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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended December 31, 1996
Commission file number: 001-14190
Kaye Kotts Associates Inc.
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(Name of small business issuer specified in its charter)
Delaware 95-4248310
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(State or other jurisdiction (I.R.S. Employer
of incorporation of organization) Identification No.)
15490 Ventura Boulevard, Sherman Oaks, CA 91403
(Address of principal executive offices, including zip code)
818-382-6300
(Issuer's telephone number, including area code)
Securities registered under Section 12(b) of the Exchange Act: None
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, $ .01 par value per share
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(Title of Class)
Check whether the issuer: (i) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports),
and (ii) has been subject to such filing requirements
for the past 90 days. Yes X No
--- ---
Check if there is no disclosure of delinquent filers in response to Item 405
of Regulation S-B is not contained in this form, and no disclosure will be
contained to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this
Form 10-KSB or any amendment to this Form 10-KSB. [X]
The issuer's revenues for the fiscal year ended December 31, 1996 were
$4,549,842.
The number of shares outstanding of the issuer's common stock as of December
31, 1996 was 2,398,900 shares. The aggregate market value of the common stock
(1,375,858 shares) held by non-affiliates, based on the average of the bid and
asked prices ($.50) of the common stock as of April 1, 1997 was $ 687,929.
Transactional Small Business Disclosure Format (Check one): Yes No X
---- ----
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DOCUMENTS INCORPORATED BY REFERENCE
The Company is currently subject to the reporting requirements of the
Securities Exchange Act of 1934, as amended (the "Exchange Act") and in
accordance therewith files reports, proxy statements and other information with
the Securities and Exchange Commission (the "Commission"). Such reports, proxy
statements and other information may be inspected and copied at the public
reference facilities of the Commission at 450 Fifth Street, N.W., Washington
D.C. 20549; at its New York Regional Office, Room 1400, 7 World Trade Center,
New York, New York, 10048; and at its Chicago Regional Office, 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661-2411, and copies of such materials
can be obtained from the Public Reference Section at prescribed rates. The
Company intends to furnish its stockholders with annual reports containing
audited financial statements and such other periodic reports as the Company may
determine to be appropriate or as may be required by law.
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PART I
ITEM 1. DESCRIPTION OF BUSINESS.
Kaye Kotts Associates Inc. (the "Company") was organized in 1989 to
provide representation for delinquent taxpayers residing in Southern California,
before the collection divisions of the Internal Revenue Service "IRS" or the
State of California. These delinquent taxpayers owe income taxes and/or payroll
taxes and may be subject to enforced collection activities by taxing
authorities. The Company is not retained to challenge the amounts owed but
rather to facilitate an acceptable payment arrangement which usually concludes
in an Offer-In-Compromise or Installment Agreement. An Offer-In-Compromise
constitutes a complete resolution of a taxpayer's liability for an amount less
than 100%. An Installment Agreement constitutes an agreement to pay an amount
due over a period of time, usually not exceeding three years.
The original focus of the Company was to provide its services to a small
number of clients against whom Federal or state tax liens had been filed. In
1992, the Company expanded its market base by advertising in print media and
reaching a greater number of delinquent taxpayers than those that had tax liens
filed against them. This approach changed the character of the business from a
small boutique operation directing its services to a small number of consulting
clients to a higher volume mass marketing business. The Company's competition is
still principally from sole practitioners, accountants and attorneys, and small
firms who are unable to benefit from the economies of scale flowing from a
volume oriented business. In 1990, the Company serviced approximately 175
delinquent taxpayers with one office. As of December 31, 1996, the Company
serviced approximately 1200 delinquent taxpayers. It currently has four fully
staffed regional service centers and seven satellite sales offices located in
California and Texas, and has its executive offices located in Los Angeles,
California.
THE COMPANY'S SERVICES
Although each taxpayer's situation is unique and requires personal
attention, the Company seeks to categorize the service needs of its clients so
that cases can be handled in as efficient a manner as possible. Taxpayers need
short-term relief and a long term solution.
Short-term relief strategies include wage and bank levy releases and
voluntary payment strategies to "buy time," show good faith and provide the
information required by the IRS. Each taxpayer grants a Power of Attorney to the
Company to designate the Company as its representative, so that during the
entire process, the taxpayer need not communicate directly with tax collection
officers.
Long-term solutions include Offers-In-Compromise, Installment
Agreements, sales of assets, refinancing of loans, possible bankruptcy planning,
penalty abatements or combinations of the foregoing.
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Services provided to the Company's clients include the preparation of
financial information forms in a manner acceptable to the IRS and other taxing
authorities, strategy discussions and financial planning necessary to implement
the recommended solution. The servicing of clients is a dynamic process which
includes both knowledge of the taxing authorities requirements and the client's
rights, and providing a degree of comfort and security to people who are
experiencing a high degree of stress.
OFFERS-IN-COMPROMISE. Prior to February, 1992, the IRS insisted upon
substantially full collection from delinquent taxpayers. In February of 1992 the
IRS issued a policy statement providing for the acceptance of an
Offer-In-Compromise when it is unlikely that the tax liabilities can be
collected in full and the amount collected reasonably reflects collection
potential. In practice, the Company has found that this means that if a taxpayer
cannot pay a tax bill within five years by installment payments and/or by
selling or refinancing assets, with certain exemptions, then the taxpayer may
offer a reduced amount to be paid from funds borrowed or received as a gift. For
a majority of the Company's clients this has been the solution used to address
their tax problems.
The Company's experience has been that, with proper and detailed
financial information provided by the taxpayer and a carefully prepared
submission, a taxpayer is likely to have a reasonable Offer-In-Compromise
accepted with a substantial savings to the taxpayer. This provides the IRS with
a mechanism to resolve the delinquency, collect what the IRS may consider to be
a reasonable sum, close the IRS's case and allow the taxpayer to continue his
life or business without the constant concern of awaiting the IRS garnishing
income and/or seizing assets.
Currently, within the geographic area in which the Company operates, it
takes approximately a year for the IRS to complete the processing and
investigation cycle of an Offer-In-Compromise. During the year ended December
31, 1996, the Company submitted 685 new cases for resolution of collection
matters, had 750 Offer-in-Compromise submissions accepted, and 243
Offer-in-Compromise submissions rejected.
Prior to October 1996, clients were asked to sign a Full Service
Agreement retaining the Company to analyze the clients' tax problem and
implement a solution. In October of 1996, the Company introduced a program under
which the client could elect to retain the Company's services in separate
phases. Phase 1 is an analysis to determine a proposed solution to the
taxpayers' problem. The client is then given the option to move on to Phase II
wherein the Company will submit and negotiate the solution with the taxing
authority. The Company also performs special services, such as penalty
abatement, levy releases, statute of limitations analyses, and IRS appeals.
THE MARKET FOR THE COMPANY'S SERVICES
The Collection powers of the IRS are formidable, and it is those powers
which the Company believes create a demand for its services. Unlike ordinary
debtor-creditor relationships, IRS liens do not attach to specific property, but
to all property and rights to property of a taxpayer. An IRS lien even applies
to property acquired by the taxpayer after a tax assessment. There is no final
judgment needed to perfect an IRS lien against other creditors and the seizure
and sale of property is accomplished without "pre-seizure" hearings.
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The Company believes it benefits from the facts that the number of
taxpayers with unpaid taxes is substantial, and the need to settle those debts
timely is a pressing need both for the United States government and the
delinquent taxpayers.
At December 31, 1996, the Company had approximately 1200 clients in
California and Texas. The Company believes it has sold its services to only a
small fraction of the national marketplace. Relating this exclusively to the
California and Texas districts currently being serviced, the Company believes it
has sold its services to only a small portion of the California and Texas
markets. In addition, the Company offers its services to "non-filers". The IRS
claims that there are 6 to 10 million potential taxpayers who do not file income
tax returns and that this "non-filer" problem results in $7 billion in lost
revenues each year. The IRS does not usually prosecute "non-filers" who come
forward voluntarily before a criminal investigation is commenced. It is the
Company's opinion that many of these "non-filers" would best be served by
seeking advice from the Company or another tax consultant, prior to presenting
themselves to the IRS, in order that proper tax planning and strategy can be
accomplished prior to the filing of delinquent tax returns.
The IRS puts a high priority on the collection of delinquent payroll
taxes, as these taxes were to be held in "trust" for the benefit of the U.S.
government, but instead were used by enterprises for other purposes. Business
owners who are operating as either partnerships or sole proprietorships and who
fail to pay over these employment taxes, are personally liable for the full
amount of these taxes including penalties and interest. If a corporation fails
to pay its payroll taxes, then the IRS can go beyond the corporate entity and
assess, against those persons it deems to be responsible and willful, the Trust
Fund Recovery Penalty which is the amount of the withheld income and social
security taxes.
The Company's present market includes California taxpayers owing state
income and payroll taxes, which are collected in a similar manner to the IRS.
Based upon the Company's experiences in California, employers who divert payroll
tax funds to other business uses are subject to criminal prosecution and in the
last few years the state has been aggressively applying that law against
individual business managers and owners.
MARKETING
The Company solicits its business through advertisements in the media
(primarily newspapers) and through word-of- mouth referrals from clients,
friends, relatives, employers and other professionals. The advertisements target
delinquent taxpayers, and provide a toll free number through which the caller
reaches an operator. The operator schedules the prospective client to meet one
of the Company's Tax Delinquency Analysts (TDA) for a small fee (currently $50).
The TDA explains the Company's services and tries to identify a possible
solution to the prospect's tax delinquency problem which can be implemented by
the Company's professional staff.
