UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q SB
[X] Quarterly Report Pursuant to Section 13 OR 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended November 30, 1996
-----------------
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from N/A to N/A
---- ----
Commission File No. 0-24058
TOUCH TONE AMERICA, INC.
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(Exact name of registrant as specified in its charter)
California 33-0424087
------------------------------ ------------------------
State or other jurisdiction of (I.R.S. Employer
incorporation or organization Identification Number)
4110 N. Scottsdale Road, Suite 170, Scottsdale, Arizona 85251
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (800) 535-2211
--------------
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such
shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90
days. [X]Yes [ ]No
At October 14, 1996, 3,320,800 shares of common stock, no par value
were outstanding.
Page 1 of 14 pages.
<PAGE>
TOUCH TONE AMERICA, INC. AND SUBSIDIARY
INDEX TO FORM 10-QSB
NOVEMBER 30, 1996
PAGE NO.
--------
PART I
- ------
CONSOLIDATED FINANCIAL STATEMENTS
a. Balance Sheets as of May 31, 1996 and
November 30, 1996 (Unaudited) F-2
b. Statements of Operations for the Three and
Six Months Ended November 30, 1995 and 1996 (Unaudited) F-3
c. Statements of Cash Flows for the Six Months
Ended November 30, 1995 and 1996 (Unaudited) F-4
d. Notes to the Consolidated Financial Statements F-5
MANAGEMENT'S DISCUSSION AND ANALYSIS F-11
PART II
- -------
a. OTHER INFORMATION
b. SIGNATURES
F-1
<PAGE>
TOUCH TONE AMERICA, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
May 31 November 30,
1996 1996
-------- --------
(Unaudited)
ASSETS
------
CURRENT ASSETS:
Cash $5,278,000 $1,630,000
Trade receivables, net allowance
for doubtful accounts of $124,000
and $182,000, respectively 264,000 243,000
Prepaid expense - 36,000
---------- ----------
Total current assets 5,542,000 1,909,000
EQUIPMENT, net of accumulated depreciation
of $62,000 and $159,000, respectively 429,000 1,065,000
OTHER:
Intangibles, net of accumulated
amortization of $97,000 and $181,000,
respectively 738,000 654,000
Refundable deposits 76,000 80,000
Other 143,000 129,000
---------- ----------
TOTAL ASSETS $6,928,000 $3,837,000
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Accounts payable $ 477,000 $ 500,000
Accrued liabilities 1,170,000 679,000
Deferred revenues 76,000 103,000
Notes payable to stockholders 393,000 -
Current portion of capital lease
obligations 61,000 64,000
---------- ----------
Total current liabilities 2,177,000 1,346,000
DEFERRED REVENUE 25,000 25,000
CAPITAL LEASE OBLIGATIONS, net of
current portion 134,000 99,000
COMMITMENTS AND CONTINGENCIES (Notes 5 and 7)
REDEEMABLE PREFERRED STOCK LIABILITY 750,000 -
COMMON STOCK AND OTHER STOCKHOLDERS' EQUITY:
Preferred stock, no par value, 10,000,000
shares authorized; none outstanding - -
Common stock, no par value, 100,000,000
shares authorized, and 3,204,300 and
3,320,800 shares issued and
outstanding, respectively 7,195,000 7,945,000
Accumulated deficit (3,353,000) (5,578,000)
---------- ----------
Total stockholders' equity 3,842,000 2,367,000
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $6,928,000 $3,837,000
========== ==========
See accompanying notes to these consolidated financial statements.
F-2
<PAGE>
TOUCH TONE AMERICA, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE FOR THE SIX
MONTHS ENDED MONTHS ENDED
NOVEMBER 30, NOVEMBER 30,
---------------------- ----------------------
1995 1996 1995 1996
--------- -------- --------- --------
<S> <C> <C> <C> <C>
NET REVENUES:
Long distance resell $ 512,000 $ 273,000 $1,200,000 $ 613,000
Internet access 28,000 174,000 28,000 350,000
---------- ---------- ---------- ----------
540,000 447,000 1,228,000 963,000
COST OF SALES
Long distance resell (346,000) (222,000) (782,000) (451,000)
Internet access (17,000) (115,000) (17,000) (190,000)
---------- ---------- ---------- ----------
(363,000) (337,000) (799,000) (641,000)
---------- ---------- ---------- ----------
GROSS MARGIN 177,000 110,000 429,000 322,000
OPERATING EXPENSES:
Selling 124,000 94,000 294,000 152,000
General and administrative 401,000 684,000 697,000 1,406,000
Amortization and depreciation 20,000 93,000 22,000 183,000
Severance agreements - 55,000 - 285,000
Excess circuit commitments 168,000 365,000 301,000 431,000
---------- ---------- ---------- ----------
713,000 1,291,000 1,314,000 2,457,000
---------- ---------- ---------- ----------
LOSS FROM OPERATIONS (536,000) (1,181,000) (885,000) (2,135,000)
OTHER INCOME (EXPENSE):
Interest income (expense), net (12,000) 16,000 (16,000) (90,000)
Absorbed offering and
acquisition costs (115,000) - (115,000) -
---------- ---------- ---------- ----------
(127,000) 16,000 (131,000) (90,000)
---------- ---------- ---------- ----------
NET LOSS $ (663,000)$(1,165,000) $(1,016,000) $(2,225,000)
========== ========== ========== ==========
LOSS PER SHARE $ (.44) $ (.35) $ (.67) $ (.68)
========== ========== ========== ==========
WEIGHTED AVERAGE COMMON SHARES
AND EQUIVALENTS 1,508,000 3,321,000 1,508,000 3,263,000
========== ========== ========== ==========
</TABLE>
See accompanying notes to these consolidated financial statements.
