carryovers from previous years.
The 1995 Plan contains anti-dilution provisions authorizing
appropriate adjustment under certain circumstances. Options
to purchase an aggregate of 125,000 shares of the Company's
common stock exercisable at $4.125 - $8.063 per share have
been granted.
F-16
<PAGE>
DIVERSIFAX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
8. STOCK OPTIONS
AND WARRANTS (Continued) In September, 1995, the Company adopted a
Director's option plan pursuant to which all current
non-employee Directors and non-employees who thereafter
become Directors of the Company will receive an option to
purchase 100,000 shares of the Company's common stock at the
market value thereof at the time of grant. Said options
become vested at the rate of 20,000 per year and terminate 90
days after the Director ceases to serve as a Director.
Options to purchase 100,000 shares at an exercise price of
$4.125 per share were granted to each of two directors.
In October 1996, the Company amended the 1995 Plan and The
Director's Plan so that no further options could be granted
thereunder and adopted the 1996 Stock Option Plan ("the 1996
Plan"). In December 1996, the Company amended the 1996 Plan
to increase the number of common shares reserved for the
issuance upon the exercise of options to 3,000,000. In
connection therewith two directors each received additional
options to purchase 100,000 shares of common stock at an
exercise price of $2.375. In connection with such grant, the
two directors each agreed to cancel the unvested portion (for
60,000 shares) of their original options.
The 1996 Plan provides that the Company may grant stock
options to officers, employees, directors, consultants and
advisors. Under the Plan, the purchase price of the common
stock underlying each option shall be determined by the Board
of Directors, provided, however, that in no event shall the
purchase price of incentive stock options be less than 100%
(110% in the case of optionees who own more than 10% of the
total combining voting power of all classes of stock of the
Company) of the fair market value of the common stock on the
date the option is granted.
At November 30, 1997, the Company has outstanding options to
purchase an aggregate of 2,291,000 shares of common stock at
exercise prices of $2.375 - $4.125 per share.
In addition, the Company has outstanding warrants to purchase
an aggregate of 2,975,599 shares of common stock at exercise
prices of $0.6875 - $4.50 per share.
As permitted, the Company applies Accounting Principles Board
Opinion 25 and related Interpretations in accounting for its
stock-based compensation plan. Stock options are granted at
fair market value of the common stock at the grant date.
F-17
<PAGE>
DIVERSIFAX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
8. STOCK OPTIONS AND
WARRANTS
(Continued) Accordingly, no compensation expense has been recognized for
stock option awards. Had compensation cost for the Company's
stock-based compensation plan been determined based on the
fair value at the grant dates for awards under the plan
consistent with the alternative method of Statement of
Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation," (SFAS 123) the effect on the
Company's net loss for the year ended November 30, 1997 is
estimated to have increased the Company's net loss by
approximately $48,000. The options granted in connection with
the stock-based compensation were valued by an investment
banking firm who considered the exercise price of the
options, their expected life, the market price of the
underlying stock and its volatility, the Company's dividend
paying capacity and the risk-free interest rate for the
expected term of the option.
The pro-forma impact on the net loss in 1997 using the fair
value method of SFAS 123 is detailed below.
Net Loss
As reported $1,895,885
Pro-forma $1,944,085
The pro-forma impact on the loss per share in 1997 is not
material.
9. INCOME TAXES In connection with the acquisition, IMSG and Affiliates
(formerly S corporations) became subject to income taxes
which are being accounted for under the provisions of SFAS
No. 109. Accordingly, deferred income taxes in the amount of
$300,000 were provided as of November 1, 1993. The deferred
taxes arose as a result of the difference between the
carrying value of IMSG and Affiliates' assets and their tax
bases.
During the years ended November 30, 1997 and 1996, as a
result of the continued operating losses, the Company further
evaluated the realizability of the deferred tax asset and
determined increases in the valuation allowance in the amount
of $640,000 and $630,000, respectively, were required,
resulting in a net deferred tax asset equal to the existing
deferred tax liabilities at November 30, 1997 and 1996.