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The Company employs an advertising agency for the creation and placement
of its print advertisements. Other clients come from, referrals from attorneys
and other professionals, such as financial advisors and accountants, referrals
from clients and former clients, and general word of mouth.
COMPETITION
The Company currently confines its activities to providing tax
consultation services to those taxpayers in contact with the IRS's Collection
Division and/or similar authorities in California. The Company encounters
competition from attorneys, accountants and "Enrolled Agents." "Enrolled Agents"
are persons allowed to practice before the IRS without being an attorney or a
certified public accountant, based upon an IRS examination or qualifying years
of employment with the IRS. Most of these competitors, however, do not devote
almost all of their time and energy to the business of negotiating payment plans
for delinquent taxpayers, as does the Company. To date, the Company has
encountered only minimal competition from these sources. There are, however,
other companies who advertise that they provide services similar to those
provided by the Company. Based on interviews with its clients and its awareness
of the marketplace, management of the Company believes that there are no other
companies engaging in the same business as that of the Company on the same
scale, but no assurance can be given to that effect. The Company competes on the
basis of fee structure, and its specialty of providing advice and assistance
solely to taxpayers in contact with the IRS's Collection Division or similar
California authorities.
REGULATION
The IRS's Regulations, specifically Section 31 of the Code of Federal
Regulations, Part 10.30, imposes substantial limitations on mail solicitation
and substantially prohibits telephonic solicitation of taxpayers who are in
contact with the IRS. That Regulation further requires that any mailing "shall
be clearly marked as such in capital letters on the envelope and at the top of
the first page of such mailings." That Regulation further prohibits any
"individual eligible to practice before the IRS from making directly or
indirectly, an uninvited solicitation of employment, in matters relating to the
IRS." Solicitation includes but is not limited to, in person contacts and
telephone communications.
The Company's past solicitations could be deemed to be in violation of
that Regulation, since prior mail solicitations may not have been clearly marked
as required by the Regulation and telephonic solicitations were made. As a
result, the Company's personnel who appear before the IRS could be subjected to
disciplinary proceedings, which may result in their suspension or disbarment
before the IRS and may subject the Company to inquiries resulting in substantial
expense to the Company. In January, 1995, the Company changed its mail
solicitation practices to comply with the Regulation. In October, 1995, the
Company ceased telephone solicitation of taxpayers.
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The foregoing Regulation permits print and broadcast advertising with
certain restrictions. Based upon the text of the Regulation, which is summarized
above, the Company believes that its current advertising complies with the IRS's
print and broadcast advertising restrictions but it has not obtained an opinion
of counsel to that effect.
ANCILLARY SERVICE
The Company has engaged the services of local accountants and enrolled
agents to prepare tax returns for its clients as an accommodation to its clients
and others who may seek tax preparation services. The Company derives only
nominal revenue from this tax preparation service.
EMPLOYEES
At April 4, 1997, the Company had 59 employees, including 4 executive
employees, 31 devoted to client services, 14 in sales, and 10 administrative .
Of the 30 devoted to client services, 7 are either enrolled agents (6) or
attorneys (1) there are no certified public accountants employed by the Company
who are devoted to client services. The Company is not subject to any collective
bargaining agreement and believes that its relationships with its employees are
good.
RISK FACTORS
There is a limited public market for the Company's Common Stock. Persons
who may own or intend to purchase shares of Common Stock in any market where the
Common Stock may trade should consider the following risk factors, together with
other information contained elsewhere in the Company's reports, and other
available public information, as filed with the Securities and Exchange
Commission, prior to purchasing shares of the Common Stock:
IMPAIRED FINANCIAL CONDITION. The Company incurred losses of
approximately $4.2 million during the year ended December 31, 1996. The
likelihood of the success of the Company must be considered in light of the
problems, expenses, difficulties, complications and delays frequently
encountered in connection with the restructuring of a business. As of March 31,
1997 the revenues generated from the Company's operations are not adequate to
meet the Company's operating expenses. There can be no assurances that the
Company will ever achieve profitable operations or that revenues will be
adequate to meet the Company's ongoing operating expenses. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
NEED FOR ADDITIONAL CAPITAL. The Company's successful transition to
profitable operations is dependent upon obtaining adequate financing to fund
current operations and to develop and maintain a market share in an industry
which is new and uncertain. In the event the Company fails to raise additional
funds, and fails to generate adequate revenues from operations, the Company may
be unable to continue operations. There can be no assurances that any sources of
financing will be available from existing stockholders or external sources on
terms favorable to the Company, or at all, or that the business of the Company
will ever achieve profitable operations. Further, any additional financing, may
be senior to the Company's Common Stock or result in significant dilution to the
holders of the Common Stock. In the event the Company does not receive any such
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financing or generate profitable operations, management may have to suspend or
discontinue its business activity or certain components thereof in its present
form. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
QUALIFIED FINANCIAL STATEMENTS. The Company's auditors have included an
explanatory paragraph in their Report of Independent Certified Public
Accountants to the effect that recovery of the Company's assets and its ability
to continue as a going concern are dependent upon obtaining adequate financing .
There can be no assurances that such a financing can be completed on terms
favorable to the Company or at all, or that the business of the Company will
ever achieve profitable operations. The accompanying Financial Statements do not
include any adjustments relating to the recoverability and classification, of
recorded asset amounts or the amounts and classification of liabilities that
might be necessary should the Company be unable to continue as a going concern.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations."
INTERNAL REVENUE SERVICE CRIMINAL INVESTIGATIONS DIVISION (CID)
INVESTIGATION. In April, 1996, a former employee of the Company was accused of
violating the law in connection with negotiations with the IRS. The employee,
who was not an executive officer, director or principal stockholder of the
Company, pled guilty to one felony count charging the employee with a violation
of 26 U. S. C. 7212, a statute proscribing the corrupt obstruction or impeding
of the due administration of the Internal Revenue laws. He received probation.
On March 13, 1997, the Company's counsel was advised that the U. S.
Attorney had requested authorization from the Tax Division of the Justice
Department to file criminal tax charges against the Company, allegedly arising
out of the Company's representation of taxpayers in collection matters before
the IRS. Management is unaware of the nature of any charges, other than
liability for the conduct of its former employee, that may be filed or the
potential liability of the Company which may arise therefrom. See "Legal
Proceedings" Internal Revenue Service Investigations.
LIMITED PUBLIC MARKET FOR COMMON STOCK. There is currently a limited
public market for the Company's Common Stock. Holders of the Company's Common
Stock may, therefore, have difficulty selling their Common Stock, should they
decide to do so. In addition, there can be no assurances that such markets will
continue or that any shares of Common Stock which may be purchased may be sold
without incurring a loss. Further, the market price for the Common Stock may be
volatile depending on a number of factors, including business performance,
industry dynamics, news announcements or changes in general economic conditions.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Market for Common Equity and Related Stockholder Matters".
LISTING OF THE COMPANY'S COMMON STOCK ON THE NASDAQ SMALL-CAP MARKET. On
December 2, 1996, NASDAQ informed the Company that the Company did not meet all
the requirements for continued listing on the NASDAQ Small-Cap Market,
specifically that the Common Stock did not maintain a closing inside bid price
of at least $1.00 for ten consecutive trade dates prior to the NASDAQ letter to
the Company. To be eligible for continued listing, the Company's Common Stock
must maintain a minimum bid price of $1.00 or, as an alternative if the
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bid price is less than $1.00, maintain capital and surplus of $1,000,000 and a
market value of the public float of $1,000,000. The Company does not meet either
of the latter alternatives at this time. The Company was given 90 days to bring
itself into compliance. On February. 28, 1997, the Company submitted a plan,
which management believed may be sufficient to continue the Company's listing,
although no assurance can be given to that effect. NASDAQ has not yet replied to
the Company's proposed plan. Changed circumstances require that the Company
amend the plan submitted. If the Company's plan, as amended, is not accepted and
if the Company is otherwise unable to meet the technical listing requirements,
then NASDAQ may delist the Company, with the consequence that holders of the
Company's Common Stock will find it more difficult to dispose of, or even obtain
quotations on the Company's Common Stock.
RISKS OF LOW-PRICED SECURITIES. The Company's Common Stock is currently
listed for trading in the NASDAQ small cap market and on the Boston Stock
Exchange. If the Common Stock were to be suspended or delisted from the NASDAQ
System and the Boston Stock Exchange, the Common Stock would become subject to
the "penny stock rules" adopted pursuant to Section 15 (g) of the Securities
Exchange Act of 1934 (the "Exchange Act"). The penny stock rules apply to
non-NASDAQ companies whose common stock trades at less than $5.00 per share or
which have tangible net worth of less than $5,000,000 ($2,000,000 if the company
has been operating for three or more years). Such rules require, among other
things, that brokers who trade "penny stocks" to persons other than "established
customers" complete certain documentation, make suitability inquiries of
investors and provide investors with certain information concerning trading in
the security, including a risk disclosure document and quote information under
certain circumstances. Many brokers have decided not to trade "penny stocks"
because of the requirements of the penny stock rules and, as a result, the
number of broker-dealers willing to act as market makers in such securities is
limited. In the event that the Company becomes subject to the "penny stock
rules" for any significant period, there may develop an adverse impact on the
market, if any, for the Company's securities.
LACK OF DIVIDENDS ON COMMON STOCK. The Company has paid no dividends on
its Common Stock as of March 31, 1997 and there are no plans for paying
dividends on the Common Stock in the foreseeable future. The Company intends to
retain earnings, if any, to provide funds for the expansion of the Company's
business.