F-3
<PAGE>
TOUCH TONE AMERICA, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE SIX
MONTHS ENDED
NOVEMBER 30,
-----------------------
1995 1996
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(1,016,000) $(2,225,000)
Adjustments to reconcile net loss to
net cash from operating activities:
Depreciation and amortization 22,000 183,000
Common stock for exchange of debt
at below market - 127,000
Options issued at below market - 173,000
Bad debt expense 25,000 151,000
Absorbed acquisition costs 118,000 -
Change in assets and liabilities:
Decrease (increase) in:
Trade receivables 171,000 (130,000)
Other assets (56,000) (28,000)
Increase (decrease) in:
Accounts payable (161,000) 23,000
Accrued liabilities 218,000 (184,000)
Deferred revenue and other (9,000) 27,000
---------- ----------
Net cash used in operating activities (688,000) (1,883,000)
CASH FLOWS FROM INVESTING ACTIVITY:
Purchase of equipment (80,000) (733,000)
Acquisition costs incurred (25,000) -
---------- ----------
Net cash used in investing activities (105,000) (733,000)
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of capital lease obligations (13,000) (32,000)
Payment of notes payable to stockholders - (183,000)
Repayment of preferred stock - (750,000)
Proceeds from issuance of redeemable
preferred stock 113,000 -
Proceeds from issuance of common stock 700,000 -
Offering costs incurred (162,000) (67,000)
---------- ----------
Net cash provided by (used in)
financing activities 638,000 (1,032,000)
---------- ----------
NET DECREASE IN CASH (155,000) (3,648,000)
CASH, beginning of period 512,000 5,278,000
---------- ----------
CASH, end of period $ 357,000 $1,630,000
========== ==========
See accompanying notes to these consolidated financial statements.
F-4
<PAGE>
TOUCH TONE AMERICA, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS:
--------------------
The consolidated financial statements include the accounts of Touch
Tone America, Inc. (Touch Tone) and from November 1, 1995, GetNet
International, Inc. (GetNet) (collectively referred to as "the
Company"). Touch Tone acquired the outstanding common stock of GetNet
effective November 1, 1995.
Touch Tone is engaged in the reselling of long distance
telecommunications products and services primarily in the western and
southwestern United States. As a reseller of long distance services,
Touch Tone offers its customers the use of routing equipment and phone
lines of large carriers; in turn, the large carriers offer Touch Tone
volume discounts based on the use of this equipment.
GetNet is a provider of Internet and World Wide Web access services to
individuals and businesses in Arizona and other parts of the United
States. The Internet is a network of millions of computers around the
world which are able to communicate with one another, as well as
access the World Wide Web which is a system of documents on a
multitude of subjects.
2. DISCLOSURE SUMMARY:
------------------
Pursuant to rules and regulations of the Securities and Exchange
Commission, the Company has elected to omit substantially all the
disclosures normally included in financial statements prepared under
generally accepted accounting principles. Readers of these financial
statements should refer to the Company's Form 10-KSB filed for the
year ended May 31, 1996, for additional disclosures.
3. UNAUDITED INFORMATION:
---------------------
The Company's balance sheet as of November 30, 1996, and the statement
of operations for the three and six months ended November 30, 1995 and
1996 are taken from the Company's books and records without audit.
Management believes, however, that such information includes all
accruals, which are considered recurring in nature, required for the
fair presentation of the Company's financial position and results of
their operations as of and for the periods then ended. The results of
operations for the interim periods presented are not necessarily
indicative of results expected for the full year.
The preparation of the Company's consolidated financial statements in
conformity with generally accepted accounting principles requires the
Company's management to make estimates and assumptions that affect the
amounts reported in these financial statements and accompanying notes.
Actual results could differ from those estimates. The Company makes
significant estimates as to the amortization period used for its
intangibles. Due to the uncertainties inherent in the life of
intangibles, and increased competition and technology changes in the
telecommunications industry, it is reasonably possible that the
estimated life of intangibles and the ultimate liability the Company
could have to AT&T under its SDN commitment and fraudulent usage (see
Note 7) could materially change in the forthcoming year.
F-5
<PAGE>
TOUCH TONE AMERICA, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. ADOPTION OF NEW ACCOUNTING POLICIES:
-----------------------------------
IMPAIRMENT OF LONG-LIVED ASSETS - Effective June 1, 1996, the Company
adopted Financial Accounting Standards Board Statement 121 (FAS 121).
In the event that facts and circumstances indicate that the cost of
assets or other assets may be impaired, an evaluation of
recoverability would be performed. If an evaluation is required, the
estimated future undiscounted cash flows associated with the asset
would be compared to the asset's carrying amount to determine if a
write-down to market value or discounted cash flow value is required.
Adoption of FAS 121 had no effect on the unaudited November 30, 1996
financial statements. GetNet is still in the developmental stages and
has not yet experienced significant revenues from its "Internet
Backbone" operations, however, if future revenues do not support the
cost capitalized associated with this system, the Company could be
required to impair such costs, including related intangible costs,
under this accounting standard.
