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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
(Mark One)
[x] Annual Report pursuant to section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended December 31, 1996.
[ ] Transition Report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from ___ to
____.
Commission file number 000-21463
Murdock Communications Corporation
(Exact name of small business issuer as specified in its charter)
Iowa 42-1337746
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(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
1112 29th Avenue S.W., Cedar Rapids, Iowa 52404
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: 319-362-6900
Securities registered pursuant to Section 12(b) of the Exchange Act:
Name of each exchange on
Title of each class which registered
NA NA
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Securities registered pursuant to Section 12(g) of the Exchange Act:
Common Stock, No Par Value
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(Title of class)
Redeemable Common Stock Purchase Warrants
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(Title of class)
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Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for
such shorter period that the Issuer was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. Yes X No
Check if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-B is not contained herein, and will not be contained, to the best
of Issuer's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
the Form 10-KSB. [ X ]
State the issuer's revenues for its most recent fiscal year. $8,164,602
The aggregate market value of the common stock held by nonaffiliates of
the issuer as of February 28, 1997 was $14,077,039.
On February 28, 1997, there were outstanding 4,152,494 shares of the
issuer's no par value common stock.
Transitional Small Business Disclosure Format (check one): Yes No X
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Annual Meeting of the Shareholders
of the issuer to be held May 28, 1997 are incorporated by reference into Part
III of this report.
PART I
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ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
Murdock Communications Corporation ("MCC" or the "Company") is a provider
of telecommunications services principally to hotels and motels. MCC was
founded and incorporated in 1989 by Guy O. Murdock, who has served as its Chief
Executive Officer since inception. From 1989 to 1994, MCC primarily provided
traditional automated operator and call processing services ("OSP services") to
its customers. These OSP services consisted of reselling credit card and
collect calls originating at the hotel property and providing a commission to
the hotel property. By 1994, the Company determined that dial-around, fueled
by the intense advertising of AT&T Corp. ("AT&T"), MCI Communications
Corporation ("MCI") and Sprint Corporation ("Sprint"), would continue to reduce
the number of calls that traditional OSP companies could carry and require the
OSP companies to charge higher prices to maintain the same commission levels.
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The Company adapted to this fundamental change in the industry by pursuing
a cooperative marketing relationship with AT&T. In October 1994, the Company
entered into a contract with AT&T to route operator services traffic to AT&T
through the Lodging Partnership program. Because AT&T currently bills more
calls than any other carrier, the Company has experienced a dramatic increase
in call traffic since starting the Lodging Partnership program. At the same
time end users pay less for calls directed to AT&T through the Lodging
Partnership than that charged by most other OSP companies. Accordingly, the
Company can offer its hotel and other customers payment on more calls and, at
the same time, the value added technology and services of MCC. In late 1995,
the Company entered into the Management Company Commission Agreement with AT&T
(as amended, the "AT&T Agreement") to supersede the Company's 1994 agreement
with AT&T. Under the AT&T Agreement, the Company will continue to receive
commissions on calls routed to AT&T's network and will also receive a monthly
recurring management fee for these calls.
MCC's revenues are currently generated primarily through the Lodging
Partnership program with AT&T. Through the Lodging Partnership, the Company
offers AT&T's operator services bundled with certain "value-added" systems
provided by MCC. These systems include answer detection technology, fraud
prevention, equipment sales such as Private Automatic Branch Exchanges ("PABX")
and specialized management consulting and reporting targeted at improving the
profitability of the hotel's telecommunications department. The Company
receives recurring revenue in the form of commissions and management fees from
AT&T for calling card or collect long-distance calls placed from hotel rooms
subscribing to this program. The Company also provides automated operator and
call processing services to certain hotels not suitable for enrollment with the
Lodging Partnership. In July 1996, the Company commenced introduction of its
"TeleManager" system in key pilot sites around the country. TeleManager
monitors telephone activity at a hotel to identify and locate problems in the
hotel's telecommunications system and to produce reports reflecting analyses of
the costs and revenues derived from the hotel's telecommunications system.
Effective March 10, 1997, the Company formed a joint venture with MATRIXMedia
Holdings, Inc. ("MMH") to market telephones with a patented credit card-swipe
feature and speed dial access to restaurants and other businesses and services.
The Company also is developing a system to allow hotels to offer and charge
guests for high-speed Internet access from designated hotel rooms.
Based on the Company's internal market research, management estimates that
there are approximately 60,000 hotels and motels in the United States. MCC
currently targets hotels and motels that have 100 or more rooms or have owners
that control multiple hotel or motel properties. Of the 60,000 properties,
management estimates, based on the Company's internal market research, that
20,000 have more than 100 rooms or have owners that control more than one
property, and that these properties consist of approximately 3,000,000 to
3,500,000 rooms in total. As of December 31, 1996, MCC provided services to
approximately 96,000 rooms or slightly more than 2.5% of the rooms in its
targeted market. As of December 31, 1996, hotels representing
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approximately 91,000 rooms had enrolled in the Lodging Partnership program. As
of December 31, 1996, the Company provided OSP services to approximately 5,000
rooms. As of February 28, 1997, the Company provided services to approximately
108,000 rooms, including approximately 104,000 rooms enrolled in the Lodging
Partnership program.
To date, MCC has provided its services through equipment installed at the
hotel premises. The Company has recently entered into a strategic alliance
with Gateway Technologies Inc. (the "DSP Provider") to develop an off-premise
network-based technology referred to as the Digital Services Platform ("DSP")
to deliver the same value-added services currently provided by the Company's
premise-based equipment. If implemented, this network-based technology is
expected to make it possible to provide services profitably to significantly
small hotels, thus increasing the number of rooms in MCC's target market.
The Company completed its initial public offering of securities in October
1996. The Company's Common Stock and Redeemable Common Stock Purchase Warrants
are listed on the Nasdaq SmallCap Market under the symbols "MURC" and "MURCW,"
respectively.
THE AT&T AGREEMENT
The Company entered into the AT&T Agreement effective December 16, 1995,
superseding the October 1994 agreement between the Company and AT&T. The AT&T
Agreement provides that the Company will route collect, calling card and
operator assisted calls from hotels included in the Lodging Partnership program
through AT&T's long-distance network. The Company is entitled to receive three
different types of payments from AT&T under the AT&T Agreement: call
processing commissions, compliance incentive bonuses and a guest room
attainment bonus. The Company derived 63% and 42% of its revenues from AT&T
for the years ended December 31, 1996 and 1995, respectively.
Call processing commissions are payable monthly, generally at a rate of
between $.35 and $.44 for each completed call directed by MCC to the AT&T
long-distance network. For the year ended December 31, 1996, the Company
earned $2.9 million in call processing commissions from AT&T.
Each quarter AT&T will pay to the Company a compliance incentive bonus
based on the number of completed calls directed by MCC to the AT&T
long-distance network for each month during the quarter. For the year ended
December 31, 1996, MCC earned compliance incentive bonuses of $1 million. AT&T
may conduct audits of a sample of hotel locations included in the Lodging
Partnership to determine if MCC's system in such hotels complies with certain
standards set forth in the AT&T Agreement. These standards include matters
such as identifying AT&T as the provider of operator services,
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providing dialing instructions near each telephone and assuring the
quality of telephone service and minimum standards for connection. Based on
the results of these audits, the compliance incentive bonus may be reduced by
up to 100% depending on the percentage of noncomplying locations. For purposes
of the AT&T compliance audits, any hotel property with one or more noncomplying
rooms is considered to be noncomplying as an entirety. Accordingly, the
Company would not be entitled to commissions or bonus payments with respect to
calls from rooms in any such hotel property until the hotel property was
brought into full compliance. AT&T has generally performed compliance audits
on a monthly basis and, as of December 31, 1996, had not found any noncomplying
locations.
The Company earned a single, nonrecurring guest room attainment bonus of
$1 million for placing more than 100,000 rooms in the Lodging Partnership
program prior to July 1, 1996. This guest room attainment bonus is payable in
four installments of $250,000. As of December 31, 1996, the Company had
received $500,000 of this bonus from AT&T. AT&T paid the third installment of
$250,000 on February 28, 1997. In the fourth quarter of 1996 the Company and
AT&T executed an amendment to the AT&T Agreement which provides that, if the
Company falls below 100,000 rooms after February 28, 1997 and prior to
May 1, 1998, the Company will be required to reimburse $250,000 to AT&T.
The AT&T Agreement expires on December 16, 1998, although it is
automatically renewed for an additional two year period unless either party
thereto terminates the AT&T Agreement by providing written notice to the other
party within 30 days of the expiration date. If the Company terminates the
AT&T Agreement for any reason, the Company must reimburse AT&T for certain
payments that have been paid by AT&T. The amount of such bonus payments
subject to reimbursement upon termination by the Company as of December 31,
1996 was $1 million. AT&T has also reserved a number of grounds to terminate
the AT&T Agreement prior to its expiration, including (1) the receipt by AT&T
of complaints regarding MCC, (2) claims made against AT&T arising from MCC's
acts or omissions, (3) if AT&T determines that its tariffed services or its
public image or goodwill may be adversely affected by the AT&T Agreement, (4)
MCC uses AT&T's name, logo or trademark in an unauthorized manner, or (5)
AT&T's audits establish that more than 20% of the hotels included in the
Lodging Partnership are not in compliance with the standards set forth in the
AT&T Agreement for two successive quarters.
THE COMPANY'S SERVICES AND TECHNOLOGY
MCC generally provides telecommunications services to hotels and motels
pursuant to three to five year contracts. These contracts normally are
negotiated with a management company or owner for multiple properties.
Operator service is either
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provided as part of the Lodging Partnership utilizing AT&T operator services,
or is provided by MCC's traditional OSP service. In both cases MCC generally
utilizes an "intelligent" call processing system to process the calls. This
equipment is attached by MCC technicians directly to the hotel's telephone
trunk lines. The microcomputer in the call processing system is programmed
with procedures defining how to route and process calling card and collect
calls depending on which operator service program the property utilizes. The
Company pays commissions to its customers based on calling card and collect
calls as well as providing the benefit of other value-added services available
from MCC. These value-added services are provided by equipment installed by
MCC at the customer's premises.
CALL PROCESSING THROUGH THE LODGING PARTNERSHIP. If the Company's call
processing equipment is used in conjunction with the Lodging Partnership, the
equipment routes all calling card and collect calls to the AT&T network. AT&T
then processes and bills the calls to the end user and is responsible for the
collection of the amounts billed. The Company's equipment stores the
origination and destination number and the length, date and time of the call.
This information is sent by modem to MCC's Cedar Rapids facility where it is
compared to the calls AT&T shows as being processed. On a monthly basis AT&T
remits commissions, fees and management bonuses to the Company.
CALL PROCESSING THROUGH OSP SERVICE. If the call processing equipment is
used for MCC's OSP service, most calling card and collect calls are handled on
an automated basis. When a guest makes a calling card or collect call, the
microprocessor in MCC's equipment provides dialing instructions via digitized
voice messages, identifies the long distance carrier as MCC, and validates the
calling card being used. The equipment then stores the billing information of
the call. This would include the length of the call, date, time of the call,
calling card number, and the origination and destination telephone numbers.
This information is accumulated and sent by modem to MCC's Cedar Rapids
facilities where it is priced and processed for billing to the guest. The
priced billing records are then forwarded to a billing and collection service
where they are billed to the guest with his or her monthly phone bill.
CHARGED SERVICES. Although the Company earns most of its revenues by
routing calling card, collect and operator assisted calls (0+) to AT&T through
the Lodging Partnership, the Company also charges its institutional customers
for certain other technology and services offered by the Company. The Company
currently expects that it will also charge for its TeleManager program. See
"Forward-Looking Statements."
Equipment Sales. MCC provides its customers with communications
technology and support, including voice mail and PABX. MCC generally owns or
leases the telephone equipment. MCC also provides lease financing to its
customers, primarily through Berthel Fisher & Company, Inc. and certain of its
affiliates (collectively "Berthel"), for the equipment and installs the
equipment on the hotel's premises.
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One-plus Services. Hotels using MCC's call processing services for
calling card, collect and operator assisted calls can continue to access long
distance carriers for direct dial (one-plus) calls through their own
arrangements with a preferred long-distance carrier. MCC, however, also offers
its customers access to long distance carriers, such as MCI and AT&T, for
one-plus services. Any such one-plus services are outside the scope of the
Lodging Partnership program with AT&T. In providing one-plus services to its
customers, MCC arranges access with the long distance carrier and resells long
distance access to its customer at a price greater than MCC's cost.
VALUE-ADDED TECHNOLOGY AND SERVICES. Along with operator services MCC
also provides its customers with technical expertise, equipment maintenance
services and other value-added offerings without additional charge. These
value-added offerings include answer detection, fraud deterrence, equipment
maintenance and consulting and management reporting aimed at improving the
profitability of hotel telecommunications departments.
Answer Detection. The Company's call processing equipment provides answer
detection to ensure that all room billed calls are timed correctly. Answer
detection not only makes the hotel more money by ensuring that all room billed
calls are charged to the guest, but it also ensures that uncompleted calls do
not appear on the guest's bill at check out. If answer detection were not
provided by MCC's equipment, the hotel would need to invest in expensive stand
alone equipment to receive this same benefit.
Fraud Deterrence. MCC's equipment can be programmed to provide fraud
control by denying completion of certain collect 800 and 900 calls.
Equipment Maintenance. Equipment located on customer premises can be
accessed remotely by MCC technicians, enabling rapid response to customer
problems. All technicians are trained and manufacturer certified to service
and install equipment manufactured by leading industry vendors, thus enabling
MCC to diagnose problems with all types of telecommunications equipment.
Technicians are on call 24 hours a day and can be dispatched immediately to the
customer site. Additionally, MCC maintains a relationship with qualified
technicians located in all regions of the United States who also are on call 24
hours a day.
Consulting and Management Assistance. MCC provides its customers with a
wide variety of assistance in the management of the customer's
telecommunications system. As MCC contracts with a new customer, it provides
assistance in determining the selection of services. Thereafter, MCC serves as
a single point of contact to support the customer's telecommunications needs
and to address problems, including service issues relating to third party
vendors of telecommunications equipment or services. MCC expects that its new
TeleManager program will complement its traditional consulting and management
services, although the Company expects to offer TeleManager separately for an
additional fee. See "Forward-Looking Statements."
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TELEMANAGER. MCC's TeleManager system commenced operation in July 1996
with its installation at a few key pilot sites. TeleManager provides the
Company's customers with information regarding the hotel's telecommunications
system in graphs and reports which are easy to read and understand by persons
lacking specialized expertise in telecommunications. MCC generates this
information by remotely accessing information from the hotel's PABX,
premise-based call processing equipment or, potentially in the future, by the
DSP. The information is then analyzed based on proprietary computer software
programs developed by MCC. The results of this analysis are summarized in
reports and graphs, and remotely transmitted to the hotel. Thus, MCC can
provide hotel and motel general managers with succinct and useful information
on a daily, weekly or monthly basis, including evaluations and recommendations
regarding system performance and an analysis of equipment, service and
billings. TeleManager allows hotels to monitor the accuracy of costs charged
and refunds paid by telephone carriers. The Company will be able to market
TeleManager both to hotels participating in the Lodging Partnership program and
to hotels using the Company's OSP services.
Commencing in July 1996, the Company installed the TeleManager system in a
few key pilot sites to develop system enhancements and to establish customer
references prior to a wider installation program which the Company started late
in the first quarter of 1997. The Company expects to charge its customers for
TeleManager either through flat monthly fees or through a contingent fee based
on a percent of the cost savings realized by the TeleManager customer. The
Company may also offer TeleManager as a value-added service without charge to
certain customers and/or for a limited period of time while TeleManager gains
market acceptance. See "Forward-Looking Statements."
DSP. The Company and Gateway Technologies, Inc. (the "DSP Provider")
entered into a memorandum of understanding on July 5, 1995 (the "DSP
Memorandum"), providing for the development of DSP for use in the hospitality
industry. Similar to MCC, the DSP Provider provides call processing services
primarily to correctional facilities through the installation of premise-based
equipment. However, the DSP Provider utilizes its own proprietary system which
was developed by its own engineering staff. Both the DSP Provider and MCC
identified the need for a "network" based alternative to premise-based systems.
A large segment of the market is comprised of hotel and motel properties too
small to economically justify the cost of on-site equipment. In recent years,
traditional switching technology has begun to merge with personal computer
technology. Today, numerous components and proven technology are available to
construct small, cost effective switches. The DSP Provider and MCC saw the
opportunity to install these "small switch" DSPs in areas where either or both
companies had a high concentration of customers. Using these DSPs, the
companies could provide most of the services provided by premise-based
equipment, but at a capital cost low enough to justify marketing to smaller
properties. The DSP technology uses a scaleable open architecture platform,
facilitating system expansion and upgrades, and includes
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integrated voice response, a feature allowing the user to trigger various
options and prompts using simple voice commands.
Pursuant to the DSP Memorandum, the DSP Provider and MCC currently are
jointly developing DSP. The DSP Provider is currently working to enhance the
design of the DSP system to reduce costs and thereby increase its potential
utilization. The DSP Provider and the Company have decided to delay the
anticipated testing of the DSP system in certain of the Company's markets until
the third quarter of 1997 while the DSP Provider continues the system
enhancements. If implemented, the DSP is expected to significantly expand
MCC's target market and reduce the capital cost of expansion, regardless of
property size. Additionally, MCC plans to combine the capabilities of the DSP
with TeleManager. See "Forward-Looking Statements."