SHARES ELIGIBLE FOR FUTURE SALE: ISSUANCE OF ADDITIONAL SHARES. Future
sales of shares of Common Stock by the Company and its stockholders could
adversely affect the prevailing market price of the Common Stock. There are
currently 1,150,000 shares of Common Stock which are free trading shares or are
eligible to have the restrictive legend removed pursuant to Rule 144(k)
promulgated under the Securities Act. Further, 1,293,400 shares may be the
subject of future registration statements pursuant to the terms of certain
agreements between the Company and certain of its stockholders. Sales of
substantial amounts of Common Stock in the public market, or the perception that
such sales may occur, could have a material adverse effect on the market price
of the Common Stock. Pursuant to its Articles of Incorporation, the Company has
the authority to issue additional shares of Common Stock. The issuance of such
shares could result in the dilution of the voting power of the currently issued
and outstanding Common Stock.
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GOVERNMENT TAX POLICIES; CHANGES MAY RESULT IN ELIMINATION OF
COMPANY'S BUSINESS. The Company's present services are based upon current tax
policies of the IRS which encourage and provide inducements for taxpayers to
settle tax liabilities. These policies do not have the force of law or
regulation. In the event of a change in the current IRS policies, the Company's
current services could be eliminated or curtailed and the entire business of the
Company would cease. There can be no assurance that current tax laws,
regulations and policies will remain in effect for any period of time. See
"Description of Business "The Company's Services."
LAWS PROHIBITING CERTAIN ACTIVITIES BY UNLICENSED PERSONS. The practices
of law and accounting are subject to extensive state and local laws, rules and
regulations prohibiting their practice by persons not licensed to practice in
those respective fields, prohibiting the unlawful rebate or division of fees and
controlling the manner in which prospective clients may be solicited. The
Company has not received an opinion of counsel or any regulatory authority that
the Company is not in violation of any such laws, rules or regulations. In the
event that it is determined that any such laws, rules or regulations prohibit or
require the Company to alter its business conduct, its current operations will
be materially adversely affected and may be curtailed or eliminated.
Additionally, it is possible that in certain states the proposed activities of
the Company will not be permissible on terms acceptable to the Company, in which
case the Company will not be able to do business in such states. Furthermore,
the Company's operations in a state may be challenged subsequent to the
commencement of its activity in that state. In such an event, the Company's
business operations could be materially and adversely impacted.
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ITEM 2. DESCRIPTION OF PROPERTIES.
The following table lists the location and general character of each of
the Company's locations as of March 31, 1997.
<TABLE>
<CAPTION>
REGIONAL OFFICES
Approximate
Address Approximate Gross Square Feet Approximate Date of Opening Lease Expiration Date
------- ----------------------------- --------------------------- ---------------------
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
15456 Ventura Boulevard
Sherman Oaks, CA 91403
Tel. No. (818) 789-6516 1,969 September 1996 June 2001
1650 Iowa Ave. Ste #280
Riverside, CA 92507
Tel. No. (909) 320-1380 2,074 August 1993 Month to Month
3550 Watt Avenue
Sacramento, CA 95821
Tel. No. (916) 979-7040 951 August 1994 June 1997
12001 N Central Expressway #850
Dallas TX 75243
Tel No. (972) 308-8445 2,164 September 1997 September 2002
Corporate Offices
15490 Ventura Blvd.
Sherman Oaks Ca 91403 7,500 January 1990 December 1998
Tel No. (818) 382-6300
</TABLE>
The above locations are used on a full-time basis. The Company also
has 7 sales offices that are used on a part-time basis principally for sales and
client meetings.
ITEM 3. LEGAL PROCEEDINGS.
CLARK NISS LITIGATION. On or about December 4, 1996, Clark E Niss, as
Trustee of the Clark E. Niss Revocable Trust, filed suit against the Company and
David Kaye in Los Angeles County, California, Superior Court (Case No. BC
161947). The complaint claims violation of California Corporations Code Section
25401 (misrepresentation of material facts in connection with the offer or sale
of a security), breach of fiduciary duties and violation of California Business
and Professions Code Sections 17200 et seq. (unfair business practices).
The claims relate to alleged misrepresentations and nondisclosures in
the Company's public offering in early 1996 and seeks, alternatively, rescission
of the plaintiff's purchase of warrants and
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restitution of the purchase price of $37,500 together with pre-judgment interest
thereon at 10% per annum, costs of suit and such further relief as the court
deems just and proper. The Company and Mr. Kaye have filed an Answer denying
liability and raising affirmative defenses. The Company believes it has valid
defenses and intends to vigorously defend the claim.
INTERNAL REVENUE SERVICE CRIMINAL INVESTIGATIONS DIVISION (CID)
INVESTIGATION. In April, 1996, a former employee of the Company was accused of
violating the law in connection with negotiations with the IRS. The employee,
who was not an executive officer, director or principal stockholder of the
Company, pled guilty to one felony count charging the employee with a violation
of 26 U. S. C. 7212, a statute proscribing the corrupt obstruction or impeding
of the due administration of the Internal Revenue laws. He received probation.
On March 13, 1997, the Company's counsel was advised that the U. S.
Attorney had requested authorization from the Tax Division of the Justice
Department to file criminal tax charges against the Company, allegedly arising
out of the Company's representation of taxpayers in collection matters before
the IRS. Management is unaware of the nature of any charges, other than
liability for the conduct of its former employee, that may be filed or the
potential liability of the Company which may arise therefrom.
WRONGFUL DISCHARGE LITIGATION. On November 22, 1995, The Company and its
Chief Executive Officer, among others, were served with a lawsuit by two former
employees whose services had been terminated by the Company in May and June
1995, respectively, for what, in management's opinion, was cause. The plaintiffs
alleged wrongful discharge in contravention of public policy, fraud,
misrepresentation and intentional infliction of emotional distress. The lawsuit
was settled in January 1997 for $49,000 paid by the Company.
PEASE LITIGATION. On September 16, 1996, the Company and other
defendants, not affiliated with the Company were served with a lawsuit, alleging
breach of contract and exercise of due care in connection with negotiation by
the Company for an Offer-In-Compromise. Pursuant to the written retainer
agreement between the Company and the plaintiff in February, 1997, the Company
filed a demand for arbitration with the American Arbitration Association.
Pending that arbitration, the Court has stayed the Superior Court action.
Management of the Company believes that there are valid defenses to this action
and intends to defend this lawsuit vigorously.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
As of March 31, 1997, the authorized capital stock of the Company
consisted of 10,000,000 shares of common stock, par value $0.01 per share (the
"Common Stock") and 1,000,000 shares of preferred stock, par value $0.01 per
share ("Preferred Stock"). The Company has issued and outstanding Redeemable
Class A Warrants to purchase 2,515,000 shares of Common Stock and Redeemable
Class B Warrants to purchase 105,000 shares of Common Stock.
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The Class A Warrants are exercisable until February 22, 2001. The
Class B Warrants are exercisable until February 22, 1999.
The Class A Warrants are exercisable, at a price of $6.00 per share, and
are redeemable by the Company commencing one year after issuance, on not less
than 30 days' written notice, at a price of $ .08 per warrant, at any time after
the market price (as defined below) of the Common Stock shall have exceeded
$10.00 per share. For these purposes, the market price shall mean (i) the
average of the closing bid prices for the 30 consecutive business days, ending
within 15 days of the date of the notice of redemption of the Common Stock, as
reported by the NASDAQ or (ii) the last reported sale price, for 30 consecutive
business days, ending within 15 days of the date of the notice of redemption, on
the primary exchange on which the Common Stock is traded, if the Common Stock is
traded on a national securities exchange or the national market system of
NASDAQ. All of the outstanding Class A Warrants must be redeemed if any are
redeemed. The Company has agreed with the Underwriters not to redeem the Class A
Warrants until August 22, 1997, 18 months from the date of the Prospectus,
without the consent of the Underwriters.
The Company must have a currently effective registration statement on
file with the Commission in order for a Class A Warrant holder to be able to
exercise his Class A Warrants. The Warrant Agreement requires the Company to
endeavor to maintain a registration statement current and effective for such
purposes. The Company does not have an effective registration statement at April
10, 1997.
The Class B Warrants are exercisable, at a price of $7.50 per share, and
are subject to redemption by the Company, in whole or in part, on not less than
30 days' written notice, at a price of $.05 per Class B Warrant, at any time
after the closing bid price (as defined therein) of the Company's Common Stock
for ten consecutive business days, ending within five days of the date notice of
redemption is given, averages in excess of $8.00 per share as reported by
NASDAQ. The Company must have a currently effective registration statement on
file with the Commission in order for a Class B Warrant holder to be able to
exercise his Class B Warrants. The Company will endeavor to maintain such
registration statement current and effective.
STOCK PRICE LIST
<TABLE>
<CAPTION>
Bid Prices Asked Prices
---------- ------------
Year Ended December 31, 1996 High Low High Low
----- --- ---- ---
<S> <C> <C> <C> <C>
1st Quarter $ 8.38 7.75 $ 9.50 8.50
-------------------- --------------------
2nd Quarter 8.75 5.75 9.25 6.50
-------------------- --------------------
3rd Quarter 5.75 1.88 6.72 2.47
-------------------- --------------------
4th Quarter 2.25 0.63 2.50 1.13
-------------------- --------------------
1997 Through April 9
(Closing Price) $ 0.50 $ 0.75
-------------------- --------------------
</TABLE>
13
<PAGE> 14
SUMMARY FINANCIAL INFORMATION
The summary financial information as of December 31, 1996 and 1995 and
for the years then ended are derived from the financial statements of the
Company which have been audited by Feldman Radin & Co., P.C., independent public
accountants, whose report thereon is included elsewhere in this Annual Report
along with such financial statements.
The financial data set forth below should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the financial statements of the Company appearing elsewhere in
this Annual Report.