STOCK-BASED COMPENSATION - In October 1995, the Financial Accounting
Standards Board issued a new statement titled "Accounting for Stock-Based
Compensation" (FAS 123), which the Company adopted effective
June 1, 1996. FAS 123 encourages, but does not require, companies to
recognize compensation expense for grants of stock, stock options, and
other equity instruments to employees based on fair value. Companies
that do not adopt the fair value accounting rules must disclose the
impact of adopting the new method in the notes to the financial
statements. Transactions in equity instruments with non-employees for
goods or services must be accounted for on the fair value method. The
Company has elected not to adopt the fair value accounting prescribed
by FAS 123 for employees, but is subject to the disclosure
requirements prescribed by FAS 123.
5. CONTINUED OPERATIONS:
--------------------
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue operating as a going concern,
which contemplates the realization of assets and liquidation of
liabilities in the normal course of business. The Company has
incurred significant losses since inception. Furthermore, as
discussed in Note 7, the Company has entered into sales volume
commitments with service providers.
The Company has a continuing service commitment with AT&T of
$1,800,000 annually, which as of May 31, 1996, the Company had
satisfactorily met. However, as discussed in Note 7, monthly revenues
under this commitment have declined, and it is likely revenues will
continue to decline, and the Company will not be able to continue to meet
this commitment. As of November 30, 1996, no loss accrual has been
recorded on management's belief that the contract will be renegotiated
on favorable terms with AT&T. If such renegotiations are
unsuccessful, the parties will most likely litigate the contract.
Furthermore, AT&T has claimed the Company owes approximately
$1,000,000 for the fraudulent use of the Company's long-distance
service by an unknown party. The Company also has other significant
telecommunications commitments for its Internet backbone and the
Company has experienced only nominal revenues from its backbone. If
the Company is unsuccessful in renegotiating its contract with AT&T,
does not favorably resolve the fraudulent usage matter, and/or if
revenues on its Internet
F-6
<PAGE>
TOUCH TONE AMERICA, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
backbone fail to materialize, substantial losses, the amount of which
cannot currently be estimated, could be recorded.
The Company's ability to continue as a going concern is dependent upon
several factors, including meeting and/or renegotiating its future
carrier commitments, and ultimately achieving and maintaining
profitable operations. The Company is also aggressively working to
increase revenues, seek a merger with a larger entity, and renegotiate
its contract with AT&T, which it believes will ultimately lead to
profitable operations and enable the Company to meet its continuing
service commitments. The accompanying consolidated financial
statements do not include any adjustments that might result from the
outcome of these uncertainties.
6. ACQUISITIONS:
-------------
In November 1996, the Company signed an agreement to merge with Arcada
Communications Inc. (Arcada), based in Seattle, Washington, whereby
the Company would issue to Arcada's shareholders promissory notes
totaling $1,500,000 and 12,500,000 shares of the Company's common
stock. As a result, Arcada would acquire control of both management
and the board of directors of the Company. The completion of the
merger is subject to and approval by the shareholders of both
companies and the resolution of various contingencies generally to the
satisfaction of Arcada. If this merger is successfully completed, for
financial reporting purposes, it would be considered a purchase
transaction of Touch Tone by Arcada. Therefore, future financial
statements would include Arcada operations for all prior periods and
Touch Tone only from the date of the merger.
In November 1995, the Company acquired the outstanding common stock of
GetNet through the issuance of 400,000 shares of its common stock,
which was valued at $800,000. This acquisition was accounted for
under purchase method of accounting. The excess of the purchase price
over the net liabilities acquired of approximately $835,000 is being
amortized over a period not to exceed five years. All other assets
and liabilities were recorded at book values, which approximated fair
value. Unaudited pro-forma financial information is provided below:
THREE MONTHS SIX MONTHS
ENDED ENDED
NOVEMBER 30, NOVEMBER 30,
1995 1995
-------- --------
Net Revenues $ 640,000 $ 1,328,000
========== ==========
Net Loss $ 712,000 $(1,107,000)
========== ==========
Net Loss per Share $ (.76) $ (1.18)
========== ==========
F-7
<PAGE>
TOUCH TONE AMERICA, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The above pro-forma financial information assumes the GetNet
acquisition occurred at the beginning of the period presented. This
information is not necessarily indicative of the financial results
which would have resulted if the acquisition had occurred at such
earlier date nor of future financial operating results.
In October 1996, the Company entered into an agreement to acquire
certain long-distance customers through the issuance of its common
stock. After three months, the number of shares issued will be based
upon a multiple of future revenues generated by the customer base acquired
and the then average price of the Company's common stock. It is
estimated that the total common shares to be issued will range between
35,000 and 40,000 shares. This acquisition is not expected to have a
material effect on the Company's net loss.
7. COMMITMENTS AND CONTINGENCIES:
-----------------------------
The Company has a continuing commitment with AT&T to provide long
distance service of $1,800,000 annually, under its SDN contract which as
of May 31, 1996, it had satisfactorily met. However, monthly revenues have
declined substantially due to increased competition and more competitive
rates being offered by other service providers. The Company's current
contract with AT&T provides for the purchase by the Company of
telecommunications services generally at a greater wholesale rate per
minute than currently being offered by AT&T to its retail customers.
Therefore, it is expected that revenues will continue to decrease
under the Company's SDN contract.
The Company is hopeful it will be able to renegotiate its contract
with AT&T to obtain a more favorable rate per minute and commitment
level and replace its existing SDN contract. However, there is no
assurance that the Company will be able to ultimately renegotiate its
existing contract. If it is not renegotiated, it is expected the
parties will litigate this contract, the outcome of which cannot be
predicted. Should the Company be unsuccessful in these efforts, the
loss incurred by the Company, the amount of which cannot be estimated,
would be substantial, whereby it would jeopardize the Company's
ability to continue operations.