ACCESS TELEPHONES. Effective upon the filing of Articles of Organization
with the State of Iowa on March 10, 1997, the Company and MMH formed Link*
Star, LLC as a joint venture (the "Joint Venture") to market telephones with a
patented card-swipe feature and speed dial access to restaurants and other
businesses and services. The access telephones, along with the Company's
interactive voice response ("IVR") technology, allow hotel guests to order and
pay for goods and to access information services such as news, weather, sports
headlines and financial reports, from a hotel room. MMH currently markets
advertising for IVR applications.
The Company contributed contractual rights to use the speed dial access
and the IVR technology to the Joint Venture. In consideration for the
Company's contribution, the Company received a 50% ownership interest in the
Joint Venture and the right to receive distributions based upon the Joint
Venture's cash flow in preference to payments to MMH until approximately
$496,000 of the Company's contribution to the Joint Venture is returned. The
Company expects that it will seek to provide telecommunications services for
the access telephones, while the Joint Venture will market access to the
telephones to local restaurants and other businesses. The access telephones
are currently installed in approximately 100,000 hotel rooms across the nation
and the Company also has approximately 33,000 access telephones available to be
installed.
INTERNET ACCESS. The Internet is the world's largest computer network
allowing people with computers around the world to interact with each other.
Persons who use general hotel telephone lines to access the Internet tend to
remain on the telephone for a much longer duration than other users. Hotel
telecommunications systems have limited capacity to handle outgoing calls.
Generally, the amount of capacity is based upon past experience with respect to
the number and the average duration of calls from the rooms in the hotel. A
few lengthy Internet calls during any given period can cause the use of the
hotel's telephone system to exceed capacity, preventing other users from being
able to complete calls. In addition, because most Internet calls are local
calls, hotel call processing revenues from such calls are based on the number
of calls placed rather than
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their duration, so that a hotel will not generate additional revenue as a
result of the longer duration of calls placed by Internet users.
The Company has recently introduced an Internet consulting service
designed to evaluate the effect of Internet use at specific hotels and to
provide those hotels with recommendations regarding Internet-related revenue
opportunities and service enhancements. The Company will also work with hotels
to develop programs to use the Internet as a marketing tool. This service will
include assistance in the design of home pages and other Internet links.
To complement its Internet consulting services, the Company is also
currently developing a program to provide special Internet access from
designated hotel rooms. The Company would offer its hotel customers the
opportunity to have a number of rooms equipped with more efficient, high speed
lines designed to better accommodate Internet use. The telephone lines from
these rooms would be separate from the rest of the hotel's telecommunications
system so that Internet users in such rooms would not burden the hotel's
capacity. The Company anticipates that hotel guests would be able to access
the Internet from the other hotel rooms, but that the telephone lines from such
rooms would lack the high speed access capability that would be present in the
special Internet rooms. The Company and its hotel customers could generate
additional revenues from Internet use either from charging premium rates to
guests who use the designated Internet rooms or by charging usage fees for
calls from the Internet rooms. The Company expects to have its Internet access
program available to offer to hotels during the second quarter of 1997. See
"Forward-Looking Statements."
THE COMPANY'S EXISTING MARKETS
MCC currently markets its products primarily to hotel chains and
management groups controlling multiple properties. The Company concentrates on
groups with properties having 100 or more rooms. By developing relationships
with these owners and managers, and providing additional value-added services,
MCC has been able to enter into long-term contracts with these properties.
The Company's standard location agreement has a term of three to five
years, with optional renewal periods of one to two years.
MCC provides services to hotels and motels in 40 states and in the
District of Columbia. These customers range from properties primarily serving
the business traveler in metropolitan areas to resort properties serving the
vacationing public. Although there are many independent hotels and motels in
MCC's customer base, the majority of the properties are affiliated with one of
the more well known franchise operations. MCC's base includes properties
affiliated with the following franchise names:
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Holiday Inn Radisson
Marriott Sheraton
Hilton Embassy Suites
Harvey's Doubletree
Howard Johnson Econolodge
Ramada Inn Comfort Inn
Days Inn Hampton Inn
Regency Suites Travelodge
Best Western Roadway Inn
Meridian
The Company is also exploring opportunities to provide telecommunications
services to hospitals, universities and military bases. As of December 31,
1996, the Company provided telecommunications services to two hospitals and one
university through the Lodging Partnership under agreements similar to those
the Company uses with its hotel customers. Hospitals and universities provided
less than 1% of the Company's gross revenues in 1996. The Company has not yet
secured a contract to provide telecommunications services to a military base.
COMPETITION
The hospitality telecommunications market in the United States totals
60,000 properties with over 6 million hotel rooms. MCC currently targets a
segment of this market that totals 20,000 properties and nearly 3.5 million
rooms. The Company competes for hospitality long distance business with a
variety of long distance interexchange carriers, including Sprint, MCI and
AT&T. Secondarily, MCC also competes with traditional OSP companies who
specialize in providing services to hotels and pay phone providers. Should
Sprint, MCI or AT&T choose to compete directly with the Company in providing
bundled telephone services to the hospitality industry, such entity would be
capable of devoting substantially greater financial, lobbying, technical and
marketing resources to such a venture than the Company is capable of providing.
There can be no assurance that the Company will be able to compete
successfully in its markets. The Telecommunications Act also may increase
competition by reducing barriers to competition. As a result, startup
companies may also choose to enter into the Company's markets with similar
products. Any of these companies could form a strategic alliance with a
significant partner, such as the Company's relationship with AT&T, and
establish itself as a formidable competitor. In addition, the Company may face
competition from alternative technologies which are currently under development
or which may be developed in the future.
MCC believes that the 50% of the market not controlled by the three
long-distance major carriers may provide the best opportunity for growth. As
dial-around continues to adversely impact the profitability of OSP providers
and as the hospitality industry continues to move away from OSP providers, the
Company anticipates that the Lodging
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Partnership will provide additional opportunities for growth. Competition to
provide telecommunications services to the hospitality industry is based
principally on price, quality, reliability and customer service. The Company
believes that customer service is a particularly significant factor because
many hotel managers have recognized that the costs and complications of
operating a telecommunications system for their guests may outweigh the revenue
opportunities for the hotel. The Company seeks to assist its customers in
maximizing their telecommunications revenue and simplifying telecommunications
management.
MARKETING AND SALES
The Company will seek to expand its business based on its value-added
equipment and management offerings and its relationship with AT&T.
VALUE-ADDED EQUIPMENT AND MANAGEMENT OFFERINGS. By including value-added
equipment offerings as a part of its long distance offerings MCC is able to
meet the total telecommunications needs of hotels and motels more fully than
either the interexchange carriers or the OSP companies. MCC value-added
equipment offerings include telephone call accounting, direct dial answer
detection, voice mail and proprietary telemanagement services.
Additionally, the Company offers its customers a single point of contact
management program. MCC coordinates the efforts of various suppliers and
vendors to resolve any telecommunications problems and issues on behalf of
individual properties. Management believes this program is particularly
appealing to the hotel industry which has been confounded by the multiple
vendor environment created by deregulation.
RELATIONSHIP WITH AT&T. In the past two years AT&T has dramatically
increased demand for its 0+ long distance services among the traveling public.
Management believes AT&T's national advertising and promotion along with
continued poor performance on the part of some members of the OSP industry have
helped create a perception that AT&T service is fair and reasonable while other
services are suspect. One of the results of this perception is that more and
more hotel guests are dialing around non-AT&T carriers. According to published
reports OSP companies have seen their calling volumes decline by over 50% in
the last two years. Not only does the reduction in calling volume adversely
affect the OSP's basic economics but it also reduces the OSP's value to the
hotel property as less commission revenues are generated on behalf of the
hotel. MCC's utilization of AT&T services allows the Company to take full
advantage of the demand for AT&T 0 + service among hotel guests.
Another important advantage of the AT&T affiliation is MCC's participation
in the cooperative advertising program. Under this program, AT&T substantially
shares in the costs of promoting MCC and AT&T services to the traveling public.
This cost sharing
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enables MCC to undertake a substantial national advertising program at
dramatically reduced costs.
REGULATION
OVERVIEW. The Company's services are subject to federal and state
regulation. The FCC exercises jurisdiction over all facilities of, and
services offered by, telecommunications common carriers to the extent those
facilities are used to provide, originate or terminate interstate or
international communications. State regulatory commissions retain some
jurisdiction over the same facilities and services to the extent they are used
to originate or terminate intrastate common carrier communications. The
Company holds various federal and state regulatory authorizations.
FEDERAL REGULATION. The Telecommunications Act became effective February
8, 1996. The Telecommunications Act preempts state and local laws to the
extent that they prevent competitive entry into the provision of any
telecommunications service. Subject to this limitation, however, the state and
local governments retain most of their existing regulatory authority. The
Telecommunications Act imposes a variety of new duties on incumbent local
exchange carriers in order to promote competition in local exchange and access
services. The Company does not believe that the Telecommunications Act has had
a significant effect on the Company's operations.
The Company also makes informational filings with the FCC with respect to
all tariffs charged for OSP services. The FCC may request further information
with respect to, or otherwise challenge, any tariffs that the FCC considers to
be unreasonably high. Based upon the Company's understanding of the practices
of other OSP companies, the Company believes that its tariffs are significantly
below a level likely to cause a comment from the FCC.
STATE REGULATION. The Company is also subject to various state laws and
regulations. Most public utilities commissions subject OSP providers such as
the Company to some form of certification requirement, which requires providers
to obtain authority from the state public utilities commission prior to the
initiation of service. In most states, the Company also is required to file
tariffs setting forth the terms, conditions and prices for OSP services that
are classified as intrastate (for example, inter-LATA calls that are within a
single state). The Company also is required to update or amend its tariffs
when it adjusts its rates or adds new products, and is subject to various
reporting and recordkeeping requirements. 'Accordingly, each time the Company
changes its tariffs with respect to intrastate OSP services, it must obtain the
necessary regulatory approvals from the state. The length of time required to
obtain certification or approval for a tariff varies from state to state, but
generally does not exceed a period of between 90 days and 6 months. Because
the state requirements regarding tariff filings do not apply to the Company's
services provided through the Lodging Partnership, the Company does not believe
that such regulations have a material effect on the Company's business.
13
<PAGE> 14
Many states also require prior approval for transfers of control of
certified carriers, corporate reorganizations, acquisitions of
telecommunications operations, assignment of carrier assets, carrier stock
offerings and incurrence by carriers of significant debt obligations.
Certificates of authority can generally be conditioned, modified, canceled,
terminated or revoked by state regulatory authorities for failure to comply
with state laws and/or the rules, regulations and policies of state regulatory
authorities. Fines or other penalties also may be imposed for such violations.
There can be no assurance that state utilities commissions or third parties
will not raise issues with regard to the Company's compliance with applicable
laws or regulations.
EMPLOYEES
As of December 31, 1996, MCC had 31 employees, all of whom are employed
full time. The Company believes its relationships with its employees are good.
None of the Company's employees is subject to a collective bargaining
agreement.
ITEM 2. DESCRIPTION OF PROPERTY
MCC maintains its principal business offices in Cedar Rapids, Iowa, where
it owns and occupies approximately 8,000 square feet of combined office and
warehouse space, subject to a first mortgage held by Venture Investments, an
unrelated third party. Although this space is adequate for the Company's
present needs, management expects to lease a larger space within the next 36
months. In the event that the Company moves its operations to a larger
facility, the Company would intend either to sell its present facility or to
lease it to a tenant. The Company believes that suitable space is readily
available in the Cedar Rapids area at commercially reasonable rates and that a
move to a new facility could be accomplished with minimal cost and disruption
to the Company's operations.
ITEM 3. LEGAL PROCEEDINGS
There are no material proceedings pending, or known to be contemplated by
any governmental authority, to which the Company is a party, or to which any of
its properties are subject, and the Company knows of no material pending legal
proceedings or judgments entered against any director or officer of the Company
in his capacity as such.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 1996.
14
<PAGE> 15
PART II
-------
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock is traded on the Nasdaq Small Cap Market under
the symbol "MURC" and the Company's Redeemable Common Stock Purchase Warrants
("Warrants") are traded on the Nasdaq Small Cap Market under the symbol
"MURCW." The following table sets forth the high and low bid quotations for
the Company's common stock and Warrants as reported by Nasdaq. Such
transactions reflect interdealer prices, without retail mark-up, mark-down or
commission and may not necessarily represent actual transactions.
<TABLE>
<CAPTION>
Fiscal 1996 Common Stock Warrants
-------------- -----------
Quarter High Low High Low
- ------------------------------ ------ ------ ----- ----
<S> <C> <C> <C> <C>
Fourth (from October 21, 1996) 4-1/2 2-3/8 1-5/8 3/8
</TABLE>
At December 31, 1996, there were approximately 112 holders of record of
Common Stock.
The Company has not paid any cash dividends on its common stock in the
last two years. The Company intends to retain any earnings for use in the
operation and expansion of its business and, therefore, does not anticipate
paying any cash dividends in the foreseeable future.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
From its inception, the Company's primary source of revenue was generated
by providing operator services to the hospitality industry as an OSP services
provider. Initially, the Company entered into contracts with hotels or motels
pursuant to which the Company carried call traffic and recorded the entire
gross price of the call as revenue. The Company then processed and billed the
end user through a third party billing and collection company. The Company's
gross margin was the gross price of the calls, less the costs of (1)
commissions paid to the hotels and motels, (2) transmission, (3) maintenance,
and (4) billing and collection. The Company also provides long distance
services for direct dial calls (one-plus services) to one hotel management
company by arranging access with a long distance carrier and reselling such
access to hotels or motels at a premium.
15
<PAGE> 16
For the past several years the number of calls placed through OSP
companies has been decreasing dramatically due to the use of proprietary
calling cards and other dial-around activities (such as 1-800-CALL ATT).
Additionally, due in part to the negative publicity caused by the unethical
practices of some OSP companies and the intense advertising directed at the
traveling public by interexchange companies (primarily AT&T), hotels and motels
have become increasingly more reluctant to sign long term agreements with OSP
companies. In response to this fundamental change in the industry, the Company
sought and secured a cooperative marketing relationship with AT&T.
In October 1994, the Company entered into a contract with AT&T to route
operator services traffic to AT&T through the Lodging Partnership program.
Through such a relationship the Company could achieve a significant marketing
advantage and would provide customers with AT&T operator services. Through the
Lodging Partnership, management believes that MCC will be compensated on calls
which would have been dialed-around in the past. See "Forward-Looking
Statements." In addition, a hotel utilizing AT&T operator services
historically carries two to three times more billable calls than a hotel
utilizing OSP services.
This agreement changed the way that MCC records revenue on each call.
Under the 1994 agreement, AT&T carried the traffic, processed the calls and
billed the end user. In return, AT&T paid MCC commissions on calls and paid a
signing bonus for each hotel or motel room added to the Lodging Partnership
program. Rather than recording the gross revenue per call, MCC started
recording a net commission per call. The gross margin for calls routed over
the AT&T network consisted of the net commissions and bonuses paid by AT&T,
less the cost of (1) commissions paid to hotel and motels and (2) maintenance.
This change resulted in lower gross margins, offset by larger call volumes with
existing customers and rapid growth in new customers.
The Company entered into the AT&T Agreement effective December 16, 1995,
superseding the October 1994 agreement between the Company and AT&T. The AT&T
Agreement continues the Lodging Partnership program but effectively eliminates
most signing bonuses and replaces them with a recurring monthly management
bonus based upon the number of operator service calls placed over the AT&T
network. Monthly recurring bonus revenue based on call volume more closely
matches the current cash requirements of the Company. As a result of this
change, the Company receives bonus revenue on a monthly basis, in lieu of
periodic payments for adding hotel rooms to the Lodging Partnership Program.
The Company believes that this change in the criteria for payment under the
AT&T Agreement will even out the revenue stream and provide the opportunity for
increased revenues for the term of a given contract with a hotel or motel in
the Lodging Partnership based on historical occupancy percentages and guest
calling patterns. See "Forward-Looking Statements." The number of rooms in
the Lodging Partnership exceeded 91,000 as of December 31, 1996 (approximately
95% of the total number of rooms serviced by the Company) since the AT&T
relationship began in October 1994.
16
<PAGE> 17
RESULTS OF OPERATIONS
Twelve Months Ended December 31, 1996 Compared to Twelve Months Ended December
31, 1995
The following table sets forth statements of operations items and the
percentages that such items bear to revenues:
<TABLE>
<CAPTION>
Twelve Months Ending
--------------------
December 31,
--------------------
1996 1995
--------------------
<S> <C> <C>
Revenues............................ 100% 100%
Cost of sales....................... 64 57
Selling, general, and administrative 34 26
Depreciation and amortization....... 28 31
--------- ---------
Total operating expenses............ 126% 114%
Operating loss...................... (26) (14)
Interest expense.................... 18 14
Income taxes........................ 0 0
Extraordinary gain.................. 13 0
--------- ---------
Net loss............................ (31)% (28)%
========= =========
</TABLE>
REVENUES. Call processing revenues decreased to $6.3 million for the
twelve months ended December 31, 1996 from $6.9 million for the twelve months
ended December 31, 1995, representing a decrease of $600,000 or 9%. This
decrease was primarily caused by the decrease in OSP calls carried by the
Company as it converted customers into the Lodging Partnership program with
AT&T because the Company receives a commission on a per call basis under the
Lodging Partnership rather than recording the gross amount of the phone call
based on the phone calls' duration. OSP revenues decreased to $1.2 million for
the twelve months ended December 31, 1996, from $3.2 million for the twelve
months ended December 31, 1995, representing a decrease of $2 million or 63%.