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------
1996 1995
-------------- --------------
OPERATING RESULTS
<S> <C> <C>
Fee Income $ 4,549,842 $ 6,014,867
Costs and Expenses
8,626,321 6,068,164
Operating (Loss) (4,076,480) (53,297)
(Loss) Before Income Taxes (4,061,523) (186,063)
Provision for Income Taxes -- (9,442)
Net (Loss) (4,174,320) (176,621)
Net (Loss) per Common Share $ (1.87) $ (0.14)
Weighted Average Number of Shares Outstanding 2,228,292 1,237,400
BALANCE SHEET DATA
Working Capital (Deficit) (374,528) (263,556)
Total Assets 2,588,802 1,914,525
Total Liabilities 2,238,706 1,925,597
Stockholders' Equity 350,096 (11,072)
</TABLE>
14
<PAGE> 15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction with
the financial statements and notes thereto appearing elsewhere in this Annual
Report on form 10KSB.
In February 1996, the Company raised $4,500,000, net of expenses, in a
public offering the proceeds of which were intended to be used for expansion and
related marketing expenditures. During the year operations were expanded and
additional amounts were spent for staffing, marketing and facilities. However,
in spite of these efforts, sales revenues declined. This decline in revenues was
due primarily to a change in IRS policy defining "allowable expense" and the IRS
investigation described in "Fee Income" below. As a result of the lack of sales
growth, late in the fiscal year the Company reversed the expansion and began to
close offices. Further, the Internal Revenue Service investigation and other
litigation adversely affected the Company's operations. The result of these
events was a substantial loss for the year. On March 31, 1997 the Company had
cash and marketable securities of approximately $690,000 with a $500,000 bank
loan collateralized by such securities. During the three months ended March 31,
1997 the Company had continued losses from operations. The Company's ability to
continue as a going concern is dependent upon attaining profitable operations
and obtaining adequate financing.
The Company initiated a cost reduction program during the third quarter
of 1996 which resulted in a reduction of the member of employees from 108 on
June 30, 1996 to 59 on April 4, 1997. Annualized payroll and fringe costs have
decreased from $4.1 million in June 1996 to $2.4 million in April 1997. Facility
and communication costs were reduced through the consolidation of 7 regional
operating centers in June 1996 into 3 operating centers in April 1997. After
these and other cost reductions, the Company's annualized expense rate in April
1997, excluding the provision for bad debts, is approximately $4 million
compared with the actual expense of $7.5 million in 1996.
As indicated in the Notes to the Financial Statements, the accompanying
financial statements do not include any adjustments relating to the
recoverability and classification of recorded asset amounts or the amounts and
classification of liabilities that might be necessary should the Company be
unable to continue as a going concern.
COMPARISON YEARS ENDED DECEMBER 31, 1996 AND 1995
RESULTS OF OPERATIONS
For the year ended December 31, 1996, the Company had a loss before
income taxes and extraordinary items of approximately ($4,061,523) compared with
a loss of $(186,063) for the year ended December 31, 1995. The increase in the
loss of ($3,875,460) resulted primarily from (1) costs incurred to build the
organization required to support the Company's planned national expansion, (2)
increases in legal fees relating to litigation and the Internal Revenue service
Investigation described in Notes 11 and 12 to the Financial Statements, (3) an
increase in the
15
<PAGE> 16
provision for doubtful accounts, and (4) a change in the estimate of the period
over which revenues are recognized. The national expansion has been deferred
while the company consolidates its California and Texas operations. The Company
had a net loss of approximately ($4,174,000) for the year ended December 31,
1996 compared with a net loss of ($177,000) for the year ended December 31,
1995. The 1996 loss was ($1.87) per share compared with a loss of ($0.14) per
share for the year ended December 31, 1995. The net loss for the year ended
December 31, 1996, includes an extraordinary charge of $112,797 for the
write-off of deferred financing charges.
FEE INCOME.
In 1996 the Company's historical trend of annually increasing fee
income, reversed significantly. 1996 fee income of $4.6 million was
approximately $1.4 million less than 1995's reported $6.0 million. This reversal
had an even more negative effect when considered in the light of the 1996
operating plan. That plan called for a minimum 10% increase in 1996. Therefore,
the effect of this reversal in trend can be viewed as a $2 million drop in
anticipated revenues.
This reversal in real and anticipated revenues was due primarily to two
unrelated events. The first of these was a significant change in IRS policy as
they redefined their definition of "allowable expenses". Under the new
definition, the delinquent taxpayer is now forced to limit the amount of
"allowable expenses" used in the computation of an acceptable
Offer-In-Compromise proposal or installment payment arrangement, to
pre-determined national and local standards as derived from various government
statistics. This new policy was applied retroactively beginning in 1996. The
effect on the Company was two-fold. First the retroactive aspect of the change
caused client dissatisfaction resulting in numerous claims for refunds and an
increased amount of cancellations and uncollected accounts receivable.
In addition, the Company's approach to the market place had to be
altered to compensate for the shift in IRS policy. Initial consultations with
prospective clients are no longer free. Prospective clients now must pay a fee
for the first meeting. Emphasis is now on other potential solutions to the tax
payment problems rather than considering almost every problem solvable by an
Offer-In-Compromise. Sales are now made in two phases rather than the previous
single sale. The first phase being an analysis to determine the solution, the
second phase being the actual negotiation of the recommended solution. Within
the latter half of 1996 considerable time and expense was devoted toward making
these marketing adjustments.
The other significant "trend breaker" in revenues was directly related
to the illegal action of a former employee. The Company in two instances was
subjected to a national IRS undercover "sting" operation. In one case, the
Company's employees acted appropriately and no further action occurred.
Unfortunately in the other instance the Company's internal systems of checks and
balances failed and the acts of an employee caused his arrest and a subsequent
raid on the Company's corporate offices. Although that employee subsequently
pled guilty and even though the Company has received no information that this
was more than an isolated incident, the effect on revenue was significant and
adverse. Marketing was geared down in those offices
16
<PAGE> 17
directly effected. Key staff were relocated to review past operations and
continue current operations. Advertising was curtailed for a period and the
focus of the management was directed away from revenues and profitability toward
issues of ethics and integrity. During this difficult time, which continued for
almost half of 1996, revenues were severely negatively impacted, resulting in a
substantial portion of the 1996 downturn.
Management is of the opinion that it has now successfully addressed both
the issue of the IRS incident and the change in allowable expense policy and
revenues from remaining operations will attain a positive trend in 1997.
COSTS AND EXPENSES
Operating costs increased by $2,658,158 to $8,626,322 from $6,068,164 in
1995. The major components of this increase are:
1. Payroll and employee benefits increased by $500,911 because of the
addition of management and professional staff required to support the
Company's planned expansion.
2. Marketing and Sales promotion costs increase by $420,883 primarily
because of increased media advertising, marketing tests and research
projects undertaken to support the Company's planned expansion and to
offset the impact on sales of the Internal Revenue Service Investigation
described in Note 12 to the Financial Statements.
3. Facilities, equipment and communication costs increased by $143,821
primarily because of the opening of additional offices and related costs
to support the Company's planned expansion.
4. Professional fees and other outside service costs increased by $835,205
primarily because of the litigation and Internal Revenue Service
Investigation described in Note 11 and 12, and the compliance costs
associated with being a public company.
5. The provision for bad debts and cancellations increased by $477,576.
Management believes that the primary reasons for this increase were the
retroactive application by the IRS of a new policy limiting the amount
of allowable expenses for offers-in-compromise and client reaction to
the IRS investigation described in Note 12 to the Financial Statements.
CERTAIN BALANCE SHEET DATA
Net accounts receivable were reduced by $603,595 or approximately 47%
from the 1995 balance and stood at $527,611 at December 31, 1996. This amount
represented approximately 20% of the Company's total assets at December 31, 1996
and approximately 26% of its current assets at the same date. This decline in
accounts receivable results primarily from the Company's decrease in fee income.
The allowance for doubtful accounts and cancellations was charged with
provisions of approximately $1,066,000 and $588,000 for 1996 and 1995,
respectively, and offset by actual write-offs of $1,030,000 and $449,000 for the
respective periods. The Company reviews the provisions for uncollectible
accounts monthly, and adjusts the provisions based on actual write-offs and an
aging analysis of accounts receivable.
17
<PAGE> 18
At December 31, 1996, accounts receivable greater than 90 days old stood
at $116,525 which sum included $40,105 in accounts receivable greater than 120
days old. Accounts Receivable greater than 90 and 120 days old represented
approximately 14% and 5%, respectively, of total receivables at December 31,
1996.
The accounts receivable turnover rate improved from approximately 84
days at the end of 1995 to 67 days at the end of 1996. This improvement in the
turnover rate reflects the changes in payment terms under the new two phase
sales contracts. Phase 1 payments are scheduled over an eight week period, as
compared to the twenty week period provided in the Company's previous full
service sales agreements.
Property and equipment, before allowance for depreciation and
amortization, increased by $291,666 from $354,456 at December 31, 1995 to
$646,122 at December 31, 1996 as the result of an investment in and the
modernization of the Company's computer systems.
Trade payables, accrued expenses and other accrued liabilities increased
by $432,562 from $636,305 at December 31, 1995 to $1,068,867 at December 31,
1996. Trade payables and other accrued liabilities include an increase of
$168,307 in accrued professional fees, an increase in accrued costs on
capitalized leases of $165,861, and an increase in media costs payable of
$78,361 December 31, 1996.
Loans payable decreased from $1,062,213 at December 31, 1995 to $523,943
at December 31, 1996. This decrease resulted from the repayment of substantially
all outstanding loans upon the completion of the Company's Initial Public
Offering, offset by borrowing under a new line of credit of $500,000. See
"Liquidity and Capital Resources".