The Company is obligated to pay for actual monthly usage at Internet
backbone circuits, irrespective at the related usage by the Company's
Internet customers, which for November 1996 approximated $80,000. This
usage consisted of circuit orders of $45,000 from WilTel, and term
commitments of $35,000 from other providers. Effective January 1997,
the Company has entered into a 3 year commitment to purchase a minimum
of $70,000 per month of Internet circuits from WilTel. When combined
with the existing $35,000 of circuit commitments from other providers,
the total backbone circuit commitment equals $105,000 per month beginning
in January 1997. Revenues related to the Internet backbone have continued
to be nominal through November 1996. If the Company is unsuccessful
in marketing its Internet services, these commitments will result in
a substantial loss to the Company, including the possibility of
impairing the capitalized costs associated with building the backbone
and the intangible cost recorded in connection with the acquisition of
GetNet by Touch Tone.
The Company has a commitment with WilTel which commenced in October 1996
to sell $50,000 per month of long distance services. The Company is
currently meeting this obligation through its actual long distance
billings. This commitment can also be satisfied through leases of
telecommunication circuits from WilTel for the Internet backbone.
Commencing in June 1996, an unknown party fraudulently charged over
$1,000,000 in long distance charges on the Company's account. The
Company is currently investigating the matter and has contacted the
carrier, AT&T, who denies any responsibility. AT&T has made a formal
claim to the Company indicating it owes for this fraudulent usage, is
currently withholding funds otherwise payable to the Company for its
long-distance service, and has indicated it will discontinue providing
service to Touch Tone unless the payment is received. The Company
believes it has recourse in the matter, and will not
F-8
<PAGE>
TOUCH TONE AMERICA, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
be held responsible for these charges, and AT&T continues to provide
service, but the outcome of this matter cannot be predicted at this
time.
The Company has also filed legal action against its former president
in August 1996. The former president has filed a response to the
Company's claim and, in addition, the former president has made
various allegations that he intends to pursue legal action for
unspecified damages against the Company, however, none have been
formally filed. If such action occurs, the Company intends to defend
itself vigorously and believes no adverse material consequences would
result. The president has filed an answer and the Company continues
to prosecute this matter. The ultimate resolution of this matter
cannot presently be determined.
In September 1996, two officers at GetNet (including a current
director of the Company) were terminated. These terminations are
being disputed by the former officers and action has been formally
filed against the Company. The resolution of this matter has not been
resolved, but management believes the ultimate outcome will not have
a material impact on the Company's financial position.
8. CAPITAL TRANSACTIONS:
--------------------
In June 1996, the Company repaid its preferred shareholders $750,000.
Also subsequent to year-end $67,000 in additional printing costs
associated with the offering were recorded.
In August 1996, the Company issued 70,000 shares of common stock for
the exchange of a note payable of $210,000. In connection with this
exchange, the Company recorded approximately $254,000 of expense (of
which $127,000 was recorded as an expense in the period ended November
30, 1996 and the balance in the prior year) based on the quoted market
price at the time the parties agreed to the exchange. The Company has
agreed to register these shares for sale under The Securities Act.
Also in August 1996, the Company issued 45,000 shares to a
telecommunications company in settlement of a past debt. Accrued
expenses at May 31, 1996 include $180,000 related to this debt. The
Company has agreed to register these shares for sale under The
Securities Act.
In September 1996, the Company issued 1,500 shares of common stock in
settlement of a past agreement to issue shares of common stock based
on 50% of the initial public offering price.
In July 1996, the Company terminated two employees. In connection
with their termination, they were granted options to purchase in the
aggregate 45,000 shares of common stock at $4.00 and 40,000 shares at
$5.00. In connection with this severance agreement, the Company has
recorded approximately $172,000 of expense based on the difference
between the option exercise price and the price of the Company's
common stock on the date of the agreement. The Company had agreed to
register, within ninety days, the shares underlying the options, and
failed to do so. One employee has filed suit against the Company in
connection with the failure of the Company to register such options.
The employee is seeking damages at approximately $44,000.
F-9
<PAGE>
TOUCH TONE AMERICA, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. SIGNIFICANT SALES AGENT RELATIONSHIP:
------------------------------------
The Company has an agreement with an independent sales agent, whereby
the agent receives maximum commissions of approximately 32% on AT&T long
distance sales it originates. At this sales levels, the Company does
not realize a gross margin from the sales generated by the agent.
If the Company successfully renegotiates its contract with its provider,
the Company believes it will then realize profit on sales originated
by the agent, if a greater discount can be obtained from the
provider. Payment of the commissions to the agent is secured by
the customer base generated by the sales agent. For the six months
ended November 30, 1995 and 1996, the sales originated by the agent
have accounted for 35% and 41%, respectively, of company AT&T long
distance sales. During these periods, the Company has recorded a related
expense to the agent of approximately $217,000 and $72,000, respectively.
F-10
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
NOVEMBER 30, 1996
THE FOLLOWING DISCUSSION OF THE FINANCIAL CONDITION AND RESULTS OF
OPERATIONS FOR TOUCH TONE SHOULD BE READ IN CONJUNCTION WITH THE TOUCH TONE
FINANCIAL STATEMENTS AND NOTES HERETO ATTACHED HERETO.
Forward-Looking Statements May Not Prove Accurate. When used in this
Form 10-QSB, the words "anticipate," "estimate," "exptect," "project" and
similar expressions are intended to identify forward-looking statements.