OSP revenues decreased because the Company moved hotel and motel rooms from its
OSP services to the Lodging Partnership program with AT&T. Calling commissions
primarily from AT&T increased to $4.2 million for the twelve months ended
December 31, 1996 from $2.6 million for the twelve months ended December 31,
1995, an increase of $1.6 million or 65%. This increase is primarily due to
the increased number of rooms and to an increased commission per call. In
December 1995, the Company entered into an agreement with AT&T that provides
for recurring payments made to the Company based upon the number of calls
carried by AT&T from hotels in the Lodging Partnership. The Company recorded
$1 million under this new arrangement for the twelve months ended December 31,
1996. The Company believes that the movement of its hotel and motel customers
from OSP services to the Lodging Partnership will provide more consistent
recurring revenues over a longer period of time. However, the Company's
experience with the new payment criteria is limited,
17
<PAGE> 18
and no assurance can be given that the Company will be able to successfully
replace nonrecurring signing bonuses with revenues derived from monthly bonuses
based on call volume. Furthermore, the Company to date has not been profitable
during is transition from OSP services to the Lodging Partnership and no
assurance can be given that this business will become profitable. See
"Forward-Looking Statements." One-plus revenues decreased to $800,000 for the
twelve months ended December 31, 1996 from $1.1 million for the twelve months
ended December 31, 1995, representing a decrease of $300,000 or 27%. The
decrease was attributable to a decrease in the number of hotel or motel
properties provided one-plus services, from 38 to 26, as a result of the
reduction in the number of properties owned by Larken, Inc., the hotel
management company that purchases the Company's one-plus services.
Signing commissions and bonuses from AT&T decreased to $1.0 million for
the twelve months ended December 31, 1996 from $1.25 million for the twelve
months ended December 31, 1995, a decrease of $250,000 or 20%. For the twelve
months ended December 31, 1996, the Company earned a nonrecurring guest room
attainment bonus of $1 million for placing more than 100,000 rooms in the
Lodging Partnership program prior to July 1, 1996. For the twelve months ended
December 31, 1995, the Company earned nonrecurring guest room attainment
bonuses of $500,000 for placing more than 75,000 rooms in the Lodging
Partnership program, and $750,000 for placing more than 90,000 rooms in the
Lodging Partnership program. In subsequent periods, the Company expects to
earn commissions and bonuses under the Lodging Partnership program based
primarily on the volume of calling traffic rather than on the placement of
hotel rooms in the Lodging Partnership program. The Company believes that this
change in the criteria for payment under the AT&T Agreement will even out
revenues and provide the opportunity for increased revenues for the term of a
given contract with a hotel or motel in the Lodging Partnership based on
historical occupancy percentages and guest calling patterns. See
"Forward-Looking Statements."
The Company provided services to a total of 96,000 hotel and motel rooms
as of December 31, 1996, as compared to 90,000 hotel and motel rooms as of
December 31, 1995.
Equipment sales generated a net profit of $58,000 for the twelve months
ended December 31, 1996, and a net profit of $124,000 for the twelve months
ended December 31, 1995, or a decrease of $66,000 or 53%.
Other income increased to $196,000 for the twelve months ended December
31, 1996 from $64,000 for the twelve months ended December 31, 1995, an
increase of $132,000 or 206%. This increase was primarily derived from an
increase in equipment rentals of $87,000 and an increase in service income of
$63,000.
COST OF SALES. Cost of sales for call processing was $4.8 million for the
twelve months ended December 31, 1996, and
18
<PAGE> 19
1995. Cost of transmission associated with providing OSP services
and 1+ services decreased to $932,000 for the twelve months ended December 31,
1996, from $1.26 million for the twelve months ended December 31, 1995, for a
decrease of $328,000 or 26%. Other expenses of providing OSP services
decreased to $74,000 for the twelve months ended December 31, 1996, from
$293,000 for the twelve months ended December 31, 1995, for a decrease of
$219,000 or a decrease of 75%. These decreases were offset by an increase in
the cost of commissions resulting from the Company's decision to move hotels
and motels to the Lodging Partnership. Commissions paid to hotels and motels
increased to $3.7 million for the twelve months ended December 31, 1996 from
$3.3 million for the twelve months ended December 31, 1995, and increased as a
percent of revenues to 45% for the twelve months ended December 31, 1996, from
37% for the twelve months ended December 31, 1995. Commissions paid to certain
hotels and motels which were transferred to the Lodging Partnership program
from the Company's OSP program are based on historical gross profits derived
with respect to that property regardless of whether services are provided
through OSP or the Lodging Partnership. The commission expense paid to these
certain hotels and motels was approximately $274,000 more than if these
properties were paid under a typical Lodging Partnership program. The Company
intends to enter into discussions to renegotiate these agreements during 1997.
Cost of sales as a percentage of revenues increased to 65% for the twelve
months ended December 31, 1996, from 59% for the twelve months ended December
31, 1995.
GROSS OPERATING PROFIT. Gross operating profit decreased from $3.8
million for the twelve months ended December 31, 1995 to $2.9 million for the
twelve months ended December 31, 1996, representing a decrease of $900,000 or
24%. This decrease was primarily due to the higher commissions of
approximately $274,000 paid to certain hotels and motels described above, a
decrease of $250,000 in nonrecurring AT&T bonuses and lower margins on rooms
switched from OSP services to the Lodging Partnership program of approximately
$375,000.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses, increased to $2.7 million for the twelve months ended
December 31, 1996, from $2.3 million for the twelve months ended December 31,
1995, an increase of $400,000 or 17%. This increase is due primarily to normal
salary increases, the addition of four full time employees and the
establishment of an office and warehouse in Dallas, Texas. Selling, general
and administrative expenses include expenses incurred as the Company expands
its customer base. Adding new customers to the Company's base generally
requires up-front selling expenses and equipment installation expenses which
may vary significantly depending on the customer.
DEPRECIATION AND AMORTIZATION EXPENSE. Depreciation and amortization
decreased to $2.3 million for the twelve months ended December 31, 1996 from
$2.7 for the twelve months ended December 31, 1995. During 1995, the Company
adopted Statements of Accounting Standards No. 121 "Accounting for Impairment
of Long-Lived
19
<PAGE> 20
Assets and for Long-Lived Assets to be Disposed Of." Adoption of this standard
resulted in the reduction in carrying amount of idle telecommunications
equipment under capital leases in the amount of $400,000. No
impairment-related expense was recorded in 1996.
INTEREST EXPENSE. Interest expense increased to $1.45 million for the
twelve months ended December 31, 1996, from $1.29 million for the twelve months
ended December 31, 1995, an increase of $160,000 or 12%. The increase is
attributable to additional borrowings in the form of notes payable,
lease obligations and bridge financing.
EXTRAORDINARY GAIN. In 1996, the Company repaid certain obligations to
Intellicall, Inc. resulting in an extraordinary gain on debt restructuring of
$1.1 million. This was a one time gain resulting from a 1994 restructuring of
debt and the purchase price of a group of assets purchased from Intellicall,
Inc. by the Company. The gain was deferred pending payment of all amounts due
under a note issued in connection with the restructuring, since the gain was
contingent on such repayment. This note was repaid on June 29, 1996.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1996, the Company's current assets of $2.7 million
exceeded current liabilities of $2.1 million resulting in working capital of
$600,000. During 1996, the Company used $1.3 million in cash for operating
activities, and used $1.7 million in investing activities, primarily the
purchase of equipment. The Company received proceeds from new debt and capital
lease financing of $2.4 million and repaid borrowings on notes payable and made
payments on capital lease obligations of $4.7 million. During 1996, the
Company received $8 million in proceeds of the sale of common stock, incurred
$1.5 million in offering costs (including underwriting discounts) and paid
$102,000 in dividends declared in 1995. These activities resulted in an
increase in available cash of $1.1 million for the twelve months ended December
31, 1996.
On October 24, 1996, the Company completed a public offering of 800,000
units, each unit consisting of two shares of Common Stock and one Warrant, at
$10.01 per unit. Net proceeds received by the Company, after deducting
offering expenses and underwriting discounts, were approximately $6.5 million.
As of January 24, 1997, the Company had used approximately $3.3 million of the
net proceeds to repay bank debt and lease financing and approximately $2.2
million for the purchase of capital equipment and site contracts and for
working capital needs. The Company had the balance of the proceeds invested in
short-term, interest bearing obligations pending the use of such proceeds in
fiscal 1997.
In addition to the proceeds of the public offering, the Company's
principal sources of capital to date have been cash flow from its operations,
private offerings of debt and equity securities and lease financing
arrangements with Berthel
20
<PAGE> 21
to purchase telecommunications equipment. The total amount of lease financing
with Berthel at December 31, 1996 was $3.4 million. The Company paid
$2.7 million in 1996 pursuant to such lease financing and currently makes
monthly lease payments of approximately $80,000 in the aggregate. Berthel
also holds a 48 month $750,000 term note, collateralized by certain equipment
and contracts owned by the Company.
The Company has $250,000 available under a revolving credit facility
ending December 1, 1997. As of December 31, 1996, no amounts were outstanding
under this facility. The Company borrowed $350,000 from a financial
institution under a promissory note, with interest payable at 1.5% over the
applicable prime rate, and repaid this loan in the fourth quarter of 1996 using
a part of the proceeds from the public offering. The Company used part of the
proceeds of this note to acquire certain of the assets of PowerTel of Delaware,
Inc.
The Company believes that the net proceeds from the public offering,
together with existing capital and anticipated funds from operations, including
the final $250,000 installment from AT&T for the guest room attainment bonus,
will be sufficient to meet its anticipated cash needs for working capital and
capital expenditures for the foreseeable future. However, if the Company's
funds from operations are less than anticipated in 1997 or if the Company
undertakes financing of any significant future equipment or property
acquisitions or expanded service offerings, the Company would need to obtain
additional debt or equity financing. See "Forward-Looking Statements."
FORWARD-LOOKING STATEMENTS
This report contains certain forward-looking statements and is subject to
certain risks and uncertainties that could cause actual future results and
developments to differ materially from those currently projected. Such
statements include statements identified as based on the Company's belief,
expectation or plans and in each case precede a cross-reference to this
section. The following discussion highlights some of the risks and
uncertainties.
DEPENDENCE ON CONTINUING RELATIONSHIP WITH AT&T. The Company derived 63%
of its revenues from AT&T for the year ended December 31, 1996. The AT&T
Agreement initially expires on December 16, 1998, but is automatically renewed
for an additional two-year term unless either party objects. AT&T has also
reserved a number of grounds to terminate the AT&T Agreement prior to its
expiration, including: (1) the receipt by AT&T of complaints regarding MCC,
(2) claims made against AT&T arising from MCC's acts or omissions, (3) if AT&T
determines that its tariffed services or its public image or goodwill may be
adversely affected by the AT&T Agreement, (4) MCC uses AT&T's name, logo or
trademark in an unauthorized manner, or (5) AT&T's audits establish that more
than 20% of the hotels included in the Lodging Partnership are not in
compliance with the standards set forth in the AT&T Agreement for two
successive
21
<PAGE> 22
quarters. If the Company terminates the AT&T Agreement for any reason, the
Company must reimburse AT&T for certain bonus payments that have been paid by
AT&T. The amount of such bonus payments as of December 31, 1996 was $1
million.
AT&T also competes with the Company by providing long-distance services
directly to hotels and motels, although AT&T does not presently offer
value-added technology and services comparable to those offered by the Company.
AT&T's competitive position may cause potential conflicts of interest and may
affect AT&T's business strategy with respect to the Lodging Partnership,
including a decision with respect to renewal of the AT&T Agreement. Management
believes the value that MCC adds to the Lodging Partnership program (through
the Company's contracts with hotels and motels) should assure a long-term
relationship with AT&T, and that a similar relationship could be developed with
other long distance carriers such as Sprint or MCI. No assurance can be given,
however, that the Company could successfully negotiate and enter into an
agreement with MCI, Sprint or any other long-distance carrier if the AT&T
Agreement is terminated or not renewed, or that any such agreement would be on
terms favorable to the Company. Moreover, AT&T currently controls a
significant portion of the long-distance telephone market, and AT&T has a
reputation for quality network services. Approximately 56% of the Company's
contracts with hotels and motels require that the Company provide its services
through the Lodging Partnership. Although the Company's other contracts with
hotels and motels in the Lodging Partnership do not permit the customer to
terminate in the event that the AT&T Agreement is terminated, no assurance can
be given that the Company's relationships with its customers would not suffer
if the AT&T Agreement were terminated. Accordingly, MCC's business and
financial prospects would be adversely affected if its relationship with AT&T
were disrupted.
LIMITED EXPERIENCE UNDER AT&T AGREEMENT. The Company entered into the
AT&T Agreement effective December 16, 1995, superseding the October 1994
agreement between the Company and AT&T. The AT&T Agreement continues the
Lodging Partnership program but effectively eliminates most signing bonuses and
replaces them with a recurring monthly bonus based on call volume. The Company
believes that the new payment criteria under the AT&T Agreement will even out
the Company's revenues and provide the opportunity for increased revenues for
the term of a given contract with a hotel or motel in the Lodging Partnership.
However, the Company's experience with the new payment criteria is limited, and
no assurance can be given that the Company will be able to successfully replace
the nonrecurring signing bonuses with revenues derived from monthly bonuses
based on call volume. Furthermore, the Company to date has not been profitable
during its transition from OSP services to the Lodging Partnership, and no
assurance can be given that this business will become profitable.
COMPETITION. Competition in the telecommunications industry is intense.
The Company competes with numerous companies, including AT&T, MCI, Sprint, U.S.
Long Distance and National Operator Services, to provide telecommunications
services to the hospitality industry. Should any of these entitles choose to
compete directly with the
22
<PAGE> 23
Company in providing bundled telephone services to the hospitality
industry, such entity would be capable of devoting substantially greater
financial, lobbying, technical and marketing resources to such a venture than
the Company is capable of providing. In addition, start up companies may
choose to enter into the Company's markets with similar products. Any of
these companies could form a strategic alliance with a significant partner,
such as the Company's relationship with AT&T, and establish itself as a
formidable competitor.
RELIANCE ON CONTINUED RELATIONSHIPS WITH CUSTOMERS. In recent years the
Company has experienced problems maintaining customer relationships and
attracting new customers with its OSP services. In response to the declining
OSP business, the Company sought and secured the Lodging Partnership program
with AT&T. As the Company has marketed its services through the Lodging
Partnership, the number of hotel and motel rooms under contract has increased
from 58,000 as of December 31, 1994 to 96,000 as of December 31, 1996. Because
the Company has been operating under the Lodging Partnership for approximately
two years, the Company does not currently have a reliable indication of the
rate at which hotel and motel customers will renew contracts under the Lodging
Partnership.
FUTURE CAPITAL REQUIREMENTS. MCC's business is capital intensive and
requires substantial capital investment to achieve growth. The Company expects
that it will require additional capital in the future for working capital as
well as to finance its continuing expansion and the development of new products
and services. If the Company needs additional capital in the future, the
Company would likely seek such capital through public or private borrowings or
equity financings. Adequate funds may not be available when needed, or in an
amount or on terms acceptable to the Company. Insufficient funds may require
the Company to delay, scale back or eliminate some or all of its product or
market development plans with an adverse effect on the Company's future
performance.
IMPLEMENTATION OF NEW TECHNOLOGY. Completion of the development of DSP
requires several significant steps, including completion of the testing of
technological feasibility, selection and procurement of platform sites, and
installation of the DSP equipment. There can be no assurance that the Company
and the DSP Provider will be able to implement DSP without encountering
performance problems which may result in the loss of or delay in market
acceptance. Because the Company has not yet tested the DSP technology in any
of its markets, no assurance can be given that such technology will work for
its intended purpose. Any delay in or cancellation of the implementation of
DSP may have an adverse effect on the Company by limiting its ability to expand
its customer markets. Moreover, the Company has not yet entered into a
definitive agreement with the DSP Provider, and no assurance can be given that
the Company will be able to enter into an acceptable definitive agreement with
the DSP Provider regarding the development or use of DSP technology.
23
<PAGE> 24
The Company's future growth will be dependent in part on its ability to
identify and develop new services. There can be no assurance that the Company
will be successful in identifying and developing new services, that the new
services developed by the Company will achieve market acceptance or that the
technology necessary for such new services will be free from defects. Because
of the importance of telecommunications services to the hospitality industry,
the Company's customers and potential customers may be particularly sensitive
to product defects. Despite testing by the Company and by current and
potential customers, there can be no assurance that errors will not be found in
new products after installation, resulting in loss of revenues or delay in
market acceptance, diversion of development resources, damage to the Company's
reputation, or increased service and warranty costs, any of which may have a
material adverse effect upon the Company's business, operating results and
financial condition.
ITEM 7. FINANCIAL STATEMENTS
The information required by this Item 7 is set forth beginning at page
F-1 of this Report and is incorporated herein by reference.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
The Company's change of accountants for the 1995 fiscal year was
previously reported in the Company's Registration Statement on Form SB-2
(Commission File No. 333-05422C).