Deferred income increased by $418,917 from $226,979 at December 31, 1995
to $645,896 at December 31, 1996, primarily from a change in the estimate in the
period over which revenues are recognized.
Additional Paid In Capital increased by $4,523,873 primarily from the
Company's Initial Public Offering of Common Stock and Warrants on February 22,
1996, in which a total of 1,150,000 shares of common stock were sold for $5.00
per share and 1,265,000 of Class A Redeemable Warrants (the "Warrants") were
sold for $.15 per warrant. The warrants entitle the holder to purchase one share
of common stock at $6.00 per share through February 22, 2001. Warrants are
redeemable by the Company commencing one year after issuance, on not less than
30 days written notice, at a price of $.08 per warrant, at any time that the
average closing bid price of the common stock exceeds $10.00 per share for
thirty consecutive business days. Consent of the underwriters is also needed to
redeem the warrants until August 22, 1997, eighteen months after the completion
of the initial public offering.
18
<PAGE> 19
LIQUIDITY AND CAPITAL RESOURCES
The Company incurred substantial losses during 1996 and its continuation
as a going concern is dependent upon obtaining additional financing and
attaining profitable operations, neither of which can be assured. On March 31,
1997 the Company had cash and marketable securities of approximately $690,000
with a $500,000 bank loan collateralized by such securities. During the three
months ended March 31, 1997 the Company had continued losses from operations.
These factors raise substantial doubt about the Company's ability to continue as
a going concern.
See "Certain Balance Sheet Data" for information pertaining to the
Company's Initial Public Offering in February 1996.
In April 1996, the Company borrowed $500,000 under a revolving line of
credit with a lending institution. Interest is payable on the loan at 1% over
the prime rate. The loan is collateralized by the Company's short term
investments.
The Company initiated a cost reduction program during the third quarter
of 1996 which resulted in a reduction of the member of employees from 108 on
June 30, 1996 to 59 on April 4, 1997. Annualized payroll and fringe costs have
decreased from $4.1 million in June 1996 to $2.4 million in April 1997. Facility
and communication costs were reduced through the consolidation of 7 regional
operating centers in June 1996 into 3 operating centers in April 1997. After
these and other cost reductions, the Company's annualized expense rate in April
1997, excluding the provision for bad debts, is approximately $4 million
compared with the actual expense of $7.5 million in 1996.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(a) OF THE EXCHANGE ACT.
The directors and executive officers of the Company are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
David Kaye 60 Chairman of the Board, Chief Executive Officer,
President and Treasurer
Arnold Levitt 59 Vice President/Chief Financial Officer
Peter Banner 43 Director
Robert Friedland 61 Director
David Peteler 45 Director
Susan E. Phillips 34 Vice President, Administration, Corporate Secretary
</TABLE>
19
<PAGE> 20
Set forth below is a brief background of the executive officers and
directors of the Company, based on information supplied by them.
David Kaye has been Chairman of the Board and President of the Company
since September 1989 and Treasurer since April 1995. Mr. Kaye also served as the
Company's Secretary from September 1989 until April 1995. He is the spouse of
Linda Kaye who owns 800,000 shares of the Company's Common Stock.
Arnold Levitt became Vice President Finance/Chief Financial Officer in
May 1996. He was a consultant to the Company for two months prior to his
employment. From 1994 to 1996, Mr. Levitt was the executive vice president and
Chief Operating Officer of Wico Gaming Supply Corp., a manufacturer and
distributor of gaming supplies located in Las Vegas Nevada. From 1991 to 1994
Mr. Levitt was the Chairman of the Board, President and Chief Executive Officer
of Ocean Pool Company, a manufacturer and distributor of competitive swimwear
and swimwear accessories, located in Commack, New York. Mr. Levitt is a
Certified Public Accountant in the state of New York.
Peter Banner became a director in April 1997. Mr. Banner is the
President of Support Resources, Inc., a multi-faceted business management
consulting firm. Since 1975, he has been providing marketing, financial, and
general business consulting services to both private and public companies. For
the last three and a half years he has been working extensively in India
representing various U.S. companies and assisting in putting together strategic
alliances between U.S., Danish, and Indian companies.
Robert Friedland became a director in April 1997. He has been retired
since 1994. From 1988 to 1993, he was the President and Chief Executive Officer
of Cort Financial Services, a mortgage broker and banker.
David Peteler became a director in April 1997. Mr. Peteler is an
attorney who has been of counsel to the law firm of Tisdale & Nicholson since
1995. From 1992 to 1995, he had his own law practice which specialized in
international business transactions, mergers and acquisitions, corporate,
securities and finance matters.
Susan E. Phillips has been Vice-President, Administration of the
Company since 1995, and became Corporate Secretary in 1996. Ms. Phillips joined
the Company in September of 1989 as Mr. Kaye's Administrative assistant, was
promoted to Mr. Kaye's executive assistant in November 1992 and remained in
that position until elected to her current position in April 1995.
Directors serve until the next annual meeting of stockholders or until
their successors are elected and qualified. Officers serve at the discretion of
the Board of Directors. Directors do not currently receive fees for their
services as directors, but are reimbursed for travel expenses.
ITEM 10. EXECUTIVE COMPENSATION.
Summary Compensation Table. The following table sets forth certain
information concerning compensation of the Company's executive officers,
including the Company's Chief Executive Officer and all executive officers whose
total annual salary and bonus exceeded $100,000, for the fiscal years ended
December 31, 1996 and 1995:
20
<PAGE> 21
<TABLE>
<CAPTION>
Long Term Compensation
- -------------------------------------------------------------------------------------------------------------------
Fiscal Year
Name and Ended Other Annual All Other
Principle Position December 31, Salary ($) Bonus ($) Compensation($) Compensation ($)
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
David Kaye (1)
1996 $150,000 0 (1) (1)
1995 $150,000 0 (1) (1)
</TABLE>
(1) SEE "EMPLOYMENT AGREEMENT" BELOW
EMPLOYMENT AGREEMENT
The Company has entered into an employment agreement dated as of January
1, 1995, with Mr. Kaye pursuant to which he will act as Chairman of the Board
and Chief Executive Officer of the Company for a five year period at an annual
salary of $150,000, subject to annual increases as may be determined by the
Board of Directors. Mr. Kaye will be entitled to receive performance
compensation equal to ten percent of the Company's annual pretax net income. Mr.
Kaye's employment agreement requires the Company to maintain $1,000,000 in life
insurance for his benefit. The employment agreement also provides Mr. Kaye's
beneficiary and Mr. Kaye, respectively, with three months salary in the event of
his death or disability and indemnifies him to the full extent permitted under
the Delaware General Corporation Law.
The Company leases an automobile for Mr. Kaye, principally used in the
Company's business. Mr. Kaye derives a personal benefit from the use of that
automobile which the Company estimates to be less than $6,000 per year.
Additionally, the Company pays for Mr. Kaye's life insurance and provides his
family with health insurance at an approximate cost of $5,000 and $6,000 per
year, respectively
STOCK OPTION PLANS
The Company maintains stock option plans which permit the grant of
options to purchase shares of Common Stock. The plans provide for the granting
of both incentive stock options ("Incentive Stock Options"), as defined in
section 422 of the Internal Revenue Code of 1986, as amended (the "Code"), and
options that do not qualify as options defined by Section 422 of the Code
("Non-Qualified Options"). Under the plans, Incentive Stock Options may be
granted to key employees, including officers and directors who are also
employees, and Non-Qualified Options may be granted to officers, directors,
advisors and consultants who may or may not be employees of the Company. The
Company's two plans are the Kaye Kotts Associates Inc.'s 1995 Stock Incentive
Plan
21
<PAGE> 22
("1995 Plan") and Kaye Kotts Associates Inc. Directors Stock Option Plan
("Directors Plan").
The maximum term of any option under the plans is ten years and, the
option price per share may not be less than the fair market value of the Common
Stock on the date of grant, (110% in the case of incentive stock options granted
to persons owning more than 10% of the voting stock of the Company).
The 1995 Plan permits the grant of options to purchase up to 666,000
shares of Common Stock. The Directors Plan permits the grant of options to
purchase 50,000 shares of Common Stock. No Options have been granted under the
Plans.
Compensation of Directors. The Company does not currently compensate
directors for services rendered as directors.
Directors and Officers Liability Insurance. The Company has obtained
directors' and officers' liability insurance with an aggregate limit of
liability for the policy year, inclusive of costs of defense, in the amount of
$1,000,000.
Indemnification of Officers and Directors. The Company's Certificate of
Incorporation and Bylaws designate the relative duties and responsibilities of
the Company's officers, establish procedures for actions by directors and
stockholders and other items. The Company's Certificate of Incorporation and
Bylaws also contain extensive indemnification provisions which will permit the
Company to indemnify its officers and directors to the maximum extent provided
by Delaware law.
Under Delaware laws, an officer or director of the Company may be
entitled to indemnification from the Company against expenses (including
attorneys, fees), judgments, fines and amounts paid in settlement actually and
reasonably incurred in connection with a pending or completed action, suit or
proceeding, whether civil, criminal, administrative or investigative. Under the
Company's Certificate of Incorporation, no director of the Company shall be
liable to the Company or its stockholders for monetary damages for breach of
fiduciary duty as a director, except for liability: (i) for any breach of the
director's duty of loyalty to the Company or its stockholders; (ii) for acts or
omissions not in good faith or which involve intentional misconduct or a knowing
violation of law; (iii) under Section 174 of the Delaware General Corporation
Law; or (iv) for any transaction from which the director derives an improper
personal benefit.
22
<PAGE> 23
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.