Such statements are subject to certain risks, uncertainties and assumptions
including the possibility that the merger with Arcada will not be consummated,
the Company's Internet backbone will fail to generate projected revenues or
the Company will be unable to successfully renegotiate certain of its
commitments. Should one or more of these risks or uncertainties materialize,
or should underlying assumptions prove incorrect, actual results may vary
materially from those anticipated, estimated or projected.
RECENT DEVELOPMENTS; SIGNIFICANT DECREASE IN LONG DISTANCE REVENUES; NEED
- -------------------------------------------------------------------------
FOR ADDITIONAL FINANCING
- ------------------------
Through January 1, 1997, the Company's long distance revenues have continued
to decline. The Company's management believes the AT&T SDN contract discussed
herein is non-competitive with AT&T's own customers and other long distance
carriers. Specifically, the Company pays approximately $.17 per minute
wherein its competitors, including AT&T, sell long distance at rates of $.15
and below. As a result, the Company has experienced greater than normal
customer attrition and the loss of several of its independent agents. In
addition, in August 1996, AT&T made a claim against the Company for long
distance charges of over $1,000,000 fraudulently charged by an unknown third
party to the Company's account. As a consequence, AT&T is holding all payments
made by long distance customers on the Company's account and is applying these
funds to the $1,000,000 claim. Consequently, the Company has been unable to
pay its independent agents, resulting in their switching their customer bases
to other long distance resellers.
Accounts receivable and related allowances for bad debt have also increased
substantially due to the Company's inability to receive accurate billing
records from AT&T and the Company's lack of clerical personnel to assist in
their collection and the failure of one of the Company's agents to remit
certain long distance payments it has collected.
The Company is trying to renegotiate with AT&T both of these situations,
however, negotiations to date have been limited to discussions between the
parties and their respective legal counsel. If the Company is unsuccessful in
its negotiations with AT&T, in all probability the parties will litigate this
matter.
The Company is obligated to pay for actual monthly usage of Internet backbone
circuits, irrespective of the related usage by the Company's Internet
customers, which for November 1996 approximated $80,000. This usage consisted
of circuit orders of $45,000 from WilTel, and term commitments of $35,000
from other providers. Effective January 1997, the Company has entered into a
3 year commitment to purchase a minimum of $70,000 per month of Internet
circuits from WilTel. When combined with the existing $35,000 of circuit
commitments from other providers, the total backbone circuit commitment
equals $105,000 per month beginning in January 1997. Revenues related to the
Internet backbone have continued to be nominal through November 1996. If the
Company is unsuccessful in marketing its Internet services, these commitments
will result in a substantial loss to the Company, including the possibility of
impairing the capitalized costs associated with building the backbone and
the intangible cost recorded in connection with the acquisition of GetNet by
Touch Tone.
The Company has a commitment with WilTel which commenced in October 1996 to
sell $50,000 per month of long distance services. The Company is currently
meeting this obligation through its actual long distance billings. This
commitment can also be satisfied through leases of telecommunication circuits
from WilTel for the Internet backbone.
Further, the Company's working capital resources have declined significantly
since its initial public offering in May, 1996.
On November 13, 1996, the Company entered into a Merger Agreement providing
for the Merger of Arcada with and into a wholly-owned subsidiary of Touch Tone
in exchange for 12.5 million shares of the Company Common Stock and $1.5
million in Promissory Notes. As a result of the Merger, Arcada would acquire
control of both management and the Company Board. The completion of the Merger
is subject to the satisfaction of certain closing conditions set forth in the
Merger Agreement and the approval of the shareholders of the Company and
Arcada.
If the Merger is completed, Arcada will be considered the acquiring entity,
even though the Company is legally the surviving company. Therefore, future
financial statements of the Company will reflect the operations of Arcada for
prior years and the Company operations only from the date of the Merger.
In October 1996, the Company entered into an agreement to acquire
certain long-distance customers through the issuance of its common
stock. After three months, the number of shares issued will be based
upon a multiple of future revenues generated by the customer base acquired
and the then average price of the Company's common stock. It is
estimated that the total common shares to be issued will range between
35,000 and 40,000 shares. This acquisition is not expected to have a
material effect on the Company's net loss.
GENERAL
- -------
In May 1996, the Company completed its initial public offering of securities
from which it received net proceeds of approximately $5,763,000 from the sale
of 1,725,000 shares of Common Stock and 1,725,000 Common Stock Purchase
Warrants. As of November 30, 1996, working capital was approximately
$563,000. The Company intends to use its remaining funds for future
Internet development and to fund current losses. These remaining funds
are not sufficient to fund the Company's future development and the continued
payment of existing carrier commitments and general and administrative
expenses.
The Company's financial statements have been prepared on the basis that the
Company will continue operating as a going concern, which contemplates the
realization of assets and liquidation of liabilities in the normal course of
business. The Company's ability to continue as a going concern is dependent
upon several factors, including meeting the terms of its commitments and
achieving and maintaining profitable operations. The Company's financial
statements were audited by its independent certified public accountants, whose
report includes an explanatory paragraph stating that the financial statements
have been prepared assuming the Company will continue as a going concern and
that the Company has incurred losses from operations and has entered into
significant sales volume commitments that raise substantial doubt about its
ability to continue as a going concern.