F-18
<PAGE>
DIVERSIFAX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
9. INCOME TAXES
(Continued) The Company's total deferred tax liabilities and deferred tax
assets at November 30, 1997 are as follows:
<TABLE>
<CAPTION>
<S> <C>
Total deferred tax assets $2,330,000
Total deferred tax liabilities ( 180,000)
Valuation allowance ( 1,970,000)
-----------------------------------------------------------------------------
NET DEFERRED TAX ASSET $ 180,000
-----------------------------------------------------------------------------
</TABLE>
A reconciliation of income tax (benefit) at the statutory
rate to the Company's effective rate is as follows:
<TABLE>
<CAPTION>
1997 1996
----------------------------------------------------------------------------------
<S> <C> <C>
Computed "expected" tax expense (benefit) ($630,000) ($690,000)
Losses for which no benefit was provided 50,000 220,000
State income taxes 5,861 7,977
Reversal of previously established
deferred tax liability ( 30,000) ( 30,000)
Change in valuation allowance 640,000 630,000
----------------------------------------------------------------------------------
$ 35,861 $137,977
----------------------------------------------------------------------------------
</TABLE>
The Company has a net operating loss carryforward of
approximately$7,300,000 at November 30, 1997 which may be
used to reduce taxable income in future years. The
carryforward will expire through the fiscal year 2012. The
annual utilization of the available net operating loss
carryforward may be limited by the provisions of section 382
of the Internal Revenue Code, as amended.
10. SUPPLEMENTAL DISCLOSURE
OF CASH FLOW
INFORMATION During the year ended November 30, 1997, the Company incurred
capital lease obligations of approximately $273,000 in
connection with lease agreements to acquire equipment.
During the year ended November 30, 1997, the Company issued
117,500 shares of common stock in connection with marketing
and other services provided to the Company.
F-19
<PAGE>
DIVERSIFAX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
10. SUPPLEMENTAL DISCLOSURE
OF CASH FLOW
INFORMATION
(Continued) During the year ended November 30, 1997, the Company issued
40,000 shares of common stock in settlement of a litigation
matter.
During the year ended November 30, 1997, the Company issued
options in connection with certain financing arrangements and
recorded a discount of $347,195.
11. FOURTH
QUARTER
ADJUSTMENTS During the fourth quarter of fiscal 1996, the trademark,
covenant not to compete, goodwill and the customer lists that
were acquired in connection with the purchase of MDM Copying
Services, were deemed to be impaired. Management determined
the impairment as a result of the loss of the majority of the
customers acquired in such acquisition. Accordingly, these
intangible assets have been written down to zero. The
write-down is included in depreciation and amortization in
the accompanying 1996 consolidated statement of operations.
During the fourth quarter of fiscal 1996, management
determined that a deposit in the amount of $50,000 made in
connection with a potential acquisition was not recoverable,
and, accordingly, was written down to zero. The write-down is
included in selling, general and administrative expenses in
the accompanying 1996 consolidated statement of operations.
During the fourth quarter of fiscal 1997, the Company
determined to write-off the unamortized balance of intangible
assets in the amount of approximately $42,000, acquired in
connection with one of its acquisitions as a result of
misrepresentations made by the seller.
During the fourth quarter of fiscal 1997, in connection with
certain reconciliation procedures, the Company determined
that certain adjustments, recorded during the quarter ended
August 31, 1997, in the aggregate amount of approximately
$278,000 were inadvertently credited to cost of sales and
selling, general and administrative expenses. Accordingly,
this matter was corrected in the fourth quarter with a
corresponding increase to loans payable officer/stockholder.
F-20
<PAGE>
DIVERSIFAX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
12. RELATED PARTY
TRANSACTIONS The Company's general counsel is a director of the Company.
Invoices for legal services paid to the Company's general
counsel during the year ended November 30, 1997 amounted to
approximately $89,000, of which approximately $5,000
represents an advance payment for future services to be
provided. Fees incurred to the general counsel amounted to
approximately $33,000 for the year ended November 30, 1996.