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<PAGE> 25
PART III
--------
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
Information regarding the executive officers and directors of the Company
is incorporated herein by reference to the discussions under "Election of
Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the
Company's Proxy Statement for the 1997 Annual Meeting of Shareholders which the
Company plans to file with the commission on or before April 30, 1997 (the
"Company Proxy Statement").
ITEM 10. EXECUTIVE COMPENSATION
Incorporated herein by reference to the discussion under "Executive
Compensation" in the Company Proxy Statement.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated herein by reference to the discussion under "Security
Ownership" in the Company Proxy Statement.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated herein by reference to the discussions under "Executive
Compensation--Employment Agreements" and "Certain Relationships and Related
Transactions" in the Company Proxy Statement.
25
<PAGE> 26
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits:
EXHIBIT NUMBER DOCUMENT DESCRIPTION
- -------------- ------------------------------
3.1 Restated Articles of
Incorporation of the Company
(1)
3.2 Amended and Restated By-Laws
of the Company (1)
4.1 Form of Warrant Agreement
between the Company and
Firstar Trust Company (1)
4.2 Form of Redeemable Warrant (1)
10.1 AT&T Management Company
Commission Agreement, dated
as of December 16, 1995, by
and between the Company and
AT&T Communications, Inc.
("AT&T") (1) (2)
10.2 Amendment No. 1 to AT&T
Management Company Commission
Agreement, dated as of
January 16, 1996, by and
between the Company and AT&T
(1)
10.3 Amendment No. 2 to AT&T
Management Company Commission
Agreement, dated as of
January 16, 1996, by and
between the Company and AT&T
(1) (2)
10.4 Memorandum of Understanding
dated July 5, 1995 regarding
the development of DSP
technology (1)
10.5 Technical Evaluation
Agreement dated July 18, 1996
regarding the development of
DSP technology (1)
10.6 Credit Agreement dated as of
May 31, 1994, by and between
the Company and Berthel
Fisher & Company Leasing,
Inc. (1)
10.7 Letter Agreement dated
September 12, 1995 by and
between the Company and J.C.
Poss & Co., Inc. (1)
10.8 Indemnification Agreement,
dated as of March 3, 1995, by
and between the Company and
Larken, Inc. (1)
26
<PAGE> 27
10.9 Bi-Party Intelli-Max Billing
Agreement, dated as of May 8,
1992, by and between the
Company and Intellicall Inc.
(1)
10.10 Restructuring Agreement,
dated as of December 31,
1994, by and between the
Company and Intellicall, Inc.
(1)
10.11 $1,000,000 Preferred Stock
Subordinated Note from the
Company to Intellicall, Inc.
(1)
10.12 License Agreement dated May
31, 1994 by and between the
Company and Intellicall, Inc.
(1)
10.13 Account Purchase Agreement
dated June 25, 1992, by and
between the Company and OAN
Services, Inc. (1)
10.14 Operator Billing and Related
Services Agreement, dated May
11, 1992, by and between the
Company and OAN Services,
Inc. (1)
10.15 1993 Stock Option Plan (1) (3)
10.16 Unit Purchase Warrant to
purchase 41,667 Units, dated
August 5, 1996, from the
Company to George N. McDonald
(1)
10.17 Promissory Note in the
principal amount of $250,000
dated August 1, 1996, from
the Company to George N.
McDonald (1)
10.18 Letter Agreement, dated
August 5, 1996, by and
between the Company and
George N. McDonald (1)
10.19 Credit Agreement, dated as of
May 31, 1994, by and between
the Company and
Telecommunications Income
Fund X, L.P. (1)
10.20 Credit Agreement, dated as of
May 31, 1994, by and between
the Company and
Telecommunications Income
Fund IX, L.P. (1)
10.21 Lease Agreement for Lease
#076-18000-012, dated as of
February 27, 1996, by and
between the Company and
Berthel Fisher & Company
Leasing, Inc. as agent for
Telecommunications Income
Fund X, L.P. (1)
27
<PAGE> 28
10.22 Lease Agreement for
Lease
#074-18000-016,
dated as of June
14, 1996, by and
between the Company
and Berthel Fisher
& Company Leasing,
Inc. as agent for
Telecommunications
Income Fund IX,
L.P. (1)
10.23 Lease Agreement for
Lease
#076-18000-017,
dated as of July 3,
1996, by and
between the Company
and Berthel Fisher
& Company Leasing,
Inc. as agent for
Telecommunications
Income Fund X, L.P.
(1)
10.24 Modification
Agreement for 21
Leases, dated as of
May 30, 1996, by
and between the
Company and Berthel
Fisher & Company
Leasing, Inc. as
agent for
Telecommunications
Income Fund IX,
L.P. (1)
10.25 Modification
Agreement for Lease
#063-17000-001,
dated as of May 30,
1996, by and
between the Company
and Berthel Fisher
& Company Leasing,
Inc. (1)
10.26 Modification
Agreement for Lease
#076-17000-443,
dated as of May 30,
1996, by and
between the Company
and Berthel Fisher
& Company Leasing,
Inc. as agent for
Telecommunications
Income Fund X, L.P.
(1)
10.27 Modification
Agreement for Lease
#076-17000-943,
dated as of May 30,
1996, by and
between the Company
and Berthel Fisher
& Company Leasing,
Inc. as agent for
Telecommunications
Income Fund X, L.P.
(1)
10.28 Modification
Agreement for Lease
#076-18000-012,
dated as of May 30,
1996, by and
between the Company
and Berthel Fisher
& Company Leasing,
Inc. as agent for
Telecommunications
Income Fund X, L.P.
(1)
10.29 Modification
Agreement for Lease
#076-46698-000,
dated as of May 30,
1996, by and
between the Company
and Berthel Fisher
& Company Leasing,
Inc. as agent for
Telecommunications
Income Fund X, L.P.
(1)
10.30 Equipment Lease
#076-17000-443,
dated as of May 31,
1994, by and
between the Company
and Berthel Fisher
& Company Leasing,
Inc. (1)
28
<PAGE> 29
10.31 Equipment Lease
#076-46698-000,
dated as of January
18, 1995, by and
between the Company
and Berthel Fisher
& Company Leasing,
Inc. as agent for
Telecommunications
Income Fund X, L.P.
(1)
10.32 Equipment
Lease/Purchase
Agreement
#063-18000-000,
dated as of May 30,
1996, by and
between the Company
and Berthel Fisher
& Company Leasing,
Inc. (1)
10.33 Assignment of Lease
of Security
Agreement, dated as
of May 31, 1994,
from Berthel Fisher
& Company Leasing,
Inc. to
Telecommunications
Income Fund X, L.P.
(1)
10.34 Demand Note for
$50,000, dated as
of December 26,
1995, between the
Company and Berthel
Fisher & Company
Leasing, Inc. (1)
10.35 Demand Note for
$200,000, dated as
of January 25,
1996, by and
between the Company
and Berthel Fisher
& Company Leasing,
Inc. (1)
10.36 Demand Note for
$200,000, dated as
of January 31,
1996, by and
between the Company
and Berthel Fisher
& Company Leasing,
Inc. (1)
10.37 Demand Note for
$100,000, dated as
of February 27,
1996, by and
between the Company
and Berthel Fisher
& Company Leasing,
Inc. (1)
10.38 Equipment Lease,
dated as of August
16, 1995, by and
between the Company
and Harvey Leasing.
(1)
10.39 Lease Agreement for
Lease
#074-18000-004,
dated as of
November 30, 1995,
by and between the
Company and Berthel
Fisher & Company
Leasing, Inc. as
agent for
Telecommunications
Income Fund IX,
L.P. (1)
10.40 Lease Agreement for
Lease
#074-18000-005,
dated as of
November 30, 1995,
by and between the
Company and Berthel
Fisher & Company
Leasing, Inc. as
agent for
Telecommunications
Income Fund IX,
L.P. (1)
29
<PAGE> 30
10.41 Lease Agreement for
Lease #074-18000-006,
dated as of November
30, 1996, by and
between the Company
and Berthel Fisher &
Company Leasing, Inc.
as agent for
Telecommunications
Income Fund IX, L.P.
(1)
10.42 Employment Agreement,
dated as of August 16,
1996, by and between
the Company and Guy O.
Murdock. (1) (3)
10.43 Employment Agreement,
dated as of August 16,
1996, by and between
the Company and Colin
P. Halford. (1) (3)
10.44 Employment Agreement,
dated as of August 16,
1996, by and between
the Company and David
F. Schultz. (1) (3)
10.45 Employment Agreement,
dated as of August 16,
1996, by and between
the Company and Bill
R. Wharton. (1) (3)
10.46 Amendment No. 3 to
AT&T Management
Company Commission
Agreement, executed on
December 13, 1996, by
and between AT&T and
the Company
24 Power of Attorney
(included as part of
the signature page
hereof)
27 Financial Data Schedule
(1) Filed as an exhibit to the Company's Registration Statement on Form SB-2
(File No. 333-05422C) and incorporated herein by reference.
(2) Portions of these exhibits were granted confidential treatment by the
Securities and Exchange Commission by order dated October 21, 1996.
(3) Management contract or compensation plan required to be filed as an
exhibit to this annual report on Form 10-KSB.
(b) Reports on Form 8-K.
The Company did not file any reports on Form 8-K for the three months
ended December 31, 1996.
30
<PAGE> 31
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
MURDOCK COMMUNICATIONS CORPORATION
By /s/Guy O. Murdock
____________________________________
Guy O. Murdock
Chief Executive Officer
Date: March 31, 1997
Each person whose signature appears below hereby appoints Guy O. Murdock
and David F. Schultz, and each of them individually, his true and lawful
attorney-in-fact, with power to act with or without the other and with full
power of substitution and resubstitution, in any and all capacities, to sign
any or all amendments to the Form 10-KSB and file the same with all exhibits
thereto, and other documents in connection therewith, with the Securities and
Exchange Commission, granting unto said attorneys-in-fact and agents full power
and authority to do and perform each and every act and thing requisite and
necessary to be done in and about the premises, as fully to all intents and
purposes as he might or could do in person, hereby ratifying and confirming all
that said attorneys-in-fact and agents, or their substitutes, may lawfully
cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated
/s/Guy O. Murdock
______________________
Guy O. Murdock Chairman of the Board March 31, 1997
of Directors and
Chief Executive
Officer (Principal
Executive Officer)
/s/Colin P. Halford
______________________
Colin P. Halford President and Director March 31, 1997
/s/David F. Schultz
______________________
David F. Schultz Chief Financial March 31, 1997
Officer and Secretary
(Principal Financial
Officer and Principal
Accounting Officer)
31
<PAGE> 32
/s/Steven R. Ehlert
____________________
Steven R. Ehlert Director March 31, 1997
32
<PAGE> 33
MURDOCK COMMUNICATIONS CORPORATION
Financial Statements for the
Years Ended December 31, 1996 and 1995 and
Independent Auditors' Report
<PAGE> 34
MURDOCK COMMUNICATIONS CORPORATION
TABLE OF CONTENTS
PAGE
INDEPENDENT AUDITORS' REPORT F-1
FINANCIAL STATEMENTS:
Balance Sheets F-2
Statements of Operations F-3
Statements of Redeemable Securities F-4
Statements of Common Shareholders' Equity (Deficit) F-5
Statements of Cash Flows F-7
Notes to Financial Statements F-10
<PAGE> 35
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Murdock Communications Corporation
Cedar Rapids, Iowa
We have audited the accompanying balance sheets of Murdock Communications
Corporation (the "Company") as of December 31, 1996 and 1995, and the related
statements of operations, redeemable securities, common shareholders' equity
(deficit) and cash flows for the years then ended. 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 audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of Murdock Communications Corporation at
December 31, 1996 and 1995, and the results of its operations and its cash
flows for the years then ended in conformity with generally accepted accounting
principles.
DELOITTE & TOUCHE LLP
Cedar Rapids, Iowa
March 17, 1997
F-1
<PAGE> 36
MURDOCK COMMUNICATIONS CORPORATION
BALANCE SHEETS
DECEMBER 31, 1996 AND 1995
<TABLE>
<CAPTION>
ASSETS (Note 7) 1996 1995
<S> <C> <C>
CURRENT ASSETS:
Cash $1,241,897 $159,007
Accounts receivable, less allowance for doubtful
accounts: 1996 - $30,000, 1995 - $10,000 726,282 547,152
AT&T commission receivable (Note 2) 500,000 750,000
Current portion of lease receivable, net of unearned
portion of $31,062 12,378 -
Inventory 51,091 50,564
Prepaid expenses 167,261 72,634
------------ ------------
Total current assets 2,698,909 1,579,357
------------ ------------
PROPERTY AND EQUIPMENT:
Land and building (Note 7) 432,472 428,667
Telecommunications equipment 7,490,209 1,156,055
Furniture and equipment 242,168 209,157
Vehicles 27,843 28,541
------------ ------------
8,192,692 1,822,420
Accumulated depreciation (6,234,203) (870,382)
------------ ------------
1,958,489 952,038
Telecommunications equipment under capital lease,
net of accumulated amortization: 1996 - $3,324,850,
1995 - $6,344,631 (Note 1) 1,845,437 3,632,109
------------ ------------
Property and equipment, net 3,803,926 4,584,147
------------ ------------
OTHER ASSETS:
Lease receivable, less current portion and net of
unearned portion of $60,688 91,352 -
Deposits 16,509 5,947
Cost of purchased equipment location contracts,
net of accumulated amortization: 1996 - $1,185,682,
1995 - $875,562 626,723 991,443
Technology license from a related party, net of
accumulated amortization: 1996 - $258,333,
1995 - $158,333 241,667 341,667
------------ ------------
Total other assets 976,251 1,339,057
------------ ------------
TOTAL $7,479,086 $7,502,561
============ ============
</TABLE>
<TABLE>
<CAPTION>
LIABILITIES, REDEEMABLE SECURITIES AND 1996 1995
COMMON SHAREHOLDERS' EQUITY (DEFICIT)
<S> <C> <C>
CURRENT LIABILITIES:
Notes payable, including $750,000 to a related party (Note 6) $ - $1,225,000
Accounts payable 530,482 776,937
Accrued expenses, including $58,036 in 1995 to a related party 537,962 629,255
Current portion of capital lease obligations
principally with a related party (Note 15) 895,526 1,352,577
Current portion of long-term debt with related parties (Note 7) 133,541 315,000
Current portion of long-term debt, others (Note 7) 15,217 13,981
---------------- ------------
Total current liabilities 2,112,728 4,312,750
---------------- ------------
LONG-TERM LIABILITIES:
Capital lease obligations principally with a related party,
less current portion (Note 15) 2,608,952 4,129,331
Long-term debt with related parties, less current portion (Note 7) 1,206,117 956,045
Long-term debt, others, less current portion (Note 7) 278,358 293,574
Deferred income (Note 8) 73,875 245,366
Deferred gain related to a related party restructuring (Notes 9, 11 and 13) - 1,799,500
---------------- ------------
Total liabilities 6,280,030 11,736,566
---------------- ------------
COMMITMENTS AND CONTINGENCIES (Notes 2 and 15)
REDEEMABLE SECURITIES:
10% Series A Redeemable Preferred Stock, no par
or stated value (Notes 9 and 11):
Authorized-45,000 shares
Issued and outstanding: 1996 - 200; 1995 - 22,650 24,480 2,000,940
Common stock put warrants (Note 11) - 227,143 warrants in 1995
held by a related party - 161,766
---------------- ------------
Total redeemable securities 24,480 2,162,706
---------------- ------------
COMMON SHAREHOLDERS' EQUITY (DEFICIT):
Common stock, no par or stated value (Notes 10 and 12):
Authorized - 7,500,000 shares
Issued and outstanding: 1996 - 4,152,494 shares; 1995 - 1,168,986 shares 10,820,898 193,588
Common stock warrants (Note 11):
Authorized-1996 - 920,000 detachable warrants
Issued and outstanding: 1996 - 883,089; 1995 - 349,843 13,336 559,008
Additional paid-in capital (Note 19) 224,000 124,000
Accumulated deficit (9,883,658) (7,273,307)
---------------- ------------
Total common shareholders' equty (deficit) 1,174,576 (6,396,711)
---------------- ------------
TOTAL $7,479,086 $7,502,561
================ ============
see notes to financial statements
</TABLE>
F-2
<PAGE> 37
MURDOCK COMMUNICATIONS CORPORATION
<TABLE>
<CAPTION>
STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1996 AND 1995
1996 1995
<S> <C> <C>
REVENUES:
Call processing revenues (Notes 2 and 16) $6,248,317 $6,908,597
AT&T commissions (Note 2) 1,000,000 1,250,000
Sales of equipment inventory (Note 15) 483,937 399,930
Recognition of gains deferred from equipment sales
with a related party (Notes 8 and 15) 236,266 293,898
Other income 196,082 64,138
-------------------- -----------------
Total revenues 8,164,602 8,916,563
-------------------- -----------------
COST OF SALES:
Call processing (Note 16) 4,813,177 4,817,205
Equipment inventory 426,215 276,431
-------------------- -----------------
Total cost of sales 5,239,392 5,093,636
-------------------- -----------------
GROSS OPERATING PROFIT 2,925,210 3,822,927
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES (Note 16) 2,756,586 2,302,045
DEPRECIATION AND AMORTIZATION EXPENSE 2,284,258 2,738,079
-------------------- -----------------
OPERATING LOSS (2,115,634) (1,217,197)
-------------------- -----------------
INTEREST EXPENSE:
Interest on capital leases, principally to a related party
(Notes 15 and 16) 1,014,020 916,890
Other interest expense (Note 16) 434,187 371,120
-------------------- -----------------
Total interest expense 1,448,207 1,288,010
-------------------- -----------------
LOSS BEFORE INCOME TAXES AND EXTRAORDINARY ITEM (3,563,841) (2,505,207)
INCOME TAXES (Note 14) 8,112 19,200
-------------------- -----------------
LOSS BEFORE EXTRAORDINARY ITEM (3,571,953) (2,524,407)
EXTRAORDINARY ITEM - GAIN ON RELATED PARTY
RESTRUCTURING (Note 13) 1,084,314 -
-------------------- -----------------
NET LOSS $(2,487,639) $(2,524,407)
==================== =================
PRO FORMA NET LOSS (Unaudited - Note 1) $(2,457,016)
====================
PRO FORMA NET LOSS PER COMMON SHARE (Unaudited - Note 1):
Loss before extraordinary item $ (1.41)
Extraordinary item 0.43
--------------------
Net loss $(0.98)
====================
PRO FORMA WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING (Unaudited - Note 1) 2,508,329
====================
See notes to financial statements.