To increase revenues to a sufficient level to meet its carrier commitments,
general and overhead expenses and future expansion, the Company has been
actively seeking acquisition candidates with existing customer and revenue
bases. The Company will attempt to issue shares of its authorized, but
unissued, Common Stock to acquire customer bases and/or assets of acquisition
candidates and retain its existing cash for further development of its Internet
backbone and to fund current losses. There can be no assurance that the
Company will be successful in this regard.
The Company's net revenues were approximately $963,000 for the six months
ended November 30, 1996 and $1,228,000 for the six months ended November
30, 1995.
CHANGE IN GETNET'S MANAGEMENT
- -----------------------------
In September 1996, the Company terminated two (2) Officers of GetNet, who
were also two (2) of the three (3) original founding shareholders of
GetNet. The Company is unable at this time to predict the ultimate effect
of these terminations. As of the date of this report, one of these
individuals remains a Director of the Company.
RESULTS OF OPERATIONS - FOR THE THREE AND SIX MONTHS ENDED NOVEMBER 30,
1996 COMPARED TO THE THREE AND SIX MONTHS ENDED NOVEMBER 30, 1995
Long distance resell revenue for the three and six months ended
November 30, 1996 was $273,000 and $613,000 compared to revenues of
$512,000 and $1,200,000 during the three and six months ended November 30,
1995. The Company currently has an "SDN" contract which extends through
July 1999 with AT&T. Due to competition within the telecommunications
industry, the price the Company is required
F-11
<PAGE>
to pay AT&T has become less competitive than the current market price for
comparative service. Currently, AT&T is offering retail long distance
services to its retail customers at approximately $.02 per minute less than
the Company's wholesale cost for the same service. The Company is hopeful
it will be able to renegotiate its contract with AT&T to obtain a more
favorable rate per minute and commitment level, and replace its existing
SDN contract. However, there is no assurance that the Company will be able
to ultimately renegotiate its existing contract. The Company intends to
find another long distance reseller with a substantial telecommunications
customer base and negotiate a favorable transfer of the Company's SDN long
distance base and obligations to that SDN reseller. At this time, no loss
accrual has been recorded in the financial statements based on management's
belief that the contract will be renegotiated on favorable terms with AT&T.
It such renegotiations are unsuccessful, substantial losses could be
recorded, which would impair the Company's ability to continue operations.
The Company expects to experience most of its future growth through
acquisitions of long distance customer bases with regional switch-based
carriers as well as through the growth of its Internet services, especially
its backbone facilities and services which are in service as of November
1996.
Cost of sales for long distance service for the three and six months ended
November 30, 1996 was $222,000 and $451,000, resulting in a gross margin of
approximately $51,000 and $162,000 or 19% and 26% of net revenue. The
gross margin for the three and six months ended November 30, 1995 was
$166,00 and $418,000 or 32% and 35% of net revenue. The gross margin
percentage has decreased due to lower volume. The AT&T contract is
structured on a tiered discount with the more volume achieved, the greater
the discount.
Financial statements ended November 30, 1996, reflect the inclusion of the
operation of GetNet which was acquired effective November 1, 1995.
GetNet's sales were $174,000 and $350,000 for three and six months with
cost of sales of $115,000 and $190,000. GetNet is still a development
stage company and has not yet begun to develop its market. The majority of
GetNet's revenues are from subscriber fees for Internet access. The Internet
backbone was not operational until October, 1996. The Company,
however, expects the ramp-up of revenue on the Internet backbone to take an
extended period and this operation will most likely not be profitable in
the near future.
Selling expenses were $94,000 and $152,000 or 21% and 16% of net revenues
for the three and six months ended November 30, 1996 from $124,000 and
$294,000 or 23% and 24% of net revenues for the prior comparable periods.
A significant sales agent, TMO Communications, Inc. (TMO), accounted for
approximately 41% of AT&T long distance revenues for the six months ended
November 30, 1996 and receives commissions of approximately 32%. At this
level, the Company does not receive gross margin on sales originated by this
agent. Management believes the selling expenses attributed to Company agent
commissions will decrease as a percentage of net revenues if a new contract
with AT&T is negotiated; however, selling expenses in general will increase
because of marketing efforts and variety of services offered. GetNet's
selling expenses were $18,000 for the period ended November 30, 1996, or 2%
of its sales.
Under the Company's current contract with independent sales agents for
reselling long distance services, commissions are paid as long as the
Company receives revenues from the customer. The Company intends to revise
this arrangement for new agents to provide for continuing commission
payments only if certain sales levels are maintained, however, no such
contracts have been entered into.
For marketing GetNet services, the Company has two full time sales agents
on staff. These persons are paid a combination of salary and commissions.
F-12
<PAGE>
General and administrative expenses increased to $684,000 and $1,406,000 or
153% and 146% of net revenue for the three and six months ended November
30, 1996 compared to $401,000 and $697,000 or 74% and 57% for the three and
six months ended November 30, 1995. During the six months ended November
30, 1996, the Company paid increased salaries and benefits to its employees
of approximately $595,000 compared to $447,000 in the prior comparable
six-month period primarily as a result of additional employees, including
GetNet employee related expenses of approximately $377,000. The remaining
$561,000 increase in general and administrative costs between the two
periods is mainly due to increased office and travel costs, increased
internal costs associated with search for potential acquisition candidates,
the inclusion of GetNet's other general and administrative expenses, which
totaled $117,000, and bad debt expense, which increased by $126,000 in the
six months ended November 30, 1996, as compared to the prior comparable
period. Furthermore, during the six months ended November 30, 1996, the
Company has incurred approximately $60,000 in costs associated with the
Arcada merger which have been expensed. Since May 1996, the Company has
reduced its number of personnel due to decreasing revenues. In connection
with the termination of two employees, the Company granted options at below
the then market price of its common stock. Therefore, an additional
$172,000 of expense was recorded in the six months ended November 30, 1996
based on the difference of the exercise price and traded price of its
common stock. Total general and administrative expense, relative to fiscal
1996 is, however, expected to increase due to compensation commitments to
Officers of the Company and a contract entered into with a significant
consultant (who previously was the Chairman of the Board and an Officer) of
$15,000 per month (see "Commitments").