The following table sets forth, as of April 10, 1997, certain
information concerning beneficial ownership of shares of Common Stock with
respect to (i) each person known to the Company to own 5% or more of the
outstanding shares of Common Stock, (ii) each director of the Company, (iii)
the executive officer named in the Summary Compensation table, and (iv) all
directors and officers of the Company as a group:
<TABLE>
<CAPTION>
Name and Address of
Beneficial Owner Number of Shares Percentage
---------------- ---------------- ----------
<S> <C> <C>
David Kaye (1) 800,000 33%
Linda Kaye 800,000 33%
Robert M. Rubin (2) 187,500 8%
Lawrence Cohen (3) 25,342 1%
Susan E. Phillips (4) 10,200 0.4%
Peter Banner - 0 - --
Robert Friedland - 0 - --
David Peteler - 0 - --
All officers and directors as a
group (six persons) (1)-(4) 1,023,042 42%
</TABLE>
The address for the above identified officers and directors of
the Company, is c/o Kaye Kotts Associates Inc., 15490 Ventura Boulevard, Sherman
Oaks, California 91403.
Pursuant to the rules of the Securities and Exchange Commission,
shares of Common Stock which an individual or group has a right to acquire
within 60 days pursuant to the exercise of options or warrants are deemed to be
outstanding for the purpose of computing the percentage ownership of such
individual or group, but are not deemed to be outstanding for the purpose of
computing the percentage ownership of any other person shown in the table.
1. Includes 800,000 shares of Common Stock owned by Linda Kaye.. Ms. Kaye
is the spouse of David Kaye, the Company's Chairman of the Board,
President and Chief Executive Officer. Mr. Kaye has advised the Company
that he disclaims any pecuniary beneficial interest in the shares of
Common Stock owned by his spouse.
3. Includes 25,342 shares of Common Stock owned by Ms. Donna Cohen, the
spouse of Larry Cohen. Mr. Cohen resigned as a director of the Company
April 3, 1997.
4. Ms. Phillips resigned as a director of the Company in February, 1997.
23
<PAGE> 24
Compliance with Section 16 of the Securities Exchange Act of 1934.
Section 16(a) of the Exchange Act requires the Company's directors and executive
officers and beneficial holders of more than 10% of the Company's Common Stock
to file with the Securities and Exchange Commission (the "Commission") initial
reports of ownership and reports of changes in ownership of such equity
securities of the Company. Based solely upon a review of such forms, or on
written representations form certain reporting persons that no other reports
were required for such persons, the Company believes that all reports required
pursuant to Section 16(a) with respect to its executive officers, directors and
10% beneficial stockholders for the fiscal year ended December 31, 1996 were
timely filed.
Item 12. Certain Relationships and Related Transactions.
During the two years ended December 31, 1996, David Kaye borrowed
$199,928 from the Company.
On December 31, 1996, Mr. Kaye executed a promissory Note to the Company
in the amount of $208,082 which includes interest at 8% per annum computed from
the time of each loan to Mr. Kaye through December 31, 1996. The Note bears
interest at the rate of 8% per annum and is secured by 200,000 shares of Company
Common Stock owned by Linda Kaye, the spouse of David Kaye.
Monthly interest payments on the outstanding balance are due commencing
January 31, 1998. The Note plus accrued interest for 1997 is payable in three
equal installments of $74,910 on June 30, 1998, June 30, 1999 and June 30, 2000.
PART IV
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
A. Financial Statements
The consolidated balance sheets of Kaye Kotts Associates Inc. include
the accounts of the company and its wholly owned subsidiary Kaye Kotts Texas
Inc.(all inter-company accounts have been eliminated) as of December 31, 1996
and 1995, and the related statements of operations, stockholders' equity
(deficiency) and cash flows for the years then ended.
B. Reports on Form 8-K
None.
C. Other Exhibits
24
<PAGE> 25
Incorporation of Certain documents by Reference
Certain documents listed above as exhibits to this Report on Form 10-KSB
are incorporated by reference from other documents previously filed by the
Company with the Commission as follows:
Previous Filing Exhibit Number
Incorporated by Reference in Form 10-KSB
------------------------- --------------
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
and Exchange Act of 1934, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
Dated: April 14, 1997 Kaye Kotts Associates Inc.
By: /s/ David Kaye
---------------
David Kaye
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated below.
Kaye Kotts Associates Inc.
Dated: April 14, 1997 By: /s/ David Kaye
--------------
David Kaye
Chief Executive Officer
Dated: April 14,1997 By: /s/ Arnold Levitt
------------------
Chief Financial Officer
SIGNATURES
Dated: April 14,1997 By: /s/ Peter Banner
----------------
Director
Dated: April 14,1997 By: /s/ Robert Friedland
--------------------
Director
Dated: April 14,1997 By: /s/ David Peteler
-----------------
Director
25
<PAGE> 26
Pursuant to the requirements of Section 13 or 15(d) of the Securities
and Exchange Act of 1934, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
Dated: April 14, 1997 Kaye Kotts Associates Inc.
By:
David Kaye
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated below.
Kaye Kotts Associates Inc.
Dated: April 14, 1997 By:
David Kaye
Chief Executive Officer
Dated: April 14, 1997 By:
Arnold Levitt
Chief Financial Officer
26
<PAGE> 27
KAYE KOTTS ASSOCIATES, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995
<TABLE>
Page
<S> <C>
INDEPENDENT AUDITORS' REPORT F-1
CONSOLIDATED BALANCE SHEET F-2
CONSOLIDATED STATEMENTS OF OPERATIONS F-3
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIT) F-4
CONSOLIDATED STATEMENTS OF CASH FLOW F-5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-6-12
</TABLE>
<PAGE> 28
Independent Auditor's Report
To the Board of Directors and Stockholders
Kaye Kotts Associates Inc.
We have audited the accompanying balance sheet of Kaye Kotts Associates
Inc. as of December 31, 1996, and the related statements of operations,
stockholders' equity and cash flows for each of the years in the two year period
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, the financial statements referred to above present
fairly, in all material respects, the financial position of Kaye Kotts
Associates Inc. as of December 31, 1996, and the results of its operations and
its cash flows for each of the years in the two year period then ended in
conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that
the Company will continue as a going concern. As discussed in Note 2 to the
financial statements, the Company experienced a significant net loss in 1996 and
continues to incur operating losses. These factors raise substantial doubt about
the Company's ability to continue as a going concern. Management's plans in
regards to these matters are also described in Note 2. The accompanying
financial statements do not include any adjustments relating to the
recoverability and classification of recorded asset amounts or the amounts and
classification of liabilities that might be necessary should the Company be
unable to continue as a going concern.
As discussed in Note 12 to the financial statements, the Internal
Revenue Service (IRS) commenced an investigation in April 1996 to determine if
certain employees of the Company (who were not officers, directors to a
principal stockholder of the Company) were violating the law in connection with
their dealings with the IRS. On or about March 13, 1997, the Company's counsel
was advised by the U.S. Attorney in charge of the aforementioned investigation,
that authorization had been requested from the tax Division of the Justice
Department to file criminal tax charges against the Company, allegedly arising
out of the Company's representation of taxpayers in collection matters before
the IRS. Management is unaware of the nature of any charges that may be filed
and is unable to determine what, if any, potential liability of the Company may
arise therefrom.
Certified Public Accountants
New York, New York
April 9, 1997
<PAGE> 29
KAYE KOTTS ASSOCIATES, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1995
------------ ------------
ASSETS
CURRENT ASSETS:
<S> <C> <C>
Cash $ 23,255 $ 18,642
Short-term investments:
Unrestricted 742,125 --
Restricted 500,000
Accounts receivable, net of allowance for doubtful accounts of $310,075
and $275,000 at December 31, 1996 and 1995 respectively 527,611 1,131,206
Prepaid expenses and other current assets 98,187 196,574
Deferred offering costs -- 315,619
----------- -----------
TOTAL CURRENT ASSETS 1,891,179 1,662,041
----------- -----------
Property and Equipment- Net of accumulated depreciation of $214,677
and $195,415 at December 31, 1996 and 1995 respectively 431,445 159,041
Other Receivables 208,083 18,443
Other Assets 58,096 --
Deferred Financing Costs -- 75,000
----------- -----------
$ 2,588,802 $ 1,914,525
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Accounts payable-trade $ 510,239 $ 217,773
Other accrued liabilities 558,628 418,532
Loans payable 523,943 1,062,313
Deferred revenues 645,896 226,979
----------- -----------
TOTAL CURRENT LIABILITIES 2,238,706 1,925,597
----------- -----------
STOCKHOLDERS' EQUITY (DEFICIT IN ASSETS)
Common Stock, $0.01 par value; 10,000,000 shares authorized: 2,398,900 and 1,237,400
shares issued and outstanding at December 31, 1996 and 1995, respectively 23,989 12,374
Additional paid-in-capital common stock 4,692,328 168,455
Deficit (4,366,221) (191,901)
----------- -----------
350,096 (11,072)
$ 2,588,802 $ 1,914,525
=========== ===========
</TABLE>
See notes to consolidated financial statements
F-2
<PAGE> 30
KAYE, KOTTS ASSOCIATES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------
1996 1995
------------------- ------------------
<S> <C> <C>
FEE INCOME $ 4,549,842 $ 6,014,867
COSTS AND EXPENSES
Payroll & Employee Benefits 4,108,814 3,607,903
Marketing & Sales Promotion 1,047,110 626,327
Facilities Equipment & Communications 1,095,855 952,034
Professional Fees & Other Outside Services 916,181 80,976
Provision For Bad Debts & Cancellations 1,065,682 588,166
Other Administrative Costs 392,680 212,758
----------- -----------
8,626,321 6,068,164
OPERATING (LOSS) (4,076,480) (53,297)
Interest Income 121,196 1,758
Interest Expense (106,239) (57,321)
Amortization of Debt Discount -- (77,203)
----------- -----------
(Loss) Before Income Taxes & Extraordinary Item (4,061,523) (186,063)
Provision for (Benefit From) Income Taxes -- (9,442)
----------- -----------
(LOSS) BEFORE EXTRAORDINARY ITEM (4,061,523) (176,621)
Extraordinary Item: Write off of Deferred Finance
Charge and Unamortized Debt Discount Upon
Repayment of Debt 112,797 --
----------- -----------
NET (LOSS) $(4,174,320) $ (176,621)
=========== ===========
(Loss) Per Common and Common Equivalent Share $ (1.87) $ (0.14)
=========== ===========
Weighted Average Number of Common
And Common Equivalent Shares Outstanding 2,228,292 1,237,400
=========== ===========
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE> 31
KAYE, KOTTS ASSOCIATES, INC.