</TABLE>
F-3
<PAGE> 38
MURDOCK COMMUNICATIONS CORPORATION
<TABLE>
<CAPTION>
STATEMENTS OF REDEEMABLE SECURITIES
YEARS ENDED DECEMBER 31, 1996 AND 1995
COMMON
10% SERIES A STOCK
REDEEMABLE PUT REDEEMABLE
PREFERRED STOCK WARRANTS SECURITIES
<S> <C> <C> <C>
BALANCES AT DECEMBER 31, 1994 $1,907,785 $161,766 $2,069,551
Repurchase of 900 shares of 10%
Series A Redeemable Preferred
Stock (Note 9) (64,080) - (64,080)
Accretion of put price on 10%
Series A Redeemable Preferred Stock 157,235 - 157,235
Accrued dividends on 10% Series A
Redeemable Preferred Stock 231,030 - 231,030
Dividends declared on 10% Series A Redeemable
Preferred Stock (231,030) - (231,030)
----------------- ----------- ---------------
BALANCES AT DECEMBER 31, 1995 2,000,940 161,766 2,162,706
Accretion of put price on 10%
Series A Redeemable Preferred Stock 131,029 - 131,029
Accrued dividends on 10% Series A
Redeemable Preferred Stock 192,865 - 192,865
Exercise of 227,143 common stock put warrants
held by a related party (Note 11) - (161,766) (161,766)
Conversion of 22,450 shares of 10% Series A
Redeemable Preferred Stock into 821,221
shares of common stock (Note 9) (2,300,354) - (2,300,354)
----------------- ----------- ---------------
BALANCES AT DECEMBER 31, 1996 $24,480 $ - $24,480
================= =========== ===============
See notes to financial statements.
</TABLE>
F-4
<PAGE> 39
MURDOCK COMMUNICATIONS CORPORATION
<TABLE>
<CAPTION>
STATEMENTS OF COMMON SHAREHOLDERS' EQUITY (DEFICIT)
YEARS ENDED DECEMBER 31, 1996 AND 1995
COMMON STOCK COMMON
COMMON STOCK WARRANTS SHARE-
NUMBER NUMBER ADDITIONAL HOLDERS'
OF OF PAID-IN ACCUMULATED EQUITY
SHARES ISSUED WARRANTS ISSUED CAPITAL DEFICIT (DEFICIT)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCES AT DECEMBER 31, 1994 1,168,986 $193,588 363,745 $581,220 $124,000 $(4,355,127) $(3,456,319)
Repurchase of common
stock warrants - - (13,902) (22,212) - (5,508) (27,720)
Accretion of put price on 10%
Series A Redeemable
Preferred Stock - - - - - (157,235) (157,235)
Accrued dividends on 10%
Series A Redeemable
Preferred Stock (Note 9) - - - - - (231,030) (231,030)
Net loss for 1995 - - - - - (2,524,407) (2,524,407)
----------- ------------- ---------- ----------- ----------- ---------------- --------------
BALANCES AT DECEMBER 31, 1995 1,168,986 193,588 349,843 559,008 124,000 (7,273,307) (6,396,711)
----------- ------------- ---------- ----------- ----------- ---------------- --------------
(Continued)
</TABLE>
F-5
<PAGE> 40
MURDOCK COMMUNICATIONS CORPORATION
<TABLE>
<CAPTION>
STATEMENTS OF COMMON SHAREHOLDERS' EQUITY (DEFICIT)
YEARS ENDED DECEMBER 31, 1996 AND 1995 (CONCLUDED)
COMMON STOCK COMMON
COMMON STOCK WARRANTS SHARE-
NUMBER NUMBER ADDITIONAL HOLDERS'
OF OF PAID-IN ACCUMULATED EQUITY
SHARES ISSUED WARRANTS ISSUED CAPITAL DEFICIT (DEFICIT)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCES AT DECEMBER 31, 1995 1,168,986 193,588 349,843 559,008 124,000 (7,273,307) (6,396,711)
Issuance of common stock, net of
offering costs of $1,481,629
(Note 10) 1,600,000 6,518,371 800,000 8,000 - - 6,526,371
Consideration attributable to equity
conversion terms of first tranche
of bridge financing notes payable
(Note 10) - - - - 80,000 - 80,000
Conversion of first tranche of
bridge financing notes payable
into common stock and warrants (Note 10) 160,000 479,600 80,000 400 (80,000) - 400,000
Conversion of shareholder notes
payable into common stock
(Notes 7 and 10) 175,144 613,000 - - - - 613,000
Conversion of 10% Series A Redeemable
Preferred Stock and associated
common stock warrants into
common stock (Notes 9 and 10) 821,221 2,854,426 (346,754) (554,072) - - 2,300,354
Exercise of common stock put warrants
held by a related party (Note 11) 227,143 161,913 - - - - 161,913
Issuance of warrant to consultant
(Note 19) - - - - 100,000 - 100,000
Accretion of put price on 10%
Series A Redeemable Preferred Stock - - - - - (131,029) (131,029)
Accrued dividends on 10% Series A
Redeemable Preferred Stock - - - - - (192,865) (192,865)
Gain on related party restructuring
(Note 11) - - - - - 201,182 201,182
Net loss for 1996 - - - - - (2,487,639) (2,487,639)
------------ ------------ --------- ------------ ----------- ------------ -----------
BALANCES AT DECEMBER 31, 1996 4,152,494 $10,820,898 883,089 $13,336 $224,000 $ (9,883,658) $1,174,576
============ ============ ========= ============ =========== ============ ===========
</TABLE>
See notes to financial statements.
F-6
<PAGE> 41
MURDOCK COMMUNICATIONS CORPORATION
<TABLE>
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996 AND 1995
1996 1995
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(2,487,639) $(2,524,407)
Extraordinary gain on related party restructuring (1,084,314) -
Adjustments to reconcile net loss to net
cash flows from operating activities:
Depreciation and amortization, including amortization of technology license 2,384,258 2,838,079
Noncash interest expense 188,717 178,319
Recognition of deferred gains from equipment sales with a related party (236,266) (293,898)
Changes in operating assets and liabilities, excluding the
effects of an acquisition:
Receivables 70,870 1,466,291
Inventory (527) 13,929
Prepaid expenses 5,373 (11,451)
Accounts payable (144,458) 169,762
Accrued expenses (68,249) (328,121)
Deferred income 64,775 (55,139)
-------------- ---------------
Net cash flows from operating activities (1,307,460) 1,453,364
-------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (1,213,470) (258,499)
Purchase of equipment for lease receivable (108,614) -
Payments on lease receivable 4,884 -
Payments for equipment location contracts (419,403) -
Proceeds from sales of property and equipment - 4,773
Payments for deposits (10,562) (1,684)
Cash acquired with acquisition - 2,334
-------------- ---------------
Net cash flows from investing activities (1,747,165) (253,076)
-------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on capital lease obligations, primarily to a related party (2,425,514) (1,080,635)
Proceeds from capital lease obligations 389,941 311,585
Borrowings on notes payable, including $100,000
in 1996 with a related party 1,890,000 1,225,000
Borrowings of long-term debt with related parties 122,698 -
Payments on notes payable (1,965,000) -
Payments on long-term debt with related parties (285,000) (1,419,194)
Payments on long-term debt, others (13,981) (12,845)
Dividends paid on 10% Series A Redeemable Preferred Stock (102,000) (129,030)
Repurchase of 10% Series A Redeemable Preferred Stock
and common stock warrants - (91,800)
Proceeds from issuance of common stock and warrants 8,008,000 -
Payments of offering costs (1,481,629) -
-------------- ---------------
Net cash flows from financing activities 4,137,515 (1,196,919)
-------------- ---------------
NET INCREASE IN CASH 1,082,890 3,369
CASH AT BEGINNING OF YEAR 159,007 155,638
-------------- ---------------
CASH AT END OF YEAR $1,241,897 $159,007
============== ===============
SUPPLEMENTAL DISCLOSURE:
Cash paid during the year for interest, principally to a related party $1,355,184 $1,718,283
Cash paid during the year for income taxes 8,355 7,227
See notes to financial statements.
</TABLE>
F-7
<PAGE> 42
MURDOCK COMMUNICATIONS CORPORATION
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996 AND 1995 (CONTINUED)
SUPPLEMENTAL DISCLOSURES OF 1996 NONCASH INVESTING AND FINANCING ACTIVITIES:
During 1996, in conjunction with an initial public offering of the Company's
common stock, the Company converted $400,000 of bridge financing notes payable
into 160,000 shares of common stock and 80,000 warrants; $613,000 of
shareholder notes payable were converted into 175,144 shares of common stock;
and 22,450 shares of 10% Series A Redeemable Preferred Stock with a carrying
amount of $2,300,354 were converted into 821,221 shares of common stock.
During 1996, the Company repaid the amounts due on the note payable to
Intellicall and recognized the $1,799,500 deferred gain as discussed in Notes
9, 11 and 13. Related decreases are as follows:
<TABLE>
<S> <C>
Cost of purchased equipment location contracts $ 514,004
Accumulated deficit 201,182
Extraordinary item - gain on related party restructuring 1,084,314
--------------
Deferred gain $1,799,500
==============
</TABLE>
The Company accreted the 10% Series A Redeemable Preferred Stock by $131,029
during 1996.
The Company accrued dividends on the 10% Series A Redeemable Preferred Stock of
$192,865 during 1996.
During 1996, 227,143 shares of common stock put warrants with a carrying amount
of $161,766 were exercised for $147 and converted into common stock.
During 1996, accrued interest of $23,044 was added to the principal balance of
long-term debt with related parties.
During 1996, $750,000 of notes payable were renegotiated as long-term debt with
related parties.
During 1996, a common stock warrant valued at $100,000 was granted for a
prepaid consulting agreement.
See notes to financial statements.
F-8
<PAGE> 43
MURDOCK COMMUNICATIONS CORPORATION
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996 AND 1995 (CONCLUDED)
SUPPLEMENTAL DISCLOSURES OF 1995 NONCASH INVESTING AND FINANCING ACTIVITIES:
During September 1995, the Company purchased from a related party (Note 3)
Hotelco Telecommunications Technology Texas, L.P., a partnership to which the
Company had provided certain management services during the first nine months
of 1995. The changes resulting from the purchase are summarized as follows:
<TABLE>
<S> <C>
Accounts receivable $ 26,530
Telecommunications equipment under capital lease 906,066
Equipment location contracts 344,838
Accounts payable (233,275)
Accrued expenses (43,150)
Capital lease obligations with Berthel Fisher & Company, Inc. (906,066)
Long-term debt, net of related discount (97,277)
------------
Cash acquired with acquisition ($2,334)
============
</TABLE>
The Company accreted the 10% Series A Redeemable Preferred Stock by $157,235
during 1995.
The Company accrued dividends on the 10% Series A Redeemable Preferred Stock of
$231,030 for 1995.
See notes to financial statements.
F-9
<PAGE> 44
MURDOCK COMMUNICATIONS CORPORATION
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996 AND 1995
1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS - Murdock Communications Corporation (the "Company")
is engaged in the business of providing long-distance telecommunications
services to patrons of hotels with which the Company has contracts to
provide such services. Services include, but are not limited to, credit
card billing services, live operator services, automated collection and
messaging delivery services, voice mail services and telecommunications
consulting. At December 31, 1996, the Company maintains equipment location
contracts with approximately 480 hotels (420 hotels at December 31, 1995)
throughout the United States.
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
significantly from those estimated. Material estimates that are
particularly susceptible to significant change in the near-term relate to
the determination of the collectibility of receivables, useful lives of
property and equipment and impairment of long-lived assets.
Telecommunications equipment under capital lease with a net book value of
approximately $280,000 and $420,000 at December 31, 1996 and 1995,
respectively, has not been placed in revenue generating locations.
Management has developed a plan to place all of this idle equipment into
service within the next year, and believes that the remaining net book value
of the idle equipment will be recovered. However, the Company has continued
to depreciate the idle equipment in recognition of the equipment's declining
economic utility.
CERTAIN RISK CONCENTRATIONS - The Company derived 63% and 42% of its
revenues from AT&T in 1996 and 1995, respectively. At December 31, 1996 and
1995, 68% and 79%, respectively, of the Company's receivables were due from
AT&T. Also, substantially all of the Company's leasing arrangements are
with Berthel Fisher & Company, Inc. and subsidiaries and their affiliated
leasing partnerships ("Berthel"). Berthel owned 9.5% and 8.5% of the
Company's outstanding common stock at December 31, 1996 and 1995,
respectively.
REVENUE RECOGNITION - After a hotel location agreement is signed, the
Company installs equipment at the hotel site to provide the services called
for under the hotel location agreement. The Company generally purchases the
equipment from the manufacturer, Intellicall, Inc. ("Intellicall"), and
incurs certain expenses in installing the equipment at the hotel. The
Company then generally sells the equipment to Berthel at cost (including
installation costs) plus a margin for profit and enters into a leaseback
transaction with Berthel. Any profit on the sale under these transactions
is deferred and amortized to income over the amortization period of the
related leased equipment (generally five years) using the straight-line
method.
A portion of the Company's revenues are derived from processing credit card
long-distance telephone calls made by the patrons of the hotels under the
Company's contracts with the hotel. The gross charges for these calls are
recognized as revenues by the Company as the calls are placed. At the same
time, amounts are recorded as cost of services for long distance charges
from the carrier of the calls, as well as charges for processing the calls,
bad debts and commissions to be paid to the individual hotels based on the
Company's prior experience for these items.
F-10
<PAGE> 45
Revenues derived from the AT&T commission agreement related to calls are
recognized as revenues as the calls are placed. Additional bonuses,
primarily for reaching the number of contracted rooms specified in the
agreement, are recognized when the specified criteria has been met.
INVENTORY - Inventory is carried at the lower of cost or market with cost
determined using the first-in, first-out ("FIFO") method and consists of
telecommunication hardware and software awaiting installation at hotel
sites.
PROPERTY AND EQUIPMENT - Property and equipment are stated at cost. For
financial reporting purposes, depreciation and amortization are computed on
these assets by the straight-line method over their estimated useful lives
ranging from three to 28 years. For income tax purposes, accelerated
methods are used. Amortization of telecommunications equipment under
capital lease is included with depreciation expense.
The Company accounts for its telecommunications equipment leases as capital
leases under the provisions of Statement of Financial Accounting Standards
("SFAS") No. 13. Accordingly, the cost of the leased assets and the related
obligations under the lease agreements are recorded at the inception of the
lease. The leases are generally for four to seven years.
The Company periodically reviews long-lived assets and certain identifiable
intangibles held and used by the Company for impairment whenever events or
changes in circumstances indicate that the carrying amount of these assets
may not be recoverable. During 1995, the Company recorded an impairment
write-down with respect to idle telecommunications equipment under capital
lease of $400,000 based on the estimated discounted future cash flows
expected to be generated by such idle equipment. The write-down was
included with depreciation and amortization in the 1995 Statement of
Operations.
COST OF PURCHASED EQUIPMENT LOCATION CONTRACTS - The cost of obtaining
equipment location contracts is amortized over the term of the related
contracts, generally five years, using the straight-line method.
TECHNOLOGY LICENSE - The technology license is stated at cost and is being
amortized over the technology's estimated useful life of five years using
the straight-line method.
INCOME TAXES - Deferred income taxes are provided for the tax consequences
in future years of temporary differences between the tax basis of assets and
liabilities and their financial reporting amounts, based on enacted tax laws
and tax rates applicable to the periods in which the differences are
expected to affect taxable income. Valuation allowances are established
when necessary to reduce deferred tax assets to the amounts expected to be
realized. Income tax expense is the tax payable for the period and the
change during the period in deferred tax assets and liabilities.
ACCRETION ON 10% SERIES A REDEEMABLE PREFERRED STOCK - Up to the date of the
put, the Company will accrete the carrying value of the 10% Series A
Redeemable Preferred Stock (net of offering costs incurred) to the put price
by the effective interest method.
CUMULATIVE DIVIDENDS ON 10% SERIES A REDEEMABLE PREFERRED STOCK - Cumulative
dividends on the 10% Series A Redeemable Preferred Stock are deducted from
accumulated deficit as the dividends are earned by the holders and the
carrying value of the 10% Series A Redeemable Preferred Stock is increased
until the dividends are declared by the Company. Dividends declared are
reported as a payable.