Amortization and depreciation expense increased by approximately $161,000
related primarily to amortization of goodwill recorded in connection with
the GetNet acquisition in November 1995 for the six months ended November
30, 1996 compared to 1995.
The Company incurred $301,000 of excess circuit commitment expense under its
agreement with ICG during the six months ended November 30, 1995 and none
was incurred in the six-month period ended November 30, 1996, as the contract
was terminated in April 1996. During the six months ended November 30, 1996,
the Company incurred $431,000 in excess circuit commitments primarily related
to Internet backbone. These amounts are recorded as period expenses under
operating expenses, as the Company experienced insignificant revenues
associated with either of these contracts.
Interest expense, net of interest income in the six-month period ended
November 30, 1996, increased from $16,000 in 1995 to $90,000 in 1996
primarily as a result of 70,000 shares of common stock being issued in
August 1996 to satisfy an outstanding debt of $210,000. The difference of
approximately $254,000 between the then market price of common stock and
the related debt was expensed in operations over the period the note was
outstanding. For the six months ended November 30, 1996, $127,000 was
expensed and the balance was previously expensed in fiscal 1996. During
the six months ended November 30, 1996, the Company had interest income of
approximately $57,000 from its cash investments received from proceeds of
its public offering.
The Company had a net loss of $2,225,000 for the six months ended November
30, 1996. For the six months ended November 30, 1995, the Company had a
net loss of $1,016,000. The increase in net loss between periods is
directly attributed to the decreasing revenues, the cost of share and
option issuances at less than market, the increase in selling, general and
administrative costs in fiscal 1997, and other reasons discussed above.
F-13
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
The Company's cash position at November 30, 1996 was $1,630,000 and net
working capital was $563,000. The Company's cash position reflects the
receipt of the proceeds Company's public offering of its common stock
completed in May 1996. Included in the Company's current liabilities
is $200,000 for monthly payments of $33,000 due to AT&T in settlement
of having failed to meet certain service commitments under prior
agreements with AT&T.
Cash used in operations for the Company totaled $1,883,000 during the six
months ended November 30, 1996 as compared to $688,000 for the six months
ended November 30, 1995. This increase in cash outflows can be primarily
attributed to a loss from operations, partially offset by the current
period non-cash expenses resulting from an increase in the bad debt
allowance and the non-cash cost of common share and option issuances
related to the exchange of a note payable for common stock and severance
agreements. The Company also paid certain payables from proceeds of the
public offering resulting in a decrease in accounts payable and accrued
expense.
Cash flows used in investing activities consisted primarily of additions to
equipment of $733,000 in the six months ended November 30, 1996, primarily
for constructing GetNet's Internet Backbone. The initial phase of
constructing this backbone is substantially complete and the Company does
not intend to incur substantial additional capital costs.
Cash flows used in financing activities were $1,032,000 during the six
months ended November 30, 1996 as compared to $638,000 provided by
financing activities for the six months ended November 30, 1995. During
the six months ended November 30, 1996, cash outflows can be primarily
attributed to payments made to preferred stock holders for the redemption
of their preferred stock and repayments of notes payable to stockholders.
During the six months ended November 30, 1995, cash inflows represent
proceeds from issuance of redeemable preferred stock which were partially
offset by stock offering costs incurred.
Under the Company's current arrangement with AT&T, customer billings and
collections are performed by AT&T. Accounts receivable represents the amount
the Company's customers owe for actual usage. However, the amount the Company
will receive from AT&T will be offset by the payable due to AT&T for the cost
of providing the service, which is reflected as an account payable in the
financial statements. The net of the receivable and payable is the gross
margin the Company receives. AT&T is currently responsible for maintaining
the Company's account receivable accounts and withholds payment to the
Company for customer accounts over 30 days past due. Such amounts withheld
from the Company are offset by the gross margin otherwise payable to the
Company.
CONTINGENCIES
- -------------
Commencing in June through July 1996, an unknown party fraudulently charged
over $1,000,000 in long distance charges on the Company's account. The Company
has been diligently investigating the matter and has contacted the carrier,
AT&T, who denies any responsibility. The Company has retained counsel to
represent it in this claim and has submitted a letter to AT&T stating its
position that it has no liability for the fraud. As of the date of this
Report, AT&T has not formally responded to the Company's letter although
discussions are ongoing between the parties. AT&T is also withholding payments
to the Company on its long distance service until this matter is resolved. It
is a condition to Arcada's obligation to consummate the Merger that the Company
settle this dispute with AT&T prior to the Effective Time in a manner
satisfactory to Arcada. The Company believes it has recourse against AT&T and
will not be held responsible for these charges, but the outcome of this matter
cannot be predicted at this time.
On October 10, 1996, two identical lawsuits were filed in Superior Court of
the State of Arizona, Maricopa County by two former officers and employees of
GetNet, including Stephen Shearin, a current director of the Company, for
compensation due pursuant to employment agreements pending final resolution of
their respective employment agreements. The plaintiffs have requested specific
performance as it relates to past compensation, attorneys' fees and costs.