Legal fees incurred to Dr. Horowitz's son, a stockholder,
amounted to $1,500 during the year ended November 30, 1997.
13. COMMITMENTS AND CONTINGENCIES
LEASE
COMMITMENTS IMSG and Affiliates lease office and warehouse space at
certain locations under operating leases. Minimum annual
lease payments are as follows:
1998 $61,000
1999 58,000
2000 56,000
Other locations are rented on a month-to-month basis. Rent
expense totaled approximately $177,000 and $150,000 for the
years ended November 30, 1997 and 1996, respectively.
EMPLOYEES
SAVINGS
PLAN IMSG and Affiliates on behalf of their employees participate
in a deferred savings and profit sharing plan (the "Plan"),
whereby eligible employees may voluntarily contribute a
percentage of compensation. In addition, the Plan provides
for a discretionary contribution by IMSG and Affiliates at
the end of each plan year as determined by IMSG and
Affiliates. No discretionary contributions were made for the
years ended November 30, 1997 and 1996.
SALES TAX
ASSESSMENT The State of Connecticut previously assessed Advanced for
sales tax plus interest and penalty. The assessment was made
based upon the Commissioner of Revenue Services finding that
sales by Advanced of photocopies by machines placed in public
and other libraries are subject to the State of Connecticut
sales tax. Advanced was not successful before the State Tax
Commission nor through the appeals process.
As a result of the unfavorable determination with the State
of Connecticut, the Company accrued $200,000 in the fourth
quarter of fiscal 1996 to provide for any other assessments
by any other states that may arise.
F-21
<PAGE>
DIVERSIFAX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- ------------------------------------------------------------------------------
13. COMMITMENTS AND CONTINGENCIES (Continued)
EMPLOYMENT
AGREEMENTS On October 29, 1996, the Company entered into a renewable one
year employment agreement with Dr. Horowitz, pursuant to
which the Company agreed to pay Dr. Horowitz a salary of
$125,000, together with an annual incentive bonus equal to a
percentage of the Company's pre-tax profits. Such incentive
bonus ranges from 6% to 18% of the Company's pre-tax profits,
based on the level of such pre-tax profits. In addition, upon
execution of the agreement, Dr. Horowitz received options to
purchase 750,000 shares of common stock, which options vest
as to 150,000 shares on the date of grant and upon each of
the next four anniversary dates thereof. The Company further
agreed to grant Dr. Horowitz options to purchase an
additional 100,000 shares of common stock, in consideration
of Dr. Horowitz' prior guaranty of the Company's payments
under the bank loan agreement that was paid in full on
December 19, 1995.
The employment agreement was not renewed in October, 1997.
In June, 1996, J.A. Hunt entered into a three year employment
agreement with its president, providing for an annual salary
of $85,000 and certain incentive compensation based on a
percentage of the net income of J.A. Hunt, as defined in the
agreement.
PURCHASES On October 1, 1996, the Company entered into a supply and
distribution agreement with ScreenScan, pursuant to which the
Company will act as the exclusive distributor of ScreenScan's
100c Centronics interface scanners in North and South America
until March 31, 1998. In connection with the agreement, as
amended, the Company agreed to purchase a minimum of
$1,080,000 of scanner units during the period from October
1997 to March 31, 1998.
CASH Due to the nature of its business and the volume of sales
activity, the Companies accumulate, from time to time, bank
balances in excess of the insurance provided by Federal
and/or other insurance sources.
LITIGATION In June, 1997, the Company entered into a settlement
agreement in connection with an action brought against the
Company and Dr. Horowitz claiming that the Company owed and
had refused to pay certain amounts due under an alleged oral
agreement made with the plaintiff, to assist the Company in
becoming the exclusive distributor for ScreenScan. Pursuant
to the settlement agreement, the plaintiff has been made a
distributor of the ScreenScan product in a limited area,
subject to a required quota of sales, and 40,000 shares of
common stock of the Company were issued to a designee of the
plaintiff.