F-11
<PAGE> 46
IMPACT OF NEW ACCOUNTING PRONOUNCEMENT - During 1996 the Company adopted
SFAS No. 123, "Accounting for Stock-Based Compensation." This standard
defines a fair value based method of accounting for employee stock options
or similar equity instruments. This statement gives entities a choice of
recognizing employee stock-based compensation expense by adopting the new
fair value method or to continue to measure compensation using the intrinsic
value approach under Accounting Principles Board ("APB") Opinion No. 25, the
former standard. If the former standard for measurement is elected, SFAS
No. 123 requires supplemental disclosure to show the effects of using the
new measurement criteria. The Company has elected to continue using the
measurement criteria prescribed by APB Opinion No. 25. This pronouncement
did not materially affect the Company's financial position, results of
operations or cash flows and the supplemental disclosures required by SFAS
No. 123 have been omitted because the impact is immaterial.
PRO FORMA PER SHARE INFORMATION (UNAUDITED) - Due to the conversion of the
10% Series A Redeemable Preferred Stock and related common stock warrants
and of certain shareholder notes upon the closing of the Company's initial
public offering of its common stock during 1996, as discussed in Note 10,
historical per share information is not considered relevant and pro forma
per share information has been presented in accordance with Securities and
Exchange Commission requirements. The Company's pro forma net loss per
common share is based upon the weighted average number of common shares
outstanding during 1996 and the shares issued upon conversion of the 10%
Series A Redeemable Preferred Stock and related common stock warrants and of
certain shareholder notes. Equivalent shares in the form of stock options,
unit options and other warrants are excluded from the calculation since they
are antidilutive.
The pro forma per share information presented for the year ended December
31,1996 is based upon the following:
<TABLE>
<S> <C>
Historical net loss $ (2,487,639)
Interest on certain shareholder notes 30,623
--------------
Pro forma net loss $(2,457,016)
==============
Weighted average common shares outstanding 1,511,964
Common shares issued upon conversion of:
Preferred stock and related common stock warrants 821,221
Certain shareholder notes 175,144
--------------
Pro forma weighted average common shares outstanding 2,508,329
==============
</TABLE>
PRO FORMA SUPPLEMENTAL PER SHARE INFORMATION (UNAUDITED) - Proceeds from the
issuance of 914,924 shares of common stock, net of offering costs, were used
to retire debt of $3,727,382 during 1996. Pro forma supplemental loss per
common share for the year ended December 31, 1996 was ($0.58). Such pro
forma supplemental per share amount assumes the debt was retired at the
beginning of the year or from date of issuance if later, resulting in
interest savings of $462,000 and the weighted average common shares
outstanding used in the pro forma loss per share computation discussed above
plus the 914,924 incremental shares.
F-12
<PAGE> 47
2. AT&T COMMISSION AGREEMENT
On October 10, 1994, the Company entered into an agreement (the "Old
Agreement") with AT&T to provide long-distance service from AT&T to certain
equipment locations under contract with the Company for a term of three
years. The Company could receive commissions of up to $3,550,000 based on
the number of rooms for which services are provided and for any new rooms on
contract to AT&T by the Company. During 1995, the Old Agreement was amended
to provide for additional annual retention bonuses of up to $1,850,000 based
on the total number of rooms under contract to AT&T on the second and third
anniversary dates of the Old Agreement.
During 1995, a new agreement was executed with an effective date of December
16, 1995 (the "New Agreement"). By executing the New Agreement, the Company
received a signing bonus of $750,000. Under the New Agreement, the Company
will receive commissions based on the number of calls made, management fees
based on 10% of the commissions earned, compliance incentive bonuses
determined quarterly and paid monthly based on the number of calls processed
each month and various additional bonuses, including a $1 million bonus to
be paid in four quarterly installments for contracting 100,000 rooms under
the New Agreement by July 1, 1996. Prior to July 1, 1996, the Company had
reached the 100,000 room threshold and recognized the $1 million bonus.
During 1996, an amended agreement was executed (the "Amended Agreement")
which accelerated the payment dates of the final two quarterly installments
to February 28, 1997 and May 1, 1997. Under the Amended Agreement, if the
Company falls below 100,000 rooms after February 28, 1997 and prior to May
1, 1998, the Company will be required to reimburse $250,000 to AT&T.
The New Agreement, as amended, includes provisions for the refund of
$1,000,000 in bonuses paid to the Company by AT&T should the Company
terminate the agreement or fail to comply with the agreement. AT&T has
reserved a number of grounds to terminate the New Agreement, as amended,
prior to its expiration, primarily related to certain compliance and quality
standards. AT&T is responsible for determining if the Company is in
compliance with the standards as set forth in the New Agreement, as amended,
including achieving a 94% compliance rate with respect to AT&T dialing
standards. The Company has achieved a compliance rate above 94% and
therefore has not forfeited any compliance bonuses received during 1996.
Management is not aware of any noncompliance nor has the Company been
notified of any noncompliance with the New Agreement, as amended, and has no
present intentions to terminate the New Agreement, as amended.
3. ACQUISITION OF HOTELCO TELECOMMUNICATIONS TECHNOLOGY TEXAS, L.P.
On January 15, 1995, the Company entered into an agreement with Hotelco
Telecommunications Technology Texas, L.P. ("Hotelco"), an entity owned by a
member of the Company's Board of Directors. Under this agreement, the
Company provides management services for Hotelco in return for fees based on
a percentage of billable call records processed. The Company received call
processing revenues of $92,090, commissions from AT&T of $117,514, and
management fees of $39,219 for the period from January 15, 1995 to September
1, 1995.
Effective September 1, 1995, the Company purchased 100% of the limited and
general partnership interests of Hotelco. In consideration of the interests
purchased, the Company assumed various liabilities of the entity totaling
$1,182,491 and issued a noninterest bearing uncollateralized note payable
(net of the related discount of $22,722) valued at $97,277, for a total
purchase price of $1,279,768. The combination was recorded under the
purchase method for financial reporting purposes. In addition to acquiring
the partnership interests of the entity, the Company also obtained certain
call processing equipment and call processing contracts; as well as any
related dealer and license agreements.
F-13
<PAGE> 48
Pro forma results of operations for the acquisition for the year ended
December 31, 1995 is as follows:
<TABLE>
<S> <C>
Total revenues $9,932,760
Cost of sales 5,732,513
--------------
Gross operating profit 4,200,247
Selling, general and administrative expense 2,364,209
Depreciation and amortization expense 2,921,412
--------------
Operating loss (1,085,374)
Interest expense 1,397,544
--------------
Loss before income taxes (2,482,918)
Income taxes 26,778
--------------
Net loss $(2,509,696)
==============
</TABLE>
4. PURCHASE OF ASSETS OF POWERTEL OF DELAWARE, INC.
On August 26, 1996, the Company purchased approximately 130,000 telephones,
related rights and interests, and various assets, such as computers and
office furniture, from PowerTel of Delaware, Inc. ("PowerTel") for a cash
price of $250,000. The Company assumed no liabilities of PowerTel as a
result of this purchase.
5. PURCHASE OF ASSETS OF INTERACTIVE COMMUNICATIONS, INC.
On December 13, 1996, the Company purchased all rights and interests in
interactive voice response hardware ("IVR Hardware") from Interactive
Communications, Inc. ("ICI") for a cash price of $361,600. The Company
assumed no liabilities of ICI as a result of this purchase, except that the
Company reimbursed ICI for all telephone and leasing costs incurred by ICI
prior to the date the IVR Hardware was assumed by the Company, which totaled
$64,545. Also, pursuant to this agreement, the Company entered into an
Audiotext Services Agreement with ICI covering thirty-eight IVR Hardware
platforms. This agreement is effective from January 1, 1997 until January
1, 2000, with an option to renew for successive periods of twelve months.
Under the terms of the agreement, ICI will provide information updating
services for each IVR Hardware platform in exchange for a $1,000 per
platform monthly licensing fee to be paid by the Company. In addition, the
Company will pay a monthly fee to ICI in the amount of 5% of the gross
monthly revenues generated by the business activities supported by the IVR
Hardware platforms after the Company has received gross revenues of
$6,000,000.
F-14
<PAGE> 49
6. NOTES PAYABLE
Notes payable at December 31, 1995, consisted of the following:
<TABLE>
<S> <C>
$250,000 variable line-of-credit with a financial institution through
December 1, 1996, with interest on borrowings payable monthly
at 2% above the financial institution's prime rate (combined rate of
10.5% at December 31, 1995), collateralized by substantially all
assets of the Company not otherwise encumbered and personally
guaranteed by the Company's majority shareholder. The note and
related accrued interest were subsequently repaid on October 25, 1996. $ 250,000
Note payable to financial institution bearing interest at 12%, due
December 31, 1995, collateralized by substantially all assets of the
Company not otherwise encumbered and personally guaranteed by
the Company's majority shareholder. The note and related accrued
interest were subsequently repaid on January 2, 1996. 225,000
Demand note payable to Berthel, bearing interest at 2% over
prime (combined rate of 10.5% at December 31, 1995), collateralized
by $1,750,000 of bonus payments to be received under the AT&T
Commission Agreement as discussed in Note 2, and personally guaranteed
by the Company's majority shareholder. The note was subsequently
converted to long-term debt during 1996 (see Note 7). 700,000
Demand note payable to Berthel, bearing interest at 2% over prime
(combined rate of 10.5% at December 31, 1995), collateralized by
$1,750,000 of bonus payments to be received under the AT&T Commission
Agreement as discussed in Note 2, and personally guaranteed by the
Company's majority shareholder. The note was subsequently
converted to long-term debt during 1996 (see Note 7). 50,000
-------------
Total $1,225,000
=============
</TABLE>
On December 1, 1996, the $250,000 variable line-of-credit with a financial
institution was extended to December 1, 1997. No amounts were outstanding
under the line-of-credit at December 31, 1996.
Also see Note 18 with respect to the estimated fair value of notes payable.
7. LONG-TERM DEBT
Long-term debt, others as of December 31, 1996 and 1995 consisted of the
following:
<TABLE>
<S> <C> <C>
1996 1995
Mortgage note payable to partnership due in monthly
installments of $3,299, including interest at 8.5%,
until September 15, 2000, when the balance is due.
The note is collateralized by a first mortgage on the
Company's office facilities and land. $293,574 $307,555
Less current portion 15,217 13,981
---------- ----------
Long-term debt, others $278,358 $293,574
========== ==========
</TABLE>
F-15
<PAGE> 50
Long-term debt with related parties at December 31, 1996 and 1995
consisted of the following:
<TABLE>
<S> <C> <C>
1996 1995
Uncollateralized note payable to the Company's majority shareholder
due August 3, 1997 and subordinate to the notes payable to Berthel
in Note 6. Interest is due monthly and is calculated at 2%
over the prime rate (combined rate of 10.5% at December 31,
1995). The note and related accrued interest were converted
into common stock in conjunction with the Company's initial
public offering of its common stock, effective October 21,
1996 (see Note 10). $52,532
Uncollateralized notes payable to minority shareholders due in
monthly installments of $79,996 until March of 1994, $2,754
from April to December of 1994 and as cash flows permit until
August 3, 1997 when the balance is due, including interest at 7%.
The notes and related accrued interest were converted into
common stock in conjunction with the Company's initial public
offering of its common stock, effective October 21, 1996
(see Note 10). 320,643
Uncollateralized noninterest-bearing note payable to Intellicall
resulting from the December 31, 1994 debt restructuring,
(net of discount of $5,114 at December 31, 1995) due April
15, 1996 (effective rate of 11.5%). Payments include
$800,000 made in January 1995 and quarterly payments
thereafter of $125,000 beginning April 15, 1995. 244,886
Uncollateralized note payable to Intellicall resulting from the
December 31, 1994 restructuring of the 10% Series A
Redeemable Preferred Stock, due January 31, 2005, (net of
discount of $410,342 and $439,294 at December 31, 1996
and 1995, respectively). Interest payable quarterly at 4%,
beginning March 31, 1995 until maturity, when the balance
is due (effective rate of 11.5%) (see Note 9). The note was
purchased by Berthel from Intellicall during 1996. $589,658 560,706
Uncollateralized noninterest-bearing note payable to related
party, due in monthly installments of $5,000 until October 31,
1997, net of discount of $22,722 at December 31, 1995
(effective rate of 18%). $80,000 of the note was converted
to common stock in conjunction with the Company's initial
public offering of its common stock, effective October 21,
1996 (see Note 10). The remaining balance of $12,278 was
repaid during 1996. 92,278
Note payable to Berthel, due in monthly installments of $21,064
including interest at 15.5%, until January 31, 2001, collateralized
by property and equipment with a net carrying value of $85,000 at
December 31, 1996, all subsequent additions affixed to the
equipment, all revenues derived from the equipment, and
assignment of all of the Company's rights in the equipment.
750,000
------------- -------------
Total 1,339,658 1,271,045
Less current portion 133,541 315,000
------------- -------------
Long-term debt with related parties $1,206,117 $956,045
============= =============
</TABLE>
F-16
<PAGE> 51
Maturities of long-term debt for each of the five years subsequent to
December 31, 1996 are as follows:
<TABLE>
<S> <C>
1997 $148,758
1998 185,437
1999 215,019
2000 473,565
2001 20,795
Thereafter 1,000,000
-------------
2,043,574
Less unamortized discounts (410,342)
-------------
$1,633,232
=============
</TABLE>
Also see Note 18 with respect to the estimated fair value of long-term debt.
8. DEFERRED INCOME
As described in Note 1, the Company enters into sale and leaseback
arrangements with Berthel for much of the Company's telecommunications
equipment used in call processing. During the years ended December 31, 1996
and 1995, the Company had equipment sales of $389,941 and $311,309, with
related cost of sales of $327,331 and $159,169, respectively, under such
arrangements with Berthel. The Company deferred gains under these
arrangements of $62,610 and $152,140 during the years ended December 31,
1996 and 1995, respectively. Deferred income recognized for the years ended
December 31, 1996 and 1995 was $236,266 and $293,898, respectively.
9. 10% SERIES A REDEEMABLE PREFERRED STOCK
The 10% Series A Redeemable Preferred Stock (the "Preferred Stock") includes
a detachable common stock warrant (see Note 11), pays a 10% cumulative,
preferred dividend and includes certain liquidation preferences. The
Company can redeem the Preferred Stock at any time at its option. The
stated redemption price is 110% for the first year after issuance in 1993
and decreases by 2% until six years after issuance, when the Preferred Stock
can be redeemed at its original issue price of $102. The Preferred Stock
can also be put back to the Company, at the holders' option, during 1998 at
the original purchase price plus any accumulated and unpaid dividends. Upon
exercise of the put, the Company has 90 days to make a cash payment equal to
10% of the total repurchase price and deliver a 10% uncollateralized note
payable due in equal monthly installments over three years for the balance.
Dividends of $4,080 and $333,030 were in arrears on the Preferred Stock at
December 31, 1996 and 1995, respectively. On April 25, 1995, the Company
declared dividends of $231,030 and paid cash dividends of $129,030 during
1995 and $102,000 during 1996 on the Preferred Stock to shareholders of
record as of April 25, 1995 for dividends accumulated through December 31,
1994.
Effective October 21, 1996, the holders of 22,450 shares of the Company's
Preferred Stock and associated common stock warrants, with a net carrying
value of $2,300,354 (including $419,815 of dividends in arrears at October
21, 1996), agreed to convert their Preferred Stock into 821,221 shares of
the Company's common stock, in conjunction with the Company's initial public
offering, as discussed in Note 10.
Concurrent with the restructuring of debt with Intellicall, as discussed in
Note 13, the Company repurchased 14,706 shares of Preferred Stock held by
Intellicall with a carrying value of $1,049,004 in exchange for an
uncollateralized note payable with a face amount of $1 million and an
estimated fair value of $535,000. The estimated fair value was determined
based on the discounted future cash flows using the Company's incremental
borrowing rate. The Company deferred the gain of $514,000 as a result
of the forgiveness, as also discussed in Note 13. On June 29, 1996,
the Company paid all amounts due as
F-17
<PAGE> 52
provided in the restructuring agreement and realized the $514,000 gain which
was recorded as a reduction of the original purchase price of the equipment
location contracts purchased from Intellicall.
During 1995, the Company repurchased 900 shares of the Preferred Stock and
related common stock warrants with a net carrying value of $86,292 for
$91,800. The $5,508 excess of the purchase price paid over the carrying
value of the Preferred Stock and common stock warrants was recorded as a
charge to accumulated deficit for the year ended December 31, 1995.
10. COMMON STOCK
On July 29, 1996, the shareholders approved a 15.4456 for one common stock
split to shareholders of record on July 19, 1996 and amended the Company's
articles of incorporation to increase authorized common stock to 7,500,000
shares. Retroactive restatement has been made in the financial statements
to all share and per share data.
Effective October 21, 1996, the Company completed an initial public offering
of the Company's common stock (the "Shares") and common stock purchase
warrants (the "Warrants"). The offering consisted of 800,000 units
comprised of two shares of common stock and one warrant to purchase common
stock (the "Units"). The Company sold 800,000 Units at $10.01, which
resulted in gross proceeds of $8,008,000. The Company paid underwriting
commissions of $800,800, underwriting fees of $240,240 and accounting, legal
and other expenses of $440,589. The total expenses of $1,481,629 incurred
in connection with the initial public offering have been netted against the
proceeds.
In conjunction with the initial public offering, the Company converted
$598,918 of shareholders' notes payable as discussed in Note 7 plus accrued
interest of $14,082 into 175,144 shares of common stock.