The Company will vigorously defend these suits and maintains the employment
agreements were terminated for cause.
In July 1996, the Company terminated two employees. In connection
with their termination, they were granted options to purchase in the
aggregate 45,000 shares of common stock at $4.00 and 40,000 shares at
$5.00. In connection with this severance agreement, the Company has
recorded approximately $172,000 of expense based on the difference
between the option exercise price and the price of the Company's
common stock on the date of the agreement. The Company had agreed to
register, within ninety days, the shares underlying the options, and
failed to do so. One employee has filed suit against the Company in
connection with the failure of the Company to register stock options.
The employee is seeking damages of approximately $44,000.
F-14
<PAGE>
TOUCH TONE AMERICA, INC.
PART II
ITEM NO. 1 Legal Proceedings
-----------------
On August 30, 1996 a lawsuit was filed in the superior Court
of the State of Arizona, Maricopa County by Touch Tone
against Touch Tone's former President, Jonathan Miller and
his wife, Janeece Miller. The complaint details various
causes of action against Mr. Miller, in his capacity as a
former Officer and Director of Touch Tone and seeks damages
in the amount of $360,835 from the defendants. Mr. Miller
filed an answer in September 1996 denying the allegations of
the complaint. Touch Tone is, and will vigorously pursue
this legal action. The case is in the discovery stage and
no date has been set for trial.
Mrs. Janeece Miller filed a request with the American
Arbitration association regarding an alleged breach of her
employment agreement. She has made a claim for $32,500 plus
attorney's fees and costs as part of her severance package.
This claim was filed with the Arbitration Association on
July 31, 1996 and Touch Tone has responded, consenting to
the arbitration but contesting the allegations in the
complaint, asserting that Ms. Miller voluntarily resigned
her employment with Touch Tone and that the terms of the
severance package do not apply in her situation. No hearing
date has yet been set and Touch Tone will defend the claim.
In July 1996, an unknown party fraudulently charged over
$1,000,000 in long distance charges on Touch Tone's
account. Touch Tone has been diligently investigating the
matter and has contacted the carrier, AT&T, who denies any
responsibility. Touch Tone has retained counsel to
represent it in this claim and has submitted a letter to
AT&T stating its position that it has no liability for the
fraud. As of the date of this Report, AT&T has not formally
responded to Touch Tone's letter although discussions are
ongoing between the parties. AT&T is also withholding payments
to Touch Tone on its long distance service until this matter is
resolved. It is a condition of the business combination
with Arcada that Touch Tone settle this dispute with AT&T
prior to the effective date of the business combination in a
manner satisfactory to Arcada. Touch Tone believes it has
recourse against AT&T and will not be held responsible for
these charges, but the outcome of this matter cannot be
predicted at this time.
On October 10, 1996, two identical lawsuits were filed in
Superior Court of the State of Arizona, Maricopa County by
two former officers and employees of GetNet, including
Stephen Shearin, a current director of Touch Tone, for
compensation due pursuant to employment agreements pending
final resolution of their respective employment agreements.
The plaintiffs have requested specific performance as it
relates to past compensation, attorneys' fees and costs.
The Company will vigorously defend these suits and maintains
the employment agreements were terminated for cause.
Rebecca F. Kelley, a former employee, has filed a lawsuit
against the Company in Superior Court, Maricopa County,
Arizona, case number CV96-22519 on December 13, 1996. She
has alleged Breach of Contract and Breach of the Covenant of
Good Faith And Fair Dealing and has requested damages in the
amount of $43,735.00. The Company will file an answer to
the complaint by or before January 18, 1997. The Company
may not prevail on the merits of this case.
A discussion of this litigation and other matters also
under "Commitments and Contingencies" appears at Footnote 7
of the Financial Statements.
ITEM NO. 2 Changes in Securities
---------------------
None
ITEM NO. 3 Defaults Upon Senior Securities
-------------------------------
None
ITEM NO. 4 Submission of Matter to a Vote of Securities Holders
----------------------------------------------------
None
ITEM NO. 5 Other Information
-----------------
None
ITEM NO. 6 Exhibits and Reports on Form 8-K
--------------------------------
On September 2, 1996, the Registrant filed a Form 8-K
reporting under Item 2 relating to the proposed business
combination with Arcada, Inc. of Seattle, Washington.
<PAGE>
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be
signed on its behalf by the undersigned thereunto duly authorized.
TOUCH TONE AMERICA, INC.
/s/ MICHAEL J. CANNEY
- --------------------------------
Michael J. Canney, President
Principal Executive Officer
/s/ DAVID J. SMITH
- --------------------------------
David J. Smith, Principal
Financial and Accounting Officer
Date: January 13, 1996
--------------------------
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<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> MAY-31-1996
<PERIOD-START> JUN-01-1996
<PERIOD-END> NOV-30-1996
<CASH> 1,630,000
<SECURITIES> 0
<RECEIVABLES> 425,000
<ALLOWANCES> 182,000
<INVENTORY> 0
<CURRENT-ASSETS> 1,909,000
<PP&E> 1,224,000
<DEPRECIATION> 159,000
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<BONDS> 99,000
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<COMMON> 7,945,000
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<TOTAL-LIABILITY-AND-EQUITY> 3,837,000
<SALES> 963,000
<TOTAL-REVENUES> 963,000
<CGS> 641,000
<TOTAL-COSTS> 2,457,000
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