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIT)
YEARS ENDED DECEMBER 31, 1996 AND 1995
<TABLE>
<CAPTION>
COMMON STOCK Additional
------------ Paid-in Treasury
Shares Amount Capital Deficit Stock Totals
------ ------ ------- ------- ----- ------
<S> <C> <C> <C> <C> <C> <C>
Balance - December 31,1994 2,010,688 $ 20,107 $ 315,098 $ (15,280) (300,000) 19,925
Net loss (176,621) (176,621)
Retirement of treasury stock (775,688) (7,757) (292,243) 300,000 --
Issuance of warrants in connection with debt 136,000 136,000
Issuance of common stock as employee bonus 2,400 24 9,600 9,624
--------------------------------------------------------------------------------------
Balance - December 31, 1995 1,237,400 12,374 168,455 (191,901) -- (11,072)
Net loss (4,174,320) (4,174,320)
Issuance of common stock and Warrants in
Public Offering net of expenses 1,157,000 11,570 4,514,918 4,526,488
Issuance of common stock 4,500 45 8,955 9,000
--------------------------------------------------------------------------------------
Balance - December 31, 1996 2,398,900 $ 23,989 $ 4,692,328 $(4,366,221) -- 350,096
======================================================================================
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE> 32
KAYE KOTTS ASSOCIATES, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
--------------------------
1996 1995
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C>
Net (Loss) $(4,174,320) $ (176,621)
----------- -----------
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED (USED) BY OPERATING
ACTIVITIES:
Depreciation 91,797 114,166
Issuance of common shares for services provided 9,930 9,624
CHANGES IN ASSETS AND LIABILITIES:
(Increase)/decrease in accounts receivable-trade 603,595 (288,118)
(Increase)/decrease in prepaid assets 98,387 (120,167)
(Increase)/decrease in other assets (247,735) (20,756)
Increase/(decrease) in accounts payable-trade 292,466 49,190
Increase/(decrease) in accrued expenses (0) (53,387)
Increase/(decrease) in other accrued liabilities 140,096 124,402
Increase/(Decrease) in other deferred revenues 418,917 (93,021)
(Decrease) in deferred income taxes -- 54,279
--------- ---------
TOTAL ADJUSTMENTS 1,407,453 (223,788)
NET CASH (USED) BY OPERATING ACTIVITIES (2,766,867) (400,409)
---------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (349,431) (112,377)
---------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Increase in restricted cash -- 25,000
Payments on loans payable (1,041,550) (11,111)
Proceeds from loans payable 499,943 722,644
Issuance of common stock and warrants net of $288,436 of expenses 5,057,339 --
Proceeds from issuance of warrants -- 100,000
Increase in deferred offering costs -- (247,739)
Increase in deferred financing costs -- (90,000)
Printing of Prospectus (90,000)
Repayment of legal fees (9,930) --
Payments on capital equipment leases (52,767) --
--------- -------
NET CASH PROVIDED BY FINANCING ACTIVITIES 4,363,036 498,794
--------- -------
NET INCREASE/(DECREASE) IN CASH 1,246,738 (13,992)
CASH AT BEGINNING OF PERIOD 18,642 32,634
-------- ------
CASH AND SHORT TERM INVESTMENTS AT END OF PERIOD $ 1,265,380 $ 18,642
=========== ========
</TABLE>
See notes to financial statements.
F-5
<PAGE> 33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996 AND 1995
PAGE F-6
- --------------------------------------------------------------------------------
1. BUSINESS
Kaye Kotts Associates, Inc. (hereinafter referred to as the
"Company"), is a financial services firm engaged in providing mediation
and compromise services to individuals and businesses who have
outstanding tax liabilities. These liabilities are the result of
deficiencies or nonpayment of tax liabilities to the Internal Revenue
Service, state and local taxing authorities.
2. GOING CONCERN
The Company incurred substantial losses during 1996 and had a
working capital deficiency of $348,000 at December 31, 1996, therefore,
its continuation as a going concern is dependent upon obtaining
additional financing and attaining profitable operations. On March 31,
1997, the Company had cash and marketable securities of approximately
$690,000 with a $500,000 bank loan collateralized by these securities.
During the three months ended March 31, 1997, the Company had continued
losses from operations. These factors raise substantial doubt about the
Company's ability to continue as a going concern. The accompanying
financial statements do not include any adjustments relating to the
recoverability and classification of recorded asset amounts or the
amounts and classification of liabilities that might be necessary
should the Company be unable to continue as a going concern.
The Company initiated a cost reduction program during the
third quarter of 1996 which resulted in a reduction in the number of
employees from 108 on June 30, 1996 to 59 on April 4, 1997. Annualized
payroll and fringe costs have decreased from $4.1 million in June 1996
to $2.4 million in April 1997. Facility and communication costs were
reduced through the consolidation of 7 regional operating centers in
June 1996 into 3 operating centers in April 1997. After these and other
cost reductions the Company's annualized expense rate in April 1997,
excluding the provision for bad debts is approximately $4 million
compared with the actual expense of $7.5 million in 1996.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A. ACCRUAL BASIS OF ACCOUNTING: The accompanying financial
statements were prepared under the accrual basis of
accounting.
B. PRINCIPLES OF CONSOLIDATION: The Consolidated Financial
Statements include the accounts of the Company and its wholly
owned subsidiary Kaye Kotts, Texas Inc. All intercompany
accounts have been eliminated.
C. PROPERTY AND EQUIPMENT: Property and equipment are stated at
cost. Depreciation is provided using the straight line method
over the estimated useful lives of the assets, generally
ranging from three to five years.
<PAGE> 34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996 AND 1995
PAGE F-7
- --------------------------------------------------------------------------------
D. REVENUE RECOGNITION AND ALLOWANCE FOR DOUBTFUL ACCOUNTS:
Revenues are recognized as income as services are performed
(and the associated costs incurred) over the contract term, as
measured by various milestones. Costs are expensed when
incurred, accordingly, the Company does not defer any costs. A
proper matching of costs with revenues is accomplished by
utilizing the stage of completion of the matter to determine
the portion of the total contract revenues that should be
recognized and the amount that should be deferred.
The Company provides for doubtful accounts on the allowance
method. The Company records its provision for doubtful
accounts based upon historical data generally as a percentage
of revenues, as well as specifically reserved items
E. LOSS PER SHARE: Loss per share is computed using the weighted
average number of common shares and common share equivalents
outstanding during each year. The number of shares used to
compute earnings per share amounted to 2,228,292 and 1,237,400
for the years ended December 31, 1996 and 1995, respectively.
F. ACCOUNTING ESTIMATES: The preparation of financial
statements, in conformity with generally accepted accounting
principles, requires management to make estimates and
assumptions that affect the reported amount of assets and
liabilities, and disclosure of contingent assets and
liabilities at the date of the financial statements, and the
reported amount of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
G. STOCK BASED COMPENSATION: The Company accounts for stock
options in accordance with APB Opinion no. 25," Accounting For
Stock Issued To Employees." In accordance with Statement No.
123 of the Financial Accounting Standards Board," Accounting
for Stock Based Compensation the Company intends to continue
to apply APB Opinion No. 25 for purposes of determining net
income and has adopted the pro-forma disclosure requirements
of Statement No. 123 in its 1996 financial statements for
purposes of the 1996 financial statements the differences
between amounts calculated under SFAS 123 and APB 25 are not
significant and therefore pro-forma information is not
presented.
H. FAIR VALUE OF FINANCIAL INSTRUMENTS: Effective January 1,
1996, the Company adopted Statement of Financial Accounting
Standards No. 107, "Disclosures About Fair Value of Financial
Instruments," which requires disclosure of fair value
information about financial instruments whether or not
recognized in the balance sheet. The carrying amounts reported
in the balance sheet for cash, short-term instruments,
accounts receivable, accounts payable and accrued expenses
approximates fair value based on the short-term maturity of
these instruments.
<PAGE> 35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996 AND 1995
PAGE F-8
- --------------------------------------------------------------------------------
I. RECLASSIFICATION: Certain amounts in the 1995 Statement of
Operations have been reclassified to conform with the 1996
presentation.
4. PROPERTY AND EQUIPMENT
Property and equipment and related accumulated depreciation are
summarized below:
<TABLE>
<CAPTION>
1996 1995
----------- -----------
<S> <C> <C>
Furniture & Fixtures $160,103 $143,021
Office Equipment 404,675 137,318
Leasehold Improvements 13,405 63,967
Computer Software & Other 67,939 10,150
-------- --------
646,122 354,456
-------- --------
LESS ACCUMULATED DEPRECIATION (214,677) (195,415)
-------- --------
Net Property & Equipment $431,445 $159,041
======== ========
</TABLE>
5. LOAN PAYABLE - LINE OF CREDIT
At December 31, 1996, the Company had borrowed $500,000 under a line of
credit with a bank. The line of credit expires April 1, 1998. Interest
is payable on the loan at 1% over the prime rate. The loan is secured
by the Company's short term investments.