During 1996 the Company also entered into a bridge financing arrangement
with the underwriters for the Company's initial public offering for $650,000
of 12% subordinated notes, due April 1997, issued in tranches of $400,000
and $250,000. In October 1996, the first tranche of $400,000 was
automatically converted into 80,000 Units at a conversion ratio equal to 50%
of the initial public offering price. The second tranche of $250,000 was
issued with detachable warrants to purchase 41,667 Units exercisable at $6
per Unit. The second tranche was repaid on October 25, 1996. The
detachable warrants expire on August 5, 1998.
The Company recorded $80,000 of additional interest expense in relation to
the first tranche of subordinated notes payable. The Company derived this
additional interest expense based on the 10% greater discount to the initial
public offering price reflected in the 80,000 Units issued on conversion of
the first tranche of notes as compared to the discount reflected in the
exercise price of the detachable warrants issued with the second tranche of
notes.
In conjunction with the initial public offering, the Company sold to the
underwriters, warrants to purchase 80,000 Units (the "Underwriter Warrants")
exercisable at $12.51 per Unit. The Underwriter Warrants are exercisable
after October 21, 1997 or at any time thereafter for a period of four years
from October 21, 1997. The Company has also agreed to allow the
underwriters the right to nominate one member to the Company's Board of
Directors.
The Company has reserved 1,298,089 shares of common stock in connection with
Unit warrants and common stock warrants outstanding at December 31, 1996.
F-18
<PAGE> 53
11. COMMON STOCK WARRANTS
Each share of outstanding Preferred Stock includes 15.4456 detachable common
stock purchase warrants enabling the holder to purchase one share of common
stock of the Company for each warrant. The warrants can be exercised at
$1.81 initially; however, the price can increase $1.20 each March 15 if all
dividends are paid as required and the Company achieves certain financial
results. At December 31, 1996 and 1995, the exercise price was $1.81. The
warrants expire during 1998. In conjunction with the Preferred Stock
conversion discussed in Note 9, 346,754 common stock warrants with a
carrying value of $554,072 were also converted.
Concurrent with the Intellicall restructuring described in Note 13 and
related repurchase of the Preferred Stock described in Note 9, the Company
renegotiated the exercise price of the 227,143 detachable common stock
warrants originally issued to Intellicall. The exercise price on these
shares was reduced from $1.81 to effectively $0. From February 15, 1996
through April 15, 1999, the price that Intellicall could have put the common
stock warrants and/or the resulting warrant shares to the Company was also
reduced from $1.81 to $.71. As a result of the put, the Company reclassified
the warrants as a redeemable security and reduced the carrying value from
$362,948 to $161,766. The $201,182 gain was deferred pending payment of the
Intellicall restructuring obligation, as discussed in Note 13, and was
recorded directly to accumulated deficit on June 29, 1996 when the obligation
was repaid. On December 31, 1996, Berthel purchased the common stock put
warrants from Intellicall and purchased the 227,143 shares of common stock
from the Company for $147.
As discussed in Note 10, 800,000 common stock warrants were issued in
conjunction with the initial public offering at a price of $.01 per warrant.
Each warrant is exercisable to purchase one share of common stock at a
price of $6.50 per share. The warrants are exercisable at any time after
issuance and expire on October 21, 1999. The warrants are redeemable at the
Company's option commencing 270 days after October 21, 1996 upon 30 days
notice to holders at $.01 per warrant if the closing bid price of the common
stock averages in excess of 110% of the exercise price of the warrants for a
period of 20 consecutive trading days ending within 15 days of the notice of
redemption.
See Note 19 for discussion of a common stock warrant issued in connection
with the Company's agreement with a consultant.
12. STOCK OPTION PLANS
The Company has adopted a Stock Option Plan (the "Plan"). Under the Plan,
options may be granted to employees to purchase up to an aggregate of
272,529 shares of the Company's common stock. The Plan is administered by
the Compensation Committee of the Board of Directors who determine to whom
options will be granted. The Plan provides for the grant of incentive stock
options (as defined in Section 422 of the Internal Revenue Code) to
employees of the Company. The exercise price of stock options granted under
the Plan is established by the Compensation Committee, but the exercise
price may not be less than the fair market value of the common stock on the
date of grant of each option. Each option shall be for a term not to exceed
ten years after the date of grant, and a participant's right to exercise an
option vests at the rate of twenty percent on the date of grant and each
anniversary date until the option is fully vested.
F-19
<PAGE> 54
A summary of stock option activity under the Plan during the years ended
December 31, 1995 and 1996, is summarized as follows:
<TABLE>
OPTION PRICE
PER SHARE SHARES
<S> <C> <C>
Balance at December 31, 1994 $1.81 102,621
Granted - -
Cancelled - -
------------ --------
Balance at December 31, 1995 1.81 102,621
Granted 1.81 45,518
Cancelled 1.81 (10,395)
------------ --------
Balance at December 31, 1996 $1.81 137,744
============ ========
</TABLE>
At December 31, 1996, 82,646 shares were exercisable, an additional 134,785
shares were available for future grants and the weighted average remaining
life of the options outstanding was seven years. Also, at December 31,
1995, an additional 45,518 shares had previously been granted for contingent
stock options exercisable at $1.81 per share that were available for future
exercise contingent upon the exercise of the detachable common stock
warrants held by the preferred stockholders as discussed in Note 11. During
1996 the detachable common stock warrants were exercised, therefore, the
contingent stock options were granted as stock options during 1996. The
Company has reserved 272,529 shares of common stock in connection with the
Plan at December 31, 1996.
During 1996 the shareholders also approved the allocation of an additional
272,529 shares of common stock to an incentive performance plan to be
developed by the Company (the "Incentive Performance Plan"). The Company
has determined that the Incentive Performance Plan will be a nonqualified
stock option plan and that the exercise price of any options granted
pursuant to such plan will be at an exercise price at least equal to $6.50.
No options have been granted under this plan as of December 31, 1996.
13. EXTRAORDINARY ITEM
During 1994, the Company restructured a $1,600,000 uncollateralized note and
a $500,000 uncollateralized note with a total carrying value of $2,034,499,
all held by Intellicall. The notes, including capital lease obligations of
$418,787, were exchanged for a note payable with a face amount of $1,425,000
and an estimated fair value of $1,368,972. The estimated fair value was
determined based on the discounted future cash flows using the Company's
incremental borrowing rate. The resulting gain of $1,084,314 was deferred
pending payment of all amounts due under the $1,425,000 uncollateralized
note payable, as provided in the underlying restructuring agreement. On
June 29, 1996, the Company paid all amounts due as provided in the
underlying restructuring agreement and recorded the $1,084,314 extraordinary
gain.
14. INCOME TAXES
The provision for income taxes consisted of the following for the years
ended December 31, 1996 and 1995 as follows:
<TABLE>
<S> <C> <C>
1996 1995
Current:
Federal $ - $ 2,300
State 8,112 16,900
---------- ----------
Total $8,112 $19,200
========== ==========
</TABLE>
F-20
<PAGE> 55
The provision for income taxes for the years ended December 31, 1996 and
1995 is less than the amounts computed by applying the statutory federal
income tax rate of 34% to the loss before income taxes and extraordinary
item due to the following items:
<TABLE>
<S> <C> <C>
1996 1995
Computed expected amount $(1,211,700) $(722,300)
Meals and entertainment 8,000 7,800
Officer's life insurance 4,100 4,100
State income taxes, net of federal tax benefit 5,400 14,600
Net operating losses for which no tax benefit was provided 1,202,312 715,000
---------------- ------------
Income tax provision $8,112 $19,200
================ ============
</TABLE>
At December 31, 1996 the Company has net operating loss carryforwards for
federal income tax purposes of approximately $4.5 million to use to offset
future taxable income. These net operating losses will expire, if unused,
from December 31, 2008 through 2011.
Certain restrictions under the Tax Reform Act of 1986, caused by a change in
ownership resulting from sales of common stock, limit the annual utilization
of net operating loss carryforwards. The initial public offering of the
Company's common stock described in Note 10 resulted in such a change in
ownership. The Company estimates that the post-change taxable income that
may be offset with the pre-change net operating loss carryforward will be
limited annually to approximately $600,000. The annual limitation may be
increased for any built-in gains recognized within five years of the date of
the ownership change.
Significant components of the Company's deferred tax assets and liabilities
as of December 31, 1996 and 1995 are as follows:
<TABLE>
<CAPTION>
1996 1995
<S> <C> <C>
Deferred tax assets:
Current:
Allowance for doubtful accounts receivable $11,000 $4,000
Accrued interest on capital lease obligations - 22,000
Deferred income - 53,000
------------- --------------
11,000 79,000
------------- --------------
Noncurrent:
Intangible asset amortization and valuation allowance 320,000 218,000
Differences in net book value of property and equipment 720,000 14,000
Capital lease adjustment 620,000 715,000
Deferred income 28,000 39,000
Carryforward of net operating loss 1,870,000 559,000
------------- --------------
3,558,000 1,545,000
------------- --------------
Total deferred tax assets 3,569,000 1,624,000
Valuation allowance for deferred tax assets (3,569,000) (1,624,000)
------------- --------------
Net deferred tax assets $ - $ -
============= ==============
</TABLE>
A valuation allowance for the entire balance of deferred tax assets has been
recorded because of uncertainty over their future realization.
F-21
<PAGE> 56
15. COMMITMENTS AND CONTINGENCIES
The Company is obligated under long-term capital leases for
telecommunication equipment. Substantially all of the leases are with
Berthel and have been capitalized and are personally guaranteed by the
Company's majority shareholder. The Company also leases a vehicle under a
noncancellable operating lease. At December 31, 1996, future minimum rental
payments on lease obligations are as follows:
<TABLE>
<CAPTION>
CAPITAL LEASES OPERATING
BERTHEL OTHER TOTAL LEASES
<S> <C> <C> <C> <C>
Years ending December 31:
1997 $1,161,036 $20,217 $1,181,253 $10,695
1998 1,274,356 12,761 1,287,117 1,701
1999 1,169,461 - 1,169,461 696
2000 540,662 - 540,662 696
2001 82,339 - 82,339 174
------------ --------- ------------ ---------
Minimum rental payments 4,227,854 32,978 4,260,832 $13,962
=========
Less amounts representing interest 753,134 3,220 756,354
------------ --------- ------------
3,474,720 29,758 3,504,478
Less amounts due within one year 878,034 17,492 895,526
------------ --------- ------------
Capital lease obligations due
after one year $2,596,686 $12,266 $2,608,952
============ ========= ============
</TABLE>
Rent expense under operating leases for the years ended December 31, 1996
and 1995 was $12,120 and $11,535, respectively.
On May 31, 1996, the Company modified its existing lease agreements with
Berthel by deferring the March, April and May 1996 lease payments until the
end of the lease term as an additional balloon payment for leases with a
carrying value of $3,550,750 at December 31, 1995. Monthly lease payments
for the remaining leases, with a carrying value of $1,916,358 at December
31, 1995, were also reduced with the amount of the reduction included as a
balloon payment at the end of the lease term.
The leases with Berthel contained certain restrictive covenants requiring
the maintenance of gross revenues at defined levels and debt service
coverage ratios as defined in the lease agreements and measured on a
quarterly basis. The Company obtained waivers of compliance with these
covenants for the year ended December 31, 1995. Such covenants were not
applicable subsequent to December 31, 1995 and were terminated upon
completion of the Company's initial public offering of its stock.
In conjunction with the PowerTel purchase discussed in Note 4, the Company
leases warehouse space on a month-to-month basis, with payments of $3,200.
The Company also leases a portion of this warehouse space to an unrelated
third party on a month-to-month basis for $1,000.
The Company received a notice and demand dated September 20, 1996 (the
"Demand") from the trustee for the Value-Added Communications Litigation
Trust, as successor-in-interest to the bankruptcy estate of Value-Added
Communications, Inc. (collectively, "VAC"), relating to revenues received by
the Company for providing telecommunications services to the hotels managed
by Larken, Inc., a related party (see Note 16). The Demand alleges that all
revenues received by the Company for providing telecommunications services to
the Larken, Inc. managed hotels constitute avoidable transfers under the
federal Bankruptcy Code and demands payment to VAC of all such amounts. The
amount of revenues subject to the Demand is not specified. The Company
generated revenues of $1,316,571 and $1,458,805 for the years ended December
31, 1996 and 1995, respectively, in connection with such telecommunications
services. The Company believes that the Demand is without merit, that it has
meritorious defenses to VAC's allegations as set forth in the Demand and that
a loss with respect to this matter is not probable, primarily because the
Company's agreements to provide telecommunications
F-22
<PAGE> 57
services to Larken, Inc. were made by the Company in good faith, for
value and without knowledge as to the alleged avoidable nature of such
agreements. In addition, Larken, Inc. and its 50% owner (a minority
shareholder), have acknowledged that the VAC matter is covered by an
indemnification agreement and the minority shareholder's guarantee, and that
such indemnification agreement with Larken, Inc. will cover any losses,
costs or expenses incurred by the Company in connection with this threatened
claim. Pursuant to the indemnification agreement, Larken, Inc. has assumed
the defense of the VAC claims. VAC's attorney sent a second threatening
letter, but has not yet filed a lawsuit. Nonetheless, such a lawsuit could
be filed at any time. Pursuant to the indemnification agreement, Larken,
Inc. will defend any such lawsuit and indemnify the Company for any costs,
damages or expenses relating to the lawsuit, including attorney's fees. The
indemnification agreement requires Larken, Inc. to keep the Company informed
regarding the status of the litigation, if any. The Company intends to
actively monitor this matter, and any litigation that might be commenced, to
be sure that the Company's interests are being adequately represented by
Larken, Inc. and the attorneys retained by Larken, Inc. on the Company's
behalf pursuant to the indemnification agreement. The Company has not made
an independent investigation of the minority shareholder's financial
position or net worth, although the minority shareholder has previously
represented to the Company that he is an accredited investor as defined in
Regulation D under the Securities Exchange Act, with net worth in excess of
$1 million. The outcome of this matter cannot presently be determined and
no assurance can be given that the Company will not incur liability or
expenses in connection with the allegations contained in the Demand. Also,
no assurance can be given that either Larken, Inc. or the minority
shareholder will have sufficient assets to meet their respective obligations
in the event that the Company incurs liability pursuant to this matter. No
provision for any loss that may result upon the resolution of this matter
has been made in the financial statements.
On August 16, 1996, the Company entered into three-year employment
agreements with the Chief Executive Officer, President, Chief Financial
Officer and the Vice President of Operations. Pursuant to these agreements,
the Chief Executive Officer, President, Chief Financial Officer and the Vice
President of Operations will receive base salaries of $150,000, $130,000,
$65,000 and $65,000, respectively. In addition, each of these individuals
will be eligible to participate in the Stock Option Plan and the Incentive
Performance Plan discussed in Note 12. Each agreement contains a provision
restricting competition with the Company for a period of two years following
their termination of employment. If employment with the Company is
terminated by the Company for any reason, including for cause, the employee
is entitled to receive continuation of their base salary for two years.
16. RELATED PARTY TRANSACTIONS
The Company conducts a significant amount of business with Berthel,
Intellicall and other affiliated entities. Berthel provided lease and other
financing services, including underwriting, to the Company. In addition to
the previously discussed transactions with Intellicall, the Company has paid
royalty and validation fees to Intellicall for processing of phone calls
under an agreement with Intellicall. The Company also has an agreement with
an entity owned by the Company's majority shareholder for the use of
aircraft. The Company has also paid consulting expenses to a member of the
Company's Board of Directors and had loans from certain shareholders.
F-23
<PAGE> 58
On July 1, 1994, the Company entered into an agreement with a then
preferred shareholder (subsequently a minority shareholder) to provide
telecommunication services to hotels owned and managed by a company owned by
the shareholder. See Note 15 for discussion of a contingent liability
related to this agreement. The agreement provided for 75% of the net income
derived from the hotels, as defined under the agreement (after direct costs
and compensation to the Company for administrative expenses), to be paid to
the shareholder. Revenues of $1,316,571 and $1,458,805 were generated for
the years ended December 31, 1996 and 1995, respectively. Further, the
Company had call processing receivables from the hotels included under the
agreement of $141,641 and $189,792 at December 31, 1996 and 1995,
respectively. Effective July 1996, the agreement was amended to provide for
a set payment of $25,000 per month in commissions to be paid to the
shareholder, until January 1, 1997, when the commission payment will be
increased to $30,000 per month for a period of 24 months. Also in
conjunction with this agreement, effective July 1, 1996 and through June 30,
2000, the Company will pay an additional $6,000 per month to Berthel for
commissions payable to the minority shareholder pursuant to a settlement of
a dispute between Berthel and the minority shareholder.
A summary of transactions with related parties for the years ended December
31, 1996 and 1995 is as follows:
<TABLE>
<CAPTION>
1996 1995
<S> <C> <C>
Rental of aircraft $60,881 $18,503
Consulting expense 69,914 43,955
Interest expense on shareholder notes payable 30,623 30,975
Commissions/75% profit share to minority shareholder 274,410 432,689
Interest expense on notes payable to Berthel 179,250 29,269
Lease payments to Berthel 2,445,429 1,794,340
Equipment sales to Berthel 389,941 311,309
Royalty fees to Intellicall 1,942 6,381
Validation fees to Intellicall 22,933 71,921
Interest expense to Intellicall 127,943 116,620
Commissions to Berthel 18,000 90,000
Underwriting fees to Berthel 132,531
</TABLE>
Also see Note 3 with respect to an acquisition from a related party.