F-22
<PAGE>
DIVERSIFAX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- ------------------------------------------------------------------------------
13. COMMITMENTS AND CONTINGENCIES (Continued)
LITIGATION
(Continued) The Company was involved in an action in the Supreme Court,
State of New York, New York County, entitled DIVERSIFIED
INVESTORS CORP. V. DIVERSIFAX, INC. AND JUDD
Rothman. The suit was brought seeking payment owed to
plaintiff pursuant to prior non-interest bearing loans
totalling $228,670, made to the Company by various creditors,
two of whom have assigned their rights under the loans to
Diversified Investors Corp. The Company acknowledged the
amount due, but had not paid because the creditors had not
indicated how the amount was to be allocated (due to a
dispute between the creditors). Based upon the agreement
describing the debt, the Company believed that the amount was
payable in Common Stock of the Company.
The plaintiff was seeking cash in lieu of stock. The Company
and the plaintiff each appealed to the Appellate Division. In
June, 1997, the Appellate Division determined that payment of
the debt should be made in cash. The Company filed a motion
for leave to appeal to the Court of Appeals, which motion was
denied and the $287,000 the Company had placed in escrow was
ultimately disbursed to the plaintiff.
In October, 1995, the Company instituted an action against
a former employee and a company to enforce a restrictive
covenant. The Company counterclaimed for $1,750,000 based
upon an alleged unfair or trade practice in seaking to
prevent the company from hiring the former employee. The
Company's motion for a preliminary injunction has been
denied by the court.
The Company is a party to a suit brought by Nassau County to
obtain an accounting of amounts which it believes are due to
the county pursuant to a contract with IMSG Systems, Inc. The
Company believes that all appropriate payments were made to
the county.
The Company is a party to a suit brought by a former public
relations firm of the Company. The firm alleges that it
performed marketing and public relation services on behalf of
the Company pursuant to an oral agreement with the Company,
and is seeking $214,000 for fees and out-of-pocket expenses
in connection therewith. The Company disputes the existence
of an oral agreement and the amount of claimed services
performed, including whether or not any services were
performed at all.
Although the ultimate liability, if any that might
result from the final resolution of these matters is not
presently determinable, the Company believes that the
outcome of the above actions will not have a material
adverse effect on the Company's financial condition.
14. MAJOR
CUSTOMERS During the years ended November 30, 1997 and 1996, one
customer accounted for 11.5% and 11.6% of the total sales,
respectively.
In March, 1996, the Company was not successful in its bid for
the renewal of its contract with a major library system. The
customer accounted for approximately 12.3% of the total sales
for the year ended November 30, 1995.
F-23
<PAGE>
DIVERSIFAX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
15. FAIR VALUE OF
FINANCIAL
INSTRUMENTS The carrying amount approximates fair value of cash and
short-term instruments.
16. SUBSEQUENT
EVENT In February 1998, the Company, through its wholly-owned
subsidiary JA-Hunt Services, Inc., acquired the assets of a
Florida-based company engaged in the retail sale and
servicing of copier supplies and equipment for a purchase
price of $80,000 ($40,000 in cash and $40,000 in common
stock) plus the assumption of liabilities.
F-24
<PAGE>
Exhibit 23
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the Registration Statements
(Nos. 333-19567, 333-15183, 333-03122, 333-15023, 333-08803, 333-03122,
33-90498, 33-87820, 33-87920, 33-86360, 333-32265, 333-6023) of DiversiFax,
Inc. and Subsidiaries on Forms S-3 and S-8, of our report dated February 20,
1998, appearing in the Annual Report on Form 10-KSB of DiversiFax, Inc. and
Subsidiaries for the year ended November 30, 1997.
HOBERMAN, MILLER, GOLDSTEIN & LESSER, P.C.
February 20, 1998
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<PERIOD-END> NOV-30-1997
<CASH> 804,931
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