6. PROVISION FOR FEDERAL AND STATE INCOME TAXES
The Company uses the asset and liability method of accounting for
income taxes in accordance with SFAS 109. This method requires the
recognition of deferred tax assets and liabilities for the expected tax
consequences of temporary differences between the tax bases and the
financial reporting bases of assets and liabilities.
The following presents the components of the provision/(benefits) of
income taxes for the years ended December 31, 1996 and 1995:
<TABLE>
<CAPTION>
1996 1995
--------- ----------
<S> <C> <C>
Deferred
Federal $ - $(8,000)
State - (1,442)
--------- ----------
$ - $(9,442)
========= ==========
</TABLE>
Deferred tax assets and liabilities arise from differences in the
expected tax consequences derived from the timing of recognition of
income and expense items for financial reporting and taxation
<PAGE> 36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996 AND 1995
PAGE F-9
- --------------------------------------------------------------------------------
purposes. Listed below are the tax effects of the items related to the
Company's net deferred tax asset:
<TABLE>
<CAPTION>
December 31,
-----------------------
1996 1995
---------- ----------
<S> <C> <C>
Deferred Tax Assets:
Net Operating Loss Carry forward $1,386,700 $ 246,500
Cash to Accrual Adjustment 317,300 --
---------- ----------
Total: 1,704,000 246,500
---------- ----------
Less Valuation Allowance 1,684,000 116,500
---------- ----------
Total 20,000 130 ,000
---------- ----------
Deferred Tax Liabilities:
Cash to Accrual Adjustment -- 113,000
Accelerated Depreciation 20,000 17,000
---------- ----------
20,000 130,000
Net Deferred Tax Asset $ -- $ --
========== ==========
</TABLE>
The provisions for income taxes varied from the appropriate Federal
Statutory rates for the following reasons:
<TABLE>
<CAPTION>
1996 1995
------------------- ---------------------
AMOUNT RATE AMOUNT RATE
---------- ---- ---------- ----
<S> <C> <C> <C> <C>
Benefit at statutory rate (1,386,700) (33.0)% $(63,240) (34.0)%
Increase in valuation allowance 1,567,500 38.0 % 61,200 32.9
State taxes net of federal
tax benefit and other, net (180,800) (5.0)% (7,402) (4.0)
---------- ---- -------- ----
TOTALS: -- -- % $ (9,442) (5.1)%
========== ==== ======== ====
</TABLE>
7. LEASES
The Company leases twelve facilities in California and three
in Texas pursuant to operating leases; none of which exceeds five years
in duration. Minimum annual rental payments required for each of the
next five years are as follows:
<TABLE>
<S> <C>
1997 443,000
1998 352,000
1999 140,000
2000 93,000
2001 66,000
</TABLE>
<PAGE> 37
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996 AND 1995
PAGE 10
- --------------------------------------------------------------------------------
8. MAJOR CUSTOMERS
Due to the nature of the Company's business, there is no one customer
whose loss would have a material effect on its financial condition or
results of operations.
9. STOCKHOLDERS' EQUITY
As of December 31, 1996, the Company has authorized 10,000,000 shares
of common stock. The Company has issued 2,398,900 shares. An additional
40,000 shares will be issued in April 1997 as additional consideration
for a loan that was repaid by the Company in 1996. The Company is
authorized to issue 1,000,000 shares of Preferred Stock, par value $.01
per share (the "Preferred Stock") of which 300,000 are designated
Series A Preferred Stock. Shares of the Series A Preferred Stock rank
prior to all other classes of capital stock of the Company as to
dividends and the distribution of assets upon liquidation, carry a
liquidation preference of $1.00 per share plus any accumulated
dividends and bear interest at the rate of eight percent (8%) per year.
The Company completed an Initial Public Offering on February 22, 1996,
selling a total of 1,150,000 shares of common stock for $5.00 per
share, and 1,275,000 Class A Redeemable Warrants (the "Warrants") at
$.15 per warrant. The warrants entitle the holder to purchase one share
of common stock at $6.00 per share through February 22, 2001. Warrants
are redeemable by the Company commencing one year after issuance, on
not less than 30 days written notice, at a price of $.08 per warrant,
at any time that the average closing bid price of the common stock
exceeds $10.00 per share for thirty consecutive business days. Consent
of the underwriters is also needed to redeem the warrants for up to
eighteen months after the completion of the initial public offering.
In August 1995, the Company sold an aggregate of $400,000 of its 4%
notes and 1,250,000 Class A warrants to a group of private investors
for $500,000. The notes were repaid in February 1996. The Company has
outstanding 105,000 Class B warrants to purchase Common Stock at $7.50
per share.
10. STOCK OPTION PLANS
The Company maintains stock option plans which permit the grant of
options to purchase shares of Common Stock. The plans provide for the
granting of both incentive stock options, as defined in section 422 of
the Internal Revenue Code of 1986 as Amended (the Code), and options
that do not qualify as options, as defined in section 422 of the Code
(Non-Qualified Options). Incentive Stock options may be granted to key
employees, including officers and directors who are also employees, and
Non-Qualified Options may be granted to officers, directors, advisors
and consultants who may or may not be employees of the Company.
<PAGE> 38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996 AND 1995
PAGE F-11
- --------------------------------------------------------------------------------
The maximum term of any option under the plans is ten years and, the
option price per share may not be less than the fair market value of
the Common Stock on the date of grant, (110% in the case of incentive
stock options granted to persons owning more than 10% of the voting
stock of the Company).
The Plans permit the grant of incentive options to purchase up to
666,000 shares of Common Stock and Non-Qualified Options to purchase
50,000 shares of Common Stock. No options have been granted under the
Plans.
11. LITIGATION
On November 22, 1995, the Company and its Chief Executive Officer,
among others, were served with a lawsuit by two former employees whose
services had been terminated by the Company in May and June 1995,
respectively, for what, in management's opinion, was cause. The
plaintiffs alleged wrongful discharge in contravention of public
policy, fraud, misrepresentation and intentional infliction of
emotional distress. The lawsuit was settled in January 1997 for $49,000
to be paid by the company..
On September 16, 1996, the Company and other persons not affiliated
with the company, were served with a lawsuit, alleging breach of
contract and exercise of due care in connection with negotiation by the
Company for an Offer in Compromise. Pursuant to the written retainer
agreement between the Company and the Plaintiff, in February, 1997,
the Company filed a demand for arbitration with the American
Arbitration Association. Pending that arbitration, the Court has stayed
the Superior Court action. Management of the Company believes that
there are valid defenses to this action and intends to defend this
lawsuit vigorously.
On December 4, 1996, the Company and its Chief Executive Officer, were
served with a lawsuit by a stockholder for $37,500. The plaintiff
alleges the Company's prospectus omitted material facts regarding the
company's operations; the Company breached its fiduciary duties; and
the Company failed to disclose facts regarding the company's negative
operating results in a timely manner. Management believes that the
action is without merit and is vigorously defending the case.
12. INTERNAL REVENUE SERVICE INVESTIGATION
In April 1996 a former employee of the Company was accused of violating
the law in connection with negotiations with the IRS. The employee, who
was not an executive officer, director or principal stockholder of the
Company, pled guilty to one felony count charging the employee with a
violation of 26 U. S. C. 7212, a statute proscribing the corrupt
obstruction or impeding of the due administration of the Internal
Revenue laws. He received probation.
On March 13, 1997, the Company's counsel was advised that the U. S.
Attorney had requested authorization from the Tax Division of the
Justice Department to file criminal tax charges against
<PAGE> 39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996 AND 1995
PAGE F-12
- --------------------------------------------------------------------------------
the Company, allegedly arising out of the Company's representation of
taxpayers in collection matters before the IRS. Management is unaware
of the nature of any charges, other than liability for the conduct of
its former employee, that may be filed or the potential liability of
the Company which may arise therefrom.
14. REVENUE RECOGNITION
The Company recognizes revenues as income as services are performed.
Upon review of current operations the company has changed its estimate
of the period over which revenues should be recognized resulting in an
increase in deferred revenue of approximately $419,000 at December 31,
1996.
15. OTHER RECEIVABLES
Other receivables consists of a loan to the President of the Company
which bears interest at 8% per annum and will be repaid over a three
year period commencing June 30, 1998.
<TABLE> <S> <C>
<ARTICLE> 5
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-1-1996
<PERIOD-END> DEC-31-1996
<EXCHANGE-RATE> 1
<CASH> 23,255
<SECURITIES> 1,242,125
<RECEIVABLES> 837,686
<ALLOWANCES> 310,075
<INVENTORY> 0
<CURRENT-ASSETS> 1,891,179
<PP&E> 646,122
<DEPRECIATION> 214,677
<TOTAL-ASSETS> 2,588,802
<CURRENT-LIABILITIES> 2,238,706
<BONDS> 0
0
0
<COMMON> 0
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 2,588,802
<SALES> 4,549,842
<TOTAL-REVENUES> 4,688,882
<CGS> 0
<TOTAL-COSTS> 8,626,321
<OTHER-EXPENSES> 106,239
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 106,239
<INCOME-PRETAX> 0
<INCOME-TAX> 0
<INCOME-CONTINUING> (4,076,480)
<DISCONTINUED> 0
<EXTRAORDINARY> 112,797
<CHANGES> 0
<NET-INCOME> (4,174,320)
<EPS-PRIMARY> (1.87)
<EPS-DILUTED> 0
</TABLE>