17. PROFIT SHARING PLAN
The Company has a profit sharing plan under Section 401(k) of the Internal
Revenue Code. Employees are eligible to participate in the plan after
completing three months of service. There were no contributions required
and no discretionary contributions made to the plan for the years ended
December 31, 1996 and 1995.
18. FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value amounts disclosed below are based on estimates prepared by
the Company utilizing valuation methods appropriate in the circumstances.
Generally accepted accounting principles do not require disclosure for lease
contracts. The carrying amount for financial instruments included among
cash, receivables, notes payable, and other short-term payables approximates
their fair value because of the short maturity of those instruments. The
estimated fair value of other significant financial instruments are based
principally on discounted future cash flows at rates commensurate with the
credit and interest rate risk involved.
F-24
<PAGE> 59
The estimated fair values of the Company's other significant financial
instruments at December 31, 1996 and 1995 are as follows:
<TABLE>
<CAPTION>
1996 1995
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
<S> <C> <C> <C> <C>
Long-term debt $1,633,233 $1,541,192 $1,578,600 $1,638,161
</TABLE>
19. CONSULTING AGREEMENT
On December 20, 1996 the Company entered into a consulting agreement
(the "Agreement") with a consultant to provide advisory services to the
Company for a fee of $3,000 per month. The term of the agreement is January
1997 through June 1998, renewable in additional three month increments
unless terminated in writing by either the Company or the consultant. In
addition, pursuant to the Agreement, the consultant received a warrant to
purchase up to 50,000 shares of the Company's common stock at an exercise
price of $2.50 per share. The Company has assigned a fair value of $100,000
to the warrant. The warrant expires, if not exercised, on December 20, 1999.
20. SUBSEQUENT EVENTS
On January 7, 1997, the Company paid a $150,000 refundable security
deposit for a technology license, related to international faxing over the
Internet, to a company managed by a member of the Company's Board of
Directors. The right to execute the agreement expires March 31, 1997. Until
execution of the agreement, the deposit will accrue interest at 12%, which
may be applied towards the technology license.
On January 31, 1997, the Company entered into an agreement with an unrelated
third party to form a limited liability company. The Company has
contributed the IVR platforms and other assets with a carrying value of
$456,904 in exchange for a 50% ownership interest and a preferential
distribution of $496,934. The other party contributed $209,970 in cash in
exchange for a 50% ownership interest. The limited liability company will
provide consumer telecommunications services related to the IVR platforms.
Under the agreement, cash shall be distributed first, in an amount equal to
95% of the net distributable cash to the Company until the preferential
distribution is repaid and the remainder shall be distributed in accordance
with the ownership interests.
At any time during the 90-day period immediately following the second, third
and fourth anniversaries of the execution of the agreement, either party may
purchase the other entity's ownership interest. The purchase price shall be
the greater of $4.5 million plus the other entity's capital account or the
balance of the other entity's capital account plus five times the sum of the
limited liability company's income before income taxes for the most recently
completed fiscal year.
F-25
<PAGE> 60
EXHIBIT INDEX
SEQUENTIAL PAGE
EXHIBIT NUMBER DOCUMENT DESCRIPTION NUMBER
- -------------- ------------------------------ ---------------
3.1 Restated Articles of
Incorporation of the Company
(1)
3.2 Amended and Restated By-Laws
of the Company (1)
4.1 Form of Warrant Agreement
between the Company and
Firstar Trust Company (1)
4.2 Form of Redeemable Warrant (1)
10.1 AT&T Management Company
Commission Agreement, dated
as of December 16, 1995, by
and between the Company and
AT&T Communications, Inc.
("AT&T") (1) (2)
10.2 Amendment No. 1 to AT&T
Management Company Commission
Agreement, dated as of
January 16, 1996, by and
between the Company and AT&T
(1)
10.3 Amendment No. 2 to AT&T
Management Company Commission
Agreement, dated as of
January 16, 1996, by and
between the Company and AT&T
(1) (2)
10.4 Memorandum of Understanding
dated July 5, 1995 regarding
the development of DSP
technology (1)
10.5 Technical Evaluation
Agreement dated July 18, 1996
regarding the development of
DSP technology (1)
10.6 Credit Agreement dated as of
May 31, 1994, by and between
the Company and Berthel
Fisher & Company Leasing,
Inc. (1)
10.7 Letter Agreement dated
September 12, 1995 by and
between the Company and J.C.
Poss & Co., Inc. (1)
10.8 Indemnification Agreement,
dated as of March 3, 1995, by
and between the Company and
Larken, Inc. (1)
<PAGE> 61
10.9 Bi-Party Intelli-Max Billing
Agreement, dated as of May 8,
1992, by and between the
Company and Intellicall Inc.
(1)
10.10 Restructuring Agreement,
dated as of December 31,
1994, by and between the
Company and Intellicall, Inc.
(1)
10.11 $1,000,000 Preferred Stock
Subordinated Note from the
Company to Intellicall, Inc.
(1)
10.12 License Agreement dated May
31, 1994 by and between the
Company and Intellicall, Inc.
(1)
10.13 Account Purchase Agreement
dated June 25, 1992, by and
between the Company and OAN
Services, Inc. (1)
10.14 Operator Billing and Related
Services Agreement, dated May
11, 1992, by and between the
Company and OAN Services,
Inc. (1)
10.15 1993 Stock Option Plan (1) (3)
10.16 Unit Purchase Warrant to
purchase 41,667 Units, dated
August 5, 1996, from the
Company to George N. McDonald
(1)
10.17 Promissory Note in the
principal amount of $250,000
dated August 1, 1996, from
the Company to George N.
McDonald (1)
10.18 Letter Agreement, dated
August 5, 1996, by and
between the Company and
George N. McDonald (1)
10.19 Credit Agreement, dated as of
May 31, 1994, by and between
the Company and
Telecommunications Income
Fund X, L.P. (1)
10.20 Credit Agreement, dated as of
May 31, 1994, by and between
the Company and
Telecommunications Income
Fund IX, L.P. (1)
10.21 Lease Agreement for Lease
#076-18000-012, dated as of
February 27, 1996, by and
between the Company and
Berthel Fisher & Company
Leasing, Inc. as agent for
Telecommunications Income
Fund X, L.P. (1)
ii
<PAGE> 62
10.22 Lease Agreement for
Lease
#074-18000-016,
dated as of June
14, 1996, by and
between the Company
and Berthel Fisher
& Company Leasing,
Inc. as agent for
Telecommunications
Income Fund IX,
L.P. (1)
10.23 Lease Agreement for
Lease
#076-18000-017,
dated as of July 3,
1996, by and
between the Company
and Berthel Fisher
& Company Leasing,
Inc. as agent for
Telecommunications
Income Fund X, L.P.
(1)
10.24 Modification
Agreement for 21
Leases, dated as of
May 30, 1996, by
and between the
Company and Berthel
Fisher & Company
Leasing, Inc. as
agent for
Telecommunications
Income Fund IX,
L.P. (1)
10.25 Modification
Agreement for Lease
#063-17000-001,
dated as of May 30,
1996, by and
between the Company
and Berthel Fisher
& Company Leasing,
Inc. (1)
10.26 Modification
Agreement for Lease
#076-17000-443,
dated as of May 30,
1996, by and
between the Company
and Berthel Fisher
& Company Leasing,
Inc. as agent for
Telecommunications
Income Fund X, L.P.
(1)
10.27 Modification
Agreement for Lease
#076-17000-943,
dated as of May 30,
1996, by and
between the Company
and Berthel Fisher
& Company Leasing,
Inc. as agent for
Telecommunications
Income Fund X, L.P.
(1)
10.28 Modification
Agreement for Lease
#076-18000-012,
dated as of May 30,
1996, by and
between the Company
and Berthel Fisher
& Company Leasing,
Inc. as agent for
Telecommunications
Income Fund X, L.P.
(1)
10.29 Modification
Agreement for Lease
#076-46698-000,
dated as of May 30,
1996, by and
between the Company
and Berthel Fisher
& Company Leasing,
Inc. as agent for
Telecommunications
Income Fund X, L.P.
(1)
10.30 Equipment Lease
#076-17000-443,
dated as of May 31,
1994, by and
between the Company
and Berthel Fisher
& Company Leasing,
Inc. (1)
iii
<PAGE> 63
10.31 Equipment Lease
#076-46698-000,
dated as of January
18, 1995, by and
between the Company
and Berthel Fisher
& Company Leasing,
Inc. as agent for
Telecommunications
Income Fund X, L.P.
(1)
10.32 Equipment
Lease/Purchase
Agreement
#063-18000-000,
dated as of May 30,
1996, by and
between the Company
and Berthel Fisher
& Company Leasing,
Inc. (1)
10.33 Assignment of Lease
of Security
Agreement, dated as
of May 31, 1994,
from Berthel Fisher
& Company Leasing,
Inc. to
Telecommunications
Income Fund X, L.P.
(1)
10.34 Demand Note for
$50,000, dated as
of December 26,
1995, between the
Company and Berthel
Fisher & Company
Leasing, Inc. (1)
10.35 Demand Note for
$200,000, dated as
of January 25,
1996, by and
between the Company
and Berthel Fisher
& Company Leasing,
Inc. (1)
10.36 Demand Note for
$200,000, dated as
of January 31,
1996, by and
between the Company
and Berthel Fisher
& Company Leasing,
Inc. (1)
10.37 Demand Note for
$100,000, dated as
of February 27,
1996, by and
between the Company
and Berthel Fisher
& Company Leasing,
Inc. (1)
10.38 Equipment Lease,
dated as of August
16, 1995, by and
between the Company
and Harvey Leasing.
(1)
10.39 Lease Agreement for
Lease
#074-18000-004,
dated as of
November 30, 1995,
by and between the
Company and Berthel
Fisher & Company
Leasing, Inc. as
agent for
Telecommunications
Income Fund IX,
L.P. (1)
10.40 Lease Agreement for
Lease
#074-18000-005,
dated as of
November 30, 1995,
by and between the
Company and Berthel
Fisher & Company
Leasing, Inc. as
agent for
Telecommunications
Income Fund IX,
L.P. (1)
iv
<PAGE> 64
10.41 Lease Agreement for
Lease #074-18000-006,
dated as of November
30, 1996, by and
between the Company
and Berthel Fisher &
Company Leasing, Inc.
as agent for
Telecommunications
Income Fund IX, L.P.
(1)
10.42 Employment Agreement,
dated as of August 16,
1996, by and between
the Company and Guy O.
Murdock. (1) (3)
10.43 Employment Agreement,
dated as of August 16,
1996, by and between
the Company and Colin
P. Halford. (1) (3)
10.44 Employment Agreement,
dated as of August 16,
1996, by and between
the Company and David
F. Schultz. (1) (3)
10.45 Employment Agreement,
dated as of August 16,
1996, by and between
the Company and Bill
R. Wharton. (1) (3)
10.46 Amendment No. 3 to
AT&T Management
Company Commission
Agreement, executed on
December 13, 1996, by
and between the
Company and AT&T
24 Power of Attorney
(included as part of
the signature page
hereof)
27 Financial Data Schedule
(1) Filed as an exhibit to the Company's Registration Statement on Form SB-2
(File No. 333-05422C) and incorporated herein by reference.
(2) Portions of these exhibits were granted confidential treatment by the
Securities and Exchange Commission by order dated October 21, 1996.
(3) Management contract or compensation plan required to be filed as an
exhibit to this annual report on Form 10-KSB.
v
<PAGE> 1
Exhibit 10.46
Amendment No. 3
to
AT&T Management Company Commission Agreement
The AT&T Commission Agreement entered into as of January 16, 1996
("Agreement"), between AT&T Communications, Inc. acting on behalf of the
Interstate Division of AT&T Corp. and the AT&T Communications interexchange
companies ("AT&T") and Murdock Communications Corporation (formerly known as
Murdock Remmers & Associates), ("Agent") is amended and shall be effective upon
the signing of this Amendment by both parties, as follows:
WHEREAS, the above referenced Agreement contained, among other things,
certain terms and conditions associated with a Guest Room Attainment Bonus as
set forth in the Attachment B - Management Company Commission Payment Plan and
Rate Schedule and Compliance Incentive Bonus Addendum; and
WHEREAS, Attachment B provided for, among other things, Agent's
eligibility to earn a bonus payment based upon contracting a specified number
of guest rooms, and,
WHEREAS, it has become necessary for the parties to modify the
requirements and provisions contained in the Guest Room Attainment Bonus
provision.
NOW, THEREFORE, in consideration of the mutual benefits accruing to each
party, the parties hereby covenant and agree as follows:
1. Subsection 2.2 of Section 2.0 COMPLIANCE BONUS, of Attachment B to the
Agreement, is hereby deleted in its entirety and replaced with the following:
2.2. Guest Room Arrangement Bonus.
Agent shall be entitled to bonus payments, not to exceed a total of One
Million Dollars ($1,000,000.00), to be earned and paid as follows:
(a) Both parties acknowledge that the first and second installments of
Two Hundred Fifty Thousand Dollars ($250,000.00) each have been paid to
Agent as of the effective date of this Amendment.
<PAGE> 2
(b) A third installment of Two Hundred Fifty Thousand Dollars
($250,000.00) shall be payable to Agent no later than February 1, 1997,
provided that:
(i) a minimum of one hundred thousand (100,000) guest rooms must
be accumulated and covered under this Agreement and be an "Active
Location" no later than January 15, 1997. To be an Active
Location, the Location must be tracking in AT&T's Systems and be
earning commissions for AT&T Undesignated Non-Sent Paid Calls in
accordance with the Agreement; and,
(ii) Failure to meet this 100,000 room goal by January 15, 1997
will result in forfeiture of the third and fourth installments or
any additional portion of the $1,000,000 bonus; and,
(iii) If at any time between the effective date of this Amendment
and January 15, 1997, the total guest room count covered under the
Agreement falls below eighty thousand (80,000) rooms, Agent will
forfeit the third and fourth installments or any additional
portion of the $1,000,000 bonus.
(c) If Agent has earned and received the third installment payment, a
fourth installment of Two Hundred Fifty Thousand Dollars ($250,000.00)
shall be payable to Agent no later than May 1, 1997, provided that:
(i) Agent maintains a minimum of one hundred thousand (100,000)
guest rooms at all times under this Agreement, they must be
considered by AT&T to be at an Active Location on February 15,
March 15 and April 15, 1997, and they must be in compliance with
the terms and conditions of the Agreement.
(d) If Agent earns and receives all four installment payments of the
Guest Room Attainment Bonus, and, if prior to May 1, 1998 the total guest
room count drops below one hundred thousand (100,000) rooms at Active
Locations, Agent shall reimburse AT&T a total of Two Hundred Fifty
Thousand Dollars ($250,000.00). Agent shall have the option of AT&T
withholding said amount from future commission payments due Agent under
the Agreement.
(e) The Guest Room Attainment Bonus payment shall be added to the
Compliance Incentive Bonus and, if applicable, reduced by the applicable
percentage reduction in the event of non-compliance.
2
<PAGE> 3
2. In the event of an inconsistency between the terms of the Agreement and this
Amendment, the terms of this Amendment shall prevail.
MURDOCK COMMUNICATIONS AT&T COMMUNICATIONS
CORPORATION
/s/ Guy O. Murdock /s/ John Powell
-------------------------- -----------------------------------------------
Authorized Signature Authorized Signature
Guy O. Murdock John Powell
-------------------------- -----------------------------------------------
Typed or Printed Name Typed or Printed Name
Chief Executive Officer Sales Vice President-Consumer Sales Division
-------------------------- -----------------------------------------------
Title Title
11/12/96 12/13/96
-------------------------- -----------------------------------------------
Date Date
__________________________ Contract #_____________
Contact Telephone Number Agent ID______________
Location______________
3
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM MURDOCK
COMMUNICATION'S CORPORATION AUDITED FINANCIAL STATEMENTS FOR THE YEAR ENDED
DECEMBER 31, 1996, AS ARE CONTAINED IN MURDOCK COMMUNICATIONS CORPORATION'S FORM
10-KSB AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH AUDITED FINANCIAL
STATEMENTS AND THE ACCOMPANYING FOOTNOTES.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 1,241,897
<SECURITIES> 0
<RECEIVABLES> 1,268,660
<ALLOWANCES> 30,000
<INVENTORY> 51,091
<CURRENT-ASSETS> 2,698,909
<PP&E> 13,362,979
<DEPRECIATION> 9,559,053
<TOTAL-ASSETS> 7,479,086
<CURRENT-LIABILITIES> 2,112,728
<BONDS> 0
24,480
0
<COMMON> 10,820,898
<OTHER-SE> (9,646,322)
<TOTAL-LIABILITY-AND-EQUITY> 7,479,086
<SALES> 7,732,254
<TOTAL-REVENUES> 8,164,602
<CGS> 5,239,392
<TOTAL-COSTS> 10,280,236
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,448,207
<INCOME-PRETAX> (3,563,841)
<INCOME-TAX> 8,112
<INCOME-CONTINUING> (3,571,953)
<DISCONTINUED> 0
<EXTRAORDINARY> 1,084,314
<CHANGES> 0
<NET-INCOME> (2,487,639)
<EPS-PRIMARY> (0.98)
<EPS-DILUTED> (0.98)
</TABLE>
